Concepts of Mergers and Acquisitions

Introduction

“The phrase Mergers and Acquisitions refers to the aspect of corporate strategy, corporate finance and management dealing with the buying and selling and combining of different companies that can aid, finance or help a growing company in a given industry grow rapidly without having to create another business entity”

The above sums up in a nutshell the concept of mergers and acquisitions. There are multiple reasons for companies to get into M&A activity whether to expand into a new market or geography, to gain market share in a current market, to overcome competition or for regulatory reasons as some governments make a tie up mandatory to operate in their local economy. However it is essential to mention that in the current economic scenario M&A has become an essential tool for companies to expand and grow, as successful M&A strategy can be a differentiating factor for successful organization.

The words and Mergers and Acquisitions are quite often used interchangeably in the current corporate world and hence can be seen in the project as well. Here is an attempt to list out some salient features which differentiate between the terms Mergers and Acquisitions.

Merger

A Merger can be descried as a combination of two companies into one larger company; such activities are normally voluntary in nature and involve a stock swap or cash payment to the target organization. Stock swaps allow the shareholders of both companies to share the risk involved in the deal. A merger normally results in a new company with a new brand and a new company name being created. Oxford Dictionary of Business defines mergers as “A combination of two or more businesses on an equal footing that results in the creation of a new reporting entity formed from the combining businesses. The shareholders of the combining entities mutually share the risks and rewards of the new entity and no one party to the merger obtains control over another.”

Acquisition

Acquisitions or takeover are different from Mergers. In the case of an acquisition a company unilaterally relinquishes its independence and adopts to the acquiring firms plans. As a legal point of view the target company ceases to exist as the buyer “swallows” the business.

Acquisitions have the following characteristics

• They are a part of a well-considered company development plan
• It is a unilateral process
• Top management structure will have fewer problems
• Contractual regulations are simpler
• Time taken for an acquisition is normally shorter than a merger.

However it is essential to mention here that whether a purchase is to be considered as merger or an acquisition actually depends on the whether the purchase is friendly or hostile or in the manner it is announced. The real difference hence lies in the way it is communicated and the way it is received by the shareholders, directors and employees of the target company.

History of M&A

Mergers and Acquisition movements were normally defined and associated with the behavior of US organizations. Various authors have tried to classify the merger movements into wave. The most prominent was Weston who in 1953 described three major periods of merger movements while studying the US business behavior.

Merger waves are a very generic way to describe the predominant strategy that was being adopted by organizations in that era. This has been interpreted by the different authors in different ways depending on how they have perceived by them. However it would be wrong to consider that all organizations followed the same strategy as described in the various.

The start or the first wave of the Merger movement is said to be have been post the Sherman Act in 1890. Prior to 1890 there was a predominance of the polypoly market structure, this was reduced post 1890 and partial monopolies started increasing.

The economic history has been divided into Merger Waves based on the merger activities in the business world as:

The Great Merger Movement was primarily a US business phenomenon from 1895 to 1905. It is said that during this time 1800 of small firms disappeared into consolidations with similar firms to form large, powerful institutions that dominated their markets. The relaxation of corporate laws in the United States helped the mergers, transportation and communication networks were developed which helped achieved economies of size.

The second wave (1916 to 1929) saw even greater activity in mergers. The motive behind these mergers was vertical integrations. Organizations tried to achieve technical gains and to avoid their dependence on other firms for raw materials.

The third wave saw the large conglomerates looking at diversification in the 60’s. the process actually reached its zenith during the merge wave and was carried to its logical extreme by the conglomerate firms that rose to prominence during that time.

The fourth wave in 90s saw increase in hostile takeovers and corporate raiding by the large firms. This was a wave during which vulnerable companies were grabbed up by the larger firms.

The fifth wave has been categorized as starting from the year 2000 onwards and has seen a trend of increase in Cross border acquisitions. The rise of globalization has seen increased the market for cross border M&A. This rapid increase has taken many M&A firms by surprise as most of them never used to consider this due to the complexity involved in cross border M&A. The success of these acquisitions was also limited and we saw a vast majority of them failing. Even then in 1997 alone there were over 2300 cross border acquisition worth a total of approximately $298 Million.

Source: Boston Consulting Group Research Report “ The Brave New World of M&A-How to Create value from M&A”, July 2007

Types of Mergers and Acquisitions

There are various types of mergers and acquisitions depending on the type of the business structure. The classification can be based on the type of companies merging or by the way the M&A deal is being financed.

Here is some type of mergers on the basis of the relationship between the two companies that are merging:

• Horizontal Merger- This type or a merger is between two companies that share the same product line and markets and are in direct competition with each other
• Vertical Merger – This is between a customer and company of between a supplier and a company
• Market Extension Merger – This between two companies that sell the same products in different geographies or markets
• Product Extension Merger – This is between two companies that are selling different but related products in the same market.
• Circular Merger – A circular merger is very similar to a product extension merger however in this case the products being sold are completely unrelated. The merger brings in benefits by utilizing the same channels for marketing these unrelated products, allowing shared dealerships. An example of this kind of a merger is of McLeod Russel (A Team company) with Eveready Industries ( A batteries company) in 1997. McLeod Russel however was de-merged from Eveready in 2005.
• Conglomeration – This type of a merger is between two companies that have no common business areas.

Mergers can also be classified depending on how the merger is being financed as described below

• Purchase Mergers – This kind of a merger occurs when a company purchases another. The purchase is made through cash or through the issue of a debt instrument.
• Consolidation Mergers – In this type of a merger a new company is formed and both the companies are bought and combined under the new entity.

