Executive Summary In the Case study, Cooper Industries is trying to acquire Nicholson File Company. However, there are two other companies that are interested in Nicholson as well: VLN Corporation and H. K. Porter Company. In 1971, VLN together with Nicholson management constructed a deal that, however, didn’t get the support from the majority of common stockholders. After having done a discounted cash flow analysis, I determined that Nicholson stock is undervalued. Also, Nicholson seems to be a good strategic fit for Cooper.
Therefore, Cooper could acquire Nicholson on friendly terms with a relatively large premium to attract the majority of the shares needed. The problem for Cooper is to determine how best to acquire Nicholson and the adequate price to pay. 1. ) and 2. ) In my opinion, Mr. Cizik should make an attempt to gain control of the Nicholson File Company. Cooper Industries has been pursuing a policy of expansion through the acquisition of other companies and this strategy appears to be working well for them. They have acquired a number of companies and have been successful in integrating them into Cooper Industries.
They have established three criteria that potential companies for acquisition must meet and Nicholson meets all three criteria. Nicholson holds 50% of the market share in files and rasps, its main products, therefore implying that Cooper could be a “major factor” in this industry. Nicholson is also a leading company in their markets and it is a stable company in terms of not being dependent on a few major customers. Nicholson has a great deal of potential for greater sales growth as it is only growing sales at 2% compared with the industry average of 7%.
Due to the strengths of its products and distribution system they should be capable of raising growth rates to the industry average. The company is further desirable to Cooper as the two companies sales forces could be combined leading to cost savings. Nicholson’s European distribution system could also be very helpful in expanding Cooper’s sales in Europe. As Cooper Industries sells more of their product to industry and Nicholson to the consumer market by combining the companies they may be able to increase sales of both product lines to the market segment they are weaker in. All in all, Mr.
Cizik should try to gain control on Nicholson File company as it seems to be a good strategic fit. 3. Nicholson’s firm value derived by the means of DCF analysis amounts to $ 39. 86 mio. After subtracting net debt, the value of Nicholson’s equity amounts to $ 28. 86 mio. meaning an equity value per share of $ 49. 42 (undervalued). This should also be the maximum price that Cooper should afford to pay for Nicholson. 4. Cooper analyzed the benefits of the merger with Nicholson. Cooper estimated that the cost of goods sold after acquiring Nicholson could be reduced from 69% of sales to 65% meaning a dollar value of this synergy of $ 11. 7 Mio. Also, SG&A could be reduced from 22% of sales to 19% of sales resulting in a dollar value of this synergy of $ 8. 45 Mio. These numbers are based on the combined net sales for 1972 using a 7% growth rate in sales from previous net sales (growth of industry level). The opposite distribution of business activity in business and consumer market is likely to result in revenue growth. The numerical effect of this revenue pulling, however, is highly vague at this point in time. 5. The exchange value Cooper could afford to pay out without causing any dilution according to my calculation is $ 37. 2 per share meaning an Exchange Ratio of 1. 55. Thus, we could offer 1. 55 Cooper shares for every Nicholson share they need. This amounts to 133,013 of Coopers shares for 86,000 Nicholson shares. If they wanted to pay cash for the remaining stocks it would then be $37. 12 * 86000 = $ 3. 19 mio. for the remaining stocks needed to gain control via 50. 1% of all shares. Despite the threat of EPS dilution, Cooper might be willing to pay a price higher than $ 37. 12, if the negative short-term effect will be outweighed by positive ones in the ong-run. In general, it is crucial to consider the effect of acquisitions on EPS as a significant, or enduring dilution of EPS will harm the corporation’s performance significantly. 6. I do recommend a loan as capital preferred financing structure. This use of debt rather than equity financing for the acquisition of Nicholson causes a higher return on equity, as well as an increase in the efficiency of existing capital structure. Also, there are tax advantages to be realized through debt financing (tax shield).
