POTENTIAL MERGER ANALYSIS

Course: FIN440 Section: 4

Submitted to: Mr. Adnan Habib (Anb)

Lecturer

Department of Accounting & Finance

School of Business & Economics

North South University

Submitted by:

NAME ID

Muhammad Miftah Ul Alam 122 0301 030

Mohammad Refaet Rahman 132 0161 030

Jarin Tasnim 123 0008 030

Ruhana Zareen Gofran 132 1618 030

LETTER OF TRANSMITTAL

August 19, 2015

Mr. Adnan Habib,

Lecturer, Department of Accounting & Finance

School of Business & Economics

North South University

Subject: Submission of the project on Potential Merger Analysis

Respected Sir,

We thank Almighty Allah for giving us the opportunity to learn this course and make this project

under your supervision. We have tried to follow your guidelines in making this project and have

tried to work together as a group to make it happen. From the project we have learned a whole

lot of practical application of the theories that we have learned in the class- such as Financial

Modeling, WACC calculation, valuation of companies, and analysing the potential merger

between two companies.

Thank you for giving us the chance to do this project, as this will serve us hopefully in our

professional lives.

Thankfully,

Muhammad Miftah Ul Alam (ID: 122 0301 030)

Mohammad Refaet Rahman (ID: 132 0161 030)

Jarin Tasnim (ID: 123 0008 030)

Ruhana Zareen Gofran (ID: 132 1618 030)

ACKOWLEDGEMENT

We express our ardent gratitude to the Almighty for giving us the courage and ability to work on

this topic till the very end. We would like to thank the School of Business of North South

University to design FIN440 (Corporate Finance) course in such a way that we had got an

opportunity to make this report and learn from it. We would also like to thank Dhaka Stock

Exchange (DSE) for providing us the crucial information which we needed for a successful

completion of this project work. Last but not the least, we express our heartiest gratitude to our

faculty, Mr. Adnan Habib, for helping us from the beginning till the end of the completion of this

report.

Table of Contents

Title Page No.

Brief Description 1

Ratio Interpretation 2

Part-1 3

Part-2 7

Part-3 9

Synergy 11

1

BRIEF DRESCRIPTION

Beximco Pharmaceuticals Ltd (Beximco Phrama) is operating under the Beximco Group as a

leading manufacturer of pharmaceutical formulations and Active Pharmaceutical Ingredients

(APIs) in Bangladesh. Beximco Pharma's manufacturing facilities are certified by many

international regulatory bodies and currently it is exporting its products to forty seven countries

across the continents. Beximco Pharma produces more than five hundred products encompassing

broad therapeutic categories and has created strong differentiation by offering a range of high-

tech, specialized products which are difficult to imitate. It is the only Bangladeshi company that

is listed on the AIM of London Stock Exchange. Beximco Pharma got enlisted in Dhaka Stock

Exchange in 1986 with the trading code BXPHARMA. Currently the market capital of Beximco

Pharma is BDT 25,144.5(mn) and paid up capital is BDT 3,862.4(mn). Total number of trading

shares is 386,244,234.

GlaxoSmithKline (GSK) Bangladesh Limited is a subsidiary of GlaxoSmithKline plc which is

one of the world’s leading research based pharmaceutical and healthcare companies whose sole

mission is to improve the lives of people by enabling them to do more, feel better and live

longer. The company’s main tasks include producing secondary pharmaceutical healthcare

products, marketing of vaccines, pharmaceutical healthcare products and healthfood drinks. GSK

got itself listed in Dhaka Stock Exchange in the year 1976 in Pharmaceuticals & Chemicals

segment with a trading code of GLAXOSMITH. It’s market capital is BDT 25,914.321 (mn) and

paid up capital is BDT 120.5(mn). Total number of trading securities of GSK is 12,046,449. It

has been carrying an excellent position in Bangladesh for the last 6 decades.

2

Ratio interpretations

Net Working Capital is the calculated using the following equation:

NWC= Current Assets- Current Liabilities

NWC tells us whether a company has enough current assets to cover its short term liabilities.

BEXIMCO has NWC of BDT 3,658,531,677. That means, BEXIMCO is supposed to pay

all its current liabilities, and even after that, remain with cash of BDT 3,658,531,677.

GSK has NWC of BDT 1,876,912,000. That means, GSK has enough cash to pay its

short term liabilities as well.

