The Timken Company

In this case we analyst whether Timken should acquire Torrington company from Ingersoll-Rand by cash, issuing share to public or issuing share directly to IR. IR wanted to divest Torrington and Timken aim to acquire it. After merging with Torrington Timken will be world third largest company in bearing industry and Timken would gain more sales as Timken and Torrington has about 80% of overlapped customer. Moreover after the synergy they can reduces cost, increase market shares and have more production lines. As Timken leverage ratio is not good, so they couldn’t raise cash that needed to be paid for the acquiring because if they did so the investment-grade rating will be deceased. Timken rating now is BBB so they couldn’t risk it to go lower.

As Timken stock price is 19$/share they would have to require a lot of shares for the public to gain enough money for the acquisition and there is a risk that Timken couldn’t sell all of shares. For the last option is by issuing share directly to IR would benefit Timken as it will change capital structure reduce debt more equity. But it wouldn’t happen either because this option will make IR take the risk for holding to Timken stocks while they already have plan to invest in other segment. Our group suggests that Timken should acquire Torrington by issuing share directly to IR and pay cash by doing this will cause a win-win situation.

Introduction
Timken Company was a bearing company who was the manufacturer and also the developer at the same time. They have been operating their business for over 100 years which is well-known that their business is the leader in the bearing industry. In the year of 2002, the company was deciding in acquiring the Torrington Company from Ingersoll-Rand Company because they want the synergies to support their growth. Thus, Timken had to spend more than 80$ million in this acquisition which could make the company facing the financial troubles. That is if they give a big amount of acquisition, it will certainly affect to their balance sheet and directly impact on their investment-grade rating. This was a quite challenge to Timken Company. They have to carefully decide on what the best way to manage their financial deal. The Timken Company SWOT Analysis

Strengths
Timken was found since 1898, therefor the company had expertise in bearing manufacturing. Weaknesses
Timken wasn’t the biggest bearing manufacturers. There are a few bigger competitors compare to Timken which could have access to wilder group of customers. Timken could not adapt their business in economic recession so well. In 1999, it had to cut 20% of production capacity. Opportunities

The federal government increased antidumping duties up to 59.3%. As a result, price of imported bearing were expected to increase. Timken could expand to foreign countries to attract more of foreign customers. Enhancing basic products with additional component to add more value could be an opportunities for Timken to fight with foreign competitors which only offer simple products. The company can offer installation and maintenance service, as well as ongoing engineering. This would benefit customers by reducing the number of suppliers and relieving them of routine labor- and cost- intensive tasks. If Timken successfully merge with Torrington, it will become third-largest producer of bearing in the world. Treats

The policies related to steel industry didn’t consider the benefit of bearing industry since it’s a secondary steel product. Foreign competitors could sell the same quality products at cheaper price. Economic recession decreased automotive demand, thus decreased bearing demand. Analyst predicted that bearing industry would have only 2-3% domestic growth.

Torrington with Timken Company
If Timken successfully acquired Torrington, it would become 3rd largest bearing manufacturer in the world. The two companies had 5% overlap of products but 80% of customer list. Customers would benefit by a more complete product line and the ease of having less supplier to work with. By combining the products that Timken and Torrington have, it creates more value to products, and therefore more earning for the company. Timken also planned to increase penetration of global bearing market from 7% to 11% by introducing Torrington products its distribution network. Moreover, $80 million annual cost saving was expected by reducing the combined sale
forces.

Valuation of Torrington
For stand-alone valuation and synergy valuation of Torrington we can calculate by use free cash flow (FCF) and use discount cash flow to find firm value.

From formula, we can calculate in same methods for two case. First case, firm value of stand-alone valuation is $189.9 million and second case, firm value of synergy valuation is $1,353.34 million by use 8.78% of discount rate (WACC) and 6.5% of planning growth from assumptions. Therefore, If Torrington was acquired by Timken, firm value of synergy with Torrington will be larger more than stand-alone.

