William Hill Plc acquired 624 betting shops of Stanley Leisure an Evaluation - Coursework Example

?William Hill Plc acquired 624 betting shops of Stanley Leisure – an Evaluation Introduction On June 18, 2005 a leading betting company d as William Hill Plc undertook an acquisition deal and purchased 624 licensed betting offices of Stanley Leisure with upfront cash consideration of ?506.6 million. This article highlights the basic motive of William Hill Plc behind this acquisition, the impact of this acquisition on the capital structure of the company and lastly the impact of this deal on the value of the firm. The outline of this article is framed in such a manner that the first section describes the theory of investment decisions for the acquisitions. Next section highlights the motivation of top management of William Hill Plc behind this acquisition deal. Subsequent section emphasizes the impact of this acquisition on the capital structure of William Hill Plc. Last section of this article describes the impact of this acquisition on the value of William Hill Plc followed by a conclusion section which leads to the end of this article. Growth Forms – Organic v/s Acquisition There are different forms of growth approaches that companies generally follow. Typically if a company wants to make growth, then in such circumstances the company has two choices whether to go for an organic growth or to go for acquisition or a combination of both. For organic growth, the companies generally expand their business operations by opening up new branches, adding up new product lines etc. On the other hand, for acquisitions, the companies generally purchase an existing business such that the company owns that business and in this way it brings expansion in its existing business operations. Valuation Tools for Investment Opportunities Capital budgeting is a tool which is used to evaluate the financial viability of the projects whether in the form of organic growth or in acquisitions. In this technique the future cash flows are estimated including both the outflows and the inflows pertaining to that project after which net cash flows are computed. Those net cash flows are discounted by a relevant cost of capital of the company to arrive at the present values of all the net cash flows. Those net cash flows are then summed up to obtain the Net Present Value of the project. The NPV is then used as a tool to decide whether a project is feasible or not such that if the NPV figure is positive, then the project should be accepted and if it comes as a negative figure, then that project is advised as not to be accepted. Capital budgeting also has some other related criteria for checking the viability of the projects. Those criteria include Internal Rate of Return, Profitability Index, Discounted Payback and other similar techniques. Most of these techniques work on the basic principle of discounted cash flows. These financial projections and the computation of NPV are generally prepared by the finance departments of the companies and they are used for internal reporting purposes. Those kinds of information are not disclosed to the general public because these valuations can certainly influence the share price of the company as there are likelihoods that investors may welcome those valuations and in this way share prices can be increased. If the valuations are not consistent with shareholders’ expectations, then there comes a decline in the share prices. If the projects are not likely to influence the existing operations and financial results of the company, then the shareholders might remain indifferent as to which way they should react. In case of acquisitions, generally when the terms and conditions of the purchase are settled, then some of the details of the proposed acquisitions are disclosed to the shareholders. The company does not provide them the comprehensive financial prospects and projections of the acquisition deal, rather it provides the necessary information to the shareholders such as purchase price, amount of goodwill, total amount of synergies that can be obtained from the acquisition, the capital structure of the company before and after the proposed acquisition, the funding resources for the proposed acquisition, the date of proposed acquisition etc. Motivation for the Acquisition The opportunity of acquisition was vital for William Hill. To a large extent, this opportunity increased the scale of its betting estates located in U.K. This helped William Hill Plc in developing the leading network of Licensed Betting Offices (LBOs) in U.K. In subsequent paragraphs, some traits of this acquisition are mentioned: Increment in Licensed Betting Offices (LBOs) By doing this acquisition, there was an addition of 624 LBOs in Northern Ireland, Great Britain, Jersey, Isle of Man and Republic of Ireland. Highly Complementary Estate This acquisition was highly complementary with the Retail Bookmaking of Stanley. It was expected to provide an existence in those areas in which William Hill Plc was underrepresented. Such areas include Republic of Ireland as well as Northern Ireland. Incorporation of Retail Bookmaking of Stanley under the brand of William Hill was expected to provide a substantial