It has been requested to review whetherLoblaw Companies Limited shouldinvest in the potentialtakeover of Shoppers Drug Mart. This has been doing rounds in the media circles, necessitating the LoblawCompanies Limited to take a formal step of evaluating the profitability of taking over the Shoppers. This report captures my comments and recommendations on whether Loblaw Companies Limited should invest in the proposed take over, with a focus on a potential offering price and valuation of Shoppers Drug Mart.

The Need

Loblaw Companies Limited is a Canadian company that is a majorstakeholder in the food and drug market. It has franchisesupermarkets and many branches in various regions in Canada. Due to the continuous rumors on the potential take over of Shoppers Drug Mart, Loblaw Companies Limited, the need to evaluate the impl3pf such action has increased. By taking over the Shoppers, Loblaw Companies Limitedhas a huge chance to expand its business activities and gain more dominance in the market. Shoppers Drug Mart is the biggest company in the Canadian drug market, and therefore, acquiring it has significant impacts on the market, especially on competition and profitmargins of Loblaw Companies Limited. However, due to the size of Shoppers Drug Mart and its position in the market, coming up with an acceptable and reasonable offer for the takeover is a daunting challenge.

Key Findings

Acquiring Shoppers Drug Mart will lead to a sharp increase in the share prices of Loblaw Companies Limited. This can lead to unprecedented growth n the company’s revenues and profit margins.
The Loblaw Companies Limited will grow its revenues by over $4 billion. It is estimated that the pharmacy and drug store industry will grow by over $6 billion, and with a potential takeover of the Shoppers, the Loblaw Industries limited can benefit significantly from the market growth.
The Discounted Cash Flow (DCF) method was the best at arriving at a reasonable offering price. The comparable metrics method was considered, but it was later dropped as it did not offer an acceptable valuation of the Shoppers.
Health spending in the Canadian population is expected to increase significantly in the next ten years. This is a huge business opportunity for Loblaw Companies Limited. Health spending is expected to increase due to an increasingly aging population in Canada.
Loblaw Companies Limited will benefit significantly from selling the revered brands of Shoppers Drug Mart, which have always been viewed by customers as complements to the drug products Loblaw Companies Limited offers. This, together with the expected increase in the profit margin per customer sale, has the potential of elevating Loblaw Companies Limited to near-monopoly in the pharmacy and drug stores market.

The cash option is the best method of meeting the offering price is a takeover deal goes through.Other methods, such as Share exchange, were also reviewed.

Introduction

Loblaw Companies Limited has the opportunity to acquire Shoppers Drug Mart. However, this is easier said than done. Shoppers Drug Mart controls a majority of the pharmacies and drug stores industry, and this automatically complicates any potential takeover of the Shoppers. Acquiring Shoppers Drug Mart not only has the effect of influencing the revenues of Loblaw Companies Limited, but it also means dominance in the Canadian drug market. It will create somewhat of monopoly control of the drugs market, and it is expected that Loblaw Companies Limited will be the price setter. This shows that any deal to take over the Shoppers will be a huge investment, and its effects will reverberate throughout the industry. With such a huge business opportunity, Loblaw Companies Limited should prioritize the evaluation of the potential offering price and make a breakthrough with the agreement with the directors of Shoppers Drug Mart to take over their company. While it will take Loblaw Companies Limited a huge capital investment to takeover the Shoppers, the short-term and long-term implications of such an acquisition will lead to increased revenues and more market control.

Issue identification

Main issue:the main issue for the Loblaw Companies Limited to assess whether to invest in the proposed take over of Shoppers Drug Mart. This report analyses the potential valuation methods for coming up with a fair offering price and recommendations on what action Loblaw Companies Limited should take. The Discounted Cash Flow (DCF) and comparable metrics methods are considered in this report.

Sub-issues: The followingare the sub-issues that will be addressed in this report.

Evaluation of the potential increase in the revenues of the Loblaw Companies Limited as a result of the takeover
The analysis of the DCF method of valuation
The analysis of the comparable metrics method of valuation
Evaluation of the impact of the Shoppers’ products on the overall demand of Loblaw Companies Limited brands.
The pros and cons of DCF and compare metrics approach.
A sensitivity analysis of the different funding options for the proposed acquisition of the Shoppers Drug Mart.

