A Case Study of Acquisition of Spice Communications by Isaasdaddea Cellular Limited

Hamendra Kumar Porwal, Ankur Gupta, Anchal Khaneja

A Case Study of

Acquisitionof

Communications

byCommunications

Cellular Limited

ABSTRACT

Mergers and acquisitions (M&A) are increasingly being adopted by organizations today tomaintain a competitive advantage in the market. The assessment of shareholders' wealth effectsis one of the most researched areas in the field of finance. This paper is aimed at studying theimpact of mergers on the operating performance of the merged entity by examining pre-mergerand post-merger ratios. It also studies the behavior of share prices and returns 20 days before andafter the announcement of the acquisition deal of Idea Cellular and Spice Communications. Thestudy highlights that shareholders do not get value addition to their wealth around theannouncement date.

Keywords:Cumulative Abnormal Returns,Merger and Acquisition,ShareholderWealth Effects.

INTRODUCTION

Mergers and acquisitions and corporate restructuring are a bigpart of the corporate finance world. Every day, investmentbankers arrange M&A transactions, which bring separatecompanies together to form larger ones.

A merger is when two companies, more or less on equalfooting, decide to join forces. Acquisitions are different in the sense that one company is, in fact, taking over anothercompany. Of course, some companies want to be taken overand some do not.

Broadly, there are two ways to grow a business - throughorganic growth and through inorganic growth. While takingthe organic growth path, the company incrementally grows itspeople, customers, infrastructure resources and thusrevenues and profits, an inorganic growth would provideinstantaneous growth enabling the company to skip a fewsteps on the growth ladder. Mergers and acquisition is aninorganic growth strategy.

There are several reasons for M&A. M&A has been widely usedin developed economies as a growth strategy and is nowincreasingly getting accepted by Indian businesses as a criticaltool of business strategy. It is increasingly becoming the orderof the day in businesses especially in rapidly evolvingbusinesses like information technology, telecommunications,business process outsourcing as well as in traditionalbusinesses. Indian businesses are also rapidly using M&A togrow internationally.

There are several advantages attached with M&As:

Economies of Scale

The largest single driving force behind mergers andacquisitions is probably economies of scale. Economies ofscale mean that if you have a large company, you can leverageyour suppliers. This is a very powerful capability, andexercising it can be a strategic move for a company'soperations.

Saturated Market Consolidation

Another driving force for mergers and acquisitions is theconsolidation of saturated markets. If you have a market that issaturated one in which there are many players in the spacewith a lot of competition you can take over one of yourcompetitors and then automatically increase your marketshare.

Competitive Position Improvement

The third driving force has to do with simply improving yourcompetitive position because you end up with a larger assetbase and increased notoriety.

Synergy

Synergy is what organizations are attempting to achieve whenthey engage in mergers and acquisitions. It is the Cooperativeinteraction among groups, especially among the acquiredsubsidiaries or merged parts of a corporation that creates anenhanced combined effect.

16 DIAS TECHNOLOGY REVIEW VOL. 8 NO. 2 OCTOBER 2011 - MARCH 2012

cycle of the organization, and the management styles. Themergers often prove to be traumatic for the employees ofacquired firms; the impact can range from anger todepression. The usual impact is high turnover, decrease in themorale, motivation, productivity leading to merger failure.The other issues in the M&A activity are the changes in the HRpolicies, downsizing, layoffs, survivor syndromes, stress onthe workers, information system issues etc. The humanresource system issues that become important in M&A activityare human resource planning, compensation selection andturnover, performance appraisal system, employeedevelopment and employee relations.

OST MERGER ISSUES

Creating shareholder value through corporateacquisitions means negotiating a deal thatincludes a favourable price and favourableterms, but it also requires a successful

integration program. Poor integration is repeatedly cited asone of the primary reasons that corporate acquisitions fail tomeet the purchaser's expectations.

Integration Difficulties

Integration problems or difficulties that companies oftenencounter can take many forms. Major amongst them arelinking different financial and control systems, buildingeffective working relationships (especially when managementstyles differ), problems related to differing status of acquiredand acquiring companies' executives and melding disparatecorporate cultures.

InadequateValuation ofTarget

Another potential problem is that acquiring companies maypay too much for acquired businesses. Acquiring companiesmay not thoroughly analyze the target company, failing todevelop adequate knowledge of its true market value.

Large or Extraordinary Debt

Many acquirers, in addition to overpaying for targets, may beforced, due to market conditions, to finance acquisitions withrelatively high-cost debt. The use of debt has both positive andnegative effects. On the one hand, leverage can be a positiveforce by allowing the company to take advantage of expansionopportunities; however, excessive leverage can lead tonegative outcomes such as postponing or eliminating theinvestments that are necessary to maintain strategiccompetitiveness over the long term.

Inability to Achieve Synergy

Acquiring companies also face the challenge of correctlyidentifying and valuing any synergies that are expected to berealized from the acquisition. This is a significant problembecause, to justify the premium price paid for targetcompanies, managers may overestimate both the benefits andvalue of synergy. And, to achieve a sustained competitiveadvantage through an acquisition, acquirers must realizeprivate synergies and core competencies that cannot easily beimitated by competitors.

