Monmouth Inc.

Case Study

Executive Summary

Monmouth, Inc. is one of the leaders in engine and massive compressor production.

These products are used by energy companies around the world to draw resources from the

ground into accessible plants and factories. The company has long been able to remain near the

top of this industry as a whole by providing quality products in a highly specialized field. The

volatility of the industry as a whole has presented a problem over time, however, for the

company as the cyclical nature of heavy machinery usage constantly leads to soaring profits

followed by periods of stagnancy where demand is virtually absent. The company is attempting

to find a way to ultimately diversify its product and service line by acquiring smaller companies

that produce goods which are in similar fields as heavy machinery but are much less expensive

for the average consumer. The strategy that was implemented to address this change included
seeking out candidate businesses that were already leaders in their respective industries,

displayed relative stability, and had a strong hold on their market share. Monmouth would go on

to acquire three companies in the ensuing years that each produced hand tool equipment. These

companies provided different kinds of hand tools but they were all historically successful in the

years before the acquisition and any issues they had encountered that related to their struggles at

the time were due to mismanagement or other correctable errors that Monmouth felt it could

address immediately with their own resources. . First and foremost Robertson has a 50 percent

share of the clamps and vises market worth $75 million overall as well as a 9 percent market

share of the $200 million dollar scissors and shears industry. These percentages suggest that

Robertson has control of nearly $40 million dollars in the clamps and vises market and $20

million in scissors and shares, both of which represent strong assets. In addition to this the

overlap in expenses in advertising and sales will allow for a 3 percent reduction in administration

costs once these companies merge. Lastly, and perhaps most importantly, the stock for Robertson

is selling $9 below book value currently and is sure to rise again but at this moment Monmouth

can acquire this undervalued stock for a steal. With these considerations in mind it is again

highly recommended that this deal go through.

1. Is Robertson an attractive acquisition for Monmouth? (MON)

The Robertson Tool Company has long been viewed by Monmouth as the final piece of

their diversification puzzle. This company has been in existence since the 19 century and
th

specializes in cutting and edge hand tools. The company has a nearly 50 percent hold on the

market for this equipment and has also created a strong European distribution system. Most

importantly, Robertson has a positive reputation as a family owned business that consumers trust

and rely on. While the company initially denied Monmouth’s initial offers for an acquisition,
their current situation has led to a reevaluation of this proposal. Currently in the process of being

negotiated for acquisitions by two different companies, Robertson has seen the possibility that

the family-run independent leadership could be put into jeopardy. Monmouth has stepped into

this situation with a plan to retain this autonomous leadership structure while bringing the

Robertson brand into their fold.

Determining whether this is a good idea for Monmouth to purse is a complicated question. On

one hand, Monmouth is risking retaliation from NDP for moving forward with such a plan and is

also acquiring a line of tools that have been expanded past the point of reason and have several

specific lines that lag behind industry standards. On the other hand, Monmouth complements the

needs of Robertson well and the same is the case for Robertson. Monmouth focuses primarily on

consumer sales with 75 percent of their total sales going to this category while Robertson focuses

75 percent of their sales on industrial buyers. Monmouth could bring the Robertson products to a

whole new demographic of consumers and vice versa. In addition to this, Monmouth would now

be able to increase its sales presence abroad where many Robertson direct sales agents currently

operate.

Having considered these factors it seems safe to assume that it should be highly recommended

that this merger move forward. The concerns about depreciation of the Robertson stock can be

quelled by the interest that these other companies bidding for acquisition have already offered.

Monmouth will also be able to have fully invested itself in the hand tools industry which brings a

much more consistent day-to-day profit structure as compared to the cyclical industry of heavy

machinery. Perhaps most important is the fact that Monmouth already has a blueprint in place to

cut back on unnecessary expenses at Robertson because of overlaps in how they advertise and
operate. It is unlikely that this opportunity will present itself to Monmouth much longer and in

the long run both parties will benefit from this acquisition.

2. What is the maximum price that MON can afford to pay based on a
discounted cash flow (DCF) valuation?
 Given R-free = interest rate for 30-year US treasury bonds = 4.1%; Market risk premium

= 6.0%; Beta = 1.34, therefore; Re = 4.1%+1.34*(6%-4.1%) = 8.4%.

 Rd = Interest Expenses / Debt = 0.8/12=6.67%

 Given Equity = 25.7M, Debt = 12M, EV = E+D=37.7

WACC = (E/EV)*Re + (D/EV)*Rd*(1-T)

=25.7/37.7*8.4%+12/37.7*6.67%*(1-40%) = 7%

We assume that the growth rate of Net Working Capitals is equal to the growth rate of sales:

NWC (2002) = current assets – current liabilities = 24

Year 2002 2003 2004 2005 2006 2007

NWC 24 25.4 27 28.6 30.3 30.3
Increase 1.4 1.6 1,6 1.7 0

FCF = EBIT *(1-T)+DEP – CAPEX – Increase in NWC; so we will have the table as following:

Year 2002 2003 2004 2005 2006 2007

EBIT*(1-T) 1.8 2.5 3.4 4.3 4.9 4.9
+ DEP 2.3 2.5 2.7 2.9 2.9
- CAPE (4.0) (3.5) (3.6) (3.8) (2.9)
- NWC-increase (1.4) (1.6) (1.6) (1.7) 0
FCF -0.6 0.8 1.8 2.3 4.9

 Given growth rate on 2007 = 0%, WACC = 7%,

Terminal Value at the end of 2007 = FCF * (1+g) / (WACC - G) = 4.9 *(1+0) / (7%-

0)

= $ 70M
  Given DCF = FCF / (1+ r)^n

DCF-2003 = -0.56; 0.70 (04); 1.37 (05); 1.64 (06) and 53.4 (07)

Enterprise Value = NPV(7%, -0.56, 0.70,1.37,1.64,53.4) = 40.53 M

There are 584,000 outstanding shares, with total EV = 40.53M; therefore, the maximum price

that MON can afford to pay based on DCF = 40.53M/584,000 = $69.40 per share.

