10934106 merger and acquisition in steel industry

7/29/2019 10934106 Merger and Acquisition in Steel Industry

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MERGER AND ACQUISITION WITH REFERNCE

TO STEEL INDUSTRY

DISSERTATION REPORT2009

Submitted for the partial fulfillment of the requirement for the award

Of

POST GRADUATE DIPLOMA IN MANAGEMENT

SUBMITTED BY

ARABINDA KAR

Enroll No. : - 7015

UNDER THE SUPERVISION OF

Mr. Gurpreet Singh Sachdeva

Department of Management


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INSTITUTE OF MANAGEMENT EDUCATION,SAHIBABAD

INSTITUTE OF MANAGEMENT EDUCATION

G.T.Road, Sahibabad, Ghaziabad (U.P)

DEPARTMENT OF MANAGEMENT

CERTIFICATE

This is to certify that the dissertation entitled MERGER AND

ACQUISITION WITH REFERNCE TO STEEL INDUSTRY submitted

by Arabinda Kar for the partial fulfillment of the requirement of PGDM(Batch 2007-09), embodies the bonafide work done by him under my

supervision.

____________________

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Signature of the Guide

Acknowledgement

It is a matter of great satisfaction and pleasure to present this presentation on MERGER

AND ACQUISITION WITH REFERNCE TO STEEL INDUSTRY ". I take this

opportunity to owe my thanks to all my faculty members for their encouragement and able

guidance at every stage of this report.

There are people who simply by being there influence and inspire me to do thing. I am

grateful to Dr. D.P. Goyal, Director Institute of Management Education for creating a

conducive environment in the institute for a purposeful education.

I am grateful to Dr. Taruna Gautam, assistant director for his encouragement. I

acknowledge my gratitude and indebt ness to my internal project guide Mr. Gurpreet

Singh Sachdeva, faculty of Institute of Management Education, who spared his precious

time in guiding me and for making valuable suggestions in compiling this project report.

I express my gratitude towards all those people who have helped me directly or indirectly

in completing this report.

ARABINDA KAR

PGDM

Roll no. - 7015

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ABSTRACT

Even though mergers and acquisitions (M&A) have been an important element of corporate

strategy all over the globe for several decades, research on M&As has not been able to

provide conclusive evidence on whether they enhance efficiency or destroy wealth. There

is thus an ongoing global debate on the effects of M&As on firms. Mergers and

acquisitions have become common in India today. However, very little appears to be

known about the long-term post-merger performance of firms in India, and the strategic

factors that affect this performance. Our study attempts to fill this gap in knowledge aboutM&As in India. We have carried out statistical analyses of financial data pertaining to 87

pairs of merged firms. These mergers took place in the period 1996 to 2002. Out of these

87 mergers, 64 are between firms belonging to related industries and 23 to unrelated

industries. Stock is the predominant method of payment for the acquired firm (in 76 out of

87 mergers), and transfer of corporate control has taken place in 37 of the 87 mergers.

Fourteen of the acquired companies were sick and had been referred to the Board for

Industrial and Financial Reconstruction (BIFR) at the time of their merger.

The performance of mergers has been gauged in two ways in this study by

determining whether the long-term post-merger financial performance has changed

significantly, and by assessing the wealth gains to shareholders of the acquiring, acquired

and the combined firms on the announcement of mergers. It is found that the merged firms

demonstrate improvement in long-term financial performance after controlling for pre-

merger performance, with increasing cash flow returns post merger, at an annual rate of

4.3%. This improved operating cash flow return is on account of improvements in the post-

merger operating margins of the firms, though not of the efficient utilization of the assets to

generate higher sales. Increase in market power also appears to be driving gains through

mergers in India. As far as wealth gains on merger announcement are concerned, only the

shareholders of the acquired firms appear to be enjoying significant positive share price

returns of 11.6%. The shareholders of the acquiring firms and the combined firms do not

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seem to be witnessing any significant change in returns. With regard to the strategic factors

affecting long-term post-merger financial performance, related mergers seem to be

performing 5.4% lower than unrelated mergers. Both the transfer of corporate control from

the acquired firm to the acquiring firm, and the business health of the acquired firm are

positively related to the long-term post-merger performance of the firms. The relative size

of the acquired firm and the method of payment for the acquired firm do not appear to be

playing a role in affecting post-merger performance.

In the case of the effect of the strategic factors on the wealth gains on merger

announcement, we find that the mergers in which there is no transfer of corporate control

seem to be conferring significant positive share price returns of 21.1% on the shareholders

of the acquired firms. This is not the case for the shareholders of the acquiring firms and

the combined firms. In the case of mergers where there is a transfer of management control,

none of these three groups of shareholders witnesses any abnormal returns on

announcement of the merger. The wealth gains to acquired firm shareholders on

announcement of a merger are positively influenced by the relative size and the pre-merger

performance of the acquired firm. The transfer of corporate control from the acquired firm

to the acquiring firm is negatively associated with these abnormal share price returns. The

level of industry-relatedness of the acquired and the acquiring firms, the method of

payment for the acquired firm and the business health of the acquired firm do not appear to

be playing a role in affecting the share price returns to the acquired firm shareholders, on

announcement of a merger.

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CONTENTS

CHAPTER I: INTRODUCTION.............................................................................

Background ...

Objective of the study

CHAPTER II: LITERATURE REVIEW

a) Global steel industry..

b) Tata Vs Corus..

c) Arcellor Vs Mittal

CHAPTER III: RESEARCH METHODOLGY.

CHAPTER IV: DESCRIPTIVE WORK................................................................

a) Valuation of merger and acquisition .

b) Tata Vs Corus Visionary deal or Costly blunder

c) Arcellor-Mittal Vs Tata-Corus ...

d) Competition analysis of steel industry

e) SWOT Analysis.

f) Expected growth..

g) Factors holding back Indian steel industry.

h) Recent financial crisis & Indian steel industry.

i) Five-Force analysis of steel industry

CHAPTER V: CONCLUSIONS AND RECOMMENDATIONS.

REFERENCES

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LIST OF TABLES AND FIGURES

LIST OF FIGURES Page no.

Figure 1.World steel production.25

Figure 2 Global steel capacity26

Figure 3 Indian steel capacity.28

Figure 4 Indian steel production.29

Figure 5. Indian steel consumption30

Figure 6 Motives44

Figure 7 Procedure of valuation.. .46

Figure 8 Financing Merger47

Figure 9..Key sector growth64

List of Tables

Table 1Steel production share.27

Table 2Steel consumption share..27

Table 3Tata steel capacity...32

Table 4Global steel output..51

Table 5Global steel ranking53

Table 6.Tata-Corus Present capacity..54

Table 7.Tata-Corus projected capacity...54

Table 8.Corus Financials56

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CHAPTER 1: INTRODUCTION

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Background

Mergers and acquisitions (M&A) and corporate restructuring are a big part of the corporate

finance world. Every day, investment bankers arrange M&A transactions, which bring

separate companies together to form larger ones. When they're not creating big companies

from smaller ones, corporate finance deals do the reverse and break up companies through

spin-offs, carve-outs or tracking stocks. Not surprisingly, these actions often make the

news. Deals can be worth hundreds of millions, or even billions, of dollars or rupees. They

can dictate the fortunes of the companies involved for years to come. For a CEO, leading

an M&A can represent the highlight of a whole career. And it is no wonder we hear about

so many of these transactions; they happen all the time. Next time you flip open the

newspapers business section, odds are good that at least one headline will announce some

kind of M&A transaction. Sure, M&A deals grab headlines, but what does this all mean to

investors? To answer this question, this report discusses the forces that drive companies to

buy or merge with others, or to split-off or sell parts of their own businesses. Once you

know the different ways in which these deals are executed, you'll have a better idea of

whether you should cheer or weep when a company you own buys another company - or is

bought by one. You will also be aware of the tax consequences for companies and for

investors

Defining M&A

The main ideaone plus one makes three: this equation is the special alchemy of a merger oran acquisition. The key principle behind buying a company is to create shareholder value

over and above that of the sum of the two companies. Two companies together are more

valuable than two separate companies - at least, that's the reasoning behind M&A. This

rationale is particularly alluring to companies when times are tough. Strong companies will

act to buy other companies to create a more competitive, cost-efficient company. The

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companies will come together hoping to gain a greater market share or to achieve greater

efficiency. Because of these potential benefits, target companies will often agree to be

purchased when they know they cannot survive alone.

