Monmouth, Inc. is one of the leading producers of engines and massive compressors. The company is looking into acquiring the Robertson Tool Company and the value and form that the acquisition should take.
Thomas R. Piper and Heide Abelli
Harvard Business Review (4226-PDF-ENG)
July 31, 2010
Case questions answered:
- If you were Mr. Vincent, would you try to gain control of Robertson Tool? In other words, is the Robertson Tool Company a good strategic fit for Monmouth, Inc.?
- How much can Monmouth afford to pay for the Robertson Tool Company? Using the information provided in the case, value the Robertson Tool Company using the WACC method. Make sure to clearly label and explain all calculations.
- Is the above valuation reasonable? Answer this question in two parts: First, consider alternative cash flows and re-calculate the value of the Robertson Tool Company. Make sure to explain why these alternative cash flows make sense, given the case setting. Second, estimate the sales growth and operating performance that would result in a value of $50 per Robertson share, the price Simmons has stated as sufficient. Assess and discuss this scenario.
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Monmouth, Inc. (Brief Case) Case Answers
This case solution includes an Excel file with calculations.
Overview – Monmouth, Inc. (Brief Case):
In this report, we will analyze Monmouth, Inc.’s position in the heavy equipment and machinery industry. Next, we will state the key issues as well as sub-issues that must be addressed. Then, we will provide a summary of our analysis of whether to invest in the Robertson Tool Company (RTC).
About Monmouth Inc.
Monmouth Inc. is one of the leading producers of engines and massive compressors. However, this industry is heavily dependent on sales in the oil and gas industry, known to have violent earnings fluctuations. Monmouth must diversify to protect its stock price. This need leads to Monmouth’s current acquisitions of several companies. These efforts were not entirely successful.
The acquisitions broadened Monmouth’s market but still left it highly sensitive to general economic conditions. In the past, Monmouth was interested in acquiring RTC, but all of its acquisitions have not reached their intended results.
Now, however, RTC is in the middle of an acquisition fight that could provide Monmouth with an opportunity to gain control without a hostile takeover.
About Robertson Tool Company
RTC is one of the largest domestic manufacturers of cutting & edge hand tools. In this industry, it is a leader in two main product areas: clamps and vises, scissors, and shears. RTC has had relatively poor sales and profit performance in recent years; RTC’s annual sales growth of 2% has been behind the industry growth rate of 6% per year.
One of RTC’s greatest assets is its distribution network, which includes 140 local sales representatives and reaches overseas to 137 countries. The company seems to have all the necessary strengths to fully exploit the 6%-7% annual sales growth industry average. However, it lacks financial strength.
Current Situation Regarding the Hostile Takeover of RTC by Other Companies
The “Simmons Company” acquired 44,000 shares of Robertson stock in 2000 and has been an attentive stockholder ever since. In 2003, Simmons informed Robertson management of its plan to tender immediately for 437,000 of Robertson’s 584,000 outstanding shares at $42 per share in cash.
Robertson’s management was alarmed. It was feared that Simmons’s quest for higher profits might lead to aggressive cost-cutting and the elimination of marginal product lines. On the other hand, Monmouth was willing to make such an offer if Robertson’s management and directors would commit themselves to it now. Monmouth’s efforts didn’t work out.
After that, the NDP Corporation entered the battle. This battle between Simmons and NDP seemed to provide Monmouth with an unexpected second opportunity to gain control of Robertson.
A merger of Monmouth and RTC could allow Simmons to convert its shares into the common stock of Monmouth. For the same reason, Simmons tentatively agreed to support this merger on the condition that the price is at least $50 for each RTC share it held.
The Critical Decision
Main issue: Should Monmouth acquire RTC? If so, at what price and in what form the offer should the offer take?
- Is RTC a strategic fit for Monmouth, Inc.?
- What is the value of the firm?
- How much risk can we bear?
- Is Simmons’ offer reasonable?
I. RTC as a Strategic Fit for Monmouth
RTC is a strong strategic fit for Monmouth for two key reasons: 1.) the two firms can complement one another in a way that leverages each other’s strengths and mitigates weaknesses; 2.) RTC fits Monmouth’s criteria well, especially compared to the experiences with previous acquisitions.
