Analysis of two companies looking set for an acquisition.
Acquisition is a case where by a company buys in another company, normally in the same industry. This is done for many reasons which include elimination of competitions, creation of synergies, and favorable economies of scale. It is also a possible way of creating monopolies which will tend to enjoy super-normal profits for long.
Acquisition is a strategy normally undertaken by big firms in a bid to make them stay competitive in the market, and maintain or increase their market share.
Before any acquisition is undertaken, many financial, legal, and economical factors will be considered by the two prospective partners. This process calls for strong analysis which should look not only on the current issues such as financial ratios, but also long term consequences such as future market place and actions of third parties e.g. minorities, and competitors.
For this analysis, we will take the case of two companies which are still holding talks on a possible acquisition. The two are Agrium Incorporation and CF Industries where Agrium is proposing to acquire CF Industries.
Agrium is an American company which is in the Agribusiness Industry. It is a leading manufacturer and distributor of fertilizer nutrients i.e. Nitrogen, Phosphate and Potash majorly in North and South American markets, and to other parts of the world. It also supplies agricultural products and services in the American market. (Agrium, 2009)
CF Industries Inc. is the holding company for operations of CF Industries. It has its headquarters in Deerfield, Illinois and is the leading producer, marketer, and distributor of nitrogen and phosphate fertilizer products. The company is listed in the New York Stock Exchange and operates under the name CF. It has 50% interest in the Keytrade AG which is a fertilizer trading organization in Zurich, Switzerland, and is also holding talks with Terra Industries for a possibility of acquiring it. CF Industries IPO was in 2005, and since then, there is an annual improvement in their operations because they register increase in their net earnings year after year. (CF, 2009)
Agrium has forwarded a proposal to the CF Industries in a bid for the latter to be acquired by Agrium. Agrium is bidding a total consideration of $3.8 billion which shall be settled both in cash and Agrium common stock. The deal shall rest at 76% ownership for Agrium and the remainder for CF Industries.
The rationale behind the proposal is that the two firms will have a possibility of jointly forming a global leader in the production and distribution of crop nutrients, cause rise to the value for Agrium and CF Industries stockholders, operating synergies of about $150 million in three-year phase, and significant rise of earnings by 2010.
A. Financial Ratios Analysis (Financial Statement Analysis, 2008)
3.Return on Capital Employed
1,279.1 = 2.03
6,398.1 = 1.86
= (current assets –Stock)/ current liabilities
Prior charge capital×100
2974.1 × 100
1.Earnings Per Share
=Net profit after tax and pref. dividend
No. of ordinary stock
2.stock turn ratio
=cost of sales
1223 = 0.12
148.7 = 0.054
1. Profitability Ratios
The gross profit ratio of both companies combined will rest at 29.89% which is higher than that of CF Industries which is at 24.3%. Even though the combined ratio is lesser than the Agrium’s 31.39%, the difference of 1.5% is not that significant enough to allow one reject the possibility of an acquisition.
The ratio of net profit against sales is 12.87% for Agrium which is lesser than the combined one of 13.01%. The CF Industries ratio is 13.52% which is higher than the former two. The 0.52% difference is a small margin and CF Industries may not take it as a basis to turn down the offer to combine.
The Return on Owners Equity is at an equal of 31% for the two companies separately, but significantly rises to 49.8% on combination. This may explain that the utilization of equity might improve due to an acquisition.
2. Liquidity Ratios
The current asset ratio is 1.86 after acquisition, 1.8 and 2.03 for Agrium and CF Industries respectively as analyzed separately.
Acid test ratio on the other hand shows 0.74 and 1.7 for Agrium and CF Industries respectively and separately, and 0.91 for both firms as combined.
The liquidity ratios as calculated after combination are not much deviated from the industrially recommended 2 for current ratio and 1 for quick ratio.
