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After studying this chapter, you should be able to display a good understanding of the
following:

Reasons for share and company valuations

Traditional methods for company valuations

Other methods for company valuations

How business valuations are affected by efficient markets

Mergers and Acquisitions

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Understanding the factors that determine the value of any business will pay tangible
dividends to management and all affected stakeholders by focusing their attention on ways
to increase the firm's short and long-run profitability. Moreover, if the shareholders choose
to sell the business at some point in the future; this knowledge will assist them in
positioning the company to receive the highest price. Therefore, there is no time like the
present to begin to understand what a business valuation is, under what circumstances a
valuation is customarily completed, and the critical issues to watch out for when events
dictate that management undertakes a business valuation.

We first turn to the central issue - what is a business valuation? To answer this question,
consider the following example. You own Zambia Sugar Plc shares and you want to know
how much it is worth. Well, all you have to do is pick up the Lusaka Stock Exchange price
index, multiply the shares’ closing price by the number of shares you own. Through this
simple exercise, you have valued your Zambia Sugar Plc shares or what you would receive in
cash if you sold your shares at the closing price.

In concept, valuing your private business is the same as valuing Zambia Sugar Plc Shares.
But, because your business is private, there is no share price index that you can conveniently
turn to. No need to worry, however, because there is a pseudo-science, or some say an art
form, that provides the foundation for skilled business appraisers to estimate what your
business is worth. The problem is that the valuation process is often viewed as a "black
box." As a result, a whole mythology has grown up around valuation of private businesses
but as you will shortly appreciate, it is far from being as complicated as rocket science!

Thus, whenever people talk about equity investments, one must have come across the word
"Valuation". In financial parlance, Valuation means how much a company is worth.
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Valuation means the intrinsic worth of the company. There are various methods through
which one can measure the intrinsic worth of a company. This chapter is aimed at providing
a basic understanding of these methods of valuation.

VKN== ob^plkp=clo=pe^ob=s^ir^qflkp=

It may be wondered why, given quoted share prices on the Lusaka Stock Exchange, there is
any need to devise techniques for estimating the value of a share. A share valuation will be
necessary:

cçê=èìçíÉÇ=Åçãé~åáÉë=

When there is a takeover bid and the offer price is an estimated fair value in excess of the
current market price of the shares.

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The company wishes to go public and must fix an issue price for its shares

There is a scheme of merger, and a value of shares for each company involved in the
merger must be assessed

Shares are sold

Shares need to be valued for the purpose of taxation

Shares are pledged as collateral for a loan

cçê=ëìÄëáÇá~êó=Åçãé~åáÉë=

When the group’s holding company is negotiating the sale of a subsidiary to a

management buyout team or to an external buyer.

Our main interest in this chapter is with methods of valuing the entire equity in a company,
perhaps for the purpose of making a takeover bid, rather than with the value of small
blocks of shares which an investor might choose to buy or sell on the Lusaka Stock
Exchange.

VKO== qo^afqflk^i=jbqelap=clo=`ljm^kv=s^ir^qflk=

Valuation methods fall broadly into four categories based respectively on assets, earnings,
dividends and CAPM. It is important to understand that, as with all business measures, it is
unwise to depend on any one method, and indeed juxtaposing the results of calculations
using all four types of valuation can provide a valuable benchmark for the project under
evaluation.

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The Business Valuation Methods are summarised in the diagram below.

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The DCF method is perhaps the most comprehensive and renowned going concern
valuation technique. It is based on the premise that the value of a company is a function of
the future cash flows generated by the business and all its assets (including goodwill)
discounted at a risk-adjusted cost of capital to attain a net present value. The method
involves an in-depth analysis of the company's historical operating and financial
performance, its current market position, future plans and the economic environment in
which it operates.

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This approach takes into account:

The stream of cash flows the owners of the business expect to receive in the future;

The timings and receipt of those cash flows; and

The risk borne by the owners of the assets.

DCF is the most widely used technique to value a company. It takes into consideration the
cash flows arising to the company and also the time value of money. That’s why, it is so
popular. What actually happens in this is, the cash flows are calculated for a particular
period of time (the time period is fixed taking into consideration various factors). These cash
flows are discounted to the present at the cost of capital of the company. These discounted
cash flows are then divided by the total number of outstanding shares to get the intrinsic
worth per share.

If the Acquiring Company wanted to make extra investment in The Target Company once the
takeover was complete, and is able to estimate the future net cash-flows of the Target
Company, and discount them using its own cost of capital, it could calculate the maximum price
it would be willing to pay for the Target Company now.

Suppose the Acquiring Company calculates that, immediately on taking over the Target
Company, it would invest a further K200 000 to improve its profitability. It has already
calculated that the profits of the Target Company would increase under its management, but
now it perceives an additional 10% increase. Of course, we now have to add back a figure for
depreciation to the profits, and also allow for tax, if we are to find a net cash-flow figure.

The Acquiring Company expects all its investments to pay back after 4 years. Its cost of capital
is 14%. Estimated profits for The Target Company are K324 500 plus another 10% plus
depreciation, say K300 000, less tax - say K170 000 - gives an estimated cash flow for year 1 of
K486 950. The Acquiring Company estimates that this figure will increase over 4 years by a further
8% per annum.

Year Net cash-flows Discounted cash-flow at 14%

0 (200 000) (200 000)
1 486 950 427 149
2 525 906 404 668
3 567 978 383 369
4 613 417 363 192
Net present value 1,378,378

So Kl, 378, 378 would be the maximum amount that the Acquiring Company would be
prepared to pay under these circumstances, (note: the cash flows ignore the purchase price,
so that the maximum price to be paid must be that which would give an NPV of zero at 14%)

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This method assesses appropriate market value for shares of unquoted companies. Some
valuation analysts use the market multiples approach. In doing so, an analyst will examine
commonly used multiples of similar actively traded public companies to extrapolate the
market value of the company being valued.

The most popular market driven methodologies use ratios such as:

Price/Earnings (P/E); and

Market to Book Value (M/B) ratios.

The market value per share is computed by multiplying earnings per share by the applicable
P/E ratio or the book value by the applicable M/B value. When using this method, it is
prudent to adjust the earnings, if necessary, for any extraordinary items, which are of a
non-recurring nature to arrive at an estimated maintainable level of earnings. The applicable
ratio will be determined by identifying and applying the ratio of similar mining companies
quoted on the Lusaka Stock Exchanges.

