Impact of M&A

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M.P.BIRLAINSTITUTEOFMANAGEMENT Page1

DECLARATION

I hereby declare that this research project titled, Impact of

mergers and Acquisition on the performance of Indian

companies is p rep a red under the g uidanc e of Prof. S.

Santhana m, Fac ulty, MPBIM, in pa rtial fulfillment o f Ma ster of

Business Administration (MBA) program of Bangalore University

a t M. P. Birla Institute of Management. This is my o rig ina l work

and has not been submitted for the award of any other

degree, dip loma , fellowship or other simila r title or p rizes.

Plac e: Bang a lore NITIN KUMAR

PAL

Date: 06XQCM6055


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PRINCIPALS CERTIFICATE

This is to c ertify tha t the internship report titled , Impact ofmergers and Acquisition on the performance of Indian

companies has been prepared by Mr. Nitin Kumar Pal,

bea ring reg istra tion numb er 06XQCM6055, unde r the g uidanc e

of Prof. S. Santhana m, M P Birla Institute of Ma na gement,

Assoc ia te Bha rtiya Vidya Bha va n, Banga lore. This ha s not

formed a basis for the award of any degree/diploma for anyother university.

Plac e: Banga lore Princ ipa l

Date : Dr.

N.S.Mallavalli


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GUIDES CERTIFICATE

This is to c ertify tha t the internship Report entitled , Impact of

mergers and Acquisition on the performance of Indian

companies done by Nitin Kumar Pal bearing Registration

No .06XQCM 6055 is a bona fide work done und er my guidanc e

in a pa rtia l fulfillme nt o f the req uirem ent for the a ward of MBA

deg ree by Banga lore University. To the best of my know led ge

this rep ort ha s not fo rmed the basis forthe award o f any other

degree.


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Plac e: Bang a lore Prof. S.

Shanthanam

Date: (internal

guide)

ACKNOWLEDGEMENT

I am thankful to Dr.N.S.Ma lava lli, Princ ipa l, M.P.Birla institute of

ma nagem ent, Banga lore, who has g iven his va luab le support during

my projec t.

I am extremely thankful to Prof. S. Santha na m, M.P.Birla institute of

Ma nage ment, Banga lore, who ha s guided me to d o this p rojec t by

g iving va luab le suggestions and advic e.


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My special thanks to Prof. Praveen Bhagvan, who provided me the

time ly ad vic e a nd ha s helped remarkab ly to c omp lete the p rojec t.

Finally, I express my sincere gratitude to all my friends and well

w ishers who helped me to do this p rojec t.

Nitin Kumar Pa l

ABSTRACT:

This paper is an attempt to evaluate the impact of Mergers and Acquisitions on

the performance of the companies. Theoretically it is assumed that Mergers

improves the performance of the company due to increased market power,

Synergy impact and various other qualitative and quantitative factors. Although

the various studies done in the past showed totally opposite results. These

studies were done mostly in the US and other European countries.

So this is an attempt to evaluate the impact of Mergers on Indian companies

through a database of 40 Companies selected from Capitaline, using paired t-

test for mean difference for four parameters;


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Total performance improvement, Economies of scale, Operating Synergy and Financial Synergy.My study shows that Indian companies are no different than the companies in

other part of the world and mergers were failed to contribute positively in the

performance improvement in most of the cases.

TABLE OF CONTENTS

CHAPTER

No.

PARTICULARS PAGE NO.

Declaration

PRINCIPALS CERTIFICATE

GUIDES CERTIFICATE

ACKNOWLEDGEMENT

ABSTRACT

Chapter 1 INTRODUCTION 2


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1.1 Introduction 3

1.2 Objectives of the study 28

1.3 Problem statement 28

1.4 limitations 29

Chapter 2 REVIEW OF LITERATURE 30

Chapter 3 RESEARCH METHODOLOGY 37

3.1 Data sampling details 38

3.2 Statistical tools 38

3.3 Data analysis and interpretation 41

Chapter 4 RESEARCH FINDINGS 57

Chapter 5 CONCLUSION 59

Chapter 6 BIBLIOGRAPHY 61

CHAPTER: 1


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INTRODUCTION

Introduction:

We have been learning about the companies coming together to from another

company and companies taking over the existing companies to expand their

business.

With recession taking toll of many Indian businesses and the feeling of

insecurity surging over our businessmen, it is not surprising when we hear

about the immense numbers of corporate restructurings taking place, especially

in the last couple of years. Several companies have been taken over and several

have undergone internal restructuring, whereas certain companies in the same

field of business have found it beneficial to merge together into one company.


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In this context, it would be essential for us to understand what corporate

restructuring and mergers and acquisitions are all about.

All our daily newspapers are filled with cases of mergers, acquisitions, spin-

offs, tender offers, & other forms of corporate restructuring. Thus important

issues both for business decision and public policy formulation have been

raised. No firm is regarded safe from a takeover possibility. On the more

positive side Mergers & Acquisitions may be critical for the healthy expansion

and growth of the firm. Successful entry into new product and geographical

markets may require Mergers & Acquisitions at some stage in the firm's

development. Successful competition in international markets may depend on

capabilities obtained in a timely and

efficient fashion through Mergers & Acquisitions. Many have argued that

mergers increase value and efficiency and move resources to their highest and

best uses, thereby increasing shareholder value. .

To opt for a merger or not is a complex affair, especially in terms of the

technicalities involved. We have discussed almost all factors that the

management may have to look into before going for merger. Considerable

amount of brainstorming would be required by the managements to reach a

conclusion. e.g. a due diligence report would clearly identify the status of the

company in respect of the financial position along with the networth and

pending legal matters and details about various contingent liabilities. Decision

has to be taken after having discussed the pros & cons of the proposed merger


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& the impact of the same on the business, administrative costs benefits, addition

to shareholders' value, tax implications including stamp duty and last but not

the least also on the employees of the Transferor or Transferee Company.

Merger:

Merger is defined as combination of two or more companies into a single

company where one survives and the others lose their corporate existence. The

survivor acquires all the assets as well as liabilities of the merged company or

companies. Generally, the surviving company is the buyer, which retains its

identity, and the extinguished company is the seller.

