Executive Summary

• SembCorp has grown beyond its traditional mainstay of ship-repair, maritime services and offshore engineering/fabrication into environmental, plant and civil engineering, building construction, ship management and shipbuilding, properties & building materials, financial leasing and integrated logistics activities as well as in the development of industrial parks and leisure resorts.
• SembCorp underwent a major restructuring exercise in January 1996 and it's businesses are organised into five Business Groups: Marine & Heavy Industries; SembCorp Engineering & Construction Group; Transportation & Logistics Group; Properties & Building Materials; and New Businesses Group.
• In 1997, turnover hit $1.95 billion and posted a net loss of $8 million due to extraordinary losses resulting from the divestiture of certain businesses.
• During the last five years, SembCorp has witnessed steady revenue growth partially due to a series of acquisitions. However, a consistent decline in their return on investment (ROI) indicates that SembCorp might have been unable to manage its new subsidiaries effectively.

• On 2 October 1997, SembCorp announced that it had entered into an option Agreement with Alexandre Vilgrain to purchase 51% of Delifrance Asia for $165.8 million in cash or $1.80 per Share. The option was exercised on 10 November 1997 and in accordance with Singapore Company regulations, SembCorp made an unconditional takeover offer for Delifrance.
• SembCorp believed that the acquisition of a majority stake in Delifrance would provide significant benefits to both SembCorp and Delifrance. SembCorp had identified several areas as key to Delifrance’s growth:

• Repeating Delifrance’s Singapore success in other existing markets.
• Expansion in new and underdeveloped markets.
• Franchise operations to accelerate market development.
• Building on its established distribution network and facilities.
• Opportunities in the current economic conditions.
• Management expertise and strategic partners.

• Based on their stated intentions, we believe that there are several issues that will affect the operating performance of Delifrance:

• Synergies from the redeployment of fixed assets and termination of staff through the merging of operations are unlikely.
• Aggressive expansion into new and underdeveloped markets at a time of weak consumer sentiment might result in loss-making ventures.
• Use of franchise operations to accelerate market development might result in loss of strategic control over franchise holders and being locked out of strategic markets.
• Mismatch in network of operations in the region between both companies would mean that Delifrance would still have to develop its own network to capitalise on opportunities in new markets.
• Use of Delifrance’s free cash holdings to pay for the cost of acquiring Delifrance would leave the Company with little cash to fund future growth.

• Differences in management styles and culture might result in problems over day to day operational issues.

• Using the EBO model, we assign a private market value of $101.3 million or 56.1 cents per share. Based on this valuation, SembCorp will need to achieve synergies of $144m ($245.3m - $101.3m) to justify the acquisition.
• Apart from price and operational risks, we believe that many issues are still outstanding:

• Strategic direction especially in terms of culture and management.
• The financing package for the acquisition of Delifrance.
• The relationship between SembCorp with principals, Grand Moulins De Paris (GMP) over the licensing of the Delifrance Trademark.
• Aggressive growth during poor economic conditions becomes doubtful.
• Threat of new Entrants to Delifrance's position.
• The mergers between STIC and SembCorp.

SEMBAWANG CORPoration LTD

SembCorp had its beginnings in 1968 when Sembawang Shipyard was established. Five years later, it became the first shipyard to be listed on the Stock Exchange of Singapore. SembCorp has since grown beyond its traditional mainstay of ship-repair, maritime services and offshore engineering/fabrication into environmental, plant and civil engineering, building construction, ship management, rig and shipbuilding, properties & building materials, financial leasing and integrated logistics activities as well as in the development of industrial parks and leisure resorts.

Today, SembCorp has established itself as a leading marine and engineering conglomerate in Singapore, with a distinction of successfully meeting complex engineering challenges. With a turnover of $1.95 billion in 1997, SembCorp comprises more than 240 companies employing over 6,000 staff throughout the Asia-Pacific region. SembCorp is involved in significant regional infrastructure projects such as a leisure and resort development in Bintan Island, Indonesia; an information technology park in Bangalore, India; and industrial parks in Vietnam and Suzhou, China. With overseas operations spanning the Middle East to China, SembCorp is one of the most geographically diverse companies in Singapore.

Operating & Financial Performance

SembCorp has witnessed steady revenue growth over the last 5 years, partly as the result of a series of acquisitions. However, a consistent decline in their return on investment (ROI) indicates that SembCorp might have been unable to manage its new subsidiaries effectively. For a company like SembCorp, ROI is a better measure of performance since it reflects the earnings potential of long term capital employed regardless of capital structure. In 1997, SembCorp posted a net loss of $8 million due to extraordinary losses resulting from the divestiture of certain businesses. Given the current economic scenario, a further shake-up is expected in the group. This may lead to more such losses recurring over the next few years (see Tables 1 and 2 for financial statements).

Asset turnover has remained constant; indicating that sales volume has remained robust. Over the past five years, SembCorp’s cash cycle has increased from -26 days to 75 days, the reason being SembCorp’s inability to collect dues from trade debtors. Although a six-month receivable period is acceptable by industrial company standards, we note with concern that receivable days has also increased from 121 days to 175 days over the last few years (see Exhibits 1 and 2).