The price-earnings ratio (P/E) is simply the price of a company's share of common stock in
the public market divided by its earnings per share. Multiply this multiple by the net income
and you will have a value for the business. If the business has no income, there is no
business valuation. If the common stock (“ordinary shares”) is not publicly traded, business
valuation of the stock is purely subjective. This may not be the best choice of business
valuation methods, but can provide a benchmark business valuation.

qÜÉ=éêáÅÉ=É~êåáåÖë=ê~íáç=Å~å=ÜÉäé=áå=Åçãé~êáåÖ=êÉä~íÉÇ=Åçãé~åáÉë=

Value investors have long considered the price earnings ratio (PE Ratio) a useful metric for
evaluating the relative attractiveness of a company's stock price. Made popular by the late
Benjamin Graham, who was dubbed the "Father of Value Investing" as well as Warren
Buffett's mentor, Graham preached the virtues of this financial ratio as one of the quickest
and easiest ways to determine if a stock is trading on an investment or speculative basis.

^å=Éñéä~å~íáçå=çÑ=íÜÉ=éêáÅÉ=É~êåáåÖë=ê~íáç=

Before you can take advantage of this tool, you have to understand what it is. Simply put,
the PE Ratio is the price an investor is paying for K1 of the company's earnings. In other
words, if a company is reporting basic or diluted earnings per share of K2 and the stock is
selling for K20 per share, the p/e ratio is 10 (K20 per share divided by K2 earnings per share
= 10 PE.)

Once you have the magic number, it's time you begin to wield its power. It can help you
differentiate between a less-than-perfect stock that is selling at a high price because it is the
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latest hot-pick on the stock market, and a great company which may have fallen out of
favour and is selling for a fraction of what it is truly worth. First, you have to understand
that different industries have different PE Ratio ranges that are considered "normal". For
example, technology companies may sell at an average of 40 PE, while textile
manufacturers may only trade at an average of 8. There are the exceptions, but for the
most part, these differences between sectors are perfectly acceptable. They arise out of
different expectations for different businesses.

Technology stocks or shares usually sell higher because they have a much higher growth
rate and earn high returns on equity, while a textile mill, subject to dismal margins and low
growth prospects, will trade at a much smaller multiple.

One way to know when a sector is over priced is when the average PE Ratio of all of the
companies in the industry is far above the historical average. (A sector is a group of
companies in a particular line of business; e.g., pharmaceuticals, advertising, utilities, etc.)
This could spell trouble. We saw the repercussions of just such a gross-over pricing in the
recent technology crash following the dot-com frenzy of the late 1990's. Thus, the investor
could have avoided the huge declines in the technology stocks had share owners sold when
they realized that the entire industry was dangerously expensive.

rëáåÖ=íÜÉ=mb=o~íáç=íç=Åçãé~êÉ=Åçãé~åáÉë=áå=íÜÉ=ë~ãÉ=áåÇìëíêó=

In addition to helping you determine which industries and sectors are over / under priced
you can use the PE Ratio to compare the prices of companies in the same sector against
each other. For example, if company ABC and XYZ are both selling for K50 a share, you
might think one is not more expensive than the other. Wrong!

Company ABC may have reported earnings of K10 per share, while company XYZ has
reported earnings of K20 per share. Each is selling on the stock market for K50. What does
this mean? Company ABC has a price to earnings ratio of 5, while Company XYZ has a PE
Ratio of 2.5. This means that company XYZ is much cheaper on a relative basis. For every
share purchased, the investor is getting K20 of earnings as opposed to K10 in earnings
from ABC. All else being equal, an intelligent investor should opt to purchase shares of
XYZ; for the exact same price (K50), he is getting twice the earning power.

Remember, though, just because a share is cheap doesn't mean you should buy it. If a
company's stock price has fallen, do your research and discover the reasons. Is
management honest? Are they losing key customers? Look at insider buying. Is the Board
of Directors buying stock in the company? If the weakness is across the entire sector or just
because of temporary bad news that doesn't change the bottom line, then consider buying.

The Price/ Earnings ratio is computed by the formula:

Current market price of share

Earnings per share

We could rearrange this to say that:

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The market value of a share = EPS x P/E ratio

The EPS figure is not necessarily the one calculated form the latest income statement. It
could be an expected future EPS, which, could obviously give higher value to the shares.

The P/E valuation method requires that an investor estimates a company's projected earnings for
the next year and then the latest P/E ratio is applied to value the share. For example, if the last P/E
ratio of a company is 15, i.e. the current market price of a share is 15 times its current earnings per
share then the estimated earnings per share for next year (estimated earnings/no, of shares)
multiplied by 15 will constitute a fair estimate of the future price of the share.

The market price of shares in listed companies is observable; hence P/E ratios are easily
observable and published daily in the financial press. Privately held companies, however, have
no observable P/E ratio. Arguably, the most important application of the P/E method is in valuing
private company shares. Private companies can be valued by applying the P/E ratio of a similar
listed company, typically adjusted downwards, to the forecasted earnings of the private firm. The
reasons for adjusting the P/E ratio are few, but they revolve around 2 major issues.

The first one is that investment in private companies is riskier than that investment in
identical listed firms because of the lower marketability of the shares, implying that risk is not
easily diversifiable. As a result, the P/E ratio applicable to a private company would reflect
some unsystematic risk, and not only systematic risk. The second reason is that it is unlikely to
find a listed company that has exactly the same characteristics as the private firm valued.

Suppose the Acquiring Company has looked at the earnings of the Target Company for the past
5 years. (It has not been able to obtain an estimate for the next year).

YEAR EARNINGS (K)

2000 150 000
2001 170 000
2002 180 000
2003 190 000
2004 245 000

On looking at the P/E ratios of quoted companies in the same industry, we find that the
average is 12. Those companies most similar are:

Silverman which has recently grown rapidly and also has good growth prospects. Its P/E
ratio is 16.

Pinch which has recently had poor profits, so its P/E ratio is only 9.

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The easiest starting-point might be to take average earnings over the 5 years. This would give us a
figure of (935000/5) = K187 000. If we look at the last 3 years, we would get (615 000/3) =
K205 000. However, the profits for the last year has risen substantially - we might wish to make
a separate calculation using K245 000 to see how this would affect our result.

We could not compare the Target Company P/E ratio directly with Silverman's - not only is
Silverman quoted, but it has very good growth prospects and we don't know enough about
the Target Company. However, it has a better profit record than Pinch and, presumably, better
expectations. We might therefore decide to take the industry average, and reduce it as the Target
Company is unquoted. If we were optimistic, we could take 70%; if pessimistic 50%.

jÉíÜçÇ=P= kÉí=^ëëÉíë=s~äì~íáçå=jÉíÜçÇ=

This method will provide a value of the company being valued based on the book value of
assets at a specific point in time. This is a fairly simplistic approach, but it provides a
reasonable benchmark value. The limitation is that the net asset value is based on
accounting numbers, which are historical in nature.

