Merge and acquisition and valuation the case of comeco

In analyzing the target firm to arrive at a reasonable price for COMECO, theories for business analysis and valuation will be applied.. Firstly, discounted cash flow valuation will be us

MERGE AND ACQUISITION AND VALUATION – THE CASE OF COMECO

In Partial Fulfillment of the Requirements of the Degree of

MASTER OF BUSINESS ADMINISTRATION

MERGE AND ACQUISITION AND VALUATION – THE CASE OF COMECO

In Partial Fulfillment of the Requirements of the Degree of

MASTER OF BUSINESS ADMINISTRATION

In (specialization)

By Mr: Nguyen Chi Thanh ID: MBA03029 International University - Vietnam National University HCMC

August 2013

Under the guidance and approval of the committee, and approved by all its members,

this thesis has been accepted in partial fulfillment of the requirements for the degree

I would like to express my deepest gratitude to my family for their support Without their love, encouragement, and trust in me, I would not able to pursue and complete this program

Plagiarism Statements

I would like to declare that, apart from the acknowledged references, this thesis either does not use language, ideas, or other original material from anyone; or has not been previously submitted to any other educational and research programs or institutions I fully understand that any writings in this thesis contradicted to the above statement will automatically lead to the rejection from the MBA program at the International University – Vietnam National University Hochiminh City

TABLES OF CONTENTS

LIST OF TABLES 7

LIST OF FIGURES 8

ABSTRACT 9

CHAPTER I: INTRODUCTION 11

1.1BACKGROUND: 11

1.2RATIONALE FOR THE STUDY: 15

1.3RESEARCH OBJECTIVES: 16

1.4SCOPE OF THE RESEARCH: 17

1.5RESEARCH SIGNIFICANCE: 17

CHAPTER II: LITERATURE REVIEW 19

2.1M&A DEFINITION: 19

2.2MOTIVATION OF MERGER AND ACQUISITIONS ACTIVITIES: 23

2.2.1.ECONOMIC MOTIVES: 23

2.2.2.OPERATIONAL SYNERGY: 23

2.2.3.FINANCIAL SYNERGY: 24

2.2.4.THEORY OF MARKET POWER: 24

2.2.5.STRATEGIC REALIGNMENT: 25

2.2.6.REGULATORY CHANGE: 25

2.2.7.TECHNOLOGICAL CHANGE: 25

2.2.8.MIVALUATION HYPOTHESIC: 26

2.2.9.BUYING UNDERVALUED ASSETS (Q-RATIO): 26

2.2.10.DIVERSIFICATION: 27

2.2.11.AGENCY PROBLEM: 27

2.2.12.HUBRIS OF MANAGEMENT: 27

2.2.13.TAX MOTIVES: 27

2.3VALUATION MODEL: 31

2.3.1.UNDERSTANDING THE INDUSTRY AND INTERNAL OPERATIONS:32 2.3.2.VALUATION: 34

CHAPTER III: RESARCH METHODOLOGY 40

3.1RESEARCH MODEL: 40

CHAPTER IV: BUSINESS ANALYSIS 44

4.1INDUSTRY OVERVIEW: 44

4.2VIET NAM MARKET OVERVIEW: 46

4.3OPPORTUNITY: 48

4.4THREAT: 49

4.5COMPANY PROFILE: 51

4.6BUSINESS DESCRIPTION: 53

4.7SWOT ANALYSIS: 54

CHAPTER V: VALUATION 58

5.1FINANCIAL ANALYSIS: 58

5.2FORECASTING: 64

5.3VALUATION: 80

COST OF DEBT: 80

COST OF EQUITY: 81

COST OF EQUITY CALCULATED BY INDIRECT METHOD IS DEFINED AS: 84

LONG TERM GROWTH RATE: 86

CHAPTER VI: ACQUISITION OF COMECO BY PVOIL 89

6.1 VALUATION OF COMECO AS IF IT WERE MERGED INTO PVOIL: 89

CHAPTER VII: CONCLUSIONS AND RECOMMENDATIONS 92

APPENDICE 79

BALANCE SHEET: 79

INCOME STATEMENT: 87

CASH FLOW STATEMENT 90

BETA BY COMECO LISTED ON HOSE: 94

FORECAST INCOME STATEMENT: 96

FORECAST BALANCE SHEET: 99

MERGED-FIRM: 114

FORECAST BALANCE SHEET: 121

BETA BY INDUSTRY SECTOR IN U.S 127

COUNTRY RISK PREMIUM: 131

QUESTIONNAIRE OF ACQUISITION 148

REFERENCE 153

List of Tables

Table1: Price of WTI Crude oil and Viet Nam A92 since 2007 35

Table 2: Sales Revenue, Net Income and World Oil Price of COMECO in years VND 44

Table 3: Short-term Solvency Long-term Solvency of COMECO compared in years 45

Table 4: Long-term Solvency of COMECO compared in years 45

Table 5: Profitability ratio of COMECO compared in years 46

Table 6: COGs forecast of COMECO in next 10 years 47

Table 7: Comparison the annual growth rate of Revenue and Cost of Goods Sold 48

Table 8: The growth rate COGs, Crude oil and Exchange rate in years 49

Table 9: Revenue and COGs forecast of COMECO in next 10 years (VND) 50

Table 10: Selling Expense and Administrative Expense of COMECO forecast in the next 10years (VND) 50

