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Financial Analysis And Management: British Airways And Mobile Network 3 Add in library

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Question:

You work as a financial analyst for a firm of international management consultants. A very large multinational company (of your choice) has approached the firm for advice as they are considering diversification through a strategy of acquisition.

You are required to write a report to the client which:

• Identifies two potential acquisition targets and gives a brief rationale for their potential acquisition.

• Describes the importance of working capital and capital structure management and critically analyses both potential targets with regard to their current working capital and capital structure management. Your analysis should take into account the type of industry in which the potential targets are engaged.

• Compares the financial performance, risk exposures and future prospects of the potential acquisition targets.

• Concludes with a reasoned argument as to which company might be the preferred acquisition target.
 
 

Answer:

Rationale on the acquisitions target

The study will focus on the basic reason for choosing this particular topic understand the acquisition takes place between the companies. One of the major acquisition will be based on the mobile network 3 is acquiring O2 and British airways to acquire the Aer Lingus.  This will helps the both company to gain the large market base in UK. There has been ample evidence which shows that, both of the acquisition is been one of the major spending from the both of the companies (BBC News, 2015). For examples Mobile Network 3 is spending more than 10 billion to buy the O2. This will help to the mobile network 3 to reach number position in Asian region.  Apart from that, study will also focus on the risk exposure on the both of the acquisition. There have been numerous evidences, which show that acquisition is one of the major decisions making for any companies. Before acquisition, company must have to see the financial performance of the acquired company. Apart from that stud will also give an insight of the capital structure of the both of acquiring company British airways and Mobile network 3 (Berger et al. (2007).

Importance of Working capital and capital structure management

One of the major working capital structures is that it helps to gain the company to understand its cash positions and its working capital cycle.  Working capital structure of the company shows that company financial position in international market and its performance to its industry. Since the British airways are looking to purchase the Aer Lingus; the working capital of Aer lingus is needed to assess in order to identify the present condition of the company. This will help the companies, British airways and Mobile network 3 to make the make the current valuation of the company as per the market rate (BBC News, 2015).

Apart from that, capital structure is much important part to survive the business in the long run. With the help of liability side of the both of acquired company O2 and Aer lingus liability side of the balance sheet will show the actual capital structure of the company (Berry, 2009). With the help of total debt and total equity valuation, both of the companies British air ways and the Mobile network 3 will be able to assess its performance it will help the company to reduce the risk (www.theguardian.com , 2015).


Figure 1: Importance of Capital Structure

(Source: Campbell and Shiller, 2008, pp-195)

Analysis of working capital management

Working capital structure of both of acquisition is given below:

Acquiring company

Acquired by  

Total cost £

Aer lingus

British Airways

10 billion

O2

Mobile network 3

-


Working capital structures of both the companies are strong enough to invest in acquisitions. This deal will make the owner of the Mobile network 3 owner Mr. Li Ka Shing will be one of the richest man of Asia (BBC News, 2015).  The mobile network three is very much known for its optimum use of resources that has made the company to gain the large market share in Asia. Mobile network 3 sells low cost with higher quality service in Asia which is company has strong capital structure. Company total fortune for Mobile network 3 will be around £34.1bn (Dechow, 2008).

Apart from that, capital structure of the BA is very much stronger than other airlines companies. BA is one of the largest airline companies in UK. Recently company has acquired the Aer lingus which is one the Irish carrier giants. BA takeover has made the company to surpass the companies like virgin airlines and Air etihad (www.theguardian.com , 2015).

Analysis of capital structure

The capital structure of both the company is very much stronger. As the cash position of the company is strong enough to capture large customer base. The parent company of the Mobile network 3 is Hutchison Whampoa (Finger, 2008).

