mergers and acquisitions assignment - report on australian merger of anglo american

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Report Current as of 31 June, 2010 Report on Australian Acquisition Screening and Strategies

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An assignment to screen and evaluate choices of merge/takeover targets for Anglo American PLC. Uploaded for the purpose of demonstrating my graphic design skills, writing ability and skills in corporate financial analysis.The document was entirely completed with Open Source Software (Inkscape, Scribus and OpenOffice Calc) with source of images etc. listed within. Calculations and analysis have been done by me.

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Page 1: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

Report Current as of 31 June, 2010

Report on Australian AcquisitionScreening and Strategies

Page 2: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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The Australian Resources Sector 2

Performance 3

Ideal target Profile 5

Complete Multiples Valuation Data 7

Residual Earnings Valuation 9

Discounted Dividend Calculation Data 11

Company Evaluations 12

Acquisition Plan 17

Sources 18

Table of Contents

Page 3: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Three The resources sector is one of the largest

and most important industrial sectors in Australia.

The mining sector provides the most exports in the

country (39.4% in the 2009-10 financial year,

down from 41.4%) in the proceeding period) ac-

counting for almost $100bn of exports in the last

financial year (Source: Australian Government). The

industry employs approximately 135 000 people

who are collectively paid $15.5bn in wages

(Source: ABS). In the financial year from 2008-09,

mining was third highest contributor to Australia's

national GDP contributing 8% to the GPD - only

behind Finance/Insurance (at 12%) and Manufac-

turing (10%) (Source: ABS). The industry held an

EBITDA of $25.2bn, and the highest profit margin

of any industry (in a study excluding finance and

government owned institutions) at 37.1% (Source:

ABS).

The sector is largely dominated by several very big

players - some of which represent the largest

companies in Australia. Four of these are repres-

ented on the ASX/S&P 20 index - listing the 20

biggest companies in terms of market capitalisa-

tion in Australia namely (in alphabetical order) BHP

Billiton, Newcrest Mining and Rio Tinto. Ten are

represented on the ASX/S&P 50, and 43 on the ASX/S&P 200. If a companies importance can be

judged by its market capitalisation, then in Australia, mining is King.

The Australian ResourcesSector

Burton Coal Mine, Australia (Source: Peabody)

Page 4: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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The resources sector has (like the rest of

the stock market) had a varied perform-

ance history over the last five years.

The S&P/ASX300 Metals and Mining Index

(XMM) has over the last 5 years performed

relatively well. The index has doubled over

the last 5 years from 2037.36 points at the

beginning of January '05 (when the index

was first calculated) to 4078.26 points.

Over the same period, the mining index

significantly outperformed the Australian All

Ordinaries index, as can be seen in the

comparison graph (The graph was created

by dividing each value by its initial value to

create a comparable index).

Both indices also show the effect of the

global financial crisis which has been ac-

cepted by many analysts as having lasted

from December 2007 to July 2009

(Source: Newsweek). The index shows

that the mining industry lost a greater per-

centage of capitalisation then the market in

general (as represented by the all ordinar-

ies index), however it still in spite of this

performed better during the period, and

has recovered far faster. This period

should be treated as anomalous and not

treated as a common occurence.

However, some analysists believe that the

global economy is still in a fragile position -

but this is a risk involved in investing in

mining companies worldwide.

Performance

XMM - S&P/ASX300 Metals and Mining Index

Comparison of the AORD against XMM

Page 5: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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|When the CAPM regression of the daily

percentage changes of the XMM Index

against the AORD Index, there is a ß of

1.4834 - indicating that the stocks are

somewhat more risky the the naked all or-

dinaries. This is practically shown by the

mining industries often amplified reactions

(and contributions) to the market. There is

a very small, negative alpha which would

probably be small enough insignificant

enough to be safely ignored.

AORD against XMM % Daily Change Regression

Mining at Green Pit (FMG)

Page 6: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Ideal Target Profile

|The ideal target(s) should fit as much of this profile as possible. The profile provides a criterion for se-

lection that will be used and referred to for the remainder of the report. Justification is provided with

each criteria.

