Question 1
Oil Infrastructures plc is a public company that specialises in the provision of oilfield services to the international oil and gas industry. It has operational centres in major oil and gas producing regions, including Saudi Arabia, Indonesia, Scotland and the Arab states of the Persian Gulf. The company and its subsidiaries offer support services for petroleum and natural gas extraction. Its main business is the design of onshore and offshore greenfield and brownfield upstream or downstream facilities, including engineering, procurement and commissioning. The firm operates and maintains oil and gas assets for clients under commercial contracts tailored to suit its clients.
The oil and gas sector has recently come under pressure due to decreasing oil prices, which has forced some high-cost firms out of business, and led to substantial layoffs and other cost reductions across the industry. Oil Infrastructures plc is planning to profit from this downturn by consolidating the oil and gas service sector, thus reducing its costs and improving its market power. An investment bank that has been advising Oil Infrastructures plc in the past has suggested Crude Plumbing Ltd. as a valuable addition to Oil Infrastructures' portfolio.
Crude Plumbing Ltd. operates in the same industry sector as Oil Infrastructures. Although it provides similar design, construction and maintenance services to oil and gas producers, it has a limited geographical overlap with Oil Infrastructures. Initial talks between senior management of both firms have indicated a potential for cost savings in procurement and other centralised functions (e.g. design, administration) as well as operational savings in overlapping geographical regions. In addition, there would be an opportunity for Oil Infrastructures plc to gain access to additional markets currently served by Crude Plumbing Ltd. To a limited extent, both firms would also engage in the sharing of technology.
You work in Oil Infrastructures' finance department and are asked to evaluate this merger opportunity, which would be implemented in the current year 2016 if deemed profitable. Oil Infrastructures' finance department has already compiled the stand-alone DCF valuation of Crude Plumbing shown in Table 1.
Table 1. Stand-alone DCF valuation of Crude Plumbing Ltd.
|
|
Base year
|
Forecast years
|
|
|
£m
|
£m
|
£m
|
£m
|
£m
|
£m
|
|
Year
|
2016
|
2017
|
2018
|
2019
|
2020
|
2021
|
|
Period
|
0
|
1
|
2
|
3
|
4
|
5
|
|
Revenue
|
680.00
|
680.00
|
714.00
|
749.70
|
779.69
|
810.88
|
|
Cost of sales (excl. depreciation)
|
-557.60
|
-557.60
|
-549.78
|
-577.27
|
-600.36
|
-624.37
|
|
Depreciation
|
-20.00
|
-20.00
|
-20.00
|
-20.80
|
-21.60
|
-22.40
|
|
Gross profit
|
102.40
|
102.40
|
144.22
|
151.63
|
157.73
|
164.10
|
|
Operating expenses
|
-95.20
|
-108.80
|
-71.40
|
-74.97
|
-77.97
|
-81.09
|
|
Operating profit
|
7.20
|
-6.40
|
72.82
|
76.66
|
79.76
|
83.01
|
|
Depreciation &Amortisation
|
20.00
|
20.00
|
20.00
|
20.80
|
21.60
|
22.40
|
|
EBITDA
|
27.20
|
13.60
|
92.82
|
97.46
|
101.36
|
105.41
|
|
Current liabilities change
|
-11.64
|
4.47
|
-14.87
|
10.47
|
8.84
|
9.18
|
|
Current assets change
|
9.81
|
0.00
|
-9.32
|
-9.78
|
-8.22
|
-8.54
|
|
Cash flow from operating activities
|
25.36
|
18.07
|
68.64
|
98.15
|
101.98
|
106.05
|
|
|
|
|
|
|
|
|
|
Investments in tangible assets
|
-20.00
|
-20.00
|
-30.00
|
-30.80
|
-31.60
|
-32.40
|
|
Net cash used in investing activities
|
-20.00
|
-20.00
|
-30.00
|
-30.80
|
-31.60
|
-32.40
|
|
|
|
|
|
|
|
|
|
Taxes
|
-1.44
|
1.28
|
-14.56
|
-15.33
|
-15.95
|
-16.60
|
|
Free cash flow to the firm
|
3.92
|
-0.65
|
24.07
|
52.02
|
54.43
|
57.05
|
|
|
|
|
|
|
|
|
|
Discount factors
|
|
0.926
|
0.857
|
0.794
|
0.735
|
0.681
|
|
Present value
|
|
-0.60
|
20.64
|
41.30
|
40.01
|
38.83
|
|
|
|
|
|
|
|
|
|
Present value of cash flows
|
140.17
|
|
|
|
|
|
|
Residual value (perpetual growth)
|
660.06
|
|
|
|
|
969.85
|
|
Enterprise value
|
800.24
|
|
|
|
|
|
This valuation is based on a number of assumptions for the case that the acquisition does not commence and Crude Plumbing remains independent (see Table 2).
