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NMIMS University
Management of Mergers and Acquisitions
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I. Corporate Restructuring
This is an umbrella term, which covers different types such as merger,
acquisition, takeover etc.
There is no standard definition of corporate restructuring
Corporate restructuring can be defined as any change in the business
capacity or portfolio that is carried out by an inorganic route or a
change in the capital structure of a company that is not a part of its
ordinary course of business, or any change in the ownership of, or
control over the management of the company, or a combination
thereof.
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I. Corporate Restructuring
(a) Any change in the business capacity or portfolio that is carried out
by an inorganic route, or
(b) Any change in the capital structure of a company that is not in the
ordinary course of its business, or
(c) Any change in the ownership of a company or control over its
management, or a combination of any two or all of the above
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I. Corporate Restructuring
Any change in the business capacity or portfolio that is carried out by aninorganic route
Tata Motors launching Sumo and later on Indica
Acquisition of Jaguar Land Rover from Ford by Tata Motors, through itsstep down subsidiary, Jaguar Land Rover Limited
RILs backward integration from textiles to Polyester Filament Yarn (PFY)and Polyester Staple Fiber (PSF), and subsequently into Linear AlkylBenzene (LAB), Purified Terephthalic Acid (PTA), and Paraxylene (PX)
Merger of RPL, which set up a part of Hazira complex to manufactureEthylene Oxide (EO), Mono Ethylene Glycol (MEG), Vinyl ChlorideMonomer (VCM), Polyvinyl Chloride (PVC) and High DensityPolyethylene (HDPE) with RIL in 1991-92
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I. Corporate Restructuring
Acquisition of L&Ts cement division in the form of a separate company
named UltraTech Cement Limited by Grasim, by which the cement
capacity under the control of Grasim went up from 14 million tonnes to 31
million tonnes p.a. is a case of corporate restructuring by Grasim
For L&T this was reduction of its business portfolio and also amounted to
corporate restructuring of L&T.
Any change in the capital structure of a company that is not in theordinary course of its business
The capital structure is never static and changes almost daily.
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I. Corporate Restructuring
Any change in the ownership of a company or control over its
management, or a combination of any two or all of the above
Such a change could be affected through various methods such as: merger of two or more companies belonging to different promoters
de-merger of a company into two or more with control of the resulting
company passing on to other promoters
acquisition of a company
sell off of a company or its substantial assets delisting of a company
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I. Corporate Restructuring
The activities or changes which are not termed corporate restructuring
Initial creation of a corporate structure
Its various examples are:
Incorporation of a limited company Conversion of a proprietary concern into a company
Conversion of a partnership firm into a company
Conversion of a private company into a public company
Change in the internal command structure or hierarchy
Change in the business processes
Downsizing Other activities such as outsourcing, enterprise resource planning, total quality
management, franchising alliances, networking alliances, and licensing
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II. Various Forms of Corporate / Capital Structuring
a. Merger
b. Consolidation
c. Acquisitiond. Divestiture
e. De-merger (Spin Off /Split Up / Split Off)
f. Carve Out
g. Joint Venture
h. Reduction of Capitali. Buyback of Securities
j. De-listing of Securities
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III. Definitions
a. Merger
Involves combination of two (or more) companies such that one of
them survives.
b. Consolidation
Involves creation of an altogether new company owning assets and
liabilities of two or more companies, none of which survives.
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III. Definitions (continued)
Amalgamation
Merger by absorption
Merger by consolidation
Amalgamating company or Transferor company
Amalgamated company or Transferee company
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III. Definitions (continued)
c. AcquisitionAn attempt or a process by which a company or companies or anindividual or a group of individuals acquires majority orcontrolling interest in another company called target company.
Acquiring control over a company means acquiring right to controlits management and policy decisions. Since, generally, a companyis managed under the supervision of its board of directors and allpolicy decisions are made by the board, acquiring control can also bedefined as acquiring right to appoint (and remove) majority of the
directors of a company.
In acquisition, unlike merger, the target companys identityremains intact
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III. Definitions (continued)
There are many ways in which control over a company (called targetcompany) can be acquired:
1. By acquiring i.e. purchasing substantial percentage of the votingcapital of the target company;
2. By acquiring voting rights of the target company through a power ofattorney or through a proxy voting arrangement,
3. By acquiring control over an investment or holding company whether listed or unlisted that in turn holds controlling interest inthe target company,
4. By simply acquiring management control through a formal or
informal understanding or agreement with the existing person (s) incontrol of the target company.
