Report Timken 4u651z
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Table of Contents
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Executive Summary
The case ‘The Timken Company’ is about the acquisition of the Torrington from ‘Ingersoll-Rand’ by the Timken Company. Torrington produces the best quality bearing while the Timken has many wings where bearing is an important division of their business. Both these companies has 5% of product and 80% of customers redundancy. After the acquisition Timken will be world’s third largest bearing company.
The main point of this case is how the payment for this acquisition will be made. Expected value of this acquisition is estimated $800 million. How Timken will pay this large amount is the main question here. Timken can borrow or can issue stock for this amount. But this large debt will affect Timken’s leverage ratio, as well as Timken’s investment grading in the market. Another option for Timken is to offer stock in exchange for the purchase. But still Timken will be needing cash for this acquisition to be complete.
However we have found several circumstances of the financing opportunities for this acquisition which will affect the value of Timken. we analyzed various risk related to these financing like Interest Rate Risk, Overall Business Risk, Financial Risk, Degree of Financial Leverage, and Bankruptcy Risk, Du point ratio. After calculating the NPV of the financing options we have run simulation technique for the potential investment. We have tried to focus on the best option for the acquisition that will increase the value of the firm most.
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Introduction
Objective of the study
Usually we gather theoretical knowledge from course material. But it is also very much important to relate that theoretical knowledge with practical situation. The basic objective of conducting this case analysis is applying our theoretical knowledge in practical situation. The objective behind conducting this study is as follows:
To analyze the ‘The Timken Company’ scenario To analyze the acquisition of Torrington from Ingersoll Rand Analyze the financing of the acquisition Finding out the synergy of the acquisition
Scope of the study
The study topic allows us to analyze the cases named “The Timken Company” We have gone through the case thoroughly, analyzed the problems of this company and tried to find out solutions of these problems. Finally we have reached recommendations that will help to take the decision. Some external information has been used for lack of information provided.
Methodology
For preparing our report we went through the text and information collected from case and applied our sense of finance which we gained from different course especially from corporate finance and capital budgeting to evaluate and justify our assigned topic. All the data used in this report have been gathered from the case. Financial techniques taught in our BBA and MBA courses have been used here. Some reasonable assumptions have been made because of lack of information provided. 3|Page
To analyze and solving the problem Free cash flow method. Crystal ball software is to complete the simulation analysis
Limitations of the study
The limitations of the study are defined by the extensive of the facts covered by the study and those that left out. Learning all functions, moods of business, risk factors and protective covenants were quite tough within specified time framework. There was also time constraint. While attempting to solve the problem we have to assume some factors. The analysis could have been better if those data were provided
Case Briefing
The Timken Company is one of the largest bearing companies in the industry. The company was established in 1898 by Henry Timken. During the long life of the company the company faced many ups and downs in the life cycle. In 1982 the company suffered its first loss since depression for the increasing amount of competition. During the year followed the company engaged in t venture. In 2002 the company decided to acquire ‘Torrington’ Company from ‘Ingersoll-Rand’. This acquisition would make The Timken Company world’s third largest bearing company. Through the acquisition the Timken Company would be able to produce bearing with lower cost, Timken’s worldwide brand value and world class distribution will produce high quality bearing with lowest possible cost. Potential annual cost saving from the consolidating manufacturing facilities is expected to be $80 million. 4|Page
The main challenge for The Timken Company is how the acquisition will be paid. Timken has two options for the financing of this acquisition:
1. Issuing debt; but this debt issue will affect the Timken’s leverage ratio enough to virtually guarantee that Timken would lose its investment grade rating. Equity issuance; Timken’s last issuance occurred in 1987,for this huge analysis is needed for the issuance and the no. of share issuance will have to be double since it’s last issuance to raise the amount needed. Both this for the cash payment or they can 2. Offer stock along with the cash payment for this acquisition
Participators of the Acquisition The Timken Company
As a global industrial technology leader, Timken apply deep knowledge of metallurgy, friction management and power transmission to improve the reliability and efficiency of machinery all around the world.
They engineer, manufacture and market mechanical components and high-performance steel. Their bearings, engineered-steel bars and tubes -- as well as transmissions, gearboxes, chain and related products and services -- diversified markets worldwide.
With $4.3 billion sales in 2013 and approximately 19,000 people operating from 28 countries, Timken makes the world more productive and keeps industry in motion. 5|Page
The Ingersoll Rand
With a history dating back to 1871, Ingersoll Rand and its family of brands represents a proven history in construction and mining, industrial and commercial markets. Through acquisitions, innovations and customer focus, today's Ingersoll Rand offers market-leading solutions and services that enable customers to create progress through a variety of industries and markets that touch everyday life. Ingersoll Rand (NYSE:IR) advances the quality of life by creating comfortable, sustainable and efficient environments. Their people and their family of brands—including Club Car®, Ingersoll Rand®, Thermo King® and Trane®—work together to enhance the quality and comfort of air in homes and buildings; transport and protect food and perishables; and increase industrial productivity and efficiency. They are a global business committed to a world of sustainable progress and enduring results.
Torrington
Torrington is best known for its Torrington needle bearings and Torrington thrust bearings. All Torrington bearings are made using special lubrication and duplex cutting in order to ensure that they are all the same size, which helps reduce friction and makes the bearing assembly last much longer. Torrington is somewhat more expensive than some of its competitors, however, none of them compare in quality and longevity to Torrington
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Economic Analysis:
Like a battered champion in a heavyweight boxing match, the U.S. economy rose, staggered, took a knee then resumed fighting in 2002. The roaring recovery of early January gave way to fear of a ‘doubledip’ recession by midsummer. But by fall it appeared the U.S. economy had weathered a second recession GDP GDP growth in the first quarter of 2002 caught everyone by surprise. GDP jumped a staggering 5% in the first quarter after a respectable 2.7% in 2001:4. Coming out of the 1990 recession the U.S. conomy grew 2.3%, 1.0% and 2.2% in the first three quarters after the recession ended. While large growth rates are not uncommon after a severe recession such as 1981, 5% growth is unusual coming out of such a shallow recession as we had in 2001. The massive interest rate cuts enacted by the Federal Reserve during 2001 were finally showing up in the data in the form of spending. Stock Market After the recession of late 2001, the U.S. stock market appeared to recover its legs in early 2002. In early March, the Dow Jones Industrial Average was at 10,700 –only 7% lower than its all-time peak. The massive flight to safety drove up prices on bonds and drove down bond yields. Suddenly, earning 12% on a savings didn’t look too bad. Savings deposits at banks jumped a staggering 22% from 2001:10-2002:10 as households moved assets out of the equity markets into safe, liquid assets. This provided the funds in the banking system to finance consumer durables and housing in the second half of 2002.
Consumption
If historians look back at 2002 and try to explain how the U.S. recovered from the 2001 recession they will clearly see that it was on the backs of the U.S. consumer. Fueled by low interest rates and the mortgage-refinancing boom during the summer, consumer spending grew at impressive quarterly rates
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(annualized) of 4%, 2.2%, 1.22% and 2.95% over the past year. Quarter to quarter, real personal consumption expenditures increased 4.2 percent in the third quarter, compared with an increase of 1.8 percent in the second quarter. Durable goods boom waned by the end of the year raising concerns that whatever consumption growth we saw in 2002 could disappear as we move into 2003. Investment After six consecutive quarters of negative growth, gross private investment finally showed some life in the first half of the year but turned negative again in the third quarter. Non-residential investment contracted during the first half the year. Residential investment grew respectably in the first half but fell off during the third quarter. Inventories jumped 2.6% and 1.3% in the first half of the year after six quarters of contraction as businesses rebuilt good stocks in the belief that the recession was over.
Government expending & Taxes
Standard economic wisdom suggests that the federal government should increase spending during a recession to dampen the decline in output. From 2001:3-2002:3, the U.S. government clearly did its part (due also in no small part to the war on terrorism). Real federal government spending increased from $568.9 billion in 2001:3 to $613.1 billion in 2002:3 – a 7.7% increase for the period. However, almost 80% of that ($35 billion) went to national defense. Whether or not defense spending aimed at fighting terrorism stimulates the U.S. economy is an open question. Transfer payments increased 9.8% during the same period as more people relied on welfare and unemployment compensation to get them through tough economic times. Inflation & Unemployment Inflation remained well under control in 2002. The Consumer Price Index increased a mere 1.5% from 2001:9-2002:9. The GDP deflator, a broader measure of inflation increased a mere 1% over 2002. As a result, low inflation gives the monetary and fiscal authorities substantial room to pursue expansionary policies if need be. The unemployment rate increased through the first half of 2002 hitting 6% for the first time since 1994. However, by the fall of 2002, the unemployment rate began dropping and was at 5.7% by October 2002. The median duration of unemployment also climbed in the first half of the year
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to 11.7 weeks before falling to 9.6 in October. This is nearly double the 6 weeks duration observed in the last year of the nineties expansion
Industry Analysis
Porter’s 5 forces Analysis
Porters five forces model is a helpful tool to assess the relative attractiveness and risks inherent in an industry. So with porters five forces model it will be attempted to analyze different components of riskiness of this industry.
