Dautens Proposed Acquisition of Record Masters Medical Records Archiving Business - Case Study Example

Case Study- Dauten’s proposed acquisition of Record Masters Medical records archiving business Question 1: This financial case study relates to acquisitions or better stills a “leveraged buyout.” (Leveraged Buy-Out). This would be more in line with an acquisition or buyout, with Dauten having to decide on the modus operandi (MO) of whether, in the first place, he would be interested in this deal (RM, on their part are ready to sell) and if so at what price per share to the existing shareholders in four differently located branches of Record Masters- Detroit, New Orleans, Pittsburg and Philadelphia. The present prospective buyer, Dauten is an erstwhile general partner of the Chicago Private Equity Firm that goes by the name of Madison Dearson Partners and needs to delve deep into the financial aspects of whether this would be a worthy sponsorship. However, one of the major advantages of this buyout would be that he would be in a position to play a more active management role in this resurrected company of which he would perhaps, be the main functionary. The main aspect that needs to be considered at this stage, would be a reasonable amount that Dauten needs to pay off to the existing stakeholders of Record Masters (RM) that would be well within his budgeted estimates, and also a price that the present owners of RM would find irresistible. Discounted Cash Flow method for determining purchase price: This could be done through the Discounted Cash Flows method that, applying the assumed discount factor of 11%, would consider the present value of future cash flows. There are certain assumptions that need to be considered, the first being that Dauten would only be interested if the growth rates are maintained that is 40% annual growth rates are maintained. This is a conservative estimate keeping in view future fall in growth due to competitive and other reasons. As per the Excerpts from the Selling Memorandum, the “compound annual growth rate” is 49%.” (Record Masters 9). Further, the outside debts owned by the present owners of RM would be reduced in arriving at the final purchase consideration. We shall consider the projection for the next four years to arrive at the purchase consideration For the first year, that is1993, the revenue is $6858,000. (Exhibits 12-4-Financial Summary - P. 8 ) It is conservatively estimated that this revenue has growth rate of 40% every year. The projections for the next 5 years are tabled below: Particulars Basis Year 0 Year 1 Year 2 Year 3 Year 4 Revenues 40% + 6958,000 9741,200 13,637,680 19,092,752 26,729,853 Oper. costs 83% 5775,140 8085,196 11,319,274 15,846,984 22,185,778 Oper. profits 1182,860 1656,004 2318,406 3,245,768 4,544,075 Taxes 3.2% 37,852 52,992 74,189 103,865 145,410. post tax profit 1145.008 1603,012 2,244,217 3,141,903 4,398,665 Yearly Increase portion in working capital (Note I ) Yearly 10% increase 115,176 126,694 139,363 153,300 168,630 Net cash flows 1029,832 1476,318 2104,854 2,988,603 4,230,035 NOTE 1: It is assumed that working capital demands increase by 10% every year. Working capital = Trade debtors – trade creditors = 1278,267 – 126,502 = 1151,765 (Record Masters 23). 10% increase = $115,176 TREND OF WORKING CAPITAL OVER 5 YEAR PERIOD Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 1151,765 1266,941 1393,635 1532,998 1686,298 1854,928 + 115,176 126,694 139,363 153,300 168,630 - Calculation- DCF of estimated 5 year cash flows: Record Masters @ 11% interest rate Serial Year Cash flows ($) Discounted rate Product ($) 1. 0 1029,832 0.900900 927,775 2. 1 1476,318 0.81162 1198,209 3. 2 2104,854 0.73179 1540,311 4. 3 2988,603 0.65873 1968,682 4. 4 4230,035 0.59345 2510,314 Total ∑ $ 8145,291 The next step would be to reduce the outside debts acquired by Record Masters from the total purchase consideration. Thus, the final purchase consideration which would have to be paid by the acquirer, Dauten, would be reduced by the outside debt of $ 99410, which is the current portion of long term debts. (Record Masters 23). Thus, the final PC or Purchase consideration would be as follows: Total present net value of future cash flows for 5 years - $ 8145,291 Less: Current portion of long term debts 99,410 NPC payable by KD to stakeholders of RM $ 8,045,881, around $ 8 Million. It is necessary to examine this proposal from the perspective of the buyer, Dauten. It does meet the major four criteria for acquisition in terms of: Budgeted Purchase Price “$ 5-15” – Price only around $8 million Minimum $1 Million Earnings before Interest Taxes (EBIT) – projection up to $ 4 million envisaged cash flows in Year. Stable industry – since it has direct business nexus with hospital