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Mergers & Acquisitions : A Conce

Mergers & Acquisitions : A Conceptual

Overview
Posted in: NewIndia
Thursday 09th, July 2009
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Towards Perfection

Proprietora
In today’s dynamic Business world Mergers &
Acquisitions (M&As) are becoming a common
and regular feature for majority of corporate
houses. This article throws light on various
implications and aspects connected with a
Merger & Acquisition transaction. A merger is
said to occur when two or more business
combine into one. This can happen through
absorption of an existing company by another.
In a consolidation, which is a form of merger, a
new company is formed to takeover existing
business of two or more companies. In India,
mergers are called amalgamations in legal
parlance. The acquisition refers to the
acquisition of controlling interest in an existing
company. A takeover is same as acquisition,
except that a takeover has a flavor of hostility
in majority of cases. For this reason, the
company taken over is usually called the target
company and the acquirer is called the
predator. The mergers are different from
acquisitions in the sense that acquisitions
generally do not involve liquidation of the
target company.
1. Why Mergers and Acquisitions take
place?
The common objective of both the parties in a
M&A transaction is to seek synergy in
operating economies by combining their
resources and efforts. Now we shall see the
reasons for M&A from the perspective of both,
the buyer company as well as the seller
company.
1.1 What is the buyer looking for in a M&A
transaction?
 An opportunity for achieving faster growth
 Obtaining tax concessions
 Eliminating competition
 Achieving diversification with minimum
cost
 Improving corporate image and business
value
 Gaining access to management or
technical talent
1.2 Why Companies go for sale or offer
themselves for sale?
 Declining earnings and profitability
 To raise funds for more promising lines of
business
 Desire to maximize growth
 Give itself the benefit of image of larger
company
 Lack of adequate management or
technical skills
2. Procedural aspects under the
Companies Act, 1956
The procedure for putting through a M&A
transaction under the Companies Act, 1956 is
very tedious and a lot of time is consumed in
completion of the process. Sections 391 to 396
deal with the procedure, powers of the court
and allied matters. The basic difference
between a court merger and an acquisition is
that the transferor company will be dissolved in
case of a merger, whereas in case of
acquisition the transferor company continues
to exist.
3. Implications under the Income Tax Act,
1961
Tax implications can be understood from the
following three perspectives:
a) Tax concessions to the Amalgamated
(Buyer) Company
b) Tax concessions to the Amalgamating
(Seller) Company
c) Tax concessions to the shareholders of an
Amalgamating Company
3.1 Tax concessions to the Amalgamated
Company
If the amalgamating company has incurred any
expenditure eligible for deduction under
sections 35(5), 35A(6),35AB(3), 35ABB, 35D,
35DD, 35DDA, 35E and/or 36(1)(ix), prior to
its amalgamation with the amalgamated
company as per section 2(1B) of the Act and if
the amalgamated company is an Indian
company, then the benefit of the aforesaid
sections shall be available to the amalgamated
company, in the manner it would be available
to the amalgamating company had there been
no amalgamation. Also under section 72A of
the Act, the amalgamated company is entitled
to carry forward the unabsorbed depreciation
and unabsorbed accumulated business losses
of the amalgamating company provided certain
conditions are fulfilled. The CBDT is expected
to reckon on the possibility of extending the
benefits of section 72A to M&As in the financial
sector. Currently, the benefits of this section
are applicable to manufacturing sector only.
3.2 Tax concessions to the Amalgamating
Company
Any transfer of capital assets, in the scheme of
amalgamation, by an amalgamating company
to an Indian amalgamated company is not
treated as transfer under section 47(vi) of the
Act and so no capital gain tax is attracted in
the hands of the amalgamating company.
3.3 Tax concessions to the Shareholders of an
Amalgamating Company
When the shareholder of an amalgamating
company transfers shares held by him in the
amalgamating company in consideration of
allotment of shares in amalgamated company
in the scheme of amalgamation, then such
transfer of shares in not considered as transfer
under section 47(vii) of the Act and
consequently no capital gain is attracted in the
hands of the shareholder of amalgamating
company. The above are only few out of the
various tax concessions available to the
aforementioned categories of the assesses due
to M&A transaction.
4. Valuation of Target Company
The principal incentive for a merger is that the
business value of the combined business is
expected to be greater than the sum of the
independent business values of the merging
entities. The difference between the combined
value and the sum of the values of individual
companies is the synergy gain attributable to
the M&A transaction. Hence,
Value of acquirer + Stand alone value of Target
+ Value of Synergy = Combined Value.
There is also a cost attached to an acquisition.
The cost of acquisition is the price premium
paid over the market value plus other costs of
integration. Therefore, the net gain is the value
of synergy minus premium paid.
Suppose VA = Rs. 200, VB = Rs. 50 and VAB =
Rs. 300, where VA and VB are the values of
companies A and B before merger respectively
and VAB is the combined value after merger.
Therefore, Synergy = VAB – ( VA + VB ) = Rs.
50.
If the premium is Rs. 20,
Net gain from merger of A and B will be Rs. 30
(i.e. Rs. 50 – Rs. 20). One of the essential
steps in M&A is the valuation of the Target
Company. Analysts use a wide range of models
in practice for measuring the value of the
Target firm. These models often make very
different assumptions about pricing, but they
do share some common characteristics and can
be classified in broader terms. There are
several advantages to such a classification : it
is easier to understand where individual
models fit into the bigger picture, why they
provide different results and where they have
fundamental errors in logic.
There are only three approaches to value a
business or business interest. However, there
are numerous techniques within each one of
the approaches that the analysts may consider
in performing a valuation.
4.1 Income Approach
Under this approach two primary used