Threat of new entrants:
Low
Bargaining power of sellers:
Rivalry among existing competitor:
Moderate
High
Bargaining power of buyers:
Moderate
Threat of substitute products: Low
Figure: Porter’s five forces Bearing Industry 9|Page
Threats of new entrants: Low
Market is segmented to large companies. These company comprise of majority of the total market Required huge capital investment Brand image is required
Rivalry among existing firms: High There are some major competitors exists in the market Severe economic and competitive pressure Increasing demand of the existing firms
Threat of substitute products: Low No proper substitute products exist; bearing is very important elements for automotive & mechanical industry; substitute is not a strong option for this industries. Bargaining power of buyers: Moderate High switching cost Low cost products available in the market Threat of dumping by foreign producers Bargaining power of suppliers: Moderate Availability of suppliers in the market No scope for forward integration High maintenance of raw materials are required
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Company Analysis
The company was founded by Henry Timken in St. Louis in 1899 and incorporated as The Timken Roller Bearing Axle Company. In 1898, Henry Timken obtained a patent for the tapered roller bearing. Timken influences the fundamentals of motion through the creation, transfer and control of power. Imagine the possibilities and multitude of applications where power must be generated, transferred or monitored. For more than 100 years, Timken has refined the science of managing friction. From Ploeisti, Romania to Bangalore, India and beyond, Timken operates 9 technology and engineering centers dedicated to developing solutions for customers’ toughest application problems. Market Segments Timken serve many diverse market segments, including aerospace, automotive, construction, consumer, defense, energy, industrial equipment, health, heavy industry, machine tool, positioning control, power generation and rail.
t Ventures o
CoLinx, LLC – Greenville, SC, U.S.A. (PTplace.com)
o
S.E. SETCO Service Co. – Norcross, GA, U.S.A.
o
Timken XEMC (Hunan) Bearings Co., Ltd. – Xiangtan, China
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Strategic Analysis
The Timken team will continue to transform business and create unparalleled value for customers, investors, communities and other stakeholders. They:
Applying Knowledge Using knowledge of metallurgy, friction management and mechanical power transmission to create unique solutions used in demanding applications
Differentiate Products offering a broad array of mechanical power transmission components, high-performance steel and related solutions and services
Expanding Reach Extending knowledge, products, services and channels to meet customer needs, wherever they are in the world
Perform with Excellence Delivering exceptional results with a ion for superior execution
SWOT Analysis
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Strength Custom-Made products for the buyers Sharing 80% customer with Torrington Familiar industry of both the acquirer and acquired firm Acquisition will reduce the production cost Weakness Issuing debt for acquisition will affect the leverage ratio of Timken High debt to equity ratio Higher price of Torrington’s products relative to market
Opportunity Strong brand value in the market Acquisition will set the stage for international growth International distribution network Market leadership will give the opportunity to negotiate with suppliers and sellers
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Threat Non-favorable bearing industry policy Threat of dumping by foreign producers Highly competitive market
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Ratio Analysis
Computation of Financial Ratios
1. Evaluating Internal Liquidity: Internal liquidity (solvency) ratios are intended to indicate the ability of the firm to meet future shortterm financial obligations. a. Current Ratio: Clearly the best known liquidity measure is the current ratio, which examines the relationship between current assets and current liabilities. In our analysis we have found current ratio of The Timken Company is 1.53 and of Ingersoll-Rand is 1.08 for the year 2002.This means that Timken does have liquid funds to cover their immediate needs more than Ingersoll-Rand b. Quick Ratio: the quick ratio relates current liabilities to only relatively liquid current assets (cash items and receivable). In 2002 Timken quick ratio was 0.7 and Ingersoll-rands was .46 c. NWC Ratio: This ratio measures company’s net working capital available to run its day to day activities. In 2002 Timken had NWC ratio 0.53 and Ingersoll-rand .08 d. Cash Ratio: The most conservative liquidity ratio is the cash ratio, which relates the firm’s cash and short-term marketable securities to its current liabilities. In 2002 Timken’s cash ratio was 0.13 and Ingersoll-rand’s was 0.09 which indicates lower liquidity solvency
Timken’s Liquidity Ratio
Liquidity Ratio
2001
2002
i.Current Ratio
1.29
1.53
ii.Quick Ratio
0.53
0.70
iii.NWC Ratio
0.29
0.53
iv.Cash Ratio
0.05
0.13
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Ingersoll-rand’s Liquidity Ratio
Liquidity Ratio
2001
2002
i.Current Ratio
1.24
1.08
ii.Quick Ratio
0.49
0.46
iii.NWC Ratio
0.24
0.08
iv.Cash Ratio
0.04
0.09
2. Evaluating Leverage:
The Timken Company
Leverage Ratio
2001
2001
i. D/E Ratio
0.47
0.57
ii. Debt-Asset Ratio
0.15
0.13
iii. Equity Multiplier
3.24
4.51
iv. Times Interest Earned
(1.37)
1.29
Leverage Ratio 8.00
iv. Times Interest Earned
6.00 4.00
iii. Equity Multiplier
2.00 2001
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2001
ii. DebtAsset Ratio
Ingersoll-Rand Leverage Ratio
2001
2002
i. D/E Ratio
0.74
0.60
ii. Debt-Asset Ratio
0.26
0.19
iii. Equity Multiplier
2.84
3.11
iv. Times Interest Earned
3.01
1.62
Leverage Ratio 10.00 iv. Times Interest Earned
5.00 2001
2002
3. Profitability Ratios:
The Timken Company
Profitability Ratio
2001
2002
i. Net Profit Margin
-0.02
0.02
ii. ROE
-0.05
0.06
iii. ROA
-0.02
0.01
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Profitability Ratio 0.10 0.00 2001
2002
-0.10 i. Net Profit Margin ii. ROE iii. ROA
Ingersoll-Rand
Profitability Ratio
2001
2002
i. Net Profit Margin
0.03
-0.02
ii. ROE
0.06
-0.05
iii. ROA
0.02
-0.02
Profitability Ratio 0.10 0.00 2001
2002
-0.10 i. Net Profit Margin ii. ROE iii. ROA
4. Efficiency Ratio:
The Timken Company
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Efficiency Ratio
2001
2002
i. TA Turnover
0.97
0.93
ii. Equity Turnover
0.32
0.24
Efficiency Ratio 1.50 i. TA Turnover
1.00 0.50
ii. Equity Turnover
2001
2002
Ingersoll-rand
Efficiency Ratio
2001
2002
i. TA Turnover
0.77
0.83
ii. Equity Turnover
2.20
2.57
Efficiency Ratio 3.00 i. TA Turnover
2.00 1.00
ii. Equity Turnover
2001
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2002
The total asset turnover ratio of both Timken & Ingersoll-Rand indicates the effectiveness of the firm’s use of its total asset base (net assets equal gross assets minus depreciation on fixed assets). The equity turnover ratio reflects the firm’s utilization of equity. In 2002 Ingersoll-Rand’s efficiency ratio was good which indicates, firms operating performance was efficient but Timken was not good in this particular ratio.
5. Du Pont Ratio:
The Du Pont identity breaks down Return on. This analysis enables the analyst to understand the source of superior (or inferior) return by comparison with companies in similar industries (or between industries).The Du Pont identity is less useful for industries such as investment banking, in which the underlying elements are not meaningful. Variations of the Du Pont identity have been developed for industries where the elements are weakly meaningful. The Timken Company
a. b.
DUPONT ANALYSIS
2001
2002
ROE
-0.05
0.06
-0.02
0.02
Net profit Margin Total asset
c.
Turnover
0.97
0.93
d.
Financial Leverage
3.24
4.51
-0.05
0.06
a=b*c*d
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Dupont ratio 5.00
ROE
4.00 Net profit Margin
3.00
Total asset Turnover
2.00 1.00
Financial Leverage
0.00 2001
2002
-1.00
Ingersoll-Rand
DUPONT ANALYSIS
2001
2002
ROE
0.06
-0.05
0.03
-0.02
a. b.
Net profit Margin Total asset
c.
Turnover
0.77
0.83
d.