Table 11: Cash of COMECO forecast in the next 10 years (VND) 51

Table 12: Inventory Forecasting of COMECO in next 10 years (VND) 52

Table 13: Forecast of Account Receivable of COMECO in the next 10 years (VND) 52

Table 14: Forecast of Other Current Asset of COMECO in the next 10 years (VND) 53

Table 15: Fixed Assets forecasting of COMECO in the next 10 years (VND) 54

Table 16: Capital Expenditures and Depreciation forecasting of COMECO in the next 10 year (VND) 55

Table 17: Account Payable Forecasting of COMECO in the next 10 years (VND) 55

Table 18: Change in Net Working Capital forecasting of COMECO in the next 10 years (VND) 56

List of Figures

Figure 1: Historical data on M&A Activity – Vietnamese Targets 11

Figure 2: Viet Nam Oil Production and Consumption, 1990-2011 12

Figure 3: Model Of Business Analysis And Valuation 22

Figure 4: SWOT Analysis Framework 24

Figure 5: Equity valuation with FCFE 28

Figure 6: Equity valuation with FCFF 29

Figure 7: Model of Methodology 30

Figure 8: Common Theories of What Causes Mergers and Acquisitions 31

Figure 9: World liquid fuels consumption, world GDP, and WTI crude oil price 34

Figure 10: Materials-Petroleum Joint Stock Company (COMECO)’s ownership structure 2011 39

Figure 11: Viet Nam Real GDP growth rate and Inflation rate 48

Figure 12: Inventory Forecasting of COMECO in next 10 years (VND) 63

Abstract

In recent years, Merger and Acquisition (M&A), has been developing very fast in the value and number of deals The aim of this research is to investigate the competition between Vietnam Oil Corporation (PVOIL) and Sai Gon Petro Company Limited (SGP) in acquiring Materials-Petroleum Joint Stock Company Oil (COMECO), specifically about the acquisition decision between PVOIL and COMECO Several models and methods are applied in order to find the intrinsic value of COMECO as a stand-alone firm and as a merged firm Being merged into PVOIL, COMECO may receive potential additional value from the acquisition by PVOIL The analysis and valuation based mainly on the data and information sources given by the valuation process and the interviews with key personnel in PVOIL

The findings of the research are that the merge may bring significant benefit to COMECO The discussion further expands to the fact that price fluctuation after the announcement has not reached to reflect the premium due to the nature of the negotiation process, the bargaining power of PVOIL and its timing of the market This research with its interesting findings, are expected to give the managers of COMECO and PVOIL clearer views about valuation, benefits and costs realized from the acquisition, so that they can proceed with suitable strategies to make more benefit from the deal

Abbreviations

APEC : Asia-Pacific Economic Cooperation

ASEAN : Association of South East Nations

COGS : Cost of Goods Sold

COMECO : Materials-Petroleum Joint Stock Company Oil

EIA : Energy Information Administration

GDP : Gross Domestic Product

M&A : Mergers and Acquisitions

OPEC : Organization of the Petroleum Exporting Countries

PETEC : Petec Trading & Investment Corporation

Petechim : Petro Vietnam Trading Company

Petrolimex : Vietnam National Petroleum Group

PVOIL : Vietnam Oil Corporation

SGP : Sai Gon Petro Company Limited

WTI : West Texas Intermediate

WTO : World Trade Organization

Chapter I: Introduction

In the Sixth National Party Congress in December 1986, Viet Nam launched

“Doi Moi”, popularly known as renovation policy which officially abandoned the central planned system and shifted Viet Nam to a market-oriented economy under a Socialist Orientation, aiming to restructure and modernize the economy to encourage foreign investment The main elements were the state‟s recognition of private ownership and multi-sector development, the liberalization of foreign trade and FDI, and the implementation of the socio-political and economic reforms (des Lestrange &

Richet 1998; Mai, Bilbard, & Som 2009

For more than two decades, Viet Nam has been becoming a true emerging market, growing opportunities for investors and integrating into the world economy ever since Viet Nam is involved in several ongoing economic integration processes when becoming a full member of Association of South East Nations (ASEAN) in

