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Equity Valuation

Fixed Investment Management
Case Background:

This case study deals with the analysis of merger and acquisition, where Tim Harris, founder of
Broadway Industries is planning to acquire Landmark Facility Solutions. Broadway, located in
USA, was founded by Mr. Harris in 1982. Broadway is providing facility services like janitorial
services, floor & carpet maintenance services, HVAC and other building maintenance services. It
has 12 regional offices from New England to Florida. Its major clients include several
industrials, retails, and manufacturing, government and education facilities. Broadway has been
seeking significant growth and aim to spread its operations in addition to gain expertise in
building engineering and energy solution to become a truly integrated service provider. For this
purpose, it is considering acquiring the Landmark facility solutions.

Landmark Facility Solution is operating since 1956. It started as a regional Janitor services
provider; thereafter it has witnessed good growth over three decades. Today it is a large
integrated supplier to commercial customers. It has specialized in the areas like building
engineering and energy solution, janitorial and commercial cleaning and other general building
maintenance. It has gained the experience of servicing high end clients like large hospitals,
Fortune 500 biotech and pharma companies. Due to its strong brand recognition, Landmark is
capable to charge premium prices.

Despite of charging premium prices, Landmark is currently facing the problem of reduction in
operating profit from 4% in 2010 to 1% in 2014. Its cash balance is also expected to decline to
lowest level. The current financial position of Landmark encourages Mr. Harris to acquire
Landmark because it is expected that the acquisition of Landmark will satisfy the strategic needs
of the Broadway in order to expand its services. However, two board members of Broadway
suggested that the current demand of $120 Million from Landmark is high and the expected
benefits from the acquisition will not justify the cost. Hence, Mr. Harris is evaluating how much
Landmark is worth to Broadway and considering the financing of the acquisition.


 To analyze the worth of Landmark Facility Solutions

 To recommend the optimum financing solution to Broadway to acquire Landmark.

Problems Identified:
1. Concerns over building good synergy between two firms:
 Managerial complacency and cost mismanagement at Landmark have degraded the
operating margin and thus the bottom line which is difficult to rebound. Replacement
of Landmark’s management team and cutting executive pay, lavish perquisites and
reducing non-essential expenses will not be without repercussions from the
employees at Landmark. It will also take away huge part of the expertise which
Landmark has gained over the years especially in Hospital and pharmaceutical sector.
 Landmark employs around 5000 employees and service more than 300 million square
feet. Management of large employee base will be challenging for Broadway as they
will bring on different set of problems which Broadway might not have dealt with
 Cultural integration between the two firms will be an issue. It will require full clarity
and efficient execution of post-merger integration process in order to merge hassle

2. Declining Profit Margins at Landmark:

 Despite charging premium from the customers, Landmark is already beating
customers in terms of pricing. But still, its operations margins have declined to 1 %
from 3% in four years. Even its expected cash balance is going to be $ 400,000 by
end of 2014 which is lowest in last five years. This is a sign of worry for Broadway.
 There is uncertainty on whether Broadway’s accounting team and financial officers
could manage the larger, more complex firm which would be double the size of
Broadway with coast to coast operations. It is thus challenging.

3. Varied market expectations and mixed responses:

 Some investment banks have reacted negatively to the merger citing concern if
Broadway can manage the combined business and effectively implement the
proposed cost cutting measures.

 Some board members were also of the similar view and need more convincing about
the pricing strategy and service model that Broadway will implement. The price
demanded by Landmark is also very high compared to their current business results.
 However, Harris has approval from Stanley Investment Company, a leading
investment bank and it also believe that the financing of the acquisition can be well

4. Issue over premium pricing strategy:

 It is likely that Broadway will not be able to benefit much from Landmark’s premium
brand recognition in the market as clients will be in a better position to negotiate for
the new contracts given that they know about the size of the deal between Broadway
and Landmark.
 Given the nature of the contracts which are long term in nature, it will take time until
all contracts are up for renewal and for bargaining again. It will take a while to effect
the market at a large scale.
 The premium pricing strategy will have an impact on the demand due to price
elasticity thereby it will reduce the revenues in the beginning.