After posting a phenomenal operating profit in 1994, SembCorp has seen its profits decrease in the years after that. This was primarily due to the group’s over-reliance on the shipping & construction industry, which follow a cyclical pattern in terms of performance. Realising this drawback, the group set out on a path of diversification, mainly into businesses that were less prone to cyclic performance patterns. This led to the creation of the New Business Group (NBG) in late 1995. The NBG focuses on three growth industries: information media, food and financial services.

Corporate Restructuring

SembCorp underwent a major restructuring exercise in January 1996 to optimise the use of its resources for future growth, to encourage synergy among different core competencies within the Group and to promote greater cohesion in seeking new business opportunities. SembCorp’s businesses were organised according to their core capabilities within business groupings. The objective was to achieve a clearer focus and direction for the Group. Under this new structure, SembCorp’s businesses were organised into five new Business Groups (see Exhibit 3).

Marine and Heavy Industries (MHI)

The MHI Group is the region's leading marine and heavy engineering group with the distinction of successfully meeting complex engineering challenges in the areas of ship repair and conversion. With ship-repair facilities in Singapore, Indonesia, China and the Middle East, as well as a global network of 23 agents, the MHI Group's commitment to excellent service and quality is well recognised throughout the world.

SembCorp Engineering & Construction Group

This group provides turnkey engineering and contracting services to clients in diverse industries both at home and abroad. The flagship company, Sembawang Engineering & Construction, is driven by ten strategic business divisions that specialises in servicing companies in the oil and gas, chemical and petrochemical, civil infrastructure, industrial, environmental, power and building construction industries.

Transportation & Logistics Group (TLG)

The TLG offers fully integrated logistics solutions backed by extensive capabilities in marine, land and air transport. Its operations span the Middle East to the Far East and Australasia.

Properties & Building Materials Group

This group engages in resort development, development and investment in commercial, residential and industrial properties and a whole spectrum of building materials businesses. Currently, it is developing integrated resorts offering themed sports and recreational facilities and other lifestyle facilities in locations such as Bintan and is planning to expand into other tourist destinations in the Asia-Pacific region.

New Businesses Group (NBG)

The New Business Group has changed its form since its inception in late 1995. Originally formed to drive SembCorp's diversification outside of traditional activities, namely; ship repair, engineering, marine and logistics businesses, NBG was recently restructured to focus on three fledging businesses – information media, food and financial services. As of the end of December 1997, NBG employed 1,285 people, of which 330 were executives and managers. NBG's strong emphasis is on earnings generation from its three core areas. The New Business Group was created to contribute new streams of income in the medium to long term to complement SembCorp’s traditional activities.

Post-Restructuring Financial Performance

Exhibits 4 and 5 show the revenue contribution of SembCorp before and after its restructuring exercise. As seen from the two pie charts, the divisions that contribute to the bulk of revenues were Marine & Heavy Industries, Engineering and Construction and Properties and Building Materials. Between 1996 and 1997, two major sectors have seen a decrease in their percentage contribution to total revenues, namely Marine & Heavy Industries and Properties & Building Materials.

The problems faced by Marine & Shipbuilding division and Property & Building Materials division were as follows:

• Volatile market conditions in the shipbuilding industry. In terms of business volume, there was a 13% year on year decrease in 1996. However, Sembawang Shipyard managed a to increase its revenues by 14% mainly due to improved costs & operational efficiencies. SembCorp had also focussed on a niche market for ship-repair, namely; cruise ships, upgrading and refurbishment, chemical tankers and liquefied gas carriers which was less volatile than the overall market.
• Property & Building Materials. The intense competition from international investors led to a fall in the division’s percentage contribution to the total revenues.

SembCorp diversified into three main businesses under the NBG. These businesses were in industries that were in their growth phase and showed a lot of promise in terms of additional revenue from the Asia-Pacific region. Within the first year of existence, the NBG division increased its contribution to total revenue by 1% or $20.1 million dollars.

SembCorp had very low levels of long term debt prior to some acquisitions in 1997, but the level short-term debt has been alarmingly high. Times-interest earned has been falling over the years and turned negative in 1997 due to extraordinary losses. Given the current economic outlook, there is an increasing risk of SembCorp not being able to service the high level of short-term debt. Consequently it might have to reschedule its debt. Although it is generally acceptable to have a debt equity ratio of 30-70% in the engineering services sector, the use of short-term debt for long-term deployment amounts to speculation on interest rates and is not advisable (see Exhibit 6).

Diversification through Acquisition

SembCorp has followed a strategy of organic growth complemented by small acquisitions over the past decade. The typical acquisition involved buying over smaller firms in one of their related business areas, followed by the divestiture of any unprofitable segments of the target acquired.

SembCorp is also diversifying into other new businesses. In June 1997, it entered into a joint-venture with retail-based Metro Holdings to start a luxury leisure and cruise business to capitalise on the fast growing Pacific cruise market.