Debt Ratio is calculated using the following formula:

𝐷𝑒𝑏𝑡 𝑅𝑎𝑡𝑖𝑜 =𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

BEXIMCO's debt ratio of 0.2786 indicates that 27.86% of BEXIMCO's assets are

financed by debt.

The debt ratio of GSK is 0.539 which means 53.9% of GSK's total assets were financed

by taking debt.

Retention Ratio is calculated using the following formula:

𝑅𝑒𝑡𝑒𝑛𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑖𝑜 =𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡

The retention ratio is 0.6667 for BEXIMCO in 2014 that means in this year 66.67% of

the net income was retained by BEXIMCO to expand the business.

The retention ratio of GSK is 0.563 which means 53.6% of the net income of the year

2014 is retained for further expansion of the business.

3

Interest Expense/ Total Interest Bearing Debt basically tells us how much interest the

company has to pay for its interest bearing debt. In other words, this is the interest rate or cost of

borrowing for the company.

The ratio is 0.1489 for BEXIMCO. That means the interest rate or the cost of borrowing

for BEXIMCO is 14.89%.

The ratio is 0.1248 for GSK. That means, the interest rate or cost borrowing for GSK is

12.48%

P/E Ratio is calculated using the following formula:

𝑃

𝐸𝑅𝑎𝑡𝑖𝑜 =

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒

𝐸𝑃𝑆

BEXIMCO's P/E Ratio of 14.14 means that the investors are willing to pay 14.14 Taka

for a BEXIMCO share to get 1 Taka earning.

GSK's P/E Ratio of 22.031 means that the investors are willing to pay 22.031 Taka for a

GSK share to get 1 Taka earning.

Part-1

The following steps were taken to find out the Complete Pro-forma Balance Sheets of both

BEXIMCO and GSK:

1. We have taken the Balance Sheets and Income Statements of both the companies for 3 years

from 2012 to 2014, and copied it in two separate excel files.

Pro-forma Income Statement:

2. Using the FORECAST function and the Sales Revenue of the last 3 years, we have forecasted

the Sales Revenue of the next 3 years (2015-2017) for both the companies.

4

3. From the predicted Sales Revenue, we have calculated the predicted Sales Growth Rates for

year 2014-2017 for both the companies using the following formula:

𝑆𝑎𝑙𝑒𝑠 𝐺𝑟𝑜𝑤𝑡𝑕 𝑅𝑎𝑡𝑒 =𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑌𝑒𝑎𝑟 𝑆𝑎𝑙𝑒𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑒𝑎𝑟 𝑆𝑎𝑙𝑒𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑒𝑎𝑟 𝑆𝑎𝑙𝑒𝑠

4. The forecasted Sales Growth Rates have been used to forecast all the items of the Income

Statement except the Interest Expense and Income Tax Expenses.

Assumption

Here we have assumed that Sales Growth Rate is the rate at which all the major components of

the income statement will change except Interest Expense which will change at a constant rate

with the interest bearing debt.

The following items have forecasted using the Sales Growth Revenue:

BEXIMCO GSK

Cost of Goods Sold Cost of sales

Administrative Expenses Selling expenses

Selling, Marketing and Distribution Expenses Distribution expenses

Other Income Administrative expenses

Contribution to WPPF & Welfare Funds Other income

Finance cost (except interest expense) Finance income

For Income Tax Expense, we have calculated the Income Tax Rate that BEXIMCO and GSK

had paid in the year 2014. For BEXIMCO, the tax rate was 27.55% and GSK it was 28.82%. To

find out the forecasted Income Tax Expense of BEXIMCO for Year 2015-17, we have used

27.55% Tax Rate as it was calculated. However, for GSK, we have used 27.5% Tax Rate (not

28.82%) to forecast the Income Tax Expense for Year 2015-2017. .

5. Addition to Retained Earning has been calculated for Year 2015 using the Retention Rate of

the Year 2014 for the both the companies.

Partial Pro-forma Balance Sheet:

5

6. In the Balance Sheet part for both the companies, all the Current Assets and Non-current

Assets have been changed using the respective forecasted Sales Growth Rate for all the

forecasted Year from 2015-2017.

