Professional Documents
Culture Documents
LESSON 39:
REVERSE MERGER
Takeover of Lakme brands, sales and distribution network was the funds garnered for acquisition of a Department Store I
through a complex deal for environmental and fiscal reasons. Littlewoods. The entire cosmetic business under the Lakme
The sale was done in two stages: brand is now owned and I managed by HLL.
Stage I - In January 1995, the Lakme trademark, technology Case Study : Krone Communication Limited-
and related intellectual property was transferred to a 100 per Conditional Exemption
cent subsidiary of Lakme Ltd.-Lakme Brands Ltd. The transfer Krone Communications Ltd., M/s. GenTek Inc., USA (the
consideration was determined at Rs. 78 crore. Lakme Brand acquirer company) I entered into a re-construction and restruc-
Ltd.’s capitalization was represented by equity capital of Rs. 3.25 turing agreement with Jenoptik AG, through I its subsidiary,
crore subscribed by Lakme and optionally fully convertible for the acquisition of its entire shareholding in Krone AG
debentures of Rs. 75 crore subscribed to by Hindustan Lever. which holds I 51% of the issued, subscribed and paid up equity
At the same time, a new joint venture company Lakme Lever capital of Krone Communications I Limited (target company).
Limited was formed, wherein Hindustan Lever and Lakme both Pursuant to this, it made an application dated July 22, 1999 to
held 50 per cent of the 21 lakh equity shares each. Sales and the Board seeking exemption from the applicability of the
marketing infrastructure in India as well as abroad owned by provisions of the SEBI I (Substantial Acquisition of
Lakme was transferred to the joint venture for a consideration Shares and Takeovers) Regulations, 1997 (the ‘Regula-
of Rs. 32.39 crore. This included payment for goodwill, net tions’) for the said acquisition. The Board forwarded the
current assets and relevant fixed assets. Also, Hindustan Lever application to the Takeover Panel which vide its report dated
paid Rs. 30 crore (Rs. 25 crore to Lakme Ltd. and Rs. 50 lac to August 5, 1999 rejected the application on the ground that in
Lakme’s wholly owned subsidiary Lakme Exports Ltd.) for the process of the acquisition of Krone AG, the control over
non-compete agreement. the target company would be shifted in favour of the acquirer
For Lakme, entry of Unilever group and other MNCs in the company through the holding company i.e. Krone AG and that
field was imminent, which would have led to heightened Regulation 12 would be applicable. During the course of the
competition and decline in margins. Therefore, an alliance with personal hearing held on September 6, 1999, the acquirer
an established MNC was a mutually beneficial arrangement. brought to the notice of the Board certain additional facts. It
Further, technological/marketing inputs from Unilever group was stated that the purpose of acquisition of Krone AG is not
would give an edge over the competitors and allow the joint to secure the control of the target company and that it would
venture selling company to cash upon its distribution network. not lead to an indirect acquisition of the target company by the
However, HLL’s traditional distribution network, although one acquirer. Also it contended that the said acquisition would not
of the largest, was not tuned to market cosmetic products bring about any change in the shareholding of the target
which are primarily sold through specialised shops/boutiques. company and that the controlling stake of Krone AG in the
So tie up with Lakme enabled the company to leverage on the target company i.e. 51% would not alter pursuant to the said
Lakme distribution channels also. acquisition. It was stated that they believed that the acquisition
would not result in a change in management or a reconstitution
Stage II - In 1998, Lakme Limited divested its 50 per cent stake
of the Board of Directors of the target company. Therefore the
in Lakme Lever Ltd. to HLL for a consideration of Rs. 90.5
Board referred the case back to the Panel for reconsideration of
crore. The entire stake of Lakme Ltd. in its wholly owned
the case based on the new facts. On consideration of the same
subsidiary Lakme Brands Ltd. was also acquired by HLL.
as well as the undertaking given by the acquirers that the
Lakme’s manufacturing facility at Deonar was taken over for Rs.
