Saturday, December 17, 2011

Harvard case: Singulus

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1- What is the nature of the opportunity?


Denton Vacuum Inc (DVI), a New Jersey based manufacturer of vacuum deposition equipment for precision optics decided to acquire Singulus, a compact disc metallizer business in Germany that Oehrlikon-Buhrle Holding AG (OBH) has put up Singulus for sale.


DVI choosed Schroder Ventures, one of the first LBO group in Germany, as financial partner on this deal.


The market for metallizers was dominated by two companies, Balzers (a subsidiary of OBH) and Singulus (owned by Leybold). In November 14, OBH acquired Leybold, bringing Leybold under the same ownership as Blazers, meant that 0% of CD metallization business would be under one single ownership. OBH had to sell one of the two-metallization businesses, and Singulus has then been put up for sale.


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Friedrich von der Groeben, Managing Partner of Schroder Ventures Frankfurt office, found the deal very interesting DM0 million purchase price for a DM 0 million in revenues and DM8 million in EBIT firm.


However, beside attractive figures, the deal was not turned out to be a simple one. In fact, the nature of the deal was unusual


First, the market for CDs was highly seasonal, with a peak during Christmas. Demand was difficult to predict in advance and in 14, capacity was only used at 44% (demand for CDs was .1 billion, output was . billion and capacity was 4.8 billion).


Then, OBH didn’t sale a company or a manufacturing plant, but intellectual property. The acquirer would then possess property rights, a customer database, processes and technologies. The deal was not made of any tangible assets.


Moreover, the selling parent would become Singulus main competitor, giving OBH an interest in selling to the weakest bidder.


Another issue was that there would be business interdependence between Singulus and Leybold, even after the deal was complete. Leybold was a major supplier and customer of Singulus and used to share sales, marketing and service with it.


On the other hand, the deal offered excellent returns and could put Schroder Ventures in good position in the emerging market for corporate buyouts in Germany. The metallizer market also looked promising with an expected doubling CD production capacity over the next four to five years, an increase of 60% in CD demand for the next 4 years (exhibit ) and a relative low threat of new entrants.


Singulus purchase price was set in between DM0 to DM40 million. Schroder Ventures would put up just over DM11 million. The rest would be covered by contingency payments, other shareholders equities and loans. A high need of cash is required to take the business over, so loans represents 78% of the total Schroder Ventures investment (DM8.65 million).


Finally, the deal economic transfer would be done on May, 1st 15 and be finalized until around December of the same year, giving Schroder Ventures less than two weeks to make a decision.


- What will it take for Schroder Ventures to make this deal happen successfully?


Schroder Ventures has to address several issues to make the deal successful.


First, none of the key staff has interest in leaving Leybold to join Singulus. Moreover, Friedrich von der Groeben didn’t find a CEO with enough credibility within Leybold to convince them. However, he approached Roland Lacher (ex General Manager of the Coatings Division including Singulus) who is not entirely happy at Leybold anymore.


The big issue for Schroder Ventures is to convince Lacher to join Singulus, giving him enough power, flexibility and compensation (company’s shares). If he doesn’t want to join, Schroder Ventures will still have to find someone to take the command of the company, either an internal candidate like Reiner Seiler (head of sales for the Singulus business) who is probably not experienced enough, or hiring an external candidate, which seems more risky. In any case, Friedrich von der Groeben will still have to persuade the rest of the management team to join the new venture. With Roland Lacher on board, convincing the rest of the key staff seems realistic and feasible.


Second, Schroder Ventures must restructure Singulus as an independent entity since they are only buying a bundle of property rights. In fact, as previously stated, they will acquire a set of rights, a customer list, processes and technologies. The issue for Schroder Ventures is to raise the funds for buying Singulus, but also for building facilities, hiring the people (management, sales, service organization, accounting & administration and R&D) and making the operations up and running. They need to get the financial structure of the deal right, and Schroder Ventures must estimate it quickly.


Finally, Schroder Ventures has to ensure that Singulus, once independent, will not become excessively vulnerable to Leybold. Today, Leybold is the exclusive Singulus vacuum pump supplier and a major customer as well (Leybold represents % of the total units sold in 15 � exhibit 1). Schroder Ventures must find other suppliers to create a competitive environment and must enlarge its customer database by regaining, for example, customers lost due to the uncertain Singulus’ status regarding its disposal by Leybold.


- What are the major risks for Schroder Ventures? In the short term? In the long term?


The major risks that Schroder Ventures might encounter are


In the short term


- Not being able to convince Roland Lacher and the rest of the management team to join the new venture.


- Not being able to raise the required money to make the deal. Investors are difficult to convince since there are no tangible assets to the business and Germany is not a high cultural environment for entrepreneurship.


- Leybold sees DVI as an ideal acquirer for Singulus. However, OBH has also interests to sell to the weakest bidder. There is a risk that Schroder Ventures be the weakest bidder.


- Not being ready for the high season in Christmas.


In the Long term


- Failing of turning Singulus property rights as a viable business.


- Offering an integrated replication line strategy, and cannibalise most of its metallizer sales.


- Not being able to regain the customers lost due to the uncertainty of the deal.


- Losing market shares against Blazers.


4- What price should Schroder Ventures offer for Singulus?


To value the firm, I chose to use different methods The Basic Venture Capital Formula and the traditional method consisting of discounting the yearly free cash flows.


