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Company Background
In 1969
The Crescent Niagara Corporation( It has high quality wrenches, pliers, and screwdrivers
Strengths
One of the largest domestic manufacturers of hand tool and was a leader in its two main
product areas
It had 50 % share of 50 million market for files & rasps
Also 9% share of 200 million markets for hand saws and saw blades compare to Sears,
Roebuck and co, Inc.
Its highest assets was distribution systems
These strengths forecasts 6% to 7% future annual growth
Drawbacks
Annual sales growth 2% (Industry growth 6%)
Profit margin 1/3rd those of other hand tool business
Book value $ 51.25(Market value $44 on May,1972)
P/E ratio 10-14
The company could contribute less than one-sixth of the combined sales
Nicholsons Atkins saw division seemed vulnerable in view of its low profitability
H.K.Porter Company
A conglomerate with wide ranging interests in electrical equipment, tools, nonferrous
metals, and rubber products
It had acquired 44000 shares of Nicholson in 1967
Porter offer $ 42 per share in cash for 437000(out of 584000) to Nicholson
Porter offer $ 50 per share in cash for 177000(out of 584000) to Cooper
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Case: Cooper Industries. Inc. 3
VLN
VLN was broadly diversified company with major- interests in original placement
automotive equipment and in publishing
Under the VLN merger term one share of VLN new cumulative convertible preferred
stock would be exchanged for each share of Nicholson
Preferred dividend $1.60
1. If you were Mr. Cizik of Cooper Industries, Inc., would you try to gain control of
Nicholson File Company in May 1972?
Mr.Cizik could try to gain control of Nicholson in May 1972 due to their opportunities
Potential profits from every market segments
Cost of goods sold could be reduced from 69% to 65%
Selling, general and administrative expenses from 22% to 19% due to the elimination of
sales and advertising duplications
Currently, Sales were made to industrial market and consumer market same
proportionately (50:50) which can be offset through Nicholsons sales ratios (75:25) in
this market
Use European distribution systems
Battle between VLN & porter
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Case: Cooper Industries. Inc. 4
2. What is the maximum price that Cooper can afford to pay for Nicholson and still
keep the acquisition attractive from the standpoint of Cooper?
The maximum price that Cooper would be able to pay Nicholson, in the form of cash or
common stock, would depend on the intrinsic value of Nicholson, based on which, Cooper
can make the decision to acquire Nicholson. If the synergistic value of acquisition for Cooper
exceeds the premium that Cooper has to pay to Nicholson, only then they can go for the
merger. Otherwise, Cooper needs to forecast the long term future of Nicholsons performance
to predict the prospect of their merger.
Synergy is the value that the two firms gain after the merger i.e. the difference between the
summation of value of the two firms before the merger and the combined value of the two
firm in the form of surviving firm after the merger.
If we can derive the market value of Nicholson, then this would be the maximum value that
Cooper could afford to pay, because if Cooper pays more than that value, then Coopers
shareholders would not be better off from the merger.
Therefore, in order to estimate the value of Nicholson, we used the free cash flow method to
valuating the firm and also consequently to determine their value of each share of stock.
The data given for Nicholson in the case is for the year of 1967 to 1971 in Income Statement
and the Balance Sheet is given only for the year 1971. We estimated the free cash flow of
Nicholson based on forecasting from 1972 till 1976, including considering their survival of
business forever.
During estimating the free cash flow from Nicholson after the merger, the necessary changes
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Case: Cooper Industries. Inc. 5
Particulars Assumptions
Net Sales Forecasted based on Avg.
growth rate of 3.39% during
1972-73 and of 6% aligning
1972 1973 1974 1975 1976 with industry growth rate
based on their future
57.2 59.1 62.7 66.4 70.4 prospect during 1974-76.
4 Selling &
Administrative Goes down to 22% from
Expenses 19% 10.9 11.2 11.9 12.6 13.4
5 Depreciation Same as of 1971 2.1 2.1 2.1 2.1 2.1
6 Interest Expense Assumed no new loan
has been availed 0.8 0.8 0.8 0.8 0.8
12 Add back:
Depreciation 2.1 2.1 2.1 2.1 2.1
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Case: Cooper Industries. Inc. 6
cash inflow
Notes:
i) Interest Expense:
Since we are calculating the free cash flow from Nicholson, we ignored the interest expense
in calculating Income before tax (EBT) (which would be actually the Earnings before Interest
& Tax, EBIT) and we considered the cost of debt during discounting the cash flow to get the
present value of the cash flow.
