Finance - Company Takeover - Case Study Example

Finance - Company Takeover Table of Content Introduction 2 Review of TPG’s private equity purchase of Myer 2 Transforming risk into advantage by TPG 10 Classic steps of private equity takeover 11 Advantages & disadvantages of private equity model 12 Review of other private equity takeover 14 Conclusion 16 Reference 17 Introduction 3 Review of TPG’s private equity purchase of Myer 4 Transforming risk into advantage by TPG 9 Classic steps of private equity takeover 10 Advantages & disadvantages of private equity model 10 Review of other private equity takeover 13 Conclusion 14 Reference 15 Introduction A takeover is the acquisition or purchase of a company referred to as ‘target’ by another referred as ‘acquirer’. The private equity firms invest in companies with good prospects with the aim of improving its governance and operations. Their main objective is to turn around the performance of the company in which they invest. Suppose a company has certain business plans but is unable to fulfill it on account of dearth of resources then the private equity fund steps in by providing the necessary financial support. In June 2006, Myer a departmental store was taken over by private equity group Texas Pacific Group (TPG). The acquisition of another business enables the acquirer to expand the market size or to diversify his business operations as in the case of TPG Capital taking over Myer. Moreover it leads to ‘synergies’ which is the main reason behind the takeover. There can be managerial synergies, financial synergies, cost synergies etc. The private equity buy-out of Myer brought about a significant change in its cultural practices. In the words of the CEO of Myer the PE structure proved to be advantageous for the company. It widened the authority and scope of the company. As the company is no more public it saved on the extra resources that the company shelled out in maintaining investor relations. In short it saved the company from the responsibility of making extra disclosures to the shareholders and financial analysts. Review of TPG’s private equity purchase of Myer On 2006, Myer, a well know retail company was taken over by an international PE firm, TPG1. On March 13, 2006 Coles Myer sold its 61 Myer stores to Newbridge Capital (TPG) at $1.4 billion. In Aug 17, 2006 Mayer received first takeover offer for buyout but it was reject. Later on in Aug 22, 2006 Kohlberg Kravis Roberts (KKR)-led consortium gave a new offer of 17.3 billion where each share was offered at $14.50 but it was also rejected. Finally the consortium of five international PE firms revived the deal by offering $18.2 billion with $15.25 per share; however this was also rejected as the company found this offer as quite low2. The takeover of Myer by TPG was one of the historical takeovers in Australian history where a local retail company was taken over by an international PE firm. This was a preplanned strategy of takeover by the private equity firm. The main aim of this takeover was to gain synergy as the PE firm already existed in the retail sector in US and UK. “Within 18 months TPG revived supply chain of Myer by opening four distribution centers, four international hubs supported by new inventory and warehouse management systems and e-commerce initiatives3. Therefore, the strategy development, planning and execution process in supply chain management of Myer were induced with characteristics of world class supply chain management standards. Such changes in supply chain were effective enough to introduce competitive edge to Myer in Australian retail industry. After the buyout TPG had 84.2 percent stake in the retail company. Later, in 2009 the PE firm was quite positive about the growth and profitability of Myer and it took the decision of institutional book-builds for floats. For IPO the price range was $ $3.90 to $4.90 to add $2 billion to the company’s kitty4. This IPO resulted to a profit of $1.5 billion for the private equity firm that attracts tax liability of $678 million5. Though this IPO made a healthy profit but the expense made for the IPO negatively affected the profitability of the company. Still the \company reported a healthy profit growth on year on year basis. Earnings accretive- An immediate indicator of the success of an acquisition is whether it accretes or dilutes the earnings of the acquiring company (EPS). An accretive acquisition enhances the earnings per share of the company. This situation arises when the P/E ratio of the acquiring company is higher than the company being purchased. On the other hand a dilutive acquisition decreases the EPS of the company. This situation arises when the P/E ratio of the purchasing company is lower than the company being purchased6. It appears that the private equity takeover benefitted Myer as the company is expecting to perform fairly in 2010. For 2013 the company expects its non-GAPP EPS to be at least $1.95. This is anticipated to grow on a sustained basis in 20147. The growth anticipated in EPS of Myer suggests that the company has gained from the PE takeover. As discussed an accreting EPS is a sign of success for takeover. Scrip bid- A takeover deal that is settled partly or wholly in shares instead of cash is known as ‘scrip bid’. This kind of takeover is mandated by some disclosure requirements. For instance in Australia for a deal relating to scrip bid the bidder’s statement must be in conformity with the prospectus requirements8. The deal between TPG private equity and Myer was settled by the former paying $1.4 billion for the transaction9 TPG Capital acquired an ownership stake in the company in the form of shares