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The present chapter discusses the conceptual framework of mergers

and acquisitions. It focuses on demarcations between various terms
like mergers, acquisitions, takeovers, consolidations, reverse
mergers, management buyouts etc. The concept of demerger is also
introduced. Various Indian laws and statutes having a bearing on
merger process have been outlined and trends traced. Few other
related procedural issues are also covered.

“The decision to invest in a new asset would mean internal expansion for the firm. The
new asset would generate returns raising the value of the corporation. Mergers offer an
additional means of expansion, which is external, i.e. the productive operation is not
within the corporation itself. For firms with limited investment opportunities, mergers
can provide new areas for expansion. In addition to this benefit, the combination of two
or more firms can offer several other advantages to each of the corporations such as
operating economies, risk reduction and tax advantage1.”

Today mergers, acquisitions and other types of strategic alliances are on the agenda of
most industrial groups intending to have an edge over competitors. Stress is now being
made on the larger and bigger conglomerates to avail the economies of scale and
diversification. Different companies in India are expanding by merger etc. In fact, there
has emerged a phenomenon called merger wave.

The terms merger, amalgamations, take-over and acquisitions are often used
interchangeably to refer to a situation where two or more firms come together and
combine into one to avail the benefits of such combinations and re-structuring in the
form of merger etc., have been attempted to face the challenge of increasing
competition and to achieve synergy in business operations.

1.1 Corporate Restructuring

Restructuring of business is an integral part of the new economic paradigm. As controls

and restrictions give way to competition and free trade, restructuring and reorganization
become essential. Restructuring usually involves major organizational change such as
shift in corporate strategies to meet increased competition or changed market

Schall, L.D. and Hally C.W., Introduction to financial Management, McGraw Hill
Book Company, New York, P.682.

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This activity can take place internally in the form of new investments in plant and
machinery, research and development at product and process levels. It can also take
place externally through mergers and acquisitions (M&A) by which a firm may acquire
another firm or by which joint venture with other firms.

This restructuring process has been mergers, acquisitions, takeovers, collaborations,

consolidation, diversification etc. Domestic firms have taken steps to consolidate their
position to face increasing competitive pressures and MNC’s have taken this
opportunity to enter Indian corporate sector. The different forms of corporate
restructuring are summarized as follows:

Corporate Restructuring

Expansion Contraction Corporate Control

• Amalgamation • Demerger • Going Private
• Absorption + Spin off • Equity Buyback
• Tender offer + Equity carve out • Anti Takeover
• Asset + Split off • Leveraged
acquisition + Split up Buyouts
+ Divestitures
• Joint Venture
• Asset value


• Amalgamation: This involves fusion of one or more companies where the

companies lose their individual identity and a new company comes into existence to
take over the business of companies being liquidated. The merger of Brooke Bond
India Ltd. And Lipton India Ltd. Resulted in formation of a new company Brooke
Bond Lipton India Ltd.

• Absorption: This involves fusion of a small company with a large company where
the smaller company ceases to exist after the merger. The merger of Tata Oil Mills
Ltd. (TOMCO) with Hindustan Lever Ltd. (HLL) is an example of absorption.

• Tender offer: This involves making a public offer for acquiring the shares of a target
company with a view to acquire management control in that company. Takeover by
Tata Tea of consolidated coffee Ltd. (CCL) is an example of tender offer where more
than 50% of shareholders of CCL sold their holding to Tata Tea at the offered price
which was more than the investment price.

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• Asset acquisition: This involves buying assets of another company. The assets may
be tangible assets like manufacturing units or intangible like brands. Hindustan
lever limited buying brands of Lakme is an example of asset acquisition.

• Joint venture: This involves two companies coming whose ownership is changed.
DCM group and DAEWOO MOTORS entered into a joint venture to form
DAEWOO Ltd. to manufacturing automobiles in India.

There are generally the following types of DEMERGER:

Spinoff: This type of demerger involves division of company into wholly owned
subsidiary of parent company by distribution of all its shares of subsidiary company on
Pro-rata basis. By this way, both the companies i.e. holding as well as subsidiary
company exist and carry on business. For example Kotak, Mahindra finance Ltd.
formed a subsidiary called Kotak Mahindra Capital Corporation, by spinning off its
investment banking division.

Split ups: This type of demerger involves the division of parent

company into two or more separate companies where parent company ceases to exist
after the demerger.

Equity carve out: This is similar to spin offs, except that same part of shareholding of
this subsidiary company is offered to public through a public issue and the parent
company continues to enjoy control over the subsidiary company by holding
controlling interest in it.

Divestitures: These are sale of segment of a company for cash or for securities to an
outside party. Divestitures, involve some kind of contraction. It is based on the
principle if “anergy” which says 5-3=3!

• Asset sale: This involves sale of tangible or intangible assets of a company to

generate cash. A partial sell off, also called slump sale, involves the sale of a
business unit or plant of one firm to another. It is the mirror image of a purchase of
a business unit or plant. From the seller’s perspective, it is a form of contraction:
from the buyer’s point of view it is a form of expansion. For example, When
Coromandal Fertilizers Limited sold its cement division to India Cement limited,
the size of Coromandal Fertilizers contracted whereas the size of India Cements
Limited expanded.

Corporate controls

• Going private: This involves converting a listed company into a private company
by buying back all the outstanding shares from the markets. Several companies like
Castrol India and Phillips India have done this in recent years. A well known
example from the U.S. is that of Levi Strauss & company.

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• Equity buyback: This involves the company buying its own shares back from the
market. This results in reduction in the equity capital of the company. This
strengthens the promoter’s position by increasing his stake in the equity of the

• Anti takeover defenses: With a high value of hostile takeover activity in recent
years, takeover defenses both premature and reactive have been restored to by the

• Leveraged buyouts: This involves raising of capital from the market or institutions
by the management to acquire a company on the strength of its assets.

Merger is a marriage between two companies of roughly same size. It is thus a

combination of two or more companies in which one company survives in its own
name and the other ceases to exist as a legal entity. The survivor company acquires
assets and liabilities of merged companies. Generally the company which survives is
the buyers which retiring its identity and seller company is extinguished2.


Amalgamation is an arrangement or reconstruction. It is a legal process by which two

or more companies are to be absorbed or blended with another. As a result, the
amalgamating company loses its existence and its shareholders become shareholders of
new company or the amalgamated company. In case of amalgamation a new company
may came into existence or an old company may survive while amalgamating company
may lose its existence.

According to Halsbury’s law of England amalgamation is the blending of two or more

existing companies into one undertaking, the shareholder of each blending companies
becoming substantially the shareholders of company which will carry on blended
undertaking. There may be amalgamation by transfer of one or more undertaking to a
new company or transfer of one or more undertaking to an existing company.
Amalgamation signifies the transfers of all are some part of assets and liabilities of one
or more than one existing company or two or more companies to a new company.

The Accounting Standard, AS-14, issued by the Institute of Chartered Accountants of

India has defined the term amalgamation by classifying (i) Amalgamation in the nature
of merger, and (ii) Amalgamation in the nature of purchase.

M.A.Weinberg, takeover and Amalgamations (London: Sweet and Maxwell
Publishers, 1967)

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1. Amalgamation in the nature of merger: As per AS-14, an amalgamation is
called in the nature of merger if it satisfies all the following condition:

• All the assets and liabilities of the transferor company should become, after
amalgamation; the assets and liabilities of the other company.

• Shareholders holding not less than 90% of the face value of the equity shares of the
transferor company (other than the equity shares already held therein, immediately
before the amalgamation, by the transferee company or its subsidiaries or their
nominees) become equity shareholders of the transferee company by virtue of the

• The consideration for the amalgamation receivable by those equity shareholders of

the transferor company who agree to become equity shareholders of the transferee
company is discharged by the transferee company wholly by the issue of equity
share in the transferee company, except that cash may be paid in respect of any
fractional shares.

• The business of the transferor company is intended to be carried on, after the
amalgamation, by the transferee company.

• No adjustment is intended to be made in the book values of the assets and liabilities
of the transferor company when they are incorporated in the financial statements of
the transferee company except to ensure uniformity of accounting policies.

Amalgamation in the nature of merger is an organic unification of two or more entities

or undertaking or fusion of one with another. It is defined as an amalgamation which
satisfies the above conditions3.

2. Amalgamation in the nature of purchase: Amalgamation in the nature of

purchase is where one company’s assets and liabilities are taken over by another and
lump sum is paid by the latter to the former. It is defined as the one which does not
satisfy any one or more of the conditions satisfied above.

As per Income Tax Act 1961, merger is defined as amalgamation under sec.2 (1B) with
the following three conditions to be satisfied.

1. All the properties of amalgamating company(s) should vest with the amalgamated
company after amalgamation.

2. All the liabilities of the amalgamating company(s) should vest with the
amalgamated company after amalgamation.

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3. Shareholders holding not less than 75% in value or voting power in amalgamating
company(s) should become shareholders of amalgamated companies after
Amalgamation does not mean acquisition of a company by purchasing its property and
resulting in its winding up. According to Income tax Act, exchange of shares with
90%of shareholders of amalgamating company is required.

1.2 Acquisition
Acquisition refers to the acquiring of ownership right in the property and asset
without any combination of companies. Thus in acquisition two or more companies
may remain independent, separate legal entity, but there may be change in control of
companies. Acquisition results when one company purchase the controlling interest in
the share capital of another existing company in any of the following ways:

a) controlling interest in the other company. By entering into an agreement with a person
or persons holding
b) By subscribing new shares being issued by the other company.
c) By purchasing shares of the other company at a stock exchange, and
d) By making an offer to buy the shares of other company, to the existing shareholders of
that company.

1.2.1 Merger

Merger refers to a situation when two or more existing firms combine together and
form a new entity. Either a new company may be incorporated for this purpose or one
existing company (generally a bigger one) survives and another existing company
(which is smaller) is merged into it. Laws in India use the term amalgamation for

• Merger through absorption

• Merger through consolidation

Absorption An absorption is a combination of two or more companies into an existing

company. All companies except one lose their identity in a merger through absorption. An
example of this type of merger is the absorption of Tata Fertilisers Ltd.(TFL) TCL, an
acquiring company (a buyer), survived after merger while TFL, an acquired company ( a
seller), ceased to exist. TFL transferred its assets, liabilities and shares to TCL.

Consolidation A consolidation is a combination of two or more companies into a new

company .In this type of merger, all companies are legally dissolved and a new entity is
created. In a consolidation, the acquired company transfers its assets, liabilities and shares
to the acquiring company for cash or exchange of shares. An example of consolidation is
the merger of Hindustan Computers Ltd., Hindustan Instruments Ltd., and Indian
Reprographics Ltd., to an entirely new company called HCL Ltd.

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. N. R. Sridharan and P. H. Arvind Pandian , Guide to Takeover and Mergers (Nagpur:
Wadhwa and co. 1992).

1.2.2 Takeover

Acquisition can be undertaken through merger or takeover route. Takeover is a general

term used to define acquisitions only and both terms are used interchangeably. A
Takeover may be defined as series of transacting whereby a person, individual, group
of individuals or a
company acquires control over the assets of a company, either directly by becoming
owner of those assets or indirectly by obtaining control of management of the

Takeover is acquisition, by one company of controlling interest of the other, usually by

buying all or majority of shares. Takeover may be of different types depending upon the
purpose of acquiring a company.

1. A takeover may be straight takeover which is accomplished by the management of

the taking over company by acquiring shares of another company with the intention
of operating taken over as an independent legal entity.

2. The second type of takeover is where ownership of company is captured to merge

both companies into one and operate as single legal entity.

3. A third type of takeover is takeover of a sick company for its revival. This is
accomplished by an order of Board for Industrial and financial Reconstruction
(BIFR) under the provision of Sick Industrial companies Act, 1985. In India, Board
for Industrial and Financial reconstruction (BIFR) has also been active for arranging
mergers of financially sick companies with other companies under the package of
rehabilitation. These merger schemes are framed in consultation with the lead bank,
the target firm and the acquiring firm. These mergers are motivated and the lead
bank takes the initiated and decides terms and conditions of merger. The recent
takeover of Modi Cements Ltd. By Gujarat Ambuja Cement Ltd. was an arranged
takeover after the financial reconstruction Modi Cement Ltd.

4. The fourth kind is the bail-out takeover, which is substantial acquisition of shares in
a financial weak company not being a sick industrial company in pursuance to a
scheme of rehabilitation approved by public financial institution which is
responsible for ensuring compliance with provision of substantial acquisition of
shares and takeover Regulations, 1997 issued by SEBI which regulate the bail out

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M.A. Weinberg, op, cit, pp3 3, 4

Takeover Bid

This is a technique for affecting either a takeover or an amalgamation. It may be

defined as an offer to acquire shares of a company, whose shares are not closely held,
addressed to the general body of shareholders with a view to obtaining at least
sufficient shares to give the offer or, voting control of the company. Takeover Bid is
thus adopted by company for taking over the control and management affairs of listed
company by acquiring its controlling interest.

While a takeover bid is used for affecting a takeover, it is frequently against the wishes
of the management of Offeree Company. It may take the form of an offer to purchase
shares for cash or for share for share exchange or a combination of these two firms.
Where a takeover bid is used for effecting merger or amalgamation it is generally by
consent of management of both companies. It always takes place in the form of share
for share exchange offer, so that accepting shareholders of Offree Company become
shareholders of Offeror Company.

Types of Takeover Bid

There are three types of takeover bid

1. Negotiated bid
2. Tender offer
3. Hostile takeover bid

Negotiated bid: It is also called friendly merger. In this case, the management /owners
of both the firms sit together and negotiate for the takeover. The acquiring firm
negotiates directly with the management of the target company. So the two firms reach
an agreement, the proposal for merger may be placed before the shareholders of the two
companies. However, if the parties do not reach at an agreement, the merger proposal
stands terminated and dropped out. The merger of ITC Classic Ltd. with ICICI Ltd.;
and merger of Tata oil mills Ltd. With Hindustan Lever Ltd. were negotiated mergrs.
However, if the management of the target firm is not agreeable to the merger proposal,
then the acquiring firm may go for other procedures i.e. tender offer or hostile takeover.

Tender offer: A tender offer is a bid to acquire controlling interest in a target company
by the acquiring firm by purchasing shares of the target firm at a fixed price. The
acquiring firm approaches the shareholders of the target firm directly firm to sell their
shareholding to the acquiring firm at a fixed price. This offered price is generally, kept
at a level higher than the current market price in order to induce the shareholders to
disinvest their holding in favor of the acquiring firm. The acquiring firm may also
stipulate in the tender offer as to how many shares it is willing to buy or may purchase
all the shares that are offered for sale.

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In case of tender offer, the acquiring firm does not need the prior approval of the
management of the target firm. The offer is kept open for a specific period within
which the shares must be tendered for sale by the shareholders of the target firm.
Consolidated Coffee Ltd. was takeover by Tata Tea Ltd.by making a tender offer to the
shareholders of the former at a price which was higher than the prevailing market price.
In India, in recent times, particularly after the announcement of new takeover code by
SEBI, several companies have made tender offers to acquire the target firm. A popular
case is the tender offer made by Sterlite Ltd. and then counter offer by Alean to acquire
the control of Indian Aluminium Ltd.

Hostile Takeover Bid: The acquiring firm, without the knowledge and consent of the
management of the target firm, may unilaterally pursue the efforts to gain a controlling
interest in the target firm, by purchasing shares of the later firm at the stock exchanges.
Such case of merger/acquisition is popularity known as ‘raid’. The caparo group of the
U.K. made a hostile takeover bid to takeover DCM Ltd. and Escorts Ltd. Similarly,
some other NRI’s have also made hostile bid to takeover some other Indian companies.
The new takeover code, as announced by SEBI deals with the hostile bids.

Takeover and merger

“The distinction between a takeover and merger is that in a takeover the direct or
indirect control over the assets of the acquired company passes to the acquirer in a
merger the shareholding in the combined enterprises will be spread between the
shareholders of the two companies”.

In both cases of takeover and merger the interests of the shareholders of the company
are as follows:

1. Company should takeover or merge with another company only if in doing so, it
improves its profit earning potential measured by earning per share and

2. The company should agree to be taken if, and only if, shareholders are likely to be
better off with the consideration offered, whether cash or securities of the company
than by retaining their shares in the original company.

1.3 Merger through BIFR5

The companies (Amendment) Act, 2001 has repealed the sick Industrial Companies Act
(SICA) 1985, in order to bring sick industrial companies within the purview of
companies Act 1956 from the jurisdiction of SICA, 1985. The Act has introduced new
provisions for the constitution of a tribunal known as the National Company Law
Tribunal with regional benches which are empowered with the powers earlier vested
with the Board for Industrial and Financial reconstruction (BIFR).

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Board for Industrial and Financial Reconstruction was established by central
government under SICA, 1985 for detection of sick and potentially sick industrial units
and speedy determination pf their remedial measures and to exercise the jurisdiction
and powers and discharge the functioning and duties imposed on the Board by or under
the Act.
Before the evolution of SICA, the power to sanction the scheme of amalgamation was
vested only with the high court. However, sec.18 of the SICA 1985 empowers the BIFR
to sanction a scheme of amalgamation between sick industrial company and another
company over and above the power of high court as per section 391-394 of companies
Act, 1956. The amalgamation take place under SICA have a special place in law and
are not bound by the rigour of companies Act, 1956, and Income Tax Act,1961.

There is no need to comply with the provisions of sec.391-394 of companies Act,1956

for amalgamation sanctioned by BIFR. The scheme of amalgamation however must be
approved by shareholders of healthy company after getting approval from BIFR.
Sec.72A of the Income Tax Act has been enacted with a view to providing incentives to
healthy companies to takeover and amalgamation with companies which would
otherwise become burden on the economy. The accumulated losses and unabsorbed
depreciation of the amalgamating company is deemed to loss or allowance for
depreciation of the amalgamated company. So amalgamated company gets the
advantage of unabsorbed depreciation and accumulated loss on the precondition of
satisfactory revival of sick unit. A certificate from specialized authority to the effect that
adequate steps have been taken for rehabilitation or revival of sick industrial
undertaking has to be obtained to get these benefits. Thus the main attraction for the
healthy company to takeover a sick company through a scheme of amalgamation is the
tax benefits that may be available to it consequent to amalgamation. The approach
usually followed is to quantify the possible tax benefits first and then get an order as
part of rehabilitation package from BIFR. Once BIFR is convinced about the
rehabilitation benefit it passes an appropriate order to see that benefits of tax
concessions properly ensure to the transferee isolation

Section 18 of SICA provides for various measures to be recommended by the operating

agency in the scheme to be prepared by it for submission to the BIFR concerning the
sick industrial unit. Before the amendment, in 1994 under SICA, only normal
amalgamation (of sick company with healthy one) was possible and the Act did not
provide for reverse merger of a profitable company with sick company. Now the
amended Sec.18 of the Act contains provision for effecting both normal and reverse
merger. It provides for the amalgamation of

• Sick industrial company with any other company

• Any other company with the sick industrial company6.

1.4 Types of Merger

There are four types of merger are as follows:

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1. Horizontal merger:

It is a merger of two or more companies that compete in the same industry. It is a

merger with a direct competitor and hence expands as the firm’s operations in the same
industry. Horizontal mergers are designed to produce substantial economies of scale
and result in decrease in the number of competitors in the industry. The merger of Tata
Oil Mills Ltd. with the Hindustan lever Ltd. was a horizontal merger.

In case of horizontal merger, the top management of the company being meted is
generally, replaced, by the management of the transferee company. One potential
repercussion of the horizontal merger is that it may result in monopolies and restrict the

Weinberg and Blank7 define horizontal merger as follows:

“A takeover or merger is horizontal if it involves the joining together of two companies

which are producing essentially the same products or services or products or services
which compete directly with each other (for example sugar and artificial sweetness). In
recent years, the great majority of takeover and mergers have been horizontal. As
horizontal takeovers and mergers involve a reduction in the number of competing firms
in an industry, they tend to create the greatest concern from an anti-monopoly point of
view, on the other hand horizontal mergers and takeovers are likely to give the greatest
scope for economies of scale and elimination of duplicate facilities.”

2. Vertical merger:

It is a merger which takes place upon the combination of two companies which are
operating in the same industry but at different stages of production or distribution
system. If a company takes over its supplier/producers of raw material, then it may
result in backward integration of its activities. On the other hand, Forward integration
may result if a company decides to take over the retailer or Customer Company.
Vertical merger may result in many operating and financial economies. The transferee
firm will get a stronger position in the market as its production/distribution chain will
be more integrated than that of the competitors. Vertical merger provides a way for total
integration to those firms which are striving for owning of all phases of the production
schedule together with the marketing network (i.e., from the acquisition of raw material
to the relating of final products).

“A takeover of merger is vertical where one of two companies is an actual or potential

supplier of goods or services to the other, so that the two companies are both engaged
in the manufacture or provision of the same goods or services but at the different stages
in the supply route (for example where a motor car manufacturer takes over a
manufacturer of sheet metal or a car distributing firm). Here the object is usually to

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ensure a source of supply or an outlet for products or services, but the effect of the
merger may be to improve efficiency through improving the flow of production and
N.R. sridharan and P.H. Arvind Pandian .Guide to takeovers and mergers (Nagpur:
wadhwa and co.1992)
M.A., Weinberg and M V Blank, op. cit. Para 167.pp.5
Reducing stock holding and handling costs, where, however there is a degree of
concentration in the markets of either of the companies, anti-monopoly problems may

3. Co generic Merger:

In these, mergers the acquirer and target companies are related through basic
technologies, production processes or markets. The acquired company represents an
extension of product line, market participants or technologies of the acquiring
companies. These mergers represent an outward movement by the acquiring company
from its current set of business to adjoining business. The acquiring company derives
benefits by exploitation of strategic resources and from entry into a related market
having higher return than it enjoyed earlier. The potential benefit from these mergers is
high because these transactions offer opportunities to diversify around a common case
of strategic resources8.

Western and Mansinghka9 classified cogeneric mergers into product extension and
market extension types. When a new product line allied to or complimentary to an
existing product line is added to existing product line through merger, it defined as
product extension merger, Similarly market extension merger help to add a new market
either through same line of business or adding an allied field . Both these types bear
some common elements of horizontal, vertical and conglomerate merger. For example,
merger between Hindustan Sanitary ware industries Ltd. and associated Glass Ltd. is a
Product extension merger and merger between GMM Company Ltd. and Xpro Ltd.
contains elements of both product extension and market extension merger.

