Corporate finance: Expand Ltd Case - Assignment Example

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Corporate Finance Table of Contents 0 Introduction……………………………………………………………………………… 3 2.0 Meaning of Mergers and Acquisitions………………………………………………….. 4 3.0 Methods of Valuation…………………………………………………………………..... 5 3.1 The comparative worth method………………………………………………… 5 3.2 The asset valuation method…………………………………………………….... 5 3.3 Financial performance methods………………………………………………… 6 3.4 Book value method……………………………………………………………….. 7 4.0 Microsoft Corporation…………………………………………………………………… 7 5.0 Skype Corporation……………………………………………………………………….. 8 6.0 Microsoft’s Acquisition of Skype………………………………………………………... 8 7.0 How Microsoft and Skype were valued…………………………………………………. 9 8.0 Factors considered in the valuation of Microsoft and Skype………………………….. 10 9.0 Negotiations held by Microsoft and Skype……………………………………………… 11 10.0 Recommendations……………………………………………………………………….. 12 11.0 Conclusion……………………………………………………………………………….. 12 12.0 Executive Summary……………………………………………………………………... 13 References……………………………………………………………………………………... 14 1.0 Introduction Expand Ltd is planning to grow their business. It wishes to do so by acquiring the business of another existing company or merging with another company. To do so, the firm will require a valuation to be undertaken so as to determine its worth and the worth of the other company that it will either acquire or merge with. This valuation may be done on both the assets and liabilities of Expand Ltd and the other firm that may be acquired or merged with Expand Ltd. This is necessary so as to determine the worth of both companies before a merger or acquisition is possible. In corporate finance, valuation may be described as the process of estimating or approximating the worth of a corporation or a firm. The most commonly valued items are financial assets or liabilities. Assets that may undergo valuation may include marketable securities such as business enterprises, options and stocks or intangible assets which may include trademarks and patents. Liabilities that may undergo valuation may include bonds that have been issued by a company. Valuations may be necessary for a number of reasons such as in litigation, determination of proper tax liability, financial reporting, capital budgeting, investment analysis and merger or acquisition transactions. This report will focus on the methods of valuations that Expand Ltd may use as it seeks to either merge with another company or acquire it. The report will refer to stock market valuations and how they work. This report will also discuss the recent acquisition of the Skype by Microsoft Corporation, an American multinational corporation. This report will explain how the two companies involved in this acquisition were valued and the factors that were considered in the decision process. The report will also focus on the negotiations held by the concerned parties. 2.0 Meaning of Mergers and Acquisitions Firms seek to expand and grow their business after being in operation for some time. This is done for a number of reasons such as increasing profits, satisfying the unique needs of the customers, attracting and retaining more customers and remaining highly competitive. Expansion and growth of businesses can be done through various means (Harwood 2006). Mergers and acquisitions are ways through which this can be achieved. Mergers and acquisitions simply refer to the aspect of corporate finance, management and corporate strategy that deals with the combining, dividing, selling and buying of similar entities and different companies that can assist in the rapid growth of an enterprise in its location of origin, new location, new field or its original sector by using a joint venture without creating a subsidiary (DePamphilis 2008). Many corporate finance specialists such as DePamphilis (2008) and Harwood (2006) note that in various respects, the distinction between an acquisition and a merger has become more and more blurred. This is especially true when it comes to the ultimate economic outcomes of both mergers and acquisitions. However, they also point out that the distinction between the two terms is not completely lost in every situation. An acquisition is defined as the purchase of a company or business by another business entity or company (DePamphilis 2008). Surveys show that achieving successful acquisition has been a very difficult venture. In fact, various studies conducted on major acquisitions show that 50% of those acquisitions have been unsuccessful. The term acquisition is usually used to refer to the purchase of a smaller company by a larger one. However, there are cases where smaller firms have purchased larger firms. A merger on the other hand refers to the situation whereby two distinct companies or businesses come together and agree to move forward as a single new entity or company that is no longer separately operated or owned. In a merger, both companies are considered to be equal and no company appears to have taken over the other company (Harwood 2006). 