This article has been written by Naresh Trivedi, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
Table of Contents
Introduction
ergers and Acquisitions (M&A) are the backbone of the healthy business ecosystem. A thoroughly worked out M&A deal can work wonders for any given business. Having said that, a strategically carried out hostile M&A deal can also be beneficial to the acquirer company, if not to the target company.
When we say a strategically carried out M&A deal we also mean about any M&A transaction carried out in the M&A world. Strategies pertaining to M&A transactions are not only limited to the strategies related to the success of the M&A transaction in terms of business synergies or gaining larger pie of the target market. But these strategies also involve strategies related to mitigation of risks involved in any given M&A transaction carried in any part of the world.
One cannot avoid all risks involved in the M&A transactions but of course a certain degree of risk can be tackled by adhering to proper strategies in mitigating the risks involved in the M&A transactions. We shall discuss those strategies in brief in this article.
An improperly strategized or an unplanned M&A transaction can lead to severe impact on functioning and future existence of an established organisation. A failed M&A deal may result in closure or insolvency of the acquirer company and its promoters. It may not only lead to erosion of the shareholders value but it may also leave a cascading effect on the other stakeholders of the acquirer company and a target company.
On the contrary, if we look at the statistics, based on an article in Mint, 75% M&A deals fail to create value. However, certain risk in M&A transactions are not avoidable like sudden change in regulatory policies or government policies, we have the best example of Cairn Energy.
Therefore, it is highly recommended to assess the risks involved in the M&A transactions and the measures or strategies should be adopted to mitigate such risks, if not avoided completely.
Following are the risks involved in M&A transactions and strategies to be adopted in mitigating such risks.
Financial risk
The important aspect of any M&A transaction is finance as well as the taxation part. Any point of disagreement between the parties to M&A transactions related to the finance part may act as deal breaker and it may kill the deal. However, the taxation part of M&A transactions is the matter of appropriate planning.
While considering the financial part of a given M&A deal the target company will always desire to gain as much as possible and the acquirer company will try to make the deal as reasonable as possible.
The probability of paying higher value by the acquiring company or of receiving lesser value by the target company is quite high if the deal is not valued properly.
Mitigation of financial risk
The financial risk involved in any given M&A transaction can be mitigated by proper financial due diligence.
Apart from thorough financial due diligence the questions why?, how? and when? should internally assessed by the acquiring company.
Why? – Why the deal is important to the business.
How? – How the acquisition will be helpful to the business, is the acquisition aligned with the vision and goal of the business.
When? – When the company will be able to cover the invested amount or when it will be able to generate the decent ROI.
In order to justify the deal value the answers to the above questions should be affirmative.
Case studies
The Companies who failed to foresee the financial risk prior to acquisition:
Acquisition of Pipavav Defence by Reliance Infra (ADAG) in year 2015
In 2015, Reliance Infrastructure Limited had acquired controlling stake in Pipavav Defence and Offshore Engineering Limited for up to Rs. 2,082.30 crore. Approximately, after 3 years of acquisition, i.e. in March, 2018 Reliance Infrastructure Limited had sent Rs. 5440 crore arbitration notice to promoters of Pipavav Defence and Offshore Engineering Limited for serious breach of warranties and representations made in the share purchase agreement.
Subsequently, in February, 2020 Government of India had sent show cause notice to Reliance Defence for failure to deliver five naval offshore patrol vessels. The deal was allotted to Pipavav in year 2011 and the delivery of first naval offshore patrol vessels was due in 2014-15 but Pipavav failed to deliver. During the same year Reliance acquired Pipavav but Reliance also could not deliver.
Moreover, after acquisition the order book of Pipavav has shrink drastically and borrowings in the company has rose sharply.
|
FY 2013-14 |
FY 2014-15 |
FY 2015-16 |
|
|
Borrowings |
|||
|
Long Term |
207,463.35 |
5,10,172.79 |
5,66,880.49 |
|
Short Term |
255,105.40 |
1,12,936.75 |
1,64,104.70 |
|
Net Revenue |
227,899.32 |
83,100.70 |
30,626.25 |
(Rs. in lakhs)
Based on above table it can be identified that Pipavav Defence was already under trouble when it was acquired by ADAG. Ultimately, now the company is under corporate insolvency resolution process as per the provisions of Insolvency and Bankruptcy Code, 2016.
Acquisition of Senvion by Suzlon in year 2007
In year 2007 Suzlon acquired Senvion for €1.4 billion. The deal was financed mostly through borrowed money. The acquisition of Senvion helped Suzlon to become leader in offshore wind energy sector and Senvion soon became one of the most profitable asset for Suzlon.