Table 2. Stand-alone valuation assumptions
|
Year
|
2016 (Base)
|
2017
|
2018
|
2019
|
2020
|
2021
|
|
Revenue growth
|
-5.00%
|
0.00%
|
5.00%
|
5.00%
|
4.00%
|
4.00%
|
|
Cost of sales in % of revenue (excl. depreciation)
|
82.00%
|
82.00%
|
77.00%
|
77.00%
|
77.00%
|
77.00%
|
|
Operating expenses in % of revenue
|
14.00%
|
16.00%
|
10.00%
|
10.00%
|
10.00%
|
10.00%
|
|
Non-current (tangible) assets in £m
|
250.00
|
250.00
|
260.00
|
270.00
|
280.00
|
290.00
|
|
Depreciation of tangible assets in %
|
8.00%
|
8.00%
|
8.00%
|
8.00%
|
8.00%
|
8.00%
|
|
Current liability days
|
120.00
|
120.00
|
120.00
|
120.00
|
120.00
|
120.00
|
|
Current asset days
|
100.00
|
100.00
|
100.00
|
100.00
|
100.00
|
100.00
|
|
Corporate tax rate %
|
20.00%
|
20.00%
|
20.00%
|
20.00%
|
20.00%
|
20.00%
|
|
Revenue growth in perpetuity from year 2022
|
2.00%
|
|
|
|
|
|
|
WACC
|
8.00%
|
|
|
|
|
|
The acquisition will have several effects on the target. Management estimates higher revenue due to increased market power and the broader range of services that can be offered after the merger. Growth will also be slightly higher due to the sharing of technology between both firms. Small cost savings will come from shared administration and marketing and a small reduction of head count in administrative departments. The relative amount of working capital (i.e., relative to revenue) required to run the business will be unchanged.
Crude Plumbing would also invest £60m in new and more efficient production facilities at its main operational centres, which are expected to be depreciated in line with all other non-current tangible assets at 8% of the remaining book value per year (i.e., geometric depreciation), beginning in the year following the construction of the facilities. The restructuring of Crude Plumbing's business and integration with Oil Infrastructures will render £40m worth (book value) of equipment useless, which will be written off completely in 2017.
Table 3 shows the changes to Crude Plumbing's business expected by management.
Table 3. Assumptions for acquisition
|
Forecasting inputs
|
2017
|
2018
|
2019
|
2020
|
2021
|
|
Revenue growth
|
5.00%
|
10.00%
|
8.00%
|
6.00%
|
5.00%
|
|
Cost of sales as % of revenue (excl. depreciation)
|
82.00%
|
77.00%
|
77.00%
|
77.00%
|
77.00%
|
|
Operating expenses in % of revenue (excl. merger expenses)
|
12.00%
|
10.00%
|
10.00%
|
10.00%
|
10.00%
|
|
Non-current (tangible) assets (£m)
|
270.00
|
278.40
|
286.93
|
295.57
|
304.33
|
|
Extraordinary write-off (£m)
|
40.00
|
|
|
|
|
|
Investment in new plant (£m)
|
60.00
|
|
|
|
|
|
Implementation costs (£m)
|
|
|
|
|
|
|
Fees for investment bank, lawyers
|
8.00
|
|
|
|
|
|
Severance, redundancy payments
|
2.00
|
1.00
|
|
|
|
|
Retention bonuses
|
1.50
|
|
|
|
|
|
Integration of production processes
|
10.00
|
5.00
|
1.00
|
|
|
For the calculation of the target's terminal value it is assumed that the target's cost structure as well as the relative size of all other items will remain constant from the year 2021 onwards. To simplify the calculation, is it further assumed that depreciation will be matched exactly by replacement investments from the year 2021. Hence, no detailed calculation is needed beyond 2021.
