Overview Of Shenzhen Zhongjhin Lingnan Nonfemet Co. Ltd

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1. Case Overview
As the financial crisis became more severe in early 2008, the prices of base metals, such as zinc and lead, declined greatly. As a result many mining companies suffered significant operating losses and experienced extreme difficulty obtaining financing from the capital markets. Consequently some companies had to either sell some of their assets or find a strategic buyer.
 
In the late November 2008, Zhang Shuijan, the chief executive officer (CEO) of Shenzhen Zhongin Lingnan Nonfemet Co. Ltd. (SZLN) and his management team had identified an opportunity to acquire Perilya Limited (PEM), a base metal mining company listed on the Australian Securities Exchange (ASX). Before making an offer it is needed to determine the strategic benefits of the acquisition, the risk that might be incurred as a result of the purchase and the maximum price SZLN will be willing to pay.
 

2.1 SHENZHEN ZHONGJIN LINGNAN NONFEMET CO. LTD.
 
China Nonferrous metal Industry Shenzhen Co. the predecessor of Shenzhen Zhongjin Lingnan Nonfemet Co. Ltd. (SZLN) was founded in 1992 and went through several restructurings including a merger with Guangdong Shaoguan Lingnan Lead Zinc Group Ltd. Co. (Lingnan) in 1999. The mazor asset of Lingnan were the Fankou Lead Zinc Mine and the Shaognun Smelter. At the time of the merger, Lingnan was chaina’s largest lead zing ore mining company and Chaina’s third largest lead zinc smelter. In January 1997, the company listed its stock on the Shenzhen stock exchange and after the amalgamation, changed its name to Shenzhen Zhongjin Lingnan Nonfemet Co. Ltd. (SZLN). SZLN’s largest shareholders was Guangdong rising Assets Management Co. Ltd, a state owned enterprise. As of 1999, lead zinc products contributed approximately 80 percent to profits, construction materials and decoration 10 percent and trading approximately 6 percent.
 
Due to an economic downturn and continuously depressed demand for lead and zinc, the price of lead and zinc fells to historical lows, resulting in 2001, in a decline in SZLN’s net income of more than 75 percent compared with 2000. In response, company formed a new management with Zhang Shuijan as the new CEO. This team stringent cost controlled and restructure the business to make lead and zinc products the company’s main focus. As a result of this restructuring, net income in 2002 increased by more than 30 percent over the previous year, despite the low metal prices.
 
    2.2 PERILYA LIMITED
 
Perilya Limited (PEM) was an Australia base metals mining and exploration company, listed on the Australia Security exchange. It operated the Iconic zinc, lead and silver mine in Broken Hill, New south Wells. PEM’s operation also included the finder project in South Australia and the mount oxide project in Queensland.
 
Established in 1987, PEM had grown rapidly since its purchase of the Fortnum Gold Mine in 1994. In anticipation of the closure of the Fortnum Gold Mine in 2001, PEM embarked on an evaluation and acquisition program. Broken Hill, one of the largest and most renowned zinc, lead and silver mines in the world, was acquired in May 2002.
 
3. Industry Analysis
In China Mining industry is a fragmented industry as the total capacity of the top 10 domestic lead zinc companies was less than 50 percent of domestic total capacity. The industry competition intensified as a result of capital market developments. The Chinese government intended to consolidate the industry. As a result SZLN would likely either acquire other companies or would be acquired. On the other hand there had a large number of mining industries in Australia as the availability of ore metals.
 
3.1 PEST Analysis
 
PEST analysis means Political, Economical, socio-cultural and Technological analysis. There are many factors in the macro-environment that will effect the decisions of the managers of SZLN. Tax changes, new laws, trade barriers, demographic change and government policy changes are all examples of macro change. To help analyzing these factors managers can categorize them using the PEST model.
 
