Dublin Caf

Submitted by: Castaneda, Mary Cheryl Duenas, Erwin Lim, Alexander Allen Wongchuking, Lizsa

FINANCIAL MANAGEMENT (FNC 5110)

Submitted to: Professor Edgardo C. Grey Jr. Graduate School of Business De La Salle University March 19, 2011

I.

CASE BACKGROUND

Bob Radliff, Globals vice president for restaurant operations, is considering the acquisition of Dublin Cafe, a chain of eight restaurants that operates in the Boston area. The brew pub atmosphere, which is growing in popularity, has allowed Dublin to charge premium prices for its food, and in each of its locations, Dublin has been able to compete successfully with nearby national chains. Dublin was founded in 1990 by Tom and Ed OBrien with the initial capital coming from their father. In early 1997 the company went public to raise additional capital. The offering was for 3 million shares at $1 per share, but the offering was not well received and only 1.4 million shares were actually sold. The company currently has 2,000,000 shares outstanding. The OBrien brothers own 400,000 shares, others in management own 200,000 shares, and 1.4 million shares are held by outside (public) investors. The stock is traded infrequently and in small amounts. The last trade was at a new all-time high price of $1.97, but the stock is volatile, and its beta coefficient is 1.7. Radliff has tentatively decided to try to acquire the company after a thorough analysis of Dublins situation. The primary issues he now faces are (1) how much to offer for Dublins stock, (2) how to approach Dublins management, and (3) how to expand the business if and when the acquisition has been completed. The projections assume that Global would make a number of changes in Dublins operations, including the following (All of these changes are tentative and speculative): o o o With Globals financial support and pool of managerial talent, Dublins rate of new store openings would be increased significantly, dramatically increasing the growth rate. With Globals stable, diversified operations providing a backup, Dublin could employ a higher debt ratio. Even with more debt, Globals better access to capital markets and improved coverages would result in a lower cost of debt. Also, Dublins beta should decline somewhat after the acquisition, thus lowering the CAPM cost of equity. Radliffs analysts forecast that Dublins post-merger beta will be 1.4886 versus a pre-merger beta of 1.7. Global has both more knowledge about purchasing and more clout with suppliers than Dublin. Also, its faster growth and larger size would lead to economies of scale. As a result, both the operating cost/sales and the depreciation/sales ratios should decline. Dublins tax rate is expected to increase in 2001 because tax loss carry forwards and other tax shelters derived in its first few years of operations would be used up. The merger would not affect the tax rate, which would be 40% with or without the merger. Dublin currently pays no dividends, and if it remains independent, this situation would continue on into the future. Under Global, Dublin would pass any excess earnings (i.e., earnings not needed for operations) on to Global in the form of dividends.

o o o

Radliff thinks that the OBriens, with their strong entrepreneurial instincts, might help him expand Globals overall restaurant operation. His own staff is competent at managing existing operations, but less so in creating new opportunities. So, Radliff thinks a Dublin acquisition might bring with it management talent as well as a good business.

The offer price is a critical issue. Below is a list of the steps Radliff plans to go through to establish the offer price:

1. Perform a DCF analysis to determine just how much Dublin is worth to Global. This would set an upper limit on the offer price. 2. Hire a consulting firm or an investment banking firm to do an independent evaluation of Dublin. This would serve as a check on Globals own appraisal, and it would also be used as a Fairness Opinion which would be presented first to Dublins managers and then to its shareholders when they are asked to vote to approve the merger. In very large mergers, a highly-regarded firm such as Goldman Sachs or Morgan Stanley will be asked to make the fairness opinion. Generally, both the acquiring firm (Global) and the target firm (Dublin) will hire their own consultants or bankers to get independent opinions.

