Red October Bid

The Hostile Bid for Red October

Case Study

Corporate Finance II

Issues

There are several key issues that arise in the bid for Red October. First, what is the stand-alone value of Red October and how does it compare to the bid offered by Koloss? Also, if the bid is higher than the stand-alone value, is it greater than the value of Red October with possible synergies? Second, how did Koloss structure the bid and what were possible reasons for this structure? Last,what measures should Red October take to defend itself if it deems this offer insufficient?

Valuation

Both bids ($7.50 and $9.50) are very low, and fall well below the stand-alone value for Red October. The $9.50 bid represents a market capitalization of roughly $60 million. The land that Red October sits on alone is valued at roughly $60 million. Take into account existing cash of $4.5 million, and futures cash flows that, when discounted at 23%, equal roughly $72 million, this puts a total valuation of Red October and its land at $136 million.

There are two major caveats to this valuation, however. First, the valuation assumes a certain level of liquidity in the stock market, similar to what we see with companies listed on US stock exchanges. Russia is a nascent capitalistic economy with legal and regulatory uncertainties, meaning that a company trading on the Russian exchange is subject to limited liquidity. This lack of liquidity inherently decreases the value of any company on the exchange.

The second caveat is that the DCF valuation assumes constant future revenue in determining the terminal value. While this valuation assumption is acceptable with more established markets, Russia’s economy provides much less certainty for companies, which leads to less certainty in future cash flows. This lack of certainty with future cash flows should futhur decrease the valuation of the company.

All of this being said, even if the estimated value of Red October using DCF were discounted...