Examine iiNet Ltd's acquisition of Internode Pty ltd

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  1. Background of takeover

The iiNet Ltd, Australia’s second largest ISP (Internet Service Provider) has announced acquisition of the Internode Pty ltd on 22 December 2011 and it can be seen as process of expanding its market power across national broadband network (NBN) market in Australia, in order to take over position of largest ISP in Australia from Telstra (Big pond).

According to the iiNet annual report 2012, the Internode had approximately 260,000 active internet and phone services, including approximately 190,000 broadband subscribers. This feature can represents that Internode had strong brand power and market position in internet service market in South Australia region at 2011.

Before acquisition of the Internode, iiNet had approximately 1.3 million active broadband, telephones, IPTV and other services, including over 640000 broadband DSL (digital subscriber line) subscribers in accordance with the iiNet annual report 2012. After, this acquisition, iiNet is expected to have more market share by absorption of additional 260,000 of active internet and phone service subscribers and 190,000 of broadband subscribers who are Internod’s previous customers.

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According to the iiNet annual report 2012 and Michael Malone, iiNet Chief Executive Officer, both iiNet and Internode has similarities in business operations. First, these two companies are Australia based ISPs with B2C business model (business to consumers) that targeting individual consumers in public and providing service to those individuals. Moreover, these two firm’s main service and products are providing broadband services such as DSL, phone services and IPTV to local individual customers and homes in domestic market and these service and product are major resources which generate most of profit.

  1. Details of the takeover

iiNet offered $105 million to Internode which represents 4.2 times the estimated earnings before interest, tax, depreciation, amortization of financial year 2012 pre-synergies and 3.3 times pro-forma earnings before interest, tax, depreciation and amortization post-synergies. The purchase consideration on acquisition was a combination of cash consideration and shares consideration. Cash consideration equal $72 million and approximately 12 million iiNet share issued to Simon Hackett, the managing director and the largest shareholder of Internode and the total number of share would represent 7.5% of the total share capital of iiNet and also 7.5% of voting power.

The reason of iiNet takeover structure was based on the fair value of identifiable assets and liabilities of Internode at acquisition date. The fair value of assets was approximately $89.7 million and liabilities equal about $68 million so the fair value of identifiable net assets acquired was $21.3 million. Also Internode has $80 million of revenue and net profit after tax of $5 million to iiNet from the acquisition date to the end of financial year 2012.

According to iiNet 2012 annual report, the transaction cost of iiNet acquired Internode was approximately $2 million which have been showed under administrative and other expense in comprehensive income statement for the year ended 30 June 2012.

The implication of goodwill is the appreciation of net value, in particular, it can be say as when a organization require sales transaction, which it is worth more than its market value. The additional value from the transaction is the goodwill, and it will be classified as an intangible asset on the balance sheet. Since goodwill is an intangible asset, therefore they will all be the result of the acquisition.

The calculations of goodwill is using the purchase price deducted the market value price of the product or company. For example, A home-brand pencil sales for 10c in the market, 5c is the material and the processing charges, the reset of 5c is the profit of it. But what if this pencil is from the “Eagle”, which is a really famous company, and per pencil sales for 1 dollar.10c per pencil is the fair market value, which means the reset of 90c it is the goodwill of the brand name, and it is accounted as a acquisition.

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Above it is the example from the annual report.

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According to the iiNet annual report (2012), the accounting table above shows the process stage of goodwill calculation. As in the table, it starts with the opening balance of the company or item, since goodwill is treated as a result of the acquisition, therefore the goodwill on acquisition of Internode is positive, and when they doing the closing balance at the end of the month, they add up the goodwill and the opening balance as the final result.

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There are two accounting standards that are relevant to the iiNet annual report, which is AASB 1015 and AASB 3.

According to the AASB 3,”The objective of this Standard is to improve the relevance, reliability and comparability of the information that a reporting entity provides in its financial statements about a business combination and its effects. To accomplish that, this Standard establishes principles and requirements for how the acquirer”

The financial report below shows the financial disclosure by iiNet company, as we can see, iiNet has basically done all of the essential part of it, with accurate, reliable and comparability of information.

finacial

Refer to AASB 1015,”This Standard applies to each entity which is required to prepare financial reports in accordance with Part 2M.3 of the Corporations Law and which is a reporting entity; or holds those financial reports out to be, or form part of a general purpose financial report.”In the iiNet annual report, they have clearly complete a financial report that are exactly following the AASB 1015.

