MF0011 & MERGERS & ACQUISITIONS

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Q.1 Give the meaning of advantages and disadvantages of mergers and
acquisitions? Explain the types of Mergers and Acquisitions?

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Answer- Advantages of mergers and acquisitions

Mergers and acquisitions are strategic decisions leading to the maximizing of
company's growth by enhancing its production and sales. The benefits of M & A
are:
1. From the standpoint of Promoters: Promoters get the advantage of
increasing the size of the company, restructuring the financial composition
of the firm and altering its strength as per their requirement. Promoters
can change a private company into a public company without much
investment and without losing control.
2. From the standpoint of Managers: Managers often look forward to
mergers as an opportunity to enhance their status financially and
otherwise. They are also concerned about the overall growth of the
company and are ready to support mergers where these benefits are seen
to accrue. On the other hand managers work against combinations that
generate fear about their future.
3. From the standpoint of shareholders: Shareholders may gain from
mergers through economies of scale, which helps in lowering of cost. This
results in increased profits, better investment opportunities which is not
available otherwise, and the increment in the value of share caused by the
premium paid by the acquiring company to the acquirer company.
4. From the standpoint of Consumers: The benefits of mergers get passed
to the consumers in the form of better products and services at lower
prices supported by enhanced after sales and service.
Disadvantages of mergers and acquisitions
A merger has disadvantages too. One of the disadvantages is that a merger must
be approved by the stockholders of the firm. Typically, two-thirds (or even more)
of the votes are required for approval. Obtaining the necessary votes can be
time-consuming and difficult. Furthermore, the cooperation of the management
of the target firm is a necessity. This cooperation is not easy or cheap. There can
also be diseconomies of scale if the business becomes too large. Clashes of
culture between different types of businesses Could happen and reduce the
effectiveness of the integration. Merger may create a conflict of objectives
between the different businesses. In view of sharing of services, staff positions
may come down and this will result in employee dissatisfaction. A merger can be
extremely beneficial to all stakeholders of a business but if handled wrongly it
can cause serious disruption all round.
Q2-Write a note on the five-stage model of mergers and acquisitions?
Answer- The Five-Stage Model
A five-stage model of mergers and acquisitions was developed by the author Sudi
Sudarsanam. This model advocates a view of M & A as a process rather than a
transaction. The process is considered as a multi-stage one and a holistic view of
the process is required to appreciate the links between different stages and
develop effective value-creating M & A strategies.

Stage 1: Corporate strategy evolution

The goal of M & A is to achieve corporate and business strategic objectives.
Corporate strategy aims to achieve ways to optimize the portfolio of businesses
that a firm has and how that portfolio can be modified in the interest of the
shareholders. Business strategy aims to enhance the firms competitive
positioning on a sustainable basis in its chosen markets. Both the objectives can
be met by M & A but is only one of several alternatives including, for instance,
strategic alliances, outsourcing, organic growth, etc. Generally, acquisitions are
made by companies due to one or more of the following strategic intents:

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to gain market power

to achieve economies of scale
to internalize vertically linked operations to save cost on dealing with
markets
to acquire complementary resources.

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Stage 2: Organizing for acquisition

It is important to understand the decision process of acquisition because it has a
bearing not only on the quality of the decision and its value creation logic but
also on the ultimate success of the post-merger integration.

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There are two primary perspectives here:

1. The rational perspective: This view is based on hard economic, strategic
and financial evaluation of the acquisition proposal and the potential value
creation. The acquisition is basically a matter of measurement of expected costs
and benefits.
2. The process perspective: This is based on soft human dimension. In this
view the process of decision-making is more politically complex and has to be
carefully managed so that the required clarity and commitment of managers is
achieved, which is taken for granted in the rationalist approach.
Stage 3: Deal structuring and negotiation
The result of the processes described in Stages 1 and 2 is the specific target
selection. Once the selection has been made by the firm, the merger transaction
has to be negotiated or a takeover bid to be made. The deal making takes place
in this stage. The deal structuring and negotiation
process is complex and involves many interconnected steps including:

valuing the target company

choosing experts like investment bankers, lawyers and accountants as
advisors to the deal
obtaining and evaluating maximum intelligence possible about the target
company
performing due diligence
negotiating the senior management positions of the both firms in the postmerger context
developing the appropriate bid and defense strategies and tactics within
the regulatory and other parameters.