Type of acquisitions can be described as below

• Amalgamation – In this type of an acquisition a new corporation is created by uniting the companies voluntarily.
• Acquisition/Takeover – In this form one company acquires another companies total or controlling interest. The acquired company either operates as a subsidiary or can be liquidated completely.
• Sale of Assets – A company can sell off all its assets to another and cease to exist.
• Holding Company Acquisition – This involves the acquisition of either the total or majority of a firm’s stock by a company. The purpose of this form is mainly to gain management control of other companies
• Reverse Merger – In this form of an acquisition a private company with strong prospects buys a publicly listed shell company, usually one with no business or limited assets. This helps the private company to get publicly listed in a short span of time.

All mergers though have one common goal and that is to create a synergy between two companies which makes the value of the combined companies to be greater than the sum of the two companies

M&A Process

M&A process can be laid down in 3 basic phases:

First Phase – Start with an Offer

The acquiring firm once decides that they want to do a merger of acquisition, they start with an offer. The acquiring company starts working with financial advisors and investment bankers to initiate contact with the target company. The acquiring must have a strategy for a merger programme, formulated by company management and approved by the director and majority stockholders. The acquiring company also at this point does a soft due diligence with the help of publicly available data and financial advisors. The purpose of this is to arrive at an overall price that the acquiring company is willing to pay for its target in cash, shares or both.

Second Phase – Target’s Response

Once the offer has been made the target company can do one of several things mentioned below.

Accept the offer

If the target companies top management and shareholders are happy with the offer they can simply accept the offer and go ahead with the deal.

Attempt to Negotiate

If the target company management and shareholders are not satisfied with the offer they might try and work out more agreeable terms with the acquiring company. Since a lot is stake for the management of the target i.e. their jobs in particular, they might want to work out better deal to keep their jobs or leave with a big compensations package. Target companies which are highly sought after with multiple bidders would obviously have a better chance of negotiating a sweeter deal. Even manager who are crucial to the operation of an organization have a better chance of success into negotiating a good deal for them.

Execute a Poison Pill or similar Hostile Takeover Defense

A poison pill can be initiated by a target company if it observers a potential hostile suitor acquiring a predetermined percentage of Target company stock. To execute its defense, the target company grants all shareholders – except the acquiring company – options to buy additional stock at a dramatic discount. This dilutes the acquiring company’s share and thwarts the potential hostile takeover attempt.

Find a White Knight

In this alternative a target company seeks out a friendlier company as a potential acquiring company. The friendlier company would offer an equal or higher price with better terms as compared to a hostile takeover bid.

Third Phase or Closing the Deal

Once the target company accepts the offer and all the regulatory requirements are met then the deal would be executed. The acquiring company will them pay for the target companies shares with cash, stock or both.

A cash-for-stock transaction is fairly straightforward: target company shareholders receive a cash payment for each share purchased. When a company is purchased with stock, new shares from the acquiring company’sstock are issued directly to the target company’s shareholders, or the new shares are sent to a broker who manages them for target company shareholders

GROWTH STRATEGIES

Concept of Growth

Growth in firms can be looked at by two broad views: organic growth, or inorganic growth. Organic growth is achieved through mainly internal expansion while inorganic growth is achieved through external expansion, i.e. through consolidations, acquisitions and mergers.

Growth is something for which most companies, large or small, strive. Small firms want to get big, big firms want to get bigger. As observed by Philip B. Crosby, author of The Eternally Successful Organization, “if for no other reason than to accommodate the increased expenses that develop over the years. Inflation also raises the cost of everything, and retaliatory price increases are not always possible. Salaries rise as employees gain seniority. The costs of benefits rise because of their very structure, and it is difficult to take any back, particularly if the enterprise is profitable. Therefore cost eliminations and profit improvement must be conducted on a continuing basis, and the revenues of the organization must continue to increase in order to broaden the base.”

Most firms, of course, desire growth in order to prosper, not just to survive. Organizational growth, however, means different things to different organizations. Indeed, there are many parameters a company can select to measure its growth. The most meaningful yardstick is one that shows progress with respect to an organization’s stated goals. The ultimate goal of most companies is profit, so net profit, revenue, and other financial data are often utilized as “bottom-line” indications of growth. Other business owners, meanwhile, may use sales figures, number of employees, physical expansion, or other criteria to judge organizational growth. Companies which are run by a product minded entrepreneur are more concerned with the growth and profitability of a firm as an organization for the production of goods and services. While companies run by empire builders type of entrepreneurs are continuously looking at expanding the scope of the enterprise. Empire builders are not satisfied are not satisfied with product improvement or maintaining competitive edge

In terms of access to finance there are broadly five growth stages in a company’s lifespan: inception, organic growth, purchased, IPO and Beyond IPO as shown in the figure below. Each stage has its own characteristics, risks and potential financial sources.

Organic Growth without M&A

In Organic growth, growth depends on the ability to avail the available opportunities and existing resources in a more efficient way. The extent of growth of a firm is actually determined by the ability of managers, product or market factors. There is no limit to the absolute size of the firm keeping in mind the assumption that there is no fixity of capital, labor and management and the firm is capable of acquiring these resources at a price. In addition it is also assumed that there are opportunities in the economy for investments.

The economies available within the firm (such as excess productive resources or managerial capabilities) disappear after the expansion is completed as they get utilized in a new activity. This means that it is only an “entry advantage”. However the firm may have these advantages in its new operations, often set up as new subsidiaries or divisions, which may grow in response to the economies in the same manner as the rest of the firm. New operations may later be spun off from the original firm without any loss of efficiency. Further, both the original and the spun off firms will have some unused productive resources which can then be used to develop new activities

Inorganic growth through M&A

The inorganic growth strategy is dependent on M&A. The idea of acquisition is that it accelerates the business model, giving it greater impetus than organic growth. Because acquisition gives the business what it cannot get quickly or incrementally. It may be a joint venture – an agreement that gives both parties something they want that the other has. Acquisition targets can include both complementary and competitive businesses – complementary when the target can give something an acquirer needs or competitive when the target can stop someone else having what the acquirer wants.