industry- business would only grow in commensuration with increase in level of activities of hospitals and health care centers. “Controllable” expenditures and prospects of increased revenue in latter years. (Record Masters 4). Question 2: Now that Dauten has taken a decision to invest $ 8 million into Record Masters; he needs to arrange for funds for the proposed buyouts and also for future payments against the interest on loans taken to finance this scheme. In the first place, it could be said that 70% ($ 5.6 Million) of the funds for this project could be borrowed by Dautenfrom outside sources, preferably banks and financial institutions at lower rates of interests than if he were to approach private finance. In the event this is not possible, it could be possible to raise bank finance it would be necessary to issue 8% Redeemable Preference shares for the value of 70% of the value of the buyouts. The reason why equity public issue is not been done is being discussed below. The balance $ 2.4M would be done through private placements by Kent, his associates and others. In the event the bank loan is passed for 70% value, the interest on loans would be paid off from the amounts receivable from reconstituted RM earnings and profits. SCHEME FOR ACQUISTION OF MAJORITY HOLDINGS IN RM Acquisition price: Around $8 Million Status: profitably run leadership status business unit in medical record keeping industry. Good growth prospects. Almost unique of its kind in the US, besides microfilming, etc. Particulars GA NA ($) First part : Option 1. Secured loan for 70% of the purchase consideration amount of $8 Million with assets of other Dauten companies pledged as collaterals and interest payable out of RM future earnings OR Option B. 8% Redeemable (at premium of 5%) Cumulative Debentures in acquired company issued to existing stockholders, members of group companies etc Second part : Private placement of shares 24,000 ordinary shares of $100 each issued at par ( private placements ) Total Value of allotments $5.6 Million $5.6 Million (Par value ) $ 2.4 Million (Par value ) $ 8 Million Debentures have been preferred over equity Capital for two reasons: 1. For management control to vest on owners themselves and not diluted to outsiders 2. Further Dividend payments could be postponed till such time large reserves are accumulated that could take care of future contingencies. 3. Fixed interest carrying shares would make future cash projections and budgeting easier while also allow ownership and control to vest on new owners. “The capital structure refers to the kind and proportion of different securities for raising funds … If long term finances are required then share capital and debentures may be useful.” (Gupta and Sharma 15.7). Justification: Equity issue would dilute the ownership and control further and would not be a viable option at this stage. In the present state it would be next to impossible to get bank loans for such a large amount and even if it were it would be only for a short term and would not serve Kent’s purpose. Public have lost faith in bonds due to the plethora of junk bonds floating in the market and would even put Kent’s other business interests at stake. Thus the best options would be in terms of a private placement and a larger debenture issued (issued against a fixed charge/lien on assets of the company). Private placements would ensure that funds are within the inner circles and could be maneuvered easily. Question 3: In order to increase the value of his newly acquired business, it is necessary to seek non medical business sources also for record and archiving prospects. Medical recording for one thing, is not bereft of legal implications and needs a very strong and robust infra-structured facility. This is not to infer or assume that RM are not equal to their tasks, but depending 80% on just Medical businesses for a large scale business unit does entail a great deal of risks. Professionals like accountants, lawyers, architects, judges, etc need a lot of private and confidential data and are often at a quandary on how to preserve and retrieve them. Dauten needs to move exponentially into other major areas of archiving to improve business. Another critical aspect that Dauten needs to do now is to cut cost and cut them dramatically. Operating costs now constitute 83% of revenues. He needs to take a good hard look at the expenses and decide which are material and critical and which are not. The immaterial costs need to be trimmed fast and even wiped out, while others may be economized. This may be taken as a 12 year program. Some of the high costing payroll expenses, rent and bonus expenses need to be rationalized and economized. They could even think in terms of leasing some of their operations or even outsourcing