Advanced Financial Management

Profit for the year (already net of tax & interest)

+ depreciation, amortisation etc (non cash)

- asset expenditure

-increase/+ decrease in WC

+new debt raised

-debt repayments

= FCFE

• CF available only to Equity investors
• calculated AFTER financing decisions
  • Equity shareholders get what is left after
    • interest is paid
    • debt is repaid
    • new debt is raised
• discount with ke cost of equity

Operating Profits

- Tax & / Interest

+ depreciation etc (non cash CF)

-increase/+ decrease in WC

-/+ asset expenditure

= FCFF

• calculates CF available to all investors
• pre interest
• pre financing decision
• use WACC for discounting

FCFF - debt = FCFE

• valuation shouldbe based on future, but forecasting CF is very subjective due to the uncertainty associated with high-growth start ups
• in practice, multiples of proxy's are used. but the proxy might be under or over valued or a suitable proxy may not exist as start-ups tend to be uniqie

1. Revenue Synergies
   1. monopoly power enabling price increases
   2. cross-selling opportunities
   3. surpulus assets can be sold off & reinvested
   4. cash - buy company with surplus cash to reinvest
2. Cost Synergies
   1. economies of scale
   2. economies of vertical integration - remove middle man
   3. economies of investment - use of shared PPE
   4. economies of Mgmt
   5. skills transfer
3. Financial Synergies
   1. Reduction in variability of cash flows - more stable CF might reduce borrowing costs and achieve a better credit rating. plus the stability reduces risk
   2. Tax losses - reduced tax by acquiring a company with tax losses
   3. tax shield - acquiring a company with lower gearing to gear up and benefit from the tax shield on debt interest
   4. internal hedging of interest rate & FX rsk - companies might have opposite positions regarding fixed/variable debt and assets/liabilities in foreign currencies

• acquisition decision was based on incomplete or incorrect information
• unexpected costs & problems exist when combining different organisational strucftures/cultures/managerial styles
• managers are not given suitable incentives to achieve maximum synergies

Important

• diversification by a company can only reduce unsystematic risk. but if shareholders have balanced portfolios they have removed unsystematic risks and are only concerned about systematic risks which canot be diversified away. (depends if companies are listed or not, private shareholders might not be diversified)
• usually an average P/E weighted by the two companies' earnings would be used

where a company joins a public market without the issue of any new shares or any marketing of existing shares

• suits a company which has already raised capital through other means and has a broad shareholder base
• private shareholders sell their shares to the public
• no new capital is raised through the listing

Reasons

1. To provide liquidity to all existing shareholders by allowing them to sell their shares freely.
2. To avoid dilution of EPS (because there are no new shares).
3. To conduct market-driven pricing (rather than a fixed price range negotiated beforehand for an IPO).
4. To provide access to all buyers. Any investor can buy as many shares as they want in the market.

an auction in which the lowest price necessary to sell the entire offering becomes the price at which all securities offered are sold.

A reverse takeover (RTO) is a method used by private companies to become publicly listed without resorting to an IPO:

• The private company first buys enough shares to control a publicly listed company.
• The public company then buys the private company’s shares from the existing private company shareholders. It pays for these shares using a new issue of shares in the public company. The private company becomes a subsidiary of the public company.

Type 1

• does neither disturb business risk nor financial risk (no additional external financing required)
• CF models: DVM, FCFF, FCFE
• use acquiring companies WACC for discounting
• if using FCFF, remember that only shares are bought not debt

Type 2

• only disturbs Financial risk
• APV model
• use predators asset beta to find cost of equity ungeared. use this to discount the targets forecasting op. CF
• APV = total value of company. deduct market value of target's debt to arrrive at equity

Tpye 3

• Disturbs business risk (& potentially financial risk)
• if value of debt after acquisition is known:
  • the asset betas and cash flows in each business to arrive at two “base case” values; or
  • a weighted average asset beta, using the proportion of the new company in each of the two businesses.
• if D/E ratio after acquisition is known: Weighted average asset beta can be regeared to find adjusted WACC

Bidder

• Advantages
  • quick transactio
  • no dillution of ownership/control
• Disadvantages
  • may deplete cash reserves

Target

• Advantages
  • immediate liquidity to shareholders
• Disadvantages
  • no upside potential in any future grwoth

Bidder

• Advantages
  • preserves cash for other uses
  • may achieve better acquisition terms if target's shareholders want ownership
• Disadvantage
  • wider share ownership dilutes control/Voting power
  • dilution of EPS

Target

• Advantages
  • ownership stake to share in future growth
• Disadvantages
  • share value is uncertain

Bidder

• Advantages
  • preserves cash
  • does not dilute ownership/control
• Disadvantages
  • increased gearing, affects credit rating & financial flexibility
  • higher financial risk profile

Target

• Advantage
  • fixed income stream & predictable returns
• Disadvantage
  • loss of potential upside in growth potential
  • increased debt exposure if bidder's creditworthiness is a concern

Bidder

• Advantage
  • preserves cash
  • lower IR compared to traditional bonds
  • equity issue may be delayed
• Disadvantage
  • increases gearing
  • dilution on conversion to equity

Target

• provides opportunity to benefit from the potential future growth
• offers a potential hedge against downside risk

