Indian Takeovers: A Residual Income Approach to Analyse Value Creation for the Acquirer

Abstract

The objective of the paper is to test financial performance of major merger and acquisition deals done by Indian companies in the past. The traditional accounting methodologies do not sufficiently address the key issue that whether mergers and acquisitions have a positive value creation for the acquirer and hence, is a positive NPV proposition or not. The paper employs residual income approach for valuing, and comparing the present value of the acquirer’s future earnings before the acquisition, with those that actually result following the takeover. The cost of the acquisition, the acquirer’s cost of capital, and the earnings have been taken into account. The residual income approach is used for evaluating a few major Indian takeovers during 2000-10. Using the traditional accounting method, it was observed that acquisitions result in a significant or marginal decline in profitability. However, the results using the residual income approach shows that the fundamental valuation of acquirers is significantly lower after the acquisition than it is before the acquisition.