U.S. Stores Inc is a US based retailer thats half the size of Wal-Mart Stores (valued at 136 billion GBPs or USD 207.8) and is planning to increase its market beyond North America by expanding into Europe, Gulf States and the Far East. To put U.S. Stores Incs size and plans in perspective, recall that Wal-Mart Stores is the worlds leading retailer, with 374.5 billion in sales revenue and 22 billion in profits in 2008. U.S. Stores Inc is initially interested in merging with a suitable retailer in the United Kingdom and has Morrisons Supermarkets Plc, J Sansburys Plc, and Mikes Spencer as potential targets. The market capitalization of Morrisons is currently estimated at 7.79 GBPs, while Marks Spencer and Sainsburys are 5.78 and 6.20 GBPs, respectively. However, the three firms must be valued and their financial statements analyzed to get a picture of their worth as potential takeover targets.
Since there are several methods of valuing comparable companies in an industry, I decided to analyze comparative financial ratios to assess the suitability of Sansburys, Morrisons, or Marks Spencer as targets. I selected Morisons as a takeover target based on results of its consolidated income and balance sheet statement statements together with those of Sansburys and Mikes Spencer between 2006 and 2009, 2006 being the base year. Their consolidated income statements provided the following results
Revenues- of the three firms, Sainsburys had the highest net sales overall during the analysis period, followed by Morrisons, and lastly by Marks Spencer. However, a trend analysis indicated that Morrisons was consistently had the highest percentage increases during this period, relative to the other two firms, which had volatile results. See the tables below.
Gross profit The Gross Profit Margin measures the basic structure of a firm and its evident from this analysis that this ratio has been volatile during the four years of analysis, even although Sainsburys and Marks Spencer firms had higher ratios relative to Morrisons. However, while Morrisons ratio was lower, it increased consistently during this period. Its possible that the firms management team had a better product mix strategy compared to its main competitors. Marks Spencer and Sainsburys had higher gross profits figures compared to Morrisons. But these results changed upwards or downwards every year. Morrisons on the other hand showed an upward swing in these profits through the analysis period. Trend analysis also indicated that Morrisons experienced the greatest percentage increase on this profitability metric every year. However, Morrisons gross profit margin ratio was the lowest but was increasing every year between 2006 and 2009. The two competitors had higher rates that were changed up and down during this period.
Net income Marks Spencer had the highest net income compared to the other two firms during this period. But a trend analysis indicated that Sainsburys was experiencing the highest percentage growth rate in net income per year, relative to its two competitors during the years of this review. Morrisons had the second highest percentage growth. Looking at income statements overall scorecard between 2006 and 2009, its safe to conclude that Morrisons was more stable compared to Sainsburys and Marks Spencer.
An analysis of their consolidated balance sheets revealed the following information
Current Ratios The Current Ratio examines the relationship between current assets and current liabilities and its computed by dividing current assets by current liabilities. This ratio measures a firms short term liquidity and whether it. A higher ratio is generally preferred by most firms. These current ratios experienced small changes during the four years of this analysis and this is consistent with the normal current ratio. Sainsburys had the highest ratio in 2006 which kept declining over the next three years. Morrisons on the other hand started off with the lowest ratio and kept increasing it every year.
This was a very impressive feat to achieve considering the fact that its rivals were either experiencing declining or volatile ratios. However, its always necessary to compare these ratios with similar figures for in the same industry and the aggregate market. If they differ from industry results, then its crucial to determine what reasons that might explain the discrepancies. Generally, the higher the ratio, the more likely it is that the firm will be able to meet its short-term obligations but a ratio of less than one implies that the firm has negative working capital and could be having liquidity problems. Working capital equals current assets minus current liabilities.
Debt-Equity Ratios The Debt to Equity Ratio measures a firms proportion of capital that is derived from debt relative to other sources of capital, such as common stock, preferred stock, and retained earnings. A higher amount of debt compared to equity makes earnings very volatile and hence increases the probability that the firm will be unable to meet the required payments and default on debt. A higher proportion of debt indicates greater financial risk. Marks Spencer had the highest debt to equity ratio during the period of this analysis, even though there were minimal increases and decreases each year. Morrisons had the lowest ratio, with Sainsburys falling in between.
