GENERAL ARTICLE and Shareholders’ Wealth: An Empirical Study of Automobile Industry in India

Anam Charan Raul Abstract Faculty (M&As) have become a symbol of the new RIMS economic world. All most every day one reads of a new merger and Rourkela acquisition doing the rounds of the corporate world. Corporate world is in the midst of a restructuring wave to meet the challenges of global competition and global economy. Indian companies are changing their strategic operations through their restructuring processes to acquire the required efficiency to survive into global economy. Mergers and Acquisitions are the best and effective route to increase the corporate efficiency and to maximize the shareholders value.. This article tests whether value based frameworks are applicable in India or not. So, an attempt has been made in the current study by using various models like, Economic performance measures (EVA), market assessment measures (MVA) and traditional measure (RONW). This paper will cover the different valuation methods used to measure shareholders’ value creation of three Automobile companies merged and it also judges the pre- and post- merger financial performance and economic value addition to their shareholders.

Introduction he process of economic liberalization and globalization that swept the Indian economy in 1990’s created a highly competitive Tbusiness environment forcing Indian companies to restructure their operations. Due to increased global competition, fast changing technology, regulatory changes, need industries growth and required excess capacity – the mergers and acquisitions has fuelled in recent times. The Merger and Acquisition activity has been noticeable not only in developed markets but also in emerging markets like India. Merger and Acquisition is a generic term used to mean different types of corporate restructuring exercise. Like capacity expansion, vertical integration and diversification. Mergers and Acquisitions is a strategic move since it can make or break a company. However, mergers and acquisitions involved unique challenges such as the valuation of the company being acquired and integration of the pre-merger entities. The well-established rule of capitalism is that companies are expected to make financial capital from shareholders and make some value addition on accustomed derivation. Disappointingly in the practical business world – specially in the Indian economy, this principle does not seem to hold. “ Maximizing Shareholders Value” is a popular slogan, Srusti Management Review Vol.- IV, Issue-II, Jan-2011 especially in the minds of top brass of the corporate world. pp. 35-42 ISSN 0974 - 4274

