Structuring Repsol’s Acquisition of YPF

How significant are the expected synergies and restructuring effects? Please prepare an estimate of the value of these.
For Repsol and its shareholders, the YPF acquisition deal is seen as an ideal strategic match. The Spanish oil company gets most of its revenues from activities like refining and gasoline stations, and must buy much of its crude oil from others, while YPF owns substantial reserves because its activities are dominated by exploration and production of oil. As a united company, Repsol will have a much better balance of business, quadrupling its reserves, and vaulting into the big leagues of the top 10 international players. But with the reserves of YPF, it will instead benefit from rising prices, and expand its activities to other countries in Latin America.
Repsol-YPF seeks to achieve a balance between upstream and downstream operations, position itself as a market leader in Latin America, achieve operating and capital expenditure synergies and consolidate its business scale and financial strength. As part of its integration strategy, Repsol-YPF will begin to dispose of select assets which do not correspond to its core businesses outlined above or to its core geographic areas which include Spain, Latin America and North Africa.

Synergies Estimate
Cost savings after tax of $350 million by 2000, 1.6% cost savings in 1998, reduction in capital expenditure from $15.6 billion to $13.6 billion, reduced finding costs by 25.0%, as a result of decreased test drilling activity and the implementation of new technology, and lifting costs by 4.6%, as a result of synergies with YPF’s operations and increased levels for gas production, which has lower lifting costs than oil production, divesting non-core assets to yield $2.5 billion in 2002.
2) Please assess the price that Cortina proposes to offer to YPF shareholders. At $44.78 per share, would Repsol underpay, overpay, or just offer a fair price?
Attached Excel,
The price of $44.78 per share was a fair price as there was a strategic fit and synergies between the two companies. YPF was focused on upstream and thus balanced Repsol’s downstream activities.
In the attached excel, I performed valuation of YPF by subtracting PV of Repsol from PV of Repsol-YPF combined with synergies at WACC of 10.9% (all debt financing).
I got the value as 10.472 billion dollars./ The additional (13 billion- 10.472 billion) is the premium which Repsol is paying for geographic and business diversification.
Adj PV Formula used by me:
EBIT
– Taxes on EBIT
=Net Operating Profit After Tax (NOPAT)
+ Non cash items in EBIT
– Working Capital changes
– Capital Expenditures and Other Operating Investments
=Free Cash Flows
Take Present Value (PV) of FCFs discounted by Return on Assets % (also Return on Unlevered Equity %) + PV of terminal value
=Value of Unlevered Assets
+ Excess cash and other assets
=Value of Unlevered Firm (i.e. firm value without financing effects or benefit of interest tax shield) + Present Value of Debt’s Periodic Interest Tax Shield discounted by Cost of Debt Financing % =Value of Levered Firm
3) Please assess the current pricing of Repsol shares in the market. Is
Repsol undervalued, overvalued, or just fairly valued in the global equity markets at this time? Is now a good time to issue Repsol shares?
From Exhibit 11, the current price of Repsol stock is 18-19 $ per share. Actual Value of Repsol share is 7010/900 = $7.78per share from Exhibit 3.
Using valuation using DCF, I arrived at $ 22.33 per share for Repsol(attached Excel). Hence it is fairly valued.
4) Compare the relative advantages and disadvantages of offering to the shareholders of YPF either (a) cash or (b) shares of Repsol. If you were a shareholder in YPF, which form of consideration would be more attractive (assuming that the amount of consideration would be constant at $44.78 per share)?
Advantages of cash financing are
Cheaper than equity, tax benefits from tax shields, Decrease in combined cost of capital, creating value for shareholders, largest fixed income offer.
Disadvantages of cash financing are
Sudden increase in Repsol’s leverage, downgrade in debt ratings, increased cost of debt, inability to meet future unforeseen financial requirements, probability of default, sensitive to price changes, signaling to investors, shorter maturity period and uncertainties.
Advantages of stock financing are
Expand its unused debt capacity, prepared for aggressive growth via acquisitions, maintain coverage ratios and credit ratings.
Disadvantages of stock financing are
Reduced EPS due to dilution, more business risk, dependence on Repsol’s share price, clash in investors’ interests between shares of developed and developing economies.
Cash financing is a better option for shareholders of YPF as they would receive a fixed price and would not participate in additional gains or losses post acquisition.
5) Whether or not you favor a cash-based offer for YPF, please compare the relative advantages and disadvantages of the (a) all-debt-financed cash offer, (b) all-equity financed cash offer, and (c) blended financing of debt, preferred stock, and equity. How significant are variations in default risk in the assessment of the financing alternatives (see case Exhibit 10)?
Attached Excel sheet,
Considering Country Risk, all debt financing gives the highest valuation of Repsol-YPF and variation due to risk is least in all debt financing offer.
Considering minimum Country Risk, all equity financing gives the highest valuation of Repsol-YPF but variation due to risk is highest in all equity financing offer.
Blended financing gives minimum variation in valuation of Repsol – YPF . The variations in default risk are significant in assessing the alternatives as that affects WACC and hence valuation.
6) What course of action would you recommend that Alfonso Cortina adopt regarding form of payment and financing for the tender offer for YPF? On what “key bets” does your recommendation depend?
