The primary motive behind a merger is the creation of synergy which means creating a value much larger than the value of two companies combined. If a company is worth 100 million and another company is worth 50 million there combined value would be 150 million and if they merge they could increase the value to 170 million and this would be the resulting synergy from a merger. This is the basic motive of a merger where the two companies can not only increase their combined values but also take advantage of individual benefits.
This synergy is based on the concept of one plus one equals three which entails that when two companies merge the combined value should be greater than the sum of their individual values. If this synergy is not achieved a merger is useless. The synergy from the mergers should be higher with a fact that the merger should also include added individual benefits for each merging company as well.
When British Airways and Qantas merge the companies would not only benefit individually but the combined strength and value of the two companies would enable the new merged organisation to take advantage of monopolistic conditions. When two companies merge or when one company is acquired by another company the competition between these two companies is basically eliminated and individual efforts of the management of both companies now combine to achieve a common goal or objective.
When a company merges with or acquires another company the amount paid in exchange of the target company’s shares or assets is usually higher than the book value which creates a new asset in the form of goodwill which automatically increases the total value of the newly formed organisation after the merger. This would result in a synergy higher than the sum of values of as British Airways and Qantas when estimated individually.
The two companies would benefit in a variety of ways including cost cutting as both British Airways and Qantas could utilise and take advantage of each company’s resources. The most important aspect of merger the companies can benefit from is the cost efficiency which will be achieved through economies of scale. The concept of economies of scale is based on the theory that the larger the size of an organisation the lower will be the average cost per unit.
Each of the two companies would have an advantage of geographical presence after the completion of merger. When the merger is completed there would be lower competition in the market and the newly formed entity would be quite large and it would be difficult for other organisations and airlines to compete. The two companies would bring the technical expertise, experience and amply trained human resource and key employees to the new organisation.
The grouping of expert human resources from both companies would enhance the decision making and management process. British Airways and Qantas both are competitors before the merger and have a different set of customers and percentage of the market share. Through merging both companies can not only take advantage of each other’s customers but the market share of the newly formed organisation would also be quite high. The company created as a result of the merger would not only have greater value but would benefit the two companies as well.
Due Diligence Process
The process companies go through before mergers and acquisitions to verify that the information about the merging or target company is disclosed properly in the financial statements and all other information related to the companies is fair and appropriate is the due diligence process. The financial statements of merging companies or the target company are scrutinised and evaluated thoroughly by individuals from both the acquiring company and the target company.
These financial statements are analysed to evaluate the accuracy of the data presented in them and all assumptions, standards, concepts and techniques used in preparing these statements are appropriate and accurate. The due diligence process provides a clear and relevant position of the target company to the management of the acquiring company with respect to the actual stability, growth and transparency of business operations (Galpin and Herndon).
The due diligence process in a merger involves four phases which start with the identification phase where relevant information is gathered and levels of risks are analysed, the second phase is the analysis of loss runs where current and previous legal proceedings are analysed, the third phase involves the synopsis and interpretation of data gathered during the previous phases and the fourth and final phase of the due diligence process entails post acquisition activities where business operations, policies and procedures are unified and standardised by analysing business and administrative activities in various departments of the merging organisations (Howson).
The due diligence process in acquisition of Qantas Airlines by British Airways will be performed by analysing the various aspects of business operations in Qantas Airlines. The due diligence process will be divided into five different areas which are described below.