methods to value a business interest include :
a) Discounted Cash flow method
b) Capitalized Cash flow method
Each of these methods depend on the present
value of an enterprise’s future cash flows.
4.1.1 Discounted Cash flow Technique
The Discounted Cash flow valuation is based
upon the notion that the value of an asset is
the present value of the expected cash flows
on that asset, discounted at a rate that reflects
the riskiness of those cash flows. The nature of
the cash flows will depend upon the asset :
dividends for an equity share, coupons and
redemption value for bonds and the post tax
cash flows for a project. The Steps involved in
valuation under this method are as under :
Step I : Estimate free cash flows available to
all the suppliers of the capital viz. equity
holders, preference investors and the providers
of debt.
Step II : Estimate a suitable Discount Rate for
acquisition, which is normally represented by
weighted average of the costs of all sources of
capital, which are based on the market value of
each of the components of the capital.
Step III: Cash flows computed in Step I are
discounted at the rate arrived at in Step II.
Step IV : Estimate the Terminal Value of the
business, which is the present value of cash
flows occurring after the forecast period.
TV = CFt (1+ g ) ,
k-g
where CFt is the cash flow in last year,
g is constant growth rate and
k is the discount rate
Step V : Add the present value of free cash
flows as arrived at in Step III and the Terminal
Value as arrived at in Step
IV. This will give the value of firm.
Step VI: Subtract the value of debt and other
obligations assumed by the acquirer to arrive
at the value of equity.
4.1.2 Capitalized Cash flow Technique
The Capitalized Cash flow technique of income
approach is the abbreviated version of
Discounted Cash flow technique where the
growth rate (g) and the discount rate (k) are
assumed to remain constant in perpetuity. This
model is represented as under :
Value of Firm = Net Cash flow in year one
(k–g)
4.2 Market Approach
The market approach to business valuation has
its origin in the economic principle of
substitution which says, “Buyers would not pay
more for an item than the price at which they
can obtain an equally desirable substitute.” The
market price of the stocks of publicly traded
companies engaged in the same or similar line
of business can be a valid indicator of value
when the transactions in which stocks are
traded are sufficiently similar to permit a
meaningful comparison. The difficulty lies in
identifying public companies that are
sufficiently comparable to the subject company
for this purpose.
Suppose a company operating in the same
industry as ABC with comparable size and
other situations has been sold at Rs. 500
crores in last week provides a good
measurement for valuation of business.
Considering the circumstances, value of the
business of ABC should be around Rs. 500
crores under market approach.
4.3 Assets Approach
The first step in using the assets approach is to
obtain a Balance Sheet as close as possible to
the valuation date. Each recorded asset
including intangible assets must be identified,
examined and adjusted to fair market value.
Now all liabilities are to be subtracted, again at
fair market value, from the value of assets
derived as above to reach at the fair market
value of equity of the business. It is important
to note here that any unrecorded assets or
liabilities should also be considered while
arriving at the value of business by the assets
approach.
None of the above methods is the best or none
of them is the worst but each one has its own
advantages and view points different from
others. All these methods should be used in
combinations to arrive at proper valuation of
the business.
5. Accounting for Mergers and
Acquisitions
In India, Accounting Standard (AS) 14
“Accounting for Amalgamations” deals with the
accounting to be made in the books of
Transferee Company. This AS is applicable
where the acquired company is dissolved and
its separate entity ceased to exist and the
purchasing company continues the business of
acquired company.
As per AS-14 there are two types of
amalgamations : (a) Amalgamation in the
nature of Purchase and (b) Amalgamation in
the nature of Merger. An amalgamation will be
in the nature of Purchase if any of the
conditions regarding amalgamation in the
nature of merger is not satisfied. An
amalgamation is in the nature of Merger if all
the conditions as prescribed in AS-14 for it are
satisfied.
5.1 Accounting treatment for amalgamation in
the nature of Merger
 In preparing the Balance Sheet of
transferee company after amalgamation,
all the assets and liabilities of the
transferor and transferee company will be
added line by line except share capital.
  The difference between the purchase
consideration paid by the transferee
company to the transferor company and
the share capital of the transferor company
should be adjusted with reserves.
 If the purchase consideration is more than
the share capital of the transferor
company, then the excess shall be debited
to reserves, if reverse is the case, then
credited to reserves.
5.2 Accounting treatment for amalgamation in
the nature of Purchase
 In the books of the transferee company
assets and liabilities (except fictitious
assets and reserves & surplus) shall be
recorded at the value at which they are
taken over by the transferee company
from the transferor company.
 If the purchase consideration exceeds the
net assets taken over (Net Assets =
Agreed value of assets less agreed value
of liabilities), the difference will be debited
to Goodwill account which is to be
amortized over a reasonable period of time
generally not exceeding five years and if
reverse is the case then the difference is
credited to Capital Reserve.
 To fulfill the requirement of maintenance
of Statutory Reserves, the transferee
 company maintains such reserves created
by transferor company for some more
years in its books by passing the following
journal entry,
Statutory Reserve Account Debited
To Amalgamation Adjustment Account
The accounting treatment in the books of the
transferor company is not a big issue. The
assets and liabilities which are being takenover
in the M&A transaction are to be reversed in its
books i.e. assets are to be credited and
liabilities are to be debited.
6. Conclusion
These aspects which we talked about in this
article will justify the exchange process in a
Merger & Acquisition transaction if they are
duly considered and their impact is properly
arrived at. Hence their review becomes a
prime and critical stage before proceeding with
the big deal.

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