FIN3130 Coursework 2015-16

Introduction

Robinson Investments is a private equity fund specialising in the acquisition of underperforming publicly quoted companies. Its strategy is to buy-out the target company?s shareholders, take the company off the stock market and aggressively restructure its operations with a view to returning it to the stock market within 4 years. The aim is to produce high returns for Robinson?s equity providers.

1. The Investment Opportunity

Donaldson PLC is a leading supermarket chain operating in the UK. Having analysed Donaldson?s Annual Reports for the period from 2011 to 2015, Robinson?s management believes that it is failing to realise its earnings potential and, as a result, is planning a bid for the company. Robinson?s analysis of Donaldson emphasises the following points:

Disposal of Assets

Many of Donaldson?s portfolio of supermarkets have been trading at a loss for some years, making closures and sell-offs necessary in order to improve the company?s longer-term profit potential. Robinson estimates that asset disposals will generate 100 million in 2016 and 250 million in 2017.

The assets will be sold at a loss compared to their book values. The 2016 asset disposals are expected to reduce the 2015 book value of ?non-current assets? by 300 million, with the 2017 disposals producing a further reduction of 500 million.

The losses will however reduce the company?s corporate tax liabilities by 40 million in relation to the 2016 disposals and 50 million for the 2017 disposals. Donaldson pays taxes one year in arrears.

Operating Revenues

The closures and sell-offs will reduce Donaldson?s sales revenues in the short term. The sales estimate for 2016 is 23200 million. For 2017 it is 22500 million. These figures already include the effects of the forecast for price inflation. Thereafter, sales are expected to grow by 3.5% per cent per annum in real terms over the subsequent 2 years.

Cost of Goods Sold

Management of supplies can be improved with the result that the cost of goods sold will average 90% of sales revenues for the 4 trading years from 2016-2019.

Managerial and Administrative Expenses

Robinson would restructure Donaldson?s administrative processes incurring additional expense initially. As a result, the estimate for ?Administrative Expenses? for 2016 is 600 million. However, this figure is expected to fall by 5% per year in nominal terms over the subsequent 3 years.

Working Capital

Improvements in Donaldson?s operational efficiency would release 50 million of working capital. This could be achieved by the end of 2016.

Tax and Capital Allowances

Corporate taxes are paid a year in arrears, and Donaldson?s has an outstanding tax liability (including the capital allowances effect) of 102 million payable at the end of 2016.

Assume that the calculation of capital allowances for tax purposes is based on fixed assets whose opening value for 2016 is the same as the figure for ?Non-Current Assets? contained in the Balance Sheet.

The non-current assets attract capital allowances averaging 3%, calculated on a reducing balance basis. These allowances are claimed on assets net of the effects of the disposal of assets outlined above. The rate of corporation tax is 20%. Both tax payments and capital allowance claims occur one year in arrears.

Robinson?s Transaction Costs

In 2015 Robinson had already spent 1.5 million in research, legal and consultancy fees associated with its interest in launching a bid for Donaldson. A successful takeover of Donaldson would incur further legal, administrative and consultancy costs of 20 million, payable immediately.

Inflation

Inflation is expected to average 1% per annum over the next 4 years.

Re-flotation of Donaldson

The plan is to re-float Donaldson on the London Stock Exchange in 4 years? time. The senior management of Robinson forecasts that Donaldson will be sold at a value equivalent to 6 times the 2019 net cash flow.

2. Financing the Acquisition and Cost of Capital

Acquisition of Donaldson?s Equity Capital Robinson?s Debt Finance

Robinson plans to borrow the additional funding needed to acquire Donaldson?s equity. Robinson?s management has succeeded in negotiating a 4-year loan of 2000 million from a consortium of finance companies. However the consortium, aware of the high level of financial leverage connected to the takeover, would charge an annual fixed rate of interest of 8.5%. The loan would be paid back as a single payment after 4 years.

