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Think Before you Swallow it

Rahul Oberoi/Money Today | Print Edition: May 2011

Do mergers and acquisitions (M&As) excite you? Are you hoping to make a quick buck by buying into the shares of a company that has announced its plans to acquire another company? Well, there is a good chance that you might see the value of your investment getting eroded over the subsequent days or weeks.

Trends show that the share price of an acquiring company declines after the acquisition announcement is made. The share price of the company that is being acquired - if it is a listed company- however, goes up after the intention is made public. But analysts say that the bad days for the acquirer don't last for long with the stock generally recovering in the long run.

Brijesh Koshal, managing director, investment banking at Daiwa Capital Markets says, "Most of the time, the company buying a business has to use its cash for acquisition. In the market, cash is the king. Investors are averse to uncertainties and they, at times, think that cash may not have been used properly. It could result in uncertainty in returns. Most of the time, the acquisition is at a premium to fair value, especially in competitive bidding, making it appear expensive in the short run. Thus, if the acquirer is a listed company, it might get negative response from the capital markets."

$66 billion is the total value of merger and acquisition deals by Indian firms during 2010
However, the share prices of target companies generally tend to go up. The acquirers generally are bigger and better companies than the target companies. Naturally, the target company's existing investors are happier irrespective of the quality of the existing company and its management. "Better reputation of acquiring company always attracts more investors to the target company. The share price always reflects the future and the investors do not mind paying a premium for future of the target company, resulting in upward price movements of its shares," Koshal added.

M&As AND STOCK PRICES

Mergers and acquisitions, which are intimated to the stock exchanges, are generally aimed at gaining additional market share, reducing competition or improving a company's pricing power. Some acquisitions are also done to gain a foothold in new markets.

Then why is it that after the announcement of a merger or an acquisition the share price of the acquiring company comes under pressure in the short term? Rajesh Jain, executive vicepresident, and head of research, Religare Securities, says, "The reason is that the acquiring company has just expended its assets on a business venture that has an uncertain outcome."

In case of JSW Steel's buyout of a majority stake in Ispat Industries, the share price of Ispat increased by Rs 0.40 or about 2% to Rs 21.60 from the date of announcement (December 21, 2010) till March 21, 2011. However, the share price of JSW Steel dropped from Rs 1,212 on the day of announcement to below Rs 900 on March 21, 2011.

"The target firm's share price moves up before a merger on expectations that the merger will be beneficial for the company," adds Jain. However, he says that if the acquiring company is able to integrate the acquired company's strengths with its own, the upside will be much better than organic growth.

The JSW case is not an isolated one. The Reliance Power share price - after the announcement on July 4, 2010 that Reliance Natural Resources (RNRL) will merge with Reliance Power - fell by 35% from Rs 181.40 on July 5, 2010 to Rs 118.55 on March 21, 2011. Axis Bank, which acquired the financial services business of Enam Securities, dropped more than 10% from Rs 1,426.90 on November 18, 2010 (the date of announcement) to Rs 1,278 on March 21, 2011.

Tata Motors' share price got a thumbs-down from the stock market after it made public its plan to acquire Jaguar Land Rover (JLR) in March 2008. At that time, not only was the global economy in the grip of an economic recession, there were concerns that Tata Motors will have to raise around $750 million or around Rs 3,500 crore to repay the JLR debt. The Tata Motors stock dropped more than 73% to Rs 160 for the next one year after the acquisition was announced. The company also reported a loss of Rs 2,465 crore in 2008-09. However, with good moves on controlling costs and some new launches, the management was able to turn JLR around and the share price of Tata Motors rebounded. The company has been one of the best performing stock over the past one year, gaining 50% during March 22, 2010 to March 21, 2011.

Samar Vijay, director, InvestCare says, "The initial reaction to Tata Motors' acquisition of JLR was negative, well reflected in its stock price. However, JLR alone would contribute approximately Rs 7,000 crore to the operating profit of Tata Motors for the financial year ended March 2011."

Vijay adds that the initial fall in the share price of the acquiring company is due to near-term issues such as earning per share (EPS) dilution and the cost of the deal. K Jayaraman, consultant and equity research advisor at Bonanza Portfolio says, "M&As could affect the share prices of the acquiring company and the acquired company differently. This will depend on the bargaining power of the two companies. Also, a lot depends on whether the deal is an all-cash deal or a hybrid deal (part equity, part cash). The share price of the acquiring company may sometimes fall in the short-term as there could be a huge cash outflow which could increase interest cost etc."

Brijesh Koshal
"If the acquirer is a listed company, it might get negative response from the capital market."
Brijesh Koshal
MD (Investment Banking), Daiwa Capital
For instance, in the year 2000, Bank of Madura merged with ICICI Bank through an equity swap deal with a swap ratio of 2:1 (two shares of ICICI Bank for each share of Bank of Madura). At that time, it was touted as an expensive buy but ICICI Bank went ahead with it. In the long run, the deal has proved to be a good decision with the standalone net profit of ICICI Bank surging 24.98 times to Rs 4,024.98 crore in 2009-10 against Rs 161.10 crore in the 2000-01.

THE TREND BUSTERS

There have been instances when, even in the short term, the share price of the acquiring company has shot up with that of the target firm. After the announcement of ICICI Bank's plan to acquire Bank of Rajasthan, the stock prices of both companies surged. The stock price of ICICI Bank gained around 22% between the date of announcement (May 19, 2010) and August 23, 2010.

The stock price of Bank of Rajasthan surged around 78% in the same period from Rs 119 to Rs 212 on August 23, 2010. "ICICI Bank was active immediately after the deal due to the arbitrage opportunity between ICICI Bank and Bank of Rajasthan as it was a share swap deal between two listed entities," points out Samar Vijay of InvestCare.

In a share swap, each shareholder of the acquired company receives a certain number of shares of the acquiring company for each share held. In the above case, the shareholders of Bank of Rajasthan received 25 shares of ICICI Bank for 118 shares of Bank of Rajasthan.

"On an average, target firm shareholders receive positive and statistically significant returns following M&A announcements, while the acquirer firm shareholders receive negative, zero, or small positive returns," says Rajesh Jain of Religare Securities.

So, even as you eye the M&A deal, consider the short-term as well as the long-term impact of the announcement before taking a decision on whether to buy or sell the shares of the companies involved.

Methods Of Investing

Payment by cash: Such transactions are usually termed acquisitions rather than mergers because the shareholders of the target company are removed from the picture and the target company comes under the control of the bidder's shareholders.

Share-swap deal: The shareholders of the acquired company receive shares of the acquiring company.

Leveraged buy-out: Merger of a company which is substantially financed through debt.

Hybrids: Acquisition can involve a combination of cash transaction, raising debt and exchange of stocks.

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