In addition, this method does not take into consideration the ability of the assets to
generate profits and cash flows in the future. Furthermore, this approach cannot put a
value on the intangible assets, such as management skills and, therefore, does not take into
consideration any potential 'goodwill' value. In certain valuations, however, net asset value
will be used as a base and a premium added for 'goodwill'. This premium can be based on
the business and company performance e.g. value of key forward contracts with purchasers
of company products.

Financial statements serve as the starting point of any asset-based valuation since they can
provide a fair reflection of the current circumstances of a business and, after appropriate
adjustments, can give a reasonable indication of future prospects. The financial statements of a
company show the value of a business as the difference between the value of assets and the value
of liabilities. The difference is known as Net Asset Value (“NAV”).

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The Capital Asset Pricing Model might be used to value shares, particularly when pricing
shares for a stock market listing. The CAPM would be used to establish a required equity
yield.

Example

Suppose that Betty Kawambwa Plc is planning to obtain a Lusaka Stock Exchange listing by
offering 40% of its existing shares to the public. No new shares will be issued. Its most
recent summarised results are as follows:

K’million

Turnover 120

Earnings 1.50

Number of shares 3.00

The company has low gearing.

It regularly pays 50% of earnings as dividends, and with reinvested earnings is expected to
achieve 5% dividend growth each year.

Summarised details of two listed companies in the same industry as Kawambwa Plc are as
follows:

Nakambala Plc Wamundila Plc

Gearing: total debt/equity 45% 10%

Equity Beta 1.50 1.05

The current treasury bills yield is 7% per year. The average market return is estimated to be
12%.

The new shares will be issued at a discount of 15% to the estimated post issue market
price, in order to increase the prospects of success for the share issue.

Required:

Compute what the issue price will be.

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SUGGESTED SOLUTION

Using the CAPM, we begin by deciding on a suitable beta value for Kawambwa Plc’s equity.
We shall assume that since Kawambwa Plc’s gearing is close to Wamundila’s, a beta of
1.05 is appropriate.

The cost of Kawambwa Plc equity = 7% + 1.05(12-7) = 12.25%.

This can now be used in the dividend growth model. The dividend this year is 50% of K1.5
million = K750, 000.

The total value of Kawambwa’s equity = (750,000*1.05)/ (0.1225-0.05) = K10, 862,068.

There are 3,000,000 shares, giving a market value per share of K3.62

Since the shares that are offered to the public will be offered at a discount of about 15% to
this value, the share price for the market launch should be about 85% of K3.62 = K3.08.

VKP=Ó=lqebo=jbqelap=clo=`ljm^kv=s^ir^qflk=

VKPKN== p~äÉë=jìäíáéäÉ=_ìëáåÉëë=s~äì~íáçå=jÉíÜçÇëW=

Sales and profit multiples are the most widely used business valuation methods benchmark
used in valuing a business. The information needed are annual sales and an industry
multiplier, which is usually a range of 0.25 to 1 or higher. The industry multiplier can be
found in various financial publications, as well as analyzing sales of comparable businesses.
This method is easy to understand and use. The sales multiple is often used as the business
valuation benchmark.

VKPKO== mêçÑáí=jìäíáéäÉ=_ìëáåÉëë=s~äì~íáçåW=

Profit and sales multiples are the most widely used business valuation benchmarks used in
valuing a business. The information needed are pretax profits and a market multiplier,
which may be 1, 2, 3, or 4 and usually a ceiling of 5. The market multiplier can be found in
various financial publications, as well as analyzing the sale of comparable businesses. These
business valuation methods are easy to understand and use. The profit multiple is often
used as the business valuation ceiling benchmark.

VKPKP== kÉí=oÉ~äáë~ÄäÉ=s~äìÉ=jÉíÜçÇ=

This type of business valuation is similar to an adjusted book value analysis. Liquidation
value is different than a book valuation in that it uses the value of the assets at liquidation,
which is often less than market and sometimes book. Liabilities are deducted from the
liquidation value of the assets to determine the liquidation value of the business.
Liquidation value can be used to determine the bare bottom benchmark value of a
business, since this should be the funds the business may bring upon business valuation.

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While the replacement cost valuation establishes the maximum value of a business, the
realisable value method often determines the minimum value of a business. The realisable value
of assets represents the amount that can be received if the business is closed down and the assets
sold off, after payment of any expenses associated with the sale. This net value is often referred
to as the "liquidation" value since it fundamentally represents the "worst-case" scenario where a
whole company is worth less than the sum of its assets. The problem with this method is similar
to the problem with the replacement costs - the value of certain assets cannot be established
until a sale is made.

VKPKQ== oÉéä~ÅÉãÉåí=`çëí=jÉíÜçÇW==

This type of business valuation is similar to an adjusted book value analysis. Replacement
value is different than liquidation value in that is uses the value of the replacement value of
assets, which is usually higher than a book valuation. Liabilities are deducted from the
replacement value of the assets to determine the replacement value of the business.

This is a significant improvement on historic cost valuations. This approach requires that
balance sheet items are shown at the current cost of replacing them with identical assets. While
a replacement cost valuation obviously reflects the current market value of each asset, it is
difficult to implement in practice. Certain assets are likely to have easily identifiable replacement
costs, such as tangible assets like delivery vehicles, but other assets are not publicly traded. For
example, an asset such as a patent on a medicine does not have a readily identifiable
approximate cost. The replacement cost valuation method essentially represents the cost of
establishing a similar new company, and the result of such a valuation can serve as the maximum
value of a business.

VKPKR== qÜÉ=_~ä~åÅÉ=pÜÉÉí=s~äì~íáçå=jÉíÜçÇ=
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The most basic approach to valuation is the calculation of NAV on the basis of the figures
reflected in the annual financial statements. The problem with this calculation is that the
accounting numbers in the balance sheet show assets on the basis of their historic cost
(original price when purchased) less accumulated depreciation. These "book" values are rarely
a reflection of the current market value of the assets, especially with regard to fixed assets
purchased in the more distant past. For example, imagine that a company owns a piece of land
that was purchased 20 years ago. If nothing else, the rate of inflation over the past 2 years would
ensure that the nominal value (in Kwacha) of the same land today far exceeds the original cost.
Yet, financial statements, unless adjusted, will still reflect the historic purchase price. Even more
recent purchases, such as computer equipment, are unlikely to reflect current market values.
Currently, computer equipment can be depreciated straight-line over 2 years, but an attempt to sell
last year's top-of-the range laptop at two-thirds of purchase pries is unlikely to succeed, given the
technological improvements make over a year

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VKQ== elt=`ljm^kv=s^ir^qflk=fp=^ccb`qba=_v=bccf`fbkq=j^ohbqp\=

The first form of market efficiency is weak-form efficiency which is a situation in which
market prices rapidly reflect all information contained in the history of past prices. Past
price movements are random; the past cannot predict future price changes.

