1.1. Overview
Dairy Crest was started in 1983 for processing of milk by the Milk Marketing Board, a public body established in 1933 to manage the production and distribution of milk in the UK. The organisation has grown over the years to become an integrated dairy business that is focused on 2 market-leading categories, namely foods and dairies. The company floated in the London Stock Exchange in 1996.
Dairy Crest is well known in the UK. Its brands are family favourites and can be found in millions of refrigerators throughout the country. The butter and spreads division of the company produces a variety of well known brands. Dairy Crest's cheeses are sold in the country's supermarkets and in numerous other shops and stores. The company is a large purchaser of fresh milk and buys more than 2.4 billion litres of milk a year.
Dairy Crest has been expanding steadily since 1992. The company has through a chain of acquisitions become the country's leading chilled dairy foods company and one of the ten largest food companies in Britain. It entered into a joint venture with Yoplait for the establishment of Yoplait Dairy Crest, which produces and markets chilled yogurts as well as cottage cheese, desserts and ice cream. Its performance is driven by numerous food brands like Cathedral City, Country Life, and Clover.
The group's ongoing focus on brand reinforcement and satisfaction of evolving customer needs ensures its position within the dairy sector, which is among the largest food grocery categories, worth over 8 billion GBP and growing every year. Dairy Crest***
The board of directors of Dairy Crest has initiated a study for the takeover of Cranswick plc, a fast growing and profitable company engaged in the production and sale of a range of pork products.
Cranswick was founded by farmers in the initial years of the 1970s for production of pig feed. The company initiated a strategy in 1988 to widen the base of organisational operations and seek opportunities for expansion into associated areas that had potential to add to organisational processes. Organisational activities have since been expanded from this agricultural foundation into the food sector. Cranswick is now focused mainly on the supply of fresh and processed pork items to the food retail, manufacturing and service categories of the UK. Such growth was achieved through a mix of acquisitions and organic growth.
The company now supplies a variety of fresh pork, sausages, cooked meats, air-dried bacon, charcuterie, sandwiches and other items to customers from many UK based production facilities. The company has won many awards across product categories. Cranswick
1.2. Purpose
This assignment aims to investigate various strategic aspects of the proposed takeover of Cranswick by Dairy Crest, with especial regard to the following:
Evaluation of relative financial positions and strategies of the target and bidder firms and the opportunities for synergies
Valuation of the target firm for the bidder and calculation of bid price
Discussion on whether the target firm should accept or reject the bid.
Consideration of whether the acquisition is likely to increase shareholder wealth of the bidding firm and identification of factors that might lead to success or failure of the acquisition
Evaluation of likely market response to the bid announcement
2. Evaluation of Relative Financial Positions and Strategies of the Target and Bidder Firms and Opportunities for Synergies
The latest financial statements of both organisations have been analysed in detail. The table provided below provides a broad summary of their latest profit and loss accounts, balance sheet and cash flow positions. Both***
Profit and Loss Account
Dairy Crest
Group plc
Bidder
Million GBP
Cranswick
plc
Target
Million GBP
Sales
1652
740
Cost of Sales
1150
644
Gross Profit
502
96
Administration, Distribution and Other Expenses
390
40
Profits before Depreciation, Interest and Tax
112
56
Depreciation
36
12
Profits before Interest and Tax
76
44
Tax
23
11
Profits after Tax
53
33
Balance Sheet
Non-Current Assets
820
236
Current Assets
328
126
Total Assets
1148
362
Non Current Liabilities
602
66
Current Liabilities
253
103
Shareholder's Equity
293
193
Total Liabilities
1148
362
Net Cash Flows from Operations
113
32
Increase in Cash Equivalents
(80)
12
Outstanding Shares (Weighted Average)
134 Million
47.6 Million
Earnings per Share
44 P
70 P
An analysis of the above results leads to the following conclusions:
Dairy Crest is considerable larger than Cranswick in terms of sales, assets and profits.
Cranswick appears to however have better profitability ratios. Its post tax profits at 33 million GBP on a turnover of 740 million GBP are certainly more by way of percentage than those achieved by Dairy Crest, namely 53 million GBP on a turnover of 1652 million GBP. Such improvement in sales and profits during recessionary times, whilst surprising, reflects the tendencies of people to buy basic, inexpensive and nourishing foods during times of economic stress.
A perusal of the financial statements also reveals that whilst Cranswick has achieved significant year on year growth from 2009 to 2010, both in terms of sales and profits, the corresponding figures for Dairy Crest have declined, marginally in terms of sales but significantly in terms of profits after tax. Profits after tax for Dairy Crest have declined by nearly one third from 74 million to 53 million GBP from 2009 to 2010.
