1. Why is the distinction made between ‘synergies in place’ and ‘real option synergies’?

Synergies in places are those synergies considered ‘realisable’ through the combination of
existing resources and capabilities of the merging entities. While there is still risk attached to
the achievement of synergies in place, the resulting cash flows may be estimated and
reasonably expected to be implemented upon successful closure of the bid.

Real option synergies, on the other hand, depend on another outcome, or trigger, to occur.
These commonly refer to the option to grow, exit, defer or alter some form of operation in
response to another factor. This optionality can be viewed as flexibility to the manager and
consequently is more valuable than a synergy without flexibility (synergy in place). Real option
synergies then need to be valued using an option framework (such as binomial tree or Black-
Scholes model) to capture their full value.

2. Identify whether the following synergies are classified as (A) revenue enhancements,
(B) cost reductions, (C) asset sales, (D) financial synergies, or (E) real option synergies:

i. Rationalising existing assets through sell offs. C

ii. Improved economy of scale through combination of production facilities to increase output.
B
iii. Enhanced access to debt capital markets through increased scale of operations. D

iv. Potential to defer new investment for up to two years. E

v. Increased sales through expansion of products sold through complementary

logistics networks. A

3. In valuing synergies, what is the importance of classifying the type of synergy in place?

Synergies in place can be classified as revenue enhancement, cost saving, asset sales (these
three collectively being operational synergies), tax reduction and financial synergies.
Classification of synergies has the initial benefit of guiding an analyst in determining how the
acquisition meets the strategic objectives of the acquiring firm. Synergy classification also sets
the framework for synergy valuation as the risk varies across different synergies. As a rule of
thumb, asset sales are generally considered the least risky (near risk-free), then cost savings
and revenue enhancement being the most risky synergies.

4. How do analysts typically measure the necessary adjustments for control and liquidity?

We will typically use a comparable transactions approach to also measure the cost of control
and liquidity. The interpretation of results from this form of analysis must be considered in the
context of the differences between the firms in the comparable transactions set and the firm
under analysis.

5. Ryder System is a full-service truck leasing, maintenance and rental firm with operations in
New Zealand and Australia. The following are selected numbers from the financial statements
for 2012 and 2013 (in millions).

2012 2013
Revenue 5192 5400
Operating Expenses 3678.5 3848
Depreciation 573.5 580
EBIT 940 972
Interest Expenses 170 172
Taxes 652.1 670
Net Income 117.9 130
Working Capital 92 -370
Total Debt 2000 2200

The firm had capital expenditures of $800 in 2012 and $850 million in 2013. The working
capital in 2011 was $34.8 million, and the total debt outstanding in 2011 was $1.75 billion.
There are 77 million shares outstanding, trading at $29 per share.
a. Estimate the cash flows to equity in 2012 and 2013.

b. Estimate the cash flows to the firm in 2012 and 2013.

c. Assuming that revenues and all expenses (including depreciation and capital expenditures)
increase 6%, and that working capital remains unchanged in 2014, estimate the projected cash
flows to equity in 2014. (The firm is assumed to be at its optimal financial leverage)

6. Case Study: Coca-Cola Amatil’s bid for Neverfail

Coca-Cola Amatil (CCA) is a top-50 ASX-listed bottler, producer and distributor of beverages,
packaged fruit and snack products. It is best known as the producer of Coca-Cola and its
associated brands for the Australian market, with U.S.-parent The Coca-Cola Company owning
29% of the business.

In April 2003, CCA announced a $2.25 per share cash takeover offer for all ordinary shares
(100 million SOI) in Neverfail Springwater. This offer represented a 21.6% premium to
Neverfail’s prior day close price of $1.85. Neverfail’s primary business is the sale and delivery
of bulk bottled water (approximately 70% of revenue) and leasing of water cooler systems
(approximately 25% of revenue) to residential and commercial customers in Australia. At the
time of the acquisition announcement Neverfail held a 65% share in the market for home and
office water delivery. Given the strength of CCA’s existing water products in the individual
retail space, including Mount Franklin, Deep Spring and Pump, CCA Managing Director Terry
Davis identified the opportunities of the Neverfail acquisition at the Annual General Meeting
on 1 May 2003:

With water being one of the largest and fastest growing beverages in Australia, the acquisition
would represent an important step in increasing our non-carbonated business. Neverfail will
complement our existing packaged water business and doubles our annual water volume in
Australia. Additionally, we will look to extent the Neverfail brand to CCA’s retail customers
particularly foodstores, convenience and petroleum outlets.

Neverfail’s management, however, rejected the offer arguing “that the CCA offer is
inconsistent with the premium multiples that comparable bottled water businesses have
achieved globally... [and] offers no value for the substantial synergies available to CCA...”
among other reasons.

Use the synergy information in Table 1 and the comparable transactions summarised in Table
2 to answer the questions below. Assume a risk-free rate of 5%, cost of debt of 7%, cost of
equity of 10.4%, nominal after-tax WACC of 9.6% and a perpetual nominal growth rate of
3.5%. Further assume Neverfail has forecast 2003 revenue of $76.5 million and EBITDA of
$32.4 million.

1. Classify each of the four synergies in this deal and determine an appropriate risk-adjusted
discount rate.

2. Calculate the synergy value from this deal.

3. Estimate an appropriate control premium based on precedent transactions analysis.

4. Based on your answers in (2) and (3), comment on the initial decision by Neverfail’s
management to reject the offer.

5. Also in 2003, CCA acquired small private water bottler Peats Ridge as a bolt-on
acquisition and unsuccessfully launched a bid to acquire Berri Fruit Juice Company.
Identify and discuss the strategy of CCA.

See accompanying spreadsheet for answers.

Table 1 Expected synergies in CCA-Neverfail acquisition

Synergy After-tax adjustment to FCF

Elimination of duplicated costs (eg listing fees, Immediate savings of $50,000 p.a. expected in
customer service centres, etc) perpetuity with minimal implementation costs.

Redundancy costs of $400,000 in first year

Reduction of management and administration
expected to deliver perpetual cost savings of
costs
$70,000 p.a. from 2005/6.

Asset sales in 2004/05 returning $300,000 net of

Rationalisation of production facilities
costs.

Initial investment upon successful acquisition of

Enhanced utilisation of CCA /Neverfail $55,000 generating additional revenue of
distribution network to cross-sell products $40,000 in 2004/05, $30,000 in 2005/06 and
$10,000 in 2006/07.

Table 2 Comparable transactions, Jan 2000 to Feb 2003

Consideration EBITDA
Date Target Acquirer Revenue multiple
(millions) multiple
Feb-03 Clear Water Nestle SA US$32.5 2.0x 8.1x
Feb-03 Powwow Ltd Nestle SA E 560 4.7x 60.0x
Sparkling Spring
Dec-02 Groupe Danone E 390 3.9x 13.0x
Water
Oct-02 Chateau d’Eau Groupe Danone E 220 4.4x 24.4x
Dec-01 Aqua Cool Pure Nestle SA US$220 3.1x 13.8x
Oct-00 Salute Neverfail A 11.7 2.9x 6.2x
Feb-00 Piccadilly Neverfail A 15.8 1.7x 5.1x
McKesson Water
Jan-00 Groupe Danone US$870 2.3x 10.4x
Co