Pinkerton (A) Case Solution & Answer

Pinkerton (A) Case Solution


Tom Wathen– the CEO of California Plant Protection, a successful security guard firms was concerned about the acquisition of Pinkerton. In 1987, Pinkerton was recognized as one of the largest security guard firms in the US, with 150 offices in UK, US & Canada, and sales of over 400 million dollar. Wathan made the acquisition decision based on various reasons. First, he always had the objective of creating the largest firm in the security guard industry, and he was convinced that the American brand was mismanaging Pinkerton as well as destroying the image of brand with its pricing strategy. When Morgan Stanley made Wathen realized that his bid of $85 million was too low and they wouldnot accept the bid that is lower than 100 million dollar, Wathenhad to decide whether the decision of acquiring Pinkerton would be feasible or not.(Berger, 2001).

Problem statement

The California based security guard firm considered the acquisition of similar company i.e. Pinkerton. The key issues are the value of the target organization and the financing of the potential acquisition. Wathen has two options: to finance the bid by either $75 million at the rate of 11.5 percent interest or 100 million dollar debt at 13.5 percent interest.

Pinkerton valuation

The valuation of Pinkerton involves the estimation of revenue, gross margin, operating expense, net property, plant and equipment and net working capital based on the provided assumptions. The cash flows of Pinkerton are projected from 1988 to 1992. The present value of free cash flows at equity cost of capital amounts $45.21 million. It is because of the fact that there is not any information provided in the case related to debt used by Pinkerton, therefore the equity discounted cash flow method is chosen to estimate the net present value of the future cash inflows. The all-equity cost of capital is calculated by assuming that the value of equity is 70.2 million dollar which is calculated by multiplying the number of outstanding shares with the price of share whereas the book value of debt is 10.6 million dollars.The equity beta is converted into the asset beta and then multiplied with the historical risk premium of 7.4%, thus all-equity cost of capital is 13.6 percent. The positive cash flows for the company shows that the acquisition of Pinkerton would provide greater financial outcomes to California Plant Protection(Edleson, 2015).

What is the net present value (NPV) of the Pinkerton acquisition if Mr. Walthen pays $100M to purchase Pinkerton?

The net present value of the acquisition of Pinkerton is $37.95 million which is calculated by deducting the amount of purchase of $100 million from the net cash-inflows that the company would be generating over the period of projected years. The projected cash inflows are calculated on the basis of the assumptions provided in the case. The value of the net present value if Mr. Walthen pays 100 million dollars to purchase Pinkerton shows that the decision of acquiring-Pinkerton would be feasible and viable for the company and generate greater financial outcomes.

Sources of value to CPP from the acquisition of Pinkerton

The value to California Plant Protection from the acquisition of Pinkerton is calculated on the basis of four sources such as; value of incremental improvements to CPP, estimated base case continuing value at times 0, value of incremental tax shields and present value at all-equity cost of capital. Combining of all these synergies resulted in total value of $113.50 million.

The incremental tax shield value is calculated by adding CPP incremental EBIT &Pinkerton EBIT for each projected year and divided by assumed interested coverage ratio of 6x, thus the tax shield by multiplying the tax rate with the interest expense at 6x coverage ratio. Furthermore, the present value of tax shield is calculated with the use of 10.58% – a BBB coronate bond yield. The value of incremental tax shield is a sum of present value of tax shield at BBB rate and present value of the terminal value.

On the other hand, the value of incremental improvements or synergies is calculated by adding the present value of the increased free cash flows and present value of terminal value. The present value of increased free cash flows is calculated by discounting back the increased income after tax at 13.6 percent all-equity cost of capital. Hence, the value of incremental improvements or synergies provides a strong foundation of acquiring the Pinkerton.

How can CPP improve Pinkerton’s performance?

Under the pessimistic scenario; the present value of the free cash flows at all-equity cost of capital is calculated to be $34.5 million, which shows that the company needs to bring many improvements in Pinkerton’s performance. Therefore, CPP would be at risk of acquiring Pinkerton if it doesn’t-improve the performance of Pinkerton, but since CPP is expert in the business of security guard; there is a likelihood that CPP would successfully improve the performance of Pinkerton.

There are many ways through which CPP could improve the Pinkerton’s performance, such as; the synergies and incremental improvements created by the consolidation of two companies, which would contribute to an increased level of profit returns. This could be done through eliminating the overhead. The overhead tends to reduce the cost through letting go of the excessive support staff, closing down the redundant offices as well as other common facilities. In addition to this, CPP could improve Pinkerton’s  working capital at the management level, to enhance Pinkerton’s overall performance. Additionally, the brand name of Pinkerton is well known among the customers of CPP, due to which the company could utilize Pinkerton’s brand name to generate higher amount of revenues. Since the industry is highly fragmented and price-competitive, CPP could successfully market the services of both CPP and Pinkerton, under the name of Pinkerton, at the premium price.

What is the value of synergies associated with the Pinkerton-CPP combination?

As per the information provided in the case; the cash flows of the CPP are discounted back at the discount rate of 13.5 percent, to calculate the net present value of the cash flows. The net present value of the company amounts $13.41 million; whereas, the value of incremental improvements amounts $15.9, which shows that the company would be benefited by the synergistic effect of the acquisition……….

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