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III. Definitions (continued)
Acquisition of a target company through acquisition of its shares
How much percentage of shareholding an acquirer needs to acquirer?
There is no standard figure
Various Levels of Control
Absolute control
Practically absolute control
General control over a company
Substantial acquisition of shares can lead to three situations:
successful acquisition
partially unsuccessful acquisition
unsuccessful acquisition
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III. Definitions (continued)
d. Divestiture
Out and out sale of all or substantially all the assets of the company
usually for cash. (But could also be for a combination of cash and
debt).
In short divestiture means sale of assets, but not in a piecemeal
manner.
It is also called slump sale under the Income Tax Act, 1961.
The consideration is normally payable in cash. It could be cash plus
debt but no part of consideration is payable in the form of equity
shares.
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III. Definitions (continued)
e. De-merger (Spin Off /Split Up / Split Off)
Spin Off
Involves transfer of some of assets and liabilities of a company
normally of one of the business divisions- to a new company
whose shares are allotted to the original shareholders of the
company on a proportionate basis.
Split Up
Involves transfer of assts and liabilities to two or more companies
in which, again like spin off, the shares in each of the new
companies are allotted to the original shareholders of the
company on a proportionate basis.
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III. Definitions (continued)
Split Off
It is a spin off with the difference that some of the shareholders of
the original company get shares in the new company in exchange of
their shares in the original company.
De-merged company
Resulting company
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III. Definitions (continued)
f. Carve Out
Is a hybrid of divestiture and spin off. In this case, a company spins
off some the assets and liabilities to a new company and then sells a
part or all of the equity of a new company to a set of shareholders
which may or may not be the shareholders of the original company.
g. Joint Venture
It is an arrangement in which two or more companies contribute to
the equity capital of a new company.
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III. Definitions (continued)
Normally joint ventures are formed to pool the resources of the partnersand carry out a business or a specific project beneficial to both the partnersbut which none of the partners wants to carry out under its own corporateentity for any one of the following reasons:
The venture may be highly risky Joint venture partners may be otherwise competitors
Neither of the partners may be willing to dilute control on hisbusinesses
To ensure that management control of the common business or projectis shared in the agreed proportion
To ensure that rewards of the common business or the project areshared in the predetermined ratio
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III. Definitions (continued)
h. Reduction of CapitalThis is a legal process U/s 100 to 105 of the Companies Act, 1956 by
which a company is allowed to extinguish or reduce liability on any
of its shares in respect of share capital not paid up, or is allowed to
cancel any paid up share capital which is lost or is allowed to pay
off any paid up capital which is in excess of its requirement.
i. Buyback of Securities
This is a legal process U/s 77A, 77AA, and 77B of the Companies
Act, 1956 by which a company is allowed to buy back its shares or
other securities.
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III. Definitions (continued)
Why would a company reduce its capital?
1. By extinguishing or reducing the liability in respect of share capital not
paid up (since not called as yet).
2. By writing off or canceling the capital which is lost
3. By paying off or returning excess capital that is not required by the
company
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III. Definitions (continued)
j. De-listing of Securities
A company can list either its equity shares or preference shares or
debt securities on a stock exchange or exchanges. Therefore delisting
of a security could be delisting of any of the securities (and notnecessarily all) from any of the stock exchanges (and not necessarily
all).
When we refer to delisting of a company as a form of corporate
restructuring, we are mainly referring to delisting of its equity sharesfrom all stock exchanges
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IV. Pros and Cons of Organic and Inorganic Routes
a. Organic RoutePros:
Choice of Technology
Choice of Location
Milestone based consolidation
Overhead Control
Cons:
Slow Process
Does not eliminate or reduce competition immediately
Can involve disproportionate marketing expenditure
Regulatory hurdles Registration hurdles
Image / Brand hurdles
Funding for capacity expansion or marketing may be difficultto obtain but relatively easy for acquisition.
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IV. Pros and Cons of Organic and Inorganic Routes
b. Inorganic Route
Cons:
Valuation of target company may be difficult Acquirer may end up paying higher price
Post acquisition integration may pose serious problems in
terms of cultural integration, retrenchment or
redeployment of employees, software integration,
acceptance by customers and suppliers.
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V. Takeover Tactics
Friendly Takeover
Hostile Takeover
Tactics of Hostile Takeover:
a. Dawn Raid
In this tactic brokers acting on behalf of predator / raiderswoop down on stock exchange (s) at the time of its openingand buy all available shares before the target / prey wakesup.
b. Bear HugRaider / Predator sends a very attractive tender offer meantfor the target / preys shareholders to the targets / preysmanagement and asks them to consider the same in theinterest of the shareholders.