Since, the acquisition of Senvion was mostly out of the borrowed funds, it trapped Suzlon in to the debt and interest costs ballooned. In order to reduce the debt burden, Suzlon decided to sell its one of the good profitable business arm, Senvion for €1 billion or around Rs. 7,200 crore to American private equity firm Centerbridge Partners LP in January 2015.
Statutory compliance risk
A proper due diligence pertaining to statutory compliances of the target company will throw lesser surprises on the acquiring company, post closure of the deal. Perfunctory due diligence exercise related to statutory compliances applicable to the target company may lead to huge penal charges on the target company and ultimately post closure of the deal the same may have to be borne by the acquirer company.
Simultaneously, the acquirer company will have to comply with statutory compliances like notification of deal to the Competition Commission of India (CCI).
Mitigation of statutory risk
Involvement of the industry experts and professionals in the M&A transaction can drastically reduce the risk of non-compliance. Further, using the virtual data rooms and compliance manager software tools can also be helpful in compliance related due diligence exercises.
Getting the past violations compounded before the regulatory authority by filing an application for compounding of offences and securing immunity against the offence committed in the past.
Case Studies
Sun Pharma and Ranbaxy received CCI show cause notice in takeover deal in year 2014.
In May, 2014 Sun Pharma and Ranbaxy notified Competition Commission of India (CCI) about proposed merger scheme between both the companies. CCI had sought additional details from the parties to the transaction and several communications were exchanged between the CCI and both the companies.
Based on information received from both the companies, CCI decided that the transaction will amount to cause an appreciable adverse effect on competition in the relevant markets in India.
Ultimately, CCI decided to send show cause notice in July, 2014 to the parties involved in the transaction. Upon perusing the response of the parties to the show cause notice the CCI concluded that the transaction will amount to cause an appreciable adverse effect on competition in the relevant markets in India. However, the transaction was allowed subject to the divestment of certain products by Sun Pharma and Ranbaxy from their products.
RBI intervened and repudiated in the Lakshmi Vilas Bank and Indiabulls Housing Finance Limited Merger deal in year 2019
Reserve Bank of India (RBI) intervened and cancelled the Lakshmi Vilas Bank and Indiabulls Housing Finance Limited merger. RBI saw the deal as more of a backdoor entry of Indiabull Housing Finance Limited into a banking system.
RBI had put Lakshmi Vilas Bank under the prompt corrective action due to high level on bad loans, lack of capital to manage risks and negative returns on assets for two consecutive years.
Further, the Delhi Police’s Economic Offences Wing had registered the complaint against the Lakshmi Vilas Bank board for alleged cheating and misappropriation of funds.
The aforesaid could be the broad reasons for cancellation of deal, as RBI had cancelled the deal without giving any specific reason for cancellation.
Caterpillar acquired ERA Mining Machinery Ltd in year 2012
In order to enter Chinese coal markets and in a try to make easy money Catterpillar acquires ERA Mining Machinery Ltd. In this approach the company filed to do proper due diligence and later accounting misconduct was observed in ERA which impacted the deal drastically.
Catterpillar had written down $580 million i.e. 86% of the deal value, in the form of goodwill impairment charge. Catterpillar overlooked the problems in ERA before acquisition.
Cultural and integration risk
Historically, any given M&A transaction across the sectors have faced the cultural resistance in embracing the cultural shift post closure of transactions. Scientifically, it is mere human nature to resist any change. Certainly, this factor will impact many M&A transactions in the future.
It is challenging for the employees of target company as well as for the acquiring company to integrate the operating procedure i.e. SOPs and to embrace the new culture. Mostly, it is observed in M&A transactions the employees of the target company resign post acquisition or during the acquisition process, the attrition rate increases due to insecurity among the employees.
Mitigation of Cultural and Integration Risk
In order to mitigate the cultural risk the acquiring company should try to start understanding the culture of the target company right from the moment LOI(Letter of Intent) is executed between the companies entering into the transaction. The cultural risk can be avoided if the acquirer company try to understand the work culture of the target company. In this process the human resources (HR) department of both the companies can play a major role.
The next in tier is the head of every department (HOD) and the reporting managers of the respective departments, they shall play the vital role in explaining the work culture and the deliverables by the employees. The HODs and reporting mangers of both the companies may resort to one to one conversation and try to understand the view of employees on the target company’s management. This exercise can resolve or highlight the leadership issues that may be faced post transaction.
The information and data collected by the HR department and the HOD or reporting managers should be analysed properly in order to understand the gaps between the culture of the acquiring company and the target company.
