APPLIED VALUATION |

Case: Pinkerton (A)
Copyright © 2010 by Harvard Business School

Mr. Wathen, the exclusive owner of California Plant Protection (CPP) has the opportunity, and most of all desire, to acquire one of the most recognizable brand names in the security guard industry, Pinkerton, for $100 million. Throughout the bidding process, he has faced skepticism from his board of directors as they consider the purchase to result in a overload for CPP’s corporate management. Can Mr. Wathen convince his board of directors that Pinkerton is worth the $100 million? If yes, how should Mr. Wathen finance the acquisition? Is he in any danger of being outbid by other players? We value Pinkerton under American Brands to $73.25 million, using a P/E multiple (Wackenhut) of 12.2 times Pinkerton’s NOPLAT in 1988 of $5.98 million. For Wathen however, including the possibility of any synergies created by a potential takeover, we reach a final value of $187.06 million, where synergy effects value is estimated to $19.4 million. However, in a pessimistic scenario the value of Pinkerton would be $141.51 million without any synergy effects. Taking the assumption of a 50/50 probability of either of the two scenarios might occur (in lack of better information); we reach an estimated value of $166.28 million. We recommend that Wathen bid the $100 million, by raising $75 million debt and $25 million equity. Wathen (CPP) should bid on Pinkerton, as our estimated value of a merger exceeds the cost. However, Wathen has insufficient solvency to finance the entire bid with debt, and should thus choose the other option with 75% debt financing. An overview of the valuation, when using the $75 million debt to finance the bid can be seen in exhibit 1.

By estimating Pinkerton’s future cash flow, we have taken the task force prediction and estimation into account when calculating Pinkerton’s enterprise value through the enterprise DCF model. From the estimation provided by the task force, we have reached two estimated values in the two scenarios as can be illustrated in exhibit 2. The appropriate discount factor is derived from the benchmark of company Wackenhut where we calculated the necessary WACC. The WACC is weighted with the merged firm’s market value of equity and its combined debt, including the necessary debt for the acquisition. The risk premium used in the calculation of the cost of equity is based on S&P’s 500 index development from 1928 – 1987 and its corresponding long term T-Bills.

Furthermore, with the potential benefits the acquisition brings, CPP can consolidate into a bigger firm and thus, enjoy larger market power. In addition, through Pinkerton’s recognizable brand CPP would be able to implement a new pricing strategy, even though this puts pressure on corporate management to communicate this strategy to the market. Regarding the finance required to purchase Pinkerton, we can conclude that raising $25 million in equity and $75 million in debt, is Wathen’s best alternative. Based on the cumulative cash flow available to the merged firm, it cannot service a $100 million debt at 13.5% interest rate if the pessimistic scenario occurs (exhibit 3).

However, financing the purchase through $75 million debt (at 11.5% interest rate) and $25 million equity will prove to be beneficial in either of two scenarios the task force has projected for the first 5 years. Although the cumulative cash flow is negative in the last year (see exhibit 4) in both scenarios, Wathen has only expressed concern for CPP’s debt service ability over the initial 5 years. Thus, we assume CPP will somehow be able to repay the debt. This gives a debt ratio of 1.6 in optimistic case and 2.8 in pessimistic case (using market value of equity).

The proposed terms of the raised 25% in equity by the investment firm is debatable. While the investment firm receives 45% of the equity issued, we assume that the firm will work as an underwriter where they perform a mix between so called ”firm commitment and best effort offering”. In our case, the investment bank receives 45% of the new equity issued, while the remaining 55% will be attempted to be sold in the market. Given our assumption, a non-public company such as CPP might experience a more in-liquid market in terms of OTC trading of their new equity issued. Therefore, we conclude that the terms of agreement regarding the equity is fair for both CPP and the investment bank. The estimated value of Pinkerton is $72.25 million under American Brands. This value differs from what Pinkerton is worth to Wathen. The difference comes to $113.82 million, which is the value of the synergy effect, Wathen’s proposed change of strategy and change in cost structure. In order to give a realistic estimate of what other buyers could bid for Pinkerton, some assumptions has to be made. Consider two potential buyers. Buyer A benefits from synergy effects by acquiring Pinkerton, while buyer B does not. We know there was another bid on Pinkerton, but like Wathen’s bid on $85 million, this was also rejected, hence, the bid was not $100 million. From this we deduct three possible scenarios. Either the bidder does not benefit as much Wathen would, the bidder does not have the financial stability to cover the expenses this price entails or they have calculated a different valuation. If buyer A made this offer, this train of thought indicates that the benefits of the synergy effects is less than that of CPP and thus we could say that they are, in some sense, unique to Wathen. If buyer B made this offer the price is most likely to high, since he gets no benefit from synergy effects and thus the bid would be in the low end of the price range. If we assume that another buyer valued Pinkerton to $85 million, we get a range of plausible bids. In conclusion, other buyers may bid $85 million < bid > $100 million.