ERGERTYPES

When companies decide to engage in a mergertheir reasons typically fall into one of sixcategories. The first type of merger is aHorizontal Merger. This is when two

companies who are currently in direct competition jointogether and share their product lines, their markets, and theircustomer base.

AVertical Merger is when a company, and perhaps one of theirsuppliers, join together to be able to offer a contiguous, non-interrupted supply of merchandise to their companies. Anexample might be an ice cream cone manufacturer mergingwith an ice cream maker so that both products can be acquiredfrom a single entity, thereby presumably making it easier forthe customer.

A Market Extension Merger is with two companies that sell thesame product in different markets. This is an interesting typeof merger because companies can be regional. Companies canhave different segments of the marketplace in which they havegained a reputation. By acquiring another company that has afoothold in another market, you can automatically increasethe markets that you address.

A Product Extension Merger is when two companies sellingdifferent products in the same market merge.

A Conglomeration Merger is where two companies who don'thave a lot to do with one another decide to merge. The reasonfor this would be economies of scale, and getting a largeridentity and more assets to be able to leverage for loans andother financial purposes.

And finally, a Strategic Merger is the newest type of merger thatmay involve some or all of the features of the other mergertypes mentioned above.

In today's globalized world, businesses need to invent newways of competing. M&A have thus become universal tools toattain greater market share, acquire additional brands, createnew synergies and capitalize on economies of scale.

This study examines the acquisition of Spice CommunicationsLimited by Idea Cellular Limited. It investigates the effect ofmerger announcement on the wealth of the shareholders ofIdea Cellular and Spice Communications. It also examines thepost merger corporate performance of the merged entity.

RE MERGER ISSUES

While deciding on entering a merger or anacquisition, the bidder firm faces thefollowing financial issues:

It needs to evaluate the portfolio of the target company

It has to evaluate the fixed assets of the target firm.

It then needs to calculate the value of the deal.

The pre acquisition period involves an assessment of thecultural and organizational differences, which will include theorganizational cultures, role of leaders in the organization, life

MM

PP

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A CASE STUDY OF ACQUISITION OF SPICE COMMUNICATIONS BY IDEA CELLULAR LIMITED

OTIVATION BEHINDTHE STUDY

The Indian telecom industry is the mostdynamic in the world with an evolvingregulatory environment. It is the second

fastest growing telecom market in the world after China.Indian telecom operators are driven towards specializationand consolidation to achieve economies of scale and improvemargins. The industry is changing at a rapid pace withconstantly changing policies, new players, alliances andpartnerships being announced on daily basis. Mergers andacquisitions (M&A) are increasingly being adopted byorganizations today to maintain a competitive advantage inthe market. So it becomes very important to study the gainsand costs relating to a merger strategy in the real world.

In the Indian telecom industry there have been quite a fewmerger and acquisition cases. But in our belief, no researchhas been taken up yet. This was the main motivation behindthe study undertaken on acquisition and we studied variousacquisition deals before settling on Idea and Spice which was one of the major deals happening in India. It included twodomestic players and one Telecom Company of Malaysia tomake it a perfect piece to study.

This study examines the acquisition of Spice CommunicationsLimited by Idea Cellular Limited. It investigates the effect ofmerger announcement on the wealth of the shareholders ofIdea Cellular and Spice Communications. It also examines thepost merger corporate performance of the merged entity.

COPE

The scope of this paper is to examine the valueaddition to the shareholders' wealth by themeans of an event study of the abnormal stockreturns of the merging entities.

The paper also analyses the corporate performance of themerged entity by using the following set of ratios: CurrentRatio, Return on Assets, Return on Equity, Return on CapitalEmployed, Profit Margin and Earning Per Share.

IMS AND OBJECTIVES

The objectives of the present study are:

To examine the effect of mergers on thewealth of the shareholders.

To analyze the immediate impact of mergers on the shareprices of the merging companies.

To examine the post merger corporate performance of themerged entity.

YPOTHESES

To attain the above objectives the followinghypotheses will be tested:

H1 (null hypothesis): There is no significant difference in themean abnormal returns of the pre and post mergerannouncement period for the bidding firm.

H2 (null hypothesis): There is no significant difference in themean abnormal returns of the pre and post mergerannouncement period for the target firm.

H3 There is zero or negative combined excess return for themerging entities.

HEORY AND METHODOLGY

Operating Performance Study

This kind of research, along with theirexplanations, could partially not be correct, as

many other factors influence stock prices and theirconclusions do not provide clear and conclusive resultsargumentation. In this context, the use of post-mergeraccounting data and, in particular, financial ratios fromfinancial statements that have been examined for theircredibility is a better and safer path to test directly for changesin operating performance that result from mergers than stockprice studies.

