Deal Structuring in M&A

Group 7Corporate Restructuring

Agenda

1. The Merger & Acquisition Process2. Deal Structuring Process3. Buyer4. Seller5. Combined Entity6. Payment Consideration7. Tax, Accounting and Legal Consideration

Course Layout: M&A & Other Restructuring Activities

Part IV:Stage - IIStage – I

Deal Structuring & Financing

Valuation of the Company

Purchase Agreement

Due Diligence

Comprehensive Documentation

Part V

Accounting, Legal & Tax

Considerations

Deal Closure

Exploiting Synergies

Post Merger Integrations

Engaging an Investment Bank

Motivations for M&A

Stage - III

Initial Memorandum to

Potential Investors

Financing Strategies

Valuing and Exploring Synergies

The Merger & Acquisition Process

Presentation to Investors

Major Components of Deal Structuring Process

1. Legal Structure of the Buyer2. Legal form of the Seller3. Post-closing organization4. Form of payment5. Legal Considerations6. Tax considerations7. Examples of a few Deals

Legal Structure of the Buyer• Different investment vehicles depending on Buyer Motivation

Acquirer’s Objective Potential Organization

Maximizing Control or Facilitating post closing Integration

Create a subsidiary

Minimizing or Sharing Risk Partnership / Joint Venture Holding Company

Gaining Control While Limiting Investment

Holding Company

Transferring Ownership Interest to Employees

Employee Stock Ownership Plan

Legal Structure of the Seller• The seller can either be a Private Company or a Public

Company• Different Legal Implications for each• Private Company can be acquired through a private deal• The deal can be structured to suit both the buyer and the

seller• For a public company, open offer is required to obtain

controlling stake• The shareholders must approve the transaction• Creeping Acquisition – Buying 5% a year to avoid open offer• Sale agreement is made in both cases• Level of Indemnities and Warranties also differ among deals

Post-Closing Organization

Significantly affecting the after tax proceeds to the target’s shareholders

• Purchase of Assets▫ Target becomes a Shell company with cash

• Purchase of Stocks▫ Target becomes a subsidiary of the buyer

• Merger Structure▫ Target merged with buyer or buyer’s subsidiary

Form of Payment

Cash (Capital Gains tax implications but not if the merged entity is Indian, Securities Transaction Tax, Stamp Duty, VAT)

Non-cash forms of payment

Common equity (Possible EPS dilution but defers tax liability)

Preferred equity (Lower shareholder risk in liquidation)

Convertible preferred stock (Incl. attributes of common & pref.)

Debt (secured and unsecured) (Lower risk in liquidation)

Some combination

Asset Aquisitions

• Cash for assets acquisition: Acquiring firm pays cash for target firm’s assets, accepting some, all, or none of target’s liabilities. ▫ If substantially all of its assets are acquired, target firm dissolves after paying off

any liabilities not assumed by acquirer and distributing any remaining assets and cash to its shareholders2

▫ Shareholders do not vote but are “cashed out”• Stock for assets acquisition: Acquirer issues shares for target’s assets, accepting

some, all, or none of target’s liabilities.▫ If acquirer buys all of target’s assets and assumes all of its liabilities, the

acquisition is equivalent to a merger. ▫ Target’s shareholders must approve the transaction if substantially all of its

assets are to be sold• Advantages/disadvantages:

▫ Allows acquirer to select only certain target assets and liabilities; asset write-up & no minority shareholders but lose tax attributes and assets not specified in contract and incur transfer taxes

Stock Acquisitions

• Cash for stock acquisitions: ▫ Acquirer buys target’s stock with cash directly from target’s shareholders and

operates target as a wholly- or partially-owned (if < 100% of target shares acquired) subsidiary

• Stock for stock acquisitions: ▫ Acquirer buys target’s stock directly from target’s shareholders, generally

operating target in a parent/subsidiary structure• Advantages/disadvantages:

▫ Eliminates need for target shareholder vote (buying from target shareholders); tax attributes, licenses, and contracts transfer to acquirer; and may insulate parent from subsidiary creditors but responsible for all liabilities and have minority shareholders

Legal Considerations

Broad Legal Issues involved in M&A

• SEBI Takeover Regulations• Exchange Control Issues• Competition Act• Tax Implications

