When corporate marriages affect stock price

Five things to look at when companies go for mergers and acquisitions

When Cairn India and Vedanta announced their merger, not many pointed out the risks involved for the latter's shareholders. Experts only talked about the benefit Vedanta will get out of the deal after its standalone debt (excluding subsidiaries' liabilities) of Rs 37,636 crore is transferred on Cairn India's books, which is a cash-rich company. However, billionaire Anil Agarwal-led mining firm will ultimately be held accountable for Cairn India's Rs 20,495-crore tax liability after it absorbs the oil firm. The matter, which is now in the court, can impact the new entity if the judgment goes against Cairn.

Mergers and acquisitions (M&A) transactions are complex and even the best brains cannot predict the outcome. Chances of such deals succeeding are only 50 per cent. "It has the same probability of getting head when someone tosses a coin," says Samir Sheth, partner (transaction advisory services) at BDO India. But for small shareholders, here are a few things they can look at to evaluate whether an M&A deal will benefit them.

Gauge the gains
For a retail investor, the most important thing is financial returns from short-and-long term perspectives. In case of a company getting acquired and the consideration is being paid in cash, there's an open offer. The potential there is to look at the premium to the existing market price. If the premium is good, it's a win.

When companies swap shares instead of a buyback, existing investors need to look at the final value of shares. Let's say company A is acquiring company B. The current market price of company A's shares is Rs 100 and of B's is Rs 30. If company A offers one share for every three of company B, investors gain about 11 per cent in this transaction as the value of their current holding is Rs 90. The stock price may fall after the merger in such cases due to equity dilution. Experts say that would be a temporary blip if the acquiring firm has a previous track record of turning around the acquisitions. In a reverse case, where you are a shareholder of a company acquiring another, the key thing to look at is whether the deal is accretive to earnings.

Company overpays
When companies of the same promoter group merge with listed or unlisted subsidiary, there have been few instances that companies put a high valuation on the acquiree. This benefits the promoter group as they receive higher money for their stake in the target.

Proxy advisory firms have raised a red flag in deals that seemed to be structured in this manner. Shriram Subramanian, managing director of InGovern, points out Akzo Nobel as an example of a company valuing a subsidiary at higher valuations. The firm structured merging of three promoter-held unlisted entities with Akzo Nobel. InGovern felt it was done at seemingly high valuations. While the proxy advisory firm recommended shareholders should vote against the deal, the existing investors voted in favour of the chemical giant that owns the Dulux Paints brand. If your company overpays, the only option is to vote against the deal if you are unhappy.

Inadequate disclosures
Proxy advisory firms say despite the rise in corporate governance, many firms still don't offer proper disclosure and structure of the deals.

J N Gupta, co-founder and managing director of Stakeholders Empowerment Services (SES), says the valuation reports that companies come out with only give theory and the merger ratio without adequate disclosures. "If you pick valuation report, fairness report, audit report, and board approval, there's never difference of opinion though valuation is a subjective issue. In fact, these reports carry the same date and same language."

Recently, (SES) raised concerns on disclosures when Jindal Stainless proposed to spin off its business units into three separate corporate entities. The proxy firm advised shareholders to vote against the deal. "Very little information regarding this is shared with the investors," says an SES report.

Leveraging balance sheet
Then there's the issue of excessive debt. If the company takes on excessive debt for the purpose of acquisition, it might not be good for the shareholder because acquisition becomes risky. Apollo Tyres, for example, was trying to take over some overseas company with a large debt.

When Apollo Tyres was trying to acquire Cooper Tire & Co in 2013, the price of the Apollo Tyres stock dropped from the previous day's close of Rs 92 to Rs 68.60 a share a day after the announcement. The next day, it reached its 52-week low on concerns that Apollo was taking on too much debt to pay Cooper - nearly $2.5 billion. Shareholders were worried that with so much debt, whether it made sense to do such a transaction. Experts said it's better to avoid companies leveraging their balance sheet and taking excessive debt for acquisition.

Unrelated businesses
Companies go for M&As either for growth or vertical integration. For example, cement or power companies buying firms with mining assets. But they might also get interested in another businesses for expansion, new technology, gaining access to new markets or products, increasing their market share, and so on. But there are times when promoters merge companies for financial management, that is, to make one company look healthy by using the cash in the other one. The two entities might have vastly different business. Many experts say the Cairn and Vedanta merger is one such.

When companies go for unrelated businesses, they disclose the reasons. The key thing to look at will be whether the shareholder is really comfortable with the new sector. Also, there is a need to analyse what value the promoters can add to the unrelated business by bringing it in a healthy company.

If you had got the stock to take exposure to a particular sector, it would make sense to look for another company than stay with the one that has unrelated businesses within one group.