Whilst both companies have achieved strong cash generation during 2010, Dairy Crest has used its cash generation to retire its revolving credit.
Dairy Crest is geared much more than Cranswick, with Non Current Liabilities of 602 million on equity of 293 million. The total non-current liabilities of Cranswick, of 66 million GBP on equity of 193 million GBP are comparatively much lesser.
Mergers and Acquisitions, whilst often used synonymously, are actually different activities. An acquisition occurs when a business firm takes over another and proclaims itself to be the new owner. The target company, from a legal perspective, ceases to exist in such cases. The buyer swallows up the business and its shares continue to be traded. Mergers on the other hand happen when two firms agree to operate as a single new corporation rather than remain under separate ownerships. Such actions are termed to be mergers of equals and involve (a) the surrender of stocks of both companies and (b) issuance of the stock of the new company. The 1999 merger of SmithKline Beecham with Glaxo Wellcome resulted in the cessation of both firms and the formation of GlaxoSmithKline, a new corporate entity.
Actual mergers of equals do not however happen often. A company will often buy another and allow the acquired company to term it to be a merger. A purchase deal is often termed a merger when both managements agree that working together is in the best interests of both companies. However such deals, when unfriendly, are regarded to be acquisitions.
Organisations engage in merger and acquisition activity for a range of reasons, the most important of which is achievement of organisational growth. Organisations achieve growth either through organic growth from within or through externally driven growth by means of acquisitions. Externally driven growth results in much faster expansion than what can be achieved through organic means and is becoming an increasingly common event in modern day business. Benninga, Galpin, Lajoux
The turnover of the acquiring company, Dairy Crest, was approximately 1600 million GBP, even as the turnover of the target company Cranswick plc was 740 million GBP in 2010. It will in the normal course of things take Dairy Crest many years to achieve additional sales of 740 million GBP. An acquisition of this sort however will enable the organisation to increase its turnover by practically 50% with just one deal. Whilst such growth adds to sales of companies, it also benefits organisations through increased market share where products are identical, provides synergies for growth through the establishment of new customers for both parties, and creates opportunities for cross-selling and moving into new geographic locations.
Both organisations, Dairy Crest and Cranswick have been growing over the years through a mix of organic growth and acquisitions. They have stayed within the UK and have not actively sought to expand into other countries. Dairy Crest has steadily used the acquisition route to further growth and much of this activity has been financed through external debt. Dairy Crest*** Dairy Crest and Cranswick plc are both members of the UK food sector and whilst their products are different, it is easy to understand that most people who consume sausages also drink milk and eat cheese.
The mergers of these two businesses could provide substantial opportunities to both companies to approach each other's customers, engage in cross-selling and achieve joint turnovers that could be significantly higher than the turnovers of their individual organisations. With the products of the two companies not being similar or identical in any way, even though they belong to the same sector, it should be possible for Dairy Crest to achieve very significant increases in turnover if it manages to acquire Cranswick plc.
Dairy Crest and Cranswick can also achieve multiple synergies in other marketing related functions like supply chain management, stocking of finished products, transportation, distribution and retailing. Dairy Crest would, after acquisition, also be able to obtain much better terms and conditions from its various institutional customers like supermarkets and other smaller retail stores. Transportation, cold chain management, distribution, advertising and selling expenses can also be rationalised and reduced significantly. With both organisations operating in the same country and moreover selling in the same cities, towns and villages, the merged organisation should also be able to achieve significant savings in administrative costs and in salaries of support staff like HR, accounting and finance.
Whilst Dairy Crest's operations have been affected because of the economic downturn, especially in its premium segments, the operations of Cranswick have benefited during the period because of the general perception of sausages and other pork products being inexpensive but nourishing and filling foods. The operations of the two organisations can thus complement and reinforce each other during periods of economic growth and slowdown.
3. Valuation of Cranswick plc for Dairy Crest and Calculation of Bid Price
The board of directors of Dairy Crest will need to arrive at a realistic valuation of Cranswick plc in order to decide upon a bid that would serve the objectives of obtaining control of the company and of financial viability.
Companies are valued through the utilisation of a range of valuation techniques, sometimes in isolation and sometimes in tandem. The value of an organisation is very often represented through the market value of its shares, which comes about through the interplay of various factors that include the perceived value of its assets, its past and expected operational and financial performance and a range of overall market condition. McKinsey ***The chart provided below shows the movement of the company's share price over the last twelve months.
(Source: Thompson Reuters, 2010, p 1)
The share value of Cranswick plc has been increasing steadily over the last year and is now moving in the range of 850 to 900 P.