acquirers were willing to abide with the conditional exemption
24 crore. The manufacturing plant at Kandla owned by Lakme
granted by SEBI to the effect that the shareholders of the target
Exports, the 100 per cent subsidiary of Lakme Ltd. was taken
company ratify the change in control by an appropriate resolu-
over by HLL for a consideration of Rs. 5.71 crore.
tion passed at the meeting of its shareholders. The Takeover
Statistics Panel vide its report dated January 20, 2000 recommended the
The table given below displays the total consideration involved grant of exemption as sought by the acquirers subject to the
in the sale of Lakme Lever stake, manufacturing facility and shareholders of the target company passing a special resolution
brand by Lakme Ltd. at the meeting of the shareholders permitting voting through
postal ballot thereat, ratifying the change in control. Also a
Consideration paid for Rs. (crore) further condition was imposed that the notice of such a
Stake in Lakme Lever Ltd. 90.5 meeting to the shareholders of the target company should
Deonar manufacturing facility 24.03 accompany an envelope for postal ballot with pre-paid postage
Kandla manufacturing facility (from Lakme Export) 5.71 stamps affixed. SEBl also noted that the acquisition of the
Trade mark, Designs, Brands, Copyrights (from Lakme Brands Ltd.) 110.05
R&D infrastructure (from Lakme Brands Ltd.) .27
target company was merely an unintended consequence of the
Total 230.56 global restructuring of Krone AG, and that the controlling
stake of the acquirer company would not alter Krone AG
Benefits Occurring pursuant to such acquisition. It was also noted that the
Lakme Limited utilized part of the proceeds to redeem the acquisition would not constitute an indirect acquisition in terms
Rs.75 crore Optionally Convertible Debentures subscribed to by of the Regulations and that adequate intimation of the
HLL in Lakme Brands Ltd. in I 1996. Lakme, sans its cosmetics acquisition was given to all the shareholders of the target
In companies/industries having high growth in profits and depressed conditions in the stock market.
significant increase in equity (including ploughing back of a The value of C Limited shares based on the PECV method,
significant portion of the profits), the past average profits outlined above, is liven below:
would not be reflective of the future maintainable profits. In 3-
such circumstances, it would be appropriate to work out the
Rs. lakhs
future maintainable profits based on ‘Return on Equity Funds’
as at the valuation date. The future maintainable profits were, Future maintainable profits after tax 815.44
therefore worked out on the basis of Return on Equity Funds, Capitalised at 12.50% 6523.49
as follows: Number of shares 74 lakhs
The rate of return on average equity funds employed during the PECV per share Rs. 88.16
year was calculated as follows
Future earnings per share
Return = Profit before tax / Average funds employed Under this method the fair value of C Limited shares were
As the merger was effective from April 1, 1997, the weighted determined based on I the value of the future earnings per
average rate of return was then applied to the “funds em- share.
ployed” as on March 31,1997 to arrive at the future maintainable The projected earnings for the five years 1997-98 to 2001-02
profits. were considered I assuming that there would be no increase in
The average capital employed during the years 1994-95, 1995-96 share capital during this period.
and 1996-97 were worked out, after adjusting for the period the As the projected earnings were computed based on the constant
funds which were employed during the financial years, i.e., after prices these I were not discounted. Weightages were assigned
adjustments for issues of capital. starting with a weightage of 5 for I 1997-98 and ending with 1
The average returns for the years 1994-95 to 1996-97 worked for 2001-02. The weightages represent probabilities with I the
out to 25% and the weighted average returns for the same most distant future having the lowest weightage.
period 23.71%. The weighted earnings per share worked out to Rs. 8.42.
The FMP based on Adjusted Capital Employed as at March 31, Applying the same multiple of 8 referred to above, the value of
1997 worked out to Rs.1,254.52 lakhs. the share worked out to Rs. 67.36.
