EMPRESAS POLAR vs. BAVARIA, S.

A
ACQUISITION OF MINORITY BLOCKS OF BACKUS & JOHNSTON’S VOTING STOCK

A INTERNATIONAL CORPORATE GOVERNENCE CASE STUDY

CASE SUBMITTED TO:
PROFESSOR LOPEZ DE SILANES

STUDENT DETAILS
NAME VINEETH VIJAYAN

COURSE
TRACK

MS FINANCE
CORPORATE FINANCE & BANKING

17 JANUARI 2014

ROLL NUMBER 13030

• •

DO A DCF OF BACKUS.

SPELL OUT YOUR ASSUMPTIONS ABOUT THE COMPANY, THE INDUSTRY AND PERU. IN ADDITION TO ASSUMPTIONS ABOUT THE GROWTH OF BEER DEMAND IN PERU, YOU WILL NEED TO USE INFORMATION ABOUT PRICE AND INCOME ELASTICITY'S TO MAKE YOUR PROJECTIONS.

DCF MODEL ASSUMPTIONS Key Input Metric  COST OF EQUITY METRIC Risk free rate Levered Beta Equity Risk Premium Cost of Equity VALUE 4.01% 11.7 9.0% REMARK Peruvian Brady Bonds corrected for country risk Based on Exhibit 22.nyu.edu/~adamodar/ Using the Classic CAPM Model for market . Stock Market Synchronocity Country base equity spread. http://pages.7% 0.stern.

42% (Exhibit 18) Exhibit 19: Financial Results of Backus & Johnston Company.5% Projected Consumer Price Index used as proxy spread over 10 year period Depreciation Rate 10% Based on Net fixed Assets projected on historical data NET WORKING CAPITAL: a function of EBITDA( 40%) ( Based on Industry Average and Analyst reports) . Average Analyst Projections for the year 2002-2003 normalized over long term growth CAPITAL EXPENDITURE GROWTH RATE 7% Based on industry standards accounting for firm’s present capex spread over a 10 year window Inflation Rate 2.MACRO ECONOMIC INPUTS METRIC PERU LONG TERM GROWTH RATE VALUE 3.

89% .49% We subtract the given value with CPI Index ( inflation metric) factoring in assumed 5% price growth in beer * Negetive Price Elasticity( -1.676) arriving at net macro economic proxy= 6.498) incorporated into model as a lever of GDP Growth ( proxy for beer growth potential) This is multiplied with assumed increase of 3x in per capita beer intake to arrive at a macro economic proxy of 7.CASH FLOW GROWTH RATE Cash flow growth taken as function of both fast growing macro economic factors + company specific performance Macro Economic Factors Beer growth in local Peru market taken at 3% growth p.42% (Average Analyst Projections for the year 2002-2003 normalized over long term growth) Per capita beer consumption of Peru assumed to triple over 10 year time and matching global standards of 72 litres by terminal year Income elasticity (0.a ( Exhibit 1-5) GDP Growth rate of 3.

Final cash flow growth rate used in DCF Model= 25.6% ( Company specific revenue growth) The arrived growth rate is accounted for a inflation of 2.5% assumed.69 mn USD(01) The rate is normalized and reduced gradually with power of 5% decrease to arrive at terminal value growth rate of 2.4% ( 50.39% ( To account for rising estimated competition locally and South American Brewery industry and unfavourable govt policy) Terminal Value Growth Rate = Function of long term Peru growth rate* Industry Beta Cash flow growth rate arrived for first 10 years 6.89%( Macro-economic proxy)+ 21.4 mn USD(02) 31.5% .CASH FLOW GROWTH RATE-II Cash flow growth taken as function of both fast growing macro economic factors + company specific performance Company Specific Growth Rate Historic EBITDA growth rate given in case =52.

DISCOUNTED CASH FLOW MODEL ( All figures in USD Mln) .

. what the value would be and how it would differ from the DCF results.QUESTION 1(b) Can you think of an alternative way to value Backus based on the information of the case? Explain how you would do it.

RELATIVE VALUATION -I ( Data Source-Exhibit 16).12) We multiply average P/S multiple with Company Sales (137. we finally arrive at a Share price of 3.82 USD Mln) Dividing by number of open class A shares(87.19) to arrive at market determined Firm Value ( 290. ( 2.All figures in USD Mln Approach-1 > Price/Sales Method • First we get the comparable south American targets and compute the average P/Sales multiple.35 USD • • .2 mln).