Distinction between Mergers and Acquisitions

Although they are often uttered in the same breath and used as though they were

synonymous, the terms merger and acquisition mean slightly different things. When one

company takes over another and clearly established itself as the new owner, the purchase is

called an acquisition. From a legal point of view, the target company ceases to exist, the

buyer "swallows" the business and the buyer's stock continues to be traded. In the pure

sense of the term, a merger happens when two firms, often of about the same size, agree to

go forward as a single new company rather than remain separately owned and operated.

This kind of action is more precisely referred to as a "merger of equals." Both companies'

stocks are surrendered and new company stock is issued in its place. For example, both

Daimler-Benz and Chrysler or Arcellor and Mittal ceased to exist when the two firms

merged, and a new company, DaimlerChrysler and Arcellor-Mittal, was created. In

practice, however, actual mergers of equals don't happen very often. Usually, one company

will buy another and, as part of the deal's terms, simply allow the acquired firm to proclaim

that the action is a merger of equals, even if it's technically an acquisition. Being bought

out often carries negative connotations, therefore, by describing the deal as a merger, deal

makers and top managers try to make the takeover more palatable.

A purchase deal will also be called a merger when both CEOs

agree that joining together is in the best interest of both of their companies. But when the

deal is unfriendly - that is, when the target company does not want to be purchased - it is

always regarded as an acquisition. Whether a purchase is considered a merger or an

acquisition really depends on whether the purchase is friendly or hostile and how it is

announced. In other words, the real difference lies in how the purchase is communicated to

and received by the target company's board of directors, employees and shareholders.

Synergy

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Synergy is the magic force that allows for enhanced cost efficiencies of

the new business. Synergy takes the form of revenue enhancement and cost savings. By

merging, the companies hope to benefit from the following:

Staff reductions - As every employee knows, mergers tend to mean job losses.

Consider all the money saved from reducing the number of staff members from

accounting, marketing and other departments. Job cuts will also include the former

CEO, who typically leaves with a compensation package.

Economies of scale - Yes, size matters. Whether it's purchasing stationery or a new

corporate IT system, a bigger company placing the orders can save more on costs.

Mergers also translate into improved purchasing power to buy equipment or office

supplies - when placing larger orders, companies have a greater ability to negotiate

prices with their suppliers.

Acquiring new technology - To stay competitive, companies need to stay on top of

technological developments and their business applications. By buying a smaller

company with unique technologies, a large company can maintain or develop a

competitive edge.

Improved market reach and industry visibility - Companies buy companies to reach

new markets and grow revenues and earnings. A merge may expand two companies'marketing and distribution, giving them new sales opportunities. A merger can also

improve a company's standing in the investment community: bigger firms often have an

easier time raising capital than smaller ones.

That said, achieving synergy is easier said than done - it is not automatically realized once

two companies merge. Sure, there ought to be economies of scale when two businesses are

combined, but sometimes a merger does just the opposite. In many cases, one and one add

up to less than two. Sadly, synergy opportunities may exist only in the minds of the

corporate leaders and the deal makers. Where there is no value to be created, the CEO and

investment bankers - who have much to gain from a successful M&A deal - will try to

create an image of enhanced value. The market, however, eventually sees through this and

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penalizes the company by assigning it a discounted share price. We'll talk more about why

M&A may fail in a later section of this tutorial.

Varieties of Mergers

From the perspective of business structures, there is a whole host of

different mergers. Here are a few types, distinguished by the relationship between the two

companies that are merging:

Horizontal merger - Two companies that are in direct competition and share the same

product lines and markets.

Vertical merger - A customer and company or a supplier and company. Think of a

cone supplier merging with an ice cream maker.

Market-extension merger - Two companies that sell the same products in different

markets.

Product-extension merger - Two companies selling different but related products in

the same market.

Conglomeration - Two companies that have no common business areas. There are two

types of mergers that are distinguished by how the merger is financed. Each has certain

implications for the companies involved and for investors:

Purchase Mergers - As the name suggests, this kind of merger occurs when one

company purchases another. The purchase is made with cash or through the issue of

some kind of debt instrument; the sale is taxable. Acquiring companies often prefer this

type of merger because it can provide them with a tax benefit. Acquired assets can be

written-up to the actual purchase price, and the difference between the book value and

the purchase price of the assets can depreciate annually, reducing taxes payable by the

acquiring company. We will discuss this further in part four of this tutorial.

Consolidation Mergers - With this merger, a brand new company is formed and both

companies are bought and combined under the new entity. The tax terms are the same

as those of a purchase merger.

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Acquisitions

An acquisition may be only slightly different from a merger. In fact, it may be different in

name only. Like mergers, acquisitions are actions through which companies seek

economies of scale, efficiencies and enhanced market visibility. Unlike all mergers, all

acquisitions involve one firm purchasing another - there is no exchange of stock or

consolidation as a new company. Acquisitions are often congenial, and all parties feel

satisfied with the deal. Other times, acquisitions are more hostile. In an acquisition, as in

some of the merger deals we discuss above, a company can buy another company with

cash, stock or a combination of the two. Another possibility, which is common in smaller

deals, is for one company to acquire all the assets of another company. Company X buys

all of Company Y's assets for cash, which means that Company Y will have only cash (and

debt, if they had debt before). Of course, Company Y becomes merely a shell and will

eventually liquidate or enter another area of business. Another type of acquisition is a

reverse merger, a deal that enables a private company to get publicly-listed in a relatively

short time period. A reverse merger occurs when a private company that has strong

prospects and is eager to raise financing buys a publicly-listed shell company, usually one

with no business and limited assets. The private company reverse merges into the public

company, and together they become an entirely new public corporation with tradable

shares. Regardless of their category or structure, all mergers and acquisitions have one

common goal: they are all meant to create synergy that makes the value of the combined

companies greater than the sum of the two parts. The success of a merger or acquisition

depends on whether this synergy is achieved.

Valuation Matters

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Investors in a company that is aiming to take over another one must determine whether the

purchase will be beneficial to them. In order to do so, they must ask themselves how much

the company being acquired is really worth.

Naturally, both sides of an M&A deal will have different ideas

about the worth of a target company: its seller will tend to value the company at as high of

a price as possible, while the buyer will try to get the lowest price that he can. There are,

however, many legitimate ways to value companies. The most common method is to look

at comparable companies in an industry, but deal makers employ a variety of other methods

and tools when assessing a target company. Here are just a few of them:

1. Comparative Ratios - The following are two examples of the many comparative

metrics on which acquiring companies may base their offers:

Price-Earnings Ratio (P/E Ratio) - With the use of this ratio, an acquiring company

makes an offer that is a multiple of the earnings of the target company. Looking at the

P/E for all the stocks within the same industry group will give the acquiring company

good guidance for what the target's P/E multiple should be.

