The Previous Declaration by BAE Systems - Assignment Example

?EADS-BAE MERGER CASE ANALYSIS Introduction The previous declaration by BAE systems plc and EADS N.V to merge on 12th September2012 was put off on 10th October, 2012. The two firms were made to merge based on a dual listed company structure but the discussions were put off based on various reasons. According to BAE systems and EADS the merger was founded on reasonable industrial hypothesis and presented a chance to make a combination from two famous and strong firms (DePamphilis, 2011; p. 7). The proposed merger was projected to create a combined business that would have formed a strong force for growth and competitiveness in the defense sector and the commercial aerospace, delivering sound benefits to the stakeholders. Even though the companies had not revealed benefits and a detailed business structure for the merger it is believed that negotiations with the respective states had not reached that level. The two firms were optimistic that the merger would have built a strong case to pass to the owners of the business. This discussion will address the valuation of the two firms using various models, the motivation and strategy evaluation, the response in the security market and corporate governance analysis to seek ways of making such moves successful and establish the reasons behind the failure. Strategy and Motivation Analysis The motivation of the proposed merger were based on global rivalry, share in the market by the firms, the level of complimentarity, variation in the industrial structure like offsetting of the monopoly. BAE was also believed to be the springboard that would enable EADS to have its biggest jump it craved for in the Northern American continent (Jane's Defense Industry, 1900; p. 75). BAE has a chief role in the manufacture of military equipment as it was noted that 95% of the BAE systems total sales were related to military sales. BAE also plays a vital role in the production of military aircraft such as the Typhoon fighter and the Tornado fighter bomber. The terms of the negotiations were that EADs was to offer 35 billion Euros which was 12% bid premium even though the new ownership was to be divided on a ratio of 3:2 in favor of the shareholders of EADS. In case the term was favorable to BAE it would shape the likelihood of the merger’s success. The US state would also call for disposal of asset upon the merger strategy which was set for security review. There are no current plans to divest any of the company’s operations in the United States as a section of merger with EADS according to the spokesman of BAE (Spulber, 2007; p. 3). EADS and BAE had a deal to have cost savings without necessarily giving details in regard to the scale and the manner in which they might be generated. Amongst the potential opportunities was the potential to accumulate more sales as the network by BAE in the export markets was immense such as ties with India, Australia and Saudi Arabia which would open doors for the EADS. The benefits from the merger were meant to extend over widening markets and that the firms were to target industrial benefits and operational synergy in all joint business. The likely synergy from the merger comprised of a minimum synergy which could be derived as the value of the pre-merger of both companies + the synergy = pre-merger security value + the number of shares for the post-merger. Taking S = Synergy and taking data on 11th September where the EADS share price was 29.30Euros while the number of outstanding shares as at 31st December 2012 being 8.21 billion shares, it then stipulates that the pre-merger value for EADS was 26 billion Euros. Conversely, taking the share value for BAE on 11th September, 2012 as 4.75Euros and the number of outstanding shares on 31st December, 2012 as 3.59 billion, it applies that the premerger value for BAE is 17.05 billion Euros found as 3.59X4.75 Euros (Financial times, 2013; p. 1-7). Now; by taking the pre-merger security price = the average price of the stock prior to the merger to be EADS + BAE It concurs that (26+17.05)/ (3.59+8.21) +S = (29.3+ 4.75)/2, 43.05/11.80+S =17.025 then 3.6483+S=17.025 Hence; S=13.3767 billion The joint firm has to accumulate €13.3767bn synergy By going with the capitalization of the firms in comparison with the 35 Euro post merger assessment, BAE has a pre-merger capitalization of about 12.268 billion Euros while EADS has a pre-merger capitalization of 21.46 Euros hence the after the merger value of 1.32 billion has to be generated derived as [35 Euros-(12.268+21.46)] (Financial times, 2013; p. 1-7). Stock Market Response Following the announcement by BAE systems and EADS plc to merge the stock market response was very overwhelming and moving. The shareholders, responded rapidly when the shares in EADS dropped by 10% to $ 32.44 in Paris trading. BAE securities relinguished most of their gains on Wednesday after the news before the deal was broken, dropping by 7.3% to $ 5.43 in the London stock exchange. The deal could also be in a position to intensify the