Name : Avinash Agrawal
SID : B17134
Case – TSE International Company
Case Background
TSE International Company, in 2000, manufactured products ranging from advanced industrial
components to chains, cables, nuts, bolts, castings and forgings and similar other products. It
had several division of products ranging from aerospace propulsion, a second was of assembly
and allied products. The third was of missile and fire control systems. It had a good reputation
in the industry and gave tough competitions to its contemporises.
The company was doing well but there were some problems with the research and development
department of the company and therefore, TSE in the last few years had not been able to
introduce any new products in the market. The top management had decided to diversify and
focus on aggressive growth by acquisition program designed to create more opportunities and
entries into more dynamic markets.
Therefore, it decides to acquire Yeats Valves and the process of acquisition is on going. Yeats
Valves and Controls Inc. was founded in 1980 by its CEO, Bill Yeats. It was principally
engaged in the manufacture of specialty valves and heat exchangers. The firm had many
standard items, but nearly 40% of its volume and 50% of its profit derived from special
application for the defence and aerospace industries. In 1987, as soon as the product was
brought to the commercial stage, the company was organized to acquire the patents and
properties, both owned and leased, of the engineering corporation. The Research Department
of the YVC is renowned in the industry and the acquisition will definitely help TSE to become
more valuable. The CEO and Vice President of the TSE are working on the acquisition and the
entire trust of board of director is dependent on this acquisition. If this doesn’t go well, the
board would be unlikely to give its support to future mergers.
Both the firms want profit from the merger. TSE had realized the time of the essence as many
other competitors were interested in Yeats and wanted to ensure that it acquires YVC. The
other challenges were that how Yeats employees will manage the transition from a small firm
to a big firm.
Financial Problems:
1. Valuation
TSE has to find the Standalone value of Yeats as well as its Synergy value.
The firms Vice President wanted to estimate the value of YVC and he was not sure whether
the firm’s share were fully priced or whether the market has not capitalized its full
expectations or not.
The other parameter was the synergy value. Synergy is the concept that the value and
performance of two companies combined will be greater than the sum of the separate
individual parts. Synergy is a term that is most commonly used in the context of mergers
and acquisitions. Synergy, or the potential financial benefit achieved through the combining
of companies, is often a driving force behind a merger. Shareholders will benefit if a
company's post-merger share price increases due to the synergistic effect of the deal. The
Name : Avinash Agrawal
SID : B17134
expected synergy achieved through the merger can be attributed to various factors, such as
increased revenues, combined talent and technology, or cost reduction.
TSE’s greater purchasing power will decrease the cost of procurement of materials and
components. The research expertise of Yeats will also add to the value of TSE as TSE has
huge financial backing which will mean greater diversion of funds towards research and
development.
2. Form of transaction: form of payment; financing
The term didn’t exactly know whether the transaction will be structured as a merger or
acquisition and the merits of the alternatives has been considered by counsel for both
parties. TSE was open to a straight common stock to stock
Exchange, although he is open to other sort of payments. He had also evaluated the cash
option but to finance the transaction in cash, he needed to ensure that he arranges the money
and for that he had two options whether to borrow money from the market or raise more
equity in the market.
3. What would be the Exchange ratio in case of a stock to stock exchange?
In the context of mergers and acquisitions, the exchange of an acquiring company's stock
for the stock of the acquired company at a predetermined rate. Usually, only a portion of
a merger is completed with a stock-for-stock transaction, with the rest of the expenses being
covered with cash or other payment methods.
For example, in order to satisfy the expenses of an acquisition, an acquiring company may
use a combination of 2 for 3 stock-for-stock exchange with shareholders of the target
company and a tender offer of cash.
If this deal was also to be structured as a share for share exchange, then Eliot needed to
offer Yeats a ratio of the no. of TSE shares offered per YVC shares. He wanted to evaluate
the value that the YVC will add to the TSE and make an offer depending upon this value.
He wanted to make an offer that would not be too expensive for TSE and similarly he did
not want to derail the discussion by offering a price that would be less than the minimum
that Yeats can accept.
