Potential Investment by Merger Companies - Essay Example

? Moorer Browne Limited Merger Valuation Here of Report on Potential Investment by Merger Companies May 6, 2012 Prepared for Board of Director Moorer Browne Limited Prepared by XXXXX Financial Advisor (Signature) More than often, mergers and acquisitions remain as viable strategy used by companies worldwide to maximise dominant growth. More significantly, companies decide to increase its business ventures as a way of increasing its earning to high levels of returns, considering that it saves on cost as the predator company takes over effective running of the business (Frankel, 2005). In most cases, predator companies focus on target companies with good profit levels and high expected returns levels over long periods as they wish to maximise value on their shareholders investments. It is more decisive to get the investors with high values to merge with Moorer Browne Limited especially those, with markets that are widely distributed to allow for maximisation of profits and growth in the highly competitive market trend expected in 2012 (Frankel, 2005). Below are calculations, based on the possible range of possible valuations, upon which prospective purchasers might offer on the ordinary shares of the company based on different methods of share valuation. Net Asset Value (Market Values) Net asset value =Market value of asset- Market value of liabilities Outstanding shares (Pinto et. al, 2010) Market value of assets from balance sheet 2011 = 96.7+12+8+66 +6.5 = 189.2m Market value of liabilities from balance sheet 2011= 54.5 + 30 = 84.5m Number of outstanding preference shares = 8,500,000/1=8,500,000 Number of outstanding ordinary shares= 25,000,000/0.50 =50,000,000 Total outstanding shares = 50,000,000+8,500,000 = 58,500,000 Net asset value =189,200,000 – 84,500,000 = 104,700,000 58,500,000 58,500,000 Net asset value = 1.79 Profit/ Earning Basis P/E basis=Market Value per Share (Pinto et. al, 2010) Earnings per Share (EPS) Earnings per share= Net Income Available to Common Shareholders Number of Common Shares Outstanding (Pinto et. al, 2010) Earnings per share = 9.0 Market Price per Share = Net Income - Preferred Dividends Number of Shares of Common Shares Outstanding (Pinto et. al, 2010) = 27.0 – 0.6 =0.528 50 P/E basis = 0.528/ 9.0 = 0.0587 Dividend Yield with No Growth Dividend yield= Do (Pinto et. al, 2010) r Do is the current dividend = 18,500,000/50,000,000 = 0.37 r- is the rate of return= 14% Dividend yield= 0.37 0.14 Dividend yield = 2.643 Dividend Growth Valuation Model g-is the constant growth rate = 5.25% Dividend growth valuation model = D0 (1+K)+ D1 (1+K)+ ------- Dr(1+K) (1+r) 0 (1+r)1 (r-K) (Pinto et. al, 2010) Do is the current dividend = 18,500,000/50,000,000 = 0.37 r- is the rate of return= 14% Year Dividend Expected 1/1+.14 Dividend Year 1D0 0.37 0.37 1.1400 0.4218 2D1 0.37 + (0.37* 0.0525) 0.389425 1.2995 0.5061 3D2 0.389425 + (0.389425*0.0525) 0.409870 1.5209 0.6234 4D3 0.409870 + (0.409870*0.0525) 0.431388 1.8281 1.7489 3.3002 D4 0.431388+(0.431388*0.0525) 0.454036 Dividend growth= 3.3002 + 0.454036 (1+.14)4 Dividend growth = 3.3002 + (0.454036 *1.7489) 3.3002 + 0.7941=4.0943 Discounted Cash Flow Year Cashflow (1+ 0.14)t Discounted cash flow value 2012 ?21.0 million 0.8772 18.4212 million 2013 ?20.5 million 0.7695 15.77475 million 2014 ?27.5 million 0.6575 18.08125 million 2015 ?26.3 million 0.5718 15.03834 million 2016 ?31.4 million 0.4972 15.61208 million 2017 ?34.5 million 0.4323 14.91435 million 2018 ?27.5 million 0.3759 10.33725 million 2019 ?26.4 million 0.3269 8.63016 million 2020 ?31.3 million 0.2843 8.89859 million 2021 ?35.2 million 0.2434 8.56768 million 134.27565 million Valuation Based on Super Profits Super Profits = Actual Profits - Normal Profits Normal Profits = Capital Invested X Normal rate of return/100 (Lonergan, 2003). Normal Profits = 25,000,000* 11.5/100 = 2,875,000 Super Profits = 27,000,000 - 2,875,000 = 24,125,000 Use multiple of 4.25 to value goodwill Goodwill super profit= Super Profits x multiple of goodwill Goodwill super profit = 24,125,000 * 4.25 = 102, 531,250 Valuation Based on Earn-Out Arrangement Earn-Out Arrangement = net asset value + 62.5 of projected profits 2012 ?21.0 million 2013 ?20.5 million 2014 ?27.5 million 2015 ?26.3 million 95.3 million* 62.5% = 59.5625 Earn-Out Arrangement = 104.7+ 59.5625 = ?164.2625 Appraisal of the Valuation Methods More significantly, the decision made by the potential investor companies depend on the valuation method they choose that suits their expectation. Nonetheless, it is decisive to consider the outcome of adoption of any of the valuation models considering whether it increases the viability of a company being productive or not. If the investors choose to use the net asset value or the market values, they will be able to ascertain the mutual fund's value per share. As a common pool of investments, the mutual fund can be divided into shares to be purchased by investors. As a result, the net asset value of each share gives a weighted portion of each investment in the collective pool. The main advantage of using this valuation model is that the premise of grouping is possible and as a result, investors are able to minimize risk by diversifying (Lonergan, 2003). However, investors might not only consider using the net asset value method as it only looks at the fund's per share value based on its net assets available in a company. In addition, net asset value method does not either look at future dividends and growth or other expected stock or bond valuation methods. Therefore, the net asset value of 1.79 shows the ratio to which each share has attribute to the company’s net asset as per the year 2011. Investors are more likely to consider the price per earning to growth ratio basis as it considers the stock's potential value as it takes into the account