Strategic M&A Analysis: Evaluating Target Company and Recommendations

This report provides a comprehensive analysis of a potential merger and acquisition (M&A) strategy for Morrison's, focusing on the acquisition of WH Smith plc. It critically evaluates different types of mergers (horizontal, vertical, conglomerate, and concentric), ultimately recommending a horizontal acquisition to enhance market reach and economies of scale. The report justifies the selection of WH Smith plc as the target company, presenting its key financial information and profitability ratios. It delves into the target company's capital structure, calculates its weighted average cost of capital (WACC), and estimates its value using the discounted free cash flow (DCF) method. The analysis includes an assessment of WH Smith's financial trends, liquidity, and overall financial health, culminating in strategic recommendations for Morrison's senior management team based on the findings. This report is available on Desklib, where students can find a wealth of solved assignments and study resources.

Corporate Finance, Merger and Acquisition
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TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
MAIN BODY..................................................................................................................................1
1. Critically evaluating the benefits and drawbacks of each category of merger and acquisition
.....................................................................................................................................................1
2. Justifying reasons behind selection and present the target company’s key financial
information..................................................................................................................................4
3. Presenting and discussing the target company’s capital structure and computing its WACC 8
4. Calculating the value of the target company using the discounted free cash flow method...12
5. Summarizing findings and giving recommendations to the senior management team.........14
REFERENCES..............................................................................................................................16
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INTRODUCTION
In the recent times, business units lay high level of emphasis on undertaking merger and
acquisition activities with the motive to explore business operations. Usually, business unit
employs strategy pertaining to merger and acquisition when current market lies at saturation
level. Along with this, merger & acquisition plan also enables firm to expand business in other
area and attain success with the help of loyal customer base. For this project report, Morrison’s
has been selected, a leading business units operating in retail sector. Due to the existence of high
level of competition now such business unit is planning to acquire WH Smith plc. Hence, target
company such as WH Smith plc is a leading British retailer having wide supply chain at railway
station, airport, port, hospital and motorway service station. Thus, by acquiring such proposed
company Morrison’s would become able to enhance its geographical reach and explore business
operations more effectually.
MAIN BODY
1. Critically evaluating the benefits and drawbacks of each category of merger and acquisition
Introduction
This section will provide deeper insight about different types of merger and acquisition
that can be undertaken by Morrison’s along with their pros & cons.
Main body
According to the views of Greve and Zhang (2017), acquisition is a corporate action that
is undertaken by business unit for exploring the business operations and functions. Under
acquisition, one business unit buys another unit for gaining ownership status. Further, Boschma
and Hartog (2014) stated that acquisition strategy provides high level of assistance in enhancing
the business performance. Moreover, when business operates at a large level then it enjoys high
economies of scale which in turns result into profit maximization. However, on the critical note,
Reddy (2016) presented that, in case of acquisition whether horizontal, vertical and
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conglomerate, business unit faces issues in managing as well as coordinating several aspects
such as culture, personnel etc. Brigham and Houston (2012) investigated that acquisition
accelerates growth as it helps in diversifying risks associated with the particular sector. Along
with this, it also enables company to maintain and enhance the customer base to a great extent.
Specifically, there are mainly four types of acquisition that can be undertaken by business
unit such as follows:
Horizontal merger:
Chakrabarti, Hsieh and Chang (2017) presented that horizontal merger is when
both the companies belong from same industry such as retail, hospitality etc. Hence, horizontal
merger is the most common among firms where competition level tends to be high. The study
assessed in their study that horizontal merge strategy helps in gaining high economies of scale.
Besides this, it also facilitates Reduction in the large number of competitors which in turn places positive
impact on both profit margin and overall growth. However, Lin, Officer and Shen (2018),, argued that
it increases monopoly within the industry. Along with this, horizontal mergers also create
difficulty in the integration of culture, employee’s behavior and other aspects. Sherman (2018),
entailed that horizontal acquisition provides top management with ease, pertaining to acquiring company,
in relation to handling business more effectually.