Financial Leverage
2.84
3.11
a=b*c*d
0.06
-0.05
Dupont ratio 3.50
ROE
3.00 Net profit Margin
2.50 2.00
Total asset Turnover
1.50 1.00
Financial Leverage
0.50 0.00 -0.50
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2001
2002
6. ALTMAN Z Score Analysis: The Z-score formula for predicting bankruptcy can be used to predict the probability that a firm will go into bankruptcy within two years. Z-scores are used to predict corporate defaults and an easy-tocalculate control measure for the financial distress status of companies in academic studies. The Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company. As Zoot is a private equity firm so we have used Z score estimation for private firms. Here Z score Bankruptcy Model: Z = 0.717T1 + 0.847T2 + 3.107T3 + 0.420T4 + 0.998T5 The Timken Company
ALTMAN Z Score Timken Coefficien 2001
2002 t 2001
2002
Working Capital /Total Asset
0.29
0.53
1.2
0.35
0.63
Retained Earning /Total Asset
0.00
0.00
1.4
0.00
0.00
EBIT/Total Asset
0.01
0.04
3.3
0.05
0.13
debt
2.12
1.74
0.6
1.27
1.04
Sales/TA
0.97
0.93
1
0.97
0.93
2.64
2.73709
Book value of Equity/Book value of total
Score
Z<3
Possibility of Default
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Grey
Safe
Zone
Zone
Z<3
1.81
<3
Z>3
Ingersoll-Rand
ALTMAN Z Score Ingersoll-rand Coefficien 2001
2002 t 2001
2002
Working Capital /Total Asset
0.06
0.03
1.2
0.08
0.03
Retained Earning /Total Asset
0.00
0.00
1.4
0.00
0.00
EBIT/Total Asset
0.04
0.06
3.3
0.12
0.19
debt
1.35
1.66
0.6
0.81
1.00
Sales/TA
0.77
0.83
1
0.77
0.83
1.78
2.05244
Book value of Equity/Book value of total
Score
Z<3
Possibility of Default
Grey
Safe
Zone
Zone
1.81
Zones of Discrimination: Z' > 2.9 -“Safe” Zone 1.23 < Z' < 2.9 -“Grey” Zone Z' < 1.23 -“Distress” Zone 23 | P a g e
<3
Z>3
Z<3
Here, our calculated Z Score for Timekn is 2.75 and for Ingersoll-rand is 2.05. Both the companies are in safe zone.
Case Analysis
Problem Statement
The Timken Company is considering acquiring Torrington from Ingersoll Rand. The acquisition will cost more than $800 million (estimated minimum value for the company). Whether Timken Company should pay for this acquisition by issuing debt or share.
Possible Alternatives
1. Cash payment for the acquisition through Issuing Debt Issuing Stock Issuing 50% debt & 50% stock 2. Offering share of $100 million worth and cash payment $700 million through debt and stock
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Base case of the Acquisition Parties The Timken Company WACC Risk free Rate
3.55%
Market Return
10.0%
Beta Cost of Equity
1.1 10.65%
Cost of Debt
7.23%
After Tax cost of debt
4.34%
Weight ot Debt
0.36499166
Weight of Equity
0.63500834
Total Debt
350.1
Total Market Value of Equity
609.1
Total Value(Debt+ Equity)
959.2
Income Tax
40%
WACC
8.34%
Enterprise Value
1663.80
Cash Asset value of the firm Debt Equity value of the firm
82.10 1745.90 350.10 1395.80
No of shares outstanding
63.40
Equity Value Per Share
22.02
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Ingersoll-Rand Company WACC Risk free Rate
3.55%
Market Return
10.0%
Beta Cost of Equity
1.2 11.29%
Cost of Debt
5.84%
After Tax cost of debt
3.50%
Weight ot Debt
0.375581207
Weight of Equity
0.624418793
Total Debt Total Market Value of Equity Total Value(Debt+ Equity) Income Tax
2092.10 3478.2 5570.30 40%
WACC
8.37%
Enterprise Value
9339.57
Cash
342.20
Asset value of the firm
9681.77
Debt
2092.10
Equity value of the firm
7589.67
Shares outstanding
216.85
Equity value per share
35.00
% of torrington shares outstanding
29.17
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Torrington WACC Risk free Rate
3.55%
Market Return
10.0%
Beta
0.9
Cost of Equity
9.36%
Cost of Debt
5.84%
After Tax cost of debt
3.50%
Weight ot Debt
0.375581207
Weight of Equity
0.624418793
Total Debt Total Market Value of Equity Total Value(Debt+ Equity) Income Tax WACC
Enterprise Value Cash
281.39 467.8179 749.21 40% 7.16%
714.72 46.03
Asset value of the firm
760.75
Debt
281.39
Equity value of the firm
479.36
price per share Price per share after
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16.44 1.64 18.08
Synergy Synergy is the combined value of the acquired and acquire firm. There are four sources of synergy 1. Revenue enhancement 2. Cost savings 3. Operating expense savings 4. Capital expenditure savings Synergy of the acquisition in three situations; a) Base b) Best & c) Worst are given below Assumptions for the base cases are: Base Case Revenue Enhancement
3.00%
Cost Savings
3.85%
Capex Savings
2.00%
Terminal Revenue Enhancement
2.00%
Terminal Cost Savings
1.50%
Discount rate for Revenue enhance
9.00%
Discount rate for cost savings Discount rate for capex savings
10.00% 8.00%
Value of the Synergy: Base Case Revenue Enhancement
1,769
Cost Saving
1,208
Operating expense savings
239
Capital expenditure saving
114
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Assumptions for the best cases are: Best Case Revenue Enhancement
4.00%
Cost Savings
4.50%
Capex Savings
3.00%
Terminal Revenue Enhancement
2.50%
Terminal Cost Savings
2.00%
Discount rate for Revenue enhance
8.00%
Discount rate for cost savings
9.00%
Discount rate for capex savings
7.00%
Value of the Synergy: Best case Revenue Enhancement 2,859 Cost Saving
2,046
Operating expense savings
407
Capital expenditure saving
182
Assumptions for the worst cases are: Worst Case Revenue Enhancement
2.00%
Cost Savings
2.50%
Capex Savings
1.50%
Terminal Revenue Enhancement
1.50%
Terminal Cost Savings
1.00%
Discount rate for Revenue enhance
10.00%
Discount rate for cost savings
12.00%
Discount rate for capex savings 29 | P a g e
9.00%
Value of the Synergy: Worst case Revenue Enhancement 860 Cost Saving
735
Operating expense savings
147
Capital expenditure saving
50
Net Synergy: Sources
Best
Worst
Revenue Enhancement
1,769
2859
860
Cost of revenue savings
1,208
2046
735
Operating cost savings
239
407
147
Capex Savings
114
182
50
Total Synergy
3,330
5494
1792
Weight
0.50
0.25
0.25
Value*Weight
1,665
1374
448
Estimated Total Synergy
3,487
(-)integration cost net synergy
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Base
130 3356.619152
Possible Alternatives Alternative 1: Acquisition of Torrington Company from Ingersoll-Rand by a cash deal: Timken could raise the needed amount of cash by using following financing options:
Financing Options: a) Raising $800 million for the cash deal by issuing shares to the public b) Raising $800 million for the cash deal with a debt offering c) Raising $800 million with a combination of debt and equity financing(50:50 ratio)
By using these three alternatives Timken could raise its needed amount of cash for the acquisition. In each of the cases, Timken’s capital structure will be altered. The optimal capital structure will ensure Timken with highest amount of Net Acquisition Value (NAV) and highest equity value per share.
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Financing Option A: Raising $800 million for the cash deal by issuing shares to the public
A. WACC Calculation for the combined firm: Timken(after acquiring Torrington) Risk free Rate
3.55%
Market Return
10.0%
Beta Cost of Equity
10.65%
Cost of Debt
7.23%
After Tax cost of debt
4.34%
Weight of Debt
0.309
Weight of Equity
0.691
Total Debt
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1.1
631.49
Total Market Value of Equity
1409.10
Total Value(Debt+ Equity)
2040.59
Income Tax Terminal Growth rate WACC
40% 3% 8.69%
Here, Timken will raise $800 million by issuing shares to the public. So they will issue 42.11 new shares at current market price which is 19 to raise $800 for the cash deal. As a result, Timken’s numbers of outstanding shares will become 105.51 (64.2+42.11).
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By adding the values of Timken and Torrington we can get combined value of Timken after aquiring Torrington.
Here we get enterprise value as 2102.48 million and after adding goodwill and net synergy value we get 6086.95. Here goodwill is determined by deducting the market value of land and property of Torrington from purchase price (800-172.15=627.85).Then we have added cash value of 128.13 which is the combined cash value of Timken and Torrington. The long term debt of 631.49 million is then deducted to find out the equity value of the firm which is 5583.59. And the number of shares are given here as 105.51 million and we got equity value per share as 52.92 dollar which is quite higher than Timken’s equity value per share without acquisition.
