Financial Analysis and Management

Summary of the acquisition targets and rationale for acquisition

BHP Billiton is an Anglo-Australian multinational company  dealing in industry of metal and mining. Company was established in 2001 through the giant merger of Anglo–Dutch Billiton plc and Australian Broken Hill Proprietary Company Limited (BHP). To maintain their leading position in the industry they are planning to acquire Anglo-American Plc or Antofagasta. Through this acquisition company will be able to expand their market share and resource. Further they can create situation of cartel in the industry by attaining competitive position. They will able to conduct their operational activities in more effective manner through merging their core-competencies. Strategy of acquisition is adopted by the organization to achieve the strategic and financial objectives. Primary objective of entity is self-evidently growth and expansion in sales, assets and market share. Further this strategy will also enhance their shareholder's wealth which will create sustainable competitive advantage. According to the modern theory of finance, maximization of wealth of the shareholders is posited as rational criteria for making investment and financing decision. Thus this acquisition will satisfy the purpose of wealth maximization of company.

Companies targeted by BHP Billiton has strong position in the mining industry. Acquisition of these companies will enhance calibre of operational strategies and their technological systems. Through this strategy company will be able to reduce their competitors and strengthen their functional activities. Anglo-American plc is largest producer of platinum and major producer of diamonds.  It had market capitalization of £31.2 billion and have top position of primary listing on the London Stock Exchange and has secondary listing on the Johannesburg Stock Exchange. By acquiring  Anglo-American plc,  BHP Billiton can increase their productivity and achieve better position in market. Further they can expand their operational area to enhance sources of revenue.

Antofagasta is Chilean-based entity that operates is several sector of economy. It is listed company and has market capitalization of approx. £12.1 billion. Through the acquisition of Antofagasta entity will be able to diversify their business operations to explore new markets.   Further targeted company is major producer of copper at comparatively low cost. Thus by acquiring this company, BHP Billiton improve their cost structure to enhance scope of profitability. Thus acquisition of both the company will be beneficial for the entity in their respective areas. For better profitability and opportunities financial analysis will be done of both the companies to determine which company should be acquired.

Importance of working capital and capital structure management

Working capital management

Working capital management is a process of balancing the requirement of short term assets and liabilities. Management of working capital is vital to run healthy and successful business. Working capital can be defined as available resources to operate daily operational activities of business (Burns, Hopper and Yazdifar, 2004). These sources is used to settle regular bills such as supplies and wages. Further unplanned costs and uncertain expenses are also covered by working capital. It represents liquidity of entity to meet out their current obligations. Through the appropriate management of working capital assurance is provided that current assets will always exceed current liabilities and situation of working capital deficit will not arise (Cohen and Kaimenaki, 2011). Poor management of working capital can lead to increase in business loss and damage ability of business to attract potential customers. In order to prevent situation of bankruptcy and financial difficulties it is essential that business should have appropriate cash flow.  Working capital is nerve centre and life blood of business. It enhance goodwill of the entity as it enable organization to make prompt payments of operating expenses and other obligations (Hopwood and McKeown, 2003). Adequate working capital represents high amount of solvency and good credit rating which helps in availing loan from financial institutions at easy and favourable terms. With the quick payment of raw material provides assurance of regular supply of materials from suppliers. Industrial minerals giant is focused on management of working capital in order to release cash, reduce their interest cost and improve their earnings (Kastantin, 2005). Capital efficiency of entity is measured by cash conversion cycle.

Capital structure management

Capital structure management is crucial for survival of business in long run. Liability side of  the position statement is covered under perfect capital structure planning. It helps in reduction of over all risk of company. Through management of working capital prior adjustments can be made for risk assessment (Kate-Riin,  2012). Further sources of finance can be adjusted according to the business environment. Through suitable planning of capital structure of future resources will help in enlarging of area for funds generation. In financial terms it is known as manoeuvrability. Through this strategy mobility of resources is created to include maximum alternatives in the planned capital structure (Kont, 2013).  Optimal mixture of debt and equity in mining is most appropriate manner for maximization of wealth of shareholders and it is basic challenge for each financial analyst. Management of Capital structure helps in tax planning, reduction in  interest cost and enhancement of retained earning. Efficiency of capital structure is determined by capital gearing ratios (Portz and Lere, 2010).