4. Conglomerate merger:

These mergers involve firms engaged in unrelated type of business activities i.e. the
business of two companies are not related to each other horizontally ( in the sense of
producing the same or competing products), nor vertically( in the sense of standing
towards each other n the relationship of buyer and supplier or potential buyer and
supplier). In a pure conglomerate, there are no important common factors between the
companies in production, marketing, research and development and technology. In
practice, however, there is some degree of overlap in one or more of this common

Conglomerate mergers are unification of different kinds of businesses under one

flagship company. The purpose of merger remains utilization of financial resources,

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P.Lorange, E Kotlarchuk and H Singh, “Corporate Acquisitions: A strategic
perspective in the management Acquisition”.
F. J. western and K.S. Masinghka, “Tests of efficiency performance of

enlarged debt capacity and also synergy of managerial functions. However these
transactions are not explicitly aimed at sharing these resources, technologies, synergies
or product market strategies. Rather, the focus of such conglomerate mergers is on how
the acquiring firm can improve its overall stability and use resources in a better way to
generate additional revenue. It does not have direct impact on acquisition of monopoly
power and is thus favored through out the world as a means of diversification.

1.5 Demerger

It has been defined as a split or division. As the same suggests, it denotes a situation
opposite to that of merger. Demerger or spin-off, as called in US involves splitting up of
conglomerate (multi-division) of company into separate companies.

This occurs in cases where dissimilar business are carried on within the same company,
thus becoming unwieldy and cyclical almost resulting in a loss situation. Corporate
restructuring in such situation in the form of demerger becomes inevitable. Merger of
SG chemical and Dyes Ltd. with Ambalal Sarabhai enterprises Ltd. (ASE) has made
ASE big conglomerate which had become unwieldy and cyclic, so demerger of ASE
was done.

A part from core competencies being main reason for demerging companies according
to their nature of business, in some cases, restructuring in the form of demerger was
undertaken for splitting up the family owned large business empires into smaller

The historical demerger of DCM group where it split into four companies (DCM Ltd.,
DCM shriram industries Ltd., Shriram Industrial Enterprise Ltd. and DCM shriram
consolidated Ltd.) is one example of family units splitting through demergers. Such
demergers are accordingly, more in the nature of family settlements and are affected
through the courts order.

Thus, demerger also occur due to reasons almost the same as mergers i.e. the desire to
perform better and strengthen efficiency, business interest and longevity and to curb
losses, wastage and competition. Undertakings demerge to delineate businesses and fix
responsibility, liability and management so as to ensure improved results from each of
the demerged unit.

Demerged Company, according to Section (19AA) of Income Tax Act, 1961 means
the company whose undertaking is transferred, pursuant to a demerger to a resulting

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Resulting company, according to Section2(47A) of Income Tax Act,1961 means one

10 .
M.A. Weinberg, and M.V.Blank op, cit, Para 107, pp 5
or more company, (including a wholly owned subsidiary thereof) to which the
undertaking of the demerged company is transferred in a demerger, and the resulting
company in consideration of such transfer of undertaking issues shares to the
shareholders of the demerged company and include any authority or body or local
authority or public sector company or a company established, constituted or formed as
a result of demerger.

1.6 Merger Procedure:

A merger is a complicated transaction, involving fairly complex legal considerations.

While evaluating a merger proposal, one should bear in mind the following legal
Sections 391 to 394 of the companies act, 1956 contain the provisions for
amalgamations. The procedure for amalgamation normally involves the following

1. Examination of object Clauses: The memorandum of association of both the

companies should be examined to check if the power to amalgamate is available.
Further, the object clause of the amalgamated company (transferee company)
should permit it to carry on the business of the amalgamating company (transferor
company ) .If such clauses do not exists, necessary approvals of the shareholders,
boards of directors and Company Law Board are required.

2. Intimation to stock Exchanges: The stock exchanges where the amalgamated and
amalgamating companies are listed should be informed about the amalgamation
proposal. From time to time, copies of all notices, resolutions, and orders should be
mailed to the concerned stock exchanges.

3. Approval of the draft amalgamation proposal by the Respective Boards: The

draft amalgamation proposal should be approved by the respective boards of
directors. The board of each company should pass a resolution authorizing its
directors/executives to pursue the matter further.

4. Application to the National Company Law Tribunal (NCLT): Once the draft of
amalgamation proposal is approved by the respective boards, each company should
make an application to the NCLT so that it can convene the meetings of
shareholders and creditors for passing the amalgamation proposal.

5. Dispatch of notice to shareholders and creditors: In order to convene the

meeting of shareholders and creditors, a notice and an explanatory statement of the

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meeting, as approved by the NCLT, should be dispatched by each company to its
shareholders and creditors so that they get 21 days advance intimation. The notice
of the meetings should also be published in two newspapers (one English and one
vernacular). An affidavit confirming that the notice has been dispatched to the
shareholders/creditors and that the same has been published in newspapers should
be filed with the NCLT.

6. Holding of Meetings of shareholders and creditors: A meeting of shareholders

should be held by each company for passing the scheme of amalgamation. At least
75 percent (in value) of shareholders in each class, who vote either in person or by
proxy, must approve the scheme of amalgamation. Likewise, in a separate meeting,
the creditors of the company must approve of the amalgamation scheme.

7. Petition to the NCLT for confirmation and passing of NCLT orders: Once the
amalgamation scheme is passed by the shareholders and creditors, the companies
involved in the amalgamation should present a petition to the NCLT for confirming
the scheme of amalgamation. The NCLT will fix a date of hearing. A notice about
the same has to be published in two newspapers. After hearing the parties the parties
concerned ascertaining that the amalgamation scheme is fair and reasonable, the
NCLT will pass an order sanctioning the same. However, the NCLT is empowered
to modify the scheme and pass orders accordingly.

8. Filing the order with the Registrar: Certified true copies of the NCLT order must
be filed with the Registrar of Companies within the time limit specified by the

9. Transfer of Assets and Liabilities: After the final orders have been passed by the
NCLT, all the assets and liabilities of the amalgamating company will, with effect
from the appointed date, have to be transferred to the amalgamated company.

10. Issue of shares and debentures: The amalgamated company, after fulfilling the
provisions of the law, should issue shares and debentures of the amalgamated
company. The new shares and debentures so issued will then be listed on the stock

Important elements of merger procedure are:

1.6.1 Scheme of merger

The scheme of any arrangement or proposal for a merger is the heart of the process and
has to be drafted with care. There is no specific form prescribed for the scheme. It is
designed to suit the terms and conditions relevant to the proposal but it should generally
contain the following information as per the requirements of sec. 394 of the companies
Act, 1956:

1. Particulars about transferor and transferee companies

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2. appointed date of merger

3. Terms of transfer of assets and liabilities from transferor company to transferee


4. Effective date when scheme will came into effect

5. Treatment of specified properties or rights of transferor company

6. Terms and conditions of carrying business by transferor company between

appointed date and effective date

7. Share capital of Transferor Company and Transferee Company specifying

authorized, issued, subscribed and paid up capital.

8. Proposed share exchange ratio, any condition attached thereto and the fractional
share certificate to be issued.

9. Issue of shares by transferee company

10. Transferor company’s staff, workmen, employees and status of provident fund,
Gratuity fund, superannuation fund or any other special funds created for the
purpose of employees.

11. Miscellaneous provisions covering Income Tax dues, contingent and other
accounting entries requiring special treatment.

12. Commitment of transferor and Transferee Company towards making an

application U/S 394 and other applicable provisions of companies Act, 1956 to their
respective High court.

13. Enhancement of borrowing limits of transferee company when scheme coming into

14. Transferor and transferee companies consent to make changes in the scheme as
ordered by the court or other authorities under law and exercising the powers on
behalf of the companies by their respective boards.

15. Description of power of delegates of Transferee Company to give effect to the

scheme. Qualifications attached to the scheme which requires approval of different

16. Effect of non receipt of approvals/sanctions etc.

17. Treatment of expenses connected with the scheme.

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1.6.2 Valuation in a merger: Determination of share exchange ratio

An important aspect of merger procedure relates to valuation of business relates to

valuation of business in order to determine share exchange ratio in merger. Valuation is
the means to assess the worth of a company which is subject to merger or takeover so
that consideration amount can be quantified and the price of one company for other can
be fixed. Valuation of both companies subject to business combination is required for
fixing the consideration amount to be paid in the form of exchange of share. Such
valuation helps in determining the value of shares of acquired company as well as
acquiring company to safeguard the interest of shareholders of both the companies.

Broadly there are three(3) methods used for valuation of business:

1. Net Value Asset (NAV) Method

NAV is the sum total of value of asserts (fixed assets, current assets, investment on the
date of Balance sheet less all debts, borrowing and liabilities including both current and
likely contingent liability and preference share capital). Deductions will have to be
made for arrears of preference dividend, arrears of depreciation etc. However, there
may be same modifications in this method and fixed assets may be taken at current
realizable value (especially investments, real estate etc.) replacement cost (plant and
machinery) or scrap value (obsolete machinery). The NAV, so arrived at, is divided by
fully diluted equity (after considering equity increases on account of warrant
conversion etc.) to get NAV per share.

The three steps necessary for valuing share are:

1. Valuation of assets
2. Ascertainment of liabilities
3. Fixation of the value of different types of equity shares.

All assets (value by appropriation method -

all liabilities - preference shares)
Fully diluted equity shares

2. Yield Value Method

This method also called profit earning capacity method is based on the assessment of
future maintainable earnings of the business. While the past financial performance
serves as guide, it is the future maintainable profits that have to be considered. Earnings
of the company for the next two years are projected (by valuation experts) and simple
or weighted average of these profits is computed. These net profits are divided by
appropriate capitalization rate to get true value of business. This figure divided by

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equity value gives value per share. While determining operating profits of the business,
it must be valued on independent basis without considering benefits on account of
merger. Also, past or future profits need to be adjusted for extra ordinary income or loss
not likely to recur in future. While determining capitalization rate, due regard has to be
given to inherent risk attribute to each business. Thus, a business with established
brands and excellent track record of growth and diverse product portfolio will get a
lower capitalization rate and consequently higher valuation where as a cyclical business
or a business dependent on seasonal factors will get a higher capitalization rate. Profits
of both companies’ should be determined after ensuring that similar policies are used in
various areas like depreciation, stock valuation etc.

3. Market Value Method

This method is applicable only in case where share of companies are listed on a
recognized stock exchange. The average of high or low values and closing prices over a
specified previous period is taken to be representative value per share.

Now, the determination of share exchange ratio i.e., how many shares of amalgamating
company, are to be exchanged for how many shares of amalgamated company, is
basically an exercise in valuation of shares of two or more of amalgamating company.
The problem of valuation has been dealt with by Weinberg and Blank (1971)49 by
giving the relevant factors to be taken into account while determining the final share
exchange ratio. These relevant factors has been enumerated by Gujarat High court in
Bihari Mills Ltd. and also summarized by the Apex court in the case of Hindustan
Levers. Employees union vs. Hindustan Lever Ltd. (1995)51 as under.

1. The stock exchange prices of the shares of the companies before the
commencement of negotiations or the announcement of the bid.

2. The dividends presently paid on the shares of two companies. It is often difficult to
induce a shareholder to agree to a merger if it involves a reduction in his dividend

3. The relative growth prospects of the two companies.

4. The cover, (ratio of after tax earnings to divided paid during the year) for the
present dividends of the two companies. The fact that the dividend of one company
is better covered than the other is a factor which has to be compensated to same

5. The relative gearing of the shares of the two companies. The gearing of an ordinary
share is the ratio of borrowings to equity capital.

6. The value of net assets of the two companies.

7. The voting strength in the company of shareholder of the two companies.

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8. The past history of the prices of two companies.

There are however, no rules framed specially for the working out of share exchange

M.A. Weinberg and MV Blank, op. cit., Para 67 pp5
Bihari Mills Ltd. (1985) cited here from A.K. Majumdar and Dr. G.K. Kapoor Co.
Law and practice) N.D. Taxmann 2002. pp 1084
ratio in case of amalgamations. According to Delhi High Court statement, “The
valuation of shares is a technical matter which requires considerable skills and
expertise. There are bound to be difference of opinion as to what the correct value of
the shares of the company is. If it is possible to the value the shares in a manner
difference from the one adopted in the given case, it cannot be said, that the valuation
agreed upon has been unfair.”

In CWT vs. Mahadeo Jalan (1972) 86 ITR 621 (SC), Supreme Court has evolved the
following guidelines and aspects which should be considered:

• Regard should be had to price of shares prevailing in stock market

• Profit earning capacity (yield method) or dividend declared by the company

(dividend method) should be considered. If result of two methods differs, a golden
mean should be found.

• In computing yields, abnormal expenses will be added back to calculate ‘yield’ (e.g.
company incurring expenses disproportionate to the commercial venture, possibly
to reduce income tax liability)

• If lower dividend or profits are due to temporary reasons, then estimate of share
value before the set-back and proportionate fall in price of quoted shares of
companies which have suffered similar reverses should be considered

• If company is ripe for winding up, break up value method to determine what would
be realized in winding up process should be considered.

• Valuation can be done on basis of asset value, if reasonable estimation of future

profits and dividend is not possible due to wide fluctuations in profits and uncertain

Valuation of shares on book value method is proper and valid mode of valuation of
shares- Tinsukhia Electric Co. Ltd. vs. State of Assam. Often share value cannot be
finalized on basis of one parameter only. Thus, final decision depends on judicious
consideration of usual methods of valuation i.e. break –up value, yield value, market
value or on net worth basis. Qualitative factors like market fluctuations, competition,

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Government policy, managerial skills are also relevant for the purpose-Sanghi
industries Ltd.

1.7 Reverse Merger

Normally, a small company merges with large company or a sick company with healthy
company. However in some cases, reverse merger is done. When a healthy company
merges with a sick or a small company is called reverse merger. This may be for
various reasons. Some reasons for reverse merger are:

a) The transferee company is a sick company and has carry forward losses and
Transferor Company is profit making company. If Transferor Company merges with
the sick transferee company, it gets advantage of setting off carry forward losses
without any conditions. If sick company merges with healthy company, many
restrictions are applicable for allowing set off.

b) The transferee company may be listed company. In such case, if Transferor

Company merges with the listed company, it gets advantages of listed company,
without following strict norms of listing of stock exchanges.

In such cases, it is provided that on date of merger, name of Transferee Company will
be changed to that of Transferor Company. Thus, outside people even may not know
that the transferor company with which they are dealing after merger is not the same as
earlier one. One such approved in Shiva Texyarn Ltd.

Many times, reverse mergers are also accompanied by reduction in the unwieldy capital
of the sick company. This capital reduction helps in unity of the accumulated losses and
other assets which are not represented by the share capital of the company. Thus, a
capital reduction aim rehabilitation scheme is an ideal antidote (by way of reverse
merger) for sick company. For example Godrej soaps Ltd. (GSL) with pre merger
turnover of 436.77 crores entered into scheme of reverse merger with loss making
Gujarat Godrej innovative Chemicals Ltd. (GGICL) (with pre merger turnover of Rs.
60 crores) in 1994.The scheme involved reduction of share capital of GGICL from Rs.
10 per share to Re. 1 per share and later GSL would be merged with 1 share of GGICL
to be allotted to every shareholder of GSL. The post merger company, Godrej Soaps
Ltd. (with post-merger turnover of Rs. 611.12 crores) restructured its gross profit of
49.08 crores, higher turnover GSC’s pre-merger profits of Rs. 30 crores.

The amalgamated company, GGICL reverted back to the old name of amalgamating
company, Godrej Soaps Ltd. Thus, this innovative merger which was by way of
forward integration in the name of GGICL was completed with the help of financial
institutions like IDBI, IFCI, ICICI, UTI etc. All financial Institutions agreed to waive
penal interest, liquidate damages besides finding of interest, reschedule outside loans
and also lower interest rate on term loans.

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1.8 Laws statutes in India

1.8.1 Laws applicable to Takeover

1. Clauses 40A and 40B of the listing Agreement the company has entered into with
stock exchange.

2. SEBI’s (Substantial Acquisition of shares and Takeover’s) Regulations, 1997.

1. Takeover and Listing agreement exemption Clauses 40A and 40B of Listing

Clause 40A deals with substantial acquisition of shares and requires the offeror and the
offeree to inform the stock exchange when such acquisition results in an increase in the
shareholding of the acquirer to more than 10%.

Clause 40B deals with takeover efforts. A takeover offer refers to change in
management where there is no change in management, Clause 40B of listing agreement
will not apply. However, sub clause 13 of amendment of Clause 40B also provides an
exemption to the scheme approved by BIFR. There is no provision under clause 40B
for exemption of non BIFR companies.

2. SEBI (Substantial Acquisition of shares and takeover) Regulations Act,


On the basis of recommendations of the Committee, the SEBI announced on

Febuary20, 1997, the revised take over code as Securities and Exchange Board of India
(Substantial Acquisitions of shares and Takeovers) Regulations, 1997. The objective of
these regulations has been to provide an orderly framework within which substantial
acquisitions and takeovers can take place. The salient features of this new takeover
code (Regulations, 1997) may be enumerated as follows:

i. Any person, who holds more than 5% shares or voting rights in any company, shall
within two months of notification of these Regulation disclose his aggregate
shareholding in that company, to the company which in turn, shall disclose to all the
stock exchanges on which the shares of the company are listed, the aggregate
number of shares held by each such person.

ii. Any acquirer, who acquires shares or voting rights which (taken together with
shares or voting rights, if any, held by him) would entitle him to more than 5%
shares or voting rights in a company- (a) in pursuance of a public issue, or (b) by
one or more transactions, or (c) in any other manner not covered by (a) and (b)
above, shall disclose the aggregate of his shareholding or voting rights in that
company, to the company within four working days of the acquisition of shares or
voting rights, as the case may be.

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iii. Every person, who holds more than 10% shares or voting rights in any company,
shall, within 21 days from the end of the financial yea, make yearly disclosures to
the company, in respect of his holdings as on 31st March each year.

iv. No acquirer shall agree to acquire, of acquire shares or voting rights which (taken
together with shares or voting rights, if any, held by him or by persons acting in
concert with him), entitle such acquirer to exercise 10% or more of the voting rights
in a company, unless such acquirer makes a public announcement to acquire shares
of such company in accordance with the Regulations.

v. No acquirer holding, not less than 10% but not more than 25% of the shares or
voting rights in a company, shall acquire, additional shares or voting rights entitling
him to exercise more than 2% of the voting rights, in any period of 12 months,
unless such acquirer makes a public announcement to acquire shares in accordance
with the Regulations.

vi. The minimum offer price shall be the highest of- (a) the negotiated price under the
agreement ; (b) average price paid by the acquirer for acquisitions including by way
of allotment in a public or rights issue, if any, during the twelve-month period prior
to the date of public announcement; (c) the price paid by the acquirer under a
preferential allotment made to him, at any time during the twelve month period up
to the date of closure of the offer; (d) the average of the weekly high and low of the
closing prices of the shares of the target company during the 26 weeks proceeding
the date of public announcement.

vii. The public offer shall be made to the shareholders of the target company to acquire
from them an aggregate minimum of 20% of the voting capital of the company
provided that acquisition of shares from each of the shareholders shall not be less
than the minimum marketable lot or the entire holding if it is less than the
marketable lot.

viii. Within 14 days of the public announcement of the offer, the acquire must send a
copy of the draft letter to the target company at its registered office address, for
being placed before the Board of Directors and to all the stock exchanges where the
shares of the company are listed.

ix. Any person other than the acquirer who had made the first public announcement,
who is desirous of making any offer, shall, within 21 days of the public
announcement of the first offer, make a public announcement of his offer for
acquisition of some or all of the shares of the same target company. Such offer shall
be deemed to be a competitive bid. No public announcement for an offer or
competitive bid shall be made during the offer period except during 21-day period
from the public announcement of the first offer.

x. Upon the public announcement of a competitive bid or bids, the acquirer(s) who
had made the public announcement (s) of the earlier offer(s), shall have the option

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to make an announcement revising the offer or withdrawing the offer with the
approval of the SEBI.

xi. Irrespective of whether or not there is competitive bid, the acquirer who has made
the public announcement of offer, any make upward revisions in his offer in respect
of the price and the number of shares to be acquired, at any time up to 3 working
days prior to the date of the closure of the offer.

xii. No public offer, once made, shall be withdrawn except under the circumstances
mentioned in this regulation, namely-(a) the withdrawals is consequent upon any
competitive bid; (b) the offer did not receive the minimum level of acceptances, to
which it was subject to; (c) the statutory approvals(s) required have been refused;
(d) the sole acquirer, being a natural person has died, and (e) such circumstances as
in the opinion of SEBI merits withdrawal.

xiii. The acquirer shall deposit in an Escrow Account a sum equivalent to at least 25%
of the total consideration payable under the offer up to Rs, 100 crores and 10% of
the consideration thereafter. Where the acquirer specifies a minimum level of
acceptance and does not want to acquire a minimum 20%, the 50% of the
consideration payable is to be deposited in Escrow Account.

xiv. In case, there is any upward revision of offer, consequent upon a competitive bid or
otherwise, the value of the Escrow Account shall be increased to equal to at least
25% of the consideration payable upon such revision.

xv. In case of a substantial acquisition of shares in financially weak company not being
a sick industrial company, the scheme prepared by a financial institutions may
provide for acquisition of shares in the financially weak company in any of the
following manner (a) outright purchase of shares, or (b) exchange of shares, or (c) a
combination of both; provided that the scheme as far as possible may ensure that
after the proposed acquisition, the erstwhile promoters do not own any shares in
case such acquisition is made by the new promoters pursuant to such scheme.

xvi. The person acquiring shares from the promoters of the persons in- charge of the
management of the affairs of the financially weak company or the financial
institutions shall make a public announcement of his intention for acquisition of
shares from the shareholders of the company. Such public announcement shall
contain relevant details about the offer including the information about the identity
and background of the person acquiring shares, number and percentages of shares
proposed to be acquired, offer price, the specified date, the date of opening of the
offer and the period for which the offer shall be kept open.

xvii. No person shall make a competitive bid for acquisition of shares of the financially
weak company once the lead institution has evaluated the bid and accepted the bid
of the acquirer who has made the public announcement of offer acquisition of
shares from the shareholders other than the promoters.

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An amendment to the Regulations, 1997 on substantial acquisition of shares and
takeovers has been notified on 28, 1998. SEBI had decided to increase the creeping
acquisition limited to 5% from the 25 and the thresh hold limit to 215% from 10%. The
rationale for SEBI’s decision to increase the creeping limit and the threshold limit is
difficult to understand. The decision to increase the creeping to 5% and thresh hold
limit to 15% appears to be working against the basic spirit of the takeover code. The
increase in creeping acquisition will bring in quiet acquisition without the trigger of
making a minimum offer of 20%. In fact the 20% offer was to facilitate the market
movements and competitive process and also to keep the management on their toes.
The decision to increase the creeping acquisition from 2%to 5% disregards the
objective of protection of small shareholders. The decision to increase the threshold
limit from 10% to 15% is also difficult to be justified.

