QUESTION
- From a prospective investor's (or buyer's) point of view, determine the price you are willing to pay, if you are to invest.
- Write a brief paper (two pages maximum) supporting your rationale for the valuation you have chosen, and provide appropriate financial appendices (in addition to the two pages of text) showing your analyses.
CASE
Abstract
James Dougan, chief executive of Dataline Oil Services (DOS), faced a tough decision. A bid, which he and his fellow managers had put together to buy DOS from its parent company, had just been topped unexpectedly by another company. He and his team now had to decide whether they could justify raising their bid.
Dataline Oil Services
In December 2001, Albion Industries announced its intention to sell its fully owned subsidiary, Dataline Oil Services (DOS). Albion was engaged in a number of other businesses, but DOS represented 90% of its net worth and 150% of its net cash flow.
DOS had been established in 1983 as a British oilfield services company to capitalise on the development of North Sea drilling activity, providing a range of specialised 'down hole' services to offshore oil operators. By 2001 DOS was one of the three major operators in the business worldwide.
After difficult trading in 1998-99, principally due to the decline in oil prices, business recovered dramatically under the direction of a highly regarded management team, as shown below:
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Dataline Oil Services Trading Results
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£millions
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Year to March 31
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1998
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1999
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2000
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2001
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Sales
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20.3
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25.6
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31.5
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46.1
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EBIT
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0.7
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3.5
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5.7
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8.1
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In the late summer of 2001 management had been forecasting EBIT of £8.8m and £10.0m for the years ending 31 March 2002 and 2003 respectively. These forecasts were keyed to anticipated offshore drilling activity, which in turn was likely to be influenced by the future level of oil prices.
Over a three- to five-year cycle, mandatory capital expenditures tended to equal depreciation of £2.5-3.0m annually, although management had some ability to phase spending within the cycle.
The balance sheet at 30 September 2001 is summarized below:
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Dataline Oil Services balance sheet at September 30, 2001
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£millions
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Cash
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1.6
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Debtors
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12.8
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Stocks
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2.3
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Total Current
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16.7
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Net Fixed
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12.3
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Total Assets
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29
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Less: Creditors
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18.2
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Net Assets to be Sold
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10.8
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DOS management, itself keen to attempt to buy out, had won the backing of a major London institutional investor, which was experienced in financing similar-sized MBOs. It did, however, require the management team to make a total equity investment in the deal of £500,000, which represented their total net worths and then some.
James Dougan, chief executive of DOS and leader of the MBO team, anticipated a price in the area of £51m. This was based on his analysis of UK buy-outs in recent years, which suggested that a 'normal' price was in the region of six to eight times EBIT. The rule-of-thumb seemed to be that for a reasonable business five times or less was 'cheap', while a price approaching ten times was 'expensive'.
The institution had devised a financial plan that included £26m of senior bank debt, £7m of 'mezzanine' subordinated debt, £18.25m of redeemable preference shares carrying a 5% fixed dividend, and £1.75m of ordinary capital (including management's £500,000). Management would initially hold 30% of the equity, but a 'ratchet' provision would enable the team to increase its share to 40% if certain performance targets were met. Professional fees and other expenses of the transaction were budgeted at £2m.
Unexpectedly, Albion management announced that an offer of £64m had been received from a major European conglomerate. Management and its backer wondered whether a purchase price of £64m could 'work'.
There were no really comparable companies quoted on the London Stock Exchange. Baker Hughes, a direct competitor of DOS (albeit a very much larger and stronger business), was quoted on the New York Stock Exchange at 28.1 times net income.
A bid of £64m might win the deal, but could management recommend it to its backer? Indeed, did management itself want the deal at that price? In the short term, it was thought that world oil prices were coming under pressure because of the market operations by Saudi Arabia. Management's institutional backer, however, stated that they were only concerned with the long term.
The FT 100 Index was quoted at 21 times historic after-tax profits; base rate was 5.25%; and corporation tax rate was 30%.