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Acquisition Case #4
Case #4
An acquisition is a decision that a company makes where they buy or take most of another firm. They must take over or obtain more than fifty percent ownership from the company for it to be considered an acquisition (Investopedia, 2017). Many companies do this for many different reasons. The first step in the acquisition process is to first make that primary contact. The acquiring firm will contact the manager of the potential candidate to be acquired and will set up a meeting where there will be an in-depth discussion about some mutual opportunities that they may be able to capitalize on. Once the company that is being acquired decides to sell, both parties must sign a Non-Disclosure Agreement (NDA) (Accounting Tools, 2017). This is a form ensuring that all stamped information is confidential. These forms must not be passed on to other parties as that would violate the Non-Disclosure Agreement. For example, If Home Depot was in the acquisition process with Menards. They would not be able to share any stamped information with anyone such as Lowes.
The next step in the acquisition process is for the company to send all their document regarding past results and historical information to the Acquirer. Also, they must send past and current financial statements to give the firms as much information for them to make a well-rounded decision. Once the purchasing company goes through and reviews all the documents and have decided to keep going thorough with the acquisition, they will need to issue a Letter of Intent (LOI) (Accounting Tools, 2017). The purpose of a LOI is where the purchasing firm will make a guideline outlining what they are planning between the two parties, then they send it to the company they are pursuing. Usually with an LOI, the acquiring company will also issue an exclusivity request. This request simply demands that the selling company only does business with them for a certain period. What often happens, is that the selling company will take that sell price and then go to other companies and see if they can sell for even higher. When this occurs, they have violated that exclusivity agreement and the purchasing company can walk away from the deal due to lack of trust.
The following step is for the acquirer to issue a list of due diligence demands to the target company. This will normally take a few weeks to complete. Once all the information has been reviewed, the due diligence team will share with management to see if the price offering will fluctuate at all (Accounting Tools, 2017). Once they come up with a final price, they then give the seller the first purchase agreement. This will go back and forth until both parties are finally satisfied with pricing and terms, then finally the acquisition process is complete.
A firm that may want to acquire another firm may have one or multiple reasons or the acquisition. Some may do it for economies of scale, which is being able to increase output while decreasing cost per unit (Investopedia, 2017). They could also choose to perform an acquisition to gain a greater market share, which is the percentage of total sales the corporation has in the total sales of the industry they may be in. Another cause may be to increase synergy which is the concept where combining two companies will increase the performance and value overall of the company (Investopedia, 2017). This can also be obtained by merging. While many benefits may come from acquiring another firm, there can be many risks as well. For example, acquisitions may be a bad for stakeholders in the sense that it may not benefit them as expected. This is due to higher than expected acquisition prices, longer than expected acquisition processes, and even fewer synergies than expected (Investopedia, 2017). It can also be tough to manage and combine two different companies that may have different working cultures or procedures where the other company may not like.
Some cons that come with acquisition could be the acquisition cost itself. Firms may project a cost but most of the time those costs change very quickly and steeply (Nead, 2017). When combining two firms there can also be a very different process of how things are done. The acquired firm’s employees may not interlock very well with the new processes which can result in strong anger moving through the firm. Many employees may often resign as well due to the acquisition process (Nead, 2017).
After running all the calculations there were a few results that were very noticeable. The firms result for the weighted average or the expected value comes out to be around 82 million. This was acquired by taking the sum of cash flow, sales, net income, and the market and book value. These values were calculated from the actual results in quarter four which were then combined with the assumptions that were made from the synergy. With a fifteen percent increase in sales per year for the next four years and asset growth of twelve percent per year we. With the weights represented in the pie chart below, we can see that those weights were considered when solving for the expected value.
It was crucial that we find the available cash flow at the end of year four to determine the discounted cash flow and multiple cash flows. This was calculated by taking the cash flows and subtracting the change in total equity. Once we have the free cash flows for each year and the expected terminal value in year four, we can take the net present value of that to determine the maximum total offer. Based upon this, the maximum that we would offer is $92,177,223. Another good thing to notice is that since assets climb at a steady twelve percent and we have an assumed forty percent total assets to total liabilities, we also must assume that liabilities are also increasing at a steady twelve percent as well. As previously mentioned, sales would increase due to synergy. It is important to notice how this will affect the free cash flows. As shown in table one, free cash flows increase each year. This is the main thing that helped to increase the total maximum offer.
One final advice to the firm would be to go through with the acquisition process. Based on the numbers in the valuations it would be a very good outcome if they acquired the other firm. The most noticeable calculation was seeing that the returns came back much higher than the estimated value. With the estimated value of the firm at around 82,500,000 dollars and an expected return of 92,177,000 dollars, this is a 11 percent increase which is very good. Another couple big factors to consider would be that synergies would be higher as performance of the company would be expected to improve. Also, there will be a much better brand recognition for this firm since they will be much larger and more noticeable. There were no big signs that indicate this would be a bad acquisition. With that being said, acquiring the firm will be a very good option for this firm as it will help them grow both financially and bring them more brand recognition.
Table 1
Annual
T + 1
T + 2
T + 3
T + 4
$15,172,587.20
$14,949,004
$17,596,163
$20,249,602
$105,754,029
References
Accounting Tools. (2017). The acquisition process [Web]. Retrieved from http://www.accountingtools.com/acquisition-process
Investopedia. (2017). Acquisition [Web]. Retrieved from http://www.investopedia.com/terms/a/acquisition.asp
Nead, Nate. (2017). Acquisition pros and cons. Investment Bank. Retrieved from http://investmentbank.com/pros-and-cons/