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Porter Company and VLN Corporation are entangled in a battle over the takeover of Nicholson File Company. Both H.K. Porter Company and VLN Corporation have already made their offers to the Nicholson File Company shareholders and now the management of Cooper Industry have to decide whether to jump into the foray for the control of Nicholson File Company or not. The major issues faced by the management of Cooper Industry are as following: 1.Is Nicholson File Company an attractive acquisition target for Cooper Industries? Specifically, what synergies can be created by merging these firms, and in what other aspects is Nicholson an attractive target? In what respect, if any, is Nicholson not an attractive target? Overall, is there sufficient strategic fit to justify pursuing this acquisition? 2.What sort of integration issues is Cooper Industry likely to face if it is successful in acquiring Nicholson? What should Cooper's management do to facilitate successful integration? 3.What should be the range of prices Cooper Industries should be willing to pay for each share of Nicholson's stock, in case it wants to acquire the firm? Strategic Analysis - how does Nicholson fit into Cooper's acquisition strategy Cooper could become a major factor in the hand tools business given its expertise in manufacture of machine tools. Moreover, one of the main problems that Cooper faces currently is a large cyclicality in its business, characteristic of the heavy machine tool industry, but more pronounced because of its dependence on Oil and Gas industries. These industries are heavily correlated with the state of the economy. So when there is a slowdown, Cooper would be one of the first companies to go down - something that they would want to avoid through diversification by way of acquisitions. The hand tools business is a lot less cyclical and cash flows are likely to be less lumpy. This fits in with Cooper's requirement of smoothing its income flows. The hand tools industry has a broad focus ranging from files to saws and hammers - mostly small ticket items. This ensures that Nicholson does not depend on any particular customer/industry for its revenues, as is the case with Cooper. Nicholson is the market leader in files and rasps and ranks 4th in handsaws and saw blades. Thus it very much fits into Cooper's strategy of acquiring only leading companies. The Nicholson acquisition would come on the heels of 3 previous acquisitions, all in the hand tools business, showing definite intent on the part of Cooper to move into this line. Nicholson would provide a wider range to Cooper's current hand tools portfolio. The idea was to build a comprehensive hand tools company that could share the common distribution channels as the parent company, thus improving returns. As per its outlined strategic policy Cooper should look at Nicholson as a favorable acquisition target. Improvements in Nicholson's operations as a result of the acquisition Cooper believes that some of Nicholson's product lines are not profitable, a case which is very common in family run businesses. Cooper's view is that if Nicholson focuses on its profitable product lines then it can reduce its inventory costs and manufacturing efficiency causing the COGS to reduce by 4% of sales. The distribution network required for selling Nicholson's products are the same as those maintained by Cooper for its acquired hand tools businesses. So in case Cooper acquires Nicholson, the Selling, General and Administrative expenses will reduce by 3% of sales. On the basis of these two reductions itself, the PBT of Nicholson would rise by about 7% of its sales value. In 1971, the net sales figure was $55.3 mn. Therefore the PBT would increase by $ 3.87 mn. PBT = $ 5.89 mn PAT = $ 3.54 mn (tax @ 40%) Equity = $ 31 mn ROE = 11.4% This is much higher than the current ROE levels. Thus Nicholson has a lot to gain from increases in ROE. As per our projections of ROE, (assuming that the synergies take around 4 years to settle in) the ROE rises from 6.73% in 1972 to 12.25% in 1977, meaning an increase of almost 100% in 5 years. There are more synergies to be gained from the acquisition, though these are more difficult to quantify. As mentioned in the case, the sales pattern of Nicholson and Cooper's hand tools business are complementary. Nicholson has strengths in the industrial sector, whereas Cooper is more into the consumer market. Thus an acquisition would lead to a possibility of Nicholson pulling Cooper's hand tools line into the industrial sector (as a result of its strong brand equity in this sector) and vice versa. This would help both to increase their share of the pie in either sector. Bargaining power of Cooper vis--vis Porter Shareholding pattern of Nicholson industries: Shareholder# of sharesRemarks Porter177,000Does not want VLN preferred shares. Will sell at approx $50 / share to Cooper
