California Plant Protection (CPP) is a very successful security guard firm. Tom Wathen is the CEO and sole owner of CPP. Pinkerton, in 1987, was a competitor of the firm with a good brand image. Wathen wanted to buy Pinkerton when it was available for sale. Morgan Stanley represented American Brands in the sale and the bidding. They would not accept a bid of lower than $100 million. He has to decide whether the acquisition of Pinkerton was profitable enough to buy it at that price. He has two financing options. He can raise money by either a $75 million at 11.5% interest or a $100 million debt at 13.5% interest. Wathen has to decide whether to acquire Pinkerton and if so, how to finance the bid. The free cash flow technique coupled with the continuing value and incremental improvements are used to analyze the decision.
A. All-equity Cost of Capital Based on Wackenhut's Numbers.
B. Projected Pinkerton Free Cash Flows Through 1992
Free cash flowFree cash flow
PV Free cash flow at All-Equity Cost of Capital
Estimated pessimistic value of Pinkerton
Value of 45% of CPP Equity -Expected Cash Flows
Financing the Acquisition
75% Debt100% debt
Debt service requirements,75% debt
Debt service requirements,100% debt
Total FCF - total debt service burdenCumulative excess cash flow
Why is Wathen acquiring Pinkerton’s Inc.? How specifically will he create value? What should his bid strategy be?
What is the proper cost of capital for evaluating this acquisition? Consider this from the standpoint of WACC and APV.
Develop and find the present values of the free cash flows from Pinkerton’s Inc., and also from the CPP margin improvements. Calculate this only on the assumption of a 25-75 equity-debt split.
How will we make our decision on financing choice / capital structure? Consider the issue of meeting debt service requirements.
What is the value of the equity Wathen must give up if he chooses the 25 percent equity alternative?
What are the costs and benefits of the all-debt choice? The debt-equity choice? Which would you recommend and why?
How should Wathen respond to Morgan Stanley?