Effect of Mergers and Acquisitions on Performance of Enterprise Value

MUDRA: Journal of Finance and Accounting Volume 5, Issue 2, July-December 2018, pp. 60-69 doi: 10.17492/mudra.v5i2.14330

T. Sathishkumar* and P.N. Assai Tamby**

ABSTRACT

In this study, we have made an analysis on the impact of Mergers and Acquisitions (M&A) on the performance of Enterprise Value in the post-merger period. For this purpose, ten firms were selected based on the adequacy of data for a period of ten years on a year-to- year basis from 2006-2007 to 2016-2017. The firms, which had gone into the M&A process during the financial year 2011–2012 are also considered for the study. Paired samples t- test is applied to study the mean difference in performance of Enterprise Value of the acquiring firms in the pre-and post-merger periods. From the analysis, it has been found that the acquiring firms drastically improved in stock price and business performance. As a result the acquiring firms are visible among competitors with a capacity to develop into something big in the future and merged firms feel that they have chosen a good acquirer firm. Hence, most of the acquiring firms have significant change in the performance of Enterprise Value in the post-merger period.

Keywords: Mergers; Acquisitions; Enterprise value; Post-merger performance; Firm Performance.

1.0 Introduction

Enterprise Value (EV) is one of the most important concept in investing for variety of reasons, especially when discussions on Mergers and Acquisitions (M&A) arises. The EV measures the value of the ongoing operations of a company. It attempts to measure the value of a company’s business instead of measuring the value of the company. The EV is used as an alternative to market capitalization and a more accurate estimate to takeover price of a company then the market capitalization. ______*Corresponding Author; Lecturer in Commerce, GHSS, Neravy, Karaikal, Puducherry, India (E- mail: [email protected]) **Department of Revenue and Disaster Management, Puducherry, India (E-mail: [email protected] )

Effect of Mergers and Acquisitions on Performance of Enterprise Value 61

The EV helps in comparison of companies with different capital structure and stock market investors. It is used to neutralize the risks and accordingly compare the returns expected. With this brief introduction the research paper proposes to analyse the impact of M&A on Performance Enterprise Value in the post-merger period of the acquiring manufacturing firms in India.

2.0 Review of Literature

Levine and Aaronovitch (1981) concluded that there was no evidence of any significant difference between the acquiring and target firms for the profit related variables and their growth. Ikeda and Do (1983) tested the operating performance by using parameters such as profitability, efficiency, growth, and research development and found that the financial performance in respect of profitability was higher in the post-merger period. Scherer (1988) revealed that most of the firms did not show significant improvement in long-term profitability after M&A. Healy et al. (1992) found that the merged firms registered improvement in the post-merger operating performance in comparison to that of their industry peers, these increases from improvements in asset productivity. Lee et al. (1996) revealed that the horizontal acquisitions showed the strongest predictive ability with the variables such as long-term debt / total assets, long- term debt / market value, market value / book value, and asset growth and sales growth showing significance in the post-merger period. Rau and Vermaelon (1998) found that the acquiring firms under-perform during the three years after M&A while tender offers earned a small but statistically significant positive abnormal return. However, the long- term performance of acquiring firms, due to M&A, is not uniform across the firms which went for M&A. Pawaskar (2001) elucidated that the acquiring firms were at the lower end in terms of growth, tax and liquidity of the industry, and the target firms performed better than that of the industry in terms of profitability. Martynova et al. (2007) found that the acquiring and target firms significantly outperformed the median peers in the industry prior to the takeover event, but the profitability of the combined firm decreased significantly following the takeover. Kar et al. (2014) elucidated that the throughout the period of study, turnover increased after the companies experienced an merger and acquisition which is in line with the findings that Indian companies grew in size and attained bigger market share. Merger and acquisitions did not have any impact on return on net worth for the period of study. Mixed results have been reported for other variables. Kar and Soni (2016) concluded that the analysis can throw some light on the strategic acumen of Indian IT companies. Kalsie and Nagpal (2017) found that the Kotak Mahindra-ING Vysya Bank and Sun Pharma- 62 MUDRA: Journal of Finance and Accounting, Volume 5, Issue 2, Jul-Dec 2018

