Mergers and Acquisitions (FIN330)

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Which sale process would you recommend to the Darryl board and why?

 

 

SKU: Fin1003032

Learning outcomes (LO) mapping:

1. Apply the regulatory framework to acquisitions and takeovers.

2. Compare different forms of acquisitions and divestments.

3. Apply valuation methods to mergers and acquisitions.

4. Implement offeror strategies.

5. Implement defensive strategies.

6. Compare methods of structuring and funding the acquisition.

 

Section A

Question 1 

LO3: Apply valuation methods to mergers and acquisitions.

You are the adviser to Lookout Ltd (Lookout), an Australian company that is considering potential acquisitions.

One of your trainees has analysed several potential targets, including Carpentaria Ltd (Carpentaria). Carpentaria operates in Australia and the USA however there are minimal transactions between the two companies.

The trainee’s research into Carpentaria has revealed the following financial data about the company for the financial years 2010 to 2012 and for the half year ending 31 December 2012:

Table 1 Financial year 2010

Historical financial data (in $ millions)

Half years ending

RIMA

 

NOTES:

Investments are held at market value on balance sheet and investment income includes change in market value.Tax rate of 40% (federal plus state) can be assumed for the US business (actual US company tax is more complicated).Other comprehensive income items (e.g. foreign currency translation reserve) and dividend flows not included.Figures may not add exactly due to rounding.

 

Table 2              Financial year 2012

Historical financial data (in $ millions)

MARI

Exchange rate used:1.0739

NOTES:

Investments are held at market value on balance sheet and investment income includes change in market value.Tax rate of 40% (federal plus state) can be assumed for the US business (actual US company tax is more complicated).Other comprehensive income items (e.g. foreign currency translation reserve) and dividend flows not included.Figures may not add exactly due to rounding.

Table 3                    Financial year 2012

Historical financial data (in $ millions)

mari1

NOTES:

Investments are held at market value on balance sheet and investment income includes change in market value.Tax rate of 40% (federal plus state) can be assumed for the US business (actual US company tax is more complicated).Other comprehensive income items (e.g. foreign currency translation reserve) and dividend flows not included.Figures may not add exactly due to rounding.

 

Table 4                       Half year ending 31 December 2012

Historical financial data (in $ millions)

MARI2

NOTES:

Investments are held at market value on balance sheet and investment income includes change in market value.Tax rate of 40% (federal plus state) can be assumed for the US business (actual US company tax is more complicated).Other comprehensive income items (e.g. foreign currency translation reserve) and dividend flows not included.Figures may not add exactly due to rounding.

The trainee also identified the following transactions and calculations for listed Australian and US comparables:

Table 5                     Australian transactions

MARI3

Table 6                     Australian balance sheet items

MARI4

Table 7                     Australian P&L

MARI5

 

Table 8                    US transactions

MARI6

 

Table 9                   US balance sheet items

MARI7

 

Table 10                  US P&L

MARI8

 

Based on these, the trainee has assessed the value of Carpentaria at approximately $A1116 million using the DCF methodology as follows:
• total NPAT $A41.8 million for year ending 30 June 2012
• 9% p.a. projected future earnings growth, citing relatively high historic aggregate profit growth rates
• 11.5% discount rate based on Australia-only comparables
• 12 times NPAT terminal value at 30 June 2032.

 

Table 11               Carpentaria value — discounted cash flow (DCF)

MARI9

 

(a) Describe five (5) errors in the trainee’s valuation approach.

(b) Determine the most appropriate methodology for valuing Carpentaria (before consideration of any special value to Lookout). Provide four (4) reasons justifying the methodology you have chosen relative to alternatives.

(c) Calculate the value of Carpentaria at 30 April 2013 using your selected methodology. Note that $A1 = $US1.0368 at 30 April 2013. Show all workings.

 

Question 2

LO2: Compare different forms of acquisitions and divestments.
Darryl Engineering Ltd (Darryl) is an ASX listed company with a market capitalisation of $2 billion. Its core business of engineering and contract mining services has been adversely affected by a slump in demand.
Darryl has $1 billion in debt facilities maturing in six months time. At a recent review, its bank advised that the facilities will be rolled over, but Darryl must reduce its core debt by $200 million (this was announced to the ASX). At this stage, there is no prospect of an extension.
Darryl also holds a 50% interest in WaterCo Pty Ltd (WaterCo), which owns and operates a water treatment plant. WaterCo:

• has long-term offtake contracts with commercial users and municipalities
• has earnings before interest, taxation, depreciation and amortisation (EBITDA) of $90 million and interest bearing debt of $300 million
• is subject to a law suit in which it is alleged that WaterCo failed to meet relevant standards of water quality, resulting in 1000 people contracting giardiasis. The plaintiffs have sought $20 million in damages. WaterCo denies liability under the claims and believes it has compelling evidence to refute the matter. The matter has not yet been set down for trial.
Ozzie Ltd (Ozzie), an ASX listed company with a market capitalisation of $5 billion, is the other 50% shareholder in WaterCo.
A shareholders’ agreement between Darryl and Ozzie sets out pre-emptive rights which arise in the event that one party wishes to sell its interest. However, the provisions are poorly drafted and, according to Darryl’s legal advice, are void for uncertainty. Accordingly, Darryl believes that it is free to sell its interest on the open market.
The Darryl board’s primary objective is to be in a position to meet its financial obligations at maturity of the debt facilities. The board believes that this is best achieved in the time frame through selling its interest in WaterCo.
You are a corporate adviser and have been engaged by the Darryl board to present on the structural and legal sale options for WaterCo.
Your research has provided additional information:
• Given the poor state of equity markets and the outlook for Darryl’s core business, raising new equity is not a viable option.
• The market for infrastructure assets with characteristics sufficiently comparable with those of WaterCo is relatively resilient. Such assets have sold in recent transactions at enterprise value (EV)/EBITDA multiples of around 10 times. This values the 50% interest at approximately $290 million (including any allowance for 100% of the contingent liability), which is well in excess of the required debt reduction (estimated tax on the proceeds is nil).
• Ozzie is likely to have the most strategic interest in an acquisition of the 50% share in WaterCo, as it is already very familiar with the asset and would be bringing its ownership to 100%. Ozzie has strong cash flows, low gearing and an estimated $400 million in additional debt capacity.
• There are three other parties, Molly, Red and Wilbur, with the financial capacity and likely strategic interest in acquiring the 50% share in WaterCo.

 

(a) Evaluate the two (2) legal forms a sale can take. What legal form of sale would you recommend (taking into account any legal and structural issues) and why?

(b) Describe three (3) solutions to deal with the potential legal liability as part of the sale transaction.

(c) Evaluate the one-on-one negotiations sale versus a sale by closed tender. Which sale process would you recommend to the Darryl board and why?

(d) Evaluate three (3) potential bid tactics you would recommend to Ozzie if they had engaged you in respect of an acquisition of Darryl’s interest in WaterCo. What bid tactic would best maximise Ozzie’s chances in the bidding process and why?

 

Question 3

LO6: Compare methods of structuring and funding the acquisition.

Bondi Ltd (Bondi) is a major Australian apparel manufacturer with a market capitalisation of $600 million (with a current share price of $2.00 and 300 million shares on issue), net debt of $200 million and forecast EBITDA of $80 million. Bondi’s shares are widely held.
Bondi has been approached by Waikiki Inc. (Waikiki), an American apparel manufacturer and a major global competitor of Bondi. Waikiki wishes to make a proposal to acquire Bondi for cash at a 40% premium to Bondi’s current share price.
You have been asked to assess Waikiki’s proposal. Your analysis reveals the following:

• Waikiki has forecast EBITDA of $200 million and currently has no net debt

• Waikiki has identified synergies of $40 million that could be generated by integrating Bondi into its global operations

• Waikiki’s banks (debt financiers) have indicated that Waikiki can borrow net debt up to three and a half times its EBITDA (i.e. 3.5 × EBITDA) for the purposes of funding an acquisition. For the purposes of this calculation, the banks are willing to include EBITDA from any acquisitions and identified synergies that are realisable in Year 1.

• Bondi has a number of retail stores (Retail Division) that contribute $15 million EBITDA to Bondi’s total $80 million EBITDA. Waikiki regards this business as non-core and would prefer not to acquire it as part of the transaction. Estimated market value of Retail Division is $60 million.

Bondi has asked you the following questions concerning Waikiki’s acquisition proposal:

(a) Assuming transaction costs equal 2% of the deal value, calculate the total amount of financing required by Waikiki to fund an acquisition of Bondi assuming Bondi’s net debt is refinanced. Show all workings.

(b) Determine the total amount of debt that Waikiki will be able to raise under its current debt arrangements. Show all workings.

(c) What is the maximum amount of debt that Waikiki could use to fund its Australian acquisition vehicle and still deduct 100% of the interest for Australian tax purposes? (Assume that the acquisition vehicle’s net Australian assets are equal to the total cost of the acquisition excluding transaction costs.) Give reasons for your answer and include the relevant rules contained in the Income Tax Assessment Act 1997 (ITAA 1997) in your answer.

(d) Describe two (2) potential strategies Waikiki could put in place to avoid acquiring or taking risk on the value of Retail Division or as part of the transaction.
Kirra Limited (Kirra) is Bondi’s major Australian competitor. It has a market capitalisation of $1.2 billion (with a current share price of $8.00 and 150 million shares on issue).
Following Waikiki’s proposal, Kirra approaches Bondi with an alternative proposal. Under the terms of the proposed transaction, Kirra would make a takeover offer for 100% of Bondi’s shares under which Bondi shareholders would receive one Kirra share for every two-and-a-half Bondi shares they currently hold.
If completed, the parties believe annual pre-tax synergies of $80 million can be generated by integrating the two companies’ management and supply chains. Kirra’s current EBITDA is $120 million.