Enterprise-Value-to-Sales Ratio (EV/Sales) - With this ratio, the acquiring company

makes an offer as a multiple of the revenues, again, while being aware of the price-to-

sales ratio of other companies in the industry.2. Replacement Cost

In a few cases, acquisitions are based on the cost of replacing the target

company. For simplicity's sake, suppose the value of a company is simply the sum of all its

equipment and staffing costs. The acquiring company can literally order the target to sell at

that price, or it will create a competitor for the same cost. Naturally, it takes a long time to

assemble good management, acquire property and get the right equipment. This method of

establishing a price certainly wouldn't make much sense in a service industry where the key

assets - people and ideas - are hard to value and develop.

3. Discounted Cash Flow (DCF)

A key valuation tool in M&A, discounted cash flow analysis

determines a company's current value according to its estimated future cash flows.

Forecasted free cash flows (operating profit + depreciation + amortization of goodwill

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capital expenditures cash taxes - change in working capital) are discounted to a present

value using the company's weighted average costs of capital (WACC). Admittedly, DCF is

tricky to get right, but few tools can rival this valuation method.

Synergy: The Premium for Potential Success

For the most part, acquiring companies nearly always pay a substantial

premium on the stock market value of the companies they buy. The justification for doing

so nearly always boils down to the notion of synergy; a merger benefits shareholders when

a company's post-merger share price increases by the value of potential synergy. Let's face

it, it would be highly unlikely for rational owners to sell if they would benefit more by not

selling. That means buyers will need to pay a premium if they hope to acquire the

company, regardless of what pre-merger valuation tells them. For sellers, that premium

represents their company's future prospects. For buyers, the premium represents part of the

post-merger synergy they expect can be achieved. The following equation offers a good

way to think about synergy and how to determine whether a deal makes sense. The

equation solves for the minimum required synergy:

In other words, the success of a merger is measured by whether the value of the buyer is

enhanced by the action. However, the practical constraints of mergers, which discussed

often prevent the expected benefits from being fully achieved. Alas, the synergy promised

by deal makers might just fall short.

What to Look For - It's hard for investors to know when a deal is worthwhile. The burden

of proof should fall on the acquiring company. To find mergers that have a chance of

success, investors should start by looking for some of these simple criteria given as below.

A reasonable purchase price - A premium of, say, 10% above the market price seems

within the bounds of level-headedness. A premium of 50%, on the other hand, requires

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synergy of stellar proportions for the deal to make sense. Stay away from companies

that participate in such contests.

Cash transactions - Companies that pay in cash tend to be more careful when

calculating bids and valuations come closer to target. When stock is used as the

currency for acquisition, discipline can go by the wayside.

Sensible appetite An acquiring company should be targeting a company that is

smaller and in businesses that the acquiring company knows intimately. Synergy is hard

to create from companies in disparate business areas. Sadly, companies have a bad

habit of biting off more than they can chew in mergers.

Mergers are awfully hard to get right, so investors should look for acquiring companies

with a healthy grasp of reality.

Doing the Deal

Start with an Offer When the CEO and top managers of a company decide that they want

to do a merger or acquisition, they start with a tender offer. The process typically begins

with the acquiring company carefully and discreetly buying up shares in the target

company, or building a position. Once the acquiring company starts to purchase shares in

the open market, it is restricted to buying 5% of the total outstanding shares before it must

file with the SEC. In the filing, the company must formally declare how many shares it

owns and whether it intends to buy the company or keep the shares purely as an

investment.

Working with financial advisors and investment bankers, the acquiring

company will arrive at an overall price that it's willing to pay for its target in cash, shares or

both. The tender offer is then frequently advertised in the business press, stating the offer

price and the deadline by which the shareholders in the target company must accept (or

reject) it.

The Target's Response

Once the tender offer has been made, the target company can do one

of several things:

Accept the Terms of the Offer - If the target firm's top managers and shareholders are

happy with the terms of the transaction, they will go ahead with the deal.

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Attempt to Negotiate - The tender offer price may not be high enough for the target

company's shareholders to accept, or the specific terms of the deal may not be

attractive. In a merger, there may be much at stake for the management of the target -

their jobs, in particular. If they're not satisfied with the terms laid out in the tender

offer, the target's management may try to work out more agreeable terms that let them

keep their jobs or, even better, send them off with a nice, big compensation package.

Not surprisingly, highly sought-after target companies that are the object of several

bidders will have greater latitude for negotiation. Furthermore, managers have more

negotiating power if they can show that they are crucial to the merger's future success.

Execute a Poison Pill or Some Other Hostile Takeover Defense A poison pill

scheme can be triggered by a target company when a hostile suitor acquires a

predetermined percentage of 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

intercepts its control of the company.

Find a White Knight - As an alternative, the target company's management may seek

out a friendlier potential acquiring company, or white knight. If a white knight is found,

it will offer an equal or higher price for the shares than the hostile bidder.

Mergers and acquisitions can face scrutiny from regulatory bodies. For example, if the two

biggest long-distance companies in the U.S., AT&T and Sprint, wanted to merge, the deal

would require approval from the Federal Communications Commission (FCC). The FCC

would probably regard a merger of the two giants as the creation of a monopoly or, at the

very least, a threat to competition in the industry.

Closing the Deal

Finally, once the target company agrees to the tender offer and

regulatory requirements are met, the merger deal will be executed by means of some

transaction. In a merger in which one company buys another, the acquiring company will

pay for the target company's shares with cash, stock or both. A cash-for-stock transaction is

fairly straightforward: target company shareholders receive a cash payment for each share

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purchased. This transaction is treated as a taxable sale of the shares of the target company.

If the transaction is made with stock instead of cash, then it's not taxable. There is simply

an exchange of share certificates. The desire to steer clear of the tax man explains why so

many M&A deals are carried out as stock-for-stock transactions. When a company is

purchased with stock, new shares from the acquiring company's stock 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. The shareholders of the target company are only

taxed when they sell their new shares. When the deal is closed, investors usually receive a

new stock in their portfolios - the acquiring company's expanded stock. Sometimes

investors will get new stock identifying a new corporate entity that is created by the M&A

deal.

Break Ups

As mergers capture the imagination of many investors and companies, the idea of getting

smaller might seem counterintuitive. But corporate break-ups, or de-mergers, can be very

attractive options for companies and their shareholders.

Advantages

The rationale behind a spin-off, tracking stock or carve-out is that "the

parts are greater than the whole." These corporate restructuring techniques, which involve

the separation of a business unit or subsidiary from the parent, can help a company raise

additional equity funds. A break-up can also boost a company's valuation by providing

powerful incentives to the people who work in the, making it more difficult to attract

interest from institutional investors. Meanwhile, there are the extra costs that the parts of

the business face if separated. When a firm divides itself into smaller units, it may be losing

the separating unit, and help the parent's management to focus on core operations. Most

importantly, shareholders get better information about the business unit because it issues

separate financial statements. This is particularly useful when a company's traditional line

of business differs from the separated business unit. With separate financial disclosure,

investors are better equipped to gauge the value of the parent corporation. The parent

company might attract more investors and, ultimately, more capital. Also, separating a

subsidiary from its parent can reduce internal competition for corporate funds. For

investors, that's great news: it curbs the kind of negative internal wrangling that can

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compromise the unity and productivity of a company. For employees of the new separate

entity, there is a publicly traded stock to motivate and reward them. Stock options in the

parent often provide little incentive to subsidiary managers, especially because their efforts

are buried in the firm's overall performance.

Disadvantages

That said, de-merged firms are likely to be substantially smaller than

their parents, possibly making it harder to tap credit markets and costlier finance that may

be affordable only for larger companies. And the smaller size of the firm may mean it has

less representation on major indexes synergy that it had as a larger entity. For instance, the

division of expenses such as marketing, administration and research and development

(R&D) into different business units may cause redundant costs without increasing overall

revenues.