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Details
($ in millions)
Enterprise value
2102.48
Add: Goodwill
627.85
Add: net synergy
3356.62
Enterprise value with synergy
6086.95
Add: cash
128.13
Asset value of the firm
6215.08
Less: Debt
631.49
Equity value of the firm
5583.59
shares outstanding
105.51
Equity Value Per Share
52.92
Net Acquisition Value:
It is calculated by using following formula:
NAV = Value of combined firm adjusted with synergy and integration cost - (value of Timken + value of Torrington) - paid
Net Acquisition Value for the combined firm for this financing option is $3535.02 million
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Financing Option B: Raising $800 million for the cash deal with a debt offering
WACC Calculation for the combined firm: Timken(after acquiring Torrington) Risk free Rate
3.55%
Market Return
12.0%
Beta Cost of Equity
13.69%
Cost of Debt
10.84%
After Tax cost of debt
6.50%
Weight of Debt
0.702
Weight of Equity
0.298
Total Debt
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1.2
1431.49
Total Market Value of Equity Total Value(Debt+ Equity) Income Tax Terminal Growth rate WACC
609.10 2040.59 40% 3% 11.65%
Here, Timken will raise $800 million with a debt offering. So their total debt will increase by 800 million and will become 1431.49 million. By adding the values of Timken and Torrington we can get combined value of Timken after aquiring Torrington.
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Here we get enterprise value as 1407.216 million and after adding goodwill and net synergy value we get 5391.68. Here goodwill is determined by deducting the market value of land and property of Torrington from purchase price (800-172.15=627.85).Then we have added cash value of 128.13 which is the combined cash value of Timken and Torrington. The long term debt of 1431.49 million is then deducted to find out the equity value of the firm which is 4088.328. And the number of shares are given here as 63.4 million and we got equity value per share as 64.48 dollar which is quite higher than Timken’s equity value per share without acquisition and financing option A. But in this option, Timken will be forced to borrow the money at “highyield” rates which will lead to non- investment grade rating and that is not good for the company.
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Details
($ in millions)
Enterprise value
1407.216
Add: Goodwill
627.8535
Add: net synergy
3356.619
Enterprise value with synergy
5391.688
Add: cash
128.13
Asset value of the firm
5519.816
Less: Debt
1431.49
Equity value of the firm
4088.328
shares outstanding
63.4
Equity Value Per Share
64.48468
Net Acquisition Value:
NAV = Value of combined firm adjusted with synergy and integration cost - (value of Timken + value of Torrington) - paid
Net Acquisition Value for the combined firm for this financing option is $2109 million which is lower than the previous financing option. So it will not maximize Timken’s value
Financing Option C: Raising $800 million with a combination of debt and equity financing (50:50 ratio)
WACC Calculation for the combined firm: Timken(after acquiring Torrington) Risk free Rate
3.55%
Market Return
10.0%
Beta Cost of Equity
10.65%
Cost of Debt
7.69%
After Tax cost of debt
4.61%
Weight of Debt
0.505
Weight of Equity
0.495
Total Debt
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1.1
1031.49
Total Market Value of Equity
1009.10
Total Value(Debt+ Equity)
2040.59
Income Tax
40%
Terminal Growth rate WACC
3% 7.60%
Here, Timken will raise $800 million with a combination of debt and equity financing where they will issue shares worth of 400 million with a debt offering of 400 million. So their total debt will increase by 400 million and will become 1031.49 million. Equity will also increase by 400 million and will become 1009.10. For raising 400 million Timken will issue new shares of 21.05 at current market price which is 19. By adding the values of Timken and Torrington we can get combined value of Timken after aquiring Torrington.
Here we get enterprise value as 2587.49 million and after adding goodwill and net synergy value we get 6571.97. Here goodwill is determined by deducting the market value of land and property of Torrington from purchase price (800-172.15=627.85).Then we have added cash value of 128.13 which is the combined cash value of Timken and Torrington. The long term debt of 1031.49 million is then deducted to find out the equity value of the firm which is 5668.607. And the number of shares are given here as 84.45 million and we got equity value per share as 67.12 dollar which is quite higher than Timken’s equity value per share without acquisition and financing option A as well as B. Details 40 | P a g e
($ in millions)
Enterprise value
2587.494
Add: Goodwill
627.8535
Add: net synergy
3356.619
Enterprise value with synergy
6571.966
Add: cash
128.13
Asset value of the firm
6700.094
Less: Debt
1031.49
Equity value of the firm
5668.607
shares outstanding
84.45263
Equity Value Per Share
67.12173
Net Acquisition Value:
NAV = Value of combined firm adjusted with synergy and integration cost - (value of Timken + value of Torrington) - paid
Net Acquisition Value for the combined firm for this financing option is $3655 million which is higher than previous financing options.
Alternative 2: Acquisition of Torrington Company from Ingersoll-Rand by stock offering to IngersollRand: Timken could acquire Torrington by offering its stocks to Ingersoll. For this purpose Timken could issue $400 million equity and $300 million debt and could make the payment of $700 million in cash. As well as it can offer its stocks worth $100 million. In our case study analysis the new shares that Torrington would get have been calculated through exchange ratio. Exchange ratio:
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New shares of target firm =
α × Old shares of acquiring firm (1-α)
Exchange ratio =
New shares of target firm Old shares of target firm
Here α has been calculated by dividing the purchase price $800 million of Torrington by the after acquisition equity value of the firm with stock and cash offering of $5770.58 million. New shares exchanged for existing shares of Timken Company to Ingersoll would be $1.11805204. Total shares outstanding would be the addition of new shares with the old shares by 63.4+1.11= 64.52 shares. Exchange ratio comes from the new shares 1.11 divided by the existing shares of Torrington of 29.17. Here Torrington’s shares have been calculated assuming the accordance with the sales percentage of 13.45% of Ingersoll Company. Thus 29.17 shares have been calculated by the percentage of Torrington’s sales of Ingersoll company out of Ingersoll’s share outstanding shares of 216.85.
Assumptions for the combined firm: Timken(after
acquiring
Torrington) Terminal Growth rate
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3%
WACC
7.59%
Risk free Rate
3.55%
Market Return
10.0%
Beta
1%
Cost of Debt
7.69%
Income Tax
40%
WACC Calculation for the combined firm: WACC Risk free Rate
3.55%
Market Return
10.0%
Beta
1
Cost of Equity
10.00%
Cost of Debt
7.69%
After Tax cost of debt
4.61%
Weight ot Debt
0.5060816
Weight of Equity
0.4939184
Total Debt
931.49
Total Market Value of Equity
909.10
Total Value(Debt+ Equity)
1840.59
Income Tax
40%
WACC
7.27%
Here additional $300 million debt has been added with existing $631.49 million debt. As well as new equity has been added by $400 million shares with existing equity of Timken of $609.1 million. As $100 million worth shares would be given to Ingersoll equivalent amount would be deducted from the total value of equity.
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Here we get enterprise value as $2777.21 million and after adding goodwill and net synergy value we get $3356.619. Here goodwill is determined by deducting the market value of land and property of Torrington from purchase price ($800-$172.15=$627.85).Then we have added cash value of $128.13 which is the combined cash value of Timken and Torrington. The long term debt of $931.49 million is then deducted to find out the equity value of the firm which is $5770.58. And the number of shares are given here as 63.4 million plus the new shares found from equity issuing worth of ($400/19=21.05) million and we got equity value per share as $69.6596 which is quite highest than Timken’s equity value per share without acquisition and cash financing options. In this option, Timken will be able to borrow the money at “lower-yield” rates which will enable Timken to keep its existing investment grade rating and that is good for the company. Enterprise Value (+)Goodwill
627.8535
(+)net synergy
3356.619
Enterprise value with synergy
6761.683
(+)cash Asset value of the firm (-)Debt Equity value of the firm shares outstanding Equity Value Per Share
Recommendation
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2777.21
128.13 6889.81 931.49 5958.32 85.53485 69.6596
At the last of our analysis we would like to recommend that Timken should acquire Torrington form Ingersoll-Rand. Positives: It will increase market share within Global Industry from 7% to 11% Will become 3rd largest producer of Bearings in the World 5 % overlap in product offerings and 80% consumer overlap Expected annual cost savings of $80 million annually by 2007
Financing method: Optimal capital structure is the combination of debt and equity. Timken should acquire Torrington by a cash deal of $700 million and the additional $100 million worth of shares will be issued directly to Ingersoll-Rand as consideration for Torrington with an exchange ratio of .038:1 where 1.12 shares will be issued as new shares. Equity value per share will be $89.44 and Net Acquisition value will be $3755 million which is the highest among all other alternatives. Cash deal of $700 million will be financed by raising equity of $400 million and a debt deal of $300 million
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1|Page
Executive Summary
The case ‘The Timken Company’ is about the acquisition of the Torrington from ‘Ingersoll-Rand’ by the Timken Company. Torrington produces the best quality bearing while the Timken has many wings where bearing is an important division of their business. Both these companies has 5% of product and 80% of customers redundancy. After the acquisition Timken will be world’s third largest bearing company.
