Fvc Case Summary
SABANCI UNIVERSITY
FACULTY OF MANAGEMENT
FIN524
Mergers and Acquisitions
CASE #1:
Flinder Valves and Controls Inc
Submitted to:
Ast.Prof. Dr. Serif Aziz Simsir
Prepared by
Polat Sen
Chaimae Mabrouk
Strengths and Weaknesses of FVC and RSE
FVC has a good top-management team, skilled workers, and had a reputation for engineering excellence. This strong reputation allowed the company to do prime contract work on high engineering devices for the government. FVC has acquired the patents it needs in developing its products. Its management team believes that a continuous introduction and development of new products with patent protection is a key to success. The company is currently working on …show more content…
the widening-gyre project that could have a broad application in nautical, aerospace, and automotive products, and is expected to generate considerable economic benefits if successful. Moreover, the company is financially stable, and its sales have witnessed a two digits growth rate during the last two years (i.e: 2006 and 2007). On the other hand, FVC’s weaknesses include a low access to capital; i.e not enough funds to support the cost of expending and bankrolling more research.
RSE has a high access to capital. As stated in the case it is “a deep pocketed” potential partner. The company follows a policy of focused diversification. As a result, RSE has gained considerable know-how and experience in the industrial machinery sector. The firm was considered a low-cost producer that possessed unusual production knowledge. Furthermore the firm has been implementing the project CORE to improve its profitability, and by 2008, the project has already been considered successful. Likewise, RSE has a large marketing and distribution network, and know-how for high-volume manufacturing. However, the company’s earnings growth rate is quite low and needs to be boosted.
These companies want to negotiate because each one of them sees potential synergies and future survival/development opportunities. From Flinder’s perspective, one of the reasons is that many competitors in the industry have already been acquired or have merged with other companies and became stronger (i.e: the rivalry became tougher). Hence, in order to survive, the company needs a financially strong partner with a particular know-how and experience within the industry. Moreover, it is believed that FVC will generate significant cost gains thanks to RSE’s greater purchasing power, which will lower the cost of materials and components for FVC. Also, RSE’s new resource-management system could be expected to reduce FVC in-process costs. Pretax constant-dollar savings of $2 million in the first year of operation and $ 4 million thereafter are expected to be achieved. Other synergy gains arise from RSE’s stronger marketing clout, cross-selling with other RSE products, and its deep financial pockets.
From RSE’s perspective, FVC is growing company with an exceptional know-how, and good financial health.
Also, acquiring it goes hand in hand with their focused diversification strategy.
FVC Value
To start with, the common assumptions in our valuation calculations are as follows: Assumptions of CAPM hold (i.e. investors have homogeneous expectations, no information asymmetry, etc...). Also, in our WACC calculations we assume that we assume that debt carries no market risk (has a beta of zero).
Using the Free Cash Flows model to find the stand-alone value of FVC, we found that the total value of the firm is $ 126,790,150.
In FVC’s WACC calculations, we assumed that the corporate projects run by the company are long term in …show more content…
nature.
Also, we estimated the terminal/perpetuity value using the constant-growth valuation model.
We have assumed that company will grow at a 1% lower rate than US Economy starting from 2013. This pessimistic vue is due to the expected increasing competition. the nominal growth rate of GDP have been calculated using using Fisher equation using as inputs the long term real GDP growth and the U.S long term inflation forecasts.
We have used FVC’s forecasts in our FCFF’s calculations. The capital expenditure has been calculated using the beginning PPE, Ending PPE, and depreciation expense.
After that, we have moved forward to calculate the value of FVC with merger, and we found that the total value of the firm is $ 171,262,180. As stated in the case, this merger would result in a pretax constant-dollar savings of $2 million in the first year of operation and $ 4 million thereafter. Hence, these cost cuts have been add to the EBIT in our calculations. Furthermore, we assumed that this merger will help FVC increase its sales by 5% thanks to RSE’s superior marketing clout and wide distribution network.
By calculating the difference between the stand-alone value and the with-merger value, we found that the value of control (i.e: premium for control) is $
44,472,030.
To find the value of synergies, we first calculated the value of RSE which is $ 1,585,454,400. For the WACC calculations, we again assume that the corporate projects run by the company are long term in nature. Also, because RSE is a conglomerate operating in several industries, we decided to discard the regression beta given in the case. We calculated the beta using the bottom-up method.