which it later offloaded through IPO. At the time of acquisition of Myer by TPG in June 2006, the price tag of $1.4 billion involved TPG and Blum Capital contributing $390 million, Myer family putting in $38 million and the balance of $1 billion was raised in the form of borrowings10. Synergies- Any value addition by the takeover is termed as “synergy”. Sirower (1997) defines synergy as an increase in the competitive strength thereby resulting in cash flows that cannot be achieved by the companies independently. There can be various types of synergies like cost synergy, operating synergy, etc. Another form of synergy referred as ‘Managerial synergies’ may arise when the company taking over another company can improve upon the management capabilities of the latter. With the change in ownership nearly 60% of the senior management of Myer was changed. This infusion of new talent paved the way for new ideas. There has been a significant change in the working of the company as authority and responsibility passed down to the store level. This gives the store managers a say in the stocking of product, marketing and handling of staff. With private equity takeover the shareholding of the company vests in some sophisticated people who can look beyond the short term business profits. One such Example for Myer was its clearance sale where the company sold stock worth $400 million for $150 million. No doubt this pulled down the short term profits of the company but it boosted the annual profit to $160 million as compared to $60 million for the last year11 Synergy can also arise from the saving of unnecessary costs. It is believed that most of the growth in profit after the takeover has been achieved by the reduction in staff. However the company has not been able to make any significant increase in sales12. However Myer is in a better shape as compared to its time of acquisition. Nearly $540 million has been spent on revamp. Besides this the trimming of costs has helped in pushing up the Earnings Before interest and tax (EBIT) of the company to 8.3 percent till July this year. The newly opened stores of the company are likely to push up its sales. These stores will be competing in an intensely crowded market. But the increase in selling space and store numbers will help in expanding sales and improving profit figures13. Market rerating- After three year of the takeover, TPG decided to sell off Myer and thus it planned for IPO. Considering the healthy performance of the company and its competitive edge in the retail market, TPG decided price range at $ $3.90 to $4.90. On the day one of the IPO of Myer the new shareholders who bought the stock in $4.10 find the stock price sliding over 8.5 percent. To this the management explained that value of the Myer was close to $2.90. Therefore, such rerating of the market is quite logical14. Strategic purchase & TPG’s other takeovers- Taking over another business may look an easy task on the surface but the process of acquisition is followed by a host of complications. The profit growth after the takeover deal of Myer has mostly come from cost-cutting without any significant rise in the sales. TPG continued its aggressive cost reduction strategy for nearly 40 months. The company failed to generate any significant sales from its new stores. The takeover deal of Myer is similar to the previous takeovers of TPG with underperforming departments. These departments were maneuvered to show profits on low sales growth and then released into the market with much fanfare. TPG purchased Gate Gourmet, Swiss Air’s catering division in the year 2002. This debt was financed mainly be debt. From the very beginning TPG initiated a “cost reduction program” in order to make a lucrative exit from the investment. To achieve this cost reduction the company put in place a plan to cut down employment by nearly one-third in UK; in Germany the company planned to reduce wages by 25% in Dusseldorf and 20% in other locations15. TPG Group in partnership with Carlyle Group entered into a profitable deal for the purchase of shares of Healthscope at $6.26 per share16. The total value of this deal was A$2 billion. The price offered for the hospital’s shares after the takeover announcement rose by nearly 39%. The shares of Healthscope surged to three year’s historical highs after the news of takeover announcement17 More recently the private equity firm’s plan of taking over Pipe Network has been approved by the latter’s shareholders. When the announcement for this deal was made the financial analysts viewed this deal to be in favor of Pipe18. TPG had disclosed plans to takeover Pipe in November 2009. With the support of the company directors and majority shareholders TPG’s interest in the company at that time was pushed to 19.9%. The value of the Pipe’s shares was agreed to be between $6 and $6.72 by Ernst & Young19. Market growth/ looking for new product and/or platform- Myer is a biggest department store chain in Australia. The company is actively involved in retail sales of women’s, men’s and children’s clothes, footwear, accessories, home related goods, stationary, confectionaries and food products. The company always had a healthy market growth potential with revenue increasing at a constant rate. While taking the decision of takeover, TPG analyzed that Myer group possesses strong market growth potential. Before making the takeover, TPG group already had a track record of managing well known brands in retail sector. Therefore, the company had the confidence that through takeover of Myer group it will be able to further strengthen the supply chain of the target company. TPG knew that with efficient