1. Background to the Acquisition
This proposed acquisition is between two firms, Congoleum Corporation (Abridged) and Prudential Insurance Company of America where by Congoleum is the targeted company and Prudential the acquiring one. The negotiations of the acquisition shall be handled by First Boston and Century Capital Corporation whereby the former is the lead negotiator while the latter shall one of the prospective equity participants. Congoleum is a highly diversified company with three products market segment; home furnishings, ship building and automotive and industrial distribution. The firm has an asset and revenue base of $323million and $576million respectively. In the 1978 financial year, the firm made a profit of $42million.
Congoleum’s impressive performance can be traced back acquisitions over the past years, a diversified investment portfolio, internal reorganization and finally superior products. Prudential on the other hand is the largest institutional investor in America with assets worth over $21billion and an annual cash flow of $6billion. The firm has interests in over 1,400 companies spanning all the major industries in the country. Prudential’s growth strategy can be traced back to the fact that most of its investments are high-risk in nature which implies that the return is magnanimous and that over 60% of its investors are investment banks with technical know-how of the operations of the financial markets.
2. Financial Analysis: Strengths and Weaknesses
Financial analysis of Congoleum’s fiscal records for the past five years reveals the following. From the analysis, it is clear that the firm’s strength lies in the home furnishings segment. In fact as earlier mentioned Congoleum is amongst the fourth largest of resilient flooring in America. To this effect, Congoleum’s earnings from its home furnishing segment has been on a steady increase for the past five years i.e. the figure has risen from $143million in 1974 to $225million in the year 1975. In addition to this, compared to the three segments, the assets of the home furnishing segment has been on a steady rise for the past five years.
On the other hand, Congoleum’s weakness lies in the ship-building segment. Specifically, the firm had a backlog of $445million by the close of the 1978 financial year a figure that was expected to increase to $453million despite the fact that BIW plans to meet $225million of its outstanding backlog. Finally, financial analysis has also revealed that of the three business segments, BIW has the least asset base which stood at $59million by the close of 1978 and operating costs that were spiralling out of control at an alarming rate; the increased exponentially from $1million in 1975 to 19million in 1978 which represents a period of three years. Prudential’s strength and weakness can be pin pointed to one factor; the insurance company is more risk oriented than its competitors. This implies that the firm’s returns are always worth the risk when everything goes according to plan and also Prudential’s losses are similarly colossal in case of breakdown of the financial situation a case that was experienced in the 1930s during the Great depression.
3. Reasons for the Acquisition
In this merger and consequent acquisition if the two parties reach an agreement, Congoleum is the target firm while Prudential is the acquiring firm. The acquiring firm is interested in the target firm for the following reasons. To begin with as earlier mentioned in this brief, Congoleum has a very diverse business portfolio that includes home furnishing, shipbuilding and automotive accessories. This is in line with Prudential’s investment portfolio that spans all the major industries and major corporations in the world. So basically, it is clear that Congoleum is the perfect entity for Prudential to invest given its highly diversified investment portfolio. Congoleum on the other hand is interested in this buy out by Prudential for one single reason; the directors of the firm have obligations to get their shareholders the best deal possible and these seems to be one of them. In addition, the firm needs the capital injection that shall come with acquisition given the fact that most of its long term debts are due in the next five years.
4. Financial Package
Initially, the idea was for private and institutional investors affiliated to purchase share owned by Congoleum at $38 per share. However, the final deal involved a combination of cash and stock returns. This merger cannot be termed as being a stock swap because Congoleum is being completely swallowed up by Prudential. Basically the proposal under consideration constitutes of a two-step merger and sale exercise which involves the formation of a holding company to initiate the process. Basically, Prudential and the investment banker which in our case is First Boston proposed that the stocks of BIW would be bought by the formed holding company at price of $92.3million. This would then be followed by BIW being merged into Prudential.