1.8.2 Laws governing merger

Various Laws governing merger in India are as follows:

1. Indian Companies Act, 1956

This has provisions specifically dealing with the amalgamation of a company or certain
other entities with similar status. The most common form of merger involves as
elaborate but time-bound procedure under sections 391 to 396 of the Act.

Powers in respect of these matters were with High Court (usually called Company
Court). These powers are being transferred to National Company Law Tribunal (NCLT)
by companies (second Amendment) Act, 2002.

The Compromise, arrangement and Amalgamation/reconstruction require approval of

NCLT while the sale of shares to Transferee Company does not require approval of

Sec 390 This section provides that “The expression ‘arrangement’ includes a
reorganization of the share capital of the company by the consolidation of shares of
different classes, or by the division of shares into shares of different classes, or by both
these methods”

Sec 390(a) As per this section , for the purpose of sections 391 to 393,’Company’
means any company liable to be wound up under the Act.

Sec 390(b) As per this section, Arrangement can include reorganization of share capital
of company by consolidation of shares of different classes or by division of shares of
different classes.

Sec 390(c) As per this section, unsecured creditors who have filed suits or obtained
decrees shall be deemed to be of the same class as other unsecured creditors. Thus, their
separate meeting is not necessary.

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Sec 391 This section deals with the meeting of creditors/members and NCLT’s
sanction to Scheme.

If majority in number representing at least three-fourths in value of creditors or

members of that class present and voting agree to compromise or arrangement, the
NCLT may sanction the scheme. NCLT will make order of sanctioning the scheme only
if it is satisfied that company or any other person who has made application has
disclosed all material facts relating to the company, e.g. latest financial position,
auditor’s report on accounts of the company, pendency of investigation of company etc.
NCLT should also be satisfied that the meting was fairly represented by

Sec 391(1) As per this sub-section, the company or any creditor or member of a
company can make application to NCLT. If the company is already under liquidation,
application will be made by liquidator. On such application, NCLT may order that a
meeting of creditors or members or a class of them be called and held as per directions
of NCLT.

Sec 391 (2) As per this sub-section, if NCLT sanction, it will be binding on all creditors
or members of that class and also on the company, its liquidator and contributories.

Sec 391(3) As per this sub-section, Copy of NCLT order will have to be filled with
Registrar of Companies.

Sec 391(4) As per this sub-section, A copy of every order of NCLT will be annexed to
every copy of memorandum and articles of the company issued after receiving certified
copy of the NCLT order.

Sec 391(5) In case of default in compliance with provisions of section 391(4), company
as well as every officer who is in default is punishable with fine upto Rs 100 for every
copy in respect of which default is made.

Sec 391(6) After an application for compromise or arrangement has been made under
the section, NCLT can stay commencement of any suit or proceedings against the
company till application for sanction of scheme is finally disposed of.

Sec 391(7) As per this sub-section, Appeal against NCLT order can be made to
National Company Law Appellate Tribunal (NCLAT) where appeals against original
order the NCLT lies.

Sec. 392 This section contains the powers of NCLT to enforce compromise and

Sec 392 (1) As per this section, where NCLT sanctions a compromise or arrangement,
it will have powers to supervise the carrying out of the scheme. It can give suitable

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directions or make modifications in the scheme of compromise or arrangement for its
proper working.

Sec 392 (2) As per this section, if NCLT finds that the scheme cannot work, it can order
winding up.

Sec 393 This section contains the rules regarding notice and conduct of meeting.

Sec.393 (1) Where a meeting of creditors or any class of creditors, or of numbers or any
class of members, is called under section 391:-

a) With every notice calling the meeting which is sent to a creditor or member, there
shall be sent also a statement setting forth the terms of the compromise or
arrangement and explaining its effect, and in particular stating any material interests
of the directors, managing directors, or manager of the company, whether in their
capacity as such or as members or creditors of the company or otherwise and the
effect on those interests of the compromise or arrangement if, and in so far as, it is
different from the effect on the like interests of other person, and

b) In every notice calling the meeting which is given by advertisement, there shall be
included either such a statement as aforesaid or a notification of the place at which
creditors or members entitled to attend the meeting may obtain copies of such a
statement as aforesaid.

Sec 393 (2) As per this sub-section, if the scheme affects rights of debenture holders,
statement should give details of interests of trustees of any deed for securing the issue
of debentures as it is required to give as respects the companies directors.

Sec 393 (3) As per this sub-section, the copy of scheme of compromise or arrangement
should be furnished to creditor/member free of cost.

Sec 393 (4) Where default is made in complying with any of the requirements of this
section, the company and every officer of the company who is in default, shall be
punishable with fine which may extend to Rs. 50,000 and for the purpose of this sub-
section any liquidator of the company and any trustee of a deed for securing the issue of
debentures of the company shall be deemed to be an officer of the company.

Provided that a person shall not be punishable under this sub-section, if he shows that
the default was due to the refusal of any other person, being a director, managing
director, manager or trustee for debenture holders, to supply the necessary particulars as
to his material interests.

Sec 393 (5) As per this section, any director, managing director, manager or trustee of
debenture holders shall give notice to the company of matters relating to himself which

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the company has to disclose in the statement, if he unable to do so, he is punishable
with fine upto Rs.5,000.

Sec 394 This section contains the powers while sanctioning scheme of reconstruction
or amalgamation.

Sec 394(1) NCLT can sanction amalgamation of a company which is being wound up
with other company, only if Registrar of Companies (ROC) has made a report that
affairs of the company have not been conducted in a manner prejudicial to the interests
of its members or to public interest.

Sec 394 (2) As per this sub-section, if NCLT issues such an order, NCLT can direct that
the property will be vest in the transferee company and that the transfer of property will
be freed from any charge.

Sec 394 (3) As per this sub-section, Copy of NCLT order shall be filed with Registrar
within 30 days. In case of default, company as well as every officer who is in default is
punishable with fine upto Rs.500.

Sec 394A As per this section, if any application is made to NCLT for sanction of
arrangement, compromise, reconstruction or amalgamation, notice of such application
must be made to Central Government. NCLT shall take into consideration any
representation made by Central Government before passing any order.

Sec 395 This section provides that reconstruction or amalgamation without following
NCLT procedure is possible by takeover by sale of shares. Selling shareholders get
either compensation or shares of the acquiring company. This procedure is rarely
followed, as sanction of shareholders of at least 90% of value of shares is required, and
not only of those attending the meeting. This procedure can be followed only when
creditors are not involved in reconstruction and their interests are not affected.

Sec 395(1) As per this sub-section, the transferee company has to be give notice in
prescribed manner to dissenting shareholder that it desires to acquire his shares. The
transferee company is entitled and bound to acquire those shares on the same terms on
which shares of approving share holders are to be transferred to the transferee company.
The dissenting shareholder can make application within one month of the notice to
NCLT. The NCLT can order compulsory acquisition or other order may be issued.

Sec 395(2) As per this sub-section, if the transferee company or its nominee holds 90%
or more shares in the transferor company, it is entitled to and is also under obligation to
acquire remaining shares. The transferee company should give notice within one month
to dissenting shareholders. Their shares must be acquired within three months of such

Sec395 (3) As per this section, if shareholders do not submit the transfer deeds, the
transferee company will pay the amount payable to transferor company along with the
transfer deed duly signed. The transferor company will then record name of the

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transferee company as holder of shares, even if transfer deed is not signed by dissenting

Sec395 (4) As per this section, The sum received by transferor company shall be kept
in a separate account in trust for the dissenting shareholders.

Sec395 (4A) When the transferee company makes offer to shareholders of transferor
company, the circular of offer shall be accomplished by prescribed information in form
35A. Offer should contain statement by Transferee Company for registration before it is
sent to shareholders of Transferor Company.

Sec 396 This section contains the power to Central Government to order

Sec.396 (1) As per this sub-section, if central government is satisfied that two or more
companies should amalgamate in public interest, it can order their amalgamation, by
issuing notification in Official Gazette. Government can provide the constitution of the
single company, with such property, powers, rights, interest, authorities and privileges
and such liabilities, duties and obligations as may be specified in the order.

Sec 396(2) The order may provide for continuation by or against the transferee
company of any legal proceedings pending by or against Transferor Company. The
order can also contain consequential, incidental and supplemental provisions necessary
to give effect to amalgamation.

Sec396 (3) As per this sub-section, every member, creditor and debenture holder of all
the companies will have same interest or rights after amalgamation, to the extent
possible. If the rights and interests are reduced after amalgamation, he will get
compensation assessed by prescribed authority. The compensation so assessed shall be
paid to the member or creditor by the company resulting from amalgamation.

Sec 396A This section deals with the preservation of books and papers of
amalgamated company. Books and papers of the company which has amalgamated or
whose shares are acquired by another company shall be preserved. These will not be
disposed of without prior permission of Central Government. Before granting such
permission, Government may appoint a person to examine the books and papers to
ascertain whether they contain any evidence of commission of an offence in connection
with formation or management of affairs of the company, or its amalgamation or
acquisition of its shares.

2. Monopolies and Restrictive Trade practices Act, 1969 (MRTP 1969)

Certain Amendments in the MRTP Act were brought about in 1991. The Government
has removed restrictions on the size of assets; market shares and on the requirement of
prior government approvals for mergers that created entities that would violate
prescribed limits. The Supreme Court, in a recent judgment, decided that “prior

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approval of the central government for sanctioning a scheme of amalgamation is not
required in view of the deletion of the relevant provision of the MRTP Act and the
MRTP Commission was justified in not passing an order restraining implementation of
the scheme of amalgamation of two firms in the same field of consumer articles”.

3. Foreign Exchange Regulation Act 1973 (FERA 1973)

FERA is the primary Indian Law which regulates dealings in foreign exchange.
Although there are no provisions in the Act which deal directly with transactions
relating to amalgamations, certain provisions of the Act become relevant when shares in
Indian companies are allotted to non- residents, where the undertaking sought to be
acquired is a company which is not incorporated under any law in India. Section 29 of
FERA provides that no foreign company or foreign national can acquire any share of an
Indian company except with prior approval of the reserve Bank of India. The Act has
been amended to facilitate transfer of shares two non residents and to allow Indian
companies to set up subsidiaries and joint ventures abroad without the prior approval of
the Reserve Bank of India.

4. Income Tax Act, 1961

Income Tax Act, 1961 is vital among all tax laws which affect the merger of firms from
the point view of tax savings/liabilities. However, the benefits under this act are
available only if the following conditions mentioned in Section 2 (1B) of the Act are

a) All the amalgamating companies should be companies within the meaning of the
section 2 (17) of the Income Tax Act, 1961.

b) All the properties of the amalgamating company (i.e., the target firm) should be
transferred to the amalgamated company (i.e., the acquiring firm).

c) All the liabilities of the amalgamating company should become the liabilities of the
amalgamated company, and

d) The shareholders of not less than 90% of the share of the amalgamating company
should become the shareholders of amalgamated company.

In case of mergers and amalgamations, a number of issues may arise with respect to tax
implications. Some of the relevant provisions may be summarized as follows:

Depreciation: The amalgamated company continues to claim depreciation on the basis

of written down value of fixed assets transferred to it by the amalgamating company.
The depreciation charge may be based on the consideration paid and without any re-
valuation. However, unabsorbed depreciation, if any, cannot be assigned to the
amalgamated company and hence no tax benefit is available in this respect.

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Capital Expenditures: If the amalgamating company transfers to the amalgamated
company any asset representing capital expenditure on scientific research, then it is
deductible in the hands of the amalgamated company under section 35 of Income Tax
Act, 1961.

Exemption from Capital Gains Tax: The transfer of assets by amalgamating company
to the amalgamated company, under the scheme of amalgamation is exempted for
capital gains tax subject to conditions namely (i) that the amalgamated company should
be an Indian Company, and (ii) that the shares are issued in consideration of the shares,
to any shareholder, in the amalgamated company. The exchange of old share in the
amalgamated company by the new shares in the amalgamating company is not
considered as sale by the shareholders and hence no profit or loss on such exchange is
taxable in the hands of the shareholders of the amalgamated company.

Carry Forward Losses of Sick Companies: Section 72A(1) of the Income Tax Act,
1961 deals with the mergers of the sick companies with healthy companies and to take
advantage of the carry forward losses of the amalgamating company. But the benefits
under this section with respect to unabsorbed depreciation and carry forward losses are
available only if the followings conditions are fulfilled:

I. The amalgamating company is an Indian company.

II. The amalgamating company should not be financially viable.

III. The amalgamation should be in public interest.

IV. The amalgamation should facilitate the revival of the business of the
amalgamating company.

V. The scheme of amalgamation is approved by a specified authority, and

VI. The amalgamated company should continue to carry on the business of the
amalgamating company without any modification

Amalgamation Expenses: In case an expenditure is incurred towards professional

charges of Solicitors for the services rendered in connection with the scheme of
amalgamation, then such expenses are deductible in the hands of the amalgamated firm.

1.9 Effective Date and Appointed Date

Effective Date- A compromise or arrangement takes effect from the date when it is
arrived at subject to the sanction of the court (NCLT). If the NCLT refuses sanction, it
becomes without effect, If the NCLT grants sanction it takes effect, not from the date of
the sanction but from the date when it was arrived at.Sanction of the NCLT to a
compromise has relation back and a scheme or arrangement agreed to by the creditors

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of a company becomes operative from the date of the meeting in which it is agreed to
and not from the date on which the NCLT sanction is given.

Appointed Date- Appointed date or transfer date is the date on which the property of
transferor company vests and is transferred to Transferee Company. This can be
retrospective. It is usually beginning of financial year, for convenience of accounting
and tax assessments. The transfer date specified in the scheme is the date of transfer for
purpose of Income Tax assessments, even if scheme is sanctioned later by high court
(Now NCLT).

1.10 Mergers and Takeovers: Indian scene

In India, the concept of mergers, acquisitions and takeovers has not been popular and
kept a low profile, and the reason for this is quite obvious. The regulatory and
prohibitory provisions of MRTP Act, 1969 provided for a cumbersome procedure to get
approval for mergers and acquisitions under the Act. Most of the provisions of the
MRTP Act, 1969, have been repealed as a part of economic liberalization drive of the
Government of India. Still, in most of the cases, merger in India used to be friendly
amalgamation resulting as a consequence of a negotiated deal, unless 1988 when there
was the well-known unsuccessful hostile takeover bid by Swaraj Paul (of Caparo Group
of the U.K. ) to get control over DCM Ltd. and Escorts Ltd. Many other Nonresident
Indians, such as Chabrias, Hindujas etc. also attempted to take over many Indian
companies by buying shares of these companies at stock exchanges.

During recent years, there has been a spate of merger moves by various industrial
groups. Volrho Ltd., a loss making company was amalgamated with Voltas Ltd.
Hindustan Lever Ltd., First, acquired Tata Oil Mills from the Tata Group and then
merged other group companies i.e., Brook Bond Lipton (India) Ltd. and Ponds (India
Ltd.) with it. The SCICI Ltd. which was initially promoted by ICICI Ltd. has been
merged with the latter. Jindal Ferroy Alloys Ltd. has been merged with Jindal Strips
Ltd. ITC Classic Ltd. has been merged with ICICI Ltd. British Gas Company has taken
over Gujarat Gas Company. Company like Nicholas Piramal has been built only by
mergers and acquisitions. India Cement Ltd.’s offer for Raasi cement Ltd. and the offer
of Sterlite Ltd. for taking over Indian Aluminum Company have heralded a new era of
hostile takeovers in India.

India’s increasing “turnaround expert” strategy

• Wockhardt acquired loss making Wallis Laboratories of the U.K. in 1998 for $8
million and successfully managed to turn it around in a year’s time.

• Pacakaging major Essel Propack which acquired units of the UK’s Arista tubes and
Telecon Packaging and turned it around by proper resource allocation.

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• GHCL Ltd. (formally Gujrat Heavy Chemicals) acquired a controlling stack of 65
per cent in Romanian Soda ash firm SC Bega Upsom for $ 19.50 million. A month
into the acquisition, GHCL managed to ramp up production by 34%.

• Continental engines acquired loss making European remanufactures engines firm

vege Motors in June 2005.and turned it around within six months through better
cost control.

• Bharat Forge has emerged the world’s second largest forging company mainly by
way of Mergers and Acquisitions like care Dan Peddinghaus GmbH, CDP,
Aluminiumtechink, Fedral Forge, Imatra Kilsta, along with its wholly owned
subsidiary.Scootish Stampings. And the forging major is reaping dividends as a

• Mr. Lakshmi Mittal acquired Arcelor to build the strongest steel venture Mittal

The Tata’s Journey of M&A

• Tata Tea acquired loss making Tetley of the UK in 2000 and turned it to profits.
Key- debt restructuring exercise that reduced into costs.

• Tata Group made several significant acquisitions, such as Us telecom network

operator Tyco Global, Daewoo Commercial vehicles and Boston’s Ritz Carlton

• Tata motors acquired the bankrupt commercial vehicles units of the Korean group.
Daewoo and made presence in international market with and enhanced product

• The Tata-Corus

1. The $ 11 billion deal in a maker in the ground

2. Pure cash deal confidence and aggressiveness.
3. Financial and integration maturity
4. Creditability to attract more bank financing
5. Globally Competitive.

1.11 The changing scenario

• Share of global M&A by MNC’s from developing and transition countries.


• Share in Greenfield and expansion projects exceeded 15% in 2005.

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• Most important benefit is increased competition.

• Strengths the arms of local companies and of the MNC’s to survive in a

competitive lieu.

• More investment abroad implies more the benefits of the home country.

• The acquisition boom began as a trickle with software companies picking up

small information technology companies abroad.

• Followed up by pharmaceutical and auto components outfits.

• Now, a deluge with the Birlas now going the Tata’s way, making a big ticket

• India’s outward FDI has touched $ 19 million. This calendar year, up from $96
billion in 2005.

• Since, 2000 India has made over 300 overseas acquisitions.

• Story vote of confidence in Indian management with such companies as Tata

Tea ,TataMotors, BharatFirge, Wockhardt, Esssel Propack, Continental Engines
and a host of others, leveraging their recently acquired ability to work in
challenging business environment.

• Almost 50% of top 50 companies have made at least one overseas acquisition in
the past 3 years in varied industries.

Top 10 Indian mergers (1991-97)

Companies involved in Mergers (US$ Billion)

Zee telefilms 13
Power Generators 10.7
Satyam Infoway 5.0
Air products 4.3
Broad com 2.9
Schoroedel funds 1.8
Chase manhaltam 1.6
Reliance 1.6
Xerox 1.4
Indian cements 1.4

1.12 Causes of merger:

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An extensive appraisal of each merger scheme is done to patternise the causes of mergers.
These hypothesized causes (motives) as defined in the mergers schemes and explanatory
statement framed by the companies at the time of mergers can be conveniently categorized
based on the type of merger. The possible causes of different type of merger schemes are as

1. Horizontal merger: These involve mergers of two business companies operating and
competing in the same kind of activity. They seek to consolidate operations of both
companies. These are generally undertaken to:
a) Achieve optimum size
b) Improve profitability
c) Carve out greater market share
d) Reduce its administrative and overhead costs.

2. Vertical merger: These are mergers between firms in different stages of industrial
production in which a buyer and seller relationship exists. Vertical merger are an
integration undertaken either forward to come close to customers or backwards to come
close to raw materials suppliers. These mergers are generally endeavored to:
a) Increased profitability
b) Economic cost (by eliminating avoidable sales tax and excise duty payments)
c) Increased market power
d) Increased size

3. Conglomerate merger: These are mergers between two or more companies having
unrelated business. These transactions are not aimed at explicitly sharing resources,
technologies, synergies or product .They do not have an impact on the acquisition of
monopoly power and hence are favored through out the world. They are undertaken for
diversification of business in other products, trade and for advantages in bringing
separate enterprise under single control namely:

a) Synergy arising in the form of economies of scale.

b) Cost reduction as a result of integrated operation.
c) Risk reduction by avoiding sales and profit instability.
d) Achieve optimum size and carve out optimum share in the market.

4. Reverse mergers

Reverse mergers involve mergers of profir making companies with companies having
accumulated losses in order to:

a. Claim tax savings on account of accumulated losses that increase profits.

b. Set up merged asset base and shift to accelerate depreciation.

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5. Group company mergers

These mergers are aimed at restructuring the diverse unitsof group companies to create a
viable unit. Such mergers are initiated with a view to affect consolidation in order to:

a. Cut costs and achieve focus.

b. Eliminate intra-group competition
c. Correct leverage imbalances and imprvove borrowing capacity.

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Chapter -2

Motives of Merger

The present chapter examines the financial and strategic motives

driving the mergers and acquisitions activity and identify them with real
life merger cases.

Motives of merger:

Mergers and acquisitions are strategic decisions leading to the maximization of a

company’s growth by enhancing its production and marketing operations. They have
become popular in the recent times because of the enhanced competition, breaking of trade
barriers, free flow of capital across countries and globalization of business as a number of
economies are being deregulated and integrated with other economies. A number of
motives are attributed for the occurrence of mergers and acquisitions.

2.1 Synergies through Consolidation:

Synergy implies a situation where the combined firm is more valuable than the sum of the
individual combining firms. It is defined as ‘two plus two equal to five’ (2+2=5)
phenomenon. Synergy refers to benefits other than those related to economies of scale.
Operating economies are one form of synergy benefits. But apart from operating
economies, synergy may also arise from enhanced managerial capabilities, creativity,
innovativeness, R&D and market coverage capacity due to the complementarily of
resources and skills and a widened horizon of opportunities.

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An under valued firm will be a target for acquisition by other firms. However, the
fundamental motive for the acquiring firm to takeover a target firm may be the desire to
increase the wealth of the shareholders of the acquiring firm. This is possible only if the
value of the new firm is expected to be more than the sum of individual value of the target
firm and the acquiring firm. For example, if A Ltd. and Ltd. decide to merge into AB Ltd.
then the merger is beneficial if

V (AB)> V (A) +V (B)

V (AB) = Value of the merged entity
V (A) = Independent value of company A
V (B) = Independent value of company B

A merger which results in meeting the test of increasing the wealth of the shareholders is
said to contain synergistic properties. Synergy is the increase in the value of the firm
combining two firms into one entity i.e., it is the difference value between the combined
firm and the sum of the value of the individual firms. Igor Ansoff (1998) classified four
different types of synergies. These are:

1. Operating synergy:

The key to the existence of synergy is that the target firm controls a specialized resource
that becomes more valuable when combined with the bidding firm’s resources. The sources
of synergy of specialized resources will vary depending upon the merger. In case of
horizontal merger, the synergy comes from some form of economies of scale which reduce
the cost or from increase market power which increases profit margins and sales. There are
several ways in which the merger may generate operating economies. The firm might be
able to reduce the cost of production by eliminating some fixed costs. The research and
development expenditures will also be substantially reduced in the new set up by
eliminating similar research efforts and repetition of work already done by the target firm.
The management expenses may also come down substantially as a result of corporate

The selling, marketing and advertisement department can be streamlined. The marketing
economies may be produced through savings in advertising (by reducing the need to attract
each other’s customers), and also from the advantage of offering a more complete product
line (if the merged firms produce different but complementary goods), since a wider
product line may provide larger sales per unit of sales efforts and per sales person. When a
firm having strength in one functional area acquires another firm with strength in a
different functional area, synergy may be gained by exploiting the strength in these areas. A
firm with a good distribution network may acquire a firm with a promising product line,
and thereby can gain by combining these two strength. The argument is that both firms will
be better off after the merger. A major saving may arise from the consolidation of
departments involved with financial activities e.g., accounting, credit monitoring, billing,
purchasing etc.