Although, there is not a commonly accepted concrete set offinancial ratios as a successful operating performancemeasure, profitability ratios are widely used for the purpose.Accordingly, our study also uses primarily profitability ratiosfor measuring operating performance of Idea Cellular Limitedafter merger. We have used the following six ratios in order tomeasure the profitability:

1. Return on Assets (ROA)

ROA measure company's earnings in relation to all of theresources it has employed. It tells us what earnings weregenerated from the invested capital (assets). Net income istaken as Profit afterTax (source: Capitaline Database)

ROA= Net income/Total Assets

2. Return on Capital Employed (ROCE)

ROCE is a significant measure of return that a company isrealizing from its capital calculated by the profit beforeinterest and tax divided by the capital employed. Profit beforeInterest and Tax (PBIT) and Capital Employed (Assets-Liabilities) are taken from Capitaline Database. It is calculatedas

ROCE= PBIT/Capital Employed

3. Earnings Per Share (EPS)

EPS is per share earnings of a company for a given period. It iscalculated as Net Income divided by the number of equityshares. EPS values are directly taken from audited results of thecompany

EPS= Net Income/The number of equity shares

MM

SS

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17DIAS TECHNOLOGY REVIEW VOL. 8 NO. 2 OCTOBER 2011 - MARCH 2012


EE

4. Profit Margins

It gauges a company's operating success over a given period oftime. Net income again is taken as Profit after tax.

Profit Margins= Net Income/Sales

5. Current Ratio

It measures the ability of a company to pay its debts in theshort-term and to meet unexpected cash needs.

Current Ratio= Current assets/Current liabilities

6. Return on Equity (ROE)

The amount of net income (Profit after Tax) returned as apercentage of shareholders equity (Shareholders capital,Outstanding Employee Stock Options, Reserves and Surplus).

Return on Equity= Net income/Shareholders' Wealth

FFICIENT MARKET HYPOTHESIS (EMH)

EMH forms the base of using event studymethod which is employed in this study.Hence, it is very important to understand thebasic concepts of EMH.

EMH asserts that financial markets are "informationallyefficient". That is, one cannot consistently achieve returns inexcess of average market returns on a risk-adjusted basis,given the information publicly available at the time theinvestment is made.

There are three major versions of the hypothesis: "weak","semi-strong", and "strong". Weak EMH claims that prices ontraded assets (e.g., stocks, bonds, or property) already reflectall past publicly available information. Semi-strong EMHclaims both that prices reflect all publicly availableinformation and that prices instantly change to reflect newpublic information. Strong EMH additionally claims thatprices instantly reflect even hidden or "insider" information.There is evidence for and against the weak and semi-strongEMH, while there is powerful evidence against strong EMH.Studies of the semi-strong form of the EMH can be regarded astests of the speed of adjustment of prices to new information.The leading research tool in this area is the event studymethod.

VENT STUDY RESEARCH METHOD

The core assumption of the event-studymethodology is that i f infor mationcommunicated to the market contains anyuseful and surprising content an abnormal

return will occur. In a capital market with semi-strongefficiency one can assesses the impact of the event in questionon the market value of the company by calculating theabnormal return - the difference between the actual post-event return and the return expected in the absence of theevent. An event study can be roughly categorized into thefollowing five steps:

EE

1. Identifying of the events of interest and defining the eventwindow size.

2. Selection of the sample set of firms to include in theanalysis.

3. Prediction of a normal return during the event windowin the absence of the event.

4. Calculation of the abnormal return within the eventwindow, where the abnormal return is defined as thedifference between the actual and predicted returns.

5. Testing whether the abnormal return is statisticallydifferent from zero.

Estimation Period,Event Date and EventWindow

The event of this study is the M&A announcement (t=0) of IdeaCellular with Spice Communications. It is the date on whichthe information about a merger bid first appeared in thefinancial dailies. In this case, Idea cellular first announced itsplan to acquire Spice Communications on 25th June, 2008.

thHence 25 June, 2008 is taken as t=0 in this study.

The significance of an event can be identified by examining itsimpact on the firm's stock price. To accomplish this, a periodof days is defined over which the impact of the event will bemeasured. This period is known as the event window. Theevent window covers 41 days (-20 to +20 days).

The estimation window is the control period preceding theevent period. In this study, the estimation window for theevent ends 20 days before the event and extends back to 250days (210 days for Spice) prior to it. Estimation periodsgenerally end before the event of interest so that the returnsduring the event window will not influence the modelparameters.

Sample Set

This paper is a case study based research and therefore thesample includes the acquisition of Spice CommunicationsLimited by Idea cellular Limited.

Abnormal/Excess Shareholder Return (AR)

It measures the stock market's initial reaction to a merger bidand division of any gains from any new information whichbecomes available to the market. Daily share price changeswere tracked to compute daily excess returns (AR ) for theitsecurity i as on a particular day (t) by employing market modeldenoted by equation (1):

XR = R E (R )...........(1)it it it

T0 0T1 T2

Estimation Period Event Window

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LL

Where,

t = day measured relative to an event,

XR = excess return on security i for day t,it

R = return on security i during t,it

E (R ) = expected rate of return on security i that it woulditordinarily earn for a given level of market performance for dayt. This is measured using the market model denoted by theequation (2):

E(R ) = + R ...........(2)it i i mt

The study deduced the market performance by taking the BSESENSEX Index as the market benchmark. Values of andwere estimated by regressing R (dependent variable) on Rit mt(independent variable) for the 250 day period.

Cumulative Abnormal/Excess Returns (CAR)

CAR in the days surrounding the merger (equation 3) wereneeded to examine whether shareholders of merging firmsgained from the merger.