The main point of this case is how the payment for this acquisition will be made. Expected value of this acquisition is estimated $800 million. How Timken will pay this large amount is the main question here. Timken can borrow or can issue stock for this amount. But this large debt will affect Timken’s leverage ratio, as well as Timken’s investment grading in the market. Another option for Timken is to offer stock in exchange for the purchase. But still Timken will be needing cash for this acquisition to be complete.
However we have found several circumstances of the financing opportunities for this acquisition which will affect the value of Timken. we analyzed various risk related to these financing like Interest Rate Risk, Overall Business Risk, Financial Risk, Degree of Financial Leverage, and Bankruptcy Risk, Du point ratio. After calculating the NPV of the financing options we have run simulation technique for the potential investment. We have tried to focus on the best option for the acquisition that will increase the value of the firm most.
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Introduction
Objective of the study
Usually we gather theoretical knowledge from course material. But it is also very much important to relate that theoretical knowledge with practical situation. The basic objective of conducting this case analysis is applying our theoretical knowledge in practical situation. The objective behind conducting this study is as follows:
To analyze the ‘The Timken Company’ scenario To analyze the acquisition of Torrington from Ingersoll Rand Analyze the financing of the acquisition Finding out the synergy of the acquisition
Scope of the study
The study topic allows us to analyze the cases named “The Timken Company” We have gone through the case thoroughly, analyzed the problems of this company and tried to find out solutions of these problems. Finally we have reached recommendations that will help to take the decision. Some external information has been used for lack of information provided.
Methodology
For preparing our report we went through the text and information collected from case and applied our sense of finance which we gained from different course especially from corporate finance and capital budgeting to evaluate and justify our assigned topic. All the data used in this report have been gathered from the case. Financial techniques taught in our BBA and MBA courses have been used here. Some reasonable assumptions have been made because of lack of information provided. 3|Page
To analyze and solving the problem Free cash flow method. Crystal ball software is to complete the simulation analysis
Limitations of the study
The limitations of the study are defined by the extensive of the facts covered by the study and those that left out. Learning all functions, moods of business, risk factors and protective covenants were quite tough within specified time framework. There was also time constraint. While attempting to solve the problem we have to assume some factors. The analysis could have been better if those data were provided
Case Briefing
The Timken Company is one of the largest bearing companies in the industry. The company was established in 1898 by Henry Timken. During the long life of the company the company faced many ups and downs in the life cycle. In 1982 the company suffered its first loss since depression for the increasing amount of competition. During the year followed the company engaged in t venture. In 2002 the company decided to acquire ‘Torrington’ Company from ‘Ingersoll-Rand’. This acquisition would make The Timken Company world’s third largest bearing company. Through the acquisition the Timken Company would be able to produce bearing with lower cost, Timken’s worldwide brand value and world class distribution will produce high quality bearing with lowest possible cost. Potential annual cost saving from the consolidating manufacturing facilities is expected to be $80 million. 4|Page
The main challenge for The Timken Company is how the acquisition will be paid. Timken has two options for the financing of this acquisition:
1. Issuing debt; but this debt issue will affect the Timken’s leverage ratio enough to virtually guarantee that Timken would lose its investment grade rating. Equity issuance; Timken’s last issuance occurred in 1987,for this huge analysis is needed for the issuance and the no. of share issuance will have to be double since it’s last issuance to raise the amount needed. Both this for the cash payment or they can 2. Offer stock along with the cash payment for this acquisition
Participators of the Acquisition The Timken Company
As a global industrial technology leader, Timken apply deep knowledge of metallurgy, friction management and power transmission to improve the reliability and efficiency of machinery all around the world.
They engineer, manufacture and market mechanical components and high-performance steel. Their bearings, engineered-steel bars and tubes -- as well as transmissions, gearboxes, chain and related products and services -- diversified markets worldwide.
With $4.3 billion sales in 2013 and approximately 19,000 people operating from 28 countries, Timken makes the world more productive and keeps industry in motion. 5|Page
The Ingersoll Rand
With a history dating back to 1871, Ingersoll Rand and its family of brands represents a proven history in construction and mining, industrial and commercial markets. Through acquisitions, innovations and customer focus, today's Ingersoll Rand offers market-leading solutions and services that enable customers to create progress through a variety of industries and markets that touch everyday life. Ingersoll Rand (NYSE:IR) advances the quality of life by creating comfortable, sustainable and efficient environments. Their people and their family of brands—including Club Car®, Ingersoll Rand®, Thermo King® and Trane®—work together to enhance the quality and comfort of air in homes and buildings; transport and protect food and perishables; and increase industrial productivity and efficiency. They are a global business committed to a world of sustainable progress and enduring results.
Torrington
Torrington is best known for its Torrington needle bearings and Torrington thrust bearings. All Torrington bearings are made using special lubrication and duplex cutting in order to ensure that they are all the same size, which helps reduce friction and makes the bearing assembly last much longer. Torrington is somewhat more expensive than some of its competitors, however, none of them compare in quality and longevity to Torrington
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Economic Analysis:
Like a battered champion in a heavyweight boxing match, the U.S. economy rose, staggered, took a knee then resumed fighting in 2002. The roaring recovery of early January gave way to fear of a ‘doubledip’ recession by midsummer. But by fall it appeared the U.S. economy had weathered a second recession GDP GDP growth in the first quarter of 2002 caught everyone by surprise. GDP jumped a staggering 5% in the first quarter after a respectable 2.7% in 2001:4. Coming out of the 1990 recession the U.S. conomy grew 2.3%, 1.0% and 2.2% in the first three quarters after the recession ended. While large growth rates are not uncommon after a severe recession such as 1981, 5% growth is unusual coming out of such a shallow recession as we had in 2001. The massive interest rate cuts enacted by the Federal Reserve during 2001 were finally showing up in the data in the form of spending. Stock Market After the recession of late 2001, the U.S. stock market appeared to recover its legs in early 2002. In early March, the Dow Jones Industrial Average was at 10,700 –only 7% lower than its all-time peak. The massive flight to safety drove up prices on bonds and drove down bond yields. Suddenly, earning 12% on a savings didn’t look too bad. Savings deposits at banks jumped a staggering 22% from 2001:10-2002:10 as households moved assets out of the equity markets into safe, liquid assets. This provided the funds in the banking system to finance consumer durables and housing in the second half of 2002.
Consumption
If historians look back at 2002 and try to explain how the U.S. recovered from the 2001 recession they will clearly see that it was on the backs of the U.S. consumer. Fueled by low interest rates and the mortgage-refinancing boom during the summer, consumer spending grew at impressive quarterly rates
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(annualized) of 4%, 2.2%, 1.22% and 2.95% over the past year. Quarter to quarter, real personal consumption expenditures increased 4.2 percent in the third quarter, compared with an increase of 1.8 percent in the second quarter. Durable goods boom waned by the end of the year raising concerns that whatever consumption growth we saw in 2002 could disappear as we move into 2003. Investment After six consecutive quarters of negative growth, gross private investment finally showed some life in the first half of the year but turned negative again in the third quarter. Non-residential investment contracted during the first half the year. Residential investment grew respectably in the first half but fell off during the third quarter. Inventories jumped 2.6% and 1.3% in the first half of the year after six quarters of contraction as businesses rebuilt good stocks in the belief that the recession was over.
Government expending & Taxes
Standard economic wisdom suggests that the federal government should increase spending during a recession to dampen the decline in output. From 2001:3-2002:3, the U.S. government clearly did its part (due also in no small part to the war on terrorism). Real federal government spending increased from $568.9 billion in 2001:3 to $613.1 billion in 2002:3 – a 7.7% increase for the period. However, almost 80% of that ($35 billion) went to national defense. Whether or not defense spending aimed at fighting terrorism stimulates the U.S. economy is an open question. Transfer payments increased 9.8% during the same period as more people relied on welfare and unemployment compensation to get them through tough economic times. Inflation & Unemployment Inflation remained well under control in 2002. The Consumer Price Index increased a mere 1.5% from 2001:9-2002:9. The GDP deflator, a broader measure of inflation increased a mere 1% over 2002. As a result, low inflation gives the monetary and fiscal authorities substantial room to pursue expansionary policies if need be. The unemployment rate increased through the first half of 2002 hitting 6% for the first time since 1994. However, by the fall of 2002, the unemployment rate began dropping and was at 5.7% by October 2002. The median duration of unemployment also climbed in the first half of the year
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to 11.7 weeks before falling to 9.6 in October. This is nearly double the 6 weeks duration observed in the last year of the nineties expansion
Industry Analysis
Porter’s 5 forces Analysis
Porters five forces model is a helpful tool to assess the relative attractiveness and risks inherent in an industry. So with porters five forces model it will be attempted to analyze different components of riskiness of this industry.