Merger is also defined as amalgamation. Merger is the fusion of two or more

existing companies. All assets, liabilities and the stock of one company stand

transferred to transferee company in consideration of payment in the form of:


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Equity shares in the transferee company, Debentures in the transferee company, Cash, or A mix of the above modes.

Acquisition:

Acquisition in general sense is acquiring the ownership in the property. In the

context of business combinations, an acquisition is the purchase by one

company of a controlling interest in the share capital of another existing

company.

Methods of Acquisition:

An acquisition may be affected by


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a. Agreement with the persons holding majority interest in the company

management like members of the board or major shareholders commanding

majority of voting power;

b. Purchase of shares in open market;

c. To make takeover offer to the general body of shareholders;

d. Purchase of new shares by private treaty;

e. Acquisition of share capital through the following forms of considerations

viz. means of cash, issuance of loan capital, or insurance of share capital.

Takeover:

A takeover is acquisition and both the terms are used interchangeably.

Takeover differs from merger in approach to business combinations i.e. the

process of takeover, transaction involved in takeover, determination of share

exchange or cash price and the fulfillment of goals of combination all are

different in takeovers than in mergers. For example, process of takeover is

unilateral and the offeror company decides about the maximum price. Time

taken in completion of transaction is less in takeover than in mergers, top

management of the offeree company being more co-operative.


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De-merger or corporate splits or division:

De-merger or split or divisions of a company are the synonymous termssignifying a movement in the company.

What will it take to succeed?

Funds are an obvious requirement for would-be buyers. Raising them may not

be a problem for multinationals able to tap resources at home, but for local

companies, finance is likely to be the single biggest obstacle to an acquisition.

Financial institution in some Asian markets is banned from leading for

takeovers, and debt markets are small and illiquid, deterring investors who fear

that they might not be able to sell their holdings at a later date. The credit

squeezes and the depressed state of many Asian equity markets have only made

an already difficult situation worse. Funds apart, a successful Mergers &

Acquisition growth strategy must be supported by three capabilities: deep local


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networks, the abilities to manage uncertainty, and the skill to distinguish

worthwhile targets. Companies that rush in without them are likely to be

stumble.

Assess target quality:

To say that a company should be worth the price a buyer pays is to state the

obvious. But assessing companies in Asia can be fraught with problems, and

several deals have gone badly wrong because buyers failed to dig deeply

enough. The attraction of knockdown price tag may tempt companies to skip

crucial checks. Concealed high debt levels and deferred contingent liabilities

have resulted in large deals destroying value. But in other cases, where buyers

have undertaken detailed due diligence, they have been able to negotiate prices

as low as half of the initial figure.

Due diligence can be difficult because disclosure practices are poor and

companies often lack the information buyer need. Moreover, most Asian

conglomerates still do not present consolidated financial statements, leaving the

possibilities that the sales and the profit figures might be bloated by transactions

between affiliated companies. The financial records that are available are often

unreliable, with different projections made by different departments within the

same company, and different projections made for different audiences. Banks

and investors, naturally, are likely to be shown optimistic forecasts.


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Why do mergers occur?

Economic theory generally offers two competing thoughts about the efficacy of

mergers as the means of corporate restructuring. The neo classical theory

otherwise known as value-maximizing theory postulates merger consequences

as the moving cause behind the mergers and views corporate, mergers as value-

enhancing activities in which managers work to achieve shareholders' wealth

maximization goal of the firm (Franks and Harris, 1989). In contrast,

managerial theory or non-value maximizing theory views mergers as the

extension managers' own potential interests, undertaken for the purpose of

increasing their own wealth or prestige by managing a larger post-merger entity

(Roll, 1986). The theories of merger motives can be classified into seven


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groups, which are presented in the table. The valuation, empire building and

process theory of mergers have the highest degree of plausibility. In case of

efficiency and monopoly theories, dominate the field of corporate strategy as

well as research on merger motives though provide unfavorable evidence.

Finally, the raider and the disturbance theories are unsupported by evidence

(Trautwein, 1990).

Valuation Theory Efficiency Theory Monopoly Theory Valuation theory Empire-building Theory Process Theory Disturbance Theory

In case of diversified mergers firm can use resources and infrastructure that are

already there in place. While in case of congeneric mergers it can avoid

duplication of various activities and thus can achieve operating and financial

efficiency. In addition, economic circumstances of industries may also favour

M&As. Horizontal mergers in industries with excess capacity may be used to

close the plants to bring capacities and sales into better balance. Firms in

fragmented industries may become more effective when joined together.

(Weston, pp123)

Mergers and amalgamations can be further classified based upon the objective

profile of such arrangements as Horizontal, Vertical, Circular and

Conglomerate mergers. A horizontal merger is the combinations of two


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competing firms belongs to the same industry and are at the same stage of

business cycle. These mergers are aimed at achieving Economies of Scale in

production by eliminating duplication of facilities and operations and

broadening the product line, reducing investment in working capital,

eliminating competition through product concentration, reducing advertising

costs, increasing market segments and exercising better control over the market.

It is also an indirect route to achieving technical economies of large scale. For

example merger of Tata Industrial Finance Ltd. with Tata Finance Ltd., GEC

with EEC and TOMCO with HLL.

A vertical merger is one where companies at different product or business life

cycle combines. It can be Backward Integration where company merges its

suppliers or Forward Integration where it merges its customers. The basic

motive of these sorts of merges is to reduce cost and dependence. Merge of

Reliance Petrochemicals Ltd. With Reliance Industries Ltd. can be placed in

this category.

In circular combination, companies producing distinct products in the same

industry seek amalgamation to share common distribution and research

facilities in order to obtain economies by eliminating costs of duplication and

promoting market enlargement. The acquiring company obtains benefits in the

form of economies of resource sharing and diversification (Ansoff and Weston,

1962).

