Country and Political Risk

Definition & Terminology:

• Political risk: the risk that a government action will negatively affect a company's cash flow. Also, the risk that an investment's return could suffer as a result of political changes or instability in a country. Example of risk factors:
• Nationalisation (expropriation): in its extreme form, government seize properties without compensating the owner.
• Contract repudiation: government revoke ("put an end to") contract without compensating companies for their existing investments.
• Taxes and regulations: unexpected increases in taxes, stricter standards.
• Exchange controls: doing business in countries with inconvertible currencies.
• Corruption and legal inefficiency:  Gov. corrupt act and demand biases.
• Ethnic violence, political unrest, and terrorism: internal civil wars.
• Home-country restrictions: a company's home country politics that affect foreign operations.
• Country risk: is a broader concept that encompasses both the potentially adverse effect of a country's political environment, economic and financial environment. Example:
• A recession in a country -- reduces revenues of exporters.
• Labor strike -- lowering profits: disruption in production & distribution of product.
• Clashes between ethnic or religious group.
• Also effects investors who buy emerging market securities, cause a borrowers to default on a loan. Sovereign risk: a risk that government defaults on its bond payments. The ability of a private firm and its government to pay off international debt are highly correlated.
• Financial risk: the possibility that shareholders will lose money when they invest in a company that has debt, company cash flow inadequate to meet their financial obligations.
• Economic risk: macroeconomic conditions will affect an investment (exchange rates, government regulations).

Incorporating political risk in capital budgeting: (1) Adjusting expected cash flows for political risk. (2) Adjusting the discount rates instead of cash flows -- r* = (r+p)/(1-p).
The infinite cash flow: CF*(1-p) / (r+p)

The PRS (Political Risk Services) group's ICRG (International Country Risk Guide): financial and economic factors (assessing country's ability to repay foreign debt, objective information); political risk factors (stability based on government; subjective information).
Risk stability: the difference between the worse and the bast case forecasts as indicator of the volatility of risk.

Credit spreads: the difference between the yield on the bond and the yield on a comparable Treasury Bond that is not subject to default risk.
Country credit spreads: the difference between the yield offered on international bonds and the yields on the government bonds of the developed country issuing the currency.

Managing political risk: focus on the short term; rely on unique supplies or technology (making government takeover more difficult); use local resources; bargain with the government; hire protection.
Insurance: Coverage -- currency inconvertibility and non-transferability;  expropriation; war and political violence; interference with operations. Example: OPIC (Overseas Private Investment Corporation), in emerging and transitioning economy: MIGA (Multilateral Investment Guarantee Agency), public and private insurance.

Cheese Manufacturing in Australia

Definition and Terminology: (source: http://en.wikipedia.org/wiki/Cheese)

• Cheese is milk based food product, consists of proteins and fat from milk and produced by coagulation of the milk protein casein. However, cheese is more compact and has a longer shelf life than milk,
• Their styles, textures and flavors depend on the origin of the milk (including the animal's diet), whether they have been pasteurized, the butterfat content, the bacteria and mold, the processing, and aging.
• Cheese is valued for its portability, long life, and high content of fat, protein, calcium, and phosphorus. 
• A specialist seller of cheese is sometimes known as a cheesemonger. To become an expert in this field, like wine or cooking, requires some formal education and years of tasting and hands-on experience.

Australia's Cheese Industry (source: IBIS Australia Industry Report 2012)

• Key external drive: 
• Fluctuations in exchange rate: substantial impact as high % revenue from export.
• Demand from supermarket and other grocery stores: downstream demand trends, cheese manufacturer experience hyper competitive to win supply contract w/ major retailers.
• Level of annual rain : large impact of seasonal conditions which affected milk production (pasture and water: milk yield and herd size).
• Level of consumption : consumer attitude about health and nutrition, concern about obesity and heart disease. 