The risks in growth through acquisitions are significant, but they can be contained through planning and due diligence. The primary risk is integration: post the acquisition is completed the new arrangements have to work and people who were not party to the negotiation have to work together. The same goes for systems and expectations as different business would have grown in different ways. A consistent culture is laudable but a wholly consistent culture will be impossible. Add regional diversity to this and the risk would become even higher.

Motivations for M&A

Mergers and acquisitions can be motivated by either the share-holder wealth maximizing approach or the widening share ownership. The primary objectives of M&A activities are diversifications, market expansion, improving competitive position and depression immunity. Given these basic objectives a different rationale can be assigned – at both individual and collective levels.

From the standpoint of shareholders

Investment made by shareholders in the companies subject to merger should enhance in value. The sale of shares from one company’s shareholders to another and holding investment in shares should give rise to greater values i.e. the opportunity gains in alternative investments. Shareholders may gain from merger in different ways viz. from the gains and achievements of the company i.e. through

• Realization of monopoly profits;
• Economies of scales;
• Diversification of product line;
• Acquisition of human assets and other resources not available otherwise;
• Better investment opportunity in combinations.

One or more features would generally be available in each merger where shareholders may have attraction and favor merger.

From the standpoint of managers

Managers are concerned with improving operations of the company, managing the affairs of the company effectively for all round gains and growth of the company which will provide them better deals in raising their status, perks and fringe benefits. Mergers where all these things are the guaranteed outcome get support from the managers. At the same time, where managers have fear of displacement at the hands of new management in amalgamated company and also resultant depreciation from the merger then support from them becomes difficult.

Promoter’s gains

Mergers do offer to company promoters the advantage of increasing the size of their company and the financial structure and strength. They can convert a closely held and private limited company into a public company without contributing much wealth and without losing control.

Benefits to general public

Impact of mergers on general public could be viewed as aspect of benefits and costs to:

• Consumer of the product or services;
• Workers of the companies under combination;

General public affected in general having not been user or consumer or the worker in the companies under merger plan.

VALUATION OF TARGET COMPANIES

Valuation of target companies is an essential step in the M&A process.

Due Diligence

Due Diligence of a company; answers the question of whether a deal is being done at the right time at the right price for the right reasons. It involves an investigation into the affairs of an entity and results in the production of a report detailing relevant data and points. The investigation is performed prior to the business’s acquisition, flotation, restructuring or other transactions

Due Diligence is performed by many advisors on the team. For example there may be a separate legal due diligence, financial due diligence, tax due diligence, environmental due diligence, commercial due diligence, and information technology due diligence. Financial due diligence is a vital part of the M&A process. Often a problem in the financial due diligence raises point to be dealt by other areas as well, for example a financial due diligence may uncover an unusual lease obligation which then feeds into the legal due diligence.

What a due diligence involves

Each M&A transaction is unique in its own sense hence the scope and extent of a due diligence process needs to be tailored to fit the needs of the buyer. However broadly it should cover the following aspects:

• The history and commercial activities of the business
• The organizational structure and employees
• Employee benefits and labor matters
• Its accounting policies
• The information systems
• A detailed review of financial statements
• A review of the financial projections
• Anything else the team may uncover that is relevant for the transaction

Methods of Valuation

The valuation of a target company normally depends on a lot of factors, it is not sufficient to evaluate the financial aspect alone. This is possible through a valuation of the 5 Ps which are:

• Personnel ­- senior management of the target company play an important role in an acquisition. The acquiring firm considers the motivation, energy and intelligence levels of the existing personnel before taking them on.
• Product – Proprietary products of a Target company increase the value of the company.
• Plant – The plant capacity and condition of equipments also affect the valuation of a company.
• Potential – The potential of a firms growth as compared to the industry is also a factor in its valuation
• Profit – The declared profits of the firm is the basis of determining price.

It is normally considered easier to evaluate public limited since most of the above data is publicly available in their annually published reports. In the case of a Private company it is a little more challenging to get the same information and the Acquiring company has to depend on a proper due diligence process to complete its valuation.

Financial Valuation

Financial valuation should answer the simple, but vital, question “What is something worth?” The analysis of target is hence based on either current projections or of the future. The process of valuations differ substantially for a listed and unlisted companies

Many types of valuation metrics are used, involving several sets of metrics. On of the most common is the standard P/E ration (Price to earnings ratio) however some of the other metrics include assets value, capitalized earnings, market value, investment value, book value, costs basis valuation, enterprise value and some combined methods as well.

P/E Ratio and Market Price – For an unlisted company the P/E ratio of a comparable listed company is referred to and discounted based on the voting rights in the company. For listed companies the modes of valuation can be based on either earnings or assets. The market price of shares reflects the earnings per share (EPS).

P/E ratio Calculated as:

The P/E ratio is the current price of shares divided by the EPS. The higher the P/E ratio the higher are the future earnings expectation The P/E multiple is calculated as the multiple of net profit used to compute the company’s purchase price. For example, an investor attempting to recover his initial investment in 10 years would have to earn an after-tax return of 10% on investment, plus adjustment for discounted cash flow and inflation. Discounted Cash Flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value.

