Financing an acquisition and/or merger
One of the issues presented in the Lester Electronic scenario is that while LEI is preparing to begin a joint venture with Shang-wa, they need to determine a suitable method in financing their merger. To begin their financial planning, LEI must establish guidelines for change in the firm (Ross, 2005). These guidelines should include an identification of the firm’s financial goals, an analysis of the differences between these goals and the current financial status of the firm, and a statement of the actions needed for the firm to achieve its financial goals (Ross, 2005). Working capital measures how much in liquid assets a company has available to build its business. Companies that have a great deal of working capital will be more successful in expanding and improving their operations. In order for LEI and Shang-wa to have a successful merger, LEI should work towards reducing working capital. By finding ways to do this, LEI will increase the amount of free cash flow for the company and increase their working capital giving them the ability to fund future projects or small investments. There are many ways to finance a buyout or merger of a company. This paper will compare and contrast issues that various companies had experienced in financing a merger and/or acquisition.
DETERMINE THE WEIGHTED AVERAGE COST OF CAPITAL
FedEx is a global transportation and information network that operates in the Air Ground Express Industry. Thomas Schmitt founded FedEx in 1971, with the original name of Roadway Logistics System with headquarters in Memphis, Tennessee. Today FedEx has more than 290,000 employees, delivers more than 7.5 million shipments in more than 220 countries and territories including every address in the United States. Operating companies offered by FedEx are FedEx Express, FedEx Ground, FedEx Services and FedEx Freight. FedEx has done an excellent job keeping up with the advancement and creation of good and services. FedEx is a multimillion-dollar company doing business in the global transportation and network industry.
To do this, organizations need a clear idea of the strengths and weaknesses of their existing internal labor force and to set goals for their future. FedEx has always been able to stay ahead of the competition by continuing to create new top performing products and way to do business. The announcement of their merger with Kinko’s was no different: FedEx announced in late October that it would be buying out Kinko's for a total of US$2.4 billion in cash. The transaction will happen sometime in the first part of 2004, and FedEx is expected to profit greatly from the purchase. Kinko's, a privately held company, will report a $2 million profit this year, with more than 50% of that revenue coming from digitally transmitted documents. “The weighted average cost of capital is a very essential and important factor in firms panning to take on the debt or gain of another firm. WACC is a calculation of a firms cost of capital in which each category is proportionately weighted, this includes all capital sources, common stock, preferred stock and bonds as well as any other long-term debt” (Ross, 2005). “Broadly speaking, a company’s assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances. Firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers”(investorpedia.com, 2008).
Since their merger in 2004, FedEx-Kinko’s expects to provide strategic leadership and consolidated financial reporting for the FedEx family of companies, managing a broad portfolio of transportation, e-commerce and business services. With this merger FedEx has long-term goals to grow their revenue by 10% per year, increase cash flows, increase returns and do this all by achieving a 10%+ operating margin. According to FedEx they have plans for successful growth strategies to grow their business, and fourth quarter reporting shows that they are currently operating under revenues totaling 9.87 billion, operating loss of 163 million. Taking all this into consideration FedEx capital spending for the year of 2008 totaled 2.9 billion and expects to have some difficulties due to high fuel prices and the economy.
MetroPCS formerly known as General Wireless Inc has been in existence since 1996 with headquarters in Dallas, TX. MetroPCS realizes that the telecommunications industry has become one of fast rising industries and changes come quick. In order to keep up with the changes while satisfying their customers MetroPCS has continued to think of innovative ways of doing business. Since their innovative launch in 2002 MetroPCS has seen a 30% overall growth in customers. “Beta and Leverage are in relation between the beta of the common stock and the leverage of the firm in a world without taxes” (Ross, 2005). What this really means is that it is a very important factor for management to realize the factors that go into what a firms risk are in accepting new projects. The higher the financial leverage the higher the risk to the firm. There are two kinds of beta, asset, and equity that are taken into consideration when considering accepting this kind of challenge. MetroPCS took advantage of an opportunity and as of Jun 2008 has assets totaling $6,078,779.00. Like MetroPCS, LEI wants to make sure that they are going to reap benefits of a successful merger with Shang-Wa. Remembering that a lot of different issues affect the way a company is and will be doing business in the near future. There are ways in which LEI can gain and create the capital needed in order to make this merger complete. LEI have to realize that they just have to do the adequate amount of research and analysis for it to work in their favor and leave the capital budgeting to management.
