FIN- II

Printicomms proposed acquisition of digitech:

negotiating price and form of payment

Case Analysis
Instructor: Prof Kanagraj A
Vivek Gupta, Section-C
PGP-1

Printicomms proposed acquisition of digitech: negotiating price and

form of payment

Executive Summary
In December 1998, Jay Risher, VP of Printicomm, Printicomm, a company
which handled electronic and paper submissions of print copy throughout the
world proposed an acquisition of Digitech. Risher, who believed the value of
Digitech was no greater than $30 million, negotiated a letter of intent for the
exclusive rights to purchase Digitech; however, this would expire in two
weeks. The two leaders of Digitech valued their firm at $40 million. It was
crucial for Risher to decide on the correct deal structure as Risher hoped to
maintain Digitech employees after the acquisition. Both companies would
complement each other after the acquisition and offered considerable growth
potential.
Frank Greene, founder and owner of Digitech, hoped to sell Digitech and
retire within the next few years while its value was attractive. Greene
compared the sale of Digitech to many other recently sold firms that went for
10-12 times EBITDA. The value of Digitech was said to be a function of
Greenes involvement, which would soon cause another incongruity in the
sale price. Risher was only willing to pay a maximum of $30 million for
Digitech and remained firm on this price after his valuation calculation
through a discounted-cash-flow analysis. Bidding wars continued and the
final offering was $28 million for Digitech and a firm holding price by Greene
of $40 million for the company.
Risher was concerned he would lose the Digitech deal and other competitors
would quickly acquire them. As a result of this, he proposed earn out for the
transaction. Two different earn out structures were proposed; one
extending payments to Greene and CEO Jep Buckingham over the
next five years based on Digitech earning certain operating-income
targets. The second earn out proposal offered contingent payments
over the next three years. After focusing on a fixed-price deal vs. an earn
out-based deal, Risher felt both parties could reach an suitable enterprise
valuation. After both proposals, Risher contemplated four strategic
alternatives Printicomm could accept; developing the same
technology Digitech could offer on their own, find another company
to purchase, the fixed-price deal for the acquisition, and the earn
out.

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Vivek Gupta,

Printicomms proposed acquisition of digitech: negotiating price and

form of payment

Problem Statement
Printicomm exclusive right to negotiate price and form of payment with
Digitech ended in two weeks. Risher must recommend the most attractive
structure to Greene that will also benefit his company.

Reason for Acquisition

Jay Risher, Vice President and Controller of Printicomm believed the acquisition of
Digitech would have a significant and positive impact on the performance of their
Journal Services and Point of Purchase divisions. Printicomm is in need of expanding
its internet- and technology-based offerings. Digitechs Marketelengence product is
a must-have for Risher. The product is aligned with the way the industry is
moving; less focus on hardcopy print, more focus on converting to digital asset
management.

Alternatives
Secure a fixed price (easiest alternative) - This only required a standard
purchase and sale agreement; however, the two companies remained far
apart on the fair valuation for Digitech. If Printicomm paid a premium price,
then the management of Digitech may not stay to grow the business. It was
essential to have the business knowledge passed from Digitech to
Printicomm.
Pursue an earn out - this was an acquisition payment mechanism whereby
some portion of the purchase price of the acquired company (Digitech) would
be paid by the acquisition company (Printicomm) only if the agreed upon
goals were reached.
Develop Digitech technology in-house if a purchase price could not be
reached or try to find another company to purchase

Earn out option analysis

Three elements for a successful earn out:
The earn out should be based on achievable performance goals for Digitech
after closing
Digitechs management should receive adequate compensation
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Vivek Gupta,
Sec C

Printicomms proposed acquisition of digitech: negotiating price and

form of payment
Digitechs management should receive adequate resources and freedom to
achieve these goals

Earn out option I, 5 Years Model

The first earn out structure would extend payments to Greene and Buckingham, two
employees of Digitech, over the next five years. These payments would be based on
achieving certain operating income targets.