84 USD • .2 mln). ( 11.81 USD Mln) Dividing by number of open class A shares(87.RELATIVE VALUATION-II ( Data Source-Exhibit 16) All figures in USD Mln Approach-2 > EV/EBITDA Method • First we get the comparable south American targets and compute the average EV/Ebitda multiple. we finally arrive at a Share price of 6.8) • We multiply average EV/EBITDA multiple with Company EBITDA (50.47) to arrive at market determined Firm Value ( 596.

stock prices do not reflect the fundamental and intrinsic value due to presence of different class of shares.A RECAP  We find our classic RV approach using (EV/EBITDA) & (P/S) Method returning a firm value less than that of DCF Method. shares are competitively under priced.66 06.35    Class A shares used for computation of shares outstanding for RV method while sum of Class A+ Class I shares used to compute intrinsic value of stock Due to markets with less than 100% liquidity & synchronisation ( Exhibit 22-23) and less developed stock exchanges.RELATIVE VALUATION. FIRM VALUE DCF EV/EBITDA PRICE/SALES 7.124 596 291 VALUE OF SHARE 11. .84 03.

. It also reflects in the value of share computed on lower side (3.RELATIVE VALUATION.5 USD) A lower EV/EBITDA multiple (< 10) shows a matured industry with concentrated players evident in the company mix in major South American markets( Exhibit 1-5)   Price/Sales method showing a lower value due to vastly different operating margins of peer group and also nature of industry( stable income vis-à-vis negative profitability.ANALYSIS  Company has a higher EV/EBITDA multiple compared to peer group showing it to be undervalued.

I prefer DCF over relative valuation due to its strength in assessing the fundamental business model into estimation and hence a better gauge for investment strategy than RV as stock market is not fully developed in Peru. I recommend a BUY due to the vast synergies and operational improvement prospects. I would advise my client to hold/sell their holding if seen from a trading point of view with a 1-3 year horizon.A FINAL WORD   Based on both intrinsic ( DCF) valuation & comparable study I arrive at the conclusion that market is right now over valued.   . As a method. However for an activist investment option.VALUATION.

QUESTION 2 Based on your valuations. can you make sense of the market price of Class A shares? Is that price the right one? How could you make sense of that price compared to price of your valuation? .

1 times the dividend rights .CLASS A MARKET PRICE –A RECAP Only Class A shares have voting rights Each Class I share is entitled to only onetenth the dividend and liquidation rights of a Class A share Class A and Class I shares make up the common stock of the company Class B shares constitute the preferred shares of the company and carry 1.

Exchange Rate: Peruvian Sol/USD= 3. I find Class A shares overvalued(30 SOL (market) vs 17.53 Exhibit 17: Jan 03 forecast   .  Based on recalculated the final shares (140 mn) we arrived at revised price per share for the firm and subsequently for all classes of shares using case data.58(valuation) per my analysis with marginal differences for Class I & Class B ( Exhibit 20) In contrast to financial theories stating value firms to be undervalued in market.CLASS A MARKET PRICE –ANALYSIS  First we recomputed the shares per the voting & dividend rights segmentation as mentioned in previous slide.

If we take their effect away. Class A market price is higher than normal firm market price owing to higher power with regards to voting and dividend rights on shares. I believe the market is incorrect in valuing stocks due to inefficiency of emerging market. Based on my valuation factoring in intrinsic factors.58) represents class-A voting equivalent share intrinsic value which contains Class I( 1/10th) and Class B( minimal amount after accounting for treasury stocks). the price will be slightly higher bringing closer to market price. My model’s value ( 17. non optimal stock synchronisation and short term speculation in market throwing the value off the fundamental level.CLASS-A MARKET PRICE –CONCLUSION   Is the market price ( 30 SOL) correct? Though my study finds it overvalued but I do believe its in right direction.58 in near future( As of 2002)   . I believe this is a market timing error and will revert back to the fundamental value of 17.

QUESTION 3 THE VALUE OF CLASS A SHARES AND CLASS I SHARES DIFFERS. HOW WOULD YOU EXPLAIN THIS DIFFERENCE? PROVIDE CORPORATE GOVERNANCE REASONS AND ALSO CONSIDER IMPACT OF LEVEL OF EFFICIENCY OF STOCK MARKETS IN EMERGING COUNTRIES. .

Greater dividend to Class A shareholders stronger Cash flow rights for Class A shares The discount at which limited-voting shares (Class I) usually sell is attributed to firm fundamentals.e. each Class I share is entitled to only one-tenth the dividend and liquidation rights of a Class A share. Hauser and Lauterbach. Class I shares. 2004). tunneling etc . 1994 and 1995.e.DIFFERENCE BETWEEN SHARE CLASSES CASE STRUCTURE Only Class A shareholders have voting rights. Class B shares constitute the preferred shares of the company and carry 1. This would cause a voting premium to emerge Extra Value of Class A shares can be attributed to private benefits of control Scope for opportunistic behavior increases leading to self dealing transactions. reflecting greater degree of control over strategic decisions of firm. in this case Class A shares trade at a premium over subordinated shares i. as shareholders with limited voting rights are expected to appropriate a lower proportion of the firm’s future cash flows (Zingales. Superior shares i.1 times the dividend rights FEATURES Cash flow rights and voting rights altered in a multiple class shareholder structure. Also.

