Capital Budgeting: Glazers Takeover Manchester United - Essay Example

?CAPITAL BUDGETING: GLAZERS TAKEOVER MANCHESTER UNITED Table of Contents Table of Contents 2 Introduction 3 Capital Budgeting Theories 3 Evaluation Techniques 4 1.Traditional techniques 4 2.Discounted Cash Flow (DCF) techniques 5 Corporate Valuation and Takeover 6 Takeover Bid of Manchester United – Background 7 Glazers’ Motivation 8 Conclusion 12 References 14 Introduction Capital budgeting decisions plays a pivotal role in the efficient running of a business organisation. Proper evaluation of the investment proposals is very important. Various capital budgeting theories have been discussed in this study. Moreover, Mergers and Acquisitions are quite common in today’s globalised economy. Corporate valuation of the assets of a company in a takeover process is also very important and has been included in this study. The takeover of Manchester United football club by Glazer family of United States has been studied in details. What prompted and motivated Glazer to takeover Manchester United have also been studied. The process of financing of the takeover bid by Glazer has been mentioned in this study. Capital Budgeting Theories The future prospects of any firm or company depends on its efficient capital budgeting decisions. The competitive power of an organisation is also determined through its efficient capital budgeting decisions. Capital budgeting decision by firms relies on the fact of anticipating all the future benefits that it can earn after making an investment now. Hence capital budgeting system is applied by the companies to make an evaluation of its investment decisions in which a present outlay is involved but the benefits are likely to be earned over a longer time period in future. Capital budgeting decisions can be classified as: a. Decisions which affect revenues and are income expansionary in nature. b. Decisions which results in reduction of costs for the firm. c. Decisions which are mutually exclusive in nature. d. Capital rationing approach when finance available with the firm is limited and investment opportunities are plenty (Jain, 1999, p.5.1). The data required to formulate the capital budgeting process are a series of future cash flows of the firm after considering the taxes involved in it. These cash flows are incremental in nature and are either inflows or outflows. The capital projects of a company can either be a single proposal or a case of replacement or situation which is mutually exclusive in nature. Evaluation Techniques Various evaluation techniques can be utilised for the appraisal of an investment proposal. They are: 1. Traditional techniques a. Average Rate of Return (ARR): It is also known as Accounting Rate of Return Method and is employed to measure the average income or profit as a percentage of the average investment made in the capital project. ARR involves easier computation technique and the entire income generated during the life of the project is considered. However, this method does not take into consideration the expected cash flows of the investment proposal directly and the timing of its future cash flows (Warren, Reeve & Duchac, 2011, p.1160). b. Pay Back Period: A capital investment project involves an initial investment by the firm and the future cash inflows it gets. Payback period is calculated as the time period within which the initial invested amount is recovered from the cash inflows generated from the project. This method is easier to calculate and simpler to understand. Cash flow analysis is also done in this case. However, the cash flows that are generated post payback period are not taken into account in this method and the concept of present value of different future cash flows are also not utilised (Duchac, Warren & Reeve, 2011, p.1166-1167). 2. Discounted Cash Flow (DCF) techniques a. Net Present Value (NPV): The difference of the summation of the present values of cash inflows of the capital investment project and the present value of all the cash outflows involved in the project gives the NPV of the project. It gives a measure of the net contribution towards the increase in wealth of shareholders of the company. The higher the NPV of a capital project better it is for the company. This method is often argued as the best method of evaluating a capital project based on a single criterion. Important consideration in this technique is the use of cost of capital as the discounting factor to calculate the present values of the cash flows. It depends on the riskiness of the project (Brigham & Ehrhardt, 2010, p.383-384). b. Internal Rate of Return (IRR): IRR can be defined as the rate of return which equates the present value of cash inflows with the present value of the cash outflows. It gives a measure of the rate of return yielded by the capital project. This method can be utilised to rank different projects based on IRR which is greater than the Weighted Average Cost of Capital (WACC) of the project and choose the best option amongst them (Brigham & Houston, 2012, p.373-375). c. Profitability Index (PI): It is also known as the benefit-cost ratio and is calculated as the ratio of the present value of all future cash inflows of the project to the present value of costs or cash outflows of the project. It can be considered as a different variant of NPV (Baker & Powell, 2005, p.235). Corporate Valuation and Takeover In order to decide upon the price that is appropriate to pay in a takeover bid it is important to know the value of the assets of the company which is being acquired and also the factors which determines those values. The fair value of the firm is pre requisite for any takeover decision employed by the bidding firm. Some of the special factors like synergy and valuation of control are an important consideration in a takeover valuation (Damodaran, 2011). Valuation of a company can be categorised into six different methods (Fernandez, 2004, p.2). They are: 1. Balance Sheet based methods: a) Book Value, b) Adjusted Book Value, c) Liquidation Value, d) Substantial Value and e) Book Value and Market Value. 2. Income Statement based Methods: a) Value of the Earnings, b) Value of the Dividends, c) Sales Multiples, and d) Other Multiples. 3. Methods based on Goodwill: a) “Classic” Method of Valuation, b) Simplified UEC Valuation Method, c) Anglo-Saxon Method and d) Purchase of Annual Profit Valuation Method 4. Methods based on Discounted Cash Flows: a) Free Cash Flow Valuation Method, b) Debt Cash Flow Valuation Method, c) Equity Cash Flow Valuation Method and d) Adjusted Present Value Method (APV). 