Question

Look at the following Balance Sheet and financial information for Flexics Inc. Flexics, Inc. is a leading producer of plasma technology display devices in the USA. One of the company's latest innovations is a patented process that permits the rapid production of customized semiconductor wafers using plasma-based etching technology instead of quartz plates. Flexics, based in Seattle, started business in 1987 and now has production facilities in Vancouver and a research affiliate in Princeton, New Jersey.
In late-1998 Alex Pereira, the founder and CEO of Flexics, was considering options for realization of the value of his shareholding in Flexics. Pereira was seeking a method that would offer greater
FIN 7900, Mergers and Acquisitions – Problem Set Page 2
liquidity and diversification of his and his family's investment in the company. One option was to
talk to investment bankers about an initial public offering (IPO). This would allow him to sell
some or all of his shares in the market. But he was unhappy about the IPO market in the industry,
which was weaker than in 1997 when bankers had talked about an IPO price in the $40-45 range.
In the past year, public offerings of similar technology companies had brought price/earnings ratios
of about 15. A recent private placement of Flexics shares with a venture capital investor had been
done at an effective price of $24 per share. Another possibility was to sell his shares to Photronics,
which was rumored to be interested in buying a stake in Flexics. Among the other options he was
considering was a leveraged buy-out by management. Pereira liked the idea of giving key officers
a greater stake and control, but he wanted to get a good price for his shares. He was willing to
receive payment partly in cash, and partly in the form of a $30 million, 15% pre-payable
subordinated note.
Management had discussed the LBO possibility with Seattle Partners, a venture capital firm that
was familiar with Flexics. The firm's advisors had calculated that of the minimum amount of $216
million needed for the LBO, $20 million would have to come from management, as much as $120
million could be raised through a senior debt issuance led by Bank of America (BofA), and the
remainder from a private equity group led by Seattle Partners. B of A indicated the rate would be
12% and that lenders would need a Net Operating Income/Interest Expense ratio of at least 2x. At
this time 35% of the 9 million shares outstanding were held by the founder and his family, and the
remainder was held by venture capital and private equity groups. Net operating income was $30
million. Other key indicators are listed above.
Balance sheet
Cash
Other current assets
Long term assets, net
Total assets
Noninterest bearing short term debt
Short term debt (10%)
Senior long-term debt
Subordinated debt
Equity
Total Liabilities & Equity
($ millions)
50
100
120
270
60
10
0
0
200
270
Interest Coverage
Net Operating Income
Interest Expense
- Short term debt
- Senior long term debt
- Subordinated debt
Total
NOI/Interest expense
Effective tax rate
Depreciation
30
1
0
0
1
30
30%
$20 million
FIN 7900, Mergers and Acquisitions – Problem Set Page 3
Flexics shares were expected to be (based on information of similar companies) trading at a P/E
of 10.6 on earnings of $2.26 per share. Based on past performance the company was expected to
generate free cash flows of $2.57 per share next year, an increase of 3.6% from the current level
of $2.48. The Treasury bond yield was 4.5%, the company’s beta, based on comparable companies,
was about 1.3 and the long run market return was 11.5%.
A. What is the total number of shares in Flexics currently? How many shares does the CEO
own? [5 points]
B. Based on the Balance Sheet values (shareholder’s equity), what is the book-value of each
share? [5 points]
C. What was the value of the entire company Flexics based on the recent private placement?
[5 points]
D. What is the Enterprise Value (EV) of Flexics at current market prices?[5 points]
E. Create a basic income statement (starting from operating income to net income). [5 points]
F. At the current price levels, how much cash can the CEO generate by selling all his shares?
[10 points]
G. Consider a scenario that Flexics raises debt to the tune of $20 million as senior debt from
Bank of America, at 12% interest, create a basic income statement (showing increased
interest payments, changes to net income, etc.). Will the net income be positive of negative
for this hypothetical scenario? [15 points]
H. Consider another scenario where in addition to the senior debt from BofA, Flexics also
raises debt of $10 million at 15% from Seattle partners. Create a basic income statement
(showing increased interest payments, changes to net income, etc.). Will the net income be
positive or negative for this hypothetical scenario? [20 points]
I. What is the most amount of debt (given the information given above regarding conditions
of generating debt), can the CEO of Flexics raise for an LBO? [20 points]

Answer 1

A. Given:

Number of shares currently outstanding = 9millions

CEO's shareholding in the company = 35%

Therefore,

CEO holds (9 millions shares * 35%) = 3.15 million shares

B. Given:

Shareholders' fund i.e., Equity = $200 million

Book Value of share = Shareholders' Fund/Number of shares outstanding

Therefore,

Book Value = $200 million/9 million shares

= $22.22 per share.

C. Recently a private placement has been done with a venture capital at an effective price of $24 per share.

Accordingly, value of entire company according to this share valuation = $24 * Number of shares outstanding

= $24 * 9 million shares

= $216 million

D. Enterprise Value = Market Value of Equity + Market Value of Debt - Cash

We have :

Market value of Equity (Calculated) = $216 million

Market Value of Debt (Given) = $70 million (60+10)

( In the absence of information about market value of debt we are using book value of debt)

Cash ( Given) = $50 million

Therefore,

Enterprise value = $216 million + $70 million - $50 million

= $ 236 million