DIFFERENCE BETWEEN SHARE CLASSES-II INDUSTY NORMS Companies that choose to have multiple classes issue two classes. In US 5% but in Peru say 25% but actually it is 75% as markets are not efficient Effect of liquidity . Class A and Class B shares Common objective include provide its founders.Edmans. the "super voting" multiple is about 10 votes per higher class share. although occasionally companies choose to make them much higher purpose of the super voting shares is to give key company insiders greater control over the company's voting rights. since key insiders can maintain majority voting control of their company without actually owning more than half of the outstanding shares Pvt benefits of control. Fang & Zur Source: Investopedia . and thus its board and corporate actions existence of super voting shares can also be an effective defense against hostile takeovers. executives or other large stakeholders with a different class of common stock that carries multiple votes for each single share of stock Commonly.

. This results in a weak market for corporate control Weak market for corporate control leads to inefficient stock markets  stock prices do not reflect the fundamental and intrinsic value Existence of dual class shares would only be a problem if an investor believed the disproportionate voting rights were allowing inferior management to remain in place in spite of the best interests of shareholders. which has Warren Buffet as a majority shareholder. Echostar Communications CEO Charlie Ergen has about 5% of the company's stock. Berkshire Hathaway Inc. regardless of their abilities and performance. offers a B share with 1/30th the interest of its A-class shares. EXAMPLES • • • Ford's dual-class stock structure. but 1/200th of the voting power. dual-class structures may allow management to make bad decisions with few consequences. Finally.DIFFERENCE BETWEEN SHARE CLASSES-III Corporate Governance Reasons + Impact in Emerging Markets Dual class share structure enables the family controlling the business to prevent hostile takeovers as they always have the controlling rights even though they might happen to lose out on equity. Families and senior managers can entrench themselves into the operations of the company. allows the Ford family to control 40% of shareholder voting power with only about 4% of the total equity. Source: Investopedia . but his supervoting class-A shares give him a whopping 90% of the vote.

IS THE PREMIUM ON CLASS A SHARES PAID BY BAVARIA AND CISNEROS A “PREMIUM FOR CONTROL” THAT REFLECTS AN ACT OF COLLUSION ON THE PART OF THESE TWO FIRMS.” IN YOUR OPINION.THE REPORT COMMISSIONED BY POLAR ARGUES THAT “PREMIUMS OF 30%-50% ARE TYPICALLY PAID FOR CONTROL OF A COMPANY AND SUBSTANTIALLY SMALLER PREMIUMS ARE PAID FOR ACQUISITIONS OF MINORITY BLOCKS. AS THE REPORT SEEMS TO SUGGEST? ARE THERE ANY CORPORATE GOVERNANCE REASONS THAT COULD JUSTIFY THIS PREMIUM IF IT IS NOT A PREMIUM FOR CONTROL OF THE FIRM? .

" Resignation of Directors Agreement to purchase Backus shares was conditioned on the resignation of all the directors and high officials of Backus and its subsidiaries. Common legal defense Bavaria and Cisneros launched a common legal defense against the collusion complaints "to avoid any action that would have disturbed their ownership and right as shareholders. following rule in this type of transactions. Cisneros could have only secured this condition had it been acting in collusion with Bavaria. launched a due diligence process and established an escrow account. not Bavaria.PREMIUM FOR CONTROL. Due diligence and escrow Only Cisneros.A CASE  Bavaria (Columbia) and Cisneros (Venezuela) paid 111 percent and 62 percent premiums for Backus shares respectively. The two transactions gave Bavaria and Cisneros an aggregate 46 percent stake in the company and the right to nominate eight of the fourteen directors.    . This indicates that because both companies "took control in collusive manner. only a single due diligence process and escrow account was necessary.

they would have power to control 50% +of seats on Backus' board (up to eight of 14 seats if Cisneros completes its intended acquisition of shares) Premium for control  upto 50% makes economic rationale and if control not the main motive.A CASE-II  Timing of transactions It is highly uncommon that negotiations for complex transactions would have taken place in such a short period of time (6 weeks) in the case of Bavaria's initial purchase and one week in the case of Cisneros Similar selling price  Once deductions are made for tax payments. Eg. . which the "buyers as well as Backus have explicitly affirmed.   Economic logic  dictates that rational investor would not pay premiums of the magnitude paid by Bavaria and Cisneros for passive minority investment. but potentially would pay such premiums for investment that would provides control over target company because when their stake is taken in aggregate.“ confirming a case of share intelligence by competing firms. Internal audit to resolve execessive payment to suppliers etc to get operational control. then turning the company around and realizing its true potential. both Cisneros and Bavaria paid the same price for the shares.PREMIUM FOR CONTROL.

