• Internal Code :
  • Subject Code : ACC706
  • University : Kings Own Institute
  • Subject Name : Accounting and Finance

Capital Market Reaction Analysis on Commonwealth Bank of Australia Agreement to Sell 55% Stake in Colonial First State to KKR & Co Inc.

Executive Summary

The assignment is based on the identification of a firm duly approved by the tutor which is Commonwealth Bank of Australia. After detailed analysis, option of news of "offload of 55% strategic investment in Colonial First State organization by Commonwealth Bank of Australia" has been selected. Further focused was made over the Capital market reactions topic and have a detailed examination of applicable accounting theories and risk management approaches. Further study was conducted to review the market reaction of the news over the decision of stakeholders based on stock trading patterns and recommended suitable suggestions over the corporate level.

Table of Contents

Executive Summary.

Aim of Report

Details of Topic and Transaction Details.

Accounting and Risk Management Treatment.

AccountingTheory.

Risk Management Theory (Tier 1 Capital Equity) and applicability.

Capital market Reaction over offload of Colonial First State.

Disclosure Requirements.

Regulatory aspects.

Recommendation and Conclusion.

Reference.

1. Aim of Report

The aim of the report is to discuss different theories and model of accounting and other related theories over imitative taken by an organization. The initiative must have some impact over the stakeholder’s i.e potential investor and stock holder. Such impact will be discussed as market reaction concept. This reaction will include certain issues and effects over disclosure concept. Regulatory implementation from regulatory authorities and it consequences over this initiative transaction will be monitored followed by some recommendations. Lalchandani et al., 2015).

1.1 Details of Topic and Transaction Details

Commonwealth Bank as parent of Colonial First State, decided to focus on core banking operations of organization with enhance system support and control over clients investment. Due to this response Commonwealth Bank decide to offload the stake along with generation of substantial cash for technological advancement. On 13-May-2020, Commonwealth Bank of Australia announced that it has reached an agreement to offload of 55% shareholding in Colonial First State(CFS) to KKR & Co Inc against cash consideration of more than $ 1.7 billion from KKR & Co. Colonial First State is a subsidiary of Commonwealth Bank of Australia founded in 1988 in the asset and wealth management sector (Burke, 2019).

The said offload is worth $ 3.3 Billion as the valuation of Colonial First State assumption of cash flow analysis method which discounted in nature. The valuations were based on a 100% valuation excluding capital surplus. The calculation was based on organization unlevered free cash flows based on the future based discounted on the firm capital cost which is weighted in nature (WACC) (Burke, 2019). This method is considered as one of the most accurate and appropriate business valuation models in the financial industry.

As a result of this offload, Commonwealth Bank of Australia will receive the cash consideration of $1.7 Billion which will be 15.5 times greater than profit after tax of Colonial First State Asset Management earning of $ 200 Million. Further, the said earning contains the capital of $ 173 Million which required certain financial adjustments as on 30-Apr-2020. This transaction needs to be accustomed to the predictable changes in profits margin, closures of products, and estimated operating costs. As a result, such impact will be benefiting the Commonwealth Bank of Australia as a beneficiary(Burke, 2019).

The said transaction will be carried out based on a strategic approach prepared by Chairman Catherine Livingstone during the 2019 financial year when it was decided to orderly exit from the remaining portion of wealth and asset management portfolio which include Colonial First State. Based on such an approach a program from proposing investment offload has been prepared with the intension to convey a considerable advantage to Australian national specifically stakeholders of organization which included internal and external. In such a program it was decided to focus, a more easy and attractive pricing model to members with enhanced delivery of services with a variety of services and digital channels. Improved education in the field of superannuation and pension system to help Australian citizens with a financial advisor at the doorstep was the purpose of an investment plan in cooperation with KKR Inc who was expertise at fund management (Burke, 2019).

2. Accounting and Risk Management Treatment.

2.1 AccountingTheory

From the accounting point of view, International financial reporting standards 5 (IFRS 5) deal with asset available for immediate sale and are marked as discontinued operations in statements of financial positions(IFRS 5, 2016). General such assets are not depreciated as per IFRS 5 framework. These assets are measured at fair value less expense to sell or lower of carrying amount. They are reported at separate segments under the heading of operations discontinued and offload of long-termassets at the balance sheet of Commonwealth Bank of Australia for several years. There are various criteria which are needed to be fulfilled of the asset to be treated under IFRS # 5. All these criteria were applied by the management of Commonwealth Bank of Australia over the sale of Colonial First State (IFRS 5, 2016).

The organization shall be dedicated and take appropriate measures to plan. to offload the asset. The said requirement has been fulfilled by the organization as the chairman and senior management of Commonwealth Bank of Australia has several times mentioned the intention to sell an annual financial report, directors' reports, and risk management report in the year 2018 and 2019 (Curtis et al.,2019). 