Issues analysis

Alternative 1: Acquiring the Shoppers Drug Mart

Acquisition of Shoppers Drug Mart is one of the alternative courses of action analyzed. To decide whether to pursue this option or not, various factors have to be considered. One of these is the valuation of the Shoppers Drug Mart. A reasonable valuation acceptable to both parties is necessary. Additionally, the implications on revenues growth, market dominance, competition, and profits margin have to be desirable to pursue this option. Below is an analysis of different factors and their implications.

The valuation for Shoppers Drug Mart

To come up with a fair and acceptable valuation of Shoppers Drug Mart, two valuation techniques are considered. These are the DCF model and the comparable metrics method.

Discounted cash flow method

The discounted cash flow method is one of the mostpopular methods used for determining the value of a business. This method is primarily based on the future cash flows of a company. In other words, the DCF modelmethod estimates the value of a business today by considering the revenues it may generate in the future. A discount rate of 1.5% was considered n applying the DCF model for the determination of the value of Shoppers Drug Mart. The formula for calculating the value of a business using DCF methods is shown below :

DCF =++……….

Where:

DCF= Discounted Cash Flow

r=discount rate

CF= cash flow

The purpose of the discounted cash flow model is to evaluate the amount of revenue that people looking to invest in business will get, considering the time value of money (Inselbad and Kaufold, 1997). This method assumes that money is more valuable today than it will be in the future.

The valuation using the DCF model can give an approximate value of the Shoppers Drug Mart. To do this, data show in appendixes 1 and 2 will be necessary. Estimatingworking capital and future capital expenditures requires annual revenue data for the company under study. The DCF model is the most popular valuation method for business. However, a number of factors have to be keenly looked at to arrive at a reasonable, fair, and acceptable valuation of a business. The final figures for the vacation of businesses using the DCF technique are affected by projected capital expenditures, the weighted average cost of capital, working capital projections, and the growth rate projection. To arrive at a correct figure, these factors must be correctly inputted in the DCF model; otherwise, the value arrived at will either be overstated or understated. In applying the DCF model for the valuation of Shoppers Drug Mart, it is recommended that the book value of assets is used. This is because the book value captures the value of assets less the expected depreciation over time(Burgstahler and Dichev, 1997). In essence, the book value of an asset is discounted, considering that its value today is more than it will be in the future.

Comparable metrics method

The comparable metrics method is another method that is used in the valuation of businesses. For the case of Shoppers Drug Mart, the financial statements of related companies will be used to arrive at a reasonable, fair offering price (Appendix 3). However, from the onset, it is clear this method arrives at a price that may not be acceptable to both parties. In applying this method, the most recent transactions must be given more weight since they present transactions done in the prevailing business environment. In this meth, it is also recommended that the book value of assets is considered in the calculation of the correct value of the Shoppers. After the analysis of initial findings in the approximate value of Shoppers Drug Mart, a decision was made to adopt the DCF model for the calculation of the value of the company.

Effect of acquiring Shoppers Drug Mart on competition

The Shoppers Drug Mart is a market leader in the pharmacies and drug stores industry. It controls over 50% f the market, thanks to its popular brands. It has been found that the acquisition of Shoppers Drug Mart will lead to market control of over 70%. The rest of the market will be controlled by the competitors of Loblaw Companies Limited. As evident in the expected market share, the competition will significantly reduce. This will, in turn, lead to increased revenues for Loblaw Companies Limited as a result of more sales and fewer costs on advertising..

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Implications of the takeover on Future demand

Marketresearchhas shown that there will be increased health spending in Canada, thanks to an increasingly aging population. This automatically means increased demand for drug products. This will ultimately lead to increased revenues and profits for Loblaw Companies Limited, if it acquires the Shoppers. Additionally, acquiring the Shoppers Drug Mart adds the prestige of selling its respected brands. This will lead to even greater control of the market to near-monopoly status. Therefore, in terms of expected future demand, investment in the takeover of Shoppers Drug Mart is justified.

Expected revenue growth

The revenue of Loblaw Companies Limited will grow by over $4 billion if a decision to take over Shoppers Drug Mart is taken. It is estimated that the pharmacies and drug stores industry will grow by over $7 billion in the next decade, and with the Loblaw Companies Limited controlling a majority market share, most of this growth will benefit the company. Additionally, the increase in shares value will significantly increase the revenues of the business. Therefore, a decision to invest in the takeover of the shoppers is recommended.