1995, the Asia-Pacific Economic Cooperation (APEC) in 1998 and World Trade Organization in January 2007, negotiated a trade treaty with the European Union and US in 2001 The overall cumulative impacts of economic integration process have been very positive for economic growth and development in Viet Nam and the inflation rate was reduced sharply to around 20 percent in 1990s.The whole economy has gained high development when the GDP growth rate achieved 9.5 per cent and 9.3 per cent in 1995 and 1996 before the Asian crisis and continued growing up from 4.8 per cent in 1999 to 8.5 per cent in 2007.Because of the global economic crisis, the GDP growth rate reduced to 6.3 percent and 5.3 percent in 2008 and 2009 respectively before returned 6.8 percent in 2010 and fell down to 5.9 percent in 20111.Because of the crisis, Viet Nam‟s economy had faced many

difficulties such as the credit crunch and high interest rate which caused the economic and financial crises which significantly affected on Vietnamese stock market As a result, many stocks are being traded undervalue and even below par value In addition, more than 90 per cent of companies in Viet Nam are small-and medium sized enterprises, which may have low competitive advantage, small scale, low technology, poor management skill, etc , that make them become the target in industry restructuring in Viet Nam Because of the economic downturn, many companies faced difficulties in operation and capital access so they were forced to

be bankrupt or sell to others Merger and Acquisition (M&A) have made immediate contribution to restructuring of the trouble economies such as operational restructure, more productive re-allocation of physical and financial resources in the economy The total deal volumes plunged from 41 deals in 2003 to 23 deals in 2004 and further to 22 deals in 2005 But the number of deals recovered in 2006 and reached 413 deals in 2011, set a new record, with impressive growth of 135 per cent and worth $ 4,700 billion (SeeFigure 1) 1

Total Value of Deal (US Million)

Figure 1: Historical data on M&A Activity – Vietnamese Targets

(Source: Thomson Reuters, PricewaterhouseCoopers research)

The value of Viet Nam M&A deal was USD 1,5 billion in the first quarter of

2012 , grew by 270 per cent compared to the same period last year and ranked 8th in deal value in Asia Pacific 2.Because of restructuring and seeking capital after economic crisis, the M&As in Viet Nam will increase quickly in the next few years and many foreign investors, private equities many divest in Viet Nam market through M&As which create more opportunities for other companies to expand their business The consulting firms and professional brokers will take more important role in linking the transactions M&As activities in Viet Nam are forecasted to continue rising in many sectors, ranging from finance, banking, consumer goods to even in importing and distributing petroleum products Even Viet Nam does not intend to sell stake in petroleum distribution companies to investors and this sector is dominated by state-owned, the high economic growth rate and demand on energy consumption , is forecasted increase 5 percent to 7 percent at annual rate which is highly potential for many investor and distributors

The distributors and retailer energy in Viet Nam is dominated by the State, this means there is minimal competition in the domestic market Furthermore, the high

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Viet Nam Investment Review 2012

economic growth rate and demand on energy consumption in Viet Nam, is forecast

to increase 5%-7% at annual will be very potential for many investors and distributors to acquire other company to expand their business (See Table 2)

Figure 2: Viet Nam Oil Production and Consumption, 1990-2011

(Source: EIA International Energy Statistics) Viet Nam‟s oil is running by state-owned Viet Nam Oil & Gas Corporation (Petro Viet Nam), under the Authority of Ministry of Industry and Trade who control fully the operator and regulator in the industry and contributes a quarter of the state budget The two state-own companies, Vietnam National Petroleum Group (Petrolimex) who accounts for 60 per cent and Vietnam Oil Corporation (PVOIL) holds 20 per cent of market share in petroleum distribution network Sai Gon Petro Company Limited (SGP) and Petec Trading & Investment Corporation (PETEC)

currently who hold 12-15 percent individually in market3.Because of the domination

of Petrolimex under government-support in Viet Nam whole sale and retails in petroleum market, the two major stated -owner, PVOIL and SGP are trying to compete and open more market size Although in Vietnam oil sector is still exclusively imported and domestic petroleum business, but whether after the end of

2018, will this monopoly end? At that time, retailers can negotiate directly with the distributors on price, would have more competition on market and distribution system This is probably why PV Oil has been purchasing additional shares of Materials- Petroleum Joint Stock Company Oil (COMECO) - a listed company specializing in supplying and distributing petrol and oil

1.2 Rationale for the study:

After 1975, Gas and oil control department of Public Traffic office formed to function as managing and providing petroleum product in HCMC, then renamed to Gas and oil supply department, being a former of Materials-Petroleum Joint Stock Company Oil (COMECO) In August 2006, COMECO company‟s shares firstly were exchanged in HCM securities trading center COMECO developed an infrastructure system to receive, store and distribute petroleum, oil products to Ho Chi Minh City (HCMC) and other regions in the South Until now, company has retail distribution network, mostly located in prime locations and the storage being built in Dong Nai and the COMECO building located on Dien Bien Phu street, Ho Chi Minh

In particular, COMECO owned retail distribution network throughout Ho Chi Minh City with 33 petrol stations, and continue expanding more network by expanding distribution network This is believed to be the reason for why PVOIL and SGP want to acquire COMECO in order to expand the retail distribution network in

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US Energy Information –Country Vietnam-Last updated May 2012