35 The basic question of whether Mergers and Acquisitions create value and enhance the financial performance of acquiring firms. The ‘Value added’ is described as ‘ the wealth created by the reporting entity by its own and its employees’ efforts and comprises salaries and wages, fringe benefits, interest, dividend, tax, depreciation and net profit (retained). When considering value added, we are assessing the wealth that has been created by an entity in its entirety all its machines, labour, its management and capital. So, value added is a basic and important measurement to judge the performance of an organization. It shows the net value or wealth created by the manufacturer during a specific period of time. No, enterprise can survive or grow, if it fails to generate wealth. An enterprise may exist without making profit, but can not survive without adding value. The investment made in an organization comprises investment by shareholders, debenture holders, creditors and specialized financial institutions. If such an investment does not create wealth, it means that, it is a misuse of public funds. Therefore, the concept of value added has a direct linkage with the concept of ‘ social responsibilities’. In the Indian pharmaceutical markets, there are a number of companies that have enter into merger and acquisition agreements in the context of the global market scenario. In India , the mergers and acquisitions are supposed to go on a medium term factors like, the execution of new patent regimen and companies dealing in specific pharmaceutical products are supposed to be the main driving factors behind the expected continuance of mergers and acquisitions in the Indian pharmaceutical market. There are many opportunities for the Indian Pharmaceutical after mergers and acquisitions like price controls and products and services provides according the medicinal requirements of the Indians. One of the major features of the mergers and acquisitions in the pharmaceutical sector in India has been the integration of local pharmaceutical companies. Literature Review Clark and Ofek (1994), examined a sample of thirty-eight occurring during the time period 1981-1988, (generally all within the same group) identified as an attempt to restructure distress targets. The study used the indicators that focused on post- merger performance of both combined firms and target firms alone to test whether the combination of target and bidder was a successful method of restructuring the targets. Their result indicated that most of the mergers are not successful. Out of the sample of thirty- eight takeovers classified as marginally successful and nine as successful. Nevertheless, the study could not conclude that mergers are a poor choice for restructuring distressed targets since they did not analyse the success rate for alternative method of restructuring or the consequences of doing nothing on total welfare. Kiran Nanda (1998), said that the trend of increasing take-overs shows that Indian economic reforms process has deepened and that Indian Industry is now faced with newer options towards growth. Take-overs / acquisitions are essentially a feature of a competitive economy. DeLong (2001), found that bank mergers that focus both on activity and geography increase share value by three percent. Other types of bank mergers, according to his study do not create value. Easton, et.al. (2002), developed a method for simultaneously estimating the cost of capital and the growth in residual earnings that are implied by current prices, current book value of equity, and short-term forecasts of accounting earnings. They demonstrated the use of a method by calculating the expected equity risk premium. This estimate is higher than estimates in extant studies that are based on the same earnings forecast data Abate, et.al (2004), argues that reliance on earnings and book value has resulted in a numbing array of equity styles that have little direct relationship to wealth creation. There are large-cap , and there are small-cap stocks. There are growth stocks and value stocks, along with 36 Srusti Management Review, Vol-IV, Issue-2, January-2011 several cross- combinations that fill out the equity style box. Given style limitations, it is time portfolio managers took stock of the economic profit revolution that now joins the fields of and investment management the authors have used a well-known measure of economic profit called economic value added (EVA). They call this approach to company and equity analysis the EVA style of investing because it emphasizes the fundamental ability of a company to create wealth through the generation of economic earnings rather than accounting earnings. The authors look at the pioneering role of economic profit in identifying wealth-creating and wealth- destroying companies. They expanded the EVA style foundation in the context of best practice EVA models. Jing, et.al (2007), suggested that valuations derived from industry multiples based on reported earnings are closer to traded prices than those based on reported operating cash flows. The study explores whether the balance tilts in favor of cash flows when the following are considered: 1. forecasts rather than reported numbers. 2. dividends rather than operating cash flows. 3.individual industries rather than all industries combined, and 4. companies in non-US markets. In all Cases studies, earnings dominated operating cash flows and dividends. Concept Of Economic Value Added Economic Value Added (EVA) has been redefined and popularized by US based Stern Stewart & company. EVA is a modified version of residual income concept. It is considered as the most accurate measure of the economic performance of the company. It attempts to resolve the need for a performance measure that is highly correlated to the shareholder wealth and responsive to the actions of the company’s managers. is considered as an essential measure of the corporate performance. According to Peter Drucker, Management Guru ‘ EVA is a vital measure that reflects all the dimensions by which management can increase value. It is the best financial measure than any other measure in capturing true economic profit of an enterprise. The shareholders return is not the usual dividend payment, but it is the return commensurate with the risk involved on investment made by them in the business. It the earnings that the shareholders could have earned by investing in similar risk profile investments, i.e. they have to be paid their opportunity . The basic different between EVA and Accounting model is that, the accounting model does not acknowledge the cost of equity. The current demand for adopting EVA is based on a simple idea, i.e. you can not know whether your company is creating value for your shareholders until you subtract cost of capital from income. If EVA is positive, the company is adding value for its shareholders and if the EVA is negative, the company destroying value even if positive or growing earning per share (EPS) and return on invested capital (ROIC). So, EVA is the most accurate measure of economic performance of the company and be calculated at the level of divisions and product lines. EVA = NOPAT – COST OF CAPITAL EMPLOYED = NOPAT – WACC * CE Where NOPAT : Net operating profit after taxes but before financing costs, WACC : Weighted average cost of capital, and CE : Capital employed

Economic Value Added and Shareholders’ Wealth: An Empirical Study of Automobile Industry in India 37 Steps in Computing EVA 1. Calculation of NOPAT 2. Computation of Economic Capital ( Capital Employed ) 3. Computation of WACC ( Weighted Average Cost of Capital) a. Cost of Equity b. Cost of 4. Computation of EVA NOPAT = ( profit after taxes + Non- recurring expenses + Revenue expenses on R&D + Interest expenses + written off + provision for taxes ) - Non recurring income – R&D amortization - Cash operating taxes. Cash Operating Taxes = ( Provision for taxes + Tax benefit of non-recurring expenses + Tax benefit of interest – Tax on non-recurring incomes). Capital Employed = Net fixed Assets + Investments + Current Assets - ( NIBCLs + Miscellaneous expenses not written of + Intangible Assets ) - ( Cumulative non-recurring losses + Capitalized Expenses on R&D + Gross Goodwill) - Revaluation Reserve - Cumulative non-recurring gains. Non- Interest Bearing Current Liabilities (NIBCLs) = The financing costs associated with paying suppliers and employees with some delay are already included in the cost of goods sold. Hence , these costs are excluded from capital. Cost of Equity ( using CAPM ) = Rf + â ( Rm – Rf ) Where : Rf : Risk free return. Normally 364 days Treasury Bill rates are considered as risk free. Here I am taken 4.55 as Risk free rate of return. â : is the risk – free coefficient which measures the volatility of a given script of a company with respect to volatility of markets. Mathematically, beta is the statistical measure of volatility. It is calculated as covariance of daily return on the stock market indices and the return on daily share prices of a particular company, divided by variance of return on daily stock market indices. In my research, I used the Regression formula for the calculation of Beta (â ). Beta (â )= N “ xy - (“x) (“y) / N “x2 - (“x) 2 Where X = Monthly closing return on the stock market indices ( NSE ). Y = Monthly closing return on share prices of particular company. N = no. of months in a year. Rm = The market expected rate of return. It is normally given as growth rate of market index. Today’s index - Yesterday’s index Rm =————————————————————— Yesterday’s index