Threat of new entrants:
Low
Bargaining power of sellers:
Rivalry among existing competitor:
Moderate
High
Bargaining power of buyers:
Moderate
Threat of substitute products: Low
Figure: Porter’s five forces Bearing Industry 9|Page
Threats of new entrants: Low
Market is segmented to large companies. These company comprise of majority of the total market Required huge capital investment Brand image is required
Rivalry among existing firms: High There are some major competitors exists in the market Severe economic and competitive pressure Increasing demand of the existing firms
Threat of substitute products: Low No proper substitute products exist; bearing is very important elements for automotive & mechanical industry; substitute is not a strong option for this industries. Bargaining power of buyers: Moderate High switching cost Low cost products available in the market Threat of dumping by foreign producers Bargaining power of suppliers: Moderate Availability of suppliers in the market No scope for forward integration High maintenance of raw materials are required
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Company Analysis
The company was founded by Henry Timken in St. Louis in 1899 and incorporated as The Timken Roller Bearing Axle Company. In 1898, Henry Timken obtained a patent for the tapered roller bearing. Timken influences the fundamentals of motion through the creation, transfer and control of power. Imagine the possibilities and multitude of applications where power must be generated, transferred or monitored. For more than 100 years, Timken has refined the science of managing friction. From Ploeisti, Romania to Bangalore, India and beyond, Timken operates 9 technology and engineering centers dedicated to developing solutions for customers’ toughest application problems. Market Segments Timken serve many diverse market segments, including aerospace, automotive, construction, consumer, defense, energy, industrial equipment, health, heavy industry, machine tool, positioning control, power generation and rail.
t Ventures o
CoLinx, LLC – Greenville, SC, U.S.A. (PTplace.com)
o
S.E. SETCO Service Co. – Norcross, GA, U.S.A.
o
Timken XEMC (Hunan) Bearings Co., Ltd. – Xiangtan, China
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Strategic Analysis
The Timken team will continue to transform business and create unparalleled value for customers, investors, communities and other stakeholders. They:
Applying Knowledge Using knowledge of metallurgy, friction management and mechanical power transmission to create unique solutions used in demanding applications
Differentiate Products offering a broad array of mechanical power transmission components, high-performance steel and related solutions and services
Expanding Reach Extending knowledge, products, services and channels to meet customer needs, wherever they are in the world
Perform with Excellence Delivering exceptional results with a ion for superior execution
SWOT Analysis
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Strength Custom-Made products for the buyers Sharing 80% customer with Torrington Familiar industry of both the acquirer and acquired firm Acquisition will reduce the production cost Weakness Issuing debt for acquisition will affect the leverage ratio of Timken High debt to equity ratio Higher price of Torrington’s products relative to market
Opportunity Strong brand value in the market Acquisition will set the stage for international growth International distribution network Market leadership will give the opportunity to negotiate with suppliers and sellers
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Threat Non-favorable bearing industry policy Threat of dumping by foreign producers Highly competitive market
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Ratio Analysis
Computation of Financial Ratios
1. Evaluating Internal Liquidity: Internal liquidity (solvency) ratios are intended to indicate the ability of the firm to meet future shortterm financial obligations. a. Current Ratio: Clearly the best known liquidity measure is the current ratio, which examines the relationship between current assets and current liabilities. In our analysis we have found current ratio of The Timken Company is 1.53 and of Ingersoll-Rand is 1.08 for the year 2002.This means that Timken does have liquid funds to cover their immediate needs more than Ingersoll-Rand b. Quick Ratio: the quick ratio relates current liabilities to only relatively liquid current assets (cash items and receivable). In 2002 Timken quick ratio was 0.7 and Ingersoll-rands was .46 c. NWC Ratio: This ratio measures company’s net working capital available to run its day to day activities. In 2002 Timken had NWC ratio 0.53 and Ingersoll-rand .08 d. Cash Ratio: The most conservative liquidity ratio is the cash ratio, which relates the firm’s cash and short-term marketable securities to its current liabilities. In 2002 Timken’s cash ratio was 0.13 and Ingersoll-rand’s was 0.09 which indicates lower liquidity solvency
Timken’s Liquidity Ratio
Liquidity Ratio
2001
2002
i.Current Ratio
1.29
1.53
ii.Quick Ratio
0.53
0.70
iii.NWC Ratio
0.29
0.53
iv.Cash Ratio
0.05
0.13
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Ingersoll-rand’s Liquidity Ratio
Liquidity Ratio
2001
2002
i.Current Ratio
1.24
1.08
ii.Quick Ratio
0.49
0.46
iii.NWC Ratio
0.24
0.08
iv.Cash Ratio
0.04
0.09
2. Evaluating Leverage:
The Timken Company
Leverage Ratio
2001
2001
i. D/E Ratio
0.47
0.57
ii. Debt-Asset Ratio
0.15
0.13
iii. Equity Multiplier
3.24
4.51
iv. Times Interest Earned
(1.37)
1.29
Leverage Ratio 8.00
iv. Times Interest Earned
6.00 4.00
iii. Equity Multiplier
2.00 2001
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2001
ii. DebtAsset Ratio
Ingersoll-Rand Leverage Ratio
2001
2002
i. D/E Ratio
0.74
0.60
ii. Debt-Asset Ratio
0.26
0.19
iii. Equity Multiplier
2.84
3.11
iv. Times Interest Earned
3.01
1.62
Leverage Ratio 10.00 iv. Times Interest Earned
5.00 2001
2002
3. Profitability Ratios:
The Timken Company
Profitability Ratio
2001
2002
i. Net Profit Margin
-0.02
0.02
ii. ROE
-0.05
0.06
iii. ROA
-0.02
0.01
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Profitability Ratio 0.10 0.00 2001
2002
-0.10 i. Net Profit Margin ii. ROE iii. ROA
Ingersoll-Rand
Profitability Ratio
2001
2002
i. Net Profit Margin
0.03
-0.02
ii. ROE
0.06
-0.05
iii. ROA
0.02
-0.02
Profitability Ratio 0.10 0.00 2001
2002
-0.10 i. Net Profit Margin ii. ROE iii. ROA
4. Efficiency Ratio:
The Timken Company
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Efficiency Ratio
2001
2002
i. TA Turnover
0.97
0.93
ii. Equity Turnover
0.32
0.24
Efficiency Ratio 1.50 i. TA Turnover
1.00 0.50
ii. Equity Turnover
2001
2002
Ingersoll-rand
Efficiency Ratio
2001
2002
i. TA Turnover
0.77
0.83
ii. Equity Turnover
2.20
2.57
Efficiency Ratio 3.00 i. TA Turnover
2.00 1.00
ii. Equity Turnover
2001
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2002
The total asset turnover ratio of both Timken & Ingersoll-Rand indicates the effectiveness of the firm’s use of its total asset base (net assets equal gross assets minus depreciation on fixed assets). The equity turnover ratio reflects the firm’s utilization of equity. In 2002 Ingersoll-Rand’s efficiency ratio was good which indicates, firms operating performance was efficient but Timken was not good in this particular ratio.
5. Du Pont Ratio:
The Du Pont identity breaks down Return on. This analysis enables the analyst to understand the source of superior (or inferior) return by comparison with companies in similar industries (or between industries).The Du Pont identity is less useful for industries such as investment banking, in which the underlying elements are not meaningful. Variations of the Du Pont identity have been developed for industries where the elements are weakly meaningful. The Timken Company
a. b.
DUPONT ANALYSIS
2001
2002
ROE
-0.05
0.06
-0.02
0.02
Net profit Margin Total asset
c.
Turnover
0.97
0.93
d.
Financial Leverage
3.24
4.51
-0.05
0.06
a=b*c*d
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Dupont ratio 5.00
ROE
4.00 Net profit Margin
3.00
Total asset Turnover
2.00 1.00
Financial Leverage
0.00 2001
2002
-1.00
Ingersoll-Rand
DUPONT ANALYSIS
2001
2002
ROE
0.06
-0.05
0.03
-0.02
a. b.
Net profit Margin Total asset
c.
Turnover
0.77
0.83
d.
