Provincial plc is contemplating a bid for the share capital of National plc. The following statistics are available:
Provincial plc‟s plan is to reduce the scale of National plc‟s operations selling off a division which accounts for Sh.1,500,000 of National plc‟s latest earnings, as indicated above. The estimated selling price for the division is Sh.10.2 million.
Earnings in National plc‟s remaining operations could be increased an estimated 20% on a permanent basis the introduction of better management and financial controls. Provincial plc does not anticipate any alteration to National plc‟s price/earnings multiple as a result of these improvements in earnings.
To avoid duplication, some of Provincial plc‟s own property could be disposed of at an estimated price of Sh.16 million.
Rationalization costs are estimated at Sh.4.5 million.
You are required:
(a) to calculate the effect on the current share price of each company, all other things being equal, of a two-for- nine share offer Provincial plc, assuming that Provincial plc‟s estimates are in line with
those of the market;
(b) to offer a rational explanation of why the market might react to the bid valuing National plc‟s shares at (i) a higher figure and (ii) a lower figure than that indicated Provincial plc‟s offer even though the offer is in line with market estimates of the potential merger synergy.
(c) Assume that Provincial plc is proposing to offer National plc shareholders the choice of the two-for- nine share exchange or a cash alternative.
You are required to advice Provincial plc whether the cash alternative should be more or less than the current value of the share exchange, giving your reasons.
(d) Assume now that Provincial plc, instead of making a two-for-nine share exchange offer, wishes to offer an exchange which would give National plc shareholders a 10% gain on the existing value of their shares.
You are required to calculate what share exchange would achieve this effect, assuming the same synergy forecasts as before.
(a) We need to calculate the theoretical market capitalization of the Provincial group after the merger.
National‟s initial earnings post-merger = Sh 9.3375m – Sh 1.5m = Sh 7.8375mProvincial believes that these can be improved 20%, so
National‟s maintainable earnings post-merger = Sh 7.8375m x 1.2 = Sh 9.405m
The combined group therefore has the following value:
(i) The market might value National‟s shares after the bid higher than the theoretical bid price because they believe that ultimately Provincial will have to pay more than currently offered for National. Perhaps there are other potential bidders who will be attracted into the contest Provincial‟s bid, and competitive pressures from the other bidders will push the price up. Perhaps National‟s shareholders are loyal to the company and sense that they need to be substantially rewarded for giving up their shares because of what they regard as an attractive future for National as an independent company.
(ii) The market might value National‟s shares after the bid lower than the theoretical bid price because they believe that the bid will fail. If National‟s shares are substantially held the founding family‟s interests who would not sell at any price, the bid would largely be ignored the market.
In theory Provincial should pay for National a price of one pound greater than the next available offer. If there are no other offers forthcoming, very little premium to the current market price need be paid, and all the synergistic benefits can accrue to the previous shareholders of Provincial.
(c) A cash alternative offers both advantages to potential accepts of Provincial‟s offer. One advantage is that of certainty. Cash has a known value, which can be invested in risk-free securities to offer a safe return. Shares offer a value which can vary from day to day in line with the vagaries of the market, and could fall swiftly if the anticipated merger benefits fail to materialize. Another advantage of cash is that it offers National shareholders an exit from their shares without having to pay transaction costs.
The disadvantage of cash is that a tax liability might arise for the shareholder on the forced disposal of his shares. However this depends on the tax status of the shareholder.
Indeed the relative attraction of cash over shares will depend strongly on the type of shareholders who are dominant (eg, charities, institutions, private investors etc) and their attitude to risk. For example charities are tax exempt and are generally risk-averse so might favour cash over shares.
In practice the cash alternative is generally set lower than the bid price implied shares, but it would be worthwhile Provincial carrying out research into the types and beliefs of National‟s shareholders before a final decision was taken.
(d) National’s existing share price is Sh.1.66 per share.
At 10% gain implies a share price of 1.66 x 1.1 = Sh.1.826 per share.
There are 45m shares in issue to be each rewarded with Sh.1.826 per share, so the total value given to
National‟s shares is:
45m x Sh.1.826 = Sh 82.17m
8.69 million shares are issued to compensate 45m old shares, a share exchange of 1 new share for every
5.178 old shares held.