Measuring Success of Mergers and Acquisitions

Submitted by Samarpita Raj Vardhan Archana Raghuram Sreekanth A S

Measuring success of mergers and acquisitions

CONTENTS
mergers And Acquisitions........................................................................................................................................... 2 Reasons For Mergers And Acquisitions ................................................................................................................ 2 What Measure Success? .............................................................................................................................................. 3 A Summary Of The Recent Studies ........................................................................................................................ 4 Failure In A Nutshell .................................................................................................................................................... 6 Reasons For Success ..................................................................................................................................................... 6 People And Cultural Factors ...................................................................................................................................... 7 Shareholder Value Maximization: ........................................................................................................................... 8 Tata Steels Acquisition Of Corus ........................................................................................................................... 8 Reasons For Tata Steel To Bid:............................................................................................................................ 9 Reasons For Corus To Be Sold: ........................................................................................................................... 9 Analysis Of Tata Corus Case .............................................................................................................................. 10 Return On Net Worth ............................................................................................................................................ 10 Market Value Added ............................................................................................................................................. 11 Ratio Analysis .......................................................................................................................................................... 12 Eva Calculation ....................................................................................................................................................... 13 Conclusion .................................................................................................................................................................... 14 Bibliography ................................................................................................................................................................ 15

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M E RG E R S AND ACQUISITIONS
Mergers and acquisitions or M&A are both means by which two or more business entities become one larger entity. In the case of a merger, this is often a process that is entered into after a long period of evaluation on the part of the respective officers and owners of the companies involved. When the idea is to merge companies together, there is usually a sense that all parties involved in the creation of the new and larger entity are equals in the process and will be treated as such as the structure of the new entity is planned and put into operation. Wit h an acquisition, the scenario is a little different. When one company decides to acquire another company, the process usually involves a buyout or purchase of that business. There are not necessarily any plans to continue all the operations of the acquired company; often the resources of the acquisition are absorbed into the resources held by the purchasing company while the acquired business simple ceases to exist. Mergers and acquisitions also tend to differ in one other important aspect. While mergers are generally situations where all parties want the combination of companies to take place that is not necessarily the case with an acquisition. Hostile takeovers are an example of an acquisition that is not accomplished with the enthusiastic support of the officers and shareholders of the acquired business. At best, there may be a sense of grudging acceptance that the takeover will occur whether or not shareholders and officers want the acquisition.

R E ASONS FO R M E RG E R S AND ACQUISITIONS

y y y y y y y y

Economies of scale through larger productive capacity or ability to share services Vertical integration of productive capacity or the supply chain Market share / elimination of direct or indirect competition Securing supply Asset acquisition or stripping Strategic hedging through addition of counter cyclical products to the group mix Acquisition of access to Intellectual Property Geographic expansion or access to markets with entry barriers
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y y y

Accumulation of complimentary product/service sets Suppression of emerging product line / Intellectual Property threats Acquisition of customers

W HAT M E ASU R E SUCC E SS?

The most obvious outcome of any M&A is prima-facie the elimination of an actual or potential competitor from the competitive mix. In 1999 KPMG published a study of merger outcomes over the preceding 10 years. The study identified that 75% to 83% of mergers fail where failure was measured by lower productivity, labor unrest, higher absenteeism & loss of shareholder value or even dissolution of companies. This and other studies highlight a central question in determining the strategy for a successful merger - what is the basis for measuring the success of an M&A project? Success Measure Achievement of anticipated purpose Achievement of strategic or financial object Preserve or Enhance book value Enhance shareholder value Preserve or improve NPAT Preserve or improve productivity Survey Outcome Year of Study 30-45% <20% 25%-45% 17% <50% <25% 1997 1983, 1991, 1994 1988, 1999 1995 1996, 1999 1988, 1999 1977, 1981, 1999 1978, 1988, 1999 1996

Preserve strike, absenteeism and accidents levels <50% Financially advantageous in Long Term Financially advantageous in Short Term 20-50% 50%

Zweig (1995) and KPMG (1999) study found in their respective studies of merger outcomes that on 17% of mergers resulted in an enhancement of either shareholder value or key performance drivers. Zweig found that shareholder value was actually destroyed in 53% of cases, and KPMG determined the performance drivers actually weakened in 78% of cases:
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A SUMMA RY OF TH E R E C E NT STUDI E S
Integration of the pre-merger businesses in the post-merger entity is a precursor to success in the majority of merger strategies.

