W24_TRI_ Acquisition of Existing Poultry Farm

1.      Problem recognition, definition and evaluation

As explained in previous economic analysis, the partnership model of poultry farm has benefit for farmers/investors. Although, the investment has relatively low risk, another business action may be taken to lower such a risk. Acquiring existing farming asset is seen as prospective action to be done, thus a business analysis is required to look at that option.

2.      Development of the feasible alternative

Using same Free Cash Flow (FCF) Model, there certain variables and assumptions need to be defined in order to have valuation of the asset. In valuation method, Terminal Value (TV) is known as continuing value or horizon value. This method assumes that the cash flows will grow at a constant rate forever, hence the name stable growth rate method (Gordon Model). When growth is constant, calculating the terminal value estimated using a perpetual growth model.

3.      Development of the outcome

The valuation of farming refers to forecasted Free Cash Flow (FCF) for 10 years lifespan as shown in Figure 1 and Figure 2.  

Figure 1. FCF White Farm

Figure 1. FCF Red Farm

According to above FCF, the annual growth of each type of farm is shown in Figure 3. As a result, the average of annual growth rate of white and red farm is -0.07% and -0.08% respectively.

Figure 3. Annual Farm Growth

4.      Selection of criteria

The decision will be made based on:

a.       The value of existing farm with its future prospect

b.      Price must be paid by the buyer/acquirer to acquire the existing farm at minimum value

c.       Payment got by the seller if he sells his farm to the acquirer at maximum value

In other words, criteria b and c is part of negotiation to be achieved to make a deal.

5.      Analysis

Table 1 shows the economics analysis of existing white farm if the acquisition made in end of Year 3. The price of acquisition to be paid to seller is K Rp 100,000, thus the payment will top up the seller cash flow in Year 3 (46,596 + 100,000). In acquirer side using 10 years lifespan, the farm will earn NPV 104,071.

Interestingly, when applying Gordon Model to value the existing farm using predictive cash flow in Year 6 (51,954), WACC = 15% and growth rate = -0.07%, the NPV becomes 179,291. The higher NPV in TV analysis is because Gordon Model assumes that the business will last perpetually, while NPV in ‘classic method’ only analyze FCF for 10 years lifespan.

Table 1. Acquirer-Seller FCF White Farm (Exclude Transaction’s Tax)

From Table 1, the price of 100,000 will make a total cash of 109,126 for seller in Year 3. This means that the acquisition price 100,000 is fair enough for the seller. Moreover if the seller in year 0 already applied acquisition scenario in year 3, he even can earn IRR 63%.

Then, the similar calculation is made for Red Farm as shown in Table 2. The acquirer’s NPV of 10 years lifespan is 57,997, while the NPV of TV year 6 is 115,757. But in this case, the price 100,000 can only make a total cash of 97,798 for seller in Year 3. However, if the seller in year 0 already applied acquisition scenario in year 3, he can also earn IRR 63%.

Table 2. Acquirer-Seller FCF Red Farm (Exclude Transaction’s Tax)

6.      Selection of alternative

Based on analysis above, a price Rp 100,000 K is the best price of an existing white farm for both parties, i.e. the seller and the acquirer. In an existing red farm, Rp 100,000 k is too low for the seller, only if the seller just looks at the total of cash flow at year 3. But if the seller of existing red farm already put the acquisition scenario at the beginning of the business, he can earn prospective NPV and IRR.

In the acquirer’s point of view, an Rp 100,000 is better rather than setting up a new farming system with the estimated initial cost Rp 110,000 as shown in economics analysis. A further negotiation may be made to have the best price for the acquirer position.

7.      Performance monitoring and post-evaluation of results

In conclusion, having looked at the benefit of poultry partnership model in the previous analysis, the investor should consider the acquisition scenario as seen in this analysis. However, setting up a new farm or acquiring an existing farm doesn’t include the risk in the analysis. Therefore, the risk and sensitivity analysis shall be conducted to balance the benefit of each type of farming model.

References:

·         Asmoro, Trian H. (2012, Dec 21). Investment on Poultry Farming. Retrieved from: http://aacemahakam.blogspot.com/2012/12/w23tri-investment-on-poultry-farming.html

·         Investopedia. (2012, Dec 21). DCF Analysis: Coming Up With A Fair Value. Retrieved from: http://www.investopedia.com/university/dcf/dcf4.asp#axzz2FYzUJ7NL

·         WACC ^Value. (2012, Dec 21).Terminal Value (TV). Retrieved from: http://www.waccvalue.com/valuation/terminal-value/