Ford Acquires Volvo’s Passenger Car Operations This case illustrates how the dynamically changing…

Ford Acquires Volvo’s Passenger Car Operations

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This case illustrates how the dynamically changing worldwide
automotive market is spurring a move toward consolidation among automotive
manufacturers. The Volvo financials used in the valuation are for illustration
only; they include revenue and costs for all of the firm’s product lines. For
purposes of exposition, we shall assume that Ford’s acquisition strategy with
respect to Volvo was to acquire all of Volvo’s operations and later to divest
all but the passenger car and possibly the truck operations. Note that synergy
in this business case is determined by valuing projected cash flows generated
by combining the Ford and Volvo businesses rather than by subtracting the
standalone values for the Ford and Volvo passenger car operations from their
combined value including the effects of synergy. This was done because of the
difficulty in obtaining sufficient data on the Ford passenger car operations.

Background

 By the late 1990s, excess global automotive production
capacity totaled 20 million vehicles, and three-fourths of the auto
manufacturers worldwide were losing money. Consumers continued to demand more
technological innovations, while expecting to pay lower prices. Continuing
mandates from regulators for new, cleaner engines and more safety measures
added to manufacturing costs. With the cost of designing a new car estimated at
$1.5 billion to $3 billion, companies were finding mergers and joint ventures
an attractive means to distribute risk and maintain market share in this highly
competitive environment. By acquiring Volvo, Ford hoped to expand its 10%
worldwide market share with a broader line of near-luxury Volvo sedans and
station wagons as well as to strengthen its presence in Europe. Ford saw Volvo
as a means of improving its product weaknesses, expanding distribution
channels, entering new markets, reducing development and vehicle production
costs, and capturing premiums from niche markets. Volvo Cars is now part of
Ford’s Premier Automotive Group, which also includes Aston Martin, Jaguar, and
Lincoln.

Between 1987 and 1998, Volvo posted operating profits
amounting to 3.7% of sales. Excluding the passenger car group, operating
margins would have been 5.3%. To stay competitive, Volvo would have to
introduce a variety of new passenger cars over the next decade. Volvo viewed
the capital expenditures required to develop new cars as overwhelming for a
company its size.

Historical and Projected Data

The initial review of Volvo’s historical data suggests that
cash flow is highly volatile. However, by removing nonrecurring events, it is
apparent that Volvo’s cash flow is steadily trending downward from its high in
1997. Table 8-8 displays a common-sized, normalized income statement, balance
sheet, and cash-flow statement for Volvo, including both the historical period
from 1993 through 1999 and a forecast period from 2000 through 2004. Although
Volvo has managed to stabilize its cost of goods sold as a percentage of net
sales, operating expenses as a percentage of net revenue have escalated in
recent years. Operating margins have been declining since 1996. To regain
market share in the passenger car market, Volvo would have to increase
substantially its capital outlays. The primary reason valuation cash flow turns
negative by 2004 is the sharp increase in capital outlays during the forecast
period. Ford’s acquisition of Volvo will enable volume discounts from vendors,
reduced development costs as a result of platform sharing, access to wider
distribution networks, and increased penetration in selected market niches
because of the Volvo brand name. Savings from synergies are phased in slowly
over time, and they will not be fully realized until 2004. There is no attempt
to quantify the increased cash flow that might result from increased market
penetration.

Determining the Initial Offer Price

 Volvo’s estimated value on a standalone basis is $15
billion. The present value of anticipated synergy is $1.1 billion. This suggests
that the purchase price for Volvo should lie within a range of $15 billion to
about $16 billion. Although the potential synergies appear to be substantial,
savings due to synergies were to be phased in gradually between 2000 and 2004.
The absence of other current bidders for the entire company and Volvo’s urgent
need to fund future capital expenditures in the passenger car business enabled
Ford to set the initial offer price at the lower end of the range.
Consequently, the initial offer price could be conservatively set at about
$15.25 billion, reflecting only about one-fourth of the total potential synergy
resulting from combining the two businesses. Other valuation methodologies
tended to confirm this purchase price estimate. The market value of Volvo was
$11.9 billion on January 29, 1999. To gain a controlling interest, Ford had to
pay a premium to the market value on January 29, 1999. Applying the 26% premium
Ford paid for Jaguar, the estimated purchase price including the premium is $15
billion, or $34 per share. This compares to $34.50 per share estimated by
dividing the initial offer price of $15.25 billion by Volvo’s total common
shares outstanding of 442 million.

Determining the Appropriate Financing Structure

Ford had $23 billion in cash and marketable securities on
hand at the end of 1998 (Naughton, 1999). This amount of cash is well in excess
of its normal cash operating requirements. The opportunity cost associated with
this excess cash is equal to Ford’s cost of capital, which is estimated to be
11.5%—about three times the prevailing interest on short-term marketable
securities at that time. By reinvesting some portion of these excess balances
to acquire Volvo, Ford would be adding to shareholder value, because the
expected return, including the effects of synergy, exceeds the cost of capital.
Moreover, by using this excess cash, Ford also is making itself less attractive
as a potential acquisition target. The acquisition is expected to increase
Ford’s EPS. The loss of interest earnings on the excess cash balances would be
more than offset by the addition of Volvo’s pretax earnings.

Epilogue

 Seven months after the megamerger between Chrysler and
Daimler-Benz in 1998, Ford Motor Company announced that it was acquiring only
Volvo’s passenger-car operations. Ford acquired Volvo’s passenger car
operations on March 29, 1999, for $6.45 billion. At $16,000 per production
unit, Ford’s offer price was considered generous when compared with the $13,400
per vehicle that Daimler-Benz AG paid for Chrysler Corporation in 1998. The
sale of the passenger car business allows Volvo to concentrate fully on its
truck, bus, construction equipment, marine engine, and aerospace equipment
businesses. (Note that the standalone value of Volvo in the case was estimated to
be $15 billion. This included Volvo’s trucking operations.)

Case Study Discussion Questions

1. What is the purpose of the common-size financial
statements developed for Volvo (see Table 8-8)? What insights does this table
provide about the historical trend in Volvo’s historical performance? Based on
past performance, how realistic do you think the projections are for 2000–2004?

2. Ford anticipates substantial synergies from acquiring
Volvo. What are these potential synergies? If you were a consultant hired to
value Volvo, what additional information would you need to estimate the value
of potential synergies from each of these areas?

3. How was the initial offer price determined according to
this case study? Do you find the logic underlying the initial offer price
compelling? Explain your answer.

4. What was the composition of the purchase price? Why was
this composition selected according to this case study?

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