DCF is calculated as:

• Assets Value – Tangible assets, such as land and buildings, and intangible assets are assessed as per existing business practices. Goodwill is based on the company’s excess earning power for certain number of years. The asset basis valuation is either on the fair value or the open market value. The dividend approach and the super profit approach can also be used for asset valuation. In the dividend, the present share prices are taken as the values of future dividends. While the super profit approach expects to get more value for a firm in addition to the value of the net assets.
• Capitalized Earnings – This method is based on the rate of return on the capital employed
• Market Value – This is on the basis of quoted share values at the stock exchange.
• Investment Value – This is the cost of establishing an enterprise such as the target company and the interest on the same.
• Book Value – This is the secondary factor in valuations and takes into account the total worth of the assets after depreciation. If the P/E multiplier is less than the book value then the book value has to be adjusted to reflect the true value. It takes into account the present net value of the real estate, machinery and equipment. Sometimes the book value may be understated in times of inflation and overstated during depression.
• Cost Basis Valuation – This is cost minus depreciation. Intangible assets are not taken into account.
• Reproduction Cost – This is the current cost of replacement of properties with similar design and material.
• Substitution Cost – Substitution cost is the cost of construction of the same utility and capacity.
• Enterprise Value – The valuation of a company is based on the Enterprise Value (EV) and its ratio to the company’s sales and operating profit (PBIDT – Profit before interest, depreciation and tax). Enterprise Value is calculated as:
  • A = Market Capitalization of Stock + Total Debt on Company’s books
  • B = Investments + Cash
  • EV = (B – A)

Accounting Methods

The method accounting also has a significant impact on the valuation and price the seller will receive. The acquiring firm can use two principal accounting methods for valuations, they can either use the pooling of interests method or the purchase method. The main difference between them is the value that the combined firm’s balance sheet places on the assets of the acquired firm, as well as the depreciation allowances and charges against income following the merger.

Pooling of Interests Method

The pooling of interests method assumes that the transaction is simply an exchange of equity securities. Therefore, the capital stock account of the target firm is eliminated, and the acquirer issues new stock to replace it. The two firms’ assets and liabilities are combined at their historical book values as of the acquisition date. The end result of a pooling of interests transaction is that the total assets of the combined firm are equal to the sum of the assets of the individual firms. No goodwill is generated, and there are no charges against earnings. A tax-free acquisition would normally be reported as a pooling of interests.

Purchase Method

 In this method, assets and liabilities are shown on the merged firm’s books at their market (not book) values as of the acquisition date. This method is based on the idea that the resulting values should reflect the market values established during the bargaining process. The total liabilities of the combined firm equal the sum of the two firms’ individual liabilities. The equity of the acquiring firm is increased by the amount of the purchase price.

Mark Up Pricing/ Premium

Markup pricing or premium is the percentage difference between the trading price of the target companies stock before the announcement of acquisition and the price per share paid by the acquiring firm. Bidding firms pay large premiums to acquire control of exchange-listed target firms. Normally premiums include pre-bid run up in the target firm’s stock price as part of the control premium paid by the winning bidders. The valuations by the bidder and the target depend on the information each party has at the time of the negotiation.

Mark Up or premium is partly decided on the basis of the relationship pattern of the acquiring firm. The pattern in some cases is that if interlocking directorship among firms. Most firms have stable and long standing relationships with professionals such as attorneys, investment bankers and accountants. These are likely to have similar effects as to interlock directorships. Managers take advice from both their interlock partners and professional firms when deciding how much to pay.

Financing an M&A

Organizations use various methods for financing an M&A deal. Often combinations of the below mentioned methods:

Cash

Cash payments. These are normally preferred since the organization does not have to dilute equity and there will be no change in the number of shares outstanding. Also cash transactions save time and cash can be re-invested at the face value.

Financing

Financing capital may be borrowed from banks or raised from issue of bonds. Acquisitions that are financed through debt are called as leveraged buyouts if they take the target private, and the debt will often be moved down into the balance sheet of the acquired company.

Hybrids

An acquisition can involve a combination of cash and debt or of cash and stock of the purchasing entity.

POST ACQUISITION INTEGRATION

After the acquisition is completed, the acquired company needs to be integrated with the acquiring company. The process of integration actually needs to be planned during the acquisition itself to ensure that the company integrates smoothly. The success of integration also depends on the managers who are responsible for the implementation.

Planning

The acquiring company needs to plan the post acquisition integration period. IN the initial period the target company is more receptive to drastic changes to make the company viable. Some of the basic approaches are as follows

• Adapting a program – This should be completely aligned with the companies goals and objectives of the company and should also take into account the limitations of the company.
• Effective organization and leadership structure – The integration process involves creating a group which focuses on creating value through specific activities and actions. A true partnership would mean involving the senior leadership of the acquired company as well in this strategic group.
• Minimize post acquisition exodus of critical resources – It is critical to have a preventing plan in place to minimize the damage that maybe caused to the new enterprise. Any loss of critical things like market standing, key employees, brand has to be avoided.
• Employee issues - The employees of the acquired entity need reassurance on their career planning and a competitive spirit needs to be developed.
• Establishing Priorities - Priorities have to be clearly established and communicated properly to all the employees of both companies. There is a high degree to probability of mis communications to employees of both companies and a channel of communication needs to be established.

Implementation: Areas of Focus

The failure of M&A is quite often attributed to acquiring firms obsession with the deal itself than to what is to be done post the deal. Quite often the top management of the firms are expected to deliver the implementation plan but are excluded from the planning stage of the deal. A successful M&A is the one in which acquiring firm looks at the various functional areas of the target firm and creates a structure to merge it with the acquiring firm. Some of the broad functional areas are discussed as follows:

Accounting

There are different methods of accounting and one of the key concerns is to ensure that both the acquiring and the acquired firm become aligned. The acquiring company normally has a focus on choosing a method which helps them to avoid tax and the one that helps in creating a healthy picture of the combined companies. The Institute of Chartered Accountants in India (ICAI) has suggested AS-14 as the accounting method to be followed only in the case of a transferee company. It recognizes the pooling of interest method and the purchase method as has been mentioned in the financial evaluation section.

Procurement

Procurement processes need to be optimized for a potential benefits for the combined entity. The acquiring firm's critical resources need to be assessed and recurring stock-out items have to be reviewed. There is always an opportunity of increasing efficiency of both firms in rationalizing the manufacturing process. Procurement prices can be optimized with economies of scale coming into effect while surplus stock can be removed by sharing of volumes and rationalizing production cycles of both entities.

