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Vodafone-Mannesmann Case Advance Corporate Finance Thursday, March 4th 2010

Pieters, Christine, 5656559 Priyautama, Yoga, 5923646 Tan, Jason, 0577561 Terstappen, Jon, 5786169

1 On November 19, 1999, Vodafone proposed that each Mannesmann share would receive 53.7 Vodafone shares. In effect this means that in aggregate Mannesmann shareholders would own 47.2% of the equity of the newly combined firm.1 On December 17, 1999, based on the stock prices of the two firms, the market estimated the probability of Vodafone successfully acquiring Mannesmann at around 60%. Under the assumption that both firms would trade at prices prevailing at October 21st if the bid failed, what is the markets estimate of the synergies of the deal? Based on this estimate, should Vodafone shareholders support the deal? First, the stock prices of Mannesmann in euro, on the 21st of October and on the 17th of December, are needed. The numbers can be found in the following table. Stock price (exchange GBP/EUR) October 21st in rates Vodafone 4.19 (0.645) 4.96 (0.6274) Mannesmann 145.35

December 17th


Vodafone wants a horizontal (strategic) acquisition of Mannesmann. To calculate the markets estimate of the possible synergies of the deal, we view the relation of current stock price, operating value and expected takeover premium (ETP). Therefore we assume risk neutrality, zero discount rate and therefore use the formula: Expected takeover premium: Current share price = Share price at October 21st + (takeover probability * ETP) With the previous numbers we can calculate the ETP: 234 = 145.35 + (0.6 * ETP) = ETP = 147.75 Thus the ETP per share is 147.75. Mannesmann has 517.9 million shares outstanding so the total ETP is 147.75 * 517,900,000 = 76.500.000.000. This is the markets estimate of the synergies of the deal. To answer the second question, whether Vodafone shareholders should support the deal, we view the ETP and the stand-alone value of Mannesmann. Shareholders should support the deal if the bid price is lower than the stand-alone value plus expected synergies. bid price = 53.7 * 4.96 = 266.35 per share (the take-over value of one share of Mannesmann is 266.35) Share price at October 21st + synergies (Expected takeover premium per share) > Takeover Value of Mannesmann 145.35 +147.75 (= 293.1 per share) > 266.35

Therefore, shareholders should support the bid. What is the present value of the expected synergies as shown in Exhibit 10? (Assume that the synergies related to revenues and costs grow at 4% annually past 2006, but savings from capital expenditures would not extend beyond 2006, and that the merger will not affect the firms level of working capital.) Use the average exchange rate of EUR/GBP=1.5789, and the Goldman Sachs WACC estimate (notice that total operating profit impact is pre-tax). Based on these calculations, should Vodafone shareholders support the deal? (EUR/GBP = 1.5789, WACC = 7.6%, Perpetuity growth = 4%, Tax rate = 35%) Synergies (million EUR) Total operating profit Capital Savings 2000 0 0 2001 142.1 94.7 2002 388.4 232.1 2003 2004 2005 2006

1086.3 1554.6 1927.8 2351 568.4 663.1 740.5 798.9

Calculating cash flows from synergies we use: CFT = (1 - T) EBITT + DEPRT NWCT - CAPEXT Given our data and assumptions (bold in question) reforming the formula to: CFT = (1 - T) Operating profit + CAPSAVINGST (million EUR) 2000 2001 2002 2003 2004 2005 2006

Unlevered after-tax CF from Synergies 0 Reforming; PV Synergies Into: PV Synergies







= T=0, N=7 CFT / WACCT = T=0, N=6 [CFT / WACCT] + [(V7 / WACC7)]

Assuming that the growth rate already applies from the data in the table above. Taking into account that the growth rate needs to be applied in perpetuity value of the operating synergies after 2006. Perpetuity value beyond 2006 = 2351(0.65) + 53711 V7 = 55239.2 million EUR = 2351(0.65) + ((2351(0.65)* 1.046) / 0.076 0.04)