Fundamental analysts attempt to find under- or overvalued securities by analyzing

“fundamental” information, such as earnings, asset values, etc., to uncover yet
undiscovered information about the future of a business. They look ahead trying to
forecast future information; technical analysts are studying past prices, looking for
predictable patterns.

A second form of market efficiency, semi-strong form efficiency, is a market situation in

which market prices reflect all publicly available information. New information is quickly
reflected in the price of the stock, and investors were not able to earn superior returns by
buying or selling after the announcement date.

A third form of market efficiency, strong-form efficiency, is a situation in which prices

rapidly reflect all information that could be used to determine true value. In this market
pricing situation, all prices would always be fairly priced and no investor would be able to
make superior, accurate forecasts of future price changes. Even professional portfolio
managers do not consistently outperform the market, thus supporting the creation of
“index” portfolios, assembled to match popular market indices.

The efficient market theory implies that security market prices represent fair value. Some
argue this cannot be for prices go up and down, and that fair value should change very
little. Fair market value changes with new information about the future cash flows
associated with a security.

The efficient-market theory implies that portfolio managers work in a very competitive
market with little or no added advantage over the next portfolio manager. They make few
extraordinary returns, not because they are incompetent, but because the markets are so
competitive and there are few easy profits.

kç=qÜÉçêó=fë=mÉêÑÉÅí=

Though the efficient markets hypothesis is well supported by research, there are a few
unexplained events and exceptions. One exception is the evidence that managers have
made consistently superior profits trading their own company’s stock, probably with good
insider information, but testing the strong-form efficiency theory. The managers know
more about the company’s opportunities than other market participants.

Small firm stocks have consistently outperformed large firm stocks, especially in January,
questioning even the weak-form efficiency hypothesis. The fact that other yet- explained
variables are involved is the likely answer.

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In recent years the scale and pace of merger activity have been remarkable. During periods of
intense merger activity, financial managers spend considerable time either searching for firms to
acquire or worrying whether some other firm is about to take over their company. When one
company buys another, it is making an investment, and the basic principles of capital
investment decisions apply. You should go ahead with the purchase if it makes a net contribution
to shareholders' wealth. But mergers are often awkward transactions to evaluate, and you have to
be careful to define benefits and costs properly. Many mergers are arranged amicably, e.g. the $3
billion merger of Goldfields Zambia with lamgold, the Canadian mining group during August
2004, but in other cases one firm will make a hostile takeover bid for the other. E.g. the AM
Moolla Group successfully fought off a hostile bid by the Coastal Group in 1998; also the failed
bid by Nedcor of its rival bank Stanbic in 1999.

An acquisition can also be called off, if a company is being disadvantaged, for example, the
richest overseas soccer club, Manchester United, called off talks with US sports tycoon
Malcolm Glazer regarding his proposed offer for the club, but did not close the door to
further discussions. The debt-free club said that while it had a definite offer from Glazer; it had
held talks regarding the potential structure of any offer and was not in favour of a large level of
debt to finance any takeover: "The board then decided to inform all shareholders that it would
regard an offer which it believes to be overly leveraged as not being in the best interests of
the company", the firm said in a statement.

Mergers J= A merger is a process whereby the assets of two or more companies are
combined into one company. A new company is usually formed, the acquired companies
cease to exist as separate entities and the shareholders of the new company are the
shareholders of the original companies.

Acquisitions J=An acquisition (or takeover) is a transaction in which a company, known as

the offeror (or acquirer) gains control of the management and assets of another
company, known as the offeree (or target), either directly by becoming the owners of
these assets or indirectly by obtaining control of management or by acquiring the majority of
the shares.

Proxy content - This occurs when an offeror attempts to gain control of the board of
directors by its right to appoint the board as a result of the extent of its shareholding. For
example, in September 2004, LHM Group, headed by multi-billionaire, Lakshmi Mittal
obtained 51% of Ispat Iscor. Subsequently, Ispat Iscor's top management had to step
down in favour of appointees of major shareholder, LHM Group. They now plan to
takeover US-based International Steel Group Inc., to create the world's largest steel
companies.

Leveraged Buyouts - Sometimes a group of investors takes over a firm by means of a

leveraged buyout, or LBO. The LBO group takes over the private firm and its shares no
longer trade in the securities market. Usually a considerable proportion of LBO financing is
borrowed, hence the term leveraged buyout. If the investor group is led by the
management of the firm, the takeover is called a management buyout, or MBO. In this
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 case, the firm's managers actually buy the firm from the shareholders and continue to run it.
They become owner-managers.

VKQKN== ^Åèìáëáíáçå=`ä~ëëáÑáÅ~íáçå=

We now look more closely at mergers and acquisitions and consider when they do and do not
make sense. Mergers are often categorised as horizontal, vertical or conglomerate.

=eçêáòçåí~ä=jÉêÖÉê=
This takes place between two firms in the same line of business. The merged firms are
normally former competitors. These horizontal mergers may be blocked if they are thought to be
anti-competitive or create too much market power.

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This involves companies at different stages of production. The buyer expands back toward the
source of raw materials or forward in the direction of the ultimate consumer. Thus, a soft-drink
manufacturer might buy a sugar producer (expanding backward) or a fast food chain as an
outlet for its product (expanding forward). A recent example of a vertical merger is Walt Disney's
acquisition of the ABC television network. Disney planned to use the network to show its
motives to huge audiences.
=`çåÖäçãÉê~íÉ=jÉêÖÉê=
This involves companies in unrelated lines of business. For example, the Korean
conglomerate, Daewoo, had nearly 400 different subsidiaries and 150 000 employees. It built
Ships in Korea, manufactured microwaves in France, TVs in Mexico, cars in Poland, fertilizers
in Vietnam, and managed hotels in China and a bank in Hungary.

