Tracy KellyAdvanced Corporate FinanceFebruary 26, 2015Case #50: Flinder Valves and Controls, Inc.

Flinder Valves and Controls, Inc.

Flinder Valves and Controls, Inc. known as FVC is a manufacturer of specialty valves and heat exchanges. FVC began in 1980 formally part of a small company but separated to focus more on the engineering and developmental work on experimental heat-exchanger products. A little less than half of the products manufactured were special applications for the defense and aerospace industries. Those products required expertise in engineering due to the complexity of the projects. Because of this, they often did prime contract work on highly technical devices for the government. In 1987 FVC acquired the properties, both owned and leased of the engineering corporation once FVC was organized. Bill Finder was the President of the predecessor company and since became President at FVC. FVC went public in 1996.

RSE International was founded in 1970 by Tom Eliot; it was taken public and was a part of the Russell 1000 company. RSE was a three part company. One section manufactured a diverse range of products including industrial components, chains, cables, nuts and bolts, castings and forgings, and other similar products. The second piece of the company focused on producing a wide range of nautical navigation assemblies and allied products. The third section of the company manufactured a line of components for missile and fire-control systems.

FVC caught RSE’s attention because of a U.S. government contract they held to develop an advanced hydraulic control system, code-named “widening gyre.” This system would be used in numerous military applications. In May of 2008 both Bill Flinder, president of FVC and Tom Eliot, chairman and CFO of RSE were planning to negotiate a possible acquisition of FVC by RSE. The discussions had begun in the first quarter of 2007; after a few casual conversations had taken place the previous year, 2007. The U.S. economy had suffered in areas of finance, terrorism, war, etc. which effected both companies. “Both leaders were concerned about the opportunities and risks of doing a deal in the increasingly challenging environment.” This is a case of a small technology company looking to be acquired by a conglomerate technology company.

Pros/Strengths: FVC sell itself to RSE1) Due to the economy and the tighter borrowing standards FVC would benefit with

stronger cash flows, net income when merged with a larger company. The increase in equity will allow for more research and development, something Bill Flinder has stressed in previous years. Flinder wanted to improve products, with patent protection. FVC became appealing the moment they went public; Auden Company, a competitor that owned 20% of FVC stock proposed a merger in 1996. By 1998 FVC had received various proposal requests but none reached the stage of actually working out agreements except RSE. FVC is a hot commodity and it is always a great decision to sell when you are highly admired because you will receive fair pricing.

2) Part of the acquisition agreement is that FVC will keep its identity. The company will continue its brand name and image which is priority to most companies that have worked so hard to make a name for itself in the industry.

3) Flinder would be retained along with his top management team and all employees. That is a major benefit because most companies have to deal with huge layoffs, exit interviews, severance pay, unemployment payouts, etc. The no lay-off rule was a reflection of RSE’s intention to invest in and grow the FVC operation. The management team of FVC is what caught RSE’s attention.

4) FVC had Auden Company as an important non-distribution channel under a nonexclusive distributor arrangement.

Cons: FVC sells itself to RSE1) FVC doesn’t have any long term debt; once the acquisition takes place and they become

a division of RSE the debt RSE already has in place will be shared on the balance sheet. 2) 70% of FVC stock was owned by the Board of Directors and their families.

Strengths of RSE1) RSE is in Russell top 1000 companies. 2) RSE is a low-cost producer that possess unusual production knowledge3) It is very competitive in its industry4) Project CORE: a business wide initiative to improve and unify the corporate wide

information systems. CORE is an example that RSE functions as a team amongst its employees.

Weaknesses of RSE1) The market has undervalued RSE’s shares2) The need to increase profit margin3) Notes payable to bank (one paid semi-annually4) No international connection; it is clear that Auden Company does not want to do

business with RSE but continue their shares and relationship with FVC

The two companies should want to negotiate because they both will receive a benefit. It will allow both companies to focus on more research and development of products servicing the government as well as large distributors. With Auden Company being a huge competitor FVC continuing to have its own identity will bridge the relationship that RSE will eventually benefit from.

Flinder Valves and Controls, Inc is worth between $4,710,000.00 and $8,478,000 the key value drivers are the book value is a key driver because it will give RSE the total value of FVC’s assets that that shareholders would receive if the FVC would liquidate. RSE should not be sold for anything less than $4,710,000.00 this was derived using annual cash flow and multiplying it by 2.5 (industries average). Using the book value allows for comparison to the company’s market value, the book value can indicate if a stock is over or under priced. The earnings capitalization is also a key value driver; based upon FVC current cash flow and being able to predict their future earnings. The cash flow is 4times greater than the company’s liability including the stockholders equity. FVC has a strong cash flow.

RSE should complete the deal with a cash transaction. Cash transaction will allow for FVC to have more free cash flow for further research and development of their products. Also the current pricing for RSE shares are not quite up to par with the value of FVC shares. It would be beneficial for FVC to be able to reinvest in themselves and continue to grow with a cash transaction. If they were to be purchased with shares they would need to sell them in order to avoid a loan to secure funding for growth opportunities. For FVC there is risk in accepting stock as opposed to cash; if the value of the stock price decline that will be a lost for FVC. The value of the RSE shares can drop before the closing of the merger is complete. Cash is more of a risk for RSE but beneficial for FVC. RSE has stated that the market has their shares undervalued but it is not clear that FVC agrees therefore cash is the only acceptance for this merger.