The company information and analysis of its overall standing will be performed through the following documents and procedures
- Article of association and memorandum and any changes
- A report of corporate policies and procedures implemented in the company
- The description of proceedings and minutes of board meetings held in the previous five years of operation
- A schedule showing details of members of the board of directors, executive committees, department heads and key employees
- A schedule of shareholders indicating the pattern of ownership and total number of shareholders
- A report indicating various locations of business operations of the company throughout the world
- Organisational chart of the company
Financial Information Including Assets
The financial position and information of the Qantas Airlines will be ascertained through the following documents and procedures
- Annual reports of three previous years including the audit report and audited financial statements
- Financial statements of recent quarter or period
- Credit rating and standing of the company
- Research analysis reports based on company’s financial statements
- A report indicating the internal control mechanism implemented in the company
- A list of all current and noncurrent liabilities
- Inventory and inventory class schedule of the current year
- A complete set of receivables with customer information and credit standing
- A report indicating the procedures and methods followed for inventory management, receivables management, depreciation and amortisation for the past three years
- A comprehensive list of all noncurrent assets including details of purchase, sale, lease and exchange of such assets
- A report of various business locations of the company throughout the world with details of ownership, lease and rental agreements
- List of all intangible assets owned by the company with details of internal development, purchase and amortisation of such assets
- Evaluation of fixed, variable, direct and indirect expenses of the company
- A report presenting profit margin of the company in various seasons for the past five years
- Complete set of records of transactions with books and ledgers of the company
- A forecast of the financial statements and implementation of capital budgeting technique thereof
- The details of all taxes applicable to earnings of the company with subsections dealing with various international taxation issues
- Details of value added tax, payroll tax, excise tax and other relevant taxes of the company
Employee Structure and Employee Benefit Plans
- The employee structure and benefit plans will be analysed by utilising the following reports, agreements and schedules
- A schedule declaring the status of all full time and part time staff with remuneration packages and wage rates
- A schedule including number of employees with detailed relevant information regarding status and relationship with company
- Copies of all agreements, notices, policy statements and notices to employees
- A report indicating the benefit plans offered at various levels of employment and management
- A human resource report indicating all issues relating to employee conflicts and interest with each other and with the company
- A schedule showing the insurance, retirement and health plans of employees in various departments at various levels
- A list of all stock options, purchase and repurchase plans offered to employees
Contracts and Agreements
- The details of all the contracts and agreements of the company with third parties and customers will be analysed through the following material.
- A report including copies of all agreements related to partnerships, joint ventures and other corporate relationships
- A schedule showing agreements with banks and financial institutions regarding debt and loans
- Copies of all agreements regarding leases, mortgages, pledges and indentures
- A schedule of agreements relating to customer services and travelling issues
- A list of agreements with directors, employees, sales personnel and agents
Legal and Environmental Issues
- The last area of the due diligence process covers the analysis of legal and environmental issues of the target company.
- A report indicating pending lawsuits by the company and against the company
- A report indicating all previous lawsuits against the company and outcome of these litigations
- A schedule presenting any risks of litigation in specific areas of service, operations and business
- List of environment audits performed till date
- A schedule of permits and licences related to environment
- A report on company’s policy towards conservation of environment
- A report indicating the impact of company’s services and products on the environment and measures taken by the company to limit this impact
Price and Form of Payment for Acquisition
The acquisition of Qantas Airlines by British Airways will be an all cash deal where shareholders of Qantas Airlines will be paid cash for each share purchased by the company. The valuation and pricing of shares will be performed through the discounted cash flow technique. The discounted cash flow technique is one of the most popular techniques to evaluate mergers and acquisitions and involves the discounting of expected cash flows the target company will deliver to the acquirer after acquisition. The expected cash flows are estimated by forecasting the financial statements of the target company for 3 to 10 years depending on volatility of the target company (Rock, Rock and Sikora).
The actual and forecasted financial statements of the company have been included as Appendix 1 in this article. The forecasted income statement and balance sheet have been prepared with common size financial statements concept and a growth rate of 3 percent has been applied to the income statements of the company and a growth rate of -2.5 has been applied to the balance sheets. These growth rates have been estimated on the historical year-to-year growth rates of both statements.
The cash flow statement of the company has been forecasted using the Compound Annual Growth Rate – CAGR concept where the growth rate of each component of the cash flow statement has been estimated individually. The three year forecasted cash flows of the company have been discounted with a factor of 10.5 percent which is the weighted average cost of capital of the company as indicated in its annual report (Qantas).
|Year||Free Cash Flows||Discount Rate||Discounted Cash Flow|
|Present Value of Cash Flows||3132.32|
|Number of Shares Outstanding||1929.1|
|Discounted Cash Flow Per Share||AUD 1.62|
Table 1 Discounted Cash Flows.