rivalry for the reducing military expenditure by the Western states and increasing military investments in major parts of Asia and the Middle East. It also increased the anxiety in the competition amongst the commercial jetliners between the U.S competitor Boeing Company and Airbus by +0.30% (Shein, 2011; p. 205). The diagram below shows the share price movement in the stock market during the time of negotiations and terminations of the talks for EADS. Source: Financial Times, 2013 The securities of BAE were exchanged 1% less than the average at 338.90 pence in London Exchange by 8:11 a.m in correspondence with a greater decrease in markets. EADS stock was less traded in Paris trading. Amongst the BAE largest investors, INVESCO Ltd having a share of 13.25% while Blackrock Inc. and Axa SA had an ownership of 5% each as of the latest filings. EADS has three major shareholders, where the joint ownership of 44% was owned by Daimler AG, Lagardere SCA and the French state. The rest of the shares were being traded freely on the stock market (Ng, 2011; p.95). The diagram below shows the movement of share price for BAE between the merger announcement and its termination and the subsequent movement after the merger. Between the declaration and the termination of talks, the share performance was the highest. Source: Financial Times, 2013 Synergy Analysis This analysis is based on the sales synergy via a diversified market, availability of strong client base such as the U.S defense department, synergy on cost saving via economies of scale and doing away with the duplication while upgrading the research and development in the weapons industry (Funke, 2007; p. 22). Besides, the merger was to lead to improved technology, higher pooling of skills and better management since there would be a higher dynamics amongst the teams and improved knowledge and pooling potential. According to the calculations and analysis above the offer and bid evaluation was to bring about 35 billion Euros in case it would be executed in joint with the target firm valuation. This could not be considered as overpaying (Collinson, 2011; p. 87). EADS is one of the best models of a truly triumphant European firm currently. Since its formation in 2000 through a merger between DaimlerChrysler Aerospace of Germany, CASA of Spain and French Aerospatiale, EADS has since led to the balance of trade in its local nation. However, in the European market is has tripled the volume of sales to 34 billion Euros as seen in 2011. With the total order costing over 953 billion Euros since 2000, the company has had its order book value being quadrupled to over 547 billion Euros. The net cash of the group has also increased by a factor higher than 6 to about 8.1 billion Euros (Dalamagkidis, Valavanis & Piegl, 2012; p. 294). In 2011, the group realized sales revenues of 49.1 billion Euros more than a decade ago of 24.2 billion Euros realized in 2000 during its inception. Valuation models 1. Asset based valuation model Using the asset valuation the book value per ordinary share: = ? 1.14 EADS = Total assets/total common shares outstanding 23101/3236= ?7.14 pounds BAE = Tangible assets/common stock + Paid-in capital 2626/3236 = ?0.81 pounds (Financial times, 2013; p. 1-7). Therefore the combined Book value for EADS and BAE = Combine the Book value EADS and BAE = total assets Total assets/total combined ordinary shares outstanding The total assets of EADS by the end of 2011 € 88.4bn/8.15 = € 10.85 while the total assets of BAE systems 2011 €26.52/3.59 = € 7.387 The average assets would then be; (10.85+7.387)/2= € 9.12 In comparison with the 35 billion Euros divided by the joint ordinary shares 35/ (8.27+3.59) = €2.95 The combined value will then be 2.95 Euros after the merger (Financial times, 2013; p. 1-7). 2. Dividend model By using the dividend valuation model and taking the figures for 2011 Po=Do (1+G)/(R-G) Po= share price Do = dividend in Y0 per share 20p G= expected rate of growth in dividend (10.72%) taking a similar growth rate in the future R = cost of equity capital (14.06%) presuming it is the required rate of return (5 yr average ROE) Po = 20p (1+0.1072)/ (0.1406 -0.1072) = 20p X (1.1072/0.0334) =20p x 33.15 = 663p (putting into comparison with the pre merger 412p) Applying the model, BAE valuation could be 663pX3.59bn shares outstanding =?23.8bn, double that of the market cap ?10.64bn For the purpose of financial evaluation EADS possess a 5 year growth rate in dividend, a dividend payout ratio but with a yield on dividends of 0.01% (Financial times, 2013; p. 1-7). 