Morrisons Supermarkets Plc is United Kingdoms fourth largest food retailer witha total of 403 stores, 370 of them located across the UK. Its business is mainly in the grocery and food business. The firm currently employs more than 114,000 staff working in its distribution centres, factories, head office and stores. From humble beginnings at a small stall in1899 when an egg and butter merchant, William Morrison, it now an award winning retailer in the UK. The firm went public in 1967 and has been expanding its operations since. Its expansion strategy included the acquisitions of Whelan Discount stores in 1978, Safeway in 2004, and Rathbone Bakery in 2005.
By most indications, Morrisons seemed a better target for acquisition relative to the two rivals examined in this analysis. I, therefore, would recommend to the U.S. Stores Inc, to initiate merger negotiations with it. The analysis of the sustainable growth potential examines ratios that indicate how fast a firm should grow. This enables shareholders and lenders to make the right investment decisions. Since its widely recognized that firms must be able to pay off their obligations, such analysis indicates the future potential of a firm. So, the growth of U.S. Stores Inc, will depend on the expected rate of return earned on the resources reinvested or the amount of resources retained and reinvested in it.
The cost of capital that I would use to value Morrisons Supermarkets would be the rate of return necessary to maintain its market value or the minimum rate of return on its investments. This rate of return should reflect U.S. Stores Incs weighted average cost of debt and equity funds. However, assuming that Morrisons growth will be in line with U.S. treasury bond interest rates, currently at 4.25, a fair value for Morrisons on a stand-alone basis is 4.79 billion GBP. However, according to publicly available information, its current market value is 7.79 billion GBPs. However, no matter how accurate this valuation, its prudent to consider the economic and as well as industry environments in the U.K. because of their major influences on the firms potential success and realization of rate of return for shareholders.
The success of the proposed merger could depend on the corporate strategy of the new (combined) firm. Examples of corporate strategies that have worked well for major retailers, particularly for Wal-Mart, in the past include (i) dominate the retail market in every market they enter, (ii) grow aggressively locally and abroad, (iii) build strong brand recognition, customer satisfaction and be associated with reasonable prices. These strategies have made Wal-Mart a dominant retailer world-wide and therefore might be helpful to U.S. Stores Inc as it pursues expansion abroad. The success of Wal-Mart abroad is indicated by its presence in Germany, China, United Kingdom, Mexico, Canada, Argentina, and Brazil.
The difference between Morrisons estimated value based on the treasury rate and the current market value could be explained by various factors. These factors include (i) in-built assumptions on future expectations, (ii) inflation rates, (iii) the level of interest rates, (iv) different valuation on debt, (v) different estimates on growth rates, (vi) different expected operating margins, (vii) tax rates, (viii) projections on inflation rates over the next few years, (ix) international economics, and (x) consumer sentiment. Higher inflation generally increase uncertainty on future prices and costs and could harm a firm that is unable to pass its cost increases on to consumers. Due to the fact that the U.S. and the U.K. experience different economic dynamics, domestic and international events may cause the value each countrys currency to fluctuate. The impact of such changes could lead to losses in revenues.
Since U.S. Stores Inc will be active in a foreign market and because it hopes to jumpstart its retail sales with expansion in the U.K., its necessary to consider the effects of this move on returns. The following factors come into play
The macroeconomic environment the U.K. will impact demand for retail products,
Significant changes in the exchange rate will impact the demand for American manufactured goods,
Accounting differences and their impacts on the relative valuation ratios.
The 1 cost saving in perpetuity due to the merger synergies would change the fair value of Morrisons to approximately 5.3 billion GBPs. The two types of synergies are cost savings and revenue enhancements. Cost savings could result from elimination of facilities, job functions and duplicated expenses that would no longer be required when certain activities at Morrisons get integrated with existing activities at U.S. Stores Inc. For example, cost savings could result from integration if the firms corporate properties department consolidated its functions by eliminating duplicate positions and reduced real estate space required to manage company properties across the organization. The stated costs could be computed and deducted from the expected cash outflows and therefore improve net cash flows and increase the Net Present Value of future cash flows.