CAR = AR (3) for i=-20 to +20it

Excess Returns of the Combined Firm

Excess returns of the combined firm (equation 4) werecalculated for assessing the market expectations from themerger of the two companies. It is a weighted sum of bidderand target firms' excess return.

AR = [AR * MV + AR * MV ] / [MV + MV ]. (4)(bt,t) (b,t) b (t,t) t b t

Where, MV and MV are market values (i.e. marketb tcapitalization) of the bidder and target respectively as at theday before the announcement date (t=-1).

AR is the excess returns of bidder firm as on day t and AR is(b,t) (t,t)the excess return of the target firm as on day t.

ESTINGTHE STATISTICAL SIGNIFICANCE

The Paired t-test

A paired t-test is used to compare twopopulation means. Here it is used to

determine whether there is a significant difference betweenthe average values of event-window abnormal returns. Thisaveraged difference is calculated based on the paireddifferences between the two values of each event-window day.

ATA

The historical share prices of BSE SENSEXIndex were taken from Yahoo Finance for theestimation period of 250 days. The stock

returns of Idea Cellular and Spice Communications wereextracted from Capitaline database for the estimation periodas well as event window. The data used for calculating variousratios was extracted from the Capitaline database and thecompany websites.

ITERATURE REVIEW

The assessment of shareholders' wealtheffects (value creation or destruction) ofMergers and Acquisitions is one of the mostresearched areas in the field of finance.

Anita Shukla & Mouni Geoffrey Gekara (2010) - Effects ofMultinational Mergers and Acquisition on Shareholders'Wealth & Corporate Performance. This research aimed atstudying the impact on the operating performance of theacquiring firm by examining the pre merger & post mergerfinancial ratio. It analyzed Tata Steel's merger with Corus Steel,the largest ever foreign merger by an Indian company. Itcompared the pre & post financial ratios & behavior of shareprices. The results failed to support the hypothesis thatbidder's gains are captured at the beginning of mergerprogram. It observed that negative excess returns prevail in themarket between the announcement & the outcome date. Itexhibited negative average returns in almost every intervalsurrounding the announcement period.

Barbara Dozier (2010) - Mergers & Acquisition as A Means ofCreating Shareholders Wealth- A Case of Lloyds TSB & HBOS.The study investigated the profitability for shareholders byexamining the daily excess returns that accrue to theshareholders around the date of announcement of the mergerdeal. Three levels of analysis were carried out: excess return forthe shareholders, announcement effect and finally excessreturn for the combined entity. The study showed hugepositive excess returns for the shareholders of both firmsaround the announcement date. However, the study alsostated that these excess returns cannot be solely attributed tothe merger announcement. External economic conditionsalso play a role in this.

M Jayadev and Rudra Sensarma (2009) - Mergers in IndianBanking: An Analysis. This paper analyzed some critical issuesof consolidation in Indian banking with particular emphasison the views of two important stake-holders viz. shareholdersand managers. It reviewed the trends in consolidation inglobal and Indian banking. To ascertain the shareholders'views, the paper conducted an event study analysis of bankstock returns which revealed that in the case of forced mergers,neither the bidder nor the target banks' shareholders havebenefited. But in the case of voluntary mergers, the bidderbanks' shareholders have gained more than those of the targetbanks. In spite of absence of any gains to shareholders ofbidder banks, a survey of bank managers strongly favoredmergers and identified the critical issues in a successfulmerger as the valuation of loan portfolio, integration of ITplatforms, and issues of human resource management.

B. Rajesh Kumar and K.M. Suhas (2010) - An Analytical StudyonValue Creation in Indian Bank Mergers.This study, based onIndian banking mergers, examined the impact of mergers on

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both the stock market wealth creation and operatingperformance. The study also analyzed the performance of themerged banks in relation to a control group based on financialratios. The results of cumulative abnormal returns analysissignify that merger announcements are value-creatingactivities for the acquirer banks. At the same time, mergerannouncements erode shareholder wealth for the targetbanks. The framework of pre-merger and post-mergercomparison of the operating performance of the acquirerbanks was based on three models whereby the cash flow wasdeflated by market value of assets, book value of assets, andincome. The result did not provide evidence to support theview that corporate performance improves after mergers.

Guntur Anjana Raju and Dipa Ratnakar Gauncar - Is M&A aWealth Creation Vehicle for Business Houses in India? Case ofthe Tata Group of Companies. The study examined the impactof M&A on corporate performance and shareholders wealth ofacquiring companies of Tata Group of companies in differentindustries from 1996 and 2008. The article analyzed withwhether Tata as a Business House created wealth throughM&A. It was concluded that the majority of the acquiringcompanies were not able to add value to the shareholders'wealth in Post M&A announcement period. The marketreacted to the news of the M&A in a negative manner expectingthat the M&A would not improve the performance of thecompany.

Casper Flught (2009) - Shareholders' wealth effects of M&A, AnEmpirical Investigation of Short Term Performance in theEuropean market. The paper focused on European M&Aprofitability from a quantitative perspective by examining theabnormal stock returns to shareholders in the periodsurrounding the announcement date using the event studymethodology in a short term window to see whether thefindings of the 80s and 90s merger waves were still applicable to the European data from the 2000s. Analysis found evidencethat target shareholders receive positive and significantabnormal return. The paper also examined whether themarket expectations about M&A profitability depend ondifferent attributes of the deal. Means of Payment - all cashpayments likely to have a large impact on the share price of thetarget & the bidder. Domestic vs. cross border M&A facecultural, legal and transaction barriers. No difference could befound between focus oriented vs. diversification M&A fortarget as well as bidding firms. Finally, it was demonstratedthat the premium paid statistically depends on the location ofthe target.