Stage 4: Post-acquisition integration

The objective of this important stage is to make the merged organization

operational so that the strategic value expectations can be delivered which drove
the merger in the first place. Integration of two organizations is not just about
making changes in the organizational structure and instituting a new hierarchy
of authority. It involves integration of processes, systems, strategies, reporting
systems, etc. Above all, it also involves integrating people and changing
organizational culture of the merging firms, possibly to develop a new hybrid
culture. Integration of organizations may require change in the mindset and
behavior of the people. It is, therefore, necessary to address cultural issues
during the integration process. This stage of the acquisition process is, therefore,
a major factor which determines the success of the acquisition.

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Stage 5: Post-acquisition audit and organizational learning

Companies trying to grow through acquisitions need to develop acquisition
making as a core competence and excel in it. Companies possessing the right
growth strategy through acquisition and the necessary organizational
capabilities to manage their acquisitions efficiently and effectively can sustain
their competitive advantage far longer and create sustained value for their
shareholders. For acquisition-making to become a firms core competence,
possessing robust organizational learning capabilities is a must. Developing
such learning capabilities is thus integral to the M & A core competence of
building effort by multiple or serial acquirers.

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Q3- What do you understand by creating synergy? Give the prerequisites for
the creation of synergy. Describe the important forces contributing to
mergers and acquisitions.
Answer- Creating Synergy
The creation of synergy is not automatic. Synergy requires a great deal of work
on the part of managers at the corporate and business levels. Creation of
synergy does not require only the material resources of the two companies. It
demands effective integration of the combined units human resource, physical
assets and operations. The activities that create synergy include combining
similar processes, coordinating business units sharing common resources, and
resolving conflicts among business units. Managers often underestimate the
magnitude of problems that arise in integration efforts, resulting in a situation
where creation of synergy becomes very difficult.
Prerequisites for the creation of synergy
There are certain requirements which must be met for synergy to be created.
These requirements termed as the building blocks for the creation of synergy
must be fulfilled and seen into well before and during the process of
combination. These are strategic compatibility, organizational compatibility,
managerial actions, and value creation. When all the four exist then the chances
of the firm being able to create synergy are substantially higher.
1. Strategic compatibility: Strategic compatibility refers to the matching of
organizations strategic capabilities. There are various ways in which capabilities
can be matched through a merger. Thus, when combined firms or business
organizations are both strong and/or weak in the same business activities, the
newly created combined firm displays the same capabilities , although the
magnitude of the strength or weakness is greater, and no synergy results.

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2. Organizational compatibility: Organizational compatibility occurs when two

organizations have similar management processes, cultures, systems and
structures. Organizational compatibility from an operational point of view
suggests that the integration processes that are developed and used to combine
the operations can be expected to bring about desired results effectively and
efficiently.
3. Managerial actions: The third building block for the creation of synergy is
related to the actions and initiatives that managers take for their firms to
actually realize the competitive benefits. Creation of synergy requires active
involvement and participation of the management. Managers must recognize the
importance and magnitude of integration issues and the need to involve human
resources in implementing a combination.
4. Value creation: Value creation is the fourth synergy creation building block.
The focus here is on deriving benefits from synergy in excess of the costs to be
incurred. The costs associated with the following have to be controlled:

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(a) Financing of the transaction

(b) Premium paid for purchase.

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Important Forces Contributing to Mergers and Acquisitions

Some of these are:
Safeguarding the sources of raw material
Achieving economies of scale by combining production facilities through
efficient utilization of resources
Standardizing product specifications and improving product quality
Achieving improved technical knowhow from the combined entity to cut
cost, improvise on quality and produce better products to retain and
improve market share.
Reducing competition and protecting existing market
Obtaining new markets
Enhancing borrowing power of the combined entity on better and
enhanced asset backing
Gaining economies of scale and increase income with proportionately less
investment
Q4- Demerger results in the transfer by a company of one or more of
its undertakings to another company. Give the meaning of demerger.
What are the characteristics of demerger? Explain the structure of
demerger with an example.
Answer- A demerger results in the transfer by a company of one or more of
its undertakings to another company. The company whose undertaking is
transferred is called the demerged company and the company to which the
undertaking is transferred is referred to as the resulting company. The
term Demerger has not been defined in the Companies Act, 1956.
However, according to Sub-section (19AA) of Section 2 of the Income Tax
Act, demerger in relation to companies means transfer, pursuant to a
scheme of arrangement under Sections 391 to 394 of the Companies Act,
1956, by a demerged company of its one or more undertakings to any resulting
company in such a manner that all the property and liabilities of the
undertaking being transferred by the demerged company, immediately before the

