Business

Case 4 Solution / Expected Answers

Part 1: WACC Calculation The solutions are summarized in the tables 1 & 2 Table 1:
Company Sunshine & Co Solarium ElecSun Mean Levered Beta 0.825 1.047 0.736 0.869 Market Cap Net Debt D/E 320,000,000 80,000,000 25.0% 250000,000 70,000,000 28.0% 45,000,000 110,000,000 24.4% 340,000,000 86,666,667 25.8% Unlevered Beta 0.702 0.875 0.629 0.735

Table 2: Cost of Equity Calculation Risk Free rate 5.00% Equity Risk Premium 5.00% Taxes 30% Unlevered Bta 0.735 Leverage D/E 33.3% Leveraged Bta 0.907 Cost of Equity 9.54% Cost of Debt Calculation Equity as % of Total Assets 75.0% Debt as % of Total Assets 25.0% Risk Free rate 5.00% Interest Coverage ratio 5.80 x (EBIT/Interest Expenses) Rating A+ Spread 1.50% Pre-Tax Net Cost of Debt 6.50% After Tax Cost of Debt 4.55% Debt Contribution to WACC 1.138% Equity Contribution to WACC 7.15% WACC 8.29% Pepetuity factor 1.00%

Explanation

1. Calculate the returns of each comparable and the market index Daily adjusted returns have to be calculated as follows: (Pt/Pt-1) 1. For example, for Sunshine &Co, the return as of 05-08-11 is equal to 0.11%= [(34.84/34.8)-1] 2. Calculate the levered beta of each comparable The beta is obtained by regressing the market index returns to the comparable firms returns. Players may either use the Excel function linest or calculate the historical covariance between the daily share price return and the daily index return divided by the standard deviation of the market index return. 3. Calculate the unlevered beta of each comparable The unlevered beta is calculated using Hamada Formula:

unlevered =

equity
1 + (1 T ) VD VE

Where T is the appropriate tax rate.

Example: for Sunshine & Co, the calculated levered beta is equal to 0.825. The D/E ratio is equal to 25,0% =(80 000 000 / 320 000 000), the taxes rate is equal to 30%. Hence, the Unlevered Beta is equal to 0.702 =[0.825/(1+(1-30%)x25%)] 4. Calculate the mean unlevered beta The mean unlevered beta is equal to the sum of the three calculated unlevered beta divided by 3 [(0.702 + 0.875 + 0.629)/3]=0.735 5. Based on the gearing of Sun Concentrate Co., calculate the appropriate beta that will be used to calculate the cost of equity of the target. The equity as a percentage of the total assets is equal to 75% and the debt is equal to 25% as a percentage of total assets so the Gearing (D/E) of Sun Concentrate Co. is equal to 33.33%. The levered beta of Sun Concentrate Co. is equal to 0.907 =[0.735 x (1+(1-30%)x33.3%)] The cost of Equity is calculated using the CAPM formula: Re=Rf + x (Rm-Rf). Hence, Sun Concentrates cost of equity is equal to 9.54% =[5% + 0.907 x (5%)]

6. Calculate the mean of cost of debt and the WACC

To calculate the cost of debt, we need to estimate the rating of Sun Concentrate Co. The interest coverage ratio of Sun Concentrate Co. is equal to 5.8x (EBIT/Financial expenses= 16,295,072/ 2,807,568). So the rating of the company is A+ and the appropriate spread is 1.5%. The cost of debt is equal to 6.5% =[5%+1.5%]. The WACC of Sun Concentrate Co. is obtained by using the following formula:

WACC = K E

VE VD + K D (1 T ) VE + VD VE + VD

Hence, the discount factor (the WACC) that will be used for the valuation is equal to 8.29% =[(9.54%x75%)+(6.5%x(1-30%)x25%)].

 Part 2: Targets Valuation using DCF

The correct answers for the Valuation of Sun Concentrates DCF are given in the following table Sun Concentrate Free Cash Flows in M Aces Sales % of change EBITDA in % of Sales Depreciation in % of Sales EBIT in % of Sales Tax NOPAT in % of Sales Change in WC CapEx in % of Sales Free Cash Flows As % of sales Present Value of FCF of discounted FCF Terminal Value Present Value of Terminal Value Enterprise Value Net Debt Equity Value Number of shares Price/share Actual 2011e Projections 2012 2013 2014 2015 2016

