Given the vast number of assumptions applied in the research area on the base case scenario of the business case, a sensitivity and scenario analysis is carried out to determine the robust-ness of the result towards critical assumptions. Given that neither WACC nor terminal growth is expected to change following the merger compared to pre-merger levels, the analysis varies the WACC and terminal growth rate across both stand-alone valuations and the business case cash flows simultaneously to ensure that sensitivity reflects changes in the residual value.
Figure 12-3: Sensitivity analysis - value of the business case
Table 12-3 illustrates that changes in the WACC and terminal growth rate can have an impact on the value estimated, but also illustrates that the value created is positive for minor changes in both. Given a constant terminal growth rate of 2% and all else constant, WACC could in-crease to 7.34% before the value of the business case would be 0.
Page 101 of 131 The result above prompts further analysis. While the value created is positive across the most likely levels of WACC and terminal growth, numerous assumptions impact the business case.
In order to obtain a more reliable forecast and to evaluate the riskiness of the cash flows, a subset of outcomes is evaluated rather than the single base case estimate above. The simplest simulation of the cash flows under different scenarios is to look at a best case and a worst case scenario (Petersen & Plenborg, 2012, p. 281). In addition to best and worst case scenarios, several additional scenarios have been created to model some of the uncertainty in the fore-casts, especially related to the requirements of the Competitive Authorities to gain approval for the merger.
As a starting point, best and worst case scenario have been created, in which all major as-sumptions apart from WACC and terminal growth rate is adjusted. Given that the two stand-alone forecasts are used as the baseline for the projected cash flows of the business case, in-puts are varied across the stand-alone and combined firm. Furthermore, assumptions about synergies as well as other adjustments are modelled, enabling the authors to test joint sensitiv-ity. Below, the two scenarios are outlined with key assumptions, but the reader is referred to appendix 78-79 for full overview of the variables as well as their specific values.
Table 12-3: Best and Worst case scenarios
SCENARIO 1: WORST CASE SCENARIO 2: BEST CASE
REVENUE Decreased revenue growth in all markets due to adverse market conditions or cooperative members opting out
Slightly positive market develop-ment driven by volume growth
COST Production cost not returned to historical levels with current levels representing structural changes in industry.
Production cost successfully de-creased beyond historical level through continuous focus on cost
SYNERGIES Productivity gains/ kg not fully realized.
Reduced overhead and no efficien-cy gains from dist. and adm.
Base case capacity investments too low
No monopoly effect in Denmark
Increased cannibalization effect
Productivity gains/kg fully realized
Increased overhead and efficiency gains from distribution and admin-istration
Overestimation of restructuring cost
Monopoly effect on Danish market is larger, although still limited
Page 102 of 131 In addition to best and worst case scenarios; three additional scenarios relating to the require-ments of the Competitive Authorities have been created. A total of 6 scenarios have been cre-ated due to the high reliance of the business case on key assumptions about critical inputs.
The scenarios will be weighted to determine the most likely outcome of the business case, besides the base case estimate of 440 mDKK. The results of the scenario analyses are includ-ed below including a weightinclud-ed average present value of synergies of 227 mDKK.
Table 12-4: Overview of scenarios created
Scenario Value (m DKK) Probability est.
1: Base case 440 40 %
2: Worst case – market movements and synergies -451 15 % 3: Best case – market movements and synergies 1,080 15 %
4: No monopoly effect 122 10 %
5: Commitment of 5,000 pigs to competitor weekly -134 15%
6: Commitment of 10,000 pigs to competitor weekly -707 5 %
Probability weighted value created 227
In Scenario 2 and Scenario 3, major assumptions are varied slightly simultaneously based on the notion that synergies could have been over (under) estimated or non-realizable. The varia-tions are highlighted in Table 12-3 and are included in detail in appendix 78. The base case found that Danish Crown would incur a production cost saving of 0.8 DKK per kg produced, corresponding to 50% of the difference in marginal production cost per kg in the two compa-nies. Given that Tican has multiple production plants in addition to Thisted which are not ex-pected to close and that differentiated products in the processed food segment might limit the cost savings, full realization of the 0.8 DKK per kg could be too high. The worst case scenario thus assumes that only 40% of the marginal production difference can be realized, i.e. 0.6 DKK/kg. Correspondingly, in the best case scenario, the marginal productivity improvement is increased slightly to 55% of the difference, at 0.88 DKK/kg. Changing the value of this synergy has critical impact on the attractiveness of the business case, indicating that in order to create rather than destroy value through the merger, as a negative result would indicate, effort should be put into achieving productivity improvements on pre-merger Tican products.
