Reference no: EM132175500
Mergers and Acquisitions Assignment -
1. Dave's Pizza - Fulton Pizza Merger
Dave's pizza is considering a merger with Fulton Pizza. The offer under discussion is a cash offer of $352 million for Fulton Pizza. Both companies have niche markets in the pizza industry, and the companies believe a merger will result in significant synergies due to economies of scale in manufacturing and marketing, as well as significant savings in general and administrative expenses.
Matt Robinson, the financial officer for Dave's, has been instrumental in the merger negotiations. Matt has prepared the following pro forma financial statements for Fulton assuming the merger takes place. The financial statements include all synergistic benefits from the merger:
|
2015
|
2016
|
2017
|
2018
|
2019
|
|
Sales
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$512,000,000
|
$576,000,000
|
$640,000,000
|
$720,000,000
|
$800,000,000
|
|
Production costs
|
359,200,000
|
403,200,000
|
448,000,000
|
505,600,000
|
564,000,000
|
|
Depreciation
|
48,000,000
|
51,200,000
|
52,800,000
|
53,120,000
|
53,600,000
|
|
Other expenses
|
51,200,000
|
57,600,000
|
64,000,000
|
72,320,000
|
77,600,000
|
|
EBIT
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$ 53,600,000
|
$ 64,000,000
|
$ 75,200,000
|
$ 88,960,000
|
$104,800,000
|
|
Interest
|
12,160,000
|
14,080,000
|
15,360,000
|
16,000,000
|
17,280,000
|
|
Taxable Income
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$ 41,440,000
|
$ 49,920,000
|
$ 59,840,000
|
$ 72,960,000
|
$ 87,520,000
|
|
Taxes @40%
|
16,576,000
|
19,968,000
|
23,936,000
|
29,184,000
|
35,008,000
|
|
Net Income
|
$ 24,864,000
|
$ 29,952,000
|
$ 35,904,000
|
$ 43,776,000
|
$ 52,512,000
|
Matt knows that Fulton will require investments each year for maintenance of plant. The table below has required investments and sources of financing:
|
2015
|
2016
|
2017
|
2018
|
2019
|
|
Investments
|
|
|
|
|
|
|
Net working capital
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$ 12,800,000
|
$ 16,000,000
|
$16,000,000
|
$19,200,000
|
$19,200,000
|
|
Fixed assets
|
9,600,000
|
16,000,000
|
11,520,000
|
76,800,000
|
4,480,000
|
|
Total
|
22,400,000
|
$ 32,000,000
|
$ 27,520,000
|
$ 96,000,000
|
$ 23,680,000
|
|
Sources of financing
|
|
|
|
|
|
|
New debt
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$ 22,400,000
|
$ 10,240,000
|
$ 10,240,000
|
$ 9,600,000
|
$ 7,680,000
|
|
Profit retention
|
0
|
21,760,000
|
17,280,000
|
17,280,000
|
16,000,000
|
|
Total
|
22,400,000
|
32,000,000
|
27,520,000
|
26,880,000
|
23,680,000
|
The management of Dave's feels that that capital structure at Fulton is not optimal. If the merger takes place, Fulton will immediately increase its leverage with a $71 million debt issue, which would be followed by a $96 million dividend payment to Dave's. This will increase Fulton's debt-to-equity ratio from 0.50 to 1.00. Dave's will also be able to use a $16 million tax loss carryforward in 2016 and 2017 from Fulton's previous operations. The total value of Fulton is expected to be $576 million in five years, and the company will have $192 million in debt at that time.
Stock in Dave's currently sells for $94 per share, and the company has 11.6 million shares of stock outstanding. Fulton has 5.2 million shares of stock outstanding. Both companies can borrow at 8%. The risk-free rate is 6%, and the expected return on the market is 13%. Matt believes the current cost of capital for Dave's is 11%. The beta for Fulton at its current capital structure is 1.30.
Matt has asked you to analyze the financial aspects of the potential merger. Specifically, he has asked you to answer the following questions:
1. Suppose Fulton's shareholders will agree to a merger price of $68.75 per share. Should Dave's proceed with the merger?
2. What is the highest price per share that Dave's should be willing to pay for Fulton?
3. Suppose Dave's is unwilling to pay cash for the merger but will consider a stock exchange. What exchange ratio would make the merger terms equivalent to the original merger price of $68.75 per share?
4. What is the highest exchange ratio Dave's would be willing to pay and still undertake the merger?
2. VANS is a privately owned manufacturer of light trailers that are sold to rental companies and individuals. Its sole owner, Mr. Benjamin Webster is presently considering a purchase offer from Prentice Works. The offer for the equity of VANS is as follows:
i) A cash payment for $5 million due at closing.
ii) A 7.5% annual coupon five-year subordinated note issued by Prentice Works, for $7 million with principal payable at maturity.
i) An earnout agreement stipulating a payment to take effect at the end of the third year equal to one-half times third year EBITDA.
Prentice Works will assume VANS's present net debt of $14.8 million. Furthermore, VANS will become a wholly owned subsidiary of Prentice and Mr. Webster will stay as its president with a three-year contract and competitive compensation, at the end of which he will retire.
The following additional information is available:
- Prentice Works' outstanding subordinated notes are presently priced to yield 10%.
- Mr. Webster believed that he could make VANS's EBITDA grow at 11% per year during the following three years. Current EBITDA is $6 million.
- Small companies with characteristics similar to VANS have a WACC of about 14%.
Questions:
a. What is the value of the 7.5% $7 million note offered by Prentice Works?
b. What is the value of the earnout agreement?
c. How much is Prentice Works offering for the enterprise (debt plus equity) of VANS? What is the initial EBITDA multiple offered by Prentice?
While Mr. Webster will take into account his salary as president of the subsidiary as well as the tax consequences of the transaction, you should ignore these matters in answering the above questions.
3. A selling company is a regular C corporation. Given the following data calculate the net proceeds to the shareholders of the selling firm if the buyer makes a stock acquisition versus an acquisition of assets.
Purchase price, stock $250
Purchase price, assets 250
Liabilities of seller 100
Basis in assets (seller) 150
Basis in shares (shareholders of seller) 125
Marginal corporate tax rate (federal and state) 35%
Individual capital gains tax rate (federal and state) 24%
4. Download the Bloomberg screen 'MARB" to EXCEL. Only consider the M&A deals that have been completed. For each deal, predict whether the wealth of acquiring shareholders increases or decreases in the long run. Explain your reasoning.
For bonus points, create a merger-arb portfolio on Bloomberg and track its performance through the end of this module. Use only pending deals to create the arb portfolio.