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Thus, when two firms combine their resources and efforts, they will be able to produce
better results than they were producing as separate entities because of savings various types
of operating costs. These resultant economies are known as synergistic operating

In a vertical merger, a firm may either combine with its supplier of input (backward
integration) and/or with its customers (forward integration). Such merger facilitates better
coordination and administration of the different stages of business stages of business
operations-purchasing, manufacturing and marketing –eliminates the need for bargaining
(with suppliers and/or customers), and minimizes uncertainty of supply of inputs and
demand for product and saves costs of communication.

An example of a merger resulting in operating economies is the merger of Sundaram

Clayton Ltd. (SCL) with TVS-Suzuki Ltd. (TSL).By this merger, TSL became the second
largest producer of two –wheelers after Bajaj. The main objective motivation for the
takeover was TSL’s need to tide over its different market situation through increased
volume of production. It needed a large manufacturing bas to reduce its production costs.
Large amount of funds would have been required for creating additional production
capacity. SCL also needed to upgrade its technology and increase its production. SCL’s and
TCL’s plants were closely located which added to their advantages. The combined
company has also been enabled to share the common R&D facilities.

2. Financial synergy:

Financial synergy refers to increase in the value of the firm that accrues to the
combined firm from financial factors. There are many ways in which a merger can result
into financial synergy and benefit. A merger may help in:

• Eliminating financial constraint

• Deployment surplus cash
• Enhancing debt capacity
• Lowering the financial costs
• Better credit worthiness

Financial Constraint: A company may be constrained to grow through internal

development due to shortage of funds. The company can grow externally by acquiring
another company by the exchange of shares and thus, release the financing constraint.

Deployment of surplus cash: A different situation may be faced by a cash rich company.
It may not have enough internal opportunities to invest its surplus cash. It may either
distribute its surplus cash to its shareholders or use it to acquire some other company. The
shareholders may not really benefit much if surplus cash is returned to them since they
would have to pay tax at ordinary income tax rate. Their wealth may increase through an
increase in the market value of their shares if surplus cash is used to acquire another

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company. If they sell their shares, they would pay tax at a lower, capital gains tax rate. The
company would also be enabled to keep surplus funds and grow through acquisition.

Debt Capacity: A merger of two companies, with fluctuating, but negatively correlated,
cash flows, can bring stability of cash flows of the combined company. The stability of
cash flows reduces the risk of insolvency and enhances the capacity of the new entity to
service a larger amount of debt. The increased borrowing allows a higher interest tax shield
which adds to the shareholders wealth.

Financing Cost: The enhanced debt capacity of the merged firm reduces its cost of
capital. Since the probability of insolvency is reduced due to financial stability and
increased protection to lenders, the merged firm should be able to borrow at a lower rate of
interest. This advantage may, however, be taken off partially or completely by increase in
the shareholders risk on account of providing better protection to lenders.

Another aspect of the financing costs is issue costs. A merged firm is able to realize
economies of scale in flotation and transaction costs related to an issue of capital. Issue
costs are saved when the merged firm makes a larger security issue.

Better credit worthiness: This helps the company to purchase the goods on credit, obtain
bank loan and raise capital in the market easily.

RP Goenka’s ceat tyres sold off its type cord division to Shriram Fibers Ltd. in 1996 and
also transfer’s its fiber glass division to FGL Ltd., another group company to achieve
financial synergies.

3. Managerial synergy

One of the potential gains of merger is an increase in managerial effectiveness. This may
occur if the existing management team, which is performing poorly, is replaced by a more
effective management team. Often a firm, plagued with managerial inadequacies, can gain
immensely from the superior management that is likely to emerge as a sequel to the merger.
Another allied benefit of a merger may be in the form of greater congruence between the
interests of the managers and the shareholders.

A common argument for creating a favorable environment for mergers is that it imposes a
certain discipline on the management. If lackluster performance renders a firm more
vulnerable to potential acquisition, existing managers will strive continually to improve
their performance.

4. Sales synergy

These synergies occurs when merged organization can benefit from common distribution
channels, sales administration, advertising, sales promotion and warehousing.

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The Industrial Credit and Investment Corporation of India Ltd. (ICICI) acquired Tobaco
Company, ITC. Classic and Anagram Finance to obtain quick access to a well dispersed
distribution network.

2.2 Diversification

A commonly stated motive for mergers is to achieve risk reduction through diversification.
The extent, to which risk is reduced, depends upon on the correlation between the earnings
of the merging entities. While negative correlation brings greater reduction in risk, positive
correlation brings lesser reduction in risk. If investors can diversify on their own by buying
stocks of companies which propose to merge, they do not derive any benefits from the
proposed merger. Any investor who wants to reduce risk by diversifying between two
companies, say, ABC Company and PQR Company, may simply buy the stocks of these
two companies and merge them into a portfolio. The merger of these companies is not
necessary for him to enjoy the benefits of diversification. As a matter of fact, his ‘home-
made diversification give him far greater flexibility. He can contribute the stocks of ABC
Company and PQR Company in any proportion he likes as he is not confronted with a
‘fixed’ proportion that result from the merger.

Thus, Diversification into new areas and new products can also be a motive for a firm to
merge an other with it. A firm operating in North India, if merges with another firm
operating primarily in South India, can definitely cover broader economic areas.
Individually these firms could serve only a limited area. Moreover, products diversification
resulting from merger can also help the new firm fighting the cyclical/seasonal fluctuations.
For example, firm A has a product line with a particular cyclical variations and firm B deals
in product line with counter cyclical variations. Individually, the earnings of the two firms
may fluctuate in line with the cyclical variations. However, if they merge, the cyclically
prone earnings of firm A would be set off by the counter cyclically prone earnings of firm
B. Smoothing out the earnings of a firm over the different phases of a cycle tends to reduce
the risk associated with the firm.

Through the diversification effects, merger can produce benefits to all firms by reducing
the variability of firm’s earnings. If firm A’s income generally rises when B’s income
generally falls, and vice-a versa, the fluctuation of one will tend to set off the fluctuations
of the other, thus producing a relatively level pattern of combined earnings. Indeed, there
will be some diversification effect as long as the two firm’s earnings are not perfectly
correlated (both rising and falling together). This reduction in overall risk is particularly
likely if the merged firms are in different lines of business.

The diversification motive is based on the proposition that if two risky projects are
combined, then the risk of combination will be less than the weighted average of the risk of
these two projects. The greatest benefit from diversification can be obtained by continuing
firms from different industries i.e., conglomerate mergers; where two firms poorly
correlated cash flows merged to create a portfolio of a firms. But portfolio of firms in a
conglomerate merger is costly as the acquisition of firms is a costly exercise. On the other
hand, a shareholder can easily create a diversified portfolio of firms merely by holding the

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shares of diversified companies. This is much easier and cheaper than creating a portfolio
of firms in conglomerate merger.
Thus, firms diversify to achieve:

• Sales and growth stability

• Favorable growth developments
• Favorable competition shifts
• Technological changes

2.3 Accelerated Growth

Growth is essential for sustaining the viability, dynamism and value-enhancing capability
of company. A growth- oriented company is not only able to attract the most talented
executives but it would also be able to retain them. Growing operations provide challenges
and excitement to the executives as well as opportunities for their job enrichment and rapid
career development. This helps to increase managerial efficiency. Other things being the
same, growth leads to higher profits and increase in the shareholders value. A company can
achieve its growth objective by:

• Expanding its existing markets

• Entering in new markets.

A company may expand and/or diversify its markets internally or externally. If the
company cannot grow internally due to lack of physical and managerial resources, it can
grow externally by combining its operations with other companies through mergers and
acquisitions. Mergers and acquisitions may help to accelerate the pace of a company’s
growth in a convenient and inexpensive manner.

Internal growth requires that the company should develop its operating facilities-
manufacturing, research, marketing etc. Internal development of facilities for growth also
requires time. Thus, lack or inadequacy of resources and time needed for internal
development constrains a company’s pace of growth. The company can acquire production
facilities as well as other resources from outside through mergers and acquisitions.
Specially, for entering in new products/markets, the company may lack technical skills and
may require special marketing skills and/or a wide distribution network to access different
segments of markets. The company can acquire existing company or companies with
requisite infrastructure and skills and grow quickly.

Mergers and acquisitions, however, involve cost. External growth could be expensive if the
company pays an excessive price for merger. Benefits should exceed the cost of acquisition
for realizing a growth which adds value to shareholders. In practice, it has been found that
the management of a number of acquiring companies paid an excessive price for
acquisition to satisfy their urge for high growth and large size of their companies. It is
necessary that price may be carefully determined and negotiated so that merger enhances
the value of shareholders.

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For example, RPG Group had a turnover of only Rs.80 crores in 1979. This has increased
to about Rs. 5600 crores in 1996. This phenomenal growth was due to the acquisitions of a
several companies by the RPG Group. Some of the companies acquired are Asian cables,
ceat, Calcutta Electricity Supply and company, SAE etc.

2.4 Increased Market power

A merger can increase the market share of the merged firm. The increased concentration or
market share improves the profitability of the firm due to economies of scale. The
bargaining power of the firm with labour, suppliers and buyers is also enhanced. The
merged firm can also exploit technological breakthroughs against obsolescence and price
wars. Thus, by limiting competition, the merged firm can earn super normal profit and
strategically employ the surplus funds to further consolidate its position and improve its
market power.

The acquisition of Universal Luggage by Blow Plast is an example of limiting competition

to increase market power. Before the merger, the two companies were competing fiercely
with each other leading to a severe price war and increased marketing costs. As a result of
the merger, Blow Plast has obtained a strong hold on the market and now operates under
near monopoly situation. Yet another example is the acquisition of Tomco by Hindustan
Lever. Hindustan Lever at the time of merger was expected to control one-third of three
million tonne soaps and detergents markets and thus, substantially reduce the threat of

Merger is not only route to obtain market power. A firm can increase its market share
through internal growth or ventures or strategic alliances. Also, it is not necessary that the
increased market power of the merged firm will lead to efficiency and optimum allocation
of resources. Market power means undue concentration which could limit the choice of
buyers as well as exploit suppliers and labour.

2.5 Purchase of assets at bargain price

Mergers may be explained by the opportunity to acquire assets, particularly land, mined
rights, plant and equipment at lower cost than would be incurred if they were purchased or
constructed at current market prices. If market prices of many stocks have been
considerably below the replacement cost of the assets they represent, expanding firm
considering constructing plants developing mines, or buying equipment. Often it has found
that the desired asset could be obtained cheaper by acquiring a firm that already owned and
operated the asset. Risk could be reduced because the assets were already in place and an
organization of people knew how to operate them and market their products.

Many of mergers can be financed by cash tender offers to the acquired firm’s shareholders
at price substantially above the current market. Even, so, the assets can be acquired for less
than their current cost of construction. The basic factor underlying this is that inflation in
construction costs not fully reflected in stock prices because of high interest rates and

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limited optimism (or downright pessimism) by stock investors regarding future economic

2.6 Increased external financial capability

Many mergers, particularly those of relatively small firms into large ones, occur when the
acquired firm simply cannot finance its operations. This situation is typical in a small
growing firm with expanding financial requirements. The firm has exhausted its bank credit
and has virtually no access to long term debt or equity markets. Sometimes the small firms
have encountered operating difficulty and the bank has served notice that its loans will not
be renewed. In this type of situation, a large firm with sufficient cash and credit to finance
the requirements of the smaller one probably can obtain a good situation by making a
merger proposal to the small firm. The only alternative the small firm may have is to try to
interest two or more larger firms in proposing merger to introduce completion into their
bidding for the acquisition.

The smaller firm’s situation might not be so bleak. It may not be threatened by
nonrenewable of a maturing loan. But its management may recognize that continued
growth to capitalize on its markets will require financing beyond its means. Although its
bargaining position will be better, the financial synergy of the acquiring firm’s strong
financial capability may provide the impetus for the merger.

Sometimes the financing capability is possessed by the acquired firm. The acquisition of a
cash rich firm whose operations have matured may provide additional financing to
facilitate growth of the acquiring firm. In some cases, the acquiring firm may be able to
recover all or part of the cost of acquiring the cash-rich firm when the merger is
consummated and the cash then belongs to it.

A merger also may be based upon the simple fact that the combination will make two small
firms with limited access to capital markets large enough to achieve that access on a
reasonable basis. The improved financing capability provides the financial synergy.

2.7 Increased managerial skills

Occasionally, a firm will have good potential that it finds itself unable to develop fully
because of deficiencies in certain areas of management or an absence of needed product or
production technology. If the firm can not hire the management or develop the technology
it needs, it might combine with a compatible firm that has the needed managerial personnel
or technical expertise. Any merger, regardless of the specific motive for it, should
contribute to the maximization of owner’s wealth.

2.8 Reduction in tax liability

Under Income Tax Act, there is a provision for set-off and carry forward of losses against
its future earnings for calculating its tax liability. A loss making or sick company may not

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be in a position to earn sufficient profits in future to take advantage of the carry forward
provision. If it combines with a profitable company, the combined company can utilize the
carry forward loss and save taxes with the approval of government. In India, a profitable
company is allowed to merge with a sick company to set-off against its profits the
accumulated loss and unutilized depreciation of that company. A number of companies in
India have merged to take advantage of this provision.

The following is the list of some companies along with the amount of tax benefits enjoyed:

• Orrisa synthesis merged with Straw product Ltd. (Rs. 16 crores)

• Ahmadabad cotton Mills merged with Arvind Mils (Rs. 3.34 crores)

• Sidhpur Mills merged with Reliance Industries Ltd. (Rs.3.34 crores)

• Alwyn Missan merged with Mahinder and Mahindra Ltd. (Rs.2.47 crores)

• Hyderabad Alwyn merged with Voltas Ltd. (Rs. 1600 crores)

When two companies merge through an exchange of shares, the shareholders of selling
company can save tax. The profits arising from the exchange of shares are not taxable until
the shares are actually sold. When the shares are sold, they are subject to capital gain tax
rate which is much lower than the ordinary income tax rate.

A strong urge to reduce tax liability, particularly when the marginal tax rate is high is a
strong motivation for the combination of companies. For example, the high tax rate was the
main reason for the post-war merger activity in the USA. Also, tax benefits are responsible
for one-third of mergers in the USA12.

2.9 Economies of Scale

Economies of scale arise when increase in the volume of production leads to a reduction in
the cost of production per unit. Merger may help to expand volume of production without a
corresponding increase in fixed costs. Thus, fixed costs are distributed over a large volume
of production causing the unit cost of production to decline. Economies of scale may also
arise from other indivisibilities such as production facilities, management functions and
management resources and systems. This happens because a given function, facility or
resource is utilized for a large scale of operation. For example, a given mix of plant and
machinery can produce scale economies when its capacity utilisation is increased.
Economies will be maximized when it is optimally utilized. Similarly, economies in the use
of the marketing function can be achieved by covering wider markets and customers using
a given sales force and promotion and advertising efforts. Economies of scale may also be
obtained fro the optimum utilisation of management resource and systems of planning,
budgeting, reporting and control. A company establishes management systems by
employing enough qualified professionals irrespective of its size. A combined firm with a

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large size can make the optimum use of the management resource and systems resulting in
economies of scale.

2.10 Vertical Integration

Vertical integration is a combination of companies of companies business with the business

of a supplier or customer generally motivated by a pure desire:

a) To secure a source of supply for key materials or sources

b) To secure a distribution outlet or a major customer for the company’s products.

c) To improve profitability by expanding into high margin activities of suppliers and


Thus, vertical merger may take place to integrate forward or backward. Forward
integration is where company merges to come close to its customers. A holiday tour

Weston, J.F. and Brigham, E.F., Essentials of Managerial Finance, Dryden Press, 1977,

operator might acquire chain of travel agents and use them to promote his own holiday
rather than those of rival tour operators. So forward or downstream vertical integration
involves takeover of customer business.

Backward integration occurs when a company comes close to its raw materials or suppliers.
The real gain can be achieved by integrating backward if raw material market is not
perfectly competitive and firm has to buy raw materials at monopolistic prices hence merge
to obtain control of supplies. There are many reasons why firms want to be integrated
vertically at different stages. Some of these reasons are technological economies like
avoidance of reheating and transportation cost as in the case of iron and steel producer.
Transactions within a firm might eliminate costs of searching for prices, contracting,
advertising, costs of communicating and co-ordination. Proper planning for production and
inventory management may improve due to more efficient information flow within a single
firm. Further, these merger help avoid inefficient market transactions and result in reduced
exchange inefficiencies.

Tata Tea’s acquisition of consolidated coffee which produces coffee beans and Asian
Coffee, which possesses coffee beans, was also backward integration which helped reduce
exchange inefficiencies by eliminating market transactions. The recent merger of Samtel
Electron services (SED) with Samtel Color Ltd. (SCL) entailed backward integration of
SED which manufactures electronic components required to make picture tubes with SCL,
a leading maker of color picture tube.

Thus, when companies engaged at different stages of production or value chain merge,
economies of vertical integration may be realized. For example, the merger of a company

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engaged in oil exploration and production (like ONGC) with a company engaged in
refining and marketing (like HPCL) may improve coordination and control.

Vertical integration, however, is not always a good idea. If a company does everything in-
house, it may not get the benefit of outsourcing from independent suppliers who may be
more efficient in their segments of the value chain.

2.11 Early entry and market penetration

An early mover strategy can reduce the lead time taken in establishing the facilities and
distribution channels. So, acquiring companies with good manufacturing and distribution
network or few brands of a company gives the advantage of rapid market share.

The ICICI, a leading financial institution secured a foot hold in retail network through
acquisition of Anagram Finance Company and ITC classic. Anagram had a strong retail
franchise, distribution network of over fifty branches in Gujarat, Rajasthan and Maharastra
and a depositor base of over two lakhs depositors. ICICI was therefore attracted by the
retail portfolio of Anagram which was active in lease and hire purchase, car purchase, truck
finance, and customer finance. These acquisitions thus helped ICICI to obtain quick access
to well dispersed distribution network.

Further, market penetration means developing new and large markets for a company
existing products. Market penetration strategy is generally pursued within markets that are
becoming more global. Cross border merger are a means of becoming or remaining major
players in such markets. Hence, this strategy is mainly adopted by MNC’s to gain to new
markets. They prefer to merge with a local established company which knows behavior of
market and has established customer base. One such example is Indian market. Few
instances of MNC’s related mergers are:

1. Whirlpool Corporation’s entry into India by acquiring Kelvinator India.

2. Coca Cola while re-entering India market in 1993 acquired Parle, the largest player in
market with several established brands and nationwide bottling and marketing network.

3. H.J. Heinz entered into India through acquisition of Glato Industries.

4. HLL acquired Dollops, Kwality, Milk food to gain an entry into ice cream market with
the help of their marketing networks, production facilities, brands etc.

2.12 Revival of sick companies

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An important motive for merger is to turn around a financially sick company through the
process of merger. Amalgamation taking place under the aegis of Board for Industrial
(BIFR) fall under this category.

BIFR found revival of ailing companies through the means of their with healthy company
as the most successful route for revival of their financial wealth. Firstly, the purpose is to
revive a group of sick companies by merging it with groups of healthy company by
obtaining concessions from financial institution and government agencies and obtaining
benefits of tax concessions u/s 72A of Income Tax Act, 1961. Secondly, it also helps to
preserve group reputation. Some of the group companies which have amalgamated through
the BIFR include Mahindra Missan Allwyn with Mahindra and Mahindra, Hyderabad,
Allwyn with Voltas etc.

BIFR motivated Rehabilitation Merger

Year Transferor sick company Taken over by Transferee

April 95 Tata Keltron Ltd. Tata Telecom Ltd.
April 95 Titagarh Papers Mills Ltd. Titagarh Steels Ltd.
April 95 Pentasia Chemicals Ltd. Asian Paints Ltd.
April 96 Biax Ltd. Cimmco Birla Ltd.
May 96 Powmex Steels Ltd. GKW Ltd.
April 97 Universal Steel Alloys Ltd. Bharat Gears Ltd.

2.13 Consolidation at Group level

Group company mergers are generally initiated with a view to affect consolidation to
derive critical mass to cut costs in order to achieve focus and eliminate competition. Such
mergers within group are also aimed at restructuring their diverse units to create a more
viable unit, to revive sickness, improve borrowed capital. There are few other micro
economic reasons to decide on mergers with group consideration as their sole

• To achieve economies of scale

• To reduce cost of administration and management expenses in companies within same


• To bifurcate business by floating separate products this is referred to as demerger.

Example of restructuring and consolidation within the group companies is the case of
Nirma Ltd. merging with it, its group companies, Nirma detergents, Nirma soaps and

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detergents, Shina soaps and detergents and Nirma chemicals. The objective was to make
Nirma a strong and resilient corporate entity capable of facing global competition by
restructuring management, sizable reduction in management costs and increased

Merger of Videocon groups Videocon Narmada Electronics with its flagship company
Videocon International led to operating efficiencies by controlling costs under one head.

2.14 Following Parent’s Footsteps

Some of mergers in India belonging to Multinational giants take place as a result of direct
fall out of mergers of their parent companies taking place in their home countries.
Some instances of such mergers are listed below:
1. As per the dictates of their parent companies, their two Indian counter parts, visa. The
General Electric Company of India Ltd. and The English Electric Company of India
Ltd. were merged from Ist April 1992 and changed their name to GEC. Alsthen India
Ltd.( just like the GEC, Alsthen N.V. Ltd. formed by merger of two largest industrial
groups The General Electric company plc. U.K. and Alcatel Alsthen, France)

2. Consequent of the merger of Grand plc. and Guiness plc. In London in Dec. 1997, their
Indian offspring’s IDL Ltd. and united Distilleries India Ltd. both liquor companies
followed this in India.

3. Novartis India (51% of Novartis AG) was formed in India by the merger of Hindustan
ciba Giegy and Sandoz India Ltd. in 1996 following the merger of their global parents.