1% mark. We will now move to the valuation of the Nicholson File Company to find out what should be the price Cooper should be ready to pay for each share of Nicholson File Company for the takeover. Uncommitted shareholders172. 1972. coupled with constant dividend of $1. which in its view are not valuable. Cooper needs 265. and it may not be directly possible to extend this to Cooper's entire line of products. So even if this entire lot sells its stock to Cooper (a highly unlikely event) they would still be short of the 50. This could be a very significant roadblock in the path of affecting the synergies between the two companies. it may be possible for Cooper to negotiate and try and bring down its costs from $50/share of Nicholson's as quoted by Porter.66 % Assuming the tax rate to be 40%. since the Nicholson brand is specific to a particular set of tools. and Cooper's preference shares seem to be a plausible arrangement.6.000They will go wherever they find short term gains Cooper29. the capital appreciation expected in the Nicholson.8 mn on the long term debt of $ 12 mn. This gives the cost of debt for Nicholson as: Cost of Debt = (0. In fact Cooper's entire offer is based on the premise of improving operations at Nicholson.6 is equivalent to the annual growth rate of 6% on dividend. the expected return wanted of the equity investment in Nicholson is calculated as shown: MV of share = PV of future dividends . D1 = $1. The distribution network used by Nicholson is likely to be rationalized post-merger. starting with dividend at time t=1.Nicholson family117. This again might not be exactly what Cooper is expecting in terms of the coordination. then the price of approximately $50/share that it will land up paying would probably be too much.4) = 4% Estimation of cost of Equity: The company's common stock had the market value of $30 on 3rd March. Now. then after tax cost of debt is: After tax cost of Debt = 6.000 more shares to get a simple majority in order to take control. The industry has been growing at annual rate of 6%.000They would most likely go by the management's advice Speculators75. It is quite unlikely that Nicholson's top management would remain with the merged firm. we believe that in spite of few hiccups. Porter is stuck with a huge stockholding of 177. In the event of Cooper going in for the acquisition without the buy-in of the Nicholson management and shareholders. This would mean laying off a number of workers. Therefore. Hence. Will probably make an open offer and get into an agreement with Porter VLN14. there is likely to be friction between the two operations post-merger.6 per annum. This might not go down very well with the rest of the personnel. In the event of this. In case the merger does not work out in the sense that Cooper is expecting it to. Keeping in mind the various strategic and integration issues of Nicholson File Company with the Cooper Industries. Valuation of the Nicholson File Company Estimation of Cost of Debt: Nicholson pays an interest of $0.000They want to take control of Nicholson.000 shares. This would require retiring certain lines of business and cutting down on the distribution and sales personnel and using Cooper's distribution network. it should be good acquisition target for Cooper. Given Nicholson's sound market presence a distribution network.000They won't sell stake unless assured of management independence. This may not happen.000They want to take control of Nicholson. Integration issues of Cooper with Nicholson The entire analysis of projected cash flows and ROE assumes that Cooper is successful in brining about the changes in Nicholson's operations and bring about effective synergies.8 / 12) * 100 = 6. Are more likely to take the VLN offer than Cooper. The total shareholding of the speculators and uncommitted shareholders is 247000. M&M theory states that the dividend policy does not matter. Hence. The premise that Nicholson would help Cooper gain market share in the industrial sector is an estimate at best. since Cooper is not likely to allow independent management. This is not likely to be acceptable to Nicholson's management. So they cannot afford to not get into an agreement with Porter. This would mean extra costs for Cooper to put in a new management in place. as had been the case with the previous 3 mergers. Therefore they would be quite desperate to get out of this shareholding. The Nicholson family would not part with any of its shareholding. On the other end. This is because the distribution network already owned by Cooper for its hand tools business more or less covers the requirements of Nicholson as well. Their offer is dubious in terms of the value of the preferred stock in the future. both sides Cooper and Porter are somewhat on loose bargaining grounds. Porter will have to accept VLN preference shares. In case the VLN offer goes through then as per Rhode Island laws. but are willing to allow management independence.666 * (1-0. we assume that the investors expect it to grow at CAGR of 6%. the company has been paying a dividend of $1. while Nicholson had been growing at 2%.