3. Earnings Based Model In line with ratio data from the website the P/E ratio of BAE are about 7.1 in comparison with the financial information, the market stock price and the earnings in income statement the share price is very costly and might not be relevant due to its misleading nature. In common, the higher price earnings show that the market soundness and growth nonetheless where the earnings decreased while the stock price went down, it would imply that the stock is very costly and the shareholder would be shy to get involved in the market (Chaudhuri, 2006; p.5). Corporate governance analysis Owing to the termination of the merger, the management of EADS is currently having a tactical review and the stakeholders at the BAE submitted a notice to the CEO requesting him to quit. The EADS chairman Mr. Lagardere who has an ownership of 12% in the EADs stopped the merger efforts but currently he is disposing off his shareholding to make room for the probable merger. The German state opposed the merger while on the other hand the merger was highly supported by the French government. The fundamental aspects were the losers and winners, same treatment to all stakeholders, divergence of interest amongst the shareholders, the quality of the management in both firms, the obligatory strategy and values to operate the BAE and EADs including the accountability of the managers among others (Suder, 2011; p. 353). BAE systems started their reforms of their board of directors after its merger talks with EADS went sour by appointing the former director of finance of Diageo to be its top independent director. On the other hand, Nick Rose came in for Sir Peter Mason who was targeted by INVESCO the biggest stakeholder of BAE (Haddon-Cave, C. (2009; p. 202). The chairman of BAE Dick Oliver and Sir Peter Mason were meant to retire indefinitely. Mr. Rose is currently on the BAE board of directors but he is likely to be promoted hence the search for a non-executive director is ongoing. The new overhaul of the board of directors is expected to ensure that the management conforms to the highest principles of corporate governance (Kokkoris & Olivares-Caminal, 2010; p. 135). EADS executive committee’s chairman is Louis Gallois who doubles as the CEO with other members on the committee such as Stefan Zoller, Carlos Suarez, and Ralph Crosby among others (Houldsworth & Jirasinghe, 2006; p. 118). The executive committee is selected by the board of directors who are appointed by the two main shareholders who appoint each an independent director. The board then appoints the chairman of the company. After the collapse of the proposed merger that led to the disgrace of EADS at the Paris Air Show the selection was affirmed by the board of directors of EADS whilst Gustav Hubert was named the CEO and president of Airbus (Andrea & Kim, 2012; p.3). Conclusion From the discussion above it is evident that the merger would have been one of the most successful mergers in history in case it the deal could be finalized. The French government one of the stakeholders in EADS was in favor of the merger while the German government did not approve of the merger. Nevertheless the merger talks can still progress with the new overhaul of the board of directors in both firms. This would uplift the image of both firms in sense that it would help the firms beat competition globally. Moreover the synergy that can be generated from the merger is quite immense to a figure of 1.32 billion Euros as opposed to the firms operating individually. Bibliography Andrea S. and S. Kim 2012, Analysis: BAE-EADS merger collapse shifts focus to smaller deals, Washington/New York, Thomson Reuters Chaudhuri, S. K 2006, Case studies on competitive strategies. Hyderabad: ICFAI Books. Jane's Defense Industry 1900, Surrey, UK: Jane's Information Group. Collinson, R. P. G 2011, Introduction to avionics systems. Dordrecht: Springer. Dalamagkidis, K., Valavanis, K., & Piegl, L. A 2012, On integrating unmanned aircraft systems into the National Airspace System: Issues, challenges, operational restrictions, certification, and recommendations. Dordrecht: Springer Science Business Media B.V DePamphilis, D. M 2011, Mergers and acquisitions basics: Negotiation and deal structuring. Burlington, MA: Academic Press. Financial Times 2013, European Aeronautic Defense and Space Company EADS NV, Financial Times ltd Financial Times, 2013, BAE Systems Ltd, Financial Ltd Funke, C 2007, Ownership Structure as a Determinant of Capital Structure - An Empirical Study of DAX Companies. Mu?nchen: GRIN Verlag GmbH. Haddon-Cave, C 2009, Return to an address of the honorable the House of Commons dated 28th October 2009 for an independent review into the broader issues surrounding the loss of the RAF Nimrod MR2 Aircraft XV230 in Afghanistan in 2006. London: Stationery Office. Houldsworth, E., & Jirasinghe, D 2006, Managing and measuring employee performance. London [u.a.: Kogan Page. Kokkoris, I., & Olivares-Caminal, R 2010, Antitrust law amidst financial crises. Cambridge: Cambridge University Press. Ng, I. C. L 2011, Complex engineering service systems: Concepts and research. London: Springer. Shein, J. B 2011, Reversing the slide: A strategic guide to turnarounds and corporate renewal. San Francisco: Jossey-Bass. Sherman, A. J., & Sherman, A. J 2011, Mergers & acquisitions from A to Z. New York: American Management Association. Spulber, D. F 2007, Global competitive strategy. Cambridge: Cambridge University Press. Suder, G. G. S 2011, Doing business in Europe. 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