Case: Cooper Industries. Inc
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Mergers and Acquisitions Acquisitions
Cooper Industries. Inc
Company Background
Organized in 1919 as a manufacturer of heavy machinery and equipment
A leading producer of engines and massive compressors in mid-1950s
Heavy dependence on sales to the gas and oil industries
Financial strength is attractive
Acquisition made by Cooper Ind. Inc
et!een 1959 and 1966 it acquired
"1#A supplier of porta$le industrial po!er tools
"%#A manufacturer of small industrial air and process compressors
"&#A ma'er ma'er of small pumps and compressors for oil field operations op erations and
"(#A producer of tire-changing tools for the automotive mar'et
)n 1969
*he +rescent ,iagara +orporation" )t has high quality !renches pliers and scre!drivers
Acquisition Strategy in 1966
+ooper played a ma.or role in any acquisition
*he industry should $e fairly sta$le !ith a $road mar'et for the products and a product line of largely small-tic'et items 1
1
Case: Cooper Industries. Inc
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Acquire only leading companies in their respective mar'et segment
Nico!son "i!e Company
Strengts
One of the largest domestic manufacturers of hand tool and !as a leader in its t!o main product areas
)t had 50 / share of 50 million mar'et for files rasps
Also 9/ share of %00 million mar'ets for hand sa!s and sa! $lades compare to ears 2oe$uc' and co )nc3
)ts highest assets !as distri$ution systems
*hese strengths forecasts 4/ to / future annual gro!th
#ra$backs
Annual sales gro!th %/ ")ndustry gro!th 4/#
6rofit margin 17&rd those of other hand tool $usiness
oo' value 8 513%5"ar'et value 8(( on ay19%#
67: ratio 10-1(
*he company could contri$ute less than one-si;th of the com$ined sales
,icholson
%.&.'orter Company
A conglomerate !ith !ide ranging interests in electrical equipment tools nonferrous metals and ru$$er products
)t had acquired ((000 shares of ,icholson in 194
6orter offer 8 (% per share in cash for (&000"out of 5=(000# to ,icholson ,icholson
6orter offer 8 50 per share in cash for 1000"out of 5=(000# to +ooper %
2
Case: Cooper Industries. Inc
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3
()N
>?, !as $roadly diversified company !ith ma.or- interests in original placement automotive equipment equipment and in pu$lishing pu$lishing
@nder the >?, merger merger term one share of >?, ne! cumulative converti$le preferred stoc' !ould $e e;changed for each share of ,icholson
6referred dividend 81340
Critica! issues *or making merger bet$een ()N + Nico!son
13 *he e;chan e;change ge !ould !ould $e a ta; ta; free free trans transact action ion %3 81340 preferr preferred ed dividend dividend equaled equaled the rate rate then then on the ,icolso ,icolson n +ommon +ommon toc' &3 A pref preferr erred ed share share !as !ort !orth h a minimum minimum 85&31 85&310 0
1. I* you $ere $ere Mr. Mr. Ci,ik Ci,ik o* Cooper Cooper Industri Industrieses- Inc.Inc.- $ou!d you try try to gain contro! contro! o* Nico!son "i!e Company in May 19/0
r3+izi' r3+izi' could try to gain control of ,icholson in ay 19% due to their opportunities
6otential profits from every mar'et segments
+ost of goods sold could $e reduced from 49/ to 45/
elling general and administrative e;penses from %%/ to 19/ due to the elimination of sales and advertising duplications
+urrently +urrently ales !ere made to industrial mar'et mar'et and consumer mar'et same proportionately "5050# !hich can $e offset through ,icholson
Case: Cooper Industries. Inc
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@se :uropean distri$ution systems
attle $et!een >?, porter
4
/. at is te ma2imu ma2imum m price tat tat Cooper Cooper can a**ord a**ord to pay *or Nico! Nico!son son and sti!! sti!! keep te acquisition attracti3e *rom te standpoint o* Cooper0
*he ma;imum price that +ooper !ould $e a$le to pay ,icholson in the form of cash or common stoc' !ould depend on the intrinsic value of ,icholson $ased on !hich +ooper can ma'e the decision to acquire ,icholson3 )f the synergistic value of acquisition for +ooper e;ceeds the premium that +ooper has to pay to ,icholson only then they can go for the merger3 Other!ise Other!ise +ooper needs n eeds to forecast the long term future of ,icholson
ynergy is the value that the t!o firms gain after the merger i3e3 the difference $et!een the summation of value of the t!o firms $efore the merger and the com$ined value of the t!o firm in the form of surviving firm after the merger3
)f !e can derive the mar'et value of ,icholson then this !ould $e the ma;imum value that +ooper could afford to pay $ecause if +ooper pays more than that value then +ooper
*herefore in order to estimate the value of ,icholson !e used the free cash flo! method to valuating the firm and also consequently to determine their value of each share of stoc'3
*he data given for ,icholson in the case is for the year of 194 to 191 in )ncome tatement and the alance heet is given only for the year 1913 Be estimated the free cash flo! of ,icholson $ased on forecasting from 19% till 194 including considering their survival of (
Case: Cooper Industries. Inc
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!
