Analysis of the Proposed Corporate Restructuring of Jebb Plc

JEBB plc has the intention of increasing its shareholder’s wealth. To achieve this, the directors are proposing a corporate restructure taking into consideration the takeover of a rival company. The aim of this report is to critically examine the reasons behind takeovers, the methods by which takeovers may occur and also the potential effects of the takeover process on a company.

The methods of investment appraisal will be applied to evaluate and rank potential investment opportunities and finally the capital structure of JEBB plc will analyzed, taking into consideration the nature of gearing and the effects of high gearing on perceived risk and cost of capital.

Corporate restructuring refers to the changes in ownership, business mix, asset mix and alliances with a view to enhance shareholders value (Pandey, 2004). This can be achieved through mergers and takeovers, leveraged buy-outs, divestment, joint ventures, among others. Takeover or Acquisition could be friendly or hostile depending on how the management of the target company perceives it. However, regardless of their category or structure, the main aim is to create the synergy that makes the value of the two companies greater than the sum of the companies if valued as a separate entity.

1. TAKEOVER ANALYSISTakeover is when one company x is acquired by another company y. It is an act of acquiring effective control over assets or management of a company by another company without any combination of businesses or companies (Pandey, 2004). It can also be said that, “A takeover is the acquisition by one company the share capital of another in exchange for cash, ordinary shares, loan stock or some mixtures of these” ( Pike and Neale, 2005).

In most cases, takeovers are usually threats to the target companies because of the fear of those companies gaining ownership. This usually occurs when the management of the target companies perceives the takeover as one that is hostile. Most takeovers are usually classified into three forms; * Horizontal takeover

* Vertical takeover* Conglomerate takeoverHorizontal takeover: This occurs between two companies operating in the same line of business and at the same stage of production. Examples of horizontal takeover include; Nestle (bidder) and Rowntree (target) in 1988, Glaxo (bidder) and Wellcome (target) in 1995. One of the advantages of horizontal takeover is that it allows the enlarged company benefit from economies of scale and the ability to cut costs (Geddes, 2007).

Vertical Takeover: Here, the companies are in the same line of business but operating at different stages of production. Examples of vertical takeover include; BP (bidder) and Britoil (target) in 1988. A vertical takeover could be forward by bringing the company close to their customers or backwards by securing their source of supply. An example is the purchase of automobile dealers by manufactures such as Ford, Vauxhall and others (Geddes, 2007).

Conglomerate Takeover: This occurs in a situation whereby two companies operate in different areas of business, i.e. the companies are in different industry sectors. An Example is Hanson (bidder) and Eastern Electric (target) in 1995.

In as much as Mergers and Takeovers are forms of corporate restructuring, merger is different from takeover or acquisition in the sense that, a merger is said to occur when two or more companies combine into one company. Here, a complete amalgamation of assets, liabilities and shareholder’s interest takes place. Merger could be in form of Absorption and Consolidation.

1.2 REASONS FOR TAKEOVERThe major motive behind takeover is based on financial justification, which is because it increases the wealth of the acquiring company’s shareholders; others are considered to be economic and managerial justifications (Watson and Head, 2007). However, it is pertinent to note that the more specific reasons for launching takeover bids usually reflect the anticipated benefit that a merger is expected to generate (Pike and Neale, 2005). Such motives can be analysed below;

* To obtain synergy

Synergy implies a situation whereby the combined firm is more valuable than the sum of individual combining firms (Pandey, 2004). It brings about increased performance in such a way that the company after the takeover process becomes stronger. It can be illustrated thus; ∑A+B > ∑A+∑B. i.e. the summation of company A and B after the takeover process, is greater than the summation of company A and company B as separate entities before the takeover process. This helps us understand that synergy increases the value of a company. * Exploitation of scale economies

Scale economies are generally known as “economies of scale”. This refers to a situation whereby an increase in the volume of production leads to a reduction in the cost of production per unit. This usually occurs because the companies and their operation become larger after the takeover process. It is common in horizontal takeover in areas such as production, distribution, marketing, management and finance. Here, the management of the company has an advantage of negotiating lower prices with suppliers and saving operating costs on production processes.

* To enter new marketsSome companies may takeover other companies with the intention of penetrating other geographical areas in order to increase their market share value. By doing so, they are exposed to the different opportunities such markets carry. Such takeover or merger could either result into developing new product lines, especially for companies with the intention of adding a particular product to their product line which the target company already has, for example, Daimler-Chrysler merger in 1998.

Daimler was known for highly engineered luxury vehicles and Chrysler for a fast growing market for sport utility vehicles, or for expansion purposes, like opening new offices outside their main geographical area of operation and gaining a strong dominance in such markets. An example is Compass Group of Britain acquiring a major stake in Seiyo Foods, Japan in December 2001. * For Growth

At some point in an industry life cycle, it gets to a maturity stage and at this stage; it is difficult for it to grow internally. The company therefore uses acquisition of a profitably company with its spare cash as a way of expansion in order for it to grow.

* To provide critical massDue to the fact that it is difficult for smaller companies to finance investment and R&D, large companies can acquire or merger with them to pool the resources needed to establish the critical mass required to provide sufficient cash flow to finance such investments (Watson and head, 2007). This also poses a credibility effect on such small companies, “for example companies may be unwilling to use small firms as a source of components when their future survival and hence, ability to supply, is a suspect” (Pike and Neale, 2005). * To increase Market share

Here, the profit and market share of a company increases when acquisition takes place. However, it is pertinent to note that any acquisition that increases a company’s market share is likely to mean that the other company will be eliminated. This could also be seen as a company’s strategy to eliminate competition.

It is one of our company’s (JEBB Plc.) proposed strategy to increase its market share. In the UK, a government appointed body known as the “Competition Commission” is responsible for protecting customer and consumer interest when a restructuring is proposed. During takeovers or mergers, companies are at the risk of referring to the competition commission. * Elimination of inefficient management

Takeover or acquisition can be an opportunity to review the management of a company in the sense that, a company that is not operating to the policy of maximizing shareholder’s wealth can be acquired in a bid to manage such company effectively.