9.

4 Mergers and Acquisition

Definition
A merger or an acquisition in a company sense can be defined as the combination of
two or more companies into one new company or corporation. The main difference
between a merger and an acquisition lies in the way in which the combination of the two
companies is brought about.

In a merger there is usually a process of negotiation involved between the two companies
prior to the combination taking place. For example, assume that Companies A and B are
existing financial institutions. The two companies may decide to initiate merger
negotiations.

In an acquisition the negotiation process does not necessarily take place. In an acquisition
company A buys company B. Company B becomes wholly owned by company A.

When we use the term "merger", we are referring to the merging of two companies where
one new company will continue to exist. The term " acquisition" refers to the acquisition
of assets by one company from another company. In an acquisition, both companies may
continue to exist.

Mergers and acquisitions ( M & A ) as a business transaction where one company acquires
another company. The acquiring company will remain in business and the acquired
company (which we will sometimes call the Target Company) will be integrated into the
acquiring company and thus, the acquired company ceases to exist after the merger.

Mergers can be categorized as follows:

1. Horizontal: Two firms are merged across similar products or services. Horizontal
mergers are often used as a way for a company to increase its market share by merging
with a competing company.

2. Vertical: Two firms are merged along the value-chain, such as a manufacturer
merging with a supplier. Vertical mergers are often used as a way to gain a competitive
advantage within the marketplace.

3. Conglomerate: Two firms in completely different industries merge, such as a gas

pipeline company merging with a high technology company. Conglomerates are usually
used as a way to smooth out wide fluctuations in earnings and provide more consistency in
long-term growth.

Reasons why M & A decide to merge.

Every merger has its own unique reasons why the combining of two companies is
a good business decision. The underlying principle behind mergers and
acquisitions ( M & A ) is simple: 2 + 2 = 5. The value of Company A is $ 2 billion
and the value of Company B is $ 2 billion, but when we merge the two companies
together, we have a total value of $ 5 billion. The joining or merging of the two
companies creates additional value which we call "synergy" value.
Synergies are benefits that can only come about when two entities are joined together; so that
“two plus two equals five”. To enhance shareholder value, the value of two businesses joined
together must be greater than they were when they were separate.

Synergy value can take three forms:

1. Revenues: By combining the two companies, we will realize higher revenues then if
the two companies operate separately.

2. Expenses: By combining the two companies, we will realize lower expenses then if
the two companies operate separately.

3. Cost of Capital: By combining the two companies, we will experience a lower

overall cost of capital.

The best mergers seem to have strategic reasons for the business
combination. These strategic reasons include:

! Positioning - Taking advantage of future opportunities that can be exploited when the
two companies are combined.

! Gap Filling -
One company may have a major weakness (such as poor distribution)
whereas the other company has some significant strength. By combining the two
companies, each company fills-in strategic gaps that are essential for long-term survival.
! Organizational Competencies - Acquiring human resources and intellectual
capital can help improve innovative thinking and development within the company.

! Broader Market Access - Acquiring a foreign company can give a company quick
access to emerging global markets.

Mergers can also be driven by basic business reasons, such as:

! Bargain Purchase - It may be cheaper to acquire another company then to invest
internally. For example, suppose a company is considering expansion of fabrication
facilities. Another company has very similar facilities that are idle. It may be cheaper to
just acquire the company with the unused facilities then to go out and build new facilities
on your own.

! Diversification - It may be necessary to smooth-out earnings and achieve more

consistent long-term growth and profitability. This is particularly true for companies in
very mature industries where future growth is unlikely.

! Short Term Growth - Management may be under pressure to turnaround sluggish

growth and profitability. Consequently, a merger and acquisition is made to boost poor
performance.

! Undervalued Target - The Target Company may be undervalued and thus, it

represents a good investment. Some mergers are executed for "financial" reasons and not
strategic reasons. For example, Kohlberg Kravis & Roberts acquires poor performing
companies and replaces the management team in hopes of increasing depressed values.

The Overall Process of M&A

The Merger & Acquisition Process can be broken down into five phases:

Phase 1 - Pre Acquisition Review: The first step is to assess your own situation and
determine if a merger and acquisition strategy should be implemented.