4. Control
The control of the TSE after the acquisition was also an issue. As far as, TSE is considered
its holdings are distributed among many shareholders and any single family or organisation
doesn’t have a significant holding in the firm. But, as far as Yeats was considered, 70% of
the companies share belonged to the board of directors and their families, including the
20% owned by Auden and 40% by Yeats and his family. Auden did not oppose to the
merger but it was not interested in the tag of minority stakeholders in a company like TSE
Therefore, Auden wanted to sell its part of shares and did not want to maintain an relation
with Yeats when it would operate as a division of TSE International.
Name : Avinash Agrawal
SID : B17134
5. Dilution
The dilution of shares occur in these three cases:
Conversion by holders of optionable securities: Stock options granted to individuals, such
as employees or board members, may be converted into common shares, boosting the total
share count.
Secondary offerings where the firm is looking to raise additional capital: A firm may
looking to raise new capital to fund growth opportunities or to service existing debt may
issue additional shares to raise the funds.
Offering new shares in exchange for acquisitions or services: Instead of paying for an
acquisition with shares, new shares might be offered to shareholders of the firm being
purchased. For smaller businesses, new shares could be offered to individuals for services
provided. For example, special counsel could be offered shares for representing the firm or
in exchange for other legal services.
The dilution of the earning per share of the new entity was also a concern for the
shareholders. Through the stock exchange programme and the stock options that will be
given to the employees, new shares of the company will have to be released and this would
mean an increase in the no. of outstanding shares and thus it would hamper the growth of
the shares and also result in a decrease in the value of the forecasted earnings per share.
Analysis and Interpretation:
1. P/EValuation Model:
The three primary valuation approaches, the comparable approach is the only relative
model. Both the cost approach and discounted cash flow are absolute models and look
solely at the company being valued, which could ignore important market factors. On the
flip side, the stock market can become overvalued at times, which would make a
comparable approach less meaningful, especially if comps are overvalued. For this reason,
using all three approaches is the best idea.
The P/E ratio reflects the amount investors are willing to pay for each dollar of earnings.
The average P/E ratio of the specific industry can be used to find the value of the firm by
assuming that the investors value the earnings of the firm in the same way they value the
earnings of the industry. The price/earnings multiple approach is a popular technique used
to estimate the firm’s share value; it is calculated by multiplying the firm’s expected EPS
by the average P/E ratio for the industry.
The average P/E of the Industrial Machinery Sector is 11.47. Therefore, the value of both
the firms can be found out by multiplying this no. with the earnings of both the firms.
TSE
International Yeats Valves
P/E Ratio 11.47 11.47
Earnings Per Share 2.23 3.87
Market Price/Share 25.58 44.39
Therefore, as per the P/E model TSE is valued at $25.58 which is less than $44.39.
2. P/B method
To calculate book value per share, we used the following formula.
∑ 𝑎𝑠𝑠𝑒𝑡𝑠− ∑ 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
3. Book Value per share = ∑ 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
TSE Yeats
Total Assets 1,245,825,000 421,24,000
Total Liabilities 3500,88,000 53,60,000
Total Shares
626,94,361 14,40,000
Outstanding
Book Value per share 14.29 25.53
All Prices are in dollars.
Therefore, in case both the company liquidate, the shareholders of Yeats will be paid
more than that of TSE.
3. Market share price method
Based on the exhibits, the market price of TSE is $21.98 whereas that of Yeats is $39.75.
It means that the demand of Yeats share is more than TSE in the market. This also means
that
4. DCF Model
Evaluation of WACC:
Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in
which each category of capital is proportionately weighted. All sources of capital,
including common stock, preferred stock, bonds and any other long-term debt, are included in
a WACC calculation. A firm’s WACC increases as the beta and rate of
return on equity increase, as an increase in WACC denotes a decrease in valuation and an
increase in risk.