The remainder of the debt capital required to finance the acquisition would come from fixed-rate, 4-year bond issue. Given the leveraged character of Robinson?s corporate acquisition strategy, a bond issue is likely to be given a B rating by a credit-rating agency (making it non-investment grade). The average yield on B-rated 4-year bonds is 8% above the annual yield on 4-year UK government securities, which is currently 2.9%.

Legal and administrative costs associated with borrowing funds are estimated at 1.2% of the amount borrowed and would be paid up-front rather than capitalized.

A successful bid also means that Donaldson?s loans will form part of the acquired operation?s capital structure. Donaldson?s loans, as highlighted in the 2015 accounts, stand at 4075 million and are expected to remain at broadly the same level over the next 4 years. Donaldson is currently paying an average annual rate of interest of 3.95% on the debt. A takeover by Robinson is liable to require renegotiation of some loan arrangements with the effect that the average rate of interest payable will rise to 6%.

Tasks

Task 1

Required

1a. Undertake a ratio analysis of Donaldson based on the Financial Statements, and other data provided, for the period 2011 to 2015 (Page 7). Highlight developments in Donaldson?s:

• Profitability
• Solvency
• Liquidity
• Shareholder Value

1b. Undertake a comparative analysis of developments in Donaldson?s share price over the period from 2011 to 2015 with reference to developments in the FTSE 100 index and the share prices of its main rivals over the same period (Page 8).

1c. Use the information gained from 1a and 1b to assess the strength of Robinson?s view that Donaldson is an underperforming company whose performance can be radically improved with a change of senior management.

Assessment

A total of 45 marks are available for Task 1. It comprises 18 marks for the numerical work in parts 1a and 1b, and 27 marks for the assessment of Donaldson?s financial state (1c).

In commenting on the ratio results avoid a narrative that is restricted to simply stating what has happened to a particular ratio, or group of ratios. The aim should be to use the results to judge the company?s financial performance. Bear in mind that whilst trends detected in performance ratios are useful indicators of the financial standing of companies, they do not always lend themselves to straightforward interpretations. The context within which developments unfold, and the type of business being analysed, are important factors to consider when making judgements about how well a business is being managed.

Task 2

Required

2a. Calculate how much Robinson is prepared to pay to acquire Donaldson PLC.

2b. Based on the valuation of Donaldson in 2a, explain how Robinson would structure the finance required to fund the takeover, assuming that the entire reserve of available equity (2500 million) is deployed.

2c. Calculate the cost of capital for each component of the finance that Robinson plans to use to fund the takeover.

2d. Calculate the after-tax weighted average cost of capital (WACC) for the investment. You should include the cost of Donaldson?s existing debt as part of the company?s capital structure.

Assessment

A total of 15 marks are available for Task 2. It does not require an extensive discussion beyond explanations of your approach to solving the problems and summaries of your results.

Task 3

Required

3a. Using the after-tax WACC as the discount rate, calculate the expected net present value (NPV) of Robinson?s investment in Donaldson on the basis of a 4-year net cash flow analysis. You should incorporate Robinson?s estimated resale value for Donaldson into the NPV of the investment.

3b. Calculate the investment?s expected internal rate of return and discuss whether on the analysis merits Robinson going ahead with the bid.

Assessment

A total of 30 marks are available for task. It comprises 24 marks for the numerical work and 6 marks for the discussion about whether it is in the interest of the equity providers for Robinson to press ahead with a bid.

Task 4

Required

Written Report - Present your work in a report to the Robinson?s Management, including

your ratio calculations and a copy of the investment appraisal.

Assessment

A total of 10 marks will be available. It comprises 5 marks for structure, format and clarity of

language and 5 marks for evidence of team work & quality of the group process reports

(page 11-14).