part of their business if it makes economic sense and could generate better business or save operating costs. A dollar saved is a dollar earned and nobody except perhaps Dauten could do this at this stage, especially when costs of the new acquisitions are threatening to assume menacing propositions, although the revenue earning capacity may be good, but nothing stops it from going worse in latter years, especially when a new management is managing things in the future. Another important aspect that needs to be considered by Dauten would be in making in-depth studies about his competitors, what their modus operandi are and how they tackle the various issues, legal or otherwise than crop up from time to time, in this trade. For one thing, being a relative newcomer, Dauten needs to know his business inside out, and should lap up whatever information he gains about his competitors. He must not commit the mistakes they commit, and try to gain similar kind of competitive advantages that they, by virtue of being in the business for long, and gaining the trust and confidence of their customers and exclusive clientele, they have been able to garner for long. One of the most important aspects about the kind of business that RM indulges in is the high degree of privacy, confidentiality and trust that hospitals share with these record keepers. Perhaps, even unwittingly, RM is archiving billions of dollars worth of patient information and critical data, sometimes, whose retrieval could even make a difference between life and death of the patient to whom these records belong. Besides patients and their care givers, there are whole gamuts of people and agencies that may have co-parcenary interests in these records, including near relatives, care providers, health care professionals, insurance agencies and companies, underwriters, clinics and dispensaries, and last but not the least, the patients themselves. At any point of time, any kind of record, spanning any time period (archived of course), could be required pronto and need to be delivered by RM. Thus, speed, efficiency and retrieving dexterity are critical factors in this business. The new owners, Dauten, needs to understand the time and speed implications in these critical data retrieval which could be gained through proper assimilation and perfect archiving, a transparency that needs to seep from the highest echelons to the lowest levels of the corporate administrative hierarchy. Moreover, it is also necessary that RM move with the times. Nowadays, a lot of ground has been gained in terms of imaging and storage discs, which obviates the need for any kind of paper documentation. A lot would depend upon the kind of archiving and document storage which the respective hospitals and clients feel comfortable in, and which they feel are trustworthy and dependable, beside the obvious cost factor. No hospital administrator would consider changing its entire documentation and archiving recording systems overnight – it would not only be hazardous, but positively suicidal. However, considering the floor space costs, believed to be $400/ sq feet of unproductive space, which does not generate benefits of any kind, it would indeed be a worthwhile proposition to seek out innovative solutions to clients archiving problems, in tune with the changing times. With nanotechnology being the ‘in thing’ in today’s corporate world, everything seems to be shrinking, innovators may even ask- why not shrink data record keeping to its barest minimum? The challenge which an alert and enterprising professional may ask may become the next request, especially in hospital settings where archiving and retrieval are critical and important aspects, not only of patient care, but also, in a broader level of its core functions. Thus, RM would need to consider such options for the future, and needs to be best informed and should be in a position to give sound and plausible replies to these, and other queries. While most clients would not be ready to risk privacy, confidentiality and safety of client data and records, especially when handled by offsite professionals, they would be willing to at least experiment with certain new techniques which could come of useful in terms of cost and space savings for future use. Thus, within limit ambit, experimentation with newer archiving technology could be taken up by RM, and its new management under Dauten. Another major area that needs to be taken up is with regard to whether Dauten plans to keep RM for some time beyond the point of getting back his investments or whether he would be looking for prospective buyers for this business within a short or medium term, Dauten could take pride in the RM LBO in that he has reaped in a sound and profitable business. With medical and health