Mergers and Acquisitions

An entrepreneur may grow its business either by internal expansion or by external expansion. In the case of
internal expansion, a firm grows gradually over time in the normal course of the business, through
acquisition of new assets, replacement of the technologically obsolete equipments and the establishment of
new lines of products. But in external expansion, a firm acquires a running business and grows overnight
through corporate combinations. These combinations are in the form of mergers, acquisitions,
amalgamations and takeovers and have now become important features of corporate restructuring. They
have been playing an important role in the external growth of a number of leading companies the world
over. They have become popular because of the enhanced competition, breaking of trade barriers, free flow
of capital across countries and globalisation of businesses. In the wake of economic reforms, Indian
industries have also started restructuring their operations around their core business activities through
acquisition and takeovers because of their increasing exposure to competition both domestically and
internationally.

Mergers and acquisitions are strategic decisions taken for maximisation of a company's growth by enhancing
its production and marketing operations. They are being used in a wide array of fields such as information
technology, telecommunications, and business process outsourcing as well as in traditional businesses in
order to gain strength, expand the customer base, cut competition or enter into a new market or product
segment.

Mergers or Amalgamations

A merger is a combination of two or more businesses into one business. Laws in India use the term
'amalgamation' for merger. The Income Tax Act,1961 [Section 2(1A)] defines amalgamation as the
merger of one or more companies with another or the merger of two or more companies to form a new
company, in such a way that all assets and liabilities of the amalgamating companies become assets and
liabilities of the amalgamated company and shareholders not less than nine-tenths in value of the shares in
the amalgamating company or companies become shareholders of the amalgamated company.

Thus, mergers or amalgamations may take two forms:-

 Merger through Absorption:- An absorption is a combination of two or more companies into an

'existing company'. All companies except one lose their identity in such a merger. For example,
absorption of Tata Fertilisers Ltd (TFL) by Tata Chemicals Ltd. (TCL). TCL, an acquiring company (a
buyer), survived after merger while TFL, an acquired company (a seller), ceased to exist. TFL
transferred its assets, liabilities and shares to TCL.
 Merger through Consolidation:- A consolidation is a combination of two or more companies into
a 'new company'. In this form of merger, all companies are legally dissolved and a new entity is
created. Here, the acquired company transfers its assets, liabilities and shares to the acquiring
company for cash or exchange of shares. For example, merger of Hindustan Computers Ltd,
Hindustan Instruments Ltd, Indian Software Company Ltd and Indian Reprographics Ltd into an
entirely new company called HCL Ltd.

A fundamental characteristic of merger (either through absorption or consolidation) is that the acquiring
company (existing or new) takes over the ownership of other companies and combines their operations with
its own operations.

Besides, there are three major types of mergers:-

 Horizontal merger:- is a combination of two or more firms in the same area of business. For
example, combining of two book publishers or two luggage manufacturing companies to gain
dominant market share.
 Vertical merger:- is a combination of two or more firms involved in different stages of production
or distribution of the same product. For example, joining of a TV manufacturing(assembling)
company and a TV marketing company or joining of a spinning company and a weaving company.
Vertical merger may take the form of forward or backward merger. When a company combines with
 the supplier of material, it is called backward merger and when it combines with the customer, it is
known as forward merger.
 Conglomerate merger:- is a combination of firms engaged in unrelated lines of business activity.
For example, merging of different businesses like manufacturing of cement products, fertilizer
products, electronic products, insurance investment and advertising agencies. L&T and Voltas Ltd
are examples of such mergers.

Acquisitions and Takeovers

An acquisition may be defined as an act of acquiring effective control by one company over assets or
management of another company without any combination of companies. Thus, in an acquisition two or
more companies may remain independent, separate legal entities, but there may be a change in control of
the companies. When an acquisition is 'forced' or 'unwilling', it is called a takeover. In an unwilling
acquisition, the management of 'target' company would oppose a move of being taken over. But, when
managements of acquiring and target companies mutually and willingly agree for the takeover, it is called
acquisition or friendly takeover.

Under the Monopolies and Restrictive Practices Act, takeover meant acquisition of not less than 25
percent of the voting power in a company. While in the Companies Act (Section 372), a company's
investment in the shares of another company in excess of 10 percent of the subscribed capital can result in
takeovers. An acquisition or takeover does not necessarily entail full legal control. A company can also have
effective control over another company by holding a minority ownership.