Marketing and Sales

There can be a major value creation in marketing and sales process improvements. There can be various approaches taken to create a successful sales and marketing strategy like concentrating on one channel, following a selective advertising approach, combining the marketing and sales departments (this though may be a challenge in niche area acquisitions) and aiming at more revenue with less sales force. Quite a few companies also aim at creating or designing a new product to cater to the top companies of both the entities. This is one area where integration can also have multiple fiascos like emphasizing too much on new revenue creation, assuming pricing to be too critical for adding value and not anticipating the liquidity trap.

R&D

Research and development is an area which has conflicting views in terms of affect of integration. One view is that integrating the two companies R&D wings reduces waste and managements can focus on creating value for their shareholders. The second view is that acquiring firms and the acquired firms do not benefit from acquisition integration. It is believed that acquiring firms spend less on R&D and the introduction of new products and hence come up with fewer innovations. The acquired firm that integrates with this acquiring firm also looses its niche value and reduces innovations in the acquired firm. Many firms wish to concentrate on their core businesses. In mature markets, companies try to establish economies on scale by buying other companies instead of investing in R&D. When companies acquire firms which are complimentary to their core business there is no trade-off between takeover and innovation.

Brand

Brand is normally considered as product plus added values. There are different terms which are used in connection with brand and with different meanings. Integration of brands with acquiring and the acquired company plays a critical role in a successful integration. Sometime acquisitions are also focused towards acquiring more of a brand than just infrastructure and hard assets of a firm. It is essential to talk about the term brand equity here. Brand equity has many components such as customer's habits and purchasing behavior, their attitudes to the brand, brand availability, distribution and long term relationships. Brand equity is also viewed as potential for future profits. There are also parallel situations where even though a division of a firm is acquired by another firm there are some brand which continue to be retained by the original entity. For example even thought the Indian company of Electrolux was acquired by Whirlpool in 1996, Whirlpool continued to own the ‘Kelvinator' brand. Electrolux specified that Whirlpool could not use the Kelvinator name with any other brand names.

Human Resource

Since people form the main assets of a company a successful integration of merged units has to deal with issues like people, culture, policies and systems and structures. Each organization has its own culture, i.e. values and beliefs that are nurtured through stories. Organizational culture can be both subjective and objective. Subjective cultures are concerned with leadership styles, mental frameworks and the ways of solving problems in the organization. Objective cultures are mostly physical settings, office locations and décor. There are two major phases in integration of cultures of the acquired company and acquiring company, these are:

• First Phase: Continuity - This step identifies the critical steps that are required for the continuity of the business. These, involve creation and implementation of systems to ensure competence and involves recruitment, training and development.
• Second Phase: Integration - In this phase the critical functions are identified and reorganized to make both entities function as one.
• The management needs to watch out for various issues and ambiguities that can arise during integration of human resources functions, some of these are
• Individual Stress - During a transition or integration process stress is intensified and if the people in an organization are not adept to change this can cause serious concerns.
• Uncertainty and anxiety - Rumors and lack of communication from senior management causes a high degree of anxiety among employees.
• Loss and Termination - This becomes a bigger concern particularly during hostile takeovers, where disappearance of familiar work culture and people may cause stress. People start bargaining to keep things as they were rather than to adjust to a new situation.
• Combination Preoccupation - Employees may be too worried discussion about the combination of the two companies as compared to taking care of their jobs. Hence it may result in loss of productivity.
• Lack of Trust - Employees who had low trust may further become paranoid during the merger. As the trust decreases, self interest becomes more important to the employees as compared to the interest of the company.

Top Management

Top management turnover is common byproduct of M&A activities. The nature of negotiations during the M&A between the parties also affects the subsequent relationship. This may result in the top management not being willing to work together and hence results in turnover. There have been various studies which have been conducted to understand the various attributes that cause high attrition rate among top management post M&A. Walsh (1989) identified 3 attributes of companies and 7 attributes of the transaction that affect on top management.

Company Attributes

A target companies top management turnover rate is expected to be higher

• in the case of a related merger than an unrelated merger
• in the case of a higher difference in size between the parent and target companies.
• When the company has been subject to rather than free from, previous M&A activity.

Transaction Attributes

 A target company's top management turnover is likely

• to be higher in a tender offer than a merger
• to be higher if the negotiation had multiple counter offers being made
• to vary positively with the amount of time required to negotiate a deal
• to be lower following a public assurance by the buyer of top management retention as compared to when no such communication is given.
• to be higher following a hostile merger than a friendly merger.
• to be lower following a M&A paid for in stock
• to vary positively with the premium paid for the target company.

EVALUATING SUCCESS OF A M&A

The integration of companies may take anything from 6 to 18 months depending on multiple factors like cultural assimilation, size of the Target Company, operational integration, etc. Current performance measures of the success of a merger are not very developed. Primarily, they only include short-term outcome measures and the ones being used do not adequately evaluate success. Thus there are no input or process measures that would provide guidance on the drivers and key factors of success. Better measures are needed that include both short term and long term indicators of merger success and the input processes necessary to drive the success. Using short term measures such as stock price to evaluate success are clearly insufficient to understand and predict long term merger success. Both the financial and non- financial metrics related to the performance on seven factors (strategic vision, strategic fit, deal structure, due diligence, pre-merger planning, post-merger integration and external factors) that drives to success is necessary. Researchers and managers alike need a better understanding of the management control actions and performance measures that lead to success in each of these key factors and the casual relationships of superior merger performance.

Manager and Researchers examining post-acquisition success usually focus on four key methodologies.

Accounting studies examine financial results before and after the acquisition to monitor improvement. Financial analysis is focusing around revenue growth and profit growth achieved after the M&A activity. This is normally a difficult thing to measure since there is no base to compare it with. However normally the managers take into account what the growth of the organization would have been without the M&A activity and what was the growth rate planned with the M&A activity. Both the comparison methods have certain hypothetical situations built into them but they provide some amount of insight into the effect of M&A to the firm. Similarly profit percentage figures could also be looked at in similar comparison studies to revenue numbers.

