StaffX (Pty) Ltd has three major operating divisions:
- Xecutive division, which advertises and searches for suitable permanent personnel on behalf of clients. The service offered extends to job profiling and initial screening of potential job candidates before they are interviewed by clients;
- Xtrain division, which provides customised training solutions for large corporate clients, and
- Xsearch division, which undertakes market research for clients.
Xecutive division
The profitability of this division has declined in recent years. This is due to increasing competition from Internet based advertising of jobs with the result that placement commissions have dropped. StaffX (Pty) Ltd used to receive placement commissions of up to 25% of the annual remuneration of candidates recruited for its clients. This commission percentage has shrunk to the current average of 15%, but fortunately it seems to be stabilising at this level. In view thereof this division has taken the strategic decision not to do business with overly price-sensitive clients. However, because of its poor performance in recent years, the shareholders of StaffX (Pty) Ltd are currently considering selling the Xecutive division.
Xtrain division
This division has experienced significant revenue growth over the past five years. This is attributed to the division's superior service delivery and the rise in corporate expenditure on training and development. The division produces customised training programmes for its clients and also runs training within certain client organisations on an outsourced basis. The division derives 40% of its turnover from two major clients. Training content is produced by Xtrain which also employs highly skilled facilitators to deliver training programmes. The use of the Internet as a delivery platform is on the increase and some clients find it more cost effective to have staff learn in their own time by accessing training content and interactive modules from the StaffX (Pty) Ltd website.
Xsearch division
This division is a major player in the South African market research industry. The division's main activity is the performance of surveys on behalf of clients, mostly to provide information and feedback for them on branding strategies and consumer behaviour. Survey data are collected by means of personal and telephonic interviews. StaffX (Pty) Ltd uses world leading call centre facilities for its telephonic interviews. This division's revenue and profits have steadily increased over the years despite the highly cyclical nature of corporate market research expenditure.
Although the three divisions operate independently of each other, they all share premises in the same office park, as does the StaffX (Pty) Ltd head office. The head office is responsible for the finance, accounting, administration and human resources functions of the group and of all three the operating divisions.
StaffX (Pty) Ltd is in the process of identifying potential black economic empowerment (BEE) partners to acquire a 26% shareholding in the company. The proposed structuring of the BEE shareholding transaction, subject to final negotiations with the preferred BEE partner and the approval of the board of directors and shareholders of StaffX (Pty) Ltd, can be summarised as follows:
- On 1 January 2005, the preferred BEE partner will subscribe for 1 million preference shares in StaffX (Pty) Ltd at a par value of R1,00 each. The preference shares will not be entitled to receive dividends and may be convertible into ordinary shares following the release of the audited results of StaffX (Pty) Ltd for the year ending 30 June 2007. The preference shareholders will be entitled to 26% voting rights at ordinary shareholder meetings. The number of ordinary shares that the preference shareholders will be entitled to convert their shares into, will depend on the profitability of StaffX (Pty) Ltd over the next three years.
- The percentage ordinary shareholding that the preference shareholders will be entitled to following the year ending 30 June 2007 will be determined as follows:
A = B/(B+C)
Where A = the percentage ordinary shareholding that the preference shareholders will be entitled to in StaffX (Pty) Ltd following the conversion of the preference shares into ordinary shares, subject to a maximum of 26,0%
B = (D - E) multiplied by price earnings multiple of 5
C = R75 million
D = the average profit after tax of StaffX (Pty) Ltd for the three years ending 30 June 2007
E = R15 million, being the actual profit after tax achieved by StaffX (Pty) Ltd in the year ended 30 June 2004
StaffX (Pty) Ltd will issue that number of new ordinary shares to the BEE partner, at the appropriate premium per share, to achieve the shareholding percentage to which the BEE partner is entitled.
- StaffX (Pty) Ltd will redeem the preference shares at par value in the event that the company's average profit after tax for the three years ending 30 June 2007 is less than R15 million.
- The Financial Director of StaffX (Pty) Ltd derived a valuation of R75 million for the company for the purposes of the BEE transaction based on the audited profit after tax of R15 million achieved during the year ended 30 June 2004 and by applying a price earnings multiple of 5.
He considered this price earnings multiple of 5 to be fair in comparison with multiples of similar listed companies such as the following:
Listed company Nature of business Most recent year end
Market
capitalisation
R million
Profit
after tax
R million
Personnel Ltd Personnel recruitment June 2004 60 15
Neddison Ltd Market research August 2004 200 25
Tsolutions Ltd Corporate training July 2004 126 18
Able Ltd Personnel recruitment
and training
June 2004 390 60
The above listed companies have not historically declared dividends.
