Financial Policy
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BNFN 4304 – Financial Policy
Mr. Masood Aijazi
Case 48: Sun Microsystems
Spring Semester 2017 – 2018
Authored By
Maryam Barifah 1420023
Nour Abdulaziz 1420149
Yara El-Feki 1410435
Balquis Mekhlafi 1410231
Shrouk Al-Jaaidi 1420072
Submission Date
10/05/2018
Synopsis
This case calls for students to reevaluate the price Oracle should pay to acquire its long-term business partner, Sun Microsystems. The emergence of new suitors (e.g., IBM) forces Oracle’s corporate development team to go back to the drawing board and reevaluate all the assumptions they have made in putting together the initial bid of $7.38 million, or $9.50 per share, on April 17, 2009. Students are invited to value Sun’s stock and take a position on whether there is any room left to sweeten the offer if a bidding war unfolds. The case outlines the Oracle strategy and how long-term partnering with Sun contributed to it to date. It also allows for an in-depth discussion of the changing competitive landscape of the technology industry.
The case is an exercise in valuing a potential acquisition target. It presents an opportunity for students to develop appreciation for valuing a company using both discounted cash flow and multiples in their analysis. Particular attention should be paid to the inclusion of synergies and their relevance to the valuation. The bidding dimensions of the case are highlighted by the presence of other potential acquirers.
Objectives
The primary objectives of this exercise are to introduce or reinforce valuation tools in the context of mergers and acquisitions:
1. Analyzing a variety of strategic, organizational, financial, and economic issues associated with mergers and acquisitions
2. Developing a framework for valuing acquisition candidates
3. Evaluating both quantitative and qualitative factors affecting merger agreements
The case could benefit from being assigned together with the technical note “Methods of Valuation for Mergers and Acquisitions” (UVA-F-1274).
Executive Summary
Oracle one of the world’s biggest and most legitimate vendors of database management system and other related programming is having to deal with an acquisition decision. Oracle is thinking to acquire Sun Microsystems, which is mainly in the industry of making hardware equipment, storage and offering different services at enterprise level. Per the case study, the combination of these two companies could make the Wal-Mart of the enterprise programming industry. In addition to this, the intention of this report is to evaluate whether Sun Microsystems would be a good fit for Oracle and what price should be offered for it. For Sun Microsystems, we used both valuations which are the Base-Case (Stand Alone) and the expected synergies after acquisition. We found a way to utilize three diverse ways to deal with the value of Sun Microsystem. First approach was to include the market capitalization and the debt of Sun Microsystem to decide an enterprise value of about $6.20 billion. Second, utilizing a multiple analysis based on comparable companies to determine the enterprise value which is about $3.87 billion. The third is utilizing the discounted cash flow method, we decided that Sun Microsystem’s enterprise value to be about $4.53 billion as a stand-alone company that is about $8.95 billion. The uniqueness between the values from the different methods that were being used was because of the various assumptions.