Vertical merger:
Chakrabarti, Hsieh and Chang (2017), depicted that vertical merger is
undertaken by companies operating in the similar sector. However, such two business units, in
the same value chain of producing goods or services, differ in terms of their production stage.
Avinadav, Chernonog and Perlman (2017), found in their study that vertical merges
ensures supply chain stability to a great extent. Further, it also helps in reducing cost level as
business unit does not require paying higher to the suppliers. However, Hsu, Wright and Zhu
(2017), claimed that vertical merger type imposes high capital expenditure in front of acquiring
firm. In addition to this, vertical merger is like locking capital that can be used for other
productive or profitable business activities. Hence, such kind of mergers imposes opportunity
cost in front of the business unit. The study identified in their study that vertical mergers enables
firm to gain high economies of scale n and thereby increase the level of profit margin.
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Conglomerate merger:
As per the views of Lin, Officer and Shen (2018),, conglomerate merger implies for the
one, when unrelated business organizations combine their operations. In other words,
conglomerate merger takes place in between companies operating in a totally different sector (5
Types of Company Mergers, 2018). Sherman (2018), reported that conglomerate merger enables
firm to gain high profit margin from the funds available by investing same in growing industries
or firms. It also offers opportunity to the firm pertaining to enhancing customer base and reduces
risk level by diversifying the business operations. On the critical note, Boyson, Gantchev
and Shivdasani (2017), mentioned that, in such kind of acquisition, lack of experience might
affect the business operations and sustainability. Further, it also includes risk in relation to shifting focus
from core business to others which in turn leads to poor performance. Problems in developing
coordination among several aspects such as culture, employees etc are also common under such type of
acquisition.
Concentric merger:
Lebedev and et.al., (2015), assessed that when one firm merges its business
operations with another where products or services offering by them differs then the same is
recognized as concentric. Hence, it can be stated that, such type of merger takes place within the
firms which are offering products or services to the same customer group. However, both the
firms differ in terms of their offerings to significant level. On the contrary to this, Sherman
(2018), criticized such acquisition strategy on the basis of lack of co-ordination and monopoly
creation. Further, another Aversa and Haefliger (2017) stated that concentric merger helps in
achieving synergy to the significant level. Such merger type also provides high level of
assistance in increasing market share and facilitates significant improvement in product
development
Conclusion
By doing analysis, it has been assessed that Morrison’s is facing stiff competition from
the major retail companies, operating in UK, such as Tesco, ASDA, Sainsbury, ALDI, LIDL etc.
All such firms are offering similar kinds of retail products or services to the customers. Further,
customers also prefer to purchase products or services from the retailer which offers the same at
discounted or lower prices. Hence, due to the saturation level of UK retail market and concern
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about the potential growth Morrison’s wants to expand business by undertaking merger and
acquisition strategy. Referring Morrison’s concern and objectives, it can be stated that horizontal
acquisition will prove to be more beneficial. Moreover, in the UK retail sector, now due to the
existence of major players Morrison’s has to provide heavy discounts to the customers. This in
turn places direct and negative impact on the profit margin. Thus, by undertaking horizontal
acquisition Morrison’s can enhance its reach as well as customer base and thereby would become
able to make optimum use of financial resources. This aspect can clearly be supported with the
literature review section which presents that horizontal acquisition provides companies with high
economies of scale and enhances efficiency to the significant level. Moreover, cost pertaining to
purchasing existing product will be lesser. This in turn helps company in saving money and
enhances the level of profit margin.
2. Justifying reasons behind selection and present the target company’s key financial information
Introduction
This part of report depicts the reasons or aspects that are considered by Morrison’s while
making selection of Standard Life Aberdeen.
Main body
WH Smith plc is considered or selected as target company that listed on the recognized
stock exchange of London such as FTSE 250. Such business unit offers retail products and
services to the customers at affordable prices. Hence, this retail unit offers wide range of
products or services to the customers such as books, stationery, magazines, newspapers and
entertainment products. There are several motives which in turn considered by Morrison’s while
making selection of WH Smith plc for acquisition such as follows:
 High economies of scale: Usually, companies get cost benefits when they operate at
large level and specifically when both the companies relate from the similar sector. In the
context of Morrison, firm will get high synergies by bringing down fixed cost through the
removal of duplicate standards. In addition to this, when company places order for more
material then it gets and enjoys high economies of scale. Hence, such high economies of
scale positively contribute in profit margin.
