AFMP4
Syllabus C. Acquisitions And Mergers C4. Financing acquisitions and mergers

C4b. Cash consideration 3 / 5

Syllabus C4b)

Evaluate the advantages and disadvantages of a financial offer for a given acquisition proposal using pure or mixed mode financing and recommend the most appropriate offer to be made.

The offer is made to purchase the shares of the target company for cash.

The advantages of cash offer to the target entity’s shareholders are that:

  1. The price that they will receive is obvious. 

    It is not like share exchange where the movements in the market price may change their wealth.

  2. The cash purchase increases the liquidity of the target shareholders.

A disadvantage to target shareholders’ for receiving cash is that if the price that they receive is more than the price paid when purchasing the shares, they may be liable to capital gains tax.

The advantages to the predator company are that:

  1. The value of the bid is known and target company shareholders’ are encouraged to sell their shares.

  2. It represents a quick and easily understood approach when resistance is expected.

The main disadvantages to the predator company are that it may deplete the company’s liquidity position and may increase gearing.

Example

Cow Co. accepted a takeover offer from Milk Co, a listed company. 
The takeover offer is for $2•95 cash per share.

Cow's number of shares = 2,400,000
Cow's price per share = $2.90
Cow's Profit after tax = $620,000
Synergy gained = $150,000

Milk Co has 10 million shares in issue and these are trading for $4•80 each. 

Milk Co’s price to earnings (P/E) ratio is 15 and believes that this will enable Cow Co to operate on a P/E level of 15 as well.

Required:
Estimates the percentage gain in value to a Cow Co share and a Milk Co share under payment offer.

Solution

  • Gain in value to a Cow Co share 

    = ($2·95 takeover offer – $2·90 current share price)/$2·90 = 1·7%

  • Gain in value to a Milk Co share

    Additional earnings after acquisition = $620,000 PAT + $150,000 synergy benefit= $770,000

    Increase in market capitalisation based on P/E of 15 = 770,000 x 15 = $11,550,000

    Less: paid for Cow Co acquisition = ($2·95 x 2,400,000 shares) = $(7,080,000)

    Value added for Milk shareholders ($11,550,000 - $7,080,000)  = $4,470,000
    Gain in value to a Milk Co share = $4,470,000/10,000,000 shs = 44.7c
    or 44.7c/480c = 9.3%