In March 1997, SembCorp and Jurong Shipyard agreed to merge their ship-repair and shipbuilding business. Under the merger, SembCorp would sell its shipyard business to Jurong Shipyard in exchange for 27.56 million Jurong Shipyard shares valued at $6.80 each. This increased SembCorp’s existing 23.4% stake in Jurong Shipyard to 38.6%. In accordance with Singapore’s takeover regulations, SembCorp also made a general offer in August 1997 for the remaining Jurong Shipyard shares at $6.80 per share. Shareholders were given an alternative to either accept the offer of $6.80 in cash, or half in cash and half in SembCorp shares, which were also valued at $6.80 per share under the offer.

Entry into Food Industry

SembCorp’s entry into the food industry was a watershed event since it was not directly related to any of its existing business activities. However, diversification was viewed as SembCorp’s way of reducing its reliance on its traditional shipping business. Long-term plans for property, engineering and shipyard businesses were expected to improve the Group’s bottom-line over the next few years. However, the Food Industry has been considered more stable compared to that of shipbuilding or construction.

Other reasons that added to the attractiveness of this industry to SembCorp are:

• The food industry operates on much shorter cash cycles. This is beneficial for SembCorp which was facing the problem of a rapid increase in accounts receivable.
• Since this industry is not as capital intensive as shipping or construction, entry into the food business will definitely improve SembCorp’s falling ROI.

In August 1996 SembFood acquired 8.5% of Primary Industries, the premier hog auction and abattoir operator in Singapore, through a merger between PI and Farmers Abattoir, an associate company of SembCorp.
 
 
 
 
 
 

DELIFRANCE ASIA LTD

Delifrance was incorporated in Singapore on 4 April 1983 as a private limited company named Vie de France Singapore Pte Ltd. The Company was converted into a public limited company on 2 October 1996 and adopted its present name Delifrance Asia Limited. It has had an enviable growth record, achieving a CAGR in turnover and earnings of 26% and 42% respectively between 1992 and 1997. Its initial public offering of 45.2 million shares at 78 cents per share was five and a half times oversubscribed. Its share closed at 97 cents on the first day of trading or a premium of 24% over the offer price. This was regarded as quite remarkable given the lacklustre market conditions then.

Delifrance is a management and investment company that provides freshly baked bread, sandwiches, soups and a wide range of café beverages with time-sensitive services. Its business activities can be classified into retail, wholesale and franchising activities. Retail operations, supported by manufacturing facilities, comprise café bakeries, bakery corners and restaurants. Wholesale operations comprise sales to hotels, supermarkets, clubs and airlines. Franchising income gained prominence towards the end of 1997 with the signing of an Indonesian master franchise agreement. A value chain of its activities can be found in Exhibit 7.

Delifrance has the right to use the "Delifrance" trademark in 20 countries. These are Australia, Myanmar, Brunei, PRC, Fiji, Guam, HK, Indonesia, India, South Korea, Malaysia, New Guinea, New Zealand, Philippines, Singapore, Solomon Islands, Sri Lanka, Taiwan, Thailand and Vietnam. As of 30 September 1997, Delifrance had 155 outlets in seven countries (see Exhibit 8). Grand Moulins de Paris (previously controlled by the Vilgrain family) is the registered owner of the "Delifrance" trademark. The use of this trademark was renewed for a period of nine years commencing from 1 July 1997. Renewal will be due on 1 July 2006. Exhibit 9 provides an overview of Delifrance’s current operations in the region.

Key Success Factors

Delifrance’s record of success has been based on strong management and conservative business practices. Key to their success are the following factors:

• Economies of scale achieved through centralising manufacturing activities and spreading overheads among outlets.
• Increasing affluence in the region allowing Delifrance to ride the growth line (see Exhibit 10).
• Strong brand recognition, clear market segmentation and high perceived quality appeals to a certain lifestyle which attracts middle income and expatriate consumers.
• Good location of outlets with emphasis on revenue per square feet.

With the acquisition of Delifrance by SembCorp, it is important that these success factors are translated effectively in their strategy for a regional drive. Failure to do so may result in the dilution of the "Delifrance" brand and an increase in the cost of doing business.

Summary of Financial Performance

Delifrance has a very healthy balance sheet. Since its IPO in 1996, Delifrance’s cash position has improved tremendously and its debt to equity ratio has fallen from 1.40 to 0.53. Delifrance is a primarily a cash business, with over 80% of sales to retail customers who pay in cash terms. In terms of share price performance, EPS has risen from 3.79 cents in 1995 to 5.32 cents in. Although its PE ratio has fallen since 1995 the fall in the PE ratio should be taken against a backdrop of falling stock prices. A look at Delifrance’s stock performance can be seen in Exhibit 13.

Singapore

Singapore remains the highest contributor to profits and revenues of the Delifrance Group (see Exhibits 11 and 12). Delifrance’s longest operating presence in Asia is through its Singapore operations. As of press date, Delifrance has opened its eightieth outlet in Singapore and the bulk of its assets are concentrated here. Singapore also serves as a test-bed for new products and concepts.