3.0 Methods of Valuation There are various methods of valuation that may be used in the determination of the value of a company before it is acquired. The following are some of the most common methods of valuation that can be used by firms to determine their worth: 3.1 The comparative worth method This notion reflects the potential selling prices and performance of private and public companies in comparison to yours so as to arrive at a value. The person conducting the valuation is referred to as the appraiser. The appraiser examines a company that operates in similar or the same industry, or provides similar or the same services and/or products (Harwood 2006). This method highly involves the estimation of the market value of assets of a company by comparing the value of the two companies that enter into an acquisition agreement. This method usually leads to the finding of a preliminary range of values that need to be adjusted so as to fit the current situation of the target company. These values must also be justifiable (DePamphilis 2008). 3.2 The asset valuation method This method of valuation is mostly used if a company has a significantly large portion of its value revolves around a fixed asset. The appraiser may use this method as he or she tries to price the asset in question. In this method of valuation, all the tangible and intangible assets held by a company are carefully examined so as to arrive at the fairest valuation. Assets such as machinery and equipment, inventory, land, office fixtures, office furniture, vehicles and real estate are examined and assessed. Other intangible assets such as customer lists, trademarks or patents should also be included in the valuation (DePamphilis 2008). These intangible assets are usually referred to as company goodwill. This is the difference between the value of the hard assets of the company and the true value of the company. With this method, it is a bit difficult to convince the acquiring company about the value of the intangible assets since they usually want to deal with tangible assets (Harwood 2006). 3.3 Financial performance methods These methods tend to measure the historical performance of a company as well as predict the future performance of a company so as to determine the value of a business before it is closed. The three most common methods used here include the Net Present Value (NPV), the Return on Investment (ROI) and the Internal Rate of Return. The Net Present Value is a method that compares the current value of the proposed transaction costs and benefits. The difference found between the costs and the benefits is the Net Present Value. This is one of the most common financial performance valuation methods used to determine the worth of a company (DePamphilis 2008). The Return on Investment ratio (ROI) can be used as an important benchmark by any buyer because it is considered as a comparison between the earnings of recent years and long-term debt and equity. The Internal Rate of Return (IRR) is a representation of the discount rate which makes the comparison between the price and the profits that are anticipated from the proposed transaction (DePamphilis 2008). 3.4 Book value method In this method, historical numbers are used and the future is ignored. This method assumes that the value of a firm is equal to the book value of all the assets of the said firm. Intangibles and risk are ignored and the price that is paid for an asset of a firm may have no relation to its own value (Harwood 2006). 4.0 Microsoft Corporation The Microsoft Corporation is a multinational corporation based in Redmond, Washington, USA. The core business of the company involves licensing, supporting, manufacturing and developing a wide range of services and products that are strongly associated with computing. The Microsoft Corporation has many divisions that deal with different products and services. These include the business division, the entertainment and devices division, the windows and windows live division, server and tools division and the online services division. Microsoft was established on 4th April 1975. It initially developed and sold interpreters for Altair 8800. Later in 1980s, the Microsoft Corporation rose and dominated the market for home computer operating systems. It first used MS-DOS and later the series of Microsoft Windows operating systems (Harwood 2006). The Microsoft Corporation was founded by Bill Gates and Paul Allen. It serves worldwide because it produces operating systems for computers all over the world. In 2011, Microsoft’s revenue was estimated to be US $ 69.94 billion. Its operating income was US $ 27.16 in 2011. The company made profits worth US $ 23.15 in 2011. Its total assets as of 2011 stood at US $ 108.7 billion and its total equity during the same year was US $ 57.08 billion dollars. Currently, the Microsoft Corporation has employed over 92,000 workers. The company has numerous subsidiaries at different locations all over the world. 