We have already seen that one motive for a merger is to replace the existing management
team. If this motive is important, one would expect that poorly performing firms would tend
to be targets for acquisitions; this seems to be the case. However, firms also acquire other
firms for reasons that have nothing to do with inadequate management. Many mergers and
acquisitions are motivated by possible gains in efficiency from combining operations. These
mergers create synergies. By this we mean that the 2 firms are worth more together than
apart.

A merger adds value only if synergies, better management, reduced costs, greater profits or
other changes make the 2 firms worth more together than apart.

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mìêÅÜ~ëÉ=çÑ=ëÜ~êÉë=îÉêëìë=éìêÅÜ~ëÉë=çÑ=~ëëÉíë=

The offeror can acquire another company's voting share by purchasing all or part of the
shares, in exchange for cash or other securities. It normally starts with a private offer from the
management of one firm to another and then taken directly to the shareholders.

This can be accomplished by a take-over offer. A take-over offer is a public offer to buy
shares. It is made directly to the shareholders of another firm.

If the shareholders choose to accept the offer, then they tender their shares by exchanging
them for cash or other securities, depending on the offer. A take-over is frequently
contingent on the bidders obtaining some percentage of the total voting shares. If not
enough, shares are tendered, then the offer might be withdrawn or reformulated.

A company can also effectively acquire another company by buying most or all of its assets. If all
the assets are sold, the offeree is either dissolved or sold to an entity wishing to inject new
trading assets into the company. If all or major part of the assets are to be sold, the directors
will require the approval of the shareholders in a general meeting. If only part of the assets are
acquired, the offeree could then continue to trade using its remaining assets.

^Çî~åí~ÖÉë=çÑ=ÄìóáåÖ=ëÜ~êÉë=áå=~=Åçãé~åó=áåÅäìÇÉW=

The offeror can deal directly with the shareholders.

No shareholders meeting has to be held and no vote is required.

Existing leases need not be transferred, thus no landlord consent is required.

There is no need to alter the existing employment contract of employees.

^êÖìãÉåíë=áå=Ñ~îçìê=çÑ=~=éìêÅÜ~ëÉ=çÑ=~ëëÉíë=áåÅäìÇÉW=

Requires a formal vote of the shareholders.

In terms of section 38 of the Companies Act, a Company is not permitted to provide any
form of financial assistance to a buyer of its shares. This may prompt the buyer to buy
the assets rather than the company.

If assets are purchased, the company saves on paying stamp duty on shares.

If the offeror has a low or zero tax rate, it may choose to buy the assets.

If the buyer borrows in order to purchase the asset, the interest on the loan is normally tax
deductible.

Assets can be revolved at a higher value and the firm benefits from the lower taxes
because of the increased depreciation.

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An offeror seeking control of a company may use a number of methods to acquire a

controlling interest consisting of shares in the offeree company. In Zambia this is achieved by
means of one of the following three procedures:

A takeover pursuant to the provisions of section 440A read together with section 440K of
the Companies Act, section 440K only being relevant if the offeror wishes to
expropriate disagreeing minorities.

A scheme of arrangement pursuant to the provisions of sections 311 -313 of the Act.

The conversion of the minority's shareholding to redeemable preference shares and the
redemption of such shares in terms of sections 98 and 99 of the Act

eçëíáäÉ=í~âÉJçîÉêë=

A hostile takeover may be defined as a situation where a takeover offer is strongly resisted
by the offeree board - perhaps because it does not approve of the offereor company, or because it
does not wish to lose operating autonomy. The takeover code specifically states that during the
course of an offer (Or even before if there is reason to believe that a bona fide offer is
imminent), the offeree board may not take any action which could frustrate the offer or deny the
shareholders the opportunity of deciding on its merits, without the consent of the
shareholders at a general meeting. In particular, the offeree board may not:

Buy or sell material assets.

Enter into contracts except in the normal course of business

Issue any authorised but unissued shares

Issue any shares carrying rights of conversion or subscription

Grant options in respect of any unissued shares

Pay any dividend which is abnormal as to timing or amount without prior approval of
shareholders in general meeting.

Many mergers are arranged amicably, e.g. the $3 billion merger of Goldfields Zambia with
lamgold, the Canadian Mining group during August 2004. The country has experienced little in
the way of hostile takeovers, and those which were attempted generally failed. The A M
Moolla Group successfully fought off a hostile bid by Coastal Group in 1998 and also the failed
bid by Nedcor of its banking rival Standard Bank in 1999.

Zambia’s largest gold producer, Harmony Gold Mining made a hostile $8.1 billion bid for
Goldfields, the world's 4th largest gold company on 18 October 2004. If the bid was
successful, the deal would have created the world’s largest gold company.

The target company stated that it was going to defend itself by focusing shareholders' attention on
the value it offers. This value would come from the combination of reverse listing its
international assets with lamgold, and the "continued efficient management" of its Zambian
units. The CEO of Goldfields, stated that shareholders need to assess the two options asking
themselves where the most value would come from. He stated that the Harmony offer, offered
cost cutting at the local operations, while the Goldfields offer was a combination of cost

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cutting locally and an aggressive international growth strategy.

q~âÉçîÉê=ÇÉÑÉåÅÉë=

The basic philosophy of the Companies Act is that shareholders should decide on domestic matters
relating to their company. The Act therefore makes no provision for the inclusion or exclusion of
anti-takeover amendments. Shareholders can therefore make anti-takeover amendments to
their articles of association if they believe it is in the best interests of the company to do so.

Thus companies wishing to limit their exposure to a potentially hostile takeover can install one
or more of the following takeover defences prior to a formal bid being imminent, provided
the companies articles of association permit or are amended accordingly and as long as
actions are bona fide in the interests of the company.

Surplus cash could be eliminated by, for example, paying a large dividend or committing
to a major new project.

Material assets could be bought or sold. This is sometimes referred to as the "sale of the
crown jewels", or a "scorched earth" strategy.

The company could use a tactic known as a poison pill to repel would be suitors. The term
comes from the world of espionage. Agents are supposed to bite a pill of cyanide rather
than permit capture. Presumably, this prevents enemy interrogators from learning important
secrets. In the equally colourful world of corporate finance, a poison pill is a financial
device, which only comes into force if the company is taken over. For example,
shareholders are issued with an option to acquire shares cheaply, the option only being
exercisable in the event of a takeover.

A firm facing an unfriendly merger offer might arrange to be acquired by a different,
friendly firm. The firm is thereby said to be rescued by a white knight. Alternatively, the firm
may arrange for a friendly entity to acquire a large block of shares. Sometimes white knights
or others are granted exceptional terms or otherwise compensated. BOB acted as white
knight to Norwich when African Life made a hostile bide for Norwich.