Restructuring Methods

There are several restructuring methods: doing an outright sell-off, doing

an equity carve-out, spinning off a unit to existing shareholders or issuing tracking stock.

Each has advantages and disadvantages for companies and investors. All of these deals are

quite complex.

Sell-Offs

A sell-off, also known as a divestiture, is the outright sale of a company

subsidiary. Normally, sell-offs are done because the subsidiary doesn't fit into the parent

company's core strategy. The market may be undervaluing the combined businesses due to

a lack of synergy between the parent and subsidiary. As a result, management and the

board decide that the subsidiary is better off under different ownership. (IPO) of shares,

amounting to a partial sell-off. A new publicly-listed company is created, but the parent

keeps a controlling stake in the newly traded subsidiary. A carve-out is a strategic avenue a

parent firm may take when one of its subsidiaries is growing faster and carrying higher

valuations than other businesses owned by the parent. A carve-out generates cash because

shares in the subsidiary are sold to the public, but the issue also unlocks the value of the

subsidiary unit and enhances the parent's shareholder value. The new legal entity of a

carve-out has a separate board, but in most carve-outs, the parent retains some control. In

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these cases, some portion of the parent firm's board of directors may be shared. Since the

parent has a controlling stake, meaning both firms have common shareholders, the

connection between the two will likely be strong. That said, sometimes companies carve-

out a subsidiary not because it's doing well, but because it is a burden. Such an intention

won't lead to a successful result, especially if a carved-out subsidiary is too loaded with

debt, or had trouble even when it was a part of the parent and is lacking an established track

record for growing revenues and profits. Carve-outs can also create unexpected friction

between the parent and subsidiary. Problems can arise as managers of the carved-out

company must be accountable to their public shareholders as well as the owners of the

parent company. This can create divided loyalties.

Spin-offs

A spin-off occurs when a subsidiary becomes an independent

entity. The parent firm distributes shares of the subsidiary to its shareholders through a .

Since this transaction is a dividend distribution, no cash is generated. Thus, spin-offs are

unlikely to be used when a firm needs to finance growth or deals. Like the carve-out, the

subsidiary becomes a separate legal entity with a distinct management and board. Besides

getting rid of an unwanted subsidiary, sell-offs also raise cash, which can be used to pay off

debt. In the late 1980s and early 1990s, corporate would use debt to finance acquisitions.

Then, after making a purchase they would sell-off its subsidiaries to raise cash to service

the debt. The raiders' method certainly makes sense if the sum of the parts is greater than

the whole. When it isn't, deals are unsuccessful.

Equity Carve-Outs

More and more companies are using equity carve-outs to boost shareholder

value. A parent firm makes a subsidiary public through a raiders initial public offering

stock dividend meaning they don't grant shareholders the same voting rights as those of the

main stock. Each share of tracking stock may have only a half or a quarter of a vote. In rare

cases, holders of tracking stock have no vote at all. Like carve-outs, spin-offs are usually

about separating a healthy operation. In most cases, spin-offs unlock hidden shareholder

value. For the parent company, it sharpens management focus. For the spin-off company,

management doesn't have to compete for the parent's attention and capital. Once they are

set free, managers can explore new opportunities. Investors, however, should beware of

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throw-away subsidiaries the parent created to separate legal liability or to off-load debt.

Once spin-off shares are issued to parent company shareholders, some shareholders may be

tempted to quickly dump these shares on the market, depressing the share valuation.

Tracking Stock

A tracking stock is a special type of stock issued by a publicly held company to

track the value of one segment of that company. The stock allows the different segments of

the company to be valued differently by investors. Let's say a slow-growth company

trading at a low (P/E ratio) happens to have a fast growing business unit. The company

might issue a tracking stock so the market can value the new business separately from the

old one and at a significantly higher P/E rating. Why would a firm issue a tracking stock

rather than spinning-off or carving-out its fast growth business for shareholders? The

company retains control over the subsidiary; the two businesses can continue to enjoy

synergies and share marketing, administrative support functions, a headquarters and so on.

Finally, and most importantly, if the tracking stock climbs in value, the parent company can

use the tracking stock it owns to make acquisitions. Still, shareholders need to remember

that tracking stocks are price-earnings ratio class B

Why They Can Fail

It's no secret that plenty of mergers don't work. Those who advocate mergers

will argue that the merger will cut costs or boost revenues by more than enough to justify

the price premium. It can sound so simple: just combine computer systems, merge a few

departments, use sheer size to force down the price of supplies and the merged giant should

be more profitable than its parts. In theory, 1+1 = 3 sounds great, but in practice, things can

go awry.

Historical trends show that roughly two thirds of big mergers will

disappoint on their own terms, which means they will lose value on the stock market. The

motivations that drive mergers can be flawed and efficiencies from economies of scale may

prove elusive. In many cases, the problems associated with trying to make merged

companies work are all too concrete.

Flawed Intentions

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For starters, a booming stock market encourages mergers, which can spell

trouble. Deals done with highly rated stock as currency are easy and cheap, but the strategic

thinking behind them may be easy and cheap too. Also, mergers are often attempt to

imitate: somebody else has done a big merger, which prompts other top executives to

follow suit. A merger may often have more to do with glory-seeking than business strategy.

The executive ego, which is boosted by buying the competition, is a major force in M&A,

especially when combined with the influences from the bankers, lawyers and other assorted

advisers who can earn big fees from clients engaged in mergers. Most CEOs get to where

they are because they want to be the biggest and the best, and many top executives get a big

bonus for merger deals, no matter what happens to the share price later. On the other side

of the coin, mergers can be driven by generalized fear. Globalization, the arrival of new

technological developments or a fast-changing economic landscape that makes the outlook

uncertain are all factors that can create a strong incentive for defensive mergers. Sometimes

the management team feels they have no choice and must acquire a rival before being

acquired. The idea is that only big players will survive a more competitive world.

The Obstacles to making it Work

Coping with a merger can make top managers spread their time too thinly

and neglect their core business, spelling doom. Too often, potential difficulties seem trivial

to managers caught up in the thrill of the big deal. The chances for success are further

hampered if the corporate cultures of the companies are very different. When a company is

acquired, the decision is typically based on product or market synergies, but cultural

differences are often ignored. It's a mistake to assume that personnel issues are easily

overcome. For example, employees at a target company might be accustomed to easy

access to top management, flexible work schedules or even a relaxed dress code. These

aspects of a working environment may not seem significant, but if new management

removes them, the result can be resentment and shrinking productivity. More insight into

the failure of mergers is found in the highly acclaimed study from McKinsey, a global

consultancy. The study concludes that companies often focus too intently on cutting costs

following mergers, while revenues, and ultimately, profits, suffer. Merging companies can

focus on integration and cost-cutting so much that they neglect day-to-day business,

thereby prompting nervous customers to flee. This loss of revenue momentum is one

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reason so many mergers fail to create value for shareholders. But remember, not all

mergers fail. Size and global reach can be advantageous, and strong managers can often

squeeze greater efficiency out of badly run rivals. Nevertheless, the promises made by deal

makers demand the careful scrutiny of investors. The success of mergers depends on how

realistic the deal makers are and how well they can integrate two companies while

maintaining day-to-day operations.

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Objective of the Study

Gain an in-depth knowledge about various corporate valuation techniques.

Critically examine the rationale behind the acquisition of Corus by Tata Steel.

Understand the advantages and disadvantages of cross-border acquisitions.

Understand the need for growth through acquisitions in foreign countries.

Study the regulations governing mergers & acquisitions in the case of a cross-border

acquisition.

Get insights into the consolidation trends in the Indian and global steel industries.

