Corporate Governance and

Restructuring
(EBC4052)

Case 1: Landmark Facilities Solutions

Group 3:
Tomás Ferriera, XXX
Lucas Nötges, i6037243
Manbir Singh, i6170245
Robert Wilson, i6058439

Maastricht University
11/09/2017

Contents
1. Acquisition motives and viability.......................................................................................................2
1.1 Why is Harris acquiring Landmark?..............................................................................................2
1.2 What are the sources of synergies?.............................................................................................2
1.3 Do you believe these synergies can be realistically achieved?.....................................................3
2. Discount rate to valuate acquisition..................................................................................................3
What is the appropriate discount rate for valuing the acquisition?...................................................3
3. Justifying the Landmark bid...............................................................................................................4
Can Harris justify a $120 million bid for Landmark?..........................................................................4
3.1 Landmark valuation on a stand-alone basis.............................................................................4
3.2 Broadway valuation on a stand-alone basis.............................................................................5
3.3 Value Landmark if it were to be acquired and managed by Broadway....................................5
3.4 Value Broadway after the acquisition of Landmark..................................................................6
Question 4.)...........................................................................................................................................7
Which of the financing alternatives should Harris choose? (How) Is the capital structure decision
related to the operational strategy?..................................................................................................7

TABLE OF FIGURES

1. Acquisition motives and viability

1.1 Why is Harris acquiring Landmark?

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There are several reasons why Harris desires to acquire Landmark. Firstly, Harris is interested
in bundling and/or integrating the services both companies offer as the market is highly
competitive. In addition, the market is highly fragmented and therefore large companies have
a better chance of succeeding in the long term. This is due to the fact that clients prefer to
work with only one big facility company that offers different products and diversified
solutions and packages, which are able to satisfy all their needs at once. Therefore, offering
bundled contracts will allow Harris to lower to the operational costs and exploit a market
which is expected to grow 6% annually from 2014 to 2016 according to the article.

Secondly, Harris wants to grow his company to create an integrated facility management
company on a national scale. The acquisition of Landmark would give him the access to the
west coast in which he has shown great interest. Additionally, his company’s customer base
will be expanded by the Landmark’s (previous) clients and therefore include Broadway in the
high-tech biotechnology and pharmaceutical industry. With the experience in those markets
on the west coast, similar clients on the east coast would be much easier to attain. This leads
us to the next sub question:

1.2 What are the sources of synergies?

The sources of the synergies are costs reduction on the one hand and revenue enhancements
on the other hand. Cost will be reduced by lowering operational and overhead costs, through
cutting executive pay and reducing marketing costs, by for example integrating the respective
departments. Revenues will be enhanced by marketing current Broadway services under the
newly acquire Landmark brand as premium service and by attracting new customers with
integrated services, both in new industries and new geographical areas. Harris does not
expect any cannibalism within the newly integrated firm, as the overlap in services is fairly
small.

1.3 Do you believe these synergies can be realistically achieved?

Although the general strategy behind this acquisition seems very straightforward and the
prospects of a combined company seem very bright, we share much of the scepticism of the
investors and of some of the board members. For once we believe that getting rid of the
whole management team of Landmark will, although lowering costs, also take away a huge
part of the expertise which makes Landmark so successful within the pharmaceutical and

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high-tech industry. Thereby part of the company’s value would be destroyed straightaway.
This makes his plans to raise Landmark’s operating margin very ambitious.

It also seems very unlikely that Broadway will be able to benefit very much from Landmark’s
premium brand recognition, as clients will surely be aware of such a huge takeover in such a
small industry and will take this into consideration when negotiating new service contracts.
As such contracts are often long-run it will take time until all contracts will be up for
bargaining again and any effects if even possible will take a while. In conclusion, we think
that based on the presented information, his projected growth is too optimistic.

2. Discount rate to valuate acquisition

What is the appropriate discount rate for valuing the acquisition?

Table 1: Overview of rates

Year 2014 To calculate the appropriate discount rate for the

Value 94.64 acquisition of Landmark, we use the weighted average cost
Debt 43.80
of capital (WACC) method. This method uses the different
Rd 4.2%
Equity 50.84 costs for equity and debt with regards to their weights
Re 8.95%
within the overall capital structure. We assume a cost of
Taxes 35%
Be 1.50 debt of 4.16%, the rate for AAA rated company bonds in
Rf 0.10% the short term as stated in exhibit XX. Furthermore, we
Mkt Risk
Premium 5.90% calculate the cost of equity with the capital asset pricing
model (CAPM). Explain why CAPM and why these rates have been used. For this we take
the risk-free rate of 1-year treasury bonds (0.10%) add the market risk premium (5.90%) and
multiply them with the beta value. The beta value is estimated to be an average of the other
three given competitors’ beta values (1.50%). Based on the capital asset pricing model the
cost of equity was calculated as following: 0.10%+1.5(5.9%-0.10%) = 8.95%.

∗43.8 ∗50.85
WACC = 4.16 50.85+43.8 +8.95 50.85∗43.8 = 6.06%

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 3. Justifying the Landmark bid
Can Harris justify a $120 million bid for Landmark?

As mentioned in the guidelines the valuation of both companies have been calculated by
taking the several perspectives into account with the discount rate derived from chapter 2. At
the end of this chapter the question whether Harris is able to justify the $120 million bid for
Landmark will be answered based on the various valuations before and after the acquisition.