Table of Contents Executive Summary 3 Introduction 5 1. Is Sun Microsystems a good strategic fit for Oracle? Should Oracle acquire Sun Microsystems? 5 2. How much is Sun worth? What approaches would you use to place a value on Sun Microsystems? (Hint: Stand-Alone Value, Acquisition Price and Value with Synergies) 7 The Stand Alone and Value with Synergies methods for valuation using the WACC was calculated as follows: 8 Steps for WACC calculation are seen in the excel sheet: 9 3. Assuming a discounted cash flow valuation: 9 a. What rate of return should Oracle require on the acquisition? 10 b. What base-case cash flows do you forecast? 10 c. What is your estimate of terminal value? 11 d. What is the enterprise value of Sun Microsystems? What is the equity value? 12 4.Conduct a compare companies or multiples analysis to value Sun. What economic fundamentals are reflected in the multiples? 12 Multiples of Comparable Companies 13 Multiples Analysis 15 Economic Fundamentals 16 5. Identify the synergies and conduct a sensitivity analysis to estimate the effect of synergies on enterprise value. 16 The below table shows the sensitivity analysis for the two approaches: 20 Stand-Alone Sensitivity Analysis: 20 Synergy Value Sensitivity Analysis: 21 Summary of Results: 21 6. If a competing bidder appears, how high a price should Oracle be willing to offer? 22 Conclusion 23
Introduction
The computer industry is an extremely competitive and the organizations are always searching for new way to evolve to be a step ahead of the competition at all times. In 2009, Oracle was planning to acquire Sun Microsystems. This acquisition would allow Oracle to further diversify their brand, customers and acquire various new platforms that would be added to their portfolio such as MySQL, Solaris and Java. Oracle originally placed an offer of $9.50 per share price which is considerably higher than Sun Microsystem’s price that is $6.69. In addition to this, Oracle levered the company’s value with the acquisition of Sun Microsystems through complementing their system with hardware manufacturing. This will cut the production costs and make the company more efficient throughout all the value chain. The acquisition will pool Oracle’s leading position in the software area with Sun Microsystem’s proficiency in hardware and networking. Moreover, Oracle aimed to capitalize on Sun Microsystem’s decline by getting particular assets or the whole company at the deflated price. The main issue that Oracle needed to confront was to make an accurate valuation model to think of a reasonable price for Sun Microsystems share price. Additionally, Oracle had to ensure that acquiring Sun Microsystem would convey benefits and productivity to its operation.
1. Is Sun Microsystems a good strategic fit for Oracle? Should Oracle acquire Sun Microsystems?
The financial position of oracle in 2009 was much healthier than that of Sun Microsystems, as in that year Sun was steadily losing its market share in the hardware business market, therefore to increase their revenues they tried to leverage software systems by making the Java Solaris, and acquiring MySQL. Unfortunately, this did not sustain Sun performance for a long term especially with the 2007 crisis that affected their financial performance negatively. As a result they found that the most suitable action they could undertake is under an acquisition position. This acquisition will benefit Oracle in many aspects and will aid Oracle in becoming the enterprise software industry’s Wal-Mart.
Although both businesses are considered of similar industry, yet they sell different product as Oracle primarily manufacture business software while Sun professionalize in hardware and networking. Consequently, Oracle could add Sun Microsystems to its firm as a vertical integration acquisition and benefit from the diversification of products that would occur when adding the strength of Sun’s to Oracle’s thus creating a preferred business offering. There were two main technology system software used by Oracle in 1997 that are Java programming language and Solaris (an open-source platform), and these two were owned by Sun Microsystem. Oracle and MySQL database management systems both targeted different customers therefore they were not having a direct competition, thus the addition of MySQL will add to Oracle’s portfolio and may well be able to attract and sell their software to high-end clients. Moreover, Oracle could add Sun Microsystems solid position in the software industry to its Java MySQL, and Solaris systems toward its portfolio.
The beginning of the technology industry started with three main sectors software, hardware and services storage and peripherals, but with the industry developing in the new millennium, there began uncertain lines of segments. Considering Apple’s store, where customers could purchase their needed software, hardware and peripherals from just one store have made other technological businesses to reconsider their strategies in business development.
Sun Microsystem is considered a good fit for Oracle for several reasons, primary is to achieve their vision of becoming the Apple in the technological sector for businesses, by providing both hardware and software components, as stated by Oracle’s CEO Larry Ellison. Moreover, Ellison could achieve the vision by this acquisition and will also allow Oracle to distribute high-quality products from the combination of hardware and software components and therefore reducing customer set-up procedure.
Lastly, the addition of Sun Microsystem will allow Oracle to expand. The acquisition perfectly fits Oracle’s strategy that justifies improving through acquisition and effective integration with other companies. Moreover, Oracle has spent more than 30 billion on acquisitions since 2005, thus Oracle is familiar with similar situations as this allows them to study the intended company and perceive possible synergies. Therefore, due to all the listed benefits Sun Microsystem is considered an immense proposal.
2. How much is Sun worth? What approaches would you use to place a value on Sun Microsystems? (Hint: Stand-Alone Value, Acquisition Price and Value with Synergies)
Firstly, to know how much the Sun Microsystem is and how to value it, we must find the Stand Alone Value of the company. The Stand Alone value represents the present value of Sun Microsystem individually before factoring the synergy that would be created when Oracle acquires Sun. It is the excess amount of money that the shareholders of Sun Microsystem receive. It is a mean to value the firm before any merger or acquisition occur, and it useful to see whether or not the target company is undervalued or overvalued by comparing it with current share prices.