Primary Interest in Coal

An ideal target will be most heavily invested in coal mining over other forms of mining. Other interests in

the resources sector are acceptable, preferentially in the processing, transport or export of coal. This

preference is to create the maximum possible value creation from the narrowest possible horizontal ac-

quisition. In addition, it will also fit in with the companies current strategic goal of streamlining mining op-

erations. Any other interests if acquired as part of the deal should sold to remain compatible with Anglo

American's current business strategy.

Acquiring companies involved in coal mining will also allow Anglo American a greater share over the

greater coal markets in Australasia. A greater share will give Anglo American greater influence over the

price of coal in the Australasian market. The horizontal strategy will lead to acquisition gains through the

removal of duplicated efforts, and sales of duplicated assets.

However, an interest in coal comes with the inherent risk of the Mining Resource Rent Tax (MRRT) le-

gislation being passed (as do the companies dealing in iron ore). This risk is not present in the com-

panies dealing with other minerals.

Small Ownership Pool

An ideal target will have a small amount of large shareholders. This has the benefit of making a mana-

gerial consent to the merger/acquisition an indicator that the acquisition will almost certainly succeed.

In those few circumstances in which a managerial consent does not reflect the will of the shareholders,

there are only a few shareholders who need to consent to the sale. Unfortunately, when the managers

nor the major shareholders consent to the acquisition, the lack of a large body of smaller to medium

shareholders means that the acquisition is almost certain to fail.

Ideally, the largest owners of stock should be corporate. This is to reduce the possibility of an acquisi-

tion failing due to an emotional tie to the company. For instance, in this market Andrew Forest is far less

likely to be willing to part with his 35% ownership of the Fortescue Metals Group owing his connection

to the company that he personally incubated to the empire that it is today, then the Commonwealth

Bank would be willing to part with its 16% ownership of Newcrest Mining. The emotional connection

could either increase the required bid premium, or ensure the complete rejection of a bid.

Page 7: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Financially Sound

An ideal target will preferably be financially sound. This may not be ab-

solutely necessary providing that the cause for financial unsoundness

is either poor management, or a liquidity timing mismatch. I would de-

termine financial soundness from the following:

• Earnings per Share (in a mature company)

• Net profit after tax (in a mature company)

• Total and current assets exceeding short and long-term lliability

• Leverage of the firm

Page 8: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Complete Multiples ValuationData

Table 1: Comparitive Industry Multiple Analysis

Table 2: Complete Valuation

Page 9: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Method of Calculations

Page 10: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Residual Earnings Valuation

Table 2: Calculation Formulas for RE Analysis

Table 1:Residual Earnings Analysis

Page 11: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Page 12: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Discounted DividendCalculation Data

Table 1: Standard Discounted Dividend Model

Table 1 contains the standard dividend discounted model. Table 2 fixes some of the limitations of the

dividend discount model, by using the Modligliani-Miller theorem to utilise a dividend-EPS equivalency.

This is makes the egregious assumption of a complete lax of tax, and is only provided to address the

shortness of the Dividend Discount Model to deal with situations of zero dividends. Other models for

valuation would be better used.

Table 1: Discounted Dividend Model with Modliglian-Miller Dividend-EPS Equivalency

Page 13: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Centennial Coal (CEY)

Vital Figures

Discounted Dividend Valuation: $32.74/Share*

Price/Earnings Multiple Valuation: $2.386/Share

Market/Book Valuation: $2.037/Share

Price/Sales Valuation: $2.923/Share

Share Price (2009): $2.46/Share

Residual Valuation: $7.783/Share

Market Capitalisation: $919 122 000

Using EPS Equivalency

Company Evaluations

• Entirely focussed on coal.

• Small amount of major shareholders, with

each legally substantial major shareholder being

corporate.

• Company is currently profitable, has a large

amount of assets compared to liabilities.

• Valuation indicates that the market is prob-

ably reasonably valuing CEY Shares.

• Would be negatively effected by the MRRT.

Conclusion

Good potential target

Coal and Allied Industries (CNA)

Vital Figures

Discounted Dividend Valuation: $266.51/Share

Price/Earnings Multiple Valuation: $84.488/Share

Market/Book Valuation: $19.974/Share

Price/Sales Valuation: $32.286/Share

Share Price (2009): $75.25/Share

Residual Valuation: $149.796/Share

Market Capitalisation: $6 515 520000

• Entirely focussed on coal.

