Study for Viability of Takeover - Report Example

Business Report Study for viability of Takeover (Wolseley PLC > FKI) An Introduction When the concepts such as Mergers, acquisitions, amalgamation, or take over are exercised, the use of Management accountancy comes into handy. Through legitimate parts of accounts such as EPS, investor ratio, capital audit, etc. the acquirer will be able to analyse the accurate price at which the stocks of the target company should be purchased. (Sherman, A. & Hart, M., 2006) Since the deals of mergers and acquisitions involve a huge amount of money, a company cannot be solely purchased based on its stock prices due to the presence of a huge chance that the stock prices might be manipulated. Thus major companies conduct an investigation to discover the actual situation of the company. This investigation (by the acquirer) is not only based on accounting principles, but it is also based on various forecasting techniques and practical questions, for example: ‘Why is the target willing to sell the stake?’ ‘Will the product that is produced by the company be at a stable demand or does a chance of fall in demand exists in case of news of entry of a big competitor?’ ‘Will the company continue to generate stable profits?’ or ‘Is the profit generated by the company solely based on the sale of its product, or does a part of the profit comes from other sources such as investment in a financial market, or any other source which will not be possible for our company’s board to manage?’ (Hutchison, S., 1968) The Acquisition of FKI Plc by Wolseley Plc Well... considering the situation of these two companies at end, basically we have to imagine ourselves to be acquirers and analyze the best price for purchase and the viability of purchase of FKI for Wolseley. So, to be able to do that we will analyze the data of FKI Plc and compare its various figures against our company’s figures, so that we may establish a ratio based comparison between various factors such as Profits, Activity, Liquidity, Gearing ratio, etc. Whether Wolseley should buy FKI? To calculate the viability and expected price of the deal it is necessary to calculate the valuation of FKI. To be able to do this we would be required to evaluate the following: 1. Total value of Assets. 2. Previous income graph or data. 3. Forecasted trend of revenues. 4. Comparison with competitors. Initial Information about FKI The various segments and their respective share in turnover is as follows of FKI are as follows: Business Achievements Proportion in turnover % Turnover (2005) Windows, doors, DIYs and other office furniture U.S. no. 1 in window hardware 16.5 % £ 199.7 m Turbo generators, various machines and transformers World no. 1 independent supplier of turbo generators 24.2 % £ 292.1 m Converters, software, palletises, etc. Major worldwide provider of automated material handling systems 28.8 % £ 348.3 m Lifting products and compaction Top 3 in wire and wire ropes 30.5 % £ 367.9 m TOTAL 100 % £ 1,208 m. Tab 1.1 The Valuation and Proposed price for purchase Since we know the major factor for the occurrence of such a loss, we may try to look for a solution (although the solution mostly lies in America’s economic conditions). But we will not forget other positive factors such as the growing business in rest of the world, the creditability created by the brand names owned by FKI, and finally the fact that a larger and more renowned company such as Wolseley would definitely create a huge impact on the creditors and other parties (in a positive manner). The Valuation The Valuation of FKI will be done on the following basis: Quantitative Analysis FKI Profitability Indicator Ratio & Activity ratio: To analyse the profitability indicator ratio we will use the return on asset technique. (Lee, D. & Colon, A., 1999) Return on Asset = Net income / Average Total Assets = 65.7 / [{(363.3 + 265.6 + 0.6)/3} + {(202 + 336.3 + 5.5 + 77.3 + 78.7)/5}] = 65.7 / (209.83 + 139.96) = 65.7/349.79 = 18.78 % Liquidity Measurement Ratio: Current Ratio To calculate the liquidity ratio of the company we will use the current ratio technique: Current ratio = Current assets / Current Liabilities = 699.8 / 444.6 = 1.57 (Lee, D. & Colon, A., 1999) Wolseley Profitability Indicator Ratio & Activity ratio: To analyse the profitability indicator ratio we will use the return on asset technique. Return on Asset= Net income / Average Total Assets = 461.2 / [{(866.1 + 915.9 + 3.6)/3} + {(1705 + 2275.5 + 263.9 + 4.8 + 381.1)/5}] = 397 / (578.53 + 926.06) = 397/1504.59 = 26.38 % Liquidity Measurement Ratio: Current Ratio To calculate the liquidity ratio of the company we will use the current ratio technique: Current ratio = Current assets / Current Liabilities = 4630.3 / 2803.7 = 1.65 Commentary Wolseley FKI Current Assets 4630.3 699.8 Current Liabilities 2803.7 444.6 Working capital 1826.6 255.2 Current Ratio 1.65 1.57 Tab. 2.1 Well... the current ‘ratio’ indicates that both the companies have a very similar assets and liabilities position, with 1.65 for Wolseley and 1.57 for FKI. Both these companies have their own plus points and loopholes. Overall, Wolseley is 6 times larger in terms of Working capital. But in terms of Net Asset (Total Asset – Total Liabilities) Wolseley has a much higher reserve by superlating FKI by 13 times, this has just doubled if we compare it to the current ratio. This may also help us judge that both the companies are quite on the same track. From the perspective of investors, FKI does not look so good: Investors, Bankers, Suppliers & Employees (FKI) Primarily, we have evaluated the company’s balance sheet. According