Chapter 11 - Context of business valuations Flashcards
1
Q
Reasons for acquisitions:
A
- Operating economies
* Elimination of duplicate facilities - Management acquisition
* Acquisition of competent and go-ahead team to compensate for lack of internal management capabilities - Diversification
* Securing long-term future by spreading risk through diversification - Asset backing
* Company with high earnings = asset ratios reducing risk through acquiring company with substantial assets - Quality of earnings
* Reducing risk by acquiring company with less risky earnings - Finance & liquidity
* Improve liquidity and ability to raise finance by acquiring a more stable company - Growth
* Cheaper way of growing than internal expansion - Tax factors
* Tax-efficient way of transferring tax out of corporate sector = utilising tax losses by setting them against profits of acquired companies - Defensive merger
* Stop competitors obtaining advantage - Strategic opportunities
* Acquiring a company that provides a strategic fit - Asset stripping
* Acquiring an under-valued company in order to sell off the assets to make a profit - Big data access
* A technology company may want to acquire a company for the data it holds on users which can be of great value to that company
2
Q
Big Data Opportunities:
A
- Big data = high-volume, high-velocity and high-variety info assets that demand cost-effective, innovative forms of info processing for enhanced insight & decision making
- Extremely large data sets that may be analysed to reveal patterns, trends and associations relating to human behaviour and interactions
3
Q
Big Data Concerns:
A
- Privacy = in addition to being beneficial for companies and customers, big data also has the potential to harm individuals if it gets in the wrong hands
- Security = companies using big data should ensure that they are not infringing security of other organisations and their customers
* Relates to people who are unaware of the security risks posed by their own actions such as sharing their location - Intellectual property = includes ownership of material posted on social media and how it can be used
4
Q
Synergies
A
- Synergy = extra benefits resulting from an acquisition either from higher cash inflows or lower risk
- Described as the 2+2=5 effect, whereby a group achieved combined results that reflect a better rate of return than what was being achieved by the same resources used by two separate operations before the takeover
5
Q
Revenue Synergy:
A
- Higher revenues may be due to sharing customer contacts, distribution networks or increased market power
6
Q
Cost Synergy:
A
- Results from existence of economies of scale = as the level of operation increases, the marginal cost falls and this will result in greater operating margins for the combined entity
- Also results from being able to negotiate better terms from suppliers, sharing production facilities or sharing head office functions
7
Q
Financial Synergy:
A
- Diversification:
* Reduces risk & can lead to an increase in value
* If future cash flow streams of two companies fluctuate in different ways, it can reduce variability of total operating cash flows
* Could lead to a reduction in the level of perceived risk which would be viewed as favourable by the shareholders - Surplus Cash:
* A firm with excess cash can acquire a firm with great projects but insufficient capital to create value
* The additional value of combining the firms lies in the PV of projects that would not have been taken if they had stayed apart, but can now be undertaken - Tax Benefits:
* Tax paid by two firms combined together may be lower than the tax paid by two individual firms
* If one of the firms have tax deductions that it cannot use and another firm has significant taxes on its income, combining the two can lead to tax benefits being shared by the two firms - Debt capacity:
* By combining two firms which have little or no debt capacity could create a firm that may have the capacity to borrow and create value
* This has to be weighted against the immediate transfer of wealth that occurs to existing bond holders in both firms from the stockholders
* If two different firms are combined together, they may have less variable earnings and may have a higher debt ratio than individually
8
Q
Types of acquisitions
A
- Horizontal:
* Acquisition of a company in a similar line of business
* Although the firm making the purchase understands the business that is being acquired, there still may be post-acquisition integration problems - Vertical:
* Acquisition of a supplier (backwards vertical) or a distributor (forward vertical) to improve firm’s strategic position
* Carries the risk that the acquiring company lacks the competences to add value to the newly acquired firm
* Ties a firm in to using in-house operations that may not be as efficient or effective as other operators - Conglomerate:
* Acquisition of a company in a different line of business (there may be a link between the two businesses)
* Carries the risk that the acquiring firm lacks the competences to add value to the newly acquired firm
9
Q
Potential issues with acquisitions - Stakeholder concerns
A
- Horizontal
* Staff = redundancies
* Customers = reduced competition
* Government = impact on competition, and possible redundancies - Vertical
* Staff = Impact of changes in management procedures
* Customers = disruption caused by the acquisition & antagonism to new owner
* Government = creation of monopoly power - Conglomerate
* Staff = Impact of changes in management procedures
* Customers = disruption caused by the acquisition & antagonism to new owner
* Government = possible redundancies
10
Q
Potential issues with acquisitions - Taxation issues
A
- Acquisitions can often be motivated by tax reasons, especially in cases where the target company is based in a lower tax regime
- Tax Losses:
* Possible for acquiring company to offset past losses of acquired subsidiary against the present profits of the parent company
* In certain countries there are stricter tax rules that prevent this - Tax inversion:
* Tax inversion = a transaction used by a company whereby it becomes a subsidiary of a new parent company in another country for the purpose of falling under beneficial tax laws
* Some countries have introduced rules to prevent companies exploiting this - Withholding Tax:
* Impact of withholding tax on certain types of income from overseas branch will have to be carefully considered
* Reduced if a double taxation agreement between the two countries are in place
11
Q
Acquisition by venture capital
A
- Venture capital = specialised form of finance provided for new companies, buy-outs and small growth companies which are perceived as carrying above average risk
- Risk capital provided in return for an equity stake
12
Q
Requirements in order to be a target for acquisition by venture capital
A
- Very high growth potential
2. Very high returns (in excess of 30% per annum)
13
Q
How does venture capitalists make a profit on their investment?
A
- Venture capitalists get a return when the company is floated on the stock exchange or sold
- Venture capitalists are accused of short-termism because they require early reported profits and an early exit
14
Q
Equity ratchet:
A
- Failure to hit targets set by venture capitalist can lead to an equity ratchet
- Equity ratchet = extra shares are transferred to the venture capitalist at no additional cost
15
Q
When directors look towards venture capital institutions, they should consider:
A
- The institution will want a stake in the company
- It will need convincing that the company will be successful (management buy-outs of already successful companies have been popular in recent times)
- May want to have a representative appointed to the company’s board to look after its interests or independent director
