Question

Kingspan plc (‘Kingspan’) is a UK listed company that operates a chain of chemist shops across the South East of England. It has grown organically over the last three years since obtaining its listing and now wishes to accelerate its growth via an acquisition. The board of directors of Kingspan is considering two different options for expansion, each of which is detailed below:

Option 1 – acquire Spencer Ltd (‘Spencer’), a privately owned company that operates a chain of chemist shops in the North West of England.

Option 2 – acquire Triton plc (‘Triton’), a UK listed company that manufactures testing and measurement equipment for laboratories and research facilities.

Requirements

1. With respect to option 1, describe two different approaches by which Kingspan could arrive at a valuation for Spencer Ltd that is suitable for acquisition purposes.
2. With respect to option 2:

1. 1. Explain the risks that arise for Kingspan and its shareholders in acquiring Triton, which operates in a different industry segment to Kingspan.
2. 2. Describe how Kingspan can identify a suitable cost of equity in order to evaluate the potential purchase of Triton.
3. Identify the main sources of finance that can be used for an acquisition such as this and explain the advantages and disadvantages of each source.

Answer 1

a) With Respect to option 1, there are couple of approaches which Kingspan could use to arrive at a valuation for Spencer Ltd, they are as follows -

Enterprise Valuation Method - Under this method, the enterprise is valued using a multiple derived from enterprises in the same industry, whose valuation has been done recently. It assumes that similar firms have similar multiples. Most commonly used multiple is the EBIDTA multiple. Value of Target Firm = Multiple (M) x EBIDTA of Target Firm.

Discounted Cash Flow Method - Under this method, suitable projections and forecasts are prepared to arrive at Free Cash Flows (FCF) for the forecasted period. These FCF are then discounted using a suitable discount rate (usually it is the WACC or Weighted Avg Cost of Capital). Value of Target Firm = FCF1 / (1 + WACC) + FCF2 / (1 + WACC)2 + FCFn / (1 + WACC)n.

b) (i)The Risks for Kingspan in acquiring Triton, which is an unrelated diversification, is that management becomes an issue, with no experience of handling a manufacturing unit and that too with an unrelated product extension, is surely going to be a task. Lack of synergy in such merger, thereby not resulting in greater value for Kingspan and its shareholders, is also one risk Kingspan defintely suffers from.

(ii) Valuing a listed company is usually easier as compared to a private company for couple of reasons, few of them being that data of related cos is publicly available, also since it is listed, market value of the firm can be easily calculated.

The most common method used is the market value approach, where you first compare the firm with other firms in same industry who have recently undergone such mergers or acquisitions, then make adjustments for minor differences in operations, etc and arrive at a comparable figure. Only disadvantage of this method is that such take over of other firm in the industry should've took place within a reasonable period of time.

Main sources of Finance for Acquisition -

Cash Aquisition - Done usually where a cash rich company is acquring or taking over a cash strapped company. Advantages of such a source is that you're clear without any obligation and disadvantage at the same time can be that such method may be an expensive method.

Stock Swap Transaction - Shareholders of the target company receive shares of the merged company after taking over in exchange of shares of the target company. Advantages is it is cost effective, with no monetary exchange taking place. Disadvantage is that may not create value for existing investors and they may look to sell such stock.

Leveraged Buyout - Such a method uses assets of both the companies or rather the merged co for purposes of collateral for raising finance using which it then takes over the target company. Disadvantage being that again debt may reduce valuation for investors, advantage being no out of pocket resources are put to use. Assets of both cos are used.

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