You work for a prestigious investment bank, Goldman Sachs, which has been recently commissioned by Facebook, Inc. (Facebook hereafter) to investigate potential M&A opportunities. The lead partner has asked you to prepare a report with a detailed summary of your assessment and evaluation of potential takeover targets.
Part A – Target Selection And Firm Valuation
Facebook is seeking to grow through M&As. Your task is to locate one target firm that would interest Facebook and make a deal. Towards this end, you and your team are required to investigate all possible firms around the world and identify three target candidates. At least one of the target candidates must be a listed firm with at least five years of accounting information available from the U.S. SEC’s EDGAR database. This requirement is to ensure that you have sufficient accounting information necessary for firm evaluation in Step 4. There is no limitation on the industry or country in which the potential target candidate operates, so long as decent synergies can be created through this M&A and it fits the current and future strategic goal(s) of Facebook. It’s a challenging task. Below is a step-by-step guide.Step 1.
Conduct a full SWOT analysis (Strengths, Weaknesses, Opportunities and Threats) of Facebook.Step 2
. Based on your SWOT analysis, decide whether Facebook should make diversifying, vertical and/or horizontal M&As. Justify your choice.Step 3.
Use the questions below as potential criteria to identify three target firms that may interest Facebook. As mentioned above, at least one of the target candidates must be a listed firm and it must have at least five years of accounting information available for firm evaluation. To check the availability of accounting information, search for the firm’s annual reports on Form 10-K over the last five year using the “Company Search” for the U.S. SEC’s EDGAR database.
Carefully address the following questions about the proposed target candidates. Your answer should be specific and back up your arguments by linking them to the real (not hypothetical) characteristics of the merging firms, i.e., Facebook and the proposed target firm.
- For eachof the three proposed target candidates, identify at least two channels through which synergistic gain can be created.
Hint: For example, synergy gain can arise when: (i) a target firm has a pipe line of innovative projects that can add new features into the existing Facebook products or lead to promising new products in the future; (ii) Facebook and the target candidate are technologically complementary; or (iii) the target has a presence in a fast-growing market which Facebook wants to enter. Here, do some brainstorming! To be specific, you should clearly identify the exact product, technology, market etc. that may lead to synergistic gains.
- Discuss how likely Facebook can successfully integrate the target candidates’ business, technology, human capital, and other resources to realize the synergies that motivate the deal.
- Identify at least three external/internal factors that can potentially prevent Facebook from successfully acquiring the proposed target firms (i.e., the deal goes bust).
Step 4. Narrow it down to one specific target and use the Free Cash Flow Methodology to estimate the value of the firm. It must be a listed firm with at least five years of accounting information from the EDGAR. The purpose of this valuation is to establish a minimum offer price for the target.
To conduct firm valuation, follow the steps below. Broadly speaking, you need to use the target firm’s past five years financial data to forecast the firm’s future sales, variable cost, fixed cost, depreciation, working capital and capital expenditure. You then need to work out the Weighted Average Cost of Capital (WACC) which will be used as the discount rate in your free cash flow analysis.
Construct future cash flows to firm:
- Use the average sales growth rate over the last five years to forecast sales in the next 4 years.
- Variable cost is assumed to grow at the same rate as sales.
- Use the average depreciation over the last five years as the depreciation for the future.
- Use the average fixed cost over the last five years as the fixed cost for the future.
- Use the average sales to working capital ratio over the last five years to work out the future levels of working capital.
- Use the average capital expenditure over the last five years as the future capital expenditure.
- Make assumptions about the growth rate of future net cash flow after year 4. Justify your assumption.
Calculate the discount rate (WACC):
- Get the equity beta of the firm from Yahoo Finance; Risk free rate is assumed to be 5% and market risk premium is assumed to be 6%.
- Work out the cost of debt of the target firm by searching for information about the effective interest rate in the firm’s latest 10K annual report. If such information is unavailable, use the interest payment and its long-term debt to work out the cost of debt.
- Use the book value of long-term debt (or total liability) and market value of equity to work out the proportion of debt and equity in your WACC formula.
Calculate the value of the target firm:
- Find the present value of the cash flows for year 1-4 as well as the terminal value to get the value of the firm.
Part B – Individual Self-Reflection
Your lead partner commends you on your group effort in preparing the preliminary report for his perusal. As a final task, he has asked each of your group members to reflect on his/her personal experience of working in a group in such a fast-paced and competitive working environment. Specifically, he has asked each of you to address the following two issues (make sure you address both):
- Reflect on your role and contributions to the group.
Hint: You may discuss your contribution to various group processes such as group formation, organization of group meetings, establishment and enforcement of group policies designed to deal with team problems (e.g., free riding), and provision of feedback to other group members.
- What are the two main lessons you have learned that can help improve your teamwork next time?