scope for improvements and coherence in profitability of the Retail Bookmaking estate of Stanley. The other benefits resulting from this acquisition are listed below: Rise in Profile of LBOs: Rebranding as a result of acquisition under the brand name of William Hill improved the profile of Licensed Betting Office on high streets. Offerings of William Hill Plc: Full range of new offerings including services, products and risk managements services were introduced by William Hill Plc. Betting Opportunities for Customers: The acquisition resulted in new and better opportunities for the customers of LBOs. Development of additional services and products were encouraged in order to provide better and sustainable opportunities to customers. Leverage in Investments: Acquisition also helped William Hill Plc in making investments in existing and new technology. Contractual Terms: Contractual terms of William Hill Plc were improved as a result of greater leverage in buying. Fixed Odds Betting Terminal (FOBT): By doing so, there was a chance of improvement in mix as well as completion of FOBT roll-out. Profitability and Synergetic Effects At the end of year 2004, on May 2, Stanley Retail Bookmaking produced the profit of amounting ?37.2 million. These profits have been taken from EBITDA (earnings before interest, tax, depreciation and amortization). It had been observed that profits were slightly lower than year 2005 due to the unfavorable football and horseracing which was conducted in second half of the financial year of Stanley Leisure. The acquisition results expected by Directors for pre-tax synergies were amounted to ?13 million for the fiscal year ending on 2006. It was expected that this acquisition would: Enhance Earnings Per share earnings were expected to be enhanced from 2006, which was the first financial year in which expected completion were to be followed. Generate Excess Returns From 2006, the cost of capital for William Hill Plc was expected to generate excess returns. Capital Structure of William Hill Plc The acquisition deal normally affects the financing mix of the acquiring company such that it has to arrange funds from different resources. Those resources may be from the internal funds of the company, from the equity funds raised through general public, arrangement of a loan facility from the banks or other financial institution, raising debt funds through general public by issuing bonds etc. The acquiring company undergoes a detailed in depth analysis of its capital resources and assesses each resource in such a manner that it seeks out that finance resource, which is the cheapest and easy to manage for the company. Since acquisitions generally require huge amount of funds to pursue them, therefore, the companies make best use of their funding resource opportunities and try to utilize that resource, which leads a cheap cost of capital to the company. Other factors which are evenly important in deciding as to channelize which funding resource include the likely change in the capital structure of the firm, the investors anticipated standpoint on the funding resources etc. The capital structure comprises of the proportion of equity and debt included in the financing mix of the company. As a result of obtaining new funds, there is a tendency that the capital structure of the firm might show some changes which means that the debt and equity proportion might get disturbed. If the debt portion of the capital structure increases, it will expose the assets of the company towards more risk and the chances of the company to become bankrupt are increased as the company becomes riskier. On the other hand, if the equity portion is increased, then the company might have to incur more cost of capital as the dividends are not tax deductable and the tax expenditure of the company might be increased. So the company needs to be very careful in arranging its funding resources because each resource may influence the existing capital structure of the firm. The acquisition of the betting shops by William Hill Plc has various implications in respect of its capital structure. The company mainly utilized both equity and debt channels to fund this acquisition such that it utilized its own internally generated funds as part of its equity as well as arranged a loan from its bank which is the part of its debt. The acquisition of the Stanley’s betting shops required a cash consideration of ?506.6 but the company arranged a loan facility from its bank in such a manner around ?1.2 billion were raised. ?600 million funds were obtained by the company as a term loan for a period of five years. The rest of ?600 million funds were taken for the purpose of revolving the credit facility of the company and the repayment of the previous loans. By keeping in view all the changes in the capital structure, it can be noticed that leverage position of the company has been increased substantially after this acquisition. Prior to this acquisition, the long term liabilities of the group amounted to around ?519.1 million in the year 2004 with the debt ratio of 65% of the total capital whereas the rest of 35% of total capital belonged to equity. However, by obtaining such huge amount of credit from the bank, the