S.A. is a small, regional airline founded by Samuel Kaplan in 1986. It started service in Idaho Falls. By leasing and buying used aircraft, Kaplan increased S.A.’s seating capacity and expanded service to over 75 domestic and international destinations over the next ten years. The company was run exclusively by Samuel Kaplan, who served as chairman of the Board, CEO, CFO, and Controller. The board consisted of Kaplan, his wife, and his cousin Bob. In addition to his salary of $400,000 a year, Kaplan also had a company car and a company apartment.

As shown in Table 1, S.A. had been showing consistent profits, although profitability growth had slowed recently, and even declined slightly in the last year. Kaplan explained this as a temporary slowing of revenue growth, and was confident that cash flow would continue to grow at its historical rate in the future.

Table 1. S.A.’s profit growth in the past ten years

	1987	1988	1989	1990	1991	1992	1993	1994	1995	1996
Sales	$2250	$4500	$9000	$15000	$22500	$30000	$36000	$42200	$48600	$53000
Operating Expense	$1750	$3500	$7000	$12250	$17500	$22750	$28875	$33250	$38500	$43750
EBIT	$500	$1000	$2000	$2750	$5000	$7250	$7125	$8950	$10100	$9250

Because of the approaching birth of his triplets, Kaplan thought it was time to “pull some money off the table.” He contacted Thyestean Ventures, a local venture capital firm that was known to invest in family-owned business. Thyestean Ventures had an excellent track record and managed almost $500 million in assets.

Kaplan had wanted to retain control of the company and therefore offered to sell 30% of his company to the venture capital firm, but the venture capital firm would not get board representation. Kaplan was certain that given the good performance in the past ten years of S.A., the 30% share of S.A. was worth well over twenty million dollars.

After their due diligence, however, Stacy Simms, Thyestean’s managing general partner, informed Kaplan that Thyestean would pay no more than $6 million for the 30% equity stake.

Samuel Kaplan must negotiate with Thyestean to get what he needs/wants from the proposed transaction.  He must enter the negotiations armed with realistic expectations and a list of bargaining points or changes he can offer to improve Thyestean’s valuation of their share of the company.

Questions :

A)    Is Samuel Kaplan currently a principal or an agent at S.A.?  How will that, and decision-making, change if S.A. is sold, at least in part, to Thyestean (i.e., what kind of ownership and control structure might be required)?  What near-term decisions are Kaplan and S.A. facing?

B)    Whose S.A. market valuation calculation is correct, Kaplan’s or Thyestean’s?

C)    Why does S.A. appear to be worth much less to Thyestean than to Kaplan?

D)    What does Kaplan hope to gain from selling S.A.?  What is he willing to give up?  What kinds of incentive problems are created by the arrangement Kaplan would presently like to have with Thyestean?

E)    Is there anything Kaplan can do to improve the perceived value to Thyestean of S.A.?  Can the discrepancy in valuations be entirely removed?  Should Kaplan take steps to improve the perceived value to Thyestean or revise his own expectations downward?

Required:

Your group has been hired by Kaplan to explain the valuation discrepancy and to help him prepare for the negotiations.  In your memo to him, explain why his and Thyestean’s valuations differ and tell him what steps, if any, he can take to reduce the difference.  If you believe that the difference cannot be entirely resolved, explain why. Discuss each of the following questions with your group members, and write your consensus answers in the space provided.  

This activity is a group project, and everyone in your group should agree on the positions stated.  Be careful when making recommendations to Kaplan --- do not make any decisions that only he can make, and provide enough explanation so that he can make an informed choice about the recommendation(s) and the consequences.

1)    Describe the current and future principal-agent relationships for S.A., Inc., and what implications a change in those relationships has for Kaplan’s motivation and behavior.

2)    Explain why Thyestean’s offer is much lower than Kaplan’s estimate.

Additional Analysis (use the following table to show the calculations and refer to this analysis as an example of why there might be valuation differences between Kaplan and Thyestean):

Suppose Kaplan (as the sole owner of S.A.) is considering the purchase of a company jet for executive rather than for commercial use.  The cost of the jet is $5,000,000.  Its benefit to the company is expected to be $3,000,000 and its benefit to Kaplan personally is expected to be $1,500,000.  Will Kaplan purchase the jet?

Now suppose that Kaplan sells 30% of the company to Thyestean.  Kaplan is again considering the purchase of a jet for executive use.  Again, its cost is $5,000,000, its benefit to the company is expected to be $3,000,000, and its benefit to Kaplan personally is expected to be $1,500,000.  Will Kaplan purchase the jet under these circumstances?

Airplane Analysis (for changes in principal-agent relationships):

Compute the net benefits (costs) to Kaplan based on the following facts:

       cost of plane         $5,000,000

       company benefit  $3,000,000   so net cost to S.A. = $2,000,000

       Kaplan’s personal benefit   $1,500,000

	Situation 1 Kaplan as sole owner	Situation 2 Kaplan as 70% owner
share of cost of plane
share of company benefit
share of personal benefit
share of total benefits
share of net benefits (costs)
Kaplan’s decision

3)    What do you recommend that Kaplan do to reduce the valuation difference?  Be specific.