3. Capital Structure Ratio
The gearing ratio of Agrium is very high at 65%, but on acquisition, the figure lowers a little to 52%. This could be due to dilution effect of CF Industries which has a gearing ratio of 12%.
4. Shareholders Ratio
The EPS of both companies will come to 7.9 on combination. This will sound favorable to the CF Industries but is not attractive for the Agrium’s shareholders because they will suffer a loss of value by 0.4 to a lower of 7.9. (Transactioninfo, 2009)
B. Cash flow Statement Analysis
On analyzing the cash flow statements of Agrium and CF Industries, cash flows from operations are $1044 million and $690.1 million for Agrium and CF respectively, and cash out flows for investing activities stand at $(3,375 million) and $(343.1 million) respectively. This shows how the two companies are vibrant in putting their resources towards acquisitions and investments mostly in other firms, e.g. acquisition of UAP Holding Corp. by Agrium and the purchase of Keytrade AG by CF Industries.
The trend though changes with the flows from financing where Agrium’s figure reads $1,196 million as compared to CF’s outflows of $(4.9million). This might explain the readiness of Agrium in acquisition of CF Industries.
Agrium’s books are showing goodwill of $1783million of which $1609milion was acquired during the year. The company has tested for impairment of the goodwill and found out that there was no impairment due to changes in market factors.
On CF Industries books, the goodwill recorded is $0.9 million. The goodwill of the firm has not been assessed for impairment.
The two companies shows that the Agrium’s position in the industry is far favorable than that of CF Industries. This means that in the case of a combination, CF might ride in Agrium’s glory, and is lucrative for it.
D. Legal and other requirements
The companies looking forward to merger must satisfy a number of legal and requirements. These include the ones enforced by the Security Exchange Act of 1939 through the Security Exchange Commission. The identified acquirer shall file a proxy report with the commission. Such a requirement my have an effect of withholding the nomination of new members into the Board of Directors of the company to be acquired.
Other requirements are the ones designed and enforced by the various Standards Bodies like the GAAP and the IFRSs Board. Given that the Agrium Incorporation adopts and practices the both GAAP (Canadian) and IFRSs requirements, it shall be affected by IFRS 3 of 2008-Business Combinations.
Under this IFRS the acquirer, Agrium in this case, will have to be clearly identified, and the method of Accounting employed in the combination process must also be clearly identified and well stated. Such methods may include Acquisition method which is also known as the purchase method as per the 2004 version of the standards. This method calls for identification of total value of assets to be taken over by the acquirer, total liabilities assumed by the same and the non-controllable interests. This enables the computation of the goodwill on acquisition which may either be positive or negative, as compared to the total purchase consideration.
Assets value is supposed to be measured in value on the date of acquisition. The non-controllable interests can be measured through a choice of an accounting policy which can either be use of the fair value or the non-controllable interest’s proportionate share of net assets of the acquiree.
IAS 39 will also call for Agrium to account for acquisition costs such as costs of issuing debt instruments in accordance with the IAS. Costs of issuing equity instruments shall also be dealt with by the company in accordance to IAS 32. All other costs which may include reimbursements to the acquiree e.g. due to legal costs, valuation fees, advisory fees, accounting fees and any other professional fees met by them, shall also be expended accordingly.
Agrium shall also be required by IAS 27 to present all of its consolidated accounts, including those of CF Industries, in a manner set by the IAS. Such consolidated accounts too must be presented at the same date as that one of the Agrium, unless proven that it is impracticable so. Such accounts too must apply uniform accounting policies, and presentation of Minority Interests in the profit or loss of the group should be shown separately
Before any acquisition is concluded, such legal restrictions and accounting requirements must be adhered to. They might have an effect of changing a decision for a company to under go a combination procedure. It is an important factor to be considered given that most, if not all, must be complied with by companies looking forward to combine. (IASB, What is IASB?, 2008)
E. Economical considerations
1. Opportunity Loss
Opportunity loss is a scenario encountered when resources are committed to an undertaking which is not necessarily the most lucrative decision from a given number of decisions. This is to say that a best opportunity might have been foregone at an expense of the undertaken one.