124,494,411 134,433,263 145,165,571 156,754,679 169,268,989 182,782,362 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 21,910,207 23 659,381 25,548,197 27,587,805 29 790,242 32,168,508 17.6% 17.6% 17.6% 17.6% 17.6% 17.6% 5,615,135 6,063,413 6,547,477 7,070,187 7,634,626 8,244,127 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 16,295,072 17,595,968 19,000,720 20,517,618 22,155,616 23,924,381 13.1% 13.1% 13.1% 13.1% 13.1% 13.1% 4,888,522 5,278,790 5,700,216 6,155,285 6,646,685 7,177,314 11,406,550 12,317,178 13,300,504 14,362,333 15,508,931 16,747,067 9.2% 9.2% 9.2% 9.2% 9.2% 9.2% 1,000,000 2,000,000 2,500,000 2,200,000 3,000,000 1,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 10,000,000 1.6% 1.5% 1.4% 1.3% 1.2% 5.5% 14,021,686 14,380,590 15,347,981 17,232 520 18,143,557 13,991,194 11.3% 10.7% 10.6% 11.0% 10.7% 7.7% 13,279,844 13,088,315 13,57, 552 13,194,332 9,395,848

62,528,891 193,872,819 130,196,152 192,725,043 43,193,349 149,531,694 10,000,000 14.95

Explanation 1. Calculate the discounted FCF?

To calculate the enterprise value of Sun Concentrate Co. we have to sum the Discounted FCF over the first five years and the Discounted Terminal Value. The discounted Free cash-flows are calculated as follows: 14,380,590/(1+8.29%)^1 + . + 13,991,194/(1+8.29%)^5 = 62,528,891 Aces The terminal Value is equal to 193,872,819 Aces = [13,991,194 x (1+1%)/(8.29%-1%)]. The discounted terminal value is equal to 130,196,152 Aces = [193,872,819 / (1+8.29%)^5]. 2. Calculate the Enterprise value of the target? The Enterprise Value is equal to 192,725,043 Aces = [62,528,891 + 130,196,152]. 3. Calculate the Equity value of the target? To calculate the price per share we need to calculate the Equity Value. We need first to calculate the value of Debt: The mean cost of debt is equal to 6.5% and the interest expenses are equal to 2,807,568 Aces. So the value of debt is equal to 43,193,349 Aces = [2,807,568/6.5%] The Equity value is equal to the enterprise value minus the net debt and it is equal to 149,531,694 Aces = [192,725,043 43,193,349].

4. Target price per share

The price per share is then equal to 14.95 Aces = [149,531,694 / 10,000,000] Part 3: Comparables Valuation Based on the data given, players have to (i) calculate the mean EV/EBITDA multiple that will be used in the target valuation (ii) Calculate the mean Enterprise Value? Calculate the mean Equity Value and the price/ share of the target (iii) Based on the results obtained by the two valuation methods used (DFC & Comparables), what is the range price that the acquirer will pay for the target shareholders per share (min, mean, max)? The table below summarizes the answer:
Date Acquirer Target
ProSun Sola &Co Elesun & Co Rainbow & Co

Deal Value
57,000,000 100,000,000 38,925,950 6,275,000

% acquired
57% 100% 100% 70%

Equity Value
100,000,000 100,000,000 38,925,950 8,964,286

NetFin Debt
69,044,000 40,000,000 12,000,000 48,000,000

Enterprise Value
169,044,000 140,000,000 50,925,950 56,9642,86

N-1 Sales
140,000,000 75,000,000 30,000,000 47,000,000

janv.-11 Solarium nov.-10 Yellow & Green juil.-10 Wind & Sun juil.-09 Sunaluna

Acquirer Solarium Yellow & Green Target ProSun N-1 EBITDA 20,000,000 EV/Sales EV/EBITDA 1.21 x 8.45 x EBITDA Margin 14%

Sola &Co

15,000,000

1.87 x

9.33 x

20%

Elesun & Wind & Sun Co Rainbow & Co

6,000,000

1.70 x

8.49 x

20%

Sunaluna

6,580,000

1.21 x

8.66 x

14%

 Mean Median Min Max Method

EV/Sales EV/EBITDA 1.496 x 1.45 x 1.207 x 1.867 x 8.73 x 8.57 x 8.45 x 9.33 x

EBITDA Margin 17% 17% 14% 20%

DFC (Target Value) Comparables transactions Mean Min Max Explanation

Enterprise Equity Price Value Value share 192,725,043 149,531,694 14.95 191,332,956 148,139,608 14.81 192,029,000 148,835,651 14.88 191,332,956 148,139,608 14.81 192,725,043 149,531,694 14.95

/ EV/EBITDA 2011 8.80 x 8.73 x 8.76 x 8.73 x 8.80 x

PER 2011 15.84 x 15.69 x 15.76 x 15.69 x 15.84 x

For the deal ProSun Solarium, the acquirer pays 57,000, 000 Aces for 57% of the capital of the target. So the Equity value of 100% of the shares is equal to 100,000,000 Aces, hence the EV is equal to 169,044, 000 Aces. Indeed, the debt is equal to 69,044, 000 Aces. Based on 140, 000, 000 Aces of sales and an EBITDA of 20,000,000 Aces, the EV/Sales is thus equal to 1.21x and the EV/EBITDA is equal to 8.45x. For the Deal Sonaluna-Rainbow&Co, the EBITDA is missing but we have the EBITDA Margin so we can easily infer the EBITDA which is equal to 6,580,000 Aces =[47,000,000 x 14%]. The mean EBITDA multiple is equal to 8.73x (the sum of the four calculated EBITDA multiple divided by 4). The enterprise value ranges between 192,725,043 Aces and 191,332,956 Aces. The corresponding Equity Value ranges between 149,531,694 Aces and 148,139,608 Aces. Therefore, the price per share ranges between 14.95 Aces and 14.81 Aces while the mean price per share is equal to 14.88 Aces.

Part 4: Deal Rationales Bellow the correct answer Dear Shareholders,

As discussed earlier, please find bellow some rationals for the projected merger with SunConcentrate. One of the major advantages of this deal is that it will create economies of scale and lower production costs for us because it eliminates many of the price markups in each production step. The merger will lead to improved cost efficiencies by controlling quality at each step, which reduces repair costs and downtime. In addition, vertically-integrated companies do not have to allocate resources to pricing, paying, contracting, and coordinating with third-party vendors. Vertical integration can ultimately create barriers to entry for potential competitors and will allow as to control the solar energy Market by increasing our production capacity at a lower cost than our competitors. This merger will allow us to manufacture everything in house in order to become less dependent on third-party suppliers for various materials and, therefore, capture margin at all stages of the manufacturing process. This not only saves costs, it enables the new entity to realize greater technology and cost synergies, which is particularly useful during a period of margin compression. Solaris Omni Co will exploit the newly acquired expertise in each step of the production process, maximizing the advantages of being vertically integrated. Solaris Omni Co must know how to manufacture solar panels as well as it knows how to produce solar energy. Another considerable risk is that we may need to modify our infrastructure significantly to accommodate technological changes and other industry innovations. This investment in infrastructures can be very expensive and limit the company's flexibility. By controlling the value chain the company also becomes responsible for innovation and product variety. The deal will provide a strong strategic complement to our downstream vertical integration opportunities and will provide Sun Concentrate Power Co the opportunity to envisage extendingits operations in Universe City. In addition, the strength of our newly vertical platform should provide us with significant competitive advantages going forward. The deal will allow us to capture upstream and downstream profits margins, In fact, in the increasingly competitive international solar power market, vertical integration has become a critical competitive advantage. The ability to manufacture all the elements of the solar power value chain silicon ingots, wafers and solar cells can help us to expand margins, lower

overall production costs, control the quality of production and achieve success in this competitive industry. Solaris Omni will acquire Sun Concentrate by issuing new shares at current price. I believe that the price/share that we will offer for the shareholders of the targetted firm is attractive and its in line with the recent M&A transactions in the solar panels market. The ratio of Sun Concentrate share price to Solaris Omni Share price, aka the exchange ratio, is beneficial to both corporations.However, the deal is accretive for us as it improves our earning per share by 14% (closest value to 14.79% which is the exact answer). In addition, the target has a lower leverage ratio than our company and this will lead to reducing our leverage ratio by 29% (2). Im convinced that the deal involves a lot of advantages & synergies for Solaris Omni Co. and hope that you will actively support this transaction so we can complete the deal. If you have any remarks or further questions, dont hesitate to contact me. Regards, JMK The table bellow summarizes the correct answer: Share Price Profit After Taxes In Aces PER Number of shares Earnings Per Share (EPS) Net Debt EBITDA Leverage Ratio Net Debt / EBITDA

Solaris Omni Co 11.00 5,550,000 19.82 x 10,000,000 0.555 30,000,000 9,000,000 3.33 x

Sun Concentrate Co 14.88 9,441,253 15.76 x 10,000,000 0.944 43,193,349 21,910,207 1.97 x

 Exchange Ratio number of new shares issued by Solaris Omni Co. Offer Value New number of shares (old+new issued) Pro Foma Net Profits of the new entity Pro Forma PER of the new entity Market Capitalization of the new entity EPS of the new Entity Impact of the Merger Dillutive/Accretive (Ace per Share) Dillutive/Accretive (in % per Share) Pro Foma EBITDA of the new entity Pro Foma Net Debt of the new entity Pro Foma Leverage Ratio Net Debt / EBITDA Impact on Leverage Ratio Net Debt / EBITDA
(1)

Sun Concentrate Power Co 1.35 x 13,530,514 148,835,651 23,530,514 14,991,253 17.27 x 258,835,651 0.637 Accretive 0.082 14.79% 30,910,207 73,193,349 2.37 x -29.0%

The exchange parity is equal to 1.35x = price per share of the target/price per share of the acquirer= 14.88/11. The number of new shares issued is equal to 13 530 514 = exchange parity x number of the targets shares = 1.35 x 10,000,000. The offer value = number of shares x price per share = 14.88 x 10,000,000 = 148,800,000 Aces. And the new number of shares is equal to 23,530,514 = 13,530,514 + 10,000,000. The Pro forma Net Profits of the new entity is equal to 14,991,253 = (0.555x10,000,000) + (0.944x10,000,000). The PER of the new entity is equal to 17.27x = (the new number of shares x price per share of the acquirer)/ Pro forma Net Profits of the new entity = (23,530,514 x 11)/ 14,991,253 The new market capitalization of the new entity is equal to 258,835,651 = the new number of shares x price per share of the acquirer = 23,530,514 x 11.

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The new EPS of the new entity is equal to 0.637 = Pro forma Net Profits/ number of new shares = 14,991,253 / 23,530,514. The impact on the merger is therefore accretive as the EPS of the new entity increases by 0.082 Ace in value [0.637 0.555] and by 15% in percentage [(0.637 0.555)/0.555]. The pro forma EBITDA of the new entity is equal to 30,910,207= 9,000,000 + 21,910,207 The pro forma Net Debt of the new entity is equal to 73,193,349 = 30,000,000 + 43,193,349 So the new Debt/EBITDA ratio will drop from 3.33x [30,000,000 / 9,000,000] to 2.37x [73,193,349 / 30,910,207] and will reduce the leverage ratio of the new entity by 29% [(2.37- 3.33)/3.33]. Part 5: Valuation Update The new information given will lead to a change in the cost of Equity and the in DCF valuation model. The impact of the cost of equity: (players have just to calculate the new mean unlevered beta of the comparables)
Company Sunshine& Co Solarium ElecSun Mean Levered Beta 1.59 1.49 1.46 1.51 Market Cap 320,000,000 250,000,000 450,000,000 Debt 80,000,000 70,000,000 110,000,000 D/E 25.0% 28.0% 24.4% 25.8% Unlevered Beta 1.35 1.246 1.247 1.28

Then the cost of equity will change as shown in the table below: The Levered beta used for the cost of equity calculation is equal to 1.58. Using the CAPM formula, the cost of equity is equal to 14.49% = [5%+(1.58x6%)] and the new WACC will be equal to 12%= [(6.5%x(1-30)x25%)+ (14.49%x75%)].

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Cost of Equity Calculation Risk Free rate Equity Risk Premium Taxes Unlevered Bta Leverage D/E Leveraged Bta Cost of Equity Cost of Debt Calculation Equity as % of Total Assets Debt as % of Total Assets Risk Free rate Interest Coverage ratio Rating Spread Pre-Tax Net Interest Bearing Debt After Tax Cost of Debt Debt Contribution to WACC Equity Contribution to WACC WACC Pepetuity factor

5.00% 6.00% 30% 1.28 33.33% 1.58 14.49% 75.0% 25.0% 5.00% 5.80 x A+ 1.50% 6.50% 4.55% 1.138% 10.86% 12.00% 1.00%

The solution of the new DCF is given below (Players have to use the same formula applied in of part 2 the case) of Discounted FCF Terminal Value Present Value of Terminal Value Enterprise Value Debt Equity Value Number of shares Price/share 56,807,540 128,440,930 72,874,239 129,681,779 43,193,349 86,488,430 10,000,000 8.65

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And the new price per share of Sun Concentrate Co. will be 11.73 = (8.65+14.81)/2. Method DFC (target Valuation) Comparables transactions Mean Min Max Enterprise Equity Price Value Value share 129,681,779 86,488,430 8.65 191,332,956 148,139,608 14.81 160,507,368 117,314,019 11.73 129,681,779 86,488,430 8.65 191,332,956 148,139,608 14.81 / EV/EBITDA 2011 5.92 8.73 7.33 5.92 8.73 x PER 2011 9.16 15.69 12.43 9.16 15.69 x

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