7. In the Equity section of the Balance Sheet, the Retained Earnings of all 3 forecasted years

(2015-2017) has been calculated using the following equation:

Current Year Retained Earnings= Previous Year Retained Earnings+ Addition to Retained Earnings

Rest of the components in the Equity Section have been kept constant till this step.

8. In the Liabilities section, all the current liabilities (except the Short-term Borrowings and

Long Term Borrowings with current maturity for BEXIMCO) were changed for all 3

forecasted years using the Forecasted Sales Growth Rate of the respective years for both the

companies. All the long term liabilities were kept constant for both the companies.

9. Then we calculated the EFN of the both the companies for year 2015 using the following

equation:

EFN= Total assets- Total equity and Liabilities

The following table shows the EFN we calculated for both the companies at the end of this step:

EFN 2015

BEXIMCO 1,462,201,979

GSK -238865.5376

Complete Pro-forma Balance Sheet:

10. For BEXIMCO:

The EFN is positive in Year 2015. To allocate the EFN, we have taken the following steps and

assumptions: :

a. Short Term borrowing plan: We have increased the Short term debt of BEXIMCO to such

amount so that the Net Working Capital is fixed. The following table shows the NWC before

adjustment, how much Short term debt has been increased to keep the NWC constant, and the

Ending balance of the Short term debt in the complete Balance Sheet.

6

Year 2014 2015

NWC (before adjustment) 3,658,531,677 4,352,114,327

Increase in ST debt

693,582,650

Adjusted ST borrowing Balance

3,846,703,943

To keep the NWC constant, Short term debt was increased by BDT 693,582,650.

b. Long term borrowing plan: Then we have used the debt ratio to calculate the amount of

Long Term debt we need to increase or decrease to keep the debt ratio constant.

To keep the Debt Ratio constant, Long term debt has been decreased by BDT 26,529,623.45.

c. Interest Expense Calculation: Because the Short term borrowing has been increased and the

Long term borrowing has been decreased, the total interest bearing debt has changed, and so the

Interest Expense that had been kept constant in the Pro-forma Income Statement in STEP-4

would change as well. As we have changed the Interest Expense, the EFN changes again

d. Equity capital plan: The rest of the EFN (BDT 844,096,327) has been financed through

equity capital by issuing 84,409,633 number of new shares.

The EFN=0 for Year 2015 after this step.

e. After the partial pro-forma Balance Sheet like for the year 2015, in both 2016 and 2017, the

EFN has been positive. Hence, the steps that were taken to make the EFN=0 for Year 2015 are

similarly taken for the rest of the two forecasted years (2016-17) to make EFN=0, and to

complete the Pro-forma Balance Sheet for all 3 forecasted years.

Year 2015

Total liability before debt ratio adjustment 8,856,571,388.18

Total liability after debt ratio adjustment 8,830,041,764.72

Decrease in LT debt 26,529,623.45

LT debt (before adjustment) 901,709,327.00

New LT debt 875,179,703.55

7

For GSK:

The EFN is negative in Year 2015.. That means, GSK does not need any extra financing (equity

or debt) to achieve the forecasted sales in 2015. As a result we assume that:

a. No short term debt or long term debt would be taken, and no new shares would be issued. As

a result, the Net Working Capital and Debt ratio both cannot be kept constant.

b. Because no long term or short term debt were taken, the interest bearing debt remains the

same for all 3 forecasted years. As a result, the interest expense in the Pro-forma Income

Statement would remain same in all 3 forecasted years.

c. Since EFN<0, there would be idle cash remaining in the form of retained earnings. Thus, we

assume that GSK would use the excess cash to make dividend payments to the shareholders. As

a result, the Dividend Payout Ratio increases and the Retention Ratio falls.

After this step, the EFN becomes zero for the year 2015.

EFN remains negative after creating the partial pro-forma Balance Sheet for the rest of the 2

years as well. Hence, the same assumptions apply for rest of the two years; we assume that

dividend payments would be made to make EFN=0 in all 3 forecasted years.