Surveys of executives record the responses of managers to determine if they believe a deal has created value. More often than not in large firms it is difficult to pin point the exact revenue numbers that can be attributed to an acquisition as revenues might have come from synergy revenues or brand value creation, etc. Here however a structured questionnaire with the executives is able to shed light if they feel the acquisition has added value to the organization. This is a very subjective approach and may provide more insight on the perception the acquisition was able to create.

Clinical studies focus on a particular transaction or a small sample through interviews with executives, knowledgeable observers, and other key players.

Event studies look at whether shareholders realize returns beyond a particular benchmark in the period surrounding the announcement of a deal.

LEGAL PROCEDURES FOR M&A

M&A activity is normally monitored and regulated by various governments; particularly in the case of listed companies it becomes critical to monitor these to maintain stockholder interests. It is essential to adhere to all legal requirements for all M&A activities. Since the legal structure keeps changing regularly it is essential to follow the current laws and normally the services of corporate law firm needs to be availed. This section simply tries to list down the basic procedures that need to be followed for an M&A activity, it does not however try to look at the various Acts and its applicability in an M&A scenario. The procedures that need to be adopted are as follows:

Examination of Object Clauses

The Memorandum and Articles of Association should be examined to check if the power to amalgamate is available in both the Acquiring and the target company. If such a clause does not exist in the MOA and AOA then necessary approvals of the share holders, board of directors and company law board are required.

Obtain Required Approvals

Required approvals from Central Government and Reserve Bank of India need to be obtained. The Government has relaxed most of the rules around M&A activity since the liberalization in 1991, however in certain M&A activities Government and RBI approvals are still required. One such example is that the Government still controls acquisition of foreign banks. MRTP (Monopolistic and Restrictive Trade Practices Act) and FERA (Foreign Exchange Regulation Act) also requires Government and RBI approvals in certain cases.

Approval of Draft Merger Proposal by the respective Boards

The draft merger proposal should be approved by the respective BOD's. The board of each company should pass a resolution authorizing its directors/executives to pursue the matter further

Application to High Court

Once the drafts of merger proposal is approved by the respective boards, each company should make an application to the high court of the state where its registered office is situated so that it can convene the meetings of share holders and creditors for passing the merger proposal.

Intimation to Stock Exchanges

The stock exchanges where merging and merged companies are listed should be informed about the merger proposal. From time to time, copies of all notices, resolutions, and orders should be mailed to the concerned stock exchanges.

Notice to Share Holders and Creditors

In order to convene the meetings of share holders and creditors, a notice and an explanatory statement of the meeting, as approved by the high court, should be dispatched by each company to its shareholders and creditors. A press release should also be made in the leading newspapers by both the companies about the M&A decision.

Share Holder and Creditor Meetings

Under Section 391 of the Companies Act, 1956 and Companies Court Rules, 1959, both the companies have to make applications for an order by judge's summons convening the meeting of the members of the two companies to approve the scheme. The summonses for the meetings are issued under Rule 67. The copy of the order is filed with the Registrar of Companies.

• Notices of meetings in the prescribed form are printed and advertised in the newspapers 21 days before the date of the meeting.
• Separate meetings of equity and preference share holders, and creditors are held.
• Reports are submitted within seven days to the High Court.

Income Tax Application

The acquirer company has to submit the application in case of benefits under Section 72A of the Income Tax Act, 1961, to the specified authority.

Petition to High Court

Once the mergers scheme is passed by the share holders and creditors, the companies involved in the merger should present a petition to the HC for confirming the scheme of merger. A notice about the same has to be published in 2 newspapers.

Filing the order with Registrar of Companies

The copy of the order is filed with the Registrar of Companies within 30 days of passing the order by the Court.

Transfer of Assets and Liabilities

After the final order is passed by the High Court, all the assets and liabilities of the acquired company has to be transferred to the acquiring company.

Issue of Shares and Debentures

The merging company after fulfilling the provisions of the law should issue shares and debentures in the ratio approved under the scheme.

INDIAN M&A LANDSCAPE POST 2006 RECESSION

This section would primarily look at the M&A landscape in India post the global recession that hit around the year 2006 and is now showing signs of stabilizing. In recent years, there is a major change: There are more outbound deals, valued at US$ 0.7 billion in 2000-01, increased to US$ 4.3 billion in 2005, and further crossed US$ 15 billion-mark in 2006.Year 2007 witnessed 12 inbound and 54 outbound deals whereas 2008 saw 34 inbound and 72 outbound deals.

In the first two months of 2007, corporate India witnessed deals worth close to $40 billion. One of the major outbound deals was Mahindra & Mahindra's takeover of 90 percent stake in Schoneweiss, a German company with over 140 years of experience in forging business. Hitting the headlines in 2007 was Tata's takeover of Corus for slightly over $10 billion.

The current economic conditions due to global meltdown have reduced funding opportunities but provided opportunities for well capitalized corporate to make acquisitions at cheaper valuations than in recent history. 2009 has so far seen a slump in M&A activities of Indian companies to a 3 years low with the corporate world facing a liquidity crunch in the wake of the crisis. It is down 33% on the same period last year, making it the lowest year to date level since 2006 comparatively there had been M&A deals worth about $29.70 billion in the corresponding period in 2008.

Buoyant Indian Economy

India's economy picked up pace in the latest few quarters as government spending helped to overcome the worst of the global downturn. Growth in gross domestic product accelerated to 6.1 percent from a year earlier in the April-June quarter from 5.8 percent in the previous quarter, as per the government's Central Statistical Organisation. India's foreign exchange reserves increased by US$ 4.2 billion to US$ 255.9 billion for the week ended May 8, 2009. FDI inflows during April 2008-January 2009 stood at US$ 23.9 billion compared with US$ 14.4 billion in the corresponding period of the previous fiscal, witnessing a growth of 65%.