3. The fairness opinion would undoubtedly begin with Dublins current market value. The last stock price was $1.97 per share, and there are 2 million shares outstanding. Thus, the current market value of Dublins common stock is just under $4 million. Radliff would probably conclude that he must offer a minimum of $1.97 per share, or $4 million in total, to get Dublins stockholders to agree to the acquisition. In all likelihood, he would have to offer a premium of 25 to 30 percent, or about $2.50, to get stockholder approval. 4. While the current market price tells us what The Market thinks the stock is worth, and Globals DCF analysis gives an estimate of what Dublin is worth to it, analysts always consider other data when appraising the value of a stock such as Dublin. Stock prices are volatile, and the current stock price probably does not reflect the effects of a merger, so the current market value is flawed as a measure of Dublins value when merger possibilities are considered. Moreover, any DCF value is extremely sensitive to cash flow estimates and the cost of capital used as the discount rate, and those inputs are just educated guesses. Thus, it is dangerous to place a great deal of confidence on DCF values. 5. Therefore, analysts typically supplement their DCF valuations with valuations based on a multiples approach. 6. The final valuation is generally determined as a weighted average of the current market value, the DCF valuation, and the different multiple valuations. The weights used are judgmental.

II.

STATEMENT OF THE PROBLEM Should Dublin Caf agree to a merger or remain independent?

III.

OBJECTIVES a. To evaluate the current financial status of Dublin Caf. b. To compare the projected financial status of Dublin Caf if they merge with Global or remain independent c. To determine the advantages and disadvantages of a merger

IV.

AREAS FOR CONSIDERATION

Input Data: Independent Company Model

Input Data for Model of Dublin if Acquired By Global

V.

ALTERNATIVE COURSES OF ACTIONS a. ACA # 1: Dublin Caf to merge with Global

Sensitivity Analysis: DCF Value/Share as Function of Various Inputs Operating Cost Ratio in 2002 83% 84% 85% 86% 87% 88% 89% 90% DCF Value/Share Sales Growth Rate in 2002 15% 10% 5% $10.70 $5.27 $2.94 $9.22 $4.44 $2.44 $7.70 $3.59 $1.93 $6.11 $2.73 $1.42 $4.42 $1.84 $0.89 $2.57 $0.90 $0.35 $0.43 ($0.10) ($0.21) ($2.32) ($1.23) ($0.81)

Output:

$5.34

Effect of discount rate on post-merger DCF value WACC 12.0% 14.0% 16.0% 18.0% DCF Value $21.39 5.41 2.74 1.64

Advantages of a Merger

Increased market share Lower cost of operation and/or production Higher competitiveness Industry know how and positioning Financial leverage Improved profitability and EPS stability as a corporate entity provide for higher political influence and industry leadership Benefits on account of tax sheilds like carried forward losses or unclaimed depreciation Restructuring and strengthening the balance sheet Investment of surplus cash Easy to acfquire economies of scale .

b. ACA # 2: Deublin Caf to remain independent

Sensitivity Analysis: DCF Value/Share as Function of Various Inputs Operating Cost Ratio in 2002 85% 86% 87% 88% 89% 90% DCF Value/Share Sales Growth Rate in 2002 15% 10% 5% $6.95 $3.70 $2.11 $5.93 $3.06 $1.70 $4.88 $2.41 $1.29 $3.79 $1.74 $0.86 $2.60 $1.04 $0.43 $1.23 $0.27 ($0.03)

Output:

$1.70

Disadvantages of a Merger

Legal expenses Short-term opportunity cost Cost of takeover Potential devaluation of equity Intangible costs Increase in cost to consumers Decreased corporate performance and/or services Potentially lowered industry innovation Suppression of competing businesses Decline in equity pricing and investment value Diseconomies of scale if business becomes too large, which leads to higher unit costs. Clashes of culture between different types of businesses can occur, reducing the effectiveness of the integration. May need to make some workers redundant, especially at management levels - this may have an effect on motivation. May be a conflict of objectives between different businesses, meaning decisions are more difficult to make and causing disruption in the running of the business.

VI.

CONCLUSION & RECOMMENDATION

Based on the above given, computations (as attached) and information, the group concludes that Dublin Caf should consider a merger with Global.

VII.

SOURCES

1) http://www.nvca.org/index.php? option=com_docman&task=doc_download&gid=368&Itemid=93 2) http://www.economicshelp.org/m icroessays/competition/benefit s-mergers.html 3) http://www.economicshelp.org/m icroessays/competition/uk-merg ers.html 4) http://www.investopedia.com/un iversity/mergers/mergers5.asp 5) http://www.gbata.com/docs/jgba t/v1n2/v1n2p1.pdf