Mergers and Acquisitions in India: A Strategic Impact

Analysis for the Corporate Restructuring

Abstract

In today‟s globalized economy, competitiveness and competitive advantages have

become the buzzwords, for corporate around the world. Corporate restructuring has
gained considerable importance all over the world because of intense competition,
globalization and technological changes and in this context mergers and acquisitions
(M&A) are being increasingly used the world over, for improving competitiveness of
companies through gaining greater market share, broadening the portfolio to reduce
business risk, for entering new markets and geographies, and capitalizing on economies
of scale etc. Mergers are important corporate strategy actions that, among other things,
aid the firm in external growth and provide it competitive advantage. This area has
spawned a vast amount of literature over the past half a century, especially in the
developed economies of the world. India too has been seeing a growth in the number of
mergers over the past one-and-a-half decades since economic liberalization and
financial reforms were introduced in 1991.

Therefore an attempt is made in this paper to evaluate the performance of merged banks
based on comparing key financial position indicates before and after acquisition period
of 5 years. This Research focuses on accounting ratios metric viz. profitability ratios to
elicit financial position of the banks during pre and post acquisition periods. This will
help to assess the implications of M&A on the financial position of acquisition bank in
the deal. The methodology basically used is ratio analysis, statistical techniques etc. This
study will significantly contribute to the knowledge, society and industry.

Keywords: M&A, Indian Banking Sector, liquidity, profitability.

Introduction

Companies come and go. Chief Executive Rise and fall, Industry Sector Wax and Wane,
but an outstanding feature of the past decade has been the rise of business combinations,
which may take forms of mergers, acquisitions, amalgamation and takeovers are the
important features of corporate restructure changes. They have played an important role
in the external growth of a number of leading companies‟ world over.

Globally mergers and acquisitions have become a major way of corporate restructuring
and the financial services industry has also experienced merger waves leading to the
emergence of very large banks and financial institutions. The key driving force for
merger activity is severe competition among firms of the same industry which puts focus
on economies of scale, cost efficiency, and profitability. The other factor behind bank
mergers is the “too big to fail” principle followed by the authorities. In some countries
like Germany, weak banks were forcefully merged to avoid the problem of financial
distress arising out of bad loans and erosion of capital funds. Several academic studies
(see for example Berger [Link]. (1999) for an excellent literature review) examine merger
related gains in banking and these studies have adopted one of the two following
competing approaches. The first approach relates to evaluation of the long term
performance resulting from mergers by analyzing the accounting information such as
return on assets, operating costs and efficiency ratios. A merger is expected to generate
improved performance if the change in accounting-based performance is superior to the
changes in the performance of comparable banks that were not involved in merger
activity. An alternative approach is to analyze the merger gains in stock price
performance of the bidder and the target firms around the announcement event. Here a
merger is assumed to create value if the combined value of the bidder and target banks
increases on the announcement of the merger and the consequent stock prices reflect
potential net present value of acquiring bank.

A Brief Overview of Indian Banking Sector

The history of Indian Banking shows that seeds of banking in India were sown back in
the 18th century when efforts were made to establish the General Bank of India and
Bank of Hindustan in 1786 and 1790 respectively. Later some more banks like Bank of
Bengal, Bank of Bombay and the Bank of Madras were established under the charter
of British East India Company. These three banks were merged in 1921 and it formed
the Imperial Bank of India, which later became the State Bank of India. The period
between 1906 and 1911 witnessed the establishment of banks such as Bank of India,
Bank of Baroda, Canada Bank, Corporation Bank, Indian Bank and Central Bank of
India; these banks have survived to the present. The banking sector in India can be
divided into two era i.e. pre-liberalization era and post liberalization era since 1991. In
the pre-liberalization era, the Government of India nationalized the 14 largest
commercial banks in 1969. A second dose of nationalization of six more commercial
banks followed in 1980. The stated reason for the nationalization was to give the
government more control of credit delivery. Later, in the year 1993, the government
merged New Bank of India with Punjab National Bank. It was only the merger between
nationalized banks and resulted in the reduction of the number of nationalized banks
from 20 to [Link] banking sector has seen a tremendous amount of change in the post
liberalization raise. in the early 1991; the then Narasimha Rao government embarked the
policy of liberalization. Licences were given to small number of private banks like
Global Trust Bank, which later amalgamated with Oriental Bank of Commerce, Axis
Bank (earlier UTI Bank), ICICI Bank and HDFC Bank. This move had augmented the
growth in Indian Banking.

Along with the rapid growth in the economy of India, followed by the growth with strong
contribution from all the three sectors of banks, viz. government banks, private banks
and foreign banks. The impact of globalization on Indian Banking has caused many
changes in terms of regulations and structural. With the changing environment, many
different strategies have been adopted by this sector to remain efficient and to surge at
the forefront in the global arena. One such strategy is in the course of consolidation is
merger and acquisition.

Concept of Mergers and Acquisition

The phrase M&A refers to the aspect of corporate financial strategy and management
dealing with the merging and acquiring of different companies as well as other assets.
Usually, merger occurs in a friendly setting, where executives from the respective
companies participate in a due diligence process to ensure a successful combination of
all parts. On other occasion, acquisitions can happen through hostile takeover by
purchasing the majority of outstanding shares of company in the open stock market.

