Schneider Square D

Strategic Rationale for a Combination of Schneider and Square D (1) 1.
Historically, the industry has been segmented by country or by region. Barriers to entry in these different markets have been perpetuated by: Differences in standards across countries and regions; Costs of R&D for new products and costs of translating technologies for different regional standards; Proprietary distribution networks; 2. Industry trends point towards increased globalization: Product standards are becoming common across regions; R&D costs continue to grow increasing the benefits of economies of scale;
SCHNEIDER - SQUARE D
SCHNEIDER - SQUARE D Strategic Rationale for a Combination of Schneider and Square D (2) Given the above factors, Schneider and Square D appear to be a good match: Schneider is a leader in Europe whereas Square D is a major player in the US market; Schneider appears to be especially strong in industrial distribution whereas Square is strongest in residential distribution;
SCHNEIDER - SQUARE D Synergies between Schneider and Square D Rationalization of R&D efforts and benefits from sharing existing technologies; Access to larger distribution channels for both companies; Rationalization of manufacturing capabilities; Benefits from cross-selling products;
SCHNEIDER - SQUARE D Effect of Acquisition on Goodwill
Purchase Price $60 Square Ds SE ($m) Adjustment for inventory revaluation Revalued SE ($m) Nb of shares (m) Price per Share 603.6 138.1 741.7 23.2 $60 $65 603.6 138.1 741.7 23.2 $65 $70 603.6 138.1 741.7 23.2 $70
Market Value of Square 1390.9 1390.9 1390.9 Ds Equity ($m) Goodwill ($m) 649.1 765.1 881.0
SCHNEIDER - SQUARE D Effect of Acquisition on Schneiders Earnings
($m) (1FFr = $0.184) Schneiders Earnings Square D Earnings Merger Synergies Goodwill Amortization Combined Firms Earnings
Purchase Price $60 $65 $70 251.2 251.2 251.2 120.7 120.7 120.7 60.0 60.0 60.0 (16.2) (19.1) (22.0) 415.7 412.8 409.9
The goodwill effect is thus significant; There is however little reason to believe that investors will not be able to understand the effect of the goodwill calculation;
SCHNEIDER - SQUARE D Assumptions Made by Lazard 1. Sales Growth of 3.5% in 1991 and 7% thereafter; 2. EBIT/Sales of 15 to 16%; 3. Net Working Capital/Sales at a minimum of 11 to 13%; 4. Projected Capital Expenditure/Sales of 5%; 5. Depreciation Expense/Sales at 4% between 1991 and 1997 and 4.3% thereafter;
SCHNEIDER - SQUARE D Prior Years Financial Performance Based On Square Ds Continuing Operations
(%) Sales Growth EBIT/Sales NWC/Sales D&A/Sales CAPEX/Sales
90 3.4
89
88
87
86 4.2
85
6.7 12.5 4.4
12.9 12.0 13.1 15.9 16.8 17.4 23.6 12.1 11.9 14.5 16.0 16.5 3.6 5.7 3.1 5.0 3.0 4.8 3.2 2.7 3.0 5.6 2.7 5.1
SCHNEIDER - SQUARE D Some General Observations on Prior Years Financial Performance 1. Square Ds performance declined in the mid80s from 17% to 12%; 2. In spite of the recession, there is a modest upturn in 1990. Is this an indication that the firms restructuring efforts are paying off? 3. Net Working Capital/Sales steadily declined until 1990, when there is a large increase due to a build-up in cash; 4. Capital Expenditure/Sales declined dramatically in 1987 as the firm responded to the deterioration in its business by cutting back on new investments;
SCHNEIDER - SQUARE D Some General Observations on the Assumptions Made by Lazard 1. Sales Forecasts: - Perhaps somewhat optimistic given the recession in 1990; - Analysts however envision a recovery by the end of 1991 or in 1992; - But for how long can a 7% growth rate be sustained? 2. EBIT/Sales: - This profitability margin was equal to 12.9% in 1990; - It never exceeded 13.1% over the last three years; 3. Net Working Capital Requirements/Sales: - About right?
SCHNEIDER - SQUARE D Pro Forma Statements Exhibit 1
SCHNEIDER - SQUARE D Square Ds Cost Of Equity Capital Equity : 0.95; In early 1991, interest rates were as follows: - 3 month Treasury Bills rates: 6%; - 30 year Government Treasuries: 8.25%; Based on these rates, the appropriate risk free rate is 8.25%; Assuming a market risk premium of 7.9%, Square Ds cost of equity capital is: 15.9%;
SCHNEIDER - SQUARE D Valuation of Square D Using Lazards Assumptions DDM Assuming cost savings from the merger of $60m after tax per year, Square Ds stock is worth approximately $86.6; On a stand-alone basis, Square Ds stock is thus worth approximately $69.0; Assuming cost savings increasing at the rate of growth of sales, Square Ds stock is worth around $100.0; These estimates are substantially higher than the stocks market price before any takeover rumors: $40-$45;
SCHNEIDER - SQUARE D Valuation of Square D Using Lazards Assumptions PE-Based Valuation EPS from continuing operations were $4.76 in 1990; Assuming that Square Ds price before the effect of any merger rumor is $45, the firms (trailing) PE ratio is about 9.5; Given Lazards assumptions of operating savings of $60m per year, the stock should be worth about $69! ($45+(9.5*$60/23.181))
SCHNEIDER - SQUARE D Implications of Lazards Assumptions for Pro Formas and Valuation (1)
(%) Growth in SE D/(D+E) ROE AT
1991 1995 1998 (13) 29 23 1.45 6 30 30 1.51 5 31 31 1.56
SCHNEIDER - SQUARE D Implications of Lazards Assumptions for Pro Formas and Valuation (2) ROE increases from 21% in 1990 to 31% by 1998; Asset Turnover increases from 1.33 to 1.56 in the same period; Lazard most probably did not intend making that optimistic implications; These implications arose primarily because fixed assets are growing at only 3 to 4% per year whereas sales are growing at 7%;
SCHNEIDER - SQUARE D Revised Valuation Assumptions 1. Sales Growth of 3.5% in 1991, 7% in 1992 and 1993, 5% for 1994, and 3% thereafter; 2. EBIT/Sales of 14%; 3. Net Working Capital/Sales at 13%; 4. Net PPE to grow at the same rate of growth as sales; 5. Depreciation Expense/Sales at 7.5% of PPE (BY); 6. Long-term growth of 4%;
SCHNEIDER - SQUARE D Revised Valuation Under the set of revised assumptions, as shown in Exhibit 2: Square D is valued at around $59 per share including the effect of improved operating performance from the merger; Square D is valued at $41.40, which is comparable to the value assessed by the stock market before any takeover rumors;

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Strategic Rationale for a Combination of Schneider and Square D (1) 1.

SCHNEIDER - SQUARE D Effect of Acquisition on Goodwill

SCHNEIDER - SQUARE D Effect of Acquisition on Schneiders Earnings

(%) Sales Growth EBIT/Sales NWC/Sales D&A/Sales CAPEX/Sales

6.7 12.5 4.4

SCHNEIDER - SQUARE D Pro Forma Statements Exhibit 1

(%) Growth in SE D/(D+E) ROE AT

1991 1995 1998 (13) 29 23 1.45 6 30 30 1.51 5 31 31 1.56

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