 The market share of the UK mobile operator is given below:

Currents positions

Market share %

After O2 acquisitions

Market share %

EE

29%

O2 &Three

40%

O2

29%

EE

29%

Vodafone

23%

Vodafone

23%

Three

12%

Others

7%

Others

7%

 

 


Graph 1: Market share of Mobile network 3 before acquisitions of O2

(Source: Garcia-Teruel and Martínez-Solono, 2013, pp- 123)

Graph 2: Market Share after acquisition of the O2

(Source: Alawattage  et al. 2014, pp- 185)

Currently, the capital structure of the company shows that, Mobile network three has long term  sources of capital which is favorable position therefore the acquisition will help the company build strong network across the UK and Asian market. Apart from that before the acquisition of O2, Mobile network three has acquired more than 125 of the market shares. After the acquisition of O2 company will be able to gain 40% of the market share of UK and Asia (Gowthorpe, 2007)  Apart from that,  the cash position of the mobile network three is very much string enough to carry the acquisition expenditure. As the company has favorable current ratio and debt equity ratio which why Mobile network three will have margin of expenditure to spend in the acquisition (www.theguardian.com , 2015) . However, as the interest coverage ratios may be fluctuating to use the debt capital more than equity capital. Mobile network three , in spite of the better ICR the cash flow position  of the company will be weak because of the company will have need to expenses more on the  operation part.

Apart from the above, the takeover of the British airways of the Aer Lingus will make the BA one of the strong footholds in UK and European market. As per the industry information’s the acquiring of the BA will help the company to reach the large market shares. A takeover will make the Irish carrier one of the largest but the company has to sell down the 29.9% of shares for £1 billion (Balakrishnan and Sivaramakrishnan, 2008). After the acquisition of the Aer Lingus British airways shares will be rose up to 3.8p.Besides that, capital structure of British airways will stronger if the company acquires the Aer lingus  with more than 5 million customers of the Irish giants.  However, the Irish government is facing substantial opposed by the decisions as the government has hold strong market share of Ryan airlines.

 

Comparitive evaluation of the financial performance and risk exposure and future prospectus of the acquisitions targets

The aim of this essay is to critically discuss and advise ‘Noomz & Associates’, with appropriate examples from the financial industry the rationale for their firm to engage in diversification through strategic acquisition and the organizational factors that influence this process. The two potential acquisition targets our financial analyst will advise the above named company are ‘Mobile network Three to acquire O2’ and ‘British Airways to acquire Irish carrier Aer Lingus’

As cited in the Guardian newspaper on 23rd January 2015 “Mobile Network Three is set to acquire O2 in £10bn deal” This potential acquisition would make “Li Ka-Shing Asia’s richest man, one of the biggest foreign investors in the UK.”  La Ka-Shing has an estimated fortune of £34.1bn (£25.5bn) from his sprawling empire of ports, utilities, and property, according to Forbes. His conglomerate Hutchinson Whampoa is parent company of three, which confirmed it was ready to pay £10.25bn, mostly in cash, for larger rival O2. Most recently he has been snapping up mobile networks around Europe. The article further stated “this potential acquisition target would create the UK’s largest mobile phone firm with 31.5 million customers, cutting the number of network owners in the UK from four to three.” As recently as 2010, the UK had five network Owners but that became four when Orange and T-mobile merged to form EE. Although the UK telecoms regulator Ofcom has long said it wants to retain four competing mobile firms in the UK the final decision on whether to let the deal go ahead will rest with the European Union completion authorities in Brussels.” 

This strategic plan is evidence to suggest that Mobile network Three to buy O2 in £10bn, is to grow from a multinational level to a global level and to eventually operate in the main markets of the world. According to Lasserre (2003) Globalisation “is the phenomenon of the transition of industries whose competitive structure changes progressively from multinational to global.” Slack (2001) states that “operation strategy is based on a leading theory of business strategy ‘the resourced based view’ when a firm has an above average strategic performance then this is likely to have gained their sustainable competitive advantage because of the core competence or capabilities of their resources.”

Mobile network Three used their resources and capabilities to achieve a low cost mobile phone company that provides high quality service. They have positioned themselves in the mobile phone industry through its choice of low cost, high quality. This decision is central to their competitive advantage and competitive strategy.