Assumptions
WACC
In our analysis we calculate WACC by using CAPM method to find the Cost of Equity. For Weight of Equity we use a number of Shareholders’ Equity in Exhibit 2 divided by Shareholders’ Equity plus Timken’s Debt (Exhibit 8), for Weight of Debt we calculate by take Timken’s Debt divided by Shareholders’ Equity plus Timken’s Debt which we got = 56.91% and = 43.09%. And for Cost of Equity we use Risk premium rate at 4.53% which refer from the real historical risk premium in 2002, we also use Risk free rate at 4.97 and Beta at 1.10 which are given in the Exhibit 9 and 8 respectively.

Long Term Growth Rate
We use Capital Market Long Term Yield as Long Term Growth Rate in Exhibit 9 which is 4.97%.

Net Working Capital / Sale
We calculate the Net Working Capital by take Total Current Asset minus with Account Payable and Total Current Liabilities (all in exhibit 2). We use Net Working Capital / Sale in order to calculate the new Net Working Capital by multiply the it with sales.

Property Plant and Equipment / sales start
We use Property Plant and Equipment (Exhibit 2) divided by Total Operating Revenue (Exhibit 1) to find the common size of PPE in order to calculate the new PPE.

Operating Margin
For Operating Margin we use the Operating Margin from Exhibit 5.

Enterprise Value / EBITDA
We can find Timken Enterprise Value / EBITDA in Exhibit 8 which is 5.9. We calculate the Industry Value / EBITDA by using the average of all the Enterprise Value / EBITDA that’s given in Exhibit 8. Steady State Synergy

From assumption, we use $0 for standalone case and use $80 million for synergy case. In synergy case we use $80 million because this number is cost that Timken can save. Integration Costs

From assumption, we use $0 for standalone case because this case don’t have cost of integration for acquire Torrington but for synergy case we use $130 million because they have cost of acquisition or integration cost.

Investment-Grade Rating
Timken had a good EBITDA interest coverage compare to the industry, 2nd highest compare to other companies which had BBB credit rating. Although, the company EBITDA/Sales ratio was one of the lowest comparing to other companies in the industry. Its enterprise value/EBITDA ratio was also low compare to other companies. It would be very risky for Timken to issue $800 million debt in order to acquire Torrington consider that Timken had already $350 million long term debt which need to be paid $30 million for interest (around 8.5% interest rate). If Timken issued $800 million debt with 7.23% interest rate (BBB industrial yield), it would need to paid $58 million interest each year which was a huge amount compare to its operating profit of the latest year at $79 million. There is still a chance of borrowing debt if Timken can pay accumulated interest in the later year when Torrington starts to earn profit.

Timken’s Decision
If Timken decides to go forward with the acquisition of Torrington Company, they will exactly get the benefits in many ways. Timken will have substantially stronger product and service offerings for its automotive and industrial customers. This means the company would have not only complement products but also more variety types of products. It would be able to make more value for customers with a more complete product line with efficiency development. Moreover, it will increase its penetration of the global bearing market from such 7% to 11% which could make a bigger various amount of customers. Timken could have more power in negotiation with customers and suppliers. In the aspect of Ingersoll-Rand Company, we think they would better want a cash deal from Timken due to the none risk which they do not have to take the responsibilities with when compare to the stock-for-stock deal.

Risk of Ingersoll-Rand
Torrington a company of Ingersoll-Rand and acquiring target of Timken. Ingersoll-Rand wanted to divest Torrington and invest in other segment or company that are more related and Timken wanted to buy Torrington but due to the issue of debt, they may be decide to acquire Torrington by issuing share to the public to gain cash or by issuing stock directly to IR instead of cash. If IR accepts this offer, they have to accept the risk of Timken stock as you can see from exibit7 from late 1998 Timken stock price is always below S&P500 and Ingersoll-Rand moreover the stocks price didn’t brandish much. After selling Torrington Timken shares price will be dilute and if the stock price remain sideways they will have to wait for the right moment to sell the stock and that will waste more time and if it reverse to downtrend IR wouldn’t be happy as they already has other segment to invest in. In other way if free cash flow increase after synergy IR could gain profit from higher share price. In summary IR have to faces the risk of how free cash flow of Timken will be after synergy. Our group opinion is IR wouldn’t need to take the risk above as stated and they would prefer this offer more in cash.