Consolidation of business entities is a world-wide phenomenon. One of the tools for consolidation is mergers and acquisitions. Mergers and Acquisitions (abbreviated M&A) is an aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and rapidly in its sector or location of origin, or a new field or new location, without creating a subsidiary, other child entity or using a joint venture.(Wikipedia). It is not uncommon that two companies unite to achieve complete advantages. Similarly it is quite common that a company take over another company as part of its growth strategy. Usually such business combination improve productivity of resources and thus benefit shareholders of both companies. Still, we can find many evidences that their success is by no means assured. There are a number of challenges faced in case of mergers and acquisitions sometimes before they actually start to function(eg. merger between HP and Compaq) or even after the M&A. Few of the challenges faced in case of an M&A are legal contemplations ,compatibility problems, fiscal catastrophes, problems as a result of cultural dissimilarities, hospitality and hostility issues, risk management failure, obtaining the necessary votes (two-thirds (or even more) of the share votes) can be time-consuming and difficult, cooperation may not be easily or cheaply obtained, merger also may be creating a conflict of objective between different businesses ,diseconomies of scale if business becomes too large. In India ,in legal sense M&A is also known as Amalgamation. Accounting Standards -14 on accounting for amalgamation issued by ICAI which comes into effect in respect of accounting periods commencing on or after April 1st 1995 is mandatory. Merger and Acquisition Accounting is done either by Pooling of interest method Purchase method Amalgamation in the nature of Merger Amalgamation in the nature of purchase ACCOUNTING METHODS WITH THEIR CHALLENGES: 1.Pooling of Interests Method: In this method, transactions are considered as exchange of equity securities. Here, assets and liabilities of the two firms are combined according to their book value on the acquisition date. The total asset value of the joint company equals the sum of assets of the separate firms. In this case, the accounting income is found to be higher than in the purchase method, as the depreciation in the pooling method is calculated based on the historical book value of assets The drawbacks/challenges with pooling method are: Though popular in other countries, the pooling of interest is no longer allowed in some countries like Canada, U.S. Prior to the pooling, each companies must have been autonomous for at least two years and must have been independent in the sense that less than 10 percent of its stock was held by any individual investor. There must be maintenance for the ownership position in the surviving company. No debt can be used in the exchange There must be no planned future transaction that could reserve the stock nature of the exchange. There must be no significant sale of assets for two year after the pooling. 2. Purchase Method: The asset and liabilities of the merged company are presented at their market values as on the date of acquisition, in order to ensure that the resulting values of the accounting process are able to reflect the market values. This refers to the value, which was recorded before the final settlement of the acquisition deal at the time of bargaining.In this process, the total liabilities of the joint company equals the sum of individual liabilities of the two separate firms. The purchase price then determines the amount by which the acquiring firm's equity is going to increase. The drawbacks/challenges with purchase method are: it may overrate depreciation charges. the book value of assets used in accounting is generally lower than the fair value if there is inflation in the economy. Thus,if at the time of the amalgamation,the acquiror and acquiree have conflicting accounting policies ,a uniform set of accounting policies should be adopted following the amalgamation. Q.2. What are the points a specialist should keep in mind while valuing a company? There are several techniques to value a business: VALUATION TECHNIQUES MARKET BASED ASSET BASED INCOME BASED Market based method: Valuation related to mergers and acquisitions estimated by the market based method, compares various aspects of the target company with the same aspects of the other companies in the market. These companies (not the target company) usually possess a market value, which has been established previously.
. Asset based method: Valuation related to mergers and acquisitions employ this method when the subject or the target company is a loss making company. Under such circumstances, the assets of the loss making company are calculated. Along with this method, the market based method and the income based method may also be employed. Valuations obtained from this method may generate very small value, however it is more likely to generate the actual picture of the assets of the target company. Income based method:Valuation related to mergers and acquisitions employing the income based method take the net present value into consideration. The net present value of income, which is likely to be in the future, is taken into account by the application of a mathematical formula. There are many factors that need to be keep in mind while valuing a company,such as: All three methods of valuing a company are significant depending upon the situation prevailing during the course of the mergers as well as acquisitions. Valuation needs to be dynamic and not static, which means that the same transaction would be value by the same player at different values at two different times, since business is based on expectations which are dynamic. Due diligence has to be exercised in deciding the valuation parameter,since parameters differ from sector to sector. Companies/specialist need not only to respond wisely but often have to respond quickly as well because of the competitive nature of the acquisition market. A well conceived valuation programme that minimizes the risk of buying an economically unattractive company or paying too much for an attractive one is particularly important. Synergies fruitify only when social and cultural issues post merger could be sorted out very earlyin the merger. The financial soundness of the subject company. The financial trends over the past couple of years. The trends manifested in the macroeconomic indicators also need to be judged. Q.3.What do you mean by Leveraged Buy-Out(LBO)? The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. , there is usually a ratio of 90% debt to 10% equity. Often, the assets of the company being acquired are used as collateral for the loans in addition to the assets of the acquiring company. As the debt usually has a lower cost of capital than the equity, the returns on the equity increase with increasing debt. The debt thus effectively serves as a lever to increase returns which explain the origin of the term LBO. LBOs can have many different forms such as Management Buy-out (MBO), Management Buy-in (MBI), Secondary buyout and Tertiary buyout among others and can occur in growth situations, restructuring situations and insolvencies just like in companies with stable performance. The purpose of an LBO( also known as hostile takeover,or highly-leveraged transaction, or bootstrap transaction) is to make a large acquisition without having to commit a lot of capital. maximize shareholder value by attempting to create a stronger and more profitable combined entity. Some advantages and disadvantage are given below:
Advantages- 1.MBO can prevent a company from being acquired by external sources or from being shut down completely. 2. Poorly managed firms prior to their acquisition can undergo valuable corporate reformation when they become private ,a, company can revitalize itself and ear n substantial returns. 3.Since LBO involves a high debt-to-equity ratio, large corporations can easily acquire smaller companies with very little capital
Disavantages- 1.The high interest rates from the high debt-to-equity amounts can result in a corporationâÃ¢â€šÂ¬Ã¢â€žÂ¢s bankruptcy. 2.Management buyouts can produce conflicts of interest among employees, executives. 3. LBO can also lead to unemployment because of corporate restructuring.This means ,at times,companies may have to downsize their operations and reduce the number of paid staff.
EXAMPLES: The world's most famous LBO is the approximately $25 billion takeover of RJR Nabisco by private equity firm Kohlberg Kravis Roberts in 1989. The deal was so famous and bold that it was immortalized by the book and movie âÃ¢â€šÂ¬Ã‹Å“ Barbarians at the GateâÃ¢â€šÂ¬Ã¢â€žÂ¢. Another example of the largest LBOs on record was the acquisition of HCA Inc. in 2006 by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co., and Merrill Lynch. The three companies paid around $33 billion for the acquisition. Doing an LBO is expensive and the process can be complex. When a particular deal is especially large, there is often more than one acquirer which allows for sharing of the risks, costs, and rewards of the deal.