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RECOMMEND A FINANCING MIX THAT OPTIMIZES CAPITAL STRUCTURES
Every business strives to find the prefect financing mix that optimizes their capital structure. A good capital structure is a balance of relatively higher cost of equity and lower cost of debt. The goal is to fund the company with low costs without putting the company in risk of a financial distress. Below, are two companies that have used various financial mixes to optimize their capital structures.
Viragen International, Inc.
Viragen International, Inc. is a bio-pharmaceutical company that does research, development, manufacture, and commercialization of Multiferon. July, 2007, Viragen announced that its Board of Directors and the holder of a majority of its outstanding common stock have approved for a 1-for-40 reverse stock split, as part of a plan to optimize the Company's capital structure and enter into new strategic initiatives and financing agreements. Under Delaware law they were allowed to approve a reverse split without a stockholder’s meeting. “The reverse stock split will affect all shares of Viragen International's common stock, including those shares underlying stock options outstanding immediately prior to the effective date of the reverse stock split.” (DeviceSpace, 2007)
By reversing the stock split, Viragen International, Inc. was able to reduce the number of outstanding share from 77.7 million shares to 1.94 million shares (approximately). This was done by taking each of their 40 shares issued and their outstanding stock being automatically converted into one share of common stock. Viragen’s fractional shares were rounded up to the nearest whole share. The results of this decision meant, “each stockholder whose shares of common stock are not evenly divisible by forty will receive one additional share of common stock for the fractional shares of common stock that such stockholder would otherwise be entitled to receive as a result of the reverse stock split.”(DeviceSpace, 2007) A reverse stock split reduces the number of shares and increases the share price proportionately. For example, if a shareholder in LEI held 10,000 shares and LEI decided to have a one for ten reverse split, that shareholder would end up only owning 1,000 shares after the split.
Yet a reverse stock split does not affect the value of the stock the shareholder owns. “Companies often split their stock when they believe the price of their stock is too low to attract investors to buy their stock or that splitting a stock will cause small shareholders to be "cashed out" so that they no longer own the company’s shares.” (SEC, 2008) Like with Viragen’s scenario, the board of directors can reverse stock split without shareholder approval. Based on the information above LEI can find itself in the same predicament after the merge with the new direction the recent board of directors wants the combined companies to head. A reverse stock split will increase the price of the shares making them more attractive and increasing capital of the company. However, reverse split stock is not to be taken lightly. It usually indicates a bad sign if a company finds itself forced into reverse split. In the eyes of the public, it states that the company wants the stock to look more valuable when nothing has really changed.
CitiFinancial has been helping with financial goals since 1912. CitiFinancial is a subsidiary of Citigroup that is the world's largest financial services provider. Since early 2007, many banks have been hit hard with the housing crash and a meager economy. CitiFinancial is no exception and has been continually working hard to raise capital. CitiFinancial began with raising $6 billion by selling preferred stock. By April 8, 2008, CitiFinancial stated that it would sell $3 billion in common stock to the public in efforts to optimize their capital structure. The decision was made after CitiFinancial slapped with losses matching billions of dollars on mortgage-related securities and rising credit losses in its consumer business. CitiFinancial raised its Tier One capital ratio to 8.5%, which according to finance chief, Gary Crittenden, are “pleased with the strong interest we have already received regarding this issuance.”
Even though investors were disappointed by sending the stock down 3% late in trading, shareholders were fond of the idea of selling preferred stock over common stock because the sale of common stock would mean there is less strength in existing ownership stakes. (Daily Briefing, 2008) Perhaps the most powerful tax and business-planning tool LEI and the Shang-wa merger can use right now is selling stock but to sell stock to an employee stock ownership plan (ESOP), which will allow them to defer or avoid taxation on gains resulting from the sale. It is a powerful tool in raising capital, lowering taxes/debt, and increasing the loyalty from workers during the merge. It would provide employees with the knowledge of how their work affects the stock value and gives them the opportunity to give constructive input. This would make them work harder and increase the cost of stock overall.