• Industry Performance:
• As one of the largest producers and exporters of dairy products, Australia plays an important role in global dairy trade, with close to 60% of all domestic cheese production destined for overseas markets. 
• The majority of exports are sold to Asian markets. Japan is the largest destination for Australian cheese products, with Singapore and China following not far behind.
• Imports have risen strongly due to drought conditions in Australia, higher feed costs and an appreciation of the Australian dollar. New Zealand (55% of total import) is expected to remain the largest source of cheese imports, given its strong dairy activity and its geographical proximity to Australia.
• The industry is also facing a long-term threat of increased competition from up-and-coming cheese exporting nations such as Argentina and the Ukraine.
• Prices will also face upwards pressure from higher feed and oil prices, low world stock levels and population growth. Growth in world dairy consumption is projected to strengthen relative to production. Profitability for the industry is expected to remain relatively static.
• Consumer demand has shifted away from cheddar cheese and towards premium and specialty types such as hard grating, fresh and blue vein cheeses. As a result, total cheddar production falling to 44.8% of industry revenue. Further, products that address the trends of health and convenience, such as low-fat, organic and natural cheese slices that may be consumed ‘on the go’ have performed strongly over the past five years.
• Merger & acquisition: Kirin’s purchase of National Foods, and the purchase of the Kraft Foods cheese business by Bega Cheese in 2008, the purchase of Tatura Milk Industries by Bega Cheese in 2007.
• Product and service segmentation: 44.8% cheddar cheese; 24.4% fresh cheese; 19.2% semi-hard and stretch cheese; 5.8% hard grating cheese; 3.2% eye cheese; 2.6% mould-ripened cheese.
• Cheese processors have continued to introduce new products to attract health-conscious consumers. For example: 
• Dairy Farmers launched different ranges of Coon cheese, including Coon Light and Tasty, which contains 25% less fat and 30% more calcium; Coon Extra Light, which contains 50% less fat; and Coon Smooth and Mild, which is suitable for kids.
• Bega has recently launched cheese in a can for export markets in the Middle East.

• Competitive Landscape:
• Market share concentration: top four major players accounted for 85.4% of industry revenue.
• Cost Structure: Raw milk (biggest expense), Labour (wages: 8.3% of revenue); SGA and Marketing costs (3.4% of revenue), other costs (9.9% of revenue).
• Basis for competition: High competition environment: players pursue for lower production costs and product differentiation and innovation. But, consumers tend to willing to pay more for speciality cheese. 
• Producers are differentiating their products through ingredients and branding.
• Ingredients: industry participants are making their cheese low-fat, low-carbohydrate or natural and organic. Others are focusing on specific nutritional content such as calcium, protein, vitamins A and C. 
• Branding: Kraft cheese is listed within Australia’s top 20 brands, whilst Bega cheese is in the top 25.
• Barriers to Entry: Strong. Dominancy of major players, such popular brands include Bega, Fonterra’s Mainland, and Dairy Farmer’s Cracker Barrel, Coon and Mil Lel. 
• Industry Globalisation: Globalisation in the industry is increasing with international trade increasing rapidly, such as:
• The major players Murray Goulburn Co-operative Limited and Bega Cheese Limited are Australian-owned companies. 
• Fonterra Australia is owned by the New Zealand company, Fonterra Co-operative Group Limited. The Japanese company Kirin Foods Holdings Pty Ltd owns Lion Nathan National Foods.
• National Foods owned half of Dairy Farmers’ cheese business, which was previously owned by Australian dairy farmers. However, there has also been some movement towards increased nationalisation with the purchase of Kraft’s cheese business by Bega Cheese Limited.
• Market share: Murray Goulburn Co-operative Co (34.7%); Lion Pty Ltd (26.3%); Bega Cheese Limited (16.9%); Fonterra Co-operative Group Limited (7.5%); Warrnambool Cheese and Butter Factory Company Holdings Ltd (less than 5%).