utilization of resources of its own and the target company it will be able to develop new products. Thus Myer will be able to further expand its market share and the customer satisfaction will be enhanced20. Public relations- TPG was well aware of the managerial efficiency of the Myer Group, thus it gave assurance that no major turnover will be done even after the takeover. TPG also used its public relation to assure other stakeholders such as the investors and the suppliers that Myer will continue its relation as it is with them. Economies of scale/scope- While making the decision of takeover, the acquirer company is more interested to gain synergy. Company can often gain synergy through economies of scales. While the takeover, it has been analyzed that “Debenhams-Myer-Neiman Marcus co-operative” will result in economies of scale for TPG. Texas Pacific Group had already acquired companies like Neiman Marcus and Bergdorf Goodman in developed western economies like US and UK. Therefore, TPG was well aware of the fact that after takeover, Myer will be benefited because the stores will have exposure to international products at comparatively low cost. This will result in economies of scale because the resources will be utilized in more effective manner resulting in low operational cost and high profitability. Transforming risk into advantage by TPG Myer sold its shares at A$4.10. At the time of announcing the IPO the company had predicted a range of $3.90 to $4.90. This priced the company’s IPO at 15.1 times the forecasted earnings. Blum Capital and TPG who had jointly purchased the retailer with the Myer family disposed off their holdings at the time when the index gained by nearly 45%. TPG had anticipated that it would receive A$ 1.8 billion in cash from the sale of their stake. This would put the return of the company to six times the initial investment. In the initial years of the takeover the company failed to report any significant increase in the sale volume. But in the financial year 2009 the company reported an increase of 15% in net income to A$ 109 million. This even surpassed the forecasted estimates of the company for the month of June. This has been facilitated by the supply chain revamp of the store by TPG. TPG also made certain additions like “private label clothes”, cut down on the staff strength to improve profitability. In the words of Sean Peterson of Tribeca Investment partners the operational improvements can make the stock attractive in the eyes of the investor. Bernie Brookes stated that there have been significant improvements in Myer’s stores in terms of look, standard and feel. The company has been able to improve enormously in fundamental terms. When TPG had acquired Myer in 2006 the margin of the company was merely 2% but after the takeover deal this increased to 7.23%. This is close to the 10% margin reported by David Ltd the second ranked retail chain in the industry21. Like Debenhams TPG saw rapid turnaround in Myer by cutting down costs and preserving cash22. The long term strategy of TPG in a takeover is to improve its operating efficiency by designating the responsibility to the necessary authority. TPG brought about a number of cultural changes in Myer. The main aim of the private equity firm in the takeover was to cut down on the excessive costs, improve values so as to attract the investors in the market and then exiting the partnership within a span of three to five years. Classic steps of private equity takeover The PE firms lookout for companies that are undervalued but have immense potential. By making suitable changes to the business strategy, injecting capital and nurturing new talent the PE firm can unlock high values. This makes private equity an important part of the American economy as it plays a crucial role in pushing up business growth. The website of TPG states that the company does not look to get involved in the companies it takes over however its experience, industry expertise and global network has put it in a position where it can inspire the management strategically, financially and operationally23 The company works towards making the acquired business profitable by raising sales or scaling down costs and then exits the company by offloading its shares in the market. The private equity structure basically enables the company to concentrate on the operational functions without having to concentrate on the routine affairs of shareholders management. TPG gives its acquired company the liberty to concentrate on long terms aspects without having to bother unnecessarily on the short term profitability. Advantages & disadvantages of private equity model The concept of private equity is nothing new in the developed companies. Among these countries, UK is considered as one of the most attractive market where the concept of private equity industry had a high growth rate since 2003 onwards. In Australia this concept gained popular as the intensity of takeovers increased from 2006 onwards. The private equity model possesses both advantages and disadvantages. Few of them have been discussed below: Advantages: After takeover the chain of ownership declines in acquired company. After the takeover, the target company needs not to provide required explanation for its financial performance to the external stakeholder. This reduces the length of communication chain and time taken for decision making minimizes. The target company feels reduction in threat of liquidity because the requirement of investment will be taken care of by the private equity firm. Hence, dependency on the external inventor is comparatively low. Even the requirement of the reporting process