ANALYZE RISKS ASSOCIATED WITH INVESTMENT DECISIONS
“Investment planning is almost impossible without a thorough understanding of risk. There is a risk/return trade-off. That is, the greater risk accepted, the greater must be the potential return as reward for committing one’s funds to an uncertain outcome. Generally, as the level of risk rises, the rate of return should also rise, and vice versa. Before we discuss risk in detail, we should first explain that risk can be perceived, defined and handled in a multitude of ways”( Ross,Westerfield and Jaffe 2005). We have learned through our research that it is hard to avoid it, but you can find investments that have short-term maturity. They are not completely void of risk, but that will be the closest an investor can get to risk-free.
ALLTELL is known for their computer memory devices that began in the mid 1990s. Now being China's biggest producer of computer technology, ALLTELL has expanded the range of products to include digital cameras, MP3s, portable media players, and a digital microscope. ALLTELL revenue is growing 60 to 70 % a year, with 80 % of profits being invested back into research. In spite of that like other Chinese brands, ALLTELL has not developed a unique, must-have product, like the American brand iPod that yield large profit margins. That leaves ALLTELL open to demands from other low-cost competitors to merge or acquire new companies with more technology. Still Feng is optimistic to make it on his own stating, “that for now, ALLTELL has no plans for foreign acquisitions.” According to Stefan Albrecht, a McKinsey and Co. senior partner in Beijing, “China's advantage is still low costs, not creativity. The Chinese brands that succeed should climb the ranks faster than their Japanese or Korean predecessors, because Chinese companies adopt new products or strategies more quickly and are willing to expand by acquiring established foreign outfits.”
As a result, if the decision lands on not acquiring potential companies, like in the potential case of LEI, ALLTELL has limited options. First, they can continue the way they have been which leads way to two outcomes, either failing quickly in a market that is filled with big time technology companies or slowly moving towards the top making minimal waves in the technology pond. Otherwise, they can evaluate acquisition alternatives such as a recapitalization or Employee Stock Ownership Plan (ESOP), as appropriate. An ESOP is a plan that allows employees of a company to own a share of the company they work for. It can provide substantial legal and tax advantages to the seller. After the ESOP has been established, the business can disburse payments to the ESOP. The ESOP trust and the employees do not have to pay taxes on the receipts so that corporations can avoid federal income taxes. Fundamentally, cash flow is improved and buyout debt can be amortized sooner (Entrepreneur.com, 2006). The disadvantage to this plan are the starting cost of setting up an ESOP is around $30,000, employees’ existing shares will become diluted when new shares are issued, and private companies must buy back departing employees' shares (WiseGeek.com, 2003).
Between April and June, the stock market was the lowest on June 20, 2008 when FleetBank and its competitor, Citigroup, had large alarming write offs and stock market drops. To further the concerns of stockholders is the recent firing of CEO, Stan O’Neal over an unapproved merger. Yet John Thain, the replacement has been busy getting FleetBank lunched out of the hole. Thain has been busy dividing FleetBank first with the sale of its capital finance business to General Electric, which improved FleetBank capital standing by $1.3 billion. Then there was the sale of $6.2 billion in shares to Singapore’s Temasek. Even after all this, Thain is talking with Chinese and Middle Eastern sovereign wealth funds about further capital infusion (Intelligent Mergers, 2008). FleetBank over the course of several months has been able to lower both overall costs and unit costs as activities are moved into the hands of large, international merging companies who have been buying FleetBanks’ stock. FleetBank options on the table that other banks have thought about in the past. Such as buying many of small universal banks, so far there haven’t been sensible roll-up options in the larger consolidated markets. Buying small banks will only have FleetBank to acquire more in such a slow market. Therefore, what is left is the merger of equals. This has the most potential benefits. There are cost synergies from head office consolidation that lower factor costs. Furthermore, it aids in the company’s ability to import new cost advantages into each home market then it exports them to subsequent acquisitions. FleeetBank CEO knows that the initial revenue benefits can be obtained from geographic outreach through its ventures into the Chinese and Middle Eastern businesses that have roots in the international market (The Online Citizen, 2008).
To stay competitive, companies need to stay on top of technological developments and their business applications. By buying or merging with a smaller company, with unique technologies, this will aid in maintaining or developing a competitive edge for larger companies. It will also help with building potential capital in a time of need. As seen above mergers and acquisitions can be very stressful, yet mergers and acquisitions can expand two companies’ marketing and distribution, giving them new sales opportunities improving the overall organization’s performance.