Political Aspect
The politics of the Republic of China takes place in a framework of a semi-presidential representative democratic republic, whereby the President is head of state. Executive power is exercised by the government. Legislative power is vested in both the government and parliament. The Judiciary is independent of the executive and the legislature.
 
Economic Aspect
The People's Republic of China ranks as the world's second largest economy after the United States. It has been the world's fastest-growing major economy, with consistent growth rates of around 10% over the past 30 years. China is also the largest exporter and second largest importer of goods in the world. The provinces in the coastal regions of China tend to be more industrialized, while regions in the hinterland are less developed. As China's economic importance has grown, so has attention to the structure and health of that economy.
 
Socio Cultural Aspect

 
3.2 Porter’s Five Forces Model
 
To analyze profit potentiality of a company, it is essential to assess the profit potential of each of the industries in which the firm is competing as the profitability of various industries differs over time. Porters Five Forces Model is an important to analyze such potentiality. The Competitive Forces analysis is made by the identification of five fundamental competitive forces are as follows:
 
Threat of Substitute Products
Threat of Substitute Products Depends on:
 
      The relative price and performance of substitutes
      Buyers' willingness to substitute
      The costs of switching to substitutes
Substitute for mining industries are not so mentionable. Therefore the threat of substitute products for mining industry is low because there are no substitute zinc and lead for specific purpose.
 
Threat of New Entrants
Threat of New Entrants Depends on:
 
      Customer switching costs
      Economies of scale
      Brand loyalty
      Capital or  investment requirements
      Access to technology
      The likelihood of retaliation from existing industry players
      Legal Barriers
 
Mining industry has a low threat of new entrants because of high capital investments, costly established.
 
Bargaining Power of Buyers
Bargaining Power of Buyers Depends on:
 
      Concentration of buyers.
      Role of quality and service
      Threat of backward and forward integration into the industry
      Switching costs of buyers
 
This industry holds high bargaining power of buyers because they anticipate customers’ are concentrated and there has a threat of backward and forward integration into the industry.
 
Bargaining Power of Suppliers
Bargaining Power of Suppliers Depends on:
 

 
Low product differentiation, low switching cost of suppliers and firms in the industry, low level of substitute products with high supplier concentration- made the expected level of suppliers bargain option to be moderate.  
 
Rivalry among Existing Firms
Intensity of Rivalry Among Existing Firms Depends on:
 

Inter industry rivalry is  high because  many companies are operating in the industry with high growth, concentrated products & brand loyalty- customers switching cost would be low.
 
 
Industry analysis of telecommunication industry is briefly showed by the following illustration:

 

 

 

 

 

 

  

We performed company analysis based on-
 
SWOT analysis.
Ratio analysis.
DU point analysis.
Risk analysis.
Valuation.
 
4.1 SWOT Analysis of SZLN and PEM
Strength
 
SZLN and PEM, both have a large asset base.
SZLN’s largestshareholders were Guangdong rising assets Management Company limited which was a state owned enterprise.
SZLN had a qualified management team who instituted stringent cost controls and restructured the business.
PEM had a large number of projects.
 
Weakness
 
SZLN had not access to international finance.
SZLN had underutilized smelters.
PEM had a weak analysis quality so that it had failed several times in acquisition program.
Opportunities
It was forecasted that the demand for lead and zinc products would increase in future.
 
Threat
Due to the continuously falling base metal pricing and increasing operating costs, financial conditions of both the company were deteriorating.
Competitiveness in mining industry is increasing
 
4.2. Ratio Analysis
4.2.1 Ratio Analysis (SZLN)
Profitability Ratio
The profitability ratio of the company shows that the company is in profitable position. The profitability of the company increase year to year but in 2008 it is decreased. It is greater for the year 2006 under three of the scenario. The profitability of SZLN increases due to large amount of Revenue. The current economic scenario also plays as a vital role in such increased profit.
 
In 2008 profitability ratio decreased due to financial crisis of the economy.
 