• Due Diligence & Contractual Issues

Condition PrecedentManagement and ControlIntellectual Property RightsNon-Compete ClauseDeadlock provisionConfidential InformationSurvival Clause

Tax Considerations

Capital Gains Impact to Sellers:• Gains arising out of the transfer of capital assets, including shares, are taxed• If the resultant company in the scheme of amalgamation or demerger is an Indian

Company, then the company is exempted from paying capital gains tax on the Transfer of Capital Assets

Tax on Transfer of Share :• Transfer of Shares may attract Securities Transaction Tax and Stamp Duty• However, no stamp duty when the shares are in dematerialized form

Tax on Transfer of Assets/Business – Tax on transfer of property generally levied by states• Immovable Property –Stamp Duty and Registration fee on the instrument of transfer• Movable Property –VAT (determined by the State) and Stamp Duty on the instrument

of transfer

Tax Considerations

Tax on Transfer of Liabilities:• Income Tax - Predecessor liable till date of restructuring• Central Excise Tax - In case of transfer of business to another person,

the successor takes a fresh registration, the predecessor applies for deregistration. The predecessor’s CENVAT Credit could be transferred.

• Service Tax - Similar to Central Excise Tax provision• Value Added Tax – Usually, the obligation of the predecessor and the

successor is joint and several

Availability of Past Tax Losses: Restrictions on ability to set-off brought forward unabsorbed losses in case of a change in shareholding (exceeding 49%) of closely held companies

Capital Gains Tax - The Vodafone Case

In Feb, 2007, Vodafone, through its Netherlands entity, entered into an agreement with Hutchison Telecommunications International Limited,

Cayman Islands (‘HTIL’), for acquisition of a total of 66.9848% equity and interests

in the Indian telecom business of Hutchison Essar Ltd. The total value of the transaction-

$ 11.206 billion.

The Vodafone Tax Issue

Allegation by the Indian Tax Department: Vodafone, the buyer, failed to deduct Indian tax on the

payment of consideration made to HTIL Show cause notice was issued to Vodafone BV in

September 2007 for failure to withhold the tax Issue went to Bombay High Court

The Bombay High Court Verdict

The Bombay High Court held that share transfer had a significant nexus with India

“The essence of the transaction was a change in the controlling interest in HEL which constituted a source of income in India.

The Petitioner (Vodafone) by the diverse agreements that it entered into has a nexus with Indian jurisdiction.”

In September 2010, the HC dismissed the writ petition filed by Vodafone, judged in favour of IT department.

The total tax impact of the transaction is considered over Rs 11,000 cr.

Vodafone filed an appeal before the Supreme Court

The Supreme Court Verdict

Based on two key independent arguments, the highest court concluded that there was no merit in the High Court's verdict.

Firstly, the transaction between Vodafone and Hutch was a share transfer (sale) rather than a transfer of capital assets and the ownership of the capital assets remained vested in the Indian company.

The Supreme Court Verdict (cont.)

Rationale: The legal distinction between a company and its shareholders,

and that two companies have distinct identities even if one held a controlling share in the other (holding and subsidiary)

Thus, no distinction between shareholding that constituted a controlling interest and that which was a pure financial investment

The fact that the shares actually transferred were not of the company located in India but of offshore companies that ultimately controlled the shares that constituted the controlling interest in the Indian company becomes immaterial

The Supreme Court Verdict (cont.)

Secondly, it argues for a "look at" test in which tax authorities consider the entire Hutchison structure holistically and not adopt a "dissecting approach“

Meaning: The authorities should not ask whether the transaction is a tax avoidance method, but apply the "look at" test to ascertain its legal nature.

The Supreme Court Verdict (cont.)

The Supreme Court was not in favour of the High Court's "look through" (where the property is situated) test

Reason: It claimed this was inconsistent with the need for certainty and consistency of tax policies that are crucial for taxpayers' confidence, especially foreign investors

The Supreme Court Verdict (cont.)

The SC felt that the structuring of the transfer of control from Hutch to Vodafone was not done with the specific intention of avoiding taxes

Hence the corporate veil need not be pierced (“look-through” approach need not be adopted)

The fact that there was a transfer of control from Hutch to Vodafone must be ignored.