EVALUATE DIVIDEND POLICY ON WEALTH MAXIMIZATION
Overtime companies have come to issue dividends less and less. In other words, there are fewer companies now than say ten years ago that are willing to issue dividends to their shareholders. Another issue with dividends is the way that corporations are issuing their dividends, and how much they are willing to do. On another note, there are also companies such as Microsoft, which have decided to issue dividends when tax law changes affected their major shareholders and it was more beneficial to some of the leaders of the companies to receive dividends at a tax rate, which is quite lower than their normal tax rates. These are ways of maximizing wealth for the shareholders in a way that is not always addressed. By issuing dividends, the shareholders have more money to spend to reinvest, or they can also be given the opportunity to reinvest without receiving the money directly from the company. Either way, they are able to use the current reduced capital gains rates on qualified dividends, if they do not cash out their stock. There is one major difference in the scenario between Lester Electronics Inc. and Shang-wa Electronics when it comes to how each company uses common dividends payable to their shareholders. Shang-wa Electronics has money available to their shareholders to release dividends, but they have not released any common dividends, holding the money inside the company for future purchases instead. On the other hand, Lester Electronics Inc. has issued some common dividends, but not the entire amount that was available to their shareholders. One part of buying stocks as a shareholder is the expectation that eventually the shareholder will receive some type of dividend in the future at some point from the company which they have bought stock from. As mentioned earlier Microsoft Inc. is one company that has recently changed their dividend policy to allow more money that is current available to their shareholders, thus increasing their wealth.
In 2003, the Internal Revenue Service changed the guideline with regards to how dividends are taxed. They instituted a policy, which spilt dividends into two separate classifications: ordinary and qualified. The change from the old policy, is that the amount that are considered qualified are now taxed at the capital gains rate, versus a rate that was in the past usually the same as the taxpayer’s regular tax rates. Over time, and such as in 2003, capital gains rates have dropped and come to the point where they are now less than the regular tax rates that are being charged. Before this law change took place, Microsoft had been one of many companies that did not issue dividends to their shareholders. When they decided to release their dividends after the policy was changed Microsoft issued dividends to all its shareholders. One major thing to take into consideration is that some of their biggest shareholders and at that place in time, company leaders have income in the millions of dollars, and in some cases like Bill Gates, in the billions of dollars. The benefits of the qualified dividend law change made it so that these shareholders were able to take out their own money, or reinvest it, while paying a maximum of fifteen percent on that money, compared to their normal rates when they would pay upwards towards forty percent in tax. By issuing the dividends, the company has given their shareholders more wealth, while at the same time giving an underlying encouragement for the shareholders to reinvest their dividends, and therefore giving Microsoft even more money to use for expenditures and investments inside the company.
The wealthy shareholders are the ones who really won in this scenario, since they are the ones who were able to save the most amount of money when it came to their own personal tax returns. In other words, the company got a tax break on their return for releasing the dividends, and many of the shareholders also received a tax break on their own personal tax returns. In regards to the two companies in the scenario presented, it is hard to understand why Shang-wa Electronics does not issue dividends when it has the ability to do so. Since they are a foreign held company currently, this is probably the most likely reason. Each country has its own tax system, and depending on the home country’s tax code, it may not be a good way to maximize the wealth of either the shareholders or the company’s. In the case of Lester Electronics Inc., they have release dividends, while at the same time keeping some of the money in-house for their own use such as expenditures and investments in new assets. For Lester Electronics Inc. they are paying dividends out, giving more money to their shareholders, therefore maximizing their wealth, and keeping money for more investment activities therefore maximizing their chances at future wealth.
Boeing is another company that is located in the Pacific Northwest. They also have been changing their dividend policy, in order to encourage more purchase of their stock, but also to encourage performance by employees who work for the company. Boeing is one of those companies that allows their employees to purchase stock at an option price instead of the going market price, and will award stock options to their employees. These stock options are also available to receive dividends from the company. Despite the downturn in the United States economy lately, Boeing has continued to issue dividends each quarter, and if they have increased their profit for that quarter, they also increase their dividends paid to their shareholders. Boeing has been increasing their profits, so their shareholders have been receiving dividends paid each quarter. The company is content with sharing their profits with their shareholders, because it helps motivate their workers to keep increasing the profit, and it encourages the current shareholders to invest even more into Boeing.