demerger, become the property and liabilities of the resulting company by virtue
of the demerger.
Characteristics of Demerger
Given below are the key characteristics of demerger:
1. Demerger is basically a scheme of arrangement under Sections 391 to 394 of
the Companies Act which requires:
approval by majority of shareholders holding shares that represent threefourths value in a meeting convened for the purpose
Sanction of the High Court.
2. Demerger results in transfer of one or more undertakings.

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3. The transfer of undertakings is done by the demerged company, otherwise

known as Transferor Company. The company to which the undertaking is being
transferred is known as resulting company, otherwise known as Transferee
Company.

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Structure of Demerger
A demerger is distribution of the shares of a firms subsidiary to the
shareholders of the firm on a pro rata basis. Neither the dilution of equity nor
the transfer of ownership from the current shareholders is involved. After the
distribution, the operations and management of the subsidiary are separated
from those of the parent. Since no cash transaction is involved in a demerger, it
is a unique mode of divesting assets. Thus, it cannot be motivated by a desire to
generate cash to pay off debt, as is often the case with other modes of
divestitures.

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Example
The structure of demerger can be understood from the following example of Bajaj
Auto
Structure
Demerger

Prior

to

Post Demerger Structure

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5- Explain Employee Stock Ownership Plans (ESOP). Write down the rules
of ESOP and types of ESOP.
Answer- Employee-owned corporations are corporations owned wholly or in part
by the employees. Employees are usually given a share of the corporation after a
certain length of employment or they can buy shares at any time. A corporation
owned entirely by its employees (a worker cooperative) will not, therefore, have
its shares sold on public stock markets. Employee-owned corporations often
adopt profit-sharing where the profits of the corporation are shared with the
employees. These types of corporations also often have boards of directors
elected directly by the employees. .

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Rules of employee stock ownership plans (ESOP)

1. Vesting: Before an employee acquires entitlement to ESOP, he must work for
a certain period, which is referred to as the vesting period. If an employee leaves
before vesting, he loses the right. An ESOP must comply with minimum
schedules for vesting, called as cliff vesting or graded vesting. In cliff vesting, the
first three years do not require vesting. There is 100% vesting after three years of
service. In graded vesting, there is 20% vesting in the second year of service and
20% is added for each year of service. After the sixth year, employees are 100%
vested.
2. Distributions after termination: Distribution of vested benefits with
retirement, disability or death, takes places during the following plan year. The
following are the exceptions to this rule:
(a) If the termination occurs for reasons other than the ones stated above, the
distribution must commence no later than the sixth plan year following
termination.
(b) Repayment of the loans that have been taken against the ESOP benefits
must be done.
Distribution occurs in the plan year after repayment.

(c) ESOP distributions comprise of a lump sum or equal payments over a fiveyear period.
Large amounts due could lead to an extended payment plan.
3. Distribution during employment: Cash or stock can be received directly by
employees by diversifying their accounts. Dividends may be paid by the
employer to a participant who is at least a 5% owner beyond the age of 70,
although still working in the company. In some situations, a plan may offer inservice distributions after a fixed number of years of service, once a specific age
is reached or with a hardship necessity.

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4. Put Option: A put option is offered by some companies, for company stock
bought via the ESOP benefits plan. In this option, the employee can sell their
company stock back to the employer within 60 days after distribution and within
60 days during the following plan year.

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5. Taxation: No tax is required to be paid by the employees on stock until they

receive distributions. Payments are subject to applicable taxes, and an
additional 10% excise tax will be levied. Dividends that have to be paid directly
to participants on stock are taxable.

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Types of ESOPs
There are two types of ESOPs leveraged and non-leveraged. Additionally,
ESOPs may be combined with or converted from other employee benefit plans.