Analysis of working capital management

Anglo-American Plc

According to the strategy of Anglo-American Plc, requirements of working capital of company will be funded through the shareholders loans at prime plus 1%. Flat 10% of this fund will be for Small business start up fund combined with the commercial repayment terms and conditions. Further company had assisted 179 entrepreneurs with seed and working capital for their fledging operations or emerging enterprises (AAL ANGLO AMERICAN PLC ORD USD0.54945, 2014). Principal financial assets of the entity is cash, short-term investment, trade and other receivables and derivative financial instruments. Company is not focused on credit risk in respect of trade receivables due to the large number of customers. Their liquidity risk is managed by sufficient committed loan facilities. These funds are used to meet short-term requirements of business after considering cash flows from operations. In addition to this certain projects of entity is financed by scarce means of limited recourse project finance.

As a global group, company is exposed to many currencies due to operating costs  and revenues in terms of non-US dollars. Operational policies of the company is hedge to such exposures. Further exceptional policies of the entity is approved by Group Management Committee.

There is fluctuating trend in the interest rate risk due to rapid change in interest rates of the economy. It has adverse impact on financing activities and value of short-term investments. To manage this risk policy of the group is to borrow rates at the floating rates to give natural hedgge against the movements in price of commodity (Anglo American group foundation. N.d.). This policy is correlated with the economic growth and industrial activities.  In some situations, interest rate swap contracts is used by entity for better management of risk.

Antofagasta

According to the “macroaxis”, Antofagasta is rated below average is category of working capital among related companies. Properties of the company are in exploration state and company is dependent on the external sources of finance for the funding of activities. Review of capital management approach is done on the ongoing basis and they believe that this approach is reasonable in accordance with the size of the company (Annual report of Antofagasta, 2012). There were not significant changes in approach of company in management of working capital. Further company is not subject to the external impose of working capital requirements.

Debt to equity ratio

This ratio find outs how the company finance its assets. The figures reflects that there is a stability in the financing done by the company. They are well capable of achieving balance between equity and debt financing. The ratio between the two financing is maintained very effectively. Depending heavily on debt financing is not good for the business. It can create lot of burden and pressure on the business. Anglo-American are needed to focus on its business strategies so that revenue and income can be generated at higher level. This will encourage the business to go for adopting equity financing (Reid, 2002). They can go for debt financing only in the case if company's business is performing well and doing expansion effectively across the world. The ratio indicates that company has not been aggressive in financing its growth with the debt. This results in voltaic earnings due to rise of additional expenses. The ratio trend is also indicating that there is a sound relationship between the capital contributed by the company's creditors and the capital contributed by the shareholders (Sisaye and Birnberg, 2010). It can be said that the business can show the extent to which shareholders equity can fulfil a company's obligations to creditors in the condition of a liquidation.

Current ratio of Anglo-American Plc in 2013 1.94. It is near to ideal ratios but it has drastic fluctuation. In 2011 and 2012 Current ratio of the company was .24 and .20 respectively which is quite low. However company is able to manage their current assets and liabilities in two year to cope up with ideal ratio. For this purpose they are generating funds from the shareholders loans at prime plus 1%. Through this strategy they are able to generate sufficient funds to meet out their current obligations. Company believes in amendment in operational strategies to provide standard performance (Annual report of Anglo American Plc, 2012). Further they had improve their cash conversion cycle for the management of working capital. Due to increase in current liabilities in 2011 and 2012 there was adverse impact on the quick ratio. However with the improvement in their operational strategy they had balance their current liabilities to generate sufficient funds for operational activities and to maintain solvency of business.

