Question 12.1: Ixus plc is a large sugar-refining business that is currentl...
Ixus plc is a large sugar-refining business that is currently considering the takeover of Decet plc, an engineering business. Financial information concerning each business is as follows:
| Income statements for the year ended 30 June 2014 | ||
| Ixus plc | Decet plc | |
| £m | £m | |
| Sales revenue | \underline{432.5} | \underline{242.6} |
| Operating profit | 64.8 | 35.0 |
| Interest payable | \underline{(20.6)} | \underline{(13.2)} |
| Profit before taxation | 44.2 | 21.8 |
| Taxation | \underline{(10.6)} | \underline{(7.4)} |
| Profit for the period | \underline{33.6} | \underline{14.4} |
| Other financial information | ||
| Ordinary shares (£1.00 nominal) | £120.0m | £48.0m |
| Dividend payout ratio | 50% | 25% |
| Price/earnings ratio | 20 | 16 |
The board of directors of Ixus plc has offered shareholders of Decet plc 5 shares in Ixus plc for every 4 shares held. If the takeover is successful, the price/earnings ratio of the enlarged business is expected to be 19 times. The dividend payout ratio will remain unchanged.
As a result of the takeover, after-tax savings in head office costs of £9.6 million per year are expected.
(a) Calculate:
(i) the total value of the proposed bid
(ii) the expected earnings per share and share price of Ixus plc following the takeover.
(b) Evaluate the proposed takeover from the viewpoint of an investor holding 20,000 shares in:
(i) Ixus plc
(ii) Decet plc.
Before we consider this problem in detail we should recall from Chapter 3 that the P/E ratio is calculated as follows:
P/E ratio=\frac{Market value per share}{Earnings per share}
The P/E ratio reflects the market’s view of the likely future growth in earnings. The higher the P/E ratio, the more highly regarded are the future growth prospects. The equation above can be rearranged so that:
Market value per share(P_{0} )=P/E ratio\times Earnings per share
We shall use this rearranged formula to value the shares of both businesses.
(a) (i) Five shares in Ixus plc are offered for every four shares in Decet plc. The total number of shares offered is, therefore:
5/4 × 48.0m = 60.0m
EPS of Ixus plc = Earnings available to shareholders/No. of shares in issue
= £33.6m/120.0m
\underline{= £0.28}
Value of share in Ixus plc = P/E ratio × EPS
= £0.28 × 20
= £5.60
Total bid value = £5.60 × 60.0
= £336.0m
(ii) Following the takeover, the EPS of Ixus plc would be:
| £m | |
| Earnings of Ixus plc | 33.6 |
| Earnings of Decet plc | 14.4 |
| After-tax savings | \underline{9.6} |
| Total earnings | \underline{57.6} |
No. of shares following the takeover = 180m (that is, 120m + 60m)
EPS after the takeover = £57.6m/180m = £0.32
Value of a share following the takeover = P/E ratio × EPS
= 19 × £0.32 = \underline{£6.08}
(b) (i) Ixus plc investor
Value of shares before the takeover = 20,000 × £5.60 = £112,000
Value of 20,000 shares after the takeover = £121,600 (that is, 20,000 × £6.08)
Increase in value of shares = \underline{£9,600}
(ii) Decet plc investor
EPS of Decet plc before the takeover = £14.4m/48.0m = £0.30
Value of a share in Decet plc = 16 × £0.30 = \underline{£4.80}
Shares held in Ixus plc = 5/4 × 20,000 = \underline{25,000}
Value of 20,000 shares before the takeover = 20,000 × £4.80 = £96,000
Value of 25,000 shares after the takeover = 25,000 × £6.08 = £152,000
Increase in value of shares held = \underline{£56,000}
We can see that the gain arising from the takeover is not shared equally between the two shareholder groups. The investor in Decet plc will receive a 58 per cent increase in the value of shares held whereas the investor in Ixus plc will receive only a 9 per cent increase.
The annual dividends received by each investor will be:
| Ixus plc investor | Decet plc investor | |
| £ | £ | |
| Dividend received before the takeover | ||
| ((£33.6m × 50%)/120m) × 20,000 | 2,800 | |
| ((£14.4m × 25%)/48.0m) × 20,000 | 1,500 | |
| Dividend received after the takeover | ||
| ((£57.6m × 50%)/180m) × 20,000 | 3,200 | |
| ((£57.6m × 50%)/180m) × 25,000 | 4,000 |
The investor in Decet plc is again the winner. The increase in dividend payout is 167 per cent compared with 14 per cent for the investor in Ixus plc.
The investor in Ixus plc may insist on a more equal division of the gains from the takeover. The fairly modest gains predicted for the investor in Ixus plc will depend partly on achieving substantial cost savings. These savings, however, may be difficult to achieve given that the two businesses operate in quite different industries. The gains also rely on achieving a P/E ratio of 19 times after the takeover. However, there may be problems in combining the two businesses because of differences in culture, operating systems, management conflict and so on. As a result, the predicted P/E ratio may also not be achieved.