earnings growth. In most cases, the ratio gives a measure of the expected future prospect of a company as it considers the present conditions including the current management, finances, growth prospect and future economic prospects of a company that will hinder investment (Pinto et. al, 2010). Therefore, investors can speculate future growth of over 0.0587 upon investing in Moorer Browne Limited. In some instances, investors intend to speculate the value of dividend yield considering that they expect no growth in the company’s dividends. Therefore, the expected dividend yield of a stock considers the percentage of the value of net profit allocated to shareholders as a return on their investments in the form of dividends to the current rate of expected return thus assume that there is no expected growth (Lonergan, 2003). As a result, the calculation of dividend yield with no expected growth gives estimations of return on investment expected by an investor in the form of dividends as they intend to purchase shares of Moorer Browne Limited. More significantly, calculations based on dividend yield assume that there are no expected dividend cuts in value of the company’s dividend as it will either maintain the current payout in the form of dividends or increase the dividends paid out to shareholders. On the other hand, valuation of the share of dividend growth using the valuation model takes into consideration the expected growth rate of a company. As a result, the dividend growth rate of a stock in the shares of Moorer Browne Limited takes an annualized percentage increase of in dividends for a certain period. In the above scenario, investors expect 5.25% as the dividend growth rate per year of the target company in the analysis of investor growth value based on dividends. However, the valuation considers time as a company’s good history based on high levels of dividends ensures that it has as a strong dividend growth (Pinto et. al, 2010). More significantly, the investors expect that with a growth rate on dividends they can continue to raise more dividends because of positive dividend growth as they expect trends of growth to continue into the future. If the investors choose to value the company based on discounted cash flow within a period of over ten years it will get the company’s net present value (NPV) based on the projected cash flows from investments that generate the projected growth. Most investors opt to use discounted cash flows as it shows the ability of investors to get returns on their investments depending on the fundamental expectations of the business as opposed to historical precedents as it gives valuation based on a rate of return that consider the company’s debt and equity level (Pinto et. al, 2010). The company’s positive net present value shows that investors should expect positive growth rate. Nonetheless, estimations using the discounted cash flow method would not be certain as it is based on the theoretical approach relying on numerous assumptions. More than often, valuation based on the super profits methods assumes that the company generates super profits above the expected returns as per the value of shareholders capacity. More significantly, the value of increase of super normal profits that show the value of goodwill is taken to be the value of the intangibles that are in the business company’s growth in the market (Lonergan, 2003). As a result, the calculated value of super profits over normal takes consideration of the multiple at which goodwill is accrued upon acquisition. Nonetheless, the choice of a multiplier of 4.5 on goodwill indicates that the investors would pay the value of four and half years worth of super profits of the company as part of the purchasing price. Therefore, an increase in the considering the value of ?102, 531,250 of super normal profits allow for an increase in the amount of money the investors will pay as they intend to merge with Moorer Browne Limited. As a form of contingent consideration, earn-out valuation gives a purchase price of a company by give an estimate of valuation gap between the buyer and seller. As a result, the valuation earn-out rewards the seller as it closes up the existing gap on achievement of performance targets as per the projected profits after tax, interest and preference dividend for years at a value of 62.5% considering the company’s net asset value. More considerably, the inclusion of earn-out provisions act as a valuation-bridging mechanism while investor companies intend to merge with Moorer Browne Limited as it results in a fair purchase price for both the buyer and seller (Lonergan, 2003). In addition, earn-outs give allowance for either an upward price adjustment when higher purchase amount is justifiable considering the originally agreed upon price. Nonetheless, buyers and sellers avoid using earn-outs because of existence of additional complexity in the agreements based on merger transactions. Risk-Adjusted, After-Tax Cost of Capital Rate of Return Estimation As investors, make a choice on whether to make investments or not they consider the riskiness of expected future cash flow as it lowers its present value (Lonergan, 2003). Cost of capital is considered as an estimate of the opportunity cost an investor incurs on all capital invested in a company considering the debt and equity structure of finances available to investors. To arrive at the risk-adjusted cost of capital rate of return the equity (Re) of capital is calculated as based on the opportunity cost investors undertake considering other investments with similar risk profile that result in the opportunity cost of equity capital. Based on the Capital Asset Pricing Model (CAPM) calculation of cost of equity capital is possible considering that shareholders always focus on attaining minimum rate of return that is mostly equal to return from a risk-free