Your colleagues at the finance department have compiled a list of public firms that may be comparable to Crude Plumbing in Table 4.
Table 4. Comparable firms as at 31 December 2015
|
Market value and net debt are for the financial year-end 2015, while net income, EBITDA and revenue are expected values for 2016.
|
|
Firm name
|
Industry (SIC 2007 sector codes)
|
Market value of equity (£m)
|
Net debt (£m)
|
Net income (£m)
|
EBITDA (£m)
|
Revenue (£m)
|
|
FBM Technologies Inc
|
09.10 Support activities for petroleum and natural gas extraction
|
317.44
|
201.96
|
-4.21
|
21.25
|
359.03
|
|
Mining Support Corp
|
09.90 Support activities for other mining and quarrying
|
267.80
|
104.96
|
-4.96
|
13.55
|
250.48
|
|
Spillnomoreplc
|
19.20 Manufacture of refined petroleum products
|
125.56
|
107.22
|
10.28
|
15.57
|
312.92
|
|
Gulf Island Structures Corp
|
09.10 Support activities for petroleum and natural gas extraction
|
1131.20
|
1262.23
|
22.73
|
67.31
|
1687.87
|
|
Shelf Drilling NV
|
06.10 Extraction of crude petroleum
|
180.84
|
121.01
|
-4.44
|
10.21
|
266.55
|
|
International OilwellInc
|
09.10 Support activities for petroleum and natural gas extraction
|
1368.79
|
581.72
|
19.29
|
41.85
|
1512.53
|
|
Freshwater Horizons plc
|
09.90 Support activities for other mining and quarrying
|
311.24
|
211.72
|
1.64
|
15.24
|
547.21
|
|
GulfMark Refineries Inc
|
19.20 Manufacture of refined petroleum products
|
686.40
|
888.82
|
18.06
|
28.07
|
1135.84
|
|
Total Offshore NV
|
06.10 Extraction of crude petroleum
|
1942.72
|
1667.22
|
266.71
|
270.62
|
3427.00
|
|
HalliburpInc
|
09.10 Support activities for petroleum and natural gas extraction
|
76.17
|
66.63
|
0.46
|
4.05
|
134.84
|
|
ConnectTech Ltd
|
09.10 Support activities for petroleum and natural gas extraction
|
424.44
|
470.74
|
0.92
|
40.40
|
744.41
|
|
Dril-Nom Inc
|
06.10 Extraction of crude petroleum
|
192.83
|
151.62
|
3.56
|
14.67
|
256.36
|
|
Baker Grant SA
|
19.20 Manufacture of refined petroleum products
|
1060.06
|
351.25
|
37.95
|
51.00
|
1342.55
|
Although the management's plan was to keep the merger plans a secret until negotiations with Crude Plumbing are completed, the press has learned about Oil Infrastructures' intent to acquire Crude Plumbing. Rumours of the acquisition were made public on 9 June 2016. Table 5 shows the share price for Oil Infrastructures plc.
Table 5. Share price of Oil Infrastructures plc
|
This table shows share prices for two months around the event day. The column "FTSE250" is the index value of the FTSE 250 stock index.