Revenue enhancement could also result from the merger of U.S. Stores Inc and Morrisons, especially if the combined firm achieves higher sales revenue growth than each was able to achieve on its own. For example, Morrisons might have developed a special process and skills of producing and selling a certain product in its U.K. market. With the expanded market, it will be able to do the same in the U.S. hence increasing sales in this niche. The same could be true with U.S. Stores Inc in its North American marketplace. Therefore, the synergies resulting from the merger could help the firm to attain its intentions of jumpstarting and increasing market share.
Another factor to consider regarding the success of this type of merger is the successful integration of business models and governance structures. A good governance structure enhances managerial accountability to stockholders. For example, the success of highly performing companies in the U.S. and the rest of the world is largely attributed to their good corporate governance structures.
I would recommend a bid for Morrisons using this new market value of 5.3 billion and this bid is based on the total benefits to be derived from the combined firms synergies. Whether this merger will succeeds or not would depend on several factors and U.S. Stores must be very clear on its motives for proposing a merger with Morrisons. Proponents of mergers often cite anticipated synergy to justify it. Synergy refers to the type of reaction that occurs when two substances or factors combine to produce a greater effect than that which the two operating independently and could account for. Basically, in terms of mergers this translates into the ability of a business combination to be more profitable than before two firms combined.
Since U.S. Stores Inc is interested in external expansion and growth, this is probably a rare opportunity that it must act on it immediately. This expansion strategy has been pursued successfully in three countries by Wal-Mart Stores that. For example, Wal-Mart acquired 122 Woolco stores in Canada in 1994 and then proceeded to open more than 70 new ones after establishing itself in the Canadian retail market. The company also went ahead and acquired 21 stores of Wertkauf in Germany in 1998, and today owns more than 94 Wal-Mart stores in that country. Additionally, it acquired the ASDA chain in the UK in 1999 which was then operating 229 units. It currently operates more than 250 Wal-Mart stores there.
Wal-Marts strategy of corporate takeover has proven to be a case study on how aggressive companies can expand and grow externally. In essence, a firm eliminates competitors by acquiring and then creating substantial presence in a target marketplace. Doing this helps the combined company to hold on to the old stores that already have customers base and develop its brand familiarity. After the brand is established in the new market, it redesigns the new stores to look like its own. The next step is to decide where to open brand new stores.
If competitors like Wal-Mart going global in reach, then perhaps U.S. Stores Inc must do so as well just to remain competitive, after all this strategy is increasingly becoming a common strategy. So does size matter really Not necessarily. A bigger business is not necessarily always a better option. A firm could still tap into economies of scale resulting from diligent use of capital and human resources, good management, sound business models, and strategy, but not from growing in size alone. Generally, when a merger works out, the resulting synergy enhances cost efficiencies of the new business. Examples of these benefits (also mentioned briefly elsewhere in this report) are (a) staff reductions - money will be saved from reducing the number of staff members of the combining firms, (b) Economies of scale - a bigger firm saves more on operation costs. Business mergers can also increase the ability of the combined firm to negotiate better in the marketplace, (c) acquiring new technology or skills merging with a firms with unique technologies helps the new firm tomaintain or developa competitive edge, and, (d) improved market reach and industry visibility merging helps firms to grow revenues and market share. Also, since it will be possible to acquire all of the outstanding stock of Morrisons Supermarket Plc in exchange for those belonging to US Stores Inc, the new firm will save on cash reserves that it could use to expand its operations in the U.K.
Other factors that motivate firms to consider merging are (i) deregulation, and (ii) senior management incentives and egos. Business deregulation by governments and other agencies have enabled firms to restructure their portfolios and merge operations. For example, the repeal of Glass-Steagall Act of 1933 which restricted the degree to which securities firms, insurance companies, and banks could set up business in one anothers territories, increased merger activity in the financial services industry.
Mergers are often driven by the incentive packages and egos of upper management. Most of the merger deals are very profitable incoming and outgoing management teams, hence the need to pursue and seal them. This is what happened at Chrysler, where Robert Eaton cashed out 70 million in Chrysler options and received new options as a result of the DaimlerChrysler merger. Another example is how the top three executives at Bankers Trust Company received 122 million over three years when the company was taken over by Deutsche Bank in 1999.