Ho Chi Minh to compete with Petrolimex which holds 60 per cent of the market in Viet Nam The reports on retail market share of COM showed that the company stands just behind Petrolimex Company in Ho Chi Minh In late 2011, PV Oil and SGP has been competing to buy shares COMECO and the ownership of PVOIl in June 2012 of COMECO was 31.4 per cent compared with 30 per cent last year and the shares of SGP about 26.6 per cent Especially, PVOIL and SGP have two people

in Board of Director of COMECO at the annual shareholders‟ meeting of COMECO

in April 2012 Currently, PV Oil has registered to buy 494,039 shares to raise ownership up 34.9 per cent from June 2012 to July 2012 by purchasing on stock exchange In the trading report in August 2012, PVOIL hold 31.5 percent and continues register buying in order to increase up to 33.99 percent

Furthermore, PVOIL can take advantage of the ownership of PETEC, who is the subsidiary of National Oil Corporation of Viet Nam (PVN), in COMECO of 3.4 percent Taking this into account, the ownership of PVOIL in COMECO could be more than 10 percent than that of Saigon Petro (Cafef 2012)

The announcement of acquisition of COMECO by both PVOIL and SGP, which is called "a campaign for the COMECO target", however has not ended yet PVOIL has tried hard for the target Whether the decision to purchase and take full control of COMECO is a strategically wise? What are the motivations behind the transaction? If this is a wise strategic step for PVOIL to take full control over COMECO, what should be an appropriate offer price for the deal? This research aims

to answer the above question

This research aims to perform following objectives:

 Analyze the motivations behind the acquisition of COMECO on the point of views of PVOIL and verify whether the acquisition is a good decision

 Perform business analysis and valuation of COMECO to come up with a reasonable price on the point of views of PVOIL

1.4 Scope of the research:

The scope of research is to study be the decision to acquire COMECO by PVOIL and the valuation of COMECO by collecting data for the period from June

2006, when the company initially listed on the stock market

This research might be helpful to PV Oil in a way that its findings and analyses help the company to reconsider benefits and costs of the acquisition of COMECO Also, it helps to reconsider the fundamental factors impacting on the future growth of COMECO and helps to estimate a reasonable price for COMECO, avoiding overpaying for the target

Furthermore, the fact that Vietnam is being a WTO member will bring some defined obligations requiring furthering more open markets to foreign competition, which would impress more competition on Petroleum market and distribution system

well-It is expected that the market for oil and gas distribution network be more and more fierce in the near future when foreign investors are allowed to enter the local market Building distribution network cannot be done in a short period of time Merger and acquisition in this case is a helpful tool for vertical expansion The fact that Dung Quat Refinery factory, which is currently wholly state owned, is to be privatized and sold out to foreign investors its 49 percent of ownership shows a potential increasing trend of merger and acquisition activities in oil and gas distribution sector How to value local distribution companies who enjoy across provinces gas stations, storages,

and transportation vehicles requires a deep industry understanding This research aims

at analyzing business opportunities in oil and gas distribution sector to allow achieving a reasonable valuation of local distribution companies

This research applies both qualitative and quantitative approaches to achieve

the research objectives

In analyzing the acquisition transaction to explore the motivations and benefits

of the transaction to PVOIL, qualitative research will be conducted through interviewing the key personnel of PVOIL, collecting published news, articles, about the acquisition and some previous relevant report The author will search information first by indentifying the motivation of the acquisition that happening in the market and then investigating such information about the deal based on theoretical model for merger and acquisition motivations and benefits to conduct the qualitative research

In analyzing the target firm to arrive at a reasonable price for COMECO, theories for business analysis and valuation will be applied Firstly, discounted cash flow valuation will be used in order to find the intrinsic value of firm in case of operating independently Thereafter, the author will analyze the advantage and disadvantage of COMECO being acquired by PVOIL, in which discounted cash flow model is used to value the firm as if the company were fully merged into PVOIL From this point, the deal premium coming from synergy of acquisition will be recommended for both investors and target firm

Chapter II: Literature Review

2.1 M&A Definition:

Mergers and acquisitions (M&As) and corporate restructuring have become the most popular methods of growth companies in corporate finance world Merger refers the combination of two companies into one business entity and when a small company is purchased by one firm by paying shares, cash or other assets is called the acquisition

According to Gaughan (2007) “A merge is a combination of two corporations in which only one corporation survives and the merged corporation goes out of the existence” (p.12)

Black‟s Law Dictionary defines mergers and acquisition as the following: Merger: The union of two or more corporations by the transfer of property of all, to one of them, which continues is existence, the others being swallowed or merged therein

Acquisition: The act of becoming the owner of a certain property

Divestiture: to deprive; to take away; to withdraw

Merge can be defined as an arrangement the assets of two or more firms become one, or under the control of a company In other words, merge is the combination of two companies to become a large firm and considered to be successful

if it increases the acquiring firm‟s value The activities include the conversion or payment in cash for the target firm In case of merge between two companies, there often is an exchange of stock by one firm issues new share to the shareholders of the other firm at a certain ratio The firm has the share continue to exist is referred to as the acquiring firm, even if that occurs under an alternate company name and the firm

whose shares are being replaced by the acquiring firm usually called the target firm ) According to KPMG‟s report4