• minimise cash reserves to appear less financially robust
• hold strategic cross-shareholdings with companies whose shareholders can resist hostile takeovers
• poison pills: dilute the acquirers interest and increase the cost of the bid
  • It usually allows existing shareholders to buy additional shares at a heavy discount
• golden parachute: fives mgmt the right to leave with substantial cash bonuses or share options if the business is taken over
• crown jewel: selling off the company's assets that make it attractive to predators
• fat man: issuing new shares to a friendly third party, diluting the share value

• over optimistic assessment of potential economies of scale
• missalignment in ideas of new organisation's future (culture, value etc)
• insufficient appreciation of problems of the mergers e.g. personell and communication
• problems of determining value & terms of the offer
• incompatibility of systems/processes
• incompatibility due to different strategies, business models, different values etc

• M&A acquisitions tends to be driven by the availability of cheap credit
• investment banks earn fees from M&A transactions
• overconfidence in potential synergies
• confirmation bias - choosing the valuation model that appears to confirm the value they think the company has
• mgmt followinng goals of empire building instead of working in best interest of shareholders
• miscalculations of syntergies
• overconfidence in the ability to improve the targets performance

interest rates for secured/unsecured ultra-short term borrowing = theoretical minimum return for capital with zero credit risk

Difference between Zinssätzen langfristiger und kurzfristiger Staatsanleihen

Renditeaufschlag einer Risikobehafteten Anleihe gegenüber einer als sicher geltenden Anleihe mit gleicher Laufzeit

• when a company has large accumulated losses
• when net assets are below share capital (due to losses)
• when facing financial distress
• before raising new capital

Internal

• elimination of a debit balance on RE against share capital and non-distributable reserves
  • allows dividends to be paid soon & helps attract new equity finance

External

• affects the rights of creditors/other stakeholders

• Unbundling = unravelling of closely connected businesses (usually to focus on core business)
• divestment = sale of assets or businesses
  • MBO = purchase of company by existing management
  • MBI = external mgmt team purchases the business
  • IBO = institutional buyout = where an institution identifies a target company, arranges the finance and then approaches a potential mgmt team.
• demerger = splitting a company into two or more independent units and allocating shares in each new company to EXISTING shareholders
  • assumes that shareholder wealth can be increased by splitting the groups
  • indepentend managers might perform better than a single mgmt structure
  • conflict between existing divisions
  • costs are not offerinc economies of scale

• problem for mgmt team: only 1 potential target, but financiers will look at various options and vendor might have several potential purchasers
• mgmt team needs to strengthen position by stressing benefits of having an MBO and by having alternative courses of actions
  • greater autonomy
  • potential for significant wealth creation
  • strong information advantage of management
  • motivated leadership = skin in the game
  • clean disposal
  • strategic focus

• ream brings fresh expertise, agressive growth strategies & higher capital backing
• competitive pressure

• exit route
  • enables investors to ralise their investment
• immediate source of long-term capital for the business
  • issue shares and obtain capital
• ongoing source of capital
  • shares can be issued in the future
• share-for-share acquisitions
  • more options
• raised profile
  • will give company more credibility with potential customers
• share incentive schemes
• personal factors - prestige

• Time & Cost spent preparing for flotation - lengthy procedure with significant amount of effort
• cost of flotation - expensive and involves cost to advisors, stock exchange etc
• ongoing costs of maintaining a listing - fees to be paid & significant time spent on communication with investors

• Satisfying the needs of external shareholders
  • pressure to achieve short-term results may damage long-term developments
• accountability
  • requirement of non-executive board members
• lack of privacy
• risk of takeover
• different culture
  • culture will likely change because the directors will be answerable to outside shareholders
• tax planning for investors

• mind. 3 years of audited, unqualified published accounts under the same mgmt
• minimum free float of 700'000
• 25% in public ownership

• Offer for subscription = sale of shares directly to public
• Offer for Sale = shares are sold to intermediary who sells to general public
• Placing = new shares are sold to specific individuals
• Introduction = no new shares are issued, two companies agree to trade existing shares

Private equity finance

• buy private companies, actively manage them to improve performance and then list them/sell them

venture capital

• provide seed finance to start-ups. they dont always expect complete control

business angel

• individual venture capitalists

• Private investors might be prepared to take a more LT view than investors on stock market
• investors may have existing business interessts
• might demand a seat on board
• dilutes control

Advantage

• lower issue costs
• debtholder take less risks than shareholders
• interest is tax allowable
• no dilution of controls
• success/future benefits stays with existing shareholders

Disadvantage

• only available in limited quantities
• leads to financial risks for shareholders
• risk of insolvency
• covenants may limit the company's flexibility
• lower credit rating

• Aggregation - small deposits from individual investors are combined and lent to large borrowers
• Maturity Transformation - continuous stream of ST deposits can be used to provide LT loans
• Risks of many borrowers spread across many lenders
• providing a liquid market with flexibility and a choived for lenders and borrowers
• providing products and services for hedging risk

OTC neogitable financial instruments w. maturities <1 year

• Borrowing facility associated with a current account
• liquidity fallback of choife for SME
• flexible terms of borrowing & paymens
• can be established quickly
• can be withdrawn on demand
• not suitable for long term finance