Cooper Industries, Inc.

Student Teaching Note (Adapted from Harvard Business School)

Substantive Issues The management of Cooper Industries, Inc., is considering whether to attempt to acquire the Nicholson File Company, a leading manufacturer of hand tools. The Nicholson family and other members of the management group own about 20% of the Nicholson stock; the remainder is publicly held. From the standpoint of Cooper an affirmative decision may involve Cooper in a bidding contest with two other companies, which have already bought up part of the outstanding Nicholson stock and made tender offers in an effort to acquire control of Nicholson. If Cooper decides to press forward, it must determine what price it will have to pay in order to acquire control of Nicholson, whether it can reasonably afford to pay this price for Nicholson, and the form in which its offer to Nicholsons shareholders should be made. These decisions must be made in the light of the interests, motivations, and bargaining positions of several widely divergent groups of Nicholson stockholders. After these questions are resolved, the Cooper management must determine its precise acquisition tactics. 1. If you were Mr. Cizik of Cooper Industries, would you try to acquire Nicholson File Company in May 1972? Why? 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? [Treasury Bills yielded 5.6% in May 1972.] 3. What are the concerns and what is the bargaining position of each group of Nicholson stockholders? 4. On the assumption that the Cooper management wants to acquire the Nicholson company, what offer must Cooper management make-in terms of price per share? 5. On the assumption that the Cooper management wants to acquire the Nicholson company, what offer must Cooper management make to Nicholson management? 6. What should Mr. Cizik recommend that the Cooper management do? Assignment- Complete TN1 for our next class and answer questions 1 and 3 and 5.

Table TN-A Operating Cash Flows of Nicholson If Acquired by Cooper (millions of $) Actual 1971 Net sales (6% per year growth Cost of goods sold (69%, 67%, 65%) Selling, general, administrative expenses (22%, 21%, 20%, 19%) Depreciation Other deductions Profit before taxesa Taxes (at 40%) Profit after taxes Add back: Depreciation Cash flow from operationsa
a

_____Projected______ 1972 1973 1976 $58.6 39.3 12.3 2.1 .2 $ 4.7 1.9 $ 2.8 2.1 $ 4.9 $62.1 40.4 12.4 2.1 .2 $ 7.0 2.8 $ 4.2 2.1 $ 6.3 $74.0 48.1 14.1 2.1 .2 $ 9.5 3.8 $ 5.7 2.1 $ 7.8

$55.3 37.9 12.3 2.1 .2 $ 2.8 1.1 $ 1.7 2.1 $ 3.8

No interest charges are reflected in these figures, since these cash flows will be discounted in Exhibit TN-1 at an appropriate cost of capital or arrive at a value for the total cash flows projected from the Nicholson operations. The actual 1971 data for Nicholson are adjusted to remove interest expense in 1971.

Table TN-B Rough Estimate of Weighted Cost of Capital for Nicholson

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Type of Security Debt Common stock

a

After-tax Cost of Capital .04 .13

Weight in Capital Structurea .31 .69 1.00

Weighted Cost of Capital

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In this rough calculation, market weights are used for the capital structure, with the market value of Nicholson stock at $44.

Table TN-C Exchange Ratios Causing No Dilution of Coopers EPS 1972

Maximum number of Cooper shares that could be issued for Nicholson shares without diluting Coopers earnings per share (millions) Number of Nicholson shares outstanding (millions) Number of Cooper shares that could be offered for one Nicholson share without diluting Coopers earnings per share for the year in question .96 .584

1973
1.34 .584

1974
1.45 .584

1975
1.5 .584

1976
1.46 .584

1.64

2.29

2.48

2.58

2.50

Exhibit TN-1 Calculation of Value of Nicholson to Cooper Based on Discounted Cash Flow Analysis (millions of dollars except per share data)
1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 _________________________________________________________________________________________________________________________________
4.9 77.0

Projected cash flow from operations a Terminal value at end of 10 years b Deduct: Increase in net working capital c Assumed capital expenditures Cash flows to Cooper Present value factor Present value of cash flows Total present value of cash flows Less: Long-term debt Maximum value for all outstanding Nicholson stock Maximum value per share of Nicholson stock
d

(1.5)
(2.1)

.909

.826

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a

Computed as in Table TN-A through 1976. Increased at 6% per year after 1976. Arbitrarily assigned at 10 times projected profits after taxes in 1981 (=Projected cash flow minus Capital Expenditures/Depreciation)

Estimated at 44% of increase in sales. Based on 1971 data. Inventories are assumed to increase at 33% of increase in sales; accounts receivable at 15% of sales increase; and accounts payable at 4% of sales increase.
d

Arbitrarily estimated (2.1 for 1972-1976; 2.2 in 1977, 2.4 in 1978, 2.5 in 1979, 2.7 in 1980, and 2.8 in 1981.

Exhibit TN-2 Calculation of Maximum of Cooper Shares That Could Be Exchanged for All Outstanding Nicholson Shares without Diluting Coopers Future Earnings per Share (millions except per share data) _____________________________________________________________________________ _ 1972 1976 1. Projected Cooper net income available to Common stockholders without Nicholson a 2. Projected Nicholson net income after taxes if Nicholson is acquired by Cooper b 3. Projected Cooper net income available to common Stockholders after acquisition (line 1 + line 2) 4. Projected Cooper earning per share without Nicholson a 5. Maximum number of Cooper shares after acquisition without reducing Cooper earnings per share without acquisition (line 3 / line 4) 6. Number of Cooper shares currently outstanding a 7. Maximum number of Cooper shares that could be issued for Nicholson shares without causing dilution in Coopers projected earnings per share (line 5 line 6) $11.0 2.5 $13.5 2.61 3.8 4.4 4.9 5.2 1973 1974 1975

5.17
4.21

.96

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a b

From Exhibit 8. Based on calculations underlying Exhibit TN-1 except that profit figures are adjusted to reflect interest deduction of $800,000 on account of outstanding Nicholson debt.