Satélite Distribuidora de Petróleo is considering injecting some financial resources to cater for growth opportunities. DOI Ltd, the funding company, on the other hand, demands board seats and exceptionally high return. The analysis shows that SAT should better use the current market strength to negotiate the deal in such a way that no board seat is compromised. On the other hand, DOI Ltd should limit the investment horizon to 5 years. In case SAT refuses for minority share DOI Ltd should demand a higher return over the investment horizon. Future M&A can be extremely beneficial to both companies as they might result is possible synergies due to post M&A business operation enhancement.
The financial and non financial strengths and weaknesses of SAT are described below.
1: The liquidity ratios of SAT are exceptional. In the last five years, the average of both current and cash ratios are above 68%.
2: Apart from liquidity, profitability ratios of SAT are also worth mentioning. The averages of ROA and ROE for last five years are 7% and 38% respectively.
3: The inventory turnover of SAT is relatively high and stands at an average of 37.
4: The biggest financial drawback that SAT possesses is the projected ‘low gearing ratio’. The company has leverage of 34% in 2000 which is quite sufficient. However, the future leverage ratio implies that SAT is not fully utilizing the tax shield and debt benefits.
5: The Company is ‘probably’ incurring huge costs on fuel transportation. For example, RN synthesizes 21% of revenue, yet it possess only one fuel depot.
6: The Company’s policy for selecting new franchisees is admirable (minimum 20% ROCE).
The strengths and weaknesses are described below.
1: DOI Ltd has a strong management team that possesses adequate market knowledge.
2: The targeted return to investors on investment is not compatible with the idea of minority interest. In the case of new or risky firms, capital injection is necessary; therefore they might agree on some board positions. On the other hand, most of the times growing companies reject the idea of board seats with the high specified investor return.
SAT has witnessed an average revenue growth rate of 86% in the last five years. This is a phenomenal figure. Before moving forward to the examination of ‘growth and fund needs’, this is vital to consider the current financial resources of the company. In the year 2000, the cash and cash equivalents comprise 32% of overall assets. This ratio is impressive for day to day operations of the business. At the same time, company operates on a 34% leverage ratio. Raising new debt will not be cheap because of the high leverage ratio. Meanwhile, the fact that existing gas stations were relatively not satisfied with the services of their distributors was a notion of worthwhile importance. Due to high competition and price wars, product diversification was also recommended. This product diversification would enable SAT to experiment a brand new idea. If the plan goes successful and generated revenues, company can gain a handsome amount of financial reward. Additionally, SAT was also ISO 2002 certified which was an added advantage for future acquisitions. Other prominent companies are also looking forward for acquisitions. If SAT defers the growth idea to a further date, it may lose possible small and medium size acquisition candidates. On the other hand, DOI Ltd demands a minority interest in SAT. The funding could prove expensive as a net return of 25-30% is additional to the board seats. If DOI Ltd, which is not a national or local company, gains minority interest, prospective acquisition candidates may be alarmed. The company backs itself on the strong management team of Marcelo Alecrim. The impression of a ‘new entrant’ in decision making process may hamper the image of the company. The best way for SAT is to negotiate the deal with DOI in such a way that no ‘board seat’ is compromised. The negotiations can be backed up by the ideas that the projected conservative ROCE of SAT for next five years is 44% and that the brand name and possible future growth opportunities complement this fact.
The evidence that, at the end of year 2000, the combined equity and debt value do not account to a significant number makes SAT a small company (In relation with $300 million mark). The brand name is prestigious, and the management team is adequately trained and well aware of the business. The next five years projected ratios (conservative) including the ROCE are remarkable. FCFs of next five years also depict an increasing trend (they start decreasing after that). If SAT can offer a net return in between 35-40% for next five years, DOI Ltd should remove the minority or majority stake issue. Additionally, it will not be wise to refute the idea of a possible exit after five years as the company may face some Cash flow concerns.
Any future merger and acquisition activity will be valuable for both the concerned parties. From the perspective of DOI Ltd, it is a vital and essential step that SAT should stick to. The possibility of enhanced returns is increased by product line diversification and expansion into small industry segment as there is quite a likelihood that the small ‘inefficient and alone’ franchisees can benefit from the experience of SAT after M&A.