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Literature Review The steel industry

THE GLOBAL STEEL INDUSTRY

The current global steel industry is in its best position in comparing to last decades. The

price has been rising continuously. The demand expectations for steel products are rapidly

growing for coming years. The shares of steel industries are also in a high pace. The steel

industry is enjoying its 6th consecutive years of growth in supply and demand. And there is

many more merger and acquisitions which overall buoyed the industry and showed somegood results.

The subprime crisis has lead to the recession in economy of different

Countries, which may lead to have a negative effect on whole steel industry in coming

years. However steel production and consumption will be supported by continuous

economic growth.

CONTRIBUTION OF COUNTRIES TO GLOBAL STEEL INDUSTRY

Fig-1

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The countries like China, Japan, India and South Korea are in the top of the above in steel

production in Asian countries. China accounts for one third of total production i.e. 419m

ton, Japan accounts for 9% i.e. 118m ton, India accounts for 53m ton and South Korea is

accounted for 49m ton, which all totally becomes more than 50% of global production.

Apart from this USA, BRAZIL, UK accounts for the major chunk of the whole growth.

The steel industry has been witnessing robust growth in both domestic as well as

international markets. In this article, let us have a look at how has the steel industry

performed globally in 2007.

Capacity: The global crude steel production capacity has grown by around 7% to 1.6 bn in

2007 from 1.5 bn tonnes in 2006. The capacity has shown a growth rate of 7% CAGR since

2003. The additions to capacity over last few years have ranged from 36 m tonnes in 2004

to 108 m tonnes in 2007. Asian region accounts for more than 60% of the total production

capacity of world, backed mainly by capacity in China, Japan, India, Russia and South

Korea. These nations are among the top steel producers in the world.

Fig-2

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Production: The global steel production stood at 1.3 bn tonnes in 2007, showing an

increase of 7.5% as compared to 2006 levels. The global steel production showed a growth

of 8% CAGR between 2003 and 2007. China accounts for around 36% of world crude steel

production followed by Japan (9%), US (7%), Russia (5%) and India (4%). In 2007, all the

top five steel producing countries have showed an increase in production except US, which

showed a decline.

Rank Country Production (mn tonnes) World share (%)

1 China 489 36.0%

2 Japan 120 9.0%

3 US 98 7.0%

4 Russia 72 5.0%

5 India 53 4.0%

6 South Korea 51 3.5%

Source: JSW Steel AR FY08

Table-1

Consumption: The global steel consumption grew by 6.6% to 1.2 bn tonnes as compared

to 2006 levels. The global finished steel consumption showed a growth of 8% CAGR, in

line with the production, between the period 2003 and 2007. The finished steel

consumption in China and India grew by 13% and 11% respectively in 2007. The BRIC

countries were the major demand drivers for steel consumption, accounting for nearly 80%

of incremental steel consumption in 2007.

Rank Country Consumption (mn tonnes) World share (%)

1 China 408 36.0%

2 US 108 9.0%

3 Japan 80 6.7%

4 South Korea 55 4.6%

5 India 51 4.2%

6 Russia 40 3.3%

Source: JSW Steel AR FY08

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Table-2

Outlook: As per IISI estimates, the finished steel consumption in world is expected to

reach a level of 1.75 bn tonnes by 2016, growth of 4% CAGR over the consumption level

of 2007. The steel consumption in 2008 and 2009 is estimated to grow above 6%

Indian Steel Industry

India, which has emerged among the top five steel producing and consuming countries over

the last few years, backed by strong growth in its economy.

Capacity: Steel capacity increased by 6% to 60 m tonnes in FY08. It registered a robust

growth of 8% CAGR between the period FY04 and FY08. The capacity expansion in the

country was primarily through brown field expansions as it requires lower investments than

a greenfield expansion.

Fig-3

Production: Steel production has registered a growth of 6% to reach a level of 54 m tonnes

in FY8. The production has grown nearly in line with the capacity expansion and registered

a growth of 7% CAGR with an average capacity utilization of 92% between the period

FY04 and FY08. India is currently the fifth largest producer of steel in the world,

contributing almost 4% of the total steel production in world. The top three steel producing

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companies (SAIL, Tata Steel and JSW Steel) contributed around 45% of the total steel

production in FY08.

Fig-4

Consumption: Steel consumption has increased by 10% to 51.5 m tonnes in FY08.

Consumption growth has been exceeding production growth since past few years. It grew

at a CAGR of 12% between FY04 and FY08. Construction & infrastructure, manufacturing

and automobile sectors accounted for 59%, 13% and 11% for the total consumption of steel

respectively in FY08. Although steel consumption is rapidly growing in the country, the

per capita steel consumption still stands at 48 kgs. Moreover, in the rural areas in the

country, it stands at a mere 2 kg. It should be noted that the worlds average per capita steel

consumption was 189 kg and while that of China was 309 kg in 2007.

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Fig-5

Trade equations: India became net importer of steel in FY08 with estimated net imports

of 1.9 m tonnes. In the past few years, its exports have remained at more or less the same

levels while on the other hand, imports have increased on the back of robust demand and

capacity constraints in the domestic markets. The imports showed a growth of around 48%

while exports declined by around 6% in FY08.

Outlook: As per IISI estimates, the demand for steel in India are expected to grow at a rate

of 9% and 12% in 2008 and 2009. The medium term outlook for steel consumption remains

extremely bullish and is estimated at an average of above 10% in the next few years.

Tata Vs Corus

Corus

The Corus was created by the merger of British Steel and Dutch steel company,

Hoogovens. Corus was Europes second largest steel producer with a production of 18.2

million tonnes and revenue of GDP 9.2 billion (in 2005). The product mix consisted ofStrip steel products, Long products, Distribution and building system and Aluminum. With

the merger of British Steel and Hoogovens there were two assets the British plant asset

which was older and less productive and the Dutch plant asset which was regarded as the

crown jewel by every one in the industry. They have union issues and are burdened with

more than $ 13 billion of pension liabilities. The Corus was making only a profit of $ 1.9

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billion from its 18.2 million tonnes production per year (compared to $ 1.5 billion form 8.7

million tone capacity by Tata).

The Corus was having leading market position in construction and

packaging in Europe with leading R&D. The Corus was the 9th largest steel producer in the

world. It opened its bid for 100 % stake late in the 2006. Tata (India) & CSN (Companhia

Siderurgica Nacional) emerged as most powerful bidders.

CSN (Companhia Siderurgica Nacional)

CSN (Companhia Siderurgica Nacional) was incorporated in the year 1941. The

company initially focused on the production of coke, pig iron castings and long products.

The company was having three main expansions at the Presidente Vargas Steel works

during the 1970s and 1980s. The first completed in the year 1974, increased installed

capacity to 1.6 million tons of crude steel. The second completed in 1977, raised capacity

to 2.4 million tons of crude steel. The third completed in the year 1989, increased capacity

to 4.5 million tons of crude steel. The company was privatized by the Brazilian government

by selling 91 % of its share.

The Mission of CNS is to increase value for the shareholders. Maintain

position as one of the worlds lowest-cost steel producer. Maintain a high EBITDA and

strengthen position as a global player. CNS is having fully integrated manufacturing

facilities. The crude steel capacity was 5.6 million tons. The product mix consisted of

Slabs, Hot and Cold rolled Galvanized and Tin mill products. In 2004 CSN sold steel

products to customers in Brazil and 61 other countries. In 2002, 65 % of the steel sales

were in domestic market and operating revenues were 70 %. In 2003, the same figures were

59 % and 61 % and in 2004 the same figures were 71% and 73 %. The principal export

markets for CSN were North America (44%),Europe(32%) and Asia(11%).

Tata Steel

Tata steel, Indias largest private sector steel company was established in the

1907.The Tata steel which falls under the umbrella of Tata sons has strong pockets and

strong financials to support acquisitions. Tata steel is the 55th in production of steel in

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world. The company has committed itself to attain global scale operations.