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V. Takeover Tactics (continued)
c. Saturday Night Special
This is the same tactic as bear hug, but made on the Friday
or Saturday night asking for a decision by Monday. This is
also called Godfather Offer.
d. Direct Offer to the Shareholders of the Target Company
Raider makes a straight open offer to shareholders of the
target company without giving chance to the existing
management to evaluate the same.
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V. Takeover Tactics (continued)
Sound Tactics of Hostile Takeover in the Indian Context:
a. Market Accumulation followed by an Open Offer
b. Negotiated Deal with Financial Institutions followed by an Open Offer
c. Negotiated Deal with a Breakaway Promoter Faction followed by an
Open Offer
d. Direct Offer to the Shareholders of the Target Company
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VI. Defence Tactics
a. Crown Jewels
Target company sells its highly profitable or attractive
business / division to make the takeover bid less attractive tothe raider
b. Blank Cheque
Target company makes a preferential allotment to existing
promoters or friendly shareholders to increase the control of
promoter group. This may involve issuing a new class of
shares also.
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VI. Defence Tactics (continued)
c. Shark Repellents
The target company amends its charter i.e. MOA or AOA to
make the takeover expensive or impossible. E.g. stipulating a
certain minimum educational qualification for directors orstipulating that a supermajority would be required to approve
a merger
d. Poison Pill
The term poison pill is used to generally refer to any strategy,which upon successful acquisition by the acquirer creates
negative financial results and leads to value destruction.
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VI. Defence Tactics (continued)
Poison pill can take various forms:
1. Issue rights / warrants to the existing shareholders entitling them toacquire large number of shares in the event an acquirers stake in thecompany reaches a certain level (say thirty percent). This is also called
shareholders rights plan.
2. Add to its charter a provision that gives the current shareholders a rightto sell their shares to the acquirer at an increased price (say hundredpercent above the last two or four weeks average price)
3. Borrow large long term funds from banks or financial institutions, orother lenders, for its genuine need. But the repayment terms would besuch that in the event of takeover of the target company the same wouldbecome repayable immediately.
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VI. Defence Tactics (continued)
4. Borrow not for its genuine needs but for paying one time huge dividend
to the shareholders. This tactic is also called as leveraged cash
out
5. Buy back shares using borrowed funds. This is also called as leveraged
recap (orleveraged recapitalization).
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VI. Defence Tactics (continued)
e. Poison Put
The tactics of leveraged recapitalization and leveraged cash
out discussed above are called as poison put by some
authors.
f. Scorched Earth Strategy
This is extreme form of Poison Pill that can endanger the
viability of the target immediately upon takeover being
successful.
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VI. Defence Tactics (continued)
g. Pacman
Target company or its promoters start acquiring sizable
holding in raider, threatening to acquire the raider itself,
making it run for cover and forcing it to hammer out a truce.
h. Green Mail
The target company or existing promoters arrange through
friendly investors to accumulate large stock of its shares with
a view to raising its market price high to make the takeover
very expensive to the raider.
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VI. Defence Tactics (continued)
Some times green mail is used to describe an arrangementcalled target block repurchase with standstill agreement.This means that the target company or its present promotersagree to buyback the shares being accumulated by the raiderat a substantial premium and in return the raider enters into
agreement that neither he nor any of his associates shallacquire any sizable stake in the target company for astipulated period of time.
i. White Knight
In this, the target company or its existing promoters enlistthe services of another company or group of investors to actas white knight and takeover the target thereby foiling thebid of the raider and retaining the control of existingpromoters
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VI. Defence Tactics (continued)
j. Grey Knight
In this, the services of a friendly company or group of
investors are engaged to acquire shares of the raider itself to
keep the raider busy defending himself and eventually force
a truce.
k. Golden Parachute
The contractual guarantee of a fairly large sum of
compensation to top and / or senior executives of the target
company whose services are likely to be terminated in casethe takeover by the raider succeeds.
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VII. M&A Theories
Though primary motive is growth, there are other motives such as various
synergies etc. Also the growth motive has different dimensions.