16 Working Capital:
Accounts Receivables Accounts
Receivables to
sales ratio in 1971 8.3 8.6 9.1 9.6 10.2
Inventories Inventories to sales
ratio in 1971 18.6 19.2 20.4 21.6 22.9
Accounts Payable Accounts Payable
to sales ratio in
1971 2.1 2.1 2.3 2.4 2.5
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Case: Cooper Industries. Inc. 7
18 Capital Expenditure:
Net Plant & Equipment Net Plant &
equipment to Sales
ratio of 1971 16.5 17.1 18.1 19.2 20.4
Change in Capital
Expenditure 0.5 0.6 1.0 1.1 1.2
This is the cash flow to Cooper from Nicholson after the merger.
Notes:
iii) Terminal Value:
Considering that after 1976, Nicholson will operate forever after getting merge with Cooper,
and grow at constant rate. In this case, our conservative assumption is 2.00% of growth rate
keeping in view their present performance.
Now, in order to find the appropriate discount rate, we determine the Weighted Average Cost
of Capital.
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Case: Cooper Industries. Inc. 8
Cost of Debt is calculated assuming no new debt has been availed by the company.
B Cost of Equity:
market price per share (average that of
1971) p $ 27.5
Dividend per share = D1 d $ 1.6
Growth rate (industry rate) g 6.00%
Cost of Equity ke = (d/p)+g 11.82%
The cost of equity has been determining based on the Constant Growth Model.
Nicholson has been paying fixed dividend of $1.6 over the years. We assumed that the cash flow
in the form of dividend would be $1.6 which we consider D*(1+g) = D1 = $1.6. The dividend is
expected to grow at 6% in align with the industry =growth rate if Nicholson can achieve this
growth rate after receiving the synergistic effect during the post merger period.
Figures in $ Million
Estimating Market Value of Nicholson
after merger: Forecasted
Forecasted Years 1971 1972 1973 1974 1975 1976
Net Cash Flow to Cooper ($ Million) 3.5 3.6 2.6 2.7 88.1
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Case: Cooper Industries. Inc. 9
This implies that, if Cooper has to pay more than $66.90 million to Nicholson, then the
shareholders of Cooper will loose. On the other hand, if Cooper can pay less than this value,
their shareholders will gain.
Now, if we consider the no. of shares of Nicholson to be 584,000 and the market price of
share of stock to be $44, then the total market value of Nicholson appears to be $25.69
million. Now, if the shareholders of Nicholson receive more than this value from Cooper for
acquisition, then they will be better off.
The gap between the market value of $25.96 million and $66.90 million is the Bargaining
Range which equals to the synergy.
3. What are the concerns and what is the bargaining position of each group of
Nicholson stockholders? What must Cooper offer each group in order to acquire its
shares?
The different stockholders of Nicholson offered different offer in different form. Their
bargaining position is as below:
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Case: Cooper Industries. Inc. 10
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Case: Cooper Industries. Inc. 11
offer made in the market, Cooper can just offer $50 to these shareholders keeping in mind the
offer made by Porter that supports the Cooper-Nicholson merger.
To finance an acquisition by cash or by shares of stock depends on several factors that can be
considered by Cooper as follows-
i) Over valuation: If the acquiring companys stock is overvalued, then using shares of
stock is less costly than using cash.
ii) Taxes: Acquisition by cash is a taxable transaction whereas that with stock is tax free.
iii) Sharing Gains: Using stock for acquisition can help the shareholders of the acquiring
company to gain as well as to incur loss depending on the companys performance.
On the other hand, acquisition with cash lead the shareholders to get fixed price.
In order to acquire the 80% of shares of Nicholson, Cooper do not need to offer VLN
considering the factors pointed out by Porter. Therefore, to attract the speculators and the
shareholders of shares unaccounted for, Cooper can offer a price that satisfies these shareholders
along with the management of Nicholson. Cooper also need top consider the offer made by the
Porter of $50 per hare of stock.
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Case: Cooper Industries. Inc. 12
Assumption:
If Cooper offer price of $50
Exchange After
Particulars Before Merger as on 1972 ratio Merger
Cooper Nicholson Cooper
5. What should Mr. Cizik recommend that the Cooper management do?
From our calculation based on free cash flow method, the estimated value of each share of
Nicholson came to be $114.53. It obviously exceeds any offer made in the market to acquire the
Nicholsons shareholder. Since valuation has been determined considering the synergistic effect
along with several conservative assumptions, though which the value came to be quite higher, it
implies that if Nicholsons business survive in the form of merging with Cooper from 1976
afterwards, the market value of Nicholson is undervalued and the acquisition of their shares
should benefit the shareholders of Cooper for taking the decision to get merge with Nicholson.
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