Study of M&A and their determinants

across various sectors in India

Prateek Grover
079/2014
PGDM (GEN)

Flow of presentation :
Introduction
Literature review
Objective
Research methodology
Output
Results
Limitations
references

Introduction

Mergers and acquisitions (M&As) play a key role in the economy. At the aggregate level,
M&A transactions represent the main mechanism for consolidation and restructuring
within industries.

(M&A) activity in India witnessed a jump of 236% to $12.1 billion in the first quarter of
2015 as compared with $3.6 billion a year ago, on the back of big-ticket deals, according
to the M&A intelligence service

The biggest deal in the quarter was the acquisition of 23% stake in wind turbine
manufacturer Suzlon Energy Ltd for $3.1 billion by a consortium led by billionaire Dilip
Shanghvi

Mergers and acquisitions in the renewable energy sector in Asia Pacific has grown 22 per
cent in 2014 to $6 billion, driven by JSW Energys $1.6-billion acquisition of Jaypee
Groups hydro power assets along with other deals in China and Australia.

M&A in India

Source : http://www.ey.com/Publication/vwLUAssets/EY-power-transactions-and-trends-2014-review-and-2015outlook/$FILE/EY-power-transactions-and-trends-2014-review-and-2015-outlook.pdf

Contd
The Mergers and Acquisitions (M&A) process is one researchers have spent the past four decades examining.
M&A deals exist for both publicly held and privately held companies
Mergers and acquisitions are important, infrequent events that are difficult to predict.
A number of empirical studies have attempted to find determinants using publicly available financial
information to predict acquisition targets.
These include Simkowitz and Monroe (1971) Stevens (1973) Castagna and Matolcsy (1976) Belkoui (1978),
Dietrich and Sorensen (1984) and Palepu (1986)
The results reported by these studies indicate that such factors have impressive ability to predict acquisition
targets six to twelve months before the announcement of takeovers.
For example,
Simkowitz and Monroe(1971) reported that their multiple discriminant model correctly predicts 83% of the
targets and 72% of the non-targets in the sample used in estimating the model, and 64% of the targets and
61% of the non-targets in a holdout sample.
The other studies report prediction accuracies ranging from 70% to 90%.

Contd
Predicting potential targets of an M&A deal using financial characteristics began with the work of
Simkowitz and Monroe (1971). They find evidence of a difference in financial characteristics between
target firms and acquiring firms.
Using a multiple discriminant model, they find that targets have smaller market capitalization, lower priceto-earnings (P/E) ratios, lower dividend payout ratios, and lower equity growth than that of their acquiring
firm counterparts .
Abnormal returns :
It is interesting to note that, although one of the predominant motivations behind takeover prediction
studies cited in the literature is to beat the market and make abnormal returns, very few researchers have
actually attempted to find the abnormal returns of the predicted portfolio of companies .

Literature review :
Author and year

Paper

Findings

Monroe, R. J. and Simkowitz, M. Investment characteristics

A. (1971).
of conglomerate targets

Undervaluation , FCF , inefficient

management, liquidity

Palepu, K. G. (1986).

Predicting takeover targets

Low growth and low leverage

Powell, R. G. (2004)

Takeover Prediction Models and

Portfolio Strategies

Market capitalization, ROCE

Panigrahi, P. K. (2004)

An alternative predicting model for

corporate mergers and acquisitions.

expected returns to shareholders

Jandik, T., and Makija, A. K.

(2005)

Leverage and the complexity

of takeovers

Leverage

Kumar, R., and Rajib, Prabina

(2007)

Characteristics of merging
firms in India

historical growth in sales &

growth

Misra, S. D. (2009)

Determinants of target firms in a

takeover

trading volume & ratio of

dividend to net profits

Research methodologies
Objectives :
Finding the difference between characteristics of target and non-target firms
Analysing the determinants of mergers and acquisitions in target firms over a period of
5 years

Proxy variables affecting M&A from previous researches :

1. Management inefficiency :
ROCE, accounting return on capital employed ; which talk about the efficiency level of work taken up by
management.
Ho 1 : Takeover likelihood is negatively related to ROCE

2. Free cash flow :

Free cash flow implies resources which otherwise should have been paid to shareholders, but is retained
by managers. The agency cost of that cash reduces the value of the firm and makes them attractive targets.
FCF = CFO / TA
Ho 2 : Takeover likelihood is positively related to FCF

3. Growth :
In the Indian context, a growing firm within one industry ought to be attractive to all acquirers,
irrespective of motive.
Growth is taken as the average sales growth of 5 years
Ho 3 : Takeover likelihood is positively related to GRO
4. Leverage :
Several studies (Stulz, 1988; Jandik & Makija, 2005) have shown that debt serves as an impediment
to acquisition results since acquisition of a highly levered target would exhaust a bidders borrowing
capacity.
leverage is denoted by debt-equity ratio
Ho 4 : Takeover likelihood is negatively related to leverage

5. Firm Size :
It is generally acknowledged that, larger firms are more costly to be acquired and have the financial
muscle to fight takeovers.
Size is estimated as the book value of total assets
Ho 5 : Takeover likelihood is negatively related to size
6.