All valuation exercises must be done keeping account of the company's share price.
The use of Price Earnings ratios often provides managements with an easy way to arrive at a base valuation for the shares of a company. The P/E ratio indicates the multiple of the market value of a share of a company to its current earnings per share (EPS). The use of this ratio enables an acquiring company to make an offer of a multiple of the EPS of the target company. An analysis of the P/E of various stocks in the same sector provides acquiring companies with good guidance about the target firm's likely P/E multiple. Book on Price earning Ratios***
The table provided below provides some relevant information for computing Cranswick plc's P/E based offer.
Fundamentals
Units
2010
2009
2008
2007
2006
Revenues
Million GBP
740
606
559
510
441
Profits before Tax
Million GBP
44
35
33
33
31
EPS
P
70
54
49
50
48
PE
Numbers
11.5
10.8
10.5
18.8
13.2
EPS Growth
%
30
9
(2)
5
15
Dividend Cover
Times
2.79
2.47
2.47
2.77
2.9
Yield
%
3.1
3.7
3.9
1.9
2.6
With the PE of the food sector in the pre-downturn days being about 15, industry analysts expect the share of the company to rise in future and all analysts are advising investors to hold on to and buy Cranswick stocks. The above indicators, when read with existing market sentiments, suggest that Dairy Crest will have to pay a significant premium over the current market price of 890 P in order to acquire the company. It must however be kept in mind that such shortcut methods frequently do not have any correlation with the particulars of the company of interest, with reference multiples for PEs being collected over several years. Many experts could for example feel that it does not make much sense to compare the PE of Cranswick with other food companies. Whilst such criticisms of the PE model for valuation are valid, examination of PEs can certainly help in providing relevant points of reference.
Most detailed valuation exercises depend upon application of discounted cash flow (DCF) techniques to value companies. The DCF approach for M and A purposes attempts to determine values of companies by calculating the present value of expected cash flows over the lives of such companies. With corporations assumed to have infinite lives, such analyses are normally broken into two components, namely forecast periods and terminal values. Explicit values of free cash flows must be developed for the forecast period, which duly incorporate the economic benefits and costs of transactions. Whilst the forecast periods should actually correspond to the intervals wherein firms enjoy competitive advantages, most valuation exercises are done with forecast periods of five to ten years.
The company value that results from free cash flows that are expected to arise subsequent to the forecast period is said to be the terminal value. The terminal value is calculated in the last year of the forecast period and is used to capitalise the present value of cash flows beyond the forecast period. The Weighted Average Cost of Capital (WACC) is thereafter used to discount the values to determine the present value, which represents the company value.Miller***
Cranswick's financial year ends in March. The results for 2010 reveal the following figures:
Sales of GBP 740 million were 22 % higher than 2009
Operating profits of GBP 46 million were 19.6 % higher than 2009
Profits before Tax of GBP 43.8m were 26.1 % higher than 2009
The earnings per share (EPS), at 69.70p was 29.8 % higher than 2009.
The dividend per share was 25p
Return on capital employed for 2010was 31.7%
The ROCE of the company has stayed between 29% and 35.5% over the last five years.
Net gearing at 31st March 2010 was 87%, down from 137% in 2009.
The WACC of Cranswick is calculated as under:
Cost of Equity Capital:
Risk free rate + Beta * Risk premium of 6 % = 4.23 + 0.8 * 6 = 4.23 + 4.8 = 9.03
Equity: 193 Million
Debt: 50 Million
Interest: 5.5 * .75 = 4.125
Weighted Average Cost of Capital: 8 %
Expected Cash Flows:
Year
2011
2012
2013
2014
2015
Sales; YOY increase of 15 %
850
975
1120
1290
1485
Cost of Sales @ 85 % of sales
722
830
950
1095
1260
Administrative and
Distribution Expenses : increase of 10 %
40
42
44
46
49
Depreciation; same
12
12
12
12
12
Profit before Tax
76
93
118
137
164
Tax; effective rate of 20 %, like in 2010
15
20
23
27
33
Profit after Tax
61
73
95
110
131
Add: Depreciation
12
12
12
12
12
Less: Capital Expenditure
10
10
10
10
10
Less: Increase in
Net Working Capital
5
5
5
5
5
Free Cash Flows
58
70
92
107
128
Terminal Value: 128 X 15 (PE for the sector) = 1920
Calculation of Present Value
Million GBP
Year
2011
2012
2013
2014
2015
Free Cash Flows
58
70
92
107
128
Terminal Value
1920
Total Cash Flows
58
70
92
107
2048
Discount Factor @ 8 %
0.93
0.86
0.79
0.74
0.68
Present Value
54
60
73
79
1393
The terminal value of a company at the end of the forecast period can be calculated by multiplying the last year's free cash flows with variables like the WACC of the company or the PE of the appropriate sector. The calculation has thus to be done with care. Whilst the choice of the PE as the multiplying factor in this case might lead to a high terminal value, it will help in reducing the chances of the preparation of too low a bid offer. Page***
The total present value of the company thus works out to 1659 million GBP.