The price of a single share of Qantas airlines as calculated by the discounted cash flow technique is AUD 1.62. This value was derived by discounting the forecasted cash flows of the company with a factor of 10.5 percent and dividing the present value of cash flows with the outstanding shares which are 1929.1 million in total. The share price calculated for the merger is lower than the share price of the corporation trading on the Australian Securities Exchange. The last traded price for Qantas was AUD 2.78 which is AUD 1.16 higher than the price calculated for acquisition (Australian Securities Exchange). This means that the calculated share price is undervalued and makes the acquisition of Qantas more attractive for British Airways.
Review of Estimated Value with Market Multiple
The market multiple or P/E ratio is a good indicator of a company’s share value and earnings. It shows the relationship between the market price and earnings per share of a company. The P/E ratio based on the actual earnings per share and market price of shares is compared with the forecasted earnings per share and price per share. The actual earnings per share have been obtained from the financial statements included in the annual report of the company (Qantas).
The current market price per share of AUD 2.78 has been obtained from the Australian Securities Exchange website (Australian Securities Exchange). The table below indicates that the P/E ratio obtained from actual values is quite higher than the P/E ratio based on forecasted values. This indicates that though the share price estimated for the merger is quite lower than the current market price the P/E ratio is also lower as the estimated average earnings per share for the next three years are also quite low.
|Comparison of P/E Ratio|
|Price per Share||2.78||1.16|
Table 2 Comparison of P/E Ratios.
The main objective of this report is to provide a recommendation and acceptance or rejection of loan application of Debenhams. The acceptance and rejection of a loan for a company is based on the historical stability and ability to meet previous and current obligations. The financial strength of a company is based on the liquidity, profitability and ability to generate future cash flows. The profitability of a company is quite important in considering a debt agreement and loan application but high profitability does not necessarily indicate that the company will in fact be able to meet its short term and long term obligations. In order to evaluate a debt offering the liquidity and cash generation ability of the company provide a more vivid picture of repayment of loan including both the principal amount and the interest.
The loan applied by Debenhams will be evaluated through the analysis of the financial statements of the company for the past three years with an evaluation of the forecasted cash flow statements of the company. The following sections cover various methods and assumptions implemented in the analysis of financial statements and forecasting of cash flows for next three years. The loan conditions including the interest rate, the justification of interest rate and the schedule of repayment are also discussed with reference to probable actions in case of default and non payment by the company.
As the loan to Debenhams is a securitised transaction the details of the securities required for granting the loan are presented with an exit strategy for the financial institution in case of default and non payment by Debenhams. The eventual recommendation and acceptance or rejection of the loan application is provided at the end of this report after careful analysis and evaluation of all sections of the debt agreement.
Assumptions and Methods of Forecasting
The three year financial statements of Debenhams including forecasted cash flow statements of Debenhams are presented as Appendix 2 of this report. The financial statements of the company have been obtained from the annual reports of the company. The financial statements provided here and used for appraisal of loan application include the income statement, balance sheet and statement of cash flows. The forecasting process has been applied only to the statement of cash flows of the company as the statement would be the most relevant source of information regarding the ability of the company to meet future short term and long term obligations.
The historical financial statements of the company will be used for ratio analysis regarding the debt management and liquidity of the company. The liquidity and debt management ratios are calculated and analysed for three previous fiscal years and provide an insight into the company’s future outlook regarding stability and liquidity. The statements of cash flows for the next three years have been forecasted based on several assumptions.
The basic assumption applied in the forecasting process is that the company will continue its policies regarding the inflows and outflows in various areas. The methodology applied in forecasting involves the Cumulative Annual Growth Rate – CAGR method where all major components of cash flows have been forecasted by applying CAGR. The components of cash flows where inflows and outflows are of an individual nature and have a low probability of being repeated in the future have not been included in the forecasted statements to avoid any ambiguity and complication.
Debenhams has applied for a £50 million long term loan payable in a period of 3 years. The current interest rates of the company on long term loans and borrowings fall between 6.30 and 6.50 percent and the total amount of long term loans of the company in various forms amounts to approximately £1,036 million (Debenhams). Considering the deteriorating financial conditions throughout the world and lower availability of credit has pushed interest rates on long term loans much higher than previous levels.