YEAR
1999
2000
2001
2002
2003

EARN OUT TARGETS

$2.5 m
$3.0 m
$3.0 m
$3.5 m
$3.5 m

NPV
$2,380,952.38
$2,857,142.86
$2,857,142.86
$3,333,333.33

Earnings before interest and taxes, is the income the company earns without regard
as to how the business is financed. If the management were to run the business into
the ground then they could distribute the cash flow to owners and creditors. Most
companies; however, retain some of the cash flow to pay for capital expenditures.
So, the free cash flow is what is available for distribution to creditors and this is the
amount after taxes, depreciation, capital expenditures and working capital.
The operating ratio which is total expenses/sales is between 88 and 90% on both
the projections by Printicomm and Digitech. This ratio indicates the expenses are
almost equal to the sales revenue for the product.
The profit margin, which is net income/sales, is each sales dollar that is filtered into
income. Based on profit margins of similar companies, the profit margins are in the
medium range. The net income is at the low end based on industry comparability.
PRINTICOMM VALUATION

Base Year Sales (1998) = $23450,

Earn out Period = 5
Sales Growth rate:
Min 5%
Most likely 10%
Profit Margin:
Min 5%
Most likely 10%
5 year earn out analysis:
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Max 15%
Max 15%

Vivek Gupta,

Printicomms proposed acquisition of digitech: negotiating price and

form of payment

Sales
Growth
Rate
Sales

Profit
Margin
Profit

5 Years
1999 2000
10%
10%

2579
5
10%

2001
10%

2002
10%

2003
10%

$
$
$
$
28,37 31,21 34,33 37,76
5
2
3
6
10%
10%
10%
10%

$
$
$
$
$
2,58
2,837 3,121 3,433 3,777
0
Earn
out
$
$
$
$
$
Target
2,50
3,000 3,000 3,500 3,500
0
Annual Earn
$ $ $ $ $
out
80
121
277
DIGITECH VALUATION

Base Year Sales (1998) = $23450

Sales Growth rate:
Min 10%
Most likely 20%
Profit Margin:
Min 15%
Most likely 20%
5 years earn out analysis:
5 Years
1999 2000
Sales
Growth 20%
20%
Rate
Sales
2814 3376
0
8
Profit Margin
20%
20%
Profit
5628 6754
Earn out Target
2500
Annual Earn out 3128
Value

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3000
3754

Max 30%
Max 25%

2001
20%

2002
20%

2003
20%

4052
2
20%
8104

4862
6
20%
9725

3000
5104

3500
6225

5835
1
20%
1167
0
3500
8170

Vivek Gupta,

Printicomms proposed acquisition of digitech: negotiating price and

form of payment

Earn out option II, 3 Years Model

PRINTICOMM VALUATION

Sales
Rate
Sales

3 Years
1999 2000
Growth 10%
10%

2579
5
Profit Margin
10%
Profit
2,580
Earn out Target 2,000
Annual
Earn 580
out Value

28,37
5
10%
2,837
2,500
337

2001
10%
31,21
2
10%
3,121
2,500
621

Present value of earn out at 10% discount rate = $1272

DIGITECHs VALUATION

3 Years
1999 2000
Growth 20%
20%

Sales
Rate
Sales
Profit Margin
Profit
Earn out Target
Annual Earn out
Value

28140
20%
5628
2000
3628

33768
20%
6754
2500
4254

2001
20%
40522
20%
8104
2500
5604

Present value of earn out at 10% discount rate = $11024

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Vivek Gupta,

Printicomms proposed acquisition of digitech: negotiating price and

form of payment

Conclusion
Based on the alternatives presented above, we would recommend earn out over
three years to the Digitech management in order to keep the management and
expertise in the company. This alternative would enable Printicomm to establish
goals for the earn out and the three year payout would be less costly to the
company.

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Vivek Gupta,