GRADUATE SCHOOL OF BUSINESS

UNIVERSITI KEBANGSAAN
MALAYSIA

ZCZC6303: FINANCIAL MANAGEMENT

CASE STUDY OF CFC FOODS

CORPORATION

PREPARED BY:

MOHD FAHMI BIN ABD RAHIM

ZP00585
SHAMEEL ANUWAR BIN SAMSUDIN
ZP00582
NOORUL AMALINA BINTI MOHD DAUD
ZP00571
MOHAMAD ZAWAVI BIN MUDA
ZP00575
NOOR OSMERA BIN ABU HASSAN
ZP00601

MERGER: CFC FOODS and MMD FISHERIES CORP

Introduction

Merger can be defined as two companies combine to form a

single company. It refers to the aspect of corporate strategy, corporate
finance and management dealing with the buying, selling and
combining of different companies that can aid, finance, or help a
growing company in a given industry grow rapidly without having to
create another business entity.

From the fact of the case, both companies are in the same line of
business. CFC Foods Co is a highly diversified food processing company
with eleven processing plant and eight whole sale distributors while
MMD Fisheries Corp is a large processor of fish and other seafood
product. Based on this fact, both companies are said to have a
horizontal merger of which being defined when firm in the same line of
business merged.

The primary motive of the exercise is to acquire an improved

financial position. It will later extend and merge the operation of both
companies which in turn will give opportunity to reap of the economies
of scale and putting their assets into maximization of utilization. It is
also assumed that with the merger and the trend of people consuming
more fisheries product, the evolved company will be able to capture
higher market value and simultaneously increase its revenue. Synergy
of the company can also be achieved. With the merger, specialization
of activities can be done. The acquired MMD fisheries Corp can
concentrate and specialize only on the Fisheries division. This will give
other division or plantation to concentrate and specialize on other
frozen food or seafood production.

Analysis of Financial Statement

There are several conditions that have to be taken into
consideration in analyzing the merged data figure. Consolidated and
merged balance sheet is provided. Cash payment of twenty two million
five hundred thousand being paid as consideration. This is thirteen
times the value of MMD Corp as at 2003.

In constructing projection of revenue and cash flow of the

merged entities, several assumptions are being made. The first
assumption is the increase in revenue by seven percent. Being
conservative, although reduction of cast is expected as a result of a
merger, cost of sales remains constant as per ratio before the merger.
Similar assumption is being made for the operational expenses, as no
lay off personnel or management being expected. Income tax rate is
set at twenty five percent similar to Malaysian Tax rate.
Table 1: Forecast Revenue and Cash Flow
Forecast - Revenue and Cash Flow of
Merge Entity
2003 2004 2005 2006
Consolid Project Project Projec
ated ed ed ted
761,71
Net sales 621,783 665,308 711,879 1
613,59
Costs of sales 500,873 535,934 573,449 1
148,12
Gross Profit 120,910 129,374 138,430 0
Operational and general expenses 96,112 102,840 110,039 117,74
 1
Operating profit 24,798 26,534 28,391 30,379
Other Income 2,708 2,979 3,277 3,604
Interest Expense 2,666 2,666 2,666 2,666
Tax reduction charge due to
investment tax credit 358 0 0 0
Income before tax and gains on sale
of properties 24,482 26,847 29,002 31,317
Provision for income tax excluding
gains tax 12,611 6,712 7,250 7,829
Net Income after tax excluding
capital gains and tax 11,871 20,135 21,751 23,488
Capital gains net of tax (53) 0 0 0
Total net income 11,818 20,135 21,751 23,488
add: Depreciation 9,100 10,100 10,300
Operating Cash Flow 29,235 31,851 33,788
Less gross retention for growth 26,700 14,000 19,000
Less: Dividend 6,000 6,500 7,000
Less: Long Term debt 4,800 3,900 3,900
Free Cash Flow (8,265) 7,451 3,888
Minimum Working Cash balance 13,500 13,500 13,500
Additional Fund 21,765 6,049 9,612
Say - round up additional fund
needed 22,000 6,100 9,700
Data such as depreciation, payment of long term debt, gross
retention for growth and minimum working cash balance are given in
the article extracted in constructing the above table. From the table
above, in year 2004, it is expected that the company is having a
negative cash flow of over eight million, while additional fund of twenty
two million is being expected to be raised to cover its minimum
working cash balance.