Current ratio of Antofagasta is higher than the ideal ratio which is not good as per financial ratios. Company had created blockage in their funds due to which they are not able to utilize it in effective manner. However company had implemented strategic policies to reduce current ratio but still there is huge scope of improvement. Similar trend can be noticed in the quick ratios of the company (Annual report of Antofagasta, 2012).  However organization has justified reason for the higher investment in current assets i.e. they are reviewing their cost structure for the reduction of capital cost. Further this strategy emphasize on use of  Chinese-sourced equipment instead of EPCM contractor. Current strategy of entity is suitable because it is not able resource in optimum manner.

Activity ratios

Activity ratios are calculated to analyse capability of organization in utilization of their resources. In these ratio amount of sales is contrasted with the amount of assets. Through the increase or decrease in the ratio assessment of  performance of company can be done (Wahlen and et.al., 2011).

Activity ratios of Anglo American Plc

Stable trend can be noticed in the activity ratio of Anglo-American Plc. In all financial year total asset turnover ratio is near by .6. In 2013 increase of .9 can be noticed in this ratio. It indicates that company is using similar strategy over the years to maintain their standards and outcome. Inventory turnover ratio defines eligibility of company is stock management (Anglo American plc’s “Sell” Rating Reiterated at Goldman Sachs (AAL). 2014).  Inventory turnover ratio of the company is very high which indicates low stock in the end of the financial year. Organization is able to sell their maximum production in order to generate revenue and profits. Debtor turnover ratio of the company indicates that company is able to recover the credit amount from debtor and there is less possibility of bad debts.

Activity ratios of Antofagasta

Activity ratios of Antofagasta are not fluctuating but there are significant ups and downs in  turnover of the company. It is due to continuous reduction in the turnover of the organization from 2010. In present year there is reduction in total turnover asset ratio by .5. It indicates that company is able to make effective utilization of their resources in comparison to the Anglo-American Plc. Further increase in inventory turnover ratio can be noticed over the year (Annual report of Antofagasta, 2012). It is due to continuous increase in inventory of the entity. It represents inefficiency of organization in stock management in accordance with rapid change in the sales. Debtor turnover ratio of the Antofagasta is less which shows company is operating on cash basis and they are providing good credit policies to their customers.

Profitability Ratios

Profitability ratios are computed to measure the ability of entity in generation of profits comparison to sales, equity and assets. Further these ratios helps in assessment of ability of organization to generate profits, earning and cash flows. It describes management of company in regards of expenditure and obligations (Wahlen and et.al., 2011). For most of these ratios, higher value is desirable to indicate  growth and improvements. These ratios provide meaningful information through inter or intra comparison. Thus these ratios are crucial part of trend and industry analysis to draw valid conclusion regarding profitability of the company.

Profitability ratios of Anglo American Plc

Profitability ratios of organization does not indicate good position of organization. In 2010 there is drastic reduction in gross profit ratio which lead to negative operating profit. However Company recovered from this loss and in 2013 they were able to make increase in profits. Further net profit of the organization is same from previous four years (Annual report of Anglo American Plc, 2012). This fact is star point for the company because even in situation of negative operating profit they were able to generate positive net profit. In 2013 similar net profit is due to the recovery of previous losses.

Profitability ratios of Antofagasta

Profitability ratios of Antofagasta is comparatively better than Antofagasta as they are able to generate better revenue from their resources. Still performance in 2013 is lower than 2012 due to reduction in sales of organization. Further there is fluctuating trend in the profitability ratios of the organization which will work as adverse factor for strategy of acquisition.  From previous five years  there is 5-10% decrease in net profits ratios of the company (Kinney and Raiborn, 2012).