, six periods of high merger activity, often called merger waves, have taken in the history of the world by categorizing types of M&A‟s The First Wave (1893-1904) was known as major horizontal mergers in the manufacturing and transportation industries After that, in the Second wave in 1919-

1929 bring the consolidation of the industries which created by the first Wave The third Wave (1955-1970) indicated the new picture of expansion and diversification which was helpful for firm entering in new markets In the Fourth Wave (1974-1989) was known as the leveraged taker over and the collapse of bank‟s capital structure because of the large investment bank financed this transactions, commonly in “hostile takeover” The Fifth wave (1993-2000) was one of major appetite for larger economies of scale and made multinational conglomerates The Sixth Wave (2003-2008) was the picture of the globalization of firms needs to create a multi-national reach

A merger activity is occurring when the two firms are in the same industry and agreeing to combine in new business with the greater scale and higher competitiveness Considering the financial structure, a merge differs from a consolidation and are sometime used interchangeably The consolidation happens when two or more companies are merged under new legal entity and formed an entirely new company whose name is a combination of the names of the merged companies A Merger between Lien Viet Bank and Viet Nam Postal Saving service Company created Lien Viet Post Commercial Joint Stock Bank in 2011 Vietnam Postal Saving Service had fund raising from the public but was not allowed to lend meanwhile Lien Viet Bank was a young bank and wanted to invest and develop their

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KPMG;The Seventh Wave of M&A (2011)

branches and transaction office network The merge had saved a huge amount of money of Lien Viet Bank by using nearly 10,000 outlets of the postal company to expand its banking services 5

According to the Law on enterprises 2005, the consolidate enterprise is “Two or more enterprises transfer all the assets, rights and liabilities, and legal interests to form a new enterprise, simultaneous cease the exits of consolidating enterprises” (Article 17 Competition Law) In case of one company has consolidated market share since 30 per cent to 50 per cent of relevant market, the legal representative of company being consolidate must notify the agency managed competition before proceeding consolidate However, the competition law prohibits the consolidation of market shares of enterprises participating in economic concentration account for over

50 per cent on the relevant market, except of bankruptcy or the consolidation which contributes the socio-economic development, technical and technological advance5 ( Article 18,19 Competition Law )

Like mergers, the term “acquisition” tends to be used when larger firm absorbs a smaller firm for seeking advantage of synergies such as economies of scale, efficiencies and enhanced market visibility from this acquisition Unlike all mergers, all the acquisition involves one firm purchasing another can integrate or create a larger company from two smaller companies (Adward & Gerald, 2005).The term acquisition is used instead of takeover, to replace of owner ship or by acquiring the right to control the management by an individual, group or individual company In take over activities, the company owner has the right to alter the Executive Committee and redirect the business of the target company The brand name of target companies can be retained or changed depending on the acquiring firm and it increases efficiency

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Stoxplus 2011

of business, market share and especially the competitiveness The activities include not only the purchasing firm in cash, shares or combination of both, but also by buying all the assets of the purchased company An acquisition may be friendly or hostile In case of hostile, the two companies‟ proceed negotiations, but the target company is either not willing to sell or the management of Target Company being unaware of intention of the buyer Takeovers can occur in many ways such as merger, tender offer, or proxy contest and the combination of all activities In case of merger through tender offer, the buyer will proceed to buy common stock of target firm at a price which could be over the market value by bidding firm who will negotiated and approved by target‟s board of directors before voting of target shareholder for approval The tender refers the buying of shares directly with the shareholders of target firm who are to sale stocks to the bidding firm In addition, the proxy contests indicate the group of dissatisfied manager or large stockholder try to take control on the board of directors.(Jensen and Ruback ,1983)

There are three types of mergers and acquisition and classified into horizontal, vertical, and conglomerate The horizontal refers the synergies or economies of scale

of competing companies in the same industry, which reduce competition and gain greater market power Vertical is between the firms have buyer – seller relationship or

in the value chain in order to reduce uncertainty and transaction costs and control the whole value chain The advantage of vertical merger is to ensure and control the quality of raw materials or products, reduce the intermediaries cost and manage source of competitor's outputs When two or more companies are not in the same business but want to diversify and expand their business activities in the other area, the transaction is called a conglomerate merger It provides the advantage of decentralization and autonomy of the acquired (Gaughan,2007)

