Class Discussion Summary

Date of Session: 3rd Aug 15

Case for Discussion: General Motors Value of E Contingent Notes
Submitted by: Suresh Bhasin (1401049)
The discussion began with:
Professor: What is your view of the case?
Aditya Agarwal: Calls/ options companies involve in for compensation, for
their employees, share-holders etc.
Professor: Consider the M&A Mechanism, give Equity (Share Exchange) as
compensation, if accepted, I will have shares of the company which
acquires?
Piyush Mishra: Earlier majority share-holders of the target firm, now
minority shareholder of the acquirer firm, loss of management control.
Professor: Control is given up, but at what price, Partial control of a good
business is better than full control of a bad business.
Arun M: Employees performance do not affect the returns?
Professor: No, it completely depends upon the performance of employees.
Chaudhary Abhinav: Sir, if that is the case then why profit of Tata Chorus
is declining & it is facing problems post-merger?
Professor: In most of the transactions propensity is higher for problems,
basically because of cultural issues. Success rate of Mergers is very low i.e.
33%, while 66% of them fail not because of Strategic implementation, but
because of cultural problems. Management should have a clear plan of postmerger implementation.
Professor: What else shareholder ask for
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Sayantan Dasgupta: Cash

Professor: What is the problem with cash?
The main problem is that it is not Tax Efficient. However, on the other hand if
shares are given instead of cash, no tax has to be paid at that time & tax
gets deferred.
Benefits of share exchange:
1) No cash to spend
2) Risk Sharing (Yes/ No) Risk + Reward (Control)
When firm has neither cash nor equity, what it should do?
Anirudh Mangipudi: Options
Professor: Options come far later, prior to them comes Debentures i.e.
Debt. Why do not we leverage this debt?
Suresh Bhasin: Because earlier Debt holders are already there, which
might have put some covenants.
Piyush Mishra: Coupon rates, i.e. you are asking a risky investor to become
a less risky one.
Professor: There are 2 reasons for that:
1) Value should be same
2) Requirements of both sides shall be met
Sumit Chauhan: If interest rate varies, debentures price may fluctuate &
will affect the value?
Professor: Volatility of equity is more than Debt, besides systematic risk will
always be there. What kind of investor are there, to be seen always, i.e.
understanding products & buyers. Brokers, Investment bankers have better
understanding of the type of capital to be issued. Any package can be
provided by Financial Engineering.
2

Professor: What are the options given in the case?

1) Cash of $22
2) $17.6 + 2/10 of a unit
Where 1 unit = 1 share + 1 Put Option
1 unit = 1 GME + 1 Contingent Note
Contingent Note will be exercised if the value of GME is less than $22.
Investors have to be believed for workable values to be same.
Structure/ Value of Put Options:
GME + Contingent Note = $62.5
If the value of GME share price of goes down below 62$.5 contingent note i.e.
Put Option will be exercised, which is there to save the loss in value. It can be
treated as convertible equity, its economic effect is to save from downside.

Professor: Value of the call option will depend on what factors?

Prakhar Medatwal:
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1)
2)
3)
4)
5)

Strike Price X
Share price S
Maturity t
Risk Free Rate Rf
Volatility

If Dividend is given in previous years, Share price minus PV of all dividend

values will be considered for evaluation.
Valuation of Put is used to check fairness transaction/ deal. Structure of
Transaction is to be considered.
Equity Types: 3 Types
1) GM
2) GME - EDS
3) GMH Higher Aircraft
If the unit is broken up into separate Securities:
S >> Equity Share

P >> Debenture

Factors to be considered post

1) Voting rights
2) EPS of GME is linked to EDS Assets
3) Except synergy, nothing will differ
If return of share is greater than 16%, I will go early to execute.
According to CAPM model: r = 8.2 + 1.1 * 5.6 = 14.36%
When calculating the volatility, it can be calculated from Historic Data. Other
way of calculating Volatility is implied Volatility.
Sayantan Dasgupta: Probability of Cash outflow my calculating value of
Put?
Professor: It is to make provision in budget for that quarter of that amount.
Deliberately Structure whose share price is lower.
In Mogen Case it was: Debt + Call Option
In GM Case it is: Equity + Put
However, the basic of the both the units remain same.
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Pay Off Diagram:

Professor: It depends on the investor, what kind of options to choose? As

each will have different implications in different perspectives.
Accounting Implications: Different
Taxation Implications: Different
Regulatory Implication: Different
It is the Corporate Finance Strategy, which one to opt.
According to Miller & Modigilani Assumptions for a perfect Capital Market:
There should be no effect on capital structure on the EBIT.
Rating Agencies like CRISIL, see these things from different perspectives, as
in which type of security to issue. (Equity Grading is similar to Debt Rating)
Financial Engineering: It is about making a product satisfy your need,
fundamentally of Supplier & Buyer. This will happen if financial markets are
perfect. However, following aspects are to be considered:
a) Transactions Costs
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b) Accounting
c) Taxation
d) Difference in Equity & Debt Markets

Name of Discussants:
Sl.

Name of Student

Roll Number

M. Arun

1401008

Aditya Agarwal

1401001

Prakhar Medatwal

1401037

Sayantan Dasgupta

1401046

Sumit Singh

1401048

Piyush Mishra

1401090

Anirudh Mangipudi

1401031

Suresh Bhasin

1401049

Abhinav Chaudhary

1401012

No