Question

The economy is back up on its feet. This is a merger and acquisition question between golf companies.

This has caused many changes in the deal metrics. Sales, Terminal values, capital structure, and the risk metrics are all changed, …And in addition, Birdie’s(a golf company) TAX advisors believe that Hybrid’s Net Operating Losses (NOLs) can now be utilized and applied to Hybrid’s total Cash Flows; in addition to the dividends. Please answer all the questions associated with this new set of figures below:

Birdie Golf, Inc (Stock price is $108. Per share, 18,000,000 shares outstanding) has been in Merger talks with the Hybrid Golf Co. for 6 months. Hybrid has 8 million shares outstanding. Birdie has superior, asymmetric, marketing intelligence and has learned that the GOLF industry is picking up new and massive interest from teens through 30 year-olds. Birdie has made a CASH offer for Hybrid agreeing to $300,000,000.

Topline revenue growth (demand) is expected to increase since more youth players are anticipated and the prices of the combined products can also fetch higher price points. Meanwhile, thanks to long term fixed price agreements, the strength of the US$, we expect the cost of manufacture to only slightly increase. Bryce Bichon has calculated the new Dividends which are furnished below.

In addition, Hybrid has found a new funding source from Swiss FD Bank Corp. lowering its cost of debt.   

Hybrid will pay a $70,000,000 immediate cash dividend to Birdie.

Birdie’s very capable tax advisors feel that Birdie can now additionally use Hybrid’s NOLs. The Total Net Operating Loss is $25,000,000 as of 2019. The Schedule for using the NOLs is spread evenly over the next 5 years.

Hybrid will be kept as a captive corporation and thus can be sold at the end of 5 years. Birdie expects a constant Growth Rate on Dividends to be 2 3% going forward

Dividends Calculated after TAXES from Hybrid;

2019 35,000,000

2020 40,000,000

2021 45,000,000

2022 50,000,000

2023 55,000,000

For WACC purposes:

The capital structure at Hybrid is 40% debt and 60% equity. With the new Swiss Bank funding resulting in a Cost of Debt of 7 %. The Corporate Tax rate is 30% The BETA for Hybrid is 1.44, The Risk-Free Rate is 3% and the Return on the Market is 8.5%

PLEASE ANSWER ALL OF THE FOLLOWING QUESTIONS:

1. What is the Valuation of Hybrid Golf (NPV)? Should the shareholders of Birdie agree to this deal? (70% of Grade)

2. What is the highest share price Birdie can pay per share of Hybrid? (5%)

3. Suppose Birdie decides to trade its shares in exchange for Hybrid stock. What exchange ratio would make the merger terms equivalent to a cash offer? (5%)

4. What is the highest exchange ratio Birdie should be willing to pay and still undertake the merger? (5%)

5. Discuss how a merger will impact all of the Cash Flows of an M & A deal, in particular; the change in Taxes and how can NOL’s be utilized. Is it difficult to utilize NOL’s? (5%)

6. Are Mergers beneficial to a society based on academic literature? Who are often the winners? (5%)

Please answer as many as possible

Answer 1

Refer following screenshots for the solutions.

0 - Sign in AutoSumĄY O 0 x & Share Wrap Text General H D D x Fill - Insert Delete Format Clear Sort & Filter Editing Find & Select Cells A O P Q R S T U BSSY Jabe = Dividend Valuation.xlsx - Excel File Home Insert Page Layout Formulas Data Review View Power Pivot Tell me what you want to do... % Cut Arial -11 A === On BE Copy Paste B IU D , A, E Merge & Center, $ % 4809 Conditional Format as Cell Format Painter Formatting Table Styles Clipboard Font Alignment G Number Styles A1 X fac Answer 1. B с G H I J K L M N 1 Answer 1 Computation of Cost of Capital: 2 Cost of Equity Risk Free Rate + Beta * (Risk Premium) 3% + 1.44* (8.5% -3%) 10.92% 5 WACC (Weighted Average Cost of Capital) (K) 40% * Cost of Debt* (1 - Corporate tax rate) + 60% * Cost of Equity 8.51200% Valuation of Hybrid: Using Dividend Capitalization Method 8 Dividend /(k-) g is the growth rate of dividends at 3% 694,444,444 However, this value is as at Year 5. Hence, we need to discount this to today's value using WACC of 10.92% Value of Hybrid = 461,581,790 Since Birdie is paying an all cash deal of USD 300,000,000, which is lower than the value as derived above. Shareholders should not agree for the deal. 16 Answer 2. Value of Hybrid Add: Immediate cash dividend to Birdie 461,581,790 70,000,000 531,581,790 8,000,000 66.45 No. of shares of Hybrid Maximum Price per share Answer 3. 24 Cash offerred Less: Immediate Dividend Net Cash offerred Share Price of Birdie No. of shares that can be offerred 300,000,000 (70,000,000) It is assumed that in a shareswap deal, there will be no cash inflow or outflow. 230,000,000 108 2,129,630 25 26 28 Answer 3. 29 Maximum value of Hybrid Share Price of Birdie No. of shares that can be offerred Sheet1 461,581,790 108 4,273,905 30 Ready O -- + 8:25 PM 2 ? x 29/03/2020