Liquidity :

This effect might be more pronounced in the Indian scenario, where reports have repeatedly pointed out
that, large Indian companies are riding high on a booming economy and sitting on cash mountains, with
very few investment opportunities.
Foremost among these are IT companies, banks, mid-cap and small cap fund management firms, and
conglomerates.
Ho 6 : The hypothesis thus is, takeover likelihood is negatively related to LIQ

Cont
7. Tangible fixed Assets :
In this study, TNG, i.e., tangible fixed asset is specified by the ratio of tangible fixed assets to total
assets of the firm, and is averaged over the three years prior to the takeover.
Ho 7 : The hypothesis thus is, takeover likelihood is positively related to TNG.

Methodology :
Two sets of firms would be chosen for this study: one set of targets , spanning a five-year period
from 2009 to 2014, and another set of non-targets, spanning from 2009 to 2014. For inclusion
into either sample, the data requirements were to:
1) have data for all the above variables in Prowess database, Bloomberg database and website of
SEBI for acquired firms .
2) be listed in Mumbai Stock Exchange (BSE).
ANOVA model will be applied on the values of the following proxy variables , for the sole purpose
of understanding the significance of the variables in the group , which will tell us which factors are
distinct parameters found in acquired firms and not in non-acquired firms.
ANOVA F ratio values more than 1 mean that variation among groups is more than expected.

Contd
Binomial logistic regression is employed to measure takeover likelihood as a function of financial
characteristics, and is given by the equation:

p(t) = 1 / ( 1 + e - x(i) )
where,
p(i) : probability that firm i will be acquired,
x(i) : vector of attributes of the firm
: unknown parameters to be estimated
Financial variables will be independent variables and target (1) and non target (0) , will be dependent variables.

Output :
Mcfadden R-square and likelihood ratio statistic , which will tell me the overall explanatory power
of the model and its accuracy .
Logit model significance values will tell us which variables will affect more in case of M&A

Results :
1) ROCE for a set of target and non- target

F-Test Two-Sample
for Variances

Variable 1

Variable 2

Mean

8.74399

14.5198

Variance

69.31675298 126.1222493

Observations

10

10

Df

0.549599721

P(F<=f) one-tail

0.192944846

F Critical one-tail

0.314574906

Interpretation :
F value : 0.549 which is quite more than 0.10 ; thus
its not a significant variable different b/w targets
and non-targets.

2) FCF for a set of targets and non-targets:

F-Test

Two-Sample

for Variances
Variable 1

Variable 2

Mean

0.019704959

0.056625008

Variance

0.003770036

0.008359197

Observations

10

10

Df

0.451004605

P(F<=f) one-tail

0.125614591

F Critical one-tail

0.314574906

Interpretation :
F value : 0.451 which is quite more than 0.10 ;
thus its not a significant variable different b/w
targets and non-targets.

3) Liquidity for a set of targets and non-targets :

F-Test
Sample

Twofor

Variances

Variable 1

Variable 2
0.40744392

Interpretation :

Mean

0.452361998

7
0.04818536

Variance

0.123580181

F value : 2.56 which is quite more than 0.10 ; thus

its not a significant variable different b/w targets
and non-targets

Observations

10

10

Df

F
P(F<=f)

2.564682693

tail
0.088407333
F Critical one-

tail

one-

3.178893104

4) Firm size for a set of targets and non-targets :

F-Test

Two-

Sample

for

Variances

Interpretation :
Variable 1

Variable 2

Mean

65435.67

104881.232

Variance

14107619023

25392249617

Observations

10

10

Df

0.05555876

P(F<=f) one-tail

0.197214577

F Critical one-tail 0.314574906

F value : 0.055 which is less than 0.10 ; thus it is

a significant variable different b/w targets and
non-targets

5) Real property as a set of targets and non-targets :

F-Test Two-Sample
for Variances
Variable 1

Variable 2

Interpretation :

Mean

0.243656553

0.262307195

Variance

0.052519814

0.032817494

F value : 1.60 which is quite more than 0.10 ; thus

its not a significant variable different b/w targets
and non-targets

Observations

10

10

Df

1.600360297

P(F<=f) one-tail

0.24729461

F Critical one-tail

3.178893104

6) Leverage as a set of targets and non-targets :

F-Test

Two-

Sample

for

Variances

Interpretation :
Variable 1

Variable 2

Mean

1.2907254

2.738107564

Variance

0.743303609

19.46678958

Observations

10

10

Df

0.038183164

P(F<=f) one-tail

2.08848E-05

F Critical onetail

0.314574906

F value : 0.038 which is quite less than 0.10 ; thus

it is a significant variable different b/w targets and
non-targets

7) Growth as a set of targets and non-targets :

F-Test

Interpretation :

Two-Sample

for Variances
Variable 1

Variable 2

Mean

0.13916

0.34004

Variance

0.025303945

0.145405712

Observations

10

10

Df

0.114023046

P(F<=f) one-tail

0.007851269

F Critical one-tail

0.314574906

F value : 0.114 which is more than 0.10 ; thus

its not a significant variable different b/w
targets and non-targets

Output :
These tests show that leverage and firm size differ significantly between targets and non-target firms.
Here, leverage has been taken as total debt divided by total equity, explaining the meaning of leverage
i.e. how much debt has been taken as compared to the equity raised for the firm to operate smoothly.
And firm size talks about the book value of the total assets of the firm, which represents the
cumulative value of certain types of assets including cash, non- cash, inventory, office and other nontangible assets.