The organization shall treat the asset as immediately available for sale. Commonwealth Bank of Australia has parked this asset which is evidence of considering the same for immediate sale. In the past years, Commonwealth Bank of Australia has imitated an expression of interest in the financial industry to locate a potential buyer. The said shall be able to sell within 12 months from the date of classification. According to the Commonwealth Bank of Australia, the transaction will be completed by 1st half of 2021.

Organizations need to exhibit the offload of assets at fair value. Commonwealth Bank of Australia has been successful in selling 55 % of stake to KKR Global at the Price ratio of Multiple of 15.5 times. This transaction is subject to the completion of regulatory requirements of the Board of Foreign Investments Review (FIRB) Australia and Australian Prudential Regulation Authority for necessary approval (Mendelsohn and Fels, 2019). Such actions are evidence to complete the plan indicate without significant changes or withdraws (Authority, 2018).

2.2 Risk Management Theory (Tier 1 Capital Equity) and applicability.

From the risk management point of view Tier, 1 Capital Equity calculated based on core capital of financial institution along with common shares. It also includes surplus on share capital, premium, previous year retain earning, common shareholding among 3rd party, and comprehensive other income. The components of Tier 1 Capital Equity are the bank's capital, disclosed reserves, and common stock. The CET1 ratio consists of financial institution capital against its assets, instruments (not common equity). Financial institutions Tier 1 Capital Equity pretax gain in addition to the reduction from goodwill and investment accounting treatment based on net tangible assets (Bojarenko, 2017).

The strategic sale of First State Asset Management resulted in revenue of more than $ 1.7 Billion translated to approximately $ 1.5 billion which is an after-tax gain on sale of disposal. Such transactions will incur costs of $ 180 million which include different expenditure and regulatory fees. This sale will result in a positive impact on an increase of approximately $ 1.4 to 1.9 billion to Tier 1 Capital Equity know as (CET1). It is consisting of shared held by financial institution introduced in 2014 by Committee named BASEL promulgated to prepare a set of standards of international level to evaluate and supervise the capital adequacy of the financial institution (Demirguc et al., 2019).

 It is anticipated that all financial institutions including banks should get together for bare minimum essential CET1 ratio of 4.50% by 2019.As a result of such sell, Commonwealth Bank of Australia Tier 1 Capital Equity has raised to 30 to 40 basis points according to financial figures of 31 Mar-2020. Colonial First State is de-consolidated based on a bookkeeping perspective. Further entire Tier 1 Capital Equity assumption is functional for the remaining 45% holding in Colonial First State stake (Demirguc et al., 2019).

3. Capital market Reaction over offload of Colonial First State

The sell-off always considers news for market positional and current investors. It is due to the reason that the news primarily affects the financial statement of 03 organizations. The seller, the target company as the buyer. The transaction affects the substantial cash flow from the buyer to the seller in the shape of cash consideration whether as a parental change of target company leads to the market participant to reconsider the prospects of the target company. The entire transaction will require a reconsideration of benefits to stakeholders (Gurun et al., 2016).

However, the offload of strategic investment not always consider beneficial for the organization. There may be certain conditions under which organizations consider or forced to sell the stake comparative to the low market price. As a result, the seller may deprive of substantial gain and buyer my add synergy in the group which adds value to shares of an organization. Such impact is reviewed by investor and potential sellers to consider for negative impacts (Gurun et al., 2016).

Considering this sell-off, the share prices from 11-May-2020 till 15-May-2020 of Commonwealth Bank of Australia has been given below. On the day of announcements of sell-off i.e 13-May-2020, investors appreciated the news, and share prices have been raised by AUS $ 1.140 and share volume has increased to 1,376,936 shares from last working day. Later on the next day, shareholders and market participants have discounted the factor with a decrease in price by AUS $ -1.195 and share volume has decreased by 32,090 shares from the last working day. According to the table, It was analyzed that the investors have taken a new position in shares based on offload news (Bergh and Sharp, 2015)

Day

Price AUS $

Volume Traded (Shares)

Change in Price AUS $

Change in Volume (Shares)

11-May-2020

60.140

3,138,014

-

-

12-May-2020

59.710

3,095,215

-0.430

(42,799)

13-May-2020

60.850

4,472,151

1.140

1,376,936

14-May-2020

58.900

4,440,061

-1.950

(32,090)

15-May-2020

59.600

2,541,031

0.700

(1,899,030)

(Extracts of Share trading from Austrian Stock Exchange)

The offload symbolizes the last phase of Commonwealth Bank of Australia proclaims the intended exit strategy from a variety of wealth organization activities in past years. The predictable monetary impacts of the deal are subject to the concluding result relating to the capital structure of Colonial First State Asset Management at completion, bookkeeping adjustments, and taxation impacts and disjointing expenses (Sui and Sun, 2020).

4. Disclosure Requirements

Under the International Financial Reporting Standard board IFRS 5, an organization has to disclose the intended user of balance sheet related tothe impact of discontinued operations and assets held for sale under this category. Such disclosure shall be separated from assets and liabilities of financial statements and shall be restricted to combine into a single line. This regulation has been complied with by the Commonwealth Bank of Australia in the financial statement of 2019. The subject disclosure will help intended investors or shareholders to evaluate and examine the potential prospects of the seller, target, and acquirer organization (Hodgdon et al., 2018).