• Contains vertical integration potential.

• One very large corporate shareholder (Rio

Tinto).

• Company is currently profitable, has a large

amount of assets compared to liabilities.

• Price/Earnings ratio indicates strong

performance.

• Valuations are conflicted in share value,

though price seems reasonable

• Would be negatively effected by the MRRT.

Conclusion

Extremely good potential target

Page 14: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Fortescue Metals Group (FMG)

Vital Figures

Discounted Dividend Valuation: $20.01/Share*

Price/Earnings Multiple Valuation: $2.049/Share

Market/Book Valuation: $0.317/Share

Price/Sales Valuation: $1.189/Share

Share Price (2009): $3.79/Share

Residual Valuation: $6.752/Share

Market Capitalisation: $11 709 180 000

*Using EPS Equivalency

• Entirely focussed on iron ore, only partially

consistant with Anglo American's international op-

erations, and not constistant with Australian opera-

tions.

• 3 legally substantial shareholders holding a

controlling 60% stake. Primary shareholder per-

sonally owns 34.73% of the company

• Company is profitable. Figures may seem

uncertain due to the young nature of the company.

Long term profits seem likely

• Valuation suggests shares may be over-

priced, but this may be owing to the early stage

growth of the company

• Would be negatively effected by the MRRT.

• Company has a market capitalisation of

$11bn, risking an overexposure and dilation of the

value of Anglo American if acquired/merged with.

Conclusion

Reasonable potential target. Chances of successful acquisition are uncertain.

Iluka Resources (ILU)

Vital Figures

Discounted Dividend Valuation: $28.47/Share*

Price/Earnings Multiple Valuation: $-3.236/Share

Market/Book Valuation: $0.313/Share

Price/Sales Valuation: $1.634/Share

Share Price (2009): $3.58/Share

Market Capitalisation: $1 498 950 000

Residual Valuation: $7.317/Share

*Using EPS Equivalency

• Focused on mineral sands, focussed on ti-

tanium extraction. Inconsistant with Anglo-Americ-

an's worldwide mining operations.

• 5 legally substantial shareholders, mostly

corporate. Potential for a lower bid premium.

• Company is not currently profitable. Asset-

s/Liability ratio is worse then some other compan-

ies. Losses seem mostly concerned with drop in

sales - profitability may return

• Valuation related to the shares is uncertain.

• Would not be negatively effected by the

MRRT.

Conclusion

Not an appropriate target at this stage..

Page 15: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Macarthur Coal (MCC)

Vital Figures

Discounted Dividend Valuation: $91.14/Share*

Price/Earnings Multiple Valuation: $8.634/Share

Market/Book Valuation: $4.763/Share

Price/Sales Valuation: $3.514/Share

Share Price (2009): $6.6/Share

Residual Valuation: $21.265/Share

Market Capitalisation: $1 610 270 000

*Using EPS Equivalency

• Entirely focussed on coal. A purchase

would come with strong vertical integration games,

and an already existing exportation chain that

could be further exploited.

• Large amount of minor shareholders.

Largest shareholders are corporate, but own only

20%, 10% and 5% respectfully. Potential for higher

bid premium required.

• Company is currently very profitable, has a

large amount of assets compared to liabilities.

• Valuation indicates that the market is prob-

ably reasonably valuing MCC Shares.

• Would be negatively effected by the MRRT.

Conclusion

Extremely good potential target. Chances of successful acquisition are uncertain

Newcrest Mining (NCM)

Vital Figures

Discounted Dividend Valuation: $4456/Share*

Price/Earnings Multiple Valuation: $6.410/Share

Market/Book Valuation: $10.285/Share

Price/Sales Valuation: $6.455/Share

Share Price (2009): $30.51/Share

Residual Valuation: $61.379/Share

Market Capitalisation: $14 746 830 000

*Using EPS Equivalency

• Focussed on gold, copper and silver with

no focus on coal nor iron core, and not consistant

with Anglo-American's Australian operations

• Large amount of minor shareholders.

Largest shareholders are corporate, but own only

16%, 10% and 5% respectfully. Potential for higher

bid premium required. The board holds almost no

shares.

• Company is currently profitable.

• Valuation indicates that the market is prob-

ably overvaluing shares MCC Shares.

• Would not be negatively effected by the

MRRT.