Secondly, the value of Sun Microsystem with synergies, which after being acquired by Oracle, must be found. This is done to see whether or not the acquisition was a proper strategic decision or not; keeping in mind that the value of synergies was considered to be the added amount of money that has been received by Oracle’s shareholders. If the acquisition proves to be a fit strategic decision then the value of the company included within this deal will grow significantly; this is known as the synergy effect. The cost saving and the extra gain in revenue and efficiency that is achieved when two companies merge is represented through Synergies, as show in the attached excel sheet in Q.3.2, Q.3.3, Q.5.2, and Q.5.3 and as explained in Question 5. Another method of valuating the Sun Microsystem is through the comparative company analysis (CCA), aka. Trading comps. That is done through the thorough assessment of rival and peer businesses of similar size and industry.
Finally, the acquisition price, which is the price that is paid to the target when it is first acquired, is also used as a separate method of valuation. The value of the acquisition price ranges between the values of the stand-alone and the synergies.
To be able to find the values of both, the Stand Alone and the synergies, we have decided the best way to do so is by calculating the discounted cash flow (DCF) by using the multiples and the perpetuity growth methods and finding the average of both.
However, there are a few challenges that we potentially could face using both of these methods and they are as following:
The DCF using the multiples method does not consider long-term growth or the econometrics of business. It is also very difficult to identify comparable companies.
The DCF using the perpetuity growth method appears inaccurate as the company assumes a certain growth rate will remain the same which is impossible.
The Stand Alone and Value with Synergies methods for valuation using the WACC was calculated as follows:
The weighted average cost of capital (WACC) is the average of the cost of individual sources of capital. The capital is comprised of equity that has been invested, or simply debt that lenders decided to invest in; with each source of equity being proportionally weighted. WACC can be defined as the minimum rate of return. Companies must generate returns greater than their WACC to be above the break-even point. In case a company goes below, they would enter a deficit.
In order for shareholders and lenders to be able to estimate the returns that their investments might yield, the WACC must be calculated.
Steps for WACC calculation are seen in the excel sheet:
The formula: WACC = Wd x Rd x (1-T) + We x Re
Wd= weight of debt
Rd= cost of debt
We= weight of equity
Re= cost of equity
T= tax rate
To calculate the WACC, the weight of debt in the capital structure must be calculated using: Debt/(Debt + Market Capitalization)
(The numbers can be found in exhibit 9.
Then, a calculation of the weight of equity must be done by: 1-Wd or 1-%Debt
Furthermore, the corporate bond yield from Exhibit 10 is used for the BB+ ratings since in Exhibit 9 it was shown that the bond rating for Sun Microsystem is Ba1 (Moody’s), which is equivalent to BB+ (S&P) .
Moreover, the cost of equity is calculated by using the Capital Asset Pricing Model: Rf + Beta x (Rm).
All using the following data: a market risk premium (MRP) of 6% (assumed) and the 10-year Treasury Yield as the risk-free rate (from Exhibit 10) of 2.82% and a Beta of 1.73 (the levered beta for Sun Microsystem found in Exhibit 9).
Finally, determining the WACC using the assumed tax rate of 35%, providing us with a WACC of 12.05%.
3. Assuming a discounted cash flow valuation:
The Discounted Cash Flow (DCF) Method is considered to the be the superior valuation techniques to use in case of mergers and acquisitions compared to the comparable company’s analysis (CCA) since it is considered to be forward looking and will consider time value of money. DCF in addition focuses on cash flows instead of profits, and reflects on other non-cash charges such as depreciation and amortization and also investment inflows and outflows.
a. What rate of return should Oracle require on the acquisition?