Valuation 1 The Basic Venture Capital Formula


Fact summary


o Required IRR 50% - We can consider Singulus as a first-stage financing business. Discount rates at this stage are generally 40% to 60%. I chose the middle value 50%.


o Investment DM.4 million (exhibit 1)


o Term 4 years (15 to 18)


o Year 4 net income = EBIT � taxes (45%) = DM15.5 million x 0.55 = DM8.5 million.


o Year 4 PER Singulus is closely related to the storage business. I looked to major storage companies PER (StorageTek, Seagate etc…) and we can assume that Singulus prospective PER for 18 is around 5.


Required Future Value (Investment) = 1.5᠀ x .4 = DM1.15 million


Total Terminal Value = PER x Terminal Net Income = 5 x 8.5 = DM1.5 million


Final Ownership required = RFV/TV = 1.15/15.5 = 5.7%


Post-Money Valuation = investment/%ownership acquired = .4/5.7% = DM4 million


Pre-Money Valuation = Post-Money Valuation � Investment = 4-.4 =


DM.6 million.


Valuation Traditional Method


Only a few elements are available to apply the method. However I made a few assumptions


Depreciation and amortization should increase in the time because of the development of the business, especially if Singulus decides to offer an integrated replication line. I also assumed that interests would occur every year at a rate of 10% of the loan (kDM880). I also assume that capital expenditure will be higher in 16 because of an extension of the business.


Finally I assumed that Singulus ß=1, Rf=0.0 and g=0.1. Then, k=0.14.


With this method, I value the deal at DM4.4 million.


(See Appendix 1 for details).


By using these two methods, we can estimate Singulus around DM45 million.


I think that Schroder Ventures should make an offer below this estimation, may be around DM5 million. They know that they are seen as the only ideal acquirer for Singulus, and they also know that DM0 to 40 million would be required to purchase it, so OBH may agree to sign the deal at this price.


Moreover, buying Singulus at a bargain price could be very interesting for Schroder Ventures. First, they will keep cash to finance the rest of the business (facilities, equipment, personnel etc…) and second, the market predictions for the next 4 years are promising, so investments will probably be heavy.


5- What incentives does Schroder Ventures need to set for Singulus’ management?


One of the key elements to make the deal successful is to convince the management team to leave their current positions and take jobs with the new venture. For that, a CEO with experience and credibility had to be found.


Roland Lacher was an ideal candidate. To attract him, Schroder Ventures need to offer him a good compensation package (in addition to the 5% bonus given by OBH), power and flexibility.


Moreover, Roland Lacher as well as the rest of the management team should own shares of the firm and need to have incentives on the following objectives


- Short term (within 6 months)


o Building an operational organization and structuring Singulus as an independent entity.


o Buying or leasing facilities.


o Being effective and ready before high season (Christmas).


- Mid term (within 1 year)


o Regaining lost business due to uncertainty about Singulus’ status.


o Recapturing OEMs market (50% of the total OEM market share in 1 year).


o Improving handling system.


o Building an integrated lines business strategy.


- Long term (within 5 years)


o Being positioned and ready for the DVD market.


o Extending expertise to injection molding machines (or other technologies to gain competitive advantage).


o Being recognized as an innovative and high technology company.


o Entering into the global market and using economies of scale.


6- Should Singulus offer an integrated replication line?


There are two main issues concerning the integrated replication line first, if Singulus chooses to build an integrated line, it could reduce its dependence on OEMs and help the company to increase margins. Moreover, an integrated line strategy would attract key people that otherwise would be almost impossible to hire. On the other hand, that strategy could cannibalise the metallizer business.


The second option is to not re-enter the lines business. This strategy would help to recapture some lost market shares, OEMs in particular.


I think that Singulus should offer an integrated replication line for the following reasons


First of all, an important reason is the financial interest in the integrated line business. Assuming that the financial projections described in Exhibit 8 don’t include an integrated line strategy, we can calculate EBIT margin for each year from 15 to 18. We find that EBIT margin in 15 is 40%, in 16 %, in 17 0% and 18 7%. There is a decrease of the EBIT margin mostly due to a continuous increase of the cost of goods (cost of good represents 1/ of the sales in 15 and moves up to 50% in 18). Based on Singulus projections, offering an integrated replication line will reduce costs and will increase margins; moreover sales would increase by DM10 million in 16, rising to DM5 million by 18.


This strategy will also help Singulus to put pressure on Balzers and act on an opportunity to improve their position.


The second point is the opportunity to attract and convince key people to leave their current positions and take jobs with the new venture. At this stage of the deal, building the management team is a key issue for Schroder Ventures because none of the key staff indicated any interest in leaving Leybold. Nevertheless, if an integrated line business is chosen, Friedrich von der Groeben can still hope to convince them to join the new venture because they are all very strong supporters of that strategy.


The third idea is that the metallizers market is essentially composed of two main competitors, Balzers and Singulus, and the threat of new entrants in the market is very low. Balzers already offers integrated lines. Therefore, it is critical for Singulus to compete in this segment to reduce Balzers’ differential advantage and to maintain the rivalry between the two competitors.


The completion of the entire value-added chain will thus offer to Singulus a significant strategic competitive advantage for all current and future disc formats.


Finally, the risk of offering integrated line is to miss the opportunity to recapture some OEMs businesses. However, there was evidence that margins in the OEM segment would not fall dramatically because of open architecture strategy that key OEMs tend to follow.


Based on those elements, Schroder Ventures should offer integrated replication lines.





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