ABC plc is considering launching a takeover bid for XYZ plc. The two companies are in the industry and have identical cost of equity capital, which is 12% after tax.
Below is an extract of some financial data on both companies:
ABC plc XYZ plc
Earnings per share (eps) 50 pence 10 pence
Dividend per share (dps) 25 pence 5 pence
Price per share (pps) £9.00 75 pence
Number of shares 5 million 3 million
XYZ plc is expected to produce growth in dividend per share of 5% per annum to infinity with its current strategy and management. However, if ABC plc acquired XYZ plc, the resulting synergy from the acquisition would be such that the growth rate of dividend per share for XYZ plc can be raised to 8%. In addition, ABC plc is also confident that it can bootstrap the earnings of XYZ plc using its own higher P/E after the acquisition of the company.
The transaction costs of the acquisition, which covers payment to the investment banks and accountants advising ABC plc, are estimated to amount to £400,000.
a) Calculate the total value of the synergy that would be created from the combination of ABC plc and XYZ plc:
(i) using constant-growth dividend valuation model
(ii) using Price-earnings multiplier model
b) Comment on the limitations of the valuation models you have used in (a) above in the particular situation of this case scenario.
c) Explain the possible sources of synergy arising from the acquisition of XYZ plc by ABC plc.
d) If ABC plc paid £1.20 cash for each share of XYZ plc, what value of the synergy calculated in (a ii) above would be available to the shareholders of each company?
e) What are the advantages and disadvantages to ABC plc of paying cash to acquire XYZ plc?
f) Using two recent cases, discuss the ways in which UK companies, which have been the subject of unwanted (hostile or unfriendly) takeover bids defended themselves from such bids.
The solution calculates the total value of the synergy between the two companies as well as uses the constant-growth dividend valuation model and the price-earnings multiplier model.