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Reason 1 Poorly planned and managed integration 2 Neglect of existing business due to the attention being paid to the acquired business 3 Underestimating the depth & pervasiveness of human issues triggered by the merger 4 Loss of key staff in acquired business 5 Demotivation of employees of acquired business 6 Underestimating problems of skill transfer 7 Selecting the wrong partner 8 Cultural incompatibility 9 Delayed decisions due to breakdown of responsibilities, delegations & authority Too much focus on doing the deal - not enough on to integration planning & management

% 100 68 50 50 50 34 34 17 17

10

17

11 Insufficient research (due diligence) into the acquired business 12 Paying the wrong price or at the wrong time 13 Buying for the wrong reasons 14 Incompatible business and IT systems

17 17 17 JB JB

15 Doomed by negotiation

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FAILU R E IN A NUTSH E LL
Where business integration is a key ingredient of the post-merger mix, the studies allow us to identify the top 5 risks of that result in merger failure: 1. Integration poorly planned and managed 2. Underestimated cultural & human risks 3. Loss of key success enablers (e.g.: staff) 4. Inaccurate financial due diligence 5. Neglecting current business As these studies examined mergers that actually completed (i.e. the takeover survived the acquisition process), the studies ignored a common reason for merger failure: That of noncompletion. Reasons for non-completion might include: 1. Legal (non-participating competitor) or regulatory intervention 2. Unacceptable risks, asset/liability valuations or cultural issues emerging during suediligence 3. Exogenous market shifts during the merger process (such as changes in market conditions of demand, financing, etc.) 4. Death or departure of key personnel from the target entities 5. Excessive regulatory or judicial hurdles causing the process to extend unacceptably for the participants 6. Failure, or inability to offer sufficient compensation to the vendors 7. Gazumping by competitor acquirers

R E ASONS FO R SUCC E SS
Conversely both formal studies and deductive reasoning allows us to identify the key reasons for successful mergers.
y

No need to achieve an integrated business, and "right" price paid

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y y y y y y y y y y y y y y

Nature of post-merger structure (vertical, conglomerate or geographic, etc.) Clearly enunciated & communicated direction Acquisition-specific & flexible integration strategy Clear decision structure and role definitions A sense of urgency and outcome ownership Compatible business systems Compatible business cultures Compatible accounting practices Integration ready culture Commonality of merger goals Active risk management strategy Actively managed, tracked & resourced integration project Minimized debt service load Pre-existing partnering or cohabitation

PE O P L E AND CULTU R AL FACTO R S

According to a KPMG study, "83% of all mergers and acquisitions (M&As) failed to produce any benefit for the shareholders and over half actually destroyed value". Interviews of over 100 senior executives involved in these 700 deals over a two-year period revealed that the overwhelming cause for failure "is the people and the cultural differences" The cultural incompatibility is the single largest cause of lack of projected performance, departure of key executives, and time consuming conflicts in the consolidation of business. Culture plays a vital role in the way how employees react to the new organization culture environment. The term Culture clash has been coined to describe the conflict of two companies philosophies, styles, values, and missions. This may, in fact, be the most dangerous factors when two companies decide to combine. Even in the best circumstances, mergers can so change the nature, orientation and character of one or both of the merger partners; this means five to seven years are typically required for employees to feel truly incorporated into a merged entity. Due to the multitude of these changes, the post-merger period witnesses many problems. Most of these adjustments problems arise from employees fears regarding the loss of job, also financial debt regarding job
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loss. Moving into the realm of the unknown wit h a new manager and a new team is also distressing and anxiety provoking. Other fears include the loss of effective and close team members, as well as the uncertainty about the new team members and supervisors to be inherited. When forced to deal with new team members and supervisors, employees may frequently develop fears of taking risks and raising sensitive subject. This may adopt us verses them thinking, where trust for the new team members will be minimal. Corporations facing this kind of behavior may have to pay the high price of loss of cooperation and initiative among the employees of the new business combination. The synergies that were initially sought may be harder to achieve, conflicts and disagreement will be more difficult to resolve, if at all, and this friction occur more frequently, post-merger will be the most difficult time for the new team to mo ve forward as a whole.

