Question

Firm Yahoo has attracted the attention of Firm Verizon because of its poor operating performance. Firm Verizon believes that the way Firm Yahoo is managed is inefficient and that replacing the current management team would increase the cash flow of Yahoo by $25,000 every year up to perpetuity. Firm Yahoo has 50,000 shares outstanding and is not listed. Firm Verizon has 250,000 shares outstanding that are currently trading at $40/share. Firm Verizon already owns a 1% stake in Firm Yahoo. Firm Yahoo has two other shareholders, ABC and DEF. Both of them hold a 49.5% stake in Firm Yahoo. To change the management team, Firm Verizon needs to get control of Firm Yahoo (i.e., at least 50% of shares). Firm Verizon hires Levan Brothers, a prestigious investment bank, to get advice on the transaction. Levan Brothers estimates that the value of one share of Firm Yahoo under the current management team is $15 per share. They also advise Firm Verizon to pay a premium for the acquisition of Yahoo and to offer ABC and DEF $17 in cash for every share of Firm Yahoo. Fees charged by Levan Brothers to Firm Verizon are $6,000. Assume that there are no taxes and markets are perfectly efficient. The appropriate annual discount rate is 10%. (Note that Investment bankers usually receive a success fee, i.e., they are paid only if the transaction takes place i.e. their fees are NOT a sunk cost and the fee is typically paid by the acquiring firm.)

a) Compute the maximum price per share that Firm Verizon is willing to pay to acquire the remaining 99% of Firm Yahoo via an all-cash offer.

b) Compute ABC’s gains if it accepts the all-cash offer of $17/share.

c) ABC believes that DEF will accept the offer and tender its shares. What is the optimal strategy for ABC: accept the offer or decline the offer? Show your answer.

d) What will happen if DEF also believes that ABC will tender its shares? What is the minimum share price Firm Verizon should offer to ABC and/or DEF to avoid that?

e) Compute the gains or losses per share for Firm Verizon if an all-cash offer to acquire 99% of Firm Yahoo is made at a price of $20.

f) Under the assumption that ABC always believes that DEF will accept the cash offer (and vice versa), what is the likelihood that the inefficient management team is replaced some day? Explain.

Answer 1

Present value of Benefit to Verizon= PV of Perpetuity

Now  PV of Perpetuity = D/R

D=Benefit Per Year = $25000

R=Discount Rate

PV of Perpetuity = $25000/10% = $250000

Fees charged by Levan Brothers = $6000

No of share held by ABC & DEF = 50000*99%= 49500

(a) Maximum price offer = current price per share + per share benefit to Verizon

=$15 + ($250000-$6000)/49500) = $19.93

(B) Gain to ABC = Share price received-Market Value of share price

($17*24750)-($15*24750)=$49500

(C) if ABC beleives that DEF will accept the offer then ABC should not sell the share as it is anticipitaed that after acquiring the share of DEF Verizon has the required no %shares for change of management and it would benifited of revenue of $25000 every year to the yahoo and the share price of yahoo will go up in future and which also benefitted to ABC.

(d) As the Verizon only required 50% share for change of management which need 49% share for reaching to 50% it will offer the price =$15-($6000/(50000 share*49%)=14.755 per share.

(e) Maximum price that Verizon should offer = $19.93

Loss per share to Verizon if accept $20= $20-$19.93=$0.07 per share

(f) on Assumption that ABC always believes that DEF will accept the cash offer (and vice versa) there is 100% chance that insuficient management team will change as Verizon only needs 49% share to hold the control of yahoo and change the insufficient management if one of them (either ABC or DEF) will accept the offer then Verizon will have the required 50% share and management will become changed.