Manufacturing

Merger Creates Wealth

For Riordan Manufacturing to gain from a merger it has to create synergies. Synergies are anticipated benefits from the merger. Basically shareholders of both firms must come to a consensus that merged stocks is more beneficial than holding to individual share of the merging companies Factors contributing to a pro-merger argument are: (1) economy of scale; (2) tax benefits; (3) capitalization on unused debts; (4) complimentary in financial slack; (5) removal of ineffective managers; (6) increased market power; (7) reduction in bankruptcy costs; and (8) buying below replacement costs merger.

Economy of Scale.

"Wealth can be created in a merger through economies of scale." In a typical merger number of operational layers become one; thus, redundancies are eliminated. Also, by merging two entities better producing resources are kept and unwanted financial burdens are phased out.

Tax Benefits.

Tax reduction through a merger is in fact creation of wealth.There are two ways that tax-benefits can create wealth: (1) utilization of operation loss tax-credit (forward and back); and (2) reevaluation of depreciated assets.

Utilization of operation loss tax-credit.

In a merger, it is stipulated that one of the two merging firms has a weaker financial status; and the other merging firm has strong finances. Tax credits gained from operation loss by one of the merging firms can compensate for tax liabilities incurred by profitability of the other firm.

Reevaluation of depreciated assets.

In a merger, previously depreciated assets can be revalued and tax benefits arising from increased depreciation of revalued assets create wealth.

Capitalization on Unused Debts.

Companies for various reasons may not take maximum advantage of their debt capacity. Merger creates climate of development opportunities, and a strong management that emerges from the merger can increase debt financing, and fully utilize the tax benefits associated with the increased advantage.

Complimentary in Financial Slack.

"When cash-rich bidders and cash-poor targets are combined, wealth may be created." A cash-poor entity has a more difficult time accessing market capital; therefore, a merger allows positive net present value project to be accepted.

Removal of Ineffective Managers.

Merger opens the door for a wider selection of human capital, especially selecting effective managers. If one of the merged firms has ineffective management, as a result of the merger, more effective managers are kept and others are marginalized or eliminated.

Increased Market Power.

"The merger of two firms can result in an increase in market or monopoly power." Although a merger that monopolizes a market is illegal; nonetheless, such merger creates wealth and provides wider market access and cross-marketing opportunities to both merging firms.

Reduction in Bankruptcy Costs.

Undoubtedly, diversification minimizes enterprise failure. In case where a firm is failing and is forced to a possible liquidation or bankruptcy be creditors, assets are sold at a depressed value, and what channels down to stockholders are even less amusing since legal fees and selling costs are levied before disbursement of any fund to anyone. A merger may be a good solution for the creditors and the stockholders to absorb least amount of collateral damage.

Buying Below Replacement Costs Merger.

"Situations sometimes arise where it is cheaper to acquire an entire company than to acquire the assets the company owns." Due to reality of market, sometimes it is cost-effective to merge with a rival to acquire its assets than to attain those assets in any other way.

Determination of a Firm's Value

For a merger to be of value to Riordan Manufacturing, the company must analyze the value of the potential merger by quantifying the worth of acquired firm (Reference book Chapter 23 page 808). The value of acquired firm depends on number of elements such as: (1) book value; (2) appraisal value; (3) "chop-shop" or "break-up" value; (4) "free cash flow" or "going concern" value.

Book Value.

"Book value generally used in this context to refer to the book or historical cost value of the firm's net worth."

Appraisal Value.

Appraisal value is quantifying the worth of a company by an independent appraiser. This value is closely tied to the replacement cost of the assets.

"Chop-Shop" or "Break-Up" Value.

Dean Lebaron and Lawrence Speidell theorized that multiline companies that are undervalued can worth more if separated and sold individually.

"Free Cash Flow" or "Going Concern" Value.

The going concern value is estimated based on "incremental fee cash flows to the bidding firm as a result of the merger or acquisition."

Situational Analysis

Riordan Manufacturing has two derogatory circumstances: first, replacement of the Pontiac plant with a plant in Mexico; and second, excess cash. These circumstances create numerous opportunities and conflicts for the company; however, with proper planning, the company can capitalize and reach a net gain.

Pontiac Plant Closure

Based on the company's executive summary, the Pontiac plant is was shut down; however, to make matter more unfavorable is opening of the Mexican factory, which at the very minimal raises eyebrows over jobs going south. This negative publicity can have tremendous impact with the Defense Department, one of Riordan's clientele.

As a recourse to loosing clientele due to closure of Pontiac Plant and shifting operations south to the Mexican Factor, Riordan Manufacturing may choose to acquire or merge with a U.S. based company in the same industry that is suffering due to lack of access for capital or poor management disciplines and practices.

Excess Cash

Excess cash on hand can be problematic, because, it is display of management's inability to manage resources properly. Additionally, the company paid $943,274 in taxes, which is six and half times the amount of interest paid ($143,175) to secure over $3.5 million in credit. The company can afford to secure a $23 million worth of mergers to offset money paid to taxes.