Interest expenses ( 1 – Tax ) Cost of Debt = ———————————————— Total borrowings

38 Srusti Management Review, Vol-IV, Issue-2, January-2011 Market Value Added Another important measure that assesses the value addition to shareholders or not, i.e. Market Value Added (MVA). If the total market value of the company of a company is more than the amount of capital invested in it, the company managed to create shareholder value. But, if market value is less than capital invested, the company has destroyed shareholder value. The difference between the company’s market value and book value is called Market Value Added (MVA). Market Value a Added (MVA)= Market Value of the company – Capital invested in the company ( Book value of equity) Market Value : For a public listed company, it is calculated as the number of shares outstanding * the share price + book value of ( since the market value of debt is generally not available). Capital Invested : It is the book value of investments in the business made up of debt and equity. Return on Net Worth (ROWN) Return on Net Worth is relatively narrow measure of shareholder value creation metrics. It is calculated the Net profit after tax divided by the shareholders wealth in the company, i.e. paid up capital plus free reserves. This measure nets out the pre- committed payment obligations to creditors and wealth created for the shareholders. Profit after Tax (PAT) Return on Net Worth =————————————— Net Worth Pre- and Post-Merger Performance Analysis The present article makes an attempt to measure and analyse the post-merger performance of three merged firms i.e. Eicher Motors Ltd., Mahindra and Mahindra Ltd. and Maruri Suzaki India Ltd. by using the value added metrics, namely Economic value added, Market Value Added and Return on Net Worth to ascertain whether mergers have resulted in value addition for shareholders or not. Testing of Null Hypothesis Ho =Mergers do not result in value addition to shareholders. Sources of Data The financial data used for this analysis has been mainly taken from National Stock Exchange (NSE) and respective Annual reports of companies which contains Trading, Profit and Loss Account, Balance Sheet and some market data . I hope, it is an authentic source of information and has the advantage of greater availability and consistency of data. Time Period The empirical analysis of the three merged companies has been conducted for three post- merger years to get clear picture of success and failure of mergers in terms of value addition to shareholders.

Economic Value Added and Shareholders’ Wealth: An Empirical Study of Automobile Industry in India 39 Empirical Findings Eicher Motors Ltd. Post- merger years (EVACE) Post- merger years (MVACE) Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 -0.07 -0.8 -2.81 58.9 40.03 -79.16 Post- merger years (RONW) Year 1 Year 2 Year 3 14.83 13.77 8.11 Mahindra and Mahindra Ltd. Post- merger years (EVACE) Post- merger years (MVACE) Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 -1.41 -3.38 -1.06 -11.09 10.47 -50.36 Post- merger years (RONW) Year 1 Year 2 Year 3 25.11 27.98 30.17 Maruri Suzaki India Ltd. Post- merger years (EVACE) Post- merger years (MVACE) Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 -0.12 -2.30 -0.55 20.79 20.57 13.04 Post- merger years (RONW) Year 1 Year 2 Year 3 20.79 20.57 13.04 Observations a. EVA EVA has been computed for all three merged the companies for three post-merger years to see whether shareholder value has improved in the post merger period, i.e. has shareholder value addition improved in each passing year after the merger since it takes a year or two to start getting these benefits. After anlysis of above table, it is find that all Eicher Motors Ltd. decrease in value addition from first post-merger year to the third year. Mahindra and Mahindra Ltd.and Maruti Suzuki India Ltd. decreases their economic performance in first two post- merger period and slightly increase in third post-merger period.. That means there is no economic value addition (EVA ) in post merger period. So, M&A failed to the economic value addition to the shareholders. b. MVA MVA has been computed for three merged companies for three post-merger year to know the market value addition after merger. From the above table it shows that the Eicher Motors Ltd. and Maruti Zuzuki Ltd. decreases continiously their value addition in terms of market 40 Srusti Management Review, Vol-IV, Issue-2, January-2011 assessment first year to third year, but Mahindra and Mahindra Increases value addition in terms of MVA with compare to first post-merger year but decreases in third year. c. RONW In case of analysis of RONW, the Eicher Motors Ltd. and Maruti Suzuki India Ltd. losses their value continuously from first post-merger period to third post-merger period. But Mahindra and Mahindra Ltd. increases value addition in terms of Return on Net Worth (RONW) in post-merger period.

