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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:
- 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?
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Case answers for Landmark Facility Solutions
This case solution includes an Excel file with calculations.
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 the 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 the 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 the light of expected growth rate (6%) in the integrated facility services market and the problems, Landmark is having with their operating margins, Mr. Tim Harris plan to acquire the Landmark with $120 million bid made by another side. Another reason for the acquisition is the plan of Tim to enter the high-tech, biotechnology, and pharmaceutical industries in 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 pays, 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 the mix of debt and equity. Although some of the investment banks have also 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 of 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 100% debt financing option is utilized (around 140 million dollars). With 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 to consider. Overall, the value of Landmark to Broadway is due to operational efficiency that Broadway thinks to bring. 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 sale 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 the necessary requirement in the industry.
Elimination of overhead cost, 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 50/50 financing model) when the Networking Capital ratio becomes higher than expected and revenue growth rate falls under the 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 interest tax shield will increase significantly.
In the first option 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. From the first sight, an alternative with 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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