We estimated the terminal value in year 2013 using the constant-growth valuation model. This formula assumes that RSE has reached some level of steady state growth, with an average annual growth rate of 1.2%. In other words, the future free cash flows can be regarded as perpetual inflows with the simple assumption of a constant growth rate of 1.2%.
Then, we calculated the value of the merged company, which is $ 1,789,934,590. In this part, we assumed that the perpetuity/ terminal value growth rate of merged company will be 2%. We assumed that the potential synergies will increase the average annual growth rate of RSE from 1.2% to 2%. This is a very realistic assumption because even if the potential synergies are expected to drive the growth up by more than 0.8%, the integration costs may cancel this growth to a certain extent.
By calculating the difference between the merged company’s value and the sum of RSE’s stand-alone value and FVC’s value with premium for control, we find that the value of synergies is $ 33,218,010.
The key drivers of FVC value are its stand alone value in addition to value control and the value of synergies. Hence, the maximum price that RSE will be willing to pay is calculated using the following formula:
Maximum payment for Target= VStand-alone + VSynergies+ ∆illiquidity and control = $ 126,790,150 +$ 33,218,010 +$ 44,472,030 = $ 204,480,190
The minimum price that FVC will be willing to accept is the stand-alone value of FVC, which is $ 126,790,150. Each of the companies will try to capture more of the premium value. Consequently, in order to capture a higher share of the premium, the opening price that Flinder should ask to sell the company to RSE should be close to $ 204,480,190. However, we have to keep in mind that the values of the synergies are split between the two parties. If RSE pays a premium that is equal to the value of synergies and control, all the benefits of this deal will accrue to FVC’s shareholders. In other words, this merger will represent a zero NPV to RSE’s shareholders. Likewise, Flinder should walk away from the negotiation if the price is lower than $ 126,790,150.
We recommend RSE to pay in cash because it is believed that RSE’s stock price is undervalued. Also, the company has the ability to raise debts to pay for the deal. The debt to capital ratio is low and will not significantly increase if the company raises more debts. This will result in a moderate tax shield. Furthermore, the deal is small compared with the size of the acquirer.
FACULTY OF MANAGEMENT
FIN524
Mergers and Acquisitions
CASE #1:
Flinder Valves and Controls Inc
Submitted to:
Ast.Prof. Dr. Serif Aziz Simsir
Prepared by
Polat Sen
Chaimae Mabrouk
Strengths and Weaknesses of FVC and RSE
FVC has a good top-management team, skilled workers, and had a reputation for engineering excellence. This strong reputation allowed the company to do prime contract work on high engineering devices for the government. FVC has acquired the patents it needs in developing its products. Its management team believes that a continuous introduction and development of new products with patent protection is a key to success. The company is currently working on …show more content…
the widening-gyre project that could have a broad application in nautical, aerospace, and automotive products, and is expected to generate considerable economic benefits if successful. Moreover, the company is financially stable, and its sales have witnessed a two digits growth rate during the last two years (i.e: 2006 and 2007). On the other hand, FVC’s weaknesses include a low access to capital; i.e not enough funds to support the cost of expending and bankrolling more research.
RSE has a high access to capital. As stated in the case it is “a deep pocketed” potential partner. The company follows a policy of focused diversification. As a result, RSE has gained considerable know-how and experience in the industrial machinery sector. The firm was considered a low-cost producer that possessed unusual production knowledge. Furthermore the firm has been implementing the project CORE to improve its profitability, and by 2008, the project has already been considered successful. Likewise, RSE has a large marketing and distribution network, and know-how for high-volume manufacturing. However, the company’s earnings growth rate is quite low and needs to be boosted.
These companies want to negotiate because each one of them sees potential synergies and future survival/development opportunities. From Flinder’s perspective, one of the reasons is that many competitors in the industry have already been acquired or have merged with other companies and became stronger (i.e: the rivalry became tougher). Hence, in order to survive, the company needs a financially strong partner with a particular know-how and experience within the industry. Moreover, it is believed that FVC will generate significant cost gains thanks to RSE’s greater purchasing power, which will lower the cost of materials and components for FVC. Also, RSE’s new resource-management system could be expected to reduce FVC in-process costs. Pretax constant-dollar savings of $2 million in the first year of operation and $ 4 million thereafter are expected to be achieved. Other synergy gains arise from RSE’s stronger marketing clout, cross-selling with other RSE products, and its deep financial pockets.