Let us look at the theoretical framework
Friedrich Trautwein has propagated the following theory. He classifies Merger
(incl. Acquisition) Motives or Theories as follows:
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VII. M&A Theories (continued)
a. Merger as Rational ChoiceMergers that benefit the bidders / raiders shareholders
y Monopoly Theory
(Wealth transfer from the targets customers)
y Efficiency Theory
(Net gains through synergies)
y Valuation Theory
(Wealth transfer through private information)
y Raider Theory
(Wealth transfer from the targets shareholders)
Mergers that benefit the bidders / raiders managers
Empire Building Theory
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VII. M&A Theories (continued)
b. Merger as Process Outcome
Process Theory
c. Merger as Macroeconomic Disturbances
Disturbance Theory
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VII. M&A Theories (continued)
Monopoly Theory
This theory explains M&A as being planned and executed to achieve Market
Share and Market Power including at times Pricing Power. In other words it
confirms that M&A is primarily used as growth strategy.
As mentioned earlier, the growth motive / strategy itself has different
dimensions:
a. Market leaders trying to consolidate their position furtherb. Profitable and Cash Rich companies trying to gain market leadership
c. India / Global entry Strategy
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VII. M&A Theories (continued)
1. King Fischer Airlines acquiring Deccan Airways and Jet
Airways acquiring Sahara Airlines.
2. Mittal Steel acquiring Arcelor
3. Tata Steel acquiring NatSteel and then Corus
4. Idea Cellular acquiring Spice Communication
5. Tata Tea acquiring Tetley
6. Daiichi Sankyo acquiring Ranbaxy
7. Vodafone acquiring Hutchison Essar
8. Grasim acquiring L&Ts UltraTech Cement Division.
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VII. M&A Theories (continued)
Manufacturing Synergy
Manufacturing Synergies can be achieved not only through vertical
acquisitions but also through horizontal acquisitions. It essentially involves
combining core competence of the acquirer company and target company in
the different areas of manufacturing, technology, design and development etc.
It could also mean rationalising usage of the combined manufacturing
capacities.
1. Tata Motors acquiring Daewoos commercial vehicle unit
2. M&M acquiring Jiangling Motors in China
3. Daiichi Sankyo acquiring Ranbaxy
4. Tata Steel taking over Corus
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VII. M&A Theories (continued)
Operations Synergy
Operations Synergy involves rationalising the combined operations in such a
manner that through sharing of facilities such as warehouses, transportation
facilities, software, common services such as Accounts & Finance, Tax, HR,Administration etc. duplication is avoided or logistic is improved leading to
quantumcost saving.
1. King Fischer Airlines acquiring Deccan Airways and Jet Airways
acquiring Sahara Airlines2. Star TV acquiring a stake in Balaji and Zee TV acquiring ETC
3. VSNL acquiring Tyco
4. Reliance acquiring FLAG
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VII. M&A Theories (continued)
Marketing Synergy
Marketing synergy involves using either common sales force, or distribution
channel or media to push the products and brands of both the acquirer and
target companies at lower costs.
1. Dilip Piramals VIP acquiring Universal Luggage
2. HLL acquiring Lakme brand and its cosmetics business
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VII. M&A Theories (continued)
Financial Synergy
Financial Synergy involves achieving either lower cost of capital or better
gearing ratio, or other improved financial parameters by combining both the
balance sheets.
Merger of Reliance Petrochemicals with Reliance Industries in the year 1991
-92.
As on 31-03-91 the RIL had following capital structurePUC Rs. 152.12 Crore
Reserves Rs. 995.53 Crore
Net Worth Rs.1147.65 Crore
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VII. M&A Theories (continued)
As on the same day RPL had PUC and Net Worth of Rs. 749.28 Crore. Its
refinery was just about to go on stream. Ambanis merged RPL with RIL at a
ratio of 10:1. This added only Rs. 74.93 Crore to PUC of RIL and whopping
Rs. 674.35 to its Reserves. Along with the retained earnings of Rs. 40.87 Crore
from 1991-92 operation RIL capital structure as on 31-12-92 became:
PUC Rs. 227.07 Crore
Reserves Rs. 1710.75Crore
Net Worth Rs. 1937.82 Crore
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VII. M&A Theories (continued)
Ambanis repeated the same thing in 1994-95 when they merged Reliance Poly
Ethylene Ltd. (RPEL) and Reliance Poly Propylene Ltd. (RPPL) with RIL and
added Rs. 99.58 Crore to PUC and Rs. 603.00 Crore to Reserves of RIL.
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VII. M&A Theories (continued)
Tax Synergy
Tax Synergy involves merging loss making company with a profitable one so
that the profitable company can get tax benefit by writing off accumulated
losses of the loss making company.