Ruud A.I Van Frederickslust examined in his paper(Shareholder Wealth effects of M&A) the wealth creation andredistribution theories of M&A using a Dutch sample in theperiod 1954 till 1997. The research found that 60% of themerger partners had positive total return. Also researchpointed out that the method of payment had a large influenceon performance. Payment in shares had a significant negativerelation while payment in cash a positive influence on the totalreturn. It also showed that takeover targets had a betterpositive share price performance than the takeover bidders.The study analyzed the various merger motives and found outthat synergy was the most convincing.

Olaf Rieck (2007) in his paper investigated M&A in the telecomindustry and analyzed the conditions under which such M&Acan be considered successful. The study applied the eventstudy method to examine the shareholders' value effects ofM&A. The findings showed that there was an overall positiveshareholders wealth effect associated to M&A announcement.This was especially true for communication operatorsengaging in cross border M&A. They experience positiveabnormal returns and outperform firms that expanddomestically. In addition, it found that mergers (that are bothnon conglomerate and cross border) add value to theacquiring telecommunication operator, whereas nosignificant stock reactions are found when acquirers engage inconglomerate domestic mergers.

DEA CELLULAR'S ACQUISITION OF SPICECOMMUNICATIONS

About the Companies

IDEA Cellular: A leading GSM mobile servicesoperator, Idea Cellular has licenses to operate in all 22 serviceareas of India with commercial operations in 11 service areas.With a customer base of over 26 million, Idea Cellular runsoperations in Delhi, Himachal Pradesh, Rajasthan, Haryana,Uttar Pradesh (East), Uttar Pradesh (West) & Uttaranchal,Madhya Pradesh & Chattisgarh, Gujarat, Maharashtra & Goa,Andhra Pradesh, and Kerala, holds spectrum for Mumbai,Bihar, Orissa, Tamilnadu (including Chennai), and Karnataka,and licenses for the remaining 6 service areas. Idea is listed onthe National Stock Exchange (NSE) and the Bombay StockExchange (BSE) in India. Idea Cellular is a part of the US $ 28billion Aditya Birla Group, Indias first truly MultinationalCorporation. The group has a market cap in excess of US $ 31.5billion, operates in 20 countries, and is anchored by 100,000employees belonging to 25 nationalities.

Spice Communications Limited: Spice was incorporated asModicom Network Private Limited on 28 March 1995 as aprivate limited company. Spice subsequently became adeemed public company under Section 43(1A) of theCompanies Act, 1956 of India with effect from 1 April 1999 andits name was changed to Modicom Network Limited. Spiceassumed its present name via a fresh Certificate ofIncorporation dated 3 December 1999. As of 30 April 2008,Spice had 4.4 million subscribers representing a 1.7% marketshare in India, and was the second and fifth largest mobiletelecommunication service provider within the Punjab andKarnataka circles, respectively. Spice was listed on the BombayStock Exchange Limited on 19th July 2007 and on the NationalStock Exchange of India Limited on 16 June 2008.

II

1Extracted from the website of Idea Cellular

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Acquisition Background

Idea Cellular acquired the 40.8% stake of the promoter group(Modi group) in Spice Communications for a price of Rs77.30 per share in the FY08. Apart from this, it also made a paymentof Rs544cr to the promoter group of Spice as non-compete fee.As per Indian securities laws, Idea made an open offer alongwith Telecom Malaysia International (TMI) and its affiliatesand associates for a further 20% stake in SpiceCommunications (Telekom Malaysia, which initially had a39.3% stake in Spice Communications, got a proportionalstake in the combined entity). The Boards of Idea and Spiceapproved the merger of Spice into Idea and the swap ratio hasbeen determined at 49 shares of Idea for every 100 shares ofSpice. Idea made a preferential allotment to TMI of 46.473crequity shares at a price of Rs156.96 per share, which represents14.99% of Idea's equity capital post allotment.

Primary Benefits

Idea gains entry in the contiguous wireless markets ofPunjab and Karnataka, which account for 11% of India'stotal wireless subscribers.

Spice, a pioneering operator, delivers a strong runningstart in Punjab and Karnataka

4.4 million subscribers as at 30 April 2008, equivalentto a 15.1% market share in the two service areas

wireless operator in Punjab with a 22.3% market share.

Idea to consolidate its position with its all-India subscribermarket share increasing from 9.5% to 11.1%. Importantly,Idea would be No.1 in 3 service areas, in the top 3 in 5 moreservice areas, and with a rapidly improving share in all itsother operating service areas.