The recommendation for interest rate to be implemented on the loan facility to Debenhams is 7 percent which is higher than the company’s current interest rates due to increased risks and declining sales and inflows of the company. The clauses of the loan agreement will include the description of assets or securities being provided by the company in case of default of payments and Debenhams will be required to improve its liquidity management issues in the earlier years of the loan. The loan of £50 million is scheduled to be returned in 3 years and the repayment schedule is provided in the loan amortisation schedule below.
|Year||Beginning Balance||Payment||Interest||Principal||Remaining Balance|
|£ million||£ million||£ million||£ million||£ million|
Table 3 Amortisation Schedule.
Ratio and Cash Flow Analysis
The ratio analysis of three previous financial statements of Debenhams as indicated in the table below indicates that the current ratio and quick ratio of the company are neither too good nor too poor and the company is able to manage its cash flows in a stable manner as the current and quick ratio for three years do not show a significant change and the company is in a position to pay off its short term obligations as current liabilities and interest expense in an effective manner but the company can improve these ratios in future years. The debt management ratios on the other hand are better than the liquidity ratios as the debt ratio is close to 1 which means that Debenhams is quite effectively balancing its assets and liabilities.
The short term and long term liabilities of the company can be met by selling of its assets if the company is unable to pay its dues and defaults on loans. The most interesting ratio is interest coverage or times interest earned ratio as it indicates how efficiently the company is managing its operating income to pay interest expenses. The interest coverage ratio for Debenhams indicates that the company is managing interest expense at a rate of 1.37, 2.60 and 2.41 times in 2006, 2007 and 2008 respectively. The growth in this ratio indicates that the company is increasing its efficiency in covering interest expenses which is a good sign for creditors and financial institutions.
|Interest Coverage Ratio||1.37||2.60||2.41|
Table 4 Ratio Analysis.
The forecasted cash flow statements included in Appendix 2 of this report indicate that the company will be able to generate £219.23, 221.06 and 217.98 million from operations in the years 2009, 2010 and 2011 respectively. The net increase or decrease in cash flows of Debenhams in 2009, 2010 and 2011 is expected to be £93.74, (106.89) and 121.89 million respectively. This indicates that though the company may face some problems in 2010 the overall stability in cash flows is quite healthy. If the company manages to keep the net change in cash flows at a positive level it would have no problem in meeting the yearly payments of the loan.
Securities Required for Loan
The loan application for Debenhams is reviewed with a condition that the company will provide some assets or securities for mortgage or pledge as a safety precaution to the loan and these assets or securities will be kept with the financing institution until the whole amount of loan has been paid off. In case of securities the financial institution will gradually decrease the number of securities held with yearly payment of the loan. The clauses of loan agreement with Debenhams allow the financing institution to sell of the assets or securities in case of default by the company and pursue any litigation against Debenhams for damage claims. The securities required for the loan will have a market value of 80 percent of the total amount of the loan which is £80 million at the time of debt agreement.
Exit Strategy in Case of Default
The financial institution will hold securities or assets of Debenhams during the course of the loan and in case of default by the company the financial institution can sell off these securities or assets to recover any amount due from Debenhams. If the amount of principal and interest are not fully recovered from the sale of assets or securities the financial institution will further pursue litigation against the company to claim for any remaining balances and damages to the financial institution. These assets or securities will be held by the financial institution during the course of loan repayment and the institution may gradually decrease and return the amount if these securities with subsequent yearly repayments from Debenhams.
The application for a 3 year loan of £50 million from Debenhams will be approved and recommended with specific clauses related to the repayment and security of loan. Debenhams will be required to improve its liquidity ratios in the earlier years of loan repayment period and will mortgage or pledge assets and securities with the financial institution to receive the amount of the loan. Debenhams will be responsible for repaying the interest and principal amount due each year without any delays and failure in repayment or default will result in sale of the mortgaged assets and litigation against the company. The overall financial position and outlook of the company indicate no specific dangers in approving the required amount and would be quite beneficial on a long term basis for the financial institution.
Analysis of Journal Article
Summary of Article
The article under review deals with the basic concept of Activity Based Costing – ABC and provides a practical approach to the successfulness of ABC. The article selected for review is entitled “Is ABC Adoption a Success in Australia?” and is based on a research involving the implementation of ABC costing in Australian organisations. The research carried out in the article is based on survey questionnaires sent to various organisations in Australia with review and analysis of relevant academic and professional literature. The article deals with two basic areas of ABC implementation and success. The research carried out in this article is substantial in that a similar research has not been carried out involving the success of ABC implementation in Australian organisations.