$usiness forever3
During estimating the free cash flow from Nicholson after the merger, merger, the necessary changes due to the synergistic effect has een incorporated in the assumptions.
Be are providing here the $rea'do!n of our assumptions along !ith calculation to determine the cash flo! to +ooper and thereafter the value of ,icholson3 Particulars
Assumptions
Net Sales
19! &.!
193
19
&9.1
#!.
Particulars !
(ost ost of of )oo )oods ds Sold Sold
3
)ross Profit
Selling + Administrative ,-penses epreciation /nter ntere est ,-p ,-pense ense
& #
*
9 1'
0ther deductions
19& ##.
19# '.
Forecasted based on Avg. Avg. growth rate of 3.39% during 19!"3 and of #% aligning with industr$ growth rate based on their future prospect during 19"#.
Assumptions )oe )o es dow down n to to #&% #&% from from #9 %
11
Net /ncome
1!
Add b ba ac56 epreciation
193
19
19&
19#
3.! !'.' !'
3*. !'.
'. !1.9
3.! !3.!
&.* !.#
1'.9 !.1
11.! !.1
11.9 !.1
1!.# !.1
13. !.1
'.*
'.*
'.*
'.*
'.*
'.!
'.!
'.!
'.!
'.!
#.*
.!
.
*.3
9.'
at '%
!.
!.9
3.1
3.3
3.#
After ad2usting for i investment ta- credit and ii income of e4uit$ in net income of partiall$ owned foreign companies.
!.& .1 .
!. .3
!.9 .#
3.1 &.'
3.3 &.
!.1
!.1
!.1
!.1
!.1
)oes down to !!% from 19 % Same as of 191 Assumed no new loan has been availed (onsidering the pa past trend
/ncom come be before a-es a-es Net a-es
19!
5
Case: Cooper Industries. Inc
"
.
13
(ash Fl Flow
# .! #.
#.
#.
.1
.&
1
7ess 7ess66 8et 8eten enti tion on needed for growth
o finance asset replacement and growth assumed !'% retention of cash inflow
1.!
1.3
1.3
1.
1.&
Notes4 i Interest 2pense4
ince !e are calculating the free cash flo! from ,icholson !e ignored the interest e;pense in calculating )ncome $efore ta; ":*# "!hich !ould $e actually the :arnings $efore )nterest *a; :)*# and !e considered the cost of de$t during discounting the cash flo! to get the present value of the cash flo!3
ii 7etention needed *or gro$t4
ome of the cash flo! generated from ,icholson is need to $e retained $ac' in the company if in case they need fund to finance replacements of assets3 *he fund could cou ld $e used for cooper to pay dividend on their stoc' and for redeployment !ithin the firm3 *he particular fund is $asically require to retain considering the gro!th of the company3 Be Be assumed %0/ of cash flo! to $e retained for the a$ove purpose3
Particulars 1&
1#
Add6 ermi ermina nall :alue alue ;as on $ear end 19#
Bor5ing 5ing (ap (apiital6 tal6 Accou ccount nts s 8ece 8eceiv ivab able les s /nventories
Assumptions !.''% conservativel$? iscount rate>9.1#% Nicholson@s (ash Flow is e-pected to grow !.''% after 19#
Accou ccount nts s 8eceivables to sales ratio in 191 /nventories to sales ratio in 191
4
19!
193
19
19&
19#
*&.3
*.3
*.#
9.1
9.#
1'.!
1*.#
19.!
!'.
!1.#
!!.9
Case: Cooper Industries. Inc
#
.
Accounts Pa$able
1
1*
19
Accounts Pa$able to sales ratio in 191
!.1
!.1
'.3 '.#
'.3 '.#
'.& 1.!
'.& 1.!
'.# 1.3
'.1
'.1
'.1
'.1
'.1
'.9
1.'
1.*
1.9
!.'