From the statement of comprehensive income, there is a disclosure requirement to disclose the profit or loss after tax from assets held for sale or discontinued operation for the year ended. Through such disclosures, investors can be able to examine the revenue, expenses, and operational activities of said asset. Under this umbrella, applicable taxation standards of IAS 12 can also be review by a potential buyer for future calculations of cash flows.

An organization must exhibit one of the following in cash flow statements for discontinued operations under the operating or investing cash flows for the period. Also, depreciation, amortization, the expenditure of capital nature in operating and investing noncash items (Duhovnik, 2018).

5. Regulatory Aspects

Commonwealth Bank of Australia has applied for approval for sale stake of 55% of Colonial First stake to KKR Inc (foreign buyer) to Foreign Investment Review Board (FIRB) Australia. Its analysis the application by overseas individual or organization to invest in Australia. They recommend and suggest changes to the Australian Treasury and foreign policy for investment attraction. FIRB examines the application under Foreign Acquisition and Takeover Regulations 2015. It considers the investing party details, equity participation, monitoring parameters of foreign control banks, and necessary regulatory liaison with the local and federal government. These regulations are consisting of chapters for necessary guidelines to foreign investors (Guthrie, 2016).

6. Recommendation and Conclusion

After the details study, it has been concluded that this sell-off is an opportunity for all 03 parties. Commonwealth Bank of Australia (Seller) got the opportunity to sell off the stake at a suitable price and will use the proceeds to core banking operations by providing services to members. KKR Inc (Buyer) has now entered in Australian financial markets to capture the clients for foreign investments. Local and International Levels. Whereas the Colonial First state (target company) has got the opportunity to market its acquisition as restricting of organization with the help of buyers to capture more clients by using the parent company goodwill. This sell-off will require certain approvals from the Australian Prudential Regulation Authority (APRA), Australian Securities and Investments Commission (ASIC), and foreign Investment Review Board (FIRB) approvals. Certain provisions of time and cost shall be kept in mind before proceeding future steps.

7. Reference

Authority, A. P. R. (2013). Australian Prudential Regulation Authority. Authority.

Bergh, D.D., and Sharp, B.M., 2015. How far do owners reach into the divestiture process? Blockholders and the choice between spin-off and sell-off. Journal of Management, 41(4), pp.1155-1183.

Bojarenko, J., 2017. Variability of accounting policies–advantages and disadvantages. Copernican Journal of Finance & Accounting, 6(3), pp.9-19.

Burke, B.V., Every Penny Counts Inc, 2019. Funds distribution system connected with the point of sale transactions. U.S. Patent 6,088,682.

Curtis, A., McVay, S., and Wolfe, M., 2019. An analysis of the implications of discontinued operations for continuing income. Journal of Accounting and Public Policy, 33(2), pp.190-201.

Demiurgic‐Kunt, A., Detragiache, E., and Merrouche, O., 2019. Bank capital: Lessons from the financial crisis. Journal of Money, Credit and Banking, 45(6), pp.1147-1164.

Duhovnik, M., 2018. Improvements of the cash-flow statement control function in financial reporting. ZbornikradovaEkonomskogfakulteta u Rijeci: časopis za ekonomskuteorijuipraksu, 26(1), pp.123-150.

Gurun, U.G., Johnston, R., and Markov, S., 2016. Sell-side debt analysts and debt market efficiency. Management Science, 62(3), pp.682-703

Guthrie, G., 2016. Regulating infrastructure: The impact on risk and investment. Journal of Economic Literature, 44(4), pp.925-972.

Hodgdon, C., Tondkar, R.H., Harless, D.W., and Adhikari, A., 2018. Compliance with IFRS disclosure requirements and individual analysts' forecast errors. Journal of international accounting, auditing and taxation, 17(1), pp.1-13

Baijnath, R. (2017). IFRS 5: non-current assets held for sale and discontinued operations. Professional Accountant, 2017(31), 18-19. Operations.

Kumar, B.R., 2019. KKR’s Acquisition of First Data. In Wealth Creation in the World’s Largest Mergers and Acquisitions (pp. 335-338). Springer, Cham.

Lalchandani, N.A., Baumann, M. and Hogarth, T.R., COMMONWEALTH BANK OF AUSTRALIA, 2015. Systems and Methods for Facilitating Authorisation of Payment. U.S. Patent Application 14/431,432.

Mendelsohn, R., and Fels, A., 2019. Australia's foreign investment review board and the regulation of Chinese investment. China Economic Journal, 7(1), pp.59-83.

Sui, L., and Sun, L., 2020. Spillover effects between exchange rates and stock prices: Evidence from BRICS around the recent global financial crisis. Research in International Business and Finance, 36, pp.459-471.

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