Production capacity of Tata steel is given in the table below:-

Table-3

The product mix of Tata steel consist of flat products and long products which are in the

lower value chain. The Tata steel is having a low cost of production when compared to

Corus. The Tata steel was already having its capacity expansion with its indigenous

projects to the tune of 28 million tones.

Indian Scenario

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After liberalization, there have been no shortages of iron and steel materials in

the country. Apparent consumption of finished (carbon) steel increased from 14.84 Million

tonnes in 1991-92 to 39.185 million tonnes (Provisional) in 2005-06. The steel industry

which was facing a recession for some time has staged a turn around since the beginning of

2002. Demand has started showing an uptrend on account of infrastructure boom. The steel

industry is buoyant due to strong growth in demand particularly by the demand for steel in

China. The Steel industry was de-licensed and de-controlled in 1991 & 1992 respectively.

Today, India is the 7th largest crude steel producer of steel in the world. In 2005-06,

production of Finished (Carbon) Steel was 44.544 million tonnes. Production of Pig Iron in

2005-06 was 4.695 Million Tonnes. The share of Main Producers (i.e. SAIL, RINL and

TSL) and secondary producers in the total production of Finished (Carbon) steel was 36%

and 64% respectively during the period of April-November, 2006.

Corus decides to sell Reasons for decision:

Total debt of Corus is 1.6bn GBP

Corus needs supply of raw material at lower cost

Though Corus has revenues of $18.06bn, its profit was just $626mn (Tatas revenue

was $4.84 bn & profit $ 824mn)

Corus facilities were relatively old with high cost of production

Employee cost is 15 %( Tata steel- 9%)

Tata Decides to bid: Reasons for decision:

Tata is looking to manufacture finished products in mature markets of Europe.

At present manufactures low value long and flat steel products while Corus

produces high value stripped products

A diversified product mix will reduce risks while higher end products will add to

bottom line.

Corus holds a number of patents and R & D facility.

Cost of acquisition is lower than setting up a green field plant and marketing and

distribution channels

Tata is known for efficient handling of labour and it aims at reducing employee

cost and improving productivity at Corus

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It had already expanded its capacities in India.

It will move from 55th in world to 5th in production of steel globally.

Tata Steel Vs CSN: The Bidding War

There was a heavy speculation surrounding Tata Steel's proposed takeover of

Corus ever since Ratan Tata had met Leng in Dubai, in July 2006. On October 17, 2006,

Tata Steel made an offer of 455 pence a share in cash valuing the acquisition deal at US$

7.6 billion. Corus responded positively to the offer on October 20, 2006.

Agreeing to the takeover, Leng said, "This combination with Tata, for Corus shareholders

and employees alike, represents the right partner at the right time at the right price and on

the right terms." In the first week of November 2006, there were reports in media that Tata

was joining hands with Corus to acquire the Brazilian steel giant CSN which was itself

keen on acquiring Corus. On November 17, 2006, CSN formally entered the foray for

acquiring Corus with a bid of 475 pence per share. In the light of CSN's offer, Corus

announced that it would defer its extraordinary meeting of shareholders to December 20,

2006 from December 04, 2006, in order to allow counter offers from Tata Steel and CSN...

Financing the Acquisition

By the first week of April 2007, the final draft of the financing

structure of the acquisition was worked out and was presented to the Corus' PensionTrusties and the Works Council by the senior management of Tata Steel. The enterprise

value of Corus including debt and other costs was estimated at US$ 13.7 billion

The Integration Efforts

Industry experts felt that Tata Steel should adopt a 'light handed integration approach,

which meant that Ratan Tata should bring in some changes in Corus but not attempt a

complete overhaul of Corus'systems (Refer Exhibit XI and Exhibit XII for projected

financials of Tata-Corus). N Venkiteswaran, Professor, Indian Institute of Management,

Ahmedabad said, If the target company is managed well, there is no need for a heavy-

handed integration. It makes sense for the Tatas to allow the existing management to

continue as before.

The Synergies

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Most experts were of the opinion that the acquisition did make strategic

sense for Tata Steel. After successfully acquiring Corus, Tata Steel became the fifth largest

producer of steel in the world, up from fifty-sixth position.There were many likely

synergies between Tata Steel, the lowest-cost producer of steel in the world, and Corus, a

large player with a significant presence in value-added steel segment and a strong

distribution network in Europe. Among the benefits to Tata Steel was the fact that it would

be able to supply semi-finished steel to Corus for finishing at its plants, which were located

closer to the high-value markets.

The Pitfalls

Though the potential benefits of the Corus deal were widely appreciated, some analysts had

doubts about the outcome and effects on Tata Steel's performance. They pointed out that

Corus' EBITDA (earnings before interest, tax, depreciation and amortization) at 8 percent

was much lower than that of Tata Steel which was at 30 percent in the financial year 2006-

07.

The Road Ahead

Before the acquisition, the major market for Tata Steel was India. The Indian market

accounted for sixty nine percent of the company's total sales. Almost half of Corus'

production of steel was sold in Europe (excluding UK). The UK consumed twenty nine

percent of its production.

After the acquisition, the European market (including UK) would consume 59 percent of

the merged entity's total production.

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Arcellor- Mittal Deal

A new steel giant is to be created out of a bitter battle, after Arcelor formally agreed on a

26.5 billion takeover by rival Mittal Steel. The deal combines Arcelor - a symbol of

successful, pan-European cooperation and economic revival, with operations that span

Luxembourg, Belgium, France and Spain - with a fast- growing conglomerate founded by

the India-born Lakshmi Mittal, who built a fortune turning around sick steel plants in

rapidly expanding markets from Trinidad to Kazakhstan.

The deal, valued at $33.1 billion, is the latest sign that shareholder activism is

marching through the once staid and sleepy boardrooms of Europe. The agreement to pair

with Mittal caps a wrenching turnaround for Arcelor's management, which once dismissed

Mittal as a "company of Indians" but was forced to backtrack after shareholders threatened

to revolt.

Politicians in Europe who once criticized Mittal have remained mum in recent

days, and the merger brings hope that protectionist barriers against such deals may be

eroding in Europe.

Mittal is paying 40.37 a share for Arcelor, nearly double what the company was trading at

when Mittal first made an offer in January. The new company named Arcelor-Mittal and

headquartered in Luxembourg. Joseph Kinsch, chairman of Arcelor, is chairman of the new

company, and succeeded by Mittal when Kinsch retires next year.

"It's been a long struggle," for investors and Mittal board member.

"Now that we have had an opportunity to be inside, with management.The deal would

create "global leadership in steel" not just by ton but by value.

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Getting to this point has involved a bruising fight for both sides. Mittal first made

an unexpected 18.6 billion offer for Arcelor and was swiftly and harshly rebuked by

Arcelor management and a chorus of European politicians who criticized everything from

his grammar to his Indian origins to the quality of his company's steel. Arcelor's bare-

knuckled defense strategy included refusing to meet with Mittal until a string of demands

were met, and simultaneously orchestrating a 13 billion deal with Severstal of Russia to

keep him away.

The case

Mittal makes surprise 18.6 billion bid for Arcelor in January 2006

Arcelor management announce large dividend

Arcelor makes very positive profit report, which is later found to be inflated

Arcelor makes rosy forecast for future performance

Arcelor management and European politicians criticize Mittal

Arcelor management refuses to meet with Mittal until a string of demands were

met

Arcelor tries to get Luxembourg government to write a takeover law shutting

out Mittal

Arcelor unions fear job cuts, reduction in social standards

Arcelor managers fear Mittal will shift emphasis from long- to short-term goals

Arcelor commits to buy North American steel company that will cause Mittal

anti-trust problems

o Agreement contains clause making it costly to not go through with sale

Arcelor made 13 billion deal with Severstal of Russia, including break-up fee

of 140 million

Arcelor, Mittal, and Severstal engage in heavy advertising, meetings with

investors and politicians

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Arcelor arranges for shareholder meeting where Severstal deal would be

approved unless 50% plus one of shareholders were present and voted it down,

an unusually high percent. The meeting isnt scheduled until after Severstal

deal has been nearly finalized.