2.15 Increase Promoter’s stake

Another motive for merger could be to increase the stake of promoters. Thus, ‘A’ company
which is family owned could be merged with ‘B’ company which is a listed company with
family stake in it. By the process of merger, the family stake could be consolidated without
going through
the complications of SEBI guidelines of 4th august 199415. So, mergers could be motivated
by the need to enhance promoter’s holdings in post- merger company.

For instance, Nanda family’s holding in escorts Ltd. was 20% before merger. Its merger
with Escorts Tractors Ltd. increased their holding by another 20%. Similarly, merger of
Reliance Polythylene and Reliance Polypropylene into Reliance Industries swap ratio of
100: 30 and 100:25 respectively resulted in an increase in Ambani’s stake from 23% to
37%. The higher stakes helps to ward off takeover bids.

2.16 Defensive Maneuver

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Merger can be used as shields for protection from raiders. A merger or acquisition can be
used by a company as defensive maneuver to resist takeover by another company. If a firm
feels that it could be acquired by another firm, it may consider getting involved in a merger
game. In doing so, it is able to expand its size, making its acquisition very expensive. Also,
by increasing market capitalization of the merged company’s threat of takeover can be
tackled. For instance, merger of Jindal Ferro Alloys with Jindal Strips helped Jindal Ferro
Alloys improve its share price from Rs. 65 to Rs. 170 and market capitalization of Rs. 160
crores to Rs. 550 crores with the help of swap ratio of forty five Jindal strips for every
hundred Jindal Ferro alloy shares.

2.17 Acquire Global Competitive strength

With competitive forces resulting from globalization and deregulation, many industries
have forced most corporate to consolidate. European and Asian market have become more
receptive to merger and acquisitions. On the one hand, European countries face competitive
pressures from creation of single Euro currency, on the other hand, Asian crisis has forced
most Asian nations to look to the west for technological and capital support. Hence, merger
are planned to acquire global competitive strength.

After the pitched Battle against Multi National Company (MNC) in domestic arena, Indian
companies have also felt the need of becoming global. The globalized business
environment thus demands that Indian Industries also restructured. Its size and capacities
are small as compared to MNC’s. Industries have to increase its capacity, induct new
technology and development markets. Globalization has thus resulted in major implications
for industrial competitiveness by lowering the cost of labour and opening markets to a great
number of producing firms. To meet the opportunities thrown open by fast growing world,
generic market and to acquire global competitive strength. Cross border mergers and
acquisitions are being resorted to such mergers provide opportunities for taking up larger
projects. Also the merged company is able to compete more effectively with increased size.

The recent acquisition of Tetley, the world’s largest Tea brands by Tata tea, the world’s
largest integrated tea company has been driven by the fact that Tetley fits perfectly into
Tata tea’s globalization drive and could be a perfect launch vehicle to achieve greater
synergies in global arena. The acquisition has brought with it, greater market penetration,
helped improve operating efficiencies and resulted in instant expansion of product lines of
Tata tea –Tetley combines.

The process of globalization and increasing integration of Indian economy with the
international market will have its impact sooner or later.

Ansoff16 suggested a number of reasons that are attributed to the occurrence of mergers and
acquisitions. For example, it is suggested that mergers and acquisition are intended to:

• Limit competition
• Utilize under-utilization market power
• Overcome the problem of slow growth and profitability in one’s own industry

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• Achieve diversification
• Gain economies of scale and increase income with proportionately less investment
• Establish a transnational bridgehead without excessive start-up costs to gain access to
a foreign market
• Utilize under-utilized resources-human and physical and managerial skills
• Displace existing management
• Circumvent government regulations
• Reap speculative gains attendant upon new security issue or change in P/E ratio
• Create an image of aggressiveness and strategic opportunism empire building and to
amass vast economic powers of the economy.

SEBI (Substantial Acquisition of shares and takeovers) Regulations, 1994
Ansoff H.L. et. al., Acquisitive Behaviour of U.S. Manufacturing Firms 1946-65,
Vanderbilt University Press, 1971.

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This chapter covers the historical background of acquisition, process of

acquisition, how to develop acquisition strategy. the matters relating to
the valuation of the synergies, amount paid to the target firm, and the
accounting consideration involved in merger and acquisition

Firms are acquired for a number of reasons. In the 1960s and 1970s, firms such as Gulf and
Western and ITT built themselves into conglomerates by acquiring firms in other lines of
business. In the 1980s, corporate giants like Time, Beatrice and RJR Nabisco were acquired
by other firms, their own management or wealthy raiders, who saw potential value in
restructuring or breaking up these firms. In the 1990s, we saw a wave of consolidation in
the media business as telecommunications firms acquired entertainment firms and
entertainment firms acquired cable businesses. Through time, firms have also acquired or
merged with other firms to gain the benefits of synergy, in the form of either higher growth,
as in the Disney acquisition of Capital Cities, or lower costs.

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Acquisitions seem to offer firms a short cut to their strategic objectives, but the process has
its costs. In this chapter, we examine the four basic steps in an acquisition, starting with
establishing an acquisition motive, continuing with the identification and valuation of a
target firm, and following up with structuring and paying for the deal. The final and often
the most difficult step is making the acquisition work after the deal is consummated.

3.1 Background on Acquisitions

When we talk about acquisitions or takeovers, we are talking about a number of different
transactions. These transactions can range from one firm merging with another firm to
create a new firm to managers of a firm acquiring the firm from its stockholders and
creating a private firm. We begin this section by looking at the different forms taken by
acquisitions, continue the section by providing an overview on the acquisition process and
conclude by examining the history of the acquisitions in the United States.

3.2 The Process of an Acquisition

Acquisitions can be friendly or hostile events. In a friendly acquisition, the

managers of the target firm welcome the acquisition and, in some cases, seek it out. In a
hostile acquisition, the target firm’s management does not want to be acquired. The
acquiring firm offers a price higher than the target firm’s market price prior to the
acquisition and invites stockholders in the target firm to tender their shares for the price.

In either friendly or hostile acquisitions, the difference between the acquisition price and
the market price prior to the acquisition is called the acquisition premium. The
acquisition price, in the context of mergers and consolidations, is the price that will be
paid by the acquiring firm for each of the target firm’s shares. This price is usually based
upon negotiations between the acquiring firm and the target firm’s managers. In a tender
offer, it is the price at which the acquiring firm receives enough shares to gain control of
the target firm. This price may be higher than the initial price offered by the acquirer, if
there are other firms bidding for the same target firm or if an insufficient number of
stockholders tender at that initial price. For instance, in 1991, AT&T initially offered to buy
NCR for $80 per share, a premium of $ 25 over the stock price at the time of the offer.
AT&T ultimately paid $110 per share to complete the acquisition.
There is one final comparison that can be made and that is between the price paid on the
acquisition and the accounting book value of the equity in the firm being acquired.
Depending upon how the acquisition is accounted for, this difference will be recorded as
goodwill on the acquiring firm’s books or not be recorded at all.

3.3 Steps in an Acquisition

There are four basic and not necessarily sequential steps, in acquiring a target firm. The
first is the development of a rationale and a strategy for doing acquisitions, and the
understanding of what the strategy requires in terms of resources. The second is the choice
of a target for the acquisition and the valuation of the target firm, with premiums for the
value of control and any synergy. The third is the determination of how much to pay on the
acquisition, how best to raise funds to do it, and whether to use stock or cash. This decision

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has significant implications for the choice of accounting treatment for the acquisition. The
final step in the acquisition, and perhaps the most challenging one, is to make the
acquisition work after the deal is complete.

3.3.1 Developing an Acquisition Strategy

Not all firms that make acquisitions have acquisition strategies, and not all firms that have
acquisition strategies stick with them. In this section, we consider a number of different
motives for acquisitions and suggest that a coherent acquisition strategy has to be based on
one or another of these motives. These motives were studied in detail in the last chapter, as
the motives behind merger and motives behind acquisitions are same.

Firms that are undervalued by financial markets can be targeted for acquisition by those
who recognize this mispricing. The acquirer can then gain the difference between the value
and the purchase price as surplus. For this strategy to work, however, three basic
components need to come together.

1. A capacity to find firms that trade at less than their true value: This capacity would
require either access to better information than is available to other investors in the market,
or better analytical tools than those used by other market participants.

2. Access to the funds that will be needed to complete the acquisition: Knowing a firm
is undervalued does not necessarily imply having capital easily available to carry out the
acquisition. Access to capital depends upon the size of the acquirer – large firms will have
more access to capital markets and internal funds than smaller firms or individuals – and
upon the acquirer’s track record – a history of success at identifying and acquiring under
valued firms will make subsequent acquisitions easier.

3. Skill in execution: If the acquirer, in the process of the acquisition drives the stock price
up to and beyond the estimated value, there will be no value gain from the acquisition. To
illustrate, assume that the estimated value for a firm is $100 million and that the current
market price is $75 million. In acquiring this firm, the acquirer will have to pay a premium.
If that premium exceeds 33% of the market price, the price exceeds the estimated value,
and the acquisition will not create any value for the acquirer.
While the strategy of buying under valued firms has a great deal of intuitive appeal, it is
daunting, especially when acquiring publicly traded firms in reasonably efficient markets,
where the premiums paid on market prices can very quickly eliminate the valuation
surplus. The odds are better in less efficient markets or when acquiring private businesses.

Acquire poorly managed firms and change management

Some firms are not managed optimally and others often believe they can run them better
than the current managers. Acquiring poorly managed firms and removing incumbent
management, or at least changing existing management policy or practices, should make
these firms more valuable, allowing the acquirer to claim the increase in value. This value
increase is often termed the value of control.

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Prerequisites for Success

While this corporate control story can be used to justify large premiums over the market
price, the potential for its success rests on the following.

1. The poor performance of the firm being acquired should be attributable to the incumbent
management of the firm, rather than to market or industry factors that are not under
management control.

2. The acquisition has to be followed by a change in management practices, and the change
has to increase value. As noted in the last chapter, actions that enhance value increase cash
flows from existing assets, increase expected growth rates, increase the length of the
growth period, or reduce the cost of capital.

3. The market price of the acquisition should reflect the status quo, i.e, the current
management of the firm and their poor business practices. If the market price already has
the control premium built into it, there is little potential for the acquirer to earn the
premium. In the last two decades, corporate control has been increasingly cited as a reason
for hostile acquisitions.

3.3.2 Choosing a Target firm and valuing control/synergy

Once a firm has an acquisition motive, there are two key questions that need to be
answered. The first relates to how to best identify a potential target firm for an acquisition,
given the motives. The second is the more
concrete question of how to value a target firm.

Choosing a target firm

Once a firm has identified the reason for its acquisition program, it has to find the
appropriate target firm.

• If the motive for acquisitions is under valuation, the target firm must be under valued.
How such a firm will be identified depends upon the valuation approach and model
used. With relative valuation, an under valued stock is one that trades at a multiple (of
earnings, book value or sales) well below that of the rest of the industry, after
controlling for significant differences on fundamentals. Thus, a bank with a price to
book value ratio of 1.2 would be an undervalued bank, if other banks have similar
fundamentals (return on equity, growth, and risk) but trade at much higher price to book
value ratios. In discounted cash flow valuation approaches, an under valued stock is one
that trades at a price well below the estimated discounted cash flow value.

• If the motive for acquisitions is diversification, the most likely target firms will be in
businesses that are unrelated to and uncorrelated with the business of the acquiring
firm. Thus, a cyclical firm should try to acquire counter-cyclical or, at least, non-
cyclical firms to get the fullest benefit from diversification.

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• If the motive for acquisitions is operating synergy, the typical target firm will vary
depending upon the source of the synergy. For economies of scale, the target firm
should be in the same business as the acquiring firm. Thus, the acquisition of Security
Pacific by Bank of America was motivated by potential cost savings from economies of
scale. For functional synergy, the target firm should be strongest in those functional
areas where the acquiring firm is weak. For financial synergy, the target firm will be
chosen to reflect the likely source of the synergy – a risky firm with limited or no stand-
alone capacity for borrowing, if the motive is increased debt capacity, or a firm with
significant net operating losses carried forward, if the motive is tax benefits.

• If the motive for the merger is control, the target firm will be a poorly managed firm in
an industry where there is potential for excess returns. In addition, its stock holdings
will be widely dispersed (making it easier to carry out the hostile acquisition) and the
current market price will be based on the presumption that incumbent management will
continue to run the firm.

• If the motive is managerial self-interest, the choice of a target firm will reflect
managerial interests rather than economic reasons.

Valuing the Target Firm

The valuation of an acquisition is not fundamentally different from the valuation of any
firm, although the existence of control and synergy premiums introduces some complexity
into the valuation process. Given the inter-relationship between synergy and control, the
safest way to value a target firm is in steps, starting with a status quo valuation of the firm,
and following up with a value for control and a value for synergy.

a. Status Quo Valuation

We start our valuation of the target firm by estimating the firm value with existing
investing, financing and dividend policies. This valuation, which we term the status quo
valuation, provides a base from which we can estimate control and synergy premiums. In
particular, the value of the firm is a function of its cash flows from existing assets, the
expected growth in these cash flows during a high growth period, the length of the high
growth period and the firm’s cost of capital.

b. The Value of Corporate Control

Many hostile takeovers are justified on the basis of the existence of a market for corporate
control. Investors and firms are willing to pay large premiums over the market price to
control the management of firms, especially those that they perceive to be poorly run. This
section explores the determinants of the value of corporate control and attempts to value it
in the context of an acquisition.

Determinants of the Value of Corporate Control

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The value of wresting control of a firm from incumbent management is inversely
proportional to the perceived quality of that management and its capacity to maximize firm
value. In general, the value of control will be much greater for a poorly managed firm that
operates at below optimum capacity than for a well managed firm. The value of controlling
a firm comes from changes made to existing management policy that can increase the firm
value. Assets can be acquired or liquidated, the financing mix can be changed and the
dividend policy reevaluated, and the firm can be restructured to maximize value. If we can
identify the changes that we would make to the target firm, we can value control. The value
of control can then be written as:

Value of Control = Value of firm, optimally managed - Value of firm with current

The value of control is negligible for firms that are operating at or close to their optimal
value, since a restructuring will yield little additional value. It can be substantial for firms
operating at well below optimal, since a restructuring can lead to a significant increase in

c. Valuing Operating Synergy

There is a potential for operating synergy, in one form or the other, in many takeovers.
Some disagreement exists, however, over whether synergy can be valued and, if so, what
that value should be. One school of thought argues that synergy is too nebulous to be
valued and that any systematic attempt to do so requires so many assumptions that it is
pointless. If this is true, a firm should not be willing to pay large premiums for synergy if it
cannot attach a value to it.

While valuing synergy requires us to make assumptions about future cash flows and
growth, the lack of precision in the process does not mean we cannot obtain an unbiased
estimate of value. Thus we maintain that synergy can be valued by answering two
fundamental questions.

(1) What form is the synergy expected to take? Will it reduce costs as a percentage of sales
and increase profit margins (e.g., when there are economies of scale)? Will it increase
future growth (e.g., when there is increased market power) or the length of the growth
period? Synergy, to have an effect on value, has to influence one of the four inputs into the
valuation process – cash flows from existing assets, higher expected growth rates (market
power, higher growth potential), a longer growth period (from increased competitive
advantages), or a lower cost of capital (higher debt capacity).

(2) When will the synergy start affecting cash flows? –– Synergies can show up
instantaneously, but they are more likely to show up over time. Since the value of synergy
is the present value of the cash flows created by it, the longer it takes for it to show up, the
lesser its value.

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Once we answer these questions, we can estimate the value of synergy using an extension
of discounted cash flow techniques. First, we value the firms involved in the merger
independently, by discounting expected cash flows to each firm at the weighted average
cost of capital for that firm. Second, we estimate the value of the combined firm, with no
synergy, by adding the values obtained for each firm in the first step. Third, we build in the
effects of synergy into expected growth rates and cash flows and we value the combined
firm with synergy. The difference between the value of the combined firm with synergy and
the value of the combined firm without synergy provides a value for synergy.

d. Valuing Financial Synergy

Synergy can also be created from purely financial factors. We will consider three legitimate
sources of financial synergy - a greater “tax benefit” from accumulated losses or tax
deductions, an increase in debt capacity and therefore firm value and better use for
“excess” cash or cash slack. We will begin the discussion, however, with diversification,
which though a widely used rationale for mergers, is not a source of increased value by

3.3.3 Structuring the Acquisition

Once the target firm has been identified and valued, the acquisition moves forward into the
structuring phase. There are three interrelated steps in this phase. The first is the decision
on how much to pay for the target firm, synergy and control built into the valuation. The
second is the determination of how to pay for the deal, i.e., whether to use stock, cash or
some combination of the two, and whether to borrow any of the funds needed. The final
step is the choice of the accounting treatment of the deal because it can affect both taxes
paid by stockholders in the target firm and how the purchase is accounted for in the
acquiring firm’s income statement and balance sheets.

Deciding on an Acquisition Price

The value determined in consideration of synergy and control represents a ceiling on the
price that the acquirer can pay on the acquisition rather than a floor. If the acquirer pays the
full value, there is no surplus value to claim for the acquirer’s stockholders and the target
firm’s stockholders get the entire value of the synergy and control premiums. This division
of value is unfair, if the acquiring firm plays an indispensable role in creating the synergy
and control premiums.

Consequently, the acquiring firm should try to keep as much of the premium as it can for its
stockholders. Several factors, however, will act as constraints. They include:

1. The market price of the target firm, if it is publicly traded, prior to the acquisition:
Since acquisitions have to base on the current market price, the greater the current market
value of equity, the lower the potential for gain to the acquiring firm’s stockholders. For
instance, if the market price of a poorly managed firm already reflects a high probability
that the management of the firm will be changed, there is likely to be little or no value
gained from control.

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2. The relative scarcity of the specialized resources that the target and the acquiring firm
bring to the merger: Since the bidding firm and the target firm are both contributors to the
creation of synergy, the sharing of the benefits of synergy among the two parties will
depend in large part on whether the bidding firm's contribution to the creation of the
synergy is unique or easily replaced. If it can be easily replaced, the bulk of the synergy
benefits will accrue to the target firm. If it is unique, the benefits will be shared much more
equitably. Thus, when a firm with cash slack acquires a firm with many high-return
projects, value is created. If there are a large number of firms with cash slack and relatively
few firms with high-return projects, the bulk of the value of the synergy will accrue to the

3. The presence of other bidders for the target firm: When there is more than one bidder for
a firm, the odds are likely to favor the target firm’s stockholders. Bradley, Desai, and Kim
(1988) examined an extensive sample of 236 tender offers made between 1963 and 1984
and concluded that the benefits of synergy accrue primarily to the target firms when
multiple bidders are involved in the takeover. They estimated the market-adjusted stock
returns around the announcement of the takeover for the successful bidder to be 2% in
single bidder takeovers and -1.33% in contested takeovers.

Payment for the Target Firm

Once a firm has decided to pay a given price for a target firm, it has to follow up by
deciding how it is going to pay for this acquisition. In particular, a decision has to be made
about the following aspects of the deal.

1. Debt versus Equity: A firm can raise the funds for an acquisition from either debt or
equity. The mix will generally depend upon both the excess debt capacities of the acquiring
and the target firm. Thus, the acquisition of a target firm that is significantly under levered
may be carried out with a larger proportion of debt than the acquisition of one that is
already at its optimal debt ratio. This, of course, is reflected in the value of the firm through
the cost of capital. It is also possible that the acquiring firm has excess debt capacity and
that it uses its ability to borrow money to carry out the acquisition. Although the mechanics
of raising the money may look the same in this case, it is important that the value of the
target firm not reflect this additional debt. The additional debt has nothing to do with the
target firm and building it into the value will only result in the acquiring firm paying a
premium for a value enhancement that rightfully belongs to its own stockholders.

1. Cash versus Stock: There are three ways in which a firm can use equity in a transaction.
The first is to use cash balances that have been built up over time to finance the acquisition.
The second is to issue stock to the public, raise cash and use the cash to pay for the
acquisition. The third is to offer stock as payment for the target firm, where the payment is
structured in terms of a stock swap – shares in the acquiring firm in exchange for shares in
the target firm. The question of which of these approaches is best utilized by a firm cannot
be answered without looking at the following factors.

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The availability of cash on hand: Clearly, the option of using cash on hand is available
only to those firms that have accumulated substantial amounts of cash.

The perceived value of the stock: When stock is issued to the public to raise new funds or
when it is offered as payment on acquisitions, the acquiring firm’s managers are making a
judgment about what the perceived value of the stock is. In other words, managers who
believe that their stock is trading at a price significantly below value should not use stock
as currency on acquisitions, since what they gain on the acquisitions can be more than what
they lost in the stock issue. On the other hand, firms that believe their stocks are overvalued
are much more likely to use stock as currency in transactions. The stockholders in the target
firm are also aware of this and may demand a larger premium when the payment is made
entirely in the form of the acquiring firm’s stock.

Tax factors; when an acquisition is a stock swap, the stockholders in the target firm may
be able to defer capital gains taxes on the exchanged shares. Since this benefit can be
significant in an acquisition, the potential tax gains from a stock swap may be large enough
to offset any perceived disadvantages.

The final aspect of a stock swap is the setting of the terms of the stock swap, i.e., the
number of shares of the acquired firm that will be offered per share of the acquiring firm.

While this amount is generally based upon the market price at the time of the acquisition,
the ratio that results may be skewed by the relative mispricing of the two firm’s securities,
with the more overpriced firm gaining at the expense of the more under priced (or at least,
less overpriced) firm. A fairer ratio would be based upon the relative values of the two
firm’s shares.

Accounting Considerations

There is one final decision that, in our view, seems to play a disproportionate role in the
way in which acquisitions are structured and in setting their terms, and that is the
accounting treatment. In this section, we describe the accounting choices and examine why
firms choose one over the other.

Purchase versus Pooling

There are two basic choices in accounting for a merger or acquisition. In purchase
accounting, the entire value of the acquisition is reflected on the acquiring firm’s balance
sheet and the difference between the acquisition price and the restated value of the assets of
the target firm is shown as goodwill for the acquiring firm. The goodwill is then written off
(amortized) over a period of 40 years, reducing reported earnings in each year.

The amortization is not tax deductible and thus does not affect cash flows. If an acquisition
qualifies for pooling, the book values of the target and acquiring firms are aggregated. The
premium paid over market value is not shown on the acquiring firm’s balance sheet.

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For an acquisition to qualify for pooling, the merging firms have to meet the following
Each of the combining firms has to be independent; pooling is not allowed when one of
the firms is a subsidiary or division of another firm in the two years prior to the merger.
Only voting common stock can be issued to cover the transaction; the issue of preferred
stock or multiple classes of common stock is not allowed.
Stock buybacks or any other distributions that change the capital structure prior to the
merger are prohibited.
No transactions that benefit only a group of stockholders are allowed.
The combined firm cannot sell a significant portion of the existing businesses of the
combined companies, other than duplicate facilities or excess capacity.