is funded through Short term debts. Now from the above discussion.The selling.66% pa.33% Calculation of WACC: At present Nicholson has a Long term Debt of $12 mn and equity of $ 31mn. So if Cooper was to lure the other shareholders (uncommitted and speculators) it would have to make an offer with a premium over $44.000 shares would be $50. Now the next factor to consider is whether the price that Cooper will have to pay for the Nicholson shares is worth the value.to . Calculating the Market value of Nicholson after acquisition by Cooper: Using the above assumptions. But then there are some caveats to this recommendation. Thereafter they remain constant at 19% of sales. Accounts payables. 12. 10.Discounted FCF 2.The company maintains a constant operating cash of $1 mn.2 mn Value of single share$ 36. Firstly. For this purpose.160 Common stock11.718.Long-term debt remains constant and no further new Equity is issued. 4.Number of shareholders remains constant at 5.2 mn per annum 7.Tax rate remains constant at 40% 2.279 WACC9.73. our recommendation to Cooper would be to not go into this deal. Therefore just looking at these numbers. Afterwards it remains constant at 65% until 1981. the $50/share value that we are paying to Porter is based on the premise that . the market value was arrived at with the help of 2 methods: 1. Any cash requirement.2 mn$ 26.291. we first performed a valuation of Nicholson using 2 methods: oDiscounted Free Cash Flows oEquity-value to Book-value multiple The two methods resulted in different values of a Nicholson share viz.Interest is paid on the debt at 6.Other deductions remain constant at $0. This gives the values of: D / (D + E) = 12 / 43 = 29% E / (E + D) = 31/43 = 71% We assume that after acquisition.275. So Cooper will land up paying a lot more than the actual value it stands to gain from this merger. 11. 8. $36 and $45 respectively.We assume that the investments in subsidiaries are operating. 5.7 Calculations shown in Appendix 1-5 Does the merger make Economic Sense for Cooper? Thus far we have considered the strategic overtures of the merger. we make the following assumptions: 1. inventories and net Plant. Any excess cash that is generated is considered non operating. 3.1 mn per year. the current market (in May 1972) was quoting $44 per Nicholson share.The Cost of goods sold decreases from 68% of the sales in 1972 to 65% in 1975. general and administrative expenses change from 22% of sales to 19% from 1972 to 1975.06) r = 11. Moreover.Sales grow at the rate of 6% pa from 1972 to 1976. the average value of each share would be approximately $40-42. Cooper will maintain the same capital structure in Nicholson. they grow at 4% per annum. we can fairly say that as a strategic initiative this merger makes good sense to Cooper. Thereafter. Now as per our valuation. This assumes that the subsidiaries further the business ambitions of the company. the weighted average cost of capital (WACC) is as calculated below: Type of securityAfter-tax cost of capitalWeight in capital structureWeighted cost of capital Debt40. 9.Equity value . 6.Accounts receivables. Now if Cooper was to agree to Porter's demand of $50/share then the amount it would be paying for 177.Book value multiple The results are summarized as shown below: Discounted FCFEquity value-to-BV Market Value$ 21. property and equipments grow at the same rate as the sales.6 / (r .660. if any.6$ 45.$ 30 = $1.439 Predicting the future Free Cash Flows (FCFs): In predicting the future Free Cash Flows (FCF). We can safely assume that the final cost per share for this merger would be anywhere between $48 and $50.0.Depreciation remains constant at $2. Hence.
and also with possible acquisitions in the near future. Moreover the synergies that are expected out of the merger might be very significant. Moreover. These inflows might just make the $3-4 premium that Cooper is paying over the market value at present worthwhile. This may not materialize in which case the cost of the acquisition may not be as much as it comes out of this analysis.the share price of Cooper is set to rise in the years to come. and hence Cooper should take a decision based on its estimate of the synergies that are possible with the present portfolio. it may be possible to negotiate the price to somewhat below the quote of $50/share. . our recommendation would be that the spread between the value received and paid is quite thin. and have not been factored into the analysis. Therefore. considering the bargaining position of Cooper vis--vis Porter.
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