 
According to the chart we see that, Profitability ratio consists of Net Profit Margin (NPM), Return on Asset (ROA) and Return on Equity. Net Profit Margin is increased from 2004 to 2006 and then it is steadily decreased from 2006 to 2008. Both Return on Assets and Equity are follows the same pattern over the five years which indicates that Profitable position of this company is not quite satisfactory.
 
Liquidity Ratio
 
The liquidity ratio of SZLN shows that the company has sufficient level of liquidity to meet up its current liabilities and debt. The company is also able to meet up any of its current obligations. The liquidity ratio shows that the company is going to perform well in future.
 

 
From the graph we see that, Liquidity ratio consists of Current ratio, Quick ratio and Net working capital to total Asset. Liquidity condition is in increasing pattern of this company from 2004 to 2008 which indicates the ability of the company to meet its current liabilities is gradually increased.
 
Leverage/Debt Ratio
 
 

 
In Accordance with the graph we see that, Leverage ratio consists of Debt ratio and Debt to Equity ratio. Leverage ratio is in decreasing pattern over the five years due to lower amount of debt.
 
Efficiency Ratio
 

 
 
 

 
In Accordance with the graph we see that, Efficiency ratio consists of Total Asset Turnover and Fixed Asset Turnover. It is in fluctuating over the five years. Here, Both Total Asset Turn over and fixed assets turnover are gradually increased from 2004 to 2007 and then it is decreased due to technological advantages and asset growth.
 
 

 
 

 
Inventory turnover ratio is stable over the years but it is increased in 2008. Accounts Receivable Turnover is in increasing pattern over the 5 years which indicates that Accounts Receivable will make payment delay to the company is not well in the future.
 
Revenue Growth Rate
 

 

 
From the graph we see that, Revenue growth is in decreasing pattern from 2005 to 2008 and it is negative in 2008.Growth is fluctuating due to higher investing activities, Technological Advantages and efficient utilization of fund.
 
 
 
Total Assets Growth Rate
 
 

 
 

 
Total assets growth rate are fluctuating over the period of time. Here, Total assets growth has increased from 2005 to 2006 and then steadily decreased from 2006 to 2008 and it is negative in 2005 and 2008.
Financial Ratio
 

 
 

 
According to the graph we see that, EPS is increased from 2004 to 2006 and then it is steadily decreased but OCF per share is fluctuating over the 5 years and in 2008 it is 1.58.
 
 
 
DuPont Analysis
 

 

 

 
 

 

 
Du Pont Analysis consists of several factors like NPM, Total Assets Turnover, Leverage and Return on equity. On the basis of the analysis we see that, Leverage is in decreasing pattern and other factors are almost stable over the 5 years.
 
4.2.2 Ratio Analysis (PEM)
Profitability Ratio
The profitability ratio of the company shows that the company is in profitable position. The profitability of the company is increased over the year but in 2008 it is decreased and it is in negative figure. It is greater for the year 2007 under three of the scenario. The profitability of PEM decreased due to the Revenue is decreased steadily. The current economic scenario also plays as a vital role in such decreased profit.

 

 
According to the chart we see that, Profitability ratio are fluctuating over the 5 years and it is
negative in 2005 and 2008 due to revenue decreased which indicates Profitable position of this company is not quite satisfactory.
 
 
 
Liquidity Ratio
 
The liquidity ratio of PEM shows that the company has higher level of liquidity to meet up its current liabilities and debt. The company is also able to meet up any of its current obligations. The liquidity ratio shows that the company is going to perform well in future.
 
 

 
From the graph we see that, Liquidity ratio consists of Current ratio, Quick ratio and Net working capital to total Asset. Liquidity condition is in increasing pattern of this company from 2004 to 2008 which indicates the ability of the company to meet its current liabilities is gradually increased.
 