As expected, in the next two years, the merged entity will benefit
from its operational efficiency where revenue increased and additional
fund needed to fund the minimum working cash balance reduced.
However, the management should be highlighted with the elements of
dividend payment shown on the table. They might want to consider
and study the idea of making dividend payment to shareholders. From
the table above, it shows that payment of dividend is quite significant
affecting the cash flow needed in their operation. Consideration has to
be made to concentrate first on ensuring stability by investing the fund
available for distribution to shareholders, to improve and finance its
operation. This will result in lower amount needed to be financed
through debt.

There are two methods of financing the minimum working cash

balance; through debt and stock financing. Here, assumption is being
made for CFC Co to finance its requirement by raising long term debts
alternatively, following their treasurer’s proposition of raising it
through equity of thirty million by issuance of common equity for forty
ringgit per share.

Tables below defined its projected balance sheet of merge entity

for both alternatives.

Table 2: Balance Sheet position with debt financing

 Balance Sheet
as at 31 Dec 2003
Cash
Accounts Receivable
Inventories
debt. From
Prepaid Expenses
Table above shows the impact of financing through long term
the article, the management should consider the

Total Current Assets

compliance requirement of which the merged company have to
comply. The first compliance check is that the company’s position of
the current ratio should not be less than two to one. From the above
table, with the injection of twenty two million in cash, the company’s
current ratio is being improved to three to one position. This will
enable CFC Co to cover its operational expansion. The position above
also shows that there are reductions in the tangible net growth and
short term compliance but still in a good health condition.

Plant & Equipment

 Table 3: Financing with common equity

Balance Sheet
as at 31 Dec 2003
Cash
Accounts Receivable
Inventories
Prepaid Expenses
Table 3 above shows results from financing it through common
stock. This in tandem with the proposal put through by the treasurer.

Total Current Assets

Thirty million are being raised for a forty ringgit per share. All
compliance requirements are being fulfilled. Attached is the summary
of the two methods.

Table 4: Summary of compliance

Compliance
Plant & Equipment ch
Less: Depreciation
 The current ratio of the merged company just comply the
requirement. However, the situation improved as both debt and
financing activity created additional cash for the operation of the
merged company. The other requirements also show positive excess of
compliance. However, looking closely, the financing through equity
give better statistics. Therefore, the management should look and
study further the potential of financing through the equity.
Furthermore, the debt ratio of the merged company is quite high,
recorded at fifty two percent.

The management should also look into possibility of financing the

merger using other methods. The assumption made in the merged
balance sheet provided is that payment of twenty two million five
hundred thousand settled in cash. This has resulted in reduction in
their current assets drastically, of which affecting its ability to finance
its operation. Further studies to ensure win-win situation, i.e. half
payment by common equity and half cash, could be arranged. These
elements will help the merged company to have a healthy financial
position and simultaneously fulfill settlement to MMD Co’s
shareholders. Their ability to improve efficiency, gaining economies of
scale and synergy will promise good return of investment. This will
entice the shareholders to take up payment for the merger in stock
option.

Other Considerations

Other than financing activities, the management had to consider

also some other factors which will affect the process and decision
making. The first factor is to get advice or consultation from the
expert. Consultation with investment banks, auditors or consultant
specialist in merger and acquisition activities will provide them with
better analysis and review. All angles will be covered and therefore
minimizing potential oversight.

The effects on the management of MMD Co should also be

studied. It must be re-affirmed that good relationship already in
existence before the merger. Normally, merger activities will destroy
leadership continuity in target companies’ top management team. It is
therefore essential to ensure that good atmosphere being exercised
from top hierarchy to down liners. This is also to ensure that the
merged management does not face with any litigation issues.

The short and long term factors of business should also be taken
into consideration. In this case, it is presumed that the demand for the
product is going to improve by seven percent annually. As demand
increases, it is norm to concur that the price of the product remains
high. With the intention to reap this profit, the capital expenditure
budget normally increased to cope with new technologies and
machineries needed. This however, must be studied carefully. In long
run, as demand slowly swift below, the demand and supply effect will
later affect the long run revenues and profits. Payback period of each
project or capital expenditure must be watch carefully. Failure to do so
will result in company being in high debt ratio which later leads to
financial difficulties or bankruptcy.

Conclusion
Looking at a glance, the financial analysis does show that CFC Co
will benefit from the merger. However, a detailed study has to be
performed to ensure a comprehensive framework being made to cover
all relevant perspective. Organizational behavior, variables acquisition
experience, cultural differences are areas that need to be addressed as
well. On top of it, acquisition premium, bidding negotiation and process
and due diligence exercise must be performed in ensuring the
objectives of the merger has been achieved.