𝐷 𝐸
𝑊𝐴𝐶𝐶 = ∗ 𝑟𝑑 (1 − 𝑡) + ∗𝑟
𝐷+𝐸 𝐷+𝐸 𝑒
𝑟𝑒 = 𝑟𝑓 + 𝛽 ∗ (𝑟𝑚 − 𝑟𝑓 )
where Risk free premium=6.6%, Market return=5.5%
For TSE, Beta=0.85
Therefore, Cost of Capital=
Yeats Valves
Tax 40%
Beta 1.5
Debt 0%
Cost of Debt 0%
Risk Free 6.60%
Risk
5.50%
Premium
Cost of
14.85%
equity
WACC 14.85%
Growth
7%
Rate
TSE International
Tax 40%
Beta 0.85
Debt 1191,00,000
Cost of debt 6%
Risk Free 6.60%
Risk Premium 5.50%
Cost of equity
11.28%
C/S
Equity Value 1415883880
D/(D+E) 0.08
E/(D+E) 0.92
WACC 10.87%
Growth Rate 10.83%
DCF method to evaluate the valuation:
A discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of
an investment opportunity. DCF analysis uses future free cash flow projections and
discounts them to arrive at a present value estimate, which is used to evaluate the potential
for investment. If the value arrived at through DCF analysis is higher than the current
investment, the opportunity may be a good one.
𝐻
𝐹𝐶𝐹 𝐹𝐶𝐹𝐻
𝑃𝑉 = ∑ 𝑖
+
(1 + 𝑟) (1 + 𝑟)𝐻
𝑖=1
𝐹𝐶𝐹𝑙𝑎𝑠𝑡 𝑑𝑎𝑡𝑎 (1 + 𝑙𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒)
𝐹𝐶𝐹𝐻 =
(𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒 − 𝑙𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒)
Where, FCFs can be obtained from exhibit 3 and r (discount rate) is WACC of given financing
situation. The given long term growth rate is 4.75%.
This analysis gives the following results:
All values are in thousand dollars:
Actual Projected
1999 2000 2001 2002 2003 2004
Sales $21,87,208 $23,29,373 $24,80,785 $26,42,037 $28,13,769 $29,96,658
Cost of goods
sold $17,93,511 $19,10,086 $20,34,244 $21,66,470 $23,07,291 $24,57,260
Gross profit $3,93,697 $4,19,287 $4,46,541 $4,75,567 $5,06,478 $5,39,398
Selling,
general, admin. $1,20,296 $1,25,786 $1,31,482 $1,40,028 $1,46,316 $1,55,826
Depreciation $26,800 $27,950 $29,770 $31,700 $33,170 $35,960
Income before
tax $2,46,601 $2,65,551 $2,85,290 $3,03,839 $3,26,992 $3,47,612
Tax $98,640 $1,06,220 $1,14,116 $1,21,535 $1,30,797 $1,39,045
Net Income $1,47,961 $1,76,101 $1,89,036 $2,01,323 $2,16,097 $2,08,567
Cash Flow
Net Income $1,47,961 $1,76,101 $1,89,036 $2,01,323 $2,16,097 $2,08,567
Depreciation $26,800 $27,950 $29,770 $31,700 $33,170 $35,960
Operating
Cash Flow $1,74,761 $2,04,051 $2,18,806 $2,33,023 $2,49,268 $2,44,527
Capital
Expenditure
Working
Capital
Free Cash Flow $1,74,761 $2,04,051 $2,18,806 $2,33,023 $2,49,268 $2,44,527
Terminal Cash
Flow $59,59,306
Total $1,74,761 $2,04,051 $2,18,806 $2,33,023 $2,49,268 $62,03,833
PV of FCF $10,13,975 $1,83,685 $1,77,310 $1,69,985 $1,63,686 $1,44,548
PV of TCF $35,57,340
Total $45,71,315
Debt $30,900
Firm Value $45,40,415
Shares $64,416
Value per
share $70
The value of a share of TSE is 70 dollars as per DCF and value of the firm is $4,540,415,000
Valuation of Yeats Valves before merger
Actual Projected
1999 2000 2001 2002 2003 2004
Sales $49,364 $59,600 $66,000 $73,200 $81,200 $90,000
Cost of goods
sold $37,044 $42,316 $47,850 $52,704 $58,058 $63,900
Gross profit $12,320 $17,284 $18,150 $20,496 $23,142 $26,100
Selling, general,
admin. $2,936 $3,612 $4,024 $4,464 $4,952 $5,492
Other income,
net $228 $240 $264 $288 $320 $352
Depreciation $1,508 $1,660 $1,828 $2,012 $2,212 $2,432