As the previous data for the last few years clearly show that with the growth the mergers and acquisitions made by Indian companies increased, so there is direct correlation between the M&A and the growth.

Since the market conditions are getting better with economy coming back on track, there is a positive outlook towards the M&A in coming times.

In a tight market, cash is king. Indian companies, more cash-rich than their western counterparts, are facing an once-in-a-lifetime opportunity to pick up valuable assets abroad. The average cash Indian firms are holding is 43% of their capital, against 16% at their US and Europe counterparts. Besides, the debt levels at Indian firms are just 60% of equity, against 250% at western companies.

So, this is an excellent opportunity for the Indian firms to go abroad and do the M&A as cash-rich Indian corporations have a competitive advantage in bidding against firms whose traditional sources of financing have become restricted

CASE STUDY: GROWTH THROUGH ACQUISITION

Wipro's “String of Pearls” Strategy

Wipro is a leading global IT MNC with its head offices based out of Bangalore. Incorporated in 1945, Wipro Limited is a public limited company listed in the Bombay Stock Exchange and National Stock Exchange (Stock Code - Wipro) as well as the New York Stock Exchange (Stock Code - WIT). It is a diversified global business conglomerate with interests across Information Technology, FMCG, Lighting, Infrastructure Engineering and Eco-Energy. Wipro is known for its strong relationship, client commitment and the value added to clients. Major group companies include Wipro Technologies, Wipro Consumer Care & Lighting and Wipro Infrastructure Engineering. Wipro Limited had revenues of USD 5 Billion during the last financial year (2007-08).

Wipro's growth strategy over the years has seen a marked change in the pattern it had. Between the periods of 1945-2000, Wipro grew through diversification, partnerships and organically, through innovations it pioneered. Post 2000 Wipro planned an aggressive inorganic growth strategy based on acquiring entities in new markets and geographies. Wipro crafted a comprehensive strategy for building internal competencies and capabilities to integrate new companies rapidly and to ensure that new acquisitions always declare results. Azim Premji calls it his "string of pearls" strategy of acquiring niche boutique firms, and it's helping Wipro expand its global footprint.

Wipro identified its rationale for the M&A strategy as best described through 2 sets of criteria which overall would help create value for their stakeholders. They can be labeled as Primary criteria and secondary criteria.

Primary Criteria

• To fill identified gaps in Services and Geographies
• Enlarge customer base and Augment Service portfolio
• Increased Value addition to existing services

Secondary Criteria

• Compared positively with Organic growth opportunities
• Creating synergies
• Potential for significant growth

The Wipro acquisition strategy was driven by the Wipro Corporate however the key actions were initiated at the Business Level. Hence the focus on inorganic initiatives was based on Business needs and to plan integration to successful capture value of these acquisitions. To successfully achieve this strategy Wipro corporate came up with the following two high level action plans

Action 1: M&A based on Strategic Plan from each vertical and each service line

• Strategic planning exercise to align organic and inorganic targets at the Sub-Vertical, Service lines and Geo levels.
• Create leveraged organization in each Business Unit and Service Line to support increased M&A activity.

Action 2: Strengthen competence for successful M&A integration

• Create a team from functions - such as HR, Finance, Legal and IS - who can be a part of the acquired company.
• Create a full time position of Integration Officer for each transaction.
• Ensure all learning is captured and implemented for future use.
• Assimilate local talent from acquired entity.

It has been observed that Wipro maintained a fairly aggressive acquisition strategy until the end of the FY 2009, doing the highest number of acquisitions among its peer group of top five software exporters. Wipro has invested over $1 Billion in acquisitions across various geographies and services lines. However post the start of the global economic slowdown the senior management has sobered down the overall strategy to look at smaller acquisitions that affect overall growth at Wipro.

Snapshot of Acquisitions

Year	Space	Acquisition	Benefits	Emp	Location	Financial (Revenue)
2002	Technology Services	Spectramind	ITes	2000	India	$48 M
2002	Medical Services	GE Medical Systems	Medical Equipments	NA	India	$ 110 M
2002	Infrastructure Engineering	Hydroauto AB	Hydraulics	600	India	$112 M
2003	Financial Services	Nervewire	IT Consulting	90	US	$18.7 M
2005	Semiconductors	NewLogic	Wireless RFID, IP	120	Austria	Euro 14 M
2005	Financial Services	mPower	Payments Space	351	US/India	$18 M
2006	Business Services Management	cMango Inc	ITIL, BMC Competence	120	US	$13 M
2006	Oracle Retail Solutions	Enabler	Oracle Retail Expertise	300	Portugal & Brazil	$30 M
2006	Automotive, Aerospace & Consumer Industries	Quantech Global Services	CAD/ CAE space	500	US/ India	$13 M
2006	ADM for Wireless Networks	Saraware	Nextgen Network applications	200	Finland	Euro 14 M
2006	Technology	3D Networks	Business Communication	270	India, ME	$ 36 M
2006	Consumer Goods	North West Switches	Switch Gear	NA	India	$ 8.5 M
2007	IT Infrastructure Outsourcing	Infocrossing	Datacenter, infrastructure Management	900	US	$250 M
2007	Wireless Design	OTCS	Design Services in RF and baseband	40	Japan/ Singapore	$6 M
2008	Pharma Industry	Aquatech	Water Treament Solutiosn	NA	India	NA
2008	Financial Services	Gallagher Financial	Mortgage Lending	120	US	$15 M
2009	Financial Services	Citi Technology Services	Technology outsourcing for bank	2500	India	$127 M

A Closer Look at Some Key Acquisitions

Wipro acquired mPower in 2005. The company was and exclusive offshore vendor to MasterCard and specialized in providing custom developed consulting services to companies in the financial services and payment processing space. They had 320+ employees out of which 80% of them were based out of the Offshore Development Center in Chennai.