2.2 Motivation Of Merger And Acquisitions Activities:

The motivation of M&A activities have been discussed for many years and numerous theories to classify M&A motives into economic scope and scale, efficiency improvement and cost reduction or based on types of M&A activities such

as horizontal, vertical and conglomerate Three main motives for takeovers which have been figured of in the literature as synergy motive, which indicates the benefit of economic scale when merging two sources of companies Secondly, the agency motive refers the potential profit to both acquirer and target firm or main purpose is to maximize the share holder value Finally, the hubris hypothesis is mentioned that there is no synergy in the acquisition but and overestimation in valuing in the target firm, which causes the losses of the bidder to the target firm.(Berkovitch, E., & Narayanan, M.P 1993) Because of the numerous explanations available, we will categorize the motives of takeovers in the most common in the literature which have development of some hypotheses to explain motives The motives of takeovers are divided into: Economic motives, Strategic realignment, Market timing and other

motivation

2.2.1 Economic Motives:

Theory of synergies: this term refers to the combination of two businesses creates greater shareholder value than if they are operated separately The two basic types of synergy are operational and financial synergy

2.2.2 Operational Synergy:

The operating synergy has a important role to create wealthy of shareholder which has both economies of scale and economies of scope (Houston, James, and Ryngaert, (2001); Delong, 2003 (cited by Depamphilis 2012)) It refer the economies

of scale by dividing the fixed cost such as depreciation of equipment and amortization

of capitalized software, maintenance expense on more number of units and consequently, it increase profit margin or decrease selling price, sale increase Economic of Scope tends to show the ability of firm to create a broader range of products and services from the inputs In general, Operational Synergy tends to look for cost-reducing synergies, improve market reach and industry visibility

2.2.3 Financial Synergy:

It refers the possibly of lower cost of capital by combining one or more companies The combination of two firms would reduce the cost of capital, risk if the firm's cash flow stream are not correlated It is the possibly to use of the surplus funds

of the subsidiaries When the two companies have cash flow uncorrelated merger together this will increase shareholder value because of taking surplus capital of each others in order to reduce the cost of capital This is explained because if a company is growing (often short of cash) was merged with a stable company operating in saturated markets (have abundant cash receipts and stability), will support each other

very well in combining capital resources in stable operating companies

2.2.4 Theory of Market Power:

In the theory of market power, the purpose of merge is to increase their monopoly power in the current market, but there are less empirical which prove such theory In fact, many studies proved the market power theory has affects on the performance of operating firm more efficiency than to increased market power of the

the ability of firm when taking over, the possibility of rapid growth, extend more powerful on current geographical and environment, the firm could take more control the quality, price and supply of its products because of the profit on the economic scale

2.2.5 Strategic Realignment:

The strategic realignment theory refers the change in external environments consist of two factors regulatory and technological innovation by using M&As to make rapid adjustments, even though that the change can come many different sources (Depamphilis 2012, page 9)

2.2.6 Regulatory Change:

Those industries that have been subject to significant deregulation in recent years, financial services, healthcare, utilities, media, telecommunications, defense-have been at the center of M&A activity because deregulation breaks down artificial barriers and stimulates competition (Mitchell and Mulherin, 1996,Mulherin and Boone, 2000, (cited by Depamphilis 2012, page 10) When Viet Nam became a member of World Trade Organization (WTO) in January 2007, Viet Nam had to issue the licenses to wholly foreign-owned banks such as Hong Kong and Shanghai

international commitments and regulation of WTO

2.2.7 Technological Change:

The development of technology creates new products and industries The large companies have been putting that money to work in mergers and acquisitions, building on their strong position by moving into new product and service lines By M&A s , they are pursuing vertical acquisition opportunities to capture a large share

of the value chain , cost-reducing in R&D and innovating new products, technologies Google announced an entrance into the mobile handset market in a big way with the acquisition of Motorola Mobility Microsoft Corporation plays a role in developing prepackaged software specializing in social and real-time communication over the Internet by acquiring Skype Global

2.2.8 Mivaluation Hypothesic:

In the shortage of full information, investors can ascertain over-or undervalue

a firm And the acquirers can make profit from purchasing undervalue targets by cash below the true value or by using equity In case of the target is overvalued, the acquirers still make profit if the value of target which is overvalued still lower than the bidding firm‟s stock.(Dong et al., 2006, Ang and Cheng, 2006 cited by

2.2.9 Buying Undervalued Assets (Q-Ratio):

The q-ratio is the ratio of the market value firm‟s asset divided their replacement value The value of firm could be undervalue because of economic crisis, inflation, depression, lower management and some acquirers will try to purchase with

a market value less than what it would cost to replace the assets in order to expand their business activities or believe that good management will increase the the firm‟s performance and profitability.(Depamphilis 2012, page 11) According to Viet Nam M&A Research Report 2012, Stoxplus, the average of stock price listed in Viet Nam Stock market are traded undervalue or below book value, account 75 percent and especially many cheap stock currently is under par value ( VND 10,000 or US 0.5) account 60 percent because of global economy crisis since 2008 and credit crunch Furthermore, the tightening monetary policy, high inflation which leaded the high interest rate caused many companies hardly looking for capital or no longer afford to finance Along with that, the impact from the economic crisis, investors lack capital to abandoned projects and real estate consists of housing and landing in Ha Noi and Ho Chi Minh City decrease 40 – 50 percent during 2011 Many investors have many opportunities to purchasing cheap assets such as the total value of M&A deal in Viet Nam in real estate accounted 251 million during the first nine months in 2011