So, the success of the proposed merger between U.S. Stores Inc. and Morrisons Supermarkets Plc might depend on the real motives of its management and financial due diligence thats accessible to this team. From a financial point of view, I would recommend that they proceed with this proposal.
Since there are several methods of valuing comparable companies in an industry, I decided to analyze comparative financial ratios to assess the suitability of Sansburys, Morrisons, or Marks Spencer as targets. I selected Morisons as a takeover target based on results of its consolidated income and balance sheet statement statements together with those of Sansburys and Mikes Spencer between 2006 and 2009, 2006 being the base year. Their consolidated income statements provided the following results
Revenues- of the three firms, Sainsburys had the highest net sales overall during the analysis period, followed by Morrisons, and lastly by Marks Spencer. However, a trend analysis indicated that Morrisons was consistently had the highest percentage increases during this period, relative to the other two firms, which had volatile results. See the tables below.
Gross profit The Gross Profit Margin measures the basic structure of a firm and its evident from this analysis that this ratio has been volatile during the four years of analysis, even although Sainsburys and Marks Spencer firms had higher ratios relative to Morrisons. However, while Morrisons ratio was lower, it increased consistently during this period. Its possible that the firms management team had a better product mix strategy compared to its main competitors. Marks Spencer and Sainsburys had higher gross profits figures compared to Morrisons. But these results changed upwards or downwards every year. Morrisons on the other hand showed an upward swing in these profits through the analysis period. Trend analysis also indicated that Morrisons experienced the greatest percentage increase on this profitability metric every year. However, Morrisons gross profit margin ratio was the lowest but was increasing every year between 2006 and 2009. The two competitors had higher rates that were changed up and down during this period.
Net income Marks Spencer had the highest net income compared to the other two firms during this period. But a trend analysis indicated that Sainsburys was experiencing the highest percentage growth rate in net income per year, relative to its two competitors during the years of this review. Morrisons had the second highest percentage growth. Looking at income statements overall scorecard between 2006 and 2009, its safe to conclude that Morrisons was more stable compared to Sainsburys and Marks Spencer.
An analysis of their consolidated balance sheets revealed the following information
Current Ratios The Current Ratio examines the relationship between current assets and current liabilities and its computed by dividing current assets by current liabilities. This ratio measures a firms short term liquidity and whether it. A higher ratio is generally preferred by most firms. These current ratios experienced small changes during the four years of this analysis and this is consistent with the normal current ratio. Sainsburys had the highest ratio in 2006 which kept declining over the next three years. Morrisons on the other hand started off with the lowest ratio and kept increasing it every year.
This was a very impressive feat to achieve considering the fact that its rivals were either experiencing declining or volatile ratios. However, its always necessary to compare these ratios with similar figures for in the same industry and the aggregate market. If they differ from industry results, then its crucial to determine what reasons that might explain the discrepancies. Generally, the higher the ratio, the more likely it is that the firm will be able to meet its short-term obligations but a ratio of less than one implies that the firm has negative working capital and could be having liquidity problems. Working capital equals current assets minus current liabilities.
Debt-Equity Ratios The Debt to Equity Ratio measures a firms proportion of capital that is derived from debt relative to other sources of capital, such as common stock, preferred stock, and retained earnings. A higher amount of debt compared to equity makes earnings very volatile and hence increases the probability that the firm will be unable to meet the required payments and default on debt. A higher proportion of debt indicates greater financial risk. Marks Spencer had the highest debt to equity ratio during the period of this analysis, even though there were minimal increases and decreases each year. Morrisons had the lowest ratio, with Sainsburys falling in between.
Morrisons Supermarkets Plc is United Kingdoms fourth largest food retailer witha total of 403 stores, 370 of them located across the UK. Its business is mainly in the grocery and food business. The firm currently employs more than 114,000 staff working in its distribution centres, factories, head office and stores. From humble beginnings at a small stall in1899 when an egg and butter merchant, William Morrison, it now an award winning retailer in the UK. The firm went public in 1967 and has been expanding its operations since. Its expansion strategy included the acquisitions of Whelan Discount stores in 1978, Safeway in 2004, and Rathbone Bakery in 2005.