Phase 2 - Search & Screen Targets: The second phase within the M & A Process is to
search for possible takeover candidates. Target companies must fulfill a set of criteria so
that the Target Company is a good strategic fit with the acquiring company.
Phase 3 - Investigate & Value the Target: The third phase of M & A is to perform a
more detail analysis of the target company.

Phase 4 - Acquire through Negotiation: Now that we have selected our target
company, it's time to start the process of negotiating a M & A. We need to develop a
negotiation plan based on several key questions:

! How much resistance will we encounter from the Target Company?

! What are the benefits of the M & A for the Target Company?

! What will be our bidding strategy?

! How much do we offer in the first round of bidding?

Phase 5 - Post Merger Integration: If all goes well, the two companies will announce an
agreement to merge the two companies. The deal is finalized in a formal merger and
acquisition agreement.

Reason for failure of M&A

Mergers and acquisitions are extremely difficult. Expected synergy values may not be
realized and therefore, the merger is considered a failure.

Some of the reasons behind failed mergers are:

1. Poor strategic fit - The two companies have strategies and objectives that are too
different and they conflict with one another.

2. Cultural and Social Differences - It has been said that most problems can be traced
to "people problems." If the two companies have wide differences in cultures, then synergy
values can be very elusive.

3. Incomplete and Inadequate Due Diligence - Due diligence is the "watchdog"

within the M & A Process. If you fail to let the watchdog do his job, you are in for some
serious problems within the M & A Process.

4. Poorly Managed Integration - The integration of two companies requires a very

high level of quality management. In the words of one CEO, "give me some people who
know the drill." Integration is often poorly managed with little planning and design. As a
result, implementation fails.
5. Paying too Much - In today's merger frenzy world, it is not unusual for the acquiring
company to pay a premium for the Target Company. However, if synergies are not
realized, then the premium paid to acquire the target is never recouped.

6. Overly Optimistic - If the acquiring company is too optimistic in its projections

about the Target Company, then bad decisions will be made within the M & A Process.

M & A Agreement
As the negotiations continue, both companies will conduct extensive effort to identify issues
that must be resolved for a successful merger. If significant issues can be resolved and both
companies are convinced that a merger will be beneficial, then a formal merger and
acquisition agreement will be formulated.

The M & A Agreement can be very lengthy based on the issues exposed.

Some of the ways to formulate M&A Agreement:

1. Representations
One very important element within the M & A Agreement is representation by both
companies. Both sides must provide some warranty that what has been conveyed is
complete and accurate.

2. Indemnification
The M & A Agreement will specify the nature and extent to which each company can
recover damages should a misrepresentation or breach of contract occur.

3. Confidentiality
It is very important for both sides to keep things confidential before announcing the
merger. If customers, suppliers, employees, shareholders, or other parties should find out
about the merger before it is announced, the target company could lose a lot of value:

M & A Closing
Once all issues have been included and addressed to the satisfaction of both companies, the
merger and acquisition is executed by signing the M & A Agreement. The buyer and the
seller along with their respective legal teams meet and exchange documents. This
represents the closing date for the merger and acquisition. The transaction takes place
through the exchange of stock, cash, and/or notes. Once the agreement has been finalized, a
formal announcement is made concerning the merger between the two companies.
An Overview of International Finance
Management (IFM)
International financial management is also known as ‗international finance‘.
International finance is the set of relations for the creation and using of funds (assets), needed for
foreign economic activity of international companies and countries. Assets in the financial aspect
are considered not just as money, but money as the capital, i.e. the value that brings added value
(profit). Capital is the movement, the constant change of forms in the cycle that passes through
three stages: the monetary, the productive, and the commodity. So, finance is the monetary
capital, money flow, serving the circulation of capital. If money is the universal equivalent,
whereby primarily labor costs are measured, finance is the economic tool.

The definition of international finance is the combination of monetary relations that develop in
process of economic agreements - trade, foreign exchange, investment - between residents of the
country and residents of foreign countries.

Financial management is mainly concerned with how to optimally make various corporate
financial decisions, such as those pertaining to investment, capital structure, dividend policy, and
working capital management, with a view to achieving a set of given corporate objectives.

