On Monday, September 8, 1988, Greg Rudka, managing director at Scotia Capital, called James Vaux to office to discus about a story that has appeared in the newspaper that morning. There is a resignation of former president and chief operation officer in Oshawa Group Limited. Their client Empire Company Limited interested in takeover Oshawa to expanding beyond their Atlantic Canada roots.
Decisions need to be made
James Vaux needs to determine whether use debt or equity to finance the acquisition of Oshawa Group Limited.
Factor to Consider
1）The Grocery Business Environment in Canada
The grocery business was a mature industry. In 1998 grocers faced increasing competition not only from other grocers, but also increasingly from various non-traditional vendors including drug stores, discount retailers, wholesale clubs and internet-based operations.
2）The key Success Factors in Canada
On the revenue side, growth occurred primarily through horizontal merger and acquisition activity. First, it was generally cheaper to acquire a competitor than to open new stores. Acquisition also mitigated risks associated with entering a new market including lack of local knowledge, difficulty of attracting a qualified work force and the threat and intensity of competitive response. Horizontal acquisition activity also generated the economies of scale in marketing, procurement, distribution, technology, and corporate overhead and private-label development.
3）The Strength of Oshawa Group Limited：
The Agora food merchants is second largest food retailer. It provides Oshawa a strong source of revenue; the food retailer generates most portion of revenue. The SERCA foodservice was Canada’s largest foodservice business and distributed a full line of grocery. It provides the company a strong competitive advantage in foodservice and distribution line in Canada. Company may reduce cost and taking advantages of product pricing. Geographic advantages:
The Agora food merchants is operated in all provinces of Canada. The company has captured the wide range of market shares in all the provinces in Canada; it provides company more sources of generating revenues.
4）The Weakness of Oshawa Group Limited：
Human Resource disadvantage
The company has limited themselves on the decision-making. Because the family member has all the voting rights and they are active in the operation of the company. Which means, the senior management could not easily to make decision based on the outside factors.
5）The Threats of Oshawa Group Limited：
The major competitors are Loblaws, Metro-Richelieu and Provigo. Among those competitors, the Loblaws is a strong competitor for Oshawa. From market shares to the revenues, Loblaws is already a matured business in Canada.
6）The Opportunity of Oshawa：
The store improvements had traditionally been low, which means that some of the stores would be in very poor condition and would require substantial investment. The company could improve its store facilities; it will increase the store efficiency.
7）The Oshawa Group Limited Operations:
Oshawa was a food retail, wholesale and distribution company. It directly operated some grocery stores, but the majority (82 per cent) of their 845 stores were franchised operations. The company was divided into a grocery division, Agora Food Merchants and a food service division, SERCA Foodservice. Agora Food Merchants was Canada’s second largest food retailer and was responsible for 82 per cent of Oshawa’s revenues in 1998. It operated in all provinces of Canada, except British Columbia, primarily as a supplier of products and marketing programs to independent grocers under the IGA, Knechtel, Omni and Bonchoix banners. SERCA Foodservice was Canada’s largest foodservice business and distributed a full line of grocery and perishable products to the institutional, health care, hotel and restaurant trades. It operated in all 10 Canadian provinces, but the majority of its revenue came from the western provinces. Between 1997-1998, the company has restructuring which involved, sale of non-core holdings, including the divestitures of its drug store operation, its cold storage facilities and non-strategic real estate, and expansion of its retail and foodservice business.
8）The Human Resource Management：
The company was formed in 1951 when Ray Wolfe first brought the Independent Grocers Alliance to Canada. The Wolfe family remained relatively active in the operation of the company, retaining all of the voting equity in the firm, as well as occupying senior management positions and five of the 12 board seats.
Empire does not make bid (and acquired), Oshawa Group Limited as a stand-alone entity. Empire does not spin off its food distribution and takes $ 1520 million ($40/share) included premium new debt to purchase Oshawa ‘s Class A Shares to acquire Oshawa. Empire does not spin off its food distribution and acquire Oshawa by financing the Oshawa common share by issuing 35 million shares ($23/share). Empire spins off its food distribution and acquires Oshawa, and then using $145.5 million cash included premium and issuing 6 million shares ($44/share) from new food distribution Company to finance Oshawa common shares.
Industry and type of company. Is Empire looking for a business similar to its business, or does Empire want to diversify? Level of sales and profit margin. Would Empire consider a company with a lower EBITDA margin than itself? Geographic location. Where does Empire want to buy? Is there any operation advantage by taking Oshawa? Bid price and risk management of company. What price would Empire make bid? Does it have any risk of issuing new equity? Is it worth to take the price? The PV of the total cash flow after synergy. Is the PV of total cash flow great than 0? Or smaller than 0? Greater than without acquisition?
