1) Explain and critically assess how Meter-matic measures up as a candidate for a leveraged buy-out? Include information about economic references from the graphs shown in the text. What are the implications of the bond rate declining and the rand becoming stronger against the US dollar? A MBO of Meter-matic Limited (Meter-matic) was considered by the CEO his management team for mainly strategic reasons. Meter-matic did not fit into SAFREN’s strategic vision (according to Piet Malan and his management team) and was not seen as a core activity by its parent company -Meter-matic was too small to warrant much attention within the SAFRAN group. Its products required a high level of technical skill and management was becoming increasingly indispensable to the operations (all of which SAFREN perceived as a weakness). The management team made up their conclusion by the fact that Meter-matic had received no attention at a strategic retreat and several of the SAFRAN board members clearly knew very little about the division. Capital expenditure was rarely allocated to the division.
A concern is that due the lack of strategic fit Meter-matic was not able to take advantage of investment opportunities of which: -Industry outlook for the foreseeable future in South Africa was good by the nature of the product, due to opportunities by governmental initiatives. It was apparent that potential existed to market the company’s technology to other fluid-handling industries. -Meter-matic’s own designed products had received considerable interest from overseas suppliers and there was a strong possibility of exports in this area.
SAFREN had insufficient resources to actively market and support technology exports. Besides the strategic arguments the CEO, Piet Malan felt that he might be better able to retain his senior management team if they felt they “owned” a significant share of their company and raised additional capital for growth. His management team, especially the sales manager, was very keen to take over the management control of Meter-matic. The following features make Meter-matic more attractive as a leverage buyout candidate [reference Wikipedia, 12manage. om]: Parent company -SAFREN may be willing to cooperate with the MBO as Meter-matic is not one of their core competencies. -Meter-matic is a stand-alone entity and could be separated from the parent company. Management -Metermatic has a competent management team with extensive experience in the business/industry and with an acknowledged track record. The management team was committed to a MBO as it wanted to gain independence and autonomy, a chance to influence the strategy of the company and the prospect of a capital gain. Market and market position The market of fluid control systems for the petrochemical industry was stable and mature as the industry provided a basic non-substitutable product for the foreseeable future and the need for fluid control systems existed due to the issue of “shrinkage” (abnormally high in South Africa). -Metermatic has high technology, system-orientated, fluid control products, the company operates within a defined market. The business appeared to have significant growth prospects, both with the petrochemical industry and for other applications (e. g. water reticulation, diaries, etc. , and there was the possibility of significant export revenue being realized. -Dominant market share in its niche of the market, the installation of new fluid control systems in the petrochemical industry. A differentiator was its ability to design a customized, integrated turnkey system which addressed the specific needs of the client. Strong relationships with several of the major oil companies. Financial -Profitable history (last 3 years relative high EVA) and proven record. It has a multi-year history of stable and recurring cash flows. -The purchase price of R100 million is largely supported by assets of high quality. Low capital expenditure and working capital requirements (this is not the case for Meter-matic!!! ) need hard evidence -It had low existing debt loads (debt had decreased from 16% in 2000 to null in 2003). -It had hard assets (buildings, plants, inventory and receivables) that may be used as collateral for lower cost secured debt. Price of long term borrowing is decreasing therefore the costs of taking debt is at an all time low. (5) Rough value for the convertible debt •The convertible debt amounts R5m •The R5m would be the debt’s par (and maturity) value •Conversion option on an equal portion of the debt The value of the stock EQUIS would receive if the debt was converted at t=0, is R(5/100)*valuation company beginning 2004. However this value can’t be paid out, cash will be received at a sale or liquidation or going public. If the value of the company is getting higher than just after the MBO the debt will be converted before/during a sale or exit. Therefore the value of the convertible debt can be seen as an option (I can’t find exact theory, the book describes bonds to be converted to common stock which can be liquidated on order.
In the reader ‘a note on private equity securities’ I can’t match the private equity securities as described ??? ) Given the uncertainty of future value of the share you can make projections with different possibilities and calculate the NPV. A better method (Poppe) is real options Calculation (excel is attached) •Assumption is sales or exit after 5 years •Valuation of Meter-matic end of 2008 (sales price used in question 3) •Ps = NPV of all FCF / value of the company (calculated in Q2) * 5/100 -> R5/R100 •Pe=NPV of the fixed costs (=investment now: R5m) Volatility ??? as used in Q? ( has to be consistent) •R= risk free interest (< 12 %; assumption necessary? •d=5 REAL OPTION CALCULATION • Ps = NPV of all FCFs / value of the company (as calculated in Q2) * (5/100) • Pe=NPV of the fixed costs (=investment now: R5m) • Var(ri) = volatility as used in Q? ( has to be consistent)volatility and probability • R= risk free interest (< 12 %; assumption necessary? ) • d=5 Ps250. 0000,0512. 500 Pe5. 000 Var(ri)0,110% R8,50% d5 x2,250424935
N(x)0,98 y1,543318154 N(y)0,9394 premium9. 179 The Pe may have to be subtracted from the premium! (6) To what extent are MBOs unethical? Do you foresee any problems in Piet Malan taking this proposal to the SAFRAN Board? In management buyout transactions (MBOs) one could say that there is a conflict of interest—an incentive is created for managers to mismanage (or not manage as efficiently) a company, thereby depressing its stock price, and profiting handsomely by implementing effective management after the successful MBO.
Management joins forces with other investors and buys the company from the public. The critic is about fairness for the shareholder. Management’s position on both sides of the bargaining table may make buyout price suspect even when shareholders are bought out at premiums. Critics find it difficult to see how management members of the buyout team can serve effectively as fiduciaries of selling shares and at the same time negotiate on their own behalf as buyers.
Further the management’s knowledge of the company and their special appreciation for its value give management a decided advantage vis-a-vis shareholders and potential competitors when progressing a buyout. Management has also the ability to control the company’s stock price by controlling the flow of information, by its choice of accounting procedures and by its timing of strategic decisions. However there may be cases in which a MBO is in the shareholders best interest and we believe that this could be valid in the case of Meter-matic.
We don’t foresee any problems in Piet Malan taking this proposal to the SAFRAN Board as there are clear strategic reasons for selling Meter-matic. However, the Board would have to deal with the transaction carefully and would the right measurement to guarantee a fair process to its shareholders. The conflict of interest inherent in management buyouts can be dealt with through a system of disclosure and review provided that management, board members, shareholders, and judges apply an appropriate standard of fair price.
References Sources (references): Table 1 Characteristics of a successful MBO candidate Wikipedia http://www. 12manage. com/methods_leveraged_buy-out_nl. html http://faculty. darden. virginia. edu/brunerb/Bruner_PDF/Management%20Buyouts%20and%20Managerial%20Ethics. pdf http://www. springerlink. com/content/x44141133177815p/ http://en. wikipedia. org/wiki/Leveraged_buyout#Management_buyouts http://cmr. berkeley. edu/search/articleDetail. aspx? article=4618