Leverage/Debt Ratio
 
 

 
In Accordance with the graph we see that, Leverage ratio are fluctuating over the 5 years and in 2008 it is increased than 2007 due to higher amount of debt and in 2008 debt ratio is 1.906 and debt to equity ratio is 1.661.
 
 
Efficiency Ratio
 
 

 
In Accordance with the graph we see that, FAT is fluctuating over the 5 years and TAT is increased from 2004 to 2005 and then it is steadily decreased due to decreasing pattern of revenue and total assets.

 

 
Inventory Turnover is fluctuating over the 5 years and in 2008 it is only 1 days. Accounts Receivable Turnover is also fluctuating over the 5 years and in 2008 it is 137 days which indicates that Accounts Receivable will make payment delay to the company in future.
 
 
Revenue Growth Rate
 

 
From the graph we see that, Revenue growth is fluctuating from 2005 to 2007 and then it is decreased  and it is negative i.e. -.295.Growth is fluctuating due to higher investing activities, Technological Advantages and efficient utilization of fund.
 
Total Assets Growth Rate
 

 
 
 

 
Total assets growth rate are fluctuating over the period of time. Here, Total assets growth has increased from 2005 to 2006 and then steadily decreased from 2006 to 2008.

 
EPS

 

 
According to the graph we see that, EPS is fluctuating from 2004 to 2007 and then it is steadily decreased from 2007 to 08.
 
DuPont Analysis
 

 

 
 

 

 
Du Pont Analysis consists of several factors like NPM, Total Assets Turnover, Leverage and Return on equity. On the basis of the analysis we see that, NPM, ROE and Leverage is Fluctuating over the 5 years but these ratios are decreased from 2007 to and other factors are almost stable over the 5 years.
 
4.3 Risk Analysis
 
4.3.1 Risk Analysis of Shenzhen Zhongjin Lingnan Nonfemet Co. LTD (SZLN)
 
Business Risk
Business risk is defined as both the staying power of market demand, as well as the integrity of the revenue streams from the various products and services offered to that market. The nature and level of business risk is specially evaluated for each mining company and then used to determine the financial benchmark levels for credit evaluation. Naturally, these become more stringent as risk increases.
 
Demand side risk
In 2008 global refined zinc production increased by 5.1% to 11.9million tons, and consumption by 3.8% to 11.8 million tons, which indicates that in Chinese market demand for mining industry has an increasing trend. So demand side risk is low.
 
Operational risk
SZLN firm required to purchase ore from both domestic and international companies to feed its manufacturing operations, so operational risk is moderate.
 
Price risk
As the financial crisis became more severe in early 2008, the prices of base metals of many mining companies in china such as zinc and lead declined greatly. So the price risk of SZLN Company is high.
 
Sensitivity to Business Cycle
Mining industry Business is cyclical in nature because zinc is used in Rubber, Paint, Chemical and agricultural industries. When the economy is in downturn and the demand of zinc decreases then it also affect the dependent industries because they use zinc as a raw material.
 
Regulatory Risk:
SZLN would need to receive approval from Chinese regulators such as NDRC, SASAC etc., and also from its largest Chinese shareholders, Australian regulators and the shareholders of PEM.As a result the regulatory risk of SZLN is high.
 
 
Sales Variability
 

 
In accordance with the chart of sales variability, variability in sales of SZLN Company is low over the years. The Standard Deviation and average of revenue variability is 2020.906 and 5944.8. The Coefficient of variation of revenue variability is 34%, which indicates that lower level of sales variability.
 
Variability in EBIT
 

 
In accordance with the chart of EBIT variability, variability in EBIT is high over the years. The Standard Deviation and average of EBIT variability is 606.9831134and 1057. The Coefficient of variation of EBIT variability is 57% which indicates that higher level of EBIT variability.
 
Degree of Operating Leverage
 

                            
Degree of operating leverage ishigh over the year except 2007.it is 4.4483 in 2008 which indicates higher level of business risk.
 On the basis of our whole business risk analysis, we think there is higher level of business risk of SZLN Company.
 