 

The board of Bondi has asked you the following questions concerning an acquisition by Kirra:

(e) Is the Kirra or Waikiki proposal more attractive to Bondi shareholders? In your answer, consider the implied takeover premium, synergies and capital gains tax implications for Bondi shareholders.
(f) In Kirra’s bidder’s statement, what disclosure requirements (under the Corporations Act 2001 (Cth) and Takeovers Panel) must it meet with respect to the funding for the transaction? Give reasons for your answer.

 

Section B

Question 1

LO1: Apply the regulatory framework to acquisitions and takeovers.

During the period of November 2009 to November 2010 there were four publicly announced proposals from AMP, National Australia Bank (NAB) and AXA Société Anonyme (AXA SA) to acquire AXA Asia Pacific Holdings Ltd (AXA APH).

(a) Describe each proposal, the consideration offered and the implied value per share at the time of the announcement.
(b) AMP and AXA SA’s revised joint proposal included a last and final statement. Describe what the statement proposed.

On 11 November 2010 AMP and AXA SA departed from their last and final statement and submitted another offer to AXA APH.
(c) What are the two (2) risks to a market participant if they make a last and final statement and then depart from it? Include the relevant sections of the Corporations Act 2001 (Cth) and Takeovers Panel guidance notes in your answer.
(d) Did the Takeovers Panel subsequently declare this latest bid ‘unacceptable circumstances’? Give two (2) reasons for your answer.
(e) The exclusivity arrangements contained in the AXA SA and AMP consortium deed prevented AXA APH from entering into legal documentation to effect NAB’s proposal.

Describe how AXA APH and NAB dealt with the terms of the exclusivity arrangements.
(f) The AMP and AXA SA scheme booklet contained an independent expert’s report.
Was there a statutory requirement for the inclusion of an independent expert’s report? If so, explain why and include any relevant ASX Listing Rule and ASIC condition in your answer.

 

Question 2

LO4: Implement offeror strategies.

The final AMP and AXA SA offer for AXA APH was announced on 15 November 2010. The consideration was structured with a mechanism that included a variable cash component, determined by reference to AMP’s post scheme 10-day volume-weighted average price (VWAP).
(a) Describe how the consideration structure would operate from a minority shareholder perspective, based on AMP post scheme VWAPs between $4.25 and $6.00. Show all workings.
(b) What was the maximum amount of cash that AXA SA was required to contribute for the minority AXA APH shares (in aggregate, excluding options)? Show all workings.
(c) What was the rationale of the consideration structure from AMP’s perspective?
(d) What was the rationale for supporting the consideration structure from AXA APH’s perspective? From a minority shareholder’s point of view, provide two (2) advantages and two (2) disadvantages in comparison to a cash offer.

 

Question 3

LO1: Apply the regulatory framework to acquisitions and takeovers.

In April 2010 the Australian Competition and Consumer Commission (ACCC) announced that it would oppose NAB’s acquisition of AXA APH, but would not oppose AMP’s from a competition perspective.

(a) Outline the ACCC’s rationale for opposing NAB’s proposal while allowing AMP’s.
In September 2010 the ACCC explained in its public competition assessment why it also dismissed the proposed divestment undertakings by NAB.

(b) Describe NAB’s four (4) divestment undertakings to address the ACCC’s competition concerns.

(c) What were the three (3) key reasons given by the ACCC in rejecting the NAB’s divestment undertakings?

 

LO5: Implement defensive strategies.

On 9 November 2009, AXA APH announced that it had received an offer and conditional scheme proposal from AMP and AXA SA. The independent board committee of AXA APH formally rejected the proposal.

(a) What basis did the independent board committee give in formally rejecting the AMP and AXA SA proposal? Identify four (4) reasons that formed the basis of the independent board committee’s decision in rejecting the proposal.

(b) Following the independent board committee’s rejection:

(i) Provide three (3) potential strategies AMP and AXA SA could have implemented to effect the acquisition of AXA APH. List the advantages and disadvantages of each strategy.
(ii) Provide four (4) potential strategies the AXA APH board could have implemented to generate incremental value for AXA APH shareholders. What issue/s could arise with the Takeovers Panel?

 

Question 4

LO5: Implement defensive strategies.

On 9 November 2009, AXA APH announced that it had received an offer and conditional scheme proposal from AMP and AXA SA. The independent board committee of AXA APH formally rejected the proposal.

(a) What basis did the independent board committee give in formally rejecting the AMP and AXA SA proposal? Identify four (4) reasons that formed the basis of the independent board committee’s decision in rejecting the proposal.
(b) Following the independent board committee’s rejection:

(i) Provide three (3) potential strategies AMP and AXA SA could have implemented to effect the acquisition of AXA APH. List the advantages and disadvantages of each strategy.

(ii) Provide four (4) potential strategies the AXA APH board could have implemented to generate incremental value for AXA APH shareholders. What issue/s could arise with the Takeovers Panel?

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