Object: Recommendation regarding PowerUp's strategy and the possible merger with The Bubbly

Hipster

Dear Mr. Krüger,

After reviewing the situation and the various documents you have sent us, I will show you why I think
it would be better for PowerUp to merge with The Bubbly Hipster (TBH) rather than to sell PowerUp.

First, it is essential to identify the key decision factors to know if the merger looks promising. I t is
important to assess whether PowerUp subsidiary constitutes a threat for FizzCo financial stability .
Indeed, PowerUp has not yet managed to deliver a positive EBIT since its creation seven years ago
even though it is close to break even. Also, Fizzco bears most of the costs incurred by PowerUp such
as R&D investments and marketing & advertising spends. Thus, one important decision factor is
whether PowerUp is going to be profitable soon. If not, divesting it would allow to raise cash and
make up for the investment opportunity costs incurred by Fizzco shareholders. Nevertheless,
PowerUp differentiated brand positioning is attractive for customers as it provides a healthier
alternative than existing energy drinks on the market. As competitors are trying to develop their own
healthier products, PowerUp could become a serious industry player in the future. Thus, FizzCo
should decide whether to keep and expand its competitive advantage in the energy drinks market or
sell the division to another company. As PowerUp complements well FizzCo other divisions, a merger
with enough synergies would accelerate Powerup's path to profitability.

Hence, we are going to discuss the opportunity of merging PowerUp with the TBH energy drinks
division. The goal is to understand what are the implications for FizzCo shareholders resulting
from the share swap deal agreed by both parties. First, considering the proposed terms, the
valuation of PowerUp's equity is $105 million with an implied share price of $21. This valuation is
lower than the pre-merger equity valuation of TBH Energy’s being $130 million. We calculated
PowerUp equity value based on the EV/Net sales multiple (2021 numbers) of TBH Energy’s to
determine whether PowerUp valuation is underestimated. By applying this multiple to PowerUp Net
sales and deducting Net debt, we obtain an equity value of $119 million. Hence, PowerUp equity
valuation is underestimated in the proposed deal. But that’s not all: FizzCo shareholders will own
45% of the new entity post-merger versus 55% for TBH Energy shareholders. By proceeding with this
transaction, Fizzco shareholders will give up a part of their ownership for the benefit of TBH Energy.
The potential risks resulting from this minority ownership are the loss of control and a smaller share
of profits attributable. To avoid those risks, the transaction could be structure differently with an
exchange ratio being more advantageous for PowerUp. By doing so, TBH Energy should review
upward PowerUp’ implied equity valuation. 

Secondly, it is essential to determine what the potential synergies of the merger of TBH with
PowerUp are. To merge effectively, it is important that both companies have a good fit and that they
have common values and ambitions. Both FizzCo and TBH want to produce quality beverages with
natural ingredients and reduced sugar content. While TBH wants to build a new R&D center,
PowerUp has already invested heavily in a new research center with high-end equipment that has
enough space to accommodate TBH. By avoiding the construction of a TBH’s new research center, we
are therefore dealing with a cost synergy. To produce quality products, you also need quality raw
materials. While PowerUp has a low bargaining power towards retailers, TBH works hand-in-hand
with their suppliers to get the best ingredients at a fair price. PowerUp will therefore be able to take
advantage of the agreements already put in place by TBH to buy raw materials. This is another cost
synergy. TBH Energy is currently present on the American, Canadian, Mexican and Asian markets
(with an office in Singapore). PowerUp products are sold only in Europe. The two companies sell
similar products in complementary markets. By joining forces, the two companies will have a
presence in the three largest soft drink markets, North America, Europe and Northeast Asia, which
account for more than 70% of the total market. The two companies will be able to expand their
market, attract new customers in new geographical areas and be much more competitive with other
players in the market: this is also a revenue synergy. It is also worth noting that it would be wise to
carry out the merger before Mr. Muller's retirement, as he will be able to contribute essential skills,
especially when the two R&D departments are merged. Finally, while the current atmosphere within
FizzCo is tense, notably because of the pressure of the shareholders, a successful merger could ease
the tensions and bring back a pleasant working atmosphere.

Although the merger seems to be very advantageous for FizzCo, the potential risks must also be
identified. The key risks in this merger are multiple, already the reaction of the customers to the
merger. While PowerUp products have a very good reputation, TBH energy products are perceived as
unhealthy and artificial. By merging, there is a risk that the bad image of TBH Energy will impact on
the current reputation of PowerUp: this would be a disaster for both companies. By merging, it is
also possible that there will be problems of agreement between the teams, which may lead to
management problems. The retirement of Mr. Muller, who is a central figure of PowerUp's R&D and
a key element of the negotiation with TBH, may also be a potential risk. In fact, if PowerUp's loses its
R&D advantage then the deal is less valuable for THB and the balance of power will be greatly
altered.  There is also a risk of product cannibalization, since both companies target the same
customers who are looking for quality drinks, with a particular focus on health.

Although the risks are there, I think it is still more beneficial for PowerUp to proceed with the merger
with TBH Energy. To be well prepared for the negotiation with TBH, we have to prepare the potential
questions that TBH managers will want to ask. The CEO of TBH will probably want to have an
explanation on the past 7 years of negative results, he will no doubt address the ability to be
profitable in the short-term future, along with an explanation on the ability to negotiate with
suppliers. He will also certainly ask what economies of scale can be achieved through the merger,
and what is PowerUp's plan to reduce its very high fixed costs.The question of timing will also come
up, especially as to why PowerUp wants to merge now when it is still not profitable, and why it would
not wait until it has better results to have a better negotiating capacity. Mr. Muller's retirement will
also potentially be discussed, since he plays a key role in the company. Perhaps they will ask if it is
possible for him to extend his contract, or if they have already thought of a qualified person who can
replace him quickly. Finally, since TBH is in an advantageous situation, they will potentially want to
negotiate the price, not to mention that PowerUp has a significant amount of debt that TBH may not
want to incorporate.

In conclusion, I think the best solution is to merge PowerUp with TBH Energy. By sharing the same
values and the same strategy, the two companies combined will be able to be a strong competitor in
the energy drink business, present in the biggest markets of the sector.
 Pre-merger
  PowerUp TBH Energy

Number of shares outstanding (in million) 5 20

Value of equity (in million of $) 105 130
Share implied price 21 6,5

PowerUp Equity value based on TBH Energy

multiple
EV/Net Sales 1,29
Net sales (in millions of $) 96,4
Net debt 5,5
Enterprise value 124,67
Equity value 119,17

Post-merger [TBH Energy]

Value of equity (in millions of $) 310

Issuance of TBH shares (in million) 16,15
Total number of shares outstanding (in
million) 36,15
Legacy TBH Energy shareholders 55,32%
Legacy Fizzco shareholders 44,68%