Logistic Regression : output

1) Model Summary

Model Summary
Step

-2 Log likelihood Cox & Snell R Nagelkerke

28.325a

Square

Square

.280

.389

a. Estimation terminated at iteration number 6 because parameter

estimates changed by less than .001.

It tells us that, how much of the variance in the

dependent variable is explained by the predicted
variable .
Nagelkerke R2 = 38.9% , which is quite decent for the
model.

2)

Hosmer and Lemeshow Test

Here, we want the p-value to be greater than 0.10 and if the

p-value is greater, then our model is significant.

3) Contingency Table for Hosmer and Lemeshow Test

Contingency Table for Hosmer and Lemeshow Test

Target = .00

Step 1

Target = 1.00

Total

At the last row; observed no. of targets is 3 from

the data and from our model its 2.955 so , the
closer it is better its accuracy is

Observed

Expected

Observed

Expected

2.490

.510

2.040

.960

1.595

1.405

1.100

1.900

.924

2.076

.747

2.253

.536

2.464

.316

2.684

.208

2.792

10

.045

2.955

4) Classification Table :

Classification Table

Observed

Predicted
Target

Target
Step 1

Percentage

.00

1.00

Correct

.00

50.0

1.00

17

85.0

Overall Percentage

73.3

a. The cut value is .500

It tells how good the model is, at predicting actual outcomes.
It says that about 73% of the outcomes are correctly predicted by the model.

It tells how good the model is, at predicting

actual outcomes.
It says that about 73% of the outcomes are
correctly predicted by the model.

Variables in the Equation

ROCE

Step 1a

-.028

S.E.

.080
10.77

Wald

Df

Sig.

Exp(B)

90% C.I.for EXP(B)

Lower

Upper

.124

.725

.972

.853

1.109

.501

.479

.000

.000

24220.120

FCF

-7.619

Liquidity

.821

2.637 .097

.756

2.272

.030

173.780

Firmsize

.020

.022

.063

1.006

0.962

1.051

Realprop

-1.952

3.150 .384

.535

.142

.001

25.254

Growth

-7.246

5.457 1.763

.184

.001

.000

5.642

Leverage

-.455

.239

3.632

.057

.634

.428

.940

Constant

4.813

2.519 3.652

.056

123.153

0.065

Output :

The variables with significance value less than 0.10 are the significant factors for the
reason leading to a decision of M&A
So, Firm size with value - 0.063 and Leverage ratio with value - 0.057 are
significant variables .

Higher the Exp(B) value over 1, its more likely that these features will make a firm a
potential target i.e
LIQ - Exp (B) 2.27 , so firm with lower liquidity is twice more likely to get acquired
and
Firm Size - Exp (B) 1.00 ; low firm size will have have a more possibility of being
taken over.

Conclusion :
The test concludes a value called f- value which here is considered to be significant at 10%
significance level
The ANOVA tests show that, Firm Size and LEV differ significantly between target and nontarget firms.
Here, what we have got is firm size (total asset value of the firm) is a significant variable that is
different among the target firms and non-target firms.
And similarly another variable leverage i.e. the percentage of debt in the total capital structure
of the firm plays a key role being different among the set of target and non-target firms taken
for study.

 Logit estimates also show that Firm Size and LEV are significant at 10 per cent level.
Thus, what these Logit estimates are telling about the typical target firm is that, high value of
total asset size and high comparative levels of debt with equity are key factors for acquisition.
Seen in totality, this does make eminent sense. That is, firms which have a low value total asset
size, and will be beneficial for the acquirer because it doesnt have to pay a heavy amount to
acquire .
And of course, less leveraged firms will be more prone to be get acquired, as the company has
less financial responsibilities to pay to .

Limitations :
The project may have a scope of studying the impact of the various other factors which may be
present, depending upon uncertain or regularly occurring issues causing M&A. The other various
events could be:
Firm valuation (Market value to Book value)
Survival issues (Satyam vs Tech Mahindra
The study has a scope of expansion to a broader sample which could not be accommodated due to
time constraints

References :
Barnes, P. (1998). Can takeover targets be identified by statistical techniques? Some UK
evidence. Journal of the Royal Statistical Society: Series D (The Statistician), 47(4), 573-591
Simkowitz, M., and Monroe, R. J. (1971). A discriminant analysis function for conglomerate
targets. Southern Journal of Business, 38(1), 1-16.
Panigrahi, P. K. (2004). An alternative predicting model for corporate mergers and acquisitions.
Vilakshan XIMB Journal of Management, 1(1), 12-21.
Mizuno, M., and Tabner, I. T. (2009). Corporate governance in Japan and the UK: Codes, theory
and practice. Pacific Economic Review, 14(5) 622-638.

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