Table 1: Donaldson Summarised Income Statements 2011 - 2015
	2011	2012	2013	2014	2015
	000m	000m	000m	000m	000m
Sales	21184	22376	23370	24015	23780
Less Cost of Goods Sold	-19474	-20597	-21522	-22026	-22022
Gross Profit	1710	1779	1848	1989	1758
Less Administrative Expenses	-417	-419	-462	-444	-504
Less Depreciation	-468	-486	-504	-536	-545
Operating Income	825	874	882	1009	709
Less Interest Payments	-84	-103	-123	-139	-161
Less Taxation	-187	-201	-174	-182	-102
Net Income	554	570	585	688	446

Table 2: Donaldson Summarised Balance Sheets 2011 - 2015
	2011	2012	2013	2014	2015
	000m	000m	000m	000m	000m
Current Assets
Inventories	812	938	987	1005	997
Receivables	343	286	306	433	471
Cash	501	739	517	1592	1285
Total Current Assets	1656	1963	1810	3030	2753
Non-Current Assets	9678	10308	10781	12171	12032
Total Assets	11334	12271	12591	15201	14785
Current Liabilities	-3136	-2942	-3115	-3520	-3528
Loans	-3033	-3575	-3846	-3770	-4075
Net Assets (Equity)	5165	5754	5630	7911	7182

Table 3: Donaldson PLC Shareholder Value Data 2011 ? 2015[1]
	2011	2012	2013	2014	2015
Number of Issued Shares	1,817,000,000	1,883,000,000	1,893,000,000	1,907,000,000	1,919,000,000
Dividend Per Share	14.5 pence	15.3 pence	16.4 pence	16.9 pence	17.3 pence
Share Price	306 pence	359 pence	395 pence	310 pence	266 pence
Book Value Per Share	284 pence	306 pence	297 pence	415 pence	374 pence

Table 4: FTSE 100 Index Values and Share Prices for Donaldson?s 3 Main Rivals 2011 ? 20151
	2011	2012	2013	2014	2015
FTSE 100 Index	5488	5896	6622	6310	6945
Toral PLC Share Price	272 pence				204 pence
Gleeson PLC Share Price	403 pence				233 pence
Gray PLC Share Price	337 pence				493 pence

[1] Share prices and FTSE 100 index levels are closing values on the day corresponding to the end of Donaldson?s trading year.