The question whether an acquisition will qualify for pooling seems to weigh heavily on the
managers of acquiring firms. Some firms will not make acquisitions if they do not qualify
for pooling, or they will pay premiums to ensure that they do qualify.

Furthermore, as the conditions for pooling make clear, firms are constrained in what they
can do after the merger. Firms seem to be willing to accept these constraints, such as
restricting stock buybacks and major asset divestitures, just to qualify for pooling.

In-process R&D

In the last few years, another accounting choice has entered the mix, especially for
acquisitions in the technology sector. Here, firms that qualify can follow up an acquisition
by writing off all or a significant proportion of the premium paid on the acquisition as in
process R&D. The net effect is that the firm takes a one-time charge at the time of the
acquisition that does not affect operating earnings12, and it eliminates or drastically
reduces the goodwill that needs to be amortized in subsequent periods. The one-time
expense is not tax deductible and has no cash flow consequences. In acquisitions such as
Lotus by IBM and MCI by Worldcom, the in-process R&D charge allowed the acquiring
firms to write off a significant portion of the acquisition price at the time of the deal.

The potential to reduce the dreaded goodwill amortization with a one-time charge is
appealing for many firms and studies find that firms try to take maximum advantage of this
option. Lev (1998) documented this tendency and also noted that firms that qualify for this
provision tend to pay significantly larger premiums on acquisitions than firms that do not.

In early 1999, as both the accounting standards board and the SEC sought to crack down on
the misuse of in-process R&D, the top executives at high technology firms fought back,
claiming that many acquisitions that were viable now would not be in the absence of this
provision. It is revealing of managers’ obsession with reported earnings that a provision
that has no effects on cash flows, discount rates and value is making such a difference in
whether acquisitions get done.

3.3.4 Final Considerations

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The managers of acquiring firms clearly weigh in the accounting effects of acquisitions,
even when accounting choices have little or no effect on cash flows. This behavior is rooted
in a fear of how much financial markets will punish firms that report lower earnings,
largely as a consequence of the write off of goodwill. Given the transparency of this write
off (firms report earnings before and after goodwill amortization), we believe that this fear
is misplaced and the empirical evidence backs us up.

When accounting choices weigh disproportionately in the outcome, the results can be
expensive for stockholders in the acquiring firm. In particular,
Firms will reject some good acquisitions simply because they unable to meet the
pooling test or because in-process R&D cannot be written off.
Firms will overpay on acquisitions, just to qualify for favorable accounting treatment.
To meet the requirements for pooling, firms will often acquire entire firms rather than
the divisions that they are interested in and defer asset divestitures that make economic

Chapter – 4

Change forces and Mergers

This chapter deals with the changed forces affecting mergers,

consequences of changed forces, merger movements, regulations of
tender offers ,global acts governing mergers and acquisitions .It also
describes the merger performance during the 1980’s and the factors
affecting mergers and acquisitions and the cross border mergers.

Mergers and restructuring activities accelerated through the first quarter of 2000. The
volume of deal activities declined quarter by quarter through the first quarter of 2001. But
overcapacity in a number of industries will predictably result in consolidation mergers. The
rules of the games are changing as well. The Hart-Scott-Rodino Act of 1976 was amended
on December 21, 2000. The abolition of the pooling method of accounting appears to be

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likely. The rules for writing off goodwill and other intangibles are being changed. So while
the pace of M&A activities may decline from the torrid levels of the late 1990s, they
continue to represent a major force in the financial and economic environment.

Merger activity in the United States and worldwide rose to unprecedented levels in 1998
and 1999, as shown in Table 4.1.Merger activity leveled off in 2000. The stock market
indexes reached their peak in March 2000, and stock prices continued to decline during the
fourth quarter. This was associated with a decline in merger activity toward the end of the
year. As shown in Table 4.1, the year 2000 represented a leveling off of worldwide M&A
activity, but from unusually high levels. The average dollar volume of M&A activity in the
United States for the years 1998 through 2000 was slightly more than $1.5 trillion; for the
rest of the world the corresponding figure was somewhat more than $1.3 trillion. For both
segments of the world, the percentage increases compared with average levels in 1995 to
1997 were approximately 157 percent.

The current merger activity is a part of what has been called the fifth merger movement,
which began in 1993 and has been characterized by strategic mega-mergers. Table 4.2 lists
the top 10 mergers in all history through January 2001. All these mergers are greater than
$50 billion, and have occurred since 1998. The Vodafone–Air Touch transaction involved a
foreign (United Kingdom) acquirer. The ninth largest transaction involved foreign

T A B L E 4.1

Announced M&A Activity ($ Billion)

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U.S. Domestic Worldwide Rest of the World

Year $ Totals %Change $Totals %Change $Totals %Change

1985 $201 $237 $36
1986 205 2 260 10 55 53
1987 214 4 312 20 98 78
1988 356 66 503 61 147 50
1989 306 –14 556 11 250 70
1990 172 –44 430 –23 258 3
1991 133 –23 339 –21 206 –20
1992 132 –1 322 –5 190 –8
1993 219 66 435 35 216 14
1994 310 42 527 21 217 0
1995 404 30 825 57 421 94
1996 564 40 1003 22 439 4
1997 811 44 1497 49 686 56
1998 1480 82 2302 54 822 20
1999 1436 –3 3072 33 1636 99
2000 1661 16 3180 4 1519 –7

95–97 $593 $1108 $515
98–00 1526 157.3 2851 157.3 1326 157.2

Source: Thomson Financial Securities Data.

Firms on both sides of the deal. Five of the ten were in telecommunications, two in oils and
financial services. The largest of all was AOL and Time Warner, which will be placed in the
Internet/media category, combining the new and old economies.

To understand the reasons for the strong growth of M&A activity worldwide in recent years
and whether the slowing toward the end of 2000 will continue requires some historical

T A B L E 4.2

Top 10 Merger

Rank Acquirer Acquired Announcement Amount Industry

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date ($Billion)
1 AOL Time Warner January 2000 $165.9 Internet/media
2 Exxon Mobil December 1998 78.9 Oil
3 Travelers Citicorp April 1998 72.6 Financial
Group services
4 SBC Comm. Ameritech May 1998 62.6 Tele
5 Nations Bank Bank America April 1998 61.6 Financial
6 Vodafone Air Touch January 1999 60.3 Tele
group Communication communication
7 AT&T Media One Group April 1999 56.0 Tele
8 AT&T Tele- June 1998 53.6 Tele
communications communication
9 Total Elf July 1999 53.5 Oil
Fina Acquitaine
10 Bell Atlantic GTE July 1998 53.4 Tele

Major Mergers & Acquisitions 2000-2006

(1) Hewlett-Packard; with Compaq (Announced Sept. 2001 - Final May 2002) ($25 billion)
(2) Procter & Gamble buy Gillette (2005, $54 billion) ([6])
(3) Paramount; acquiring Dreamworks for $3.1 billion
(4) The Walt Disney Company; acquiring Pixar, announced January 2006, $7 billion
Microsoft and Wininternals Inc., announced July 2006,


The increased pace of M&A activity in recent years has reflected powerful change
forces in the world economy. Ten change forces are identified:

1. The pace of technological change has accelerated.

2. The costs of communication and transportation have been greatly reduced.

3. Hence markets have become international in scope.

4. The forms, sources, and intensity of competition have expanded.

5. New industries have emerged.

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6. While regulations have increased in some areas, deregulation has taken place in other

7. Favorable economic and financial environments have persisted from 1982 to 1990 and
from 1992 to mid-2000.

8. Within a general environment of strong economic growth, problems have developed in

individual economies and industries.

9. Inequalities in income and wealth have been widening.

10. Valuation relationships and equity returns for most of the 1990s have risen to levels
significantly above long-term historical patterns.

Overriding all are technological changes, which include personal computers, computer
services, software, servers, and the many advances in information systems, including the
Internet. Improvements in communication and transportation have created a global
economy. Nations have adopted international agreements such as the General Agreement
on Tariffs and Trade (GATT) that have resulted in freer trade. The growing forces of
competition have produced deregulation in major industries such as financial services,
airlines, and medical services.

The next set of factors relates to efficiency of operations. Economies of scale spread the
large fixed cost of investing in machinery or computer systems over a larger number of
units. Economies of scope refer to cost reductions from operations in related activities. In
the information industry, these would represent economies of activities in personal
computer (PC) hardware, PC software, server hardware, server software, the Internet, and
other related activities. Another efficiency gain is achieved by combining complementary
activities, for example, combining a company strong in research with one strong in
marketing. Mergers to catch up technologically are illustrated by the series of acquisitions
by AT&T.

Another major force stimulating M&A and restructuring activities comprises changes in
industry organization. An example is the shift in the computer industry from vertically
integrated firms to a horizontal chain of independent activities. Dell Computers, for
example, has been very successful concentrating on PC sales with only limited activities in
the many other segments of the value chain of the information industry.

The economic and financial environments have also been favorable for deal making. Strong
economic growth, rising stock prices and relatively low interest rates have favored internal
growth as well as a range of M&A activities.

Individual entrepreneurship has responded to opportunities and, in turn, created further

dynamism in industrial activities. Examples are Bill Gates at Microsoft, Andrew Grove at

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Intel, Jack Welch at General Electric, John Chambers at Cisco Systems, and Bernie Ebbers
at MCI WorldCom, among the many.


The change forces are having major impacts. The technological requirements for firms
have increased. The requirements for human capital inputs have grown relative to physical
assets. The knowledge and organizational capital components of firm value have increased.
Growth opportunities among product areas are unequal. New industries have been created.
The pace of product introductions has accelerated. Economic activity has shifted from
manufacturing to services of increasing sophistication. Distribution and marketing methods
have changed. The value chain has deconstructed in the sense that more activities are
performed by specialist firms. Forces for vertical integration have diminished in some
areas, but increased in others. Changes in the organization of industries have taken place.
Industry boundaries have become increasingly blurred. The forms and number of
competitors have been increasing. New growth opportunities have attracted such large
flows of resources that unfavorable sales-to-capacity relationships have developed, even in
new industries such as telecommunications and e-commerce. The decline and failure rates
of firms in some sectors have accelerated. Strategy formulation and revisions are more
important. Real-time financial planning and control information requirements have

These impacts have expanded opportunities and risks. A wide range of adjustment
processes have been used by firms in response to their increasingly changing environment.


The foregoing describes M&A activities beginning in 1993, the fifth major merger
movement—the era of strategic megamergers. This M&A activity exists worldwide, not
just in the U.S. economy. The forces in Europe have been similar to the factors in the
earlier merger movements in the United States. The four previous merger movements in the
United States can be briefly summarized:

First Merger Movement—1893 to 1904

The merger movement at the turn of the century was associated with the completion of the
transcontinental railroad system. It created the first common market. Europe is
experiencing similar forces from its effort at integration. In relation to the gross domestic
product (GDP), this merger movement in the United States has thus far been of greater
magnitude than any others, so the merger forces in Europe are very strong. In the United
States, major horizontal mergers took place in steel, oil, telephone, and the basic
manufacturing industries at the time.

Second Merger Movement—1920s

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This period was characterized by an increase in vertical mergers. These were associated
with the development of the radio, which made national advertising possible, and the
automobile, which permitted more effective geographic sales and distribution
organizations. Vertical mergers enabled manufacturers to control distribution channels
more effectively.

Third Merger Movement—1960s

The conglomerate mergers of the 1960s represented in part an adjustment to the slowdown
in defense expenditures. In every sample of conglomerates, at least one-half of the
companies were aerospace or natural resource–depleting companies (oil, forest). Also
influencing this was the idea that a good manager, with the new planning literature, could
manage anything. Also at this time, industries like the food industries, hoping to avoid their
growth being tied down to population growth, diversified. Much of the diversification at
this time was ill advised as companies moved away from their core competencies.

Fourth Merger Movement—1980s

Financial innovations, junk bonds, made all firms vulnerable to a takeover bid. Any
company that was not performing up to its potential could be taken over. Chemical Bank
and Disney were both almost taken over. So the availability of high-risk financing strongly
propelled the 1980s and there was some dismantling of the diversification of the 1960s.

Each of the merger movements in the United States was driven by a different set of
economic and development forces. But these movements did not occur randomly. A distinct
group of change factors propelled each movement. In the fifth merger movement described
above, more than 50 percent of the M&A activity in a given year has been accounted for by
five or six industries. However, the identity of the industries has varied at different time
periods. The industry characteristics related to strong M&A pressures can be summarized
as follows:

• Telecommunications: Technological change and deregulation in the United States

and abroad (particularly Europe) have stimulated efforts to develop a global presence.

• Media (movies, records, magazines, newspapers): Technological changes have

impacted the relationship between the content and delivery segments. There is
potential overlap in the content of different media outlets. It is an attractive and
glamorous industry (attracted Japanese investors beginning in late 1980s).

• Financial (investment banks, commercial banks, insurance companies).

Globalization of industries and firms requires financial services firms to go global to
serve their clients.

• Chemicals, pharmaceuticals: Both require high amounts of R&D, but suffer rapid
imitation. Chemicals become commodities. Pharmaceuticals enjoy a limited period of
patent protection, but this is eroded by “me, too” drugs and generics. Changes in the

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technology of basic research and increased risks due to competitive pressures have
created the stimulus for larger firms through M&As.

• Autos, oil and gas, industrial machinery: All face unique difficulties that give
advantages to size, stimulating M&A to achieve critical mass. Autos face global
excess capacity. Oil faces the uncertainty of price and supply instability due to actions
of the OPEC cartel.

• Utilities: Deregulation has created opportunities for economies from enlarging

geographic areas. New kinds of competitive forces have created needs for broadening
managerial capabilities.

• Food, retailing: It is hampered by slow growth. Food consumption will only grow at
the rate of population growth. Expanding internationally offers opportunities to grow
in new markets.

• Natural resources, timber: Both face exhausting sources of supply. Problems exist
in matching raw material supplies with manufacturing capacity.


The regulation of tender offers stems from the original Securities Acts of 1933 and 1934.
The Securities Act of 1933 has primary responsibility for recording information. Section 5
prevents the public offering and sale of securities without a registration statement. Section
8 provides for registration and permits the statements to automatically become effective 20
days after it is filed with the SEC. However, the SEC has the power to request more
information or to issue a stop order, which delays the operation of the 20-day waiting
period. It is the Securities Exchange Act of 1934 (SEA) that provides the basis for the
amendments that were applicable to takeover activities. Section 12(j) empowers the SEC to
revoke or suspend the registration of a security if the issuer has violated any provisions of
the 1934 act. The SEC imposes periodic disclosure requirements under Section 13. The
basic reports are (1) Form 10-K, the annual report; (2) Form 10-Q, the quarterly report; and
(3) Form 8-K, the current report for any month in which specified events occurred.

Williams Act

The Williams Act, in the form of various amendments to the Securities Exchange Act of
1934, became law on July 29, 1968. Its stated purpose was to protect target shareholders
from swift and secret takeovers in three ways: (1) by generating more information during
the takeover process that target shareholders and management could use to evaluate
outstanding offers; (2) by requiring a minimum period during which a tender offer must be
held open, thus delaying the execution of the tender offer; and (3) by explicitly authorizing
targets to sue bidding firms. Section 13(d) of the Williams Act of 1968 required that any
person who had acquired 10 percent or more of the stock of a public corporation file a
Schedule 13D with the SEC within 10 days of crossing the 10 percent threshold. The act
was amended in 1970 to increase the SEC powers and to reduce the trigger

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point for the reporting obligation under Section 13(d) from 10 to 5 percent. Basically,
Section 13(d) provides management and the shareholders with an early warning system.
Section 14(d) applies only to public tender offers but applies whether the acquisition is
small or large, so its coverage is broader. The 5 percent trigger rule also applies under
Section 14(d). Thus, any group making solicitations or recommendations to a target group
of shareholders that would result in owning more than 5 percent of a class of securities
registered under Section 12 of the Securities Act must first file a Schedule 14D with the
SEC. An acquiring firm must disclose in a Tender Offer Statement (Schedule 14D-1) its
intentions and business plans for the target as well as any relationships or agreements
between the two firms. SEA Section 14(c) prohibits misrepresentation, nondisclosure, or
any fraudulent, deceptive, or manipulative acts or practices in connection with a tender


This law contains two sections. Section 1 prohibits mergers that would tend to create a
monopoly or undue market control. This was the basis on which the DOJ stopped the
merger between Staples and Office Depot. Section 2 is directed against firms that had
already become dominant in their markets in the view of the government. This was the
basis for actions against IBM and AT&T in the 1950s. Both firms were required to sign
consent decrees in 1956 restricting AT&T from specified markets and requiring that IBM
sell as well as lease computer equipment. Under Section 2, IBM and AT&T were sued
again in the 1970s. The suit against IBM, which had gone on for 10 years, was dropped in
1983. The suit against AT&T resulted in divestiture of the operating companies effective in
1984. The Microsoft case illustrates the policies of the Department of Justice under Section
2 of the Sherman Act. Parallel to DOJ’s suits against IBM during the 1970s, the DOJ turned
its attention to Microsoft during the decade of the 1990s.


The Clayton Act created the Federal Trade Commission for the purpose of regulating the
behavior of business firms. Among its sections, two are of particular interest. Section 5
gives the FTC power to prevent firms from engaging in harmful business practices. Section
7 involves mergers. As enacted in 1914, Section 7 made it illegal for a company to acquire
the stock of another company if competition could be adversely affected. Companies made
asset acquisitions to avoid the prohibition against acquiring stock. The 1950 amendment
gave the FTC the power to block asset purchases as well as stock purchases. The
amendment also added an incipiency doctrine. The FTC can block mergers if it perceives a
tendency toward increased concentration—that the share of industry sales of the largest
firms appeared to be increasing.


The Hart-Scott-Rodino Act of 1976 (HSR) consists of three major parts. Its objective was
to strengthen the powers of the DOJ and FTC by requiring approval before a merger could
take place. Before HSR, antitrust actions were usually taken after completion of a

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transaction. By the time a court decision was made, the merged firms had been operating
for several years, so it was difficult to “unscramble the omelet.”

Under Title I, the DOJ has the power to issue civil investigative demands in an antitrust
investigation. The idea here is that if the DOJ suspects a firm of antitrust violations, it can
require firms to provide internal records that can be searched for evidence. We have seen
cases in which firms were required to provide literally boxcar loads of internal files for
review by the DOJ under Title I.

Title II is a premerger notification provision. On December 21, 2000, an amendment to

Title II was signed into law by President Clinton. The amendment was designed to reduce
the number of transactions that require HSR notification and to increases the fees for large
transactions. The HSR amendment increases the amount of time the reviewing agency has
from 20 to 30 days. It became effective February 1, 2001.

The amendment increases the minimum threshold that requires filing from $15 million to
$50 million and eliminates the alternative 15 percent of target voting stock threshold. The
transaction threshold will be annually adjusted to follow GNP. Some deals that currently
are not covered would become reportable (firms with assets below the $10 million
threshold that have an acquisition price over $200 million would become reportable). It is
expected that the amendment will cut the number of reportable transactions in half.

In the interest of maintaining the same HSR revenue levels the amendment increases the
filing fees. There will now be a three-tier fee system in place of the old $45,000 fee. For
transactions under $100 million, the fee is $45,000. From $100 million to $500 million, the
fee will increase to $125,000. For transactions that are valued at more than $500 million,
the fee will become $280,000.

Title III is the Parens Patriae Act—each state is the parent or protector of consumers and
competitors. It expands the powers of state attorneys general to initiate triple damage suits
on behalf of persons (in their states) injured by violations of the antitrust laws. The state
itself does not need to be injured by the violation. This gives the individual states the
incentive to increase the budgets of their state attorneys general. A successful suit with
triple damages can augment the revenues of the states. In the Microsoft case, the attorneys
general of 22 states joined in the suit filed by the DOJ.

Companies should follow a proactive strategy during the 30-day review period. The HSR
process should be viewed as an educational endeavor to provide the necessary information
to the government staff attorneys. The staff attorney’s should be contacted with an offer to
voluntarily provide additional information. A briefing package should fully develop the
business reasons for the merger. Under the guidance of attorneys, high-level business
executives should be made available for informal presentations or staff interviews.

The overriding approach should be for the lawyers and executives to convey a factual,
logical story, emphasizing the industry dynamics that make the transaction imperative for
the preservation of the client as a viable entity for providing high quality products to its
customers at fair prices. The presentation should demonstrate how the industry dynamics

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require the transaction to enable the firm to fulfill its responsibilities to consumers,
employees, the communities in which it has its plants and offices, and its owners and


In the merger guidelines of 1982, and successively in 1987, 1992, and 1996, the spirit of
the regulatory authorities was altered. In the merger guidelines of 1968, concentration tests
were applied somewhat mechanical the internationalization of competition and other
economic realities, the courts and the antitrust agencies began to be less rigid in their
approach to antitrust. In addition to the concentration measures, the economics of industry
were taken into account.


This study used a sample of 364 transactions that accounted for almost one-half of the total
M&A values between 1992 and mid-1998 (Weston and Johnson, 1999). The information
was obtained from the Mergerstat database, supplemented by proxy statements to
shareholders soliciting approval of transactions. The study summarized deal structure
patterns and calculated event returns. The results reflect large transactions whose patterns
are different from those of smaller transactions; the event return results could differ also.

The selection criteria began with all M&A in which the price paid for the target exceeded
$500 million. By 1997, this annual number became so large that the cutoff was raised to $1
billion or more. The study ended with transactions announced through June 1998. The
stock market adjustment that began in July 1998 dampened new M&A deal
announcements. For completed transactions, however, the third quarter of 1998 was still
high because of deals initiated earlier. The stock market began to recover in mid-October
and was associated with resumption in an active M&A market, with 11 major deals totaling
$65 billion announced on “Merger Monday,” November 23, 1998. Thus, the study captures
a distinctive cycle of M&A activity. The sample accounted for about 40 to 45 percent of
total deal value in most years, increasing to almost 69 percent for the first half of 1998. The
exploding number of blockbuster transactions is consistent with these data.


In an in-depth analysis of industry effects, Mitchell and Mulherin (1996) studied industry-
level patterns of takeover and restructuring activity during the 1982 to 1989 period. They
found that in their sample of 1064 firms, 57 percent were the object of a takeover attempt
or experienced a major restructuring during the 1980s. Of the firms involved in takeovers
or restructuring, 40 percent were hostile takeover targets. Somewhat more—47 percent of
the firms—were targets of friendly takeovers. The remaining 13 percent of the firms
engaged in defensive asset restructuring or financial

Among their 51 sample industries, they found significant differences in the rate of M&A
activity as well as in the timing of the activity. Most of the M&A activity occurred in

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relatively few industries, owing to identifiable major shocks defined as factors causing a
marked change in overall industry structure and corporate control activity.

