SME Connect - Mergers & Acqusitions

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‘ICICI Bank presents SME Connect’ – a unique series featured in the Times of India that explores new and innovative avenues of growth for SMEs and Emerging Corporates. Following a successful feature on ‘Structured Finance’, ‘Mergers & Acquisitions’ was the topic of discussion on July 23, 2010. It was very well-received with several queries being posted on smeconnect@icicibank.com., all of which have been answered in the following section by our expert.

     
  Q: What kind of synergies can be expected out of an acquisition?  
     
 
A: Synergy is the potential additional value from combining two firms. Most mergers and acquisitions are justified by the amount of expected synergies. Synergy could be operating or financial. Operating synergies are those synergies that allow firms to increase their operating income and growth potential. Economies of scale, greater pricing power from reduced competition, higher market share, combination of different functional strengths and higher growth in new or existing markets, are some of the operating synergies. Better leverage ratios, greater cash flows, possibility of tax benefits in case the target has accumulated losses, bigger balance sheet size, etc. are some of the financial synergies.
 
     
 
Q: My company is a medium-sized edible oil miller. I know a couple of mills in my region which are not doing good and which might opt to sell out. How do I go about acquiring them? What should be the deal structure? How do I fund such acquisition?
 
     
 
A: You should start with an analysis of the expected benefits and issues associated with the prospective acquisition. In your case, the major advantage could be increase in turnover and the time saved vis-à-vis establishing a new unit. A major issue could be funding such an acquisition.

The next step is to translate the expected benefit in money terms which will give you the maximum price which you may offer for the acquisition.

You should then try and confirm the intention of the seller and check his price expectations through associated parties like traders, neighbouring units, etc.

If there is a possibility of sell out, you may contact the company yourself or through a known intermediary. Once the contact is established and information flow starts, prepare a checklist and analyse the operations to see whether the benefits which you are expecting are realisable.

Care should be taken while negotiating the price to ensure that you have factored in every possible benefit and loss associated. It is a better idea to sign an MoU and let the lawyer and auditor carry out an extensive due diligence before agreeing on final consideration and signing final documents.

Regarding structure deal structure, if only production related synergies are aimed at, it is better to buy the unit as an asset rather than taking over the company as there are risks of unknown and contingent liabilities associated with acquiring a going concern. In case the company is making a loss, there is a possibility of availing tax credit for its accumulated losses. If such benefits justify the risks associated, one may acquire the company as a going concern.

A combination of rupee term loan and internal accruals would be the most practical option for funding the acquisition. The quantum of term loan would vary based on your company's current net-worth and cash flows to service the proposed debt.

It is advisable to engage an investment banker for the transaction as they add a lot of value in aspects like valuation, finding vendors for due diligence exercise, market feedback on the seller, negotiations, deal structure, funding, etc.