FIN3130 Coursework 2015-16 Introduction Robinson Investments is a private equity fund specialising in the acquisition of underperforming publicly quoted companies. Its strategy is to buy-out the target company's shareholders, take the company off the stock market and aggressively restructure its operations with a view to returning it to the stock market within 4 years. The aim is to produce high returns for Robinson's equity providers. 1. The Investment Opportunity Donaldson PLC is a leading supermarket chain operating in the UK. Having analysed Donaldson's Annual Reports for the period from 2011 to 2015, Robinson's management believes that it is failing to realise its earnings potential and, as a result, is planning a bid for the company. Robinson's analysis of Donaldson emphasises the following points: a. Disposal of Assets Many of Donaldson's portfolio of supermarkets have been trading at a loss for some years, making closures and sell-offs necessary in order to improve the company's longerterm profit potential. Robinson estimates that asset disposals will generate 100 million in 2016 and 250 million in 2017. The assets will be sold at a loss compared to their book values. The 2016 asset disposals are expected to reduce the 2015 book value of 'non-current assets' by 300 million, with the 2017 disposals producing a further reduction of 500 million. The losses will however reduce the company's corporate tax liabilities by 40 million in relation to the 2016 disposals and 50 million for the 2017 disposals. Donaldson pays taxes one year in arrears. b. Operating Revenues The closures and sell-offs will reduce Donaldson's sales revenues in the short term. The sales estimate for 2016 is 23200 million. For 2017 it is 22500 million. These figures already include the effects of the forecast for price inflation. Thereafter, sales are expected to grow by 3.5% per cent per annum in real terms over the subsequent 2 years. c. Cost of Goods Sold Management of supplies can be improved with the result that the cost of goods sold will average 90% of sales revenues for the 4 trading years from 2016-2019. 1 d. Managerial and Administrative Expenses Robinson would restructure Donaldson's administrative processes incurring additional expense initially. As a result, the estimate for 'Administrative Expenses' for 2016 is 600 million. However, this figure is expected to fall by 5% per year in nominal terms over the subsequent 3 years. e. Working Capital Improvements in Donaldson's operational efficiency would release 50 million of working capital. This could be achieved by the end of 2016. f. Tax and Capital Allowances Corporate taxes are paid a year in arrears, and Donaldson's has an outstanding tax liability (including the capital allowances effect) of 102 million payable at the end of 2016. Assume that the calculation of capital allowances for tax purposes is based on fixed assets whose opening value for 2016 is the same as the figure for 'Non-Current Assets' contained in the Balance Sheet. The non-current assets attract capital allowances averaging 3%, calculated on a reducing balance basis. These allowances are claimed on assets net of the effects of the disposal of assets outlined above. The rate of corporation tax is 20%. Both tax payments and capital allowance claims occur one year in arrears. g. Robinson's Transaction Costs In 2015 Robinson had already spent 1.5 million in research, legal and consultancy fees associated with its interest in launching a bid for Donaldson. A successful takeover of Donaldson would incur further legal, administrative and consultancy costs of 20 million, payable immediately. h. Inflation Inflation is expected to average 1% per annum over the next 4 years. i. Re-flotation of Donaldson The plan is to re-float Donaldson on the London Stock Exchange in 4 years' time. The senior management of Robinson forecasts that Donaldson will be sold at a value equivalent to 6 times the 2019 net cash flow. 2 2. Financing the Acquisition and Cost of Capital a. Acquisition of Donaldson's Equity Capital Donaldson's share price is 266 pence. Its issued share capital is same as that recorded in the 2015 accounts. Robinson believes that a takeover bid will force up the share price and is prepared to offer a premium of 20% over the current share price to persuade Donaldson's shareholders to accept a takeover bid. b. Robinson's Equity Finance Robinson has obtained firm commitments of equity capital from investors of 2500 million to finance corporate acquisitions. Given the financially leveraged character of Robinson's acquisition strategy, its equity providers expect returns commensurate with exceptionally high levels of risk. Though Robinson's equity, it being a private equity company, isn't publicly traded on a stock exchange, an analysis of its business and financial risks suggests that an appropriate equity beta for Robinson is 4. The prevailing risk free rate is 1%, and the expected return on the market portfolio is 8.5%. c. Robinson's Debt Finance Robinson plans to borrow the additional funding needed to acquire Donaldson's equity. Robinson's management has succeeded in negotiating a 4-year loan of 2000 million from a consortium of finance companies. However the consortium, aware of the high level of financial leverage connected to the takeover, would charge an annual fixed rate of interest of 8.5%. The loan would be paid back as a single payment after 4 years. The remainder of the debt