Acquisition Strategy for Cooper Industries’ Planned Acquisition of the Nicholson File

ACF Partners

Case Report

Subject: Acquisition strategy for Cooper Industries’ planned acquisition of the Nicholson File

Problem

Being a leading manufacturer in the heavy machinery and affiliated equipment space, Cooper Industries Inc. is considering putting forward an offer to acquire the Nicholson File Company. The purpose for its potential bid is to further diversify its business model from the cyclic-nature of heavy machinery sales, to the more predictable and stable nature of the hand-tool industry. Cooper failed in its takeover attempt of Nicholson three years ago, but now faces a unique opportunity to come in and acquire a majority stake amidst the company opening itself up to prospective offers. It is now the decision of Cooper management on whether they should proceed ahead and acquire Nicholson, and if so, at what price and through which means.

Options

The company currently owns 29,000 shares of Nicholson stock, a result of it trying to accumulate as many shares up in the open market to bolster its position & interest in the company. Porter Company, once a competing bidder, has indicated its willingness to tender its 177,000 Nicholson shares to Cooper Industries at a price/share no lower than $50. Nicholson Company currently has 584,000 shares outstanding. As such, to acquire a majority stake, Cooper would need to tender an additional 263,000 shares – 177,000 from Porter, and 86,000 from other stockholders. Thus, to facilitate the potential acquisition, Cooper faces four options:

1. Use cash to purchase the remaining shares to constitute majority
2. Raise debt capital to purchase the required shares to constitute majority
3. Raise equity capital to purchase the required shares to constitute majority
4. Raise both a mix of debt & equity capital to purchase the required shares to constitute majority

Recommendation

It is the recommendation of ACF Partners for Cooper Industries to purchase the necessary 263,000 shares of Nicholson File Company through the issuance of 547,916.667 new Cooper shares at Cooper’s previously closing price of $24. Cooper should then engage in a 2 for 1 Cooper for Nicholson share-swap to facilitate the acquisition.

Company Overview

Cooper Industries Inc. was founded in 1919 as a manufacturer of heavy machinery and equipment. This core business is heavily dependent on sales to the oil and gas industries, which is highly sensitive to general economic conditions. In order to lessen their exposure to cyclical changes in the market, Cooper has acquired several companies both related and unrelated to their core business. In 1972, the Cooper management are faced with the opportunity of acquiring Nicholson File Company, a company they have been lusting for the last couple of years. In the beginning stages of its corporate history, Cooper started operating as a manufacturer of heavy machinery and equipment in 1919. The company kept growing, and by mid-1950s they managed to become a leading producer of engines and massive compressors, designed to force natural gas and oil through pipelines out of wells. This lead to an increased dependency of sales within the oil and gas industry, an industry characterized by great cyclical fluctuations. To reduce the exposure to demand changes, especially in the oil and gas market, the management decided to acquire several companies to broaden Cooper’s potential markets.

Through 1959 to 1966, Cooper therefore acquired four companies. One company was partially related to their current area of business, a maker of small pumps and compressors for oil field applications. The three other companies were conglomerate acquisitions, a manufacturer of small industrial air and process compressor, a supplier of portable industrial power tools, and a producer of tire-changing tools for the automotive market, where the last two both are hand tools businesses. In 1966. Cooper’s acquisition strategy was reviewed, and three criterias were established for all future acquisitions. First, the target firm should be operating in an industry in which Cooper could become a major factor. This was also in line with Cooper’s management’s goal of leadership within a few distinct areas of business. Secondly, the chosen industry should be fairly stable without to much dependence on a few single customers or several large sales per year. Thirdly, the target firm should be a leading company in its respective market segments. This new strategy was implemented with the acquisition of Lufkin Rule Company in 1967.

After a revision of the company’s acquisition strategy, Cooper acquired Lufkin Rule Company in 1967. Lufkin was the world’s largest manufacturer of measuring tapes and rules. They had a high quality product line, and complimented Cooper’s current selection of hand tools. Further, the acquisition provided Cooper with a larger, established, distribution system of retail hardware stores throughout the US, Canada, and Mexico.

Nicholson File Company

Cooper had a solid amount of interest in this company primarily due to the firm’s current troubling operational state. Nicholson was a family-owned market leader in two primary product groups: files & rasps and hand saws, the combined market value of both markets was $250 million, with Nicholson having 50% and 9% market share positions, respectively. One of its key attributes was its vast distribution network, spanning across Canada, US, Mexico, and Europe. The company – being a manufacturer – also uniquely prioritized its sales force to augment sales & develop relationships with leading wholesalers & retailers, having 140 local sales representatives across 137 countries. Armed with such promising tangible & intangible assets, the company was not living up to its full potential. Its annual sales growth hovered over the 2% level relative to an industry YOY growth rate of 6%. Further, on a comparable basis, its profit margins were reportedly 2/3 of comparable companies’. This sluggish operational performance was reflected in the company’s lower PE ratio, which orbited around 10x-14x relative to comparable companies trading at 14x-17x, reflective of negative investor sentiment for the stock. Nonetheless, Cooper Industries was confident that a tuck-in acquisition would enable for Nicholson to realize the 6% yearly industry growth rate. Nicholson most recently closed at a share price of $44, less than its book value of $51.25. Cooper Industries had good reason to believe that cost synergies in COGS and SG&A would allow for Nicholson to escalate to a market value that surmounted its reported book value per share.