18 Acquisitions, Mergers and Amalgamations

Vipul Puri

1. Introduction

1.1 The most significant goal for every business firm is to achieve growth. It is possible for a firm to grow organically or inorganically in the form of mergers and acquisitions. While growth is a positive virtue and leads to a number of efficiencies, it may also cause an increase in market power of a firm giving it the ability to indulge in anti-competitive practices. This negative impact of growth underscores the need for regulation. The conduct of a firm which has grown organically or internally is regulated under the provisions of section 4 of the Competition Act, 2002 relating to abuse of dominance. The instances of inorganic growth through the route of mergers and acquisitions (M&As) are regulated ex-ante at the time of entering into the transaction. The unit is focussed on an understanding of the regulatory philosophy and the basic concepts of M&A activity and the discussions are centred on the basics of mergers and acquisitions including, the merits and demerits of merger activity, their impact on market competition and the need for regulation.

2. Learning outcome

2.1 In this unit, we will try to understand the basics of mergers and acquisitions in general and in context of the term ‘combinations’ as used under the Act. The unit is a precursor to the understanding the assessment procedure in combination cases. After the completion of this unit, the participants are expected to understand:

2. Mergers and amalgamations

3.1 The firms strive to achieve growth in terms of business operations and financial resources. There are two approaches to growth, organic and inorganic. Organic growth, which is also called as internal growth is driven by the firm’s own business activities such as innovation, development of new products or by development of markets. In contrast, inorganic growth or the external growth refers to growth in business operations or finances facilitated by the mergers, acquisitions, takeovers etc. Both the organic and inorganic growths have respective merits and demerits and the firms make a strategic choice that allows them to achieve their planned objectives.

3.2 Within the broader inorganic growth strategies, there are various forms, which are similar in spirit but different in either the structural form or the legal procedures. These sub-categories of inorganic growth may be called by different names such as amalgamation, acquisition, merger, etc. However, the nomenclature and these differencesare inconsequential to the competition assessment. The competition assessment is undertaken in accordance with the substance, the spirit of the transaction and not by its structural form. The Competition Act’2002 uses the term ‘combinations’ to include the various M&A forms stated above. In the unit, these terms have been used interchangeably, unless a particular form is required for any statutory provision.

4. Combinations – Scope under the Competition Act’2002

4.1 Not all M&As are required to be pre-notified to the Commission. When used in the context of The Competition Act, a combination means and implies M&A transactions which meet the threshold set out in the Act. The Competition Act’2002 also uses the expressions acquisition, merger and amalgamation in section 5 of the Act. However, only those transactions which exceed the value of assetor the turnover require prior-approval of the Competition Commission of India and qualify to be called a “combination”.

4.2 The Competition Commission of India has also issued The Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011 to set out the procedure. Further, the Government of India has the power to exempt class of transactions in terms of section 54 of the Act by issuing notifications in this regard. This section would focus on all the three factors relevant to the scope of combinations in the Competition Act viz., the substance of the provisions of section 5, the regulations related to notification of combinations and GOI notifications.

4.3 Notifiable Combinations – Threshold based regulation (Section 5)

4.3.1 The primary criterion for examining whether a combination needs to be notified is based on thresholds fixed on the basis of value of assets and turnover of the parties to the combination, or the assets and turnover of the group to which the parties belong. The thresholds are further affected by the geographic scope of business operations of the parties/group. The three different approaches to thresholds have been prescribed under the Act, which are discussed as under1:

i) General cases (not covered by (ii) and (iii) below): the parties to the acquisition, being the acquirer and the enterprise, whose control, shares, voting rights or assets have been acquired or are being acquired jointly have,—Criteria based on combined thresholds of the parties to the transaction

(A) either, in India, the assets of the value of more than INR 1500 crores or turnover more than INR 4,500 crores; or

(B) in India or outside India, in aggregate, the assets of the value of more than US $ 750 million, including at least INR 750 crores in India, or turnover more than US $ 2.25 billion, including at least INR 2,250 crores in India.

Criteria based on combined thresholds of the groups to which parties belong the group, to which the enterprise whose control, shares, assets or voting rights have been acquired or are being acquired, would belong after the acquisition, jointly have or would jointly have,—

(A) either in India, the assets of the value of more than INR6,000 crores or turnover more than INR 18,000 crores; or

(B) in India or outside India, in aggregate, the assets of the value of more than US $ 3 billion, including at least INR 750 crores in India, or turnover more than US $ 9 billion, including at least INR 2,250 crores in India.

