BUSINESS CASE: MONMOUTH INC.

BUSINESS CASE
PRESENTATION CASE SUMMARY

Monmouth, Inc. (Monmouth) is a leading producer of engines and massive compressors used to
force natural gas through pipelines and oil out of wells
Main consumers and clients are oil and gas industries
Harry Vincent, Executive VP of Monmouth, is reviewing acquisition candidates to diversify
Monmouth
Monmouth acquired Dessex Rule Company, the world’s largest manufacturer of measuring rules
and tapes
Monmouth acquired Keane Corporation in 2000, a high quality measuring and fastening tools
manufacturer
Monmouth acquired Kroll Electric Corporation, the world’s leading supplier of soldering tools to
the industrial, electronic, and consumer markets
Monmouth was unsuccessful in trying to acquire Robertson Tool Company (RTC) and its
competitive market shares and superior distribution system
 RTC was under performing, but had the potential for growth
 The Simmons Company (Simmons) was also interested in acquiring RTC
 Simmons had acquired 44,000 shares of RTC stock in 2000
 NDP is also in the race for investors and offered RTC a deal

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BUSINESS CASE
PRESENTATION CASE SUMMARY (CONT’D)

However, Monmouth now has an unexpected second opportunity to gain control over Robertson.
Apart from Monmouth, Simmons Company and NDP has interest in taking control of Robertson.

Previously the Simmons Company acquired 44,000 shares of Robertson in the year 2000 and later
in March 2003, Simmons acquired 133,000.00 no of shares at a price $42 per share, but they failed
to reach the target of acquiring major no of shares.

On the other hand in April 2003, there was an agreement between NDP Corporation and
Robertson regarding merger under the terms that five shares of NDP would be exchanged for each
share of Robertson. However, since Simmons had 1,77,000 shares of Robertson, they
counterattacked by pointing out the low price of NDP’s stock. Now, Monmouth is trying to seize this
opportunity of taking control of Robertson.

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BUSINESS CASE
PRESENTATION QUESTIONS?

1. Why Monmouth should gain control of Robertson?

2. What is the maximum price Monmouth can afford to pay for Robertson Tool using a
DCF analysis?
3. Why is Simmons (other competing firm) eager to sell its position to Monmouth for
USD 50 per share?
4. What offer would we make to gain the support of the Robertson family and the
great majority of shareholders, while improving the long-term trend of Monmouth's
EPS over the next five years?

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 1: Why Monmouth should gain control of Robertson?

Answer:
 
Obviously, there is certain cost of Merger but by gaining control of Robertson will ensure enough
profitability and value which will compensate this cost.
 
Moreover, Monmouth decided to consider three criteria for probable acquisition as a part of their
diversification program with a view to reduce dependency on sales of heavy machineries and
equipment related to oil and gas industries:
 
Criteria # 1: The industry should be one in which Monmouth could become a major player.
Criteria # 2: The industry should be fairly stable, with a broad market for the products and a
product line of “small ticket” items.
Criteria # 3: It was decided to acquire only leading companies in their respective market segments.
 
Based on these above established three criteria, Robertson seems to be the perfect option.
Moreover, two features of Robertson entice this deal even more attractive.

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 BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 1: Why Monmouth should gain control of Robertson?

First is the basic competitive strengths of Robertson:

1. It is one of the largest domestic manufacturers of cutting and edge hand tools and a
leader in its two main product areas.
2. It holds a 50% market share of the $75 million market for its star products, clamps
and vises, which offers a broad, high-quality line with a very strong brand name;
3. Its second product line (scissors and shears) has an excellent reputation for quality
and holds a 9% share of the $200 million market;
4. Its distribution system believed to be its greatest asset, which is supported by heavy
advertising and promotional programs, thereby has all that needed to support in the
6%-7% annual sales growth in the industry. Its products were sold in 2100 hardware
wholesalers in USA and Canada. Besides the company’s products were sold in 137
countries.
 
 

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 BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 1: Why Monmouth should gain control of Robertson?

Second is the potential benefits to be realized by Monmouth from this transaction of

merger or acquisition:
 
1. The costs of goods sold can be reduced from 69% to 65%;
2. There is a substantial overlap of the sales force that established by Robertson, which
will eliminate administrative expenses from 22% of sales to 19%;
3. Sales increase could be expected from Robertson’s “pulling” more Monmouth
products into the industrial market and vice versa for consumer market;
4. Monmouth can take advantage of Robertson’s strong European distribution system
to sell its other products.
 
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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 2 : What is the maximum price Monmouth can afford to pay for Robertson
Tool using a DCF analysis?

