Class Notes (1,100,000)
CA (650,000)
UW (20,000)
AFM (1,000)
AFM373 (50)
Lecture 3

AFM373 Lecture Notes - Lecture 3: Oshawa Group, Discounted Cash Flow, Sobeys


Department
Accounting & Financial Management
Course Code
AFM373
Professor
Alan Douglas
Lecture
3

This preview shows pages 1-2. to view the full 8 pages of the document.
The Empire Company Limited The Oshawa
Group Limited Proposal
AFM 373 Case Synopsis
Estelle Jane Padilla
20522397
March 15, 2016
find more resources at oneclass.com
find more resources at oneclass.com

Only pages 1-2 are available for preview. Some parts have been intentionally blurred.

The Empire Company Limited The Oshawa Group Limited Proposal
Page | 2
Background
Empire, founded by J. W. Sobey in 1907, is a diversified holding company with interests in food
distribution, real estate and corporate investment activities. The driving force of the company is the
support and operation of the Sobeys retail grocery business. Sobeys is the largest food retail and
distribution company in Atlantic Canada and had begun to expand into Ontario and Quebec. Empire
generated 95% of its 1998 revenue from the food distribution business, which is comprised of five
operating groups: retail, wholesale, food service, drug and industries. The retail operations were
supported by the acquisition, development, and management of property portfolios by the real estate
group. Epie’s opoate iestet atiities opised of piail log-term investments
(approximately 76%), which provided the company with both geographic and industry diversifications.
Oshawa, a competitor of Empire, is a food retail, wholesale and distribution company. The
company has been wholly owned and operated by the Wolfe family since its founding by Ray Wolfe in
1951. Oshawa management feels that return on equity had traditionally been insufficient and has
considered various options to enhance its shareholder value.
James Vaux, associate director at Scotia Capital is tasked by Greg Rudka, to value Oshawa in case
the Wolfe family would be open to a takeover offer. Rudka has long considered Oshawa an attractive
acquisition for Empire.
Key Issue
The two primary issues presented in the case include the valuation of both classes of shares that
Empire would be willing to pay for Oshawa, the identification of potential synergies and the decision of
how to finance the deal.
Alternatives
If Empire decided to acquire Oshawa, the company needs to effectively finance its proposal with
the following alternatives: pure equity, pure debt, or a mixture of both.
Quantitative Analysis
In order to value Oshawa stocks, a discounted cash flow analysis was performed. Exhibit 1 shows
the assumptions that are used in the analysis. Exhibit 2 illustrates the actual analysis for the next five
years. Vaux estimated that Oshawa would generate $7 billion worth of sales in 1998 and would grow
appoiatel si peet ased o Oshaa’s histoial eeue goth. EBITDA agis at Oshaa is
expected to increase to 2.6% of sales, which is far below the industry average given its heavy
concentration in the food service business. Depreciation and Amortization is expected to remain the
same as the previous year (about 0.97% of sales). The difference between EBITDA and depreciation and
amortization is then multiplied by 60% (after-tax rate) in order to determine earnings before interest.
The mentioned earnings before interest take non-cash items into account. Therefore, these expenses
should be reversed. For instance, depreciation and amortization is added back while capital
expenditures and change in net working capital are taken away from income before interest, which
esults i the opa’s fee ash flo. The teial alue is the alulated  takig the fee ash
flow of the company in 2013 and multiplying it by 1.05 (1 + terminal growth rate of 5%), then dividing it
by 3.36% (WACC of 8.36% subtracted by 5%). Discounting all the future cash flows from 1999-2003 and
find more resources at oneclass.com
find more resources at oneclass.com
You're Reading a Preview

Unlock to view full version

Only pages 1-2 are available for preview. Some parts have been intentionally blurred.

The Empire Company Limited The Oshawa Group Limited Proposal
Page | 3
the terminal value (approximately $2.1 billion) in 2003 by 8.36% will provide a discounted value of about
$1.5 billion which is the current value of Oshawa given its estimated future cash flows.
With the overall value of Oshawa calculated, the next step would be determining its share price
in order to figure out how much it would cost Empire to purchase each stock. Exhibit 3 shows the
appopiate shae pie alulatio. With total det of $135 illio, Oshaa’s total euit is
approximately $1.4 billion. Since Oshawa has 38 million shares outstanding, its price per share is $36.73.
Vaux also wanted to derive the value of any potential synergies, which is exhibited in another
DCF analysis (Exhibit 5). Exhibit 4 outlines the assumptions made in order to complete the DCF analysis
for the synergy. Empire management believed that there will be EBITDA margin improvements of 0.15%
in 2000, 0.25% in 2001, and 0.50% from 2002 and onwards. In addition, it is estimated to have an annual
saving of $45.60 million ($39.5 million for elimination of duplicate administration, merchandising,
buying, pricing and accounting; $4.1 million for divisional management cost savings and $2 million for
advertising savings). However, the full value of potential synergies is typically not fully realized, leading
to the realization of the cost of 37.5% in the 2000 and 75% from 2001 and onwards. Exhibit 5
summarizes all the calculations performed in order to come up with a discounted value of $514 million.
The merger would result in one-time charges of approximately $80 million, which is tax deductible.
Therefore, the effective merger costs would be $48 million since $32 million is tax deductible. With this
being said, the total value of equity is then calculated as $466 million ($415 million subtracted by $48
million). With 38 million shares outstanding, the merger would result in increase in share price of about
$12.27 per share.
Qualitative Analysis
The grocery business is a highly competitive, mature industry. On the revenue side, growth
occurred primarily through horizontal merger and acquisition activity as it is typically cheaper to acquire
a competitor than to open new stores. Acquisition also mitigates risks associated with entering a new
market including lack of local knowledge, difficulty of attracting a qualified work force and the threat
and intensity of competitive response. Horizontal activity also generates the economies of scale in
marketing, procurement, distribution, technology, corporate overhead and private-label development.
In order to succeed in the acquisition of Oshawa, it is essential to assess the potential rival
iddes i ode to aoid ueessa additioal auisitio osts. Lolas is Epie’s geatest
competitor as it is financially capable of making a rival bid and may have been able to capture high
synergistic strategic gains. By acquiring Oshawa, Loblaws would be the dominant player in the Canadian
goe usiess, oepoeig Epie’s usiess. Metro-Richelieu is also a potential rival for the
acquisition of Oshawa. If successful, it would solidify its position as the largest grocer in Quebec, giving
them national scope. Provigo, like Metro-Richelieu, would also be considered as the largest grocer in
Quebec if it were to acquire Oshawa. However, their preferred method of expansion is to build their
own corporate network. Overall, Empire should look out for Loblaws as it is the biggest threat to the
company at this moment.
Recommendation
With the threat that Empire will be facing once its competitors acquire Oshawa, Empire should
definitely pursue acquiring Oshawa befoe its opetitos. Epie should puhase Oshaa’s shaes fo
no more than $49/share ($36.73 + $12.27) or else it is at risk of overpaying.
find more resources at oneclass.com
find more resources at oneclass.com
You're Reading a Preview

Unlock to view full version