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COOPER INDUSTRIES, INC.

Tam Nguyen
Robert Ali

FIN 4930 MERGERS AND ACQUISITIONS

Professor Harvey Poniachek
Harvard Case Study #1
March 20, 2014

Table of contents
I.
II.
III.
IV.
V.

Executive Summary
The Deal
The Challenge
The Approach
Conclusion

I.

Executive Summary
Established in 1919, Cooper industries organized itself into a manufacturer of
heavy machinery and equipment. In the 1950's it specialized in producing engines and
compressors used to force natural gas through pipelines. However, this specialization
concerned management; they believed that cooper Industries now relied too heavily on
the gas and oil industries in order to thrive. Management wanted to change the cyclical
nature of their stock (due to the dependency on the oil and gas industries) to make Cooper
Industries more attractive to Wall Street investors.
To decrease its levels of volatility, cooper Industries made several acquisitions
between 1959 and 1966. Cooper Industries diversified itself by acquiring acquired a
supplier of portable industrial power tools, a manufacturer of small pumps and
compressors (primarily for oil field applications, a manufacturer of small industrial air
and process compressors, and a producer of tire changing tools (in the automotive
industry).

II.

The Deal
1. Coopers M&A Strategy
Cooper then reevaluated its acquisition strategy, and developed the following plan
for future acquisitions: Cooper decided it would only acquire a company in an industry
where Cooper could become a leader. In addition, the industry in which the target is in
must be stable. Lastly, Cooper decided it would only acquire companies that were leaders
in their respective industries. Based upon the above criteria, Cooper Industries acquired
Lufkin Rule (1967), the largest manufacturer of measuring takes and rulers. Cooper then
acquired Crescent Niagara Corporation (1969), a producer of wrenches, pliers, and
screwdrivers. Lastly, cooper Industries acquired Weller Electric Corporation (1970), a
leading supplier of soldering equipment.
2. Nicholson File Company
The following is an assessment of Nicholson File Company before any attempts
of acquisition were made:
Nicholson File Company's strengths were as follows. Nicholson's greatest
strength lied in its distribution system. Nicholson had forty-eight direct sales people,
twenty-eight file and saw engineers to market their products. These marketed products
were distributed to 2,100 wholesalers, which in turn sold to 53,000 retailers. In addition
to its distribution system, Nicholson had competitive strengths, which it gained from its
family dominated management team. It was a leader in two main product areas, and held
a 50% share of the market for files and rasps. Nicholson also had a reputation for quality
products.
Nicholson's weaknesses existed in its annual sales growth (2%) which
underperformed industry growth (6%). Its profit margins were only one third of other
hand tool manufacturers. Nicholson was trading near its lowest point in years, due to a
lack of investor interest. This lack of interest was exhibited by a poor PE ratio of 10-14.

3. If you were Mr. Cizik of Cooper Industries, Inc., would you try to gain control of
Nicholson File Company in May 1972?
Mr. Cizik should first consider the opportunities for growth from acquiring
Nicholson, and compare them to the costs associated from acquiring Nicholson. Cooper
realized that Nicholson carried an exorbitant amount of products, which decreased
manufacturing efficiency. Cooper was able to estimate that Nicholson's cost of goods sold
could be rendered from 69% of sales to 65%. It was also calculated that through the
elimination of sales and advertising expenses, selling, general, and administrative
expenses could be cut from 22% to 19%. Also, Cooper's ratio of sales made to industrial
markets and consumer markets was 1:1, while Nicholson's was 3:1. This would offset
Nicholson's sales ratio if Nicholson were to be acquired. Cooper must also consider the
assets that could be gained from Nicholson's European distribution systems, as mentioned
above; this asset is one of the primary reasons Nicholson was such an attractive target to
Cooper. Lastly, Cooper must assess the feud between VLN and H.K. Porter in order to
acquire Nicholson. While VLN permits Cooper another opportunity to acquire shares of
Nicholson, H.K. Porter still remains a threat.
However, based upon the above information, it is recommended that Mr. Cizik of
Cooper Industries attempt to gain control of Nicholson File Company in May 1972. The
long run benefits seem to outweigh the immediate costs, as Cooper will gain a
distribution system that is sorely needed to expand and diversify Cooper. Cooper will also
gain a new line of high quality products. Both these benefits are rooted in Cooper's desire
to become diversified and further Cooper's objectives of obtaining its long term goals.
III.