Financial Risk                   
 
Degree of Financial Leverage
 

 
Degree of financial leverage reflects the change in financial risk of the SZLN Company. DFL is 1.07 in 2007 and 1.35 in 2008. It reflects slow level of financial risk of this company.
 
 
Interest coverage ratio

 
 
 
 
 
                  
 
Interest coverage ratio has a fluctuating trend over the five years. In 2007 it is 14.81 and in 2008 it is 3.8, it indicates that lower level of financial risk of the SZLN Company.
 
Bankruptcy Risk

 
In accordance with Altman Z Score, the calculated Z score is

 
In accordance with Altman Z Score, the calculated Z score is 14.76 in2007 and 4.190 in 2008 which is greater than 1.81 and exists in safe zone. So bankruptcy risk is low of this company.
 
4.3.2 Risk Analysis PERILYA Limited Company
 
Business Risk
 
Business risk is defined as both the staying power of market demand, as well as the integrity of the revenue streams from the various products and services offered to that market. The nature and level of business risk is specially evaluated for each mining company and then used to determine the financial benchmark levels for credit evaluation. Naturally, these become more stringent as risk increases.
 
Operational risk
PERILYA LIMITED required purchasing ore from both domestic and international companies to feed its manufacturing operations, so operational risk is LOW.
 
Price risk
In 2008, the prices of base metals of many mining companies such as zinc and lead declined greatly. So the price risk of PEM Company is high.
 
Sensitivity to Business Cycle
Mining industry Business is cyclical in nature because zinc is used in Rubber, Paint, Chemical and agricultural industries. When the economy is in downturn and the demand of zinc decreases then it also affect the dependent industries because they use zinc as a raw material.
 
Regulatory Risk:
In case of foreign investment, the interested companies need to take permission from Australian FIRB.As a result the regulatory risk of PEM is high.
 
Sales Variability
 

 
In accordance with the chart of sales variability, variability in sales low over the years. The Standard Deviation and average of revenue variability is 97.60225407 and 270.8 .The Coefficient of variation of revenue variability is 36% which indicates that lower level of sales variability.
 
Variability in EBIT
 

 
In accordance with the chart of EBIT variability, variability in EBIT is low over the years. The Standard Deviation and average of EBIT variability is 72.48241166and 130.8The Coefficient of variation of EBIT variability is 55% which indicates that higher level of EBIT variability.
 
Degree of Operating Leverage
 

 
Degree of operating leverage is high over the year except 2007.it is 1.56 in 2008 which indicates higher level of business risk.
On the basis of our whole business risk analysis, we think there is higher level of business risk of this company.
 
Financial Risk
Degree of Financial Leverage
 

 
 
Degree of financial leverage reflects the change in financial risk of the PEM Company. DFL is 1.03 in 2007 and 1.13 in 2008. It reflects low level of financial risk of this company.
 
Interest coverage ratio
          
 

 
Interest coverage ratio has a fluctuating trend over the five years. In 2007 it is 26.25 and in 2008 it is 8.69, it indicates that lower level of financial risk of the PEM Company.
Bankruptcy Risk
 

 
In accordance with Altman Z Score, the calculated Z score is
 

 
In accordance with Altman Z Score, the calculated Z score is 20.73 in2007 and 17.40 in 2008 which is greater than 1.81 and exists in safe zone. So low level of bankruptcy risk of this company
 
4.4 Valuation of the Firm
Before going to take merger and acquisition decision it is necessary to do valuation of both acquirer company and target company. So before taking the acquisition decision and determining the purchase price of Perilya Limited (PEM) by Shenzhen Zhongjin Lingnan Nonfemet Co. Ltd (SZLN). The valuation outputs are given below with assumptions.
 