Ranbaxy deals were able to realise most of the synergies that were estimated and were on the right track towards synergy realisation in the post-acquisition period. However, the Amtek Auto-JMT Auto deal couldn’t realise cost synergies as their expenditures elevated to high levels after the merger but it managed to attain lower cost of capital financial synergies. On the other hand, Express Scripts-Medco deal badly failed because it couldn’t attain revenue synergies after the merger. Sathishkumar (2017) proved that in the post-merger period the acquiring manufacturing firms had the calibre to earn more & sustainable profit, to survive, to grow over a long-run period, the ability to pay interest, taxes & dividends, and more efficient management in utilizing its asset and equity. The previous studies, by and large, attempted to study the short-run impact, say three years prior to and after the M&A period. Moreover, most of the previous studies undertook almost similar research methods to evaluate firm performance in the pre-and post-merger periods. With these evidences and supports the present study is an attempt to measure the impact of M&A on the Performance of Enterprise Value in the long-run, say five years prior to merger year and five years after the merger year. The present paper attempts to overcome the limitations of the previous studies. Hence, the present paper aims at to fulfil the research gap in the existing literature in terms of applying Enterprise Value to analyse the shift-in-structure (impact) in the Performance of Enterprise Value due to M&A.

3.0 Research Methodology

3.1 Objectives and hypotheses The primary objective of the study is to examine the effect of M&A on Performance of Enterprise Value (PEV) in respect of Enterprise Value, Enterprise Value to Net Operating Revenue, and Enterprise Value to EBITDA of manufacturing firms in India after merger. The study has further attempted to investigate and test if there is any significant change in the results achieved by the manufacturing firms due to M&A. Based on the objective, the following hypothesis is developed:

H0 = There is no significant mean difference between the performance of enterprise value of manufacturing firms in India before and after the M&A process.

3.2 Data source and period of the study The study used secondary sources of data, which were collected from the capital market database called Centre for Monitoring Indian Economy Private Limited (Prowess CMIE). Data on the PEV for a period of five years prior to the merger year (2007–2011) and five years after the merger year (2013-2017) for each manufacturing firm was Effect of Mergers and Acquisitions on Performance of Enterprise Value 63 collected. Hence, the study period is restricted to ten years ranging from 2006–2007 to 2016–2017 considering the year 2011–2012 as the year of the M&A deal.

3.3 Sampling procedure In this study, multi-stage sampling technique is used. A total of seventy-three firms in the manufacturing and service industries had gone into the M&A deal during the financial year 2011–2012. Out of seventy-three firms, twenty-four firms only completed the M&A deal during the financial year 2011–2012. Out of the twenty-four firms, one firm was eliminated because they did a subsequent merger with another target firm in the same financial year, reducing the number of firms to twenty-three at a further stage. Out of twenty-three firms, fifteen firms fall under the manufacturing sector and eight firms fall under the service sector; hence, fifteen firms of the manufacturing sector alone are taken into account for further stages. Out of the fifteen firms, full-fledged data were available only for ten firms in the manufacturing sector. Hence, the final sample comprises ten manufacturing firms only.

3.4 Hypothesis testing A paired sample t-test is used to study the pre-and post-merger PEV ratios and these are compared to know if there is any significant change in PEV due to M&A.

4.0 Analysis and Results

4.1 Impact of M&A on Performance of Enterprise Value of Manufacturing Firms

The performance of Enterprise Value (PEV) in terms of Enterprise Value (EV), Enterprise Value to Net Operating Revenue (EV_NOR), and Enterprise Value to EBITDA (EV_EBITDA) between the pre-merger and post-merger periods have been computed to analyse the impact of M&A on the PEV of the firms. The results of the analysis are shown in Tables 1 to 3. Enterprise Value (EV) is a measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization. It is inferred (from Table 1) that the mean Performance of Enterprise Value in terms of EV of Motherson Sumi Systems Ltd, Pratibha Industries Ltd, Sterlite Technologies Ltd, Suven Life Sciences Ltd, Trident Ltd, and United Breweries Ltd is significant (t -4.31, P<0.05; -3.21, P<0.05; -2.42, P<0.10; -2.69, P<0.10; -2.71, P<0.10; and -5.89, P<0.01) at the 1%, the 5%, and the 10% levels, respectively, after the M&A process. The mean EV in the post-merger period is increased for nine out of the ten acquiring manufacturing firms. 64 MUDRA: Journal of Finance and Accounting, Volume 5, Issue 2, Jul-Dec 2018

