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Landmark
Solutions
Facility
Case Analysis
The case presents us with the basic problem that many
firms are faced with - Do we acquire another company
and if so what should we pay for it and how should we
structure the new firm?
SUBRATA BASAK (MP15043)
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Financial Management II
Executive Summary
Landmark Facility Solutions presents a situation in which a medium-sized facility
management company assesses whether to acquire a larger facility management
company that is known for its high-quality services and technical expertise. The
acquirer believes the acquisition will help it to become an integrated facility manager
and enter new industries in its home market. The case focuses on valuing the
acquisition opportunity and choosing the right financing for the transaction. It explores
the interaction between corporate investment and financing, and sets the stage for
discussions about capital structure decisions.
Introduction
Broadway, located in USA, was formed by Mr. Harris in 1992. Broadway is providing
facility services like janitorial services, floor and carpet maintenance services and
building maintenance services. In last few years, Broadway has been seeking
significant growth and has spread its operations to other countries like New England
and Florida by providing additional services like educational and industrial services.
The CEO and president of the Broadway aim to spread its operations in addition to
facility support services to building engineering and energy solution. For this purpose,
CEO and President of the Broadway industries are considering acquiring the Landmark
facility solutions.
Landmark facility is specialized in providing commercial building, engineering and
energy solution services. It was found in 1954 and it has significant brand recognition
throughout USA and due to its strong brand recognition, Landmark is capable to
charge premium prices. Instead of charging premium prices, Landmark is currently
facing the problem of reduction in operating profit.
The current financial position of Landmark encourages Mr. Harris to acquire Landmark
because it is expected that the acquisition of Landmark will satisfy the strategic needs
of the Broadway in order to expand its services. However, the management of
Broadway suggested that the current demanding consideration from the Landmark is
high and the expected benefits from the acquisition will not justify the purchasing cost.
In addition to this, Mr. Harris is considering the financing of the acquisition because
currently Broadway has two available options and it is identifying which one is suitable
if the acquisition process may proceed.
Problem Statement
1. Does Broadway benefit from acquiring Landmark? If so how and based upon
what? Can the $120 mil bid be justified and if so what justifies or does not
justify the bid?
2. If Broadway proceeds with the acquisition which financing alternatives
should be chosen, and why? How Broadway would be servicing its debt after
the acquisition.
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Financial Management II
3. How do the two financing methods affect the value of the acquisition to
existing shareholders of Broadway?
4. Does Broadway reduce shareholder value if it selects the mix of debt and
equity financing alternative? What is the cost of equity dilution?
5. What will be the cost of capital and how the cost of capital will be impacted
by the various financing options?
6. What is the value of the acquisition to Broadway under both expected and
pessimistic scenarios?
Financial Management II
which clearly supports the stance that Broadway is getting benefits by acquiring
Landmark.
Broadway has two options available in order to finance the acquisition. The first option
is debt and the other is combination of debt and equity. Currently, Broadway has 50%
debt in its capital structure and this means that the option of debt could be exercised
however, it will increase its debt ratio more than 100% and choosing the other option
will increase the debt ratio too approximately 81%.However,it is expected that
financing through other option will dilute the wealth of the shareholders as it will give
40%holding to investors, which means they are getting more than they have
invested..
If Harris were to proceed with the acquisition, which financing alternative
should be chosen and why? Would Broadway be capable of servicing its debt
after the acquisition?
The valuation of the acquisition opportunity has been performed on the basis of both
the scenarios. Looking at the valuations of the Landmark Company, it could be seen
that the alternative 2 of financing which is going for 50% debt and 50% equity is the
best financing alternative for the company. The firm value under this financing
alternative is highest and significantly high with a cost of capital of 4.67% under this
alternative. Moreover, funding the entire acquisition by 100% of debt might prove to
be risky for the company in future; therefore, the best financing alternative for the
management is to basically go ahead with a mix of debt and equity financing.
In order to determine that whether Broadway would be able to service its debt
or not, first of all the operating income and the free cash flows for the Broadway
company have been calculated on the basis of the optimistic and the pessimistic
assumptions for both the financing alternatives. The relative interest payments under
both the financing alternatives have also been calculated based upon the structures of
the $ 120 million and $ 60 million loans under alternative 1 and 2. Moreover, the
interest coverage ratio and the free cash flow over interest expense ratios have been
calculated.
The average interest coverage ratio and the FCF/Interest expense ratio for first
financing alternative under the best case and worst case scenario for Broadway would
be (2.16, 1.4) and (1.64, 2.03) times. These ratios for both the financing alternatives
for optimistic and pessimistic case would be (3.61, 2.34) and (2.85, 3.63) times. Again
it could be seen that these ratios are much higher for the second financing alternative.
Nonetheless, debt has advantagesas it is much cheaper as compared to equity and
the reason for this is that the interest expenses on the debt are basically tax
deductible and this results in the increase of the firm value also. However, if the level
of debt increases beyond a certain optimal level then the firm is at risk. Therefore, the
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Financial Management II
best financing alternative for the company in order to fund this $ 120 million
acquisition opportunity is to seek 50% debt and 50% equity.
Does Harris give up shareholder value by opting for the mix of debt and
equity financing alternative? What is the relative cost of equity dilution?
If Harris opts for the mix of debt and equity financing, then he will be giving up on the
value of the shareholders. This is because if Harris had opted for 100% of debt for
financing this transaction, then the cost of equity of the equity holders would have
also increased significantly. However, now the debt would be 50% rather than 100%,
therefore, the cost of equity of the equity holders would be lower and in this way
Harris gives up on the value of the shareholders by opting for a mix of debt and equity
for the acquisition opportunity..
Conclusions
Cash
Guide:
1. Use the projections in Exhibit 3 to value Landmark as a
standalone firm. Perform a similar valuation for Broadway as a
standalone firm. For both companies, assume that free cash flows
grow at 4% after 2019. (Note that 2014 is year 0, so we discount
cash flows from 2015 onward to find the current value of the firms).
Please turn in your case as an Excel workbook. Your Excel file only
needs to have your DCF models; text explanations are not
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Financial Management II
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