Mittal raises offer to 26.5 billion, and agreed to cede some management

control and family voting rights

o nearly double the price per Arcelor share Arcelor was trading at prior to

Mittals bid in January

Arcelors institutional shareholders and hedge funds voice disapproval in

Severstal deal, support Mittal deal

o Arcelor management fears shareholders will vote down share buyback

necessary for Severstal deal to go through

o Shareholders threaten to oust Arcelor management and sue Arcelor board

Six percent of Arcelor shareholders sued Arcelors board for selling for too

low a price

o Unlikely to succeed, given very high premium on Arcelor shares relative to

pre-takeover-battle price

Arcelor-Mittal sells valuable Maryland steel mill in August 2007 to satisfy

U.S. anti-trust authorities

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CHAPTER 3: RESEARCH METHODOLOGY

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Research Methodology

Most sciences have their own specific scientific methods, which are supported by

methodologies (i.e., rationale that support the method's validity).

The social sciences are methodologically diverse using qualitative, quantitative, and mixed-

methods approaches. Qualitative methods include the case study, phenomenology,

grounded theory, and ethnography, among others. Quantitative methods include hypothesis

testing, power analysis, Ratio analysis, observational studies, re sampling, randomized

controlled trials, regression analysis, multilevel modeling, and high-dimensional data

analysis, among others.

Types of Research

The research study under consideration is exploratory type.

Basically there are two broad kinds of researches

Exploratory Research : This seeks to discover new relationships.

Conclusive Research : It is designed to help executive choose the various

Course of action.

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As research design applicable to exploratory studies are different from objectives firmly in

mind while designing the research. Which searching for hypothesis, exploratory designs are

appropriate; when hypothesis have been established and are to be listed, conclusive designs

are needed. It should be noted however, that the research process tends to become circular

over a period of time. Exploratory research may define hypothesis, which are then tested by

conclusive research; but a by product of the conclusive research may be a suggestion of a

new opportunity or a new difficulty.

Other characteristics of exploratory research are flexibility and ingenuity, which

characterize the investigation. As we proceed with the investigating it must be on the alert

to recognize new ideas, as it can then swing the research in the new direction until they

have exhausted it or have found a better idea. Thus they may be constantly changing the

focus of invest as new possibilities come to attention.

It should be added here that formal design in the researcher is the key factor.

Study of secondary sources of information.

The reason for selecting this mode of research for this type is that its a probably quickest

and most economical way for research to find possible hypothesis and to take advantage of

the work of to others and utilize their own earlier efforts. Most large companies that havemaintained marketing research programs over a number of years have accumulated

significant libraries of research organizations furnishing continuing data.

Procedure

As it is a secondary research, all the data is selected after rigorous analysis of articles from

newspapers, magazines and internet.

All the research collected is done by professional analyst across the world and is compiled

in this project to understand the financial and business impact of merger and acquisition

more effectively.

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CHAPTER 4: DESCRIPTIVE WORK

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Valuation of Merger and acquisition

A merger is a combination of two corporations in which only one corporation survives and

the merged corporation goes out of subsistence. Alternatively, in merger two corporations

combine and share their resources in order to accomplish mutual objectives and both

companies bring their own shareholders, employees, customers and the community at

large. Acquisition takes place when one firm is purchasing the assets or shares of another

company.

Mergers are often categorised as horizontal, vertical, or conglomerate. A horizontal mergeris one that takes place between two firms in the same line of business whereas vertical

merger involves companies at different stages of production. The buyer expands backwards

in the direction of the source of the raw material or forward in the direction of the

customer. The last one, i.e., conglomerate merger involves companies in unrelated line of

business. This distinction is very much necessary to make and understand the reasons for

the mergers.

The scale and the pace at which merger activities are coming up are remarkable. The recent

booms in merger and acquisitions suggest that the organisations are spending a significant

amount of time and money either searching for firms to acquire or worrying about whether

some other firm will acquire them. Also, mergers are regarded as one of the activities the

purpose of business expansion or a measure of external growth in contrast to internal

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growths. The recent phenomenon booms in mergers and acquisitions would increase at a

much faster rate in near future because the world markets are becoming more integrated

because of open trade policies and hence more and more companies are adopting and

forming strategic alliances in order to compete in the competitive world and to maintain

there market shares.

Merger and acquisition decision is an investment decision. This is the most important

decision, which influences both the acquiring firm and the target firm, which is to be

acquired. An organization cannot make that crucial decision without incisive analysis by

financial planners and corporate managers. The acquiring firm must correctly value the

firm to be acquired and the acquired firm must get the returns for the goodwill they have

created over the years in the market. Growth through acquisition is occurring in an

unprecedented number of companies today as strategic acquisitions replace the once-

prevalent hostile takeovers by corporate raiders. In the current business environment, it is

vital to understand how to blend strategic and financial concepts to evaluate potential

acquisitions.

Motives

The findings from the theoretical material and the empirical investigation will be analyzed

both horizontally and vertically according to the following: -

Fig-6

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There are two types of motives involved in merger and acquisition and these are Explicit

and Implicit motives.

Explicit Motives

Synergy: Synergy means that the merged firm will have a greater value than

the sum of its parts as a result of enhanced revenues and the cost base.

Economies of Scale: Economic of scale refer to the reduction in unit cost

achieved by producing a large volume of a product. Horizontal mergers aim at

achieving economies of scale. This phenomenon continues while the firm

grows to its optimal size, after which a firm experiences diseconomies of scale.

Economies of Vertical Integration: Economies of vertical integration are

achieved in vertical mergers. It makes coordination of closely related operating

activities easier.

Entry to New Markets and Industries: A firm that wants to enter a new

market but lacks the know-how can do so through the purchase of an existing

player in that product or geographical market. This makes the two firms worth

more together than separately.

Tax Advantages: Past losses of an acquired subsidiary can be used to

minimize present profits of the parent company and thus lower tax bills. Thus,

firms have a reason to buy firms that have accumulated tax losses.

Diversification: One of the reasons for conglomerate mergers is diversification

of risk. There are two types of risks associated with businesses- systematic and

unsystematic risk. Systematic variability cannot be removed by diversification

and hence mergers are not able to eliminate this risk. Though, unsystematic

risk can be spread through mergers.

Managerial Motives: The management team of the acquiring firm tends to

benefit from the merger activity. The four most important managerial motives

for merger are empire building, status, power and remuneration.

Implicit Motives

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Hubris: It is like a maturity test for the owners and the company boards of

directors when they see the opportunity to form a new business cycle.

Excess of Money: When a company has excess of money, the question of what

to do with it eventually comes up and this leads towards merger and acquisition.

Steps Involved in an Acquisition Valuation

Procedures for Analyzing Valuation of the Firm

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Fig-7

An acquisition valuation programme can be segregated into five distinct steps like:

Step 1: Establish a motive for the acquisition.

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Step 2: Choose a target.

Step 3: Value the target with the acquisition motive built in.

Step 4: Choose the accounting method for the merger/acquisition - purchase or pooling.

Step 5: Decide on the mode of payment - cash or stock.

Evaluations

Implicit Motives

Financing Mergers

Fig-8

The triangle in the figure provides a view of acquisition financing mechanism. As the

options for financing the acquisition would increase, the layers in the triangle would also

increase. But the basic question that arises or the consideration that comes is whether the

transaction should be made in cash or stock as it has different effect on the various

stakeholders of both the organizations the acquiring firm as well as the target firm. The

influence of method of payment on post-merger financial performance is ambiguous.

