Strategic Management Decision Making - Term Paper Example

Strategy Management Table of Contents Strategy Management 1 Table of Contents 1 Introduction 2 The companies: A Strategic fit 3 Valuation & Other Financials 4 Merger or Acquisition 6 Funding Strategy 7 Creating Shareholders’ Value 8 Conclusion 9 Reference 10 Appendix 11 Introduction There have been many avenues for a company to expand its business. Sometimes the reasons to expansion include moving into other industry, expanding in the same industry and expanding in foreign countries. In each of the cases the company have choice of setting up business on its own or else going through mergers, acquisitions or any other consolidation processes. In this case both the companies are from the same country. The acquirer company, Games Workshop, would like to expand its business to some other areas which are quite related to what they are into right now. Setting up is the costliest process to come up with. For this reason the company has decided to go with either merger or acquisition. Games Workshop has decided to go for a transformation. This report is an attempt to articulate the changes and the reasons behind this transformation to take place. The report starts with an introduction to both the companies, Games Workshop and Hornby. After that a discussion has been put forward to see the tactical fit of the target company to the strategic policies of the acquirer company. Valuation is quite an important fact in the whole process. Positive value of the acquired firm is very much desirable. Valuation and other financials have been discussed in later topic. Later on it is time to think whether the acquirer would like to go for merger or acquisition. A comparative and tactical study has been done to choose the best way among these two. While the firm and the process have been chosen to be appropriate to carry on the acquisition process, it is of much importance to zero down on the tactical funding strategy. For this economic gain has been taken into account to have an idea about the proper funding strategy which is also in accordance with the financial structure of the games Workshop. One of the main aims to go for expansion is adding shareholders’ value, which is of quite importance to a business entity. Calculation have been done to calculate the shareholders’ value addition for each of the companies so that shareholders can have much better idea about the situation and the added shareholders’ value after the transformation. In all the Games Workshop has decided on this transformation in concern with the interests of all the stakeholders. This transformation would add value for the stakeholders of is company. The companies: A Strategic fit Games Workshop Plc is one of the world leaders in producing war games. For the last 30 years, it has been in designing, manufacturing and marketing of different war games. As they are going big and the market is more competitive, the company is looking for expansion to have more business and growth in coming years. Hornby is a leader in model railway hobby in UK. The founder of this organisation was granted a patent on an invention named as ‘Improvements in Toy or Educational Devices for Children and Young People’. The company has acquired companies in this field and has made it real big. Back in 1964, the acquisition of Meccano Ltd was such an acquisition. As both the companies have identical category of customer base comprised of mostly children and young people, it would be good to have Hornby on board. Out there is a good growing market for Hornby. In 2009, despite of having an increment in the price level for their products, the sales at that year have seen an increase. As per the chairman, raising prices was mostly ‘accepted by the market’ (Mason, 2009). That surely indicates that the company has its loyal customer base in place, who is not much bothered with the pricing as they are satisfied with the products and servicing the company is offering. Being in the toy and games industry, linking up with a renowned toy company would enhance the customer base as well as market share of Games Workshop. Starting from 2007, the market of toy and games devices is quite gloomy. As per ‘Toys & Games Market Report 2009’ the overall sales has been decreased in this period. Despite of such slowdown Hornby has managed to avail positive growth which has reached highest in 2008. This ensures that the toy market has very much potential in it. Starting from the year 2001, Hornby has availed an average growth of 12.79 % with an average profit margin of 14.91 %. These figures are quite significant to indicate the fact that the company has an increasing and at the same time loyal customer base, who help them to make profits even in the market downturn. The collective technical resources of both the companies can be beneficial to have a sustained growth in near future. The research base can work together to come up with new and improved games and toys. As the target customer base for both the companies are same, marketing and advertising would be quite easy to carry on; hence the cost are supposed to be stable in long run. The customers would be happy to find out both the products under one ceiling. Having the reputation, customer base, resources and profitability of the company, Hornby, it would not be wrong to comment that this would be a good strategic fit for Games Workshop expand in toy market for a business growth. Valuation & Other Financials While deciding on the target company, it has been very much necessary to properly calculate the value of the target company. If the firm has a positive and enhanced firm value, the acquirer is encouraged to move with the deal. From the same perspective the calculation of valuation has been done for the acquirer as well as for the target company. A proper valuation technique, which is known as Discounted Cash Flow Valuation technique, has been adapted to come to the business values of the companies. Free cash flows have been discounted using the weighted average cost of capital and the present value of the residual cash flows has been calculated using the same procedure. At last sum of these two have been calculated to reach at the business value for each of the companies. The business value for Games workshop has been calculated to 110,102 and that for the Hornby, the target company, has been calculated to 97,862. So the company possesses much positive business value which is a significant factor to choose this company as the target unity. The sales growth for this company in the year 2009 has been 10.55 % and in next year this is estimated as 12 %. The profit percentage has been assumed as 11 % in 2009 and estimated to have a value of 15 % in the coming years. The operating cash flow for this company has been calculated as £ 47, 47, 000 and would preferably continue to have such high positive values in coming years. The company has recently added some £ 42, 03,000 in its working capital, which could be beneficial for the company in coming years to generate more operating cash flows. The company has inventory accounted to £ 14, 368, 000 and receivables amounted to £ 13,119, 000. These assets would surely be of assistance in operating activities. They have payable of around £ 1, 955, 000, but with that they have enough assets to payback their payables. The company has a very positive prospective, both financially and strategically to be the target