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1. Non-leveraged ESOPs Identified as an ESOP in the plan document that

invests primarily in company stock and meets certain legal requirements.
The sponsoring employer contributes newly issued or treasury stock and/or
cash to buy stock from existing owners. Contributions generally may equal
15% of the covered payroll (which usually is the combined payroll of all
employees eligible for participation) or, if the ESOP includes a money
purchase pension plan in which the employer commits to contribute a set
percentage of covered payroll per year in cash or stock, 15% plus the money
purchase pension plan contribution percentage (from 1% to 10%) up to a
maximum of 25% of covered payroll.
2. Leveraged ESOPs: A leveraged ESOP borrows money on the credit of the
employer or other related parties to buy company stock. It is only a qualified
employee benefit plan that can do this. The loan can be towards the ESOP
itself or to the employer who then lends the money to the ESOP (lenders
generally prefer the latter). The loan from the company to the ESOP does
not have to be on the same terms, provided its terms are the equivalent of an
arm's length transaction.
Q6- Explain the factors in Post-merger Integration. Write down the five
rules of Integration Process.
Answer- Factors in Post-merger Integration
Some important factors that can decide the success or failure of a merger or
acquisition are:
Due diligence: Thorough due diligence involves comprehensive analysis of the
financial position, management capabilities, physical assets and intangible

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assets of the target company. However, it can result in failure of the project if
done badly.
Financing: Manageable debt levels should be ensured.
Complementary resources: Ideal conditions for a merger are when the primary
resources of the acquiring and target firms are somewhat different, yet
simultaneously supportive of one another. Therefore, companies should seek for
such a situation.
Friendly vs. hostile acquisitions: Friendly acquisitions tend to create greater
economic value. A hostile acquisition can reduce the transfer of information
during due diligence and merger integration, and increase turnover of key
executives in the firm being acquired.
Synergy creation: Four foundations for creation of synergy are strategic fit,
organizational fit, managerial actions and value creation.
Organizational learning: All stakeholders should participate in the acquisition
process to ensure that relevant knowledge is spread throughout the firm, and is
not lost if anyone involved leaves. Information gained should also be recorded
and its impact on the process studied and utilised.
Focus on core business: The lesser the common factors in the combining firms,
the more magnified are cultural and management differences. This in turn
restrains the sharing of resources and capabilities. The advantages of financial
collaboration will not be sufficient to negate the disadvantages of diversification
between misaligned partners.
Five Rules of Integration Process

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1. Starting the post merger integration (PMI) process early: The integration
effort should start much before the deal is closed and the contracts signed; in
fact to this extent, the expression post merger is itself a misnomer. It is
essential to consider PMI issues at the very initial stage and plan meticulously
while choosing the target company. The main advantage is the preparedness for
potential risks and challenges. It also helps in evaluating the target companys
culture. This is also confirmed by the findings of Parenteau and Weston (2003).
2. The integration manager: A due diligence team (from areas like HR, finance,
tax, technology etc.) and one or more top managers are responsible for the
acquisition. This team, which is involved in the acquisition, achieves the best
insight into the target company. However, the team is either dissolved or moved
to the next acquisition. The manager of the acquiring business unit has the
charge of running his own units. His main focus will be on operating results and
customers and not on integrating cultures, processes and people. GE Capital
was one of the first companies to realize this problem.
3. Speed: If the integration takes place faster, the company will start making
profits from the predicted collaboration earlier. The valuable resources that are
engaged in the internal reorganization should be released as soon as possible.
But as A.T. Kearney discovered there is no absolute merger integration speed.
The integration speed should be prioritized based on what steers competitive
advantage most and therefore results in selective integration speed ). Apart from
customers, nearly all the companys stakeholders will respond positively to
speed.
4. The people problem: A successful merger is the one which retains the key
people of both the companies. Efforts should be made to recognize and identify
key managers, understand their motivations and accordingly act upon them.
Measures like long-term stay bonuses that are tied to some performance

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measure will generate a positive atmosphere which in turn will improve the
chances of retention.
5. Keeping culture high on the agenda: All companies are different in what
they do and the way they get things done. This is founded in what is called the
corporate culture. It has observable and unobservable behavioral rules, norms
of work organization and philosophies which help in forming the internal
hierarchies.