Plugging data into the formula: PV Synergies = T=0, N=6 [CFT / WACCT] + [(V7 / WACC7)] = 37504.5 million EUR = 72.4 per Mannesmann share Should Vodafone shareholders support the deal? Vodafone shareholders should support the deal if deal PV value is positive. Deal NPV = PV Mannesmann + PV synergies bid price We assume that (from exhibit11a) the present value of Mannesmann (without orange): PV Mannesmann = 71387 mGBP = 112700 mEUR Deal NPV = 112000 + 37504.5 (266 * 517.9) = 11743.1 mEUR Based on these calculations, Vodafone shareholders should accept the deal. UK equities returned 7.7% over the UK risk-free rate for the period 1919-93. This suggests that Goldman Sachs WACC estimate might be too low. Assuming a market risk premium of 7.7%, leverage of 5%, risk-free rate of 5.5%, and cost of debt of 7% derive a new estimate for the WACC and redo part (b). Based on these calculations, should Vodafone shareholders support the deal? Who is benefiting more from the deal, a Vodafone or a Mannesmann shareholder? To calculate the new WACC we use assumptions given (bold above) and the following Formula: WACC adjusted = (D/D+E) (1-T) rd + (E/D+E) re Re = rf + (rm rf ) ; = 1.1 (from case data) Re = 5.5 + 1.1 (7.7) = 13.97 WACC adjusted = 0.05 (0.65) (7) + 0.95 (13.97) = 13.5 To redo b) with the adjusted WACC we use the same described methodology. Continue calculating: Perpetuity value beyond 2006 = 2351(0.65) + ((2351(0.65)* 1.046) / 0.0135 0.04) = 2351(0.65) + 14322.9 V7 = 15851.1 mEUR Plugging new data into formula: PV Synergies = T=0, N=6 [CFT / WACCT] + [(V7 + CAP7) / WACC7)] = 9598.4 million EUR = 18.5 EUR per Mannesmann share Should Vodafone shareholders support the deal?

Deal NPV = PV Mannesmann + PV synergies bid price We assume that (from exhibit 11a) the present value of Mannesmann (without orange) PV Mannesmann = 71.387 mGBP = 112.700 mEUR Vodafone shareholders should support the deal if deal PV value is positive. Deal NPV = 112000 + 9598.4 (266 * 517.9) = -16163 mEUR Based on these calculations, Vodafone shareholders should NOT accept the deal. Who is benefiting more from the deal; Vodafone or Mannesmann shareholders? A Mannesmann shareholder is benefiting more from the deal because the difference between the closing rate at the 19th of October (153) and the accepted bid of 266 per share at the 17th of December is +73.8%. Mannesmann shareholders get a premium to tender their shares. The share price of Vodafone increased in the same period with 13.5% from 2.74 GBP to 3.11 GBP. What the future will bring for the increase in post acquisition value for the Vodafone shareholders is the question, but for now the Mannesmann shareholders are better off. 2 What potential hurdles is Vodafone going to face to complete its acquisition of Mannesmann? Who is going to be its most likely supporter? Who is going to resist? Why? There are some potential hurdles Vodafone will face to complete the acquisition. First is that they have to convince their shareholders to give the green light for the acquisition. As we said in our previous answers, the shareholders of Vodafone have some reasons to oppose the proposal because of the costs but there are also a lot of opportunities there. If the takeover does not succeed, Mannesmann and Vodafone would be direct competitors in the four biggest markets of Europe: Italy, France, Germany and the UK, and it would make them both potential takeover targets for their biggest competitors, who are all based in the United States. When the bid would succeed however, they would become the worlds largest operator in (mobile) telecommunications. They would control Europes four largest non-incumbent operators and they would serve over 42 million customers worldwide, with the potential to serve another 510 million. Next to establishing the largest pan-European network, the merger could lead to a superior platform for the development of mobile data and Internet services, which are poised to become significant drivers of growth. Furthermore, they could become the partner of choice for suppliers and other providers as well as the operator of choice for multinational companies and consumers, because of their global reach. We will discuss the different interest groups and potential hurdles further below. A large stumbling block in the takeover of Mannesmann is the diversification of shareholders. Vodafone needs to acquire 50% of the votes of Mannesmann. Exhibit 13a shows that Mannesmann has only one large shareholder, Hutchison Whampoa (10.1%). So, Mannesmann does not have any big institutional shareholder blocks, which is a disadvantage for Vodafone. Small shareholders have less incentive to tender their shares, because of losing post-