investment added to a return for bearing extra risk. As a result, the extra risk is calculated based on prevailing market risk premium considering a measure of riskiness of a specific security in a total market based on the multiplier known as beta (Lonergan, 2003). Cost of equity capital = Risk-Free Rate + (Beta times Market Risk Premium). After getting the cost of equity, it is essential to come up with the capital structure. Thus, calculation is made of the proportion of which debt and equity capital contributes to the company’s total capital. As a result, calculations are made using market values of total debt and equity as it gives the expected minimum returns to investors based on the investments. Thereafter with values of cost of debt and equity respectfully it is essential to carry out components weighing to consider the cost of each kind of capital as a proportion of the company’s entire capital structure. This is calculated based on the Weighted Average Cost of Capital (WACC) that gives the cost of capital rate of return estimate with risk adjustments and tax considered. In ascertaining the level of risk, it is essential to use Porter’s PEST analysis as it allows for consideration of risks that involve political, economical, sociological and technological effects on the returns of the company. This allows for a proper analysis of factors that influence the future trends of the company. In addition, forecasting model based on the company can be used in the estimation of the impact of risk on expected results. In addition, risk is calculated from models that involve debt structuring, contract pricing, debt sizing (Hitt & Hoskisson, 2010). On the other hand, diversification of investments allows for allowance for likelihood of business risk. In addition, Monte Carlo simulation can be used to allow for time series analysis besides calculation of sensitivity analysis to allow for effective merging that is beneficial. Report on Alternative Methods of Financing a Bid May 6, 2012 Prepared for Managing Director The De Silva Group Prepared by XXXXX Financial Advisor (Signature) As any other company, intending to merge offer bids are competitively based considering an increasing value of returns on such investment. However, there are several alternative methods available of financing a bid. As Moorer Browne Limited intend to attract investors to come up together and operate the entity as a way of boosting its growth the mergers bid can take forms ranging from share exchange, cash purchases and earn out arrangements. However, decisions on the best choice of financial bid are made based on considerations of advantages and disadvantages of the bid option (Frankel, 2005). Share exchange allows the predator company to offer its shares to target company and as a result, become part of predator company shareholders. This choice is considered viable when the target company does not want to offer cash. However, the shares allocated depend on valuation of the target company depending on future gains. Even though, this form of bid opens free negotiations and needs no cash the company does not have certainty over its shares of returns as it depends on profits made by the target company. On the other hand, cash purchases consider that shareholders of the target company have no share of the entity as they are bought out completely. Its main advantage is that as predator company, one gains effective control over the target company. However, it limits a company in sourcing out of funds from debt or equity thus, affects its capital structure. In addition, the use of earn out arrangements allows for considerations to be delayed and thereafter agreed value is paid on achievement of set criteria (Depamphilis, 2009). It is advantageous because the predator company can delay payments and in case target company do not meet set profit levels it does not pay excess cash. However, it has a disadvantage because as a predator company, De Silva Group will pay additional cash in case the target company achieves set profit target levels. Before considering on whether it is viable for De Silva Group as a predator company to invest in Moorer Browne Limited or not main there is a need to consider non-financial factors before finalising a bid. It includes taking consideration that it has the right shareholders who can be influenced by the board not to sell their shares thereafter to avoid dilution (Frankel, 2005). In addition, there should be the existence of a good relationship with shareholders to allow for effective communication. In addition, it is advisable to consider poison pills as it increases the share capital because shareholders have the right to buy shares or convertible loan stocks when takeover bid is exercised. This is because, increase in share price will lead to a large offer that predator companies cannot afford thus deterring mergers. More significantly, it is necessary to consider the target company article of association rules on whether it allows the majority to approve mergers or not. In addition, asset value of target companies is important because it should undergo revaluation to reflect the true price (Depamphilis, 2009). As a result, when a higher or lower price is paid the shareholders are able to know the true price of their shares. References Depamphilis, D., 2009, Mergers, Acquisitions, and Other Restructuring Activities, Fifth Edition: an Integrated Approach to Process, Tools, Cases, and Solutions, Boston: Academic Press. Frankel, M., 2005, Mergers and Acquisitions Basics, New York: J. Wiley & Sons. Hitt, M. & Hoskisson, R., 2010, Strategic Management: Concepts, Cincinnati: South- Western College Pub. Lonergan, W. (2003). The Valuation of Businesses, Shares and Other Equity. Hoboken, N.J: Wiley Pinto, J., Henry, E., Robinson, T. & Stowe, J., 2010, Equity asset valuation, Hoboken, N.J: Wiley. Read More