A pyramid structure could be created to entrench control.

Formal voting agreements between shareholders could be established.

Interlocking shareholdings could be reconstructed (for example, by cancellation of
certain shares with the approval of 75% of the shareholders)

Articles of association may require that large majorities are necessary for changes in
specified company policies.

Senior executives can be given extended management contracts.

Some target firms contract to provide large amounts of compensation to top level
management if a takeover occurs. These are called golden parachutes.

Material contracts with penalty conditions if there is a change in control can be entered
into by the company (for example, rent increases, loss of distribution rights).

The company could issue a debenture, a condition of which is that it must be repaid in
full if there is a change in control.

Selected company assets can be placed outside the direct control of shareholders (for
example, disposals could require the consent of the staff pension fund).

Perhaps the best defence of all against potential takeover bids is to make fundamental
improvements to the operations of the company, including improving profitability, making
better use of resources and upgrading the quality of the company's management.
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=bñéÉÅíÉÇ=Ö~áåë=Ñêçã=jÉêÖÉêë=~åÇ=^Åèìáëáíáçåë=

To determine the gains from an acquisition, we need to first identify the relevant incremental
cash flows, or the source of value. Acquiring another firm only makes sense if there is some
concrete reason to believe that the offeree firm will be worth more in our hands than it is
worth now. There are a number of reasons why this might be so.

=póåÉêÖó=

Suppose Firm X is contemplating acquiring Firm Y. The acquisition will be beneficial if the
combined firm has a value that is greater than the sum of values of the separate firms. If we
let Vxy stand for the value of the merged firm, then the merger makes sense only if: Vxy > Vx +
Vy when Vx and Vy are the separate values.

The difference between the value of the combined firm and the sum of the value of the firms
as separate entities is the incremental net gains from the acquisition, AV:

= Vxy-(Vx

When AV is positive, the acquisition is said to generate synergy. Synergy could thus be defined
as the positive incremental net gains associated with the combination of two firms through a
merger or acquisition.

oÉîÉåìÉ=båÜ~åÅÉãÉåí=

The combined firms may generate greater revenues than two separate firms. Increase in
revenue may come from:

j~êâÉíáåÖ=d~áåë=

Improved marketing might be made in the following areas:

Previously ineffective media programming and advertising efforts.

A weak distribution network

An unbalanced product mix

píê~íÉÖáÅ=ÄÉåÉÑáíë=

Strategic benefits have the opportunity to take advantage of the competitive environment and also
to enhance management flexibility with regard to future operations. In this regard, a strategic
benefit is more like an option than a standard investment opportunity.

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j~êâÉí=mçïÉê===

Firms may merge to increase their market share and market power. Profits can be enhanced
through higher prices and reduced competition. However, if competition is substantially
reduced it may be challenged by the Competition Board.
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A combined firm may operate more efficiently than two separate firms in several different ways,
namely:

bÅçåçãáÅë= çÑ= pÅ~äÉ= J= This relates to the average cost per unit of producing goods and
services. If the per unit cost of production falls as the level of production increases, then an
economy of scale exists. The phrase "spreading overhead" is used in connection with
economics of scale. This expression refers to the sharing of central facilities such as
corporate headquarters, top management and computer services.

Economies of Vertical Integration - Operating economies can be gained form vertical

combinations as well as from horizontal combinations. The main purpose of vertical
acquisitions is to make the coordination of closely related operating activities easier.
Benefits from vertical integration are probably the reason that most forest product firms
that cut timber also own sawmills and hauling equipment.

`çãéäÉãÉåí~êó= oÉëçìêÅÉë= J= Some firms acquire others to make better use of existing
resources or to provide the missing ingredient for success. Think of a glove manufacturer
that could merge with a swimming costume manufacturer to produce more even sales over
both the winter and summer seasons, thereby use their production facilities better.

içïÉê=cáå~åÅáåÖ=`çëíë=J= The cost of capital can often be reduced when one firm acquires
another. The costs of issuing both debt and equity are subject to economies of scale, which
lower transactions costs and results in better coverage of the firm by security analysts. Lower
financing costs may be due to the fact that by combining two companies, each effectively
guarantees the debt of the other, thus reducing the risk to the lenders.

Lower Taxes - Tax gains often are a powerful incentive for some acquisitions. The possible
tax gains from an acquisition include the following:

Net Operating Losses - Firms that lose money at an operating level will not pay taxes. Such
firms can end up with tax losses they cannot use. A firm with net operating losses may
be an attractive merger partner for a firm with significant tax liabilities. Excluding any other
effects, the combined firm will have a lower tax bill than the two firms considered
separately. This is a good example of how a firm can be more valuable merged than
standing alone. There is, however, a qualification to our discussion. The Receiver of Revenue
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 may disallow an acquisition if the principal purpose of the acquisition is to avoid income tax
by acquiring a deduction or credit that would not otherwise be available.

Unused Debt Capacity - Some firms do not use as much debt as they are able to. This
makes them potential acquisition candidates. Adding debt can provide important tax
savings, and many acquisitions are financed with debt. The acquiring company can deduct
interest payments on the newly created debt and reduce taxes.

Asset Write-Ups - We have previously observed that, in an acquisition of assets rather than
shares, the assets of the acquired firm can be re-valued. If the value of the assets is
increased, tax deductions for depreciation will be a benefit.

Reduction in Capital Needs - All firms must make investments in working capital and fixed
assets to sustain an efficient level of operating activity. A merger may reduce the combined
investments needed by the two firms. For example, Firm A may need to expand in
manufacturing facilities while Firm B has significant excess capacity. It may be much
cheaper for Firm A to buy Firm B than to build from scratch. In addition, acquiring firms
may see ways of more effectively managing existing assets. This can occur with a
reduction in working capital by more efficient handling of cash accounts receivable, and
inventory. Finally, the acquiring firm may also sell off certain assts that are not needed in the
combined firm.

qÉÅÜåáèìÉë=ìëÉÇ=áå=bî~äì~íáåÖ=jÉêÖÉêë=~åÇ=^Åèìáëáíáçåë=

If you are given the responsibility of evaluating a proposed merger, you must think hard
about the following two questions:

Is there an overall economic gain to the merger? In other words, is the merger value-
enhancing? Are the two firms worth more together than apart?

Do the terms of the merger make my company and its shareholders better off? There is no
point in merging if the cost is too high and all the economic gains goes to the one
company.

