SCHNEIDER - SQUARE D
Strategic Rationale for a Combination of
Schneider and Square D (1)
1. Historically, the industry has been segmented
by country or by region. Barriers to entry in
these different markets have been perpetuated
by:
 Differences in standards across countries and
regions;
 Costs of R&D for new products and costs of
translating technologies for different
regional standards;
 Proprietary distribution networks;
2. Industry trends point towards increased
globalization:
 Product standards are becoming common
across regions;
 R&D costs continue to grow increasing the
benefits of economies of scale;
SCHNEIDER - SQUARE D
Strategic Rationale for a Combination of
Schneider and Square D (2)
Given the above factors, Schneider and Square D
appear to be a good match:
 Schneider is a leader in Europe whereas Square
D is a major player in the US market;
 Schneider appears to be especially strong in
industrial distribution whereas Square is
strongest in residential distribution;
SCHNEIDER - SQUARE D
Synergies between Schneider and Square D
 Rationalization of R&D efforts and benefits
from sharing existing technologies;
 Access to larger distribution channels for both
companies;
 Rationalization of manufacturing capabilities;
 Benefits from cross-selling products;
SCHNEIDER - SQUARE D
Effect of Acquisition on Goodwill
Purchase Price
$60
$65
$70
Square D’s SE ($m)
603.6
603.6
603.6
Adjustment for
inventory revaluation
138.1
138.1
138.1
Revalued SE ($m)
741.7
741.7
741.7
Nb of shares (m)
23.2
23.2
23.2
Price per Share
$60
$65
$70
Market Value of Square 1390.9 1390.9 1390.9
D’s Equity ($m)
Goodwill ($m)
649.1
765.1
881.0
SCHNEIDER - SQUARE D
Effect of Acquisition on Schneider’s Earnings
($m)
(1FFr = $0.184)
Purchase Price
$60
$65
$70
Schneider’s Earnings
251.2 251.2 251.2
Square D Earnings
120.7 120.7 120.7
Merger Synergies
60.0
60.0
60.0
Goodwill Amortization
(16.2) (19.1) (22.0)
Combined Firms’
Earnings
415.7 412.8 409.9
 The goodwill effect is thus significant;
 There is however little reason to believe that
investors will not be able to understand the
effect of the goodwill calculation;
SCHNEIDER - SQUARE D
Assumptions Made by Lazard
1. Sales Growth of 3.5% in 1991 and 7%
thereafter;
2. EBIT/Sales of 15 to 16%;
3. Net Working Capital/Sales at a minimum of
11 to 13%;
4. Projected Capital Expenditure/Sales of 5%;
5. Depreciation Expense/Sales at 4% between
1991 and 1997 and 4.3% thereafter;
SCHNEIDER - SQUARE D
Prior Years’ Financial Performance Based On
Square D’s Continuing Operations
(%)
90
89
88
87
86
85
Sales Growth
3.4
6.7 12.5 4.4
4.2
EBIT/Sales
12.9 12.0 13.1 15.9 16.8 17.4
NWC/Sales
23.6 12.1 11.9 14.5 16.0 16.5
D&A/Sales
3.6
3.1
3.0
3.2
3.0
2.7
CAPEX/Sales
5.7
5.0
4.8
2.7
5.6
5.1
SCHNEIDER - SQUARE D
Some General Observations on Prior Years’
Financial Performance
1. Square D’s performance declined in the mid80s from 17% to 12%;
2. In spite of the recession, there is a modest
upturn in 1990. Is this an indication that the
firm’s restructuring efforts are paying off?
3. Net Working Capital/Sales steadily declined
until 1990, when there is a large increase due
to a build-up in cash;
4. Capital Expenditure/Sales declined
dramatically in 1987 as the firm responded to
the deterioration in its business by cutting back
on new investments;
SCHNEIDER - SQUARE D
Some General Observations on the
Assumptions Made by Lazard
1. Sales Forecasts:
- Perhaps somewhat optimistic given the
recession in 1990;
- Analysts however envision a recovery by the
end of 1991 or in 1992;
- But for how long can a 7% growth rate be
sustained?
2. EBIT/Sales:
- This profitability margin was equal to 12.9%
in 1990;
- It never exceeded 13.1% over the last three
years;
3. Net Working Capital Requirements/Sales:
- About right?
SCHNEIDER - SQUARE D
Pro Forma Statements
Exhibit 1
SCHNEIDER - SQUARE D
Square D’s Cost Of Equity Capital
 Equity : 0.95;
 In early 1991, interest rates were as follows:
- 3 month Treasury Bills rates: 6%;
- 30 year Government Treasuries: 8.25%;
 Based on these rates, the appropriate risk free
rate is 8.25%;
 Assuming a market risk premium of 7.9%,
Square D’s cost of equity capital is: 15.9%;
SCHNEIDER - SQUARE D
Valuation of Square D Using Lazard’s
Assumptions
DDM
 Assuming cost savings from the merger of $60m
after tax per year, Square D’s stock is worth
approximately $86.6;
 On a stand-alone basis, Square D’s stock is thus
worth approximately $69.0;
 Assuming cost savings increasing at the rate of
growth of sales, Square D’s stock is worth
around $100.0;
 These estimates are substantially higher than the
stock’s market price before any takeover rumors:
$40-$45;
SCHNEIDER - SQUARE D
Valuation of Square D Using Lazard’s
Assumptions
PE-Based Valuation
 EPS from continuing operations were $4.76 in
1990;
 Assuming that Square D’s price before the effect
of any merger rumor is $45, the firm’s (trailing)
PE ratio is about 9.5;
 Given Lazard’s assumptions of operating
savings of $60m per year, the stock should be
worth about $69!
($45+(9.5*$60/23.181))
SCHNEIDER - SQUARE D
Implications of Lazard’s Assumptions for Pro
Formas and Valuation (1)
(%)
1991 1995 1998
Growth in SE
(13)
6
5
D/(D+E)
29
30
31
ROE
23
30
31
1.45
1.51
1.56
AT
SCHNEIDER - SQUARE D
Implications of Lazard’s Assumptions for Pro
Formas and Valuation (2)
 ROE increases from 21% in 1990 to 31% by
1998;
 Asset Turnover increases from 1.33 to 1.56 in
the same period;
Lazard most probably did not intend making that
optimistic implications;
These implications arose primarily because fixed
assets are growing at only 3 to 4% per year
whereas sales are growing at 7%;
SCHNEIDER - SQUARE D
Revised Valuation Assumptions
1. Sales Growth of 3.5% in 1991, 7% in 1992
and 1993, 5% for 1994, and 3% thereafter;
2. EBIT/Sales of 14%;
3. Net Working Capital/Sales at 13%;
4. Net PPE to grow at the same rate of growth as
sales;
5. Depreciation Expense/Sales at 7.5% of PPE
(BY);
6. Long-term growth of 4%;
SCHNEIDER - SQUARE D
Revised Valuation
Under the set of revised assumptions, as shown in
Exhibit 2:
 Square D is valued at around $59 per share
including the effect of improved operating
performance from the merger;
 Square D is valued at $41.40, which is
comparable to the value assessed by the stock
market before any takeover rumors;