Unit 4: Corporate reconstruction, mergers & acquisitions
Advanced Financial Management notes · PTU syllabus (BCOP 512-18)
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Unit summary
Companies grow, shrink and reshape through restructuring, mergers and acquisitions. This unit covers financial and capital reconstruction schemes, reasons for and against mergers and acquisitions, legal and procedural aspects, valuation in M&A, reverse takeovers, business unbundling, divestment, spin-offs, management buy-outs and share repurchase.
After this unit you can
- Explain financial and capital reconstruction schemes
- Evaluate reasons for and against mergers and acquisitions
- Explain legal and procedural aspects and valuation in M&A
- Explain reverse takeovers, unbundling, divestment, spin-offs, MBOs and buy-backs
PTU syllabus topics
- Financial and capital reconstruction schemes
- reasons for and against mergers and acquisitions
- legal and procedural aspects
- valuation of M&A
- reverse takeovers
- business unbundling
- divestment
- spin-offs
- management buy-outs
- share repurchase
- Merger
- Two firms combine into one
- Acquisition
- One firm buys another
- Demerger / spin-off
- A unit becomes a separate company
- Divestment
- Selling a unit
- Management buy-out
- Managers buy the business
Topic 1
Financial and capital reconstruction
Financial reconstruction reorganises the capital structure of a company in financial difficulty so that it can survive — involving shareholders and creditors.
- 1
Estimate position if liquidated
What each stakeholder would get
- 2
Estimate future earnings and funding needs
- 3
Propose sacrifices
Shareholders write down capital; creditors convert debt to equity or accept lower interest
- 4
Inject new finance
Rights issue, new investors
- 5
Check each party is better off than in liquidation
- 6
Obtain approvals
Section 66, 230–232, NCLT; or IBC resolution plan
- Capital reconstruction (non-distress): changes in capital such as consolidation, conversion, reduction of surplus capital.
- Insolvency and Bankruptcy Code, 2016: Corporate Insolvency Resolution Process — resolution plan approved by the Committee of Creditors (66%) and NCLT; else liquidation.
Exam tip
The key test of any reconstruction scheme: every class of stakeholder must be no worse off than in liquidation, or they will not agree.
Topic 2
Mergers and acquisitions: reasons for and against
| Reasons for | Reasons against / risks |
|---|---|
| Synergy — revenue, cost, financial | Overpayment (winner's curse) |
| Economies of scale and scope | Integration and culture clashes |
| Market power, entry into new markets | Managerial hubris and empire-building |
| Acquiring technology, brands, talent | Regulatory (CCI) and legal hurdles |
| Tax benefits (carry-forward losses — Section 72A) | Dilution of EPS, increased gearing |
| Diversification (debatable for shareholders) | Loss of key staff and customers |
Example
Synergy: Value(A + B) > Value(A) + Value(B). If A is worth ₹500 crore, B ₹200 crore and combined ₹780 crore, synergy = ₹80 crore; paying a premium above ₹80 crore destroys A's shareholder value.
- Types: horizontal, vertical, conglomerate, congeneric; friendly vs hostile.
Topic 3
Legal and procedural aspects
- Companies Act, 2013: Sections 230–232 (scheme of compromise or arrangement — approval by shareholders and creditors by 75% in value, NCLT sanction); Section 233 — fast-track merger for small companies and holding–wholly owned subsidiaries (approved by the Regional Director).
- Competition Act, 2002: combinations above asset/turnover thresholds or deal value above ₹2,000 crore need CCI approval.
- SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011: acquiring 25% or more voting rights triggers an open offer for at least 26% more; creeping acquisition up to 5% a year for holders of 25–75%.
- Income-tax Act: tax-neutral amalgamation (Section 47) and carry-forward of losses (Section 72A) subject to conditions.
- FEMA for cross-border deals; Stamp duty under state laws.
- Defence tactics against hostile bids: poison pill, white knight, crown jewel sale, pac-man defence, golden parachutes.
Topic 4
Valuation and payment in M&A
- Valuation methods: DCF, comparable companies and transactions (EV/EBITDA, P/E), asset-based, synergy valuation.
- Forms of consideration: cash (certainty, no dilution, needs funding), share exchange (shares risk with target shareholders), mixed, earn-outs (contingent payments).
Exchange ratio
Price offered per target share ÷ Price of acquirer share
Post-merger EPS
(Earnings A + Earnings B + Synergy) ÷ (Shares A + New shares issued)
Maximum exchange ratio (no EPS dilution)
EPS of target ÷ EPS of acquirer (ignoring synergy)
Example
A: earnings ₹100 crore, 10 crore shares (EPS ₹10, price ₹150). B: earnings ₹30 crore, 5 crore shares (EPS ₹6, price ₹72). Offer 0.5 A share per B share → 2.5 crore new shares. Post-merger EPS = 130 ÷ 12.5 = ₹10.40 — accretive for A.
Topic 5
Reverse takeovers, unbundling, divestment, spin-offs, MBOs and buy-backs
- Reverse takeover: a smaller company (often unlisted) acquires a larger listed company or a private company gets listed by merging into a listed shell — quicker listing route.
- Business unbundling: separating parts of a business to unlock value or focus on core activities.
Divestment (sell-off)
Selling a division to another company for cash
Spin-off (demerger)
New company formed; its shares distributed to existing shareholders (Reliance Jio Financial, 2023)
Carve-out
Part of a subsidiary sold to the public in an IPO
Management buy-out (MBO)
Existing managers buy the business, often with PE and debt (LBO)
Management buy-in (MBI)
Outside managers buy in
Liquidation of a unit
Sell assets piecemeal
- Share repurchase (buy-back): Section 68 — limits 25% of paid-up capital and free reserves, D/E ≤ 2:1 after buy-back; tender offer or open market; returns cash, raises EPS, signals undervaluation, adjusts capital structure. From October 2024, buy-back proceeds are taxed as dividend in shareholders' hands.
Ownership after
Same shareholders own both companies
Buyer owns the divested unit
Cash received
None by parent
Cash or shares received
Purpose
Unlock value, focus
Raise cash, exit non-core business
Key terms
- Financial reconstruction
- Reorganising capital of a distressed company with stakeholder sacrifices
- Synergy
- Combined value exceeding the sum of separate values
- Open offer
- Mandatory offer to public shareholders on crossing takeover thresholds
- Spin-off
- Creating a new company from a division and distributing its shares to shareholders
- Management buy-out
- Purchase of a business by its existing managers
Quick revision
- Reconstruction must leave each class no worse off than liquidation; IBC CIRP.
- M&A drivers: synergy, scale, market power; risks: overpayment, integration.
- Law: Sections 230–233, CCI approval, SEBI SAST 25% open offer trigger.
- Exchange ratio and post-merger EPS; cash vs shares.
- Unbundling: divestment, spin-off, carve-out, MBO/MBI; buy-back under Section 68.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.What is financial reconstruction?
- Q2.What is synergy?
- Q3.What triggers an open offer under SEBI takeover regulations?
- Q4.What is a reverse takeover?
- Q5.Distinguish spin-off and sell-off.
- Q6.What is a management buy-out?
Long-answer questions
- Q1.Explain the design of a financial reconstruction scheme.
- Q2.Discuss the reasons for and against mergers and acquisitions.
- Q3.Explain the legal and procedural aspects of M&A in India and valuation methods.
- Q4.Explain business unbundling — divestment, spin-offs, MBOs and share repurchase.
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