The ultimate goal would be to maximize shareholder value and this can be supported through a lower WACC resulting from a higher leverage (as effect outweighs increase of risk). The interest on debt is tax deductible resulting in a higher Net Income and, thus, EPS. Nicholson management had accepted an offer from VLN Corporation using convertible stock but rejected a cash offer from H. K Porter. Nicholson may not want cash for their company. If that was the case, Cooper would need to offer cumulative convertible stock. 7. With an exchange ratio of 2, about 78% of the new firm would be owned by Cooper.
The relatively high exchange ratio would result in a severe reduction of control to Nicholson’s shareholder (22%). Under the given circumstances with an exchange ratio of 2, the acquisition premium for paid would be $ 14 per share. The minimum synergies required that this offer makes sense would be $ 8. 18 Mio. Given my synergy valuation from task 4, this would definitely be a realistic achievement. 8. Porter bought Nicholson’s shares with the intention to take over the company themselves. However, as they weren’t able to acquire enough shares required to buy the company, they are now looking to tender their shares.
Obviously, they’d like to do this profitably and, thus, their primary concerns are the price- and liquidity-level. They try to get the most value out of their stocks, so price is of primary importance in a bargaining process with them. Nevertheless, they want to be able to quickly liquidate their stocks meaning a preference for cash payments. They expressed that convertible preferred stock was acceptable as they assume Cooper stock to be stable and easily tradable on the NYE. The speculators/ unaccounted for shareholders would also be primarily concerned with price.
These shareholders may be tempted to buy or not to buy based on what Nicholson family and its management suggests they do. Thus, one possible way to reach these group of shareholders may be through management. Due to this influence, the family Nicholson and its management have a greater bargaining position as implied by their shares. They are interested in more than just the price. The management is not highly attracted to a takeover, but they know they no longer have a choice. So, at least, they wish to see Nicholson remain autonomous within any acquiring company.
Nicholson’s management and family is most likely not willing to sell the majority of their shares for cash; They wish to maintain a stake in the company. As a result, Cooper would need to offer a stock exchange. VLN, as Coopers bidding competitor, is unlikely to be willing to sell their shares to Cooper for a reasonable price. Ex-Post: In 1972 Cooper industries acquired Nicolson File Company Two Cooper Industries Inc. Based on the given information in the case study regarding the acquisition of Nicholson File Company by Cooper Industries, there is no question that Cooper should try to gain control of Nicholson.
This decision is based on an analysis of the bargaining positions of each group of Nicholson stockholders which have disparate goals and needs that need to be met. In addition, an appropriate payment method and specific dollar value based on a competitora€™s offer and Cooper financial data was decided. The remainder of this paper will provide the analysis and rationale for this determination. Should Cooper Industries Acquire Nicholson File Company? Cooper Industries has been expanding through diversification since 1996.
Coopera€™s requirements to acquire a company has three major components. The target company must be: 1. In an industry in which Cooper could become a major player 2. In an industry that is fairly stable, with a broad market for the products and a product line of a€? small ticketa€™ items; and 3. A leader in its market segment. When looking at the criteria that Cizika€™s company (Cooper Industries), set forth relative to acquisitions, the acquisition of Nicholson meets all three objectives plus has significant potential short and long-term potential.
Cooper management feels that by eliminating redundancy and streamlining Nicholsona€™s operations this potential can be realized. Currently, Nicholsona€™s financial history boasts a 2% increase in profit annually but this percentage is way below the industry average of 6%. Cooper management proposed that if Nicholson stops selling to every market, increased efficiencies would result and cut cost of goods sold from 69% of sales to 65%. It was also suggested that the acquisition could lower selling, general, and administrative expenses from 22% of sales to 19%.
Nicholsona€™s position in the file and rasp market where it holds a 50% market share of a $50 million dollar market meets all three of Coopera€™s objectives. Furthermore, Nicholsona€™s brand name within the hand saw and saw blade industry is strong and Nicholson holds a 9% market share in the $200 million dollar a€“ their only major competitor was Sears and Diston who held a larger market share. Shareholder Standings At the time of the proposed merger between Nicholson File and VLN, there were a total of approximately 584,000 Nicholson shares outstanding. H. K.