Step 1: Idea acquires Spricepromoters' 40.8% stake @ Rs77.30 per share

Exit of Modi Groupfrom SpiceCommunications

Step 2: Idea to make 20% openoffer to Spice shareholders @Rs 77.30 per share

Idea gets 60.8%stake in Spicealongwith TMI

Step 3: Idea to make preferentialissue of 46.473cr equity shares toTMI @ Rs 156.96 per share

TMI gets 14.99% inIdea's equity capitalpost the issue

Step 4: TMI to get shares in Ideathrough share swap in the ratio of49:100 (49 shares of Idea forevery 100 shares held in Spice)

TMI gets around 18.20% in Idea Cellularpost the share swap

Ideas operations in the 900 MHz GSM spectrum band willincrease from the current 7 service areas to 9 service areas,driving scale economies and operational synergiesresulting in lower operating and capital expenditure.

2Current State

Additional Solicitor General Amarjit Singh Chandhiok said inhis legal opinion dated February 15 that Idea violated laws byholding more than 10% stake in two mobile companiesoperating in the same regions. Idea holds overlapping mobile permits in six telecom circles after its acquisition of SpiceCommunications in October 2008. If Chandhiok's view isaccepted, the Aditya Birla Group Company will also lose the Rs843-crore refund that it has been demanding from thegovernment for surrendering the overlapping mobile permits.In a letter to the telecom department, Chandhiok said IdeaCellular and Spice Communications also violated the April2008 merger guidelines, which prohibited new entrants fromselling stakes within three years of obtaining licenses. Spicehad obtained four of its six mobile permits in 2008 ahead of thedeal with Idea. Idea-Spice must also pay penalties for failing toroll out services in the six circles where it has two mobilepermits, the letter adds, citing laws that mandate mobilecompanies to launch commercial services within 12 months ofobtaining licenses. The telecom department had sought thelaw ministry's opinion on the Idea-Spice deal last year and hadasked if the overlapping mobile permits could be cancelled.The additional solicitor general said Idea Cellular be imposeda fine of Rs 50 crore each in the six circles where it holds twolicenses. He has also recommended a total of six show-causenotices to Idea and Spice each as both companies were inviolation of the law.

NALYSIS AND OBSEVATIONS

Operating Performance Study

Particulars 2009-10 2008-09 2007-08 2006-07 2005-06

Market Capitalization 21597.45 15547 27078.32 24515.49 0ROA 0.05 0.04 0.09 0.06 0.03ROCE 0.09 0.09 0.16 0.13 0.12ROE 0.08 0.06 0.21 0.11 0.07EPS 3.07 3.01 3.96 2.19 0.74Profit Margin 0.08 0.09 0.16 0.12 0.07Current Ratio 0.90 1.33 0.57 1.15 0.48

AA

Operating Performance Analysis

Post Merger Pre Merger

From the year 2007-08 to 2008-09 (year in which merger tookplace), Market Capitalization has decreased from 27,078.32crores to 15,547 crores which can be due to fall in share prices(Table 1). ROA has gone down from 9% to 4% and ROCE hasfallen from 16% to 9%. ROE has decreased from 21% to 6%.Profit Margins have decreased from 11% to 9%. Although thereis growth in sales but expenses have also increased more thanthe sales proportionately. Current ratio has increased from0.57 to 1.33 which could be due to preferential allotment ofshares toTMI.

Table 1Pre and Post Merger Financial

Performance of Idea Cellular Ltd.

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Table 2Share Price Study

Day t Idea Cellular Limited Spice Communications Limited

AbnormalReturn (%)

Cumulative AbnormalReturn (%)

Abnormal Return (%) Cumulative AbnormalReturn %

-20 -0.14 -0.14 8.17 8.17-19 0.54 0.40 1.42 9.59-18 0.16 0.56 9.54 19.13-17 -0.19 0.37 -0.02 19.11-16 0.76 1.13 -1.75 17.37-15 1.77 2.90 -6.05 11.31-14 -0.78 2.12 0.69 12.00-13 -1.06 1.06 -1.86 10.14-12 -0.77 0.29 5.00 15.15-11 -0.94 -0.65 5.12 20.27-10 -4.06 -4.72 2.31 22.58-9 10.78 6.06 5.21 27.79-8 0.87 6.93 2.19 29.98-7 -1.08 5.85 2.90 32.88-6 0.19 6.04 -4.49 28.39-5 0.04 6.08 2.80 31.18-4 1.58 7.65 2.70 33.89-3 -0.55 7.11 0.06 33.95-2 -0.58 6.53 -1.44 32.51-1 -2.43 4.10 -8.49 24.020 2.39 6.49 32.56 56.581 -2.74 3.75 -1.11 55.482 0.45 4.20 3.06 58.543 -2.57 1.62 2.27 60.804 -3.53 -1.91 3.10 63.905 3.57 1.66 -3.80 60.106 -3.84 -2.18 3.65 63.757 -0.65 -2.83 -1.93 61.828 -0.27 -3.10 0.13 61.959 -2.02 -5.12 1.42 63.37

10 -1.06 -6.18 -3.10 60.2711 -0.98 -7.16 0.82 61.0912 -0.05 -7.22 2.55 63.6313 -1.72 -8.94 0.60 64.2314 -4.22 -13.16 3.88 68.1215 1.51 -11.65 0.75 68.8716 -1.98 -13.62 -3.18 65.6917 1.51 -12.11 -2.91 62.7818 2.93 -9.18 -3.11 59.6819 2.71 -6.47 -0.67 59.0120 0.20 -6.26 -4.14 54.86

The above table displays the Abnormal returns (ARs) andCumulative Abnormal Returns (CARs) of Idea Cellular andSpice Communications for the event window (-20 to +20), i.e.from 20 days before the announcement date to 20 days afterthe announcement.