4.4.1 Valuation of SZLN
Assumptions
We have taken some assumptions in doing valuation of SZLN. The assumptions are as follows-

 
WACC

 

 
 
Projected revenues & Free Cash flow
The projected revenues, operating expenses and the free cash flows are given below:
 

 
At last based on the free cash flow, we have calculated the value of the firm as well as the value of the equity of shareholders

4.4.2 Simulation Analysis (SZLN)
 
Output from simulation Analysis
 

 
 
Figure: Simulation Chart (SZLN)

 
 
                                      

 
Since the co-efficient of variation of enterprise value of SZLN is lower than the 0.50 then the enterprise is not highly risky firm from the perspective of generating cash flows. The cash flows of the firm are positively skewed.

 
Sensitivity Chart
 
 
 
Figure: Sensitivity chart of SZL
 
From the simulation analysis we get a sensitivity chart which shows that cost of goods sold and the weighted average cost of capital are highly sensitive variable of this firm. Those two sensitive variables are negatively sensitive. Here the revenue growth is positively sensitive and the degree of sensitivity is not so significant. All other remaining variables are not sensitive with the firm value.
 
4.4.3 Valuation of PEM
Assumptions
We have taken some assumptions in doing valuation of PEM. The assumptions are as follows-

 

 
Projected revenues & Free Cash flow
 
The projected revenues, operating expenses and the free cash flows are given below:
 

 
 
 
At last based on the free cash flow, we have calculated the value of the firm as well as the value of the equity of shareholders

 

4.4.4 Simulation Analysis (PEM):
 
Output from simulation Analysis
 

 
Figure: Simulation Chart (PEM)
 

 

 
Since the co-efficient of variation of enterprise value of SZLN is greater than the 0.50 then the enterprise is highly risky firm from the perspective of generating cash flows. The cash flows of the firm are positively skewed.
 
Sensitivity Chart

Figure: Sensitivity chart of PEM
 
From the simulation analysis we get a sensitivity chart which shows that cost of goods sold and the operating expenses are highly sensitive variable of this firm. The firm’s weighted average cost of capital is not significantly sensitive but it is negatively sensitive.  Those two sensitive variables are negatively sensitive. Here the revenue growth is positively sensitive and the degree of sensitivity is not so significant. All other remaining variables are not sensitive with the firm value.
 
4.4.5 Synergistic Analysis
The benefits realized in a strategic acquisition are largely a result of synergies and economies of scale. Concept of Synergies: (Can 2 + 2 = 5?). In a well executed acquisition, the acquiring company can take advantage of synergies. That is, the two companies together will be stronger and more profitable than either company was previously.
Synergy is roughly defined as two or more things together being better or more effective than the sum of their parts. As it's used here, it means two or more companies merging such that the combined resources of the merged unit have more than the sum of the value they had individually.
This term is used mostly in the context of mergers and acquisitions. For example, if Company A has an excellent product but lousy distribution whereas Company B has a great distribution system but poor products, the companies could create synergy with a merger or acquisitions. The possible synergistic analysis is given below.
 
Sources of synergy
 
Valuation of Synergy
 

 

 
 
Net Acquisition Value = Synergy – Premium payment – Transaction cost
                                       = $626177535 – $ 21824225 -$ 334333944
                                      = $ 439734928
 
 
4.4.6 Simulation Analysis (PEM)
 
Output from simulation Analysis
 

 
Figure: Simulation Chart (synergy)
 

 

 
Since the co-efficient of variation of synergistic gain is very lower than the 0.50 then the synergistic gain from the acquisition of the PEM is not so risky. The benefits from the synergy are normally distributed.
 
 
Sensitivity Chart
 

 
Figure: Sensitivity chart of synergy
 
From the simulation analysis we get a sensitivity chart which shows that reduction of operating cost and change in revenues are highly sensitive variable of the synergetic gain. The firm’s changes in CAPEX and tax benefits are not significantly sensitive but it is positively sensitive.  Those two sensitive variables are negatively sensitive. Change in the other operating revenues is not sensitive with the synergistic gain.
 
