The Offer Price THE OFFER PRICE Miranda Lam, Salem State University Raminder Luther, Salem State University August 10, 2006 (Thursday) Hans Sr. walked into his son's office. \"I just got a call from Dimmons. Jimmy wants to sell his company. Are we interested?\" J.R. looked up, surprise and excitement coursed through him. This could be the opportunity he was looking for to move the company further along his vision. Acquiring Dimmons could also solve the dilemma he was wrestling with in their fuel oil division. \"Yes, we are definitely interested,\" he told his father. \"Great, I already told him to send over the NDA1 . Once we sign that we will get their financials and inventory numbers. Clear your schedule. We want to get cracking on this. I'm sure Jimmy has called others besides us. We don't want them to beat us to the table.\" COMPANY HISTORY Koehler Propane was located in Woodsville, New Hampshire, a small town in a rural area. It was founded in 1949 by Kirk Koehler and remained a family owned business. The company was a retail propane distributor and its services included monitoring customers' tanks, delivering propane from the company's storage facilities to homes and businesses and responding to customer emergency calls. Since the two main uses of propane gas among residential customers were heating and cooking, a key element in business success was to ensure that customers' tanks did not run out of propane. Koehler prided itself on customer service and reliability. In 1983, Hans Sr. bought the business from his uncle Kirk. He continued to focus on customer service, rather than price cutting, as the primary growth strategy. Their core customers were residential households and the only product they carried was propane gas until they bought Cassin in 2005, which had a heating-oil business in addition to propane delivery. HANS KOEHLER SR. Hans Koehler Sr. was born in 1941. After graduating from college, he worked for a large regional tools manufacturer for over 20 years. That job required a lot of travel and Hans Sr. became well acquainted with the businesses in the area. The recession of 1982 and changes in the tools industry led Hans Sr. to reconsider his career. While deciding on his next career move, he lived with his uncle and helped him renovate his house. During the year-long project, he also helped his uncle, Kirk Koehler, in his propane business and got to know his uncle and his business intimately. Kirk was thinking about retiring and asked if Hans Sr. would be interested in the business. Tired of traveling and working for others, Hans Sr. decided to take the leap. He bought Koehler Propane from his uncle and settled into the Woodsville community. Hans Sr. emphasized customer service and followed a focus business strategy, concentrating his efforts in the propane market instead of diversifying into other types of fuel. Over the next two decades, the company grew steadily through successful marketing campaigns, word-of-mouth referrals and two acquisitions. An avid antique car collector and racing enthusiast, Hans Sr. competed in road races across the U.S. and North America. He was well-known in the community and held leadership positions in civic and business organizations, including the Rotary Club. He was the sole owner of Koehler Propane, with his wife as the office manager, and a general manager, who took care of the logistics, equipment maintenance and managed the drivers. In 2003, the general manager announced that he was retiring. Hans and his wife were both in their sixties. Hans debated whether to find a replacement for the general manager or to sell the business and retire himself. He really wanted to devote more time to his antique cars and to compete in longer races. He had three children, all in their 20's and 30's, but none of them was in the family business at that time. He decided to offer his children the opportunity to join the family business. HANS KOEHLER JR. (J.R.) Hans Koehler Jr. (J.R.) was the youngest of three children. After high school, he had gone to college in Maryland and graduated in 1999 with a degree in Economics. When the dotcom boom was in full swing, he had landed a job doing web development in Washington DC. The bursting of the dot-com bubble in late 2000 led to radical changes in the climate of the information technology industry.J.R. found his department getting consolidated and he was taking on other duties besides web development. He worried daily about his job security. In October 2002, the Washington DC, Virginia and Maryland area was terrorized by the \"Beltway Sniper\" for more than three weeks. During that short time, ten people were killed and three were critically injured. The stress of the job environment and the violence of the DC area intensified J.R.'s thoughts to reconsider his future. When his father announced the retirement of the general manager, J.R. decided to move back to Woodsville and work with his father. In 2003 J.R. took over the general manager position. He met his wife shortly after and they married in 2005. Both of them loved Woodsville, and J.R. planned to buy Koehler Propane and continue the family business when his father retired. THE PROPANE AND HEATING-OIL DEALERS INDUSTRY2 Propane and heating-oil were commodities, with physical characteristics highly regulated and uniform throughout the industry. Not surprisingly, propane and heating-oil dealers tended to compete based on customer service, rather than on price. In a 2006 survey, LP Gas Magazine found that dealers believed their customers most valued \"quick response to problems\" followed by \"dependable tank monitoring and refilling.