Module 2.pdf

Module: 2 Mergers and Acquisitions Dr Mayuri Srivastava (Assistant Professor-Senior Scale, SOB, UPES) Contents Corporate Restructuring Mergers and Acquisition Concept of Value in M & A Valuation of M & A: DCF method Implications for regulation of business combinations Post merger integ...

Module: 2 Mergers and Acquisitions Dr Mayuri Srivastava (Assistant Professor-Senior Scale, SOB, UPES) Contents Corporate Restructuring Mergers and Acquisition Concept of Value in M & A Valuation of M & A: DCF method Implications for regulation of business combinations Post merger integration process Class Activity Briefly highlight the case of Zee Entertainment Enterprises Ltd. and Sony Pictures Networks India Pvt. Ltd. Merger. Explain whether it was a Horizontal Merger or Vertical Merger. If Horizontal, what benefits were reaped and vice versa. The merger was considered a failure, why? Time limit: 25 minutes Marks Weightage: 05 Corporate Restructuring Restructuring involves tectonic shift in corporate strategies to meet increased competition or changed market conditions. Reasons: Rapid pace of technological change; Low costs of communication and transportation; Globalization and global markets; Nature of competition in terms of forms, sources and intensity; Emergence of new types of industries; Regulation in some industries and sectors; Liberalization in some industries and sectors; Growing inequalities in income and wealth. Restructuring Process Analysis of current situation and identification of problems Development of restructuring strategy and plan Communication with stakeholders (employees, shareholders, creditors) Implementation of restructuring measures Monitoring and adjusting the restructuring process Evaluation of results and long-term impact Types of Mergers (Process-orientation) Mergers through absorption Mergers through consolidation Classification of Mergers 1. Horizontal Mergers 2. Vertical Mergers 3. Co-generic mergers 4. Conglomerate mergers Acquisition An act of acquiring effective control by one company over assets or management of another company 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. Types: 1. Friendly acquisition 2. Hostile acquisition Difference between Mergers and Acquisitions S. No Merger Acquisition Merging of two organization by Buying one org. by the other 1 one 2 It is a mutual decision Friendly/hostile it is expensive and time It is relatively cheap and requires 3 consuming less time 4 Dilution of ownership No dilution of ownership Purpose: Decrease Purpose: Instantaneous growth 5 competition and increase operational efficiency. Objectives of Mergers Strategic decisions Financial decisions Market expansion Increasing revenue Acquiring new technologies or Cost reduction through capabilities synergies Diversification Tax benefits Eliminating competition Improved profitability Vertical integration Enhanced shareholder value Concepts of Value in Mergers & Acquisitions Intrinsic Value Market Value Purchase Price Synergy Value Value gap Concepts essential while calculating the valuation of a Merger Free Cash Flow to the Firm (FCFF): When evaluating the value of a company in a merger, FCFF is used in the DCF model to estimate the cash flows that the acquiring firm can generate from the target company. Free Cash Flow to Equity (FCFE): FCFE is useful in valuation if the acquiring firm is interested in the value of equity alone, rather than the overall enterprise value. It focuses on what will be left for shareholders after meeting the company's financial obligations. Cont. Capital Asset Pricing Model (CAPM): In a merger, the acquiring firm needs to calculate the cost of equity to discount future cash flows properly. CAPM provides this cost of equity, which reflects the risk- adjusted return expectations of shareholders. Weighted Average Cost of Capital (WACC):WACC is used as the discount rate in DCF valuation when valuing the entire firm (FCFF method). It reflects the overall cost of financing the firm’s operations and is used to discount future cash flows to their present value. For accurate valuation in a merger, understanding WACC ensures that future cash flows are properly adjusted for both the cost of debt and equity.  Specimen format of FCFF FCFF= NOP-Taxes-Net Investment-Net Change in WC Or FCFF = Net Income+ Non-cash charges+ interest (1-T)- Net Investments-Net change in working capital Or FCFF=EBIT×(1−Tax Rate)+Depreciation−Change in Working Capital− Capital Expenditure Year 0 1 2 3 4 5 Remarks Revenue X X X X X X Non-cash item Less: Costs X X X X X X Less: Depreciation on assets X X X X X X Profit before tax X X X X X X Adjustment of non cash Taxation (x) (x) (x) (x) (x) (x) item Net operating profit after tax X X X X X X (NOPAT) Add: Depriciation X X X X X X Operating cash flow X X X X X X Less: Capital expenditure X X X X X X Less: Change in Working Capital X X X X X X Free cashflow to firm X X X X X X Specimen format of FCFE FCFE= FCFF – After tax interest expenses + Net borrowing OR FCFE=FCFF−Interest×(1−Tax Rate)+Net Borrowing Year 0 1 2 3 4 5 Remarks Revenue X X X X X X Non-cash item Less: Costs X X X X X X Less: Depreciation on assets X X X X X X Profit before tax X X X X X X Adjustment of non cash Taxation (x) (x) (x) (x) (x) (x) item Net operating profit after tax (NOPAT) X X X X X X Add: Depreciation X X X X X X Operating cash flow X X X X X X Less: Capital expenditure X X X X X X Less: Change in Working Capital X X X X X X Free cashflow to firm (FCFF) X X X X X X Less: After tax interest expense (Interest X X X X X X X (1-T) Add: Net borrowing X X X X X X Free cash flow to equity (FCFE) X X X X X X  Please calculate FCFF and FCFE from the following: Particulars Amounts (Rs) Sales 100000 Costs 75000 Depreciation 20000 Tax 35% Change in Working Capital 1000 Capital Expenditure 10000 Interest 1000 Net borrowing 6000 Capital Asset Pricing Model (CAPM) To calculate risk adjusted expected return on investment. A linear model with one independent variable, β (Beta), which represents relative volatility of the investment vis-à-vis the market. If β = 1, degree of volatility of market is equal to market volatility. If β1, return on investment is more than market volatility. Ke=Rf + β (Rm-Rf); where Ke= Discount rate for an all-equity firm; Rf= Risk free rate; Rm= Market return; Rm-Rf= risk premium being excess market return. How do we calculate appropriate discount rate? 1. Weighted Average Cost of Capital (WACC): Where: E = Market value of equity (i.e., the value of shares outstanding). D = Market value of debt (i.e., the value of bonds or loans). V = Total value of capital (i.e., E+D). Ke = Cost of equity (calculated using models like CAPM). Kd = Cost of debt (typically the interest rate on borrowed funds). T = Corporate tax rate.  Terminal Value Calculation TV calculation is based on the premise that the cash flows of final year of projection (usually year 10 in a ten-year projection) will keep growing at a particular rate of growth. TV= (Terminal year FCF10 X (1+g)) / (Rd-g) FCF 10 is the Free Cash Flow in the terminal year (Year 10). g is the perpetual growth rate of the company beyond the terminal year. Rd is the discount rate (often the WACC if both equity and debt are involved or the cost of equity if valuing equity only) Steps to calculate the value of the company Step 1: Calculate the Cost of Equity using CAPM Model Step 2: Calculate the WACC Step 3: Calculate the Present Value of all the Future Cash Flows Step 4: Sum up all the PVs of FCFs………..1st component Step 5: Calculate Terminal Value Step 6: Calculate the PV of Terminal Value…… 2nd Component Step 7: Add 1st component from 4th step and 2nd component from 6th step  Risk-Free Rate (R_f): 3% Market Return (R_m): 9% Beta of the Target Company (β): 1.3 Cost of Debt: 6% Tax Rate: 30% Debt-to-Equity Ratio (D/E): 0.5 The acquiring company estimates the target company's Free Cash Flows (FCF) for the next 5 years as follows: Year 1: $20 million Year 2: $22 million Year 3: $24 million Year 4: $26 million Year 5: $30 million Terminal growth rate beyond Year 5: 2% Calculate the value of the target company.  Role of β while valuing a merger Beta (β) represents the standardized measure of market risk or systematic risk. Beta (β) reflects how much a security's returns move relative to the overall market returns. A Beta of 1 means the security moves in line with the market. A Beta greater than 1 implies the security is more volatile than the market (higher risk). A Beta less than 1 indicates the security is less volatile than the market (lower risk).  Post merger integration process Planning and Preparation Customer and Market Integration Integration Strategy Customer Communication Leadership and Governance Market positioning Communication Performance Monitoring and Operational Integration Evaluation Systems and Processes Key Performance Indicators Financial Integration Feedback and Adjustments Human Resources Cultural Integration Culture Assessment Change management ExxonMobil Post Merger Integration Pre-Merger Planning (1998-1999): Joint integration team: Established to oversee the integration process, comprising representatives from both Exxon and Mobil. Clear goals: Defined objectives, including cost savings, efficiency improvements, and enhanced competitiveness. Cultural alignment: Identified common values and began merging company cultures. Immediate Post-Merger (1999-2000) Quick wins: Implemented rapid integration initiatives, such as consolidating operations, reducing costs, and eliminating redundancies. Organization design: Established a new organizational structure, combining the best elements from both companies. Leadership alignment: Appointed leaders from both companies to key positions.  Integration Process (2000-2002): Functional integration: Merged functional departments, such as finance, HR, and IT. Process standardization: Standardized processes and systems, improving efficiency and reducing costs. Talent management: Retained key employees, developed training programs, and managed change. Cultural integration: Fostered a shared culture, values, and vision. Synergy Realization (2002-2004): Identified synergies: Realized cost savings, efficiency improvements, and revenue enhancements. Implemented best practices: Adopted best practices from both companies, improving operations. Performance metrics: Established metrics to measure integration success. Long-Term Integration (2004-2006): Continuous improvement: Encouraged ongoing process improvements and innovation. Leadership development: Developed leadership capabilities, ensuring a strong, unified team. Cultural embedding: Reinforced the shared culture, values, and vision. Implications for regulation of business combinations Regulatory Framework: Impact on strategy Purpose of regulation Global Considerations: Key regulatory authorities Cross-border mergers International Relations Regulatory Aspects: Recent Trends: Antitrust Review Increased scrutiny Disclosure Requirements Geopolitical factors Approval Processes Evolving regulations Implications for companies: Strategic Planning Costs and Time