By most indications, Morrisons seemed a better target for acquisition relative to the two rivals examined in this analysis. I, therefore, would recommend to the U.S. Stores Inc, to initiate merger negotiations with it. The analysis of the sustainable growth potential examines ratios that indicate how fast a firm should grow. This enables shareholders and lenders to make the right investment decisions. Since its widely recognized that firms must be able to pay off their obligations, such analysis indicates the future potential of a firm. So, the growth of U.S. Stores Inc, will depend on the expected rate of return earned on the resources reinvested or the amount of resources retained and reinvested in it.
The cost of capital that I would use to value Morrisons Supermarkets would be the rate of return necessary to maintain its market value or the minimum rate of return on its investments. This rate of return should reflect U.S. Stores Incs weighted average cost of debt and equity funds. However, assuming that Morrisons growth will be in line with U.S. treasury bond interest rates, currently at 4.25, a fair value for Morrisons on a stand-alone basis is 4.79 billion GBP. However, according to publicly available information, its current market value is 7.79 billion GBPs. However, no matter how accurate this valuation, its prudent to consider the economic and as well as industry environments in the U.K. because of their major influences on the firms potential success and realization of rate of return for shareholders.
The success of the proposed merger could depend on the corporate strategy of the new (combined) firm. Examples of corporate strategies that have worked well for major retailers, particularly for Wal-Mart, in the past include (i) dominate the retail market in every market they enter, (ii) grow aggressively locally and abroad, (iii) build strong brand recognition, customer satisfaction and be associated with reasonable prices. These strategies have made Wal-Mart a dominant retailer world-wide and therefore might be helpful to U.S. Stores Inc as it pursues expansion abroad. The success of Wal-Mart abroad is indicated by its presence in Germany, China, United Kingdom, Mexico, Canada, Argentina, and Brazil.
The difference between Morrisons estimated value based on the treasury rate and the current market value could be explained by various factors. These factors include (i) in-built assumptions on future expectations, (ii) inflation rates, (iii) the level of interest rates, (iv) different valuation on debt, (v) different estimates on growth rates, (vi) different expected operating margins, (vii) tax rates, (viii) projections on inflation rates over the next few years, (ix) international economics, and (x) consumer sentiment. Higher inflation generally increase uncertainty on future prices and costs and could harm a firm that is unable to pass its cost increases on to consumers. Due to the fact that the U.S. and the U.K. experience different economic dynamics, domestic and international events may cause the value each countrys currency to fluctuate. The impact of such changes could lead to losses in revenues.
Since U.S. Stores Inc will be active in a foreign market and because it hopes to jumpstart its retail sales with expansion in the U.K., its necessary to consider the effects of this move on returns. The following factors come into play
The macroeconomic environment the U.K. will impact demand for retail products,
Significant changes in the exchange rate will impact the demand for American manufactured goods,
Accounting differences and their impacts on the relative valuation ratios.
The 1 cost saving in perpetuity due to the merger synergies would change the fair value of Morrisons to approximately 5.3 billion GBPs. The two types of synergies are cost savings and revenue enhancements. Cost savings could result from elimination of facilities, job functions and duplicated expenses that would no longer be required when certain activities at Morrisons get integrated with existing activities at U.S. Stores Inc. For example, cost savings could result from integration if the firms corporate properties department consolidated its functions by eliminating duplicate positions and reduced real estate space required to manage company properties across the organization. The stated costs could be computed and deducted from the expected cash outflows and therefore improve net cash flows and increase the Net Present Value of future cash flows.
Revenue enhancement could also result from the merger of U.S. Stores Inc and Morrisons, especially if the combined firm achieves higher sales revenue growth than each was able to achieve on its own. For example, Morrisons might have developed a special process and skills of producing and selling a certain product in its U.K. market. With the expanded market, it will be able to do the same in the U.S. hence increasing sales in this niche. The same could be true with U.S. Stores Inc in its North American marketplace. Therefore, the synergies resulting from the merger could help the firm to attain its intentions of jumpstarting and increasing market share.