to the balance sheet as provided by the company’s Board of Directors, the situation doesn’t look good in the current year, Fixed and current assets combined have fallen by about 98.7 million pounds, not only that but the capital employed has also fallen by about 94.8 million pounds which does not sound good. A Criticism – Based on perspective of investors, bankers, customers, suppliers and managers Along with these circumstances (para 1), the company also booked a loss for 69.2 million pounds in 2005 vs. the 26 million pound profit in 2004. Other situations along with this state that the company is near to bankruptcy as the creditors have risen by about 10 % (approx.). Net assets have decreased, borrowings have risen, the shareholders fund is down in the drain and to make it all worse the overall capital has been shrunk by about 40 % (approx.). Looking at these circumstances it is very clear that the company is no longer a share holder’s choice. So, since it has lost all its charm by providing the worse possible results after being into the business for such a long time, it is clear that the company should not be purchased over the market price. As a matter of fact, such figures do not even indicate the possibility of a bright future for the company. It might even be a mistake to purchase this company in the present market situations. Even the goodwill account shows a 15 – 18 % of decrease. So... will it be really fair to Wolseley’s shareholders if we make such a decision. Lets analyze further... does the US’s economic conditions have anything to do with FKI’s conditions? As a matter of fact ‘YES’, if we closely analyze the profits of the company according to the geographic locations, we will notice that the profits from operations in UK, Rest of the Europe, and Rest of the world have risen substantially, whereas, the loss is booked solely from the United States, which is also supposed to be the company’s largest market. Is FKI worth 65 pence per share? Please refer to table 1.1 on pg. 4, which provides us with various vital information about the present virtual goodwill and advantages of the company, most of these advantages revolve around a single factor, which is the brand – names that FKI holds and the company has been providing a great stability in services to their clients. Judging by the present economic conditions and the data provided by FKI, it is to be noted that most of the business of FKI comes from the United States, and the present economic conditions of US are a major factor to be considered here. We are definitely considering the fact that the US is facing a terrible economic breakdown and thus we might consider the fact that these economic conditions may have destroyed the company’s capital. The Amt. Wolseley will have to pay for FKI @ 65/- Total no. of shares = 1,164,600 Therefore, 1,164,600 * 65 = £ 75,699,000 If Wolseley Gives Equity instead of liquidity: 89585 shares @ 650 pence each. No. of Wolseley Shares remaining after equity transactions: 7,060,566 – 89,585 = 6,970,981 shares Debt / Equity Ratio of Wolseley = Total Liabilities / Shareholder’s equity = 4109 / 2306.9 = 1.78 Return on Capital Employed of Wolseley = Before tax Operating Profit / Capital Employed = 647.8 / 3612.2 = 0.17 Interest Coverage ratio = Before tax Operating Profit / Interest expenses = 647.8 / 29.6 = 21.88 Earnings per share = 78.53 Weighted Average Cost of Wolseley WACC = {(2306.9/6415.9)*4.46%} + {(4109/6415.9)*7.5%} * (1 – 30%) = (0.16 + 0.48) * 0.7 = 0.448 Working Notes: Cost of equity = (Next year’s dividends per share/Market value of stock) + Growth rate of dividend = (26.4/650) + 10 % = 4.46 % Viability of FKI via Capital Asset pricing method Required (or expected) Return =  Risk Free rate + (Market Return - Risk Free rate) * Beta = 5 + (15.2 – 5) * 0.8 = 13.16 % (Pratt, S. & Reilly R., 2000, Valuing a business, Pg. 151 – 204) The required rate of return calculated from the CAPM is our minimum rate required. Conclusion Looking at the above figures FKI would be extremely profitable for Wolseley, this is due to the fact that it will give Wolseley an entry in the much awaited US markets, as well as some well established range of brand names all over the world which could help it win even more market share. Not only that but the product range of FKI will be best suitable for Wolseley, as Wolseley’s range is very closely related and this will give Wolseley an edge by providing an even bigger range. References Online Sources: PLEASE NOTE: THE DATA OF WOLSELEY PLC. FOR 2005 WAS NOT AVAILABLE WITH US, THUS THIS WAS DOWNLOADED FROM ONLINE SOURCES AS ASKED IN THE PAPER: The data was available from the following links: Balance Sheet: http://miranda.hemscott.com/ir/wos/ar2005/ar.jsp?page=balance_sheets P&L: http://miranda.hemscott.com/ir/wos/ar2005/ar.jsp?page=group_profit_and_loss_account Five year summary: http://miranda.hemscott.com/ir/wos/ar2005/ar.jsp?page=five_year_summary Cash Flow Statement: http://miranda.hemscott.com/ir/wos/ar2005/ar.jsp?page=group_cash_flow_statement NOTES: http://miranda.hemscott.com/ir/wos/ar2005/ar.jsp?page=Note_7 (please note that this page states “Note_7”, please change the no. 7 from 1 – 32 to look at all the notes. 32 pages altogether) Informative online directory, investopedia, available at; http://www.investopedia.com/terms/w/wacc.asp Book Sources: Sherman, A. & Hart, M., 2006, Mergers and Acquisitions from A to Z, Pg: 23 - 25 Hutchison, S., 1968, The business of acquisitions and mergers, Pg: 117 – 124 Lee, D. & Colon, A., 1999, Basic Accounting for Lawyers, Pg: 162 – 163 Pratt, S. & Reilly R., 2000, Valuing a business, Pg. 151 – 204 Read More