Implications of M&A Activity on the Indian Stock Market

chillibreeze writer — Rajat

Before we delve into the scenarios, it would be a good idea to define the terms involved in these transactions. An ‘acquirer’ is an entity that seeks to acquire another entity either willingly or by force. The entity that is being taken over is then described as a ‘target’. The takeover or amalgamation of the acquirer and the target as defined above is termed as a merger or an acquisition as the case may be. The word ‘transaction’ always refers to M&A transactions unless mentioned otherwise.

Stock Markets usually react in a very bizarre way to an M&A deal depending on a number of factors. Some of the factors that directly affect the stock markets are:

Size of the Transaction: A small transaction will not affect the market as much as a large deal would

Market Mood: In a falling market, a higher number of transactions will lead to a further fall and vice-versa
Shareholder Value: The market usually reacts depending on whether a certain transaction will create value for its shareholders

Regulations to Control Irregular Movements in the Market

Stringent market regulations seek to control extreme market movements which may otherwise destabilize the market. In India, all such transactions are regulated and governed by the Stock Exchange Board (SEBI). The board has framed stringent regulations in order to protect interests of all parties concerned including shareholder interests. Regulations 10, 11 and 12 of the SEBI code deal with takeovers and take care to regulate them in a manner which least effects the stock markets. Regulation 25 deals with the nuances of competitive bidding, since this type of bidding usually throws markets into turmoil. This clause sets up stringent conditions in those transactions where competitive bidding occurs.

In addition, SEBI ensures that all deals have to be publicly announced within 4 days on entering into agreement or on a decision to acquire voting rights, whichever may be the case. All shareholders must also be sent a letter of offer within 45 days from the date of the public announcement, as a shareholder protection measure.

Cases

The information mentioned above was largely theoretical and legal. Let us examine these aspects from a practical viewpoint by examining two real M&A deals in the pharmaceutical industry and how they affected the stock movements. We’ll only consider those deals that have been closed as of this date.

Case 1: Matrix Labs and Strides Arcolabs

MATRIX LABS

Matrix Labs Limited is a Hyderabad based company manufacturing Active Pharmaceutical Ingredients (API) and Solid Oral Dosage Forms. They are also involved in contract R&D and contract manufacturing. The company has manufacturing facilities in Nashik and Mumbai.

STRIDES ARCOLABS

Strides Arcolabs is based in Bangalore and is involved in manufacture and export of branded and generic dosage forms. The company is also involved in Contract R&D as well as contract manufacturing. Strides have a global presence in six countries.

From the point of view of Strides Arcolabs, it was a merger of the two parties and not a takeover. When the intention to merge the two entities was announced the individual stocks along with the market registered an upward swing. Around mid year of 2005, the individual managements of both companies decided to call off the merger due to internal issues. This led to a huge fall in the prices of the individual stocks and a dip in the market for that particular day. The stocks finally stabilized in about 3 months, while the market corrected itself in about 1-2 days.

This is an excellent example of market behavior when a certain deal is called off or when it fails. The market will slide almost immediately.

Case 2: Matrix Labs and Mylan Laboratories

MATRIX LABS

Matrix Labs Limited is a Hyderabad based company manufacturing Active Pharmaceutical Ingredients and Solid Oral Dosage Forms. The company is also involved in Contract R&D as well as Contract Manufacturing. Matrix Labs has manufacturing facilities in Nashik and Mumbai

MYLAN LABORATORIES

Mylan Labs is based near Pittsburgh. The company manufactures, develops and markets generic drugs and claims of having a deep pipeline of researched drugs. Mylan Labs has a strong base in the US and over the next five years the company plans to consolidate its position in the North American market.

Matrix Labs was a target in this case. On the announcement of a possible takeover of the company, the individual stock of Matrix Labs slumped by as much as Rs. 30 per share. This also dragged down the pharma index which in turn dragged down the stock market. This slump was seen largely due to market concerns that the company was being grossly undervalued since the share price at the time discounted earnings estimates by 13 times (13x) in comparison to peer companies. However, when Mylan announced that it was planning to pay a premium on the stock, the market bounced back to normal and the share price of Matrix Labs also stabilized.

In these transactions, every single action of all parties involved can have cascading or elating effects on the markets depending on whether the action is negative or positive respectively. Any M&A activities, especially between large entities have strong market implications.

Generally speaking the target to be acquired undergoes a price increase if its valuation is done at a premium or sees a price drop if a premium is not being considered and the valuation is undervalued. Similarly, the acquirer will see a price drop if a premium is being considered on the target and vice-versa depending on the type of funding (debt or equity type) chosen to fund the acquisition. If equity-type funding is used, the acquirer sees a short term drop in the price of its own stock, which may not necessarily be the case otherwise when debt is raised instead of equity.

The stock market also tends to make an evaluation of the synergies that exist between the two organizations. Very often it is observed that cases where the mergers make perfect sense are welcomed by the market and in cases where synergies are poor.

Conclusion

The Indian markets in general are highly regulated. Due to this, huge fluctuations in the due to M&A activity are not seen. The regulations are designed in a manner so as to mitigate the impact of these transactions on the market.

The amount of the company’s own equity used in funding an acquisition will almost always impact the stock market in the short term. A premium valuation of the target will always lead to a short term decrease in the stock value of the acquirer. The converse also stands true.

Finally, the most important factor is shareholder value that the transaction will create. In transactions where a huge defensible shareholder value is created, the market will tend to boom upward, whereas in the reverse scenario the market will tend to fall heavily.

{References:

ISI Emerging Markets Database
The Wall Street Journal (Mint-Indian Edition)
Bloomberg
Financial Times}

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"Rajat is an investment banker who has worked and studied in several different countries. Currently working in India, he is seeking to strike a fine balance between work and his first love - writing. His hobbies include rifle-shooting, equestrian pursuits, collecting antique pocket watches and reading scriptures in Sanskrit."

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