Porter had not purchased enough shares to hold majority control, and this situation provided Cooper with yet another opportunity to acquire Nicholson. Nicholson and Porter stockholders had their own concerns, as well as bargaining positions, and if Cooper was to acquire Nicholson they had to address all of their concerns and convince them that the merger was a mutually beneficial proposition. The table below, Exhibit 7 in the case study, shows the estimated disposition of shares in early 1972: Estimated Distribution of Nicholson File Company Stock_______________
Shares supporting Cooper H. K. Porter 177,000 Cooper Industries 29,000206,000 Shares supporting VLN Nicholson family and management117,000 Owned by VLN 14,000 131,000 Shares owned by speculators 50,000 a€“ 100,000 Shares unaccounted for 197,000 a€“ 147,000 Total Nicholson shares outstanding 584,000 Shareholder Concerns There are three major groups of shareholders that Cooper must consider when putting together their offer to acquire Nicholson. These groups are Nicholson, H. K. Porter, and the group of Unaccounted for Shares and Spectator Shares. Nicholson File Company
Loss of control – Nicholson managementa€™s greatest fear was loss of operating control. The company had been in the Nicholson family for years, and if Cooper expected to gain support for the offer by Nicholson and gain at least 86,000 shares to tip them over the majority (206,000 + 86,000 = 292,000; 584,000/2 = 292,000) they would need to guarantee them that they would work with the current management to maintain the identity and image of Nicholson. Additionally, Wall Street investors would view the maintenance of Nicholson management as a stabilizing factor in the merger.
Loss of product lines a€“ Whichever company acquired Nicholson, there was no doubt that aggressive cost cutting measures would be pursued; this would undoubtedly mean marginal product lines would cease to exist. Although Cooper could not emphatically guarantee that nothing would change, they could guarantee that they would work with Nicholson to determine if improvements could be made to product lines at risk and thereby maintain their existence, or at the least–include Nicholson management in the decision making alternatives. H. K. Porter
Stock valuation – If the merger with VPN were successful, Porter would receive VLN preferred stock for their 177,000 Nicholson shares. VLN stock performance had been dreary, and did not show any signs of growth in the short-term. This would make it difficult for them to sell the shares of VLN on the American Stock Exchange which does not trade in large blocks. Additionally, from the years 1968 to 1971, VLN net sales had grown only 3% from $97 million to $100 million. Net income actually decreased by almost 7% for the same time period from $3. 2 million to $2. 98 million.
Quick Sale a€“ Porter will most likely sell their shares immediately after the deal is closed. They will do this because they no longer will have an interest in acquiring Nicholson, and history has shown many times over that share prices will fall rather quickly as mergers do not create synergies through added value or earnings growth. Unaccounted For Shares and Spectator Shares Valuation and Sustainability a€“ This voting bloc has the same concerns as Porter relative to share pricing, but is more concerned with sustainability unlike Porter who is concerned with making a quick dollar.
They own a lot more shares, estimated between 150,000-200,000 shares, and are not certain that VLN Corporation projected figures are truthful. VLN Corporation has not paid consistent dividends for many quarters, and has not shown any real growth, yet is still offering to match Nicholsona€™s $1. 60 dividend rate as part of the merger deal. Shareholder Negotiations Both Nicholson and Porter had strong postures regarding the merger, and Cooper needed both companies to bless the merger to get it approved by a majority of the stockholders.
Cooper only owned 29,000 shares and needed a total of 292,000 shares to gain a majority. Nicholson and Unaccounted Shares The Nicholson family and management owned 117,000 shares. However, the speculation was that 150,000-200,000 of the unaccounted for shares would vote with the Nicholson family. This amount of shares would give Nicholson immense bargaining power. Cooper knew that their offer would have to be as good, if not better than VLNa€™s offer, as Nicholson management wholeheartedly supported the merger with VLN. H. K. Porter Porter owned 177,000 shares.