Here we can cite the merger of BBLIL with HLL. Conglomerate merger are the

one where companies belongs to different or unrelated lines of business. The

basic motives of these mergers are to reduce risk through diversification. It also


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enhances the overall stability of the acquirer and improves the balances in the

companys total portfolio of diverse products and production processes. It also

encourages firms to grow by diversifying into other markets. Diversification is

a vital strategy for the firm when present market does not have much additional

opportunities for growth. Here we can cite the example of Torrent group, which

identified power as one of the growing field, acquired Ahmadabad Electric

Company and Surat Electric Company in order to diversify the risk of its

existing line of Pharmaceuticals business. In the last two decade Merger

activities in the world has rose to unprecedented level. This reflects the

powerful change force in the world economy. In fact this respond to the

changes, which took place due to high level of technology changes, reduction in

cost of communication and transportation that created international market,

Increased competition, emergence of new industries, favorable economic

and financial environment and deregulation of most of the economies also

motivate Mergers. Second set of factors that has given rise to these activities

relates to efficiency of operations. Economies of scale that reflects in cost

reduction by avoiding duplicating works and operating efficiency, which is the

result of combining complementary strength, are the other reasons. Different

growth opportunity among different products, birth of new industries, and

concept of value creation through specialization, under capacity utilization are

the other forces. (J.Fred Weston and Samual C. Weaver, Page 3).

Mergers and takeovers are prevalent in India right from the post independence

period. But Government policies of balanced economic development and to

curb the concentration of economic power through introduction of Industrial

Development and Regulation Act-1951,4 MRTP Act, FERA Act etc. made


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these activities almost impossible and only a very few M&A and Takeovers

took place in India prior to 90s. But policy of decontrol and liberalization

coupled with globalization of the economy after 1980s, especially after

liberalization in 1991 had exposed the corporate sector to severe domestic and

global competition. This had been further accentuated by the reversionary

trends resulted in falling demand, which in turn resulted in overcapacity in

several sectors of the economy. Companies started to consolidate themselves in

areas of their core competence and divest those businesses where they do not

have any competitive advantage. It led to an era of corporate restructuring

through Mergers and Acquisitions in India. The structural adjustment program

and the new industrial policy adopted by the Government of India allowed

business houses to undertake

without restriction any program of expansion either by entering into a new

market or through expansion in an existing market. In that context, it also

appears that Indian business houses are increasingly resorting to mergers and

acquisitions as a means to growth. Apart from above mentioned motives like

Synergy effect, Economy of scale, Improved profitability, Market power etc.

there are numerous other qualitative and quantitative factors also that inspires

firms to resorts to this route of corporate growth like to limit competition,

utilization of under utilized capacity/ resources/ managerial skills, improved

assets turnover, inventory turnover, reduction in consumer surplus, overcome

the problem of slow growth and profitability in ones own industry, To establish

a transnational bridgehead without excessive startup cost to gain excess to a

foreign market, to circumvent Govt. regulations, empire building, to change P/E

ratio favorably.


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P/E ratio: is an important motive in this exercise, when P/E ratios of two

companies are different. When a firm with high P/E ratio acquires another firm

with low P/E ratio, the EPS of the buyer will increase. At the same time return

to the targets shareholder also increases. Here it is assumed that the P/E ratio of

the buyer will carry over to the combined firm. But, in real life P/E magic

works in the short run only. In the longer run, the lower growth of the5 seller

(which was reflected by its low P/E ratio) will depress the earning growth of the

buyer. (Weston, pp88/90)

PEG Ratio: Price earnings ratio/Expected growth rate in earnings. This ratio is

very useful for the shareholders of the acquirers company to know the value of

the deal. This ratio casts the value on the basis of growth rate prevalent in the

industry. Though there are many methods in use, the worth of the target firm

will depend on the way in which the acquirer utilizes the resources of the target

company for achieving the expected synergies.


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Value Strategy Framework M & A

Management Strategy Type of

M&A

Value Driver Type of

synergy

Some of the managerial skills

are transferable. So a company

with strong managerial skill will

be able to takeover a company

with inefficient or bad

management and improve

efficiency by replacing existing

management.

Horizontal

and

Vertical

Total Revenue

Gain by will

increase in

Market Share

Managerial


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The Company tries to turn itself

into a miniature of capital

market allocating cash from low

growth area to fields of higher

return.

Conglome

rate

Improving ROI

by increase in

revenue per unit

Financial

Company tries to make some

tax savings as the tax law

distinguishes between internally

and Externally generated funds.

Conglome

rate

Improving ROI

by increase in

revenue per unit

Financial

Better planning and

coordination, Reduction in

bargaining time and transaction

cost.

Vertical Increase in gross

margin by

reduction in total

cost and market

inefficiency

operating

Declining the marginal cost by

increasing the quantity of

product or improving the

operating efficiency through

economies of scale

Horizontal

and

Vertical

Increase in gross

margin by

reduction in

marginal cost

Operating

Reducing cost of capital

through reduction of risk

Conglome

rate

Reducing

unsystematic

Risk by portfolio

management.

Financial

Improving the imperfect market

valuation by paying lower price

for the target company as

Vertical or

Horizontal

or

Improving P/E

Ratio

Financial


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compared to its true value Conglome

rate

Efficiency theories under mergers suggest that mergers provide a mechanism by

which capital can be used with more efficiency and the productivity of the firm

can be increased through economies of scale. The theory of differential

efficiency states that if the management of the firm A is more efficient than

the management of the firm B, and if A acquires B, the efficiency of firm

B is likely to be brought up to the level of A. According to this theory, the

increased efficiency of firm "B" is considered the outcome of merger.

Another important, theory of mergers is the synergy theory, which states that

when two firms combine, they should be able to produce a greater effect

together than what the two operating independently could. It refers to the

phenomenon of two plus two becoming five. This synergy could be financial

synergy or operating synergy.


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

Where: V (A+B): Value of the combined firm

V (A): Value of firm A

V (B): Value of firm B

A merger of two firms should invariably result in a positive i.e., it should

result in increased volume of revenue from the combined sales or decreased

operating cost or decreased investment requirements (Ansoff, 19881). If the

effect is neutral, i.e., no change is effected over the standalone positions, the

whole labor of merger exercise would go waste. On the other hand, if the

combined effect is "negative," the merger may even prove fatal later.

The increased outflows from the merged entity over that of the total output of

the units when they were operating individually is more due to operation of

either economies of scale or economies of scope. The nature of economies

of scale could vary: Some mergers look for cost-based economies of scale,

some may look for revenue based economies of scale, safety net-based

economies of scale, defense-based scale of economies, etc. Similarly,

economies of scope is also varied in nature:

Cost-based economies of scope, as a natural corollary to the underlying logic of

mergers, the stakeholders of business firms do expect positive outflows from

mergers and acquisitions. They are indeed resorted to with a hope: that mergers

result in:


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Reduction in Expenses: A merger must result in adoption of new technologies,

goals, strategies, and operational approaches in such a way that they

cumulatively lead to cost reduction in delivering the services and thereby make

the merged-entity more competitive in garnering increased sales and net

margins.