The Table 2 shows that the shareholders earned an excessreturn of 2.39% on the announcement day which reflects thatthe shareholders expected benefits from the merger. Thereturn on the announcement date is not highest in the preannouncement period signifying that there might be a possibleleakage of the information. A few days before announcementCNBC brought out news that Modi was exiting Spice and Ideawould pick up his share. The CAR of idea shows a gradualdecrease and becomes -6.26% at the end of the event window.This can be attributed to the global financial recession that

took place during the same period which led to negativeinvestor sentiments and hence a falling market.

The mean CAR in the 41 day window is -0.97% but is +5.01% in5 day window (-21to +21) signifying the immediate effect ofannouncement (Table 4).

For Spice Communications, the announcement day returnwas 32.56% (Table 2) which was the highest in the eventwindow. This signifies the immediate advantage of theannouncement for Spice's shareholders. The CAR of Spiceincreased and was 42.29% (Table 6) at the end of period.

The largest firm gets premium from the bidder for acquiring it.And therefore, shareholders of the target firm earn higherreturns than those of the bidding firm.

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Table 3 Mean and Median AR% Based on Market Model Method for Different Time

Window Periods- Idea Cellular Limited

(-)20 TO +20 Days (-)10 TO +10 Days (-)5 TO +5 Days (-)2 TO +2 Days

MEAN -0.15 -0.26 -0.40 -0.58

MEDIAN -0.27 -0.58 -0.55 -0.58

Table 4 Mean and Median CAR% Based on Market Model Method for Different Time Window

Periods- Idea Cellular Limited


MEAN -0.97 2.29 4.30 5.01

MEDIAN 0.37 4.10 4.20 4.20

Table 5 Mean and Median AR% Based on Market Model Method for Different Time Window

Periods- Spice Communications Limited


MEAN 1.34 1.90 2.88 4.92

MEDIAN 0.72 2.19 2.27 -1.11

Table 6Mean and Median CAR% Based on Market Model Method for Different Time Window

Periods- Spice Communications Limited


MEAN 42.29 45.89 46.45 45.43

MEDIAN 54.86 55.48 55.48 55.48

Table 7Paired t-test for Pre and Post-Merger AR and CAR (Idea)

Mean Number SD

Part 1: Pre-Merger AR 0.205117118 20 2.81085255

Post-Merger AR -0.637724732 20 2.271501506

Part 2: Pre-Merger CAR 2.983827822 20 3.415277505

Post-Merger CAR -5.291095791 20 5.412829849

Paired Samples

On comparing the means of pre and post periods in both ARs and CARs, we observe that both show a decrease. The standarddeviation of AR decreases in the post period whereas standard

deviation of CAR increases. This represents a state ofuncertainty in the minds of the shareholders of Idea regardingthe success of the merger deal (Table 7).

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Testing Hypothesis:Idea cellular

Table 8Paired Samples for Pre and Post Merger AR and CAR(Idea)

Pair 1: Pre Merger AR and 0.84 3.49293 0.78104 -0.7919 2.4775 1.0791 19 0.294Post Merger AR

Pair 2: Pre Merger AR 8.27 8.01924 1.79315 4.5218 12.0280 4.6147 19 0.000 and Post Merger CAR

Paired Samples

Paired Differences

Mean SDStd.

ErrorMean

95% Confidence Interval of the

Differencet value

Deg

ree

of F

reed

om

Pro

bab

ilit

y

Lower Upper

Critical value of t at 5% level of significance and df 19 = 2.093

On comparing the calculated value of t with the critical value at5% level of significance (Table 8), we find

|t calculated|(1.0791) < t critical for AR (2.093)

This implies that the difference in the means of pre and postperiod AR is statistically insignificant.

On the other hand, for CAR

|t calculated| (4.6147)> t critical (2.093)

This implies that the difference is significant.

The significance that has been observed in CARs and was not observed in the ARs may be due to the fact that a small samplehad been taken and that CARs may not give accurate answerswhen compared to ARs.

Hence we do not reject our Null Hypothesis. This means thatthe difference in the pre and post announcement day returncannot be attributed to the merger announcement alone.

H1 (null hypothesis): There is no significant difference in themean abnormal returns of the pre and post mergerannouncement period for the bidding firm.

Spice Communications

On comparing the means of pre and post periods in AR we findthat it decreases whereas the mean CAR increases in the postperiod (Table 9).

The standard deviation is lowest during the post period in bothARs and CARs at 2.69 and 3.58 respectively. This impliesstability in the post merger period.

Table 9Paired t-test for Pre and Post-Merger AR and CAR (Spice)

Part 1: Pre-Merger AR 1.201262623 20 4.4783448

Post-Merger AR -0.086064862 20 2.688770566

Part 2: Pre-Merger CAR 21.97125932 20 8.966635975

Post-Merger CAR 61.89628186 20 3.581185589

Paired Samples Mean Number SD

Table 10 Paired Samples for Pre and Post Merger AR and CAR(Spice)

Pair 1: Pre Merger AR 1.29 4.8400 1.0822 -0.9778 3.55252 1.18948 19 0.248and Post Merger AR

Pair 2: Pre Merger AR -39.93 8.34529 1.86606 -43.830 -36.019 -21.395 19 0.00and Post Merger CAR

Paired Samples

Paired Differences

Mean SDStd.

