P4 Advanced Investment Appraisal

2 Section D: Acquisitions and Mergers D1. Acquisitions and mergers versus other growth strategies D2. Valuation for acquisitions and mergers D4. Financing acquisitions and mergers Designed to give you the knowledge and application of:

3 3  Compare the various sources of financing available for a proposed cash- based acquisition.  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.  Assess the impact of a given financial offer on the reported financial position and performance of the acquirer. Study Guide C4: Financing acquisitions and mergers Learning Outcomes

4 Sources of financing for a proposed cash-based acquisition There are various ways of financing. Each type of financing will affect:  the acceptance or rejection decision of the shareholders of the target company  wealth of the existing shareholders of the acquiring company Financing an acquisition proposal depends upon Financial resources available to the bidding company Size of the purchase consideration

5 Cash offer Issue of preference shares Retained cash earnings Sale of assets Rights issue Issue of debt Bridging loan Bank loan Issue of convertible loan stock Issue of mezzanine finance Financing the purchase consideration via cash

6 Financing the purchase consideration via exchange of equity shares  Done on the basis of the market value of the shares of both companies  Results in dilution of control, changes in the existing capital structures and gearing ratios of the bidding company Acquiring company Shares of the target company Target company shareholders Issue of equity by acquiring company In most cases purchase consideration is financed through a combination of cash and exchange of shares

7 Advantages and disadvantages of a financial offer via cash From the point of view of the bidding company AdvantagesDisadvantages No dilution of control if shares are not issuedDilution of control if shares are issued Suitable for small acquisitionsCash outflow hampers liquidity of acquiring company Purchase consideration is lower than exchange of shares, as risk is lower Issue of debt to raise funds is not possible Cheap mode of financingConvertible loan stock disturbs capital gearing From the point of view of the target company shareholders AdvantagesDisadvantages Shareholders are free to invest in other securities immediately Immediate cash payment will make investors liable to capital gains tax Risk involved is lowNo share in future combined company profits Certainty of receiving incomeDisappointment if investors wish to hold shares Suitable for investors who do not want to be part of a combined entity

8 Advantages and disadvantages of a financial offer via shares From the point of view of the bidding company AdvantagesDisadvantages  reduced chances of post-acquisition liquidity problem  firm with lower EPS can acquire higher EPS firm to increase EPS of combined entity (“bootstrapping”)  issuing equity shares to outsiders leads to dilution of control Advantages  Capital gains tax liability can be “rolled over”  Can participate in future profits of combined entity  Suitable if they wish to remain shareholders Disadvantages  Growth in wealth will depend upon future performance of combined entity  Valuations uncertain as they depend upon the share price of both the acquirer and target company  Higher risk than receiving cash From the point of view of the target company shareholders

9 Making / assessing a given offer Effect on EPS Synergy gains Issue of debt Movement in share prices Increase in authorised capital Factors to be considered for making an appropriate offer & / or assessing a given offer

10 Identify the elements of a balance sheet Step 1 Ascertain the value of individual items in the equation (SLL+OC+SP+R=NCA+CA+CS+Other) Step 2 Either reduce cash or increase share capital & add new item, investments “INV” Step 3 While consolidating accounts, replace “INV” with “MI” & “GW” Step 4 Impact of financial offer on financial position & performance of acquirer Target company P/E ratio? EPS? Impact on Acquiring company P/E ratio? EPS? Impact on Balance sheet accounting for acquisitions Refer to example (page )

11 Recap  Compare the various sources of financing available for a proposed cash- based acquisition.  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.  Assess the impact of a given financial offer on the reported financial position and performance of the acquirer.