1#.&
1.1
1*.1
19.!
!'.
(hange in (apital ,-penditure
'.&
'.#
1.'
1.1
1.!
Net (ash ash Flo Flow w to to (ooper
3.&
3.#
!.#
!.
**.1
(han (hange ge in Net Net Bor Bor5i 5ing ng (apital6 (hange in Accounts 8eceivables (hange in /nventories (hange in Accounts Pa$able (hange in Net Bor5ing (apital (api (apita tall ,-pe ,-pend ndit itur ure6 e6 Net Net Pla Plant nt + ,4u ,4uip ipme ment nt
Net Net Pla Plant nt + e4uipment to Sales ratio of 191
!.3
!.
*his is the cash flo! to +ooper from ,icholson after the merger3
Notes4 iii 8ermina! (a!ue4
+onsidering that after 194 ,icholson !ill operate forever after getting merge !ith +ooper and gro! at constant rate3 )n this case our conservative assumption is %300/ of gro!th rate 'eeping in vie! their present performance3
,o! in order to find the appropriate discount rate !e determine the Beighted Beighted Average Average +ost of +apital3
! (alcul (alculatio ation n of (ost (ost of (apital (apital C discou discounti nting ng rate6 rate6 a
(ost of ebt6 7ong erm erm ebt ;as on 31"ec"191
(alculation D 1! =illion
i
!.&
Case: Cooper Industries. Inc
$
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/nterest ,-pense ;as on 31"ec"191 ii (ost of ebt 5d > ii C i
D '.* =illion #.#%
+ost of Ce$t is calculated assuming no ne! de$t has $een availed $y the company3
E
(ost of ,4uit$6 mar5et price per share ;average that of 191 p ividend per share > 1 d )rowth rate ;industr$ rate g (ost of ,4uit$ 5e > ;dCpg
D !.& D 1.# #.''% 11.*!%
*he cost of equity has $een determining $ased on the +onstant Dro!th odel3
,icholson has $een paying fi;ed dividend of 8134 over the years3 Be assumed that the cash flo! in the form of dividend !ould $e 8134 !hich !e consider CE"1g# G C1 G 81343 *he dividend is e;pected to gro! at 4/ in align !ith the industry Ggro!th rate if ,icholson can achieve this gro!th rate after receiving the synergistic effect during the post merger period3 c
Beight of ebt Beight of ,4uit$ a- 8ate BA((
wd we t wdG5dG;1"tweG5e wdG5dG;1 "tweG5e
'.3 '.## '% 9.1#%
,o! lets lets focus on the valuation of ,icholson after the merger3 merger3 Figures in $ Million ,stimating =ar5et :alue of Nicholson after merger6 Forecasted Hears Net (ash Flow to (ooper ($ ($ Million) :aluation :aluation of (ash Flows as on $ear end 191 ($ Million) 7oan amount (ash flow for Stoc5holders
191
##.9 1!.' &.9
No. No. of of shar shares es out outst stan andi ding ng of Nich Nichol olso son n &*?'''
=
19! 3.&
193 3.#
Forecasted 19 19& !.# !.
19# **.1
Case: Cooper Industries. Inc
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:alue of each share of Stoc5 of Nicholson ;D
%
93.99
*his implies that if +ooper has to pay more than 844390 million to ,icholson then the shareholders of +ooper !ill loose3 On the other hand if +ooper can pay less than this value their shareholders !ill gain3
,o! if !e consider the no3 of shares of ,icholson to $e 5=(000 and the mar'et price of share of stoc' to $e 8(( then the total mar'et value of ,icholson appears to $e 8%5349 million3 ,o! if the shareholders of ,icholson receive more than this value from +ooper for acquisition then they !ill $e $etter off3
*he gap $et!een the mar'et value of 8%5394 million and 844390 million is the argaining 2ange !hich equals to the synergy s ynergy33
. at at are are te te conc concer erns ns and and $at $at is te te barg bargai aini ning ng posi positi tion on o* eac eac grou group p o* Nico!son stocko!ders0 at must Cooper o**er eac group in order to acquire its sares0
*he different different stoc'holders stoc'holders of ,icholson ,icholson offered offered different different offer in different different form3 *heir *heir $argaining position is as $elo!