With there being 47.9 million outstanding shares, the value of each share under this method works out to 3464 P.
This figure is significantly higher than its present market price of 900 P.
Whilst the calculated valuation figure for Cranswick is significantly higher than the present market price of 900 P, it must be realised that such figure is dependent upon a number of assumptions like strong increase in sales and maintenance of all other costs. It would in such circumstances be prudent to carry out another calculation after incorporating the effect of synergies in different areas and using the WACC to calculate the terminal value.
Such an exercise leads to the following calculations:
Year
2011
2012
2013
2014
2015
Sales; YOY increase of 10 % (Toned down)
815
895
985
1085
1190
Cost of Sales @ 80 % of sales (Reduced because
of Synergies)
650
715
790
870
950
Administrative and
Distribution Expenses (no increase because
of synergies)
40
40
40
40
40
Depreciation; same
12
12
12
12
12
Profit before Tax
113
128
143
163
188
Tax; effective rate of 20 %, like in 2010
23
26
29
33
38
Profit after Tax
90
102
114
130
150
Add: Depreciation
12
12
12
12
12
Less: Capital Expenditure
10
10
10
10
10
Less: Increase in
Net Working Capital (Reduced because
of lesser sales)
5
5
5
5
5
Free Cash Flows
87
99
111
127
137
Terminal Value (with WACC of 8%)
1096
Total Cash Flows
87
99
111
127
1233
Discount Factor @ 8 %
0.93
0.86
0.79
0.74
0.68
Present Value
81
85
88
94
838
The NPV and the valuation of Cranswick's business, using the above mentioned modifications, works out to 1186 million GBP; compared to the previously computed figure of 1659 million GBP. The value per each Cranswick share on 47.9 million outstanding shares works out to 2475 P under the new method.
The calculated market values of Cranswick's shares, under both computations, are significantly higher than the existing market price of 900 P. This is understandable given the recommendations of various analysts to hold on to Cranswick shares and the significantly low existing PE ratio of 11.5. It would under these circumstances be advisable for Dairy Crest to bid for complete control of Cranswick plc at an offer price of 1600 P. Such a figure will give substantial immediate benefits to Cranswick shareholders and ensure strong long term gains for Dairy Crest. Satisfaction of value should be made through the issuance of Dairy Crest shares to Cranswick shareholders in the ratio of 4.25 shares of Dairy Crest for each Cranswick Share. Such an action would help Dairy Crest in improving its gearing ratio and enable the organisation to meet the financial demands of the merger without much financial stress.
4. Discussion on Acceptance of Dairy Crest bid by Cranswick plc Shareholders
Cranswick shareholders should prima facie welcome the bid by Dairy Crest. Whilst the market price of Cranswick shares have undoubtedly increased significantly over the last year, they are now trading in the range of 800-900 P, and most market experts expect the value of the share to stabilise in this region until the announcement of results for 2011 in April next year. It is however unlikely that the share price will jump to more than 1600 in the near future, despite the low current PE ratio and the possible undervaluation of shares at current prices.
Dairy Crest is well known for its management quality, its history of successful acquisitions and its range of strong brands. Whilst the company has not fared too well during the economic downturn, it has not incurred losses and has in fact actually used the recession to make an important acquisition. The shareholders of Cranswick and market experts should realise the significant synergies that can come about from such a merger/takeover in areas of sales, marketing and administration and distribution costs. With the current economic downturn expected to taper of slowly, it is unlikely that M&A activity will rebound to pre 2008 levels soon.
It should be apparent that an acquisition of Cranswick by Dairy Crest at an exchange price of 1600 P per share could result in a win-win situation for both sides. It would be unwise for Cranswick shareholders to reject this bid. Various financial analysts should also support the bid.
5. Impact of Acquisition on Shareholder Wealth of Dairy Crest and Discussion on Factors that can Influence Success or Failure of the Process.
Dairy Crest shareholders should benefit from the proposed acquisition of Cranswick plc. Immediate benefits from the deal will arise from significant increase in sales and profitability of the company; considering that the profitability and the ROI of Cranswick is significantly better than that of Dairy Crest. The acquisition will give the organisation significant presence in a new area of foods, and that too through a well managed and profitable organisation.