5. Methods based on Value Creation 6. Methods based on Options Takeover Bid of Manchester United – Background Manchester United F. C. is a football club that plays in the English Premier League and has a wide support base all over the world. It is based in Old Trafford in UK. It was founded in the year 1878 as Newton Health LYR Football Club. Later it was renamed as Manchester United and is commonly known as Red Devils. Manchester United is well acclaimed as a football club worldwide and has won several trophies. Manchester United went public in 1991 in the London Stock Exchange. Later in May, 2005, it was taken over by Malcolm Glazer. Glazer is a well known sports tycoon of Unites States. Apart from Manchester United F. C., Glazer is the owner of another American football team named Tampa Bay Buccaneers. After 1991, when Manchester United started floating its shares in London Stock Exchange, its shares continued to perform very well. Then in 1999, Manchester United won three major trophies, namely EPL, UEFA Champions League and FA Cup. Soon it became one of the largest sports brand in the world and it was valued around ? 670 million then (Wilson & Joyce, 2008, p.25). Hence it was unlikely that it would be taken over by anyone at that surmounting value. Taking over Manchester United meant one has to acquire 75% of its shares. With anyone having 75% of the shares of Manchester United, it can help him to remove Manchester United from the listed company category and turning it into a private company. Glazer did the same and Manchester United was turned into a private company. At the start of May, 2005, the shares of Manchester United Football Club were valued at ? 2.6 per share. Hence Glazer managed to buy shares from some of the major shareholders of Manchester United at a price of ? 3 per share. This meant the club was valued at ? 670 million and Glazer was the owner of the company with more than 75% shares in his possession by then. The takeover bid was settled at a price of around ? 790 million, which was ? 120 million more than its market value then (Wilson, 2011, p.27-28). Glazer planned to arrange this bidding amount through three different sources of fund: a. ? 265 million as borrowed capital against the assets of Manchester united club. b. ? 275 million would come from the capital raised through issuing securities but that would not be secured against the assets of the club. c. ? 272 million would come from the shares of Manchester United held by Glazer himself (BBC News, 2005a). By June, 2005 Glazer got hold of nearly 98% shares of Manchester United. He was thus in total control over the club by then and was in a position to impose a compulsory buyout of the remaining shares held by other shareholders of the club (BBC News, 2005b). Glazers’ Motivation Manchester United was taken over by Glazer in 2005. By then Manchester United was one of the richest club of the world. According to Deloitte and Touche, Manchester United generated the highest volume of income amongst all the sporting clubs in the world, continuously for eight years before its takeover. This fact proved to be a great incentive for Glazer to get motivated to takeover Manchester United Football Club. Glazer wanted to get richer through the revenues generated from the club (Fraser, 2005). Glazer was already in possession of the United States football club named Tampa Bay Buccaneers. Hence he knew the process how get hold of any sporting club. The main sources of revenue generation for Manchester United were: a. Match day Tickets: The sale of tickets by Manchester United on the match day helped to generate huge amount of revenue for the club. b. Broadcasting and Media: TV deals for different matches and the TV broadcasting rights of the club all over the world generated the largest percentage of income for Manchester United. c. Sponsorship and Commercial: Sales of Merchandised the products of Manchester United, sponsorships and other activities run by the club also helped to generate considerable revenue for the club. As per Deloitte, Manchester United generated the highest revenue amongst all the football clubs in the world (Graph 1). Graph 1 Source: (BBC News, 2005c) There was a huge demand for merchandised products of Manchester United, most prominently in the Asian market (Graph 2). Graph 2 Source: (BBC News, 2005d) Manchester United had a huge base all over the world and the club was performing very well in all the competitions. Ticket sales on the match day brought about huge revenues for the club (Graph 3). Graph 3 Source: (BBC News, 2005e) Hence, all these facts proved to be a great incentive for Glazer to takeover Manchester United. Moreover was striving to get hold of more than 75% shares of Manchester United, so that he could be the complete owner of the club. Then it would be easy for him to pass over the debt burden on the club’s assets. It was a highly leveraged takeover by Glazer because he borrowed huge sums of money to finance the takeover bid amount. As discussed earlier, ? 265 million came from borrowed capital. It meant the interest burden of all these debts are to be borne by the club and a considerable amount of money would be diverted away from the income generated by the club for debt service. Hence, Glazer was motivated to take complete ownership of Manchester United, make it a private club and raise more revenues from the club. Conclusion Capital Budgeting decisions play a vital role in any organisation. Hence evaluating those capital budgeting decisions are also equally important. In today’s globalised world, Mergers, Acquisitions, Takeovers have become a very common phenomenon for any business concern. Most of the top firms are striving to expand their market all over the world and gain control over the international market. Next while deciding on any takeover or acquisition of any organisation it is very essential and pre requisite to make proper valuation of assets of the company. That would decide the bidding price for the takeover. Takeover of Manchester United by Malcolm Glazer in the year 2005 was an important event in the history of the club. Before the takeover, shares of Manchester United were traded in the London Stock Exchange and it was performing well. The club was valued at around ? 670 million then. Hence it showed no signs of takeover by anyone. However Glazer had different plans. He was highly motivated by the club performance, which was the richest club in the world then. Hence, Glazer seized the opportunity to takeover Manchester United through buying all the shares of Manchester United and making it his own private company. Glazer borrowed the maximum part of the bid amount to takeover Manchester United for around ? 790 million. He was successful in materialising his plan and transferred all his debt obligations to the club. Hence, it can be concluded that the takeover process of Manchester United by Glazer was a highly leveraged takeover. References Baker, H. K. & Powell, G. E. (2005). Understanding Financial Management a Practical Guide. USA: John Wiley & Sons. BBC News. (2005a). Glazer Closing in on Man United. [Online]. Available at: http://news.bbc.co.uk/2/hi/business/4542913.stm. [Accessed on April 25, 2012]. BBC News. (2005b). Glazer gets 98% of Man Utd Shares. [Online]. Available at: http://news.bbc.co.uk/2/hi/business/4629401.stm. 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