Case Study-QA124

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Havard Business School

Pinkerton(A)
 

The Security Guard Industry
 
The security guard industry had two segments: (1) proprietary guards and (2) contract guards. While both types of guards performed similar services, a proprietary guard was an employee on the payroll of a no security firm. Contract guards were “rented” from specialist suppliers like Pinkerton’s, CPP, Wackenhut, and Baker Industries. The historical growth of the contract guard segment of the industry was due in part to companies concluding that they gained operating flexibility by contracting out their security needs as opposed to managing their own security operations. By late 1987, security guard services was a $10 billion industry growing at 6% a year. But the industry was also mature, fragmented, and price-competitive. As a result there was an on going trend toward consolidation at the expense of smaller, local guard companies whose employees were often imperfectly screened and poorly trained.
 

Pinkerton’s
 
The security guard industry began in 1850 when Allan Pinkerton founded the Pinkerton’s Detective Agency. The firm gained fame in the nineteenth century with its pursuit of such outlaws as Butch Cassidy and the Sundance Kid. In the film portrait of that pair, Paul Newman repeatedly asks Robert Redford, “Who are those guys?” Those “guys” were Pinkerton’s men and women.
 

California Plant Protection
 
When Wathena bought CPP in 1963, the firm had 18 employees and revenues of $163,000. By1987, Wathena had built CPP into a $250 million security guard company with 20,000 employees and125 offices in 38 states and Canada. Exhibit 2 gives selected financial data for CPP. Wathena built CPP with his consummate marketing skills and the strategy of differentiating the firm with employee screening and continual training. CPP’s expansion was aided by the explosive growth of California’s economy and because the bigger, more established East Coast security guard firms had ignored the West Coast.
 

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CPP’s Acquisition of Pinkerton’s
 
Wathen wanted to buy Pinkerton’s for several reasons. First, he had always had the goal of creating the largest firm in the security guard industry, and the acquisition of Pinkerton’s would put him in a virtual tie with Baker Industries—a subsidiary of Borg Warner and the largest provider of contract guard services. Secondly, Wathena had been convinced for some time that American Brands was mismanaging Pinkerton’s and destroying a great brand name with its pricing strategy.
 

In October 1987, American Brands announced it had decided to sell Pinkerton’s because the security guard firm no longer fit into Brands’ long-range business strategy. Upon this announcement, Jerry Brown, CPP’s secretary and general counsel, recalls, “Tom [Wathen] called mein and from that moment I knew he was going to do whatever it took to buy Pinkerton’s. Tom wasalways hung up on being the largest, and on Pinkerton’s name.”
Morgan Stanley, an investment bank, was to represent American Brands in the sale and the bidding promised to be hotly contested. A task force of senior managers was quickly formed to prepare CPP’s bid which they knew, given the time pressures of the sale, would not have the benefitof adequate preparation.

 

The task force believed there were three ways CPP could create value by acquiring Pinkerton’s. The most obvious source of value would come from consolidating the operations of CPP and Pinkerton’s by eliminating common overhead expenses such as corporate headquarters, support staff, and redundant offices. Second, the task force believed that significant improvements could be made in the management of Pinkerton’s net working capital. The third source of value, and possiblya unique insight by Wathena and the CPP task force, was the Pinkerton’s name. They believed that,

 

Financing a $100 Million Bid
 

In a last ditch effort to improve his bid for Pinkerton’s, Wathen asked his investment banker to determine the options for financing a $100 million bid. The banker responded with only two alternatives. The first alternative came from an investment firm who would provide both debt and equity financing. The debt, in the amount of $75 million, would have a seven-year maturity and an11.5% interest rate. The loan principal would not be amortized prior to maturity, at which time the entire $75 million would come due. Finally, this debt would be a senior obligation and be backed by all the assets of the new combined firm. The equity, in the amount of $25 million, would be provided in exchange for 45% of the equity in the new combined firm. The second alternative was a 100% debt financing offered by a bank. The bank would lend $100 million at the rate of 13.5% a year. The loan principal would be amortized at the rate of $5 million a year for six years, with a final payment of $70 million at the end of the seventh year. Again, this loan was collateralized by all of the assets of the new combined firm.
 

Under either financing alternative, Wathena was very concerned about the required debt service. The new combined firm’s non-public, as well as high-leverage, status could make any cash flow problems over the next five years highly problematic. The task force also reminded Wathena that a $100 million purchase price would result in the creation of good will on his balance sheet which would have to be amortized at the rate of $5 million per year for the next 10 years.1

 

Wathena sat in his office and prepared to make the biggest decision of his career. As an entrepreneur and an experienced security guard executive, Wathena was sure Pinkerton’s was a good buy. However, he had routinely relied on his board and other advisers for financial advice. His board had reluctantly approved his earlier bid of $85 million and was sure to balk at a $100 million bid. How could he justify a $100 million bid for Pinkerton, particularly in light of his earlier bid of$85 million? And if he was successful in convincing the board, how was he going to finance the acquisition?
 
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