5. Risk of Cannibalism:
 Both the firms will face the risk of overlap in services as both have a lot of common
features for the clients. This introduces the risk of cannibalism i.e. one firm might eat
away the revenues of the other firm in the same market.

Hence, a comprehensive analysis and discussion needs to be done currently to come up with a
logical recommendation.


There are several reasons why Harris desires to acquire Landmark. Firstly, Harris is interested in
bundling and/or integrating the services both companies offer as the market is highly
competitive. In addition, the market is highly fragmented and therefore large companies have a
better chance of succeeding in the long term. This is due to the fact that clients prefer to work
with only one big facility company that offers different products and diversified solutions and
packages, which are able to satisfy all their needs at once. Therefore, offering bundled contracts
will allow Harris to lower to the operational costs and exploit a market which is expected to
grow 6% annually from 2014 to 2016 according to the case.

Secondly, Harris wants to grow his company to create an integrated facility management
company on a national scale. The acquisition of Landmark would give him the access to the west
coast in which he has shown great interest. Additionally, his company’s customer base will be
expanded by the Landmark’s clients and therefore include Broadway in the high-tech
biotechnology and pharmaceutical industry. With the experience in those markets on the west
coast, similar clients on the east coast would be much easier to attain.

The sources of the synergies for the joint firms are costs reduction on the one hand and revenue
enhancements on the other hand. Since, Harris is well regarded within the industry for cultivating
a culture of operational efficiency within Broadway; costs at Landmark will be reduced by
lowering operational and overhead costs, through cutting executive pay and reducing marketing
costs, by for example integrating the respective departments. Revenues will be enhanced by
marketing current Broadway services under the newly acquire Landmark brand as premium
service and by attracting new customers with integrated services, both in new industries and new
geographical areas.

There are two growth models; optimistic and pessimistic. Both of these will be used to analyze
the worth of the firms future value and before merger values. Both the firms stand a chance to
increase their valuation with positive synergies over a period of few years. As mentioned in the
case, the combined entity is expected to grow its revenue in both the pessimistic and optimistic
scenarios from the present value. Also, the operational cost cutting will lower down the expenses
and will add to the bottom line of the firm.

Additional value created due to positive synergy = Value of the joint firm – Value of Landmark
– Value of Broadway

Analysis of the Discount Rate to value the acquisition:

For an appropriate valuation of the entities, we will be in need of the realistic discount rate to
bring the costs in present value. We will use the Weighted Average Cost of Capital (WACC)
method. This method uses the different costs for equity and debt with regards to their weights
within the overall capital structure. We assume a cost of debt of 4.16%, the rate for AAA rated
company bonds in the short term as given in the case. Furthermore, we calculate the cost of
equity with the capital asset pricing model (CAPM). For this we take the risk-free rate of 10-year
treasury bonds (2.56%), add the market risk premium (5.90%) and multiply them with the beta
value. The unlevered beta value is estimated to be an average of the other three given
competitors’ unlevered beta values which will be calculated using the levered beta and the
debt/equity ratio along with prevailing tax rates (Exhibit1). The unlevered beta for Broadway and
Landmark joint firm is calculated to be 1.1.

β (levered) = 𝛽 (𝑢𝑛𝑙𝑒𝑣𝑒𝑟𝑒𝑑) ∗ (1 + (1 − 𝑡) ∗ 𝐸 )

Ke = 𝑅𝑓 + 𝛽 ∗ (𝑅𝑚 − 𝑅𝑓)

WACC = 𝐾𝑑 ∗ (1 − 𝑡) ∗ 𝐷/𝐴 + 𝐾𝑒 ∗ 𝐸/𝐴

Beta Mkt
Funding Beta
Debt Equity Kd Tax levered Rf Risk Ke WACC
model unlevered
(β) Premium
100 %
74.8% 25.20% 4.16% 35% 1.1 3.22 2.56% 5.90% 21.60% 8.11%
50 %
39.7% 60.29% 4.16% 35% 1.1 1.57 2.56% 5.90% 11.80% 8.42%

As mentioned in guidelines in case, the valuation of both the companies is calculated by taking
the several perspectives into account with the discount rate derived above. Based on the payment
structure and debt ratios Harris should choose the debt and equity financing option.

