Case: Hony, CIFA and Zoomlion -

Creating Value and Strategic

Choices in a Dynamic Market
Please answer the following questions.

a) What are the risks of pursuing the CIFA acquisition? What are the potential

benefits?

ans.) The risks of acquiring CIFA are as follows:

1. Zoomlion had no experience of any overseas acquisition. So they may find it

difficult to oversee the complex task of integrating a foreign acquisition.

2. It might be difficult to keep CIFA’s management stable and re-energized after

the acquisition.

3. The news from Wall Street was ominous, with Lehman Brothers looking in

precarious shape. Doing a major international acquisition in such a volatile

financial environment can backfire.

Potential benefits of acquiring CIFA are as follows:

1. At that time, China’s construction equipment industry was expected to suffer

from overcapacity in the near term. So acquiring CIFA and thus,

internationalising itself, was the only option left for Zoomlion.

2. Zoomlion and CIFA had other synergies: CIFA had advanced technology that

Zoomlion did not have. In addition, their distribution networks were also

complementary with Zoomlion active in China, Africa and the Middle East and

CIFA present largely in Europe, the Persian Gulf, South America and Africa.

3. This acquisition will also help Zoomlion gain market leadership in the mature

European markets and help them capture the fast-growing Russian and

Indian markets.
 4. Another important point to note is that Zoomlion’s competitor Sany was also

looking at CIFA. Acquiring CIFA will prevent a major opponent from pursuing

an aggressive overseas expansion strategy.

b) How is investing in Zoomlion’s acquisition of CIFA different from investing in

Zoomlion itself? Does this pose fewer or more risks for Hony?

ans.) Investing in Zoomlion means investing in Zoomlion as a company whereas

investing in Zoomlion’s CIFA deal means providing investment for that particular

transaction. The deal was attractive as there was a very little downside because of

the public securities and the stability of the customer base, and there was a

substantial upside.

Investing in the acquisition deal would entail fewer risks as in this investment, the

investor will not be exposed to the operating risks of Zoomlion. The success and

failure of his investment will depend totally on the success or failure of the

acquisition.

c) What is the valuation of CIFA? Please use cash flows and cost of capital data

from the case. You may wish to assume that CIFA will grow at 5% per year through

2012 and 2% per year thereafter.

ans.) The valuation has been done in the attached excel file. After the calculations,

the firm value of CIFA comes out to be euro 461.14 million which is based on the

facts from the case and the relevant assumptions are taken.

d) Another source of profits for Zoomlion is sales of its own products through CIFA’s

distribution network. This might be assumed to begin in 2010 and to grow at the
same rate as CIFA’s sales. How significant will the after-tax profits from such sales

need to be (if any) to justify a valuation of 500 million Euros?

ans.) To quantify these after-tax profits, we obtain a figure of euro 2.9 million

calculated as the increment in the Free cash flow of the year 2010. The resultant firm

value from the increased profits due to synergies comes equal to euro 500 million

which is required as per the question. The calculations for the same have been

performed in the attached excel file in the sheet named “After-Tax profits” where

solver has been used to get to the figure of needed incremental after-tax profits

constraining the firm value of euro 500 million.

e) How much do you believe should Zoomlion bid for CIFA, based on the answers

above?

ans.) Taking the tight macro-economic situation into account, the level of systematic

risk is expected to go up and also the lack of experience of Zoomlion at overseas

acquisitions the success of buyout becomes uncertain. This leads us taking prudent

assumptions and running the sensitivity analysis, we see that with higher WACC the

firm value is crossing below euro 450 million. Thus our bid would be around euro 450

million to check both the operational and financial success of the acquisition for all

the concerned parties.

f) What is the estimated return of CIFA deal for Hony? Assume that a) Hony will exit

in 5 years; b) Hony will exercise the option at the time; c) CIFA’s entry trailing

EV/EBITDA multiple was 10, and Zoomlion would be trading at an average

EV/EBITDA multiple of 20 at the time of exit.

ans.) Using this information, IRR has been calculated to be 37.9% at the time of exit

after 5 years. The cash return for the transaction is 4.994x. The supporting

calculations have been accommodated in the excel file with the sheet named “IRR”.

g) Should Hony participate in the Zoomlion acquisition?

ans.) As we have seen, Hony stands to receive an IRR of 37.9% which is very

good. Moreover, Hony has experience of working with Zoomlion since they bought a

16.6% stake in 2006. So they understand what the firm is trying to do.

However, with the difficult macroeconomic environment and the turbulence in Wall

street, making a move now will mean playing a high-risk high-reward game.

Keeping all that in mind, I think that Hony should participate in the acquisition. This is

because, despite the difficult macroeconomic environment and the perceived

difficulties in pulling off such a complex acquisition, the opportunity to acquire CIFA

seems to be tailor-made for Zoomlion. Zoomlion’s top management have proven

themselves in the past with fantastic returns. Also investing in only the acquisition

entails slightly lesser risk for Hony.