Table 1: Impact of M&A on Enterprise Value of Acquiring Manufacturing Firms in India from 2006-2007 to 2016-2017

Sl. Pre-merger Post-merger Name of the firms Impact t- value p-value No. Mean SD Mean SD 1. Genus Power Infrastruc 0.05 0.01 0.09 0.04 + -1.60 0.18 2. Motherson Sumi Syste 0.48 0.25 3.39 1.66 + -4.31 0.01** 3. Pratibha Industries 0.06 0.03 0.17 0.09 + -3.21 0.03** 4. Reliance Industries 32.98 7.53 38.02 10.22 + -1.86 0.13 5. Reliance Infrastructure 2.33 0.78 2.52 0.38 + -0.61 0.57 6. Sterlite Technologies 0.20 0.09 0.35 0.16 + -2.42 0.07* 7. Suven Life Sciences 0.02 0.01 0.18 0.12 + -2.69 0.05* 8. Tata Steel Ltd. 6.11 2.31 5.99 0.85 - 0.15 0.88 9. Trident Ltd. 0.16 0.02 0.40 0.21 + -2.71 0.05* 10. United Breweries Ltd. 0.64 0.38 2.24 0.28 + -5.89 0.00*** Source: Compiled & Edited from the Financial Statements of Selected firms Listed-CMIE-Prowess Package. Note: Figures in parentheses denote p value. *** Significant at the 1% level. ** Significant at the 5% level. * Significant at the 10% level.

Enterprise Value to Net Operating Revenue (EV_NOR) is a measure of the value of stock that compares a company’s enterprise value to its revenue. EV_NOR is an indicator that investors use to determine whether a stock price well or not and also often used to determine a company’s valuation in the case of a potential acquisitions. EV_NOR is most commonly expressed as a number in decimal form followed by a x. as in 2.6 xs. It is inferred (from Table 2) that the mean Performance of Enterprise Value in terms of EV_NOR of Motherson Sumi Systems Ltd and Tata Steel Ltd is significant (t -3.02, P<0.05 and 3.27, P<0.05) at the 5% level, respectively, after the M&A process. The mean EV_NOR in the post-merger period is increased for six out of the ten acquiring manufacturing firms. Enterprise Value to EBITDA (EV_EBITDA) is useful for transactional comparisons because it ignores the distorting effect of individual countries’ taxation policies. The ratio may be more useful than the Price Earnings Ratio when comparing firms with different degrees of financial leverage. The EV_EBITDA is useful for valuing capital-intensive businesses with high levels of depreciation and amortization. It also used to find attractive takeover candidates, since EV includes asset, debt, and equity in its analysis and is therefore a better metric than market cap for Mergers and Acquisitions.

Effect of Mergers and Acquisitions on Performance of Enterprise Value 65

Table 2: Impact of M&A on Enterprise Value to Net Operating Revenue of Acquiring Manufacturing Firms in India from 2006-2007 to 2016-2017

Sl. Pre-merger Post-merger Name of the firms Impact t- value p-value No. Mean SD Mean SD 1. Genus Power Infrastruct 1.03 0.44 1.20 0.58 + -0.38 0.71 2. Motherson Sumi System 2.84 0.41 6.44 2.55 + -3.02 0.03** 3. Pratibha Industries 0.92 0.34 1.17 1.14 + -0.43 0.68 4. Reliance Industries 2.06 0.41 1.33 0.63 _ 1.71 0.16 5. Reliance Infrastructure 3.00 1.40 2.41 0.69 _ 0.78 0.47 6. Sterlite Technologies 1.04 0.40 1.43 0.89 + -0.96 0.39 7. Suven Life Sciences 2.20 1.14 3.63 2.21 + -1.15 0.31 8. Tata Steel Ltd. 2.62 0.88 1.44 0.11 _ 3.27 0.03** 9. Trident Ltd. 1.24 0.33 1.01 0.46 _ 0.68 0.53 10. United Breweries Ltd. 3.66 1.62 4.98 0.62 + -1.53 0.19 Source: Compiled & Edited from the Financial Statements of Selected firms Listed-CMIE-Prowess Package. Note: Figures in parentheses denote p value. *** Significant at the 1% level. ** Significant at the 5% level. * Significant at the 10% level.