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VII. M&A Theories (continued)
Valuation Theory
This theory explains that the M&A are planned and executed by the acquirer
who has better information about the valuation of the target than the stock
market as a whole and who estimates the real intrinsic value to be much higher
than the present market capitalization of the company. Therefore such an
acquirer is ready to pay premium to the present market price to acquire control
over the target company.
This theory is in sharp contrast to the Efficient Markets theory. What
Efficient Markets theory argues is that stock markets are perfect and
efficient when it comes to determining the right valuation of any company.
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VII. M&A Theories (continued)
Then how is it possible that the market capitalization is much below the true
intrinsic value of the company? Also, is there anything like true intrinsic value
of any company?
Rather than going into theoretical debate, we can look at this from different
practical aspects:
1. Though, by and large, markets are perfect, there are information gaps,
costs and also critical inside information. If acquirer becomes privy to
such information before the stock market, he will find the intrinsic value
of the company to be much higher than the market capitalization.
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VII. M&A Theories (continued)
2. The acquirer may have the same information about the company asstock market, but a different view on the future cash flows basedon his own reading of the future course of the economy or thecompany.
3. In case of those companies that have substantial off balance sheetassets or substantially undervalued non-operating assets, which arenot being encashed by the present management, the acquirer may
have a game plan to encash upon these assts and hence he would putmuch more value to the company than the stock market.
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VII. M&A Theories (continued)
4. Economies and stock markets always show a cyclical pattern. A boom
is followed by depression and vice-a-versa. During a phase of prolonged
depression in the economy and stock market, the market capitalizations
of companies go much below their replacement costs. Ratio of market
capitalization to replacement cost is known as Q Ratio. When depressionends and economy starts looking up, stock market starts valuing the
company progressively higher expecting better cash flows in the
improved times. In this sense a cash rich company planning to acquire
competitors, can find undervalued companies at the end of a
prolonged depression just before the boom picks up.
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VII. M&A Theories (continued)
5. In case of underperforming companies having strong brand (s), theacquirer may be confident of leveraging on such brands and generate
higher growth and cash flows and hence may put a much highervalue to the company than the stock market.
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VII. M&A Theories (continued)
Raider Theory
Rider Theory explains the M&A activity in the specific context of PE Fundswho acquire controlling stake in cash needy companies at much lowervaluation than potential or even present valuation, just to transfer thewealth from existing shareholders to themselves without any strategic
intent of running these companies themselves.
Empire Building Theory
Empire Building Theory tries to explain M&A as being planned and executedby the managers for expanding their own empire rather than crating
shareholder wealth.
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VIII. Intents of Target Companies
1. Exiting Non Profitable Business
Global Trust Bank being merged with OBC
NOCIL selling out to RIL
2. Exiting Non Synergistic or Non Core Business
L&T selling out Ultra Tech Cement Division to Grasim
3. Generate Cash Flow for Other Business (es)
India Cement selling 94.69% stake in Shri Vishnu
Cement to generate Rs. 385 Crore for funding its own
expansion
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VIII. Intents of Target Companies (continued)
4. Inability real or perceived to withstand
competition
} Lakme selling out to HLL
} Ramesh Chauhan selling out Thumps Up, GoldSpot to Coca Cola
5. Inability to achieve further growth
} Bazee.com selling to e-Bay
} Daksh e-Services selling to IBM
} Spice Telecom selling to IDEA
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VIII. Intents of Target Companies (continued)
6. Inability to mobilize further resources for business
growth
} Investment by Warburg Pincus in Max Group tofund Life Insurance and Healthcare businesses
} Notz Stucki investing in Camlin
} Deccan Airways selling out to King Fischer
Airlines
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IX. Typical Characteristics of Takeover Candidates
a. Low Market Capitalization vis--vis Intrinsic(Present/Potential) Value
b. Low Market Capitalization vis--vis Replacement
Cost of Assets
c. Low Market Capitalization vis--vis Book Value
d. Cash Flows in excess of Debt ServicingRequirements
e. Lowly Geared Companies
f. Moderate or low growth vis-a-vis Industry growth
g. Underperforming Companies
h. Unexploited Brand Potential
i. Undervalued and Saleable non operating assets.
j. Large off Balance Sheet Assets
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IX. Typical Characteristics of Takeover Candidates
(continued)
In all the above cases one basic requirement is low promoter holding
or willingness of Promoters or some of the promoters to sell their
stake.
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