For the purposes of arriving at the ‘Profit Earning Capacity Net Asset Value (NAV) Per Share
Value’, the future maintainable profits were considered net of This is the value of the net assets attributable to equity
tax. C Limited was not currently enjoying the benefit of a tax shareholders as on a particular date. In this case, the value of net
holiday for new undertakings. There were, consequently, no assets was taken as per the audited balance sheet as at March 31,
significant prominent differences, which required adjustment. 1997.
Since ‘timing differences’ did not affect the total incidence of tax The value of net assets as per the audited balance sheet as at
(though they may affect cash flows), the same were ignored in March 31, 1997 was worked out after considering the following:
determining the appropriate rate of tax. The rate of tax was
a. Value of Insurance premia paid. The premia paid during
considered at 35%, which was the rate likely to be applicable in
1994-95, 1995-96 arid 1996-97 had been charged to the
future years based on the indications.
Profit and Loss Account. On maturity of the Policy, the
The Future maintainable profit after tax worked out as under: proceeds received are in excess of the premia paid.
Rs. lakhs Consequently, as at March 31, 1997, the value of the premia
Future Maintainable profits before tax 1254.52 paid was considered as an asset and pro-rata share of the
appreciation attributable to the premia paid up to March
Tax @ 35% 439.08
31, 1997 net of the present value of the future
Future Maintainable profits after tax 815.44 tax liability on the pro-rata proceeds.
The next step in this method of valuation was the selection of b. Timing difference on leased assets - During 1995-96
the rate at which the future maintainable profit after tax could and 1996-97 depreciation charged in the accounts in
be capitalised to arrive at the total value of the equity capital of respect of assets leased out was Rs. 47.97 lakhs as against
the company. The capitalisation factor is the inverse of the the depreciation claimed for tax of Rs. 605.62
price/earnings ratio (P/E). Generally, in order to derive a lakhs. The tax applicable on the timing difference of
reasonable capitalisation factor, an analysis of the prices and Rs.557.65 lakhs was discounted to the present value and
earnings of “comparable” companies in the same industry, to deducted from the net asset value.
which, the company, whose share is being valued belongs to, is
No adjustments were made for contingent liabilities, as these
conducted. Having regard to the steep growth in profits of the
were unlikely to result into liabilities.
company over the last four years, the P/E multiple was
determined, which worked out to 8. The P/E ratio of Sgave a Based on the above, the Net Asset Value of C Limited as on
capitalisation factor of 12.50% which was considered appropri- March 31, 1997 worked out to Rs.5291.02 lakhs. The fair value
ate, in view of the increase in profits of the company during the of C Limited share under the Net Asset Value method was:
last few years although the actual P/E multiple of comparable
Based on the high/low of the share prices during the twelve Exchange Ratio
months ended September 30, 1997, the average market price The fair values of shares of C Limited and S Limited thus
worked out to Rs. 21.36. determined were:
of one newly-issued Pro-Tech Inc. share for one Techno Inc. Clearly, there will be product lines terminated, and jobs lost, if
share) ushers a new Pro-Tech Inc. at $87 billion, just below the “cost synergies” that Mr. ABC has spoken about before the
Moor Pte. Ltd. at $90 billion. Mr. ABC will remain chairman press, have to happen effectively.
and CEO of the new entity and Techno Inc.’s Mr. PQR will be There are significant systems overlaps between Pro-Tech Inc.
the President. and Techno Inc. Globally, systems (PCs, servers, notebooks)
Last fiscal (ending March 2001) revenues for the two added up bring in a third of Pro-Tech Inc.’s revenues, and one-half of
to Rs.3,301 crore. This takes it past the current top three in the Techno Inc.’s. Their Unix server businesses are similar. Both
Indian Industry. have proprietary computer processors and architectures. Both
Pro-Tech Inc. plus Techno Inc. group revenues for last fiscal, have announced a phase-out of these and a shift to Intel’s 64-
including software operations, adds to Rs.3,650 crore, keeping it bit Itanium processor for high-end servers over the next three
at number 3 behind the PCL group (Rs.4,413 crore) and the to five years.