     Source: Case Literature . With 5% of the firm’s capital (Class A and Class B shares in the case of Backus). and can request the compulsory distribution of up to half of the profits in the form of dividends. a shareholder gains the right to request certain information outside of the shareholders’ meetings. higher levels of ownership conferred additional rights.CORPORATE GOVERNENCE REASONS FOR PREMIUM PAYMENT  Under Peruvian law and Backus’ bye-laws. a shareholder gains the right to elect one person to the Board of Directors. a shareholder gains the right to request revisions or special investigations about concrete items in the management of the firm with respect to matters related to the financial statements for the previous fiscal year. With 10% of Class A shares. With each block of 7. a shareholder gains the right to call a shareholders meeting. strategic shareholders can yield significant influence over the decisions of the firm even if they do not control a majority stake. In this sense. The rights of strategic shareholders include the following: With 5% of Class A shares.14% of Class A shares that have effective voting rights. With 20% of Class A shares. a shareholder can request a court order to suspend any act that has been “impungando” (a decision taken by management without the approval of the shareholder).

Therefore.  Easterbrook and Fischel (1983) suggest that the premium of voting over nonvoting shares represents the ‘opportunity of those with votes to improve the performance of the corporation.  Finally. Megginson (1990) finds that low-vote shares are more actively traded than high-vote shares in his study of British dual-class firms and Zingales (1995) reports the volume in the highvote stock is less than half the volume of the low-vote stock on average. and this percent constitutes a majority of the votes at the shareholders’ meeting. due to illiquidity and reduced diversification greater risk and thus greater premium.CORPORATE GOVERNENCE REASONS FOR PREMIUM PAYMENT-II  With 25% of Class A shares. In this case.’ The liquidity risk affects shareholders’ willingness to invest in stocks and should be reflected in their prices. with 40% of Class A shares. a shareholder obtains the right to postpone the shareholders’ meeting for three to five days. a shareholder can request the elimination of the pre-emptive rights given to common stockholders. Bavaria and Cisneros acquired in aggregate almost 46 percent which is more than 40 percent which meant they could eliminate the pre-emptive rights given to other common stockholders which certainly is not in favour of Polar.   .

WHAT OTHER REASONS COULD BAVARIA OR CISNEROS HAVE FOR PAYING SUCH A HIGH PREMIUM? .BESIDES THE CORPORATE GOVERNANCE REASONS THAT YOU HAVE THOUGHT OF IN QUESTIONS 3 AND 4.

Its size has made it a strategic takeover target for several large firms in the region which see a chance to form a regional brewing group to counter the dominant position of of AmBev  After acquisition of Cervesur. Backus has become sole producer of beer in Peru  Diversification of business bottom line with ready access to a growing economy. Backus increased production capacity by buying new equipment.4% with projections in future tended at continuing double digit growth. Backus’s revenues grew by 18. Backus has taken over smaller firms in the region to consolidate its position as a market leader in Peru.4%) and EBITDA (30. During 2002. Extensive value chain strength of target.3% and net sales by 13.8%) During 2002.BLOCK ACQUISITON MANDATE     STRATEGIC BUSINESS REASONS High preference and brand loyalty for Backus. . bettered its distribution channels and its storage capacity in certain plants by north of 80%.0%). operating margin (32.    Improvements of gross margin (65.

Higher chance at creating societal & business synergies for better optimal control. Favorable political climate with ousting of General Pinochet in late 1980s and more consumerist fervor in market. an important factor while dealing in a consumer intensive sector like brewery. One of the most brand loyalist consumer segment in South America aiding in stable growth and translating into higher dollar revenue per marketing expense spent. This translates into not only higher profitability but signals favorable government initiative in place. Potential growth in Peruvian beer market Recovery of consumer purchasing power Per capita beer consumption in Peru is one of the lowest (24 liters) and is expected to catch up with the developed nations with higher economic growth aiding more beer sales.BLOCK ACQUISITON MANDATE-II       STRATEGIC MACRO-ECONOMIC REASONS The Peruvian government reduced the beer consumption tax from 65% to 54% and is expected to further reduce taxes in future. Expected increase in the figure 3x in medium to long term.  .

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