This case study is about the analysis of the acquisition plan introduced by the CEO of Broadway, Tim Harris, to acquire Landmark Facility Solutions.
William E. Fruhan; Wei Wang
Harvard Business Review (915527-PDF-ENG)
September 24, 2014
Case questions answered:
Case study questions answered in the first solution:
- Does Broadway benefit from acquiring Landmark Facility Solutions? How can Harris Justify a $120 million bid for Landmark?
- If Harris were to proceed with the acquisition, which financing alternative should be chosen, and why? Would Broadway be capable of servicing its debt after acquisition?
- Does Harris give up shareholder value by opting for the mix of debt and equity financing alternatives? What is the real cost of equity dilution?
- How do the two financing methods affect the value of the acquisition to existing shareholders of Broadway?
Case study questions answered in the second solution:
- Prepare pro forma financial statements to learn the fundamentals of financial forecasting
- Apply the discounted cash flow approach and project the cash flows to evaluate an acquisition opportunity
- Review short-term and long-term financial policies, including target capital structure and the investment restrictions imposed by debt service, and the interaction between investment and financing decisions.
- Perform sensitivity analysis to assess how key assumptions can affect the valuation of the acquisition project and debt service capacity.
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Landmark Facility Solutions Case Answers
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Executive Summary – Analysis of the Acquisition Plan for Landmark Facility Solutions
This case is about the analysis of the acquisition plan put forward by the CEO of Broadway, Tim Harris, to acquire Landmark Facility Solutions. Beginning with Broadway, it is a regional facility services provider company that was founded in 1982. It provides facility services such as floor and carpet maintenance, HVAC, and other building maintenance in the eastern part of the U.S.
On the other side, Landmark Facility Solutions is also a regional janitorial company that was established in 1956. In addition to specializing in building engineering and energy solutions, janitorial, and commercial cleaning, Landmark is also a big provider of bundled integrated facility services, which are favored by large companies. Its major clients are large hospitals and Fortune 500 pharmaceutical and biotechnology companies.
Moreover, it is important to note that Landmark is having problems with its operating margins, which had declined from 3% in 2010 to 1% in 2014.
In light of the expected growth rate (6%) in the integrated facility services market and the problems Landmark is having with its operating margins, Mr. Tim Harris plans to acquire Landmark with a $120 million bid made by another side.
Another reason for the acquisition is his plan to enter the high-tech, biotechnology, and pharmaceutical industries on the West Coast, and the client base of the Landmark might be helpful in this regard.
In addition, the acquisition might help Broadway to charge higher premiums on its products under the Landmark’s brand. Tim also thinks the fall in the operating margins is due to the lavish expenditures by the management, high executive pay, and marketing expenses, and he thinks Broadway could reverse this fall in the operating margins back to 3%.
Tim’s plans to acquire Landmark with $120 million are opposed by some of the board members, and there is skepticism about the projections after the acquisition.
Moreover, to finance the $120 million acquisition, Tim has two options: 100% debt financing or a mix of debt and equity. Although some of the investment banks also have doubts about this acquisition, the major investment bank, Stanley Investment Company, offered its services to provide the debt needed for the acquisition.
- To analyze both standalone enterprises and the combined firm after the acquisition, given 2 financing options
- To decide which financing option is in the best interest of the shareholders of the acquiring firm.
1. Does Broadway benefit from acquiring Landmark Facility Solutions? How can Harris Justify a $120 million bid for Landmark?
Under the expected scenario, the value of Landmark for Broadway is higher than the minimum amount required by Landmark, which is $120 million.
Based on the valuation of Landmark by Broadway with Discounted Cash Flow model/analysis, Landmark’s worth exceeds $120 million if a 100% debt financing option is utilized (around 140 million dollars). With a 50/50 percent equity and debt mixture, the value of the company is around 110 million dollars.
However, the benefit of synergy would still make this option worthy of consideration. Overall, the value of Landmark to Broadway is due to the operational efficiency that Broadway thinks it brings. The company expects that by replacing the management team, they will be able to increase the operating margin to 3% from less than 1%.
Moreover, the active management would decrease the net-working capital as a percentage of the sales to 5.5% during the 5 years compared to the current 7%. Besides such optimization, the acquisition will also bring synergy to Broadway, which is a necessary requirement in the industry.
Elimination of overhead costs, a lower ratio of Net Working capital, and premium prices for its service under Landmark’s brand are the expected benefits of the synergy.
Regarding the pessimistic scenario (62 Million dollars with full debt and 45 million dollars with a 50/50 financing model), when the Networking Capital ratio becomes higher than expected and the revenue growth rate falls under expectations, the value of the company is far below the required amount of money for offer. (For calculations, please refer to the Excel file).
2. If Harris were to proceed with the acquisition, which financing alternative should be chosen, and why? Would Broadway be capable of servicing its debt after acquisition?
Two options are suggested to finance this acquisition: a) 100% debt, b) 50% debt and 50% equity. Analyzing the target capital structure of Landmark Facility Solutions is essential while finding out the effects of these options. Through full debt financing, the company will increase its leverage notably, which in turn implies tax will be lower and the interest tax shield will increase significantly.
In the first option, the capital structure of the company is 75% debt and 25% equity, WACC 7.7%. In the second option, they are 40%, 60%, and 8.4% respectively.
At first sight, an alternative with a lower WACC would be more desirable because raising the additional cost of capital is less costly along with its higher Enterprise Values in both standard and pessimistic scenarios, but we need to dig deeper to know other factors.
It is no surprise that in full debt-financing, the Landmark Facility Solutions may have…
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