When there is a possibility of acquisition, the acquirer may plan to increase the level of debt or decrease it after the merger because at that moment of time the objectives of the target’s finances is not ideal. The WACC reflects the company’s business risk of the target. An intermediary for this can be acquired from the unlevered beta of the target association’s value or a normal unlevered beat for firm with comparable business risk. The targets premerger unlevered beat should then be re-levered to reflect what the acquirer expected to have as a post-merger capital structure. To un-lever a company’s expected beat, one should use the predominant tax rate and the debt to equity ratio (D/E) of the company which relates to the beta estimate. The equation is below; ßu =ßL/[1+(1– T)D/E
Then, using the unlevered beta to estimate or normalize the unlevered beta estimate if its utilizes numerous companies to appraise the unlevered beta and the to re-lever the beta to the new proposed debt to equity ratio. Using the below formula: ß’L =ßu[1+(1– T)D/E
The rate of return that Oracle should require on the acquisition is equal to the Sun Microsystem’s WACC which is equal to 12.05%.
b. What base-case cash flows do you forecast?
The cash flow projections for the target company could plausibly incorporate co-operative synergies or any cost savings picked from the consolidation of the operations of the target company into those of the acquirer. If the basis of the cash flows does exclude any economic advantages an acquirer may convey to a target, they are then introduced as a stand-alone cash flows.
We then forecasted Sun Microsystem’s free cash flows for 5 years from year 2010 till year 2014. As what is shown in the excel sheet Q3.1, the free cash flows are estimated which is then increased from year 2010 till 2011, it then declines from the year 2011 to year 2012 and then increased back again in 2012 till 2014. In Exhibit 14 the valuation of Sun Microsystems was calculated using cash flows estimates. Sun Microsystems operating income is calculated by EBIT using a tax rate of 35% and that then indicates the NOPAT. Then the next step is that we calculated the net working capital by adding the net receivables and the inventory and other current assets then we subtracted account payable and other current liabilities which is taken from Exhibit 11.
The Net Working Capital (NWC) has an average of sales of 10.12% of net revenue which is found from Exhibit 14. In addition, the PPE from Exhibit 14 was then used to calculate Net PPE. Then this change in net working capital was calculated by subtracting the Net PPE of 2009 from the Net PPE of 2010. After finding the change in Net Working Capital, the Free Cash Flows were then projected from years 2008 to 2014. To calculate the Free Cash Flows (FCF), the change in Net Working Capital and the change in capital expenditure was then subtracted from the NOPAT. In Q3.3 the approach taken was the multiples of comparable companies to get the terminal value which is 7,480.
c. What is your estimate of terminal value?
To calculate the terminal value of the company, one must then determine the perpetuity growth model and then the multiples of comparable companies. In Q3.2, the terminal value of 4,815 was calculated by dividing the perpetuity growth (444.35) by the WACC of 12.05% minus the growth rate of 2.82%.
d. What is the enterprise value of Sun Microsystems? What is the equity value?
Another method for valuation is the enterprise value for the acquirer to maintain at the levels of consideration as it will affect the bid price that a company will be willing to pay for the target firm. When deciding on the bid price, the buyer (Oracle) will perform an analysis of the future cash flows of the target (Sun Microsystems) as a stand-alone business. The effects of which will be if they have a higher enterprise value for the target then they would raise the bid price and will still undertake a positive net present value for investors. This stand-alone value will give a benchmark for businesses and shareholders to use when the decision making process occurs for the organization takeover.
The enterprise value in the DCF with perpetuity growth was calculated by adding the Net Present Value (NPV) of Free Cash Flow (FCF) and the net present value of the terminal value. In addition, to find the price per share of the equity value is was calculated as (enterprise value – debt + cash) to then be divided by the number of shares which are 739 which are found in Exhibit 9. The result of which will be a price per share of $7.40.
Then the enterprise value which is found in the DCF with the multiples was then calculated by adding the Net Present Value (NPV) of Free Cash Flows (FCF) and the present value of the terminal value. In addition, to find the price per share the equity was calculated from (the enterprise value – debt + cash) to for it then it to be divided by the number of shares which are 739 from Exhibit 9. The result will then be $9.44 price per share.
4.Conduct a compare companies or multiples analysis to value Sun. What economic fundamentals are reflected in the multiples?