On 30 November 2011, iiNet acquired all shares of TransACT for $60 million and the cost of the transaction equal $6 million which have been record under administrative and other expense in comprehensive income statement for the ended 30 June 2012. The main different between Internode acquisition and TransACT refer to the acquire consideration. In Internode case, the consideration was a mixture of cash and shares which put Simon Hackett became the first one who got iiNet shares from the acquisition. “I’m retaining a substantial shareholding interest at the completion of the deal” (Hackett, 2012). On the other hand, iiNet acquired via cash only.

Acquire by cash which means the amount of acquisition is certain and both parties face less risky than share acquisition because the value of share will fluctuate. However cash acquisition will require a large amount of cash outflow to the acquiring company and the liquid assets will reduce which may result a potential debt problems.

Different with acquire by cash, acquire by shares will have an uncertain amount as the share price are not stable. For example the 7.5% share issues to Simon Hackett was equal about $33 million before the acquisition date but it increase to $36.2 million at the acquisition date which means the total acquire consideration rise to $108.4 million shows on the yearly annual report. Also share acquisition will provide voting power to the target company.

  1. Impact of takeover

The decision of iiNet acquiring Internode generated the positive impacts on increasing its share price directly. Especially for listed companies, acquisition can be regarded as the major event which may affect the company’s future development, operational performance, interior value and the share price (Marks & Mirvis, 2011). Through the acquisition, earnings per share of iiNet would be increased, while in the stance of internal shareholders, value accretion for them would be increased as well (iiNet, 2011).

Snapshot 1 The Current Share Price of iiNet

investor.iinet.net.au

Currently, the share price of iiNet is round $ 7.00

Snapshot 2 The Share Price of iiNet on the Acquisition Announcement Date

au.finance.yahoo.com

Comparing with its share price of about $ 2.5 at the date of the announcement, it is obvious that between 2011 and 2014, iiNet’s share price was increased drastically. Therefore, these data firmly confirmed the positive value of the acquisition and the informed decision made by iiNet’s leaders.

There are some reasons for these reactions. Firstly, as revealed by iiNet (2011), Internode is an attractive acquisition and it is a successful company with the impressive social reputation. The acquisition will help to strengthen iiNet’s position in the national broadband network (NBN) marketplace (iiNet, 2011). It implies that good market performance helped iiNet to root its image deeply in the Australian market which can be reflected in the increase of its share price.

Secondly, iiNet (2011) states that Internode was skillful at dealing with management issues, and it have the outstanding customer service. Namely, the acquisition helped to enhance the internal governance of iiNet. Therefore, with the assistance of improved internal governance, iiNet can better satisfy needs of its target customers, further, the company’s assets can be increased to maintain the increase of its share price.

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One of most foreseeable impact of acquisition is up-scale of iiNet’s market share in Australia. After acquisition, iiNet has become second largest internet service provider by acquiring 13.2% of Australian market share, following Optus, 17.6% of Australian market share. (Stanley, 2013)

Internet Service Provider

Estimated relative market share (%)

3 Internet

1.8%

AAPT

1.9%

Adam

1.4%

Chariot

1.0% *

Dodo

2.6%

Exetel

0.9%

iiNet

4.9%

Internode

3.0%

iPrimus

1.8%

Netspace

1.2%

Optusnet

17.6%

TADAust Connect

1.1% *

Telstra Bigpond

49.2%

TPG

5.6%

Unwired

0.8% *

Virgin

1.2%

Vodafone

1.9%

Westnet

2.2%

TOTAL

100.0%

Estimated Australian ISP market share, March 2012(Stanley, 2013)

After acquisition, iiNet is not just beneficial from experienced staff and knowledge of the Internode, but also can save money on research and marketing by spreading the fixed cost over larger level of output. Also, when iiNet purchasing something, could get discount by bulk purchasing. Especially both company use same vendor for DSLAMs and VolP equipment, company would save $7 million on backhaul, inter-capital transmission and a consolidation of systems and supplier. (Buckingham, 2011)

However, liquidity of the company has fallen comparing before and after acquisition of Internode. Based on the annual report 2011 of iiNet, liquidity was 0.56 ($59,730,000(current asset) / $106,042,000(current liability)). But after acquisition, liquidity had fallen down to 0.52 ($90,249,000(current asset) / $173,610,000(current liability)). This result indicates that the liquidity of the company has fallen down.

