LH Acquisition of PS: Strategic Analysis and Financial Impact
Analysis of LH’s Takeover of PS
Introduction: The Strategic Decision
Loretta, an entrepreneur, established LH using her own savings and venture capital (risk capital invested in businesses with high profit potential but difficulty securing traditional financing). LH pursued external growth—business expansion via integration with another business—by taking over PS. LH purchased 50% of PS’s shares, becoming the controlling company. Loretta employed a strategy, likely informed by a SWOT analysis (a long-term plan to achieve overall objectives), for this takeover.
Initial Rationale and Expected Benefits
The takeover aimed to leverage several potential strengths and opportunities:
- International Brand Awareness: PS already possessed international brand recognition. LH planned to sell its luxury products internationally under the PS brand, anticipating higher revenue and international sales growth. This was intended to overcome a potential weakness for LH.
- Financial Metrics & Operations: Following the takeover, the company’s acid test ratio decreased. While a lower ratio typically indicates reduced liquidity, the initial period seemingly coincided with factors like achieving economies of scale, generating higher revenue ($61m in 2020), reducing average costs (including wastage and inventory holding costs), and securing reliable national suppliers.
Negative Consequences and Operational Challenges
Despite the initial rationale, the takeover led to significant problems:
- Customer Complaints: LH received numerous negative online comments and reviews post-takeover, particularly concerning failures to meet promised delivery times, with orders arriving after the festival period.
- Cash Flow Issues: These delivery problems stemmed from an increase in trade receivable days (from 6 to 25 over two years). This indicated slower customer payments, severely impacting working capital and cash flow, which in turn delayed the production process.
- Reputational Damage: The operational failures resulted in negative publicity for LH.
- Diseconomies of Scale: Contrary to expectations, LH experienced diseconomies of scale. The profit margin plummeted from 29% to 11%.
- Financial Instability: The gearing ratio increased, making LH more financially unstable. Assets had to be sold off. The decreasing acid test ratio ultimately reflected this instability.
- Shareholder Dissatisfaction: LH’s reputation suffered. The dividend per share dropped drastically from $4 to $0.5, likely leading shareholders to withdraw shares due to poor returns.
- Loss of Loyalty: Both shareholder confidence and consumer loyalty were damaged.
Further Analysis of Failures
Several factors compounded the negative outcome:
- Inventory Control: Lack of effective inventory control contributed to diseconomies of scale, increasing average costs, wastage, and obsolete stock, further delaying production.
- Poor Cash Flow Impact: The extended trade receivable days and resulting poor cash flow directly led to the reduced dividend per share ($4 to $0.5), dissatisfying investors and customers alike.
Conclusion: An Incorrect Strategic Decision
Overall, the evidence indicates that LH’s takeover of PS was a strategic failure. The acquisition contributed significantly to LH’s subsequent losses and instability. The increased gearing ratio, decreased acid test ratio, and forced asset sales highlight the financial distress. Operational issues like poor inventory control and delayed receivables led to diseconomies of scale, reduced profitability, and damaged stakeholder relationships. LH likely had to borrow further finance to maintain stability and failed to meet its long-term and short-term objectives, ultimately disappointing consumer and shareholder expectations. Therefore, LH did not make the correct strategic decision in taking over PS.