• Technology & Systems:
• Significant changes in cheese-making processes, include: membrane technology, especially ultra-filtration and reverse osmosis. The development and introduction of APV Siro Curd technology resulted in increased cheese yields from milk, and facilitated continuous automation with improved control over process variables.
• Another development has been the production of genetically engineered chymosin (used as a coagulant in cheese making). This reduces production costs and is suitable for the production of special-purpose cheese such as halal, kosher and vegan.
• Bega has installed a new state-of- the-art Alfomatic cheddaring machine, which includes in-line milk standardisation and upgraded milk- separator capacity, which will allow the production of high volumes of high- quality cheese. They also use speedy natural cheese-slicing technology with flexible packaging capabilities. Bega has recently introduced a new Bega/Arabic processed cheese in a can for specific export to Middle Eastern markets.
• Dairy Australia invests about $10 million per year on research and development in dairy manufacturing. Current research projects are looking at ultra-high temperature products and shelf life, cheese and starter cultures, milk components and their interactions, bioactivity, and human nutrition and health issues.

• Regulation & Policy:
• In July 2000, the Australian dairy sector was deregulated, the most significant change being the removal of price regulations on milk sold for consumption. Milk prices are now more transparent, which has stimulated intense price competition at the farmgate level for raw milk.
• Deregulation means that Australian dairy farmers receive a low price for milk by world standards and therefore they have to run very efficient production systems.
• The only government involvement in the industry is in relation to food standards and food safety assurance systems. On 20 December 2002, the Food Standards Code became the uniform law governing both Australia and New Zealand. 

Real Exchange Risk

Definition: the phenomenon whereby the profitability of a firm can change because of fluctuations in the real exchange rate. (= operating exposure or economic exposure)

Value of a firm is represented by the present value of its expected future profitability, thus could affect a firm's cash flows, either through changes in demand or costs.

Pricing to market: producer charges different prices for the same good in different markets.

Depreciation of local currency: hurts net importer but benefits net exporter.

Strategies for managing real exchange risk: 

• Production scheduling: use changes in inventory to meet firm's transitory fluctuations in demand.
• Input sourcing: when domestic currency is strong, domestic firms should use foreign inputs.
• Plant locations: shifting production among existing locations (firm should increase production in countries whose depreciated in currency)
• Pricing policies: when a currency depreciates, exporter to that country face a trade off (profits vs market share). If firm increase price -- they will lose market share, but if the product is inelastic, the exporter could increase its prices by a greater amount.
• The frequency of price adjustment: consumer hates it, thus company should build boundaries that will not trigger a change in price.
• Market entry decision: introducing new product in foreign markets when the foreign currencies are strong -- set up a comparatively low price for product.
• Brand loyalty -- consumer hardly to switch to other competitor's product.

The fisher hypothesis: nominal interest rates should reflect expectations of the rate of inflation. Real rates of return - measures how much your purchasing power has increased over time.

Fundamental exchange rate forecasting: econometric models (money supply, inflation, productivity, growth rates); judgment of future macroeconomic relationships; concerned with multiyear forecasts.

Technical analysis: short term forecasts; using historical data to find pattern; information about the future exchange rate is assumed to be present in past trading behaviour.

The asset market approach: the exchange rate as an asset price, just like stocks -- based on current and future cash flows; fluctuate randomly by people's willingness to hold this particular currencies; the exchange rate as a weighted average of current fundamental and its expected future values; changes as news come out or good/bad expectations.

The monetary approach: real money balance; concerned with the real value of the nominal money; function of money supplies and income levels in two countries; supply money in domestic currency increases--weaken in domestic currency; supply money in foreign currency increases--domestic strengthen; if domestic real income falls--the foreign income rises; or news expected lower domestic growth or faster foreign growth--domestic currency weakens.

Balance of Payments (BOP) = Current Account (export and import) + Capital Account (foreign investment inflows and outflows) + central bank's reserve account = 0
Ex: strong domestic currencies -- foreign goods cheaper -- increase of imports relative to exports -- current account deficit.
Higher interest rates -- increase savings and decrease real investment -- capital account deficit (losing net foreign investment).
Equilibrium: supply and demand force an equilibrium price and quantity of the real exchange rate on the current account through a "goods" channel and a "savings and investment" channel.

Potential spurious pattern: chartist rely on graphs to detect trends rather than on statistics.

