Margate Group plc is a large, long-established company whose primary interests are in transport and distribution within the United Kingdom. It is considering a bid to acquire Hastings plc, a company also in the transport and distribution industry. Hastings plc, however, has a strong operations base in Europe as well as in the UK. Both companies are listed on a recognised stock exchange. They both have a wide share ownership including many institutional investors. Hastings plc has recently fought off a bid from a company based in the United States of America and has made a public statement that it will defend itself against any future bids. The company has recently won a fiercely contested five-year contract to undertake transport and distribution services for a major supermarket group. Margate Group plc also tendered for this contract. Press comment suggests this contract will allow Hastings plc’s earnings to grow at 10% a year for at least the next five years. However, some industry experts believe Hastings plc tendered a price that was so low that the contract could result in very little profit, or even losses. If the acquisition were to succeed, it would create the largest company of its kind in the UK. A concern is that this would attract the interest of the competition authorities. However, as both companies have recently restructured their operations, redundancies are likely to be few and concentrated mainly in central administration. Financial Statements Key financial information for the two companies for the latest financial year is given below. All figures are in £ million unless otherwise stated. STATEMENTS OF PROFIT OR LOSS FOR THE YEAR TO 31 AUGUST 20X1 Margate Group plc Hastings plc £m £m Revenue 2,763 1,850 Operating costs 1,950 1,380 Operating profit 813 470 Net interest 125 85 Profit before tax 688 385 Tax 185 85 Earnings 503 300 Dividends declared 201 135 Retained profit for the year 302 165 Earnings per shares (pence) 47.90 35.29 EPS for year to 31 August 20X0 (pence) 34.85 29.50 STATEMENTS OF FINANCIAL POSITION AT 31 AUGUST 20X1 Margate Group plc Hastings plc £m £m Non-current assets (net book value) 3,250 2,580 Current assets Inventory 125 175 Receivables 550 425 450 45 Payables: due within 1 year Bank overdraft 0 420 Trade payables 755 365 Payables: due after 1 year Debentures 1,450 950 Tax 150 40 Net assets 2,020 1,450 Capital and reserves Share capital (£1 each) 1,050 850 Share premium 220 150 Retained earnings 750 450 Total shareholders’ funds 2,020 1,450 Note. Margate Group plc’s debenture is 8%, repayable 20X5. Hastings plc’s is 9%, repayable 20X4. Share price information (prices in pence) Margate Group plc Hastings plc Share price movements: High for last financial year 705 590 Low for last financial year 470 440 Share price today (20 November 20X1) 671 565 P/E ratios today 14 16 Equity betas Other information 1.1 1.2 · The average P/E for the industry is currently estimated as 13. · The return on the market is currently estimated as 12%, the risk-free rate as 6%. These rates are expected to remain constant for the next 12 months and are post-tax. · The average debt ratio for the industry (long-term debt as proportion of total long-term funding) is 30% based on book values. · Economic forecasts provided by Margate Group plc’s financial advisors expect inflation and interest rates to remain at their current levels for the foreseeable future. Inflation is currently 2% a year. Terms of the proposed bid Margate Group plc’s directors are planning to offer a share exchange to Hastings plc’s shareholders. Required (a) Calculate and discuss briefly three key ratios for both companies that are relevant to the evaluation of the proposed acquisition. (b) Calculate a range of possible values that Margate Group plc could place on Hastings plc, using both P/E basis and the dividend growth model. Accompany your calculations by brief comments or explanations. Where necessary, explain any assumptions you have made (c) Assume you are the Financial Manager with Margate Group plc. Write a report to the directors of the group that evaluates the proposed acquisition. You should use the figures you have calculated in answer to parts (a) and (b) to support your recommendations/advice where relevant. If you have not been able to do the calculations for parts (a) and (b), you should make, and state, appropriate assumptions. Your report should include the following topics. (i) Recommendation to the directors of a bid price and offer terms, assuming a share-for-share exchange. (ii) Advice on a strategy for making the offer to Hastings plc to minimise the likelihood of outright rejection by the Hastings plc board, and a discussion of the other risks involved in making the bid. (iii) Discussion of the strategic and financial advantages that might arise from the acquisition by Margate Group plc of Hastings plc. Support your discussion with calculations of the post-acquisition value of the combined group and how the estimated gains are likely to be split between the shareholders of Margate Group plc and Hastings plc. Professional marks will be awarded for the structure and presentation of the report.