Table 3: Impact of M&A on Enterprise Value to EBITDA of Acquiring Manufacturing Firms in India from 2006-2007 to 2016-2017

Sl. Pre-merger Post-merger Name of the firms Impact t- value p-value No. Mean SD Mean SD 1. Genus Power Infrastruc 6.57 2.51 7.75 2.98 + -0.51 0.63 2. Motherson Sumi Syste 16.16 2.17 31.00 12.74 + -2.81 0.04** 3. Pratibha Industries 7.12 2.92 1.73 5.65 _ 2.21 0.09* 4. Reliance Industries 11.62 2.13 8.59 1.29 _ 2.62 0.05* 5. Reliance Infrastructure 14.47 4.69 7.01 0.78 _ 3.93 0.01** 6. Sterlite Technologies 8.80 3.51 9.23 2.45 + -0.20 0.85 7. Suven Life Sciences 18.45 10.88 11.66 6.93 _ 1.08 0.33 8. Tata Steel Ltd. 6.22 1.88 5.04 0.68 _ 1.44 0.22 9. Trident Ltd. 8.39 4.16 5.11 2.05 _ 1.35 0.24 10. United Breweries Ltd. 25.24 10.19 35.03 5.37 + -1.83 0.14 Source: Compiled & Edited from the Financial Statements of Selected firms Listed-CMIE-Prowess Package. Note: Figures in parentheses denote p value. *** Significant at the 1% level. ** Significant at the 5% level. * Significant at the 10% level.

The EV_EBITDA is positively related to the growth rate in free cash flow to the firm and negative related to the firm’s overall risk level and weighted average capital. It 66 MUDRA: Journal of Finance and Accounting, Volume 5, Issue 2, Jul-Dec 2018

is inferred (from Table 3) that the mean performance of Enterprise Value in terms of EV_EBITDA of Motherson Sumi Systems Ltd, Pratibha Industries Ltd, Reliance Industries Ltd, and Reliance Infrastructure Ltd is significant (t -2.81, P<0.05; 2.21, P<0.10; 2.62, P<0.10; and 3.93, P<0.05) at the 5% and the 10% levels, respectively, after the M&A process. The mean EV_EBITDA in the post-merger period is increased for four out of the ten acquiring manufacturing firms.

5.0 Finding and Concluding Remarks

The impact of M&A on the PEV of the firms of the manufacturing sector is tested by use of the paired samples t–test, and the hypothesis tested is as follows:

Ho: There is no significant difference between the Performance of Enterprise Value of manufacturing firms in India before and after the M&A process. a) Enterprise Value: Six acquiring firms (Motherson Sumi Systems Ltd, Pratibha Industries Ltd, Sterlite Technologies Ltd, Suven Life Sciences Ltd, Trident Ltd, and United Breweries Ltd) out of ten have significant positive movement in the post- merger period compared with the pre-merger period at the 1%, the 5%, and the 10% levels, respectively. The EV provides a much more accurate valuation because it includes debt, bonds, and bank loans and not included trade creditors in its value calculation. The EV is a measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization. Generally the value of a firm’s debt needs to be paid by the acquirer when taking over a firm. Hence, the six acquiring firms out of ten in the post-merger period are having an improved EV. Therefore the six acquiring firms are visible among competitors like having the capacity to develop into something in the future and merged firms also felt that chosen as a good acquirer candidate. The four acquiring firms (Genus Power Infrastructures Ltd, Reliance Industries Ltd, Reliance Infrastructure Ltd, and Tata Steel Ltd) did not have any significant positive movement in the post-merger period compared with the pre-merger period. Hence, the hypothesis is rejected. b) Enterprise Value to Net Operating Revenue: Two acquiring firms (Motherson Sumi Systems Ltd and Tata Steel Ltd) out of ten have significant positive movement in the post-merger period compared with the pre-merger period at the 5% level, respectively. The EV_NOR is compares the actual price you would pay for a company (EV) with the money generated by that company. Generally prospective investors initially compare EV_NOR for the company being analysed to that of other public companies in the industry to get an idea of the company’s relative financial health and also Effect of Mergers and Acquisitions on Performance of Enterprise Value 67