Looking at Exhibit 10, we see that the revenue per capita is approximately $19. The entry of new competitors like Au Bon Pain and other alternative lifestyle café concepts like Starbucks and Spinelli’s pose a threat to Delifrance. The increasingly saturated market and new competition will place pressures on profitability.

Hong Kong

Hong Kong is the second largest contributor in terms of profits and revenues to the Delifrance Group (see Exhibits 11 and 12). Looking at Exhibit 10, we see that there is high potential for Delifrance to achieve similar levels of revenue per capita in Hong Kong as it has in Singapore by moving up the growth line. Sales and PBT per outlet in Hong Kong is the highest among all countries in the Delifrance Group (see Exhibit 14). Sales and profit growth in local currency terms over the past three years were 16.1% and 14.0% respectively (see Exhibit 15).

Australia

Almost half the outlets in Australia are franchise outlets. The Delifrance franchise was started in Australia by the former UK franchise-holder. A new distribution centre was started in Melbourne and a new fresh bake centre was started in Sydney in 1997. Sales to franchisees are expected to increase as more new franchise outlets are opened. Again, the potential for higher revenue per capita can be achieved by moving up the growth line. Sales and profit growth in local currency terms over the past three years were 12.1% and 16.7% respectively (see Exhibit 16).

Malaysia

Malaysia has the second most number of outlets after Singapore (see Exhibit 8), but is only the fourth largest contributor to revenues and profits (see Exhibits 11 and 12). Looking at profitability in local currency, Malaysia has the highest profit growth among all the countries over the past three years (see Exhibit 17). Delifrance operates a bakery and central kitchen in Kuala Lumpur and has both wholesale and retail activities in Malaysia. Although recent announcements by the Malaysian government to introduce currency controls have put a damper on the market, we expect such measures to have little effect on Delifrance’s Malaysian operations. This is because all capital equipment had been purchased earlier and the only currency exposure is from the import of raw materials for making the dough. We expect such costs to be only a small proportion of total expense.

Other Countries

Delifrance signed a master franchise agreement with an Indonesian partner in 1997. The People’s Republic of China (PRC) is another potentially large market for Delifrance. A survey by US&FCA reported that 5.7% of Beijing residents dined at Delifrance 3 months prior to 18 June 1997, making Delifrance the fifth most popular fast-food outlet after McDonald’s, KFC, Pizza Hut and California Beef Noodle King respectively. Delifrance has teamed up with a strong local partner (CITIC) and currently operates six café-bakeries and eight bake-off/take-away corners in Beijing (see Exhibit 8).

Looking at the remaining countries where Delifrance has been granted the right to use the "Delifrance" trademark, we feel that opportunities for growth can be ranked according to GDP per capita and population (see Exhibit 18). GDP is used as a proxy for disposable income; the larger the GDP per capita, the more disposable income consumers have to spend. A large population will enable Delifrance to spread its fixed overheads by opening more outlets. The fixed cost of setting up a factory in each country means that outlets would be needed for Delifrance to cover its manufacturing overheads.

Comparative Analysis

Delifrance’s operating performance in terms of profit margins and returns on sales, equity and assets was superior to that of its comparative firms in FY 1997. Except for Super which achieved a higher sales growth and better operating margins and return on sales, Delifrance’s double digit performance in key operating areas far exceeded those of its comparative firms.

Source: Moody’s Global Company Data Report

Impact of the Asian Economic Crisis

The recent economic crisis that has engulfed Asia since July 1997 will have an impact on the short term operating performance of Delifrance. Since Delifrance sells a relatively elastic product which is dependent on disposable income, low consumer confidence coupled with decreasing levels of disposable income due to weakening of local currencies, GDP contraction and general belt tightening by consumers should adversely affect sales.
 
 

THE OFFER

On 2 October 1997, SembCorp announced that it had entered into an option Agreement with Alexandre Vilgrain to purchase for $165.8 million in cash, option shares at $1.80 per Delifrance Share. These option shares represented 51% of the issued and paid-up share capital of Delifrance. The option shares were exercised on 10 November 1997 and in accordance with Singapore Company regulations (see Appendix 2 for a summary of these regulations), SembCorp had to make an unconditional takeover offer for Delifrance.

The 51% stake in Delifrance was bought from members of the founding Vilgrain family who held about 70% of the company. However, Chairman Alexandre Vilgrain was selling only 2% of his 20.8% stake and would retain his post. He also undertook not to sell his remaining 18.8% stake for ten years. Delifrance Managing Director Hugues Prince would also continue in his position but would reduce his stake from 4.2% to 2.5%, which he also undertook not to sell.

