LandMark Answers

Landmark Case – Group 6 Answers 1. Why is Harris acquiring landmark? What are the sources of synergies? Do you believe that these synergies can be realistically achieved? Tim Harris, CEO of Broadway Industries was considering acquiring Landmark Facility Solutions as he believed it was an exciting opportunity to make Broadway a truly integrated services facility provider. It was a $120 billion market in the US with an annual growth rate of 6% and integrated service solution providers with a presence in multiple regions were uniquely placed to take advantage of this.

The various sources of synergies that could be achieved by Broadway by acquiring Landmark are as follows.  First, given recent industry consolidation and projected higher growth for integrated facility services, the acquisition could enable Broadway to provide better bundled services to its existing customer base and therefore gain a bigger share in its home market.  Secondly, Landmark could also help Broadway gain new customers on the East Coast as Broadway mostly had presence only in the Western region of US. In addition, Harris had always wanted to enter the West Coast market in order to create an integrated facility management company on a national scale. Acquiring Landmark would facilitate this goal.  As Broadway wished to enter the high-tech, biotechnology, and pharmaceutical industries in its home market, the acquisition could help Broadway gain market share in these segments in the eastern United States because Landmark specialized in building engineering and energy solutions  Further, Harris was well regarded within the industry for cultivating a culture of operational efficiency within Broadway. He believed that Landmark’s high operating costs, which had placed it in the bottom quartile of facility management companies, in terms of operating margin, had resulted from managerial complacency and cost mismanagement. Harris was confident that by replacing Landmark’s management team and cutting down costs Broadway could increase Landmark’s operating margin to 3%. Most of the benefits of the synergy arising from the acquisition could be realistically realized. For instance, Landmark’s operating margin had declined from 3% in 2010 to less than 1% in 2014 as its operating expenses increased. With Harris’ efficient management style and

elimination of common overhead expenses the margin would surely improve. Also since Landmark was respected for its high quality service and expertise, Broadway would be able to market some of its services under Landmark’s brand at a premium price.

2. What is the appropriate discount rate for valuing the acquisition? The discount rate was considered to be the weighted average cost of capital of the firm, where in the cost of equity for Landmark facility was calculated by the Capital asset pricing model using the beta of the industry. Since, Landmark facility is not listed, the information of equity betas given in the case can provide the unlevered beta, using the average debt-equity ratio of the firms given, the levered beta helps us find the cost of equity using CAPM, and info given in the case wherein the risk free rate was chosen to be the ten year treasury bond rate of 2.56%, and market risk premium of 5.9%. The cost of debt was calculated by subtracting cost of equity from 1. The WACC turned out to be approx. of 8.44%. The formulae used in the process are: •

CAPM: Cost of Equity = Rf + β*(Rm)

•

βUnlevered = βLevered/(1+Debt(1-t)/Equity)

•

Cost of Debt = 1 - Cost of Equity

3. Derive the proforma free cash flows of Landmark and Broadway and value both companies after the acquisition. What is the value of this acquisition to Broadway, under both expected and pessimistic scenarios? Should Harris proceed with his $120mn bid? The free cash flows have been given in the excel sheet. Under normal or expected conditions the value of landmark is $172 million. While in a pessimistic scenario, the value drops to $88.9 million. Harris should proceed with deal as under expected conditions the value of landmark is significantly greater than what Broadway is paying for it. Whereas even in a pessimistic scenario, the value is only slightly less than the estimated value. Therefore considering the combined synergies this deal is definitely a plus for Broadway Industries.

4. Which financing alternatives should Harris choose? What are the implications of the chosen financing method for Broadway’s capital structure? Can Harris afford the debt service? How much in equity of the combined firm does Harris give up by opting for the mix of debt and equity financing alternative?

There are two alternatives for Harris for financing the deal – 100% Debt or 50%Debt & 50% Equity. If he goes for the 100% debt option, then Broadway would suffer from Cash deficit in the first two years after the acquisition in the normal scenario while facing cash deficit in the first four years after the acquisition. Thus this option is mostly a no-go for Harris. On the other hand going for the 50%Debt & 50% Equity option is viable as the company would not suffer from any cash shortfalls immediately after the acquisition under both normal and expected conditions. The dilution in equity can be explained as follows.

Value of the combined firm Additional Value created for Broadway after acquisition Equity raised (40% of ownership) Dilution when $ 60mn is raised

Normal Pessimistic $242.91 $158.87 $47.12 $1.87 $97.16 $63.55 24.70% 37.77%

The above table shows us that 40% of ownership is actually valued at $97.16 million compared to the $60 million they need to raise for the deal. Thus Landmark shareholders are getting a premium. By opting for the mix of debt and equity Harris gives up of equity of the combined firm as explained in the excel sheet. Optimistic Scenario Value of Combined Firm $242.91 Long term debt 8.3 Total Equity Value 234.61 % of dilution 25.57%