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M&A advice: Look before you leave
March, 19th 2010

Study shows more than half of the deals fail to create significant shareholder value.

Investment bankers are already claiming this years mergers and acquisitions (M&As) will create records, following a series of deals in the country in recent weeks.

The most recent one was Fortis Healthcares acquisition of Singapore-based Parkway Holding at Rs 3,118 crore. Prior to this, Renuka Sugar created buzz when it bought Equipav SA for Rs 1,530 crore. The biggest one this calendar year is Bharti-Zain. Bharti Airtel will shell out Rs 50,000 crore for the African telecom giant.

For retail investors, however, it is difficult to make sense of these deals. If a person holds the share of a company that is going for a big-ticket acquisition, there are limited avenues to understand whether it will add value to the portfolio or not.

Globally, consultants have seen that half or more of the big mergers, acquisitions or alliances have failed to create significant shareholder value. For shareholders, the sad conclusion is that an average corporate-control transaction puts the market capitalisation of their company at risk and delivers little or no value in return, states a McKinseys report, which has studied what it takes for such deals to create value for shareholder.

Such big deals do not have a standard trend for a small investor to reach a conclusion. The volatility of stock price movement after the acquisition further adds to the confusion.

For instance, Renuka Sugars stock movement post the acquisition announcement on February 21 (Sunday). In the following trading session (Monday), the companys share price rose to Rs 186.55. The previous closing, on February 19, was Rs 179.9. The stock remained volatile over the next few days. It underwent correction and hit a low of Rs 161.85 (March 2). Then surged again and traded at Rs 182.95 (March 8).

Similarly, when Fortis Healthcare announced Singapore's Parkway takeover on March 11, the stock went up by Rs 8.25 on the day of announcement to Rs 178.35. It hit a high of Rs 183.5 on March 16 and then fell to Rs 177.35 on March 18.

Those who believe the acquisition is good, buy stocks and those who do not, sell them. The two forces keep the stocks volatile for some days, says Devendra Nevgi, founder & principal partner, Delta Global Partners. He explains that analysis of acquisitions have two aspects the fundamental value and the financials.

The company usually provides details of the strategic details in an acquisition that would help an investor understand the fundamental value of the acquisition. In Renuka Sugar, for example, the deal will help the company to scale up capacity and make it one of the largest producers of sweetener globally. The Brazilian company will also improve access to raw material. Within financials, the first ratio to check is earnings per share (EPS).

While announcing the acquisition, the company states if the deal is EPS accretive. Ideally, the target company should also add the EPS of the acquiring firm. An acquisition of a loss-making company can affect the profitability of the parent. This is witnessed in several large acquisitions such as Tata Motors and Jaguar Land Rover.

The cost of the acquisition and the funding come next. In case the target company is listed, a rough rule for fair acquisition price is 10 per cent premium over the companys current stock price. To fund an acquisition, the company can arrange money through different forms of loans or by diluting its equity. If the transaction is done through the excess cash on the companys books, it can be a healthy financial sign. However, if the company is adding debt, it could affect its financial structure going forward. For example, heavy debt borrowing means higher debt-equity ratio. This, in turn, can affect a companys ability to raise cash in future.

Investors should also look for ratios such as price-to-earning (P/E) and price-to-book (P/B) of both the companies, says an investment advisor.

Most of the current acquisitions (including Renuka Sugar, Fortis healthcare and Bharti Airtel) are long gestation deals. The investor will need to look at the deals accordingly, said Gul Teckchandani, an investment expert.

Price-to-earning will suggest the expectation of futures earnings. Price-to-book will give a picture of the stock's market value to its book value.

Same principles apply when one holds stocks of a company being acquired. Historically, in such cases, the stock price of the company surges on announcement of the deal, says an investment analyst. The prices surge as more investors buy the share hoping that the acquiring company will come with better pricing. Take, for example, the tussle between Reliance MediaWorks and Inox for acquiring Fame India. Both the companies revised their offers to acquire shares of Fame India. The stock touched its 52-week high of Rs 95.25 on February 24. It was trading at Rs 32.25 at the beginning of the year.

One should understand the structure of the deal and work out the benefit per share. Keep a tab on whether there is a share swap or the acquiree company is buying back only a small portion of the total stocks.

If the company's stock you hold is getting acquired, look at the current market price to the actual valuation a company deserves. If the valuation of the company changes completely due to the acquisition announcement, true in case of Fame India, the investor can even exit the stock, said Teckchandani.

However, experts say one should not react quickly to acquisition news. Only four out of the 10 deals announced actually go through when it comes to M&A, says Nevgi.

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