Reasons for the Offer

In a statement by SembCorp’s chief financial officer Chan Wing Leong, Mr Chan stated that SembCorp had always intended to be a significant food player since it announced its interest in the sector since the mid-1990s. In its takeover announcement, SembCorp also stated that it believed that the acquisition of a majority stake in Delifrance would provide significant benefits to both SembCorp and Delifrance. SembCorp had identified several areas as key to Delifrance’s growth:

• Repeating Delifrance’s Singapore success in other existing markets.
• Expansion in new and underdeveloped markets.
• Franchise operations to accelerate market development.
• Building on its established distribution network and facilities.
• Opportunities in the current economic conditions.
• Management expertise and strategic partners.

Based on their stated intentions, we believe that there are several issues that will affect the operating performance of Delifrance:

• Synergies from the redeployment of fixed assets and termination of staff through the merging of operations are unlikely.
• Aggressive expansion into new and underdeveloped markets at a time of weak consumer sentiment might result in loss-making ventures.
• Use of franchise operations to accelerate market development might result in loss of strategic control over franchise holders and being locked out of strategic markets.
• Mismatch in network of operations in the region between both companies would mean that Delifrance would still have to develop its own network to capitalise on opportunities in new markets.
• Use of Delifrance’s free cash holdings to pay for the cost of acquiring Delifrance would leave the Company with little cash to fund future growth.
• Differences in management styles and culture might result in problems over day to day operational issues and

Following the announcement on 2 October 1997, investors began dumping SembCorp shares in the market. Within a week, SembCorp stock lost 11% of its value to $5.95 amid SembCorp’s growing debt levels and fear of a cash call. There was also concern over the potential write-off by SembCorp of $213.6 million in accounting goodwill.

On 22 December 1997, Bankers Trust, who was appointed to advise minority shareholders of the Delifrance takeover offer, advised acceptance of the offer, citing the possibility that Delifrance’s share price might fall below the offer price after the offer. This was in relation to the fact that share prices in Singapore had fallen by around 5% since the takeover offer was announced whilst Delifrance’s share price had remained around the offer price of $1.80 during the same period.

On 2 January 1998, SembCorp’s share price continued to decline to a 12-month low of $3.56, a fall of almost 52% from its price of $7.40 at the start of 1997. This compares negatively with a fall of 16.3% on the widely followed DBS 50 Index over the same period. The market sentiment was that SembCorp had forked out a large amount of cash for Delifrance and would be stuck with Delifrance shares that would lag the market on the way down. The regional currency turmoil which began in July 1997 saw regional currencies depreciate by as much as 50% against the U.S. dollar and increase in the local prime lending rate. This might hurt SembCorp’s earnings due to its high gearing.

Financing the Offer

The high price paid by SembCorp for Delifrance might limit the ability of Delifrance to internally fund future expansion. This assertion can be supported using the following scenario:

1. SembCorp issued no new equity for the purchase of Delifrance.
2. Delifrance’s free cash flow in 1997 was $10.2m.
3. Assume interest cost of 8% (SIBOR +1.5%).
4. Two thirds of purchase price finance or $163.5m financed.
5. Delifrance has free cash holdings of $22m.
6. Therefore, loan required: $163.5m - $22.5m = $141.5m

Valuation of Delifrance

In this section, we will look at the valuation of Delifrance using two models:

1. Discounted cash flow model (DCF).
2. Abnormal earnings or Edwards-Bell-Ohlson model (EBO).

• We expect operations in Singapore, Hong Kong and Malaysia to experience a decline in consumer demand because of the economic crisis. Given this scenario, profit before tax (PBT) contributions from these countries are expected to decline by 10% during financial years 1999 and 2000. Assuming economic recovery begins by year 2001, we believe that a 5% growth in PBT from 2001 to 2003 is achievable.
• Operations from Australia, China and the Philippines will continue to grow but at a slower rate. Australian operations should be able to sustain a PBT growth of 5%. However, operations in the Philippines will continue to experience a loss but a turnaround is expected in year 2000 when they open their tenth outlet. China experienced a decline in PBT for FY 1998 due mainly to operating adjustments. We expect growth to resume at 10% annually from next year.
• We do not take into account any potential contributions from operations in Brunei as we are of the opinion that contribution from royalties will not significantly impact the profitability of the company.
• Retail operations will continue to expand with the addition of more outlets but at a slower pace. In the past, the company opened an average of 35 outlets a year. The recent slowdown will no doubt have an impact on the growth of outlet openings. We believe that opening 25 new outlets a year for the next five years is attainable. However, we do not expect Delifrance to enter new markets, namely India, Indonesia, South Korea and Taiwan, due to current economic conditions
• The capital expenditures required to open 25 new outlets each year is approximately $12.5 million. The company uses a straight-line depreciation method and takes three to ten years to depreciate furniture, fitting and office equipment. Using a five-year time frame to depreciate such capital expenditure will increase depreciation expense by $2.5 million a year.
• The Company’s working capital grew at an average rate of 15% over the past two years. We expect this growth to remain constant, as the company would need capital to fund the expansion of new outlets.
• Based on the regression of Delifrance stock price and the Straits Times Industrial Index, the value of beta for Delifrance is -0.164 (refer to Appendix 4). The average market return to date is -42% (STII stood at 1529.84 at the beginning of 1998 but by 10 September1998, the index was at 885.46). The risk free rate used is the POSB savings interest rate of 3.65%. Using the CAPM model, the discount rate K_s, is 11.14%.