Performance Evaluation : Pre- and Post-MergerOwn Sale/ Period Growth Sl.No. CA/CL D/E Ind. Sale Net assets Eicher Motors Pre- 1.49 1.20 0.08 1.30 1. Ltd PAT/ Sl. Post PBIT/Cap3.20 Op.0.31 Exp/ 0.04 0.77Tax/ Mahindra and Pre 1.89 0.73 0.32No. of 0.02 No. 2. Employed Net Sales PBT Mahindra Ltd Post 1.93 0.43 0.36Shares 0.42 EicherMaruti Motors Suzaki Pre-Pre 0.252.19 0.10 0.83 0.57 18.71 0.660.19 3. 1. Ltd. India Ltd Post-Post 0.231.66 0.09 0.86 0.59 19.38 0.89 0.80 Mahindra & Pre- 0.04 0.87 0.89 0.08 2. MahindraFindings Ltd. Post 0.15 0.89 0.83 0.28

MarutiSome empiricalSuzaki analysisPre- done by0.26 taking some financial 0.80 ratios both 17.79 pre-and post-merger0.27 period. 3. . Here eight ratios are taken to judge the financial performance both pre- and post-merger period. India Ltd Post- 0.25 0.85 52.04 0.28 For profitability, Eicher Motors Ltd., and Maruti Suzaki Ltd decreases but Mahindra and Mahindra Ltd. increases in post-merger period with compare to pre-merger period. Operating expenses of all the merged companies increases in post-merger period. EPS Increases in Eicher Motors and Maruti Suzuki and decreases in case of Mahindra and Mahindra Ltd. Tax payment increases for all the companies. Taking the current ratio, Eicher Motors Ltd. and Mahindra and Mahindra Ltd. increases but Maruti Suzuki India Ltd. decreases in post-merger period. Eicher Motors Ltd. reduces the financial performance in terms of D/E ratio, market share and growth of the assets in post-merger period. In terms of Debt-equity ratio, Mahindra and Mahindra Ltd. and Maruti Suzuki Ltd reduces their post-merger financial performance but in terms of market share and growth of net assets Mahindra and Mahindra Ltd. and Maruti Suzuki Ltd. slightly capture some market and increases the assets.

Economic Value Added and Shareholders’ Wealth: An Empirical Study of Automobile Industry in India 41 From the above analysis it is clear that, there is no value addition ( EVA, MVA, and RONW) to the shareholder after the M&A of company and there is no maximization of shareholders wealth. Conclusions M&As have become very popular over the years especially during the last two decades owing to rapid changes that have taken place in the business environment. Generally the objectives of M&As is wealth maximization of shareholders by seeking gains in terms of synergy, economic sales, better financial and marketing advantages, diversification and reduced earnings volatility, improved inventory management, increase in domestic market shares and also capture fast growing international markets abroad. But though the number and value of M&As are growing rapidly, the results of the studies on the impact of mergers on the performance from the acquirers’ shareholders have been highly disappointing. Therefore, there also need to develop appropriate methodologies to effectively measure the performance of the M&As and effects on the shareholders. References Articles Ansoff, H.I. and Weston, F.J. (1962): Merger Objectives and Organisational Structure, The Quarterly Review of Economics and Business, Vol. 2, No. 3, p. 49. Romer, Paul M(1987), “ Growth based on increasing Returns due to Specialisation”,American Economic Review, vol . 77, No.2. Forbes, W (1994) “ The Shareholder wealth Effects of Monopolies and Merger commission Decesions”, Business finance and accounting, Vol.21 No. 6, pp. 763-790 Anand, Manoj, Garg, Ajay and Arora, Asha (1999): “Economic Value Added: Business performance Measure of Shareholder Value”, The management Accountant, May. Sakeshna, Pankaj, “ EVA and Performance Evaluation”, Management Accountant, July,1998 Bannergee, A, “EVA- Better Performance Measure”, Management Accountant, December,1997 Books Gupta,S.K. and R.K.Sharma “ Financial Management” , New Delhi: Kalyani Publishers. Das Bhagaban, Debdas Raskhit and Sathya Swaroop Debasish, “Corporate Restructuring”, 1st Edition (Mumbai: Himalaya Publishing House Pvt. Ltd., 2009). Kothari Rajesh and Bobby Dutta “ Contemporary Financial Management” Macmillan India Ltd., New Delhi Kaur Gurminder “ Corporate Merger and Acquisitions” , New Delhi: Deep and Deep Publications Pvt Ltd.) Mukherjee a and M.hanif “ Financial Accounting”, New Delhi: Tata McGraw-Hill Publishing Company Limited Web Site www. Iba.org www. Forbes.com www.finance.edu www.sebiedifur.com

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