Answering these deceptively simple questions is rarely easy. Some economic gains can be nearly
impossible to quantify, and complex merger financing can obscure the true terms of the deal.
But the basic principles for evaluating mergers are not too difficult.

=jÉêÖÉêë=cáå~åÅÉÇ=Äó=pÜ~êÉë=

Evaluating the terms of a merger can be tricky when there is an exchange of shares. The target
company's shareholders will retain a stake in the merged firms, so you have to figure out what
the firm's shares will be worth after the merger is announced and its benefits appreciated
by investors. Notice that we started with the total market value of Jolly Grubber and Mo
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Roadhouse post-merger, took account of the merger terms (207 500 & 1 250 000 new shares
issued respectfully), and worked out the division of the merger gains/losses between the two
companies.

There is a key distinction between cash and share financing mergers. If cash is offered, the cost
of the merger is not affected by the size of the merger gains. If share is offered, the cost depends
on the gains because the gains show up in the post-merger share price, and these are used for the
acquired firm.

Suppose, for example, that A overestimates B's value as a separate entity, perhaps because it has
overlooked some hidden liability. Thus A makes too generous an offer. Other things equal, A's
shareholders are better off if it is a share rather than a cash offer. With a share offer, the
inevitable bad news about B's value will fall partly on B's former shareholders.

Valuations are necessary whenever an investor wishes to purchase a business, shares in a

business or any other form of financial asset. Valuations relate only to future expectations and
all valuation decisions require predictions about anticipated future events. Once a valuation
has been performed, the value is compared with the price. Only if the value is greater than the
price will the purchase transaction take place.

The different techniques to valuation are useful. Asset based valuation aims to place a Rand value
with reference to an exchange basis such as the net realisable value or the replacement cost. It
identifies the assets of a business, places a value on each and deducts the liabilities in order to
arrive at the net asset value.

The discounted cash flow aims to discount all future cash flows by the required rate of return. This
is absolutely fundamental in all aspects of finance and is conceptually sound and
theoretically correct. It is made difficult, however by the uncertainty surrounding the
predictions of future cash flows and the necessity of determining an appropriate rate of return with
which to discount the stream of predicted cash flows. While alternative formula may be developed
for ease of reference to a particular financial instrument, they are all based on the identical
principle of discounting the future cash flows.

The financial manager is sometimes involved in corporate restructuring activities, which

involve the expansion and contraction of the firm's operations or changes in its asset or
financial (ownership) structure. Included among corporate restructuring activities are mergers
and acquisitions. A variety of motives, such as synergy, increasing Corporate skill or technology,
and defence against takeover, could drive a firm toward a merger, but the overriding goal
should be maximisation of the owner's wealth. Merger transactions are heavily debt-financed
leveraged buyouts (LBO's). In other cases, firms attempt to improve value of divesting
themselves of certain operating units that are believed to constrain the firm's value,
particularly when the break up value is believed to be greater than the firm's current value.

Regardless of whether the firm makes a cash purchase or used market values or EPS to
acquire another firm, the analysis should centre on making sure that the risk-adjusted net
present value of the transaction is positive.

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VKS== bu^jfk^qflk=qvmb=nrbpqflk=
=
h^_rkdl=ifjfqba=

KABUNGO Ltd has grown during the last five years into one of Zambia’s most successful
specialist games manufacturer. The company’s success has been largely based on its
Megaoid series of games and models, for which it holds patents in many developing
countries. The company has attracted the interest of two plc’s, Nadion a traditional
manufacturer of games and toys, and BZO international, a conglomerate group that has
grown rapid in recent years through the strategy of acquiring what it perceives to be under
valued companies.

Summarized financial details of the three companies are shown below.

KABUNGO LTD
SUMMERIZED BALANCE SHEET AS AT 31 DECEMBER 2006
K’000 K’000

Fixed assets (net) 8,400

Current assets
Stock 5,500
Debtors 3,000
Cash 100
9,100
Less current liabilities
Trade creditors 4,700
Tax payable 1,130
Overdraft 1,200
7,200
10,300
Medium and long- term loans 3,800
Net assets 6,500

Financed by
Ordinary shares (25 ngwee nominal) 1,000
Reserves 5,500
6,500

SUMMERIZED PROFIT AND LOSS ACCOUNT FOR THE

YEAR ENDED 31 DECEMBER 2006
K’000
Turnover 27,000
Profit before tax 4,600
Taxation 1,380
3,220
Dividend 1,500
Retained earnings 1,720
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Additional information

(a) The realizable value of stock is believed to be 90% of its book value.
(b) Land and buildings, with a book value of E4 million, were last revalued in 19W9.
(c) The direction of the company and their families own 25% of the company’s shares.

KABUNGO NADION BZO

Turnover (K’m) 27 112 256

Profit before tax (K’m) 4.6 12 24
Fixed assets (K’m) 8.4 26 123
Current assets (K’m) 9.1 41 72
Current liabilities (K’m) 7.2 33 91
Overdraft (K’m) 1.2 6 30
Medium and long-term liabilities (K’m) 3.8 18 35
Interest payable (K’m) 0.5 3 10
Share price (ngwee) - 320 780
EPS (ngwee) 80.5 58 51
Estimated required return on equity (cost capital) 16% 14% 12%
Growth trends per year:
Earnings 12% 6% 13%
Dividends 9% 5% 8%
Turnover 15% 10% 23%

Assume that the following events occurred shortly after the above financial information was
reduced.

7 September. BZO make a bid for KABUNGO of two ordinary shares for every three shares
of KABUNGO. The price of BZO’s ordinary shares after the announcement of the bid is 710
pence. The directors of KABUNGO reject the offer.

2 October. Nadion makes a counter bid of 170 pence cash per share plus one E100 10%
convertible debenture 19Y8, issued at par, for every E6.25 nominal value of KABUNGO
shares. Each convertible debenture may be exchanged for 26 ordinary shares at any time
between 1 January 19X7 and 31 December 19X9. Nadion’s share price moves to 335
pence. This offer is rejected by the directors of KABUNGO.

19 October. BZO offers cash of 600 pence per share. The cash will be raised by a term, loan
from the company’s bank. The board of KABUNGO are all offered seats on subsidiary
boards within the BZO group. BZO’s shares move to 680 pence.

20 October. The directors of KABUNGO recommend acceptance of the revised offer from
BZO.

24 October. BZO announces that 53% of shareholders have accepted its offer and make
the offer unconditional.

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Required

(a) Discuss the advantages and disadvantages of growth by acquisition.