acquisition shareholder value. An advantage is that 40% of the shareholders in Mannesmann have also a stake in Vodafone and it would be easier to gain their support. Mannesmann was committed to fully protecting the rights of Mannesmanns present employees. To get their votes Vodafone would have to fully safeguard the existing employment rights, including pension rights of these employees. Esser could also have had numerous reasons to resist the deal, one of which was that he could have been afraid of losing his job, especially because he had no pre-negotiated Golden Parachute, a common instrument in the US and UK, which is a contract providing benefits to a top executive in the event of losing his job because of a takeover. The other reasons he could have had are discussed in our answer on question number three. On the governmental level, the German chancellor expressed himself against the merger. He might have been against the foreign ownership of a big domestic firm and, in doing so, been protecting the rights of the workers of the firm, because of the votes of the working class. On the other hand he might have been protecting the management of Mannesmann, who were already against the merger and who could prove to be powerful friends in the future of his political career. Prime Minister Blair, however, found himself at the other end of the table and expressed himself in favor of the acquisition for the same reasons as the chancellor opposed it, the workers of Vodafone had nothing to fear and the management board appreciated it greatly. In our view the management board of Vodafone is the greatest supporter of the acquisition, because if the takeover will go through, they will be running the worlds leading international mobile telecommunications operator. If the merger will not succeed however, they will be in a potential takeover position themselves. The other supporters of the takeover are the shareholders of Vodafone. Because of the global reach of the combined group together with its global brand and the opportunities created by being the operator of choice for multinational companies and consumers. The greatest resistance will come from the target management, which advises the shareholders of Mannesmann regarding the acquisition. Vodafone would need to invite (some of) these board members to join the board of Vodafone as representatives of Mannesmann. They would also need to envisage positions for Mannesmanns senior operational management and would need to agree on the fact that there would be no redundancies as a result of the proposed merger. 3 What are potential explanations for why Esser was resisting the deal and fighting so hard? One of the potential explanations why Esser was resisting the deal could simply be due to the fact that the first bid was too low. Vodafones offer on December 17, 1999, valued Mannesmann at 266 per share. Mannesmanns management claimed that the value per share was around 350, which was a difference of 84 per share. So Mannesmanns management, including Esser, calculated a price per share, which was 31.6 % higher than Vodafones initial offer. Vodafones final offer of 266 per share had a premium of 14 percent on the daily price per share that day and 72.2 % on Mannesmanns closing price of October 18th (the day before speculation regarding a transaction between Mannesmann and Orange started).

Esser could have also resisted the deal to extract the highest possible premium to satisfy Mannesmanns shareholders. Based on this assumption, Esser fought this hard for shareholders interests and probably not for private benefits, because Esser owned no options and only a handful of shares. Most German CEOs, like Esser, dont profit handsomely because of Golden Parachutes, when their companies are acquired, in contrast to the US and UK CEOs. Maybe Esser simply had a genuine conviction that Mannesmann had more opportunities merging with Orange, because of the Oranges CAGR of 115 percent, than merging with Vodafone, which had a CAGR of 46.1 % and due to Oranges sophisticated mobile data strategy. Another potential explanation why Esser was resisting a takeover could be related to a belief of Esser that the change of control could destroy the value of the firm. This assumption is based on information in the case (p. 4) where it is stated that: The last prong of Mannesmanns strategy was the belief that control was an essential element for success. With a hostile takeover the control over the firm would change, through which the level of success could tremendously change as well, which subsequently would have consequences for the value of the firm. Essers view on the case was probably that his management with himself as CEO is better able to run the company and will provide a higher degree of success, than when the company would be taken over by Vodafone. Finally, the protection of employees could also be a reason for Esser to try to prevent a takeover. It could be that Esser wanted to be loyal to his employees. IG Metall Union, which represented Mannesmanns employees, had opposed the merger, despite the fact that Vodafone announced that it would fully protect the rights of Mannesmanns current employees. Likewise it could be possible that Esser could be fired from his own position as CEO. If the merger would go through, there would be a high possibility that he would no longer be in charge of the firm anymore and that his position would be fulfilled by Gent (Vodafones CEO).