Filter rules: provide signals on investors as to when to buy and sell currencies.
x% rules -- buy the currencies if it appreciates by x% above its support level and sell the currencies when it falls x% below its resistance level.
moving average cross-over rules: the average value of an exchange rate over a set of period. Buy (go long)-- short term (y days) moving average crosses the long-term (z days) moving average from below. Sell (go short) if it crosses from above. But, simple moving average rules works better.

Ex-post: correct the nominal interest rate with the realised or ex post rate of inflation; Ex-ante: correct the nominal interest rate with expected inflation.

Higher nominal interest rate -- higher expected rate of inflation -- country's currency expected to depreciate relative to dollar -- trade in forward discount relative to dollar.

Large increase in domestic money supply -- a depreciation of the currency. But it could be offset the money supply effect, if an increase in real income that increase the demand for money.

An increase in government spending or a decrease in taxes that causes a budget deficit should increase the real exchange rate -- increase aggregate demand which causes the real interest rates to rise.

Purchasing Power Parity (PPP)

Definition: real value of the amount of goods and services that can be purchased with a given amount of money; links exchange rates to the prices of goods in different countries.

Why you should study this theory? 

1. Provide a base line forecast of future exchange rates in order to forecast future cash flows in different currencies, especially when inflation is differ.
2. Play a fundamental role in corporate decision making, such as: international location of manufacturing plants, pricing products and other int'l capital budgeting issues.
3. Assessing cost of living differences across countries.

Price level -- a weighted average of the prices of the goods and services that people consume, providing information about the purchasing power of a currency.

Price index -- the ratio of a price level at one point in time to the price level in a designed base year, providing information about the rate of inflation between two point of time.

Absolute Purchasing Power Parity -- states that the exchange rate will adjust to equalise the internal and external purchasing power of a currency. Internal: the amount of goods and services that can be purchased with $1 inside the US, external: $1 outside the US. Overvalued: external > internal; Undervalued: External < Internal.
The failure of Absolute PPP: changes in relative prices due to different weights; non-traded goods (houses, technology/productive improvement).

Relative Purchasing Power Parity -- takes market imperfections into account, exchange rates adjust in response to differences in inflation across countries.

Law of One Price -- equivalent goods should sell for the same price in everywhere. Big Mac should cost the same (once you convert money) no matter where you go. Violations of the law of One Price: Tariffs and quotas; transaction costs; difficult in finding buyers for the same goods; Non-competitive markets; sticky prices (high cost for switching prices "menu cost").

Interest Rate Parity

Covered interest rate parity -- doesn't matter where you invest -- you'll have the same domestic currency return as long as the foreign exchange risk is covered using a forward contract.

Uncovered interest rate parity -- domestic and foreign investments have same expected returns.

Unbiasedness hypothesis -- no systematic differences between the forward rate and the expected future spot rate. If hypothesis holds, the expected return on currency speculation will be exactly zero.

Forecast error -- the differences between the actual future spot exchange rate and its forecast.

Unbiased predictors -- implies expected forecast error = 0

Market inefficiency -- interest rate differentials contain information from which profit can be obtained; exploiting forward bias and carry trades (represents the interest rate differentials between the high and the low yield currencies, i.e.: borrowing low interest rate currencies and lending high interest rate currencies). If the high interest rate currency fails to depreciate as much as the interest rate differential, the carry forward has a positive return.

Sharpe ratio: excess return per unit of risk; a measure of the risk trade-off on an asset or a portfolio of assets; the ratio of average asset return / the standard deviation.

Forward Markets and Transaction Exchange Risk

Transaction exchange risk -- possibility of taking a loss in foreign exchange transactions. Normal distribution for major currencies, but skewed distribution for emerging markets.

Forward contracts -- forward rate (specified in a forward contract); eliminates risk/uncertainty; usually a large sum of money; with bank. Costs: ex ante (before), ex post (after).

Swap: simultaneously purchase and sale of a certain amount of foreign currency for two different dates in the future.

Volatility clustering: when standard deviations (volatility) in forex rate demonstrate a pattern. -- GARCH model.