The acquisition will bring about significant complementarity between the two organisations. With sausage companies expected to do well during times of recession, the acquisition will enhance the risk management capacity of Dairy Crest and enable it to do better in future economic downturns. The potential areas for synergies between the two organisations have been discussed in detail before and are not being taken up for discussion again. It is sufficient to state that such synergies should significantly help in improving the profitability of Dairy Crest, after it acquires Cranswick.
History however reveals that many such mergers, which started off with the most optimistic of projections, culminated in terrible failures. The merger between Daimler and Chrysler in the late 1990s was then touted as the most important merger to occur in the automotive industry and one that would change the very structure of the industry. The merger between the two auto giants ended in terrible failure and resulted not just in the separation of the two companies but many years of wasted effort.
Quaker Oats acquired Snapple in 1994 for 1.7 billion USD. The company could not however manage the acquisition and sold Snapple for 300 million USD after 27 months. The revenues of Snapple reduced by 30% from the time it was purchased by Quaker to the time it was resold.
Management experts state that the successes or failures of mergers and acquisitions depend upon a range of factors that are not visible from a perusal of financial fundamentals or an examination of brand strengths or potential synergies. Bolman and Deal (2008) state that the success of mergers and acquisitions of two different organisations depend upon four important factors, namely (a) organisational structures, (b) complementarities in HR policies, (c) management of political issues and (d) creation of cohesive organisational culture. Most mergers and acquisitions take place between firms that have different structures, HR policies, political ramifications and organisational cultures. The efforts of acquiring companies to superimpose their organisational features, attributes, and ways of working on target companies, often result in significant mismatches that adversely affect successful combination of actions and creation of synergies. Bo;man Deal
The senior management of Dairy Crest will have to be careful in managing the structure of the target company as well as in dealing with the HR issues, political implications and cultural traits of Cranswick plc. Dairy Crest managers will have to adopt the best of working processes and organisational features of both companies and try to build a collaborative and cooperative environment in order to achieve the potential merger benefits. The creation of a new organisational culture that gives appropriate respect to Cranswick employees and integrates them into Dairy Crest will help in achievement of merger benefits.
6. Market Response to Bid Announcement
It is reasonable to assume that markets respond to M & A announcements in line with the essential features of the relevant bids. Such responses are however hardly consistent and markets often respond with unpredictability. It has also been noticed that shareholders of target firms invariably benefit more than the shareholders of the acquiring companies.
Very few deals take place that end up making money for the shareholders of bidding companies. Markets consistently show that bidding firms end up losing money for their shareholders, or break even at the time of the bid announcement, even as target firms attract premiums that range from 20 to 40%. Stock prices very often rise above offer prices if competing bidders are anticipated. Coping ***It would thus be quite likely that fresh buying in Cranswick shares, after the bid, pushes its market price to around 1100 to 1200 P.
7. Conclusions
This assignment deals with the hypothetical takeover of Cranswick plc by the Dairy Crest group plc. Dairy Crest has grown over the years to become an integrated dairy business that is focused on 2 market-leading categories, namely foods and dairies. Cranswick is focused on the supply of fresh and processed pork items to the food retail, manufacturing and service categories of the UK.
The mergers of these two businesses will provide substantial opportunities to both companies to approach each other's customers, engage in cross-selling and achieve joint turnovers that could be significantly higher than the turnovers of their individual organisations. With the products of the two companies not being similar or identical in any way, even though they belong to the same sector, it should be possible for Dairy Crest to achieve very significant increases in turnover if it manages to acquire Cranswick plc. Dairy Crest and Cranswick can also achieve multiple synergies in other marketing related functions like supply chain management, stocking of finished products, transportation, distribution and retailing.
Valuation exercises reveal that it would be advisable for Dairy Crest to bid for complete control of Cranswick plc at an offer price of 1600 P. Satisfaction of value should be made through the issuance of Dairy Crest shares to Cranswick shareholders in appropriately calculated ratios.
Cranswick shareholders should welcome the bid by Dairy Crest. Dairy Crest shareholders should benefit significantly from the proposed acquisition of Cranswick plc. History however reveals that many such mergers, which started off with the most optimistic of projections, culminated in terrible failures. Experts state that the success of mergers and acquisitions of two different organisations depend upon four important factors, namely (a) organisational structures, (b) complementarities in HR policies, (c) management of political issues and (d) creation of a cohesive organisational culture.
Dairy Crest managers will have to build a collaborative and cooperative environment in order to achieve the potential merger benefits. The creation of a new organisational culture that gives appropriate respect to ex-Cranswick employees and integrates them into Dairy Crest will help in achievement of merger benefits.
