Cfm Tutorial 5
-
Upload
nithin-yadav -
Category
Documents
-
view
320 -
download
0
Transcript of Cfm Tutorial 5
-
5/25/2018 Cfm Tutorial 5
1/26
1 Cases in Financial Management
Tutorial 5
The Timken Company
Piotr Korczak
-
5/25/2018 Cfm Tutorial 5
2/26
2 Summary of facts
Timken is considering acquiring Torringtonfrom Ingersoll-Rand
The acquisition would strengthen the market
position of Timken and would lead to savings
estimated at $80 million annually
Analysts estimate the minimum value of
Torrington at $800 million
The transaction may weaken Timkens financialposition, including a credit rating downgrade
-
5/25/2018 Cfm Tutorial 5
3/26
3 Main problems/questions of the case
Should Timken go ahead with the acquisition? If yes, how should they structure the deal?
How much should they offer to pay?
What method of payment should they offer?
-
5/25/2018 Cfm Tutorial 5
4/26
4 Why should Timken take over Torrington?
Little overlap in products, large overlap incustomers
Savings in sales costs
Bundling a wider offer makes them more
competitive and increases margins
To remain a global leader
To compete with foreign companies
To have a stronger position in negotiations with
suppliers and buyers
Any other arguments?
-
5/25/2018 Cfm Tutorial 5
5/26
5 Why shouldnt Timken take over Torrington?
A large acquisition Financially demandingwill Timken be able to
afford it?
Timken is already highly leveraged, the acquisition
may require further borrowingimpact on creditrating
Issuing shares to finance the deal will dilute the
control of existing shareholders
Particularly problematic if shares are undervalued Risk of value destruction if overpaid
Common M&A concern
Any other arguments?
-
5/25/2018 Cfm Tutorial 5
6/26
6 Stand alone valuation of Torrington
How much is Torrington worth as a stand-aloneentity?
Note we are looking for the enterprise value
Acquisition of all assets = Acquisition of equity and
debt
Methods
Discounted cash flows (DCF)
Market multiples
-
5/25/2018 Cfm Tutorial 5
7/26
7 Stand alone valuationDCF: cash flows
Operating income, capex, depreciationfrom Exhibit 5 Tax rate: 39.9% (assumed, equal to 2002 effective tax
rate for Timken assumed to reflect industry standard,
close to US statutory tax rate)
Working capital needs (level): 10.4% of sales (avg
2001-2002 WC/sales for Timken, assumed to reflect
industry standard)
Terminal growth rate: 4% (assumed)
-
5/25/2018 Cfm Tutorial 5
8/26
8 Stand alone valuationDCF: discount rate (1)
We need WACC for Torrington Torrington is a part of Ingersoll-Rand and as
such is unlisted (hence no direct CAPM inputs),
does not borrow on its own (hence no data for
cost of debt), and does not have a self-standing
capital structure
We have to estimate WACC from data for other
firms
-
5/25/2018 Cfm Tutorial 5
9/26
9 Stand alone valuationDCF: discount rate (2)
Candidates Average WACC for the industry
WACC for Timkenbut not because Timken is the
acquirer but because it is likely to have a similar risk
profile Note that data for Ingersoll-Rand are of little use
IR is a diversified firm and hence has a deferent risk
profile that does not reflect risks of Torrington
IRs capital structure can also be specific to adiversified firm
Here, for illustration, WACC for Timken
-
5/25/2018 Cfm Tutorial 5
10/26
10 Stand alone valuationDCF: discount rate (3)
Kd: 7.23% (BBB debt yield, Exhibit 9) Rf: 4.97% (long-term gov bond, Exhibit 9)
Beta: 1.10 (Exhibit 8)
Risk premium: 6.0% (assumed)
Ke: 11.57%
Debt: $461.2 million (Exhibit 2)
Equity: $1,065.1 million (no of shares * price, Exhibit 8)
Tax rate: 39.9% (effective historical 2002, Exhibit 1)
WACC: 9.39%
-
5/25/2018 Cfm Tutorial 5
11/26
11 Stand alone valuationDCF
2003 2004 2005 2006 2007
Operating income 90.7 96.6 102.9 109.5 116.7
Tax 36.2 38.5 41.1 43.7 46.6
Depreciation 84.2 90.0 96.0 102.0 108.5
Capex 175.0 130.0 140.0 150.0 160.0Change in WC 8.1 8.6 9.2 9.8 10.4
FCF -44.4 9.4 8.6 8.0 8.2
Terminal value 158.2
Total flows -44.4 9.4 8.6 8.0 166.4
PV of flows -40.6 7.9 6.6 5.6 106.2
Enterprise value 85.7
-
5/25/2018 Cfm Tutorial 5
12/26
12 Stand alone valuationmultiples
We are valuing the enterprise, hence focus onthe enterprise value multiple (EV/EBITDA)
Torringtons 2002 EBITDA (operating income
plus depreciation, Exhibit 5): 165.2
Average EV/EBITDA for industry (Exhibit 8):
7.15
Enterprise value: 1,181.2
-
5/25/2018 Cfm Tutorial 5
13/26
13 Stand alone valuationdiscussion
Large discrepancies between DCF and multiplesvaluation
Some differences can be justified: fundamental vs
market valuation
Critically check cash flow projections There is a projection of a sharp increase in Capex
why? Is it justified?
