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Cooper Industries Case

Cooper Industries established criteria for acquisitions including becoming a major factor in a stable industry and acquiring leading companies. Nicholson File met these criteria as the leader in two product areas in the stable hand tool industry. Additionally, Nicholson was underperforming its potential and had synergies with Cooper's business model through distribution networks and overlapping costs. However, financial projections showed acquiring Nicholson would not reach Cooper's $50/share target even with margin improvements unless Nicholson's inventory was decreased by $8.86 million. While an inventory reduction of this scale could be reasonable, exceeding the $60/share fair value would result in a negative net present value for the acquisition.

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2K views4 pages

Cooper Industries Case

Cooper Industries established criteria for acquisitions including becoming a major factor in a stable industry and acquiring leading companies. Nicholson File met these criteria as the leader in two product areas in the stable hand tool industry. Additionally, Nicholson was underperforming its potential and had synergies with Cooper's business model through distribution networks and overlapping costs. However, financial projections showed acquiring Nicholson would not reach Cooper's $50/share target even with margin improvements unless Nicholson's inventory was decreased by $8.86 million. While an inventory reduction of this scale could be reasonable, exceeding the $60/share fair value would result in a negative net present value for the acquisition.

Uploaded by

Ini Ejidele
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Cooper Industries Case

1. Why are Cooper Industries interested in acquiring Nicholson File?

Cooper Industries established three criteria for acquisitions in 1966:

(1) Industry should be one in which Cooper could become a major factor
(2) Industry should be fairly stable
(3) Company must be leading in their respective market

Nicholson File ticked many of these boxes, which is why Cooper Industries were interested in
acquiring the company. Namely:

 Nicholson File was a leader in two product areas


 Operated in a stable market (hand tool industry)

As well as this, the company fit well with Cooper Industries current business model. Firstly, Cooper
Industries had experience in the hand tool industry. Secondly, the acquisition would involve
distribution synergies due to Nicholson’s large, established distribution network. Also, it would
provide Cooper the opportunity to lower sales and marketing costs due to the overlap in the
companies’ advertising processes.

Finally, and perhaps most importantly, Nicholson File was massively underperforming in its market.
Sales growth for the firm were well below industry standards, and profit margins were also declining.
As a result, there was a general lack of investor interest in the firm, reflected by its low share price.
Not only was Nicholson underperforming the market though, it was also not realizing its full
potential. This meant the company was a good investment opportunity for Cooper Industries.

2. (a) To begin we conduct a FCF assuming 6% sales growth, and no improvements in NWC. Since
there is little information regarding CapEx and Depreciation for the target, we first choose to rewrite
the FCF equation as follows:

FCF=EBIT ( 1−t ) + Depreciation−CapEx + ∆ NWC¿ EBIT ( 1−t )−∆ Net Assets

This comes from the fact that:

∆ Net Assets=∆ NWC+∆ ¿ Assets


And by definition: ∆ ¿ Assets=CapEx −Depreciation
Therefore, we can calculate our net assets in 1971 using Exhibit 5 as follows (note we have added
$9.2m, as the case states the market value of inventory was understated by this amount):
We now assume that net assets of Nicholson will grow at the same rate as sales throughout the
period. This results in the following valuations for the companies share price.

As we can see, the higher growth rate actually results in a lower valuation for Nicholson, since the
net assets of the company are growing at the same rate as sales, thus reducing the companies FCF
and the value the acquisition creates.

This could suggest that the company may be better off liquidating in 1971, rather than persisting to
run it. If we assume that PPE has a salvage value of 50%, then due to the tax credit we receive, this
creates an economic gain of:

PPE71 x t x 0.5 = 0.5 x 16 x 0.4 = 3.2

If we similarly assume we can liquidate the full book value of NWC, then we gain (using Exhibit 5):

NWC71 = 28 + 9.2 - 4 = 33.2

This gives the following value for Nicholson’s share price:

This improves things slightly, but is still well below Nicholson’s current $50 share price valuation.
However, this is an oversimplified model in many ways, most importantly, it assumes that Cooper
Industries will be able to improve few areas of Nicholson’s business. This is something Cooper should
be able to do, and we can see the effect of this in the following questions.
(b) If there are margin improvements in COGS, such that COGS is 67% of sales in 1972 and 65%
thereafter, we see the following results:

Therefore, it is apparent that margin improvements of this scale will not result in a share price of $50
in any scenario once again. Even in the overly optimistic liquidation scenario, the share price falls
below $50.

(c) If we now assume that both the improvement in COGS and S,G & A are realised, then we still see
that the share price falls below $50. This is shown in the analysis below:
3.

Q3: Consider the optimistic scenario of question 2.c above. How large a decrease in inventory
must Cooper achieve at Nicholson to justify paying $50/share for Nicholson? In your view, is
such a decrease a reasonable target for Cooper? Explain briefly.

Cooper needs to reduce Nicholson’s inventory by $8.86m in order to justify paying $50 per share.

(EV of COGS & SG&A improvement case + Value created by reducing Inventory - net debt)/0.584 =
($20.72mm + X - $11mm)/0.584mm shares = $50 price per share. This results in 19.8 million in
value created. However, this must be achieved by decreasing inventory by 8.86 million i.e. Z +
Z(0.06)/(0.11-0.06) =19.48. Thus, decrease would be beneficial because it will improve the
inventory/sales ratio to about 32% i.e. (18+9.2-8.86)/55.3 = 32%. A further decrease to about 27%
(Cooper) could result in a price jump from $50 to $60.

Q4: Time to make your recommendation. What should Mr. Cizik do? Should he acquire Nicholson
File? If not, explain why not. If yes, explain why. 

Definitely, the acquisition should acquire Nicholson if he can pay below $60 which is the fair value.
Anything above $60 would result in a negative NPV. However, auctions theory tells us that Mr
Nicholson would need to bid slightly higher than the second highest bidder therefore Mr Cizik would
have to contemplate the possibilities of Porter and VLN taking over Nicholson before submitting a
bid.

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