Exchange Rate System

• Floating currencies: determined by the market forces of supply and demand; 
• managed floating: central banks intervene enough with the country's currencies; 
• fixed/pegged currencies: "pegging" (fix at particular level) a currency to another or a basket of currencies, often used a currency board (domestic currency 100% backed by assets payable in reserve currency; 
• target zone: forex rate is kept within band, the currency is allowed to fluctuate in a percentage band around a "central value".
• crawling pegs: changes are kept lower than preset limits that are adjusted regularly (w/ inflation), adjust for inflation differential between domestic inflation vs inflation of the pegged's currency so the domestic firm's don't lose competitiveness. Latent volatility: the true currency risk does not show up in day-to-day fluctuations, in a long time, historical volatility appears to be zero or very limited.
• special arrangements: where a regional central bank controls the forex rate system for several countries.

Central Banks: Liabilities -- monetary base or base money: deposits of financial institutions (bank reserves) and currency in circulations; Assets: official international reserves ( T-Bills of other countries, gold reserves, IMF-related reserve assets) and domestic credit (government bonds and loans to domestic financial institutions). Seigniorage: the value of the real resources that the central bank obtains through the creation of base money.

The imposible trinity (only two out of three are possible): perfect capital mobility (no capital control), fixed exchange rates, domestic monetary autonomy.

Central Bank interventions: money supply/interest rates, attempts to restrict capital movements, tax/subsidise international trade to influence demand for foreign currencies.

Foreign exchange interventions: Non-sterilised and sterilised (off-setting the effect of money supply by performing an open market operation that counteracts the effect: portfolio shifting on private investors--replace foreign bonds with domestic bonds; squeezing foreign inventories at dealer banks and generate pricing effects). Direct channel: small size - short term effect to sterilised interventions; Indirect channel: interventions can alter people expectations and affect their investments - push to the desire direction.

Defending the target zone: intervene through open market operations, raise interest rates, limits foreign exchange transactions through capital controls.

Lag operations: postpone capital inflow: receivable - exporter (especially when domestic currency devalued)

Lead operations: domestic importer prepay for goods in devaluations effect.

Dollarisation: foreign currency has exclusive or predominant status as full legal tender in a particular country (Ecuador: Dollar).

Globalisation and the Multinational Corporation

Globalisation -- increasing connectivity and integration of countries and corporations and the people within them in term of economic, political, and social activities.

Multinational corporation -- produces and sells good or services in more than one nation.

Securitisation -- repackaging of "pools" of loans or other to create receivables to create a new financial instrument. Pros: banks and companies could hedge against risk. Cons: smart financiers could exploit differences in country-specific regulations and complexity of instruments created opaqueness (not transparant, hard to understand) in the financial system --  lead to financial crisis 2008 - 2010.

Transnational corporations: a parent company in the firm's originating country and operating subsidiaries, branches and affiliates abroad. How they enter the market? Exporting/importing, licensing, franchising, joint venture, greenfield (starting company from scratch).

Important International Players: International banks; international institutions (IMF, the World Bank); multilateral development banks (regional development banks: provide financing and grants); WTO (mediates trade disputes); OECD (Organisation for Economic Cooperation and Development: examines, devised and coordinates policies across 34 countries to foster sustainable economic growth and employment, rising standards of living and financial stability); Bank for International Settlements (BIS) -- fosters international monetary and financial cooperation -- central banks to central bank; European Union (EU), governments, individual investors, institutional investors (superfund, mutual fund, insurance company); sovereign wealth funds (government-run investment pools); hedge funds; private equity funds.

Globalisation and the MNC: Benefactor or Menace? -- global crisis lead to protectionism, slowing trade liberalisation, trade openness and economic risk. Countries who had opened their markets to foreigners subsequently fell into crisis.
Benefits of openness: channels savings to most productive uses, sharing of risk beyond what is possible domestically, domestic recessions can be buffered through borrowing, cost of capital decreases.
Costs of openness: sometimes capital is not used wisely, foreign capital can leave quickly causing financial volatility, difficult in taxing profits -- MNC shift to avoid, capital control effectiveness decreases.