The first part of the article covers the implementation rates of ABC throughout the world including the United Kingdom, New Zealand, United States of America and Canada. The implementation rates of ABC in Australian organisations are discussed separately and researched thoroughly and it was found that implementation rates in Australia were lower than implementation rates in other parts of the world. The research shows that causes of low implementation rates have not been studied thoroughly and there is much room for research in this area. The researchers feel that one reason for low application rates of ABC may be that the managers of organisations do not view the implementation as a successful technique.
The second and main part of the research study involves the successfulness of ABC implementation in Australian companies. The article starts off by explaining the various criteria and interpretation of success regarding ABC costing. Some views presented in the article present that success is based on increase in profits or overall value of the firm and that success is based on the appliers of ABC and the personnel involved with the implementation should gauge the success of implementation on their own interpretations of success.
The most relevant criterion for success adopted in the research is based on the level of satisfaction and attitudes derived from implementation of a system. This theory entails that if the implementation of a system such as ABC increases the level of satisfaction and improves attitudes then it is deemed to be successful.
The article identifies the six stages during the implementation of ABC as initiation, adoption, adaptation, acceptance, routinisation and integration. The combination of last two stages of implementation has been termed as a mature stage and the research carried out in the article is based on the mature stage only to provide a clear picture of successfulness of implementation of ABC in organisations. The study of successfulness has been carried out with respect to only a single phase of implementation and not all stages of ABC as the analysis of all stages would yield varying results even within a similar organisation at different phases of implementation.
The successfulness of ABC implementation in Australian firms has been carried out focusing on four main areas of success which include the positive attitudes personnel demonstrate in implementation of ABC, a general perception among managers that information obtained by ABC system is better and superior than conventional cost accounting systems, managers and employees feel that implementation of ABC improves performance as compared to traditional cost accounting systems and that the implementation of ABC system improves and enhances organisational processes and functions.
These four areas of success are covered through research questions and form the foundation for the research with respect to survey during the research. The overall results of the survey conducted by researchers indicate that the level of success in implementation of ABC is in fact reflected by the satisfaction and positive attitudes of the individuals implementing ABC in an organisation (Byrne, Stower and Torry).
Relevance with Subject Matter
The concept of Activity Based Costing is defined and explained in the book thoroughly and comprehensively. The basic idea of Activity Based Costing is discussed in the book with theoretical aspects and a practical approach though present as examples is quite insufficient to understand the practical application of Activity Based Costing system in companies. The book provides the overall methodology and process of implementing Activity Based Costing in companies and the article under review presents the practical implication and usefulness of Activity Based Costing in companies. The subject matter in the book focuses on the basic concept and techniques involved with Activity Based Costing whereas the article relates this theory with practical application of the cost system in companies.
The conceptual framework presented in the book is practically applied by the research carried out for the article and its usefulness is tested by the researchers in Australian firms at the final stage of implementation. The basic ideology and system of Activity Based Costing is presented in the book whereas this idea is carried further by the researchers in the article as they test the rate of application and successfulness of Activity Based Costing as compared to conventional costing systems. The book explains the various stages of Activity Based Costing with respect to cost identification and allocation whereas the article presents the rate of success in these stages rather than explaining the methodology and techniques involves in these stages
Agreement with Subject Matter
The ideas presented in the article are quite relevant to the methodology of costing systems resented in the book. The book puts forth an idea that Activity Based Costing is quite useful and important in manufacturing companies and increases the process and manufacturing efficiency of companies. The article on the other hand does not present this idea but provides a practical approach in verifying the successfulness of Activity Based Costing by testing its application in Australian firms. The book presents a basic concept of Activity Based Costing as a system and its rate of success is not thoroughly discussed. The authors of the book explain that Activity Based Costing increase the efficiency in organisations and is useful in identifying the various cost pools and cost drivers of the overall manufacturing process.
