Assessment Task:
Reunert Acquires SkyWire Technologies Case Study Finance Assignment Help

 

Reunert acquires SkyWire Technologies

Reunert, the JSE-listed electronics and electrical engineering company, will acquire wireless broadband service provider SkyWire Technologies (Pty) Ltd (SkyWire), it revealed on Monday. The value of the deal has not been disclosed as SkyWire is a private company.

SkyWire mainly serves business customers and has an extensive national network. It will form part of Reunert’s ICT segment, which includes Nashua and ECN. “The acquisition strengthens Reunert’s focus on building its portfolio of earlier life cycle businesses in growth markets,” the group said in a statement.
 “This acquisition complements the ICT segment’s expansion strategy to increase its traditional suite of products and services to include broadband connectivity,” it added. The company founders will stay in the business. 

“SkyWire is a successful broadband provider that has displayed impressive growth over the past number of years. Its existing customer base and products will allow Reunert to enter the fixed-wireless broadband market as a significant player,” said Reunert CEO.

“Our access to additional customers and distribution will allow SkyWire to add further scale to its business. SkyWire also has expansion plans under way into other African territories and has already produced forecasts for the profits it will be able to generate within the African market beginning immediately following the acquisition. Reunert will assist with these ambitions, ultimately contributing towards growing our revenue base outside of South Africa.” Through Nashua and ECN, SkyWire will have a wider network for the rapid deployment of broadband connections, Reunert said. “Our services will immediately gain the benefit of one of the most successful ICT sales channels in the country and the company will become part of a major South African listed entity, which brings all the stability and skills a fast-growing business like ours requires at this stage of our life cycle,” said the CEO. SkyWire will remain as an independent business unit within the communications cluster of Reunert’s ICT segment. 

 

The Financial Director of Reunert provided the article above to your consulting firm and asked whether you would be able to provide some consulting services for them and support them as their advisor during the negotiation process for the proposed transaction from the buyer’s perspective.

During your initial meeting, the Financial Director provided you with the latest financial statements, as well as a valuation of SkyWire which was prepared by Jason Knowitall, one of the junior staff within SkyWire who had taught himself how to do valuations using YouTube videos. Being a technology company, the management was impressed with the initiative of the staff member and had therefore decided to let him produce the valuation. Jason had told them that the preparation of valuation was not difficult, it was just cashflows all discounted back to present value, with one or two adjustments. 

He had also watched a few videos which explained how many corporate finance practitioners had unnecessarily overcomplicated their valuations to ensure that non-financial people did not understand them, and therefore they could sell their services for high charge-out rates. He, therefore, offered to prepare the valuation, and save the company a fortune on consulting fees. The financial director made it clear to you that he wanted your opinion on the valuation but did not want you to reperform the valuation at your high rates, and rather just provide commentary, where there was something to fix, but not to reperform the valuation. You should assume that all calculations are arithmetically correct.

 

Valuation prepared by Jason Knowitall

The valuation is prepared on 1 March 2018. Please see Annexure for Valuation and AFS.

Notes

1.    The revenue has been increased in line with the anticipated growth of 10% from the existing operations. Inflation has not been included in the forecast as the discount rate was instead calculated excluding inflation, therefore ‘real’ cash flows and ‘real’ rate. The real rate was determined by subtracting the current inflation rate from the interest rate to get to a real interest rate. This was then applied when calculating the interest charge which was left in the cash flows.
2.    The valuation was performed using a Free Cash Flow to Equity model. Therefore debt cash flows were included in the cash flows.  
3.    The depreciation and amortisation were considered to be a good indication of the replacement of the firm’s assets over the long term and were assumed to increase at a rate of 10%. Depreciation and amortisation are however non-cash in nature and were therefore added back.
4.    Cash and cash equivalents have built up over the years. The company requires an amount of R500 000 on average for operating cash flow needs.
5.    Investments consist of shares in Cycle Laboratory Limited, a business which trades in bicycles. The shares are reflected at market value. The fair value adjustment was not included in the valuation, as it is a non-cash item.  
6.    Taxation averaged at 23% of profit in the annual financial statements. This rate was carried forward to the forecasts.
7.    The financial instruments relating to a 2-year put option that was purchased on the shares in Cycle Laboratory Limited as mentioned above. The management were concerned that the shares would drop in value, and therefore purchased a put option on the shares at a value of R3.00 per share 6 months ago. The company has 
4 million shares. The put option is marked to market, and therefore the cash flows on the instrument are actually realised and included in the discounted cash flow.
8.    The land and buildings consist of a business park which has an office building and a large piece of unutilised land. The company is located in the building which makes up a small part of the overall property. The market value of the land and business park has been reliably valued at R10 500 000 at 28 February 2018. 
9.    SkyWire currently supplies services to one of Reunert’s direct competitors. The Reunert directors indicated that if the transaction goes ahead, they would insist that the company no longer supplies to their competitors. The company currently earns R1 million in profit from these competitors.
10.    Once the transaction occurs, the administrative functions of the two firms can be combined, which will result in the accounting and marketing divisions being combined. When this occurs, it is estimated that staff will be retrenched resulting in a retrenchment cost of R500 000 in settlement for the staff to leave.
11.    The combination of the two firms will allow some of the computer hardware infrastructure to be sold. Equipment with a net book value of R800 000 will be sold for an amount of R1.5 million. The equipment had an original purchase cost of R1.2 million. 
12.    The terminal value was calculated using a combination of the PE ratio and the cash flow perpetuity model (based on Gordon’s Growth Value):
a.    The PE ratio of 12X was obtained for Smart Broadband Limited, a JSE listed company, from their market data at 1 March 2018. This was multiplied with the cash flow in 2022 to arrive at a company value.
b.    The cash flow perpetuity value was calculated using an average growth rate of 8%. The company anticipates growth in 2022 to be 10%, and thereafter growth should drop to 6%. The growth was therefore taken as the average of these two years in the terminal value calculation.
c.    The values calculated from the two methods above were then averaged to arrive at the terminal value included in the valuation.
13.    The weighted average cost of capital (WACC) was calculated as follows:
a.    The Beta for Reunert was obtained from their market data, and was un-levered using the Hamada model. The Beta was then re-levered using the debt equity ratio of SkyWire. This Beta was then used in the capital asset pricing model (CAPM) to determine the cost of equity. 
b.    The participating preference shares pay a preference dividend of 12%, and then also participate in 2% of the income attributable to ordinary shareholders. They, therefore, receive a fixed payment of 12%, and a variable payment of 2% of profits. Similar preference share instruments which have no participation element have a market-related cost of 15%. This cost was adjusted for a dividend withholding tax of 20%. The participating element was ignored for WACC purposes.
c.    The book value of the various instruments was then used to determine the weighting for the WACC calculation.
d.    Similar debenture instruments in the market are trading at an interest rate of 16%. The debentures were issued at a coupon of 15% and are 10-year instruments.
14.    The saving generated by Jason on the performance of the valuation was not included in the discounted cash flow.
15.    Other information
a.    The risk-free rate was obtained from long-dated government bonds at 10%.
b.    The estimated return on the JSE market was researched to be 18%.
c.    The corporate tax rate is 28%.

 

QUESTION 2

1.    Write a report as requested by the Financial Director of Reunert criticising the valuation prepared by Jason Knowitall, identifying and describing any errors and omissions, and suggesting how these should be corrected.

Communication skills – clarity of expression

2.    The financial director indicated that the debentures are floating rate debentures and that he is concerned about the risk of interest rates rising. Explain how the director can hedge against such risk.

 

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  • Posted on : December 12th, 2018

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