Using the DCF model:

Value of Delifrance = [7,185,933/(1.1114)] + [9,892,690/(1.1114)²]

+ [13,749,557/(1.1114)³] + [17,590,617/(1.1114)⁴]

+ [21,517,849/(1.1114)⁵]+ [215,178,490/(1.1114)⁵]

= $175,604,660

Using the EBO model:

S (ROE_i – r)(B_i-1) (P_T – B_T)

P₀ = B₀ + ----------------------------- + --------------

(1 + r)^I (1 + r)^T

Key assumptions:

• Constant dividend payment of 2 cents per share or $3,612,000;
• Ignore any change to translation reserve; and,
• Constant ROE from year 2004 onwards (reversion to mean).

Therefore,

P₀ (ROE₁ – r) (ROE₂ – r)(1+g₁) (ROE₃ – r)(1 + g₁)(1 + g₂)

----- = 1 + --------------- + ----------------------- + -----------------------------------

B₀ (1 + r) (1 + r)² (1 + r)³

(ROE₄ – r) (1 + g₁)(1 + g₂)(1 +g₃) (ROE₅ –r)(1 + g₁)(1 + g₂)(1 +g₃)(1 + g₄)

+ ---------------------------------------------- + -----------------------------------------------------

(1 + r)⁴ (1 +r)⁵

(ROE₆ –r) (1 + g₁)(1 + g₂)(1 +g₃)(1 + g₄)(1 + g₅)

+ ------------------------------------------------------------------ = 1.97

r(1 + r)⁵

The value of Delifrance using the EBO model is 1.97 * 51,420,000 or $101,297,400. The value of the company derived by both models can be compared in the following manner:

The terminal value calculation is a significant issue. From the above table, the terminal value from the DCF model constitutes 72% of the entire value of the company compared to 35% in the EBO model. This huge concentration of value in one category can be risky as the margin of error is large. Any small change in assumption will affect the terminal value greatly. This could result in a greater margin of error.

The EBO model, on the other hand, focuses on the difference between the firm value and the book value, i.e., abnormal earnings. Book value itself contains quantified future benefits as the accrual system of accounting essentially quantifies net assets in terms of future benefits. The DCF model undoes the accrual process, forecasts future cash flow and the terminal value using market multiple and then rebundles them into the present value calculation.

Using the EBO model which we believe to be the more stringent model, we assign a private market value to Delifrance of $101.3 million or 56.1 cents per share.

Based on this valuation, SembCorp will need to achieve synergies of $144m ($245.3m - $101.3m) to justify the acquisition. It is unlikely that these synergies can be achieved. Current economic conditions have crippled some of these new markets; namely, India, Indonesia, South Korea and Taiwan. This has cast doubts over Delifrance’s ability to penetrate these markets as its targeted audience are mainly middle income earners and expatriates who are also feeling the effects of the economic crisis.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Post acquisition issues

What did SembCorp gain from this acquisition? First, it exposed itself to price risk, i.e., that it paid too high a price for Delifrance. As seen from our valuation, SembCorp would need synergies of $140m to justify its purchase price. Second, it also exposed itself to operational risk. Based on our assumptions for the financing package applied, Delifrance would have to increase its revenues by at least 90% a year for the next ten years just for SembCorp to be able to pay back the loan from Delifrance’s cash flow. Based on previous operating history and the present economic situation, we feel that such a high level of growth is not achievable. Lastly, in our opinion, SembCorp has transferred part of its shareholders’ wealth to Delifrance without the requisite payback. This means that the acquisition of Delifrance by SembCorp was a value destroying exercise in SembCorp’s shareholders’ point of view.

With regards to Delifrance, certain issues also have to be raised. First, if SembCorp were to make use of Delifrance’s free cash holdings to pay for the loan, this would result in a severe weakening of Delifrance’s cash position. To the extent that SembCorp has stated that it would not pump in any more assets into Delifrance, this might severely restrict Delifrance’s ability to grow organically. Second, the management of Delifrance no longer has control over their company. Although SembCorp has stated that it would not alter Delifrance’s current strategic position, possible conflicts might arise from day to day operations.

One other interesting point to note is Delifrance’s fiduciary duty to its shareholders. Did the management of Delifrance have to accept SembCorp’s offer of $1.80 per share if they felt that it was the full value of their company? Could they have rejected the offer without discriminating against minority shareholders?

Other issues

A year after the acquisition, many issues are still outstanding:

Strategic Direction

SembCorp is faced with two important strategic decisions: cultural and management. The Delifrance management team are predominantly French - the Chairman, Managing Director and Director of Operations - and the French are generally conservative by nature and are prepared to abide by their time when it comes to growing the business. Delifrance has been in business for 15 years and it has taken its own time to come this far. It would not hesitate to sit out this economic crisis before venturing into new markets. This is likely to cause some uneasiness for SembCorp, as they are eager to expand Delifrance’s business so as to increase the value of the company to justify the huge premium paid for Delifrance. Given the cultural differences, management differences over issues such as expansion strategy and operations are likely to arise. This will result in both time and effort being expended on the checking of Delifrance’s management decisions. The recent announcement of Alexander Vilgrain’s departure as Chairman to make way for Chan Wing Leong, SembCorp’s CFO, is a clear sign a management shakeup.

