Utara Corporation and Selatan Company are competitors in the business of electrical components distribution. Selatan is the smaller firm and has attracted the attention of the management of Utara, for Selatan has taken away market share from the larger firm by increasing its sales force over the past few years. Utara is considering a takeover offer for Selatan and asked you to serve on the acquisition valuation team that will turn into due diligence team if an offer is made and accepted. Given the financial information and proposal assumptions that follows, how would you respond to (a) and (b)?

Assumptions

1. Selatan would become a wholly owned subsidiary of Utara.
2. Revenues will grow by 4% in 2021.
3. The cost of goods sold could be reduced to 91% of revenue.
4. Sales, general and administration (SG&A) expenses are expected to be reduced to 2% of revenue.
5. Depreciation expenses are expected to remain around RM7 million.
6. Interest expenses are expected to remain around RM11.5 million.
7. A tax rate of 31% is assumed going forward.
8. Cash flows from operations are expected to increase by 3% indefinitely.
9. Selatans cost of equity is 12%.
10. Selatans current market capitalization is RM250 million with 10 million shares outstanding.
11. Utara will offer Selatan a takeover premium of 20% over current market capitalization.
12. Layoffs and other restructuring charges are expected to result in after-tax restructuring charges of RM30 million, RM15 million, and RM5 million (respectively) over the next three years (2021 to 2023). (Hint: These charges are one-offs and not a part of cash flows from operations)

QUESTIONS

1. Make your recommendation about whether the acquisition should be pursued. Make and state any additional assumption that you made in solving this case.

(11 marks)

2. If Utara has 30 million shares outstanding that are currently trading at RM60.00, then how many shares should Utara offer for all shares of Selatan? Assume that the synergy created is RM100 million and Utara will offer Selatan a takeover premium of 20% over current market capitalization, which is RM250 million (Hint: This question is not related to part a).

(4 marks)

Selatan Company Condensed Income Statement Previous five years (in RM million) 2020 2019 2018 2017 2016 Revenues 1,626.50 1614.10 1485.20 1380.50 1373.40 Less: Cost of goods sold 1,488.10 1490.90 1359.50 1271.40 1268.00 Equals: Gross profits 138.40 123.20 125.70 109.10 105.40 Less: SG&A expenses 41.10 36.80 41.20 35.00 36.10 Less: Depreciation expense 7.30 6.70 7.10 6.60 6.40 Less: Operating expenses 48.40 43.50 48.30 41.60 42.50 Equals: Operating income 90.00 79.70 77.40 67.50 62.90 Less: Interest expense 11.50 12.00 12.00 12.00 12.00 Equals: Earnings before 78.50 67.70 65.40 55.50 50.90 taxes Less: Taxes paid (31%) 24.30 20.80 19.90 16.80 15.30 Equals: Net Income 54.20 46.90 45.50 38.70 35.60 1 Selatan Electrical Company Condensed Balance Sheet for the Year 2020 (RM million) Current Asset 12.20 Plus: Fixed Asset 347.80 Equals: Total Asset 360.00 Current liabilities 10.10 Plus: Long Term debt 150.00 Equals: Total Liabilities 160.10 Plus: Shareholders' equity 199.90 Total Liabilities and equity 360.00 +