%. &. 'orter Company:s ;**er4
On arch 0& 19% 6orter tendered tendered (&000 out of 5=(000 shares of ,icholson at 8(% per share in cash reflecting 81% premium over ov er the most recent price of stoc' of ,icholson3 oreover 6orter !ould support the merger $et!een +ooper and ,icholson if they receive +ooper
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Case: Cooper Industries. Inc
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1&
Cooper:s o**er to 'orter4
+ooper can ta'e the offer of 6orter of 850 for each share of stoc' for the 1000 shares of ,icholson since the mar'et value of ,icholson for each share of o f stoc' of 811(35& as derived from our calculation is far more than the offered price3
()N:s Bargaining 'osition4
>?,?,?, converti$ converti$le le prefer preferred red stoc' stoc' !ould !ould $e e;changed e;changed for each share of ,icholson common common stoc'3 *he >?, preferred preferred stoc' !ould pay an annual dividend of 8134 and !ould $e converti$le into five shares of >?, common stoc' during the first year follo!ing the merger scaling do!n to four shares after the fourth year3 *he preferred !ould $e calla$le at 850 a share after the 5th year and !ould have liquidating rights of 850 per share3 )n addition to this they assured ,icholson of colonized operating independence of the ,icholson?, common stoc' has recently sold for 8(34%5 per share that put the value in first year of 8%&31% on the >?, preferred3 ince >?, did not pay any common dividend since 190 converting into >?, common stoc' !ould result in incurring sharp income loss3 6orter do not need to offer >?, i3e3 acquire the shares of >?, since the no3 of >?, shares is as lo! as 1(000 compare to total no3 of shares of 5=(000 of ,icholson and due to a$ove mentioned reason +ooper might have to suffer in future for acquiring their shares3
*he uncommitted shareholder holding 1%000 shares and also the shareholders of shares unaccounted for !ould go $y the advice of ,icholson
Case: Cooper Industries. Inc
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11
+ooper !ould $e a$le to acquire ma.ority of the outstanding shares of ,icholson3 ,o! since the mar'et value of ,icholson as derived from the calculation is quite high than any other offer made in the mar'et +ooper can .ust offer 850 to these shareholders 'eeping in mind the offer made $y 6orter that supports the +ooper-,icholson merger3
=. ;n te te assu assump mpti tion on tat tat te te Coop Cooper er mana manage geme ment nt $ant $antss to acqu acquir iree at !eas !eastt >? perc percen entt o* te te outst outstan andin ding g Nico Nico!so !son n stock stock and to make make te te same same o**er o**er to a!! a!! stocko!ders- $at o**er must Cooper management make in terms o* do!!ar 3a!ue and te *orm o* payment @cas- stock- debt.
*o finance an acquisition $y cash or $y shares of stoc' depends on several factors that can $e considered $y +ooper as follo!si#
Over Over val valua uati tion on )f the the acq acqui uiri ring ng comp company any
ii#
*a;es *a;es Acqui Acquisit sition ion $y cash cash is a ta;a$ ta;a$le le tran transac sacti tion on !her !hereas eas that that !ith !ith stoc stoc' ' is ta; free3 free3
iii# iii#
harin haring g Dains Dains @sing @sing stoc' stoc' for for acqui acquisit sition ion can can help help the the share sharehol holder derss of the the acqui acquirin ring g company to gain as !ell as to incur loss depending on the company
)n order order to acqui acquire re the the =0/ of shar shares es of ,icho ,ichols lson on +oop +ooper er do not not need need to offe offerr >?, >?, consid consideri ering ng the factor factorss pointe pointed d out $y 6orter 6orter33 *heref *herefore ore to attrac attractt the specul speculato ators rs and the shareholders of shares unaccounted for +ooper can offer a price that satisfies these shareholders along !ith the management of ,icholson3 +ooper also need top consider the offer made $y the 6orter of 850 per hare of stoc'3
11
Case: Cooper Industries. Inc
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Assumption6 /f (ooper offer price of Particulars
Present Earnings
12
D&' Eefore =erger as on 19! (ooper Nicholson D&?# D&?#'' ''?' ?''' ''
,-change ratio
D1?3 D1?3&' &'?' ?''' ''
After =erger (ooper D#?9&'?'''
'.** Shares Outstanding Earnings per Share Price per Share Price/Earnings Price/Earnings Ratio
?!1*?#91 D1.1! D!* D!&
&*?''' D!.3! D D1!
?3!?#11 D1.
5. at sou!d sou!d Mr. Mr. Ci,ik Ci,ik recommen recommend d tat te Cooper Cooper managemen managementt do0
From our calculation $ased on free cash flo! method the estimated value of each share of ,icholson came to $e 811(35&3 )t o$viously e;ceeds any offer made in the mar'et to acquire the ,icholson
1%