It was stated in the Guardian Newspaper on British Airways Owners set moves to take over Aer Lingus.“Adding the Irish carrier to the group, would bring with it valuable extra take-off slots at Heathrow Airport. The airline share price shot up almost 20% on news of the move, but dropped back after the Aer Lingus rejection. A takeover has become likely as the Irish carrier’s largest single shareholder Ryanair, is expected to lose an appeal.” According to Joyce & Woods (1996), “in the 1960’s, a period of expansion and confidence, businesses used acquisitions and mergers to build better competitive positions.” Sudarsanam (2003) states “firms make acquisitions to gain market power, gain economies of scale and scope or internalize vertically linked operations to save on cost of dealing with markets thus adding further cost savings.” The industry formed M&A with larger business because it was easier to raise money and to acquire a greater market share.

Working Capital is the funds needed for a business to run successfully. Working Capital includes but is not limited to stock, debtors, cash, and short term investments minus what the company owners currently to the creditors. The equitation to calculate working capital is current assets minus current liabilities. Working capital is an important measure of the company’s liability. It is more concerned with the management and the relationship between current assets and current liabilities and the strategic decisions on how to create and maintain equilibrium between these two areas on a daily basis.

In order to reduce the risk the mobile network 3 looks to reduce the capital stature planning by adjusting and conducting the feasibility of study for acquisition of the O2. Company will be looking indentify the sources of funds for the acquiring the company for which equity, debt and retained profit will be used to reduce the risk of losing the high capital.

Figure 2: Sources of funds available for Mobile network 3

(Source: Banker and Chen, 2006, pp-286)

From the above, it has been found that, sources of funds available for Mobile network 3 are equity, debt and retained profit. Since the company is looking to take maximum funds from the debt which will make the deal more risky in compare to other two. One of the major benefit for the company will be company do not have to share its profit or ownership with general shareholders (DeWet, 2009). Apart from that, Mobile network 3 issuing only 30% of equity and 205 of the retained profit. One of the future prospectus for the company is to manage and control the exposure of the risk which will help the company to reduce the risk (www.theguardian.com , 2015). Since the higher amount of borrowing will be from the banks or debt financing the rising interest rate will be one of the major concern for the Mobile network three.

Another major part will adjust as per the business environment for which the company will have to raise the equity sources that will help the parent company Hutchison to manage its expenditure in the long run. Another major risk will be reduced if the funding will be buying of Forex contract which will help the company to manage the deal cost for the mobile network lower in pounds. Investment in buying O2 may be right decision for the Mobile network 3 but capacity of debt is 50% can creates lots of problems for the company in near future.  Mobile network 3 is looking to close the deal with more than 1 billion which will help the company to capture the large market area of the UK and Asia (Drumm, 2008).  The risk of issuing the capital; in long run will be higher because of the large capital investment in the company is one of the major part of the investing in the area of acquisitions.  Investment in O2  will help the company to acquire more than 5 million customer base but  it  will fails to improve the company performance in long run because of the high amount of debt  to acquired the O2 (Hansen et al. 2009). 

British airways investment in the Aer lingus will make the company one of the largest airways of Europe. However, one of the risks for BA here is the political risk and debt risk.

Figure 3: Sources funds used by the BA

(Source: Ismail, 2008, pp- 343)

BA is facing political risk because of the most of the shares are captured by the Irish government which lead the deal impossible for the BA. Political matters are very much critical side of the acquisitions which can only be resolved between the companies and government holdings.  Another major risk associated with the sources of fund of the BA would be high debt. As the companies is known for owing and controlling the entire things on their own would can creates cash flow deficit in future if the acquisition would be failed. Higher debt would increase the cost of the capital because of the rise in CRR every year.  The rising rate of CRR can creates problems for the company in near future because of BA is looking to spend more than €1 billion which is equal to £789 million (Hansen et al. 2009).  This will help the company to gain the large market share which may decrease the cash position in the long run for the BA. The financial position of the BA is much better than that of Aer lingus and holds string position to gather information which will tend the company to sustain in the future.   The working capital of the company shows that BA shows that company has strong cash position and has good current ratio that will lead the company to gain the higher position in future (www.theguardian.com , 2015).