When a firm operates in the domestic market, both for procuring inputs as well as selling its
output, it needs to deal only in the domestic currency. When companies try to increase their
international trade and establish operations in foreign countries, they start dealing with people
and firms in various nations. On this regards, as different nations have different currencies,
dealing with the currencies becomes a problem-variability in exchange rates have a profound
effect on the cost, sales and profits of the firm.

Globalization of the financial markets results in increased opportunities and risks on account of
overseas borrowing and investments by the firm.

1.1.1 TRANSFER PRICING

It is determination of exchange price when different business units within a firm exchange
the products and services .Commercial transactions between the different parts of the
multinational groups may not be subject to the same market forces shaping relations
between the two independent firms. One party transfers to another, goods or services, for a
price. That price is known as ―transfer price‖.

Uses of Transfer Pricing

When product is transferred between profit centers or investment centers within a decentralized
firm, transfer prices are necessary to calculate divisional profits, which then affect divisional
performance

evaluation. The objective is to achieve goal congruence, in which divisional managers will want
to transfer product-when doing so maximizes consolidated corporate profits, and at least one
manager will refuse the transfer when transferring product is not the profit-maximizing strategy
for the company. When multinational firms transfer product across international borders, transfer
prices are relevant in the calculation of income taxes, and are sometimes relevant in connection
with other international trade and regulatory issues.

Transfer pricing is

~ The process of setting transfer prices between associated enterprises or related parties where at
least one of the related parties is a non-resident.

~ The price at which an enterprise transfers goods and services, intangible and intangible assets,
services or lending/ borrowing money to associated enterprises.

Methods of Transfer Pricing

Variable Cost Method Transfer price = variable cost of selling unit + markup Full Cost Method
Transfer price = Variable Cost + allocated fixed cost Market Price Method Transfer price =
current price for the selling unit‘s in the market Negotiated Price Method

Strategic Factors of Transfer Pricing

 International Transfer Pricing Consideration

 Tax Rate- minimize taxes locally as well internationally

 Exchange Rate

 Custom Charges Risk of expropriation

 Currency Restriction
 Strategic relationship

 Assist bayside division to grow

 Gain entrance in the new country

 Supplier‘s quality or name

Reason for growth in international business

There are many reasons why international business is growing at such a rapid pace.
Below are some of those reasons:

Saturation of Domestic Markets:

In most of the countries due to continuous production of similar products over the
years has led to the saturation of domestic markets.

Opportunities in Foreign Markets:

Organizations have great opportunities to boost their sales and profits by selling
their products in these markets.

Availability of Low Cost Labor:

When we compare labor cost in developed countries with respect to developing

countries they are very high. As a result, organizations find it cheaper to shift
production in these countries. This leads to lower production cost for the
organization and increased profits.

Competitive Reasons:

International companies are using overseas market entry as a counter measure to

increase competition.

Increased Demands:

Reduction of Trade Barriers:

Development of communications and Technology:

Global Competition:
More companies operate internationally because

– New products quickly become known globally

– Companies can produce in different countries

– Domestic companies, competitors, suppliers have becomes international

Importance of IFM
Six aspects provide importance to IFM

i) Specialization of some goods and services

ii) Opening of new economies
iii) Globalization of firms
iv) Emergence of new form of business
v) Growth of world trade
vi) Development process of Nations

Nature of the financial Management

~ IFM is concerned with financial decisions taken in international business.

~IFM is an extension of corporate finance at international level.

~ IFM set the standard for international tax planning and international accounting.

~ IFM includes management of exchange rate risk.

Scope of the financial Management:

 IFM includes working capital management of multinational enterprises.

Scope of IFM includes

Foreign exchange markets, international accounting, exchange rate risk
management etc.
It also includes management of finance functions of international business.
IFM sorts out the issues relating to FDI and foreign portfolio investment.
It manages various risks such as inflation risk, interest rate risks, credit risk and
exchange rate risk.
It manages the changes in the foreign exchange market.
It deals with balance of payments in global transactions of nations.
Investment and financing across the nations widen the scope of IFM to international
accounting standards.
It widens the scope of tax laws and taxation strategy of both parent country and
host country.
It helps in taking decisions related to international business.
Recent Changes and Challenges in IFM
Challenges in IFM
Financial management of a company is a complex process, involving its own methods and
procedures. It is made even more complex because of the globalization taking place, which is
making the world‘s financial and commodity markets more and more integrated. The integration
is both across countries as well as markets. Not only the markets, but even the companies are
becoming international in their operations and approach.

