Reference no: EM132215738

Corporate Finance Assignment -

Aims of Assignment: This assignment aims to:

• Develop the ability of students to analyse a comprehensive case study that mimics the real world.
• Develop the analytical skills of students related to practical financial issues and decisions.
• Apply the financial technical skills and knowledge learned in the course to decision making of corporations.

Assignment Task: The Xepa-Osmond Pharmacy Deal

PHARMABIZ Plc. is an international pharmaceutical company that was once seen as a safe haven for investors when stock markets became volatile. It had a reputation as a well-managed and solid, but rather unexciting, company operating within a strong industrial sector. However, a number of problems had emerged in recent years to damage its reputation. A major problem for the company has been its failure to develop new drugs to replace a generation of successful drugs, the patents of which had either already expired or were about to expire. Where patents had already expired, rival companies had developed competing generic drugs that had seriously damaged the company's sales and profits. To make matters worse, the company had recently launched two new products, amidst much publicity, which had to be swiftly withdrawn when patients taking the drugs complained of side effects. This led to a severe loss of confidence in the management of the company and it became clear that major changes had to be made.

Key figures and ratios relating to PHARMABIZ Plc. for the past five years are set out below:

Year Ended 31 January

	Year 1	Year 2	Year 3	Year 4	Year 5 (most recent)
Sales (£m)	542.6	579.9	487.2	456.4	425.3
Operating Profit (£m)	42.1	43.5	27.8	24.3	22.8
P/E ratio	15.3	19.2	14.3	9.5	7.8

In order to restore confidence in the future of the company, a majority of the members of the board of directors was replaced and Angeline Simpson was appointed as chief executive officer. The new board agreed that the pharmaceutical sector had become fiercely competitive in recent years and it doubted whether the company had the resources or expertise to remain a successful player within the industry. The increasing costs associated with developing new drugs, along with downward pressure, exerted by governments, on prices for prescription drugs led the board to conclude that a change of direction was needed. Hence, it was decided that the company should reposition itself in the related healthcare market where it already had a small presence. For some years, PHARMABIZ Plc. had been selling a range of antiseptics and disinfectants for use in hospitals and nursing homes. The mission of the company was restated as being:

"To maximize shareholder value by becoming a leading provider of healthcare products"

Xepa-Osmond Pharmacy Ltd is a family-owned company that produces a small range of healthcare products. The main products of the company are wound dressings and surgical gloves, which are sold to hospitals, surgeries and nursing homes throughout Europe and which enjoy a reputation for their very high quality. The most recent financial statements of the company are in attached file.

Donny Osmond founded the business 35 years ago and has been the chief executive and chairman of the company since that date. However, ill health has recently forced him to consider his future and also to consider the future of the company. Although the founder has two children, neither has shown an interest in the business. The idea of allowing non-family members to manage the business was regarded by the Xepa-Osmond Pharmacy family as unacceptable and so the various family members, who owned all the issued shares, agreed to sell the company.

When Angeline Simpson discovered that Xepa-Osmond Pharmacy Ltd was for sale, she expressed an immediate interest in entering into negotiations with the Xepa-Osmond Pharmacy family. She believed that this was an outstanding opportunity to acquire a range of high quality products with a strong brand image. It provided an immediate and strong presence in markets that the board of directors of PHARMABIZ Plc. had recently identified as being of particular interest.

The finance director of PHARMABIZ Plc. David Shearwater, was the first among the new board of directors to express reservations concerning the possible acquisition. Although he acknowledged the possible benefits that might accrue, he argued that PHARMABIZ Plc. had no previous experience in acquiring companies and that the new board of directors had not yet developed a clear view as to how the acquisition process should be approached or managed. As a result, there was a risk that the acquisition of Xepa-Osmond Pharmacy Ltd would not turn out to be as successful as Angeline Simpson was expecting. David also wondered whether investors would be prepared to support the deal given the recent history of PHARMABIZ plc. The board of directors debated the issue and, by a narrow majority, decided to support Angeline's wish to enter into negotiations with the Xepa-Osmond Pharmacy family with a view to buying all the shares of the company. However, it was agreed that an independent firm of consultants, Butterworth Consulting Group (BCG), should be appointed to advise the board throughout the period of negotiations.