Enhanced Market Power and Reduced Earnings Volatility: It is obvious

that the acquired business should either add to the market share of the company

or create a fresh niche market of its own, so that volatility in earnings can be

minimized and profitability is sustained. Earnings are sustained only when sales

performance constantly improves and that is where mergers come handy

creating that extra edge over the competitors with the least loss oftime.

Extra Capital: The need for capital is another motive which leads to mergers

and acquisitions. This could be best appreciated from the recent merger

proposition announced by the Aditya Birla group that includes merger of

diversified group companies such as Indo Gulf Fertilizers, Birla Sun life, Birla

Financial Services with Indian Rayon-all with an objective to make the surplus

cash of Indo Gulf Fertilizers available to businesses engaged in offering

financial services for expansion. The need for such mergers is all the more

essential in the banking sector, where mandatory capital requirements are on the

rise with the proposed Basel II.

Smooth Privatization: The ongoing sovereigns love for deregulation and

privatization resulted in cross-border movement of capital-mostly into

developing economies for acquiring controlling interests in companies being

privatized. Indeed, many developing countries could attract fresh capital and


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modern technology into their otherwise obsolete public sector businesses and

make them competitive through cross-border mergers/ acquisitions.

Competency Buildup: In today's deregulated markets, competency of

domestic businesses has become a must, to face the onslaught from

multinationals. In this regard mergers have come handy for consolidation and

buildup of requisite economies of scale and economies of scope, to

maintain the revenue stream with least volatility.

Mergers: Why they Fail?

All the hype that usually surrounds the pre-merger phase suddenly dissipates

once the merged entity becomes a reality and problems surface. It perhaps ever

remains an enigma as to why and how the much sought after merger suddenly

threatens the very proponents of merger with unforeseen challenges. The

empirical studies/findings of Kavita Pathak and JV Vaishampayan (20052)

carried out on companies such as Sun Pharmaceuticals, Wockhardt, Nicholas

Piramal, Ranbaxy, etc, reveal that the synergy theory does not hold good in the

merger and acquisition scenario of India. It is, however, very difficult to

precisely define what makes a merger to fail since its complex nature makes it

impossible to fix a single answer fitting all situations. But one can certainly

trace the road map that led to failures of a merger on the following lines: Failure

to Anticipate a Problem before the Problem Actually Arises Managements

may unwittingly administer a merger process hoping to reap synergy or they


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may initiate a disastrous step hoping to bring cultural fusion between the

acquired and the acquirer. One common underlying reason behind these acts

could be that the acquirer firm may have no experience of such problems and

thus are not sensitized to such probabilities.

Ex: Deutsche Dresdner Bank (Merger Failure)

The merger that was announced on March 7, 2000 between Deutsche Bank and

Dresdner Bank, Germanys largest and the third largest bank respectively was

considered as Germanys response to increasingly tough competition markets.

The merger was to create the most powerful banking group in the world with

the balance sheet total of nearly 2.5 trillion marks and a stock market value

around 150 billion marks. This would put the merged bank for ahead of the

second largest banking group, U.S. based Citigroup, with a balance sheet total

amounting to 1.2 trillion marks and also in front of the planned Japanese book

mergers of Sumitomo and Sukura Bank with 1.7 trillion marks as the balance

sheet total. The new banking group intended to spin off its retail banking which


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was not making much profit in both the banks and costly, extensive network of

bank branches associated with it.

The merged bank was to retain the name Deutsche Bank but adopted the

Dresdner Banks green corporate color in its logo. The future core business

lines of the new merged Bank included investment Banking, asset management,

where the new banking group was hoped to outside the traditionally dominant

Swiss Bank, Security and loan banking and finally financially corporate clients

ranging from major industrial corporation to the mid-scale companies. With this

kind of merger, the new bank would have reached the no.1 position of the US

and create new dimensions of aggressiveness in the international mergers. But

barely 2 months after announcing their agreement to form the largest bank in

the world, had negotiations for a merger between Deutsche and Dresdner Bank

failed on April 5, 2000.

The main issue of the failure was Dresdner Banks investment arm, Kleinwort

Benson, which the executive committee of the bank did not want to relinquish

under any circumstances. In the preliminary negotiations it had been agreed that

Kleinwort Benson would be integrated into the merged bank. But from the

outset these considerations encountered resistance from the asset management

division, which was Deutsche Banks investment arm. Deutsche Banks asset

management had only integrated with Londons investment group Morgan

Grenfell and the American Bankers trust. This division alone contributed over

60% of Deutsche Banks profit.The top people at the asset management were not ready to undertake a new

process of integration with Kleinwort Benson. So there was only one option left

with the Dresdner Bank i.e. to sell Kleinwort Benson completely. However


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Walter, the chairman of the Dresdner Bank was not prepared for this. This led

to the withdrawal of the Dresdner Bank from the merger negotiations.

In economic and political circles, the planned merger was celebrated as

Germanys advance into the premier league of the international financial

markets. But the failure of the merger led to the disaster of Germany as the

financial center.

TATA TETLEY (Controversial Issue over Success And Failure).

The Tata group was infusing a fresh 30 million pounds into Tata tea that had

been used to buy an 85.7% stake in the UK-based Tetley last year. Already high

on a heady brew of a fresh buy and caffeine, most missed what Krishna

Kumar's statement meant.

Tata Teas much hyped acquisition of Tetley, one of the worlds biggest tea

brands, isnt proceeding according to the plan. 15 months ago, the Kolkatabased Rs 913 crore Tata Teas buyout of the privately held The Tetley Group

for Rs 1843 crore had stunned corporate watchers and investment bankers alike.

It was a coup! An Indian company had used a leveraged buyout to snag one of


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the Britains biggest ever brands. It was by far, the biggest ever leveraged

buyout by an Indian company.