Deal Rationale

• Expand domain expertise in payment processing services.
• Good customer name for reference
• Ability to expand footprint with MC in key areas like infrastructure, transaction processing, e-nabling, ADM etc
• Large offshore component & running profitable business. (easier integration)
• mPower in the market and this relationship will be bought over by another services vendor making Wipro's position weaker

Financials

• Total purchase consideration - US$ 25.0 Mn
• FY'07 planned revenues - US$ 24.3 M
• FY'07 planned EBIT - US$ 6.3 M(25.9%)

Wipro acquired cMango in 2005. The company was a leading player in Business Service Management space, with a focus in remedy services since 1998. 100+ employees with an elite client list which included names like UBS, SBC, Orange, P&O Nedloyd, Stanchart, etc.

Deal Rationale

• Addition of new service line - BSM
• Visible synergies with existing service lines in TIS (Technology Infrastructure Services). It helped to consolidate Wipro's leadership position in TIS.
• Acquisition of 100+ ready team with Remedy consulting, implementation and management skills

Financials

• Total purchase consideration - US$ 32.0 M
• Upfront payment - US$ 20.0 M
• FY'07 estimated revenues - US$ 20.0 M
• FY'07 estimated EBIT - US$ 4.9 M (24.3%)

Wipro acquired Saraware in 2006. Saraware was founded in 1985 and was a leading provider of Design and Engineering Services to Telecom companies. Its core offering was in Wireless Infrastructure space with competencies in design and development of base station controllers. It had 200+ domain specialists with a client list that included names like Nokia, EADS.

Deal Rationale

• Brings both telecommunications as well as local presence in Finland
• Saraware provides complementary set of product engineering and technologies
• Wipro will gain access to the Finnish employment market.

Financials

• Total purchase consideration - US$ 34.8 M
• Upfront payment - US$ 27.6 M
• FY'07 planned revenues - US$ 18.0 M
• FY'07 planned EBIT - US$ 3.8 M (21.4%)

Wipro acquired infocrossing in 2007. The company was founded in 1985 and is a publicly listed company with IPO in 1992 (NASDAQ: IFOX). A New Jersey based leading provider of selective IT infrastructure outsourcing, Healthcare solutions and ERP applications managed hosting. The company had more than 900+ employees with revenues of around $250 M at the time of acquisition

Deal Rationale

• Infocrossing opens up exciting growth opportunities for Wipro in Large Total Outsourcing space.
• Infocrossing's IT+BPO Healthcare Solutions including proprietary Platform will give boost to Wipro's fast-growing Healthcare practice.
• It will transform Wipro's TIS by giving market address to Mainframes outsourcingsegment (Expected to be $40 Bn market).

Financials

• Offer Price - US$ 18.7 per share (approximately a total of $600 Million)
• FY'06A Revenues- US$ 229.2 M
• FY'06A EBIT - US$ 25.0 M (10.9%)

Crafting an Integration Strategy

Developing a strong philosophy toward acquisition integration was the most important step in building a comprehensive integration strategy. Furthermore, this philosophy had to start at the top of the organization. The first step was to treat acquisitions as an ongoing corporate program fundamental to the company's success—and not as an event-specific response to a particular transaction.

“One of the most important mind-set changes we had through this engagement was to think of mergers and acquisitions less as a project and more as a pro­cess,” says Sudip Nandy, the Chief Strategy Office for Wipro till end of 2007 noting that handling acquisitions any other way would create too much complexity and waste.

The importance of acquisitions to each business unit and the role each manager played were also important issues that needed to be addressed. Sudip Nandy's team worked with business-unit leaders in sales, IT, human resources, finance, and other areas to reinforce these ideas, sharing best practices to help leaders develop the necessary capabilities to support the acquisition integration program. According to Mr. Azim Premji, “Wipro's experience in successfully integrating recent acquisitions gives us the confidence to pursue our inorganic growth strategy more aggressively in the future.”

Observations

Let's take a closer look at Wipro's growth over the years; we have divided it to the first 60 years and then the last 5 years through the period which we have tracked their various acquisitions. Wipro had a consistent growth rate of (CAGR- Compounded Annual Growth Rate) over 60 years in revenues of 21%. At the same the CAGR for Net Income was close to 31%.

Now let's look at the period from FY 2002-03 onwards, the details of which are shown below. Wipro's revenue has grown at a CAGR of 34% and Net Income at 30% in the last 5 years. Wipro Corporation's revenue stands at Rs 255 Billion for 2008-09, at 28% YOY.

Summary

It is evident looking at the details above that Wipro's growth rate has shot up tremendously since it embarked on it “string of pearls” acquisition strategy. The acquisition strategy itself was very well structured and involved Business Units and Managers in identifying the gaps in the market place that they would be looking to address. The team, then not only was able to provide inputs on the potential acquisition target but also own the acquisitions during the integration phase. This proved to be a major turning factor in the overall success of the acquisition.

Overall we have only been able to critically look at the overall growth of Wipro as a factor to see how acquisitions impacted their growth. It would be difficult to pinpoint the success of each acquisition in itself until and unless we involved line managers and business leaders from Wipro. However we did observe that there were various intangible benefits that Wipro looked at in these acquisitions, here is an attempt to list them out.

• Entry in to strategic markets
• Obtaining referencable clients
• Ability to cross sell to these clients, Wipro terms these as synergy revenues and they are critical factor in evaluating the success of an acquisition.
• Creating a global presence.

At the same time it is imperative to mention that while we are taking a deeper look into Wipro's acquisition strategy and its affect on Wipro's growth, we definitely cannot assume that it was the only strategy Wipro embarked on during this period. Wipro coupled the M&A strategy with its Organic growth plan and tried to create complementary strengths by successfully marrying these two together.