Discuss the influences imposed upon the company by the larger company

Case 22 Equity Valuation in a Public Stock Offering Suburban Electronics Company Suburban Electronics Company was founded in 1979 by John Marris, a graduate of the College of Engineering at a nearby university. It had been Marris' dream to own a business, and after just two years of employment with an electrical engineering design firm, he went out on his own. Suburban Electronics designed and built a variety of electronic warning devices, burglar alarms and the like. All of the items manufactured by the company were designed by Marris and on assistant, and were then built on the premises John Marris had earned a degree in electrical engineering, and his assistant, H. J. "Hank Mack, was a mechanical engineer. The small company's products were sold in several ways Some of the smaller, more commonplace products were sold to major wholesalers and retailers and were "private branded" by those companies. That is, the products were sold under the brand name of the major company. In that aspect of its business, Suburban Electronics Company had a reputation as a reliable, high-quality producer of electronic products. In fact, one of the company's best selling private branded items was an electric garage door opener sold by two very large general merchandise retail chains under their own brand names The other aspect of the company's business revolved around doing contract work for large manufacturers. For example, the company had just secured a contract to manufacture the alarms that sound when a car door is opened while the keys are in the ignition. This contract was with a Japanese automobile manufacturer, and John Marris considered the contract his bes ever and firmly believed that it would launch his company into its next phase of development. Suburban Electronics had increased its sales and earnings at a steady pace since its inception. As a result of that growth and the desire to expand the size and scope of the business to the highest proportions it could reach, Marris desired to take the company public. Marris and Mack realized a need to raise additional capital in the future, but also wanted to make their hip in the company more liquid. A public market for the stock would accomplish both objectives. Table1 is the balance sheet for Suburban Electronics. Table 2 is a summary of sales and eanings data for the company. Table 3 illustrates certain operating characteristics for a composite of firms related in customer type and other operating characteristics to Suburban Electronics Planning to go public, John Marris and Hank Mack had several conversations with Sandra Tracy, a principal in a "boutique" type investment banking firm headquartered in the southeastern city in which Suburban Electronics operated. Tracy's company was known a boutique because of its highly specialized line of business. That business consisted of takin small firms public, and valuing private companies for various purposes With Marris' wish to go public, attention turned to the valuation of Suburban's stock While Tracy was well-versed in the valuation of companies, Marris and Mack were not. As a result, Tracy wanted to be sure that her approach to the task was not only clear and correct, but Suburban Electronics Company that it was understandable and reasonable to the two owner/managers. She had learned, for example, that price-eanings multiples for several public firms in Suburban Electronics' area of the country were in the 12-14 range. The market value per share to book value per share for those firms ranged from three to five. When it was explained clearly, Tracy believed the owners would readily understand this information. In addition, it was Tracy's opinion that the company could pay at least 20 percent of its earnings as dividends. This would compare with a payout of 15-25 percent for several similar companies with which Tracy was familiar. Those firms 0 offered their equity holders a total retum of approximately 20-22 percent. All of the existing shares were owned by Marris and Mack. Marris' interest in the 5 company amounted to 270,000 shares. The funds for the initial capitalization had originated with a mortgaged home in the case of Mack, and the sale of inherited farmland in the case of Marris. There was a great emotional inclination to meintain control of the firm on the part of Marris and Mack. It was clear to them, however, that the real need was to have the firm continue to grow and prosper. Therefore, they both believed, and Tracy had provided additional urging, that a public offering of the stock was the most logical course of action. TABLE 1 Suburban Electronics Company Balance Sheet December 31, 1992 3000s) Current liabilities Current assets Fixed assets $400 $300 2 2.500 Mortgages Common stock ($1 par value) Retained earnings Total liabilities and 2050 Total assets equity $2,900 Suburban Electronics Company TABLE 2 Suburban Electronics Company Sales and Earnings History Net Income After Tax Year Sales EPS 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 $0.52 0.72 0.80 0.82 0.82 0.85 1.13 1.43 1.83 2.38 $1,292,000 1,550,000 1,861,000 1,900,000 2,010,000 2,350,000 2,820,000 3,584,000 4,600,000 6,250,000 8,000,000 $155,040 217,000 241,930 247,000 241,000 258,500 338,400 430,080 552,000 717,200 811,448 2.70 TABLE 3 Suburban Electronics Company 1992 Composite Data Electrical Component Manufacturers based upon 10-year averages) Market value common shares Total debt as a percentage of total assets Compound growth in sales Compound growth in earnings per share Return on equity $15 to $25 25% 5% 16% 25%