Advantages of Mergers & Acquisitions

The most common motives and advantages of mergers and acquisitions are:-

 Accelerating a company's growth, particularly when its internal growth is constrained due to paucity
of resources. Internal growth requires that a company should develop its operating facilities-
manufacturing, research, marketing, etc. But, lack or inadequacy of resources and time needed for
internal development may constrain a company's pace of growth. Hence, a company can acquire
production facilities as well as other resources from outside through mergers and acquisitions.
Specially, for entering in new products/markets, the company may lack technical skills and may
require special marketing skills and a wide distribution network to access different segments of
markets. The company can acquire existing company or companies with requisite infrastructure and
skills and grow quickly.
 Enhancing profitability because a combination of two or more companies may result in more than
average profitability due to cost reduction and efficient utilization of resources. This may happen
because of:-

 Economies of scale:- arise when increase in the volume of production leads to a reduction
in the cost of production per unit. This is because, with merger, fixed costs are distributed
over a large volume of production causing the unit cost of production to decline. Economies
of scale may also arise from other indivisibilities such as production facilities, management
functions and management resources and systems. This is because a given function, facility
or resource is utilized for a large scale of operations by the combined firm.
 Operating economies:- arise because, a combination of two or more firms may result in
cost reduction due to operating economies. In other words, a combined firm may avoid or
reduce over-lapping functions and consolidate its management functions such as
manufacturing, marketing, R&D and thus reduce operating costs. For example, a combined
firm may eliminate duplicate channels of distribution, or crate a centralized training center,
or introduce an integrated planning and control system.
 Synergy:- implies a situation where the combined firm is more valuable than the sum of
the individual combining firms. It refers to benefits other than those related to economies
of scale. Operating economies are one form of synergy benefits. But apart from operating
economies, synergy may also arise from enhanced managerial capabilities, creativity,
innovativeness, R&D and market coverage capacity due to the complementarity of
resources and skills and a widened horizon of opportunities.
  Diversifying the risks of the company, particularly when it acquires those businesses whose income
streams are not correlated. Diversification implies growth through the combination of firms in
unrelated businesses. It results in reduction of total risks through substantial reduction of cyclicality
of operations. The combination of management and other systems strengthen the capacity of the
combined firm to withstand the severity of the unforeseen economic factors which could otherwise
endanger the survival of the individual companies.
 A merger may result in financial synergy and benefits for the firm in many ways:-

 By eliminating financial constraints

 By enhancing debt capacity. This is because a merger of two companies can bring stability
of cash flows which in turn reduces the risk of insolvency and enhances the capacity of the
new entity to service a larger amount of debt
 By lowering the financial costs. This is because due to financial stability, the merged firm is
able to borrow at a lower rate of interest.

 Limiting the severity of competition by increasing the company's market power. A merger can
increase the market share of the merged firm. This improves the profitability of the firm due to
economies of scale. The bargaining power of the firm vis-à-vis labour, suppliers and buyers is also
enhanced. The merged firm can exploit technological breakthroughs against obsolescence and price
wars.

Procedure for evaluating the decision for mergers and acquisitions

The three important steps involved in the analysis of mergers and acquisitions are:-

 Planning:- of acquisition will require the analysis of industry-specific and firm-specific information.
The acquiring firm should review its objective of acquisition in the context of its strengths and
weaknesses and corporate goals. It will need industry data on market growth, nature of
competition, ease of entry, capital and labour intensity, degree of regulation, etc. This will help in
indicating the product-market strategies that are appropriate for the company. It will also help the
firm in identifying the business units that should be dropped or added. On the other hand, the
target firm will need information about quality of management, market share and size, capital
structure, profitability, production and marketing capabilities, etc.
 Search and Screening:- Search focuses on how and where to look for suitable candidates for
acquisition. Screening process short-lists a few candidates from many available and obtains detailed
information about each of them.
 Financial Evaluation:- of a merger is needed to determine the earnings and cash flows, areas of
risk, the maximum price payable to the target company and the best way to finance the merger. In
a competitive market situation, the current market value is the correct and fair value of the share of
the target firm. The target firm will not accept any offer below the current market value of its share.
The target firm may, in fact, expect the offer price to be more than the current market value of its
share since it may expect that merger benefits will accrue to the acquiring firm.