Lester Electronics Inc. is similar in that it issues dividends to its shareholders, and these dividends have been increasing overtime, as cash available to pay for dividends has increased over time as well. In other words, Lester Electronics Inc. also increases its dividends when the profits increase, which would encourage more productivity even during poor economic times. Shang-wa cannot be compared as well, because they do not issue dividends. Their less profitable appearance may be a result of no dividends being paid out, which does not help shareholders maximize their own wealth.
Travel Centers of America
Prior to September of 2006, Travel Centers of America had been a privately held company. At that time it agreed to be purchased by Hospitality Properties Trust which then spun it off as a publically traded company in January of 2007. When a company goes public, the investors want to ensure that their investment is going to be fruitful. To this end, the investors want the company to make wise investments with their money. “What is the company doing with my money?” often fills the empty thoughts of the investor.
For Travel Centers of America’s investors, they are especially concerned about their financial investment, considering how much the stock price has dropped. When the company initially went public in January of ’07, the stock price was at $40/share. Now it is just under $2. This gives investors pause. Travel Centers of America has recently purchased Petro, but the expected synergies are not being realized. This has made the investors worried about the investment in Petro and asking if it was worth it. There are other investment possibilities out there, but if the Petro investment is not paying off, what ensures that these others will. Conventional wisdom dictates that within the next two to three years there will only be 2 remaining major truck stop companies, Pilot and TA. That leaves Flying J and Loves available for purchase, both of which are much smaller then either of the other two. But investing in these would again take a lot of capital and time out of the company, capital it can ill afford. For the year ending December 31, 2007, TA lost over $120 million dollars although it did over $6 billion in sales. That is a serious problem.
For any company or individual, analyzing the risk of what is going to happen always involves looking at past performance. For TA, its past performance is not that stellar so the question remains, will the rewards outweigh the risks? Only time will tell.
Ford Motor Company
The entire American auto industry is having problems. The Chrysler company had been bought out by Daimler Benz and recently Daimler sold it to a private company. GM has had several years of falling sales and losses. Ford is in the same boat. When financial difficulties occur, the company needs to look at how it uses its money even closer. Ford has leveraged its entire existence on the next 5 years in an effort to turn the company around under its new plan, “The Way Forward.”
Due to that leveraging, Ford was able to secure quite a bit of money. But it has to invest that money in new strategies and new technologies in order to pay that money back and not go belly up. As a result, Ford is looking at what the American consumer wants and has learned that the big gas guzzling SUVs of the past are not what Americans want. With gas fluctuating around $4/gallon, Americans cannot afford to be driving a vehicle that only gets 15 miles/gallon. So Ford has invested heavily in the smaller car design and the hybrids in an effort to maximize the profits from those vehicles. In the past, the SUV and the trucks had been the big money maker, but Ford can no longer take that money for granted.
However, changing over to the smaller cars is a big risk for Ford. Its reputation is not one for smaller cars or for quality cars in general for that matter. For Ford to make such a big switch is a big gamble. When going in to territory that is not the most common for a company, there are serious risks. The undertaking to go into such territory requires a lot of time and money. The time and money expended constitute a serious investment in resources. This is a serious risk because if these investments do not pan out, Ford will go under. But at this point, Ford really has no choice. In the cutthroat industry of the auto industry, it is either change with the times or dies.
Financing an acquisition and/or merger can be funded through borrowing money based on assets, either already owned or based on future assets the company wants to purchase. Also frequently, is financing through stock swaps or by issuing new stock in the company to use as payment to the target company's shareholders.(eHow.com, 2008) Over time, appropriate financial leverage functions as an important part in funding capital investments and making future project purchases. Just as investments represent a vital component of assets, debt is viewed to be a long-term component of liabilities that should be managed on a long-term basis consistent with the LEI’s objectives. Regular debt and tax-exempt debt provides a limited low cost source of funding for capital projects in order to achieve the strategic objectives. Furthermore, maintaining a high standard credit rating will permit the LEI to issue debt and finance capital projects at favorable interest rates while meeting its strategic objectives. By having an objective that incurs the lowest achievable long-term risk-adjusted cost of capital, LEI will be able to balance the goal of appropriately limiting exposure to market shifts within acceptable financial constraints.
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