SHA R E HOLD E R VALU E MAXIMIZATION:

y Broad measures comprising the value added twins, namely, economic value added (EVA) and Market Value Added (MVA). y The traditional measure of Return on Net worth (RONW).

We identified three important factors which show the success or failure of M&A. The factors are: y y y Economic value Added(EVA) Market value Added (MVA) Return on Net Worth(RONW)

As part of the study we have done a comparative study between of pre-merger period and postmerger period of TATA steel and Corus.

TATA ST EE LS ACQUISITION OF CO R US
The deal (between Tata & Corus) was officially announced on April 2nd, 2007 at a price of 608 pence per ordinary share in cash. This deal is a 100% acquisition and the new entity will be run by one of Tatas steel subsidiaries. As stated by Tata, the initial motive behind the completion of
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the deal was not Corus revenue size, but rather its market value. Even though Corus is larger in size compared to Tata, the company was valued less than Tata (at approximately $6 billion) at the time when the deal negotiations started. But from Coruspoint of view, as the management has stated that the basic reason for supporting this deal were the expected synergies between the two entities. Corus has supported the Tata acquisition due to different motives. However, with the Tata acquisition Corus has gained a great and profitable opportunity to make an exit as the company has been looking out for a potential buyer for quite some time. R E ASONS FO R TATA ST EE L TO BID: y y To tap European Mature Market Cost of acquisition is lower than setting up of Green field plant&marketing and distribution channel. y Tata manufactures low value, long and flat steel products, while Corus produce high value stripped products y y y y Helped Tata to feature in Top 10 players in the World. Technology Benefit Economy of scale Corus holds number of patents and R & D facilities. R E ASONS FO R CO R US TO B E SOLD: y y y y A chance to bail out of Debt and Financial stress. Access to cheap and high quality iron ore from India Corus has high cost of production Though Corus had revenues of $ 18.06 bn, its profit was just $ 626 mn(Tatas revenue was $ 4.84 bn and profit $ 824 mn)

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ANAL Y SIS OF TATA CO R US CAS E

R E TU R N ON N E T W O R TH
Tata steel Return on net worth 2005-06 Networth PAT RONW 2009-10 Net Worth PAT RONW 13.60% 36961 5046.8 35.94% ` in cr 9755.3 3506.38

Corus (2005-2006) Return on net worth 2005-06 Networth PAT RONW 5.80% 3934 mn Pounds 229 mn pounds

Interpretation: Return on Net worth (RONW) is used in finance as a measure of companys Profitability.It reveals how much profit a company generates with the money that the

equity shareholders have invested.Therefore, it is also called return on Equity (ROE) RONW considers only equity shareholding as the base for deciding efficiency of a companys operations.

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Pre-Acquisition-The RONW of Tata Steel pre-acquisition was more than that of Corus, which means the shareholders of Tata Steel were getting more return on the equity invested as compared to Corus. Post-Acquisition-The RONW post acquisition has come to 13.60% which means that returns the shareholders are getting is less when compared to the figures before acquisition. MA R K E T VALU E ADD E D
TATA Steel ` in cr Share price Out. Shares market value Capital employed MVA 536.5 552801401 296577951636.50 1.43639E+11 15293

