Applied Valuation - Pinkerton

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.

[pic 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.

[pic 2]

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).