Pinkerton, a security guard service firm, and its CEO is looking into changing the company's capital structure. It is considering an IPO and a leveraged recap.
Elizabeth R. Lawrence and Adam S. Berger
Harvard Business Review (292136-PDF-ENG)
May 11, 1992
Case questions answered:
- Is $16 per share a fair price for Pinkerton to receive for its common stock?
- How expensive is the Berkeley subordinated debt?
- Assume that the January 1990 IPO refinancing does not take place. Can Pinkerton service its existing debt and stay within the debt covenants? If permitted by MHTC, could the company pay dividends so that Wathen could solve his financial problems?
- In view of your analysis of the questions above, what is your recommendation regarding the IPO? As management? As a shareholder?
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Case answers for Pinkerton (B)
This case solution includes an Excel file with calculations.
To: Mr. Al Berger, Chief Operating Officer, and Director of Pinkerton
Re: Whether to recommend the IPO to the CEO and the Board of Pinkerton
From the management’s perspective, we recommend the IPO option for Pinkerton, which will solve Pinkerton’s indebtedness to the existing debts and relieve Wathen from his financial situation.
First, the debts from MHTC and Berkeley have high-interest rates and draconian terms of covenants. The current cash flow is not enough to repay the annual debt principal and interest.
Second, Wathen was in massive personal debt, and he would have to accept this option as the majority stakeholder of Pinkerton. Third, the leveraged recapitalization option was rejected since it will increase Pinkerton’s leverage level and increase the risk of financial distress.
We believe the $16 per share price is overestimated though the IPO option will be good for retiring debts and raising equity for Pinkerton’s future growth.
Based on the financial assumptions of Pinkerton’s management, we apply the APV method to evaluate the pre-IPO firm value, which is about $118 million (see Exhibit 1 and 3). We then calculate the post-IPO firm value of $124 million when the IPO involves $65 million borrowing from the private sector and proceeds from IPO.
Fundraising from the private sector and $15 million of net IPO proceeds are used to pay off existing debt, and thus the equity value after IPO is $67 million. With a total of 6,371,477 shares, the implied book share price is calculated to be $10.47 (Exhibit 2). Hence, $16 per share is not a higher price for Pinkerton to receive its common stock.
Berkeley’s subordinated debt was not quite expensive on the condition that the share price is $10.47 before Berkeley vests all warrants. The company borrowed $20 million in debts in 1988, and the cost of debt as of 1988 is about $19.28 million.
The tax shield generates benefits of $4.24 million, offsetting most of the warrants’ loss, around $3.89 million (Exhibit 3). With the equity call option, Pinkerton will…