Question 12.A-S-Q.1: The directors of Kifaru plc are considering taking over Mpak...
The directors of Kifaru plc are considering taking over Mpaka plc, a smaller business in the same industry as Kifaru plc. Currently, Kifaru plc’s shares are trading at £6.40/share and Mpaka plc’s shares are trading at £9.60/share. The financial press has given Kifaru plc’s PE ratio as 20 and Mpaka plc’s PE ratio as 8. The most recent financial statements of each business show that Kifaru plc made after-tax profits of £160 million and Mpaka plc made after-tax profits of £72 million.
It is estimated that the combined business (Kifaru and Mpaka) will be able to maintain
the profits of the individual businesses, but would also be able to achieve after-tax annual savings of £38 million from operating and financial synergies. Kifaru plc’s chief financial officer estimates that the combined business’s PE ratio will fall to 16. Kifaru plc would like to finance the acquisition of Mpaka plc by offering five of its shares for three of Mpaka plc’s shares.
Required:
(a) Calculate the number of shares in each business and the number of shares in the combined business.
(b) Calculate the share price of the combined business and, based on this, calculate the percentage gain per share for each business’s shareholders.
(c) Discuss whether the shareholders of the two businesses would accept the offer made by the directors of Kifaru plc. Include any calculations you consider relevant to support your discussion.
(a) The number of shares in each business and number of shares in the combined business may be calculated as follows:
\begin{matrix}&(a)&(b)&(c)&(d)&(e)\\&&&EPS&&No.\ of\ share\\&Share\ price&P/E\ ratio&(a/b)&Profit&(d/c)\\Kifaru\ plc&£6.40&20&£0.32&£160m&500m\\Mpaka\ plc&£9.60&8& £1.20& £72m &60m \end{matrix}
Kifaru plc shares offered to Mpaka plc shareholders (60m \times 5/3) = 100m
Thus, total number of shares of the combined business (500m + 100m) = 600m
(b) Combined profit
\begin{matrix} &£m\\Kifaru\ plc\ profit &160\\Mpaka\ plc\ profit &72\\Savings &\underline{38}\\Combined\ profit &\underline{270}\end{matrix}Predicted share price
Combined business EPS (£270m/600m) = £0.45/share
P/E ratio of the combined business = 16 times
Thus, predicted share price of combined business (£0.45 × 16) = £7.20 per share
Kifaru plc shareholder benefits
Value of one share prior to takeover = £6.40
Predicted value of one share following the takeover = £7.20
%increase in value = (7.2 – 6.4)/6.4 \times 100% = 12.5%
Mpaka plc shareholder benefits
Value of three shares prior to takeover = £9.6 × 3 = £28.80
Predicted value of equivalent five shares following takeover = £7.2 × 5 = £36
% increase in value = (36 – 28.82/28.8 × 100% = 25%
(c) Based on the calculations above, the proposed takeover benefits the shareholders of both businesses. However, these benefits are not evenly allocated. This may well cause the shareholders of Kifaru plc some concern.
It is the anticipated savings arising from the takeover that make the takeover appealing. They represent 14.1% (38/270) of the combined business profits. These savings, in turn, boost the share price.
The total value of the combined business is predicted to be (£7.2 \times 600m shares) = £4,320m.
When taken together, the value of the two individual businesses is:
(£6.40 \times 500m shares + £9.60 \times 60m shares) = £3,776m
Combining the two businesses has, therefore, increased shareholder value by 14.4% ((14,320 – 3,7762) /3,776 × 100%).
We can see that the percentage contribution to the combined profits of the business by the anticipated savings, corresponds, almost exactly, to the percentage increase in value of the combined business. It seems, therefore, that the value created by combining the two businesses is heavily dependent on the savings generated. Without these savings, the logic of the takeover bid is unclear. As a result, there should be a sharp focus on whether the predicted savings can really be achieved. All too often, they prove to be illusory.