Strengths, Weaknesses, Opportunities, and Threats Analysis

A definitive parallel acquisition by Riordan Manufacturing provides an example of the ongoing consolidations in the plastic manufacturing industry. Coming after closure of Pontiac plant and launch of the Mexican plant, this acquisition provides additional evidence of growing dichotomy between aggressive management and smart investment within Riordan Manufacturing and its parent company.

Strengths

The strengths that Riordan Manufacturing could be gaining from the acquisition would be total control of the company, acquiring stock for a minimal price and reducing overall debt. There are also other factors to include with regards to the acquisition. Riordan Manufacturing could block their major competitors with this acquisition and bring in a higher net project through the acquisition. Whether the acquired firm is left independent or dissolved within Riordan's operation, the takeover can be a win-win situation.

End-to-end solutions.

Acquisition of a parallel unit will greatly augment Riordan's plastic manufacturing portfolio and allows it to offer end-to-end manufacturing and warehousing solutions.

Dominance over market share.

Acquisition can bring in a positive cash flow, untapped lines of credit, and the customer base of the acquired firm. Acquisition also provides added support to Riordan's operations and enhances Riordan's market share.

Assets control.

Riordan can control more assets for less money through the merger than if it was to acquire those assets any other way.

Weaknesses

The weaknesses in business acquisitions mostly comes from risk's taken within the merged company or through external factors. As lucrative the deal may be, facing problems are much of reality that Riordan has to encounter. A serious opposition to the merger can be the management, labor unions, the existing shareholders of the target firm, vendors, and competition.

Management and labor unions.

Management and labor unions may oppose the merger because they perceive their elimination to be inevitable. The management may act to protect their position by taking the poison pill and making the merger unviable for Riordan. The labor unions with the same notion as the management may feel that their jobs can be cut and may picket the merger, file for an antitrust lawsuit, or walk off and make the plant inoperable. Any of aforementioned situations will create a red-light for any lending company seeking to finance the deal.

Shareholders.

Shareholders of the target firm can have two perceptions: (1) they are sitting on a pile of gold and there is no reason to negotiate for what they have over what they could have; and (2) even though the company they own is facing financial setbacks; however, their return can be better through a bankruptcy liquidation or reorganization of the business.

Vendors.

Because Riordan operates in China and Mexico vendors and supplier of the target firm can see a real threat as they may get replaced by Riordan's own supplier with cheaper raw material. Subsequently, they may force the target firm to liquidate assets to repay outstanding debts; and the financial stress makes the acquisition unfeasible to finance.

Competition.

Target firm's competition as well as Riordan's competition may feel the treat that this acquisition will create larger market domination for the merged companies. As a result, other competing companies may file antitrust lawsuits or help the target firm submerge from financial stress on terms of turning down acquisition opportunities.

Opportunities

Riordan Manufacturing has an enormous opportunity to acquire another company and merge. This will provide Riordan Manufacturing with the opportunity to expand their business practices and manufacturing. By merging, Riordan Manufacturing will be able to complete more projects and acquire more clients that in turn will produce more capital for the company.

Leadership emergence.

Riordan will be able to position itself as providing a leading plastic manufacturing and warehouse solutions that include medical industry, defense industry, consumer industries, as well as hardware and high-tech industries.

Self-reliance.

Rather than relying on partners or new joint ventures for robust production and delivery, Riordan will now expands its own and thus be able to determine future product directions. Expanded operations translate to more manufacturing hours, bigger warehousing capacities, and more effective logistics system.

Tax-minimization.

Riordan can take maximum advantage of tax-breaks and reinvest its tax payments toward owning another profitable operations. Riordan pays six and a half times the amount of interest on existing liabilities to taxes; this means that with the tax incentives Riordan will gain it can invest in six other profitable entities. Typically in mergers there are two tax advantages, but Riordan has three tax advantages: (1) Riordan can use its tax reduced incentives on new projects; (2) Riordan can take advantage of target firms operation less tax-credit; and (3) reevaluation of depreciated assets at the target firm.

Threats

Riordan Manufacturing has a very big threat that comes with this acquisition and with any business merger. There is a potential that the deal could fall through or that the profits from the company will not be enough to recover. Furthermore, Riordan will need to explain why, after shutting down Pontiac Plant it is acquiring another firm in the same industry. .

Competition hostility.

Riordan's competitors can be expected to create market fear, uncertainty, and doubt about how merger effects Riordan's product line and if Riordan is going to utilize an inferior product line in favor of profitability. It would not be unexpected for plastic manufacturing competitors to aggressively target the new merged organization in many ways, direct or indirect.

Government action.

Government may see this merger as unhealthy for the target firm's consumer market, thus blocking the merger and costing Riordan time and money.

Internal factors.

The most difficult factor for the merger comes from within the Riordan family of companies. First, Riordan Manufacturing's own board and management may oppose the merger. Second, the parent company may oppose the merger. Third, employees who are uncertain of their own status with Riordan may sabotage the deal be leaking out information, bringing on rival bidder to the table for the target firm, or even worst, create an atmosphere of mistrust among workers.

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