5.0 Skype Corporation Skype is a software application and voice over the internet protocol (VoIP). It was originally created by Janus Friis and Niklas Zennstrom. Skype is a service that gives its users the opportunity to communicate with their peers through instant messaging, video and voice over the internet. The recipients may have phone calls placed on telephone networks. Users that are within the Skype service can make calls free of charge. A debit user account system charges calls to mobile phones and landline telephones. Skype also has additional features which include videoconferencing services and file transfer services. The main competitors of Skype include Google talk, Ekiga, Linphone and Empathy (Harwood 2006). As of September 2011, Skype had more than 663 million users who had registered with the service. Skype is considered a peer to peer system. It is not taken as a client-server system. The company uses background processing found on computers that run Skype software. 6.0 Microsoft’s Acquisition of Skype The Microsoft Corporation agreed was interested in acquiring Skype Communications and agreed to do so on May 10th 2011. Skype Communications was to be fully acquired by the Microsoft Corporation from its original creator and owner, Manuel Patino. Skype became incorporated as a division of the Microsoft Corporation after Microsoft fully acquired the technologies of Skype Communications. The deal was completed on 13th October 2011 after Microsoft paid US $ 8.5 billion to Skype. There has been a lot of speculation about the recent acquisition of Skype by Microsoft. Debates have been revolving around whether the acquisition was a good or a bad decision. Some people have been claiming that Skype was underpaid while others have made claims that it was overpaid for the acquisition. However, whether it was a defensive or aggressive move will remain to be seen in a matter of time as the company is allowed to operate for a while (DePamphilis 2008). 7.0 How Microsoft and Skype were valued The Microsoft Corporation was recently valued at US $ 69.94 billion in 2011. This estimate was arrived at through the asset valuation method and the financial performance method. The assets of the company were carefully examined and valued so that the true worth of the company could be established. The financial performance of the company in the New York Stock Exchange (NYSE) was also used to establish how much the company was worth through its investors. These methods of valuation were used to determine that Microsoft was the larger company of the two and it had the ability to pay for the acquisition of the smaller company, Skype. Skype Communications on the other hand was initially valued ad US $ 2.5 billion. That is why when Microsoft paid US $ 8.5 billion to acquire Skype, people did not understand why and how this was possible. Considering the number of users of Skype during that moment, the purchase translates to Microsoft having paid US $ 14.7 billion to each Skype user. Stock market valuations were also done so as to determine the true worth of both companies. This is the method of calculating the values of companies and the stocks that they own theoretically. This method is usually used so as to determine the market prices in future. Stock market valuation deals with determining the prices of the stocks of a company and how many people have invested in those stocks. This is a useful method of determining the value of a company. 8.0 Factors considered in the valuation of Microsoft and Skype Microsoft considered the fact that when Skype was bought by eBay in 2005, the amount of money paid per Skype user at that time was US $ 45.60. This was expensive considering what Microsoft paid per user to acquire Skype in 2011. Microsoft therefore knew that it had got a good deal from Skype and went ahead to purchase it at US $ 8.5 billion. Another factor that was considered in the valuation of the two companies was the costs of the acquisition. The cost of the entire acquisition is important in determining whether the purchase is worth or not. This is because it will determine whether the acquiring company will be able to break-even after the acquisition. The profits that would be made were also considered. This was closely related to the cost and it was important because the acquiring company should always consider how much money it is going to make from the acquisition. The market demand was also considered before the acquisition was done. Microsoft considered how Skype as a social network was in demand among users and sought to acquire it and make it more profitable than it already was. This was important because demand would determine the best price to make the acquisition. High demand would mean a higher price and low demand would translate into a lower price. The skill level and level of expertise to keep the business running even after it is acquired was also an important factor that was taken into consideration. Microsoft needed to ensure that it had enough skill and expertise to keep the new company running and profitable after it was purchased. This would also determine how much the companies were worth. Microsoft also had to consider its type of services and products that it offers to its customers and the type of products and services that Skype offers to its clients. This was also important in determining the overall worth of both companies. Another major factor that was taken into consideration during the valuation of the two companies was the type of clients. The type and number of clients that each company had would be important in determining the worth of the two companies. 