\" \"Low price\" was ranked last by dealers as an important factor to customers. In general, the propane and oil delivery industry in early and mid-2000s was characterized by high competition and low concentration level. This industry trend also applied to the dealers in the Woodsville area. Revenue was highly volatile and varied with energy prices and winter temperatures. Winters in northern New Hampshire were cold and unpredictable. Overhead was a major factor affecting profitability. In order to meet customers' expectations, delivery truck drivers needed to check on each customer on a regular basis and refill their tanks. When customers were located far apart, each truck driver could handle fewer customers due to longer drive time, and profit margins varied in proportion to customer density in the vicinity. The geography of the Woodsville area created unique competitive patterns. The area was relatively rural with pockets of denser population in towns scattered 15-30 miles apart. Lakes and national forests further segregated the region. Over time, each propane and heating-oil company carved out its dominant region. Competition tended to be most prevalent along regional borders in overlapping areas. Companies would strongly defend their dominant vicinity because loss of customers in the company's central region would greatly impact their profit margin. THE CASSIN ACQUISITION 2005 was a difficult year for most propane dealers. Nationally, high propane prices and competition from other energy sources such as heating-oil and natural gas resulted in a 4.7% decrease in revenue (a 7.3% decrease in gallons) between October 2005 and October 2004 (National Propane Gas Association, January 10, 2006). Bucking the national trend, Koehler embarked on an aggressive marketing campaign in 2004-2005 and successfully garnered revenue growth. A local, low budget competitor, Cassin Service Inc., called up Hans Sr. in 2005 and told him that he was selling his business. Cassin Service Inc. was located about 10 miles east of Koehler headquarter, in Gorham, New Hampshire. The two towns were separated by a national state forest. Cassin was known for their low prices. However, their low price strategy often resulted in interrupted services to customers. For example, sometimes their cut-throat margin resulted in lapses in payments to their own suppliers and subsequent inability to deliver products to customers. Poor vehicle conditions and irregular maintenance also contributed to their unreliability. The successful marketing campaign by Koehler had resulted in Cassin losing both customers and money. As the company floundered, John Cassin decided to sell the business. Hans Sr. negotiated with John Cassin while keeping J.R. in the loop. The acquisition was a success for Koehler. The Cassin customer base was an ideal geographic complement to Koehler's. Cassin provided another densely populated area outside of Koehler's dominant locales and boosted customer counts in their overlapped territories. Although they had to raise prices for many of Cassin's existing customers, their net loss of customer base was only 10-15%, compared to a national average of 30% customer loss during such acquisitions. There was one quandary in the acquisition. Cassin maintained a small heating-oil business of around 100,000 gallons per year, whereas Koehler's product line was 100% propane. The two heating-oil delivery trucks that Cassin had were 20-25 years old and in poor condition. Due to the small volume of business in this line, Cassin did not have its own bulk storage facility and purchased its heating-oil inventory from a competitor at a 6 cent per gallon mark-up, which cut significantly into its profit. Overall the heating-oil business line was barely breaking-even. DIMMONS FUEL COMPANY Dimmons Fuel Company was also located in Woodsville, New Hampshire. Their main product was heating-oil, followed by diesel, kerosene and some coal. Dimmons and Koehler were indirect competitors. Though both heating-oil and propane were energy products, once a customer invested in the equipment, e.g. a propane stove or a heating-oil furnace, the switching costs were perceived to be prohibitive. In fact, Jimmy Dimmons bought propane for his stove from Koehler and Hans Koehler bought diesel for his delivery trucks from Dimmons. It was a small town. Back in 1985 when Koehler purchased West Side fuel, Hans sold the heating-oil part of West Side to Dimmons the day after the purchase papers were signed. He had no interest in the heating-oil business at that time. In 2006, Jimmy Dimmons, who was in his sixties, found out he had cancer. He decided to sell the business and retire if he could find the right buyer. Dimmons Fuel had annual sales around 8-900,000 gallons. Its business philosophy closely resembled that of Koehler, with emphasis on customer service rather than price cutting. When Jimmy Dimmons announced his intention to sell his business, he called up the competitors, including Koehler, Verdi, and Lewis. VERDI ENERGY PRODUCTS Verdi was founded in 1927 and serviced a relatively wide area with heating-oil, propane, natural gas, coal, gasoline, diesel fuels, kerosene, and lubricants. It was located about 50 miles south east of Koehler and covered many densely populated areas. Its existing territories slightly overlapped with Koehler and they competed occasionally. However, it was looking to expand into Koehler's area and acquiring Dimmons would give them the perfect position. If they acquired Dimmons, they could add propane to their product lines and be able to compete directly with Koehler. Verdi was a much larger regional company and would have more resources to engage in a price war over Dimmons. LEWIS OIL AND PROPANE Thomas and Elizabeth Lewis had founded Lewis Oil Company in 1958. The company had started by delivering home heating-oil. As the company grew it added various products to its mix. The growth strategy of Lewis had been mainly through acquisitions, resulting in a large geographic base of customers. By 2006, the company delivered heating-oil, propane and gasoline throughout Massachusetts and southern New Hampshire. Their existing customer base was