One major force was deregulation, which had a major impact on the air transport,
broadcasting, entertainment, natural gas, and trucking industries.

A second major factor was the oil price shocks that occurrence in 1973 and 1979. These
shocks affected not only the oil industry but also the structure of industries in which energy
represented 10 percent or more of input costs. The industries most directly affected were
integrated petroleum, natural gas, air transport, coal, and trucking.

A third major factor was foreign competition. This is measured by changes in the import
penetration ratio, the ratio of imports to total industry supply. The industries with the
largest change in import penetration ratios were shoes, machine tools, apparel, construction
equipment, office equipment and supplies, autos and auto parts, tires and rubber, and steel.

A fourth major influence was innovations. The ability to use public markets for leveraged
financing increased both the rate of takeovers and the size of takeover targets.

Mitchell and Mulherin conclude that the interindustry patterns in takeovers and
restructuring reflect the relative economic shocks to the industries. Their results support the
view that a major influence on the takeover activity of the 1980s was a combination of
broad underlying economic and financial forces.

Andrade and Stafford (1999) extend the Mitchell and Mulherin results. Their data set is
based on Value Line companies and industry groupings covering the period 1970 to 1994.
Their evidence supports an impact of industry shocks. Their broader framework also
measures the role of other influences— synergy, diversification, agency costs, and market
power. Their basic economic finding is that mergers, like internal investment, are a
response to favorable growth potentials. They find a dual role in that own-industry mergers
are used in industries with excess capacity to achieve consolidation. In contracting
industries, acquiring firms appear to be those with better performance, lower capacity
utilization, and lower leverage. The asset reallocation results in improved efficiency.


When the management and the board of directors resist the takeover attempt by bidders, we
have hostile takeovers. The bidder in hostile takeovers is often referred to as a raider. Many
large and well-publicized hostile episodes have taken place. Table 4.3 shows that as a
percent of total value of transactions, hostile M&A activity is relatively small. The median
level of hostile M&A activity to the total worldwide value of transactions is 3.3 percent.
The number rises to 3.7 percent for the United States, and drops to. 2.5 percent for the rest
of the world.

Table 4.3

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Percent of Hostile M&A Activity to Total Value of Transactions

Year U.S. Domestic Worldwide Rest of the World

1985 11.9 14.3 27.8
1986 4.4 6.2 12.7
1987 3.7 3.5 3.1
1988 22.2 17.9 7.5
1989 3.6 6.1 9.2
1990 4.7 3.0 1.9
1991 2.3 2.1 1.9
1992 0.8 0.3 0.0
1993 0.0 0.5 0.9
1994 5.2 4.6 3.7
1995 5.9 6.4 6.9
1996 1.1 1.2 1.4
1997 0.5 0.8 1.2
1998 0.2 0.5 1.1
1999 7.0 15.1 22.2
2000 2.3 1.6 0.8
Mean 4.7 5.3 6.4
Median 3.7 3.3 2.5

Source: Thomson Financial Securities Data

Schwert (2000) shows the difficulty of distinguishing between hostility versus strategic
efforts to increase bidder or target gains from a potential transaction.

The outcome of hostile bids is shown in Table 4.3. The hostile bids succeed in somewhat
more than one-third of the attempts. In somewhat less than one-third of the efforts, the
target company is sold to a third party. In somewhat under 40 percent of the cases, the
company remains independent.

At best, combining companies is difficult. Differences in cultural factors, differences in

information systems, and problems in implementing the combination of two different
organizations are formidable. All these challenges are magnified in hostile mergers. The
target will not cooperate in providing information. Considerable animosity is likely to be
encountered in combining the two organizations. All empirical studies find
that the returns to bidders in hostile takeovers are negative. The probability of success of a
hostile bid is low. Given the evidence, a bidder needs to understand the difficulties likely to
be encountered and have a well-formulated plan that has a reasonable probability of

4.8 Factors affecting merger

There are several factors that motivate the mergers and acquisitions. These factors can be
broadly summarized into two categories:

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1. Exogenous Factors Affecting Mergers:

Accounting. The availability of pooling accounting for mergers has been a significant factor
in the 1990s merger activity. Pooling avoids dilution of earnings brought about by the
recognition and mandatory amortization of goodwill when a merger is accounted for as a
purchase. As pooling came under increasing pressure from the SEC and the FASB, its
impending demise, first at the end of 2000 and then in the first-half of 2001, undoubtedly
acted as a stimulant for some mergers, but it is not possible to gauge accurately how many
deals were undertaken in 1999 and 2000 to beat the deadline. Now, at the beginning of
2001, the FASB is proposing that purchase accounting replace pooling but that goodwill
should not be automatically written down, but instead should be subjected to a periodic
impairment test. An impairment charge would be taken when the fair value of goodwill
falls below its book value.

This method of accounting could be even more favorable for mergers than pooling in that it
will avoid amortization of goodwill and not saddle the merged companies with the
restrictions against share repurchases and asset dispositions that encrust the pooling rules.
Thus, accounting will basically be a neutral factor in 2001 and the foreseeable future,
neither significantly stimulating nor restraining mergers. However, the new purchase
accounting will make hostile exchange offers practical for the first time in the United States
and therefore might be a greater stimulant to merger activity than presently thought.

Antitrust. Government policy can promote, retard or prohibit mergers and is a major factor
affecting mergers. The antitrust regulators in the U.S. and the EU have been reasonably
receptive to mergers. They have recognized that markets are global and have accepted
divestitures, licenses and business restrictions to cure problems. The “big is bad” concept
has been abandoned. At this time it appears that the EU has become a bit more restrictive
and the U.S., with a change in administration, will be a bit less restrictive. The overall
situation can be summarized: Current antitrust enforcement policies will not unduly restrain
mergers in 2001.

Arbitrage. Arbitrageurs, together with hedge funds and activist institutional investors, are a
major factor in merger activity. They sometimes band together to encourage a company to
seek a merger and sometimes to encourage a company to make an unsolicited bid for a
company with which they are dissatisfied. By accumulating large amounts of stock of a
company to be acquired, they can be, and frequently are, a factor in assuring the
shareholder vote necessary to approve a merger. They will continue to be a force both
facilitating and promoting mergers.

Currencies. Fluctuations in currencies have an impact on cross-border mergers and current

conditions in the foreign exchange markets have contributed to the slowdown in merger
activity. The sharp decline in the Euro during 2000 was a deterrent to European
acquisitions of U.S. companies. The strong dollar and weak Asian currencies led to a
significant increase in acquisitions by U.S. companies in Asia. The recent strength in the
Euro has not had time to become a factor in mergers. The uncertainty as to the U.S.

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economy, the U.S. trade deficit and the strength of the dollar portend at best slow growth of
cross-border acquisitions of U.S. companies.

Deregulation. The worldwide movement to market capitalism and privatization of state

controlled companies has led to a significant increase in the number of candidates for
merger. The concomitant change in attitude toward cross-border mergers has had a similar

Deregulation of specific industries – like financial institutions, utilities and radio and
television in the U.S. – has also contributed to an increase in mergers.

Experts. The development of experts in conceiving, analyzing, valuing and executing

mergers has been a significant factor. While some consider this to be phenomenon of the
1980s, it in fact dates to the turn of the 20th Century when JP Morgan merged the Carnegie
steel interests with a number of others to create U.S. Steel. The fact that global investment
banks are calling merger opportunities to the attention of all the major companies in the
world is a merger stimulant. So too the availability of specialized lawyers, consultants and
accountants to provide backup and support to the managements and directors of merging
companies has been a merger stimulant.

Hostile Bids. With the demise of the financially motivated bust-up bids of the 1970s and
1980s, and the shift to strategic transactions, major companies have been willing to make
hostile bids. General Electric, IBM, Johnson & Johnson, AT&T, Pfizer, Wells Fargo and
Norfolk Southern are some of the companies that have done so. In addition there has been a
dramatic increase in hostile bids in Europe. The $202 billion record-setting bid by
Vodafone for Mannesmann being the prime example. The willingness of continental
European governments to step back and let the market decide the outcome of a hostile bid
has opened the door and led to a significant increase in European hostile bid activity. In the
U.S. the success rate for strategic hostile bids by major companies has similarly led to an
increase in activity.

Labor. The general prosperity and full employment in the U.S. in the 1990s resulted in
weakened resistance to mergers by the employees of acquired companies. As long as there
is a vibrant job market, employee resistance to mergers will not be meaningful. It should be
noted that the present debate in the EU with respect to the long-pending merger legislation
revolves around a last-minute attempt to require company boards to consider employees as
well as shareholders prior to effectuating a merger and to authorize target companies to
adopt takeover defenses.

LBO Funds. The growth of LBO funds from a humble beginning in the 1970s to the mega-
funds of the 1990s has been a significant factor in acquisitions. With tens of billions of
dollars of equity to support leverage of two to three to one, these funds have the capability
of doing major deals and will continue to be an important factor.

Markets. Receptive equity and debt markets are critical factors in merger activity. Prior to
mid 2000 the equity markets were very favorable for telecommunications, media and
technology stocks and for five years these sectors led merger volume to new heights. This

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same period saw an active, growing junk bond market and ready availability of bank loans,
both at attractive interest rates. With the NASDAQ down more than 50% from its early
2000 highs and many telecommunications, media and technology stocks down even more,
stock mergers in these sectors are no longer readily doable and at this time there is little
prospect of a return to conditions conducive to telecommunications, media and technology
mergers. The junk bond market has virtually dried up and banks have tightened their
lending standards. This has resulted in a reduction of cash acquisitions. Outside of the
telecommunications, media and technology sectors, merger activity has been less impacted
by the decline in the securities markets, but the uncertainty as to the economy, with concern
that the landing will be hard rather than soft, has dampened the merger ardor of many
companies. The recent actions of the Federal Reserve in twice reducing interest rates may
change market psychology and stem the fall of the equity markets.

If so, that restraint on mergers will be ameliorated. A special feature of the collapse in the
telecommunications, media and technology stocks is that there are now many good
companies with low stock market values and a need for fresh capital that may be met only
through merger with a stronger company.

New Companies. Just as the explosive formation of new companies in the latter part of the
19th Century fueled the first and second merger waves, the recent formation of thousands
of new companies in the technology areas has fueled the fifth wave and will be a major
factor in merger activity in the future.

Taxes. The general worldwide reduction in capital transaction taxes has lifted a restraint on
mergers. For example, the pending change in German tax law – to facilitate banks selling
their significant stakes in German companies – is viewed as a potential stimulant to
mergers in Germany.

Autogenous Factors Affecting Mergers:

The foregoing external factors are essentially beyond the ability of companies to control or
even to influence significantly. While they basically determine whether a particular merger
is doable at a particular time, they do not explain why companies want to merge. What are
the autogenous businesses reasons driving merger activity? There is no single or simple
explanation and again no ranking in importance is possible. Experience indicates that one
or more of the following factors are present in all mergers:

Obtaining market power. Starting with the 19th Century railroad and oil mergers, a prime
motivation for merger has been to gain and increase market power. Left unrestrained by
government regulation it would be a natural tendency of businesses to seek monopoly
The 19th Century Interstate Commerce Act and Sherman Antitrust Act were the
governmental response to the creation of trusts to effectuate railroad and oil mergers.

Sharing the benefits of an improved operating margin through reduction of operating

costs. Many of today's acquisitions involve a company with a favorable operating margin
acquiring a company with a lower operating margin. By improving the acquired company's

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operations, the acquirer creates synergies that pay for the acquisition premium and provide
additional earnings for the acquirer’s shareholders. Acquiring firms may reallocate or
redeploy assets of the acquired firm to more efficient uses. Additionally, intra-industry
consolidating acquisitions provide opportunities to reduce costs by spreading
administrative overhead and eliminating redundant personnel.

Sharing the costs and benefits of eliminating excess capacity. The sharp reductions in the
defense budget in the early 1990s resulted in defense contractors consolidating in order to
have sufficient volume to absorb fixed costs and leave a margin of profit. The Defense
Department encouraged the consolidations to assure that its suppliers remained healthy.
The pressure to control healthcare costs has had a similar impact in the healthcare industry.
The mega-mergers of, and joint-venture consolidation of refining and marketing operations
by, oil and gas companies is another example of an effort to reduce costs by eliminating

Integrating back to the source of raw material or forward to control the means of
distribution. Over the years vertical integration has had a mixed record. Currently it has a
poor record in media and entertainment, particularly where "hardware" companies have
acquired "software" companies. However, vertical integration continues to be a motivation
for a significant number of acquisitions, and, as noted below, is being widely pursued as a
response to the Internet. The acquisition of Time Warner by AOL is an example.

The advantage or necessity of having a more complete product line in order to be

competitive. This is particularly the case for companies such as suppliers to large retail
chains that prefer to deal with a limited number of vendors in order to control costs of
purchasing and carrying inventory. A similar situation has resulted in a large number of
mergers of suppliers to the automobile manufacturers.

The need to spread the risk of the huge cost of developing new technology. This factor is
particularly significant in the aerospace/aircraft and pharmaceutical industries.

Response to the global market. The usual and generally least risky means of increasing
global market penetration is through acquisition of, or joint venture with, a local partner.
Due to the increased globalization of product markets, U.S. cross-border merger and
acquisition activity has been steadily increasing. Many of the most important and largest
product markets for U.S. companies have become global in scope.

Response to deregulation. Banking, insurance, money management, healthcare,

telecommunications, transportation and utilities are industries that have experienced mid-
1990s mergers as a result of deregulation. Examples are the acquisition of investment banks
and insurance companies by commercial banks following the relaxation of restrictions on
activities by commercial banks, and the cross-border utility mergers following the
relaxation of state utility regulation.

Concentration of management energy and focus. The 1990s witnessed a recognition by

corporate management that it is frequently not possible to manage efficiently more than a

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limited number of businesses. Similarly, there has been recognition that a spinoff can result
in the market valuing the separate companies more highly than the whole. These factors
resulted in the spinoff or sale of non-core businesses by a large number of companies. The
amendment to the tax law eliminating new Morris Trust spinoff/merger transactions had a
dampening effect on the level of spinoff/merger activity, but spinoffs have continued as a
frequently used means of focusing on core competencies.

Response to changes in technology. Rapid and dramatic technological developments have

led companies to seek out acquisitions to remain competitive. Cogent examples are the
acquisitions by telephone, software, cable and media companies designed to place them in
a position to compete in an era of high-speed Internet access via cable in which people
interact with the World Wide Web for news, information, entertainment and shopping. For
instance, AT&T’s acquisition of cable companies reflected its strategy to use cable lines to
form a network for local phone and internet services. Similarly, the AOL and Time Warner
merger is premised on convergence of media and the Internet. Banking is another example
where rapid changes in technology have sparked a significant number of mergers.

Response to industry consolidation. When a series of consolidations takes place in an

industry, there is pressure on companies to not be left out and to either be a consolidator or
choose the best partner. Current examples of industries experiencing significant
consolidation are banking, forest products, food, advertising and oil and gas. A recent study
by J.P. Morgan shows that size has a major impact on a company’s price earnings multiple.
Larger companies have significantly higher multiples than smaller companies with the
same growth rate.

The receptivity of both the equity and debt markets to large strategic transactions.
When equity investors are willing to accept substantial amounts of stock issued in mergers
and encourage deals by supporting the stock of the acquirer, companies will try to create
value by using what they view as an overvalued currency. When debt financing for
acquisitions is also readily available at attractive interest rates, companies will similarly use
what they view as cheap capital to acquire desirable businesses.

Pressure by institutional shareholders to increase shareholder value. Institutional

investors and other shareholder activists have had considerable success in urging (and
sometimes forcing) companies to restructure or seek a merger. The enhanced ability of
shareholders to communicate among themselves and to pressure boards of directors has had
a significant impact. Boards have responded by urging management to take actions
designed to maximize shareholder value, resulting in divestitures of non-core businesses
and sales of entire companies in some cases. In other cases, shareholder pressure has been
the impetus for growth through acquisitions designed to increase volume, expand product
lines or gain entrance to new geographic areas.

Less management resistance to takeovers. The recognition by boards of directors that it is

appropriate to provide incentive compensation, significant stock options and generous
severance benefits has removed much of the management resistance to mergers. So too the

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ability of management to obtain a significant equity stake through an LBO has been a
stimulant to these acquisitions.


This is the first merger wave that can truly be called an international one. Many of the more
notable transactions have either involved parties entirely outside the United States or have
involved at least one non-US party. This is most clearly exemplified by the fact that the
largest deal in history, the $180 billion Vodafone-Mannesmann transaction, was between
two non-US firms. The worldwide volume of mergers and acquisitions reached $3.2 trillion
in 2000 from $322 billion about a decade previously.

Based on the trends in the marketplace, it is quite unlikely that any future waves will be
dominated by US companies as they were in the past. The relative importance of the US is
in a steady decline based on any number of factors, including economic and capital raising
ones. As a result, the landscape of mergers and acquisitions from an international
perspective is changing. Not only is the sheer volume of deals on the rise, but almost every
aspect is dramatically evolving – from the viewpoints of the regulators to the corporate
strategies employed. From a regulatory perspective, the growth of international transactions
has created a greater need for – and has forced some – global harmonization in the legal
and accounting areas. With disparate political interests involved, this is no small feat.

Both large and small companies must now think of global competition and cannot merely
focus on their neighboring competitors. Without a global perspective, companies often find
themselves an unwilling target. As many of the product markets for larger companies
become global in scope, they increasingly seek to penetrate local markets through
acquisitions or joint ventures. Since global scale is often necessary to boost earnings, many
mergers are intended to have worldwide implications. Cross-border merger and acquisition
activity has been steadily increasing and is expected to continue for many years. Below is a
brief analysis of how it is impacting various regions of the world.

United States

As more US companies engage in operations outside the US, even the most routine merger
or acquisition seems to have a transnational component. As US companies realize that
many of their brethren are being bought by companies outside the US, they seek to acquire
non-US companies to enhance the likelihood that they can compete with these non-US
giants in the future. In addition, the globalization of their clients has led to expansion of US
investment bankers, accounting, and law firms.

Even before it received a boost from the use of a single currency in the late 1990s, the
number and size of European mergers and acquisitions had climbed gradually. At the
beginning of this merger wave, European companies tended to conduct merger activity ‘‘in
market’’ (i.e. within the same country). Now, cross-border transactions are quite common
within Europe, and European companies increasingly are looking for targets outside
Europe. As the pace of European deals continues unabated, some commentators predict that

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the European level of merger and acquisition activity during 2002 may surpass that of the

In Europe, there has been an unprecedented sharp increase in the number of hostile
takeovers during the past few years. Historically, hostile takeovers have been politically
difficult in most European countries (with the notable exception of Britain). Now these
political impediments are falling, as reflected by the mid-2000 European Union Takeovers
Directive that was loosely patterned on the takeover friendly British and US regulatory
framework. Although this Directive was rejected by the European parliament due to the
objections of a few countries, it reflects the deregulatory attitude of many regulators and
should continue to boost the level of deal activity.


During the past decade, the level of Asian mergers and acquisitions activity has increased
steadily. In 1998, the Asian economic crisis caused a blip in this trend, but by 1999 activity
had rebounded. As rapid economic growth continues, this activity should grow as
regulators recognize that elimination of restrictions on foreign investment is necessary to
provide capital for their countries’ economies, and as the trend to transition from control by
family-owned enterprises to professional managers continues.

Other areas

In 2001, the level of South American mergers and acquisitions activity has fallen, reflecting
slower economic recovery and a general unwillingness to encourage foreign acquisitions.
Acquisition activity in Australia and Africa is relatively low compared with the rest of the
world, mainly as a function of the limited number of sizable companies in those continents.

4.10 Cross border mergers

Cross border mergers and acquisitions are playing an important role in the growth of
international production. ``Not only they dominate FDI flows in developing countries, they
have also begun to take hold as a mode of entry into developing countries and economies in


Although the basic merger or acquisition is the same worldwide, undertaking a cross-
border transaction is more complex than those conducted ‘‘in market’’ because of the
multiple sets of laws, customs, cultures, currencies, and other factors that impact the

How should the transaction be financed?

The financial structure of the transaction might be impacted by which country the target is
in. For example, from a valuation perspective, ‘‘flowback’’ can have a negative impact on
the acquiror’s stock price and cause regulatory problems (i.e. stock ‘‘flowing’’ back to the
acquiror’s home jurisdiction). Other types of considerations include the change in the

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nature of the investments held by institutional investors caused by a stock exchange merger
– these investors may be compelled under their own investment guidelines to sell newly
acquired stock in the acquiror; and the possible change in the tax treatment of dividends
that encourages the sale of the stock (e.g. foreign tax credit is useless to US tax-exempt
investors).The following are issues for an acquiror to address when structuring the

» If the transaction involves issuing stock, will the stock be common or preferred stock,
and will the stock be issued directly to the target the transaction. or to the target’s
stockholders? Is the acquiror prepared to be subject to the laws of the target’s country if it
issues stock in the transaction, particularly the financial disclosure laws?
» After issuing stock, how will the acquiror’s stockholder base be composed? How many
shares are held by cross-border investors? Does the new composition shift stockholder
power dramatically? Will any of the new stockholders cause problems?
» If the transaction involves debt, where will the debt be issued, from ‘‘in country’’ or
cross-border? What type of debt will be issued – senior, secured, unsecured, or mezzanine?
» If the transaction involves cash, will cash be raised by raising capital in the public
markets, and if so, in which market will the stock be issued? If cash financing is obtained in
the target’s country, can the acquiror comply with any applicable margin requirements,
such as those promulgated by the Federal Reserve Board in the US?

How are the customs and cultures of the parties different?

Before contemplating the transaction, the acquiror should be able to express a clear vision
of how the target will be operated and funded. This will be necessary to share with the
target and its employees and shareholders, as well as with its own shareholders.

Public relations are important in winning the hearts of the target’s employees, communities,
and shareholders. One cultural issue is whether the target will still be managed ‘‘in
country,’’ or whether it will be part of a regional center or managed solely from the
acquiror’s headquarters. Employees worry about overseas managers and communities
wonder about loss of jobs. From a financial perspective, investors will want pro forma
information to understand how the combined company will operate going forward. This
may require disclosure of financial information to which the target’s investors are
accustomed, but which is new for the acquiror.

How do the applicable laws govern the transaction?

If the transaction is public, such as a tender offer, the parties generally must abide by the
law of the country where the offer will be made. In comparison, the parties can choose
which law governs if the transaction is private. They can select ‘‘ground rules’’ that are the
laws from either of the home countries, or even a third-party country with established
merger laws like the US. If two sets of laws are involved, particularly if one is based on a
code system and the other is common law, it is common for both the acquiror and target to
have two sets of advisors, one from the country of each party. It is also fairly routine for
non-US parties to have their own US investment banker and law firm as advisors in a
transaction – even if neither party is from the US.