The Challenge
1. The Threat of H.K Porter Company
In addition to Cooper, H.K. Porter, a conglomerate of electrical equipment, tools,
nonferrous metals, and rubber products, was also interested in acquiring Nicholson. H.K.
Porter had acquired 44,000 shares of Nicholson stock in 1967. On March 3, 1972, H.K.
Porter made a tender offer to Nicholson's management for 437,000 of Nicholson's
584,000 outstanding shares at $42 per share in cash. H.K. Porter did not intend to acquire
fewer shares than that would establish a majority.
2. Terms with VLN Corporation
On April 3, Nicholson came to an agreement to merge with VLN Corporation.
VLN was a company with diverse interests in publishing and original and replacement
automotive equipment. The terms of the merger between VLN and Nicholson stated that
one share of VLN cumulative convertible preferred stock would be exchanged for each
share of Nicholson common stock. VLN preferred stock would pay an annual dividend of
$1.60 and could be converted to five shares of VLN common stock with in the first year
of the merger. Nicholson management stated that the exchange would be a tax-free
transaction, that the $1.60 preferred dividend would equal the current rate on Nicholson
stock, and a preferred share was worth a minimum of $53.10.

3. What are the concerns and what is the bargaining position of each group of
Nicholson stockholders? What must Cooper offer each group in order to acquire
its shares?
H.K. Porter's offered, on March 3, 1972, to tender 437,000 of 584,000 shares of
Nicholson at $42 per share in cash. This was a $12 premium to Nicholson stock's most
recent price. In order to merge with Nicholson, Cooper must give its convertible
securities in a tax free exchange worth at least $50 for each share of Nicholson to H.K.
Porter. It is only under those circumstances that H.K. Porter would allow a merger
between Cooper and Nicholson.
The terms for the merger between VLN and Nicholson state that one share of
VLN convertible preferred stock will be exchanged for each share of Nicholson common
stock. Under this agreement, VLN preferred stock would pay an annual dividend of
$1.60. This dividend would be convertible into five shares of VLN common stock with in
the first year after the merger; this scaled down to four shares after the fourth year after
the merger. It is also important to note that VLN would not interfere with Nicholson
management, as part of the merger terms.
After VLN and Nicholson decided to merge, H.K. Porter retaliated by informing
stockholders that VLN common stock had recently been sold at $4.62 per share. This put
the value of the VLN preferred at $23.12. VLN had not paid any common dividends since
1970, therefore converting preferred VLN stock to common stock would result in a
severe income loss for stockholders. Cooper will need to consider this information before
proceeding with a merger with Nicholson.
IV.

The Approach
1. Maximum Price Offer:
Even though the situation between H.K.Porter and VLN provided Cooper
Industries a great opportunity to acquire Nicholson, it is important to consider the price
range Cooper might pay that was appropriate with the synergistic value of the acquisition.
This premium was estimated based on the future performance of Nicholson after the
merger.
The financial data of Cooper and Nicholson had been used to evaluate the firm
and also determine its value of each share of stock. For the Income Statement, we used
the data for the year of 1967 to 1971. However, we only used the Balance Sheet for the
year 1971. (See Exhibit 4 and 5 for the financial summary of Nicholson.) In the
discounted cash flow analysis, we used the industry growth of 6% for Nicholson. Thank
to these merger, Nicholson would be able to reduce the cost of goods sold from 69% of
sales to 65% and also lower their selling, general, and administrative expenses from 22%
of sales to 19%. We assumed that the interest income would be constant since no new
loan has been made. Moreover, we also kept the depreciation and capital expenditure

constant at 2.1 and estimated the increase in net working capital at 44% of increase in
sales. Finally, we used the taxes rate of 40%.
In the discounted cash flow analysis, while we used the interest income and longterm debt to calculate the cost of debt, we used the dividend growth model (DDM) to
measure the cost of equity. (Exhibit 7, 8, and 9 shows the calculation of WACC through
Nicholsons cost of debt and cost of equity) We then applied the cost of capital of 9.16%
and the growth of 2% to find the terminal value of 81.6 at the end of fifth year. Overall,
we were able to estimate the cash flow of Nicholson as on year end 1971 of 65.3 and the
value per share of 91.2. This means that Cooper should pay less than $65.3 million to
Nicholson. Otherwise, Coopers shareholders will lose. (See Exhibit 11 for the estimation
of value of share outstanding by using DCF)
2. Other Scenario: Acquire at least 80% of the outstanding shares of Nicholson and
to make the same offer to all stockholders
In order to acquire at least 80% percent of the outstanding Nicholson stock,
Cooper must offer a price that satisfies the Porter as well as Nicholsons management.
Before, Mr. Evans of Porter also agreed to support Cooper-Nicholson merger only if he
will receive Cooper common or convertible securities in a tax-free exchange worth at
least $50 for each Nicholson share he held. Hence, we would set the floor price is $50.
(Exhibit 12 provided the EPS for several price that Cooper may offer to buy Nicholsons
shares)

V.

Conclusion
Based on our valuation, the estimated value of each share of Nicholson would be
$91.2, which obviously higher than the price of $50 that Porter wants. Moreover, when
considering synergistic effect of the merger, we see that both Cooper and Nicholson
would receive great financial benefits. For Cooper, it will create a stable source of cash
flow that offset the risk of other Coopers business. For Nicholson, it can rely on
Coopers current strength to reduce cost significantly and expand its market shares.
Overall, it is reasonable for Cooper to get merge with Nicholson