There must be a consistency between the target company’s earnings stream and the multiples used in the valuation process, in order to conclude the most befitting price using those evaluation multiples. In depiction, the company’s price to earnings multiple could be used (which is calculated by dividing the company’s price per share by the company’s earnings). This approach takes into account estimating the company’s equity and comparing it to the company’s income only. As mentioned earlier, the company in this case is evaluated on its free cash flow basis for its valuation method. Therefore, rating a firm based on its revenue might be misguiding as it may demonstrate presumptions about the firm’s capital structure. Hence, we have used several different multiples which assimilate the company’s capital structure (which is mirrored in the firm’s enterprise value), distinctively regarding the firm’s debt in order to evaluate the company in the same manner that an acquirer would. The P/E multiple does not amalgamate the firm’s cash on hand, sales multiples, EBITDA multiples, or EBIT multiples.
Multiples of Comparable Companies
This approach of valuation is grounded on the perception that firm’s that have suchlike assets, trade their goods and services at homogenous rates. Presuming that a proportion which assimilates specific values (for example earnings) of the company’s particular figures would be indistinguishable athwart companies in the same industry. Accordingly, the company’s valuation can be accomplished by effectuating inscribing the other firms (in the form of an index) which are comparable in size as well as products (goods or services) that operate in the same industry.
Sun Microsystems is thought-out to be a preeminent hardware firm, with a realm of business systems and utilities, stowage and software platforms (such as Java, Solaris, and MySQL). In order to carry out a compare companies analysis, a benchmark of the most comparable companies to Sun Microsystems must be done (companies that offer the same goods and services). A depiction of the different firms that offer tangible goods (hardware firms) as well as firms that offer intangible goods (software firms) is portrayed in Exhibit 4. As Sun Microsystems is a hardware firm, we decided that our comparable companies analysis would take Advanced, Micro Devices, Apple, Dell, EMC, Hewlett-Packard (HP), Intel, International Business Machines (IBM), and NetApp into consideration for our analysis. Nonetheless, the aforementioned companies’ goods and services ranges are utterly dissipated. In order to have a more veracious comparable companies analysis, we will base our analysis on the following firms: Apple, Dell, Hewlett-Packard (HP), Intel, and International Business Machines (IBM). We will not be co-opt firms that offer product lines and progression plans that are dissimilar than that of Sun Microsystems (such as Advanced Micro Devices, EMC, and NetApp).
Pertaining to Exhibit 9, the comparable companies’ levered betas are specified, which reflects a median of 1.12 for the entire industry, and a levered beta of 1.73 for Sun Microsystems. Additionally, we figured out the unlevered beta by computing the debt to equity (D/E) ratio. We used a 35% tax rate (as presumed in question 2), exhibiting a 9.35% median and a 1.58 unlevered beta for the entire industry. Whilst Sun Microsystems had a debt to equity (D/E) ratio of 25.44% and a levered beta of 2.13, hence, it is considered to be rather higher than the market. This indicates that the business is more perilous compared to the industry in which it operates. Therefore, this denotes the ideal ratio of debt to equity (D/E) that Sun Microsystems must achieve. We also computed the cost of equity by using the capital asset pricing model (CAPM). We substituted a risk-free rate of 2.82% and a market premium rate of 6% (as assumed in question 2). We further computed the debt to capital ratio as well as equity to capital ratio in order to attain the comparable companies’ weights of equity and debt both. We achieved this by using the information provided in Exhibit 9. We reasserted the optimum capital structure that needs to be attained by Sun Microsystems in order to be correspondent to the median of the industry. Each company’s bond rating is mentioned in Exhibit 9, therefore, we took the cost of debt from the corporate bond yields, which is provided in Exhibit 10 (in conformance with the bond ratings for each company).
Lastly, we calculated the WACC and reached a value of 9.50% as the industry’s median and a value of 12.05% for Sun Microsystems. Pertaining back to what the WACC signifies (as stated in question 2), we can note that Sun Microsystems has a cost of capital that is much higher than that of the industry. This is reflected in the elevated rate of return that is expected to be receive on capitalizing in Sun Microsystems (which denotes that firm is much distressful compared to the other competing companies that operate in the industry).