Conclusion

From  the above  study, it has been found that, both of the companies has been using debt as their major sources of fund to take over the  other companies. In this case the BA is looking to take over the share worth of 25% in Aer lingus. Mobile network 3 is looking to full takeover the O2. Both of the companies are looking to acquire with full of debt rather than equity. There has been ample evidence which shows that, both of the company are spending billion of money for acquisition one of the major risk faced by both of them are rising CRR rates.BA is suffering from the political risk while buying the Aer lingus. As for mobile network 3 companies will have more than 40% of share present in the current market. British airways has shares have been risen up to 4% after the new broke of BA is purchasing the Aer Lingus. Both of the company are facing tough survive in the long run if the debt amount is higher for the sources of funds.  Mobile network is subsidiary of Hutchison which why company strong financial health which will lead the company to sustain in the long run.

 

Reference List

Alawattage, C., Hopper, T. and Wickramasinghe, D. (2014) Introduction to management accounting in less developed countries, Journal of Accounting and Organizational Change, 3(3), pp. 183-91

Balakrishnan, R. and Sivaramakrishnan, K. (2008) A critical overview of the use of fullcost data for planning and pricing. Journal of Management Accounting Research, 14: 3-31

Banker, R., and Chen, L. (2006) ‘‘Predicting Earnings Using a Model Based on Cost Variability and Cost Stickiness.’’ The Accounting Review 81, 285–307.

BBC News, (2015). Li Ka-shing set to buy O2 for £10bn. [online] Available at: https://www.bbc.com/news/business-30946005 [Accessed 4 Mar. 2015].

Berger, P., Ofek, E. and Swary, I. (2007) "Investor valuation of the abandonment option", Journal of Financial Economics, 42, pp. 257–287

Berry, A., (2009). Financial Accounting: an introduction. 4th ed. California: Random House.

Brigham, E., and Houston, J., (2009) Fundamentals of Financial Management. 5th ed. London: McGraw-Hill

Campbell, J. and Shiller, R. (2008) The dividend-price ratio and expectations of future dividends and discount factors. Review of Financial Studies 1, 195–228.

Dechow, P.M. (2008) "Accounting Earning and Cash Flows as Measures of Firm Performance", Journal of Accounting and Economics, 18, pp. 3-42.

DeWet, J.H. (2009) “EVA versus traditional accounting measures of performance as drivers of shareholder value – a comparative analysis”, Meditari Accountancy Research, 13(2), pp. 1-16.

Drumm, W. J. (2008) Forecasting by consensus is riskier than it sounds. Journal of Business Forecasting, 12(1), 22–23.

Finger, C. A. (2008) "The Ability of Earnings to Predict Future Earnings and Cash Flow", Journal of Accounting Research 32, pp. 210-223.

Garcia-Teruel, P. J. and Martínez-Solono, P. (2013) “Effects of Working Capital Management on SME Profitability,” International Journal of Managerial Finance, 3(2), pp. 174-177

Gowthorpe, C., (2007). Financial Accounting: for non specialists. 5th ed. London: Routledge.

Hansen, D. R., Mowen, M. M. and Guan, L. (2009) Cost Management: Accounting & Control - Page 50, 5th ed. New Delhi: Global Indian Publications Ltd.

Ismail, A. (2008) “Is economic value added more associated with stock return than accounting earnings? The UK evidence” International Journal of Managerial Finance, 2(4), pp. 343-53

Topham, G. (2014). British Airways’ owner moves to take over Aer Lingus. [online] the Guardian. Available at: https://www.theguardian.com/business/2014/dec/18/british-airways-iag-moves-takeover-aer-lingus [Accessed 4 Mar. 2015].

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