Investor Ratios

Investment ratios are computed for the measurement of ability to provide return on investment on amount invested by investors. Isolation review of investor ratios is not beneficial thus it should be looked over a period of time by using technique of trend analysis.  In a strategy of acquisition investor ratios plays vital role because main objective of BH Billiton is wealth maximization of shareholder of the entity (Portz and Lere, 2010). If acquired entity is not able to provide better returns to the investors then it will also reduce the return of the parent company after acquisition.

Investment ratios of Anglo American Plc

There is fluctuating trend in investor ratio  of Anglo-American Plc as there are significant ups and downs. In 2011 price earning ratios of company was reduced by 5% then in 2012 it was increased by 6% and in 2013 it was again reduced by 3%. Due to higher fluctuation there is high risk  for investors. From past two years there is negative growth in earning per share but in previous year company is able to reduce the negative percentage from significant amount (Annual report of Anglo American Plc, 2012). Further there is continuous increase in the dividend yield ratio of company. Overall position of investor ratios is positive because company is able to recover from adverse situation from their effective strategies.

Investment ratios of Antofagasta

From 2011 there is continuous  increase in price earning ratio of Antofagasta however earning per share growth is continuously reducing which represents adverse performance of businesses. There are high risk associated for the investors (Annual report of Antofagasta, 2012).

Summary of ratio analysis

Liquidity ratios of Anglo-American Plc is near to ideal ratios but it has drastic fluctuation. Still company is able to manage their current assets and liabilities in two year to cope up with ideal ratios. In activity ratios, stable trend can be noticed of organization which indicates that company is able to achieve standard outcome over the years.  In all financial year total asset turnover ratio is approximately .6. In 2013 increase of .9 can be noticed in this ratio. In addition to this company is able to sell their maximum production in order to generate revenue and profits. In 2010 there is drastic reduction in gross profit ratio which lead to negative operating profit. However Company recovered from this loss and in 2013 they were able to make increase in profits. In the past years there is fluctuating trend in investor ratio  of Anglo-American Plc as there are significant ups and downs in earnings. In 2011 price earning ratios of company was reduced by 5% then in 2012 it was increased by 6% and in 2013 it was again reduced by 3%. Overall position of investor ratios is positive because company is able to recover from adverse situation from their effective strategies.

Liquidity ratios of Antofagasta is higher than the ideal ratio which is not good as per financial terms. Company had created blockage in their funds due to which they are not able to utilize it in effective manner. This will reduce their return on investment which will affect the future growth. Current strategy of entity is suitable because it is not able resource in optimum manner. Activity ratios of Antofagasta are not fluctuating but still there is significant ups and downs in  sales of the company. Increase in inventory of the entity represents inefficiency of organization in stock management in accordance with rapid change in the sales. In addition to this, Debtor turnover ratio of the Antofagasta is less which shows company is operating on cash basis and they are not providing good credit policies to their customers. There is fluctuating trend in the profitability ratios of the organization which is adverse factor for strategy of acquisition.  From previous five years  there is continuously 5-10% decrease in net profits ratios of the company. There are high risk associated for the investors. From the figures of the entity it can be noticed that company is performing well from past years.

Conclusion

From the above analysis it can be said that BH Billiton should acquire Anglo-American Plc instead of Antofagasta. Selected company has comparatively better resources and strong position in the industry. Further they can satisfy the purpose of acquisition of wealth maximization of shareholder and cost reduction. Company can enhance their calibre of operational strategies and their technological systems. Further it will reduce their competitors and strengthen their functional activities. By acquiring  Anglo-American plc,  BHP Billiton will be able to increase their productivity and achieve better position in market. Further they can expand their operational area to enhance sources of revenue. Existing strategies of Anglo-American Plc will also be beneficial for the entity to recover from the adverse circumstances. Company recovered from this loss and in 2013 they were able to make increase in profits. In the past years there is fluctuating trend in investor ratio  of Anglo-American Plc as there are significant ups and downs in earnings but overall position of investor ratios is positive.

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