A merger is said to be at a premium when the offer price is higher than the target firm's pre-merger
market value. The acquiring firm may have to pay premium as an incentive to target firm's
shareholders to induce them to sell their shares so that it (acquiring firm) is able to obtain the
control of the target firm.

Regulations for Mergers & Acquisitions

Mergers and acquisitions are regulated under various laws in India. The objective of the laws is to make
these deals transparent and protect the interest of all shareholders. They are regulated through the
provisions of :-
 The Companies Act, 1956

The Act lays down the legal procedures for mergers or acquisitions :-

 Permission for merger:- Two or more companies can amalgamate only when the
amalgamation is permitted under their memorandum of association. Also, the acquiring
company should have the permission in its object clause to carry on the business of the
acquired company. In the absence of these provisions in the memorandum of association, it
is necessary to seek the permission of the shareholders, board of directors and the
Company Law Board before affecting the merger.
 Information to the stock exchange:- The acquiring and the acquired companies should
inform the stock exchanges (where they are listed) about the merger.
 Approval of board of directors:- The board of directors of the individual companies
should approve the draft proposal for amalgamation and authorise the managements of the
companies to further pursue the proposal.
 Application in the High Court:- An application for approving the draft amalgamation
proposal duly approved by the board of directors of the individual companies should be
made to the High Court.
 Shareholders' and creators' meetings:- The individual companies should hold separate
meetings of their shareholders and creditors for approving the amalgamation scheme. At
least, 75 percent of shareholders and creditors in separate meeting, voting in person or by
proxy, must accord their approval to the scheme.
 Sanction by the High Court:- After the approval of the shareholders and creditors, on the
petitions of the companies, the High Court will pass an order, sanctioning the amalgamation
scheme after it is satisfied that the scheme is fair and reasonable. The date of the court's
hearing will be published in two newspapers, and also, the regional director of the Company
Law Board will be intimated.
 Filing of the Court order:- After the Court order, its certified true copies will be filed with
the Registrar of Companies.
 Transfer of assets and liabilities:- The assets and liabilities of the acquired company will
be transferred to the acquiring company in accordance with the approved scheme, with
effect from the specified date.
 Payment by cash or securities:- As per the proposal, the acquiring company will
exchange shares and debentures and/or cash for the shares and debentures of the acquired
company. These securities will be listed on the stock exchange.

 The Competition Act, 2002

The Act regulates the various forms of business combinations through Competition
Commission of India. Under the Act, no person or enterprise shall enter into a combination, in the
form of an acquisition, merger or amalgamation, which causes or is likely to cause an appreciable
adverse effect on competition in the relevant market and such a combination shall be void.
Enterprises intending to enter into a combination may give notice to the Commission, but this
notification is voluntary. But, all combinations do not call for scrutiny unless the resulting
combination exceeds the threshold limits in terms of assets or turnover as specified by the
Competition Commission of India. The Commission while regulating a 'combination' shall consider
the following factors :-

 Actual and potential competition through imports;

 Extent of entry barriers into the market;
 Level of combination in the market;
 Degree of countervailing power in the market;
 Possibility of the combination to significantly and substantially increase prices or profits;
 Extent of effective competition likely to sustain in a market;
 Availability of substitutes before and after the combination;
 Market share of the parties to the combination individually and as a combination;
 Possibility of the combination to remove the vigorous and effective competitor or
 competition in the market;
 Nature and extent of vertical integration in the market;
 Nature and extent of innovation;
 Whether the benefits of the combinations outweigh the adverse impact of the combination.

Thus, the Competition Act does not seek to eliminate combinations and only aims to eliminate their
harmful effects.

 The other regulations are provided in the:- The Foreign Exchange Management Act, 1999 and
the Income Tax Act,1961. Besides, the Securities and Exchange Board of India (SEBI) has
issued guidelines to regulate mergers and acquisitions. The SEBI (Substantial Acquisition of
Shares and Take-overs) Regulations,1997 and its subsequent amendments aim at making
the take-over process transparent, and also protect the interests of minority shareholders.