Evaluation of Alternatives
If Empire does not make a bid, the Oshawa is going to stand-alone operation. Criteria 1,2,3,4,5 do not satisfied. Although, Empire does not have to take risks of taking over the Oshawa, but it will loses a big chance in improving its market shares in the Food Service and Merchants industry. In a worst scenario, Oshawa becomes one of the major competitors in the market. The company faces more competitions in market.
Criteria 1: Oshawa has strong background in food service and distribution industry, since Empire has the food service division already. The advantage of acquiring Oshawa is enhancing its operations in food service industry. Not diversify its business. Criteria 2: I assume the revenue will be 7 billion; the EBITDA margin is 2.4% in1999. In 1999, Oshawa has EBITDA Margin 2.4% is too low than its major competitors Loblaws 5.1% million and Provigo 4.0%. EBITDA margin shows that the Oshawa has too many operating expense, the expenses shrink the earnings from total revenue. This problem indicates that Oshawa needs a solution on this problem. Empire has EBITDA about 6.8%, it is higher than Loblaws and Provigo. It means that Empire is doing well on controlling the expenses and enjoy profits from revenues.
By acquiring Oshawa, Empire could apply its method on Oshawa, and make Oshawa more profitable and find out its more potential profitability. Alternative 2 does satisfy in criteria 1. Criteria 3: The Oshawa had business in all provinces in Canada; it pretty much covers a great geographic market. By acquiring Oshawa, Empire gains more strength in food service and merchant industry, and more market shares around Canada. Alternative 2 does not satisfy in criteria 3. Criteria 4: The Empire will bid a price for $40 per share to purchase Oshawa’s shares. Empire takes new debt about 35*40= $1400 million dollars. But in the paper, it says Empire could not take any new debt anymore, because empire has already with too much debt. Any more additional debt means relatively expensive and threaten its A debt rating. Alternative 2 does not satisfy in Criteria 4. Criteria 5: Since it is not suggested to take additional loan. There would not be acquisition happened. There is no PV of future cash flow after synergy. Alternative 2 does not satisfy in Criteria 5.
3) Alternative 3:
Criteria 1: It will be same as alternative 2 criteria 1. The Alternative 3 will satisfy criteria 1. Criteria 2: It will be same as alternative 2 criteria 2. The Alternative 3 will satisfy criteria 2. Criteria 3: It will be same as alternative 2 criteria 3. The Alternative 3 will satisfy criteria 3. Criteria 4: The Empire will bid $23 per shares by issuing more stocks to finance the deal. But the Oshawa has controlled too many shares in Empire; there is a really high potential risk that Empire will take over by someone else if it is not Oshawa. According to its risk level, Empire should not finance the deal by issuing shares. The alternative 3 will not satisfy criteria 4. Criteria 5: Since it is not suggested to issuing more shares. There would not be acquisition happened. There is no PV of future cash flow after synergy. Alternative 2 does not satisfy in Criteria 5.
4) Alternative 4:
Criteria 1: It will be same as alternative 2 criteria 1. The Alternative 4 will satisfy criteria 1. Criteria 2: It will be same as alternative 2 criteria 2. The Alternative 4 will satisfy criteria 2. Criteria 3: It will be same as alternative 2 criteria 3. The Alternative 4 will satisfy criteria 3. Criteria 4: The Empire will spin off its food division, using some cash and issuing new shares from the new entity to acquire Oshawa. The new market share price of the food division is $44 per share, then Empire issuing 6 million shares to finance the acquisition. Additional cash was also in the deal. Because Wolfe family does not just like equity, they also need cash to expand their business. It is much more safe on the control over of the company by Empire. So this alternative satisfies criteria 4. Criteria 5: The potential PV of the company future cash flow in infinite years after synergy is $3500 million in EBITDA Margin Enhancement Method, $135 million in Cost Reduction Potential Method. The total of them are greater than not acquiring Oshawa $510. It shows that it has a potential profitability after acquisition. Alternative 4 satisfy criteria 5.
As James Vaux, I will choose alternative 5 based on the criteria analysis.
Plan of Action
The Empire will spin off its food division. And then valuate its share price, issuing new shares and cash to acquire Oshawa 65% of the total shares. $145.5 million cash included premium and issuing 6 million shares ($44/share) from new food distribution Company to finance Oshawa common shares.