Tata Tea didnt pay cash upfront. Instead, it invested 70 million pounds as

equity capital to set up Tata Tea. It borrowed 235 million to buy the Tetley

stake. The plan was that Tetleys cash flows would be insulated from the debt

burden.

When Tata Tea took the big gamble to buy Tetley, its intent was very clear. The

company had established a firm foothold in the domestic market and had a

controlling position in growing tea. Going global looked like the obvious thing

to do. With Tetley, the second largest brand after Lipton in its bag, Tata Tea

looked ready to set the Thames on fire.

Right from the start, Tetley was never a easy buy. In 1996, Allied Domecq, the

liquor and retail conglomerate had put Tetley on the block. Even then Tata Tea,

nestle, Unilever and Sara lee had put in bids, all under 200 million pounds,

Allied wanted to cash on the table. Tata Tea didnt have enough of its own. The

others bids also did not go through. Eventually, Tetley group together with a

consortium of financial investors like Prudential and Schroder bought the entire

equity stake for 190 million pounds in all cash deal. Two years later, Tetley

went for an IPO, hoping to raise 350-400 million pounds. But the IPO never

took place. Soon afterwards, the investors began looking for exit options. Tetley

was once again on the block.

It was until Feb 2000 that the due diligence was completed. By this time, the

Tata's were ready with their offer. They would pay 271 million pounds to buy

the entire Tetley equity and the funds would go towards first paying off Tetleys

106 million debt. The balance would go the owners.


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The offer price did not include rights to Tetley coffee business, which was sold

to the US-based Rowland Coffee Roasters and Mother Parkers Tea and Coffee

in Feb 2000 for 55 million pounds.

For Tetley new owners, too, the problems were only just beginning. The deal

hinged on Tetleys ability, over and above covering its own debts, to service the

loans Tata Tea had taken for the acquisition. Thats where reality bites.

Consider the facts. When Tata Tea acquired Tetley through Tata Tea, it sunk in

70 million pounds as equity and borrowed 235 million pounds fro ma

consortium to finance the deal. Implicit in the LBO was that Tetleys future

cash flows would fund the SPVs interest and principal repayment

requirements. At an average interest rate of 11.5%, Tetley needed to generate

22 million pounds in interest alone on a loan o 190 million pounds. Add to this

the interest on the high cost vendor loan notes of 30 million poundsit worked

out to be 4.5 million and the charges on the working capital portion, amounting

to 2 million pounds per annum. All this works out to about 28 million pounds in

interest alone per year.

At the same time, it also has to pay back the principal of 110 million pounds

over a nice period through half yearly installments. This works out to 12 million

pounds per year. If you were to assume that depreciation and restructuring

charges were pegged at last years levels, the bill tots up to 48 million pounds a

year. In FY 1999, the Tetleys cash flows were 29 million pounds.

Some of the problems could have been obviated if Tetleys cash flows had

increased by 40 % in FY 2001 over the previous year. That way, the company

would have covered both its own commitments as well as of the Tata's. But the


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situation worsened. Major UK retailers clamped down on grocery prices last

year. That substantially reduced Tetleys pricing flexibility.

Besides, the UK tea markets have been under pressure for some time now.

According to the UK governments national food survey, there has been a

substantial fall in the consumption of mainstream teas- tea-bag black teas drunk

with milk and sugar. Also the tea drinking population in UK has come down

from 77.1% to 68.3% in 1999. On the other hand, natural juices and coffee have

consistently increased their market share.

So, when it was confronted by Tetleys sliding performance, what options did

Tata Tea have? On its own, it could not do much. The last year has been one of

the worst years for the Indian tea industry and Tata Tea has also been affected.

The drop in tea prices and a proliferation of smaller brands in the organized

segment have taken toll on Tata Teas performance. In FY 2001, Tata Teas net

profit fell by 19.59% from Rs 124.63 crore to Rs 100.21 crore. Income from

operations declined by 8.72%.

But letting Tetley sink under the weight of the interest burden would have been

an unthinkable option, given the prestige attached to the deal.

Thus from the above case we infer that Tata had to shell out a lot of money to

cover all the debts of Tetley which was found not worthy enough by the general

public.

But Tata still calls it to be a success whereas in reality it is a failure.


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Objective:

Theoretically it is assumed that Mergers and Acquisitions improve the

performance of the company because of Synergy effect, increased market

power, Operational economy, Financial Economy, Economy of Scales etc. But

does it really improve the performance in short run as well as long run. Various

studies have already been done on this matter. Most of these studies are related

to European countries or US market. We can find hardly few studies of these

kinds in Indian context. So I made an attempt to analyse the impact of M&A on

the performance of the companies in Indian context.

Scope:


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The scope of the study is limited to the 40 Indian companies which are merged

during the past five years and the statistical measure used is T-test: paired two

samples for means.

Hypothesis:

Mergers and amalgamations do not always improve the performance of the

company.

Limitations:

Although the results obtained through this study are acceptable in light of the

previous study, yet there are few limitations of this study. And my discussion

would not be complete if I do not list them here. These limitations includes;

First, my study included results of only two years which may not provide the

true picture, especially in case of post merger results, because generally a

merger activity takes around 6months to 2years to deliver results. Second, there

are various other variable that should have been included in my study like:

Assets turnover, Inventory turnover, Market power/Market Share, Cost of


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Capital, EPS, Rate of increase in capital stock etc., but due to the time

constraint and non-availability of data I could not include them in my study.

Third, Sample size should have been wider.

CHAPTER: 2


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REVIEW OF LITERATURE

Literature Survey:

The literature in the area of mergers and acquisition is rich in terms of data and

of techniques employed. But, the results are disappointing since there is no

convergence as expected but only divergence in the prior research works with

regard to the reason to which the Corporate opt for their marriage. Most

academic studies follow one of the two approaches to estimate and evaluate the

significance of merger-related gains. The first compares the pre-merger and

post-merger performance of institutions using accounting data to determine


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whether consolidation leads to changes in reported costs, revenue or profit

figures. They suggest that mergers may alter the level of profits of a firm either

because it alters the monopoly power (the market power) or alters the efficiency

or both. However, these two changes affect consumers' surplus differently;

while the decrease in cost raises consumers' surplus, the increase in market

power lowers it. As market power hardly falls after M&A, the consumers are

most likely to lose from merger if it is not cost reducing. Therefore, if a merger

does not increase profit, it most likely does not increase consumers' surplus.