much further away from Koehler than Verdi. Acquiring Dimmons would give Lewis a head start in a new area and make it a formidable competitor to Koehler. J.R.'S VISION FOR KOEHLER The energy delivery service was a mature industry with fierce competition. Growth was usually through price competition or acquisition. After acquiring Cassin, Koehler had a dominant propane market share in the immediate surrounding areas and was able to enjoy a healthy profit margin. A number of larger regional companies were interested in entering the market. However, Koehler was able to hold them off because profit margins decreased significantly with distance to delivery. These companies were not able to slash prices to compete with Koehler until they created a presence in the local market. Koehler was aware that threats from these competitors were ever present and one company in particular, Verdi, was growing aggressively in their region. Though the Cassin acquisition was an overall success for Koehler, its heating-oil line had continued to struggle due to its low volume. The two delivery trucks were in bad shape and needed to be replaced. A new truck would cost $110,000. Hans and J.R. were deciding whether they should close down the heating-oil line or purchase two new trucks to continue. J.R. estimated the annual net after-tax operating cash flow from the heatingoil business would total $6,000 to $10,000 each year for the next 10 years. The surprise phone call from Jimmy Dimmons presented a third alternative - to expand the heating-oil part of the business. If they acquired Dimmons, the combined heating-oil volume would be about one million gallons per year, sufficient to support their own bulk storage facility, which would increase the gross profit margin and perhaps turn the heating-oil business line profitable. J.R.'s vision was to transform Koehler into an energy delivery company, not just a propane company. Acquiring Dimmons would be a significant step in that direction by greatly increasing their heating-oil business and gaining entrance into the diesel, kerosene and coal markets. He was particularly interested in the potential of green energy products such as bio-heating-oil, bio-diesel, and clean coal. Though acquiring Dimmons had a lot of strategic advantages, the decision was still contingent on the value of each alternative. AUGUST 14, 2006 (MONDAY) Hans Sr. looked over J.R.'s shoulder at the historic financial statements and inventory records in the Excel spreadsheets (see Exhibits 1-4) that Dimmons had just emailed over. Hans Sr.: \"Remember what happened with Cassin. We were able to trim off a lot of their back office expenses by moving their payroll, accounting and customer database over to our systems. I bet we can do the same with Dimmons. That should cut $45,000 to $60,000 per year off their expenses.\" J.R.: \"Yeah. It will be a lot of work and overtime pay to move their data over but you are right about the savings in the long run. Here, look at the salary and benefits the Dimmons have been paying themselves in the past 2 years. They totaled almost $200,000 in 2005 and just shy of $300,000 in 2006. And that doesn't include the distributions they took as dividends. They are definitely cashing out. We won't have those to pay after the purchase.\" Running Header: Management STUDENT NAME LECTURER'S NAME COURSE NAME DATE OF SUBMISSION 1 Running Header: Management 1. List and briefly discuss the investment/divestment alternatives available to Koehler Propane with respect to their heating oil business line. Koehler propane was a family business located in Woodsville which was founded in 1949 by Kirk Koehler . the business had undergone through numerous changes since that time. after Hans Koehler sr. Took the leap and opted to take up the company immediately after Kirk Koehler thought of retiring. Hans senior managed to buy the Koehler propane company from his uncle and settled in woods Ville community. due to Hans Koehler effective management skills, the company steadily grew. There after Koehler acquired Cassin which would guarantee dominant propane market which in turn would lead to higher profit margins. successful marketing campaigns and low prices by Koehler were the main strategies he used in this business line to boost customer base. J.R. and Hans decided to expand the heating oil part of the business which would increase the profit margin and turn the heating oil business line profitable. JR wanted Koehler to produce multiple energy like bio-heating oil, bio-diesel and clean coal not just propane. he acquired Dimmons after carefully acquiring details of the company strategic advantages and the salaries and benefits that they would accrue from purchasing demons. acquiring the Dimmons company would be significant in the sense that it would increase their capacity to produce large gallons of energy and gain entrance to the markets. this would in turn help them to increase profits . acquiring Dimmons would also give them a perfect position. they could add propane to their product line so that they could be able to compete with Koehler. It would also give Lewis a head start in a new area and make it formidable competitor to Koehler 2 Running Header: Management 2. Identify the risks and opportunities facing Koehler with respect to each alternative. Price war If the Koehler managed to acquire Dimmons, it would give them a perfect position. They could also add propane to their product line and would have more resources to engage in price war with Verdi. This is because Verdi was a much larger regional company and Koehler would have sufficient resources to engage in price war once they acquired Dimmons. The Verdi energy was located near Koehler and this will intensify competition since the products that would be produced would definitely engage them in price wars in order to dominate markets. Lose of income the Koehler devised a strategy to