• Company has a market capitalisation of

$11bn, risking an overexposure and dilation of the

value of Anglo American if acquired/merged with.

Conclusion

Reasonable merger target, but no appropriate to the current strategy.

Page 16: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Oz Minerals (OZL)

Vital Figures

Discounted Dividend Valuation: $13.68/Share*

Price/Earnings Multiple Valuation: $-2.249/Share

Market/Book Valuation: $4.274/Share

Price/Sales Valuation: $6.618/Share

Share Price (2009): $2.11/Share

Residual Valuation: $2.826/Share

Market Capitalisation: $493 210 000

*Using EPS Equivalency

• Focussed on gold and copper exploration

and extraction

• 4 legally substantial shareholders, who own

small portions of the company. Top 20 sharehold-

ers own only 58.64% of the company. May be

more difficult to acquire

• Company is not currently profitable. Uncer-

tain as to reason, as sales have increased as has

the price of gold and copper. Future financial

status is uncertain.

• Valuation related to the shares indicates

that shares may be overpriced by a small amount.

• Would not be negatively effected by the

MRRT.

Conclusion

Not an appropriate target at this stage.

Straits Resources Ltd (SRL)

Vital Figures

Discounted Dividend Valuation: $-0.48/Share

Price/Earnings Multiple Valuation: $-2.074/Share

Market/Book Valuation: $0.946/Share

Price/Sales Valuation: $0.542/Share

Share Price (2009): $1.18/Share

Residual Valuation: $4.326/Share

Market Capitalisation: $3 683 180 000

• Focussed on gold and copper exploration

and extraction. Also owns alloy distribution busi-

ness in Europe. Neither will create significant ac-

quistion gains.

• Only 2 legally substantial shareholders,

each owning only 5%. Acquisition may be more

difficult.

• Company is not currently profitable. An as-

set is currently out of commission. The circum-

stance may change in the future depending on the

success of this asset.

• Valuation related to the shares indicate that

there is a small chance of undervaluation of SRL in

the market.

• Would not be negatively effected by the

MRRT.

Conclusion

Not an appropriate target at this stage..

Page 17: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Recommendations

Out of the stocks presented for analysis and evaluation, three were indicated

as being suitable acquisition targets for Anglo American PLC at this time.

These were:

• Centennial Coal (CEY)

• Coal and Allied Industries (CNA) and

• Macarthur Coal (MCC).

Each of these potential targets offers opportunity for creating a conglamorate

entity of greater value through acquisiton.

Reasons for Selection

Whilst the reasons for the selection of these stocks were largely laid out in the

previous section, there is cause to append further detail. The three entities

have not yet been considered as a group. Considering that the market

capitalisation of the three entities is well within the range of acquisition by

Anglo American, I would highly recommmend that Anglo American seek to

acquire each of the three companies. The three companies as a group will

provide far greater acquisition gains, which will continue to be attractive but will

be reduced if bids of any of the three companies completely fail.

Macarthur Coal, whilst having the distinct possibility of being the most difficult

of the companies listed to acquire will provide the greatest acquisition gains.

These will not so much be in assets that it can directly sell, as far as in the

synergetic gains with the other coal mines that Anglo American currently owns

in Australia, and hopes to acquire if they are to follow my recommendations.

The processing facilities will be able to be further utilised to provide a greater

range of coal product to the market at a cheaper rate of supply then before the

acquisition, providing gains to both the acquired and acquiring companies. As

well, there is already an established export chain to Asia which will be able to

be more effectively utilised.

The nature of the coal product produced also opens up the possibility of an

eventual foray into the metal markets in Australia. However, this entry into the

metal markets would be better delayed until a later stage when it can be made

further in full.

Page 18: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Acquisition PlanCentennial Coal

Centennial Coal would be quite simply taking over new mines. There would be no greater strategic

purpose beyond gaining more coal to sell, and a greater chunk of the coal market in Australia. It is, in

market capitalisation, the smallest firm considered for purchase - only about 2% of Anglo American. I

would recommend that Anglo American aquire an initial 5% share to gain a greater amount of control

over the target company simply to gain greater control over the company. This should be followed by

an on-market purchase of shares over a short period of time until 20% (or greater if possible) share is

obtained. There is then a legal requirement that a bid be launched, which I would suggest be cash-

only. The bid premium should be at about 20% of the price of the share. The bid should also be

conditional on acceptance.