The finance department of PHARMABIZ Plc. extracted the following information as at 20 February Year 5 relating to healthcare companies from a financial newspaper:

12-month High  (p)	12-month Low (p)	Company	Price (p)	+/-	Div Yield (%)	P/E
673.5	478	Novartis International	622	+2	2.3	10.5
780	460	Sanofi	592.5	+12.5	1.2	11.5
279.5	172.5	Northampton Healthcare	194.5	-----	1.2	12.5
182.5	117.5	Eli Lilly	117.5	-5.5	3.3	6.8
266	121.5	BayerHealth Products	202.5	+3.5	2.6	8.3
316	164	Johnson Group	296.5	-----	1.8	9.7

The finance department also provided the following ratios for each of the companies listed above:

	Market value*/book value	Sales/market value*
Novartis International	3.7	1.7
Sanofi	2.8	1.6
Northampton Healthcare	3.6	1.5
Eli Lilly	2.9	1.9
BayerHealth Products	3.2	2.3
Johnson Group	2.7	1.4

* These values refer to the ordinary shares of each company.

In the early stages of negotiation between the two companies, the following information was provided by Donny Osmond:

• The market value of the premises of Xepa-Osmond Pharmacy Ltd was estimated to be between £30 and 33 million.
• The sales revenue of Xepa-Osmond Pharmacy Ltd is expected to grow at about 2 or 3 per cent each year over the next five years. The market is fairly competitive and there is little prospect of improved growth rate over this period. Thereafter, sales are likely to stabilise.
• Operating profit margins (profits/sales) are likely to remain at their historic levels, which are between 10 and 12 per cent, for the foreseeable future.
• Replacement costs of non-current assets will be more or less in line with the annual depreciation charge. In addition, however, the company is committed to a major upgrade of plant and equipment costing £1.8 million over the next three years. The cost of this upgrade would be spread evenly over the three-year period.
• Additional working capital over the next 5 years will be 20 per cent of sales growth.
• An exceptional dividend had been paid during the year to Year 5 of £2,600,000. In previous years, the dividend paid had varied between £220,000 and £260,000.

Following the initial negotiations, the Directors of PHARMABIZ Plc. decided that, in the event that a price could be agreed for the shares in Xepa-Osmond Pharmacy Ltd:

• The total after-tax savings in operating expenses from merging the sales and distribution channels of each company would be between £100,000 and £120,000 per year. These figures are not included in the operating profit margin estimates mentioned above.
• The shares in Xepa-Osmond Pharmacy Ltd will be paid for in cash, which would be raised by either a rights issue of ordinary shares or syndicated loan from the banks.

PHARMABIZ Plc. has an estimated cost of capital of 8 per cent. It has 10 million ordinary shares in issue and the current market value of a share is £10.64.

Assume a tax rate of 20 per cent on operating profits (payable in the current year).

The Tasks:

I. Assume that you are a consultant with BCG.

Based on the above case study and data provided:

a) From the above case study and the data provided, identify the possible corporate valuation approaches and estimate the fair values of Xepa-Osmond Pharmacy Ltd using the approaches.

b) Select THREE (3) of the approaches in part a) above and discuss their advantages and disadvantages in estimating Xepa-Osmond Pharmacy Ltd.

c) In your justification, which TWO approaches are the most suitable in estimating the fair prices of Xepa-Osmond Pharmacy Ltd and which TWO approaches are the least suitable. Why?

d) In your opinion, is corporate valuation exercise more of an art or science? Why?

e) In your opinion, is rights issue or syndicated loans more suitable for PHARMABIZ Plc. to raise capital to finance the purchase of shares of Xepa-Osmond Pharmacy Ltd? Why?

f) Assuming that the rights issue is used:

(i) Recommend an appropriate subscription price of the new shares and find the number of new shares that should be issued under the rights to finance the deal as discussed in the above case; and

(ii) Find the likely price per share of PHARMABIZ Plc. after the right issue. (Ex-right stock price).

Attachment:- Assignment File.rar