Financial leverage has increased based on the solvency of the company comparing before and after acquisition of Internode. In 2011, before acquisition, debt to equity ratio of iiNet was 0.88 ($213,971,000(total debt) / $242,506,000(total asset)). In 2012, the solvency has doubled to 1.64. ($469,861,000(total debt) / $286,649,000(total asset)). The debt of the company has increased dramatically and puts iiNet in high degree of leverage comparing before acquisition.

Share price of the iiNet also did not impacted by the acquisition of the Internode. As shown on the table below, share price of the iiNet between late 2011 and early 2012, when iiNet announced the acquisition of Internode, share price is relatively stable.

However these factors do not indicates that acquisition of the Internode is not beneficial to the iiNet. In short-term, it seemed to be unbeneficial to the iiNet, but in longer term, share price of the iiNet has increased, and both liquidity and solvency of the company has improved. (Liquidity ratio to 0.63 and solvency ratio to 1.54 based on annual report 2013). Also, through acquisition of Internode, iiNet has strong market share across Australia, especially south Australian region, and has better access to experienced staff, market and knowledge. Thus acquisition of Internode is beneficial to iiNet.

Reference

Australian Accounting Standards Board [AASB] 2010 “Acquisitions of Assets” under section 334 of the Corporations Law. , Financial Reporting Handbook 2011, volume 1, Institute of Chartered Accountants, Wiley, NSW.

Australian Accounting Standards Board [AASB] 2010, AASB 3 3 Business Combinations(as amended) , Financial Reporting Handbook 2011, volume 1, Institute of Chartered Accountants, Wiley, NSW.

ASX (2014), chart of monthly prices over 4 years for security IIN, Last accessed 6 May 2014 :

http://www.asx.com.au/asx/research/companyInfo.do?by=asxCode&asxCode=iin

Buckingham (2011), iiNet to acquire Internode for $105m. Last accessed 6 May 2014 :

http://www.itnews.com.au/News/285219,iinet-to-acquire-internode-for-105m.aspx

Hackett (2011). Q & A on the Internode iiNet transaction announcement. Last accessed 4 May 2014:

http://blog.internode.on.net/2011/12/26/q-and-a-internode-iinet/

iiNet Limited (2011). Media release iiNet acquires TransACT. Last accessed 5 May 2014:

https://www.iinet.net.au/about/mediacentre/releases/20111130-iinet-acquires-transact.pdf

iiNet Limited (2011). Media release iiNet to acquire Internode, Australia’s largest privately owned broadband services company. Last accessed 5 May 2014:

http://www.iinet.net.au/about/mediacentre/releases/20111222-iinet-to-acquire-internode.html

iiNet Limited (2011). Acquisition of Internode. Last accessed 5 May 2014:

http://investor.iinet.net.au/IRM/Company/ShowPage.aspx/PDFs/1578-45195922/InvestorPresentationAcquisitionofInternode

iiNet Limited (2011).Media release iiNet acquires TransACT to continue building scale. Last accessed 3 May 2014:

http://www.iinet.net.au/about/mediacentre/releases/20111121-iinet-acquires-transact-to-continue-building-scale.html

iiNet Limited (2012). Annual Report 2012. Last accessed 5 May 2014:

http://www.asx.com.au/asxpdf/20120921/pdf/428vkj211qpm3w.pdf

iiNet Limited (2013). Annual Report 2013. Last accessed 5 May 2014:

http://www.asx.com.au/asxpdf/20130924/pdf/42jks0nl1dm6lp.pdf

Marks, ML & Mirvis, PH 2011, 'Merge ahead: A research agenda to increase merger and acquisition success', Journal of business and psychology, vol. 26, no. 2, pp. 161-168.

Rappaport & Sirower (1999). Stock or cash? The trade-offs for buyers and sellers in mergers and acquisitions. Last accessed 5 May 2014:

http://www2.warwick.ac.uk/fac/soc/law/pg/offer/llm/iel/mas_sample__lecture.pdf

Stanley (2013), Australian ISP Market Share. Last accessed 6 May 2014 :

https://thebernoullitrial.wordpress.com/category/isp-statistics/