2.2.10 Diversification:

When the company conducts purchase other companies aims to diversify products and services or it growing outside a company‟s current industry category It could be that the firm expands in new industry for opening the market and products or

in more profitable than the acquiring firm's current industry Moreover, the benefit of

diversification refers to the new earning stream which brings more financial synergy

2.2.11 Agency problem:

The agency problem usually refers to a conflict of interest between a company's management and the company's stockholders This happens when the managers only focus to maximize their own wealth instead of increasing shareholder value And the share holder will bear the cost of such mismanagement by the current managers The manager often suffers the pressure when the stock price is low or undervalue and the mergers as way to correct such mismanagement in case of

difference between managers and shareholders

(Fama and Jensen,1983, cited by Depamphilis 2012, page 11)

2.2.12 Hubris of management:

“Acquirers may tend to overpay for targets, having been overoptimistic when evaluating synergies Competition among bidders also is likely to result in the winner overpaying because of hubris, even if significant synergies are present” (Roll, 1986 Depamphilis 2012, page 10) This hypothesis explain the bidder accept their own valuation of target is superior and tend to overpay than accept the market's valuation

or it excess of its economic value

2.2.13 Tax motives:

Tax benefit refers as motivation of M&A activity because the combined firms can reduce the accumulated losses by lower future tax liabilities In addition, the

revalued the book value of acquired assets in to current market value by purchasing method of accounting leads the increasing of assets and the depreciation, which us deducted from revenue in order to calculate a company‟s taxable income, so that the future taxable income which generated by combined firms can be reduced.(Ayers, Lefanowicz, and Robinson (2003) cited by Depamphilis 2011)

List of Theories Meaning

Academic Researches

+Theory of

synergies

Synergies are gained when the sum of the parts is more productive and valuable than the sum of individual components The value created by the combination may result from more efficient management, economies of scale; improve production techniques, the combination of complementary resources, the redeployment of assets to more profitable uses, the exploitation of market power

Jensen and Ruback (1983), Houston,

Ryngaert (2001), and Delong (2003) ( by Depamphilis)

Mulherin and Booner (2000)

+Misvaluation

Acquire assets more cheaply when the equity

of existing companies is less than the cost of buying or building the assets

Sheleifer and Vishny (2003),

Viswanathan (2004), Dong (2006), Hien (2007)

of the target would rise under its control

Lang, Stulz and Walking (1989), Servaes (1991), Martin (1996), Jovanic and Rousseau (2002), Mork, Shleifer and Vishny (1990)

Ayers, Lefanowicz, and Robinson (2003)

Figure 3: Model Of Business Analysis And Valuation

(Source: Hien & other authors,2012)

2.3 Valuation Model:

The valuation of potential firm is the combination of many analyses such as financial, legal, accounting process which focus both the acquirer and target firm The acquirer need to ascertain the value of the target to determine the proper offering price and the target need to know what its company worth Each acquisition candidate has its own unique characteristics that make it different from other firms The most significant valuation potential firm is friendly deals and hostile deals for the bidders access the internal financial data In general, a friendly transaction makes both parties work closely together to reach the detailed internal financial data In contract, the limited information required by law is shown to the bidder in hostile deals This mean that the bidder has to conducts its valuation analysis using publicly available information and it puts the bidder many disadvantages in valuation firm Before

valuation approach, most of investors need to have through understanding of business itself such as internal operations, external factor, trends in the economy and industry

2.3.1 Understanding the Industry and Internal Operations:

Analyzing internal operations of firm is a qualitative process that evaluates how the firm operates in comparison with its peer and its own past performance Albert Humphrey was an American business and management consultant devised the SWOT analysis technique while working for the Stanford Research Institute The theory seems simple enough to evaluate the Strengths, Weaknesses, Opportunities and Threat that involved in business of firm This model also provides frame work that help to analyze the strategy, potential development, and business direction of a company This model is one of the most appropriate techniques to analyze how a company running its business through indentifying the internal and external factors of that company or setting achievable goals or objective for organization

Internal factors are analyzed in the SWOT model are the Strengths and Weakness

of enterprises, besides, the external factors of SWOT model are Opportunities and Threats influenced by outside environment

Figure 4: SWOT Analysis Framework

(Source : http://www.bcelf.org/swot.htm) The internal factors may be viewed as strengths or weaknesses depending upon their impact on the organization's objectives What may represent strengths with respect to one objective may be weaknesses for another objective The factors may include all of the 4P's; as well as personnel, finance, manufacturing capabilities, and

so on are analyzed based on evaluating firms and make a comparison to the competitors In general, these internal factor tend to help to recognize the present situation of the firms

 Strengths: characteristics of the business or team that give it an advantage

over others in the industry It includes tangible and intangible to organizations like sources and capabilities of firms such as human competencies, financial resource and brand images

