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the oil industry. It is reflecting in the valuation front too. The market capitalization of
ONGC is in the tune of Rs.145,000 crore, which covers 14.5% of the total market
capitalization. However, mid-sized down-stream firms are eyeing on consolidation for
survival. One such company Indo-Gulf Petroleum (IGP) is considering the acquisition
of Gujrat Refineries Ltd. (GRL) in a stock-for-stock transaction in which GRL would
receive Rs.1680 for each share of its common stock. IGP expects an increase of 30% in
its P/E multiple after the merger and chooses to value the GRL conservatively by
assuming no earnings growth due to synergy.
With regard to this acquisition, following information of both the companies are
provided:
Particulars IGP GRL
Earnings Before Interest and Taxes
10,639,350,000 6,176,470,588
(Rs.)
Interest (Rs.) 1,773,225,000 926,470,588
Market Capitalisation (%) 4.44% 2.34%
Market Price per Share (Rs.) 1112.40 1250.00
Both the companies are enjoying tax holidays. You are required to
(a) Calculate
(i) Post-merger share price
(ii) Post-merger equity ownership distribution
(iii) Purchase price premium
(b) Comment on the decision taken by IGP.
3. (a) (i) Post merges share Price = Post merges EPS post Merges P/E
IGP will distribute its own shares of Rs.1680 for each share of GRL. This
1680
amounts to 1112.4
or 1.51 shares for every share of GRL.
Market cap for GRL = 2.34%
ONGC has a market capitalization of Rs.145,000crore equivalent to 14.5%
145, 000
So, the size of the total market is .145 = Rs.1000000 crore.
So the market capitalization of GRL = 1000 000 0.0234
= Rs.23,400 crore.
Market Price of GRL shares = Rs.1250
23400
18.72crore
So, the number of shares outstanding for GRL = 1250
= 18,72,00,000.
So, total number of shares issued by IGP is = 18,72,00,000 1.51=
28,26,72,000.
Number of shares outstanding for IGP before merges is.
1000, 000 0.0444
39.9137crore 39,91,37, 000
1112.4
So, total shares outstanding of the combined company =39.9137 + 28.2672 =
68.1809crore
1112.4
50.0855.
Pre merger P/E multiple = 22.21
1680
1.344
= 1250
The following are the details on two potential merger candidates, All-time Products and
Any-time Products: (Rs. in crore)
Particulars All-time Products Any-time Products
Revenues 6,900 2,400
Depreciation 380 55
Capital Spending 400 60
Market Value of Equity 3,200 1,100
Outstanding Debt 80 50
Tax Rate 40.00% 40.00%
Working Capital 12% of Revenue 12% of Revenue
Cost of Goods Sold (without 83% of Revenue 87% of Revenue
Depreciation)
Revenues of All-time Products are expected to have a growth rate of 17% for the first
two years, 12% for the next three years and stabilize at 5% thereafter. Capital spending
and depreciation are expected to grow at 10% for the first three years and at 6% for the
next two years. From the sixth year onwards depreciation is expected to continue at the
same growth rate of 6% and the amount of capital spending is expected to be equal to
the amount of depreciation. The beta of the equity is 1.4 and the firm is rated as A by
a leading credit rating agency.
Revenues of Any-time Products are expected to have a growth rate of 15% for the first
three years, 10% for the next two years and stabilize at 5% thereafter. Capital spending
and depreciation are expected to grow at 8% for the first three years and 5% for the
next two years. From the sixth year onwards, depreciation is expected to continue at the
same growth rate of 5% and the amount of capital spending is expected to be equal to
the amount of depreciation. The beta of the equity is 1.2 and the firm is rated as B by
the same credit rating agency.
The treasury bills are trading in the market at 6% and the market is expecting a
premium of 5% above the treasury bill rate.
As a result of the merger, the combined firm is expected to have a cost of goods sold of
only 79% of total revenues. The market perceives that there is more risk associated with
the combined entity; so it is supposed to be rated as B by the same credit rating agency
and the beta of its equity is expected to be 2.4. The growth rate of free cash flows
observed for the sixth year in the combined firm is expected to continue forever.
Rating Interest to be payable on
debt
AAA 8%
AA 9%
A 10%
B 11%
C 12%
You are required to
a. Estimate the value of All-time Products, operating independently.
b. Estimate the value of Any-time Products, operating independently.
c. Estimate the value of the combined firm.
d. Estimate the worth of the operating synergy.