9.0 Negotiations held by Microsoft and Skype Before the deal was sealed, Microsoft and Skype had to make certain negotiations. A lot of factors had to be taken into consideration before sealing the deal. Microsoft had to negotiate the overall price considering the fact that Skype had made a net loss of US $ 7 million during the previous year before the acquisition. Microsoft also had to negotiate with Skype considering the fact that in 2005, eBay acquired Skype at a price of US $ 2.5 billion. The price therefore had to be close to this because not very many years had passed. It is necessary to negotiate the selling price of any business so as to get the best deal. Sellers of businesses usually have an asking price but it is necessary for the buyer to try and have the price reduced. This is because most sellers expect buyers to make offers that are lower than their original asking price. For this reason, some sellers may ask for high prices because they expect the buyers to negotiate. It is therefore necessary for buyers to enter into negotiations with the sellers so that both parties can get the best possible deal. During the acquisition of Skype by Microsoft, a lot of negotiations were done. This is evident from the fact that Skype was originally asking for over US $ 10 billion before the US $ 8.5 billion deal was reached. This shows that bargaining in necessary when buying another firm. 10.0 Recommendations Expand Ltd may follow some of the actions that were taken by Microsoft when it was acquiring Skype. As seen in the introductory parts of this report, most mergers are known to be unsuccessful after some time. Expand Ltd should therefore venture into acquiring another firm instead of merging with it. The company should grow its business by buying another firm and taking over its business operations. This is more likely to succeed than a merger. It is also recommendable that Expand Ltd should combine the various methods of valuation so that it can determine the most accurate value of the other company that it wishes to acquire. Using more than one method of valuation is more likely to produce accurate results than using a single method. Negotiations are highly recommendable before making any acquisitions. The acquiring company should bargain the initial price that has been quoted by the firm that is being sold. This will enable the two firms to agree on a price that is suitable for both of them, thus enabling both partied to have the best possible deal. Expand Ltd should not simply agree on the first price that has been quoted. It should try to negotiate and bargain so as to land the best possible deal. 11.0 Conclusion In conclusion, many businesses, firms, organizations and companies may seek to grow their business in one way or the other. Mergers and acquisitions have been seen to be one practical way of ensuring that companies are able to expand and grow their businesses. There are many advantages that may arise from mergers and acquisitions such as increased profitability, improved customer satisfaction and more products and services among others. There are also a number of identified implications that come with mergers and acquisitions such as high costs of purchasing and disagreements that lead to business failure or breakup. However, if carefully executed, mergers and acquisitions are very advantageous to most businesses. Valuation has been seen as one of the most necessary actions that precedes any merger or acquisition. It is used to determine the value or worth of the two companies entering into the agreement so that they can both have the best possible deal. There are several methods used in valuation of firms that have been discussed in the essay. Firms should be keen on which methods they use and should enter into such agreements after careful planning and consideration of all the risks involved. By doing this, valuation can be an effective process that can ensure the success of mergers and acquisitions. 12.0 Executive Summary This report has focused on the methods of valuations that Expand Ltd may use as it seeks to either merge with another company or acquire it. The report has referred to stock market valuations and how they work. This report has also discussed the recent acquisition of the Skype by Microsoft Corporation, an American multinational corporation. This report has explained how the two companies involved in this acquisition were valued and the factors that were considered in the decision process. The report has highlighted the negotiations held by the concerned parties and has given recommendations for other companies that may seek to follow the same path by acquiring other companies. This report is useful for any company that seeks to expand and grow its business through mergers and acquisitions. The report is also useful in the process of valuation so as to determine the worth of companies because it highlights the methods of valuation that may be used. References DePamphilis, D 2008, Mergers, acquisitions, and other restructuring activities, Elsevier Academic Press, New York. Harwood, IA 2006, ‘Confidentiality constraints within mergers and acquisitions: gaining insights through a 'bubble' metaphor’, British Journal of Management, vol. 17, no. 4, pp. 347-359. Read More