The second phase of the acquisition shall involve the purchase of the remaining assets of Congoleum whose estimated value is $371.3million (this figure is inclusive of the net excess cash that Congoleum currently has and the brand name Congoleum). Finally, the old firm, Congoleum Corporation (Abridged), would be obligated to settle all its outstanding liabilities and pay out a liquidating dividend of $38 per share to its shareholders and investors. From this deal, it is clear that the merged corporation will relation the brand name Congoleum Corporation and will be listed as a privately owned firm on the stock exchange. In addition to this, the merger shall also involve First Boston, Century Capital and the management of the newly formed corporation to purchase common stocks of the firm. This is in fact usually the case in most LBOs of this nature. The other forms of compensation that have been proposed to seal the deal in addition common stock returns include consulting fees, stock options and remuneration packages as a result of contractual agreement. This is the reason why from the beginning it was clear that this merger is a combination of cash and stock purchase. Though, it clear that stocks shall play a more crucial role compared the cash option. The cash option basically involves purchase of the brand name and assets affiliated to the original Congoleum.
5. Analysis: Pre-merger and Post-merger
Basically, analysis of pre-merger financial records of Congoleum have revealed the that despite the fact that Congoleum has a relatively high revenue base, its operating costs are also relatively high henceforth effectively eating into the corporation’s profit margins. Specifically, the old Congoleum operations have been weighed my many other factor in addition to the taxation burden. Some of these factors include contract backlogs in its shipbuilding segment, corporate expenses, depreciation and amortization, maturation of most long term and short term debts, patent and licensing agreements and other inventory expenses to mention but a few. By the end of the 1979 financial year, inventories were expected to amount to $83.633million, contract backlogs at $73.5million and finally, patents and patent licensing agreements at $174million.Therefore, it can safely be concluded that Congoleum has a low return on investment margin.
Post-merger analysis reveals that the financial position of Congoleum is going to improve in the 1979 financial year. This is the case because following the acquisition of Congoleum by Prudential, the investment world will be abuzz and hence this shall catapult the corporation’s profits to $49.7million which a significant improvement from the profits experienced in the 1978 financial year. However, in the 1980 financial year, Congoleum shall encounter a decrease in its profit margins as the new firm tries to create its course in the murky waters of the investment world. The projected profits for the next five financial years post the merger are $14.97million, $26.10million, $40.77million, $50.46million and finally $55.85million for the financial years 1980, 1981, 1982, 1983 and 1984 respectively.
However, it must be mentioned that most of the financial problems that were experienced by the old firm shall spill over into the new Congoleum. This is evident in the fact that most operating costs shall increase within the next five financial years. For instance, with the LBO, depreciation and amortization is projected to $35.51million, $36.26million, $37.07million, $37.95 and finally $21.23million for the financial years 1980, 1981, 1982, 1983 and 1984 respectively. On the other hand, in case the LBO fails to go through this figure would be $7.5million, $8.3million, $9.0million, $9.9million and finally $10.9million over the same period between 1980 and 1984. Prudential on the other hand has cash flow of $6billion, a diversified investment portfolio and investors who understand the business of risk taking and henceforth is less likely to be affected by any significant changes within the investment world.
6. Value of the New Congoleum
Assuming that the asset base for the new Congoleum shall be the same with that of the old one, the new firm shall be valued as stipulated below. In the in 1984 financial year, it expected that the value of Congoleum shall be as follows; the new firm shall have a total revenue base of $937.8million, a net operating income of $166.1million and profit margins of $50.46million. Compared to the $576million revenue base and profits of $42million that was experienced in the 1978 financial year, it can be safely concluded that to some extent the merger added value to Congoleum. The ship building segment will be most affected by this merger; this is specifically so because it is projected that the total revenues earned by the segment are bound to increase from $158million to $345.4million within the six year period. All these shall be at a minimal increase in operational costs from $19million to $47.7million compared to the home furnishing segment that shall yield revenues of $370.4million out of an operating income of $94.7million. The market value of the new firm can easily be deduced by calculating the market price per share as indicated in the formula below.