The provisions may be summarized as under:

ii) Thresholds determination in case where acquirer has already direct or indirect control over other enterprise engaged in production, distribution or trading/provision of a similar good or service: In this case, the only change is that the assets and turnover of the enterprise over which the acquirer already has direct or indirect control will also be considered in addition to the figures of assets and turnover of the acquirer and the enterprise being acquired, while applying the individual threshold criteria as stated above. The determination of thresholds for group case is done in the similar manner as in case above. The limits for thresholds base remain unchanged in both the individual and group criteria.

iii) Thresholds determination on the basis of thresholds base of the merged entity: any merger or amalgamation in which—

(i) the enterprise remaining after merger or the enterprise created as a result of the amalgamation, as the case may be, have,—

(A) either in India, the assets of the value of more than INR 1,500 crores or turnover more than INR 4,500 crores; or

(ii) the group, to which the enterprise remaining after the merger or the enterprise created as a result of the amalgamation, would belong after the merger or the amalgamation, as the case may be, have or would have,—

(A) either in India, the assets of the value of more than INR 6,000 crores or turnover more than INR 18,000 crores; or

4.4 Exemptions from the notification requirements as per Regulations

4.4.1 The Commission by way of Regulation 4 of The Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011 has included some categories of combinations in Schedule I that are ordinarily not likely to cause an appreciable adverse effect on competition in India. As per Regulation 4, the notice for such combinations need not normally be filed. Some of the important combination transactions included in this category are as under2.

An acquisition of shares or voting rights not leading to holding of more than 25% shares or voting rights of the company, where such shares or voting rights are held solely as an investment.

An acquisition of shares or voting rights, not resulting in gross acquisition of more than 5% in a financial year, where the acquirer or its group, prior to acquisition, has already 25% or more shares or voting rights of the enterprise, but does not hold 50% or more of the shares or voting rights of the enterprise, either prior to or after such acquisition.However, this is subject to a proviso that such acquisition does not result in acquisition of sole or joint control of such enterprise by the acquirer or its group.

An acquisition of shares or voting rights,where the acquirer, prior to acquisition has 50% or more shares or voting rights and the transaction does not lead in transfer from joint control to sole control.

An acquisition of assets not directly related to the business activity of the party acquiring the asset or made solely as an investment. However, this clause will not be applicable if the assets being acquired represent substantial business operations in a particular location or for a particular product or service of the enterprise, of which assets are being acquired, irrespective of whether such assets are organized as a separate legal entity or not.

An acquisition of stock-in-trade, raw materials, stores and spares, trade receivables and other similar current assets in the ordinary course of business.

4.5 Exemptions from the notification requirements as per GOI notifications

4.5.1 The Central Government is empowered to exempt the application of provisions of section 5. At present, the Central Government has exempted the enterprises whose control, shares, voting rights and assets are being acquired having either the assets of the value not more than Rs.250 crores or turnover not more than Rs.750 crores3 and banking companies in respect of which the Central Government has issued a notification under section 45 of the Banking Regulation Act, 19494. In both the cases, the exemption is made for a period of 5 years from the date of publication of notification in the Official Gazette.

4.5.2 The thresholds, the methodology of calculating thresholds, the exceptions granted under the regulations and GOI notification imply that merger control regimes function on the principle of management by exception. What is desired is to regulate only those transactions which have some probability of causing an appreciable adverse effect on competition and not the entire M&A activity.

5. Merits and demerits of M&A’s

5.1 After understanding the scope of combinations for the purpose of the Competition Act, i.e. after knowing what types of combinations are to be assessed for competition impact, it would be prudent to gain better understanding of the inherent merits and demerits of these transactions.With an eye on competition assessment (to be dealt later), we may consider two approaches to the merits and demerits; the first approach is firm or business specific merits and demerits and the second approach is from the viewpoint of impact on competition in the market. Though the first approach is more relevant to a firm to decide on the M&A transaction and valuation, it is equally important to a competition agency to understand the true motive behind the transaction, which may allow the agency to give due regard to the efficiencies which may be claimed for getting the transaction approved. The second set of merits and demerits are of immediate concern to the competition agency as that may provide the basis of approving/rejecting/modifying the transaction.

5.2 Firm specific merits of M&A

5.2.1 Growth of business operations: The mergers and acquisitions have the potential to contribute significantly to the growth of business operations in terms of activity (turnover) and resources (core assets). This route has some advantages over the alternate route of internal growth which is constrained by relatively greater requirement of funds, time and uncertainty of outcomes. In case of M&A’s, the funds can be managed by alternative methods of discharging purchase consideration, implementing time and uncertainty is reduced due to pooling of complementary resources and the process of due diligence undertaken by the parties.

5.2.2 Cost advantages: A firm operating at a larger scale stands to benefit from the reduced average fixed cost as well as the average variable cost. The cost advantage may accrue due to:

Economies of scale: With increase in production volumes, it becomes possible for a firm to utilize its fixed assets in an efficient manner. As a result, the fixed costs get distributed over a larger production base, leading to fall in the average unit cost of production.

Synergies in operations: The presence of synergies implies that the value of the combined firm will be more than the sum of the values of individual firms. The synergies may be a result of the vertical integration of the firms which allows it to gain a better grip over the production process; or, due to merger leading integration of complementary resources such as technology, distribution networks etc. The net effect of such phenomena may be elimination of redundant or overlapping costs.

Financial synergies: The debt servicing capacity of a firm may go up consequent to a merger and it may allow a firm to make use of a cheaper source of capital i.e. debt in its capital structure. This will help in reducing the weighted average cost of capital and increasing the value of the merged entity.