Finally, we computed the multiples using EBIT, EBITDA as well as Sales (provided in Exhibit 9), which resulting with these outcomes.
Multiples Analysis
EBIT Multiple | EBITDA Multiple | Sales Multiple | |
Sun Microsystems | -1.41 | -13.15 | 1.72 |
Median | 9.40 | 6.28 | 1.39 |
We integrated the multiples’ average values, as they are essential in computing Sun Microsystems’ implied enterprise value (EV).
For us to do the comparable companies analysis (CCA), we needed to figure out the average price per share. We determined that the foremost thing to do was use the average EBIT, EBITDA and Sales average values for the former two years (2007-2008) in order to form our information on documented historical data. Since the accessible data was only for the former two years, we decided to include the data for both years. In the excel sheet Q.4, we included the detailed computations of our calculations in order to find the average price per share, after which we reached an outcome of $13.06 as the average share price.
Economic Fundamentals
To compute the terminal value, we took the U.S. treasury’s earnings (for 10 years) and used it as the risk-free rate (which was substituted as the growth rate). Additionally, to compute the average price per share needed foe the comparable companies’ analysis (CCA), we computed the implied enterprise value (EV) using the averages of the multiples mentioned earlier. Knowing that this comparable companies’ analysis (CCA) would be used to set a benchmark for Sun Microsystems to be valued upon, we must keep in mind that this benchmark might possibly result in an inaccurate computation of the real worth of the company. This would be due to the main fact that some companies are in a considerably more fiscally sound and firm situation compared to our target firm (Sun Microsystems), such as Apple or Dell.
5. Identify the synergies and conduct a sensitivity analysis to estimate the effect of synergies on enterprise value.
The potential synergies that Madison mentioned were the integral charges of $1.1 billion in total where $750 million which were incurred in 2010 and the rest ($350 million) being incurred in 2011. The team’s calculations which are estimated as an initial loss of $45 million in operating income due to them losing clients or/and delaying the purchases. Lastly, the cost cutting that would be faced by Sun after their acquisition would result in a reduction of the numbers of staff in Sun Microsystems by an approximate of 20-25%. In addition to this the selling, general and administrative (S, G&A) expenses would be further reduced by 22-32%. Furthermore, new products, licensing income, and the “integrated application to-disk” service would result in a potential annual increase in operating profit by a total of $900 million. As Madison had previously assumed that these synergies would be slowly increasing over a period of time, which is 3-years (from 2011 till 2013), this reaching its full capacity of $900 million in 2013. In Exhibit Q5.1 in the excel sheet there will found all the effects of the synergy sources.
Valuing Sun Microsystems with Synergies are done in Excel Sheet Exhibit Q5.1, Q5.2 and Q5.3. The levered beta was then taken directly from Q2 in the Excel Sheet, however, the unlevered beta was calculated using the following formula (levered beta divided by (1+!1-T) multiplies by D/E). Where is the weight of debt and E is the weight of Equity. In addition to this, weight of debt, weight of equity, risk free rate, market risk premium, cost of debt and equity, tax rate and lastly WACC (weighted average cost of capital) were all taken directly from Q2 in the Excel sheet. Growth rate is equal to risk free rate; this is due to the fact that there a relationship between the two. Therefore, any chnages that happen in the risk free rate is then correlated to any changes in the sustainable growth rate as well, the same issue goes for the stand alone DCF done for the above question 3. For the EBIT Exit Multiple, earning before interest and tax, on the other hand are taken from Exhibit Q4 in the Excel Sheet from the EBIT Median Multiple. Book Value (BV) of debt and Market Value (MV) of Equity are taken directly from Exhibit 9 in the attached Excel Sheet. The total is calculated by adding BV of debt and MV of equity. Finally, the percentage of debt is calculated by dividing BV of debt over the total. The second step to do is to the discounted free cash flow analysis and to determine the free cash flows using the synergies found. The steps below elaborate more:
· Sales and EBIT without synergies are going to be taken directly from Exhibit 14. EBIT without synergies is equal to operating income. As for the perpetuity growth for the sales is calculated by multiplying the last year (2014) with (1+gtwoth rate).
