Yeats Valves Controls Inc. Solution

YEATS VALVES CONTROLS INC. I.

CASE BACKGROUND 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 defense 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 raw material used by the company was obtained in ample supply from a number of competitive suppliers. However, Bill Yeats is approaching his retirement, hence, he started to make future plans for the company. Serious negotiations about a merging with TSE International Corporation, a well-known competitor, started in the late 1999. Part of the negotiation is that Bill Yeats shall remain as the CEO of the YVC who will receive a monthly salary and year-end bonuses. Auden Company, a large concern in a related field, was an important foreign distribution channel under a nonexclusive distributor arrangement. About 15% of YLC sales came from Auden. Foreign sales through Auden and direct sales through YLC own staff accounted for 30% of sales. Although the foreign-currency crisis in the mid-1990s had interrupted sales growth for the company, better economic condition in the markets of developed countries, together with its recent introduction of new product in aerospace and defense industries offered the company excellent prospect for improved performance. YLCs plants were organized for efficient handling of small production orders. From 1997 to 1999, net additions to property totaled $7.6 million. The success of YLC had brought numerous overtures from companies looking for diversification, plant capacity, management efficiency, financial resources, or an offset to cyclical business. YLC feared that without a well-financed partner, the company would be swamped by competition. Thus, when a merger with TSE International Corporation came along in 1999, YLC determined to make it work as best as he could. On the other hand, TSE International Corporation was incorporated in 1970. By 2000, the company manufactured products ranging from advanced industrial components to chain, bolts, nuts, cables, and other similar products, and they sold them, for the most part indirectly, to various industrial users. The company's raw material came from various producers. TSE plants were modern, ample, well equipped, and adequately served by railroad sidings. As the possibility o0f merging with TSE Company came up, Bill Yeats decided to make the best out of this opportunity. Yeats was also thinking about joint ventures but it did not

seem to be the best option. He is also thinking about moving on alone but that means they would have to raise new debt and equity to finance the growth of the company. The merger proposal was discussed with Auden Company due to their number of shares. Auden was not convinced about the merger but decided not to refuse the offer. Thus, they decided to sell their shares. Kate Porter, director of YVC believed that the company will be more valued if it became a part of large company. II.

CASE ANALYSIS Part of the negotiations between the YVC and the TSE are the discussions about the appropriate take over price, thus, it is necessary to come up with some calculations about the fair value of the YVC. There is also a need to determine whether the merger will benefit both companies and its stockholders. Hence, to determine whether merger will benefit for both company or not one must do this: 1. Estimate the value of the YVC after merger with TSE International. 2. Determine the minimum stock price to stockholder’s profit from merger. 3. Give recommendation to YVC to do merger or not. To do so, we must analyze evaluate different market valuation as follows: 1.

Discounted Cash Flow:

In discounted cash flows valuation, the value of an asset is the present value of the expected cash flows on the asset, discounted back at a rate that reflects the riskiness of these cash flows. Table 1. Value of Yeats before Merger

Sales Cost of goods sold Gross profit Selling, general, admin. Depreciation Other income, net Income before taxes Taxes Net income Cash Flow: Net income Depreciation Operating Cash Flow Capital expenditures Working capital needs Free Cash Flow Terminal Cash Flow Total PV of Free Cash Flow Total PV of Terminal Cash Flow Net Present Value of Free Cash Flows /Equity Value Less : Debt Divided by: Outstanding Shares Equity Value Per Share

Actual 1999 $49,364 37,044 12,320 2,936 1,508 228 8,104 3,242 4,862

2001 $66,000 47,850 18,150 4,024 1,828 264 12,562 5,025 7,537

Projected 2002 $73,200 52,704 20,496 4,464 2,012 288 14,308 5,723 8,585

2000 $59,600 42,316 17,284 3,612 1,660 240 12,252 4,901 7,351

2003 $81,200 58,058 23,142 4,952 2,212 320 16,298 6,519 9,779

2004 $90,000 63,900 26,100 5,492 2,432 352 18,528 7,411 11,117

4,862 1,508 6,370

7,351 1,660 9,011

7,537 1,828 9,365

8,585 2,012 10,597

9,779 2,212 11,991

11,117 2,432 13,549

-

1,826 3,492

2,011 3,867

2,213 4,289

2,433 4,757

2,675 5,273

6,370

3,693

3,488

4,095

4,800

6,370

3,693 $3,215.76

3,488 3036.59

4,095 $3,565.42

4,800 4,179.52

5,601 102,531 108,132 $4,876.44

$18,873.74 $89,273.96 $114,518 $0.00 1,440 $79.53

Table 2. TSE International Value before Merger

Actual 1999

Sales Cost of goods sold Gross profit Selling, general, admin. Depreciation Other income, net Income before taxes Taxes Net income Cash Flow: Net income Depreciation Operating Cash Flow Free Cash Flow