The best and worst case scenarios also varies the important revenue growth input. With the forecast being sales-driven, revenue has a significant impact on the development in future cash flows. Given that growth in the industry is driven largely by prices and volumes, scenar-io 2 and 3 includes adjustments to the price and volume, rather than overall revenue growth.
In scenario 2, the worst case scenario is impacted by an overall downward shift in both price and volume growth. Similarly, in the best case scenario revenue growth forecasted is shifted
Page 103 of 131 slightly upwards, however only driven by volume as since the strategic analysis indicated a high degree of rivalry and with competitors using price as a key competitive parameter.
The best and worst case scenario estimate more extreme values in both directions at 1,080mDKK and -451mDKK, however with the value changing the most in the base case.
Both scenarios reflect what would happen if all inputs were different simultaneously, however in reality it may be more realistic to assume that some, but not all, of the estimated synergies decrease (or increase).
Scenario 4 has been created to accommodate uncertainty of revenue synergies. Literature and empirical studies find that revenue synergies are often difficult to achieve compared to cost synergies (Koller et al., 2010, p.446). Furthermore, the requirements from the Competition Authorities in Denmark may prohibit Danish Crown from increasing prices in Denmark, to reduce the potential dead weight loss that could occur in the market if the consolidated com-pany exercised monopolism. In the merger between Steff Houlberg and Danish Crown (Dan-ish Crown, 2002) the authorities required the consolidated company to sell meat for industrial producers at the same level as export prices, in effect cancelling out any possibilities for driv-ing up prices through market power (Konkurrence - og Forbrugerstyrelsen, 2013). The fourth scenario takes into account that additional price growth may not follow the merger and thus excludes the monopoly effects previously estimated. The present value of the business case is reduced to 122 mDKK which, albeit still positive, is substantially lower than the base case scenario.
Scenario 5 refers to the competitive environment of the consolidated company. Given the consolidated joint market share of 87.5% the Danish Competition Authorities are expected to make a conditional approval, not only in terms of prices but also enabling competition in the market. The base case scenario assumed a sale of Thisted plant and has been included in the model (see section 9 to 10), however it is possible that such commitments are not sufficient to gain approval. In the 2002 merger between Danish Crown and Steff-Houlberg the Danish Competition Authorities not only required a functional slaughterhouse with a capacity of 10,000 pigs weekly to be sold off, but also required Danish Crown to deliver pigs for the slaughterhouse for 4 years to ensure that a new player could gain foothold in the industry (Konkurrence - og Forbrugerstyrelsen, 2013). Given the size of Steff-Houlberg, which slaugh-tered approximately 3.27 million pigs annually, the delivery of 10,000 pigs weekly corre-sponded to 15% of the production (Konkurrencestyrrelsen, 2002). Tican had a production of 1,9 million pigs as of 2013/14, thus a requirement of a delivery of 5,000 pigs weekly, corre-sponding to 260,000 annually, would be approximately 14% of the total production. It should be noted that the requirement would only take effect if a competitor were interested in the Thisted plant. Introducing a required delivery of pigs to a competitor ensures that competition
Page 104 of 131 in the market is maintained. The requirement is expected to last for 5 years after which a new competitor is expected to gain foothold, thus the effect is sustained in the scenario to include changed market conditions. Assuming an average weight of a pig of 75 kg and an underlying margin per kg at 1.25 DKK per kg, this would yield a negative effect on the margins of 25 mDKK in 2015 increasing to 32 mDKK by 2020. The effect of selling 5,000 pigs weekly is ultimately found to result in a present value of synergies of -134 mDKK, ultimately making the business case negative.
The final Scenario 6 is included based on the same reasoning as scenario 5, however estimat-ing a total weekly delivery of 10,000 pigs, givestimat-ing a total of 520,000 pigs annually along-side the sale of the Thisted plant. This scenario is less likely and has been granted a lower weight.
The scenario has present value of synergies of -707 mDKK.
The fourth area of research and the underlying scenario analysis not only shows that the esti-mated value created is very sensitive to changes in the underlying assumptions, but also that the positive business case rely heavily on the requirements put forth by the Competition Au-thorities. The present value of the synergies result in 227 mDKK when applying a probability weighted average of the outcome, which is 48% lower than the base case scenario.
