Question

Bentley Industrial Services Management wants to acquire Lerner Industrial Services Management Corporation. Lerner is willing to be acquired at a minimum price of $121 million and nothing less. However, two of Bentley’s major shareholders are not in favor of this acquisition. Lerner had no scientific basis for asking for a minimum of $121 million.

Industry Structure

The industry is about $120 billion in Industrial facility services management including engineering energy needs that include heating, ventilation, and air conditioning. The industry is very competitive with a few large companies offering integrated services, and many small ones offering specific single and limited services. There is a great opportunity for large companies to offer integrated solutions for “one stop shopping.” Large firms may have an advantage in that they can get premium pricing from integrated services and can get economies of scale. Companies in this industry may be able to distinguish themselves through branding and diversifying their offerings in targeted industries.

The industry had experienced steady growth over the last decade and the industry demand is expected to grow at 5% per year in 2015 and 2016, whereas small companies with limited offerings, or single service offerings is expected to grow at 3% per year.

Lerner Industrial Services

Lerner is a large industrial services company with specialization in integrated services solutions for a wide range of companies. It grew from a small single service company to a large integrated company within 30 years. Its specialization includes strong technical expertise in engineering and management services with solutions targeted to the Fortune 500 bio tech companies, large hospitals, and pharmaceutical companies. The company is highly respected and known for its high quality of services which is an advantage that can make Lerner charge premium prices. Despite this pricing strategy, the company had experienced declining operating profit margins, increase operating expenses, from 4% in 2012 to about 1% in 2015, and declining cash balance on its balance sheet.

Bentley Industrial Services

Bentley Industrial facility services Management Company is not as large as Lerner, and its service offerings are limited. The company service offerings including heating, ventilation and air conditioning services, as well as maintenance of buildings. The company wanted to expand its services, and to become a fully integrated company which can offer services such as building engineering and energy solutions. Unfortunately, the company lacks the expertise in this area. Bentley thinks that if it owns Lerner, it will have the advantage it lacks, and Bentley then will be able to increase its customer base, and diversify its services to many other industry sectors. Bentley is well known company for its operational efficiency as well. Bentley believes it can improve Lerner’s financials by replacing its management, and cutting expenses.

Bentley was convinced that the acquisition of Lerner will be good for its shareholders and the company as Bentley can cut costs when it combines the two companies and implement a premium pricing strategy.   Bentley expects Lerner revenues to grow 5% per year from 2016 to 2020, and thereafter, 4% per year into the future. Bentley did some forecasting and created the financial projections for Lerner (see Lerner’s financials)

The news of the acquisition was publicly known, and the stock market had mixed results. The financial investment firms were concerned about whether Bentley could manage Lerner efficiently and can achieve the reduction of expenses and other financial success. Some of the shareholders and Board members also were concerned. Nevertheless, Bentley convinced an investment company to provide the financing for the purchase of Lerner and decided to put together the financial information herein.

Lerner will have an acquisition debt ratio of 55% with a tax rate of 30%. The beta of Lerner is 1.5.     

1. Do you think that Bentley should acquire Lerner? Why?
2. Should Bentley pay $121 million for Lerner? Can the company justify this price?
3. What is the worst and best case value scenario for Bentley based on your analysis of the financial forecast and analysis of the merger?

Answer 1

Bentley expects Lerner revenues to grow 5% per year from 2016 to 2020, and thereafter, 4% per year into the future.

WACC Calculation:

Cost of equity=RFR+(Beta*Mkt. Risk premium)

ie.2.60%+(1.5*6.1%)=

11.75%

After-tax cost of bonds=4.43%*(1-30%)=

3.10%

Debt ratio=Total liabilities/Total assets=55%--55/100

ie. Equity=100-55=45%

So, WACC=(55%*3.10%)+(45%*11.75%)=

6.99%

Bentley's estimates	Fig.in mlns.
Year	2016	2017	2018	2019	2020
Sales	363.09	381.24	400.31	420.32	441.34
Less: COGs(Sales*90%)	326.78	343.12	360.28	378.29	397.20
Gross profit	36.31	38.12	40.03	42.03	44.13
Opg. Exp.(Sales*8%)	29.05	30.50	32.02	33.63	35.31
Depn.	2.00	2.30	2.80	3.10	3.20
Opg. Profit	5.26	5.32	5.21	5.31	5.63
Int. exp.	0.20	0.20	0.30	0.40	0.50
Income taxes	1.40	1.60	1.80	1.70	1.80
Net income	3.66	3.52	3.11	3.21	3.33
Add Back: depn.	2.00	2.30	2.80	3.10	3.20
Opg. Cash flow	5.66	5.82	5.91	6.31	6.53
Less:Chg. In NWC	1.4	0	0.1	0.1	0.1
Less: CAPEX	3.6	0.1	0.4	0.2	0.2
FCF	0.66	5.72	5.41	6.01	6.23
Add;PV at end 2020 of Future FCFs
(6.23*1.04)/(6.99%-4%)=					216.6957
Total	0.66	5.72	5.41	6.01	222.92
PV F at 6.99%(1/1.0699^Yr.n)	0.93467	0.87360	0.81653	0.76318	0.71332
PV at 6.99%	0.61856	5.00128	4.41425	4.58400	159.01489
NPV=	173.633	Millions

Alternate scenario:-- 5% constant growth
Given that industry demand is expected to grow at 5% per year in 2015 and 2016
Taking from Lerner's actuals , assuming 5% constant growth
FCF 2016(frm above , to include Chg. In NWC & capex.)=	0.66
So, PV of 5%(constant growth ) =	0.66/(6.99%-5%)=
	33.1658

So, in the worst case scenario, Lerner is woth 33. 17 million

in the best case scenario Lerner is worth 173.63 millions

Average working out to (173.63+33.17)/12= $ 103. 4 milions (with 50% probability)

Hence $ 121 million is a high price quoted by Lerner

Bentley NOT RECOMMENDED to BUY Lerner