|
|
Date
|
Oil Infra- structures plc
|
FTSE250
|
|
Date
|
Oil Infra- structures plc
|
FTSE250
|
|
20/04/2016
|
62.00
|
17018.00
|
|
20/05/2016
|
65.87
|
16922.10
|
|
21/04/2016
|
62.90
|
16979.40
|
|
23/05/2016
|
65.16
|
17031.70
|
|
22/04/2016
|
64.43
|
16871.50
|
|
24/05/2016
|
66.18
|
17135.70
|
|
25/04/2016
|
63.04
|
16965.70
|
|
25/05/2016
|
66.70
|
17232.60
|
|
26/04/2016
|
63.24
|
16945.50
|
|
26/05/2016
|
67.96
|
17192.80
|
|
27/04/2016
|
64.02
|
17083.70
|
|
27/05/2016
|
67.20
|
17232.30
|
|
28/04/2016
|
64.93
|
17066.40
|
|
31/05/2016
|
68.37
|
17184.70
|
|
29/04/2016
|
65.14
|
16801.60
|
|
02/06/2016
|
67.77
|
17076.30
|
|
03/05/2016
|
65.83
|
16730.10
|
|
03/06/2016
|
69.41
|
17067.90
|
|
04/05/2016
|
64.91
|
16659.40
|
|
06/06/2016
|
69.45
|
17181.80
|
|
05/05/2016
|
65.65
|
16661.70
|
|
07/06/2016
|
69.64
|
17195.40
|
|
06/05/2016
|
65.35
|
16648.80
|
|
08/06/2016
|
68.63
|
17177.80
|
|
09/05/2016
|
65.10
|
16687.10
|
|
09/06/2016
|
72.08
|
17111.60
|
|
10/05/2016
|
66.08
|
16724.40
|
|
10/06/2016
|
74.19
|
16827.50
|
|
11/05/2016
|
65.56
|
16720.70
|
|
13/06/2016
|
75.30
|
16574.20
|
|
12/05/2016
|
64.32
|
16659.90
|
|
14/06/2016
|
75.90
|
16232.30
|
|
13/05/2016
|
63.54
|
16650.30
|
|
15/06/2016
|
77.49
|
16298.30
|
|
16/05/2016
|
64.65
|
16699.30
|
|
16/06/2016
|
77.07
|
16032.00
|
|
17/05/2016
|
65.41
|
16845.10
|
|
17/06/2016
|
77.20
|
16422.00
|
|
18/05/2016
|
65.80
|
16881.20
|
|
20/06/2016
|
79.11
|
16959.10
|
|
19/05/2016
|
66.27
|
16730.10
|
|
|
|
|
Task
Your task is to recommend an enterprise value of Crude Plumbing Ltd. under the assumption that the firm is bought by Oil Infrastructures plc. In other words, you are asked to estimate a fair purchase price for Crude Plumbing Ltd. Briefly explain how you arrived at the answer for each of the following questions.
- a.Calculate the enterprise value of Crude Plumbing as at 1 January 2016 (treating 2016 as year ‘0'). This valuation should include all synergies and other costs and benefits caused by the merger.
- b.Calculate an enterprise value based on the set of comparable firms in Table 4.
- c.Recommend a purchase price for Crude Plumbing and discuss your choice.
- d.Calculate the cumulative abnormal return on Oil Infrastructures' shares for an event window of two days before and two days after the merger announcement in the press.
Guidelines
This TMA is not just testing your ability to perform the required calculations; it is also assessing your understanding of how to select relevant financial information and make considered decisions about whether and how to deploy them. This is reflected in the allocation of marks for the question (see above).
There is no set format for the analysis in Question 3. However, your solution should consist of a short report documenting your answers to the questions and a spreadsheet showing all calculations that led to these answers. Remember to show all your calculations in detail, including all assumptions you make. Submit a spreadsheet showing your analysis and calculations, as this will help your tutor to give feedback on your calculations. The main results and tables should be included within the body of the report. The spreadsheet should be combined with your report in a ZIP file when uploading to the eTMA system.
You should be able to answer this question using B859 unit materials only. For additional explanations and ideas of how to estimate firm value, see DePamphilis (2011) which is available through the OU Library (see link below). In particular, chapter 8 (sections "The Comparable Companies Method" and "Recent Comparable Transactions Method") and chapter 9 (section "The model-building process") may be helpful.
DePamphilis, D. (2011), Mergers, Acquisitions, and Other Restructuring Activities: An Integrated Approach to Process, Tools, Cases, and Solutions, Elsevier, available through the OU library