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 Managerial motivations: In addition to this, it has assessed from the evaluation that
management team of Morrison’s is highly skilled and efficient. Along with this, current
performance trend of WH Smith plc exhibits that such unit is managing its income over
the expenses more effectually. Thus, management team’s capabilities pertaining to the
proposed company is also the main aspect that considered for selection.
 Third party motivations: Further, proposed acquisition strategy will also offer high level
of benefits to the shareholders. Through the means of such acquisition Morrison’s would
become able to widen its customer reach and thereby sales revenue as well as profit
margin. In addition to this, such acquisition may also result into in the enhancement of
staff capabilities and thereby overall growth as well as success. In addition to this,
concerned acquisition strategy will provide high level of assistance in reducing the level
of competition to some extent and thereby increases profit margin.
Thus, referring such aspect, it can be presented that growth potential of investment and
assets management companies are higher. From assessment, it has identified that Morrison will
get synergies in terms of market power and economies of scale by acquiring WH Smith plc. In
addition to this, Morrison’s also have ability to generate high cash flows by ensuring better
management. Hence, taking into account all such aspects WH Smith plc has been selected for the
proposed acquisition plan. Morrison will use the combination of debt and equity for making
payment pertaining to proposed acquisition.
Along with the non-financial, monetary aspects are also considered while making
selection of such business unit:
Financial trend
Particulars 2014 2015 2016 2017
Sales revenue 1161 1178 1212 1234
Net income 92 101 108 116
Operating income 117 124 131 138
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Operating margin % 10.1% 10.5% 10.8% 11.2%
Net margin % 7.9% 8.6% 8.9% 9.4%
Operating cash flow 116 145 134 148
Free cash flow 84 106 92 100
2014 2015 2016 2017
10.1% 10.5% 10.8% 11.2%
7.9% 8.6% 8.9% 9.4%
Profitability Ratios
Operating margin % Net margin %
Figure 1: Operating and Net profitability Trend
In order to assess and evaluate monetary position of target company namely WH Smith
plc financial statement analysis has been done. Tabular presentation shows that sales revenue of
WH Smith plc was increased over the time frame 1161 to 1234 GBP million. Results of ratio
analysis presents that NP margin of the company was inclined from 7.9% to 9.4% respectively at
the end of accounting year 2017. This aspect shows that company’s control on its expenses is
highly good. In addition to this, increasing sales trend exhibits that customers prefer to purchaser
products and services from such retailer. Referring the current performance level it can be
depicted that in the near future both sales revenue and profit margin of the firm will incline.
Operating profit margin of WH Smith plc also shows increasing trend from 10.1% to 11.2%
significantly. All such aspects show that management of the company pertaining to financial
resources is good.
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Liquidity ratio analysis
Particulars 2012 2013 2014 2015 2016 2017
Current assets 246 233 235 230 236 242
Current liabilities 295 288 294 279 268 272
Current ratio 0.83 0.81 0.80 0.82 0.88 0.89
2012 2013 2014 2015 2016 2017
0.830000000000
001
0.81 0.8
0.820000000000
001
0.88 0.89
Current ratio
Current ratio
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2014 2015 2016 2017
116
145 134
148
84
106
92 100
Cash Flow Assessment
Operating cash flow Series2
Free cash flow Series4
Figure 2: Cash flow Assessment
Cash flow statement evaluation presents that in the period of 2014 and 2015, free cash
flow position of WH Smith plc was negative such as 84 & 106 GBP million. On the contrary to
this, in 2016 and 2017, free cash flow of WH Smith plc was fluctuated over the time frame and
accounted for 92 & 100 GBP million respectively. Referring such trend, it can be presented that
company is highly able to generate more cash after spending money that needed for the
maintenance or expansion of asset base. In addition to this, as compared to the preceding year
operating cash flow was good and increased in the latest years. Hence, by taking into account
overall assessment, it can be mentioned that financial position and performance of WH Smith plc
was good in the financial year 2016 and 2017.
