Analysis of the Proposed Rustica Industries Corp Acquisition - Example

Task B: Analysis of the proposed Rustica Industries Corp acquisition Introduction This analysis seeks to establish the merits and risks that are associated with Martin Smith’s choice of an investment. The choice of Rustica Industries Corp as the best investment option for Newport Partners is associated with both merits and risks. Thus, Martin Smith has to evaluate the investment proposal all round, to present the proposal with the most merits and the least risks possible for Newport. i) Pros/Merits and Cons/Risks of the proposed Rustica Industries Corp transaction The proposal to invest in Rustica Industries Corp appears to be an attractive investment option for Martin Smith to present. Nevertheless, while it appears to be an attractive investment opportunity for Newport Partners, the investment opportunity also presents some risks that require being considered. The applicable type of a PE deal transaction for the investment in Rustica Industries Corp is the buyout type of private equity transaction. The buyout type of private equity transaction entails the purchase of a target company through acquiring 100% of its shares or by acquiring a high percentage of the company’s shares, which will give the private equity owners the control position over the target firm (Rosenbaum, 2009:77). Specifically, the type of PE deal transaction that Newport Partners will apply in the target investment in the Rustica Industries Corp is the leveraged buyout (LBO) type, which entails the use of borrowed or debt funds to acquire stakes in another firm (Rosenbaum, 2009:72). The merit associated with Martin Smith’s presentation of this proposal is the ease of showing how Newport Partners will acquire Rustica Industries Corp with little funding difficulties and high efficiency. Thus, Newport will borrow from the creditors and apply the borrowed funds towards acquiring the stakes of Rustica Industries Corp, in return for the creditors holding an ownership interest in the acquired firm. This will then give Newport partners the control rights over the acquired company, which can henceforth be managed in accordance with the partners’ interest, in order to generate the necessary revenues that can be used to pay up the creditors debts. The major merit associated with the application of the LBO type of PE deal transaction is that it enables Newport to acquire the stakes of the target company, without using much of its capital, since the bulk of the capital used will be both debt and subordinated debt capital. a. Merits/Pros of the proposed transaction for Newport Partners Quick recouping of the investment The estimated cost of purchasing the 100% shares of Rustica Industries Corp is in the vicinity of $145 million. On the other hand, Rustica Industries Corp was able to generate revenues worth $136.2 million for the year ending March 2002, with a potential of growing the annual revenues to $158.7 million by 2005. This simply means that the company is able to generate annual revenue that is close to the total value of the company’s buyout price of $145 million. Therefore, the acquisition of Rustica Industries Corp would be advantageous for the Newport Partners, owing to the fact that they would be able to recover their investment into the newly acquired company within a short period of time, and continue to earn profitability (Gladstone, 2004:25). Ease of access of debt financing The other merit associated with the choice of the acquisition of Rustica Industries Corp is that there is ease of accessing the necessary debt financing that is required to finance the acquisition. The cost of acquisition of 100% shares of Rustica Industries Corp has been estimated at $145 million. On the other hand, there is already a prospect of $100 million worth of debt and subordinated debt that would facilitate the acquisition of the new company. This ease of access of the debt financing for acquiring the new company is based on the fact that Rustica Industries Corp has sustained the reputation of a stable performer, such that arranging for the debt financing of this company would be relatively straightforward. Thus, the mere fact that the acquisition of this company presents the prospects of ease of access of debt financing is a major advantage for the Newport partners, through enabling the firm to save on the costs associated with funding acquisition (Stowell , 2010:44). This is owing to the fact that Newport will not be required to undergo the tedious process of seeking for the necessary funding, which would be both costly and time consuming. Market share advantage Rustica Industries Corp has been a stable performing company that had already managed to acquire 65% of the industry market share. This is a great advantage for Newport Partners, owing to the fact that it will be acquiring a company that has already managed to curve a large market share for itself, meaning that the company would only need to fight to maintain the leading market share position, as opposed to fighting to acquire the market share. Most importantly, Rustica Industries Corp holds 65% of the market share in its industry, which is six times more than its closest competitor in the industry. This means that the company holds a comfortable leading position in the industry it serves, and it would be fairly difficult for its competitors to be able to reach the level of competitiveness of Rustica Industries Corp. Therefore, with a leading market share position that is relatively high, the acquiring company would only require to sustain the goodwill and the customer loyalty already created by the acquired company (Blomberg, 2008:n.p.). Management experience advantage Rustica Industries Corp is a company that is managed by considerably experienced team. The apparent heir to the CEO position of the company has been with the company for the last 16 years. Peter Volpe was the man poised to rise to the CEO position and replace the retiring CEO, and he had already taken up the management role of the firm. Additionally, the management team at Rustica Industries Corp had an average of 10 years of experience with the company. Management experience is a major asset associated with any firm, owing to the fact that it provides for a smooth transition of the operations of a firm, even after a firm has been acquired by new owners (Rosenbaum, 2009:72). In addition, the heir apparent to the CEO position of the company, Peter Volpe is still young and energetic, at only 41 years of age. This means that he can be in a position to sustain the management stability of the company, enabling the company to continue doing what it has been doing in the past in order to curve and subsequently sustain the large market share in its industry. Growth potential Rustica Industries Corp is a company that has further growth potential. This is due to the fact that the manufacturing side of the company was noted to be capable of increasing the efficiency of the company at a lower cost. Therefore, Newport Partners can be able to capitalize on the existing growth potential of the company to be acquired, and ensure that it increases its manufacturing potential at the lowest possible cost, which would in turn increase the revenues and profitability