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In early May 2008, W. B. Bill Flinder, president of Flinder Valves and Controls Inc. (FVC), and
Tom Eliot, chairman and chief executive officer of RSE International Corporation (RSE), were planning
to negotiate a possible acquisition of FVC by RSE. Serious discussions for combining the two companies
had started in March of that year, following casual conversations that dated back to late 2007. Those initial
talks focused on the broad motives for each side to do a deal, and on the management issues, including
compensation, in the new firm. What still remained was to negotiate a final term sheet on which the
definitive agreement would be drafted and signed.
In the background, the past 12 months had been associated with mounting difficulty for the U.S.
economy. The industries within which RSE and FVC operated were not immune from these effects. A
recent analyst report summarized the market view for industrial manufacturing.
Tighter borrowing standards and a severely weakened housing sector are weighing on the
domestic economy, prompting consumers to cut back on spending and industrial
manufacturers to reduce production. A similar situation now seems to be talcing hold in
western Europe.1
Both coiporate leaders were concerned about the opportunities and risks of doing a deal in this increasingly
challenging environment.
This case was written as a basis for class discussion. The companies and characters featured are fictional.
Copyright 2008 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved.
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FVC was an outgrowth of a small company organized in 1980 for engineering and developmental
work on an experimental heat-exchanger product. In 1987, as soon as the product was brought to the
commercial stage, Hinder Valves and Controls Inc. was organized to acquire the properties, both owned
and leased, of the engineering corporation. The president of the predecessor company, Bill Flinder,
continued as the president of FVC. Eventually, the company acquired the patents it had licensed.
The raw materials used by the company were obtainable in ample supply from a number of
competitive suppliers. Marketing arrangements presented no problems. Sales to machinery manufacturers
were made directly by a staff of skilled sales engineers. The Auden Company, a large firm in a related
field, was an important foreign distribution channel under a nonexclusive distributor arrangement. About
15% of FVCs sales came from Auden. Foreign sales through Auden and directly through FVCs own
staff accounted for 30% of sales. Half the foreign sales originated in emerging economies, mainly Brazil,
Korea, and Mexico. The other half originated in the United Kingdom, Italy, and Germany.
Although competitive erosion in the mid-2000s had temporarily interrupted FVCs sales growth,
better economic conditions in the markets of developed countries, together with FVCs recent introduction
of new products for the aerospace and defense industries, offered the company excellent prospects for
improved performance. Sales in the first quarter of 2008 grew 23% over the corresponding period in 2007,
at a time when many of FVCs competitors experienced limited growth prospects. Exhibits 1 and 2 show
the most recent financial statements for FVC.
FVCs plants, all of modem construction, were organized for efficient handling of small
production orders. The main plant was served by switch tracks in a 15-car dock area of a leading railroad
and also by a truck area for the companys own fleet of trucks. From 2005 to 2007, net additions to property
totaled $7.6 million.
Bill Flinder, an outstanding researcher in his own right, had always stressed the research and
development involved in improved products, with patent protection, although the companys leadership
was believed to be based on its head start in the field and its practical experience.
FVCs success had brought numerous overtures from companies looking for diversification, plant
capacity, management efficiency, financial resources, or an offset to cyclical business. For instance, when
Flinder Valves was taken public in 1996, Auden Company, which later became a holder of 20% of FVC
common stock, advanced a merger proposal. Rumors of possible antitrust action by the U.S. Department
of Justice had circulated after the news of the proposed merger became public, and Auden withdrew from
the discussions. FVC received various proposals from 1998 on, but none reached the stage of working out
an agreement until the advances of RSE International Corporation.
FV C had come to RSEs attention with the FVCs disclosure of a U.S. government contract. FVC
was to develop an advanced hydraulic-controls system, code-named widening gyre, for use
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in numerous military applications. The technology was still in research and development, but was expected
to have broad commercial value if the results were found to be economically successful.
The Situation
During the early part of2008, a series of group meetings had taken place between Tom Eliot and
Bill Flinder and their respective advisers. It seemed clear to both parties that both FVC and RSE could
profit from the merger. By early May, a broad outline of the merger seemed to be developing.
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Flinder Valves was to become a subsidiary of RSE Internationalthe deal would be structured in such a
way as to preserve FVCs identity. The two sides had explored some of the governance and compensation
issues in the merger. Flinder would be retained along with his top management team and all other
employees. No layoffs were contemplated. This reflected RSEs intention to invest in and grow the FVC
operation. FVCs solid management team was one of the factors that had attracted RSE in the first place,
and Eliot wanted to keep the same management in place after the merger. Flinder would receive a generous
option-based incentive bonus that could result in a salary increase of between $50,000 and $200,000 per
year. Because Flinder was 62 years old and nearing retirement, the compensation package was meant to
retain him in the coming years as he trained a new chief executive.
The price of the deal was less clear. FVCs shares traded on the NASDAQ, whereas RSEs traded
on the American Stock Exchange. The market capitalizations for FVC and RSE were approximately $ 100
million and $ 1.4 billion, respectively. Both companies had experienced recent rapid rises in share price
due to strong performance despite the weak economic environment. Exhibit 6 shows recent share prices
for Flinder Valves and RSE.2
The financial advisors had collected a variety of relevant capital-market data. Exhibit 7 provides
valuation information on exchange-listed comparables for Flinder Valves and RSE. Exhibit 8 presents
information on recent related acquisitions. Exhibit 9 presents historical money- market and stock-return
data through May 2008. RSEs debt was currently rated Baa.
Flinder had shared FVCs current corporate-financial-statement forecast with Eliot but had
emphasized that it did not include any benefits of the merger or the benefits of promising new technologies,
such as the widening gyre (Exhibit 10). The reluctance to include the widening gyre project stemmed from
the substantial uncertainty remaining regarding its potential economic benefits.
The companies had yet to settle on the form of consideration, either cash or RSE stock, that would
best serve the parties to the deal. Eliot expected that RSE had the financial capacity to borrow the entire
amount through its existing credit facilities. Roughly 70% of the Flinder Valves stock was held by its
board of directors and their families, including the 20% owned by the Auden Company and 40% owned
by Bill Flinder. Tire Auden Company did not object to the merger, but it had given notice that it would
sell any RSE shares received in the deal. The Auden Company was about to undertake a new expansion
of its own, and its executives were not disposed to keeping tag ends of minority interests in a company
such as RSE. They saw no reason, however, for not maintaining their satisfactory business relationships
with the Flinder Valves enterprise if it became a division of RSE International.
RSE Internationals stock had a beta of 1.25; the beta for FVC was 1.00, based on the most recent years
trading prices. Both companies faced a marginal tax rate of approximately 40%.
2