This was a major voting bloc and gaining their support was essential. Luckily, Porter was eager to work with Cooper because they believed their VLN preferred stock would only be worth $23. 12 in the first year (essentially worthless). Therefore, their support would be mutually beneficial and easier to garner. Coopera€™s Offer to Acquire Nicholson As has been detailed above, each group of shareholders has their own concerns and bargaining power. Cooper has to induce both Nicholson and Porter that their offer is more than fair, and as a result, all three companies and shareholders will profit.
Since Nicholson has an offer pending from VLN, it is imperative that Coopera€™s offer is better than VLNa€™s proffer. The VLN offer includes that (1) the exchange would be a tax-free transaction, (2) the $1. 60 preferred dividend equaled the current rate on the Nicholson stock, (3) a preferred share was worth a minimum of $53. 10. At the time of the proposed offer, the closing price of Cooper stock was $24 per share. In order to match the bid by VLN, Coopera€™s offer would have to be greater than two-for-one for each Nicholson share. The offer would need to be in the range of 2. 5/2. 50:1 to be greater than the $53. 10 offer pending. It is of extreme importance to Nicholson that they maintain control. In mergers, culture clashes are often the a€? kiss-of-death. a€? Cooper has a sincere offer to maintain the integrity of the company and Nicholson would be wise to consider Coopera€™s offer as their goals and interests for the long-term are mutual. Cooper has a history of successful mergers and acquisitions, which should be of some comfort to Nicholson as they will be acquired by some company or group of investors.
H. K. Porter Requirements Since Porter was not able to gain a majority vote, they are willing to side with Cooper over VLN. Porter realizes that a merger between Cooper and Nicholson will give them the opportunity to convert shares of Nicholson into Cooper stock a€“ a much more enticing proposition than that of VLN. Cooper needs to guarantee Porter that the exchange will be tax-free, and that the Nicholson stock he converts will be worth at least $50 each. Unaccounted for Shares and Spectator Shares
The offer to this voting alliance will need to be greater than the $53. 10 per share offer by VLN. They will also want the exchange to be tax-free to avoid capital gains taxes. As has been mentioned above, this group will most likely side with the Nicholson family so if the Nicholson family is satisfied, then this group will be also. Payment Considerations There are several considerations that Cooper management must take into account prior to deciding the specifics of the offer they will give Nicholson File Company in terms of dollar value and the form of payment.
The form of payment may include an offer of cash, stock, debt or some combination of the payment options. Furthermore, Cooper not only has to consider Nicholson shareholders when determining what to offer, but it also needs to take into account the other 80% of the shares publicly held, including a substantial percentage of shares held by competitor H. K. Porter. As previously described, one of the challenges Cooper is facing in this acquisition is to ensure a satisfactory offer that appeals to a sufficiently broad range of shareholders with different interests.
This includes H. K. Porter which currently holds about 25% of the total outstanding shares and which recently failed in its attempted acquisition of Nicholson. Also, the Nicholson family that founded Nicholson File Company currently owns approximately 20% of its own shares. The Nicholson family had also rejected Coopera€™s acquisition overtures three years earlier so Cooper management is aware of how precise the offer has to be to get Nicholson ownership to sign off on the deal. Another 50% of Nicholson shares are held by speculators and by other unknown parties.
Form of Payment & Dollar Value The form of payment and the parameters for the dollar value offer that may be accepted by Nicholson management is exhibited in the described failed and accepted acquisition offer in the case study of Cooper (see Chart #1 below). The acquisition offers by both H. K. Porter, $42 per share in cash and VLN Corporation, $53. 10 in convertible stock, help provide at least a range within which Cooper may tailor its offer. Based on these two offers, it appears that the appropriate form of payment should be Cooper cumulative convertible stock.