Financial Leverage
2.84
3.11
a=b*c*d
0.06
-0.05
Dupont ratio 3.50
ROE
3.00 Net profit Margin
2.50 2.00
Total asset Turnover
1.50 1.00
Financial Leverage
0.50 0.00 -0.50
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2001
2002
6. ALTMAN Z Score Analysis: The Z-score formula for predicting bankruptcy can be used to predict the probability that a firm will go into bankruptcy within two years. Z-scores are used to predict corporate defaults and an easy-tocalculate control measure for the financial distress status of companies in academic studies. The Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company. As Zoot is a private equity firm so we have used Z score estimation for private firms. Here Z score Bankruptcy Model: Z = 0.717T1 + 0.847T2 + 3.107T3 + 0.420T4 + 0.998T5 The Timken Company
ALTMAN Z Score Timken Coefficien 2001
2002 t 2001
2002
Working Capital /Total Asset
0.29
0.53
1.2
0.35
0.63
Retained Earning /Total Asset
0.00
0.00
1.4
0.00
0.00
EBIT/Total Asset
0.01
0.04
3.3
0.05
0.13
debt
2.12
1.74
0.6
1.27
1.04
Sales/TA
0.97
0.93
1
0.97
0.93
2.64
2.73709
Book value of Equity/Book value of total
Score
Z<3
Possibility of Default
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Grey
Safe
Zone
Zone
Z<3
1.81
<3
Z>3
Ingersoll-Rand
ALTMAN Z Score Ingersoll-rand Coefficien 2001
2002 t 2001
2002
Working Capital /Total Asset
0.06
0.03
1.2
0.08
0.03
Retained Earning /Total Asset
0.00
0.00
1.4
0.00
0.00
EBIT/Total Asset
0.04
0.06
3.3
0.12
0.19
debt
1.35
1.66
0.6
0.81
1.00
Sales/TA
0.77
0.83
1
0.77
0.83
1.78
2.05244
Book value of Equity/Book value of total
Score
Z<3
Possibility of Default
Grey
Safe
Zone
Zone
1.81
Zones of Discrimination: Z' > 2.9 -“Safe” Zone 1.23 < Z' < 2.9 -“Grey” Zone Z' < 1.23 -“Distress” Zone 23 | P a g e
<3
Z>3
Z<3
Here, our calculated Z Score for Timekn is 2.75 and for Ingersoll-rand is 2.05. Both the companies are in safe zone.
Case Analysis
Problem Statement
The Timken Company is considering acquiring Torrington from Ingersoll Rand. The acquisition will cost more than $800 million (estimated minimum value for the company). Whether Timken Company should pay for this acquisition by issuing debt or share.
Possible Alternatives
1. Cash payment for the acquisition through Issuing Debt Issuing Stock Issuing 50% debt & 50% stock 2. Offering share of $100 million worth and cash payment $700 million through debt and stock
24 | P a g e
Base case of the Acquisition Parties The Timken Company WACC Risk free Rate
3.55%
Market Return
10.0%
Beta Cost of Equity
1.1 10.65%
Cost of Debt
7.23%
After Tax cost of debt
4.34%
Weight ot Debt
0.36499166
Weight of Equity
0.63500834
Total Debt
350.1
Total Market Value of Equity
609.1
Total Value(Debt+ Equity)
959.2
Income Tax
40%
WACC
8.34%
Enterprise Value
1663.80
Cash Asset value of the firm Debt Equity value of the firm
82.10 1745.90 350.10 1395.80
No of shares outstanding
63.40
Equity Value Per Share
22.02
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Ingersoll-Rand Company WACC Risk free Rate
3.55%
Market Return
10.0%
Beta Cost of Equity
1.2 11.29%
Cost of Debt
5.84%
After Tax cost of debt
3.50%
Weight ot Debt
0.375581207
Weight of Equity
0.624418793
Total Debt Total Market Value of Equity Total Value(Debt+ Equity) Income Tax
2092.10 3478.2 5570.30 40%
WACC
8.37%
Enterprise Value
9339.57
Cash
342.20
Asset value of the firm
9681.77
Debt
2092.10
Equity value of the firm
7589.67
Shares outstanding
216.85
Equity value per share
35.00
% of torrington shares outstanding
29.17
26 | P a g e
Torrington WACC Risk free Rate
3.55%
Market Return
10.0%
Beta
0.9
Cost of Equity
9.36%
Cost of Debt
5.84%
After Tax cost of debt
3.50%
Weight ot Debt
0.375581207
Weight of Equity
0.624418793
Total Debt Total Market Value of Equity Total Value(Debt+ Equity) Income Tax WACC
Enterprise Value Cash
281.39 467.8179 749.21 40% 7.16%
714.72 46.03
Asset value of the firm
760.75
Debt
281.39
Equity value of the firm
479.36
price per share Price per share after
27 | P a g e
16.44 1.64 18.08
Synergy Synergy is the combined value of the acquired and acquire firm. There are four sources of synergy 1. Revenue enhancement 2. Cost savings 3. Operating expense savings 4. Capital expenditure savings Synergy of the acquisition in three situations; a) Base b) Best & c) Worst are given below Assumptions for the base cases are: Base Case Revenue Enhancement
3.00%
Cost Savings
3.85%
Capex Savings
2.00%
Terminal Revenue Enhancement
2.00%
Terminal Cost Savings
1.50%
Discount rate for Revenue enhance
9.00%
Discount rate for cost savings Discount rate for capex savings
10.00% 8.00%
Value of the Synergy: Base Case Revenue Enhancement
1,769
Cost Saving
1,208
Operating expense savings
239
Capital expenditure saving
114
28 | P a g e
Assumptions for the best cases are: Best Case Revenue Enhancement
4.00%
Cost Savings
4.50%
Capex Savings
3.00%
Terminal Revenue Enhancement
2.50%
Terminal Cost Savings
2.00%
Discount rate for Revenue enhance
8.00%
Discount rate for cost savings
9.00%
Discount rate for capex savings
7.00%
Value of the Synergy: Best case Revenue Enhancement 2,859 Cost Saving
2,046
Operating expense savings
407
Capital expenditure saving
182
Assumptions for the worst cases are: Worst Case Revenue Enhancement
2.00%
Cost Savings
2.50%
Capex Savings
1.50%
Terminal Revenue Enhancement
1.50%
Terminal Cost Savings
1.00%
Discount rate for Revenue enhance
10.00%
Discount rate for cost savings
12.00%
Discount rate for capex savings 29 | P a g e
9.00%
Value of the Synergy: Worst case Revenue Enhancement 860 Cost Saving
735
Operating expense savings
147
Capital expenditure saving
50
Net Synergy: Sources
Best
Worst
Revenue Enhancement
1,769
2859
860
Cost of revenue savings
1,208
2046
735
Operating cost savings
239
407
147
Capex Savings
114
182
50
Total Synergy
3,330
5494
1792
Weight
0.50
0.25
0.25
Value*Weight
1,665
1374
448
Estimated Total Synergy
3,487
(-)integration cost net synergy
30 | P a g e
Base
130 3356.619152
Possible Alternatives Alternative 1: Acquisition of Torrington Company from Ingersoll-Rand by a cash deal: Timken could raise the needed amount of cash by using following financing options:
Financing Options: a) Raising $800 million for the cash deal by issuing shares to the public b) Raising $800 million for the cash deal with a debt offering c) Raising $800 million with a combination of debt and equity financing(50:50 ratio)
By using these three alternatives Timken could raise its needed amount of cash for the acquisition. In each of the cases, Timken’s capital structure will be altered. The optimal capital structure will ensure Timken with highest amount of Net Acquisition Value (NAV) and highest equity value per share.
31 | P a g e
Financing Option A: Raising $800 million for the cash deal by issuing shares to the public
A. WACC Calculation for the combined firm: Timken(after acquiring Torrington) Risk free Rate
3.55%
Market Return
10.0%
Beta Cost of Equity
10.65%
Cost of Debt
7.23%
After Tax cost of debt
4.34%
Weight of Debt
0.309
Weight of Equity
0.691
Total Debt
32 | P a g e
1.1
631.49
Total Market Value of Equity
1409.10
Total Value(Debt+ Equity)
2040.59
Income Tax Terminal Growth rate WACC
40% 3% 8.69%
Here, Timken will raise $800 million by issuing shares to the public. So they will issue 42.11 new shares at current market price which is 19 to raise $800 for the cash deal. As a result, Timken’s numbers of outstanding shares will become 105.51 (64.2+42.11).
33 | P a g e
By adding the values of Timken and Torrington we can get combined value of Timken after aquiring Torrington.
Here we get enterprise value as 2102.48 million and after adding goodwill and net synergy value we get 6086.95. Here goodwill is determined by deducting the market value of land and property of Torrington from purchase price (800-172.15=627.85).Then we have added cash value of 128.13 which is the combined cash value of Timken and Torrington. The long term debt of 631.49 million is then deducted to find out the equity value of the firm which is 5583.59. And the number of shares are given here as 105.51 million and we got equity value per share as 52.92 dollar which is quite higher than Timken’s equity value per share without acquisition.