Managers of international firms have to understand the environment in which they function if
they are to achieve their objective in maximizing the value of their firms, or the rate of return
from foreign operations.

The environment consists of: The international financial system, which consists of two segments:
the official part represented by the accepted code of behavior by governments comprising the
international monetary system, and the private part, which consists of international banks and
other multinational financial institutions that participate in the international money and capital
markets.

The foreign exchange market, which consists of multinational banks, foreign exchange dealers,
and organized exchanges where currency futures are regularly traded. The foreign country‘s
environment, consisting of such aspects as the political and socioeconomic systems and people‘s
cultural values and aspirations. Understanding of the host country‘s environment is crucial for
successful operation and essential for the assessment of the political risk.

Recent changes in IFM

Emergence of Euro market in 1960‘s the major cause for development and growth of IFM. This
market resulted in

• A series of parallel money markets free from regulations

• led to internationalization of banking business and

• Emergence of innovative funding techniques and securities.

International financial markets have undergone rapid and extensive changes in the recent past.

Dramatic events in global financial markets, including the Asian crisis, the Russian crisis, and
the near-collapse of Long Term Capital Management (LTCM), in 2008, in US and other
European countries which was a highly leveraged hedge fund with enormous trading positions.
 Remarkable developments in stock prices around the world, and in particular in stocks in the
telecommunications and internet sectors.

Development of information and communication technology furthered the change process

9.5 Corporate Restructuring or rebuilding

Is a move made by the corporate element to alter fundamentally either its capital structure or its tasks.

• For the most part, corporate rebuilding happens when a corporate element is encountering
noteworthy issues and is in money related danger.

• The procedure of corporate rebuilding is viewed as critical to kill the entire monetary emergency and
upgrade the organization's presentation.

• Such change in the structure of the organization, maybe because of the takeover, merger, antagonistic
financial conditions, unfavorable changes in business, for example, buyouts, insolvency, absence of
combination between the divisions, over-utilized workforce, and so forth.

Types of Corporate Restructuring

Money related Restructuring: This kind of rebuilding may happen because of a serious fall in the
general deals in the light of unfavorable financial conditions. This is done to support the market and for
the benefit of the organization.

Hierarchical Restructuring: Organizational Restructuring suggests an adjustment in the authoritative

structure of an organization, for example, decreasing its degree of the chain of importance, updating the
activity positions, scaling down the representatives, and changing the detailing connections.

Reasons for Corporate Restructuring

Change in the Strategy: The administration of the troubled element endeavors to improve its exhibition
by disposing of its specific divisions and backups which don't line up with the center technique of the
organization.

Absence of Profits: The Endeavour may not be making sufficient benefit required to take care of the
capital expenses of the organization and may cause financial misfortunes.

Switch Synergy: This idea is opposed to the standards of cooperative energy, where the estimation of a
blended unit is more than the estimation of individual units on the whole.
Income Requirement: Disposing of an ineffective endeavor can give a significant money inflow to the
organization. If the concerned corporate substance is confronting some multifaceted hurdles in getting
funds, discarding a benefit is a methodology to fund-raising and to pay off past commitments.

Characteristics of Corporate Restructuring

•Staff decreases Layoffs (by shutting down or auctioning off the unfruitful areas)

•Changes in corporate administration.

•Discarding the underutilized resources, for example, brands/patent rights.

•Re-appropriating its tasks to a progressively productive outsider, for example, specialized help in matters
of finance.

•Moving of tasks, for example, moving of assembling activities to bring down cost areas.

•Revamping capacities, for example, promoting, deals, and dissemination.

•Renegotiating work agreements to decrease overhead.

•Rescheduling or renegotiating of obligation to limit the intrigue installments.

•Directing an advertising effort everywhere to reposition the organization with its customers.

Types of Corporate Restructuring Strategies

•Merger: This is where at least two business elements are combined either by method for ingestion or
amalgamation or by the framing of another organization. The merger of at least two business substances
is commonly done by the trade of protections between the procuring and the objective organization.

