Question

Explain why ‘white knights’ are often hard to find and can only be seen as a ‘partial’ solution to fending off a hostile takeover bid.

(b)

Critically discuss which factors will influence a company to finance a takeover by either a share-for-share offer or a cash offer financed by an issue of bonds.

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Two companies called X plc and Y plc are considering a merger. Financial data for

the two companies are given below:

X Y

Number of shares issued 3m 6m

Profit after tax GHS1.8m GHS0.5m

Price/earnings ratio 12.0 10.3

The two companies have estimated that, due to economies of scale, the newly merged company would generate cost savings of GHS200,000 per year.

(i) It is suggested initially that 100% of Y PLC’s shares should be exchanged for shares in X at a rate of one share in X for every three shares in Y. What would be the expected reduction of EPS from the point of view of X’s shareholders?

(ii) An alternative to this is for X’s shares to be valued at GHS7.20 and for the total share capital of Y to be valued at GHS10.5m for merger purposes. A certain percentage of Y’s shares would be exchanged for shares in X, while the remaining shares of Y would be exchanged for 6.5% bonds (issued at GHS100 nominal value) in the new company. Given that the corporate tax rate is 30%, how much would have to be raised from the bond issue as part of the purchase consideration in order for there to be no dilution of EPS from X’s existing shareholders’ point of view?

Answer 1

All amounts are in GHS

(a)

A white knight is a strategy used as a defence mechanism against any hostile turnover. Under this strategy, a friendly individual or corporation will takeover our business at a fair consideration before any unfriendly organization takes over our business. This helps in protecting the stake holders interest. This is not a complete remedy from hostile takeover but just a partial solution.

(b)

A consideration for takeover can be paid using different methods. Two such methods are in the way of shares and the other being in cash offer financed by issue of bonds.

When there exists synergy then the share holders of target company ask for shares as compensation. Also when the the acquiring company is credit worthy, then the target Company share holders ask for Shares in combined firm.

The expectations of share holders of acquiring company will be quite opposite. Also the availability of funds with acquiring company decides the way of paying consideration. If there are enough cash resources, then the compensation will be paid in shares. If there are no cash resources, then the cash will be paid to share holders in target company from the proceeds of bonds issue.

(c)

(i)

Share exchange ratio = 1 share for 3 shares held

No of shares held in Y plc = 6 million

No of shares to be issued = 6 million/3 = 2 million

Total no of shares in Combined entity = 5 million (3+2)

Present EPS of X = Total earnings/total no of shares

= (1.8 million)/3 million = 0.6 per share

New EPS = (1.8 million + 0.5 million + 0.2 million (1-0.3))/5 milliom

= 2.44 milliom/5 million

= 0.48 per share

Reduction in EPS = 0.6-0.48 = 0.12 per share

(ii)

Total consideration decided = 10.5 million

Share value of X plc = 7.2 per share

No of shares to be issued be "Z"

Bond value to be issued = 10.5 million - 7.2Z

The EPS to be maintained at 0.6 per share

So, 0.6 = [1.8 million + 0.5 million + 0.2 milion (1-0.3) - (10.5 million - 7.2Z) x 6.5% x (1-0.3)]/(3 million + Z)

0.6 = [2.44 million - 477,750 + 0.3276Z]/(3 million + Z)

0.6 (3 million + Z) = 1,962,250 + 0.3276Z

0.6 million Z - 0.3276Z = 1,962,250 - 1,800,000

0.2724 Z = 162,250

Z = 595,632 shares

Total value issued in shares = 595,632 x 7.2 = 4,288,550

How much to be issued in bonds = 10.5 million - 4,288,550 = 6,211,450