Coal and Allied Industries

Any takeover bid on Coal and Allied Industries will absolutely not succeed without the expressed

agreement with Rio Tinto for Coal and Allied Industries. This is owing to the extraordinarily large amount

of ownership and control that Rio Tinto has over the company, both as an owner and as a manager.

Any deal would be best made through explicit negotiation with the target company and its owner, with a

one-on-one attempt to bargain for the best potential outcome.

Coal and Allied Industries is, in market capitalisation, the largest of the companies considered and

would be considered somewhat of a cash cow for Rio Tinto. This amount of Market Capitalisation

would mean that a large amount of liquidity would be required to purchase Coal and Allied Industries

outright - approximately equal to a sixth of the total value of Anglo American PLC. I would recommend

then, that an all-share offer be made. If the takeover bid for Macarthur Coal was successful, then this

bid could include a large amount of, or futures or options in metallurgical coal. This may be attractive for

Rio Tinto owing to their extensive metal operations.

Macarthur Coal

Macarthur Coal is of a reasonable size, at about 4% of the market capitalisation of Anglo American

PLC. Its ownership group is varied, but largely corporate. Ideally, a friendly takeover should be

attempted. Owing to its size, either a cash, cash-and-shares or share offer could be launched. As this

is the company with the greatest potential for acquisition profits, I would suggest offering all three. If

board support is possible, a fine should be imposed on Macarthur Coal to ensure cooperation.

If a hostile takeover is required, it should be attempted. Macarthur Coal is ideally the company that An-

glo American should purchase if in any way possible. I would offer the choice of cash, cash and shares

or shares. Owing to the size of the company, I would be willing to raise the bid premium for the cash-

and-shares deal, and further to the share offer to reduce the amount of liquidity required for the pur-

chase.

Page 19: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

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Sources• Newsweek - 'The recession is over?', 13/07/2009,

http://www.newsweek.com/2009/07/13/the-recession-is-over.html

• S&P Index Figures, AORD Figures, Historical Stock Prices - Google Finance

• ABS Statistics drawn from

- 8155 - Australian Industry 2008-09, http://www.abs.gov.au/ausstats/[email protected]/mf/8155.0

- 5204 - Australian System of National Accounts 2008-09,

http://www.abs.gov.au/ausstats/[email protected]/mf/5204.0

- 5206 - Australian National Accounts: National Income, Expendature and Products, Jun 2010,

http://www.abs.gov.au/ausstats/[email protected]/mf/5206.0

• Australian Government Department of Innovation, Industry, Science and Resources

(21/09/2010), Australia's Exports Fact Sheet,

http://www.innovation.gov.au/section/aboutdiisr/factsheets/pages/australia'sexportsfactsheet.aspx

Images:

• Front Cover - Iluka Thickener Under Construction - http://www.iluka.com/?page=imagelibrary

• Table of Contents - Fortesque Metals Cloudbreak Stacker -

http://www.fmgl.com.au/IRM/content/project_imagegallery_highresimages.htm

• Peabody Energy, Burton Coal Mine, Australia - http://www.peabodyenergy.com/Media/gallery/-

operations.aspm

• Andrew Freese (LincolnStein) Coal Mining Trucks, Open Mine, http://www.flickr.com/pho-

tos/22865598@N02/3797732116/

• Iluka Mineral Sand Stockpile - http://www.iluka.com/?page=imagelibrary

• Mining at Green Pit - http://www.fmgl.com.au/IRM/content/project_imagegallery_highresim-

ages.htm

• Night Mining, Walter Mining http://walter.com.au/index.php?page=2&ssid=&mid=2

• Copper Mining in Arizona - http://zoniereport.com/?tag=rosemont-copper

Page 20: Mergers and Acquisitions Assignment - Report on Australian Merger of Anglo American

© Copyright Lachlan Kingsford 2010

This document has been prepared as part of an assignment for Mergers and Acquisitions,

at La Trobe University by a student who is (as of the time of writing), not fully qualified. As

such, any recommendations within should be considered seperately with the aid of

professional financial and legal advice.

I fully exclude any liability resulting from the following of any advice enclosed within.