capital structure of the company got severely disturbed such that the previous debt of around ?519.1 million rose to around ?1233.2 million. This increase in the debt of the group exposed the group towards more risk such that the debt ratio of the company increased from 65% to 83% of the total capital invested in the business. On the other hand, the equity ratio of the company declined twice from 35% to 17% which was a very threatening sign for the company. There is another reason as well for the decline in the equity of the company such that during the year 2005, the company executed a plan of its share purchase program due to which the equity of the group decreased from ?276.3 million to ?248.6 million. In a nutshell, there were two major reasons for the overall disturbance found in the capital structure 1) the heavy injection of credit from the bank amounting ?1.2 billion and 2) the share repurchase program which caused a reduction in the equity of the company. Both these reasons caused an increase in debt portion and decreased the equity portion of the overall financing mix of the company. The summarized capital structure comprising of debt ratio is highlighted in the following table: Capital Structure 2004 2005     Debt Ratio = Debt = 519.1 = 65% 1233.2 = 83%     Debt + Equity   519.1 + 276.3       1233.2 + 248.6     Value of Firm after Acquisition The acquisition of 624 Licensed Betting Offices of Stanley Leisure by William Hill Plc was one of the major breakthroughs for the William Hill Plc as the group found some worthy representations especially in those areas where the group was struggling to prove its presence. This move of the company was welcomed by the shareholders of the company besides the fact that the deal made the company more susceptible to risks with the disturbance in the capital structure as the share price of the company remained stable from the beginning of 2004 till the mid of 2008. William Hill Plc made some fruitful strategic financial decisions in 2005 due to which the value of the firm remained steady and even increased a bit. The reasons for such stability in the share prices of William Hill Plc includes the basic move of the company to acquire such a company which has strong presence especially in Ireland as it was deeply appreciated by the shareholders because this action made the company enter into a new geographical market. The other clever tactic made by the top management of the company was the introduction of the share repurchase program which is mainly used by the companies to increase its share price. Thus the share price of the company remained steady from 2005 till 2008 despite the fact that number of shares outstanding, were reduced. But the total market capitalization of the company including both of equity and debt increased. As a result, the overall value of the firm experienced a slight increase. After recession, the overall betting industry suffered all over the world due to which the share price of William Hill fell quite sharply and still at its struggling stage. But this decrease in the share price of the company is not due to the acquisition of 624 LBOs of Stanley rather it happened as a result of people’s reluctance and lacking interest in betting. The chart below points out the share price patterns of William Hill Plc since the time of its listing i.e. 2002 till 2012. Conclusion Acquisition is a way which is highly used by the companies to make growth on a larger scale in short span of time. The valuations of acquisition reflect the synergetic effects which are the desired results of any acquisition. William Hill Plc acquired 624 licensed betting offices of Stanley Leisure for ?506.5 million which were located in Ireland and North West part of UK. This acquisition provided William Hill Plc around ?13 million as part of the synergetic effect. The other main benefit that William Hill Plc obtained is the presence that it found especially in those areas where it was struggling. The overall value of the William Hill Plc increased as a result of this acquisition but the company’s capital structure experienced significant disorder such that the debt portion increased by a massive percentage. The equity of the company also decreased due to the share repurchase program. In a summarized way, it can be stated the company remained successful in achieving the intended objectives from the acquisition and this move assisted the company tremendously in expanding its business operations on geographical grounds. References Baker, H. Kent . and Martin, Gerald S., 2011.Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice. New York: John Wiley & Sons. Berk, Jonathan B. and DeMarzo. Peter M., 2010. Corporate finance. 2nd ed. New York: Prentice Hall. Bierman, Harold., 2003. The capital structure decision. New York: Springer. Brigham, Eugene F. and Ehrhardt, Michael C., 2008. Financial management: theory and practice. 12th ed. New York: Cengage Learning. Eckbo, Bjorn Espen., 2008. Handbook of corporate finance: empirical corporate finance. Oxford: Elsevier. Jaffe, Jeffrey. and Ross, Randolph Westerfield., 2004. Corporate Finance. New Delhi: Tata McGraw-Hill Education. Khan, M. Y., 2004. 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