MFL & MRL Merger

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MITTAL FOOD Ltd & MAHANAGAR

RESTAURANT Ltd.

Based on information gathered from KPMG and going through the recent

business new the hypothetical case study on Mergers and Acquisitions has

been developed. I took the help of my project guide (Professor

Ramakrishna) and C.A Mr. Anindo Dutta to make the valuations as practical

as possible. Some of the valuation strategies that has been incorporated, is

extract from my M.Com classes of Dr. Malayendu Shah H.O.D of finance,

Calcutta University

The assumptions, which are the keystone of the case study, are enumerated

below:

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It is assumed that the existing undertakings are operating at a level

below optimum but when they combine their resources and efforts,

they can reduce the cost of production including selling and

administrative expenses. It will take 4-5 years to achieve this synergy.

Both the companies do not have any Preference Share Capital.

All the shares are fully paid up and authorized share capital of Mittal

Food ltd. is of 157497 shares of rupees 10 each and of Mahanagar

Restaurant Ltd is of 25000 shares of Rs 10 each.

Depreciation is calculated on Diminishing Balance Method.

There is no interest to be paid by Mahanagar Restaurant Ltd after

merger on debt capital, as the loan taken from Mittal Food ltd would

be adjusted.

The earnings of both the firm for the year 2005 has been taken for

calculating the E.P.S after merger.

Both the companies are listed companies.

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Financial year for both the companies closes at 31st December.

Point to be noted: The prevailing tax rate for each year has changed

Mittal Food ltd. (M.F.L) was established in 1995 to manufacture steel

generally used for producing home appliances and machines. The company

invested Rs.4 lacks in a small concern called Mahanagar Restaurant Ltd

(M.R.L). During the past 5 years, M.F.Ls sales have grown at an average of

about 10%\year, which is below the industry benchmark, and P.A.T have

grown at about 8%. The fluctuating profit of the company has caused its P.E

ratio to be much low.

To reduce its earning instability M.F.L is now planning to acquire 51%

ownership in M.R.L, which has a poor management, and to make it, its

subsidiary. Currently M.F.Ls share is selling for Rs. 75 in the market. The

synergies for acquiring M.R.L are enumerated below:

1. The target company belonged to the related business so it will help in

vertical merger and penetrate in newer area.

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2. It has generated a stalwart goodwill among the consumer and is time

honoured as a good Quick Service Restaurant (Q.S.R).

3 It had 50 outlets in Delhi and Mumbai. The revenue generated

from these outlets will help in maintaining a stable PE ratio.

MRL is known for its quality of products and services including. It has a

strong logistic throughout its 50 outlets spread across the capital and

Mumbai. The company is planning to make its maiden entry in Kolkata.

Due to poor management and lack of innovative dishes, the companys

performance was bogged down with the entry of new kids in the block. The

company could not pay heed to product innovation due to the high cost of

raw material and processed items required for such Endeavour.

MRLs sales have grown at an average of 6% per year. The companys

earning has been low due to decline in sales and the average market price

of company s shares in recent times has been lower than its book value.

The board of MRL thinks that when they took a loan from MRL, it helped

them to deal with their financial inadequacy and now if they join with

M.F.L, they can get raw material and process ingredients at lower costs

from the humungous product portfolio of MFL. Moreover, MFLs supply

chain will enable easy availability of the products in all the outlets.

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The current price of MRLs share is Rs. 28 only. MFL thinks that if they

could acquire MRL, they could turn around the company and increase its

share value in the market. However, M.R.L favoured merger with M.F.L

instead of becoming a subsidiary. According to shareholders of M.R.L, if

one company is made a subsidiary of other the idea behind the synergy

would fall and there will not be any unified command as it tantamount to be

dominated by the parent company.

But M.F.L wanted to acquire M.R.L and claimed to grow their sales by 8%

within 3-4 yrs but as M.R.L has so low growth rate in sales, MFL will be

paying them for each share an amount much lower than their current market

price. MRL agreed to that but their condition was to get raw materials at a

much more lower costs which will help to reduce cost of goods sold at least

64% of sales. MFL anticipates that to support sales growth of 8% of M.R.L,

they have to bear a capex equal to 5% of sales for the first 5 yrs.

Now the million-dollar question arises whether both the companies will

have an increased E.P.S in the post merger milieu and what price M.F.L

should pay to M.R.L if they merge with each other. From M.R.Ls point of

view, a vertical integration of upstream suppliers like Reliance

Petrochemicals ltd. with Reliance Industries ltd in the year 1992 will help

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the company to achieve the desired result of synergy and reduce the cost of

production.

The financial statement (in a summarized form) issued by both the

companies for the year ended 31st December 2005 are given below.

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Mittal Foods Ltd

Summarized P/L statement for the last five years (Rs in 000)

Year 2001 2002 2003 2004 2005

Net Sales 5470 6150 6642 7529 8056

Cost of good sold 3900 4500 5467 5480 5975

Depreciation 110 155 139 125 143

Selling & Admin 671 788 970 1003 1020Expenses

Totalexpenses 4681 5443 6576 6608 7138

EBIT 789 707 66 921 918

Interest 132 152 160 191 284

EBT 657 555 94 730 634

Tax 353 292 - 368 226

PAT 304 263 - 362 408

Per share data

Year 2001 2002 2003 2004 2005

EPS (Rs) 1.93 1.67 1.81 2.3 2.59

Book Value (Rs) 25.28 26.00 26.41 26.75 27.55

Market Value (Rs) 54.34 61.25 57.5 71.25 75.00

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Z

Summarized Balance Sheet

As on 31st December 2005

Liabilities (Rs. In thousand)

Sources of Funds

Shareholders Fund

Paid up capital (1, 57, 497 sharesOf Rs. 10 each) 1575

Reserve and surplus 3155 4730

Borrowed Funds

Secured 1203

Unsecured 967 2170

Current Liabilities 1860

8760

Assets

Gross Block 4748

Less depreciation 143

Net Block 4605

Investment

Loan to MSUL 400Other Deposit 29 5034

Current Assets 3726

8760

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Mahanagar Restaurants Ltd

Summarized P/L statement for the last five years (Rs in 000)

Year

2001 2002 2003 2004 2005

Net Sales 1442 1490 1580 1721 1823

Cost of good sold 995 1055 1150 1244 1323

Depreciation 37 40 45 45 85

Selling & Admin 260 275 280 292 302Expenses

Total expenses 1292 1370 1475 1581 1710

EBIT 150 120 105 140 113

Interest 19 20 20 30 35

EBT 131 100 85 110 78

Tax 45 34 25 35 27

PAT 86 66 60 75 51

Per share data

Year 2001 2002 2003 2004 2005

EPS (Rs) 3.44 2.64 2.40 3.00 2.12

Book Value (Rs) 23.76 25.00 26.28 27.65 30.00

Market Value (Rs) 30.84 44.04 42.25 25.48 28.0

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Summarized Balance Sheet

As on 31st December 2005

Liabilities (Rs. In thousand)

Sources of Funds

Shareholders Fund

Paid up capital (25000 sharesOf Rs. 10 each) 250

Reserve and surplus 320 570

Borrowed Funds

Loan from MSL 400

Current Liabilities 178

1148

Assets

Gross Block 457

Less depreciation 85

Net Block 372

Investment 23

Current Assets 753

1148

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MFL & MRL Merger

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