- 30 Marks
FM – Nov 2022 – L3 – Q1 – Mergers and Acquisitions
Evaluating the acquisition of Company K3 in Togo for business expansion purposes.
Question
The following case relates to a business expansion decision for Abayomi Plc (AP):
Abayomi Plc (AP) is a major electrical company in Nigeria. The directors have recently identified Togo as a priority location for business expansion. Togo uses currency T$. Assume today is 30 August 2021.
Company K3, located in Togo, has been identified as a potential acquisition target. AP already manages two business units in Togo, named K1 and K2, and these have shown strong performance under AP’s ownership.
K3 is particularly attractive to AP because it has its own warehouse, distribution, and logistics network, all of which could be used by K1 and K2, if the acquisition goes ahead. Currently, K1 and K2 send goods to customers from AP warehouses located in Ghana. This involves considerable cost and delay in delivery.
K3 is a private company, and 100% of its shares are owned by the family that founded it. Many shareholders are keen to realize their investment by selling the company to AP.
Both companies are working towards an effective date for the sale of K3 to AP on 1 January 2022.
Financial Data for K3 for 2020:
The statement of financial position of K3 as at 31 December 2020 showed the following balances:
| T$ Million | |
|---|---|
| Long term borrowings | 375 |
| Share capital (T$1 ordinary shares) | 90 |
| Total liabilities | 465 |
| Net assets | 180 |
Additional Data:
AP aims to maintain the same capital structure as AP. That is, gearing (debt/debt+equity) would be 25% based on market values. AP would guarantee K3’s new debt, which can be assumed to have the same risk profile as AP’s debt.
A proxy company has been identified which is also located in Togo and has a similar business model to K3.
Proxy company data:
- P/E ratio of 12.
- Equity beta of 1.7 and debt beta of 0.4.
- Gearing (debt/debt+equity) based on market values of 35%.
Togo has a risk-free rate of 5% and a market risk premium of 4%.
Financial Data for AP:
Latest data available for AP shows:
- P/E ratio of 14.
- Equity beta of 1.5 and debt beta of 0.3.
- Gearing (debt/debt+equity) based on market values of 25%.
- AP pays 6.2% interest on its long-term borrowings.
- Tax rate in Nigeria is 30%.
The spot rate for T$ against Naira today is T$7/₦ (i.e., ₦1 = T$7.00) and is not expected to change in the foreseeable future.
Assume that Nigeria has the same risk-free rate and market risk premium as Togo.
Required:
Assume you are the Finance Director of AP.
a. Advise on:
i. The types of synergistic benefit that might arise from the acquisition of K3. (8 Marks)
ii. Possible reasons why both one-off and ongoing synergistic benefits might not be achieved to the extent expected. (4 Marks)
b. Calculate:
i. A Weighted Average Cost of Capital (WACC) for use in valuing K3 based on the proxy company’s business and country risk and AP’s capital structure. (6 Marks)
ii. A range of values for the equity of K3 in T$ as at 1 January 2022 using the following methods:
- Asset basis. (2 Marks)
- P/E (including bootstrapping). (5 Marks)
- DCF (with and without synergistic benefits). (5 Marks)
(Total 30 Marks)
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