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7/24/2011

Case Study: Cooper Industries


Mergers and Acquistions

Background
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.
Nicholsons European distribution system could also be very helpful in
expanding Coopers 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.

Criteria for acquisition


Cooper Industries has been expanding through diversification since 1966.
Coopers requirements to acquire a company have three major components.
The target company must be:
In an industry in which Cooper could become a major player.

In an industry that is fairly stable, with a broad market for the products
and a product line of small ticket items.

A leader in its market segment.

Cooper analyzed the benefits of merging with Nicholson, they estimated that
Nicholsons cost of goods sold could be reduced from 69% of sales to 65%.
The acquisition would eliminate the sales and advertising duplication, which
would lower the general and administrative expenses from 22% of sales to
19%. In addition, 75% of Nicholsons sales were to the industrial market and
only 25% to the consumer market compared to the inverse for Cooper, since
they distributed between the consumer market at 25% and industrial market
at 75%.

Valuations: As Is Basis

As Is Basis
1971
55.30
37.90
12.30

1972
56.41
38.92
12.41

1973
57.53
39.70
12.66

1974
58.68
40.49
12.91

1975
59.86
41.30
13.17

1976
61.06
42.13
13.43

Other Deductions

0.20

0.20

0.20

0.20

0.20

0.20

Dep

2.10

2.14

2.18

2.23

2.27

2.32

EBIT
Interest
EBT
PAT

2.80
0.80
2.00
1.35

2.73

2.79

2.85

2.91

2.98

1.64

1.68

1.71

1.75

1.79

NWC

24.00

24.48

24.97

25.47

25.98

26.50

Change in WC

0.217

0.48

0.49

0.50

0.51

0.52

0.78

16.32

14.51

12.66

10.77

8.84

16.00

16.32

16.65

16.98

17.32

17.67

0.32

0.33

0.33

0.34

0.35

Sales
COGS
Selling Exp

GFA
Plant & Equipment
Capex

FCF (Free Cash Flow)


Discounting @ 11%
DFCF
PV

Figures in Millions of Dollars


except per-share data
Assumptions Made
Sales Growth takes as 2%
It is 69% of the sales
Taken as 22% of the sales
Taken as same of the previous
years
Taken as Percentage of sales i.e.
3.8%
Should be ignored

1972

1973

1974

1975

1976

2.98
0.9009
2.6836

3.04
0.8116
2.4711

3.11
0.7312
2.2726

3.17
0.6587
2.0898

3.24
0.5935
1.9220

Tax Rate taken as 40%


CA-CL, taken as percentage of
sales i.e. 43.4%
Current Year NWC - Previous
Year NWC
Taken as a percentage of the
sales

FCFF NPV
PV of CV
PV
Less: Debt
Value of Equity
Expected Share Price

$11.44
$21.78
$33.22
$12.00
$21.22
$36.34

Valuations: To Be Basis

To Be Basis
1971
55.30
37.90
12.30

1972
58.62
38.10
11.14

1973
62.14
40.39
11.81

1974
65.86
42.81
12.51

1975
69.81
45.38
13.26

1976
74.00
48.10
14.06

Other Deductions

0.20

0.20

0.20

0.20

0.20

0.20

Dep

2.10

2.23

2.36

2.50

2.65

2.81

EBIT
Interest
EBT
Net Income (PAT)

2.80
0.80
2.00
1.35

6.95

7.38

7.84

8.32

8.83

4.17

4.43

4.70

4.99

5.30

24.00

25.44

26.97

28.58

30.30

32.12

1.44

1.53

1.62

1.72

1.82

16.96

15.76

14.48

13.12

11.68

16.96

17.98

19.06

20.20

21.42

0.96

1.02

1.08

1.14

1.21

1972

1973

1974

1975

1976

3.99
0.9009
3.5979

4.24
0.8116
3.4449

4.51
0.7312
3.2951

4.78
0.6587
3.1512

5.08
0.5935
3.0139

Sales
COGS
Selling Exp

NWC
Chg in WC
GFA
Plant & Equipment

16.00

Capex

FCF (Free Cash Flow)


Discounting @ 11%
DFCF
PV

Figures in Millions of Dollars


except per-share data
Assumptions Made
Sales Growth takes as 6%
Taken as 65% of the sales
Taken as 19% of the sales
Taken as same of the previous
years
Taken as Percentage of sales i.e.
3.8%
Should be ignored

Price Synergy: $80.78

Tax Rate taken as 40%


CA-CL, taken as percentage of
sales i.e. 43.4%
Current Year NWC - Previous
Year NWC
Taken as a percentage of the
sales

FCFF NPV
$16.50
PV of CV
$63.89
PV
$80.39
Less: Debt
$12.00
Value of Equity
$68.39
Expected Share Price $117.11

Strategy from cooper's perspective


We recommend a loan for the financing preferred capital Structure for a
number of reasons.
Debt is more than equity leads to a higher debt equity ratio. As this ratio
increases, so the leverage of the company increased by one point.
Also existing Coopers debts are going to achieve maturity beginning
from 1972. So it leaves cooper with additional margin for borrowing.
This use of debt rather than equity for the acquisition of Nicholson
would lead to higher return on equity. If the company were more shares
instead of the debt issue, it would change the existing capital structure
resulting in equity dilution , reducing ROE and company control.
Another reason is to fund a debt, the U.S. tax law that allows companies
costs, the cost of financing as interest expense in the cash flow that
subtracted from net income before taxes (TAX SHEILD) are accounted
for first calculation of the income tax .
As the company grows, the debt / equity ratio likely to change, with the
profitability and assumptions we make in the first place. The profits will
ACCUMULATE over time, and are held in the company in the form of
retained earnings .This is exactly what many companies look for in a
merger or acquisition.
Since the Cooper and Nicholson are two companies heavy load of stock
and inventory that must be funded in cash or liabilities so using existing
cash for a acquisition will not be advisable.
The key is the cost of capital which is 11% so Cooper should maintain
the cost of debt for the merger should not increase the CoC.