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The case depicts Allen Lane's attempt to acquire a business. The case highlights previous attempts as well as ethical, tax, and business issues related to buying a company. The case ends with a potential acquisition candidate and Allen preparing a bid.
Stevenson, Howard H., and Michael J. Roberts
Harvard Business School (384077-PDF-ENG)
September 1983. (Revised May 1999.)
Case questions answered:
- What factors with Plas-Tek create an opportunity for Allen Lane?
- How should he value Plas-Tek?
- How should he finance and structure the purchase if he decides to proceed?
- Finally, should he proceed with the bidding process? If so, how?
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Allen Lane Case Answers
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Introduction – Allen Lane
In this case, Allen’s goals are acquiring an existing business that he understands and successfully growing it over the years. In the beginning, Allen Lane focused on distribution businesses for three reasons: 1) these businesses were often undermanaged, and returns were promising if Allen could acquire a company in the “bottom third range and manage its margin up into upper third.” 2) availability of asset-based financing. 3) Allen was not only very familiar with the industry but also had the know-how to improve margins.
Allen learned a lot about small business acquisition during his search phase, and some of the key learnings were the following:
- Evaluating the tax implications of undervalued inventory turning into discovered inventory after the acquisition if Allen decides to declare to the IRS
- Stock acquisition transfers all the liabilities of a company to the buyer. In contrast, the sellers will remain accountable for the potential obligations (tax) under asset acquisition.
- Understanding that there is a hierarchy of buyers
Allen Lane is now trying to decide whether he should acquire Plas-Tek Industries (PTI), a business that manufactures and distributes plastic gaskets, washers, and O-rings. Currently, New York Bank’s asking price for PTI is $750,000, with a suggested minimum bid of $600,000. Below, I have summarized my recommendations for Allen based on my Quick Screen and SWOT analysis of PTI.
- Allen’s proven track record and knowledge in improving factory operations and business profitability creates opportunity for Allen to increase the value of PTI after the acquisition. Therefore, I recommend Allen to purchase PTI but only at a significant discount.
- Given the existing tax liabilities, Allen should choose asset acquisition over equity acquisition to limit his exposure to contingent liabilities and gain tax benefits.
- PTI’s weaknesses, macroeconomic environment, and contingent liabilities suggest that $600,000 is simply too expensive. I recommend Allen to use the book value of $292,000 as a starting point to anchor and adjust. Premium paid should not exceed 10% of book value ($29,200), considering that this business is not rapidly growing and does not own significant market share. I suggest that Allen Lane pay no more than $330,000 for acquiring PTI.
- Allen should consider using debt to finance the remainder ($130,000), as doing so will reduce PTI’s taxable income going forward.
Quick Screen & SWOT Analysis
I performed a Quick Screen analysis and SWOT analysis to determine the attractiveness of the target (Exhibit 1 & 2).
Exhibit 1 – Quick Screen analysis
My Quick Screen analysis indicates PTI is currently a mediocre business with a large room for improvement for several key reasons:
1. Market and Margin:
PTI has no salesman, and its historical approach to sales has been responding to requests for quotations. In the future, I believe price competition with competitors will be inevitable to maintain or gain market share, given that PTI lacks proprietary elements to product offerings.
Therefore, although Gross margin on average from 1978 to 1981 was above 55%, I believe sustaining this margin, in the long run, will be challenging. Also, the entrance of a bigger and better-capitalized competitor will be a significant threat to PTI. The same goes for the vertical integration of his customers and suppliers.
On the positive side, plastic gaskets and O-rings have extensive usage across different industries, and hence I believe the market size looks promising going forward.
2. Competitive advantages:
A. Costs: PTI is nonunion, and 44% of the production employees are part-time employees. This grants Allen Lane with flexible production capabilities and labor cost advantage going forward. However, Allen should perform in-depth research about the competitors and find out if this is PTI specific competitive advantage or an industry norm.
B. Channel: Currently, PTI’s revenue is dependent on key accounts and specific industries (food and chemicals). This situation is not ideal but not surprising, considering that PTI did not…
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