From RSE’s perspective, FVC is growing company with an exceptional know-how, and good financial health.
Also, acquiring it goes hand in hand with their focused diversification strategy.
FVC Value
To start with, the common assumptions in our valuation calculations are as follows: Assumptions of CAPM hold (i.e. investors have homogeneous expectations, no information asymmetry, etc...). Also, in our WACC calculations we assume that we assume that debt carries no market risk (has a beta of zero).
Using the Free Cash Flows model to find the stand-alone value of FVC, we found that the total value of the firm is $ 126,790,150.
In FVC’s WACC calculations, we assumed that the corporate projects run by the company are long term in …show more content…
nature.
Also, we estimated the terminal/perpetuity value using the constant-growth valuation model.
We have assumed that company will grow at a 1% lower rate than US Economy starting from 2013. This pessimistic vue is due to the expected increasing competition. the nominal growth rate of GDP have been calculated using using Fisher equation using as inputs the long term real GDP growth and the U.S long term inflation forecasts.
We have used FVC’s forecasts in our FCFF’s calculations. The capital expenditure has been calculated using the beginning PPE, Ending PPE, and depreciation expense.
After that, we have moved forward to calculate the value of FVC with merger, and we found that the total value of the firm is $ 171,262,180. As stated in the case, this merger would result in a pretax constant-dollar savings of $2 million in the first year of operation and $ 4 million thereafter. Hence, these cost cuts have been add to the EBIT in our calculations. Furthermore, we assumed that this merger will help FVC increase its sales by 5% thanks to RSE’s superior marketing clout and wide distribution network.
By calculating the difference between the stand-alone value and the with-merger value, we found that the value of control (i.e: premium for control) is $
44,472,030.
To find the value of synergies, we first calculated the value of RSE which is $ 1,585,454,400. For the WACC calculations, we again assume that the corporate projects run by the company are long term in nature. Also, because RSE is a conglomerate operating in several industries, we decided to discard the regression beta given in the case. We calculated the beta using the bottom-up method.
We estimated the terminal value in year 2013 using the constant-growth valuation model. This formula assumes that RSE has reached some level of steady state growth, with an average annual growth rate of 1.2%. In other words, the future free cash flows can be regarded as perpetual inflows with the simple assumption of a constant growth rate of 1.2%.
Then, we calculated the value of the merged company, which is $ 1,789,934,590. In this part, we assumed that the perpetuity/ terminal value growth rate of merged company will be 2%. We assumed that the potential synergies will increase the average annual growth rate of RSE from 1.2% to 2%. This is a very realistic assumption because even if the potential synergies are expected to drive the growth up by more than 0.8%, the integration costs may cancel this growth to a certain extent.
By calculating the difference between the merged company’s value and the sum of RSE’s stand-alone value and FVC’s value with premium for control, we find that the value of synergies is $ 33,218,010.
The key drivers of FVC value are its stand alone value in addition to value control and the value of synergies. Hence, the maximum price that RSE will be willing to pay is calculated using the following formula:
Maximum payment for Target= VStand-alone + VSynergies+ ∆illiquidity and control = $ 126,790,150 +$ 33,218,010 +$ 44,472,030 = $ 204,480,190
The minimum price that FVC will be willing to accept is the stand-alone value of FVC, which is $ 126,790,150. Each of the companies will try to capture more of the premium value. Consequently, in order to capture a higher share of the premium, the opening price that Flinder should ask to sell the company to RSE should be close to $ 204,480,190. However, we have to keep in mind that the values of the synergies are split between the two parties. If RSE pays a premium that is equal to the value of synergies and control, all the benefits of this deal will accrue to FVC’s shareholders. In other words, this merger will represent a zero NPV to RSE’s shareholders. Likewise, Flinder should walk away from the negotiation if the price is lower than $ 126,790,150.
We recommend RSE to pay in cash because it is believed that RSE’s stock price is undervalued. Also, the company has the ability to raise debts to pay for the deal. The debt to capital ratio is low and will not significantly increase if the company raises more debts. This will result in a moderate tax shield. Furthermore, the deal is small compared with the size of the acquirer.