acquire Dimmons in order to increase output in terms of production. They wanted to diversify products to many other more that would result into new products in order to expand their local market and compete fairly with Verdi. the cost of expansion of the oil business would cost the company extra revenue. purchase of the company trucks would cost $110,000 each. this would make the company to incur additional cost in acquiring the new trucks. Stiff competition After acquiring Cassin Koehler had a dominant propane market share in the immediate surrounding areas and was able to enjoy healthy profit margins. A number of large regional companies had shown significant level of interest in entering the propane market. The 3 Running Header: Management Koehler strived very hard to contain the competitors and as a result the companies were not able to slash the prices to compete with Koehler until they created a presence in the local market. Koehler was aware that this threat from these competitors were ever present and one company in particular verd9i was aggressively growing in the region 3.Identify valuation methods appropriate for valuing Dimmons and explain the strengths and limitations of each method in this case. Price multiples The price to earnings ratio provides an indication of how much investors are willing to pay for the company's earnings. Price to earnings equal to a company market price per share dividend by its earnings per share. Companies with a high growth rate prospects usually have a high p/e ratios because these companies are expected to reward investors with a quicker and larger return on their investments in form of dividends, increase in share price or both. Reliance on past earnings may ignore the potential for future growth Enterprise value multiples Price multiples are popular with buy side sell side analyst who are often interested in valuing a company and asses targets total value, putting more focus on the company's debt and equity. The company's enterprise value multiples is used when valuing an acquisition target. This method can understate the value of assets hence making it unreliable. Direct valuation method (discounted cash flow) This valuation method of the company determines the company value to be equal to the present value of the future but uncertain cash flows can be generated by the company's operation, discounted at a rate that reflects the ultimate riskiness or uncertainty of those cash 4 Running Header: Management flows. This method of valuation is based on risk. That means a riskier business receives a lower valuation than a stable one. 4. Compute the estimated value for Dimmons using each method. Price multiple method a price multiple is normally any ratio that use the share price of a particular company in conjunction with some specific per share financial metric in order to evaluate a company's financial status. The Price/Earnings (P/E) Ratio represents the value of the business divided by its post tax profits. post tax profits from 2005/2006= $182,000.00 Business worth = $652,000.00 $652,000/$182,000= +3.5 The lower the PE ratio, the risk of buying the business Enterprise value multiples value multiples requires two inputs - which is an estimate of the value of a firms and a measure of revenues or earnings in the denominator as illustrated in the question Firm value = market value of equity + market value of debt 15% of annual sales + inventory 15% of 789,700 +$53,103= $206118.75 5 Running Header: Management Direct valuation method (discounted cash flow) The objective of a discounted cash flow is to get the sum of future cash flow of the company businesses and discount it back to the present value. To do this we need to decide upon a discount rate. DCF Dimmons company =$ (182000 / 1.281) + $(14218.756 / 1.482) =$14218.75 + $6,400.00 =$206118.75 5. Identify the advantages and disadvantages of a cash deal versus a stock deal from the perspective of Koehler and Dimmons respectfully. Advantages Acquirers s of assets in cash deal is able to specify the liabilities it is willing to assume while leaving other liabilities behind while in a stock purchase the buyer purchases stock in a company that may have an unknown / uncertain liabilities. this is exhibited when Koehler JR wanted to acquire Dimmons. Cash deal ensures the buyer avoids the problem presented by minority share holder who normally refuse to sell their share . If the cash exceeds the aggregate tax basis of the assets that is to be acquired, the purchaser normally receives a stepped up basis in assets equal to the purchase of price Disadvantages 6 Running Header: Management Acquirers who use stock tend to be those with overvalued shares thus the premium they confer is illusory hence it is usually very easier to overprice deals when it is paid in stock Sales on the transfer taxes on the sale assets a stock transaction can avoid all the taxes that apply in the event of asset transaction. Dimmons acquirers would have to stock that they would be otherwise unable to buy in the investment market. 6.What is Koehler's best alternative? Support your answer with both qualitative and quantit ative reasons. Koehler's best alternative was to expand heating oil part of the business . This is because the estimation from the from the heating oil company business would total to$6,000 to $10,000 each year for the next 10 years. Combining the heat oil volume would be able to produce million gallons per year, which could be sufficient in supporting their own bulk storage facility therefore would result into increased gross profit margin and perhaps turn the heating oil business line more profitable. Gross profit projection would increase in Dimmons from $0.53 to $0.7 per gallon as projected in 2005/2006 financial year. net income in Dimmons fuel company recorded a gradual positive outcome $369,000 up to $494,000 on retained earnings by the end of the year. 7