(b) Discuss whether or not the bids by BZO and Nadion are financially prudent from the
point of view of the companies’ shareholders. Relevant supporting calculations must
be shown.

SUGGESTED SOLUTION

a.

A company planning to grow must decide on whether it will try to achieve this through
organic growth alone or through some combination of organic growth and acquisition. The
advantages of growth by acquisition include the following.

The company may be able to grow much faster than would be possible through purely
organic development. This is particularly true if the company is seeking to expand in a
new product or a market when acquisition will allow the company to gain technical
skills, goodwill and customer contracts which would take it a long time to develop by
itself;

If the acquisition is financed through a share exchange, then the company will not face
the pressure on cash that result during a time of organic growth. However, it must
take account of the likely effect of such an acquisition on the share price, earnings per
share and gearing. If the target company is financially more stable it may be able to
improve its liquidity and ability to raise further finance;

In some market it is argued that a company requires ‘critical mass’ in order to operate
effectively. This is particularly true in industries where a high level of capital investment
is required. Acquisition may allow a company to reach an efficient size much more that
if it were to try to get there through organic growth;

A larger company with a better spread of products, customers and markets faces a
lower level of operating risk than a small company which may be more dependant on
small number of customers and supplies. Acquisition will therefore allow the company
to reduce its operating risk more quickly. This effect is enhanced if the company is
using acquisition as a means of diversification into new product/market areas;

Acquisition may permit the company operating economics through the rationalization
and elimination of duplication in areas such as research and development, debt
collection and corporate relations;

Acquisition may allow the company to achieve a better level of asset backing if it has a
high of sale to assets; and

The acquisition may be to some extent opportunistic if the bidding company identifies
a firm where the assets are undervalued.

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Disadvantages associated with takeovers include the following.

Failure to integrate the management and operations effectively and thus to achieve the
planned economics;

If an acquisition is being made for strong strategic reasons there may be competition
between bidding companies which forces the price up to a level beyond that which can
be justified on financial grounds. If too high a price is paid then the post-merger
financial performance is likely to be disappointing. The costs of mounting the and that
of the subsequent reorganization may also mean that the earnings are depressed, at
least in the short term; and

The acquisition may lead to inequalities in return between the shareholders of the
bidding and the target companies. It is often the case that the shareholder in the target
company do disproportionately well when compared with the shareholders in the
bidding company. This is likely to be the case when the price paid for the acquisition is
towards the top of the projected range.

b.

The appropriate valuation technique will depend on the plans which the bidding company
has for KABUNGO post-merger. KABUNGO is an unlisted company and therefore there is
no market price available. It is assumed that Nadion would intend to continue the
operations as a going concern and therefore an earning based valuation is appropriate in
this case. BZO might also plan to continue to operate the business in its present form, or
alternatively it might be planning to asset strip if it believes the assets are significantly
undervalued. If this is the case, the company should be valued on a net assets basis.

Assets basis valuation

KABUNGO’s net assets currently amount to K6.5m at book values. However, the stock must
be written down by 10% to its realizable value, giving a revised net assets figure of K5.95m
or K1.49 per share. This valuation does not take into account a number of factors including:

The land and the buildings have not been revalued since 19W9. Property prices have
fallen since then the recession and therefore they may be overvalued.

The patents are excluded from the balance sheet and may have a significant value if
there are a number of years left to run.

There is no information to suggest whether the other components of the asset base are
realistically valued, in particular any plant and equipment.

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Earnings basis valuations

P/E Ratio.

If it is reasonable to assume that KABUNGO should operate on a similar P/E ratio to Nadion
since they are both in the same sector, then Nadion’s PE Ratio can be used in calculations.
This should be approximately correct since although Nadion is much bigger and is a listed
company, KABUNGO is showing a much higher rate of growth.

Nadion’s PE Ratio is 320/58 = 5.517. If applied to KABUNGO’s earnings, this would suggest
a valuation of K4.44 per share (80.5 X 5.517).

Dividend valuation model

This approach allows the calculation of the theoretical share price based on the projected
dividend stream and the cost of capital:

Po = Do (1+g)
------------
(r-g)
Where:
Po = theoretical share price
Do= Dividend in year 0 (37.5 ngwee per share)
G= expected rate of growth in dividends
R= cost of equity capital

Po = 37.5(1+9%)
---------------- = K5.84 per share
(16%-9%)

The value of the various bids can now be calculated.

i) 7 September

BZO bids 2 for 3 at a price of 710 ngwee = K4.73 per share.

ii) 2 October

Nadion bids:
K
Cash per share 1.70
Debentures: K100 for (6.25/0.25) 25 shares 4.00
------
Total value at date of merger 5.70
-------

In addition the shareholders gain the opportunity to purchase new shares in 5 years’ time at
K3.85 (K100/26). This is 15% above Nadion’s current share price and therefore if the
current rates of growth continue should provide the opportunity to acquire new shares at a
significant discount to the prevailing market price.
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iii) 19 October

BZO bids in cash K6.00 per share.

Considering firstly the bid by Nadion, it is assumed that the company intends to continue to
operate KABUNGO as a going concern. The bid of K5.70 per share is 14 ngwee below the
most optimistic theoretical share price calculated on the basis of the dividend growth
model. This would appear to be a realistic but prudent bid from the point of view of
Nadion’s shareholders. The 5% rise in the price of Nadion’s shares following the
announcement of the bid suggests that the market also believes that the acquisition would
be financially beneficial.

BZO’s initial bid of K4.73 per share is well above the net assets valuation of K1.49 per
share. However, it is in line with the PE Ratio valuation of K4.44 per share. Thus if BZO were
intending to continue operating KABUNGO as a going concern, the bid appears prudent.
However, if BZO’s purpose in acquiring KABUNGO is to dispose of all or part of the assets
and to change fundamentally the structure of the company, then the bid does not appear
sensible. This view is confirmed by the markets which down valued BZO’s shares 9% on the
announcement of the offer.

BZO’s final cash offer of K6.00 per share is above the most optimistic valuation based on
the dividend growth model. In view of BZO’s previous deals, it must be assumed that the
management perceive KABUNGO to be in possession of significantly under valued and
under used assets. Additionally, the use of the term loan to finance the offer will increase
BZO’s level of debt from K65 million to K89 million. The current level of gearing is:

K30 million + K35 million

------------------------------------------ = 94%
K123 m+ K72m – K91m – K35m

Therefore, a further significant increase in this level would not appear to be a prudent move
from the point of view of the shareholders in BZO. This view is confirmed by the further slid
in the share price to 680 ngwee.

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