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The audited financial results of StaffX (Pty) Ltd for the years ended 30 June 2003 and 2004 are summarised below:
STAFFX (PTY) LTD
INCOME STATEMENTS FOR THE YEARS ENDED 30 JUNE
2003
Audited
2004
Audited
Notes
R'000
R'000
Turnover
Cost of sales
1
363 180
(238 980)
382 800
(248 820)
Gross profit
Administrative expenses
Marketing and selling expenses
Other operating expenses
124 200
(36 215)
(40 244)
(27 403)
133 980
(37 844)
(42 296)
(31 167)
Profit from operations
Interest received
1
20 338
233
22 673
541
Profit before tax 20 571 23 214
Tax
Normal
Deferred
Secondary tax on companies
2
3
(6 221)
50
(1 200)
(7 039)
75
(1 250)
Profit after tax 13 200 15 000
Notes
1 The segmental results of each division is summarised below:
Turnover Profit from operations
2004 2003 2004 2003
R'000 R'000 R'000 R'000
Xecutive division
Xsearch division
Xtrain division
Head office
280 500
46 500
55 800
0
277 750
38 150
47 280
0
12 554
7 860
8 799
(6 540)
12 907
6 840
6 676
(6 085)
Total 382 800 363 180 22 673 20 338
2 Deferred taxation relates to temporary differences in respect of leave pay provisions.
3 StaffX (Pty) Ltd paid a dividend of R10 million to its shareholders in June 2004.
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The balance sheet of StaffX (Pty) Ltd at 30 June 2004 is summarised below.
STAFFX (PTY) LTD
BALANCE SHEET AS AT 30 JUNE 2004
Notes
R'000
ASSETS
Non-current assets
22 160
Property, plant and equipment
Deferred tax
21 850
310
Current assets
55 693
Trade and other receivables
Cash and cash equivalents
50 348
5 345
Total assets 77 853
EQUITY AND LIABILITIES
Capital and reserves
Ordinary share capital and premium
Retained income
1
10 000
30 163
Current liabilities
40 163
37 690
Trade and other payables
Provisions
Tax
2
33 080
1 160
3 450
Total equity and liabilities 77 853
Notes
1 Retained income available for distribution to ordinary shareholders at 1 October 2001 amounted to R15,1 million.
2 Provisions relate mainly to accumulated provision for leave pay.
The current shareholders of StaffX (Pty) Ltd are the Managing Director (35%), the Financial Director (25%) and a private equity fund (40%).
The current bonus scheme is based on the achievement of budgeted earnings before interest, taxation and depreciation (EBITDA). Executive directors and certain senior executives are entitled to share in a bonus pool equivalent to 20% of achieved EBITDA in excess of budgeted EBITDA annually.
The Managing Director of StaffX (Pty) Ltd has approached Afrika Investments, offering to use his best endeavours to ensure that Afrika Investments becomes the preferred BEE partner to StaffX (Pty) Ltd.
In return, the Managing Director of StaffX (Pty) Ltd has requested a 10% shareholding interest in Afrika Investments. The Managing Director has not disclosed his actions to the other shareholders of StaffX (Pty) Ltd or his fellow directors in the company.
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REQUIRED
(a) Evaluate the earnings based valuation derived by the Financial Director of StaffX (Pty) Ltd and indicate, with reasons, whether you agree with his assessment. Your answer should include the following:
(i) Your own indicative earnings based valuation, with detailed workings, of the company at 30 June 2004;
(ii) Any further information you would require in order to finalise your valuation of StaffX (Pty) Ltd for the purposes of the BEE transaction; and
(iii) Your conclusion regarding the Financial Director's valuation.
(b) Discuss the general shortcomings of earnings based valuations.
(c) Calculate the average profit after tax of StaffX (Pty) Ltd for the three years ending 30 June 2007 that is required in order for the preferred BEE partner to be entitled to a 10% shareholding, a 15% shareholding and a 26% shareholding respectively in the company.
(d) Critically review and discuss the proposed structuring of the introduction of a BEE shareholder from the perspective of the current shareholders of StaffX (Pty) Ltd. Ignore any taxation consequences of the proposed deal structuring.
(e) Identify and list the minority rights that the new BEE shareholders should insist are included in the shareholders" agreement in order to protect their interests.
(f) Identify and list the key business risks facing StaffX (Pty) Ltd.
(g) Evaluate the current bonus scheme of StaffX (Pty) Ltd and identify with reasons potential weaknesses of the scheme.
(h) Discuss the ethical issues arising from the Managing Director's approach to Afrika Investments to acquire a 10% interest in the company in return for assisting them become the preferred BEE partner to StaffX (Pty) Ltd.
(i) List the factors that the board of directors and shareholders of StaffX (Pty) Ltd should consider in evaluating whether to sell the Xecutive division. (Ignore the taxation considerations arising from the sale of the division.)
(j) Outline and discuss the potential tax consequences of the sale of the Xecutive division and the distribution of the proceeds as dividends to the shareholders of StaffX (Pty) Ltd. You should include a review of the potential normal income tax, capital gains tax and secondary tax on companies.