Interbank Market -- Communication System: SWIFT (Society of Worldwide Interbank Financial Telecommunications): links different banks and in different countries; CHIPS (Clearing House Interbank Payments System): clearing house in US for dollars; Fedwire: links computers that deposits within the US Federal Reserve; TARGET (Trans-European Automated Real-time Gross Settlement Express): euro counterpart to Fedwire.
Cross country settlement (or Herstatt) risk: the risk that a financial institutional may not deliver the currency on one side of a completed transaction -- lead to foster netting arrangements.

Strategic considerations in M&As

Questions to consider before M&As:

1. What's the firm's competitive positions? -- strategic benefits: SWOT and Porter-5 forces.
2. What's the firm's resources? -- capabilities, core competencies, sustainable competitive advantages
3. What are the target firm's complementary resources?
4. What are the key impediments to combining these resources through contracting?
5. Is a merger or an acquisition really necessary?
6. Can the merit of the acquisition be clearly communicated to both target and acquirer shareholders?
7. What are regulators likely reactions?

Common M&A strategies: merket dominance drive, overcapacity consolidation, geographic roll-ups, product extension & geographic extension, acquisition of technology and R&D capabilities, industry convergence--new industry evolution.

Can M&As destroy wealth? Yes, if two critical problems exist at the acquiring firm:

• Agency problems (managers act was not in the best of shareholders interests, intend to destroy shareholders value): empire building, entrenchment, free cash flow (over-investment).
• Managerial hubris (managers act not to do bad things): overpayment (overconfidence result in high premium prices); over-expansion; optimistic synergy forecast (not reflect the reality).

M&A Basic Concept & Terminology

• Takeover: transfer of controlling ownership (involves shares); Acquisition: purchase of one firm (involves assets); Merger: combination of two firms into a new legal entity, both shareholders must approved the transaction; Scheme of Arrangement: court approved union of two firms, governed by a set of contract.
• Hostility -- Hostile takeover: takeover without consultation and un-support by target's management. Tender offer, general offer from acquirer to target's shareholder with premium price. Friendly takeover: merger between two firms with support of target's management, target might solicit offer from other potential acquirers (hold-out problem).
• Relatedness -- Horizontal: merger of two firms in the same industry or similar product line; Vertical: merger of two firms in different steps of a production process (supply chain), merger to its upstream suppliers or its downstream buyers; Conglomerate: merger of two firms in unrelated business, to diversify by combining unrelated assets and income stream.
• Financing -- Cash deals: finance by acquirer cash or additional borrowing, size of combined firm less than acquirer+target size (1+1 < 2); Stock deal: finance by acquirer stock, target exchange their shares for acquirer shares, often with specified exchange ratio, size of combined firm near equal or more than acquirer+target size (1+1 = or > 2); Mixed deal: each target share is exchange for either cash or acquirer's shares. Note: buyers tend to offer stock deal when they believe their shares are overvalued and cash deal when their shares are undervalued. Stock deal: target shareholders still remain to control with their stocks, but Cash deal: target shareholders were removed permanently and the company under the indirect control of the bidder's shareholders.
• Vertical benefits: lower transaction costs (when making an economic exchange),;synchronisation of supply and demand along the chain of products; ability to monopolize market through the chain; strategic independence (especially when inputs are rare or highly volatile in price). Vertical disadvantage: higher coordination costs; higher organisation costs of switching to different suppliers/buyers; weaker motivation at the start of supply chain.
• M&A transaction costs might arise from: information asymmetries from searching information of target's synergic benefits; bargaining costs: costs required to reach an acceptable agreement with target; monitoring costs: cost of making sure the other party stick in the rules.
• Corporate control: a party has a dominant control of the firm if they have the veto power over the use of its assets.
• Economic driving forces of M&As waves: technology changes, competition environment, deregulation, privatisation, globalisation, equity and market conditions.
• Benefits of M&As: synergies, change of control (replace inefficient management), market power (to give additional revenue by increase the price), undervalued target (market price < intrinsic value), tax savings (acquire target company that losses in the past but should not in the future).
• Costs of M&As: overpayment (management hubris), merger integration costs (in the initial phase, usually decreasing in profits), agency costs (less of monitoring activities), increased bankruptcy risk (differ in leveraged), taxes, M&As advisory fees.
• Synergy definition: additional value created from combining two firms operations and financial structure. PV(AB) > PV(A) + PV(B) or 1+1 more than 2.
• Sources of synergy: economies of scale, economies of scope, complementary of resources, synergy from financial efficiencies, diversification, adopt a new financial structure, reduced bankruptcy costs.
• Gains in M&As: value of bidder without acquisition+value of a target as a stand alone company+synergies and operating improvements (synergic benefits and control benefits)+profit on sale of excess assets.
• M&As Deal Failures: poor post merger integration, unrealised synergies & control benefits, poor post deal management of target, overoptimism-over bidding-poor due diligence. 