Analysis of RTC’s current situation:
Current Weaknesses of RTC:
RTC has been conservative in its accounting and financial policies and has had a history of poor sales & profit performance. Its profit margin is one-third of other competitors, and the annual sales growth is 2%, behind the industry growth rate of 6% per year.
The stock is at its lowest, far below the book value of 53 USD per share. The stock has only been appealing for its dividend yield. Investors are hoping for a stock price increase, which is pressuring management and the Robertson family, as they have only a 20% stake in RTC, so it is hard for them to introduce any major strategic changes.
Unexploited strengths of RTC:
RTC is the largest manufacturer of cutting-edge hand tools and a leader in two main product areas: it controls 50% of the market of clamps and vises and 9% of the market of scissors and shears.
One of RTC’s greatest assets is its distribution network, with 48 salesmen and 28 sales engineers who can reach up to 2100 wholesalers in contact with 15000 retail outlets in the US and Canada.
With its heavy advertising and promotion program, RTC can also leverage its 140 sales representatives to reach 137 different countries to sell its products.
Currently, there is a battle between Simmons and NDP for the control of RTC. RTC prefers to make a deal with Monmouth since they are at risk with others whom they suspect will overhaul their business model and simply focus on cost-cutting and the bottom line.
The Robertson family and the managers share the long-term vision that Monmouth has. They both have a long-term strategic interest in the firm instead of divestiture, like the NDP’s intentions. For example, here is the potential that Monmouth sees in RTC:
They are reducing costs of goods sold (CoGS), reducing sales & administrative costs (S&A), increasing market share, and increasing sales using the efficient distribution network to distribute their products. Also, the sales of Monmouth’s towards industrial (75%) and consumer market (25%) are perfectly in opposite proportion for Robertson.
Respective the diversification criteria set by Monmouth to acquire other companies:
- Major player: RTC has the full potential but lacks in realization. Better management could bring the company to its fullest, bringing it to its comparable peers (6% growth annually)
- Industry stable, broad market, product line for small-ticket items: The industry of hand tools is fairly stable (not volatile like oil-related products). Also, the market is broad enough, serving 137 countries and 15000 retail stores only in the USA and Canada. Products are indeed small ticket items.
- Only leading companies in their respective market: The company lacks financial figures, but the competitive strengths are present. Robertson is a leader in the clamps and vises (50% market share) market and 3rd in the scissors and shears market (9% market share). Monmouth, together with the acquisition of Dessex and Kroll, would eventually strengthen its position.
II. Valuation of Robertson from a Monmouth perspective
How much Monmouth should pay for RTC shares in full and in part was solved with a DCF model. To obtain the calculation for RTC’s company value to discount the free cash flow to the firm in a post-acquisition scenario from 2003 to infinity using RTC’s WACC as a discount rate.
First, to accomplish this model, several assumptions needed to be made. They will be mentioned as they arise in the calculations. From the years 2003 to 2006, information was forecasted in detail by the management of Monmouth. For the years remaining, the same figures that were used in 2007 were held constant, as predicting changes in value becomes less possible over time due to uncertainties.
Based on this, the valuation was divided into six steps:
- Determination of future sales
- Determination of future expenses
- Calculation of profit after tax
- Calculation of free cash flow to the firm
- Calculation of the WACC
- Calculation of Monmouth company value and fair share price
1. For the determination of future sales, Monmouth’s management used the proforma figures they prepared. These figures were based on the actual figures of 2002, with an applied growth rate of 6% (which corresponds to the industry average) from 2003 to 2006.
From 2007 to infinity, the same figure as in 2006 is used. This perspective includes Monmouth’s view that they will be able to exploit RTC’s strengths after the acquisition.
2. RTC’s future expenses, namely costs of goods sold (CoGS), selling and administrative expenses (S&A), and depreciation, are also based on the proforma figures.
This perspective includes Monmouth Inc.’s view that they will be able to…
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