Hence, the necessary condition for merger to be socially desirable is that it

increases profitability. Hence a firm's post-merger operating performance is one

indicator of the synergy gain that is generated by a merger or an acquisition. A

second research stream based on event study methodology has used market-

based measures to compare the performance characteristics of acquisitions

under different diversification strategies (Mandelker, 1974; Jensen, 1984;

Ravenscraft and Scherer, 1987).

According to this group of researchers, the concept of economic value is

consistent with that of financial economists, so the value in the context of

merger should be reflected in the stock price of the firms (Singh and

Montgomery, 1987). Fundamental to this belief is the basic assumption of the

efficient market hypothesis, namely the share price which I would react in a

timely and unbiased manner, to any new information. In an efficient market, all

future benefits of a merger are ful1y anticipated and they are incorporated

instantaneously into the acquiring firm's stock price at the time the merger is

consummated (Lubatkin, 1983). The share price reactions do seem to reflect the

rational behavior (Roll, 1986) and can identify the expected present value of the

cash flows resulting from the restructuring activity (Seth, 1990). Hence a firm's


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post-merger share price performance is one indicator of the synergy gain that is

generated by a merger or an acquisition and the merger as a corporate strategy

can be evaluated when the long-term effect of mergers on the firm's share price

performance is considered. The conclusion that can be drawn from the earlier

studies is that, mergers harm acquiring firm's shareholders becomes stronger,

when the effect of mergers as the change in performance of the acquiring firm's

share price, upon and following the merger announcements. Gains by many

measures are either small or non-existent. The results obtained are

overwhelmingly unsupportive of the value effects. Both accounting and event

Studies offer no evidence of value gains. The average merger has either no

effect on total firm value or a slightly negative one. In all the previous research

studies there is no convergence as expected, but only divergence thereby

meaning either defects in conceptual framework or methodological framework,

or proper codification of empirical findings. Since the conceptual framework

sounds logical, an attempt is made here to have a close examination of the

methodology .adopted in all the three types of empirical research.

All the theories of mergers can be summarized into three categories. First

category is the category of Synergy; it says that total value from the

combination is greater than the sum of the values of individual firms. The

second category (Hubris) says that total value from the merger is zero. This

happens because of the mistake of the bidder to overpay for merger. Third

category of merger theories says that total value from merger is negative. This

is the result of the mistakes of the manager who put their own preferences

above the well being of the firm.


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Several studies have been done on the relationship between M&A and

performance of the company. Using a variety of financial measures (e.g. Profit,

Stock price) and non-financial measures (e.g. firms reputation) and time frame

(e.g. pre-measurement and post measurement, initial market reaction etc.).

These studies show that on average, M&A consistently benefits the targets

shareholders, but not the acquirers shareholders. In fact, there are varying

results with respect to the buying firms performance. (Schweiger, pp4) There

are two types of empirical studies on M&A performance. One is event Studies

by comparing share prices before and after the merger. Even though there are

numerous studies but there results are consistent. The target firms shareholders

benefit and the bidder firms shareholders generally break even. The combined

gain is mostly positive. Another type of empirical studies includes those which

compare individual firms profit few years before and after the merger. Results

from these studies are more complex due to difference in methodology. For

example, some studies concern absolute performance, while other concern

relative performance. However a general conclusion is that most mergers

reduce profitability.

One empirical study done on the basis of stock market prices in the US shows

that around the announcement date of the transaction average return to target

firms shareholders are about 30%. In contrast the shareholders of the acquiring

firms generally show returns that range from slightly negative to modestly

positive around the announcement date. M&A, however under perform their

industry peers or shareholder value over a longer time horizon. Other empirical

studies that concentrated on the efficiency measurement pre and post mergers

revealed that changes in ownership are associated with significant

improvements in total factor productivity. Evidences suggest that M&A


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activities tends to benefit society because it results in an increase in

shareholders value of both target and acquiring companies without increasing

concentration. The increase in related to improve operating efficiency of the

combined firms. (H.R. Machiraju, page 170).

A study done by J. Fred Weston and Samual C. Weaver shows that around 50%

mergers are successful in terms of creation of values for shareholders.

Anslinger and Copeland (1996) studied returns to shareholders in unrelated

acquisition covering the 1985 to 1995 and they found that in two third cases

companies were failed to earn their cost of acquisition. In 1993 Berkovitch and

Narayanan conducted a study on the gain and concluded that total gains from

M&A are always positive and thus can say that synergy appears. Vin (1996)

and Schwert conducted an event study for a period of forty days prior merger to

40 days post merger and concluded that Merged firms were under performing

than their industry counterparts. Healy, Palepu and Ruback (1992) studied post

merger performance of 50 largest US merger between 1979-1984 for both

operating and investment characteristic using industry adjusted technique and

concluded that as a

result of merger Assets turnover and Return on market value of assets improved

but investment in capital goods and R&D expenditures not improved

significantly. In 1992 Agarwal, Jaffe and Mandelkar also studied post merger

performance of the companies with a different perspective. They adjusted data

for size effect and beta weighted market return and found that shareholders of

the acquiring firms experienced a wealth loss of about 10% over the period of

five years following the merger completion. According to a study done by

Loughran and Vijh (1997) for a period 1970 to 1989, five year buy and hold

return for sample was 88.2% compared to 94.7% for their matching firms. This


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has a statistic of 0.96, which was not significant. Berg, Duncan and Friedman

(1982) conducted a comprehensive cross-firm and cross industry analysis to

measure the effect of joint venture activities on the performance of the

companies and found ambiguous but positive short-term gains and insignificant

long-term impact on profitability. They further noted that even short-term gains

were negative for technological or knowledge-oriented acquisitions and were

positive for production and marketing oriented acquisitions, because of

increased market power leading to increased profit margins and efficiency

gains. They further found that while short term gains depend on industry to

industry, no industry (Out of 19 industries in their sample) show long-term

significant gain. Revenscraft and Scherer (1986) found that on average Mergers

and acquisitions made by over 450 US companies during 60-70s did not lead to

an increase of market shares and profitability but instead they found declining

performance for most companies. They also found that mergers did slightly

worse than their industry peers at the time of acquisition, but results were

clearly poorer after about 10 years from acquisitions. Odagiri and Hase (1989)

found a growing number of Japanese firms engaging in mergers and

acquisitions. However they found no evidence that in general profitability or

growth improved significantly. Porter (1987) attempted to study this

relationship in a slightly different way. He took rate of divestment of new

acquisitions by companies within a few years as an indicator of success or

failure. He found that about 75 percent of all unrelated acquisition in the sample

was divested after few years and 60 percent of acquisitions in entirely new

industry.


