Mergers and Acquisitions: Creating Long Term Shareholder Value

Mergers and Acquisitions the Key for Consolidation and Growth for India Inc.

?With a V-shaped recovery across sectors and favourable economic conditions, Mergers and Acquisitions activity will pick-up across sectors in India in the next 12-18 months resulting in consolidation and super normal growth led by the Banking and Finance Sector.

?The Indian economy has witnessed a V-shaped recovery across sectors with most sectors getting back to pre COVID levels in terms of overall demand resulting in higher sales. As a result of the pandemic, millions of small business have shut down thereby resulting in greater market share for the bigger and stronger companies; as a result the strong have become stronger and weaker have either shut down or have merged or sold out to the stronger companies. Thereby the stronger companies have become stronger and moved higher in terms of overall valuation and sales.

?In order to grow shareholder value, a company has two ways, first being grow the company on its merit and grow the sales and overall profitability of the company. Second way would be to grow inorganically via the Merger and Acquisition route. A Merger?is the combination of two companies to form one. Merger or Amalgamation may take through two forms - Merger through absorption or merger through consolidation. Mergers also help to overcome existing challenges, reduce weaknesses and gain a competitive edge in the market.?

?Companies that merge together usually consider each other of equal stature and hence they help each other out to?create synergy and help the company grow faster. Thereby mergers mostly happen on friendly terms which makes restructuring easier for both directors and employees.?

?The whole idea of a merger is to create synergy by the joining or merger of two companies. The synergy value can be seen either through higher revenues, lowering of expenses or lowering of overall cost of capital thereby making the business efficient and creating overall shareholder value.

?An Acquisition?is when one company is taken over by the other. The company that is financially stronger acquires more than 50% of shares to take over another company. Unlike mergers, acquisitions may not always happen upon very cordial terms and thereby the overall chances of a success post the acquisition are relatively lower than in case of a merger. In the Indian context, a hostile takeover or a takeover by force does not really happen and may not work but it is prevalent to a large extent overseas.

?There are various kinds of mergers that can be executed between two companies depending upon the overall size of the companies. The main intent and reason for the merger alongwith the synergy is that the companies are trying to gain.

?·??????Horizontal Mergers and Acquisitions

?When companies with similar products or services come together with the main goal to expand their offerings or markets thereby trying to create synergy and grow the combined balance sheet of the entity.

?·??????Vertical Mergers and Acquisitions

?When companies in the same industry but different roles in supply chain join their forces.?Two companies integrate vertically to?improve logistics, consolidate staff or reduce time?to market their products or services.

?·??????Conglomerate Mergers and Acquisitions

?When companies in different industries join together. The key reason is to expand their portfolio of products and services and thereby reduce expenses or reduce risks by operating in a wider range of industries.

?·??????Concentric Mergers and Acquisitions

?When two companies share customer bases but provide different services.?The whole idea is to leverage the client base and cross selling of products or services in order get maximum revenue and overall profitability.

?Some of the key reason on why companies use the Merger and Acquisition route in order to grow:

?·??????Financial synergy for lower cost of capital

·??????Economies of scale

·??????Economies of scope

·??????Diversification for higher growth products or markets

·??????To increase market share and positioning giving broader market access

·??????Strategic re-alignment and technological change in order to be relevant and compete in the market

·??????Optimization of overall tax structure to get the optimum overall profitability

·??????Diversification of risk

·??????Increase market share

·??????Access to new markets and geographies

?One of the biggest mergers announced is the merger of HDFC Bank with HDFC Ltd, two leading financial lending organizations in the country. HDFC Limited, India’s largest housing finance company with Assets Under Management (AUM) worth INR 5.26 trillion and a market cap of INR 4.44 trillion will merge with HDFC Bank, India’s largest private sector bank by assets with a market cap of INR 8.35 trillion; thereby resulting in the largest merger in India and the combined entity will be one of the largest listed company in India. The combined balance sheet of INR 17.87?trillion and INR 3.3 trillion net worth.

?Shareholders of HDFC Limited, as on record date, will receive 42 shares of HDFC Bank for 25 shares of HDFC Limited. Post the merger, the swap ratio works to 1:1.68. HDFC Limited’s shareholding in HDFC Bank will be extinguished and HDFC Bank will be 100 percent owned by public shareholders. Existing shareholders of HDFC Limited will own 41% of HDFC Bank. The merger is a typical example of value creation for the shareholder of both the entities.

?HDFC Limited gets access to low cost funds. Cost of funds for HDFC Bank on an average is around 5% due to the high retail penetration and CASA deposits that the bank has access to. The bank gets access to the mortgage loans, that it was selling to HDFC Limited and thereby the long-dated mortgage book of the combined entity would be as high as 30% of all advances thereby making it more cost effective and competitive with other private banks. This merger exercise is a clear illustration of creating shareholder value for both the companies. Even though there would be slight challenges in terms of additional capital required to meet the regulatory RBI requirements, however in the long run the synergy that the Merger has seeked will create long-term shareholder value.

?Looking at the HDFC group merger, other larger NBFCs and financial groups would also explore a similar option and in the next 12 -18 months; a few larger such mergers would be witnessed in the Indian economy.

?Investors should be cautious and not take any impulsive decision when the scheme of merger is announced, as in most cases the devil lies in the detail and the stock can go up when the announcement is made but post analysis the proposed deal may not be that value accretive for the shareholders, hence the value of the stocks may fall in the near term to medium term. Plus, there is a big risk of overall integration issues among the companies.

?In these turbulent times when there is a lot of geopolitical uncertainty and the economy is faced with the risk of high inflation, the stock market would be a volatile market. Corporate action in terms of Mergers and Acquisitions would add to the volatility of the market and investors should be cautious on the investment that they make based upon such announcement. As the announcement made would take anywhere between 12 to 18 months to implement in terms of the approvals and process to be followed for most listed companies which may include the CCI, RBI, IRDA etc. approvals whichever is applicable in the respective cases. Thereby investors should take a call based upon the overall value the merger creates resulting in value creation for the shareholders as well rather than investing based upon euphoria of the news that the announcement has created.

?_Farzan Ghadially.

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