Projected 2000

2001

2002

2003

2004

$2,642,03 7 2,166,470 475,567

$2,813,76 9 2,307,291 506,478

$2,996,658 2,457,260 539,398

$2,187,208 1,793,511 393,697

$2,329,373 1,910,086 419,287

$2,480,78 5 2,034,244 446,541

120,296 26,800 -

125,786 27,950 -

131,482 29,770 -

140,028 31,700 -

146,316 33,170 -

155,826 133,314 -

246,601 98,640 147,961

265,551 106,220 159,331

285,289 114,116 171,173

303,839 121,536 182,303

326,992 130,797 196,195

250,258 100,103 150,155

147,961 26,800

159,331 27,950

171,173 29,770

182,303 31,700

196,195 33,170

150,155 133,314

174,761

187,281

200,943

214,003

229,365

283,469

174,761

187,281

200,943

214,003

229,365

283,469 9,411,099

Terminal Cash Flow Total PV of Free Cash Flow Total PV of TFCF Net Present Value of Free Cash Flows /Equity Value Less : Debt Divided by: Outstanding Shares Equity Value Per Share

174,761

$1,047,919 $8,844,416 10,067,096 $119,100.0 0 62,694 $158.67

187,281

200,943

214,003

229,365

9,694,567

$176,004

$188,844

$201,117

$215,554

$266,400

Table 3: Valuation after Merger

Actual 1999 Cash Flow: Net income Depreciation Operating Cash Flow

Free Cash Flow

Projected 2000

2001

2002

2003

152,823 28,308

166,682 29,610

178,711 31,598

190,888 33,712

205,974 35,382

161,272 135,746

181,131

196,292

210,309

224,600

241,356

297,018

196,292 210,309 224,600 241,356

297,018

181,131

24,831,790

Terminal Cash Flow

181,131

Total

196,292 210,309 224,600 241,356 25,128,808 178,448 191,190 204,182 219,415

PV of FCF Total PV of TFCF Net Present Value of Free Cash Flows /Equity Value Less : Debt Divided by: Outstanding Shares Equity Value Per Share

2004

270,016

1,063,250 22,574,355 23,818,736 $119,100.00 64,134 $369.53

From Table 1, the value of YVC is $ 114,510. Meanwhile, from Table 2, the value of TSE International is $ 10,067,096. And from the Table 3, we can see that the value of company after merger is $ 23,818,736. We can see that the value of company after merger is higher than the value from each company. It means that it is beneficial for both companies to do the merger.

2.

P/E Ratio

The P/E ratio reflects the amount investors are willing to pay for each dollar of earnings. The average P/E ratio in a particular industry can be used a guide to a firm’s value – if it is assumed that investors value the earnings of that firm in the same way they do the “average” firm in 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. Table 4 EPS for Yeats and TSE

EPS for Yeats EPS for Industrial Sector Average Value per Share of Yeats

3.87 11.1 42.957

EPS for TSE EPS for Industrial Sector Average Value per Share of TSE

2.23 11.1 24.753

From table above, we can see that Yeats’s PER is higher than TSE’s.

3. Book Value

Total Assets Total Liabilities Total Shares Outstanding Book Value per share

$ $ $ $

Yeats 42,124,000 5,360,000 1,440,000 25.53

TSE $ 1,245,825,000 $ 350,088,000 $ 62,694,361 $ 14.29

From table above, we can see that the book value per share from the Yeats is higher than TSE’s.

4. Market Value Based on exhibit 7, market value for Yeats on May 1, 2000 is $39.75, and market value for TSE International is $21.98. It shows that market price of Yeats is higher than TSE. Which means, the demand for Yeats share are higher than the TSE. From the explanations above, we can conclude that the merger between Yeats and TSE will be benefit both of them. It can be seen from the value per share was increased after the merger. The DCF calculation above shows us that the value of the merge company is higher than the sum of value of each company before merger. 5. Computation of Minimum Stock Price

Particulars DCF EPS BV Market price Minimum Stock Price

Value

Weighted $79.53 42.957 25.53 $39.75

60% 20% 10% 10%

Amount $47.72 $8.59 $2.55 $3.98 $62.84

Yeats Market Capitalization= Minimum Stock Price x Shares Outstanding $90,482,871.22

III.

Recommendation After careful analysis of the merger plan of YVC to TSE, we would recommend that YVC should merge to TSE with a minimum stock price that Yeats should ask to TSE of $ 90,482,871.22 or $ 62.84 per share.