Cadbury can use different methods to finance the acquisition of AMSA. These methods have been discussed below: Financing through share exchange Cadbury could finance its acquisition of AMSA through a share exchange. This basically means that Cadbury would purchase AMSA through buying shares in the company in exchange for its own shares. Such a consideration is known as paper consideration.
Although financing an acquisition through a share exchange would free the company from tying up its cash resources in an acquisition but this method has significant issues. For instance; - An acquisition through a share exchange is usually accompanied with a cash alternative probably because shareholders of both the acquiring and the target company might perceive the net worth of the acquiring company’s shares to be different or vice versa. In either case it would be necessary to support this financing method with a cash alternative.
- In case the P/E ratio of the target company is greater than the acquiring company, then this would result in a fall in EPS of the acquiring company; whereas if the P/E ratio of the target company is lower than the acquiring company then this might result in an increase in EPS of the acquiring company. Considering the current scenario, it can be seen that although AMSA enjoys a greater presence than Cadbury in France, Spain, Australia and Mexico itself but even then Cadbury has much greater profitability and its shares are more marketable.
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However financing an acquisition with a share exchange can also have significant tax benefits. Financing through issuance of stock Cadbury could also finance the acquisition of AMSA through raising stock on the market. This is known as cash bid. Although Cadbury has shared its concern over the dilution of its shares if new stock is raised over the money market but it should also consider the long-term benefit it could result in for both the company and its shareholders if the proposed acquisition goes ahead.
A cash bid does have its share of disadvantages particularly for the shareholders of the target company i. e. shareholders of the target company would be immediately taxed for capital gains. Similarly, it would considerably change the control structure of the acquiring company. However, when an acquisition is financed with a stock issue then the premium paid is much lower when compared with financing through a share exchange. Financing through long term borrowing When an acquisition is being financed through a long term debt then it can take many different forms.
For instance; Cadbury could use convertible loan stock to finance its acquisition of AMSA which would not only allow Cadbury to utilize the tax benefits on long term borrowing but also enable the loan stock providers to take part in the company’s profits in the future. However convertible loan stock also possesses the same problem as that of a stock issue i. e. it would eventually result in the dilution of control of the company as well. Cadbury could finance its acquisition of AMSA through either unsecured or secured loan.
An unsecured loan would require a higher interest to be paid whereas a secured loan would need to be secured on the company’s assets. Considering the fact that Cadbury has recently underwent a leveraged recapitalization it is imperative that the company has become highly geared. For instance; its debt-to-equity ratio has increased from 0. 53 in1990 to 0. 62 in 1991. Further borrowing would be an added concern for the company’s shareholders. Recommendation Considering the aforementioned financing methods, it is recommended that Cadbury uses stock issue to finance the acquisition of AMSA.
However financing the acquisition solely through stock issue would result in excessive dilution and therefore it is recommended that the company utilizes a short to medium term loan as well in order to benefit from tax advantages. A share exchange would not be recommended because this is an acquisition of a foreign company and the shareholders of the target company might not value Cadbury’s shares in the same manner. Answer to Question 3 AMSA is a subsidiary of FEMSA and is responsible for majority of FEMSA’s soft drink sales in both Mexico and elsewhere.
FEMSA is a soft drink manufacturing giant in Mexico and is in direct competition with Cadbury Beverages. As mentioned, acquisition of AMSA by Cadbury would result in substantial profit erosion of FEMSA. Moreover, there is also the risk that it could lead to a potential monopoly of the soft drink market in Mexico by Cadbury which is illegal in most jurisdictions. Although the Mexican government allows 100% takeover of domestic companies from foreign companies provided the investment is below $ 100 million, considering the fact that AMSA is a large organization it is questionable whether or not the company could be acquired under $ 100 million.
Therefore, it would be wise to partially acquire AMSA. This would not only free the company from unnecessary tying up of resources but would also provide Cadbury with a necessary insight into the Mexican market. This acquisition would help Cadbury in deciding whether or not to increase its shareholding in AMSA in future depending on the results obtained from the partial acquisition of AMSA. Financing through stock issue Since Cadbury would require lesser resources than a full acquisition therefore, it could finance the acquisition solely through a stock issue.
But this would give rise to another issue i. e. since the partial acquisition would not result in Cadbury gaining control of the company therefore shareholders would have considerable issue in the dilution of control even if that dilution is expected to be considerably lesser than would be incase of a full acquisition. On the other hand, financing through stock issue would secure the company from any further borrowing hence preventing the gearing situation to get any worse. Financing through long term debt Since Cadbury is looking to partially acquire AMSA therefore the resources needed would be less. Therefore, Cadbury could finance the acquisition through a loan.
Although this would increase the gearing level of the company but it would prevent the company from dilution in the shareholding of the company. Nevertheless increased gearing would create concerns among shareholders over possible insolvency of the company (Damodaran,2005). Answer to Question 4 Acquiring AMSA would although affect the financial risk of Cadbury but it would not affect its business risk since it is acquiring a company which serves the same industry as of Cadbury. Such an acquisition is known Type II acquisition. Under this type of acquisition the valuation of AMSA would be done through the Adjusted Present Value (APV) method.
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