· The initial loss that is noticed in operating income is taken directly from the page 679 in the book which is predicted to be $45 million in year 2010. The main reason for this loss is due to the loss of customer and/or any deferred purchases.
· As for any noticeable integration charges (any expenses) these are taken from the same page as above, and the total is $1.1 billion with $750 million which is incurred in year 2010 and the rest will be incurred in 2011 ($1.1 billion – $750 million) which is equal to $350 million.
· There is a noticeable boost in operating profit by $900 million per year where Madison assumed that synergies would slowly increase over the three years starting from the year 2011. Therefore, in 2011 it was calculated by dividing $900 million by 3 years which will give us a total of $300 million. In the 2012, an increase was calculated by ($900 million minus $300 million) which will give us a total of $600 million. In 2013 and 2014, it is taken directly from the case in page 679 so the number is $900 million.
· The following steps were taken to calculate EBIT with Synergies (EBIT without synergies minus loss in operating income minus integration charges plus increase in net operating profit). These steps were taken for all years (2010 till 2014).
· Taxes were calculated by multiplying the EBIT with synergies with the tax rate. However, for the year 2010, since it carries a negative EBIT the resulting value would be the negative value of taxes, which is why we put zero as negative taxes are unrealistic (incorrect).
· NOPAT is then calculated by subtracting EBIT with synergies and taxes. The perpetuity growth is then calculated by multiplying the last year NOPAT with (1+growth rate).
· Then both Net Working Capital (NWC) and Net PPE perpetuity growth were calculated by multiplying the last year which was 2014 with (1+growth rate). Net Working Capital (NWC) and Property, Plant and Equipment (PPE) were taken directly from Q3.1.
· Change in NWC is the new year minus the prior year which is done only from year 2010 till 2014 which is the same for the perpetuity growth.
· The changes in capital expenditure (CAPEX) is calculated by subtracting the new year PPE from the prior year PPE (for example, 2010 PPE – 2009 PPE). This is because PPE is considered as a capital expenditure (CAPEX). The same thing is also done when calculating the perpetuity growth.
· Free Cash Flows (FCF) for the year 2010 till 2014 and for the perpetuity growth are calculated as follows (NOPAT minus Change in NWC minus Change in CAPEX). These free cash flows as shown in the excel spreadsheet they are increasing throughout the years.
· The DCF (Discounted Cash Flow) analysis was done by using both the perpetuity growth and the multiples as what are shown in the Excel Sheet (Q5.2 and 5.3). The NPV (Net Present Value) for both methods were calculated by using the NPV function which includes both the WACC and the Free Cash Flows from 2010 till 2014.
· There are two methods which can be used to calculate terminal value: it is either perpetuity growth method or using comparable company multiples. Using the DCF analysis with perpetuity growth it indicates that Sun Microsystems will most likely grow forever. The growth rate that was used is equal to the risk-free rate which is 2.82%. As what was found for the terminal value in the DCF with perpetuity growth that was calculated as the last years FCF (2014) divided by (WACC minus growth rate). In addition, the DCF with multiple is calculated as EBIT for the year 2014 multiplied by the median EBIT multiple (9.40).
· When calculating the Net Present Value (NPV) of terminal value (TV), we divided the terminal value by 1+WACC to the power of 5 which indicates the 5 years which are between 2010 and 2014, this step was taken for both the DCF with perpetuity and multiple methods.
· Enterprise value is calculated by NPV of FCF + NPV of TV. Debt and cash were taken directly from Exhibit 11. Equity is calculated as enterprise value minus debt plus cash.
· The total number of shares were taken directly from Exhibit 9 and price per share is found by equity divided by the number of shares outstanding.
· The two methods will actually result in different prices per share. The DCF with perpetuity growth will result in a price per share of $12.79, whereas the DCF with the multiples price per share will give a result of $16.32.
· If Oracle will acquire Sun Microsystems, certain synergies would appear;
· Oracle will be able to utilize Sun’s Java in their own portfolio to create many of their applications.
· By adding MySQL to Oracle company this will help them in adding smaller cliental to their customer base.