In the entire process the acquiring company should involve the psychological experts to identify and analyse the cultural behaviour of both companies and address the gaps.
Case Studies
Daimler-Benz and Chrysler deal is year 1998 is the classic example of the cultural clash
The Daimler Chrysler deal had faced worst cultural clash post deal. The Germans felt that Americans has more casual style of working, whereas, Americans felt that Germans are too rigid and formal.
At the beginning the one side tried to impose its working style in the other side. This lead to conflicts and misunderstanding between the employees and it did not fit with the culture.
The company did not involve any cultural specialist counsel who could have addressed the cultural gaps between both the companies.
Hewlett Packard and Compaq deal in year 2001 failed due to work culture clash
HP Company core values are based on the ‘HP way’ where culture has always had a powerful influence on how the company functions; undertaking cultural integration poses an especially daunting task. HP’s core values include Market Leadership, Leadership Capability, Customer Loyalty, Employee, Commitment, Global Citizenship Growth and Profit.
Compaq Company has hindered “evolution” of its values. Their core values are listening and solving customer problems, being passionate about everything we do, driving innovation and building cool stuff, partnering for our customers’ advantage, communicating openly and honestly, doing what we say and having fun.
HP is more in an engineering-driven culture that values teamwork and rewards ideas and inventions whereas Compaq had a hard-charging sales culture as perceived as aggressive. Beside, according to Pimentel (2001) HP put a heavier stress on team accountability while Compaq is more in sharply defined lines of responsibility.
The aforesaid cultural differences had hampered the success of the merger.
Risk related to change in regulatory policies
The most uncertain risk in M&A transactions is related to changes in regulatory policies by the government are no lesser than the acts of God. The change in policies by the government may result in adverse impact on the business in terms of profit or revenue. The government may bring in change in policies by keeping in mind the public health, to safeguard the environment or to increase the revenue for the government and there could be many more other reasons.
The latest examples we have, the regulation of OTT (Over-the-top) platform by the government. The regulation of the OTT segment will force the filmmakers to review and revise the produced content in form of language used and the visuals shown as the consequence of which Netflix and Amazon will be hit hard.
The change in regulatory policies may also lead to unnecessary market disruptions. Jio is the best example for disruption in the telecom market. TRAI (Telecom Regulatory Authority of India) announced abolition of IUC (Interconnect Usage Charge) charges. The abolition has bit positively impacted the revenues of Vodafone and Airtel, whereas, Jio is benefited out of this move because Jio has higher number of telecom consumers and it would have ended up paying Vodafone and Airtel for any call made by its subscribers to rival network.
Mitigation of risk related to change in regulatory policies
Well, there is no specific way to overcome the change in regulatory policies by the government. However, in order to mitigate the risk the company should understand the market trends and the consumer behaviours. The company should have well skilled and equipped team to study the market and foresee the expected change in market.
The decision making and the operating process of the company should be flexible in order to absorb the shocks of certain changes in the market. Many companies have entered into new segments to mitigate the losses due to COVID impacts. Such companies have started making PPE kits, sanitizers and other solution based cleaning agents.
Case Studies
Microsoft acquired Nokia in year 2014
Microsoft acquired Nokia in year 2014 in order to enter the mobile handset segment. Microsoft decided to launch Windows operating system on its phone in order to compete with the Android platform. Microsoft could penetrate the market as much as done by the Android phones. People were more comfortable with the Android under interface as compared to the Windows under interface.
Microsoft realised the same. But deal failed because Nokia got late to switch itself to android platform.
Cisco acquired Pure Digital in year 2009
Cisco decided to enter the consumer electronic segment, as Cisco thought that it would help the company’s network business because more digital content would require bigger, better networks. Cisco spent $590 million in stock and acquired Pure Digital, the maker of affordable, consumer-friendly Flip video camera. Cisco closed the business barely within two years of acquisition. Around 2009 every newly launched smartphone had an inbuilt high definition camera increasingly shoot HD video while offering more wireless sharing options, something Flip’s camera’s never included.
However, Cisco gave reason that its is closing the Flip business as it wanted to refocus on its five areas: core routing, switching and services; collaboration; architectures; and video.
Conclusion
Upon flipping the pages of M&A history across the globe we may come across several factors that lead to success and failure of M&A transactions. Based on many researches and studies it is revealed that most of the M&A deals fail. Harvard Business Review Report reveals that between 70% to 90% M&A deals fail. Considering such a high figure of M&A deal failure it is very much clear that M&A transactions are being followed with a clear strategy and effective planning to implement the project. It can be easily understood that M&A figures and graphs as discussed in the boardroom fall flat when it comes to the execution and implementation.
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