Answer:
 
The details of calculation is given in (Annexure-1)
 
Where, D/V= 34.04% , E/V=65.96%, D/E = 0.52 , Tr=40% ,
 
rf=4.10% (30-year U.S. Treasury Bonds from (Exhibit 7);
 
Unlevered / Asset Beta, =0.725 (average of the Quasi-Comparable Firms’ Asset Beta from
Exhibit(6);
 
Note: There is no given data regarding Equity beta or Asset Beta of Robertson Tool Co. in Exhibit 6.
Hence, we assume the average of the Quasi-Comparable 06 other Firms’ Asset Beta from Exhibit 6
as the Unlevered / Asset Beta of Robertson Tool Co. Now, we may use this Unlevered / Asset Beta
to calculate the required Levered / Equity Beta of Robertson Tool Co. at the D/E ratio 0.52 as
below:

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 2 : What is the maximum price Monmouth can afford to pay for Robertson
Tool using a DCF analysis?

Levered / Equity Beta, β_L=β_u*(1+(1-Tc)*D/E)=0.725*(1+(1-0.40)*0.52)=0.95;

 
Market Risk Premium (rm-rf)= 6% (from Exhibit 7);

(Considering that the Debt to Capital Ratio of Robertson Tool Co. is 34.04% and it is an
Electrical Equipment Company; Hence as per Exhibit 7 (IV) it may be categorized as A; As per
Exhibit 7 (I), Interest Rate of A rated Corporate Bond is 5.07%);

Electrical Equipment Company; Hence as per Exhibit 7 (IV) it may be categorized as A; As per
Exhibit 7 (I), Interest Rate of A rated Corporate Bond is 5.07%);
 

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 2 : What is the maximum price Monmouth can afford to pay for Robertson
Tool using a DCF analysis?

We assume the growth rate of Working capital equal to the growth rate of
sales(Exhibit 4). So we get Net Working Capital as following:
Millions of Dollars

  Actual Forecast
  2002 2003 2004 2005 2006 2007
Sales 55.30 58.60 62.10 65.90 69.80 69.80
Growth Rate of Sales 0.06 0.06 0.06 0.06 -
Working Capital (CA- 24.00 25.43 26.95 28.60 30.29 30.29
CL)
Net Working Capital 1.43 1.52 1.65 1.69 -

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 2 : What is the maximum price Monmouth can afford to pay for Robertson
Tool using a DCF analysis?

So with Exhibit 4 and the Net Working Capital, we can get the free cash flow as following:
Actual Forecast
2002 2003 2004 2005 2006 2007

Sales 55.30 58.60 62.10 65.90 69.80 69.80

Cost of Goods 37.90 39.80 41.60 43.50 45.40 45.40
Gross Profit 17.40 18.80 20.50 22.40 24.40 24.40
Sell & Admin 12.30 12.30 12.40 12.50 13.30 13.30
Depreciation 2.10 2.30 2.50 2.70 2.90 2.90
EBIT 3.00 4.20 5.60 7.20 8.20 8.20
Tax @ 40% 1.20 1.68 2.24 2.88 3.28 3.28
EBIAT 1.80 2.52 3.36 4.32 4.92 4.92

Less Capex -4 -3.5 -3.6 -3.8 -2.9

Add Depreciation Expense 2.3 2.5 2.7 2.9 2.9
Less Net Working Capital -1.43 -1.52 -1.65 -1.69 -
Free Cash Flow - 0.61 0.84 1.77 2.33 4.92

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 2 : What is the maximum price Monmouth can afford to pay for Robertson
Tool using a DCF analysis?

Year from 2007 to infinity, we review as perpetuity:

(Assuming 2007 onward cash flow unchanged)
PV(2007-perpetuity)==4.92/0.075=65.62;
 
PV= C1/(1+r)+C2/(1+r)2+C3/(1+r)3+C4/(1+r)4+(C5+PV(2007-perpetuity))/(1+r)5=52.47
 
The Equity value = PV-Debt= 52.47-16=36.47;
 
The number of Robertson’s outstanding shares is 584,000.
So the maximum price that Monmouth can afford to pay is 36.47 Million/584,000 = $62.45

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 3 : Why is Simmons (other competing firm) eager to sell its position to
Monmouth for USD 50 per share?

Answer:
 Simmons is eager to sell it position to Monmouth for $50 per share due to the following reasons:
 1. The unsatisfied prospect from possible merger between Robertson and NDP.
 Given the fact that Simmons is holding 177,000 shares of Robertson stock, it would be receiving
NDP’s common stock after the merger. Simmons regards NDP stock as lackluster performer and
anticipates that it may not show any significant growth in the near future. Moreover, since NDP
stock is traded in small volume, Simmons is afraid it would not be easy to sell a large holding of
NDP stock if disappointing performance occurred.
 2. The attractive merger of Robertson and Monmouth.
 If a Monmouth-Robertson merger is accepted, Simmons would be able to convert its 177,000
shares into Monmouth’s common stock. Although Monmouth is experiencing a cyclical downturn,
Simmons believes that Monmouth’s earnings would rebound significantly and price would
appreciate as well due to the opposite and complementary market distribution of sales between
Monmouth and Robertson. In this case, Simmons would benefits if this merger takes place.
Furthermore the stock of Monmouth was traded in New York Exchange, which will provide
substantial liquidity.