How to value company in M&A transactions

Basically, this methods frequently being used:

1. Deal Comparable
2. Firm Comparable
3. Discounted Cash Flow (using WACC and Adjusted Present Value)

Deal Comparable: use recent M&A deals in target's industry; calculate comparable ratios such as: Price Earnings (P/E) ratio, revenue based multiple, cash-flow multiple, book-value based multiple.
Disadvantages:  simple one dimensional view of valuation (a single denominator: sales, EBIDTA); small sample size, deals in the past would not be the same concurrence with the present, based on outdated valuations and time mismatch.

Firm Comparable: compare between similar (peer) firms to target; determined a range of valuation based on appropriate multiples and placed the target within the range.
Disadvantage: simple one dimensional valuation; does not incorporate synergies and control benefits; does not incorporate shareholders resistance; subject to creative accounting.

Discounted Cash Flow: more complex valuation, but could incorporate synergies and control benefits and M&A dynamics; may avoid accounting manipulations.
Requirements:

• needs adjustments for financing effects (ex: tax shield. finance vs operating lease)
• adjusted annual free cash flow by adjusted after tax WACC (be careful: please handle tax adjustments to discount rates, might be incorrect substitutes)
• adjusted annual free cash flow by APV (adjusted present value) -- First, value the firm assuming all equity financing (discounted at the un-levered cost of equity) and then add on the present value of the tax shield. Note: APV will give different valuation instead of WACC, however APV is more suitable for highly levered situations.

Google -- Motorola

In 2001, Google paid $12.5 billion for Motorola Mobility which represents a 65% premium on a struggling firm.

Breakdown of purchasing price:

• Patents: $5.5 billion
• Cash: $2.9 billion
• Goodwill / synergies: $2.6 billion
• Customers: $0.73 billion
• Others: $0.67 billion
• Total: $12.5 billion

Compared to book assets of Motorola of:

• Cash: $3.5 billion
• Other current assets: $3.2 billion
• PPE: $0.8 billion
• Goodwill: $1.4 billion
• Other assets: $0.7 billion
• Total: $9.6 billion

Q: Why this number differ significantly? Is this premium price reasonable?

Possible answers:

1. Google might pay Motorola a premium price because of valuable Motorola's intangible assets (such as patents, goodwill, trademarks, etc) which drives from Motorola's technology advance and complementary R&D capabilities. Although this premium is still questionable as this intangible assets are hardly to quantify as precise and accurate, but Google might expect the intrinsic value will result in future benefits and could be amortised annually as goodwill of combined firms.
2. The offers might be unreasonable, since we consider about the nature of intangible assets, but in this case, by considering future cash flows, Google really give a bear hug to Motorola business and technology advance. Lots number are different, but the intense of this offer is about the appreciation of the company's intangible future performance. For example, google might consider to integrate their online business with mobile technology, since Motorola holds several mobile techno patents and rights. Customers good relationships could be quantify in synergic benefits, although in book value accounting of Motorola not recorded this number.