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M.P.BIRLAINSTITUTEOFMANAGEMENT Page42CHAPTER: 3


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RESEARCH METHODOLOGY

METHODOLOGY:

There are two different tests to measure merger gains-Product market test and

Stock market test. The former measures the effect of mergers directly on

consumers and indirectly on stockholders of merging firms. The later measures

the effect of mergers directly on stockholders of merging firms and indirectly

on consumers. There is a linkage between the two. Abnormal Stock returns are

correlated with profit changes. This signifies that the stock market anticipates

profit changes and adjusts accordingly.


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To test the impact of Mergers on performance, there are various alternative

ways. Like, Event Studies, where we compare stock prices of the firms a certain

days before and after the mergers. Another way is Regression Analysis, where

we can take after tax rate of return as dependant variable and Size of the firm,

rate of increase in capital stock, R&D expenditures etc. as independent

variables. Third way is .T-test: Paired two samples for mean, which I am going

to use in this paper. I am selecting this test because so far we have studied this

test and the data that will be required for this test is available with me. In this

paper I test impact of mergers on the performance of the company in terms of

four parameters. ROCE, Economies of scale, Operating Synergy and Financial

Synergy. I used T test: Paired two samples for means.

To test the impact I selected a sample of 40 companies (pre merger and

resulting 19 companies after merger), which were merged during the last five

years. Source for all databases is Capitaline.

Company Target Company Merged Company

1. Mulbery Investments &Trading

Company

Camphor & Allied

Projects Ltd

2. J D Properties Ltd. B L B Ltd.

3. Alstom Power Builders Ltd. Astom Projects India

Ltd.


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4. Futura Polymers Ltd. Futura Polysters Ltd.

5. Hitech Drilling Services India Ltd. Aban Lyod Chiles

Offshore Ltd.

6. Motherson Automotives

Technologies & Engineering Ltd.

+

Motherson Sumi Electric Wires

Ltd.

Motherson Sumi

Systems Ltd.

7. Gujarat Propack Ltd. Cosmo Films Ltd.8. Cescon Ltd. C E S C Ltd.

9. Annapurna Foils Ltd. Indian Alluminium

Company Ltd.

10. Croydon Chemicals Works Ltd. Glaxo Smith Kline

Pharmaceuticals Ltd.

11. Alchemic OrganicsLtd. Aarti Industries Ltd.

12. Karnataka Petro Synthese Ltd. Gujarat Petrosyntheses

Ltd.

13. Kanthal India Ltd. Sandvik Asia Ltd.

14. Idea Space Financial Technologies

Pvt. Ltd.

Idea Space Solutions

Ltd.

15. Wartsilla Operrations &

Maintenance India Ltd.

Wartsilla India Ltd.


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16. Sandeep Traders & Investments

Ltd.

+

Stanrose Holdings Ltd.

Stanrose Mafatlal

Lubecham Ltd.

17. Shrinivas Fertilizers Ltd. Khaitan Chemicals &

Fertilizers Ltd.

18. Varinder Argo Chemicals Ltd. Abhishek Industries Ltd.

19. Zuari Leasing & Finance Corp.

Ltd.

Zuari Industries Ltd.

1. RETURN ON CAPITAL EMPLOYED

Here I test the overall impact of the mergers on the performance of the acquirer

company (or amalgamated Company). For, ROCE, I take PBIT (Profit before

Interest and Tax) minus Tax. And to calculate pre merge ROCE, I used

weighted Average. I first calculated weighted average ROCE for each year than

I take simple average of two years Wt. Average ROCE. Similarly I obtained

Wt. Average ROCE for post merger. Thus I obtained two series of ROCE; one

for Pre-merger and one for Postmerger.


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When I run the t-test on this series I obtained following results. Mean (pre) is

14.4126 against the Mean (Post) 14.9489. While variance are 184.6018(pre)

and 50.54995(post). I obtained statistic t-value 0.1348 against the critical t-

value 2.101. That shows that we can accept null hypothesis at 95% confidence

level. In other words mergers did not improve the performance of the

companies under study.

ROCE- Return on Capital Employed

Company Pre Post

1. 10.5 9.75

2. 28.78 7.4

3. -29.15 27.75

4. 13.76 8.13

5. 41.8 12.32

6. 24.4 21.5


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7. 11.85 23

8. 8.47 15.4

9. 10.53 13

10. 25.44 14.25

11. 20 22.4

12. 9.35 2.14

13. 13.5 16.91

14. 19.5 22.35

15. 18.73 22.6

16. 13.45 19.54

17. 15.83 6.1

18. 9.15 11.49

19. 7.95 8

RESULTS

Paired Samples Statistics

Mean N Std

Deviation

Std. Error

Mean

Pair1 Var1 14.4126 19 13.5868 3.1170

Var2 14.9489 19 7.1098 1.6311


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Paired Samples Correlations

N Correlation Std. Error Mean

Pair1 Var1 & Var2 19 -0.2587 0.2141

Paired Samples Test

Paired

Diff.

Mean

Std.

Deviation

Std.

Error

Mean

95% Confidence

Interval of the

Difference

t df Sig.

(2tailed)

Lower Upper-0.5363 16.886 3.8739 -8.675 7.6024 .1348 18 0.891


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2. TEST OF ECONOMIES OF SCALE HYPOTHESIS

Economy of scale refers to the cost reduction due to large number of units

produced. Because there are various fixed cost involved in the operation and per

unit cost component of such cost reduces when a firm produces more units.

This economy of scale also arises because merger increases the size of the firm,

so now firm become enabling to get better terms and conditions on purchases

i.e. ram material cost also decrease. For all these reasons, cost of production per

unit is taken as a measure of economies of scale. But due to unavailability of

number of units produced, I selected cost of production to produce per rupee

sale as a measure. When I run the t-test on the series (Average cost of

production/ sale for the companies pre-merger and post merger) I obtained t-

statistic 0.7348 against the critical t-value 2.101 at 95% confidence level. That

shows that companies under study did not achieved economies of scale.