The article on the other hand does not explain the basic concept and methodology of Activity Based Costing System but it does agree with the concept that Activity Based Costing systems are quite useful in increasing the efficiency of overall manufacturing process. This agreement is not merely based on assumptions but the article implies the level of success in implementing Activity Based Accounting Systems by analysing the application of ABC in Australian firms. It can be seen that the article overall agrees with the basic concepts of Activity Based Costing system and reaffirms the fact it is quite successful than traditional systems of cost accounting.
Additional Information Acquired
The article presents various criteria for evaluating success and the complexities involved with measuring level of success. The main theme of the research presents that the best technique of evaluating success in implementing a system is to analyse the level of satisfaction derived after implementing the system and the change in attitudes of individuals after implementation and application. A theory presented in the article explains that it is difficult to analyse the rate of success when there are various stages involved in implementation of a system therefore in order to determine accurate levels of success only one stage of implementation should be analysed.
The article identifies the level of success in implementing ABC system in Australian firms which has not been analysed thoroughly in previous researches. The research performed for the article provides a comprehensive understanding of the rate of ABC implementation in Australian organisations and the level of success of this implementation.
It is generally thought that the level of success of a system can be evaluated through the cost-benefit analysis of that system or the amount that system generates or saves for the company. The article presents a fresh perspective in this area and explains that the level and rate of success can be evaluates through four variables other than monetary values.
The four scales of measuring success in implementation of Activity Based Costing systems include the display of positive attitudes by managers and employees after implementation, the perception of employees and personnel that the information they derive from ABC systems is much better than the information obtained from conventional costing systems, managers and employee also believe or are of the view that the implementation of ABC systems actually increases their performance and the last view managers have regarding ABC systems is that the implementation improves the overall business and manufacturing processes in an organisation.
Requirement of Experience in Management Accounting
The basic concept covered in the article and the corresponding area in the book is related to Activity Base Costing systems. The concept of Activity Based Costing is not new and a lot of research and study has been performed in this area in the last 20 years and much research is being done currently as well. The requirement of prior experience and knowledge regarding ABC is not necessary in understanding the basic concepts of ABC as the subject matter in the book are quite extensive in explaining the concepts of ABC costing.
Prior experience and knowledge is necessary on the other hand if a person is directly studying the article under review as it does not provide a comprehensive theory for the concept and focuses on success in implementation of ABC. In order to understand and comprehend this article completely an effectively a person with no management accounting experience and knowledge would be advised to study the concept of cost accounting and the various systems that can be applied in the costing of products, process and departments of a company. The theories and concepts presented in the article can only be understood only after the basic concept of ABC is known and understood completely.
The review of selected article as a whole and the analysis of various theories presented in the article imply that the level of success in adopting ABC system is difficult to measure if all stages of system implementation are evaluated at once. In order to deal with this situation the research carried out for the article only focused on the last two stages of implementation and combined these stages to form a mature stage of the implementation process.
The researchers analysed the change in attitudes and the perception of employees with respect to the mature stage of ABC implementation. The main conclusion derived from the analysis of the article indicates that the rate of ABC implementation is quite low in Australian firms and is quite successful in firms where it is implemented. The research carried out in the article focused only the mature stage of implementation and further research can be carried out in the post implementation phase to evaluate the level of success after the ABC system has been completely implemented and adapted by the organisation.
Australian Securities Exchange. Detailed Search – Prices, Charts and Announcements. 2009. Web.
British Airways. Annual Report. Annual Report. Harmondsworth: British Airways, 2009.
Byrne, S., E. Stower and P. Torry. “Is ABC Adoption a Success in Australia?” Journal of Applied Management Accounting Research 7 (2009): 37-52.
Debenhams. Annual Report. Annual Report. London: Debenhams, 2008.
Galpin, T. J. and M. Herndon. The Complete Guide to Mergers and Acquisitions: Process Tools to Support M&A Integration at Every Level. New Jersey: John Wiley and Sons, Inc., 2007.
Howson, P. Due diligence: The Critical Stage in Mergers and Acquisitions. Aldershot: Gower Publishing, Ltd., 2003.
Qantas. Annual Report. Annual Report. Mascot: Qantas, 2008.
Rock, M. L., R. H. Rock and M. J. Sikora. The Mergers & Acquisitions Handbook. New York: McGraw-Hill Professional, 1993.