DCF valuation is also way below the analysts
estimate of Torringtons value
-
5/25/2018 Cfm Tutorial 5
14/26
14 With-synergies valuation of Torrington
How much is Torrington worth to Timken?Stand alone valuation
PLUS the value of synergies
Methods of valuing synergies
Discounted cash flows (DCF)
Market multiples
-
5/25/2018 Cfm Tutorial 5
15/26
15 The value of synergiesDCF: inputs
Annual cost savings of $80 million by the end of2007
You need to make an assumption what happens to
savings between now (2002) and 2007; e.g. they
increase graduallyNote you need to deduct taxcost savings increase
your taxable income
Integration costs of $130 million over the first
two years, i.e. $65 million annually (less tax)
Discount rate as before
-
5/25/2018 Cfm Tutorial 5
16/26
16 The value of synergiesDCF
2003 2004 2005 2006 2007
Cost savings (pre-tax) 0.0 20.0 40.0 60.0 80.0
Cost savings (after tax) 0.0 12.0 24.0 36.1 48.1
Perpetuity (=savings/WACC) 512.0Integration costs (after tax) 39.1 39.1
Total effect on flows -39.1 -27.0 24.0 36.1 560.1
PV of effect on flows -35.7 -22.6 18.4 25.2 357.6
Synergy value 342.8
-
5/25/2018 Cfm Tutorial 5
17/26
17 The value of synergies - multiples
Note this is only an approximation Gradual increase in cost savings not considered
Integration costs not considered
EBITDA increases by $80 million
Average EV/EBITDA (Exhibit 8) 7.15
Value of synergies: 807.15= 572 ($ million)
-
5/25/2018 Cfm Tutorial 5
18/26
18 Valuation - summary
Analysts estimate of $800 million seems areasonable number
Its not as high as multiples valuation (hence looks
conservative) but reflects value in Torrington DCF
may be misestimating The underlying forecasts in DCF have to be carefully
reviewed in the processare they justified?
The value of synergies available from the deal
are about $340 million Possibly conservative estimate
It does not take into account synergies reflected in
larger sales (e.g. bundling)
-
5/25/2018 Cfm Tutorial 5
19/26
19 Timkens pre-acquisition financial standing
Current credit rating : BBB Inputs: data from Exhibit 1 and 2, EBIT before
nonrecurring
A BBB BB Timken
EBIT interest coverage 6.3 3.9 2.2 3.7
EBITDA interest coverage 8.5 5.4 3.2 8.6
EBITDA/Sales (%) 18.1 15.5 15.4 10.1
Total debt/capital (%) 42.6 47.0 57.7 43.1
-
5/25/2018 Cfm Tutorial 5
20/26
20 Timkens post-acquisition financial standing
Assume the acquisition is financed with debt, $800million paid
Assumptions: interest rate 7.23%, 2002 EBITDAs and
sales summed for both companies but no synergy effect
or cost of integration
A BBB BB Timken+Torrington
EBIT interest coverage 6.3 3.9 2.2 2.2
EBITDA interest coverage 8.5 5.4 3.2 4.8
EBITDA/Sales (%) 18.1 15.5 15.4 11.3
Total debt/capital (%) 42.6 47.0 57.7 67.4
-
5/25/2018 Cfm Tutorial 5
21/26
21 How much should Timken offer to pay? (1)
Factors to consider Analysts value estimate of $800 million as a
reference price
Stand alone valuationbottom value
It is likely that Torrington is worth that much to Ingersoll-Randthey do not have any obvious synergies
Discrepancies between valuation methods
With-synergies valuationceiling value
Paying that much leaves no value for Timken, paying more
than that destroys value for Timken
Is Ingersoll-Rand willing to sell?
It seems so, so Timken is not pressed to bid high to succeed
-
5/25/2018 Cfm Tutorial 5
22/26
22 How much should Timken offer to pay? (2)
Factors to considercontd Is there a risk of a competing bid?
Competition in the sector may increase pressures on growth
through acquisitions
Foreign companies may be interested in getting access to
the US market to overcome anti-dumping regulations
However, foreign companies may have little synergies with
Torrington (they may be specific to Timken)
-
5/25/2018 Cfm Tutorial 5
23/26
23 How should they pay? (1)
Factors to consider Options: stock, cash or stock and cash
Can Timken raise sufficient amount of cash?
Will they have access to debt?Possibly will be
downgraded if fully finance with debt
Will they be able/willing to issue new shares?
Are Timken shares correctly priced?
If they are undervalued, Timken should be unwilling to use
them as a method of payment
From Exhibit 8: Timkens PE 20.7, average for other firmsin the industry 16.9look overvalued (but Exhibit 7 shows
that the firm has been underperforming the market index,
hence possibly undervalued)
-
5/25/2018 Cfm Tutorial 5
24/26
24 How should they pay? (2)
Factors to consider What is Ingersoll-Rand preference?
They want to divest from the bearings industry hence likely
to prefer cash
-
5/25/2018 Cfm Tutorial 5
25/26
25 Recommendation (1)
There are strategic benefits from the deal henceTimken should go ahead with the bid
It is key not to overpay
It looks that IR will not be negotiating hard and there
is low risk of competing biddershence Timken canoffer a relatively low price
Timken should bid in the region of $800-900 million
it should be a good deal for IR (given analyst
estimates), still leaving room for value creation forTimken (given the estimate of the synergy)
-
5/25/2018 Cfm Tutorial 5
26/26
26 Recommendation (2)
Timken is unlikely to be able to raise debt tofinance the acquisition without losing the
investment grade credit rating
As IR is unlikely to be interested in Timken
shares, Timken should sell shares to the public
to raise cash to finance the acquisition
However, there are significant uncertainties
highlighted by DCF valuation (e.g. TorringtonCapex projection) that need to be further
investigated before the completion of the deal