Financing

Many questions remain over how SembCorp financed the acquisition. Did the debt raised for the purchase come with a recourse to Delifrance? If so, what is the current debt structure of Delifrance and what has happened to its $22 million time deposit since the takeover? We believe in the next few weeks, the answer will be revealed when Delifrance releases its annual report for 1998.

Relationship with Principals: Licensing?

The Delifrance trademark is owned by the GMP group, which used to be a subsidiary of the JL Vilgrain group. Alexander Vilgrain played a key role in Delifrance Asia’s renewal of the usage of the trademark in the region. Usage will expire in 2006 and is be subject to another renewal agreement. Questions remain over SembCorp’s ability to renew this privilege as the subject of renewal has never been a problem because of the unique relationship between Alexander Vilgrain and the GMP management.

Aggressive Growth in Poor Economic Conditions

Given the current economic conditions, it is impossible to achieve profitability in new penetrated markets such as India, Indonesia, South Korea and Taiwan since consumer demand in these countries has fallen. T his will no doubt result in more questions over Delifrance’s future as a subsidiary of SembCorp as Delifrance can no longer generate the additional value needed to justify the premium paid by SembCorp.

Threat of New Entrants

Delifrance’s success in Singapore has lured other similar businesses to set up operations here. These included Au Bon Pain, Spinelli’s, Coffee Bean & Tea Leaf and Starbucks. This has increased the intensity of the competition and will no doubt put pressure on Delifrance’s bottom line as Singapore contributes more than 50% of Delifrance Asia’s profitability. Besides expanding into new markets, Delifrance needs to defend its market share aggressively so as to prevent further erosion of its position.

The Merger between STIC and SembCorp

The approval by the High Court on the merger will cast further doubt about Delifrance’s future in the newly merged group. Recent statements by deputy CEO-designate Tay Siew Choon indicates that Delifrance has been identified as one of the companies that could face total or partial divestment. Did SembCorp destroy Delifrance inadvertently by causing it to take on more debt to finance SembCorp’s acquisition?
 
 

ABR Holdings Ltd

The principal activities of the group are:

1. Manufacture of ice cream and the operation of Swensen's Ice Cream Parlours cum restaurants and operation of a chain of fast food restaurants;
2. Manufacturing and retailing of biscuits, cakes, confectionery and other food products;
3. Sales of food related equipment;
4. Rental and leasing of properties;
5. Managing , obtaining and exploiting industrial and intellectual property rights with respect to the ice cream and restaurant business; and
6. Investment holding.

1. Operation of bakery cafe's specialising in the sale of high quality food for breakfast and lunch, including fresh baked goods, made-to-order sandwiches on freshly baked breads, soups, salads, custom roasted coffee and other coffee beverages; and,
2. The company also generates income from its franchise operation from upfront franchise fees and annual royalties.

1. Investment holding;
2. Food manufacturing such sunshine bread, frozen pizza, pies and garlic bread;
3. Wholesale distribution of food products such as distributor for Kraft General Foods; and,
4. Allied fast-moving food consumer goods.

1. The manufacture of instant cereal flakes;
2. Packers and distribution of instant beverages and convenience food products;
3. Property management;
4. Manufacture and distribute its own brand of bakery products;
5. Supply and distribution of the beverage products; and,
6. Investment holding.

Take-overs in Singapore are guided and controlled by many sets of regulations, the main ones being:

• The Companies Act (Chapter 50).
• The Singapore Code on Take-overs and Mergers (Code).
• The Stock Exchange of Singapore Listing Manual (Listing Manual).

The Companies Act (Chapter 50)

The Companies Act is the primary instrument controlling take-overs. It has the force of law behind it. This means that compliance with its provisions takes precedence over compliance of the Singapore Code on Take-overs and Mergers and the Stock Exchange of Singapore Listing Manual, both of which are non-statutory in nature.

The main provisions of the Companies Act concerning take-overs can be found in Sections 213 and 214 of the Tenth Schedule. In Section 213, the terms "take-over offer", "take-over scheme" and "acquiring effective control" are clearly defined.

• "Take-over offer" means an offer for the acquisition of shares under a take-over scheme.
• "Take-over scheme" means a scheme involving the making of offers for the acquisition by or on behalf of a corporation:-

1. of all the shares in another company or of all the shares of a particular class in another company; or,
2. of any shares in another company which results in the first-mentioned corporation acquiring effective control of that other company.

• "Acquiring effective control" means the acquiring of shares in an offeree company which (together with shares, if any, already held by the offeror corporation or by any other corporation that is deemed by virtue of section 6 to be related to that corporation) carry the right to exercise, or control the exercise of not less than 25% of the votes attached to the voting shares of that company.