Cortina should make an all cash payment to acquire YPF at 44.78$ per share to avoid the disadvantages of equity financing and also considering bylaws of YPF.
Repsol’s strategic plan is based on three fundamental premises: growth, transformation of portfolio and profitability. The primary objective for Repsol is to guarantee sustainable dividend growth for its shareholders.
Repsol will implement a strategy of profitable growth for all of its
businesses, based on the optimisation of existing projects, the development of new projects, and the analysis of possible business opportunities in areas of interest to the company. It states that the downstream business which includes chemicals will contribute solid growth and stable cash flow for the company.
The Repsol chemical business is believed to hold a ‘sound position in international markets’, strengthened by a high integration with the refining and exploration and production business areas, access to competitive technologies and the company’s ongoing efforts in cost contention.
7) In general, what is the influence of deal financing on other aspects of M&A deal design?
A widely used approach to evaluating financing alternatives is the FRICTO framework. The framework can help to identify trade-offs along six dimensions:
Flexibility: the ability to meet unforeseen financing requirements as they arise. Flexibility may involve liquidating assets or tapping the capital markets in adverse market environments or both. Flexibility can be measured by bond ratings, coverage ratios, capitalization ratios, liquidity ratios, and the identification of salable assets. Risk: This is the predictable variability in the firm’s operating cash flow. Such variability may be due to both macroeconomic factors (e.g., consumer demand) and industry- or firm-specific factors (e.g., product life cycles, biannual strikes in advance of wage negotiations).
To some extent, past experience may indicate the future range of variability in earnings before interest and taxes (EBIT) and cash flow. High leverage tends to amplify the impact of these predictable business swings—this amplification is what is commonly called leverage. In theory, beta should vary directly with leverage. The firm’s debt rating will provide a second external measure of risk of the firm. Income: This compares financial structures on the basis of value creation. Measures such as DCF value, projected ROE, EPS, resulting price/earnings ratio, and cost of capital indicate the comparative value effects of alternative financial structures.
Finance theory tells us that (all else equal) the value-maximizing capital structure is also that which minimizes the weighted average cost of capital. Thus, the analyst can devote attention to the capital cost resulting from the different financial structures. Finally, economic profit, or EVA, summarizes the joint impact of capital structure, investment, and operating profit effects. Control: Alternative financial structures may imply changes in control or different control constraints on the firm as indicated by the percentage distribution of share ownership and by the structure of debt covenants. Significant investors will be sensitive to the dilution in their voting position in the firm, implied by different acquisition financing alternatives.
Timing: This asks the question of whether the current capital market environment is the right moment to implement any alternative financial structure, and what the implications for future financings will be if the proposed structure is adopted. The current market environment can be assessed by examining the Treasury yield curve, the trend in the movement of interest rates, the existence of any windows in the market for new issues of securities, P/E multiple trends, and so on.
Chiefly, one wants to look for evidence of over- or undervaluation of securities in the capital market. Sequencing considerations are implicitly captured in the assumptions underlying alternative DCF value estimates and can be explicitly examined by looking at annual EPS and ROE streams under alternative financing sequences. Other: Since no framework can anticipate all possible effects, the “O” reminds the analyst to consider potential idiosyncratic influences on the decision. Two such items are investment liquidity of the owners and estate planning considerations. As these examples suggest, such considerations tend to be more influential in smaller and privately held firms. However, a major “other” consideration for large publicly traded firms is the signaling content of their financial choices.
The issuance of equity is typically accompanied by decreases in share prices; issuance of debt is accompanied by increases. One interpretation of this result is that the type of financing signals optimism or pessimism about the future by insiders in the firm.
This framework can be used to indicate the relative strengths and weaknesses of alternative financing plans. To use a simple example, suppose that your firm is considering two alternatives for financing an acquisition: a new issue of debt to fund a cash payment or a new issue of equity in exchange for the target’s shares. Looking across each row, the decision maker can determine which alternative dominates on each criterion.
The debt structure is favoured on the grounds of income (perhaps reflecting debt tax shields and no share dilution), the absence of voting dilution, and today’s interest rate conditions. The equity structure is favoured on the grounds of flexibility, risk, absence of covenants, today’s equity market conditions, and the long-term financial sequencing benefits.
THINK LIKE AN INVESTOR
The definition of a good capital structure would be one that maximizes shareholder value. This structure will also minimize the weighted average cost of capital and maximize the share price and value of the enterprise.

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