Conclusion
In conclusion to this section, it can be concluded that there are several motives that entice
decision making aspect of Morrison’s in relation to acquiring WH Smith plc includes high
economies of scale, synergy, managerial skills etc. Further, it can be presented from financial
section that profitability and cash position of company was good at the end of 2017.
3. Presenting and discussing the target company’s capital structure and computing its WACC
Introduction
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This part of report highlights capital structure and WACC of WH Smith plc. It will help
in ascertain the level to which solvency position of the company is good.
Main Body
Capital structure presents sources that have undertaken by the scholar for financing its
overall growth and operations such as debt, equities etc. Debt includes bonds and long term
payables on which business unit is obliged to make interest payment on periodical basis or when
it becomes due. On the other side, equities contain common and preferred stock as well as
retained earnings. Further, short-term debt, an element of working capital requirement, is also
recognized as the part of capital structure. Hence, it can be stated that capital structure is the
combination of long and short term debts as well as equity and preference shares. In accordance
with the theoretical framework capital structure is considered as aggressive when it includes high
debt over equity. Companies take more resort of debt when interest rates associated with the
same are lower. Debt-equity ratio is one of the most effectual measures that can be undertaken
for analyzing and evaluating one’s capital structure.
MM model presents that perfect capital market exists when investors are rationale and
information pertaining to market is available. It assumes no transaction cost, taxes and flotation
cost. WACC presents the proportion of minimum, after tax required rate of return, that business
unit must earn for offering enough margins to the shareholders or investors in against to the risk
undertaken by them (Weighted Average Cost of Capital, 2018). Mm model also entailed that
choice pertaining to debt and equity does not have significant or material impact on the value of
firm. However, on the critical note, considering trade-off theory of capital structure Park,
Kamcev and Freeman (2017) entailed that optimal capital structure is when balance between tax
shields and cost of financial distress exists. This theory suggests that ideal solvency position is
the one that maximizes firm’s value. Thus, business unit should use the combination of debt-
equity by taking into account standards that minimizes firm’s cost of capital. Further, referring
pecking order theory Radjamin and Sudana (2017) entailed that at the time of raising funds firm
should follow hierarchical structure. On the basis of such theoretical framework firm should give
priority to the internal sources and thereafter make focus on undertaking external modes such as
debt, equities etc.
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Capital structure of WH Smith plc at the end of 2017 is as follows:
Particulars Figures (in GBP million)
Long term debt 16
Shareholders’ equity 187 (WH Smith plc, 2018)
Debt-equity ratio 0.08
The above depicted table shows that, in the year 2017, company’s business financed most
of its operations using equities rather than other sources. This aspect shows that capital structure
of WH Smith plc has not contained debt in against to the equities which is considered as
undesirable. Moreover, as per the capital structure theory or framework ideal structure is the one
that includes both debts as well as equities. In accordance with the industry’s benchmark and
ideal aspects optimal capital structure is when debt-equity ratio accounts for .5:1 respectively.
However, financial statements, for the year ended on December 2012, clearly presents that WH
Smith plc failed to maintain optimal capital structure. Further, balance sheet of such target
company presents that short term dent sources were undertaken by the business unit for meeting
monetary requirements. In the year 2015 and 2016, long term debt accounted for 16 and 13 GBP
million. On the other side, shareholders equity of WH Smith plc implies for 187 GBP million at
the end of 2017.
Outcome of debt-equity ratio such as 0.08 presents that capital structure of company is
not good. Moreover, company has fulfilled its need through equity rather than debt which in turn
imposes opportunity cost. Moreover, debt sources offer benefit to the company under tax
brackets. Further, as per the standards, firm should issue 2 equities in against to 1 debt. Hence,
by taking into account such aspect it can be presented that financial structure of the company is
not good.
By calculating the weight or proportion of debt as well as equity and multiplying the
same with related cost WACC can be determined.
WACC: WACC = R(E) × W(E) + R(D) × (1 – t) × W(D)
In this,
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