 Weaknesses: are characteristics that place the firm at a disadvantage

relative to others It includes the limitation of financial resources, management, distributions or the lack of technology, precise marketing plan and weak market brand which detract the ability of firms to achieve their goals, maintain market segment or influence their growth

 The external factors may include macroeconomic matters, technological change, legislation, and socio-cultural changes, as well as changes in the marketplace or competitive position The results are often presented in the form of a matrix

 Opportunities: external chances to make greater sales or profits in the

environment The opportunities arise when firms can recognize and take the benefits of conditions in the environment they operate in, such as rapid

market growth, economic boom, support policies form government or discovery of new products or technology, in order to create accurate plans and execute business strategies to achieve higher profit and improve the firms‟ development

 Threats: external elements in the environment that could cause trouble for

the business The threats arise when business conditions in the external environment can be harmful to the operating activities of corporations The threats to firms appear when due to economic recession, rival firms apply new products or technologies, strict policies of government, and the products of firms go to decline in their life cycle

In fact, the SWTOT analysis is tool to recognize fully the business‟s performance by comparing to the competitors to finger out the advantage, disadvantage and opportunities in order to increase the competition in the market However, this model is only to provide a personal‟s view point and not fully recognizes the internal, external which may really affect on the firm‟s performance In fact, many investors use the historical data as availability and accuracy of financial data provided in financial statements of firms, cash flow statements, which call financial analysis to evaluate whether firms are stale, solvent, liquid or profitable through financial ratio

2.3.2 Valuation:

In general, analysts use a wide range of model to value, ranging from the simple to the sophisticated There are three approaches to valuation including discounted cash flow valuation, relative valuation and contingent claim valuation The discounted cash flow valuation which relates to the value of an assets to the present value of the estimated future cash flow Secondly, relative valuation helps to estimate

the value of business or asset by comparing the price of assets in same environment which have a common variable such as earnings, book value or sales Finally, contingent claim valuation, using option pricing models to measure the value of assets that share option characteristic

 Discount cash flow model (DCF):

According to Damodaran (2002), discounted cash flows are fundamental valuation method for determining the current value of a company using future cash flows adjusted for time value The future cash flow set is made up of the cash flows within the determined forecast period and a continuing value that represents the cash flow stream after the forecast period Therefore, the value of any assets is the present value of expected future cash flow that the asset generates

Where,

n: Life of assets

CFt: Cash flow in period t

r: Discount rate reflecting the riskiness of the estimated cash flows

Because the cash flows cannot be calculated indefinitely, the cash flow forecasting

of firm is done for a time horizon, then after completed by a terminal value of firm The terminal value can be calculated by three ways One is to assume a liquidation the firm‟s assets in the terminal year and estimate what others would pay for the assets that the firms has accumulated at that point The other two approaches are done with the assumption that firm is a going concern at the time of the terminal value estimation One applies a multiple to earnings, revenues or book value to estimate the value in the terminal year The other assumes that the cash flows of the firm will grow

at a constant rate forever- a stable growth rate With stable growth, the terminal value can be estimated using a constant growth model

 Categorizing Discounted Cash Flow Models:

There are many of valuation models in existence In this thesis only Discounted Cash flow model (DCF) and Relative Valuation in order to find out the intrinsic value

of firms based upon its fundamentals The DCF model including Dividend discounted Model (DDM), free cash flow to equity (FCFE), and Free Cash flow to firm (FCFF) There are two components to relative valuation by comparing the price to earnings (P/E), price to book value (P/B) and price to sales (P/S) with other similar firm in the same industry

The most popular valuation approach professionals rely on discounted free cash flow approach The FCFE is cash flow available to be paid out as dividends or stock repurchases, the model is used to estimate how much cash a firm can afford to return to its share holders The free Cash flow to Equity model is defined as the cash flow left after the change of working capital, net debt and net income FCFF is cash flow available to all fund providers, including both debt and equity holders

- Cost of Equity

Cost of equity is the expected rate of return required by shareholders when they invest to firms There are two methods can be used to approach the cost of equity of firms, such as direct method and indirect method

Direct Method – using The Capital Asset Pricing Model (CAPM):

Where,

rE : Cost of equity

rf: Risk free-rate

rm : Expected market return

β: Beta of the security

- Indirect Method:

Because there are many difficulties in estimating beta of companies listed on the exchange in developing stock market due to the inefficient performance and unreliable trading transaction data in these stock exchanges It will be more accurate

to calculate the cost of equity based on the standard measurement of another developed security exchanges, such as the United State of America stock exchanges

Cost of equity calculated by indirect method is defined as:

E [RA] VN = E[Rsame industry] US + RPC + RPE

RPE: The exchange rate risk premium

- Weighted Average Cost of Capital (WACC)

The Weighted Average Cost of Capital (WACC) is the rate that firms are expected

to pay on average to all its security holders to finance their assets When conducting DCF model, the WACC rate is generally used as discount rate, which reflects the risk

of the cash flows The WACC is defined as:

D Tc

r D E

E r