Income before
tax $8,104 $12,252 $12,562 $14,308 $16,298 $18,528
Tax $3,242 $4,901 $5,025 $5,723 $6,519 $7,411
Net Income $4,862 $7,351 $7,537 $8,585 $9,779 $11,117
Cash Flow
Net Income $4,862 $7,351 $7,537 $8,585 $9,779 $11,117
Depreciation $1,508 $1,660 $1,828 $2,012 $2,212 $2,432
Operating Cash
Flow $6,370 $9,011 $9,365 $10,597 $11,991 $13,549
Capital
Expenditure $1,826 $2,011 $2,213 $2,433 $2,675
Working Capital - $3,492 $3,867 $4,289 $4,757 $5,273
Free Cash Flow $6,370 $3,693 $3,488 $4,095 $4,800 $5,601
Terminal Cash
Flow $1,54,406
Total $3,693 $3,487 $4,095 $4,801 $1,60,007
PV of FCF $6,370 $3,215 $2,644 $2,703 $2,759 $2,803
PV of TCF $77,270
Total $97,764
Debt $0
Yeats Value $97,764 $6,420 $1,04,184
Shares $1,440
Value per share $68
The value of the share is $68 and that of the firm is $97,764,000
Valuation after merger
Actual Projected
1999 2000 2001 2002 2003 2004
Sales $22,36,572 $23,88,973 $25,46,785 $27,15,237 $28,94,969 $30,86,658
Cost of goods sold $18,30,555 $19,52,402 $20,82,094 $22,19,174 $23,65,349 $25,21,160
Gross profit $4,06,017 $4,36,571 $4,64,691 $4,96,063 $5,29,620 $5,65,498
Selling, general,
admin. $1,23,232 $1,29,398 $1,35,506 $1,44,492 $1,51,268 $1,61,318
$228 $240 $264 $288 $320 $352
Depreciation $28,308 $29,610 $31,598 $33,712 $35,382 $38,392
Income before tax $2,54,705 $2,77,803 $2,97,852 $3,18,147 $3,43,290 $3,66,140
Pretax saving $1,500 $3,000 $3,000 $3,000 $3,000 $3,000
Tax $1,02,482 $1,12,321 $1,20,341 $1,28,459 $1,38,516 $1,47,656
Net Income $1,53,723 $1,68,482 $1,80,511 $1,92,688 $2,07,774 $2,21,484
$0 $0 $0 $0 $0 $0
Cash Flow $0 $0 $0 $0 $0 $0
Net Income $1,53,723 $1,68,482 $1,80,511 $1,92,688 $2,07,774 $2,21,484
Depreciation $28,308 $29,610 $31,598 $33,712 $35,382 $38,392
Operating Cash
Flow $1,82,031 $1,98,092 $2,12,109 $2,26,400 $2,43,156 $2,59,876
Capital
Expenditure $0 $1,826 $2,011 $2,213 $2,433 $2,675
Working Capital $0 $3,492 $3,867 $4,289 $4,757 $5,273
Free Cash Flow $1,81,131 $1,92,774 $2,06,231 $2,19,898 $2,35,966 $2,51,928
Terminal Cash
Flow $78,14,002
Total $1,81,131 $1,92,774 $2,06,231 $2,19,898 $2,35,966 $80,65,930
PV of FCF $1,81,131 $1,73,874 $1,67,775 $1,61,354 $1,56,168 $1,50,386
PV of TCF $46,64,480
Total $56,55,168
Debt $30,900
Equity $56,24,268
Shares $65,856
Value per share $85
The value of the share after merger is $85 and value of the firm is $5,655,168,000
Synergy=$5,655,168,000-$97,764,000-$45,40,415000=1,016,989,000
As TSE wants to bag the deal, it should offer 20% of this price to the other firm therefore
valuation of Yeats=301161000.8
And therefore, it should offer 301161.8/85=3543000.08 shares to Yeats.
No. of shares given per share of Yeats=3543000.08/1440000=2.46
Recommendation:
1. The stock to stock exchange ratio of that TSE should offer to Yeats is 2.46 per share
of TSE.
2. It should definitely try to hold on the efficient management system of Yeats as Bill
Yeats is retiring therefore, the role of top management will become vital once he
retires.
3. TSE should bag this deal because Yeast due to its R&D is forecasted to grow at
10.83% whereas TSE inspite of being a large firm is just projected to grow at 7.3%.