Boon group (Rs.4,032 crore). Thus, some of the server product lines will have to converge, as
The system vendor toppers are Tin Ltd. (by total-not just will desktop and portables lines. The trimming could happen
systems -revenues), Techno Inc., Moor Pte. Ltd. Pro-Tech Inc. from either side. The Pro-Tech Inc. name will dominate, but
This now changes to the new Pro-Tech Inc. at number 1, some strong Techno Inc. brands may stay.
followed by Tin Ltd., Moor Pte. Ltd., and, significantly below, However, PCs would continue to be the largest source of
PCL. revenue for the new company at a time when prices are plum-
• Significantly, the new Pro-Tech Inc. entity, will assume the meting and unit sales are declining. And PCs are where neither
number 1 slot by revenue in PCs, Unix servers and has been able to run an operation as efficient and profitable as
workstations, PC servers, and printers, and tops by units Deil’s.
in alj these areas except for Unix servers, where Sun sold Also, it will be interesting to see if the resulting organization
more units last year. behaves more like Techno Inc., which has been a fairly aggres-
sive company driven by sales goals, or Pro-Tech Inc., which has
What do they Gain?
been more consensus-driven.
• The big gain for the combined entity is likely to be a larger
customer base. Coupled with the elimination of However, at the top level, there could be some
overlapping computer product lines, this could lead to ‘complementarity’, among the two CEOs who came on board
lower costs for the same revenues. in July 1999. Mr. ABC is known for her high-level strategy
focus; Michael Capellas, for his hands-on grasp of operations
• The new entity becomes a mammoth one-stop shop and the nitty-gritty.
spanning systems, printers, services and more, a global
number 2. However, the product range was largely there What does the merger mean for the Indian market? The
with Pro-Tech Inc. anyway, though Techno Inc. was much implications are far reaching. The merged entity will become the
stronger in PC servers, and consumer desktops. largest IT company in India, displacing Tin Ltd. We take a look
at how the merger will create ripples in each of the segments the
• Pro-Tech Inc. gains Techno Inc.’s services business, its two companies operate.
distribution network especially for consumer desktops, its
handhelds, and of course its business customers. 1. Total Revenue
Techno Inc: Rs. 1,761 crore
Product-line synergies stem from services (Techno Inc. gets 23
per cent ol its global revenues from services - 13 per cent in Pro-Tech Inc: Rs. 1,540 crore
India - with plans to push that up), peripherals (Pro-Tech Inc. is Post Merger: Rs. 3,301 crore
the global leader in printers and is very strong in other devices Analysis: It will become the largest IT company in India
including scanners), and, to a smaller extent in systems (Techno displacing Tin Ltd. (Rs.3,142
Inc. is stronger in consumer desktops, with a far better distribu-
crore) and existing number 2 company (Rs. 2,947 crore).
tion network, both in India and globally). Techno Inc. also
brings in the very successful Pocket PC, which could replace the 1. Group Revenue
Pocket PC in Pro-Tech Inc.’s portfolio. Techno Inc.: Rs.1,945 crore
Techno Inc. has anyway outlined a shift in focus to software and Pro-Tech Inc.: Rs.1,705 crore
services. Its systems margins have been under pressure in recent Post Merger: Rs. 3,650 crore
times; its PC division has been in the red for seven consecutive
Analysis: It will become the third largest group in India behind
quarters now; it lost the number 1 PC slot both globally and in
PCL (Rs. 4,413 crore)
the US market. Pro-Tech Inc., under Mr. ABC, has also been
and Boon’s (Rs. 4,032) with ‘finger’ in virtually every segment
under earnings pressure, aggravated by the slowdown and
including mainframes, servers, workstations, PCs, note-
massive restructuring costs in 2001. Pro-Tech Inc. has been keen
books, printers, storage, application software, services, etc.
to ramp up services and consulting revenue, the reason for its
abortive bid to buy consulting firm Y&P earlier. 1. Unix Servers (in units)
Techno Inc.: 394