•Demerger: Under this corporate rebuilding procedure, at least two organizations are joined into a
solitary organization to get the advantage of cooperative energy emerging out of such a merger.

•Turn around Merger: In this procedure, the unlisted open organizations have the chance to change
over into a recorded open organization, without deciding on IPO (Initial Public offer). In this procedure,
the privately-owned business procures a greater part of shareholding in the open organization with its
name.

•Disinvestment: When a corporate element sells out or exchanges a benefit or auxiliary, it is known as
"divestiture".

•Takeover/Acquisition: Under this methodology, the obtaining organization assumes, generally

speaking, the responsibility for theobjective organization. It is otherwisecalled “Acquisition”

•JointVenture (JV): Under this methodology, a substance is framed by at least two organizations to
embrace budgetary acts together. The resultant substance is known as the ‘Joint Venture’. Both the
gatherings consent to contribute in extent as agreed to shape another substance and furthermore share the
costs, incomes, and control of the organization.

•Strategic Alliance: Under this technique, at least two substances go into consent to team up with one
another, to accomplish certain destinations while as themselves going about as free associations.

•Slump Sale: Under this system, an element moves at least one endeavor for a single amount thought.
Under Slump Sale, an endeavor is sold for a thought, independent of the individual‘s estimations of the
benefits or liabilities of the endeavor in other words without any values being taken into consideration
about the individual assets and liabilities

9.1 Causes of Business Failure /Nature of financial distress:

Let’s consider the most common reasons for business failures:

1. Failure to Plan A builder would not construct a building without a plan. You should not
consider building a business without a Business Plan. Expressed another way, “Fail to Plan and Plan to
fail.”

2. Failure to evaluate realistically. Many new business owners start out with the misguided
assumption that the world will beat a path to its door the day they open for business.

3.) Failure to re-align goals. Many business people that took the time and effort to prepare a business
plan often lose track of its purpose and intent and it ends up in the back of the top drawer. A business plan
is a living, breathing document.

4.) Absence of the business person’s personal reality checks. A common cause of business
failures is no or poor accounting records. Money in a bank account does not mean that the business is
profitable.

5.) Failure to expect the unexpected. Key personnel die, retire or quit. Interest rates rise
unexpectedly. Buildings burn down. Yes, life is full of uncertainty. Businesses that failed generally
demonstrated their unwillingness or inability to adapt to their circumstances.

6.) Marital problems of the Principals . One of the singular highest causes of marital problems are
often exacerbated by the long hours and emotional strain of running a business.

7.) Failure to monitor goals of the business plan. Reviewing your success in achieving your goals can
be an emotionally and financially rewarding exercise.

8.) Failure to commit sufficient personal capital. This immediately restricts the ability of the
business to operate, acquire fixed assets or purchase inventory and consumables.

9.) Failure to commit sufficient time. “Many people start up a business with the illusion that they
only have to work half days to be successful. They may be right. Now they only have to figure out what
to do with the remaining twelve hours.”
10.) Lack of business experience/knowledge. a common trait witnessed in business people whose
business failed is a “go-it alone” attitude coupled with a basic lack of business knowledge and the
absence of resources to whom they could ask for or receive help on a day-to-day basis.

9.3 Overview of Leasing:

Meaning:

Leasing: The Transfer of Property Act defines a lease as “a transaction in which a party owning the
asset provides the asset for use over a certain period of time to another for consideration either in the
form of periodic rent and / or in the form of down payment”.

“a lease is an agreement whereby the lessor conveys to the lessee, in return for rent, the right to use an
asset for an agreed period of time”.

Characteristics of a lease.
(a) Two parties are involved, the lessor being the owner of an asset who transfers the right to use the
asset for a consideration (lease rentals) and the lessee being the user of the asset with a right to use the
asset.

(b) The consideration is in the form of lease rentals.

(c) The period of lease is agreed upon by both the parties.

Types of Lease:
Leasing takes different forms. Most important forms are

1. Financial lease

2. Operating lease 3. Sale and lease back

1. Financial Lease:
Financial lease is a lease where in the user can acquire the use of the asset for most of its useful life and
pay rentals to the lessee. The wear will be responsible for maintenance of the equipment and the
payment of taxes and insurance.