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Post merger performance maybe affected by the means of payment in the takeover. There

are mainly two ways, in which mergers can be financed,

Cash

Stock

Using cash for payment helps the acquirer's shareholders to retain the same level of control

over the company. Another obvious reason of financing mergers through cash is the

simplicity and preciseness that gives a greater chance of success. Another advantage of

using cash to the target's shareholders is that it is more certain in its value. Also, the

recipients can spread their investments by purchasing a wide-ranging portfolio. There is

also a disadvantage to target shareholders. They may be liable to pay capital gains tax. This

is payable when a gain is realized.

Estimating Cost When the Merger is financed by Stock

The cost depends on the value of the shares in the new company received by the

shareholders of the selling company.

Cost = N * P of AB - PV of B

Where,

N = the number of shares received by the sellers

P of AB = price per share of the merged firm

PV of B = present value of B (selling firm)

Workings of Mergers

Merger accounting

A merger can be either treated as a purchase or a pooling of interests. Under this method,

assets of the acquired firm must be reported at the fair market value on the books of the

acquiring firm. Under this method, goodwill, which is the excess of the purchase price over

the sum of the fair market values of the individual assets acquired, is generated. Under the

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second method, pooling of interests, the assets of the merged firm are valued at the same

level as they were carried out in acquired and acquiring firms.

Tax Considerations

An acquisition can be taxable or tax-free. In a taxable acquisition, shareholders of the

selling firm are treated for tax purposes as having sold their shares and are liable to pay tax

on any capital gains or losses. In a tax-free acquisition, the selling shareholders are viewed

as exchanged their old shares for similar ones, and they do not experience any capital gains

or losses. The taxes paid by the merged firm also depend on the tax-status of the

acquisition. There is no revaluation of assets in a tax-free acquisition, whereas, in a taxable

acquisition, the assets are devalued and any increase or decrease is treated as a taxable gain

or loss.

The Impact of Mergers

Mergers have a universal impact, practically everyone from society, shareholders,

employees, and directors to financial institutions. Society can benefit from the merger if it

results in producing goods at low costs due to economies of scale or improved

management. The acquiring shareholders usually get poor returns and therefore very small

average gains. However, target shareholders usually gain from mergers, as the acquirers

have to pay a substantial premium over the pre-bid share price to convince target

shareholders to sell. Employees may gain or lose from a merger activity. Mergers generate

significant gains to the target firm's stockholders and buyers generally break even, there are

positive benefits from mergers. The yardstick to measure a successful merger is the profit

level. Profitability is the only overall significant identifier.

Tata - Corus: Visionary deal or costly blunder?

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After four months of twists and turns, Tata Steel has won the race to acquire Corus Group.

The bidding war between Tata Steel and Brazilian company CSN was riveting and ended in

a rapid-fire auction. Initial reactions to the deal were highly diverse and retail investors

were completely puzzled by the market reaction.

Going by the stock market reaction, the acquisition was a big

blunder. The stock tanked 10.5 per cent after the deal was announced and another 1.6 per

cent. Investors were worried about the financial risks of such a costly deal.

Media reaction to the deal had been just the opposite. Almost all the reports were adulatory

while editorials praised the coming of age of Indian industry. A prominent financial daily

presented the deal almost as revenge of the natives against the old colonial masters with a

picture of London covered in our national colours. Its editorial warned the market 'not to

bet against Tata', citing the previous instances when skeptics were proved wrong by the

group. Official reaction had been no different and the finance minister even offered all

possible help to the Tata Group.

Was the acquisition too costly for Tata Steel? Was price the only criterion while evaluating

an acquisition? Should managers focus on keeping shareholders happy after every quarter

or should they focus on the long-term, big picture? These are tough questions and,

unfortunately, answers would be clear only after many years - at least in this case.

When could the steel cycle turn?

The last few years were some of the best ever for the global steel

industry as robust demand from emerging economies like China pushed up prices. Profits

of steel manufacturers across the globe swelled and their market capitalizations have

multiplied many times.

Global Steel output

(in million tonnes)

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Country 2005 2006 % change

China 355.8 418.8 17.7

Japan 112.5 116.2 3.3

US 94.9 98.5 3.8

Russia 66.1 70.6 6.8South Korea 47.8 48.4 1.3

Germany 44.5 47.2 6.1

India 40.9 44.0 7.6

Ukraine 38.6 40.8 5.7

Italy 29.4 31.6 7.5

Brazil 31.6 30.9 (2.2)

World production 1,028.8 1,120.7 8.9

Table-4

How long will the good times last? Tata Steel believes the steel cycle is in a long-term up

trend and the risk of a downturn in prices is low. In fact, managing director B Muthuraman

said the global steel industry might witness sustained growth as during the 30-year period

between 1945 and 1975.

The massive post-war infrastructure build-up in Western countries

led to the sustained steel demand growth in that period. The coming decades would see

similar infrastructure spending in emerging economies and steel demand would continue to

grow, according to this view.

The International Iron and Steel Institute (IISI), a respected steel research body,

corroborates this in its outlook. The growth in demand for global steel would average 4.9

per cent per year till 2010 according to the IISI. Between 2010 and 2015, demand growth is

expected to moderate to 4.2 per cent per annum according to IISI forecasts. Much of this

demand growth would come from China and India, where the IISI estimates growth rates to

be 6.2 per cent and 7.7 per cent annually from 2010 to 2015.

Now lets consider steel prices. Expectations of sustained demand growth have already led

to massive capacity additions, mostly in emerging markets. Chinese steel capacity has

expanded significantly over the last decade while a large number of mega steel plants are

being planned in India. Capacity additions by Russian and Brazilian steelmakers would

also be significant in future as they have access to raw material.

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Would the capacity additions outrun the demand growth and lead to

subdued steel prices? Under normal circumstances, that could have been a very strong

possibility. But many industry leaders believe that the global steel industry would see a

structural shift in the coming years.

Some of the inefficient steel mills in mature markets would face closure while others would

shift production to high value-added products using unfinished and semi-finished steel

supplied by steel mills in locations like India, Russia and Brazil with access to raw

material. This would limit aggregate supply growth and keep prices stable in future.

Major global steel makers are also not unduly worried about the possibility of large-scale

exports from China, which would depress international steel prices. Chinese capacity is

expected to continue to grow in the coming years, but so would the demand.

Besides, Chinese steel plants are not expected to emerge very efficient as they depend on

imported raw materials, which limit their pricing power. Many steel analysts expect

significant consolidation in the Chinese steel industry as margins erode further in future.

The Chinese government has already started squeezing the smaller units by withdrawing

their raw material import permits.

The need for scale

Going by the IISI forecasts, global steel demand would be 1.32 billion tonnes

by 2010 and 1.62 billion tonnes by 2015. Even Arcelor-Mittal, the largest global steel

player by far, has a present capacity, which is just 6.8 per cent for projected demand in

2015. To maintain its current share, Arcelor-Mittal would have to add another 50 million

tonnes of capacity by then. This confirms the view that there is still considerable scope for

consolidation in the steel industry.

Global steel ranking

Company Capacity (in million tonnes)

Arcelor - Mittal 110.0

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Nippon Steel 32.0

Posco 30.5

JEF Steel 30.0

Tata Steel - Corus 27.7Bao Steel China 23.0

US Steel 19.0

Nucor 18.5

Riva 17.5

Thyssen Krupp 16.5

Table-5

As the industry consolidates further, Tata Steel - even with its planned greenfield capacity

additions - would have remained a medium-sized player after a de

10934106 merger and acquisition in steel industry

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