Another factor to consider regarding the success of this type of merger is the successful integration of business models and governance structures. A good governance structure enhances managerial accountability to stockholders. For example, the success of highly performing companies in the U.S. and the rest of the world is largely attributed to their good corporate governance structures.
I would recommend a bid for Morrisons using this new market value of 5.3 billion and this bid is based on the total benefits to be derived from the combined firms synergies. Whether this merger will succeeds or not would depend on several factors and U.S. Stores must be very clear on its motives for proposing a merger with Morrisons. Proponents of mergers often cite anticipated synergy to justify it. Synergy refers to the type of reaction that occurs when two substances or factors combine to produce a greater effect than that which the two operating independently and could account for. Basically, in terms of mergers this translates into the ability of a business combination to be more profitable than before two firms combined.
Since U.S. Stores Inc is interested in external expansion and growth, this is probably a rare opportunity that it must act on it immediately. This expansion strategy has been pursued successfully in three countries by Wal-Mart Stores that. For example, Wal-Mart acquired 122 Woolco stores in Canada in 1994 and then proceeded to open more than 70 new ones after establishing itself in the Canadian retail market. The company also went ahead and acquired 21 stores of Wertkauf in Germany in 1998, and today owns more than 94 Wal-Mart stores in that country. Additionally, it acquired the ASDA chain in the UK in 1999 which was then operating 229 units. It currently operates more than 250 Wal-Mart stores there.
Wal-Marts strategy of corporate takeover has proven to be a case study on how aggressive companies can expand and grow externally. In essence, a firm eliminates competitors by acquiring and then creating substantial presence in a target marketplace. Doing this helps the combined company to hold on to the old stores that already have customers base and develop its brand familiarity. After the brand is established in the new market, it redesigns the new stores to look like its own. The next step is to decide where to open brand new stores.
If competitors like Wal-Mart going global in reach, then perhaps U.S. Stores Inc must do so as well just to remain competitive, after all this strategy is increasingly becoming a common strategy. So does size matter really Not necessarily. A bigger business is not necessarily always a better option. A firm could still tap into economies of scale resulting from diligent use of capital and human resources, good management, sound business models, and strategy, but not from growing in size alone. Generally, when a merger works out, the resulting synergy enhances cost efficiencies of the new business. Examples of these benefits (also mentioned briefly elsewhere in this report) are (a) staff reductions - money will be saved from reducing the number of staff members of the combining firms, (b) Economies of scale - a bigger firm saves more on operation costs. Business mergers can also increase the ability of the combined firm to negotiate better in the marketplace, (c) acquiring new technology or skills merging with a firms with unique technologies helps the new firm tomaintain or developa competitive edge, and, (d) improved market reach and industry visibility merging helps firms to grow revenues and market share. Also, since it will be possible to acquire all of the outstanding stock of Morrisons Supermarket Plc in exchange for those belonging to US Stores Inc, the new firm will save on cash reserves that it could use to expand its operations in the U.K.
Other factors that motivate firms to consider merging are (i) deregulation, and (ii) senior management incentives and egos. Business deregulation by governments and other agencies have enabled firms to restructure their portfolios and merge operations. For example, the repeal of Glass-Steagall Act of 1933 which restricted the degree to which securities firms, insurance companies, and banks could set up business in one anothers territories, increased merger activity in the financial services industry.
Mergers are often driven by the incentive packages and egos of upper management. Most of the merger deals are very profitable incoming and outgoing management teams, hence the need to pursue and seal them. This is what happened at Chrysler, where Robert Eaton cashed out 70 million in Chrysler options and received new options as a result of the DaimlerChrysler merger. Another example is how the top three executives at Bankers Trust Company received 122 million over three years when the company was taken over by Deutsche Bank in 1999.
So, the success of the proposed merger between U.S. Stores Inc. and Morrisons Supermarkets Plc might depend on the real motives of its management and financial due diligence thats accessible to this team. From a financial point of view, I would recommend that they proceed with this proposal.
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