Part-2

The following steps were followed to find out the WACC of BEXIMCO and GSK:

1. Determining the Annual Rates of Return: Both companies use January-December as their

fiscal year. We have calculated the Annual Return of both the companies using the closing prices

of the stocks of both the companies. The Annual Return of the years 2012-2014 of the market

has been calculated using the DGEN index which became DSE index later. Annual return was

calculated using the following formula:

𝐴𝑛𝑛𝑢𝑎𝑙 𝑅𝑒𝑡𝑢𝑟𝑛 = (Last Day of year closing price – First Day of year closing price)

𝐹𝑖𝑟𝑠𝑡 𝐷𝑎𝑦 𝑜𝑓 𝑦𝑒𝑎𝑟 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒

8

2. Determining the Beta Coefficients: To find out the Beta co-efficient, we have used the

following formula:

β =COV(Stock Return, Market Return)

Variance of the Market return

The find out the Covariance between stock return and market return, we have used the 'COVAR'

function in the excel and used the annual returns of the stocks and the market calculated in Step-

1.

To find out the Variance of the market return, we have used the 'VAR' function in the excel and

used the annual returns of the market calculated in Step-1.

3. Determining Cost of Equity: Required rate of return for both the company stocks are

determined using the Capital Asset Pricing Model (CAPM). The following formula was used to

determine required rate of return:

𝑅=𝑅𝑓+𝛽(𝑅𝑚−𝑅𝑓)

For the Risk-free return, we have used the Bangladesh Bank 364- day Treasury Bill rate that was

issued on December 22, 2014 (Bangladesh Bank, 2014).

'Rm' is the Market Return that we have calculated in Step-1.

The required rate of return determined for both companies are the costs of raising capital through

equity for BEXIMCO and GSK..

4. Determining Cost of Debt: Cost of debt capital is the interest rate that the companies pay for

the interest bearing debt.

5. Determining the WACC: WACC has been calculated using the following formula:

𝑊𝐴𝐶𝐶 = 𝐸𝑞𝑢𝑖𝑡𝑦 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

𝑇𝑜𝑡𝑎𝑙 𝐶𝑎𝑝𝑖𝑡𝑎𝑙× 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 +

𝐷𝑒𝑏𝑡 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

𝑇𝑜𝑡𝑎𝑙 𝐶𝑎𝑝𝑖𝑡𝑎𝑙× 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐷𝑒𝑏𝑡 (1 − 𝑇𝑎𝑥 𝑟𝑎𝑡𝑒)

For Equity Capital, the Total Equity of the Balance Sheet has been used. For Debt capital, only the

interest bearing debt has been used in the calculation. The Total Capital is the sum of the equity capital

and the debt capital.

9

Tax rate of 27.5% has been used in the formula to find out the WACC.

Following are the WACC of BEXIMCO and GSK:

Probable reasons for difference in WACC:

1. Difference in Capital Structure: BEXIMCO uses 18.4% debt and GSK uses only 1.06%

interest bearing debt to finance their capital. As BEXIMCO uses more debt capital than GSK

does for which it receives higher tax advantage, the WACC (cost of capital) is lower for

BEXIMCO than for GSK.

2. Difference in riskiness: The Beta co-efficient of BEXIMCO is lower than the Beta co-

efficient of GSK. That means, the sensitivity to Market return is higher for GSK than it is for

BEXIMCO. Hence, the return investors want from GSK is higher than for BEXIMCO thus

making the cost of equity higher for GSK.

Part-3

The following steps were taken to calculate the value of BEXIMCO and GSK:

1. Free Cash Flow (FCF) calculation: The following formula is used to calculate the forecasted

FCF of both BEXIMCO and GSK for each of the forecasted years (2015-2017).:

Company BEXIMCO GSK

WACC 9.55% 11.26%

BEXIMCO GSK

Equity/Total Capital 81.60% 98.94%

Debt/Total Capital 18.40% 1.06%

BEXIMCO GSK

Beta 0.169847396 0.564040314

10

FCF = EBIT(1-T)+Depreciation – Change in NWC – Change in Capital Expenditure

EBIT(1-T) is the net profit after tax that was calculated in Part-1 of the project.

Depreciation: The depreciation has been taken from the notes of the financial statements

of the Year 2014 of both the companies. Using the 2014's depreciation and Sales Growth

Rate (calculated in Part-1), we have predicted the annual depreciation for 2015-2017 of

both the companies.

Change in NWC: For BEXIMCO, the NWC is kept constant for all the forecasted years.

Thus, there has been no change in NWC for BEXIMCO in all 3 of the forecasted years.

