The BirdieGolf-Hybrid Golf Merger Case – Solution

Solution

Birdie Golf, Inc. has been in merger talks with Hybrid Golf Company for thepast six months. After several rounds of negotiations, the offer underdiscussion is a cash offer of $440 million for Hybrid Golf. Both companies haveniche markets in the golf club industry, and the companies believe a mergerwill result in significant savings in general and administrative expenses.

Bryce Bichon, the financial officer for Birdie, has been instrumental in the mergernegotiations. Bryce has prepared the following pro forma financial statementsfor Hybrid Golf assuming the merging takes place. The financial statementsinclude all synergistic benefits from the merger:

 

2010

2011

2012

2013

2014

Sales

$640,000,000

$720,000,000

$800,000,000

$900,000,000

$1,000,000,000

Production Cost

$449,000,000

$504,000,000

$560,000,000

$632,000,000

$705,000,000

Depreciation

$60,000,000

$64,000,000

$66,000,000

$66,000,000

$67,000,000

Other Expenses

$64,000,000

$72,000,000

$80,000,000

$90,000,000

$97,000,000

EBIT

$67,000,000

$80,000,000

$94,000,000

$112,000,000

$131,000,000

Interest

$15,200,000

$17,600,000

$19,200,000

$20,000,000

$21,600,000

Taxable Income

$51,800,000

$62,400,000

$74,800,000

$92,000,000

$109,400,000

Taxes (40%)

$20,720,000

$24,960,000

$29,920,000

$36,800,000

$43,760,000

Net Income

$31,080,000

$37,440,000

$44,880,000

$55,200,000

$65,640,000

 

Bryce is also aware that the Hybrid Golf Division will require investments eachyear for continuing operations, along with sources of financing. The followingtable outlines the required investments and sources of financing.

2010 2011 2012 2013 2014

Investments:

Investments 2010 2011 2012 2013 2014
Net Working Capital $1,60,00,000 $2,00,00,000 $2,00,00,000 $2,40,00,000 $2,40,00,000
Fixed Assets $1,20,00,000 $2,00,00,000 $1,40,00,000 $9,60,00,000 $56,00,000
Total $2,80,00,000 $4,00,00,000 $3,40,00,000 $12,00,00,000 $2,96,00,000

Sources of financing:

New Debt $2,80,00,000 $1,28,00,000 $1,28,00,000 $1,20,00,000 $96,00,000
Profit Retention $0 $2,72,00,000 $2,16,00,000 $2,16,00,000 $2,00,00,000
Total $2,80,00,000 $4,00,00,000 $3,44,00,000 $3,36,00,000 $2,96,00,000

The management of Birdie Golf feels that the capital structure at Hybrid Golfis not optimal. If the merger take place, Hybrid Golf will immediately increaseits leverage with a 88 million debt issue, which would be followed by a 120 milliondividend payment to Birdie Golf. This will increase Hybrid’s debt to equityration from .50 to 1.00. Birdie Golf will also be able to use a 20 million taxloss carry forward in 2011 and 2012 from Hybrid Golf’s previous operations. Thetotal value of Hybrid Golf is expected to be 720 million in five years, and thecompany will have 240 million in debt at that time.

Stock in Birdie Golf currently sells for 94 a share, and the company has 14.4million shares of stock outstanding. Hybrid Golf has 6.4millionshares of stock outstanding. Both companies can borrow at an 8% interest rate.The risk-free rate is 6%, and the expected return on the market is 13%. Brycebelieves the current cost of capital for Birdie Golf is 11%. The beta for HybridGolf stock at its current capital structure is 1.30.

Bryce has asked you to analyze the financial aspects of the potential merger.Specifically, he has asked you to answer the following questions:

1. Suppose Hybrid shareholders will agree to a merger price of 68.75 per share.Should birdie proceed with the merger?

2. What is the highest price per share that Birdie should be willing to pay forHybrid?

3. Suppose Birdie is unwilling to pay cash for the merger but will consider astock exchange. What exchange ratio would make the merger terms equivalent tothe original merger price of 68.75 per share?

4. What is the highest exchange ratio Birdie would be willing to pay and stillundertake the merger?

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