care high up in the agenda of the present government, business would never have been better- but the question is whether RM’s present management would be able to capitalize on its opportunities. For one thing, servicing large, critical and time-sensitive documentation requirements of patients, etc need to be entrusted in the hands of experienced professionals, which the present team at RM undoubtedly has. But the main factor would be how improvement could take place, considering the fact that most clients are reluctant to experiment with new technology in this area of health care management document preservation and archiving. With the formalities of the formal takeover almost over, there would definitely be a large spurt in business in times to come. Would it be necessary to augment, trim or downsize personnel? This is a critical aspect that needs to be address in the next answer. Question 4: Alignment of local owners’ incentives with goals of Dauten. A glance at the Exhibit 12-4. – Extracts of the Franchise Agreement are given below: “1. A royalty of $750 plus 1% of sales per month.” (Record Masters 20). The administrative royalty works out to $ 42,319, while the incentive bonus is a whooping $320,125 for the fiscal ending December 31, 1993. It is necessary that the new management headed by Dauten takes serious consideration of the commission which forms a sizeable part of the total expenses. One of the major reasons why Dauten has agreed to take over this business is to make it into a more profitable and viable unit and enforce modernity and development in the various activities carried out by it. At this stage, it would not be judicious to downsize the business, first considering the criticality of the contributions made by personnel at every level and secondly, the market is expanding, and more people are actually needed. However, Dauten has brand leadership in mind for Record Masters as well as being a viable and highly competitive and integral unit with professional serviceability. High costs and efficiencies do not go together and thus it would become necessary to trim costs wherever necessary or expedient to do so. However, in the case of the local owners, it is necessary that they also contribute to the newly structured company, in terms of their wealth of experience and expertise in the business, about which newcomers may not be well aware. The commission systems would need to be revamped at a later stage, perhaps after 2 years of operation. The commission, instead of being a flat rate of 1% of sales on monthly turnover would depend upon the level of business directly attributed above a fixed slab. For instance, it could be something like: 1. Below $ 1Million of turnover -no commission 2. Between $1M – 1.24 M -0.25% of monthly sales (payable every quarter) 3. Between $1.25M – 1.49M-0.50 % of monthly sales (payable every quarter) 4. Between $1.50 M – 1.74 M-0.75% of monthly sales( payable every quarter) 5. Between $1.75 M – 2.00 M -1.00% of monthly sales( payable every quarter) This would not only guarantee a minimum sale per year, but would also provide the necessary impetus for owners to try to reach the maximum stage through individual, and/ or group efforts. Again, this would also be in terms of the mission and vision statement of the newly constituted company to attain brand leadership through highest revenue generation and customer servicing. Moreover, there are possibilities that many of the existing owners may opt out of this scheme, which would make things easier for the new company in terms of new capital formation and new scope for better business in new territories or locations. It is also possible that new owners are given independent charge of their franchisees and only report of revenues, costs and stocks at periodic intervals, which would not only provide much needed business autonomy but also bring in better business in future years. Conclusions: From the above, it is seen that the capable entrepreneur that Dauten is, he has got a prize catch in the form of Record Masters. This could be evidenced in the fact that it is an ongoing profit making and growth oriented company with no turnarounds, and a strong balance sheet and net worth. How Dauten and his team are able to manage this business in the years to come would be the subject matter of yet another case study. Works Cited Gupta, Shashi K. and Sharma, R. K. Management Accounting: Principles and Practice: Nature and scope of financial management. Delhi: Kalyani Publishers, 1991. Print. Leveraged Buy-Out-Company Acquisition Method. Value Based Mangement.net. 10 Dec. 2009. Web. 21 Dec. 2009. . Record Masters: Exhibit 12-4: Excerpts from Record Masters Selling Memorandum. Coopers & Lybrand Merger & Acquisition Services, 1994. Print. Read More