· This acquisition will help Oracle to expand its products lines and risks
· There will be a combination of both companies Research and Development (R&D) and also their sales teams.
The below table shows the sensitivity analysis for the two approaches:
Stand-Alone Sensitivity Analysis:
Synergy Value Sensitivity Analysis:
The sensitivity analysis for the synergy values using both the two methods perpetuity growth method (PGM) and the exit multiple method (EMM) show a higher enterprise value then the stand alone valuation preformed.
Summary of Results:
Enterprise Value | Equity Value | Price per share | |
Stand-Alone (Base-Case) using the Perpetuity method | 3,653 million | 5,465 million | $7.40 |
Stand-Alone (Base- Case) using the Multiples method | 5,161 million | 6,973 million | $9.44 |
Synergy using the Perpetuity method | 7,632 million | 9,444 million | $12.79 |
Synergy using the Multiple method | 10,238 million | 12,050 million | $16.32 |
Comparable Company method | $13.06 | ||
Oracle’s offer price | $9.50 | ||
Sun Microsystem (Current Share Price) | $6.69 |
Based on the above sensitivity analysis, what can be seen is that in the Stand-Alone (Base Case) using the perpetuity method which gave us an enterprise value of 3,653 million and an equity value of 5,465 million which resulted in a price of $7.40 per share which is close to the price per share of Sun Microsystems. Also, what can be noticed when we used the multiple method for the Stand-Alone (Base Case) we got $9.44 price per share which has a difference of only $2.75 ($9.44-$6.69). Therefore, the synergies valuation method was used to receive the accurate results of share price. The synergy using perpetuity method which has an enterprise value of 7,632 million and an equity value of 9,444 million resulted in a $12.79 price per share. In addition, when using the multiple method for the synergy the price per share of $16.32 shows a major difference between Sun Microsystems and Oracle’s offer price.
6. If a competing bidder appears, how high a price should Oracle be willing to offer?
Sun Microsystems Implied Offer Price | Perpetuity Growth Method | Exit Multiple | Sun Microsystems Share Price |
DCF using the Standalone Value | $7.40 | $9.44 | $8.42 |
DCF using the Synergy Value | $12.79 | $16.32 | $14.55 |
Average CCA | $13.06 | ||
Current Offer Price by Oracle | $9.50 |
Oracle is presently proposing the shares for a value of $9.50 per share for Sun Microsystems. We have used the three different approaches (as portrayed in the table above) in order to ascertain the highest price that Oracle is inclined to pay. In the DCF using the standalone value with perpetuity growth method offered us a value of $7.40 per share. However, when we used the exit multiple method, we got a value of $9.44 per share. Conversely, in the DCF using the synergy value, the perpetuity growth method offered us a value of $12.79 per share while the exit multiple method offered us a value of $16.32 per share. The two values are higher than the price offered by Oracle (which is equivalent to $9.50 per share) in comparison to the DCF with the standalone value.
Moreover, the values of each method, the perpetuity method and the multiples method, were not accounted for autonomously because of the challenges faced (as stated earlier in question 2). Thus, in order to avert misrepresenting the real worth of Sun Microsystems, we decided to take the average of the two methods. Accordingly, to find out what the highest price Oracle might propose to Sun Microsystems, values ranging from $8.42 to $14.55 was given (marking the lowest and highest prices that Oracle may offer to Sun Microsystems). As portrayed, it is evident that share price derived through the comparable companies’ analysis (CCA) and the price offered by Oracle are both contained within the suggested range (prices are $13.06 and $9.50 respectively).
All in all, we decided that the optimum price that should be proposed by Oracle is $11.38. This value was computed by finding the average of all the prices represented above along with the amount that is offered by Oracle ((8.42+14.55+13.06+9.50)/4= $11.38).
7- What approaches and methods are used for valuation of Mergers and Acquisitions; their pros and cons, role of synergies in M&A valuation.
8- How the IT sector in general and software industry in particular has grown in last ten years, who are the major players, what are the key trends and future outlook. Please highlight a recent Merger and Acquisition transaction (other than Sun Microsystem) in the IT sector.