The primary basis for this recommendation is that Nicholson management had already accepted an offer from VLN Corporation using convertible stock but rejected a cash offer from H. K Porter. This is consistent with Chang and Suk (1998) research which found that a€? cash offers are more likely than stock offers to have termination initiated by the target firm. a€? It is also believed that if Nicholson management signs off on any merger, speculators and the unknown portion of shareholders will go along with the merger. However, one negative aspect of using stock is that a€? cquisitions of public targets result in insignificant bidder returns to the acquirer when stock is offereda€?. (Chang & Suk, 1998) is this a direct quote, if so we need the reference) Cooper management believes strongly that the Nicholson acquisition will not result in negative returns due to the potential improvements that can be made through simple reorganization of some Nicholson operating businesses. Also, it appears an exchange of stock is appropriate because Cooper currently only has $9 million in cash on hand and would need to incur significant debt in order to offer a decent cash offer.
It already has $5 million in long-term debt due and $34 million in long-term debt outstanding, levels significant enough that may prevent Cooper management from considering a cash offer for Nicholson. Competitor Acquisition Offer Details Type of offerOffer price per shareDividendsTax FreeOffer Accepted/Rejected H. K. CooperCash$42NoNoNo VLN CorporationConvertible stock$53. 10YesYesYes VLN and Porter Offer Details Since Nicholson management has already accepted VLN Corporationa€™s offer, it is clear that the terms Cooper needs to offer would have to exceed those already offered by VLN.
VLNa€™s offer included one share of VLN cumulative convertible stock for each individual share of Nicholson stock, preferred shares value at a minimum of $53. 10, $1. 60 preferred dividend equaling the current rate of Nicholson common stock, and convertible into five shares the first three years and four the fourth year. In addition, the offer was desirable since the exchange of stock would be tax-free as opposed to a cash offer. According to Dhaliwal et al (2005), to qualify as a a€? tax-free acquisitiona€¦tax laws require that the acquirer use its own stock as payment. a€? However, Cooper also has to consider the demands of H.
K. Porter in order to get approval for the merger. H. K. Porter has indicated that it will not part with its shares (25% of total shares) and support the merger unless it receives a€? Cooper common or convertible securities in a tax-free exchange worth at least $50 for each Nicholson share it holds. a€? This demand is below the current book value of $51. 25 for Nicholson common stock, but above the $44 per share on the open market. The final consideration that assists with setting up the range for an appropriate offer that may be accepted by a simple majority of shareholders is the total value of Nicholson stock.
With 584,000 shares of Nicholson File Company Stock and at $44 per share, this amounts to a total market value of $25,696,000. Therefore, in order to make the offer attractive, Cooper will have to make an offer that exceeds the market value of all of the stock but will have to ensure that the offer is not too high that it affects Coopera€™s long-term plans to continue to pursue acquisitions. A basic rule for Cooper acquisitions is that they bring significant long-term returns on the acquisitions as well as steady growth in earnings per share.
Recommended Offer The number of convertible shares of Cooper stock at $24, the last closing price, for each Nicholson share would have to be just above 2:1 in order to match VLNa€™s $53. 10 offer. So, Cooper should offer convertible stock fixed at 2-1/2:1 within the first five years after the offering. This amounts to an offer of $60 per Nicholson share. This would not only exceed VLNa€™s offer per share but would also help make up the deficit in dividends, $1. 40 by Cooper and $1. 60 by VLN, and make the offer more attractive to Nicholson shareholders.
Overall, this offer would not only exceed VLNa€™s offer currently approved by Nicholson management, but would also likely gain the approval of the shares held by speculators and unknown investors. In addition, this offer meets the payment method required by H. K. Porter for its Nicholson shares, and actually exceeds the $50 minimum offer per share it had requested. As a result, it appears that Cooper should be successful persuading Nicholson shareholders and unaccounted for shareholders to accept the offer, and in return acquire at least 80% of the outstanding Nicholson shares of stock
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