Question 12.E.2: Dawn Raider plc has just offered one of its shares for two s...
Dawn Raider plc has just offered one of its shares for two shares in Sleepy Giant plc, a business in the same industry as itself. Extracts from the financial statements of each business for the year ended 31 May Year 8 appear below:
\begin{matrix}&Dawn\ Raider&Sleepy\ Giant\\&£m&£m\\\textbf{Income statements}\\Sales\ revenue&150&360\\Profit\ for\ the\ year& 18&16\\\textbf{Statement of financial position data}\\Non-current\ assets&150&304\\Net current\ assets\ (Note\ 1)&\underline{ 48}&\underline{182 }\\&198&486\\Loans&\underline{ (80)}&\underline{(40)}\\&\underline{118}&\underline{446}\\Share\ capital\ (Note\ 2)&50&100\\Reserves&\underline{ 68}&\underline{346}\\&\underline{118 }&\underline{446}\\&Dawn\ Raider&Sleepy\ Giant\\1\ Includes\ cash&(£60m)&£90m\\2\ Shares&25p &50p\\3\ Dividends\ paid\ and\ proposed&£4m&£14m\end{matrix}Stock market data for each business is as follows:
\begin{matrix}&31\ May\ Year\ 6&31\ May\ Year\ 7&31\ May\ Year\ 8\\\textbf{Dawn Raider plc}\\Share\ price\ (pence)&120.0&144.0&198.0\\Earnings\ per\ share\ (pence)&5.3&6.9&9.0\\Dividends\ per\ share\ (pence)&2.0 &2.0 &2.0 \\\textbf{Sleepy Giant plc}\\Share\ price\ (pence)&45.0&43.0&72.0\\Earnings\ per\ share&8.4&7.4&8.0\\Dividends\ per\ share\ (pence)&8.0&7.0&7.0\end{matrix}If the takeover succeeds, Dawn Raider plans to combine Sleepy Giant’s marketing and distribution channels with its own, with a post-tax saving of £1 million a year. In addition, it expects to be able to increase Sleepy Giant’s profits after tax by at least £5 million a year by better management. Dawn Raider’s own profits after tax are expected to be £23 million (excluding the £1 million saving already mentioned) in the year ended 31 May Year 9.
One of the shareholders of Sleepy Giant has written to its chairman arguing that the bid should not be accepted. The following is an extract from his letter: ‘The bid considerably undervalues Sleepy Giant since it is below Sleepy Giant’s net assets per share. Furthermore, if Dawn Raider continues its existing policy of paying only 2p a share as a dividend, Sleepy Giant’s shareholders will be considerably worse off.’
Required:
(a) Calculate:
(i) The total value of the bid and the bid premium.
(ii) Sleepy Giant’s net assets per share at 31 May Year 8.
(iii) The dividends the holder of 100 shares in Sleepy Giant would receive in the year before and the year after the takeover.
(iv) The earnings per share for Dawn Raider in the year after the takeover.
(v) The share price of Dawn Raider after the takeover assuming that it maintains its existing price/earnings ratio.
(b) Comment on:
(i) the points that the shareholder in Sleepy Giant raises in his letter
(ii) the amount of the bid consideration.
(a)
\begin{matrix}&&£m\\(i)\ The\ bid\ consideration\ is\ ((200m\ shares/2) \times 198p)&&198\\The\ market\ value\ of\ the\ shares\ in\ Sleepy\ Giant\ is\ (£100m \times 2 \times 72p)&&\underline{(144)}\\The\ bid\ premium\ is\ therefore&&\underline{54}\\(ii)\ Sleepy\ Giant’s\ net\ assets\ per\ share\ are\ £446m/200m&= £2.23\\(iii)\ Dividends\ from\ Sleepy\ Giant\ before\ the\ takeover\ are 100 \times 7p&= £7.00\\Dividends\ from\ Dawn\ Raider\ after\ takeover\ are\ 50 \times 2p&= £1.00\end{matrix}(iv) Earnings per share after takeover:
\begin{matrix}&£m\\Expected\ post-tax\ profits\ of\ Dawn\ Raider& 23\\Current\ post-tax\ profits\ of\ Sleepy\ Giant&16\\Post-tax\ savings&1\\Improvements\ due\ to\ management&\underline{5}\\\textbf{Total earnings}&\underline{45}\\ \\Expected\ EPS\ (£45m/(200m + 100m shares))&15p\end{matrix}(v) Expected share price following takeover will be calculated as follows:
P/E ratio \times Expected EPS
(b) (i) The net assets per share of the business is irrelevant. This represents a past investment that is irrelevant to future decisions. The key comparison is between the current market value of the shares of Sleepy Giant and the bid price.
The dividend received from Dawn Raider will be substantially lower than that received from Sleepy Giant. However, the share value of Dawn Raider has grown much faster than that of Sleepy Giant. The investor must consider the total returns from the investment rather than simply the dividends received.
(ii) We can see above that by accepting the bid, the shareholders of Sleepy Giant will make an immediate and substantial gain. The bid premium is more than 37 per cent higher than the current market value of the shares in Sleepy Giant. This could provide a sufficient incentive for the shareholders of Sleepy Giant to accept the offer. However, the shareholders of Dawn Raider must consider the bid carefully. Although the expected share price calculated above is much higher following the bid, it is based on the assumption that the P/E ratio of the business will not be affected by the takeover. This may not, however, be the case. Sleepy Giant is a much larger business in terms of sales and net assets than Dawn Raider and has a much lower P/E ratio (nine times). The market would have to be convinced that Sleepy Giant’s prospects will be substantially improved following the takeover