M&A: Chocolate Manufacturing - Australia

In January 2010, after months of fierce negotiations, Kraft Foods Inc., the world's second-largest food company, acquired the world's largest confectioner, Cadbury plc, for an estimated $18.6 billion. Globally, the group is number one in the chocolate and sugar confectionery segments and a strong number two in the high-growth gum segment. Cadbury plc's leading brands, such as Cadbury, Trident and Halls, are highly complementary to Kraft's portfolio and benefit from its global scope, scale and array of proprietary technologies and processes. In addition, the acquisition of Cadbury significantly enhanced the strength of Kraft's presence in the confectionery market, enabling Kraft to leverage Cadbury's product development capabilities.

Established in 1824, Cadbury is the world's largest confectionery company by market share. The company has an estimated 10% share of the international confectionery market and employs more than 50,000 staff in 60 countries worldwide. Cadbury merged with Schweppes, a mineral water business, in 1969 to become Cadbury Schweppes plc. However, on 7 May 2008, the company finalised the separation of its confectionery business from the Americas Beverages business. The demerger followed a series of disposals by the company during 2007, which were intended to streamline operations. Cadbury Schweppes Australia Ltd was a wholly owned subsidiary of UK-based Cadbury plc. However, in 2009 Cadbury's Australian Schweppes beverage business was sold to Asahi Breweries for an estimated $1.2 billion.

The company has a well-entrenched position in the Australian market, with its flagship production facilities located in Claremont, TAS, and Ringwood, VIC. Cadbury owns several iconic chocolate and confectionery brands including Cherry Ripe, Crunchie, Freddo, Roses and Dairy Milk. These brands are household names and enjoy a high level of customer loyalty. Sustained new product introductions, such as Boost, Time Out and Breakaway, have also stimulated demand and consumption.

In 2011, results published at the group level reveal that net revenue increased 1.2%, driven by higher pricing and the continuing effects of the Cadbury acquisition. New product introductions such as the launch of Cadbury Dairy Milk Mousse, which targeted the premium and indulgent segment, further cemented the notion that producers within the industry are bucking the recessive trend and concentrating their products at the higher end of the market.

Given the recessive climate that dampened spending and confidence over 2009, revenue decreased 6.8% to $576.4 million. Consumers sought respite from the gloom through simple and inexpensive indulgences such as chocolate and confectionery. Cocoa and sugar prices eased, while new product introductions helped sales volumes. NPAT grew dramatically, driven by lower production costs and greater volumes of high-margin indulgent products.

In 2008, sales revenue decreased 6.3% to $618.7 million, despite world cocoa prices increasing 37.9% during the year. Growth in the Asia-Pacific region, inclusive of Australia, was driven by strong growth in the emerging markets of India and China. The deteriorating economic climates in Japan, Australia and New Zealand, however, partially offset the gains. Cost-cutting initiatives occurred during the year, with the closure of 10 of the company's manufacturing sites and the corresponding downsizing of the workforce. In addition, Cadbury announced a $135 million proposal to improve the productivity and efficiency at its chocolate manufacturing sites in Tasmania, Victoria and New Zealand.

Source: IBISWorld Industrial Report 2012

M&A in Department Store - Australia

Department stores have long been part of the Australian retail environment. Woolworths began in 1924 as a general merchandise retail operation. David Jones opened his first store in 1838 to sell imported merchandise, and the origins of Myer can be traced back to 1900 when Sidney and Elcon Myer opened their first Myer drapery store.

Maturity within this industry has been evident in the merger and acquisition activity of its major players over the past decade For example, in 1999 David Jones acquired the Aherns chain in Western Australia to expand market share. In addition, Japanese retailer Daimaru exited the Australian market in July 2002, due to poor performance within the industry, while in mid-2006 Coles Myer sold Myer to a private consortium for $1.4 billion and in November 2007, Wesfarmers acquired Coles Group, which included Kmart and Target.

In 2012, Harris Scarfe, a smaller industry player, was acquired by South African-based Pepkor. This latest acquisition is perhaps indicative of Australian department stores vulnerability to the rising possibility of globalisation.