of the company. In addition, Rustica Industries Corp was discovered to be operating under low capital utilization. A firm’s low capital utilization presents a further opportunity for growth, thorough the exploitation of the full capital potential of the company into productivity (Yuping & Rong, 2009:n.p.). Potential for rejuvenation of the product lifecycle Most of the products that are generating substantial revenues for Rustica Industries Corp are products that were developed within the last 5 years, contributing 25% of the total annual revenues earned by the company. This means that there is a high potential for developing these products to replace the older products that have already reached the market saturation point. This way, the company still presents some potential for sustaining its leading market share in the industry. This is since Newport can apply the already existing Rustica Industries Corp products to sustain the existing customer base, while innovating on other new products that might replace the older products, which have already reached the market saturation point. b. Risks and cons Market saturation risk Rustica Industries Corp has most of its products approaching or already in the market saturation category. This means that such products have little or no potential for future growth. The risk associated with market saturated product categories is that the future of the products is likely headed for the decline phase, which then means that the company might be losing both on its market share and revenues (Gladstone, 2004:24). Low barriers to entry The low barrier to entry associated with the industry that Rustica Industries Corp is serving, is a major risk for the future position of the company. With a low entry barrier to the business area of the company, there is a likelihood of future threat of new entrants growing and causing a reduction both in the market share and the revenues of the company (Blomberg, 2008:n.p.). This in turn puts the investment by Newport Partners at the risk of being unrecoverable. The low barriers to new entrants into the market means that Rustica Industries Corp faces the risk of losing its leading market share in the industry not only to the existing competitors, but also to the new entrants. ii) Key learning points acquired while working on this assignment The key learning points acquired while working on this assignment comprises of both the learning points acquired from working as a group in Task A, as well as the learning points acquired from working on the individual assignment in Task B. a. Key learning points acquired while working on group Task A The value of cooperation is a key point that was learnt from working in the group assignment under Task A. The overall success of task A was highly dependent on the ability of all the team members to cooperate, since the task presented an opportunity for diverse opinions, with each individual in the group having a different position regarding the company in which Martin Smith should opt to invest. Additionally, there were diverse opinions regarding the nature of the type of PE deal transaction that should be adopted for this investment. Nevertheless, through the members cooperating and compromising on their adapted positions, it was finally possible to reach an agreeable position regarding which investment transaction Martin Smith should present. The relevance of interpersonal communication skills is yet another key learning point that was acquired while working in the group assignment Task A. interpersonal communication skills are essential, since they enable people to negotiate positions that can finally be agreed, even though each individual initially held a different opinion. Further, while negotiating such a controversial topic has the potential of degenerating into disagreements and conflicts between the members of the group, it is through interpersonal communication skills that such conflicts and disagreements are resolved amicably, and all members result into an agreeable position. b. Key learning points acquired while working on group Task B The key learning point obtained from working in individual assignment Task B, is the multifaceted nature of financial decisions, and the role of multidimensional analysis in reaching at a conclusive financial investment decision. The determination of the merits and risks, pros and cons associated with the adopted financial decision to invest in one of the different companies evaluated by Martin Smith, requires that issues such as the ease of access to investment funding, the potential of growth of the newly acquired company, management experience, market share advantage and the ease of recouping the investment are factors that require being considered in order to arrive at a sound financial investment decision. The other key learning point obtained from the individual assignment Task B, is the relevance of a well-rounded evaluation of a financial investment decision, requiring that both the merits and risks associated with an investment option are evaluated, in order to reach at a conclusive investment decision. Thus, despite a potential investment presenting numerous advantages and merits regarding why it should be adapted, it is a key learning point that there can be a single risk/con that can cause the investment option to be disregarded, despite presenting numerous potential merits. Thus, it is not enough to evaluate the risks and merits associated with an investment option, but also essential to evaluate the strengths associated with such merits or risks, in order to arrive at a sound financial investment decision. Conclusion In conclusion, the choice of Rustica Industries Corp is informed by the ease of accessibility of debt capital to invest in the company for Newport Partners, as well as the high potential for the company to recoup its investment in the newly acquired firm within the shortest time possible. Investing in Rustica Industries Corp also presents the potential for growth and leveraging of the products offered by Rustica Industries Corp, so the company can continue to maintain its leadership role in the industry it serves, while also generating sufficient revenues. Thus, the investment in Rustica Industries Corp by Newport partners would be most appropriate and less risky. References Blomberg, A. (February 2008). Private Equity Transactions: Understanding Some Fundamental Principles. Business Law Today, 17(3). Available at: http://apps.americanbar.org/buslaw/blt/2008-01-02/blomberg.shtml Gilligan, J. & Wright, M. (2010) Private Equity Demystified. London: ICAEW. Gladstone, D. (2004). Venture Capital Investing, the complete handbook for investing in new businesses. Upper Saddle River, NJ: Pearson Education. Rosenbaum, J. (2009). Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions. Hoboken, NJ: John Wiley & Sons. Stowell , D. (2010). An Introduction to Investment Banks, Hedge Funds, and Private Equity: The New Paradigm. Academic Press. Yuping L. & Rong Y. (2009) Competing Loyalty Programs: Impact of Market Saturation, Market Share, and Category Expandability. Journal of Marketing: January 2009, Vol. 73, No. 1, pp. 93-108. Available at: http://journals.ama.org/doi/abs/10.1509/jmkg.73.1.93 (Accessed: March 30, 2015). Read More