3.1 Landmark valuation on a stand-alone basis

Figure X: Landmark on a stand-alone basis

Explanation

3.2 Broadway valuation on a stand-alone basis

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Figure X: Broadway on a stand-alone basis

Explanation

3.3 Value Landmark if it were to be acquired and managed by Broadway

Figure X: Standard scenario Landmark post acquisition

Explanation

Figure X: Pessimistic scenario Landmark post acquisition

Explanation

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3.4 Value Broadway after the acquisition of Landmark.

Figure X: Standard scenario Broadway post acquisition

Figure X: Pessimistic scenario Broadway post acquisition

Explanation

Figure X: NPV comparison Broadway and Landmark

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The NPV of Broadway post acquisition seems to be slightly more attractive in the pessimistic
scenario: Landmark increases the value of Broadway by 133.22-126.57= $6.65 million.
Previously we have shown that Landmark seems to have a relative low NPV ($73.46 million
and $106.57 million) in both scenarios when contrasted to the $120 million bid. The NPV for
Landmark after the acquisition increases to $73.46 million in the pessimistic scenario. If we
sum the value of Landmark on a stand-alone basis with Broadway’s increased value of $6.65
million due to the acquisition, the total amount will be 73.46+6.65= $80.11 approximately. As
a result, the acquisition does increase value for both companies; however, the $120 million
bid for Landmark is unfortunately overvalued and therefore not justified in the pessimistic
scenario.

On the other hand, when the Broadway considers the standard scenario, it will result in a
positive outcome. In the post-acquisition scenario the value of Broadway will increase by
173.90-126.57= $47.33 million. The NPV of Landmark post acquisition standard scenario
summed with the increased value of Broadway leads to 106.57+47.33= $153.90 million. So,
in that case the $120 million bid for Landmark is justified.

Depending on the outcome scenario after the acquisition, Harris could either benefit from the
acquisition or face a great loss if the circumstances change. What should he do in the end??

Question 4.)
Which of the financing alternatives should Harris choose? (How) Is the capital structure
decision related to the operational strategy?

4th and 5th bullet of Q.3. Sum two CF

First three CF – Mandatory debt payments – interest payments
And then see how much the company is worth

Based on the payment structure and debt ratios Harris should choose the debt and equity
financing option.

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First we set up a payment structure for the full debt financing. For this we add the available
cash in 2014 and the free cash flow and subtract the amortisation and interest expenses.

Figure 1: Full debt financing

This gives us an overview of the available cash at the end of every year, thus revealing
liquidity issues. In the years 2015 and 2016 only the interest expenses are deducted, as the
amortization doesn’t start until 2017. 2017 and 2018 both result in a negative value for “cash
after expenses” as a result of amortization and interest expenses having to be paid for. From
of 2019 the free cash flow rises above the amortization and interest expenses. In 2023 the
final payment in the amount of $90 Mio due as well as the remaining interest expenses. This
sum of $94,49 Mio cannot be covered by the cash reserves and leads to a deficit in “cash after
expenses” of $62,2 Mio. The temporary lack of liquidity could however be bridged by a
short-term loan and the final payment by follow-up financing.

The second criteria we want to check is the capital structure of Broadway and the combined
firm after receiving the loan.
Starting with Broadway we add the loan in the amount of $120 Mio to the companies debt
resulting in $163,7 Mio. In comparison Broadway has $43,1 Mio in shareholder equity.
To calculate the debt-equity ratio we divide the debt by the equity, which results in debt-
equity ratio for Broadway of 380%.

Figure 2 Capital structure Broadway - debt financing

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If we do the same for the combined firm, we add Landmark’s debt, Broadway’s debt and the
loan, which results in a combined debt of $207,5 Mio. The equity of the combined firm is $94
Mio. This results in a debt-equity ratio of 221%.

Figure 3: Capital structure combined firm - debt financing

The debt-equity ratio needs to be put into perspective to the respective industry as it can vary
strongly. The comparison companies have an average debt-equity ratio of 65% and a median
debt-equity ratio of 50%. Accordingly the debt-equity ratios calculated for Broadway and the
combined firm are substantially higher than is common in this industry.
Concluding, based on the lack of liquidity in three of the seven years and the large deficit
after the final payment, we would not recommend Harris choosing the full-debt option. This
opinion is further supported by the high debt-equity ratios, which far exceed industry
standards. What could this result in?

The second option Harris can choose from is based on debt and equity financing in a one to
one relation.
Again we first set up a payment structure taking into account interest expenses and
amortization. We can see that all interest expenses are thoroughly covered and only in year
2020 when the final payment in the amount of $60 Mio is due, the cash is insufficient by
$13,8 Mio. Furthermore, the “cash after payments” is already positive in 2021. This is a good
basis for a short term-loan in 2020 to cover final payment, which could be fully repaid by
2022.

Figure 4: Debt - equity financing

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To ultimately decide if the debt and equity financing is the best option we also take into
account the Debt-equity ratio for Broadway and the combined firm. Since debt and equity are
raised in equal amounts the debt-equity ratio stays constant at 101%. For the combined firm
this results in a debt-equity ratio of 96%. These are both ratios that do not deviate too much
from the industry standards and shouldn’t result in financial distress for Broadway or the
combined firm. Furthermore the debt-equity ratio drops to 42% and 57% in 2021 for
Broadway and the combined firm respective after the loan as been fully repaid.

Figure 5 Capital structure Broadway and combined firm - debt-equity financing

Based on the payment structure and the debt-equity ratios we would advise Harris to take this
option and include follow-up financing in 2020.

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