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Even if the parties do not use the target’s country’s laws as the ‘‘ground rules,’’ an acquiror
must consider the laws of the target in deciding whether to pursue a combination. For
example, there could be laws that pose substantial obstacles to consummating a deal, such
as restrictions on ownership. There are more than a few instances of cross-border bids that
have failed because the target’s government blocked the transaction to stop a company
from falling into the hands of another country.
The following are issues for an acquiror to address before a deal is struck with a target.
» Will the target insist on ‘‘in market’’ customs, and if so, will these customs be used as a
shield to stall or prevent a transaction?
» How difficult will it be to obtain complete financial information? Are there laws that
prohibit disclosure or enable the target to share data that are not reliable?
» What is the role of regulators in the target’s country? Do they have tools to effectively
stall or prevent a transaction, such as requisite governmental approval under exchange
control or national security laws? For example, in the US, under the Exon-Florio provisions
of the Trade Act, the President of the United States has the power to block the acquisition
or to render it void after it has been completed.
» Will the acquisition have to be approved by the target’s shareholders, and does the
target’s country have laws that make this difficult?
» Does the target have subsidiaries or do business in countries other than its home country,
such as Canada, Australia, or Germany, that makes the transfer of those subsidiaries
difficult so that they will have to be forcibly divested to consummate the deal?
» Is the target or any of its subsidiaries in a heavily regulated industry (e.g. defense
contracting, banking, or insurance) that requires regulatory approval, and if so, will the
regulatory delays make it appropriate for the acquisition to take the form of a one-step
merger (i.e. without an initial tender offer)?
» How will the formal merger or acquisition agreement be drafted? Will it be local to the
acquiror or the target, or a US agreement with one of the local laws governing, or a pure
US agreement?

What level of due diligence is appropriate?

Due diligence is critical in a cross-border transaction since there is a greater likelihood for
undesirable surprises to surface after an agreement has been reached initially. It is
important to establish in the formal agreement what type of due diligence is permitted and
what the consequences are of finding certain types of surprises.

The acquiror should ensure that it has adequate access to the target’s documentation and
personnel to facilitate the due diligence process. In addition to access to all financial
information, the acquiror should review the target’s loan agreements, severance plans, and
other employee agreements to see if the target’s change in control would impose any
previously undisclosed costs or obligations (e.g. constitute an event of default so as to
accelerate outstanding indebtedness).

Similarly, any other major agreements should be reviewed, such as licensing and joint
venture agreements, to determine whether any benefits may be lost due to the pending
change in control.

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The target’s charter and bylaws should be checked to see if they have any peculiar
provisions that might make it more difficult for the acquiror to gain full control of the
target. For example, the acquiror should determine whether the target has a shareholder
rights plan or poison pill, or has a provision that requires a super-majority vote to approve

Are there any significant antitrust or non competition issues?

Although the US generally has the most aggressively enforced antitrust laws in the world,
the European Union has become quite aggressive (e.g. blocking the General Electric-
Honeywell merger). Overall, more than 70 countries have their own competition laws, and
there are a number of regional economic organizations that have competition law
frameworks. If the target is involved in operations out of its home country, the acquiror
should conduct a review of the relevant antitrust laws.

Even if a significant antitrust problem is not present, it may be necessary to report the
acquisition in advance to a governmental agency. In the US, the Hart-Scott-Rodino
Antitrust Improvements Act requires a notice and waiting period unless the transaction is
below specified minimal levels.
The following are issues for an acquiror to address before pursuing a target.
» To what extent do the acquiror and target compete in a line of business?
» Will the acquisition substantially lessen competition in any line of business in any
particular country?
» What products or services does the acquiror sell to the target now, or vice versa?

Are there any significant tax or currency issues?

The acquiror should structure the transaction with a complete understanding of the tax
implications. This requires an analysis of the interplay of local law and tax treaties as well
as the expectation of where future revenues and deductions will be derived. Based on the
acquiror’s own tax preferences, it may desire current income (i.e. dividends) or capital
gain, and should structure the transaction accordingly.

The acquiror must also take care to consider the volatility of any currencies that are
implicated in the transaction and ensure that it has adequate protection from downward
swings in them before the transaction is closed. If it cannot tolerate the currency risk that is
involved in the target’s operations, the acquiror should consider the ongoing impact of a
volatile currency after the transaction is complete.

Chapter -5

Post-Closing Challenges

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The focus of this chapter is on understanding and anticipating the nature
and types of post-closing challenges faced by both buyer and seller after
the deal is completed. The seller must facilitate smooth transition of
ownership and management to the buyer’s team without ego, emotion,
or politics. The buyer must have procedures in place to prevent the
seller from undermining these transitional efforts and assume control of
the company—also without ego, emotion, or politics. Post-closing
challenges may arise in a wide variety of subject areas,

The closing of a merger or acquisition usually brings a great sigh of relief to the buyer,
seller, and their respective advisors. Everyone has worked hard to ensure that the process
went smoothly and that all parties are happy with the end result. But the term closing can
be misleading in that it suggests a sense of finality, when in truth the hard work,
particularly for the buyer, has just begun.

Often one of the greatest challenges for the buyer is the postclosing integration of the two
companies. The integration of human resources, the corporate cultures, the operating and
management information systems, the accounting methods and financial practices, and
related matters are often the most difficult part of completing a merger or acquisition. It is a
time of fear, stress and frustration for most of the employees who were not on the deal team
and may only have limited amounts of information regarding their roles in the post-closing
organization. Estimates are as high as three out of every five M&A deals results in an
ineffective plan for the external integration of the two companies. And even if there is a
plan, well they don’t always work out as anticipated. The consequences of a weak or
ineffective transition plan are the buyer’s inability to realize the transaction’s true value,
wasted time and resources devoted to solving post-closing problems, and in some cases,
even litigation.

A Time of Transition
Post-closing challenges raise a wide variety of human fears and uncertainties that must be
understood and addressed by both buyer and seller. The fear of the unknown experienced
by the employees of the seller must be addressed and put to rest; otherwise, the employees’
stress and distraction will affect the seller’s performance and the viability of the
transaction. The need to quickly integrate the two corporate cultures also raises personal
and psychological issues that must be addressed. Once word of a deal leaks out to
employees, the uncertainty associated with the change will likely lead to widespread
insecurity and fear of job loss at all levels of the organization.
Many of the fears experienced by the employees of both buyer and seller result from
expectations of downsizing to cut costs, avoid duplication, and achieve the economies of
scale potential provided by the transaction.

Another common problem is the psychological consequences of ‘‘seller’s remorse,’’

particularly when the seller remains on-site in a consulting capacity or even as a minority
owner. The seller can be so accustomed to managing the business that he/she may not be
open to changes in strategies or policies implemented by the buyer.

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The seller undermines the buyer’s efforts or contradicts its authority. These sellers often
want the benefit of the bargain but seem unwilling to accept the burden of the bargain and
relinquish control of the company. These problems are particularly common in mergers
where the management and flow of the deal may be one of shared objectives and values as
opposed to an acquisition that more clearly has a designated quarterback.
In attempting to realize the true value of a merger or acquisition, the buyer must coordinate
a smooth and efficient post-closing process. Important issues that need to be managed fall
into three areas—people, places, and things. Some issues are addressed in the closing
documents. Most require forethought in order to anticipate potential pitfalls. The bottom
line is that if the buyer doesn’t plan to address the following issues, the chances for for not
fully realizing success are greatly increased.

5.1 Staffing Levels and Other People Problems

One of the primary areas that an acquiring company looks to in order to realize the
projected return on its investment is the new company’s level of staffing. If a certain
number of employees can be eliminated, it is more likely that earnings projections will be
met or exceeded. The hard part is deciding who stays, and in what positions, and who goes.
Much of this depends on the nature of the acquisition. On the one hand, if the terms dictate
that the acquired firm is to maintain its independence, it is much more difficult to reduce
staffing levels. On the other hand, if the acquired firm is absorbed into the acquirer, staff
cutbacks are probably appropriate and healthy. This is the greatest source of employee fear
and is the fuel that powers the rumor mill. But some of these fears are valid. An April 2005
report published by Challenger, Gray & Christmas recommended that job cuts following
M&A deals in the first quarter of 2005 soared to nearly 77,000, over six times the rate of
the last quarter of 2004 and three times the rate of the first quarter of 2004. The biggest cuts
came in the telecom and high tech industries.

The first step in determining staffing levels is to divide the workforce into management and
staff/labor. These two groups must be distinguished because the terms of employment are
often quite different. Management is often party to employment contracts, and receives
deferred compensation, stock options, and other issues, while staff can be protected by
union contracts and/or federal or state employment laws.


In many ways, management staffing is a much easier problem to resolve. Most employment
agreements and/or management benefits can be quantified to determine the cost of such
decisions. This should have been examined during the due diligence process and worked
into the pricing for the transaction.

The primary task of resolving the level of management staffing is to determine where there
are redundancies and who the most qualified candidates are. Such a process is normally
driven by the acquiring company, but it is not a bad idea to involve the acquired company
as well. Only in this way can a true evaluation be made. Not consideration of all candidates
fairly may result in a lower return on the investment.

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All candidates must be evaluated objectively. It is often difficult to do so because emotions
often cloud the judgment of the evaluators. For the acquiring company, choosing the
incumbent management team is an easy decision. However, a formal evaluation of all
candidates can lead to a stronger, more diverse team. While change can be difficult, it is
necessary to embrace the change inherent in acquisitions to enhance your chances of


Labor is often protected by union contracts and labor laws. This limits the options available
when deciding who should stay and who should go. However, it should not prevent the
buyer from evaluating all employees. By evaluating first and then worrying about possible
protections, the buyer gains a much better sense of the quality of the workforce that does
ultimately remain.

The same rules apply to evaluating labor as to evaluating management. Be objective. Be

balanced. Be honest. The buyer shortchanges itself by not doing so. Develop a selection
methodology by targeting certain employees for layoff or retention based on performance
and experience. Make sure that the applied criteria are documented and objective and are
supported by a performance evaluation and that any review of personnel files and
performance evaluations is confidential. This may require the formation of a review
committee made up of representatives from each organization to ensure that the
terminations occur according to agreed upon procedures.

Once the selections are made, they must be examined from a legal point of view. The
following is a list of legal considerations to be examined:
• Employment agreements that may contain conditions that are unacceptable to the buyer or
conditions that may be triggered in the event of a merger or acquisition.
• Employees on family leave workers ’ compensation, or disability, which has certain rights
to comparable positions upon their return to work, which may or may not be consistent
with staffing plans after the acquisition.
• Whistle-blowers who could bring claims of wrongful discharge.
• WARN (Worker Adjustment and Retraining Notification) notices, which must be sent 60
days in advance by the seller to its employees if there is a plan to close facilities.
• Union contracts that could fall under the National Labor Relations Act (NLRA), which
protects the rights of union, as well as nonunion, employees on matters of wages, hours,
and working conditions.
• Race, religion, or sex discrimination for which the buyer may be held accountable under
civil rights legislation, even if claims are filed based on events that occurred before the

• Age discrimination under the Age Discrimination in Employment Act (ADEA) and/or
Older Workers Benefit Protection Act (OWBPA), which protects workers against changes
in the workforce or changes in benefit plans that would discriminate against workers over
40 or make age-based distinctions.

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• Compliance with the Americans with Disabilities Act (ADA), which, among other things,
requires a review of job descriptions to ensure that there, is a distinction between essential
and nonessential duties and a review of property leases to determine who is responsible
(the lessee or the lessor) for renovations required under the ADA.
• Violations of the Fair Labor Standards Act (FLSA) or Equal Pay Act, especially
concerning the determination of exempt versus nonexempt positions; a violation in this
area could lead to substantial payments to current and former employees for overtime
worked but not paid.
• Problems that could develop under the Occupational Health and Safety Act (OSHA) if
current compliance is not verified and the cost of future compliance is not factored into
operating results.
• To ensure that the employees being acquired are legally able to work in the United States,
the burden of compliance is on the employer under the Immigration Reform and Control
Act (IRCA).
• Lack of compliance with the Drug-Free Workplace Act and various government contract
laws can lead to suspended payments or terminated contracts for a seller that is a federal
government contractor.
• Whether state law counterparts to federal employment laws have precedence.
The bottom line is that the buyer needs to conduct a thorough labor and employment
review. This entails all manner of documents related to such issues. Each transaction is
unique in that the above issues will apply in differing degrees.

When a buyer acquires a business, one of the most valuable assets is the customer base.
One of the post-closing challenges is to determine the profitability of the customers. Often
the acquired company has legacy customers that they have been unwilling or unable to
terminate if the customer is unprofitable or difficult to manage. The acquirer should review
all customers for profitability and sustainability. It makes little sense to keep a customer if
it is not possible to make a profit on the relationship, unless the customer enables the
merged company to penetrate a new market or if the customer helps achieve scale
economies, thereby enabling other customers to be profitable. However, even in these
cases, there is a limit to the amount of losses that make financial sense. In addition, the
customer may be a direct competitor of the buyer or of one of the buyer’s customers. As a
result, it is important to evaluate the seller’s customer base. It may be necessary to discount
the value of the acquisition to account for a customer base that is unprofitable or
duplicative and that provides little additional strategic value.

Perhaps more important, however, is for the seller to transfer the goodwill of its customers
to the buyer. A disgruntled employee can very quickly destroy this goodwill and perhaps
jeopardize a significant income stream on which the value of the acquisition was based.
The key steps to transferring this goodwill are:

• Personal introductions to customer contacts

• Social events to acquaint customers with the new owners
• Letters from both the seller and buyer that thank customers for their business and
announce the new management and plans for the merged entity

Mergers & Acquisitions Page 87 of 93


Suppliers are much more often overlooked than customers. After all, any vendor can easily
be replaced. Since this is often true, it is necessary for the buyer to conduct a thorough
review of the existing suppliers to ensure that the seller is getting the best prices and terms.
However, there are certain suppliers whose replacement would cause significant disruption.
This can occur in situations where there is only one supplier of a given product or service,
or if the supplier is an integral part of a just-in-time inventory system.

Essential vendors are a key component of the continued success and uninterrupted
operations of a company.

Of special importance are suppliers that provide professional services—in particular,

bankers, accountants, and lawyers. The standard assumption is that the combined company
will use the buyer’s professional suppliers, but this may not always be desirable or feasible.
If a buyer is purchasing a business in a different industry, the bankers may not have the
appropriate expertise. The legal counsel of the seller may be better suited to deal with
certain local matters or be more cost-effective. The accountants of the seller may be
providing outsourcing of certain tasks for which it may not be practical to change
immediately. These factors should be considered carefully before any key relationships are
terminated. Ultimately, it may be best to continue to use both firms for certain purposes,
subject to any potential conflicts of interests being resolved.

5.2 Problems Involving Places

Often one of the larger expenses on the income statement, rent and/ or lease payments are a
natural place for a buyer to focus on when evaluating the efficiencies to be gained by a
merger. It would seem to be an easy issue to resolve: In acquiring this company, we can
reduce the staff by x percent, which means that we need x percent less of square footage in
which to work. In addition, the staff has x percent more square footage per employee than
our company. As a result, total square footage can be reduced by x percent, thereby saving
$x. But very few decisions in a merger or acquisition can be resolved with a simple
mathematical equation. There usually are people involved, and with people come emotions
and unpredictability.

This has to be accounted for when looking at space, just as much as when examining
staffing levels. When examining the space requirements of the combined entity, it is
certainly helpful to consider the square footage. The space should be evaluated to
determine if the rent is more or less expensive than other company space and if the amount
of space is more than is needed. This will go a long way toward helping to cut expenses in
order to reach the target return.
However, there must also be human considerations. How long have the employees been in
this space? How does the commute compare to where they might be relocated? How much
interaction is required between the staff being relocated and staff in a different location?
How much reconfiguration of the office and facilities of each company will be required to
accommodate additional staff or functions? How much productivity can be expected from
these people during the course of the move?

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Non-consideration of these and other related questions can open up a can of worms.
Location is a factor that can effect the overall integration of the buyer by the seller and can
lead to significant turnover. It is taken very personally by many employees. Our suggestion
is to take steps to maximize your efficiency of space and property but to do so considering
the human elements of the changes.

5.3 Corporate Identity

Now that the two companies have become one, it only stands to reason that the merged
entity is different from what existed before. Yet this is a point that can often be forgotten
when it comes to corporate identity. Since there is essentially a new company, it may be
important to consider a new corporate identity in the form of the company name and/or

This may seem obvious, but the real issue goes much deeper. A corporate identity defines
what makes a corporation unique. The company name and logo are merely manifestations
of that identity. Before such issues can be decided, it must be determined what the
corporation stands for, where it is going, and how it is different from other corporations.
Only then does it make sense to put a name on it and identify an image with it.

There are several aspects of a corporation that go into its identity. These include market
share, industry group identification, customer base, employees, and direction. Most, if not
all, of these aspects are altered in some way as the result of a merger or acquisition. The
key is to identify what changes have occurred and respond to them by shaping the image or
identity that is communicated to the public.

5.4 Legal Issues

Following the closing of the transaction, there are many legal and administrative tasks that
must be accomplished by the acquisition team to complete the transaction. The nature and
extent of these tasks will vary, depending on the size and type of the financing method
selected by the purchaser. The parties to any acquisition must be careful to ensure that the
jubilation of closing does not cause any post-closing matters to be overlooked.
In an asset acquisition, these post-closing tasks typically include the following:
• Final verification that all assets acquired are free of liens and encumbrances
• Recording of financing statements and transfer tax returns
• Recording of any assignments of intellectual property with the
Library of Congress or Patent and Trademark Office
• Notification of the sale to employees, customers, distributors, and suppliers
• Adjustments to bank accounts and insurance policies
In addition to the above, a stock acquisition may also include the following:
• Filing articles of amendment to the corporate charter or articles of merger
• Completion of the transfer of all stock certificates
• Amendments to the corporate bylaws
• Preparation of all appropriate post-closing minutes and resolutions
Such actions require legal counsel familiar with the issues of corporate governance and
intellectual property. While the buyer’s legal counsel attends to these matters, management

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can more readily focus on the other aspects of the business combination for which they are
better qualified and more effective.

5.5 Minimizing the Barriers to Transition

No matter how hard you try and how well you anticipate the issues that need to be
addressed, the natural response of most people is to avoid change. As a result, it is
important to be aware of the various aspects of change management and address them as
well. The primary emotion that will be encountered in dealings with various groups will be
fear. There will be fear on the part of employees, as relates to such things as job security,
workplace location, and reporting structure. But you may also have to deal with fear on the
part of customers (the buyer may discontinue a product line) and suppliers (the buyer may
already have someone to supply that good).

The primary tool for dealing with fear, and many of the other emotions that surface during
the course of acquisition transition, is communication. If a merger is thought of as the
beginning of a marriage, think of the amount of communication that is necessary in the first
few weeks and months of such a relationship. As with any relationship, a lack of
communication typically means a lack of success.
In a merger, the two keys to effective communication are to determine
(1) the importance of the information and (2) who should communicate it. Information
should be communicated in the order of its importance. This means that you want to first
communicate that information that affects people directly, including changes in:
• The organization, especially who is staying and who is leaving
• Reporting structures
• Job descriptions and responsibilities
• Title, compensation, and benefits
• Job location and operating procedures

As a result of the importance of this information, the person doing the communicating is
also important. A trusted person from the seller’s side, along with an important person from
the buyer’s side, works best. This will assist in the transition and add credibility to the

The next most important information is the introduction of the new management team and
the transition to new managers and employees. It is a bit disconcerting to walk the halls in
an organization and not know people. Think of how it feels on the first day of a new job.
Well, that’s how it feels for all the employees of an acquired company. By making an effort
to introduce the key players, people are more comfortable. They can place a name with a
face and know who is being referred to in discussions. This can help overall efficiency
because employees will be focusing on doing their job rather than wondering who someone
is and how that person might affect their career. It also helps in the socialization process
among the employees, which in turn contributes to efficiency! This, of course, is more
difficult as organizations grow larger. Finally, communicate the new reporting structure and
have individual managers introduce the two sides when there will be day-today interaction.
If possible, have the prior manager make some kind of handover to the new. Some kind of

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group meeting or social gathering among the employees of various departments, especially
those that interact regularly, can go a long way in making everyone more comfortable with
the new faces, functions, and procedures.

5.6 Post-Merger Task Force

One of the tools through which communication can be made more effective is a post-
merger task force. Such an entity should be composed of a representative group from both
sides of the transaction and should be formed after the due diligence process. The role of
such a group, which needs to be defined and communicated early, is to uncover, evaluate,
and resolve post-merger problems.
The importance of effectively communicating the role of the task force cannot be
emphasized enough. Failure to do so will limit its effectiveness and call into question the
resolve of the new organization. In a very real sense this is the first operating decision to be
seen by the seller’s employees and thus it will greatly influence the new employees’
perception of the acquiring organization.

The composition of the task force has a bearing on its effectiveness and the integrity of the
buyer, as viewed by the seller’s employees. As a result, the CEO should probably avoid
making him or herself a member. An honest assessment of those being considered for the
task force will go a long way toward establishing its credibility. If one of the members from
the seller’s side is an employee who is not respected by the majority of the workforce,
people will not take the task force seriously.

The role of the task force is best kept simple. It can serve as a conduit from labor to
management to resolve problems that arise during the course of the merger. In this way, a
dialogue can be opened and people will get the impression that actions are being taken to
address concerns. The task force can also be used to organize the information that needs to
be communicated to the new employees. The amount of information to be communicated
can be overwhelming, and the way it is communicated can also cause problems. The task
force can serve to communicate the issues in order of importance and to address them
accurately. This helps prevent the grapevine from disseminating erroneous information.
Creating the dialogue and organizing the information serve to help reduce or eliminate the

Once its work is completed, the task force must be dissolved. This is easier said than done,
as it is much easier to say when the merger activity begins than to define when it is over.
The first sign that the end of the task force’s life is near is when all the information deemed
to be important in relation to the merger has been disseminated. An additional indication is
the amount of information flowing back from the employees to the task force has
significantly waned. Nonetheless, it is often helpful to give the task force a set life at its
beginning—60 or 90 days—and to evaluate the situation at that time. The final call will
come from the CEO, when it is determined that the value of the task force has been
expended and it is now time to get to work to realize the true value of the combination.

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The importance of a well-planned and smooth post-closing transition cannot be emphasized
enough. Without the proper attention to these matters, the value of the transaction may
never be realized. This will require assembling a team with proven implementation skills
and a desire to see the transaction work. The sheer number of issues that need to be
addressed can seem overwhelming at first glance. But the importance of these issues in the
success of a business combination cannot be overemphasized. By planning properly, paying
attention to the details, and picking the right people for the job, a buyer will gain
confidence in its ability to successfully integrate the seller into its operations. This will
serve to encourage further growth through mergers and acquisitions.


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