Cooper's Strategy
Cooper’s strategy is to diversify through the acquisition of companies that either complement Cooper’s current structure or add different product categories or industry sectors. This diversification strategy allows it to maintain stability by offsetting it’s subsidiaries earning cycles.
Cooper identifies candidates for acquisition by a standard set of qualifying factors. These factors include stability of earnings, earnings counter cyclical to existing divisions, mature products and technology, leading market position, serving a broad customer base, high quality manufacturing, and brand recognition.
Once a company has been acquired, Cooper follows a standard set of re-engineering procedures. The first step is to break down the acquired company into its basic parts. Then duplicate functions are eliminated and incorporated into the parent company. The next step is to integrate the acquired company into the Cooper structure; this may include geographic relocation of factories and offices, downsizing of work force, and the resolution of agency conflicts within the target company. Following the integration, Cooper evaluates all of product lines to determine profitability. Those that are not profitable are eliminated. Cooper then completely re-engineers the manufacturing process to facilitate productivity and cost management.
Cooper's moderate to high level diversification strategy is successful because Cooper was able to enjoy benefits from both related and unrelated diversification. Cooper was able to create synergy through related diversification, however this synergy was limited. Cooper, at the corporate level, was able to share knowledge on manufacturing processes and cost management throughout their subsidiaries and pooled negotiating power by centralizing the purchasing function for the entire group of companies. When dealing with suppliers they bargained for Cooper as a whole in order to drive down costs of raw materials (Appendix 2). For example, Gardner, one of the acquired companies, reduced sales and administrative expenses from 16.6% to 11.4%. Cooper also reduced the number of distributors from 160 to 120 over a period of four to five years, making the relationships more effective. Each industry segment benefited from synergy created by related diversification.
Benefits that Cooper received from unrelated diversification were important to achieve success in its acquisitions because Cooper's key resources, capital and human resources came from Cooper's internal markets (Appendix3). For example, the strong cash inflow from Cooper's internal capital market enabled Cooper to acquire companies, and in addition, stability of earnings made it easier for Cooper to receive financing. Cooper also achieved internal labor market efficiencies through managerial training and interdivisional transfers. In addition Cooper promoted internal product markets such as supplying lighting fixtures and electrical components for new buildings; this however was limited due to the specialized nature of their industry segments and products.
There are several boundaries to the Cooper Strategy. First, Cooper is focused solely on low-technology and mature manufacturing industries. Moving outside this strategy will cause Cooper to focus on areas outside its core competence. Also, there is the risk that Cooper will over expand and become too diversified. This in turn, would cause Cooper to cannibalize itself for the sake of acquisitions and strain the financial condition of the entire group.
Acquisition of Champion
Cooper industries might foresee many opportunities from its acquisitions, such as; broadening existing product lines, increasing profit margin through cost leadership strategy, serving a broad customer base, to enjoying widespread brand name recognition, and building up investors’ confidence in its potential growth toward its diversification acquisitions. Essentially, Cooper was thinking critically whether to acquire Champion or not based on Champion’s strength and weakness.
However, due to the shrinking of spark plug market, Champion’s existing strengths as marketing leader, worldwide brand recognition and manufacturing facilities didn’t guarantee the acquisition’s future success. Based on a distinct example of its advances in manufacturing, Cooper needs to invest large amounts of money to overhaul old technology in Champion’s auto parts manufacturing process. Moreover, Cooper must invest a large amount of free cash flow in order to absorb the existing bloated overhead that is present in Champion.
Most importantly, the premium acquisition cost of Champion requires Cooper Industries to generate more incremental economic value and greater synergy than expected. Although the Champion acquisition might be in line with Cooper’s strategy, the acquisition does not make financial sense. Cooper’s tender offer is presently 20% over the nearest bidder and, in addition, 25% over EBIT. The price that Cooper has tendered will endanger the health of the company for the sake of expansion. Cooper is essentially offering to pay too much for Champion. The goodwill that Cooper will have to write off in the next 20 years will be enormous. Goodwill incurred in this transaction will be more than $165 million (amount paid over fair value, 20%* $ 825 million). This means that if Cooper were to amortize the amount of goodwill expense over the next 20 years, the minimum annual goodwill expense will be $8.25 million. In effect, if the bid is accepted, Cooper’s wealth will be transferred to the current shareholders of Champion and expensed on Cooper’s books.
In addition, if Cooper acquires Champion with debt (as eluded to in the case), the interest expense will further damage Cooper. The average interest expense that Cooper has paid on long term debt financing has averaged 9.91% (interest expense/ LT debt) over the last four years. At this rate, the annual interest expense for the Champion acquisition will be $82 million (9.91% * $825) annually. Cooper is not in a financial liquidity position to incur the amount of debt required to acquire Champion. The long-term debt to equity ratio, which indicates the proportion of the entity that is financed through long-term debt, has significantly escalated since 1984. Furthermore, the debt ratio, a measure of total funds provided by creditors, has more than quadrupled in the same period (Graph 1).
Conclusion
Champion will essentially have to create more value for Cooper industries than the stock market has recognized to date. It is virtually impossible for Cooper to digest Champion and expect to turn the company around to profitability through process re-engineering without cannibalizing itself in the process. The $21 per share tender offer for Champion is not financially feasible. The best strategy for Cooper Industries to follow is to make sure that mergers and acquisitions is a tool used to incorporate strategy for a specific and well planned purpose, instead of reacting to deals that that just come along.
Appendix 1 Cooper’s Value Chain
Appendix 2 Appendix 3
Appendix 4 SWOT Analysis of Champion
Graph 1
Note: Increasing Debt ratios indicate higher credit risk for creditors