Pinkerton case Discussion materials Tuck Investment Banking Case Competition
TUCKEFELLER MARIE-GABRIELLE BUI SHIV KAK JULIA SUN FEDRICK WANG
Deal Team A globally integrated deal team to advise CPP Experienced deal team from Tuck
Marie-Gabrielle Bui
Shiv Kak
• From Paris, France • 3 years of investment banking experience in France and Spain, specialized in industrials, technology and natural resources • Graduated from ESSEC Business School with a degree in Finance
• From New York, NY • 4 years of consulting experience with clients in financial services, technology and diversified industries • Graduated from Georgia Tech with a degree in Electrical Engineering and Finance
Julia Sun
Fedrick Wang
• From New York, NY • 3 years of data analytics and advisory services to financial services industry firms • Graduated from Duke University with a degree in Economics and minor in Chinese
• From Singapore • 3 years of risk management experience in sovereign wealth fund and 2 years of financial advisory experience in industrials • Graduated from Dalian Maritime University with a degree in Economics 2
Executive Summary American Brands has indicated its intention to sell Pinkerton’s • Acquired five years before for $162m, Pinkerton’s specialty focus is no longer aligned with American Brands’ long-range business strategy – American Brands is a $5bn consumer goods company with brand names such as Lucky Strike cigarettes, Jim Beam bourbon, Master locks, and Titleist golf balls • American Brands had acquired Pinkerton’s in 1982 to expand the service side of its business and capitalize on Pinkerton’s strong brand name
Pinkerton’s represents a unique pool of assets particularly attractive to industrial buyers • Strong and reputable brand in the Security Services Industry, positioning it in the premium market • Leading player in its industry, with a strong presence in the Eastern United States, the UK and Canada • Further opportunities for increased efficiency and profit growth by improving pricing strategy, eliminating common overhead expenses and reallocating Pinkerton’s net working capital
Potential key issues to be taken into consideration to maximize certainty of a successful bid • Antitrust issues and government regulations given the size of the combined entity • Potentially lower customer loyalty given incorporation of new operating strategies (i.e. new pricing scheme from low-price strategy to high-price strategy) • Potential lack of management depth given the quantum leap in size once the combination achieved, particularly in the accounting department (large geographical footprint) • Weak market conditions impacting the acquisition conditions as well as the firm’s performance and profitability in the near future • Potential liquidity issues given the cash flows needed to service the debt after the acquisition
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Contents
Section
Situation Overview Preliminary Valuation Considerations Financing Recommendation Appendix – Details on preliminary valuation considerations
1 2 3 4
Key Investment Highlights Pinkerton’s acquisition: a quantum leap for CPP Market leader in the security industry
Strong, recognized brand name
Premium positioning
Significant cost efficiency
• Combination of two leading companies, creating a strong alternative to the current market leader • Combined sales of c. $650m with 275 offices spanning the US (east and west coasts), Canada and the UK
• Strong recognition of the Pinkerton’s name creating product differentiation • Customer loyalty likely to be high • Significant part of business likely to be recurring
• Strong brand name justifying premium positioning • Slightly lower expected revenues offset by increased profitability both at gross margin (+0.25% in 1989e to +0.75% from 1991e onwards) and operating expenses levels (0.81% decrease in yearly Opex as a percentage of sales from 1990e onwards) • Exit from the commoditized, low margin security business
• Consolidation leading to fixed cost reduction (e.g. overhead) • Increased profitability given premium positioning • Best practice implementation at working capital (3.30% decrease to 6.2% per year) and PP&E spending levels (Pinkerton’s requirements lowered to 4%), lowering overall capital requirements 5
A snapshot of Pinkerton’s and CPP Within the security guard industry from 1850 to 1987 Allan Pinkerton dies, leaving firm in family control
Firm run by Pinkerton family till fourth generation dies
Pinkerton gains fame for pursuing outlaws
1850
1860
Leading security guard firm, with sales >$400m, 150 offices in the US, Canada and the UK
Bought by American Brands for $162m
1884
1963 1967
1975
Pinkerton Key Milestones
Allan Pinkerton starts Pinkerton’s Detective Agency
1982 1987
Industry Overview Brings on three external directors
Tom Wathen buys CPP with 18 employees and $163k in sales
Grows to 20,000 employees with sales of $250m and 120 offices in the US and Canada
CPP Key Milestones
• Security guards were “rented” from specialist suppliers gaining operating flexibility by contracting security needs • Late 1987, $10bn industry, growing at 6% a year; Mature fragmented, and price-competitive • Trend towards consolidation – smaller, local companies getting bought out • Market Players: CPP (private), Pinkerton, Baker Industries (conglomerate), Wackenhut (public) • Weak market conditions following dramatic dislocation of the stock market in October 1987