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Company Pre Post

1. 7 4

2. 81 42

3. -34 0

4. -2 -3

5. 19 26

6. 5 12

7. 3 19

8. 3 13

9. 8 8

10. 8 12

11. 11 11

12. 9 13

13. 7 5

14. 18 16

15. 6 8

16. -2 5

17. 8 2

18. 5 12

19. 2 1


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RESULTS


Mean N Std

Deviation

Std. Error

Mean

Pair1 VAR1 8.5263 19 20.587 4.7229

VAR2 10.842 19 10.335 2.371


N Correlation SE(Mean)

Pair1 VAR1 &VAR2 19 0.827 0.0726

Paired Samples Test

Paired

Diff.

Mean

Std.

Deviation

Std.

Error

Mean

95% Confidence

Interval of the

Difference

t df Sig.

(2 tailed)

Lower Upper

2.3158 13.371 3.0675 -8.6850 7.896 .7348 18 0.46


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3. TEST OF OPERATING SYNERGY

It is assumed that merger improves the performance of the company, because it

helps to avoid the duplication of tasks like duplicating Advertisement Expenses,

Duplicating sales and Distribution expenses etc. This should results in

decreasing operating expenses and increasing operating profit. To test this

aspect I selected Operating Profit Margin as a criterion and take weighted

average of each year and simple average of these wt. Average OPM to calculate

pre and post OPM figures. When I run the t-test on this series, I obtained t-

statistic .1126 against the table value 2.101 at 95% confidence level. That

proved that mergers do not even contribute in the operating synergy, for the

sample under consideration


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NPM- Net Profit Margin

Company Pre Post1. 5 4

2. 47 12

3. -36 7

4. 6 -2

5. 16 5

6. 8 7

7. -3 13

8. -7 -2

9. 7 9

10. 10 7

11. 5 7

12. 7 2

13. 9 5

14. 4 7

15. 5 6

16. 0 3

17. 4 -1

18. -1 3

19. 0 1


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RESULTS


Mean N Std Deviation Std. Error Mean

Pair1 VAR1 4.5263 19 14.7512 3.3841

VAR2 4.8947 19 4.2018 0.9640


N Correlation Sig.

Pair1 VAR1&VAR2 19 0.2582 0.2141

Paired Samples Test

Paired

Diff.

t df Sig. (t)

Mean Std.

Deviation

Std.

Error

Mean

95% Confidence

Interval of the

Difference

Lower Upper

-0.3684 14.256 3.2706 -7.5384 6.1699 .1126 18 0.911


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4. TEST OF FINANCIAL SYNERGY

Theoretically it is also assumed that mergers provide the financial synergy.

According to Lewellen (1971), Higgins and Schall (1975), Galai and Masulis

(1976) and Kim and McConnell (1977) Mergers increases the debt capacity of

the firm, especially in case of diversified mergers, where cash flows of the two

companies are not positively correlated. This decreases lender.s risk and as a

result cost of capital decreases. Financial synergy can also be obtained by

reducing Interest or taking benefits of Tax shield and depreciation. To test the

financial synergy, I selected Net Profit Margin as a criteria and calculated Pre

and Post Net Profit Margin in the same way I calculated OPM. When I run t-

test on this series, our results were totally opposite to the theoretical

assumption. I obtained t-statistic 0.038 against the critical t-value 2.101 at 95%

confidence level. That proved that mergers even do not contribute in achieving

financial synergy.


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Cost/Sale

Company Pre Post

1. .8 .86

2. .11 .43

3. 1.12 .84

4. .87 .85

5. .41 .49

6. .79 .747. .8 .72

8. .82 .75

9. .71 .85

10. .73 .7

11. .92 .81

12. .72 .81

13. .79 .79

14. .39 .34

15. .82 .77

16. .69 .76

17. .79 .82

18. .84 .78

19. .86 .85


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RESULTS


Mean N Std Deviation Std.Error

Mean

Pair1 VAR1 .7358 19 .2208 .0507

VAR2 .7347 19 .1495 .0343


N Correlation Sig.

Pair1 VAR1&VAR2 19 0.858 0.0605

Paired Samples Test

Paired

Diff.

Mean

Std.

Deviat

ion

Std.

Error

Mean

95% Confidence

Interval of the

Difference

t df Sig.

(2-tail)

Lower Upper

.0011 0.1202 .0276 -8.7604 4.1288 0.038 18 0.97


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CHAPTER: 4

RESEARCH FINDINGS


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FINDINGS

Out of 19 set of companies:

1. More than 7 companies showed decline in return on capital employed.

2. More than 7 companies showed decline in operating profit margin.

3. More than 8 companies showed decline in net profit margin.

4. More than 7 companies showed increase in cost of production for per rupee

sale.

So over all outcomes is that, mergers and acquisitions does not always increase

the performance of the companies. So we can accept our hypotheses.


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CHAPTER: 5

CONCLUSION


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CONCLUSION:

This study proves that Merges have failed to contribute positively in the

performance of the company, especially for the sample under consideration. It

neither provides Economies of scale nor synergy effect. When I calculate

overall impact (i.e. ROCE), mergers were failed to provide any positive

contribution here also. In fact, these results are not surprising. They are in line

with what was expected on the basis of literature survey. But still here I would

like to add one thing. There are numerous motives that motivate a company to

enter in to merger activities. Some times these motives are qualitative and cannot be interpreted in to quantitative figures. Again, a

Merger may be effective or successful to deliver the immediate objective but

may be failed to deliver all the theoretically defined benefits. So, it will be

fallacious to assume, on the basis of this study, that overall mergers do not

contribute any thing to the companies and it is a useless exercise.


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CHAPTER: 6

BIBLIOGRAPHY


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References:

APPROACHES TO M&A - Jangaiah Paladi

Value creation through Mergers: The myth and Reality -Ashutosh Dash

IMPACT OF MERGERS AND AMALGAMATION Mahesh Kumar Tambi

ICFAI publications

www.wikipedia.org

www.icfai.org

www.google.com

Documents

Impact of M&A