investors always looking at a variety of indicators, as prospective investors believe that the no single indicator can provide an accurate picture of a company’s performance. The EV_NOR is an indicates that the two acquiring firms out of ten stock price well and the eight acquiring firms (Genus Power Infrastructures Ltd, Pratibha Industries Ltd, Reliance Industries Ltd, Reliance Infrastructure Ltd, Sterlite Technologies Ltd, Suven Life Sciences Ltd, Trident Ltd, and United Breweries Ltd) did not have any significant positive movement in the post-merger period compared with the pre-merger period. Hence, the hypothesis is accepted. c) Enterprise Value to EBITDA: Four acquiring firms (Motherson Sumi Systems Ltd, Pratibha Industries Ltd, Reliance Industries Ltd, and Reliance Infrastructure Ltd) out of ten have significant positive movement in the post-merger period compared with the pre-merger period at the 5% and the 10% levels, respectively. The EV_EBITDA is regarded as a more accurate measure than the Price to Sales Ratio. The lower the EV_EBITDA the more attractive when the cash held by a company is more than the market capitalization and debt value. Investors mainly use an EV_EBITDA to determine whether a company is undervalued or overvalued, high ratio indicates that the company might be overvalued. The EV_EBITDA is considered by some to be a better valuation metric because it remains unaffected by changing capital structures and offers fairer comparisons of companies with capital structures that differ. It also removes the effects of noncash expenses on a company’s value. The EV_EBITDA provides an accurate depiction of total business performance. The EV_EBITDA is an indicates that the four acquiring firms out of ten business performance well in the post-merger period and the six acquiring firms (Genus Power Infrastructures Ltd, Sterlite Technologies Ltd, Suven Life Sciences Ltd, Tata Steel Ltd, Trident Ltd, and United Breweries Ltd) did not have any significant positive movement in the post-merger period compared with the pre-merger period. Hence, the hypothesis is rejected. The analysis overall reveals that the M&A has been found that the acquiring firms are drastically improved in stock price and business performance well, as a result the acquiring firms are visible among competitors like having the capacity to develop into something in the future and merged firms also felt that chosen as a good acquirer candidate. The most of the acquiring firms have significant change in the performance of Enterprise Value in the post-merger period. Hence, with respect to most of the acquiring manufacturing firms the hypothesis is rejected.

68 MUDRA: Journal of Finance and Accounting, Volume 5, Issue 2, Jul-Dec 2018

6.0 Limitations and Scope for Further Studies

 The study is mainly based on secondary data and is restricted to the acquiring manufacturing firms in India.  To study the shareholders’ wealth impact on mergers and acquisitions in the post- merger period with help of cumulative average abnormal return model.  To study the effect of mergers and acquisitions on operating performance and shareholders’ wealth in the post-merger period with help of factor analysis, correlation matrix, and regression analysis  To study the efficiency and performance of the banking and financial service industry in the post-merger period with the help of the CRAMEL and CAMELS Models of Research Methods  To study the shift-in-structure of mergers and acquisitions on operating performance and shareholders’ wealth in the post-merger period with help of chow test.

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Effect of Mergers and Acquisitions on Performance of Enterprise Value 69

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Appendix A: List of Manufacturing Firms in India Selected for the Study

Sl. No. Acquiring Firms’ Name Target Firms’ Name Date of Deal Completed 1. Genus Power Infrastructures Ltd. Genus Paper Products Ltd. 11/01/12 2. Motherson Sumi Systems Ltd. India Nails Mfg. Pvt. Ltd. 28/04/11 3. Pratibha Industries Ltd. Pratibha Pipes & Structural Pvt. Ltd. 03/02/12 4. Reliance Industries Ltd. Reliance Jamnagar Infrastructure Ltd. 26/03/12 5. Reliance Infrastructure Ltd. Reliance Energy Generation Ltd. 17/01/12 6. Sterlite Technologies Ltd. Sterlite Infra-Tech Ltd. 17/05/11 7. Suven Life Sciences Ltd. Suven Nishtaa Pharma Pvt. Ltd. 31/01/12 8. Tata Steel Ltd. Centennial Steel Co. Ltd. 13/04/11 9. Trident Ltd. Trident Infotech Ltd. 27/04/11 10. United Breweries Ltd. Scottish & Newcastle India Pvt. Ltd. 07/02/12 Source: Centre for Monitoring Indian Economy Private Limited (Prowess CMIE).