Market Price per Share = Net Income - Preferred Dividends/Number of Shares of Common Shares Outstanding = = $14.73 (which is the intrinsic value of the firm per share)
Financing the acquisition of Congoleum by Prudential is to a large extent a combination of debt and equity options. For Prudential to comfortable fund the acquisition, the firm must consider both two options because a combination of the two is not only the most viable but also presents the least liabilities the company. Below is a brief break down of how the merger can be financed as indicated in table one. An overview of the table indicates that a huge proportion of the funding for the proposed acquisition shall be debt incurred by Prudential from the market. These sources of funding include direct bank borrowings and indirect borrowing from insurance companies as indicated below. In addition to the debt accrued, the deal shall finance by the available equity options which includes liquidating common and preferred stocks. This equity option shall be complimented by some of the stocks belonging to the new firm being bought by Congoleum management, First Boston and Century Capital.
Being an insurance company, it is thus clear that Prudential is a position to meet this debt. This is because of the company’s annual cash flow that is estimated to be around $6billion and the fact that the firm has a very diverse investment portfolio in over 1,400 companies in all the major sectors of the economy of which Congoleum is one. Given the expected increase in revenues over the next years, the new Congoleum is well placed not only to repay old debts but also new ones that shall accrue from financing the merger and consequent operation costs.
Table 1: Sources of Acquisition Funding
Source of Financing
11% senior notes, principal amount $115,000,000 due in 1995
12% subordinated notes, principal amount $92,000,000 due in 2000
($11.00) cumulative preferred stock ($322,000 shares)
First Boston and Century Capital
8. Qualitative Analysis
Qualitative analysis of the acquisition shall be limited to FRITCO and SWOT analyses. As earlier mentioned, funds to finance the acquisition shall be from the debt and equity markets as outlined above. The biggest challenge to funding the deal in the aforementioned ways is the fact that this consequently increases the firm’s liability as far as the debt situation in concerned. This is especially risky position given that most of Congoleum’s long term and short term debts are due in the next six years. Basically, this implies that the new firm’s debt level is extremely high given that the obligations to most of its creditors must be met with the next decade. This renders the debt situation inflexible and shall restrict Congoleum from acquiring new debt in the future.
On the other hand, Congoleum’s investment portfolio is less risk oriented which therefore implies that the company can easily meet its debt obligation. This is the case because the firm’s invest portfolio is pretty solid and not subject to market fluctuations. As far as income is concerned, it is clear that the preferred financing options in this acquisition shall eventually result to increased operational income which shall eat into return equity and have negative impacts on earnings per share. Further, issuing equity shall not have any effect on the control of the company because the company is privately owned and henceforth most of the shareholding agreements have already been reached at. The timing of the deal is perfect given that the stock market is stable at the moment, and the stock prices are affordable.
Given that the entire management of the new Congoleum are shareholders and most of the investors are major players in the financial industry, the management and investors are familiar with the dynamics of the debt situation and shall do everything possible to capitalize on it. Strength of this proposal is that Congoleum can now access more funds to meets its operational expenses and debt obligations. This proposal also give the firm especially BIW segment to not only meet its backlogs contractual obligations but also to be in a position to woe new clients. On the other hand, the one weakness that evident in the proposition is the fact the deal does not come with increased market access.
9. Summary and Conclusions
In this proposal, both companies i.e. Prudential and Congoleum will eventually emerge winners. Prudential being the acquiring firm stands to gain the most from the deal because Congoleum growth rate is 22.5% per annum and henceforth if the firm reduces most of the operating expenses and debts that were carried over from the old Congoleum then it stands to start earning a high ROI in five years. Congoleum on the other hand emerged a winner because not only were the shareholder remunerated appropriately but also the fact that the firm has the opportunity to rebrand and be better placed to compete with other companies in the industry.
10. Public Policy
This acquisition will have the most minimal negative impact on the general public. This is the case because both the two merging entities are privately owned and therefore represent the interest of private entities rather than taxpayers’ money. This is especially important in the eventuality that the newly company hits a rough patch and makes losses. In addition, the acquisition does not give the merging entities dominance power. Therefore it is clear that this acquisition shall not result to a monopoly that shall consequently kill competition within the realm of operation of the two firms. In fact the merger will make it easier for the general public specifically the category that had backlog contractual agreements with the old Congoleum. The only foreseeable negative impact is increase in the prices of the firm’s products as the company tries to meet obligations to its shareholders and creditors.
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