In the case of financial lease, the lessee selects the equipment it wants and the supplier of that
equipment. Lessee negotiates terms with a leasing company. When the terms are set the leasing
company buys the equipment. The supplier delivers the equipment to the lessee. The supplier is paid by
the lessor (Leasing Company) plant; Machinery and equipment are acquired through financial lease
arrangements.
Financial lease is sometimes called capital lease. A lease should be treated as ‘Capital Lease’ if it
meets any one of the following four conditions, as per the Financial Accounting Standards Board.

• If the lease life exceeds 75% of the life of the asset

• If there is a transfer of ownership to the lessee at the end of the lease term.

• If there is an option to purchase the asset at a “bargain price” at the end of the lease term

• If the present value of the lease payments, discounted at an appropriate discount rate exceeds 90% of
the fair market value of the asset. .

2 Operating Lease:
Operating lease is a contract between the lessor and lessee such that the cost of the asset is not fully
recovered from a single lessee. The period of the lease will be shorter since the lessor will recover the
cost of the asset from multiple lessees. Repair and maintenance of the asset is the lessor’s
responsibility. Operating lease is also known as service lease, which provides for financing and
maintenance. Computers, office equipment, automobiles and trucks are acquired through operating
lease.

3. Sale and Lease Back: Sale and lease back is a transaction where the lessee already owns the
asset he wants to lease. The lessee sells the asset to the lessor who pays for the asset and immediately
leases it back to the lessee. This type of lease is an alternative to a mortgage. This method is similar to
financial lease. The only difference is that the leased equipment is not new and lessor buys it from the
user-lessee. It provides non-fund based finance to the selling company and brings down debt-equity
ratio.

4 Structure Lease: In the case of structure lease, lease rentals are not flat or equated over the
lease term. Rentals vary over the lease term. The rental structure is scheduled in such a way that it
typically fits the lessee’s inflows from the asset. Main types of structured lease are

1. Stepped up rentals where rentals are structured so that the lessee will pay smaller rental amounts at
the beginning of the lease period and larger rental amounts towards the end of the lease period.

2. Stepped - down rentals are structural so that the lessee will pay larger rental amounts at the
beginning of the lease period and lower rental amounts towards the end of the lease period.

5 Other Types
5.a Secondary Lease : A second lease period during which the lessee will pay nominal peppercorn
rentals in order to ensure that the lease period is long enough for the lessee to gain maximum benefit
from the lease.
5. b Sub – Lease : A transaction in which the lease property is re-leased by the original lessee to
another party and the lease agreement between the two original parties remain Essential Features Of
Leasing :

The essential features of leasing are as follows:

1. Leasing is a contract between the lessor and lessee and hence should satisfy the requirements of a
valid contract.

2. The parties to the lease contract are lessor and lessee. Lessor must be competent and must have a
clear title to the equipment leased; leasee must be competent to contract.

3. Equipments are bought by lessor at the request or lessee.

4. Lease contract specifies the period of contract.

5. The lessee uses the equipment.

6. The lessee in consideration pays the lease rentals to the lessor.

7. The lessor is the owner of the assets and is entitled to the benefit of depreciation and other benefits
under the Income Tax.

8. The lessee can claim the lease rentals as expenses chargeable.

Advantages of Leasing:
Advantages of leasing from the lessee’s point of view:

It is an easy method of financing capital assets requiring huge capital outlays

(i) No margin money is required as in the case of borrowing

(ii) It helps for read the capital cost over a period
(iii) (v) Lease rentals are deductible for tax purpose
(iv) It helps conserve scarce capital resources
(v) It gives the facility to possess and operate the asset without owning the asset

The advantages to the lessor are:

(i) It is a safe method of asset based financing

(ii) Lessor enjoys tax benefit arising out of depreciation on leased asset
(iii) Lease rentals provide better liquidity through regular cash inflows.

Disadvantages of Leasing:
The following are the disadvantages of leasing from the lessee’s point of view:
(i) When compared other methods, lease financing is costly
(ii) Lessee will have no flexibility once the contract terms are agreed upon

(iii) Lessee cannot claim depreciation on leased asset