Merger & acquisition

M&A is an inorganic growth strategy as compared to organic growth, M&A is a shortcut. However this shortcut is at same time costly. The acquirer justifies that the premium paid on grounds of SYNERGY

Synergy is the potential additional value resulting from M&A. It has been most used & misused rational for merger.

Source of Synergy:

1. Economics of scale
2. Avoidance of competition
3. Creation of monopoly power
4. Utilization of surplus fund complimentary resources
5. Tax shield
6. Improvement of marginal efficiency

Dubious reasons for merger

Diversification benefit: Shareholder can diversify at portfolio level

Boot strap effect: a high PE company acquiring a lower PE co resulting in higher post merger EPS which is just an illusion as post merger PE ratio should fall.

Type of mergers

1. Horizontal : Same business, same stage
2. Vertical: same business, different stage
3. Conglomerate: different & unrelated business (Risky)

Financial evaluation of merger proposal

Case I: Cash deal

VAB=VA + VB + synergy-cash

NPVA=VAB-VA

NPVB=cash-VB

NPVA + NPVB=Synergy

Case II: Stock deal

Exchange ratio (r) is the no. of share of A i.e. issued for every share of B. It may be fixed as follows:

Based on EPS: r = EPSA/EPSB

Based on Book value: r=BV of per share of B/BV per share of A

Based on MPS: r = PB/PA

Based on Intrinsic value: r= Intrinsic value B /IVA

XYZ Ltd., is considering merger with ABC Ltd. XYZ Ltd.’s shares are currently traded at Rs. 20. It has 2,50,000 shares outstanding and its earnings after taxes (EAT) amount to Rs. 5,00,000. ABC Ltd., has 1,25,000 shares outstanding; its current market price is Rs. 10 and its EAT are Rs. 1,25,000. The merger will be effected by means of a stock swap (exchange). ABC Ltd., has agreed to a plan under which XYZ Ltd., will offer the current market value of ABC Ltd.’s shares:

(i) What is the pre-merger earnings per share (EPS) and P/E ratios of both the companies?

(ii) If ABC Ltd.’s P/E ratio is 6.4, what is its current market price? What is the exchange ratio? What will XYZ Ltd.’s post-merger EPS be?

(iii) What should be the exchange ratio, if XYZ Ltd.’s pre-merger and post-merger EPS are to be the same? (10 marks)(May 2003)

The following information is provided related to the acquiring Firm Mark Limited and the target Firm Mask Limited:

	Firm Mark Ltd	Firm Mask Ltd
Earning after tax (Rs.)	2,000 lakhs	400 lakhs
Number of shares o/s	200 lakhs	100 lakhs
P/E ratio (times)	10	5

Required:

(i) What is the Swap Ratio based on current market prices?

(ii) What is the EPS of Mark Limited after acquisition?

(iii) What is the expected market price per share of Mark Limited after acquisition, assuming P/E ratio of Mark Limited remains unchanged?

(iv) Determine the market value of the merged firm.

(v) Calculate gain/loss for shareholders of the two independent companies after acquisition