 
4.4.7 Valuation of SZLN after Acquisition of PEM
 
After acquisition of PEM, SZLN’s operation would be change due to the increase of the unused capacity, reduction of operating cost, tax benefit from the loss of the operation of PEM and lower cost of capital. So by considering the synergistic effect the firm valuation would be changed. With the basic assumptions the valuation of SZLN is given below:
 
 
 
Assumptions
We have taken some assumptions in doing valuation of SZLN. The assumptions are as follows-
 

 

 
WACC
 

 

 
 
Projected revenues & Free Cash flow
 
The projected revenues, operating expenses and the free cash flows are given below:
 

 
At last based on the free cash flow, we have calculated the value of the firm as well as the value of the equity of shareholders

 

4.4.8 Simulation Analysis (SZLN)
 
Output from simulation Analysis
 

 
 
Figure: Simulation Chart (SZLN)
 

 

 
Since the co-efficient of variation of enterprise value of SZLN is lower than the 0.50 then the enterprise is not risky firm from the perspective of generating cash flows after acquisition of PEM. The cash flows of the firm are normally distributed.
 
4.4.9 Real Option Valuation
Real options valuation is a financial technique for evaluating investments under conditions of uncertainty, particularly uncertainty associated with market variables such as future product demand or the future value of an asset. Option pricing is a well-developed area of financial engineering, dealing with the valuation of puts, calls, and more complex derivatives, but when applied to non-financial assets, the term “real options” is used.  In real options valuation, the general ideas from financial options pricing theory are used along with some of the mathematics.
Basically, real options valuation is a way of capturing value that goes unrecognized in traditional NPV analysis.  In particular, when the future is uncertain, there is a value in having the flexibility to decide what to do after some of that uncertainty has been resolved. The managerial flexibility to wait, abandon, or expand on an investment opportunity is captured in a real option.  The real option value of the investment opportunity, then, is what a value-maximizing firm would pay for the right to undertake the investment project with its inherent decision points.
The SZLN would have an option from the acquisition of PEM to get the byproducts as “Lead” from the production of Zinc. Here the real option valuation has been done based on few realistic assumptions. For the real option valuation we followed “Black schools Approximation Model”. The valuations outputs are given below with assumptions and described below with simulation analysis.
 
Assumptions
 

 

 
Valuation Outputs
 

 

 
Since the value of real option is positive then there is a possibility of profit maximization by using the byproducts. So the potentiality of by products may make the business of SZLN successful acquisition decision.
 
 
Simulation analysis
Output from simulation Analysis:
 

 
Figure: Simulation Chart (real option valuation)
 
 

 

 
Since the co-efficient of variation of enterprise value of SZLN is lower than the 0.50 then the real option value is not risky for the SZLN from the perspective of generating cash flows from byproducts after acquisition of PEM. The cash flows from byproduct from PEM operation are normally distributed.
 
Sensitivity Analysis
 
Figure: Sensitivity chart of real option Valuation
 
From the simulation analysis we get a sensitivity chart which shows that the revenue produced from lead production is highly positively sensitive. Tax rate and the operating cost are negatively sensitive. But the terminal growth rate and WACC are not sensitive with the production of byproduct.
 
 
 
 
5. Problem Analysis
5.1 Statement of Problem
Zhang Shujian and his team needed to design an acquisition proposal that could increase the long term value of SZLN, meet the requirements of both Chinese and Australian regulators and satisfy the board and shareholders of PEM.
5.2 Acquisition Strategy
There are two types of acquisition strategies to acquire the target firm PEM. The alternatives are given below:
 

Now we have to find out which one would be the best strategy for the SZLN to acquire PEM.
 
