Question Tag: Acquisition strategy

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  • 20 Marks

CSEG – May 2019 – L2 – Q5 – Strategic alternatives, analysis and selection

Analysis of strategic advantages and challenges of acquiring East Legon Executive Fitness Club compared to Azugu's organic growth model and recommendations for ensuring staff retention post-acquisition.

You are a Finance Manager who works in the Finance Team of Azugu Gyms (Azugu) and your role includes giving advice on strategic projects and financial matters. Azugu is a family-owned business established in 2009 by two brothers. The two brothers invested an initial sum of GH¢300,000, splitting the share capital 50/50, issuing a total of 100,000 shares in Azugu. Azugu was launched with the aim to make gym-based fitness training highly accessible by removing the obstacles to exercise and making its gyms affordable to most people, opening more gyms for accessibility, and providing optimum flexibility in offering non-contractual membership. Azugu is currently very popular in Ghana, and total membership and new gym openings have grown rapidly since 2009.

Azugu is considering moving away from their organic growth model and has been considering and looking for a potential acquisition. The East Legon Executive Fitness Club is for sale at what seems to be a low price. East Legon Executive Fitness Club has gained a reputation over the past few years for loyal customers and has been rated as ‘outstanding’ by 95% of its members in 2017. Although the East Legon Executive Fitness Club’s annual results are excellent, it doesn’t quite fit with the current operations of Azugu. It is a luxury gym group with highly priced membership and high levels of staff/customer interaction. However, its fitness equipment is out of date by the standards of Azugu. There are concerns that when Azugu acquires the East Legon Executive Fitness Club, most of their staff may leave. The staff have expressed concerns that when it acquires East Legon Executive Fitness Club, it may make it a budget gym and are worried about the security of their jobs.

Required:

a) Discuss THREE (3) strategic advantages and THREE (3) challenges of acquiring East Legon Executive Fitness Club compared with Azugu’s usual organic approach to growth within the country.
(12 marks)

b) Identify FOUR (4) ways to ensure that East Legon Executive Fitness Club staff remain reassured, motivated, and loyal throughout the acquisition process.
(8 marks)

a) Strategic Advantages of Acquiring East Legon Executive Fitness Club:

  1. Market Expansion and Accessibility:
    • One of Azugu’s strategic aims is to make gyms more accessible to people and to open more gyms across Ghana. Acquiring East Legon Executive Fitness Club will help fulfill this aim by providing an established location with a loyal customer base. This acquisition allows Azugu to rapidly expand its market presence without the time and resources required for organic growth.
  2. Synergies and Cost Savings:
    • The acquisition could lead to synergies where Azugu and East Legon Executive Fitness Club reduce their aggregated costs by operating together as one bigger organization. For example, they may benefit from bulk buying discounts or obtain more favorable financing deals. Sharing expertise and resources could also lead to more efficient operations.
  3. Cost-Effective Acquisition:
    • The East Legon Executive Fitness Club is available at a seemingly low price, which presents a cost-effective opportunity for Azugu to grow its business. Acquiring an established business at a lower price could provide Azugu with a faster return on investment compared to building new gyms from scratch.

Strategic Challenges of Acquiring East Legon Executive Fitness Club:

  1. Cultural Integration and Fit:
    • The East Legon Executive Fitness Club operates as a luxury gym with a different business model compared to Azugu’s affordable and accessible gyms. Integrating this different culture into Azugu’s existing operations could be challenging, particularly in aligning the business models and customer expectations.
  2. Employee Retention Concerns:
    • There is a risk that staff from East Legon Executive Fitness Club may leave due to fears of job security and changes in the gym’s operational model. This could result in a loss of experienced employees, which may negatively impact the quality of service and customer satisfaction.
  3. Equipment Modernization Costs:
    • The fitness equipment at East Legon Executive Fitness Club is outdated by Azugu’s standards. The cost of upgrading the equipment to meet Azugu’s standards may be substantial, potentially reducing the overall financial benefits of the acquisition.