However, for GSK, we could not keep NWC constant by increasing short term debt

because the EFN is negative and GSK does not need any external financing. As a

result, the change in NWC is different for BEXIMCO and GSK in 2015-2017 (shown

below):

Change in Capital Expenditure: Change in capital expenditure has been calculated

using the following formula:

Change in Capital Expenditure= Current Year Fixed Assets- Previous Year Fixed Assets

2. Market price of stock: Using the P/E ratio of 2014 and forecasted EPS (calculated in Part-1)

of 2017, we calculated the forecasted market price of the stocks of both the companies. The

following formula has been used to calculate the market price :

𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡𝑒𝑑 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑖𝑛 2017 =𝑃

𝐸𝑅𝑎𝑡𝑖𝑜 × 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡𝑒𝑑 𝐸𝑃𝑆 𝑖𝑛 2017

3. Market capitalization: The following formula is used to calculate the Market cap of both

the companies:

𝑀𝑎𝑟𝑘𝑒𝑡 𝐶𝑎𝑝 𝑖𝑛 2017 = 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡𝑒𝑑 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑖𝑛 2017 × 𝑁𝑜. 𝑜𝑓 𝑠𝑕𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

4. Enterprise Value Calculation: The following formula is used to calculate the enterprise

value of BEXIMCO and GSK:

Enterprise Value= Market Capitalization + Market value of the interest bearing debt- Cash

Year 2015 2016 2017

BEXIMCO 0 0 0

GSK 249,790 405,221 501,865

11

'Market Capitalization' is calculated in the previous step.

We have taken the book value of the interest bearing debt in the Pro-forma Balance Sheet for

2017 as the Market Value of the interest bearing debt.

Cash is taken from the Pro-forma Balance Sheet of 2017.

5. NPV calculation: Net Present Value of both the companies have been calculated using the

'NPV' function in Excel. We have taken into account WACC (calculated in Part-2) as the

discount rate, and the Free cash flows of Year 2015-2017 calculated in Step-1. Enterprise Value

has been added as the salvage value with the FCF of 2017 in the calculation.

Following is the table showing the NPV that have been calculated following all these 5 steps:

Synergy

Synergy occurs when value of the merged companies is greater than the combined value of both

the companies individually.

Possible sources of Synergy if these two companies merge:

1. Revenue Enhancements:

a) Market power: BEXIMCO and GSK none are operating as the market leader in the

Pharmaceutical industry. Square Pharma, with 19.4% market share is the market leader whereas

BEXIMCO has a market share of 8.82%. GSK is not in top 10 pharmaceutical companies in

Bangladesh in terms of market share but in the health food market GSK has 85% of the market

share. If BEXIMCO and GSK merge together, both can have higher market share and can

compete against Square Pharma to be the market leader in Bangladesh.

2. Cost Reduction:

NPV (BDT)

BEXIMCO 25,417,388,811

GSK 17,764,176,000

12

a) Economies of scale: If BEXIMCO and GSK merge together, they will spread their overhead

by sharing the headquarters, top management, machineries, warehouse etc. As a result, the per

unit cost will fall and economies of scale can be achieved.

b) Complementary resources: Since BEXIMCO and GSK are in the same pharmaceuticals

industry, their products are quite similar produced using similar raw materials and resources.

Thus, if BEXIMCO and GSK merge together, they can utilize each other's resources for better

and larger scale production.

c) Elimination of inefficient Management: If BEXIMCO and GSK merge together, both can

share their most efficient managers and eliminate the inefficient managers from the company.

This way the top management will become more efficient and more proactive to be competitive

in the market by reducing the cost.

3. Tax Gains:

a) Use of unused debt capacity: GSK has used only 1% interest bearing debt to finance their

capital whereas BEXIMCO has 18.4% interest bearing debt. If they merge together, GSK can

use the unused debt capacity and be benefited by leverage.

b) Increased debt capacity: If they merge together, the risk will be diversified. As a result, both

BEXIMCO and GSK can take higher debt and get higher leverage from the debt.

4. Reduction in Capital Requirements:

Since BEXIMCO and GSK produce almost similar type of goods, their capital requirement are

similar as well. They will have duplicate fixed assets that can be reduced and as a result, the

cost can be minimized as well.

Recommendation

BEXIMCO and GSK should merge together to have higher market share and to be competitive

in the industry. BEXIMCO is currently in the third position in terms of market share. If

BEXIMCO and GSK merge together, they can eye at the No.1 position, and beat their

competitors. .