You team works for XYZ Company, which has a directional strategy focused on expanding the company through horizontal integration. Your team can determine the official name of the company and industry. The company does a great job keeping close watch on its cash position and consistently maintains a positive cash flow; is very solvent; controls its overhead expenses; has solid marketing and sales, production, and human resources performance metrics, and fosters a culture of strategic thinkers. Historically, your company has expanded through a combination of organic (new startups) and inorganic growth and feels itâ€™s time to consider acquisition opportunities.
The Board is looking to engage in a friendly acquisition of a company that will not only increase its market share, but allow it to penetrate new markets and increase the companyâ€™s abilities to meet current and future consumer needs and expectations. Since managementâ€™s attitude is to pursue a friendly acquisition as opposed to a hostile takeover, your team may consider looking at conglomerates that have experienced significant growth through inorganic growth (acquisitions) and may now be looking to refocus on their core business and are willing to consider divesting some of its businesses that are within your industry. There could be other companies that are under financial duress and receptive to acquisition offers. Your team is a part of the corporate mergers and acquisition (M&A) department and has been assigned the task of identifying two potential acquisition targets. Since your Board is committed to a strategy of horizontally integration, you will be looking for possible acquisitions from within your industry. You will be performing a preliminary analysis of the companies under consideration, and then ultimately recommend one of the companies move forward for a more in-depth valuation by M&A Department.
Notes: The target acquisitions should be publicly traded and have the same fiscal year end, preferably December 31st. In addition, your team is encouraged to select a proper name for your company and the industry for which it is aligned.
To successfully complete your preliminary analysis of the target acquisitions, your team should follow this high level process flow:
1. Select Comparable Companies that Satisfy Inclusion Criteria
2. Conduct Qualitative Research on the Companies
3. Conduct Quantitative Analyses of the Companies (financial)
4. Prepare Report of Findings with Recommendation
Select Comparable Companies
Describe the methodology used to select the target acquisitions. You may want to consider utilizing the North American Industry Classification System (NAICS) to identify companies within you r industry. Of course, there are a variety of Internet sites that can assist you in locating firms within your chosen industry, such as Google Finance and Yahoo Finance.
Conduct Qualitative Research on the Companies
Provide relevant background information on the each company, current forces affecting its operations, and its expectations for future years. The management discussion and analysis (MD&A) section of the companyâ€™s annual report will be a useful source for this type of information. In addition to the companiesâ€™ annual report, the teams may look at pulling current articles about the companies from the databases available through the University Library. There are a number of credible sources where this type of information can be obtained through the Internet.
Caution: It is dangerous to rely solely on the opinions and perceptions expressed by agents of a firm, since they may have a tendency to present an overly optimistic picture of the current state and future of their companies. After all, they have shareholders that pay close attention to their words and actions. It would be prudent to verify information through non-agents of the companies, such as financial and investment analysts who closely track the industry as well as media outlets that closely monitor and report on companies within the U. S. economy. It is understood that the opinions expressed by these sources are subject to bias regardless of how objective they attempt to be. The objective is to validate the information you obtain through more than a single source. This is a practice that all management officials should make a habit.
The teams will be expected to qualitatively analyze the content within the companiesâ€™ most recent independent audit of its financials and records. In performing this analysis, the teams should focus on the audit findings and options.
Conduct Quantitative Analyses of the Companies (financial)
- Present a comprehensive financial statement analysis of the target acquisitions. Prepare the common size statements and all the ratios and amounts for the measures given below for the most recent year for both of your companies and present in a clear tabular form. Then discuss each category given below.
- Prepare common-size financial statements for both target acquisitions
- Complete both a horizontal and vertical analysis for each target acquisition
- Compare the common-size financial statements between the two companies using cross-sectional analysis
- Calculate and interpret relevant profitability, solvency, liquidity, leverage, market value ratios for each company that will be useful in comparing the target acquisition
- For each company, graphically trend the net income and cash flow from operations over the last five years. Based on a comparison of the income statement to the statement of cash flows, what accounts explain the greatest differences between net income (loss) and cash flow from operations. Comment on the quality of the earnings numbers.
- Calculate and interpret the net present value (NPV) of the companiesâ€™ annual free cash flow (FCF) for a 5 year period (nper) taking into account a constant growth rate (which will need to be calculated), and a discount rate that is equal to your companies weighted average cost of capital (WACC), which is 7%. http://www.investopedia.com/articles/fundamental-a… (Links to an external site.)
- Any notable similarities and differences in financial reporting practices of the two acquisition targets that could potentially impact your analysis should be reported along with your team mitigation strategy. For example, perhaps the firms are using the same or different methods of accounting for property, plant, and equipment (PP&E), inventory, intangibles, etc.
The team will perform all numeric calculations using Microsoftâ„¢ Excel. Excel can be used to graphically present data, and then copied and pasted into the Report of Findings (see below) or this can be directly in the Word document using the Microsoftâ„¢ charting feature.