ANSWER ANY TWO QUESTIONS
Q1
Lochee Lighters plc owns and manages five separate business units that are located throughout the UK. The company is looking to sell “Brighton Burners” - one of these five business units – because of a new strategic plan which the board has just approved. A number of factors contributed to this decision including the distance of the Brighton Burners unit from Lochee’s headquarters and the decision by the board to shift manufacturing for mainland Europe away from Brighton to Rotterdam.
Brighton Burners makes camping stoves for the outdoor leisure sector. The unit was formed three years ago with a dynamic management team; this team has been frustrated by the constraints which are being imposed on Brighton Burners by Lochee Lighters. The management team believes there is huge potential for developing the brand of camping stoves further and start a range of outdoor heaters for external dining.
The management team of Brighton Burners want to purchase the business from Lochee Lighters plc, via a buyout (MBO) deal on 1 June 2021. The MBO team has been in initial discussions with a venture capitalist, and a bank who are interested in helping to finance the acquisition. The proposed financing arrangement is as follows:
The venture capitalist has expressed an interest in the deal provided the average growth in the book value of equity from 2021 onwards is higher than 16% per year in 2021/2, 2022/3 and 2023/4.
Additional forecasted data for Brighton Burners following the MBO has been produced by management:
Profit before interest and tax is forecast to be £72 million in the first year of the MBO and is expected to grow by 12% a year in each of the subsequent three years.
·Corporate income tax is payable at a rate of 30% per year.
No dividends would be paid for the first four years after the MBO and any retained earnings (after interest and tax) would increase the book value of equity.
·Repayment of the loans will commence in 2025.
Required:
(a) Outline the reasons why Lochee Lighters plc may be willing to sell off the Brighton Burner unit in an MBO deal.
(3)
(b) Estimate whether the growth in book value of the equity (in 2021/2, 2022/3 and 2023/4) is likely to exceed the minimum threshold of 16% per year required by the venture capital investor. Based on your answer, comment on whether the venture capital firm be willing to finance this MBO?
(7)
(c) “The markets for management buyouts in the U.K. and continental Europe have experienced dramatic growth …. In the U.K., buyouts accounted for half of the total M&A activity (measured by value) in 2005 [and]… the greatest number of U.K. buyouts in recent years have been management‐ and investor‐led acquisitions of divisions of large corporations. In continental Europe, by contrast, the largest fraction of deals has involved the purchase of family‐owned private businesses. But in recent years, increased pressure for shareholder value in countries like France, Netherlands, and even Germany has led to a growing number of buyouts of divisions of listed companies.”
(Wright et al. 2006)
Outline the trends in European buyouts since 2000 and critically evaluate whether this form of corporate restructuring will continue to grow in the future.
(40)
Q2
(a) Two companies in the horticulture sector - Glendonald plc and Dunlomand plc are contemplating the establishment of a new entity (Clover Limited) as part of a strategic alliance to produce industrial lawnmowers. This strategic alliance between Glendonald plc and Dunlomand plc is new to the two companies since they have previously operated as stand-alone companies; the alliance is being proposed following a meeting between the 64-year old CEOs of both firms where they decided that if they collaborated, they could enter a new segment of the market – industrial lawnmower machines – which they have previously avoided because of the capital commitments involved. Clover Limited will be a joint venture where 60% of the equity is owned by Glendonald plc while the remaining 40% is owned by Dunlomand plc. Both parent companies have assigned an equal number of staff to Clover Limited and hope that the joint venture will prove successful in the manufacture of lawnmower machines. Clover Limited is currently faced with a decision about the design of machines which will then be sold to businesses for lawn-care use. There are three design choices depending on the machine horsepower (large, mid-sized, basic).
It is believed that there will be orders for either 1,000 or 1,500 or 2,000 machines but there is no clear picture yet of which demand level is more likely than the others.
Required:
(i) Evaluate the choice of machine type for the different order levels if all of the prices and unit costs are assumed to be constant, in perpetuity, and if the discount rate of Clover Limited is 10%.
(9)
(ii) What other factors should Glendonald plc and Dunlomand take into account when deciding to proceed with the production of the lawnmowers via a joint venture.
(6)
(b) “Despite the attractions of strategic alliances, some estimates suggest that a large number of [them] fail.”
(Sudarsanam, 2010)
Outline the different approaches in the literature to assessing the success or failure of strategic alliances and comment on whether the evidence from some of these approaches is more credible than others.
(35)
Q3
“The conclusion that price run-ups prior to takeover announcements reflect insider trading … is contingent on the untested assumption that insider trading affects stock prices.”
(Meulbroek, 1992)
Critically evaluate whether insider trading around the time of takeovers leads to share price changes, and comment on the implications of this research for the regulation of trading by insiders when acquisitions are planned.
(50)
Q4
(a) An analyst seeks your advice on estimating the likelihood that a firm in her portfolio – Amir plc - will be taken over in the near future. She is contemplating the sale of her holding in this firm and is worried that any takeover of Amir plc might lead to a rise in their share price which she would miss out on if the acquisition was announced after she had disposed of the shares. She has supplied you with the following extracts from Amir’s financial statements:
In addition, the finance director has supplied you with the following details:
1. Shares in Amir plc (with a nominal value of £2) are currently trading at £12.00 each.
2. Sales in Amir plc were £800m 5 years ago.
Required:
(i) Estimate the likelihood that Amir plc will be an acquisition target according to the takeover prediction model of Wansley et al. (1983):
Zi= -7.061 + 0.087X1 + 10.867X2 + 1.194X3 – 0.603X4 + 3.738X5
Where X1 = price/earnings ratio (x) where earnings per share are based
on profit before interest and tax
X2 = long term bank loans to total assets ratio (fraction)
X3 = natural log of sales
X4 = compound growth in sales over the past 5 years (%)
X5 = market value to total assets (fraction)
The analyst has obtained the following cut off predictions for Wansley et al.’s model when predicting takeover targets:
Zi > 0 => Predict Not a target
Zi < 0 => Predict Target
(ii) Advise the analyst on whether or not she should sell her shares in Amir plc.
(10)
(b) “A large number of studies show that takeover targets experience significant stock price increases around merger announcements. … Unsurprisingly, [several investigations] explore whether a successful investment strategy [based on financial statement data] can be developed by predicting potential targets. However, these studies report limited success”.
(Danbolt et al., 2016)
Outline the findings of Danbolt et al. (2016) about the difficulty of using financial statement data to predict takeover targets.
(40)
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