capital required to finance the acquisition would come from fixed-rate, 4-year bond issue. Given the leveraged character of Robinson's corporate acquisition strategy, a bond issue is likely to be given a B rating by a credit-rating agency (making it non-investment grade). The average yield on B-rated 4-year bonds is 8% above the annual yield on 4-year UK government securities, which is currently 2.9%. Legal and administrative costs associated with borrowing funds are estimated at 1.2% of the amount borrowed and would be paid up-front rather than capitalized. A successful bid also means that Donaldson's loans will form part of the acquired operation's capital structure. Donaldson's loans, as highlighted in the 2015 accounts, stand at 4075 million and are expected to remain at broadly the same level over the next 4 years. Donaldson is currently paying an average annual rate of interest of 3.95% on the debt. A takeover by Robinson is liable to require renegotiation of some loan arrangements with the effect that the average rate of interest payable will rise to 6%. 3 Tasks Task 1 Required 1a. Undertake a ratio analysis of Donaldson based on the Financial Statements, and other data provided, for the period 2011 to 2015 (Page 7). Highlight developments in Donaldson's: Profitability Solvency Liquidity Shareholder Value 1b. Undertake a comparative analysis of developments in Donaldson's share price over the period from 2011 to 2015 with reference to developments in the FTSE 100 index and the share prices of its main rivals over the same period (Page 8). 1c. Use the information gained from 1a and 1b to assess the strength of Robinson's view that Donaldson is an underperforming company whose performance can be radically improved with a change of senior management. Assessment A total of 45 marks are available for Task 1. It comprises 18 marks for the numerical work in parts 1a and 1b, and 27 marks for the assessment of Donaldson's financial state (1c). In commenting on the ratio results avoid a narrative that is restricted to simply stating what has happened to a particular ratio, or group of ratios. The aim should be to use the results to judge the company's financial performance. Bear in mind that whilst trends detected in performance ratios are useful indicators of the financial standing of companies, they do not always lend themselves to straightforward interpretations. The context within which developments unfold, and the type of business being analysed, are important factors to consider when making judgements about how well a business is being managed. 4 Task 2 Required 2a. Calculate how much Robinson is prepared to pay to acquire Donaldson PLC. 2b. Based on the valuation of Donaldson in 2a, explain how Robinson would structure the finance required to fund the takeover, assuming that the entire reserve of available equity (2500 million) is deployed. 2c. Calculate the cost of capital for each component of the finance that Robinson plans to use to fund the takeover. 2d. Calculate the after-tax weighted average cost of capital (WACC) for the investment. You should include the cost of Donaldson's existing debt as part of the company's capital structure. Assessment A total of 15 marks are available for Task 2. It does not require an extensive discussion beyond explanations of your approach to solving the problems and summaries of your results. Task 3 Required 3a. Using the after-tax WACC as the discount rate, calculate the expected net present value (NPV) of Robinson's investment in Donaldson on the basis of a 4-year net cash flow analysis. You should incorporate Robinson's estimated resale value for Donaldson into the NPV of the investment. 3b. Calculate the investment's expected internal rate of return and discuss whether on the analysis merits Robinson going ahead with the bid. Assessment A total of 30 marks are available for task. It comprises 24 marks for the numerical work and 6 marks for the discussion about whether it is in the interest of the equity providers for Robinson to press ahead with a bid. 5 Task 4 Required Written Report - Present your work in a report to the Robinson's Management, including your ratio calculations and a copy of the investment appraisal. Assessment A total of 10 marks will be available. It comprises 5 marks for structure, format and clarity of language and 5 marks for evidence of team work & quality of the group process reports (page 11-14). 6 Table 1: Donaldson Summarised Income Statements 2011 - 2015 2011 2012 2013 000m 000m 000m Sales 21184 22376 23370 Less Cost of Goods Sold -19474 -20597 -21522 Gross Profit 1710 1779 1848 Less Administrative Expenses -417 -419 -462 Less Depreciation -468 -486 -504 Operating Income 825 874 882 Less Interest Payments -84 -103 -123 Less Taxation -187 -201 -174 Net Income 554 570 585 2014 000m 24015 -22026 1989 -444 -536 1009 -139 -182 688 2015 000m 23780 -22022 1758 -504 -545 709 -161 -102 446 Table 2: Donaldson Summarised Balance Sheets 2011 - 2015 2011 2012 2013 000m 000m 000m 2014 000m 2015 000m 1005 433 1592 3030 12171 15201 -3520 -3770 7911 997 471 1285 2753 12032 14785 -3528 -4075 7182 Current Assets Inventories Receivables Cash Total Current Assets Non-Current Assets Total Assets Current Liabilities Loans Net Assets (Equity) 812 343 501 1656 9678 11334 -3136 -3033 5165 938 286 739 1963 10308 12271 -2942 -3575 5754 987 306 517 1810 10781 12591 -3115 -3846 5630 7 Table 3: Donaldson PLC Shareholder Value Data 2011 - 20151 2011 2012 2013 1,817,000,000 1,883,000,000 1,893,000,000 14.5 pence 15.3 pence 16.4 pence 306 pence 359 pence 395 pence 284 pence 306 pence 297 pence 2014 1,907,000,000 16.9 pence 310 pence 415 pence 2015 1,919,000,000 17.3 pence 266 pence 374 pence Table 4: FTSE 100 Index Values and Share Prices for Donaldson's 3 Main Rivals 2011 - 2015 1 2011 2012 2013 2014 FTSE 100 Index 5488 5896 6622 6310 Toral PLC Share Price 272 pence Gleeson PLC Share Price 403 pence Gray PLC Share Price 337 pence 2015 6945 204 pence 233 pence 493 pence Number of Issued Shares Dividend Per Share Share Price Book Value Per Share Share prices and FTSE 100 index levels are closing values on the day corresponding to the end of Donaldson's trading year. 1 8 Please note the following points: Your report should be in the range of 1500 - 2000 words. This assignment lays greater emphasis on the demonstration of "soft" skills such as the ability to use information technology creatively, communicate ideas and information clearly, and work effectively as part of a team. These skills improve self-awareness, selfconfidence and employability. "Hard" skills will be adequately tested in the closed book examination, and are therefore not given an unduly high weight as far as this assignment is concerned; hence it is possible for an assignment to earn a relatively low overall mark even if it is numerically very accurate. The 'Estimate of individual contribution to group report' form (page 10) must be completed and signed by all members of a group, and submitted with the report. This will be used to determine each student's share of the group coursework mark. o If there are 4 members in a group an equal contribution would be 25% each. o If there are 5 members in a group, an equal contribution would be 20% each. o Variations from these levels of 25% and 20% are permissible for individual group members up to a maximum of 3% only for a 4-person group & 2.4% only for a 5-person group. Each group must submit a Group Process Report (pages 11 to 14), to provide evidence regarding successful group work, resolution of conflicts between group members, and completion of tasks within deadlines. This is intended to be the outcome of the individual student's personal reflection, and will be one of the contributors to the student's individual coursework mark. Students are required to sign for their attendance on the day of meeting. Each group will also present their main finding as an oral presentation during seminar sessions in weeks 21 & 22. Please see page 15 for presentation guidelines. 9 Estimate of Individual Contribution to the Group's Written Report No. Name of group Member % Student ID contribution Signature of member 1. 2. 3. 4. 5. TOTAL 100 10 Group Progress Report Meeting 1: Date: / / Discussion of the work carried out (what has been achieved and what has been missed): Goals for next meeting (per each member): Name: Next meeting Task: Date: / / Time Place Signatures of attendants 11 Meeting 2: Date: / / Discussion of the work carried out (what has been achieved and what has been missed): Goals for next meeting (per each member): Name: Next meeting Task: Date: / / Time Place Signatures of attendants 12 Meeting 3: Date: / / Discussion of the work carried out (what has been achieved and what has been missed): Goals for next meeting (per each member): Name: Next meeting Task: Date: / / Time Place Signatures of attendants 13 Meeting 4: Date: / / Discussion of the work carried out (what has been achieved and what has been missed): Goals for next meeting (per each member): Name: Next meeting Task: Date: / / Time Place Signatures of attendants 14 Presentation Guidelines Your presentation mark will depend on both the quality of the presentation contents as well as your individual preparedness and presenting skills. Students will be individually marked according to their presenting skills. Time: Each presentation should last between 10 and 15 minutes. If you reach 15 minutes, you will be asked to stop presenting. Contents: Although it is impossible to cover all the work within a few slides, the main issues and results should be there. Discussion: Distribute your discussion between the two parts of the report. You are expected to: discuss the financial status of Donaldson Plc with reference to your ratio interpretations; present the results of the investment appraisal and explain how and why you estimated your cash flows; present your overall conclusions. Structure: Design a structure for your presentation that is suitable with how you plan to address the main issues and how to answer them and conclude. Communication: Show evidence of excellent team communication skills throughout the presentation Visual aids: Ensure contents are displayed clearly and that visual aids should not have any adverse impact. Avoid using small font size and colours that are difficult to view. Do not overcrowd the contents on a single slide. Contribution: All members within a group are expected to contribute equally in presenting their study. Members that evidently make a short talk will be marked down. Eye contact: Ensure you distribute your eye contact evenly among the audience while presenting. Do not read from your notes. Voice: Do not speak too quickly or with low voice. Avoid the use of informal or slang terms. Rehearse well the part you are delivering before the presentation. Q&A: Tutors may ask students questions at the end of the presentation 15