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An Attractive Combined Entity With limited overlapping in geographical footprint
Geographical footprints of CPP and Pinkerton’s
Countries where both are present CPP main US concentration Pinkerton’s main US concentration
Note: Working capital defined as Current assets - current liabilities
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Key Issues and Mitigants Potential issues to be addressed to maximize bid success Key Issues
Mitigants
Antitrust Issues
• Potential antitrust issues given combined market share and concentration of offices, especially in the US
• Two other large players with significant market shares • Combined entity unlikely to have pricing power
Customer base loyalty
• Change in pricing policy resulting in potential need to renew customer base
• Likely increased loyalty from new customers given premium positioning
• Capacity of CPP to manage a $650m firm, given entrepreneurial spirit of CPP’s management, especially in the accounting department
• Possibility to leverage Pinkerton’s existing management team • Recourse to external hiring
Current weakness of market conditions
• Weak market conditions following dramatic dislocation of stock market • Increased difficulty to close a transaction
• Pinkerton’s valuation likely to be depressed
Potential financing issues
• Significant increase in debt burden following Pinkerton’s acquisition (vs. virtually no debt either at Pinkerton’s or CPP level before)
• Increased cash flow generation given cost synergies for the combined entity, enabling higher debt service
Potential management changes
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Contents
Section
Situation Overview Preliminary Valuation Considerations Financing Recommendation Appendix – Details on preliminary valuation considerations
1 2 3 4
Preliminary Valuation Methodology Trading multiple analysis
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Transaction multiple analysis
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Intrinsic valuation analysis
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Trading multiple analysis restricted to Wackenhut Corporation, the only available publicly listed comparable company Valuation method limited to EV/Sales multiple due to lack of information at profitability level for Wackenhut
Transaction multiple analysis restricted to the 1982 acquisition of Pinkerton’s by American Brands Forward transaction multiple based on Pinkerton’s 1983 financials, given lack of information on 1982 financials
Preliminary DCF based on estimates of the think tank - WACC: 13.2% - Three scenarios engineered to cover the range of possibilities - Valuation computed using standalone valuation for Pinkerton’s plus the value of synergies generated Business Plan to be refined with management team, particularly regarding potential financial improvement measures both at Pinkerton’s and CCP level
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Intrinsic Valuation Analysis Scenario Overview Upside case • • • •
Negative revenue synergies Improvement for Pinkerton’s at gross profit and operating profit levels Working capital and PP&E requirement improvement Increase in CPP’s profitability
Base case • • • •
Negative revenue synergies Improvement for Pinkerton’s at gross profit and operating profit levels No cash flow items improvement No profitability increase for CPP
Downside case • • • •
Negative revenue synergies No improvement for Pinkerton’s at gross profit or operating profit level No cash flow items improvement No profitability increase for CPP
Significant upside to base case business plan unlocking further potential value 11
Preliminary Valuation Summary Methodology
$m
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Financials from Base case scenario – 1988e sales: $367.5m, EBIT: $9.2m
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Trading multiple - Limited to EV/Sales multiple - Upper border: multiple including CPP’s cost synergies at EBIT level
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Transaction multiple - Limited to EV/EBIT multiple - Upper border: multiple including CPP’s cost synergies at EBIT level
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DCF - 13.2% WACC - Ranges determined using sensitivities (cf. appendix) - Base case mid-point: $83.7m
$[80-100]m valuation range for Pinkerton’s based on three valuation methods Valuation incorporates part of the upside, but significant potential value further to be unlocked 12
Contents
Section
Situation Overview Preliminary Valuation Considerations Financing Recommendation Appendix – Details on preliminary valuation considerations
1 2 3 4
Financing Strategy Evaluation of Options OPTION 1 DEBT + EQUITY
OPTION 2 DEBT
DEBT • $75M in debt at 11.5% p.a. for seven years • No amortization, and principal due at maturity EQUITY • $25M in exchange for 45% of equity in combined entity
DEBT • $100M in debt at 13.5% p.a. for seven years • Amortized at a rate of $5M a year for 6 years, and remaining principal due at maturity
