Allen Lane’s decision to acquire Plas-Tek Industries (PTI) is intriguing since the business appears to be a good match with Lane’s work experience and interest. As a manufacturer, PTI has been able to create large margins and high cash flow under Harry Elson’s leadership.
However, significant risks are prevalent in acquiring PTI. First, more one-third of PTI’s sales originated from five companies and it is uncertain that without Harry Elson’s personal efforts if their patronage will continue. Secondly, the bank valuation of PTI ($600K) appears inflated as the bank’s valuation is notably more than PTI’s book value ($292K), calculated with an inflated price/earnings multiple for a company with no proprietary …show more content…
Lane can reduce this risk through building relationships with those customers as soon as possible and keeping key personnel like Eleanor to help maintain those relationships. At the same time, Lane should implement strategies to decrease the concentration of sales from PTI’s customer base.
According the bank, Lane needs $600K to submit a bid to acquire the PTI through a stock purchase. However, the bank’s valuation is calculated using an inflated price/earnings multiple and does not account for the contingent liabilities. The P/E multiple that the bank used in its valuation is notably higher than expected for a company that does not have a proprietary product. Applying a market-based P/E multiple of 4X, the 20% cash sale discount and a $90K discount accounting for potential tax liability regarding Elson’s compensation (alternative 1), PTI should be worth $450K. While this price is notably higher than PTI’s book value, it is more realistic than the bank’s valuation. Since Lane and partner Dan Ray personally will finance $200K of this transaction, they need $250K to complete the stock purchase. Therefore, the financial need is $275K.
Considering that PTI currently has low liabilities and significant cash flow, Lane and Ray should seek debt financing. However, PTI is limited by having $92K in land/buildings and $150K in accounts receivable