 
5.2.1 Asset Acquisition Strategy
 
When assets are acquired, the purchaser buys all or specified assets of the selling entity and may assume none, some, or all of the liabilities of the business. Aside from tax considerations, an asset purchase may be more attractive to the buyer; since the buyer may be able to pick and choose the specific items desired and can attempt to avoid assuming debts and liabilities of the selling entity. An asset acquisition is also designed to reduce the buyer's exposure to possible unknown or contingent liabilities. In some cases, however, certain liabilities may follow the buyer.
 From an accounting perspective, the buyer records the assets and liabilities at the fair market value assigned to them as part of the transaction. This may increase or decrease the carrying value and/or amount of annual depreciation with respect to individual assets and liabilities. From a tax perspective, the existing business recognizes a gain or loss based on the difference between the sales price and the carrying value of the assets and liabilities.
 
 In case of SZLN to acquire PEM, the determination of probable total acquisition cost is given below:
Offer Price = Market value of the firm + premium
                 = $54560562 + 40% of 54560562
                 = $7638478
 
Transaction Cost
 

 

 
Total Cost of Acquisition = Offer Price + Transaction Cost
                                       =$ 76384787 + $ 334333944
                                       = $ 410718731
 
5.2.2 Stock Acquisition Strategy
 
Initially, it should be noted that when we discuss a Stock Purchase we are really referring to the purchase of the entire entity which most often involves a corporation's stock. To the extent that the transaction involves another type of entity such as a Partnership or a Limited Liability Company, the term that is used will be slightly different. In a Stock Purchase, all of the outstanding shares of stock of the business are transferred from the seller to the buyer. Although there may be cases where a party to a contract with the business has a right to object, the buyer in effect steps into the shoes of the seller, and the operation of the business continues in an uninterrupted manner. Unless specifically agreed to, the seller has no continuing interest in, or obligation with respect to, the assets, liabilities or operations of the business.
From an accounting perspective, the business's assets and liabilities are not adjusted, they continue to be carried and/or depreciated in the same manner as before the transaction. From a tax perspective, the seller recognizes a gain or loss based on the difference between the sales price and his or her current basis in the stock.
The stock acquisition deal of SZLN with PEM is given below:

 

 
Transaction Cost
 

 

 
 
Total Cost of Acquisition = Purchase Price + Transaction Cost
                                       = $43099702 + $ 449929293
                                       = $ 493028996
 
From analyzing both acquisition strategies we see that the cost of stock acquisition is very high due to higher transaction cost than the asset acquisition. Besides there is complexity in stock acquisition is higher than the asset acquisition and tax benefit could earn through asset acquisition.
 
5.3 Mode of Payment to PEM:
After determining the acquisition strategy of acquiring PEM by the SZLN, now we have to determine the mode of payment. This is very crucial for SZLN in decision making process. The two alternatives of payment are:
 

The payment is dependent on the decision on the management. If management thinks that the shares are overvalued then they don’t pay in cash and issue share. Again to get tax benefit cash payment is better option. If the payment is made in cash the shareholders of acquired firm get the fixed amount of cash. Then in case of market failure they don’t suffer. If the issue shares then in that case existing shareholder face severe problem and position will be more vulnerable.
In case of SZLN, if stock ownership were given then the stock ownership proportion of PEM would be 0.51%. This is very insignificant. So to protect the interest of both parties’ cash payment would be more appropriate.
 
5.4 Means of financing the acquisition:
The purchase price of PEM by SZLN would be $77.34 million. Now this payment would be financed? Before going to acquisition SZLN have to take decision about the payment and financing alternatives of the payment. The possible alternatives are given below:

Here the best option is the bank debt. Because SZLN had very good relationship with bank and it had very strong financial position. So it’s easy to get the debt financing for acquisition. Again the cost of equity is very high in Chinese stock market and needed longer time requirements. Exchange of share with the PEM’s shareholders was not possible due to regulatory requirements. And the costs of others option were very high. So bank debt would be the best possible sources of financing.
So the Financing plan would be:
 
6. Recommendations