Alternative 2: Not acquiring the Shoppers Drug Mart

Despite the obvious benefits of investing in a potential takeover of Shoppers Drug Mart, the options of deciding against such a business decision are still valid. As is expected, the investmentin the takeover will need a significant amount of capital. This is because the Shoppers is a major player in the market, and a massive company in terms of its value. Therefore, investing these huge sums of money in the takeover is always going to be a risk. There is no guarantee that the takeover will lead to growth in revenues and profits as estimated, as there are always unforeseen circumstances in business. For example, unfavorable government legislation on the licensing of personnel dealing with drugs sale could impact the business negatively. Additionally, coming up with an agreeable offering price for both parties is a daunting task, and it could significantly affect the focus of Loblaw Companies Limited on its other business interests. Despite all these possible shortcomings, investing in the takeover of the Shoppers is highly recommended.

Recommendation

In view of the analysis conducted on the implications of the takeover of Shoppers Drug Mart, I recommend that Loblaw Companies Limited determines a reasonable offering price using the discounted cash flows method, and use it to strike an agreement with Shoppers Drug Mart. In calculating the value of the Shoppers, the book value of the assets should be adopted. Despite the expected high value of Shoppers Drug Mart, it is strongly recommended that Loblaw Companies Limited goes ahead to swiftly invest in the takeover once an offering price is agreed. This will benefit the company in many ways, including the increase in revenues and an increase in market control. With regard to the method of funding the investment, the cash option is recommended as it offers fewer risks.

Conclusion

Conclusively, taking over Shoppers Drug Mart will not be an easy task. It is a rigorous process that is expected to involve the making of bold business decisions. However, the benefits of the process supersede the accumulated business risks as a result of such a massive investment. Therefore, Loblaw Companies Limited should go ahead and finalize a deal with Shoppers Drug Mart. This will be the right step towards market expansion and dominance.

References

Burgstahler, D. C., &Dichev, I. D. (1997). Earnings, adaptation and equity value. Accounting review, 187-215.

Inselbag, I., &Kaufold, H. (1997). Two DCF approaches for valuing companies under alternative financing strategies (and how to choose between them). Journal of Applied Corporate Finance, 10(1), 114-122.

Appendix 1

SHOPPERS DRUG MART BALANCE SHEETS, 2011–2012 (IN $ MILLIONS)

Year ended	Dec 29, 2012	Dec 31, 2011
ASSETS Current Assets Cash & cash equivalents	$ 105	$ 119
Accounts receivable	470	493
Inventories	2,148	2,042
Prepaid expenses and deposits	42	41
Total current assets	$ 2,765	$ 2,696
Property and equipment	$ 1,718	$ 1,768
Investment property	16	16
Goodwill and intangible assets	2,913	2,781
Deferred tax assets	39	21
Other assets	23	18
Total Assets	$ 7,474	$ 7,300
LIABILITIES CurrentLiabilities Bankindebtedness	$ 171	$ 172
Accounts payable and accrued liabilities	1,207	1,109
Current portion of long-term debt	450	250
Other current liabilities	507	245
Total Current Liabilities	$ 2,335	$ 1,776
Long-term debt	$ 247	$ 696
Finance leases	123	118
Other long-term liabilities	399	404
Deferred tax liabilities	47	39
Total Liabilities	$ 3,150	$ 3,032
SHAREHOLDERS’ EQUITY Share capital	$ 1,431	$ 1,486
Treasury shares	–	(5)
Contributed surplus	11	10
Accumulated other comprehensive loss	(35)	(30)
Retained earnings	2,916	2,806
TOTAL LIABILITIES & EQUITY	$ 7,474	$ 7,300

Appendix 2

SHOPPERS DRUG MART INCOME STATEMENTS AND OTHER FINANCIAL INFORMATION, 2011–2012 (IN $ MILLIONS EXCEPT PER SHARE AMOUNTS)

Year ended	2012	2011
Sales	$ 10,782	$10,459
Cost of goods sold	6,609	6,416
Gross profit	4,173	4,042
Depreciation expense	263	249
Operating and administrative expenses	3,029	2,882
Operating income	$ 881	$ 911
Finance expenses	58	64
Earnings before income taxes	$ 823	$ 847
Income taxes Current	236	209
Deferred	– 21	24
	215	233
Net earnings	$ 608	$ 614
Net earnings per common share Basic	2.92	2.84
Diluted	2.92	2.84
Other Financial Information:
Capital expenditures	236	390
Shares outstanding at fiscal year-end (millions)	204.5	212.5

Evaluationand Recommendations on the Proposed Takeover of Shoppers Drug Mart

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Executive summary

Expected deliverable