SOLUTION 5.
a. Valuation of All-time Products: (Rs. In crore)
1 2 3 4 5 6
Revenues 8073 9445.41 10578.8611848.32 13270.12 13933.63
COGS @ 83% 6700.59 7839.69 8780.45 9834.11 11014.2 11564.9
Dep 418 459.8 505.78 536.13 568.29 602.39
= EBIT 954.41 1145.92 1292.63 1478.08 1687.63 1766.33
EBIT (1 t) 572.65 687.55 775.58 886.85 1012.58 1059.8
+ Depreciation 418 459.8 505.78 536.13 568.29 602.39
Capital 440 484 532.4 564.34 598.2 602.39
Expenditure
Change in WC 140.76 164.69 136.01 152.34 170.61 79.63
FCFF 409.89 498.66 612.95 706.3 812.06 980.17
Terminal Value 12518.14
WACC @ 12.83% 363.28 391.7 426.73 435.8 7289.77
Firm Value 8907.28
Cost of equity = 6+ 1.4(5) = 13%
Cost of debt = 10% ( since it is rated as A)
Weighted average cost of capital = (Rs.3200 crore /Rs. 3280 crore ) 13% + (Rs.
80 crore /Rs.3280 crore) 10% (1 0.4) = 12.83%
Terminal value = Rs.980.17 crore /(0.1283 0.05) = Rs.7289.77 crore
The value of Alltime Products = Rs.8,907.28 crore
Total debt in the combined firm = Rs.80 crore + Rs.50 crore = Rs.130 crore
Total equity in the combined firm = Rs.3,200 crore + Rs.1,100 crore = Rs.4,300
crore
Cost of equity = 6+ 2.4(5) = 18%
Cost of debt = 11% (since, the combined firm is rated as B)
Weighted average cost of capital = 11% [Rs.130 crore/(Rs.130 crore + Rs.4,300
crore)]
+ 18% [Rs.4,300 crore/(Rs.130 crore + Rs.4,300 crore)]
=0.3228+ 17.4718 = 17.79 %
Growth rate in free cash flows from the year 2006 onwards= (1824.27/1586.08) -1=
15.02%
Terminal value = Rs.1824.27 crore/(0.1779 - 0.1502) = Rs.65858.12 crore
a. STL:
(Rs.lakh)
Revenues 6, 300
COGS (@84% of Revenue) 5,292
Depreciation 450
EBIT grows at 12% p.a 558 624.96
EBIT(1T) 387.48
Change in Working Capital 6300 1.12 0.15
113.4
6300 0.15 113.4
Free Cash Flow to Firm 274.08
Cost of Equity 7 1.2 8 16.6%
Cost of Debt (Post Tax) 11.5 (1 0.38) 7.13%
Weighted Average Cost of 16.6
3450
7.13
1350
13.94%
Capital 4800 4800
Firm Value 274.08
14,127.84
(0.1394 0.12)
b. CTL:
(Rs.lakh)
Revenues 4250
COGS (@88% of Revenue) 3740
Depreciation 258
EBIT grows at 12% p.a 252 282.24
EBIT(1T) 174.99
Change in Working Capital 4250 1.12 0.15
76.5
4250 0.15 76.5
Free Cash Flow to Firm 98.49
Cost of Equity 7 1.2 8 16.6%
Weighted Average Cost of
Capital
Cost of Debt (Post Tax) 11.5 (1 0.38) 7.13% 2520 1160
16.6 7.13
3680 3680
13.61%
98.49
Firm Value 6117.39
(0.1361 0.12)
(Rs.lakh)
Revenues 10550 10550
COGS (@80% of revenue) 10550 0.8 8440
Depreciation 450+258 708
EBIT grows at 12% p.a 1402 1570.24
EBIT(1T) 1570.24 (1-0.38) 973.55
Change in Working Capital 189.9
Free Cash Flow to Firm 783.65
Cost of Equity 7 1.2 8 16.6%
Cost of Debt (Post Tax) 9.5 (1 0.38) 5.89%
Weighted Average Cost of 5970 2510
16.6 5.89 13.43%
Capital 8480 8480
783.65
Firm Value 54800.7
(0.1343 0.12)
f. Combined Firm by changing debt ratio to optimal ratio and with Operational Synergy
Levered beta of the firm at the current leverage level is 1.2
1.2
2510
1 0.62
So, the unlevered beta at the current level is 5970 = 0.9519
1
0.9519 1 0.62
When equity multiplier is raised to 2%, the levered beta will raise to 1 or
1.54
Revenues 10550 10550
COGS (@ 80% of Revenue) 10550 0.8 8440
Depreciation 450+258 708
EBIT grows at 12% p.a 1402 1570.24
EBIT(1T) 1570.24 (1-0.38) 973.55
Change in Working Capital 189.9
Free Cash Flow to Firm 783.65
Cost of Equity 7 1.54 8 19.32%
Cost of Debt (Post Tax) 10.5 (1 0.38) 6.51%
Weighted Average Cost of 19.32 0.5 6.51 0.5
12.915%
Capital
Firm Value 783.65
85644.81
(0.12915 0.12)
g. (i) Value of operational synergy = Value of the firm with operational Synergy
Value of the firm without operational synergy =43536.11 20698 = Rs. 22838.11
Lakh
(ii) Value of the financial synergy when debt ratio is maintained at current level
= 54800.7 43536.11 = Rs. 11264.59 Lakh
(iii) Value of the financial synergy when debt ratio is moved towards optimum
= 85644.81 43536.11 = Rs. 42108.7 lakh.