5.2.3 Diversification: The M&A’s of the firms in unrelated businesses or the conglomerate mergers help the firm to diversify and reduce their risk profile. However, there is a school of thought according to which, diversification is easier and cheaper at the level of individual shareholder rather than at the level of companies. They believe that the conglomerate mergers may not be consistent with the financial management principle of maximization of shareholder wealth. In the absence of any synergies, the combined value of the firm is merely equal to the sum of their individual values. Any claimed increase in Earnings Per Share (EPS) under such a situation may purely be a result of share exchange ratios. This effect on EPS is called as ‘bootstrap effect’.

5.3 Firm specific demerits of M&A’s

5.3.1 Problems in integration of firms: The mergers and acquisitions are driven by the potential synergies that they offer. However at the core of this is an assumption that a firm will be able to achieve seamless integration of their resources. There is always some difference in working cultures of the merging firms and this may hamper the integration process and the desired efficiencies may not be achieved.

5.3.2 Valuation issues: The most significant factor for acquirer after the target has been narrowed down is to arrive at the purchase consideration or the valuation of the firm. Valuation depends upon a number of factors and also there are a number of approaches to arrive at firm’s valuation. This entire process is based on underlying assumptions and it is very possible that the actual outcome may be very different from the planned. Thus, there is always an additional risk due to valuation issues in the mergers and acquisitions.

5.4 Economy/Market specific merits of M&A’s

5.4.1 Industry consolidation: The mature industries are characterized by limited growth opportunities. The state of increasing costs and stagnating revenues may lead to a trend of M&A activity. The industry consolidation which results helps in optimizing the operating scale. There are many industries such as civil aviation which have undergone consolidation for survival.

5.4.2 Innovation: This merit is mainly for M&A activity in technology areas, though it is applicable to all industries. The M&A may lead to coming together of complementary technologies that may foster development of new techniques and products resulting in lowering the cost of products and enhancing the consumer choice, which is particularly relevant to consumer welfare.

5.5 Economy/Market specific demerits of M&A’s

5.5.1 Adverse effect on competition: Mergers and acquisitions, especially horizontal lead to decrease in competing market players. This reduction in number of competitors may adversely affect the degree of competition and lead to accumulation of market power with the merged entity. This market power may potentially become a source of abusive business practices impacting the development of markets and the state of consumer welfare.

5.5.2 Lackof economic growth impetus: The organic growth process involves substantial investment in new assets and creation of new jobs while in case of inorganic growth, the growth of firm does not lead to growth of industry and economy in the same proportion as the process merely leads to change in ownership of resources rather than augmenting the resources.

6. Combinations: Need behind regulations

6.1 So far, we have discussed the basics of mergers and acquisitions, the scope of notifiable combinations and the firm specific and economy/market specific merits and demerits of M&A’s. At this stage, it is appropriate to delve into the question of the need of regulating the combinations and that too on an ex-ante basis.

6.2 As discussed above, every combination involves a set of positive and negative effects for the firms in particular or the market in general. The competition law perspective is to examine whether a proposed combination is likely to harm competition. Competition is considered as a driving force behind innovation, product development and fair prices. The combinations can adversely affect the outcome of the competition process in two ways. Firstly, the combined firm may reach a position where it is big enough to operate independently of the market forces and that would reduce the incentive to innovate or charge fair prices (unilateral effect).Secondly, the proposed combination may facilitate collusion among the remaining entities (co-ordinated effect). This explains the need behind the provisions of combination regulation.

6.3 Another aspect of combination regulation is that it is undertaken on an ex-ante basis and not ex-post. This is despite of the fact that there are abuse of dominance and anti-competitive agreement provisions that allow the competition agencies to assess the firm for any anti-competitive conduct. It is important to understand the reasons for this approach. The first reason is the cost of remedies required to correct the situation. A remedy post-transaction will be far more costly for the firms as well as the society. Secondly, the uncertainty element regarding the legality of the transaction will adversely affect the business environment.

7. Summary

7.1 Mergers and acquisitions may lead to creation of a dominant enterprise or facilitate collusion thereby adversely affecting the consumer welfare and development of markets. However, it is equally true that they constitute an important route of growth and offer significant merits to the firm as well as the market. Mergers may also have the effect of increasing the competitiveness of firms comprising the industry. In fact, over a period of time, consolidation has become critical for firms to survive the fierce competition in many industries. Mergers and acquisitions based on synergies between the operations of merging firms may lead to substantial cost savings which may get passed on to the consumers in form of lower prices and may contribute to the process of innovation.

7.2 Thus, the competition law agencies are duty bound to enforce the regulation maintaining this delicate balance between the potential pro-competitive and anti-competitive potential effects that a combination may give rise to.The next unit focuses on, how to strike this balance in assessment of combination transactions under the framework of competition law

you can view video on Acquisitions, Mergers and Amalgamations

Weblinks

http://www.cci.gov.in/menu/combinations.pdf
http://www.cfainstitute.org/learning/products/publications/inv/Documents/corporate_finance_chapter10.p ptx