Broadway would not be capable of servicing its debt on 100% loan obligation as it will make its
debt to equity ratio to be close to 3. It is risky for the firm. Thus, we will consider a mixed
funding i.e. 50% debt and 50% equity to acquire Landmark which will make its total debt of
40% and total equity = 60% and a WACC of 8.42%.

We will try to analyze if Harris is justified to acquire Landmark at $120 million. Valuation of
both standalone companies and combined firm post acquisition will be evaluated to come to a
decision with respect to the acquisition.

Using the available information and the predicted revenue figures and operating margin for both
the optimistic and the pessimistic conditions the Free Cash Flow figures are calculated in Million

Broadway Landmark
NPV Post NPV Post NPV Post NPV Post
acquisition acquisition acquisition acquisition
Standalone Standalone
(optimistic (pessimistic (optimistic (pessimistic
Basis ($ Mn) Basis ($ Mn)
$ Mn) $ Mn) $ Mn) $ Mn)
105.5 134.10 110.50 66.38 103.59 74.1

The NPV of Broadway post acquisition seems to be slightly more attractive in the pessimistic
scenario: Landmark increases the value of Broadway by 110.50-105.5= $5.0 million. Previously,
Landmark seems to have a relative low NPV ($74.1 million and $103.59 million) in both
scenarios when contrasted to the $120 million bid. The NPV for Landmark after the acquisition
increases to $74.1 million in the pessimistic scenario. If we sum the value of Landmark on a
stand-alone basis with Broadway’s increased value of $5.0 million due to the acquisition, the
total amount will be 74.1+5.0= $79.1 approximately. As a result, the acquisition does increase
value for both companies; however, the $120 million bid for Landmark is unfortunately
overvalued and therefore not justified in the pessimistic scenario.
On the other hand, when the Broadway considers the standard scenario, it will result in a positive
outcome. In the post-acquisition scenario the value of Broadway will increase by 134.1-105.5=
$28.6 million. The NPV of Landmark post acquisition standard scenario summed with the

increased value of Broadway leads to 103.59+28.6= $132.19 million. So, in that case the $120
million bid for Landmark is justified.

Depending on the outcome scenario after the acquisition, Harris could either benefit from the
acquisition or face a great loss if the circumstances change.


Company 1 Company 2 Company 3

Sales 13,945.70 6,147.20 836.9
Net Income 219.4 123.8 12.1
EPS 0.95 1.84 0.55
Share Price 26.76 46.83 22.73
No. of Outstanding Shares 231.2 67.3 22
Market Capitalization 6186.9 3151.7 500.1
Debt 5,887 355 289
Assets 10,267.10 3465.9 862.4
Equity beta 1.69 1.25 1.56

P/E 28.17 25.45 41.33

D/E 1.0 0.1 0.6

Equity Beta (Levered) 1.7 1.3 1.6
Unlevered Beta 1.0 1.2 1.1
Average Unlevered Beta 1.1

Combined Optimistic Scenario 1 2 3 4 5 6

2015 2016 2017 2018 2019 2020
FCFF 9.155863 11.0294 11.14427 13.83172 16.3109 15.61037
PV @ WACC = 8.27% 8.444652 9.382464 8.74378 10.00936 10.88655 9.609664
Sum of PV of FCFF 57.07647

Terminal Growth 0.04

Terminal Value as on 2020 353.0142
PV of Terminal Value 217.3137

Enterprise Value 274.3902

Less: Non Current Liabilities -36.7
Equity Value 237.6902

Combined Pessimistic 1 2 3 4 5 6
Scenario 2015 2016 2017 2018 2019 2020
FCFF 9.05 8.84 9.23 12.48 11.25 12.49
PV @ WACC = 8.27% 8.35 7.52 7.24 9.03 7.51 7.69
Sum of PV of FCFF 47.34

Terminal Growth 4%
Terminal Value as on 2020 282.56
PV of Terminal Value 173.96

Enterprise Value 221.30

Less: Non Current Liabilities -36.7
Equity Value 184.60