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MERGER NEGOTIATIONS AND MECHANICS
Process of MERGER:
1. Search for a target company:
Whether a group firm (expansion) or a non-group firm (diversification)
The acquiring company may take help of various
agencies such as investment bank, financialinstitutions, professional experts etc. In India,
BIFR can help selecting a target firm.
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2. Primary investigations about the target firm
The suitability of a target firm can be analysed
using following types of analysis:
a. Financial analysis: to assess the financial
viability and profitability of the target firm.
b. Industry analysis: to assess the present andfuture position.
c. Management analysis: to assess the present
management.
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d. Economic analysis: to assess the competitive
condition, cyclical variations etc.
e. Marketing analysis: to assess the presentand future market shares, product life cycle
and marketing strategies.
f. Engineering analysis: to assess theproduction capacity, research and
development facilities and operating
economies etc.
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3.Selecting the Merger strategy
After selecting the target firm, the acquiring firm
then has to decide about the method ofmerger i.e. tender offer, hostile takeover etc.
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Financial evaluation of a merger proposal
An acquiring firm should pursue a merger only if itcreates some real economic values which may arisefrom any source such as better and ensured supply ofraw materials, better access to capital market, better
intensive distribution network, more efficientmanagement, greater market share, tax benefits etc.
The shareholders of the target firm will ordinarilydemand a price for their shares that reflects the firms
value. For the would-be purchaser, this price may behigh enough to negate the advantage of merger.
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The financial evaluation of a target candidate,
therefore, includes the determination of the
total consideration as well as the form ofpayment i.e., in cash or securities of the
acquiring firm.
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Aspects of financial evaluation:1. Determining the purchase price:
The following factors have a bearing on the value of a target
firm: Tangible and intangible assets of the target firm
Market/ realizable value of the assets.
Earnings of the firm
A comprehensive and analytical study of the combined effects ofthese factors will help determine the value of the firm. Themarket price of a share of the target firm can be a goodapproximation to find out the value of the firm. However,the market price of the share cannot be relied in many casesor may not be available at all.
(i) The market price of the share may be affected by insiderstrading
(ii) Sometimes, market price does not fully reflect the firmsfinancial and profitability position.
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The following approaches may be undertaken to assess the
value of the target firm.
1. Valuation based on assets:The acquiring firm purchases the target firm and therefore, itshould be ready to pay the worth of the latter. The value of
the firm may be defined as:
Value of all assetsLess: external liabilities
Net Assets or Value
The assets valuations of the target firm may be based on:
a) Book value of the assets: it is based upon the historicalvalues which may be irrelevant at present.
b) Realizable value of the assets: it gives a current and close
approximation to the worth of the target firm
Limitation of assets valuation approach?
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2. Valuation based on earnings:
The acquiring firm shows interest in taking over the target firm
for the synergistic efforts or growth of the new firm. The
estimate of future profits carry synergistic element in it.
Thus, the future expected earnings of the target firm give a
better valuation. These expected profits figures are however,
accounting figures and suffer from various limitations.
Hence, they should be converted into future cash flows byadjusting for non-cash items.
3. Dividend based Valuation:
4. CAPM based share valuation:5. Valuation based on cash flows: