Section B – TWO questions ONLY to be attemptedLouieed Co Louieed Co, a listed company, is

Section B – TWO questions ONLY to be attempted

Louieed Co

Louieed Co, a listed company, is a major supplier of educational material, selling its products in many countries. It supplies schools and colleges and also produces learning material for business and professional exams. Louieed Co has exclusive contracts to produce material for some examining bodies. Louieed Co has a well-defined management structure with formal processes for making major decisions.

Although Louieed Co produces online learning material, most of its profits are still derived from sales of traditional textbooks. Louieed Co’s growth in profits over the last few years has been slow and its directors are currently reviewing its long-term strategy. One area in which they feel that Louieed Co must become much more involved is the production of online testing materials for exams and to validate course and textbook learning.

Bid for Tidded Co

Louieed Co has recently made a bid for Tidded Co, a smaller listed company. Tidded Co also supplies a range of educational material, but has been one of the leaders in the development of online testing and has shown strong profit growth over recent years. All of Tidded Co’s initial five founders remain on its board and still hold 45% of its issued share capital between them. From the start, Tidded Co’s directors have been used to making quick decisions in their areas of responsibility. Although listing has imposed some formalities, Tidded Co has remained focused on acting quickly to gain competitive advantage, with the five founders continuing to give strong leadership.

Louieed Co’s initial bid of five shares in Louieed Co for three shares in Tidded Co was rejected by Tidded Co’s board. There has been further discussion between the two boards since the initial offer was rejected and Louieed Co’s board is now considering a proposal to offer Tidded Co’s shareholders two shares in Louieed Co for one share in Tidded Co or a cash alternative of $22·75 per Tidded Co share. It is expected that Tidded Co&39;s shareholders will choose one of the following options:

(i) To accept the two-shares-for-one-share offer for all the Tidded Co shares; or,

(ii) To accept the cash offer for all the Tidded Co shares; or,

(iii) 60% of the shareholders will take up the two-shares-for-one-share offer and the remaining 40% will take the cash offer.

In case of the third option being accepted, it is thought that three of the company&39;s founders, holding 20% of the share capital in total, will take the cash offer and not join the combined company. The remaining two founders will probably continue to be involved in the business and be members of the combined company&39;s board.

Louieed Co’s finance director has estimated that the merger will produce annual post-tax synergies of $20 million. He expects Louieed Co’s current price-earnings (P/E) ratio to remain unchanged after the acquisition.

Extracts from the two companies’ most recent accounts are shown below:

The tax rate applicable to both companies is 20%.

Assume that Louieed Co can obtain further debt funding at a pre-tax cost of 7·5% and that the return on cash surpluses is 5% pre-tax.

Assume also that any debt funding needed to complete the acquisition will be reduced instantly by the balances of cash and cash equivalents held by Louieed Co and Tidded Co.

Required:

(a) Discuss the advantages and disadvantages of the acquisition of Tidded Co from the viewpoint of Louieed Co. (6 marks)

(b) Calculate the P/E ratios of Tidded Co implied by the terms of Louieed Co’s initial and proposed offers, for all three of the above options. (5 marks)

(c) Calculate, and comment on, the funding required for the acquisition of Tidded Co and the impact on Louieed Co’s earnings per share and gearing, for each of the three options given above.

Note: Up to 10 marks are available for the calculations. (14 marks)