The tax authorities should concern themselves only with the corporate structure or "form" of a merger deal, and not the "substance" of what assets are changing hands

Implication of the SC Verdict

The Court Direction: Examine whether the means of evasion was originally intended for this

purpose In this case, the subject was the CGP, Hutchison's Cayman Islands unit

Ruling: Hutchison made its investments in India several years before this deal During that period CGP existed Hence, the purpose of the creation of the latter is not to be seen as

primarily to avoid capital gains Meaning:

Establish that a mechanism was not originally created with the intention of avoiding taxes

Then, it does not matter if it eventually led to such a consequence

Regulatory Impact

This case has made the Union Government of India and the Tax Department come up with GAAR as in line with other countries

Reason: So that these kinds of issues does not get contradicted No loss in tax collections is suffered by the Government

Recently, the Government delayed the implementation of GAAR to 2016 to boost investor confidence and attract capital inflows

Tata Steel – Corus [Deal & Timeline]

• Operating profits $840 mn Tata Steel, $860 mn Corus (2006)• Capacity 5.3 MT, 18.6 MT

• 5th October 2006, Tata Steel offers 455p per share, values Corus at $8.04 bn• 20th October 2006, Corus accepts 455p per share in cash deal

--Criticism of Corus on accepting offer, pretext: offer very low--• 18th November 2006, CSN (Brazil) offers 475p per share in cash deal

• 18th December 2006, 500p per share Tata Steel, and 515p per share CSN--Takeover panel (UK) asks for revised bids by 30th January 2007--

• 31st January 2007, Tata Steel offers 608p per share, deal accepted• Tata Steel’s Scheme of Arrangement voted for by Corus on 7th March 2007

• 100% cash acquisition, final valuation of Corus at$11,653 mn

• 33.6% premium over 1st offer, 49% premium over previous market price

Tata Steel – Corus [Financing]

Tata Steel Ltd (India)

Tata Steel Asia Holdings Pte Ltd (Singapore)

Tulip UK Holdings (UK)

Tata Steel UK Ltd (UK)

Corus Group Plc (UK)

• Internal Generation $1,267 mn• ECBs $500 mn• Rights issue proceeds $1,888 mn• Foreign Equity offering $445 mn

• Non-recourse debt by bank consortium for Tata Steel UK $6,143 mn (both senior and high yield amortizing loans)

• Bridge finance raised by Tata Steel Asia Singapore as quasi equity $1,410 mn

• Total debt amount = $8,053 mn• Almost two-third leveraged, one-third cash

outflow

Tata Steel (India)’s equity Infusion ($4100 mn) into Tata

Steel Asia Hondings (Singapore)

100% subsidiary

100% subsidiary

100% subsidiary

Tata Steel – Corus [Summary Factors]

• Could not raise large amount of debt in India cheaply ▫ => bank lending in UK

• Reduce corporate tax and outgo on purchases and capital gains ▫ => holding company in Singapore

• Control outflow of funds in foreign currency acquisition ▫ => bought GBP call / USD put options

• Can’t obtain all shareholders’ approvals ▫ => seek ‘scheme of arrangement’ (75% shareholders by value)

• Target much larger than acquirer (market cap 21% larger)▫ => highly leveraged cash deal

Tata Steel – Corus [Effect of Stock Dilution]

Indian companies don’t have to account for future dilutions even if cash flow occurs in current balance sheet

• Total additional debt raised $8,053 mn• Post-tax cost of debt @ 4.3% (Tata Steel, FY2007 Annual Report) = $346.28 mn

▫ INR 1506.3 cr at 31.03.07 INR / USD rate

• Tata Steel net income (y-o-y for q3, FY2007) = INR 3901 cr• EPS of INR 67.21, P/E of 7.5

▫ 58.05 cr outstanding shares

• Corus net income (last 4 quarters) = INR 3,013 cr• Add up net profits, less cost of servicing debt = INR 5,408 cr• Shares already issued and new rights issues to be exercised

▫ Additional 33.7 cr shares in market

• EPS INR 58 per share, P/E of 8.81• Reported EPS INR 73.76, P/E of 6.1 (Annual Report 2007)• Since these dilutions not accounted for, Tata Steel actually overvalued post acquisition

Thank You