ErrorMean

95% Confidence Interval of the

Differencet value

Deg

ree

of F

reed

om

Pro

bab

ilit

y

Lower Upper

Critical value of t at 5% level of significance and df 19 = 2.093

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On comparing the calculated value of t with the critical valueat 5% level of significance (Table 10), we find

|t calculated| (1.18948)< t critical for AR (2.093)

This implies that the difference in the means of pre and postperiod AR is statistically insignificant.

On the other hand, for CAR

|t calculated| (21.395)> t critical (2.093)

This implies that the difference is significant.

The significance that has been observed in CARs and was not

observed in the ARs may be due to the fact that a small samplehad been taken and that CARs may not give accurate answerswhen compared to ARs.

Hence we do not reject our Null Hypothesis. This means thatthe difference in the pre and post announcement day return

Table 11Combined Returns

Dat t Daily Excess Return Combined Excess Return

Idea Spice Based on Market Value

As on (t = - 1) Cumulative Gain/Loss

1 -2.74 -1.11 -2.54 -2.54

2 0.45 3.06 0.78 -1.76

3 -2.57 2.27 -1.96 -3.73

4 -3.53 3.10 -2.70 -6.43

5 3.57 -3.80 2.64 -3.79

6 -3.84 3.65 -2.90 -6.69

7 -0.65 -1.93 -0.81 -7.49

8 -0.27 0.13 -0.22 -7.71

9 -2.02 1.42 -1.59 -9.30

10 -1.06 -3.10 -1.31 -10.62

11 -0.98 0.82 -0.76 -11.38

12 -0.05 2.55 0.27 -11.10

13 -1.72 0.60 -1.43 -12.53

14 -4.22 3.88 -3.20 -15.74

15 1.51 0.75 1.41 -14.32

16 -1.98 -3.18 -2.13 -16.45

17 1.51 -2.91 0.96 -15.49

18 2.93 -3.11 2.17 -13.31

19 2.71 -0.67 2.28 -11.03

20 0.20 -4.14 -0.34 -11.37

cannot be attributed to the merger announcement alone.

H2 (Null Hypothesis): There is no significant difference in themean abnormal returns of the pre and post mergerannouncement period for the target firm.

The table depicts the combined ARs for 20 days after theannouncement date. The combined returns gradually fall andreach to -11.37% (Table 11). This signifies that there was noadditional wealth creation for the shareholders of the firm.This confirms the common hypothesis that a merger is either azero sum game or a loss game for the combined firm.

H3 There is zero or negative combined excess return for themerging entities.

ONCLUSIONS

The study analyzed Idea Cellular's acquisitionof Spice Communications. It examined theeffect of the merger on the wealth ofshareholders of both the companies by

CC

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Another limitation of the study lies in market orientatednature of the analysis. The model we used relies heavily onmarket values, and there may be a possibility of shareholdersovervaluing the shares.

Some researchers are of the view that shorter event windows(5-day or 3-day) are more reliable and longer windows havesome serious limitations. One disadvantage of using longerwindows is that other, unrelated events may be confoundedwith the event of interest. If other relevant events occurredduring the event window, it is hard to isolate the impact of oneparticular event.

The study doesn't look at other factors that can affectshareholders' returns such as means of payment (equity,cash), international diversification, merger motives and thenature of markets.

The long term effects of a merger in terms of financialperformance can be analyzed only in due course of time.Finally, the study cannot be generalized as it could not bejustified on the basis of a single case study.

UGGESTIONS FOR FURTHER RESEARCH

Similar studies can be carried out on a largerset of merger deals. Future research mightinvestigate whether the shareholders' returnsvary with the mode of payment. Also the

research can cover a wider set of ratios to measure corporateperformance.

comparing pre and post merger financial ratios and thebehavior of share prices.

The results failed to support the fact that value is created forthe shareholders of the merging entities. Focusing on theperiod around the announcement date, it is observed thatnegative excess returns prevail in the market. Also thedifference in the returns cannot be attributed to mergerannouncement alone. There are external factors also in playthat affect an organization.

EY CONTRIBUTIONS OFTHE STUDY

This study will add to the literature of M&As.Although there have been M&As in the Indiantelecom sector, to our belief, no such study hasbeen taken up in this sector yet.This paper will

help the readers gain an insight into the problems and gainsassociated with an acquisition. The case that we have pickedup involves players that are domestic and hence it helps tounderstand the Indian scenario better.

IMITATIONS OFTHE STUDY

There were few limitation in the study carriedout in this dissertation. The first and theforemost limitation of this study is that wedidn't take in to account the external

economic conditions to analyze the shareholders' wealth. Theexcess returns may be due to some external factors affectingthe stock price of target or bidding firm and in theseconditions it could be erroneous to conclude thatshareholders wealth is maximized by acquisition or merger.

KK

LLSS

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A Case Study of Acquisition of Spice Communications by Isaasdaddea Cellular Limited

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