company. Acquiring this company would provide Games Workshop with a large customer base, a good number of performing assets, good amount of working capital and good profit margin. Hornby has shown a positive and high growth prospective in terms of sales or in profit margin, which will add quite a value to Games Workshop’s future venture. Merger or Acquisition Games Workshop has two options to choose the avenues from. They can go for either merger or acquisition. Whatever way they take, they must make sure that the stakeholders’ interests are mostly met with a better economic gain from the merger or acquisition. Strategically sometimes acquisition is better than mergers, mostly when the consolidation is going to happen between two leading companies. Conflicts can arise among the management of both the companies, when both the management would like to have control over the business. Keeping this aside, it would be better to have a look at both the procedures to zero down on one. It is always important to calculate the economic gain before going out for an option. Economic capital is measured as the difference between the value of merged unit and the sum of the values of two companies. Although a merger does not entail cash in it, still the parties incurred higher legal costs than that involved in acquisition. In case of merged company the economic value will come as zero. That means no value addition to the company’s current value. While going for an expansion, the aim of a company would be to increase the firm value, but in this case this is not the situation. Acquisition is significant to increase the productivity and profitability of an organisation. Most of the times, the acquisition would result in increased output as the company would have unchanged fixed cost, yielding better profit. Games workshop would have better control over Hornby; hence there would be much lesser conflict arising in the management board. Games workshop is intended to go for acquisition as in that way they would have avail to the patent the target company is holding. They can have much better authority over the operations and would be much capable to increase the shareholders’ value, which is very much significant for a business. Moreover games workshop has access to enough funding to finance this acquisition. This would be a significant expansion plan which would let the acquirer to expand in different market with a renowned brand name, which is very much important for the future growth of the company. Funding Strategy Economic gain has been a basic to this decision. It has been very much important factor behind this decision. Before deciding on the funding part, it is very much important to measure the economic value for each of the funding options. The total price for the target company has come around £ 62,849, 000. The total capital lied with Games workshop is around £ 127,970, 000 out of which the equity portion would comprise of £ 115, 968, 000 and the rest £ 12, 002, 000 would be accounted in debt portion. The company can have different funding strategies while acquiring Hornby. Company has decided to choose the funding strategy which would result in higher economic value for the company. In the calculation, it has been noticed that the higher economic gain would come with all equity financing and the least economic value would come with all debt financing. The economic value for zero debt financing would be £ 12,633,000 and from there the value would go down the ladder with an increase in the debt portion. If the company financed the acquisition with 20 % debt, the economic gain would come to zero. From there it would result in negative economic gain with an increase in the debt percentage in the funding strategy. Negative value is surely not desirable and while going for merger and acquisition it is always preferable to strive for positive and better economic value if possible. In this case, the company has enough capital to finance the whole acquisition and hence the company has decided to go to finance the acquisition using zero debt amount. Looking at the debt equity ratio of the company which has come around 0.1, it is much apparent that the company prefers to have low leverage ratio. In such a case the company can give a thought on to finance the acquisition part with the help of equity capital. In the case the capital would decrease and the leverage ratio would come around 0.23 which is also a low one. Although in case of equity capital the cost of funding is a bit higher than that of debt, still looking at the company’s preference to have less debt on its accounting book, it would be better for the company to go for stock splits or offer more stocks to raise more equity capital. Still it would be better for the company to have bit more debt on its accounting book in near future. In such a way the funding cost would be much lower and at the same time they would avail to the tax shield and hence the profitability would increase for the company. Creating Shareholders’ Value Another reason, which was much of importance while deciding on acquiring Hornby, was the creation of shareholders’ value. Shareholders’ are very much important from the business perspective. The company always strives to ensure value creation for the shareholders while going for any strategy implementation. This decision was also taken after a cautious calculation of shareholders’ value for each of the companies. Games workshop is supposed to add value of 108,115 to the shareholders’ money. Hornby is supposed to add more 85970 total shareholders’ values. So surely the shareholders are going to get benefited by this acquisition. Conclusion Games Workshop has decided to acquire Hornby. As both the companies operate in related fields, it would be a good tactical fit for the acquirer. Some of the advantages which the acquirer would have include a customer base in the similar category, in which the acquirer operates in. Apart from that the company would avail the patent, good will, technology and resources which are of very much significance for the beneficial of Games Workshop. The financials and the business value of Hornby are quite positive and prospective. Games Workshop would have access to its enhanced asset classes. The target company has recently added a certain amount of working capital to support their business activities. This could be a reason that the company has maintained high positive operating cash flows from their business activities. The average growth rate of Hornby is quite high, and it has managed to have a high growth even in the time of market downturn, which proves that the company has a sustainable growth in both sales and profit margin. All these factors have added to the fact that Hornby would be able to add a positive and good amount of shareholders’ value, which is of utmost importance for the shareholders of the acquirer company. These all aspects have collectively been influential in the decision of Games workshop acquiring Hornby. The company is expected to grow up the ladder in games and toy industry with this significant acquisition. Reference Mason, R. January 27, 2009. Healthy hobby sector makes Hornby, Games Workshop and Future bright. [Online]. Available at: http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/4358499/Healthy-hobby-sector-makes-Hornby-Games-Workshop-and-Future-bright.html [Accessed on February 24, 2010]. Appendix Leverage ratio Calculation Read More