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 3 : Why is Simmons (other competing firm) eager to sell its position to
Monmouth for USD 50 per share?

3. Required return from shares.

 
Simmons paid $42 per share originally to proceed the tender offer for Robertson. Besides, stock of
Robertson is currently closed at $44. In order to maintain a certain return from the shares,
Simmons has to charge a proper price of $50.
 
If Simmons sold its position to Monmouth, Robertson’s cost of goods sold and other expense could
be reduced. However, the other groups of Robertson shareholders still have an alternative merger
option of NDP if the concern of continuity of Robertson management and operating independence
is taken into account. There may be a trade-off between management independence and potential
profits. If the management is in favor of operating independence more, it would support the NDP
offer given that 5 shares of NDP common stock are exchanged for each share of Robertson common
stock.

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 4 : What offer would we make to gain the support of the Robertson family and the
great majority of shareholders, while improving the long-term trend of Monmouth's EPS over the
next five years?

Answer:
 
 First, in order to gain control of Robertson Tool, Monmouth has to acquire 293,000 shares (i.e.
more than 50% of total 584,000.00 no of shares) of Robertson. Since Simmons is a large
shareholder, Monmouth has to acquire the shares at a minimum price of $50 share, which
equivalents to a total of $14,650,000.00 (= 293,000 X $50).
The cost of the acquisition is greater than Monmouth’s next year’s projected net income of
$11,000,000 (Exhibit 5). If the shares are acquired in an all cash deal, this will cancel out
Monmouth’s net income next year and will leave less cash available for use in making other value
adding acquisitions.
 
 However, at an exchange of $50/share, that is approximately double the current share price of
Monmouth’s stock ($24), this exchange would lead to 2 shares of Monmouth’s stock for every 1
share of Robertson Tool. If the full deal is done in exchange of stock, then Monmouth’s number of
shares would increase by 586,000 (i.e. 293,000 X 2) shares.

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 4 : What offer would we make to gain the support of the Robertson family and the
great majority of shareholders, while improving the long-term trend of Monmouth's EPS over the
next five years?

 The large share increase may dilute the EPS and make it difficult to improve the EPS over the next
five years. In order meet both objectives (support and EPS increase), our offer would be a
combination of purchasing shares with cash and an exchange of shares of stock.

 The optimal combination offer would gain Robertson Family/majority shareholder support
because owning Monmouth’s stock is clearly more valuable than owning NDP’s stock. A
combination will limit the dilutive effect of an all stock exchange deal, and will limit the offsetting
effect on next year’s net income from an all cash acquisition.

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 4 : What offer would we make to gain the support of the Robertson family and the
great majority of shareholders, while improving the long-term trend of Monmouth's EPS over the
next five years?

In this connection, details calculation have been conducted (Annexure-2)

regarding different combinations of cash purchase and share exchange a summary
of which are as follows-

Difference of EPS
(EPS after Taking Control of Roberson – EPS if Control of
Scenario Cash Share Roberson is not taken)
Purchase Exchange

2003 2004 2005 2006 2007

Scenario 1 100% 0% ($3.28) $0.29 $0.40 $0.46 $0.46

Scenario 2 75% 25% ($2.42) $0.19 $0.28 $0.34 $0.33
Scenario 3 50% 50% ($1.61) $0.09 $0.18 $0.22 $0.20
Scenario 4 25% 75% ($0.85) ($0.00) $0.07 $0.11 $0.08
Scenario 5 0% 100% ($0.14) ($0.09) ($0.02) $0.01 ($0.03)

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BUSINESS CASE
PRESENTATION QUESTION & ANSWER

Question # 4 : What offer would we make to gain the support of the Robertson family and the
great majority of shareholders, while improving the long-term trend of Monmouth's EPS over the
next five years?

Findings:
 
Scenario 1: This Option has immediate high degree of adverse Effect on EPS of 2003
Scenario 2: This Option also has immediate high degree of adverse Effect on EPS of 2003
Scenario 3: This option has marginal Effect the EPS for 2003
Scenario 4: This option has least effect on the EPS for earlier year and the initial negative effect on
EPS will be cancelled out in the later years
Scenario 5: All Stock Exchange Deal will dilute the EPS over the years
 
Considering all the above scenarios, our recommendation is to go the scenario 4 i.e. 25% Cash
purchase and rest 75% shares to be obtained through exchange of common stock of Monmouth.
By obtaining acquiring share of Robertson by this combination will not only ensure smooth gaining
of control of Robertson but also will ensure long-term increasing trend of Monmouth's EPS over the
next years.

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BUSINESS CASE
PRESENTATION QUERY?

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 THANKS
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