Mergers

A merger is said to be occur when two or more companies combine into one company.
One or more companies may merge with an existing company or they may merge to form
a new company. In merger, there is complete amalgamation of the assets and liabilities
as well as shareholders interest and business of the merging companies. Another mode of
the merger happens when one company purchases the another company without giving
proportionate ownership to the shareholders of the acquired company. According to the
Institute of Chartered Accountants of India, statements of Accounting Standards (AS-14)
– Accounting for Amalgamation Laws – Law of India use the term mergers and
amalgamation interchangeably. Merger or amalgamation may take two forms:

(1) merger through absorption and

(2) merger through consolidation.

Absorption is a combination of two or more companies into an existing company,

whereas, consolidation is combination of two or more companies into a new company.

The term acquisition refers to acquiring of effective working control by one company
over another. The control may be acquired either through purchase of majority of shares
carrying voting rights exercisable at a general meeting, or controlling the composition of
the Board of Directors of the other company. In acquisition, the shares may be purchased
either for cash or in exchange of shares of the acquiring company. The acquired
company continues to exist but its shareholders change without any change in its
constitution. The advantage of the acquisition is that it allows a company to acquire
control over another company by investing much less than what would be necessary for
the merger, There are various types of mergers that can take place in the form of
 1. Vertical Mergers

2. Horizontal Mergers

3. Circular Mergers

4. Conglomerate Mergers

5. Reverse Mergers

Objective of the Study

The main objective of the study is to analyze the pre and post merger operating and
financial performance of the banks who underwent M&A deals in India in the post
reforms period, from which is up to 2010.

Methodology of the Study

It is an empirical study with the intention to analyze the performance of the banks after
assuming structural changes with another bank. A comparative survey has been
undertaken from among the banks those have gone under M&A during post reform
period. Their performance in the pre and post acquisition period has been analyzed so as
to elicit the efficiency of M&A in the corporate restructuring. The study examines the
impact of the banks merged in India from 2005 to 2011. Between 1999 and 2011, around
18 amalgamations took place in Indian banking sector. Out of these, 6 banks were
selected as samples which constitute 1/3 of the population. The samples were selected on
a random sampling basis through lottery method. Among the six acquirer banks
selected, three of them are public sector banks and the remaining are private sector
banks.

Data Collection

Data of operating performance ratio of pre period of 5years and post period of 5years of
the acquisition for each acquiring banks has been extracted from the prowess database of
Centre for Monitoring Indian Economy (CMIE). The present paper is entirely based on
secondary data. RBI Publications of „A Profile of Banks‟ and „Statistical Tables
Relating to Banks in India‟ have been used throughout the study to calculate various
ratios of profitability.

Liquidity Position

Liquidity Position of a bank could be measured in terms of various accounting ratios,

such as current ratio, quick ratio and cash asset ratio to indicate liquidity position of
acquiring banks. An acquiring bank is considered to be sound if it is in a position to carry
on its business smoothly and meet all its obligations during 5 years period without any
damage to the goodwill of the bank.

Operational Efficiency

Activity ratios are financial ratios that measure how efficiently a firm is using its current
and fixed assets. Firms will typically try to turn their resources into cash as far as
possible because this will generally lead to higher revenues. The ratios such as working
capital turnover, asset turnover, etc are generally used to evaluate the activity of a firm.
Here in this article, the activities of the public and private sector banks before and after
their acquisition activities are evaluated using working capital turnover ratio, asset
turnover ratio and fixed asset turnover ratios.

Profitability Position

The primary objective of any firms is to earn profits. Profit earning capacity is
considered to be essential for the survival of the firms. A banking sector needs profits not
only for its existence but also for expansion and diversification in other financial areas.
The profitability ratios are used to test the efficiency of the management, as the measure
of worth of their investment to the creditors, the margin of safety to employees as a
source of benefits, to Government a measure of taxpaying capacity, etc. The status of
various profitability ratios in 5 year pre and post event period are compared for this
purpose.
Conclusion

An attempt has been made to analyse the financial performance of banks in the wake of
consolidation exercise. The results emerged from the profitability ratios, on an average,
showed a significant difference between the profitability of banks in post-merger
scenario. The increase in profitability of banks under study is due to an increase in
employee turnover and the subsequent reduction in operating expenses. Merger and
acquisition programmes in Indian banks cannot be regarded as a false step if the benefits
of it accrue to all stakeholders.

So far, from the entire above inferences pertaining to financial performance against
acquisition activities of public and private sector banks, The performance of private
sector banks is found to be better in pre-period compared to their performance in post-
acquisition period. It is concluded that there is notable change in liquidity position of the
public sector banks due to their acquisition activities whereas there has been significant
decline their activities in turning their assets for generating income. It is identified that
the deals pertaining to acquiring by private sector banks have significant negative effect
on their liquidity position as well as on their overall financial performance. It is also
concluded that the performance of public sector banks in terms of generating income
relative to their investment in fixed assets is significantly and negatively affected
whereas their performance in respect of their net earnings is positively influenced by
acquisition deals However, overall from combining the financial performance of both
public and private sectors banks, it is identified that that the banks‟ activities in respect
of acquiring other private sector banks does not tend to make any notable changes in their
liquidity position and profitability levels, It is finally concluded the net earnings in
longer time period of five years tend to increase against taking over of private sector
banks by public and private sector banks in India.

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