SECTION C- ACQUISITIONS AND MERGERS
QUESTION 01- MERCURY CO.
Mercury Co, a listed company, is a major supplier of educational material, selling its products in many countries. It supplies schools and colleges and also produces learning material for business and professional exams. Mercury Co has exclusive contracts to produce material for some examining bodies. Mercury Co has a well-defined management structure with formal processes for making major decisions.
Although Mercury Co produces online learning material, most of its profits are still derived from sales of traditional textbooks. Mercury Co’s growth in profits over the last few years has been slow and its directors are currently reviewing its long-term strategy. One area in which they feel that Mercury Co must become much more involved is the production of online testing materials for exams and to validate course and textbook learning.
Bid for Teddy Co
Mercury Co has recently made a bid for Teddy Co, a smaller listed company. Teddy Co also supplies a range of educational material, but has been one of the leaders in the development of online testing and has shown strong profit growth over recent years. All of Teddy Co’s initial five founders remain on its board and still hold 45% of its issued share capital between them. From the start, Teddy Co’s directors have been used to making quick decisions in their areas of responsibility. Although listing has imposed some formalities, Teddy Co has remained focused on acting quickly to gain competitive advantage, with the five founders continuing to give strong leadership.
Mercury Co’s initial bid of five shares in Mercury Co for three shares in Teddy Co was rejected by Teddy Co’s board. There has been further discussion between the two boards since the initial offer was rejected and Mercury Co’s board is now considering a proposal to offer Teddy Co’s shareholders two shares in Mercury Co for one share in Teddy Co or a cash alternative of $22.75 per Teddy Co share. It is expected that Teddy Co’s shareholders will choose one of the following options:
- To accept the 2 shares for 1 share, offer for all the Teddy Co shares;
- To accept the cash offer for all the Teddy Co shares; or
- 60% of the shareholders will take up the 2 shares for 1 share offer and the remaining 40% will take the cash offer.
In the case of the third option being accepted, it is thought that 3 of the company’s founders, holding 20% of the share capital in total, will take the cash offer and not join the combined company. The remaining two founders will probably continue to be involved in the business and be members of the combined company’s board.
Mercury Co’s Finance Director has estimated that the merger will produce annual post-tax synergies of $20 million. He expects Mercury Co’s current price/earnings (P/E) ratio to remain unchanged after the acquisition.
Extracts from the two companies’ most recent accounts are shown below:
|Profit before finance cost and tax
|Profit before tax
|Profit after tax
|Issued $1 nominal shares
|P/E ratios, based on most recent accounts
|Long-term liabilities (market value) ($m)
|Cash and cash equivalents ($m)
The tax rate applicable to both companies is 20%.
Assume that Mercury Co can obtain further debt funding at a pre-tax cost of 7.5% and that the return on cash surpluses is 5% pre-tax.
Assume also that any debt funding needed to complete the acquisition will be reduced instantly by the balances of cash and cash equivalents held by Mercury Co and Teddy Co.
a. Discuss the advantages and disadvantages of the acquisition of Teddy Co from the viewpoint of Mercury Co.