reduces. This saves a lot of efficient time that gets utilized while developing and maintaining different kinds of reports. However, some companies do maintain reports for internal audit of its performance. As the company does not have to share its earnings with the shareholders; it can make more payment to the managers. This motivates the managers to improve their productivity and turnover rates also declines. Disadvantages In the private equity model conflict of interest is quite common. This is because the private equity partners involved in running the company may have different priorities as compared to the other investors who are involved in the private equity fund. As for example, the company can be more interested in improving its operational processes whereas the other investors are more concern regarding company’s profitability. The private equity companies make investment in a company for a shorter span of time. They have an intention to sell the acquired company in nearby future and to make profit. Therefore, this model of private equity is less concerned about the long term growth of the target company. The companies that are acquired by the private equity are not answerable to others and thus they reveal comparatively less information regarding their financial and operational efficiency. This lack in transparency makes the firms less accountable to its employees and the public. One of the main disadvantages associated with public equity is high debt-equity ratio. These companies possess high financial leverage that affects the risk of long term insolvency and economic downturn. Many a time the target company feels work cultural differences with the prevailing culture in private equity firm. Therefore, the target company has to introduce required changes in its organizational culture. Sometime this spoils the natural work environment of the firm and competitive edge of the target company declines. After getting acquired by a private equity firm, the target company no more remains related to the industry and get a feel of standalone entity. After becoming an outsider in the industry, the acquired company fails to link up with other companies. Such companies loss their association with the industry or chambers of commerce24. Review of other private equity takeover In Australia there are many US buyout groups that actively participate in private equity takeovers. Few of the vital private equity companies and some information related to them has been discussed below: Blackstone Group: The private equity of this company is one of the largest in the industry. More than two decades the company is engaged in private equity business. The company is operative in this sector since 1987 onwards and it has invested more than 142 transactions in different industries. Total value of this transaction is approximately $289 billion and these transactions are related to build-up, growth capital, rescue financial and so on. At present the company is operating in industries like business services, consumer/retile, energy, financial services, healthcare, media, technology, travel and leisure and others25. Apollo Global Management: This is also a private equity firm that is operative since 1990. The company is involved in leverage buyout of distressed securities for corporate restructuring and industry consolidation. By 2009 it is one of the largest private equity firms in the world. Purchase of Citigroup Inc's (C.N) real estate investment management group is one of the most talked about latest transaction of this firm. CVC Capital Partners ('CVC') was founded in 1981 and today this firm has its operation throughout the globe. The company focuses in holding the acquired business for more than five year periods; hence the firm takes into account the long term prospect of the acquired company. Apart from US and European nations, the firm is quite operative in Asia also. Kohlberg Kravis Roberts & Co.: This company has committed the highest money for investment as compared to any other private equity firm. During the subprime mortgage crisis, KKR was an early victim of this. Now the firm is more concern in raising fund to finance the investment process. Conclusion In the contemporary business environment concept of private equity investment is gaining market. One such memorable takeover took place in 2006 where Myer Group was acquired by TPG private equity. The management of Myer Group accepted that after getting acquired by the TPG it succeeded in bringing some healthy changes in its management strategy. However it expressed that due to mismatch of the organizational culture Myer faced some initial problems. In 2009, there was IPO of Myer group. According to the market analysts, this IPO resulted in poor profitability in short term gains but the long term profitability of Myer reflects a healthy performance. Therefore, it can be concluded that private equity model has both advantages and disadvantages that needs to be taken care while taking the decision of takeover. Reference Bloomberg. (2010). Carlyle, TPG to Acquire Australia’s Healthscope for A$2 Billion. Retrieved November 13, 2010 from http://www.businessweek.com/news/2010-07-19/carlyle-tpg-to-acquire-australia-s-healthscope-for-a-2-billion.html CEO Forum Group. No Date. The new Myer – Myer under private equity. 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Business. Retrieved November 13, 2010 from http://www.nytimes.com/2009/11/03/business/03views.html Winterford, B. (2010). Pipe shareholders approve TPG takeover. Technology. Retrieved November 16, 2010 from http://www.itnews.com.au/News/169412,pipe-shareholders-approve-tpg-takeover.aspx Read More