MVA 2005-06

MVA 2009-10 Share price Out. Shares market value Capital employed MVA

` in cr 632.00 888126020.00 561295644640.00

642,327,800,000.00 -8103.22

Interpretation:Market Value Added (MVA) is the difference between the current market value of

a firm and the capital contributed by investors. If MVA is positive, the firm has added value. If it is negative, the firm has destroyed value. A high MVA indicates the company has created substantial wealt h for the shareholders. Negative MVA means that the value of the actions and

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investments of the management is less than the value of the capital contributed to the company by the capital markets. This means that the value or the wealth has been destroyed. Post-Acquisition-The value of MVA is negative for Tata steel, which means that the value of the firm is destroyed post-acquisition. R ATIO ANAL Y SIS
2009-10(`) DPS EPS Net Profit margin 13 56.37 19.76 2005-06(`) 8 63.35 22.78

Interpretation: DPS -The amount of dividend that a stockholder will receive for each share of

stockheld and used by most industry investors as a quick and simple indicator of the cash return that an investor may expect. The increase in the dividend from `8 to `13 clearly indicates that the company has grown well post acquisition. EPS-The portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serve as an indicator of a company's profitability. Earnings per share (EPS) are one of the most important measures of company strength. Obviously, the higher this number, the more money the company is making. Tata steel has not been able to increase its earnings post acquisition which can be interpreted from the data above. NET PROFIT MARGIN-Net Profit Margin tells you exactly how the managers and operations of a business are performing. Net Profit Margin compares the net income of a firm wit h total sales achieved. There is a decline in the net profit margin post acquisition for Tata Steel whic h indicates that it is not very effective in converting its sales into actual profit.This number is an indication of how effective a company is at cost control. The higher the net profit margin is, the more effective the company is at converting revenue into actual profit. The net profit margin is a good way of comparing companies in the same industry, since such companies are generally subject to similar businessconditions.

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E VA CALCULATION (PRE AND POST ACQUISITION :( ` in crores)) ELEMENTS Risk Free rate Market Premium Assumed Beta Cost of Equity Equity % Cost of Debt Tax rate After tax cost of debt Debt % WACC Capital Employed Net profit Total weighted cost EVA 2006-2007 8.00% 6.50% 1.12 15.28% 37.00% 8.00% 34.00% 5.28% 63.00% 8.98% 42074.75 4165.61 3778.313 387.297 2007-2008 5.27% 9.00% 1.5 18.77% 35.00% 8.00% 25.00% 6.00% 65.00% 10.4695% 92161.62 12321.76 9648.871 2672.9

Interpretation of EVA:A measure of a company's financial performance based on the residual wealth calculated by deducting cost of capital from its operating profit .EVA is measured by comparing your Return on Capital Employed wit h our Cost-of-Capital, also called your Return Spread. A positive Return Spread indicates we are earning more than your cost-of-capital whic h means we are creating wealth for your owners or stockholders. A negative Return Spread means we are earning less than your cost-of-capital, reducing the wealth of your owners and stockholders.
Here post acquisition the value of EVA increased to a huge extent stating that the company has created wealth for its owners, indicating that the company is doing financially very well.

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CONCLUSION
Measuring success of a merger of acquisition depends upon many factors like type of industry, organizations cultures, National policies, human factors, valuation factors and so on. If the company increases the shareholder value and achieve the motivations or objectives behind the merger or acquisition, it would consider a success. The case, Tata Chorus, analysis shows an unsuccessful merger. But it is very early to say that it is an unsuccessful merger as the acquisition took place very recently. As Tata acquired Corus for a whopping sum of approximately $12bn, there might be a factor of Hubris involved in this.As the comparison between pre-, merger and post- merger period shows a decrease in the shareholder value. So at this particular point of time it could be consider as an unsuccessful acquisition.

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BIBLIOGRAPHY

Kamal Ghosh Ray; Megers and Acquisitions-Strategy, value and integration Jennifer M. Vandeburg,Joan R. Fulton,Susan Hine,Kevin T. McNamara:Driving forces and success factors for mergers and acquisitions Gurminder Kaur:Corporate mergers and acquisitions

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