34 | P a g e
Details
($ in millions)
Enterprise value
2102.48
Add: Goodwill
627.85
Add: net synergy
3356.62
Enterprise value with synergy
6086.95
Add: cash
128.13
Asset value of the firm
6215.08
Less: Debt
631.49
Equity value of the firm
5583.59
shares outstanding
105.51
Equity Value Per Share
52.92
Net Acquisition Value:
It is calculated by using following formula:
NAV = Value of combined firm adjusted with synergy and integration cost - (value of Timken + value of Torrington) - paid
Net Acquisition Value for the combined firm for this financing option is $3535.02 million
35 | P a g e
Financing Option B: Raising $800 million for the cash deal with a debt offering
WACC Calculation for the combined firm: Timken(after acquiring Torrington) Risk free Rate
3.55%
Market Return
12.0%
Beta Cost of Equity
13.69%
Cost of Debt
10.84%
After Tax cost of debt
6.50%
Weight of Debt
0.702
Weight of Equity
0.298
Total Debt
36 | P a g e
1.2
1431.49
Total Market Value of Equity Total Value(Debt+ Equity) Income Tax Terminal Growth rate WACC
609.10 2040.59 40% 3% 11.65%
Here, Timken will raise $800 million with a debt offering. So their total debt will increase by 800 million and will become 1431.49 million. By adding the values of Timken and Torrington we can get combined value of Timken after aquiring Torrington.
37 | P a g e
Here we get enterprise value as 1407.216 million and after adding goodwill and net synergy value we get 5391.68. Here goodwill is determined by deducting the market value of land and property of Torrington from purchase price (800-172.15=627.85).Then we have added cash value of 128.13 which is the combined cash value of Timken and Torrington. The long term debt of 1431.49 million is then deducted to find out the equity value of the firm which is 4088.328. And the number of shares are given here as 63.4 million and we got equity value per share as 64.48 dollar which is quite higher than Timken’s equity value per share without acquisition and financing option A. But in this option, Timken will be forced to borrow the money at “highyield” rates which will lead to non- investment grade rating and that is not good for the company.
38 | P a g e
Details
($ in millions)
Enterprise value
1407.216
Add: Goodwill
627.8535
Add: net synergy
3356.619
Enterprise value with synergy
5391.688
Add: cash
128.13
Asset value of the firm
5519.816
Less: Debt
1431.49
Equity value of the firm
4088.328
shares outstanding
63.4
Equity Value Per Share
64.48468
Net Acquisition Value:
NAV = Value of combined firm adjusted with synergy and integration cost - (value of Timken + value of Torrington) - paid
Net Acquisition Value for the combined firm for this financing option is $2109 million which is lower than the previous financing option. So it will not maximize Timken’s value
Financing Option C: Raising $800 million with a combination of debt and equity financing (50:50 ratio)
WACC Calculation for the combined firm: Timken(after acquiring Torrington) Risk free Rate
3.55%
Market Return
10.0%
Beta Cost of Equity
10.65%
Cost of Debt
7.69%
After Tax cost of debt
4.61%
Weight of Debt
0.505
Weight of Equity
0.495
Total Debt
39 | P a g e
1.1
1031.49
Total Market Value of Equity
1009.10
Total Value(Debt+ Equity)
2040.59
Income Tax
40%
Terminal Growth rate WACC
3% 7.60%
Here, Timken will raise $800 million with a combination of debt and equity financing where they will issue shares worth of 400 million with a debt offering of 400 million. So their total debt will increase by 400 million and will become 1031.49 million. Equity will also increase by 400 million and will become 1009.10. For raising 400 million Timken will issue new shares of 21.05 at current market price which is 19. By adding the values of Timken and Torrington we can get combined value of Timken after aquiring Torrington.
Here we get enterprise value as 2587.49 million and after adding goodwill and net synergy value we get 6571.97. Here goodwill is determined by deducting the market value of land and property of Torrington from purchase price (800-172.15=627.85).Then we have added cash value of 128.13 which is the combined cash value of Timken and Torrington. The long term debt of 1031.49 million is then deducted to find out the equity value of the firm which is 5668.607. And the number of shares are given here as 84.45 million and we got equity value per share as 67.12 dollar which is quite higher than Timken’s equity value per share without acquisition and financing option A as well as B. Details 40 | P a g e
($ in millions)
Enterprise value
2587.494
Add: Goodwill
627.8535
Add: net synergy
3356.619
Enterprise value with synergy
6571.966
Add: cash
128.13
Asset value of the firm
6700.094
Less: Debt
1031.49
Equity value of the firm
5668.607
shares outstanding
84.45263
Equity Value Per Share
67.12173
Net Acquisition Value:
NAV = Value of combined firm adjusted with synergy and integration cost - (value of Timken + value of Torrington) - paid
Net Acquisition Value for the combined firm for this financing option is $3655 million which is higher than previous financing options.
Alternative 2: Acquisition of Torrington Company from Ingersoll-Rand by stock offering to IngersollRand: Timken could acquire Torrington by offering its stocks to Ingersoll. For this purpose Timken could issue $400 million equity and $300 million debt and could make the payment of $700 million in cash. As well as it can offer its stocks worth $100 million. In our case study analysis the new shares that Torrington would get have been calculated through exchange ratio. Exchange ratio:
41 | P a g e
New shares of target firm =
α × Old shares of acquiring firm (1-α)
Exchange ratio =
New shares of target firm Old shares of target firm
Here α has been calculated by dividing the purchase price $800 million of Torrington by the after acquisition equity value of the firm with stock and cash offering of $5770.58 million. New shares exchanged for existing shares of Timken Company to Ingersoll would be $1.11805204. Total shares outstanding would be the addition of new shares with the old shares by 63.4+1.11= 64.52 shares. Exchange ratio comes from the new shares 1.11 divided by the existing shares of Torrington of 29.17. Here Torrington’s shares have been calculated assuming the accordance with the sales percentage of 13.45% of Ingersoll Company. Thus 29.17 shares have been calculated by the percentage of Torrington’s sales of Ingersoll company out of Ingersoll’s share outstanding shares of 216.85.
Assumptions for the combined firm: Timken(after
acquiring
Torrington) Terminal Growth rate
42 | P a g e
3%
WACC
7.59%
Risk free Rate
3.55%
Market Return
10.0%
Beta
1%
Cost of Debt
7.69%
Income Tax
40%
WACC Calculation for the combined firm: WACC Risk free Rate
3.55%
Market Return
10.0%
Beta
1
Cost of Equity
10.00%
Cost of Debt
7.69%
After Tax cost of debt
4.61%
Weight ot Debt
0.5060816
Weight of Equity
0.4939184
Total Debt
931.49
Total Market Value of Equity
909.10
Total Value(Debt+ Equity)
1840.59
Income Tax
40%
WACC
7.27%
Here additional $300 million debt has been added with existing $631.49 million debt. As well as new equity has been added by $400 million shares with existing equity of Timken of $609.1 million. As $100 million worth shares would be given to Ingersoll equivalent amount would be deducted from the total value of equity.
43 | P a g e
Here we get enterprise value as $2777.21 million and after adding goodwill and net synergy value we get $3356.619. Here goodwill is determined by deducting the market value of land and property of Torrington from purchase price ($800-$172.15=$627.85).Then we have added cash value of $128.13 which is the combined cash value of Timken and Torrington. The long term debt of $931.49 million is then deducted to find out the equity value of the firm which is $5770.58. And the number of shares are given here as 63.4 million plus the new shares found from equity issuing worth of ($400/19=21.05) million and we got equity value per share as $69.6596 which is quite highest than Timken’s equity value per share without acquisition and cash financing options. In this option, Timken will be able to borrow the money at “lower-yield” rates which will enable Timken to keep its existing investment grade rating and that is good for the company. Enterprise Value (+)Goodwill
627.8535
(+)net synergy
3356.619
Enterprise value with synergy
6761.683
(+)cash Asset value of the firm (-)Debt Equity value of the firm shares outstanding Equity Value Per Share
Recommendation
44 | P a g e
2777.21
128.13 6889.81 931.49 5958.32 85.53485 69.6596
At the last of our analysis we would like to recommend that Timken should acquire Torrington form Ingersoll-Rand. Positives: It will increase market share within Global Industry from 7% to 11% Will become 3rd largest producer of Bearings in the World 5 % overlap in product offerings and 80% consumer overlap Expected annual cost savings of $80 million annually by 2007
Financing method: Optimal capital structure is the combination of debt and equity. Timken should acquire Torrington by a cash deal of $700 million and the additional $100 million worth of shares will be issued directly to Ingersoll-Rand as consideration for Torrington with an exchange ratio of .038:1 where 1.12 shares will be issued as new shares. Equity value per share will be $89.44 and Net Acquisition value will be $3755 million which is the highest among all other alternatives. Cash deal of $700 million will be financed by raising equity of $400 million and a debt deal of $300 million
45 | P a g e
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