ABILITY TO SERVICE DEBT • Provides comfortable excess cash flow to service debt through duration of holding, including repaying principal
ABILITY TO SERVICE DEBT • Does not provide enough excess cash flow to service debt especially repayment of principal in year 7
Option 2 does not allow CPP to service debt with a comfortable cushion of excess cash flow, especially given that the entire principal is due in year 7 (~$70M) 14
Financing Strategy Evaluation of Options EQUITY VALUATION
Option 1 allows for CPP to both service debt comfortably as well as receive a fair value for its 45% equity stake in the combined entity 15
Contents
Section
Situation Overview Preliminary Valuation Considerations Financing Recommendation Appendix – Details on preliminary valuation considerations
1 2 3 4
A two-tiered bid through earn-out mechanism Increasing the existing bid and tying it to future company results •
Potential negative factors highlighting the need for conservatism – A $100m tag price at the highest end of the valuation range and significant risks: • Capacity to realize the business plan (e.g. return to strong profitability as soon as year 1) • Capacity to capture upside beyond the base case business plan • External factors potentially weighing against the operation (e.g. economic environment, potential antitrust concerns) • Liquidity issues associated with additional debt burden to acquire Pinkerton’s – Negotiation environment likely to be unfavorable • Public knowledge of strong interest of CPP for Pinkerton’s • First bid rejected, CPP re-contacted after two weeks • Potential tactic from the Investment Bank to increase competitive tension through secondary buyer to motivate primary buyer to move faster
Recommendation: Bid at $92m + earn-out tied to profitability – $92m represents a 7% increase on previous bid; earn-out then profitability-linked • Earn-out could be $10m if Pinkerton’s 1988e EBIT reaches base case, $15m if it reaches high case and nil below base case – Advantages of this solution: • For American Brands: price higher than $100m if results better than business plan • For CPP: ensure Pinkerton’s short term return to profitability and ability to implement change in pricing strategy – Downside of this solution: Potential rejection risk given immediate offer below $100m 17
Contents
Section
Situation Overview Preliminary Valuation Considerations Financing Recommendation Appendix – Details on preliminary valuation considerations
1 2 3 4
Detailed cash flow projections Base case
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Detailed cash flow projections High case
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Detailed cash flow projections Low case
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Cash flow projections Cost of capital
Cost of capital calculation
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2 3 4
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Equity beta computation Based on Wackenhut Corporation beta in 1987: 0.89 – Wackenhut Corp only traded pure player Beta unlevered using Wackenhut’s 1987 data Overall equity beta of 0.81
Cost of capital sensitivities •
30-year Treasury bond rate in 1987
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BBB corporate bond yields in 1987
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Illiquidity premium given size of the firms
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and the uncertainty of the markets
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CPP cost synergies at EBIT level Cost synergies unlocked through combination Pinkerton’s + CPP
Methodology •
Cost synergies at CPP’s EBIT level valued on a standalone basis – Additional streams of cash estimated by the think tank up to 1992e, then growing at 5% p.a. – WACC: 13.2% – Terminal growth rate: 0% – Tax rate: 34% • Overall valuation of CPP’s cost synergies at $16.2m
CPP’s after tax cost synergies evolution
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Cash flow projections Sensitivity analyses
Scenario parameters
Base case
Upside elements • EBIT increase at CPP level, valued at $16.2m • Working capital improvement, valued at $11.2m • PP&E requirement improvement, valued at $1.6m Downside elements • Operating expenses savings, valued at $15.8m • Gross profit margin improvement, valued at $12.4m
High case
Low case
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Extrinsic preliminary valuation methods Detailed overview
Trading multiple
Transaction multiple
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Based on Wackenhut Corporation, a guard and investigative services provider – Only listed comparable – Based on 1987 financials
• Limited relevance of this method given size of sample • No data on Pinkerton’s net income – EV/Sales likely to be the relevant metric
Based on the 1982 acquisition of Pinkerton’s by American Brands – Only transaction available – Based on 1983 financials
• Limited relevance of this method given size of sample • Significant deterioration of the profitability profile of Pinkerton’s since 1982, despite steadily growing topline – EV/EBIT likely to be the relevant metric 25
Financing Strategy Evaluation Upside Debt Servicing
Base Case Debt Servicing
Financing Strategy Evaluation Upside Debt Servicing
Base Case Debt Servicing