The full offer document must be dispatched after the notice period and it must comply with Part A of the Tenth Schedule. The offer document must also include statements that comply with Part B of the Tenth Schedule (as described in the earlier paragraph) and Part C of the Tenth Schedule (to be complied by the offeree company). Part A of the Tenth Schedule requires, inter-alia, the take-over to state the following:

• Whether the offer is conditional upon a minimum percentage of shares being received under the take-over scheme and if so, that percentage;
• Whether the shares are to be acquired in cash or partly by cash with other considerations; and,
• How the shares to be acquired by cash or other means are to be paid by the acquiring company.

Section 213(18) also states that the Minister of Finance has designated a non-statutory code known as the Singapore Code on Take-overs and Mergers shall have effect in relation to take-over and merger transactions.

The Singapore Code on Take-overs and Mergers

The Singapore Code on Take-overs and Mergers (Code) is issued by the Minister for Finance pursuant to a notice made under section 213(17) of the Companies Act (Chapter 50) in order to give guidance on the principles of conduct and procedures to be observed in take-over and merger transactions.

The Code is of a non-statutory nature and is intended to supplement and, in some ways, expand on the statutory provisions dealing with take-overs to be found in sections 213 and 214 of, and the Tenth Schedule to, the Companies Act. The Code and the statutory provisions do not, however, cover the whole field of take-overs and mergers for there are provisions in the Listing Manual of the Stock Exchange which will also need to be complied with by all parties to a take-over or merger involving a company or companies whose shares are quoted on the Stock Exchange of Singapore Ltd.

The common purpose of these statutory and non-statutory requirements to ensure that sufficient information is provided to shareholders and to set out the procedures to be followed by parties to a take-over or merger transaction. The Code also included provisions, which are designed to ensure that shareholders are treated equally.

The Code is administered and enforced by the Securities Industry Council (SIC) whose members are made up of representatives from the Government, the Monetary Authority of Singapore, and the private sector.

If there appears to be a breach of the Code, the Secretary of the SIC will summon the alleged offenders to appear before the Council for a hearing. If the Council finds that there has been a breach it may have recourse to private reprimand or public censure or, in a more fragrant case, to further action designed to deprive the offender temporarily or permanently of its ability to enjoy the facilities of the securities market. In the event that the Council finds evidence to show that a criminal offence has taken place whether under the Companies Act, the Securities Industry Act or under the criminal law, it will recommend to the Attorney General that the alleged offender be prosecuted.

The Code is drafted with listed public companies in view, but unlisted public companies are expected to observe the letter and spirit of the General Principles and Rules, wherever this is possible and appropriate. The Code does not apply to take-overs or mergers of private companies. The Code also applies to offeror companies, which are incorporated outside Singapore.

Neither the Code nor the Council is concerned with the evaluation of the financial or commercial advantages or disadvantages of a take-over or merger proposition, which must be decided by the company and its shareholders.

The Code has two sections: one, which lays down the rules to be followed and the other practice notes, which illustrates the applications of the rules. There are 40 rules and 12 practice notes in total.

Of the 40 rules contained in the Code, Rule 33, which requires the making of a mandatory offer when the "trigger point" is reached, is significant. The rule state that:

Another important rule is Rule 4 which requires the board of the offeree company to obtain competent independent advice on any offer and the substance of such advice must be made known to its shareholders. The independent adviser should be one who does not have a "substantial financial connection with the offeror and offeree company of such a kind as to create a conflict of interest for that person".

In many take-overs, the profit forecasts and asset valuations may affect the decisions of the target company’s shareholders. Rule 15 essentially requires the directors of the offeror and offeree company to compile the profit forecasts and asset valuations with due care and to state explicitly the assumptions upon which the forecasts were computed. The Code recognises the obvious hazard of profit forecasting but the accounting policies and calculations for the forecasts must still be examined and reported on by the auditors or consultant accountants. Although the accountants have no responsibility for the assumptions, they should not allow the assumptions to be published without comments if they appear unrealistic.

The Stock Exchange of Singapore Listing Manual

All public-listed companies on the Stock Exchange of Singapore (SES) are governed by the provisions of the Stock Exchange of Singapore Listing Manual (Listing Manual). As such, the Listing Manual regulates listed companies involved in corporate take-overs.

In the Listing Manual are 3 chapters relevant to take-overs and mergers:

• Chapter 10 – Acquisitions and Realisations
• Chapter 11 – Take-overs
• Chapter 12 - Corporate Disclosure Policy

Within Chapter 11 on Take-overs, there is a long list of rules, many of which supplement the Code and the Companies Act. Of importance to note are the following:

In Chapter 12 on Corporate Disclosure Policy, the guiding principle is that all listed companies must make prompt and adequate public disclosure of material developments of their affairs. The listed company shall keep the SES, shareholders of the listed company and other holders of its listed securities informed, as soon as reasonably practicable, of any material information relating to the group (including information on any major new developments in the group's sphere of activity which is not public knowledge) which: -