3. What is the maximum price based on market multiples of later four years?
EBIAT? Based on prospective EBIAT?
We use Exhibit 6 for the estimation of the maximum stock price. Given from the exhibit

6, we know the EBIAT multiple = 16.1 while EBIAT ($ mil) = 1.80; finally we will get

Enterprise Value = EBIAT multiple * EBIAT = 16.1 *1.80 = $ 28.98M.

There are 584,000 shares outstanding, with Total EV = $28.98 M; therefore, the

maximum price that MON can afford based on market multiple of later four years = 28.98 M /

584,000 = $49.62 per share.

4. What price will be necessary to gain the support of the Robertson family,
Simmons, and the great majority of the stockholders?
What are the interests, concerns, and alternatives of each group?
Does MON have a competitive advantage over the NDP in the bidding contest?
How likely is NDP to increase its offer in response to the bid by MON?
The management of Monmouth Incorporation was not the only one wanted to mergers

and acquisitions Robertson Tool Company. There were two other potential merger of the

Robertson Tool Company. The first one was Simmons which was a conglomerate with wide-

ranging interests in electrical equipment, with a main business of producing nonferrous metals,

tools and rubber products. It also had invested in 44,000 shares of Robertson stock in the year

2000. On March 3, 2003, the management of the Simmons Company has approached the

Robertson Tool Company and offered to tender around 75% of Robertson’s outstanding shares

for $42 each. A premium of $12 was also included in the offered price, which was a trick to trap
the shareholders of the Robertson Tool Company. However, Simmons Company just ended up

with only 23% of shares which was not enough to constitute an operating independence.

Therefore the management of Simmons Company was trying to sell its number of shares

to Monmouth Incorporation for $50 per share. Because it will be a significant negative impact on

Simmons company if NPD mergers Robertson Tool Company. A possible merger between

Robertson Tool Company and NDP will hurts Simmons’s benefit which is Simmons will receive

NDP common stock with disappointing performance and often traded in small volume which is

going to affect performance of Robertson 177,000 shares which are in Simmons holding and it

would be difficult to sell them with NDP stock. From the point of view of Simmons’ profit, $50

per share is appropriate. On the other hand, the management of the Simmons Company believed

that the merger of the Robertson Tool Company with Monmouth Incorporation would be the

second best chose for them, because after the merger of the Robertson Tool Company with

Monmouth Incorporation, the management of the Simmons Company would convert its shares

holding in the Robertson Tool Company into the common stock of Monmouth Incorporation.

The management of the Simmons Company expected that the synergies and economies of scale

anticipated after the merger will have a significant positive impact on the share price of

Monmouth Incorporation. Therefore, Simmons Company suggested a price of $50 for each

Robertson share they hold.

The second one was NPD which was a broadly diversified company with major interest

in publishing and original and replacement automotive equipment. Under the merger term, five

shares of NDP common stock would be exchanged for each share of Robertson common stock.

We believe Robertson will not go through with the acquisition is because NDP stock does not

have a dividend and has lower earnings per share. Compare with Simmons Company and NDP,
Monmouth Incorporation has more competitive advantage than others. Monmouth estimated that

Robertson’s cost of goods sold could be reduced from 69% of sales to 65% and also could be

reduced from the selling expenses. Elimination of the sales and advertising duplications would

lower selling, general, and administrative expense from 22% of sales to 19%. On the other hand,

a merger of Monmouth and Robertson would allow Simmons to converts its shares into common

stock of Monmouth.

5. What price can MON pay without harming its long-term trend in earnings
per share (EPS) and its shareholder value?
Earning per share for Monmouth are a representation of the company’s profitability.

Currently Monmouth’s main concern for the acquisition is earning a long term return and

maintaining a growth in their earning per share for the next five years. Based on their five

year forecast they predict to increase on average 8% from year to year and 4% from their initial

projection. The company's outstanding shares remain at 4.21 million with a projected 36%

increase in earning per share through the 5 year period. Based on a market return in 2003 of

28.36% and a risk free rate of 4.10% and beta of 0.725, cost of equity is equal to 21.69%. For

method 1 using EBIT multiple comparison with a 13.31 multiple and Robertson 2002 EBIT of

1.8 the valuation multiple is equal to 23.958. Under the discounted Cash Flow we assume a

reduction of NWC of 5% annually and a growth of 6%. In order to generate the price without

harm we have to either maintain EPS or increase and not hurt long term investors. The

Assumption is that Robertson Net Income with increase at 2% from 2003 to 2007.

By acquiring Robertson, there will be decrease in cost of goods sold at 65% and its’

interest expense down to 19% which are factoring in when calculating projected net income for

the next 5 years. The depreciation , and tax remain constant. Monmouth should undergo a 2-1,

for every Robertson share we will give two Monmouth Share because if we dilute the MON
shares by 1.168M, long term investors will be satisfied because we are increasing EPS from a

$3.53 to a $3.96 post merger. Based on the calculations the price will be effective at $48.00 per

share ($24 per share *2 shares of Monmouth.) The post merger EPS is equal to the Net Income

of the buyers and the synergy which based on the assumption equals to 4.0 and increases at the

risk free rate of 4.10% and increases to 4.87 in 2007. We assumed 2007 as the ideal year in order

to maintain a long term investor prospects. The 2 for 1 deal will give Robertson a $4.00

premium, effectively $48.00 as well as the synergy value that Robertson and Monmouth will

have after post merger will result in 4.87 increase in extra net income at the end of 2007.