(3 points for advantages @ 2 marks each = 6 marks; 3 points for challenges @ 2 marks each = 6 marks)

b) Ways to Ensure Staff Retention, Motivation, and Loyalty:

  1. Clear Communication and Reassurance:
    • Azugu should communicate clearly and regularly with East Legon Executive Fitness Club staff to reassure them about their job security and the company’s plans for the gym. Face-to-face meetings and consistent messaging can help alleviate fears and build trust.
  2. Involve Staff in the Transition Process:
    • Engaging staff in the transition process by involving them in decision-making and seeking their input can make them feel valued and part of the new organization. This involvement can help maintain morale and reduce resistance to change.
  3. Offer Incentives and Retention Packages:
    • Azugu could offer incentives or retention packages to key staff members to encourage them to stay with the company during and after the acquisition. These incentives could include bonuses, improved benefits, or career development opportunities.
  4. Align Organizational Cultures:
    • Azugu should take steps to align the organizational cultures of the two gyms by integrating the best practices from both. Providing training and team-building activities can help blend the cultures and create a unified workforce.
  • 20 Marks

FM – Nov 2023 – L2 – Q2 – Business valuations | Mergers and acquisitions

Evaluate the potential acquisition of Akwaaba Films by Lekker Inc, including valuation, cost of equity, and reasons for potential merger failures.

Lekker Inc (Lekker) is a film company located in South Africa. The company is planning to expand into other African countries. The research department of Lekker recommends Ghana as a good location for establishing a subsidiary due to its abundant talent and political stability. However, the company is unsure whether to establish a completely new subsidiary or acquire an existing film company in Ghana. You have been engaged as a consultant to guide Lekker in taking this decision.

Your preliminary assessment revealed the following:

i) You have identified a Ghanaian filmmaker who owns a fast-growing film company called Akwaaba Films (Akwaaba). You observed that the Ghanaian filmmaker is likely to sell Akwaaba if Lekker could pay GH¢450,000 as purchase consideration. Akwaaba is entirely self-financed, with the owner receiving all profits as dividends. You forecast that Akwaaba’s profit after tax will grow at a rate of 6% per year for the first two years, 4% per year for the next two years, and thereafter, grow at a constant rate of 2% per year in perpetuity. The financial information extracted from Akwaaba shows the following:

Description GH¢
Revenue 250,000
Operating Cost (140,000)
Administrative cost (30,000)
Profit before tax 80,000
Tax @ 25% (20,000)
Profit after tax 60,000

ii) If Lekker decides to set up the subsidiary in Ghana by itself with the same GH¢450,000 purchase consideration for Akwaaba, its after-tax cash flows will be as follows:

Year Cash Flow (GH¢)
Year 1 15,000
Year 2 26,000
Year 3 35,000
Year 4 33,000

The overall Price/Earnings (P/E) ratio for the film industry in Ghana is 15 times. The average cash flow risk for unquoted companies in Ghana is 20%. Lekker does not intend to list on the Ghana Stock Exchange.

iii) Lekker’s cost of capital is 16%.

Required:
a) Enumerate THREE (3) advantages of expansion through acquisition over organic expansion to the owners of Lekker. (6 marks)
b) Compute the value of Akwaaba using the dividend valuation method and advise Lekker whether it should acquire Akwaaba at the purchase consideration of GH¢450,000. (8 marks)
c) Using the P/E ratio method, estimate the expected value of Lekker’s subsidiary in Ghana without the acquisition. (4 marks)
d) State TWO (2) reasons mergers and acquisitions may fail to achieve the expected outcomes. (2 marks)

a) Three Advantages of Expansion Through Acquisition Over Organic Expansion:

  1. Speed of Market Entry:
    Acquiring an existing company like Akwaaba allows Lekker to enter the Ghanaian market quickly, without the delays associated with setting up a new subsidiary from scratch.
  2. Established Market Presence:
    Through acquisition, Lekker would gain immediate access to Akwaaba’s existing customer base, established brand, and market relationships, which would take time to develop through organic growth.
  3. Lower Risk:
    Acquiring an existing, successful company like Akwaaba reduces the risk associated with entering a new market, as the business model, management team, and market strategy are already proven.

(6 marks)

b) Value of Akwaaba Using the Dividend Valuation Model:

The Dividend Valuation Model (DVM) can be used to value Akwaaba based on its expected future profits:

Note that the perpetuity is calculated from Year 4 onwards, therefor the discount
factor is the same as that of Year 4 and not Year 5
Conclusion: the purchase consideration of GH¢450,000 quoted by the Ghanaian
filmmaker is lower than the value of the firm, leading to a net gain of 33,524.92.
Based on this Lekker Inc. should purchase Akwaaba Inc

c) Expected Value of Lekker’s Subsidiary Using the P/E Ratio Method:

 

d) Two Reasons Mergers and Acquisitions May Fail to Achieve Expected Outcomes:

  1. Cultural Integration Issues:
    Differences in corporate cultures can lead to conflicts and inefficiencies post-merger, hampering the realization of expected synergies.
  2. Overvaluation of Target Company:
    If the acquiring company overestimates the value of the target company, the merger may not deliver the anticipated financial benefits, leading to losses.

(2 marks)

 

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