Refer following screenshots for the formula used.

Dividend Valuation.xlsx - Excel 0 X & Share Data Review View Power Pivot - Sign in Ay O Tell me what you want to do... === EWrap Text Merge & Center, General $ % + x BSSY Jabe = File Home Insert Page Layout Formulas Cut Arial -11 Á A 酯 Copy, Paste B IU D , A, Format Painter Clipboard Font A1 X fix Answer 1. с 1 Answer 1. Computation of Cos Autosum Fill - E 4809 Insert Delete Format Conditional Format as Formatting Table Styles Cell Styles Clear Sort & Find & Filter Select Editing Alignment Number Cells с н 1 Cost of Equity om +0000 Risk Free Rate + Beta * (Risk Premium) 3% + 1.44* (8.5% -3%) =3%+1.44*(8.5%-3%) 40% * Cost of Debt* (1 - Corporate tax rate) =40%*7%*(1-30%)+60%*F4 hted Average Cost of Capital) (K) Valuation of Hybrid: g is the growth rate o Dividend / (k-9) =55000000/(F4-3%) However, this value i Value of Hybrid =F10/(1+F6)^5 Since Birdie is payin Shareholders should 16 Answer 2. Value of Hybrid mediate cash dividend to Birdie =F12 70000000 =SUM(F16:F17) 8000000 =F18/F19 No. of shares of Hybrid Maximum Price per share 22 Answer 3. It is assumed that in 24 25 Cash offerred Less: Immediate Dividend Net Cash offerred Share Price of Birdie . of shares that can be offerred 300000000 --F17 =SUM(F22:F23) 108 =F24/F25 26 28 Answer 3. 29 Maximum value of Hybrid Share Price of Birdie . of shares that can be offerred =F16 108 =F28/F29 30 + Sheet1 € Ready @ -- + 80% 8:26 PM A 3 9 SI 29/03/2020 10

Answer 4. A merger is expected to provide synergies not only through cost savings, but also to enhance product distribution, customer base as well as customer reach, diversification and in some cases, utilization of tax losses for tax benefits. In the current scenario, utilizating tax losses would be difficult as the standalone entity Hybrid is expected to continue functioning in its entirety. In most jurisdictions, Tax losses generally are transferred when there is a allout merger and two entities become one. Additionally, in case there are transactions between the two companies for simply shifting the tax losses, then strict transfer pricing guidelines under the OECD convention get applied. These are called prevention of profit sharing and base erosion under the OECD model. In the present case, it looks difficult that Birdie would be able to use the tax losses of Hybrid to obtain any tax benefits.

Answer 5. The failure rate of mergers and acquisitions is anywhere between 70 - 90% (according to Harvard Research Papers). Implying that only a very few tend to provide value over longer periods of time. This is due to qualitative constraints such as conflicting cultures, different managements and leadership teams, regulatory hurdles, dissenting shareholders, etc. Winners in mergers and deals often tend to be those deals where there is a clear communication as to who is leading the combined organization. Its people finally who often tend not to fully realize the synergies of a deal. Communicating that there is one leadership team often tends to instill confidence across both organizations as more often having two leaderships teams brings conflict rather than cooperation. Streamling operations, supply chains, product development, R&D, HR and marketing along with clear communication of the internal strategy to all stakeholders brings in transparency and clarity on the thought process.