In analyzing the possible combination of Agrium and CF Industries, opportunity loses born by the two companies separately is considered. Taking Agrium’s case for example, the financial resources in the form of consideration worth $3.8 billion it is willing to forgo in order to acquire CF Industries, means that other options have been shunned in favor of this decision. Let’s see for example had the company instead chose to purchase government stocks with part or the entire amount. Let’s assume that the stock matures after 91 days (3 months) and have a coupon rate of 11% per the three month, and that the company will hold the stock for the four quarters. It will have forgone an interest of (($3.8billion×11%) ×4 quarters) =$0.418 billion.
On the other hand, going by the condition placed by the Agrium to CF Industries, the latter shall forgo an opportunity to buy-in Terra Industries which it is looking forward to purchase. May be Terra Industries, which is a nitrogen producer and had EBITDA of $892 million for the year end 2008 could have been a better choice than receiving a premium or goodwill from Agrium.
2. Market price conditions.
The rising prices cutting across all the economies in the world may not spare the two firms even after acquisition. This is because they are in the same industry, meaning they’ll be affected by the same economical threats, and none can cushion the other from the adverse effects.
The major reasons contributing to the rise in prices are beyond the companies’ control. These include:
a. Global prices-the rise in demand for food crops have given an equal demand of fertilizer by 14%, especially in developing countries. China and India for example, are two countries which contribute to a total population of about 40% in the whole world, is facing a steady increase in demand for cereals.
b. Supply-Morocco, the leading supplier of phosphate rock, increased its prices from $45 per half ton in 2006 to about $500 per half ton in 2008.
Sulfur, a reagent in the fertilizer process, has also diminished in supply from the US markets, hence causing a rise in prices by about 1100%.
c. International events-for instance rise in oil prices, gives a rise to transportation costs. The two companies separately highly depend on trucks and ships to distribute their products, meaning even after the acquisition, the situation may not change. This therefore causes a rise in the prices of the commodities.
Clearly, these factors are beyond the companies’ control, and form a basis of critical analysis before acquisition.
The capacities of the two firms must be checked to confirm whether they have unutilized capacities which might be satisfied on combination. If both the firms have reached their optimality points, then a merger or acquisition might not be really necessary. This is because such advantages of merger as production in huge masses will not be applicable.
F. Societal factors
1. Non-controllable interests(NCIs)
Before acquisition, the parties concerned must consider the nature of the NCIs and other minor stakeholders in the entities to be acquired. For instance, CF Industries has a 50% interest in Keytrade AG. If the memorandum entered by Keytrade and CF Industries does not allow for some kinds of actions during an acquisition of the parent company, then this might frustrate the efforts of Agrium before and after the combination.
2. Employees’ welfare.
It is normal for shake ups and changes in the employment hierarchy after a combination of two companies. Such changes must be clearly settled, and well communicated before the acquisition. This will help reduce confusion and go slows after the merger.
It is worth to analyze whether the employees will be involved smoothly in the whole process of acquisition. It can be costly if the employees are negatively affected by the process.
Agrium. (2009, March 23rd). Home. Retrieved March 29th, 2009, from Agrium: http://www.agrium.com
CF. (2009, March 24th). Home. Retrieved March 31st, 2009, from Cfindustries: http://www.cfindustries.com
Financial Statement Analysis. (2008, October 12th). Retrieved March 31st, 2009, from Accounting Management: http://www.accountingformanagement.com/accounting_ratios.htm,
IASB. (2008, November 17th). What is IASB? Retrieved March 31st, 2009, from IASB: http://www.iasb.org
Transactioninfo. (2009, March 25th). cfindusries. Retrieved March 31st, 2009, from Transactioninfo: http://www.transactioninfo.com/cfindustries