Burton Sensors, Inc. Harvard Business School, Case Number: 9-918-539.
Case 1: Burton Sensors, Inc.
1. Should Marshall continue to pursue high-growth strategy? How can she finance it?
What is the potential effect of growth on Burton’s stock price?
2.
Should Marshall purchase the thermowell machine? In calculating the WACC,
use 6% as the equity risk premium.
3. Should Marshall accept the offer of the private investor and issue new equity? How does
the deal affect Burton’s existing shareholders? What is the effect of the issuance on Burton’s balance sheet?
4. Should Marshall acquire Electro-Engineering, Inc. (EE)? What is the most important consideration? Even if the NPV of the acquisition is zero, should she still proceed?
5. Does the acquisition allow EE to gain enough funding to invest in the purchase of thermowell machines?
The
first
page
will include the Executive Summary. Which will state the problem faced by the company, and your recommended solution and why? Supported by some numbers that you had calculated in the body of the case. The other 10 pages will address the questions and include the Excel with the calculations files, fully explained and readable.
Burton Sensors, Inc. ________________________________________________________________________________________________________________ Harvard Business School Professor Emeritus William E. Fruhan and Queen’s University Professor Wei Wang prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. Although based on real events and despite occasional reference to actual companies, this case is fictitious and any resemblance to actual persons or entities is coincidental. Copyright © 2018 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. 9-918-539 J U N E 2 7 , 2 0 1 8 W I L L I A M E . F R U H A N W E I W A N G Burton Sensors, Inc. In February 2017, Amy Marshall, president of Burton Sensors, Inc. (Burton), located in Fort Wayne, Indiana, met with the company’s financial consultant to discuss three key issues: • Should Burton purchase new thermowell machines? • Should Burton raise additional capital through a private placement? • Should Burton acquire Electro-Engineering, Inc., which manufactures fiber-optic sensors? Company Background Burton was engaged primarily in the design and manufacturing of temperature sensors. Its products included a variety of highly accurate standard and customized thermocouple sensors, resistance temperature detectors (RTDs), and bearing temperature probes, as well as temperature transmitters. Its end users covered a wide range of industries, including oil and gas, petrochemicals, industrial machinery, automotive, food processing, medical, and aerospace. While majoring in mechanical engineering, Marshall became interested in sensor technology. Shortly after her graduation in 2002, she founded AMI Labs with a loan from her family and began supplying temperature sensors to several local food processors. To meet growing demand, she acquired Burton Sensors in 2004 and adopted the target firm’s name for the combined enterprise. Initially, Burton financed its growth primarily through internally generated cash flows; however, Marshall saw that Burton needed more funds than it could generate internally to finance growth opportunities. Consequently, Burton had an initial public offering in 2011. Shortly after the equity issuance, Marshall realized that Burton needed yet more financing to expand even further. She approached her bank to request a substantial increase in Burton’s line of credit in 2013. Exhibits 1, 2, and 3 show Burton’s balance sheet, income statement, and statement of cash flows, respectively. This document is authorized for use only by Georgeta Stan (
[email protected]). Copying or posting is an infringement of copyright. Please contact
[email protected] or 800-988-0886 for additional copies. 918-539 | Burton Sensors, Inc. 2 BRIEFCASES | HARVARD BUSINESS SCHOOL The Market for Sensors Sensors were essential equipment in many industries.1 They provided vital information about crucial variables such as temperature, position, and pressure that affected products, processes, and systems. These variables had to be measured, tested, and monitored, and were often automated.2 Original equipment manufacturers (OEMs) manufactured many types of sensors.3 Among them, temperature sensors had the widest applications for industrial production because temperature affected every aspect of manufacturing; it was the most monitored parameter in various end-user applications, especially in critical and hazardous applications. By product type, the temperature sensors market was classified into seven major segments: thermocouples, RTDs, thermistors, infrared temperature sensors, fiber-optic temperature sensors, bimetallic temperature sensors, and integrated circuit (IC) temperature sensors. Each segment had unique properties and end users. Traditional contact types such as RTDs and thermocouples dominated the market, but industry insiders expected the market for fiber-optic sensors, which were used primarily in low-volume niche applications, would grow more rapidly. Compared to traditional sensors, fiber-optic sensors had unique properties. They were immune to electromagnetic radiation and compatible with high-voltage, high-radio frequency, and high-magnetic field environments. These qualities made them ideal for applications in which traditional sensors would fail. In addition, they could be positioned in hard-to-reach or hard-to-view places and could withstand environments that were more corrosive. In the United States, the sensors industry was fragmented and competitive. In 2017, over 4,000 sensor OEMs served both the domestic and international markets in the United States. Three-quarters of these firms had annual sales of less than $10 million. Each type of sensor manufacturer faced distinct industry structures and competition. Over 200 OEMs produced temperature sensors. Most were privately held and family controlled. (Exhibit 4 provides financial data on four publicly-traded companies in the sensors industry.) Larger firms produced a diversified line of sensors and had more efficient distribution channels. To stay competitive, smaller companies like Burton needed to build close relationships with customers and design customized products that met specific customer needs. Smaller companies reviewed their distribution networks regularly to ensure that operating expenses were in line with industry norms. They also had to expand these networks to grow sales. Having experienced sales representatives was often the key to opening new markets. Many companies ran large inventory costs because they needed to keep stock for reorders. The overall market was expected to grow at a cumulative annual growth rate (CAGR) of 4.5% between 2017 and 2023 and to reach $6.86 billion by 2023.4 The market for fiber-optic sensors was expected to have a 15% CAGR and reach $3.5 billion by 2024. The projected growth was attributed largely to high demand for accurate temperature measurement in harsh environments and heavy investment in research and development (R&D) by large semiconductor firms. The aerospace and 1 These industries included mechanical and plant engineering, automotive, aerospace, entertainment and other consumer industries, medical technology and life sciences, and safety and security technology. 2 See Srinivasa Rajaram, “Global Markets and Technologies for Sensors—Focus on Temperature Sensors,” BCC Research (April 2013): 21. 3 The most common types included sensors for temperature, radar, optical, biosensors, touch, image, pressure, proximity, motion and position, humidity, accelerometer, and speed. 4 “Temperature Sensors Market by Product Type (Bimetallic, Thermistor, IC, RTD, Thermocouple, IR, Fiber Optics), End-Use Application (Oil and Gas, Chemical, Refining, HVAC, Automotive, Electrical, and Electronics), and Geography—Global Forecast to 2023,” July 2017, available at marketsandmarkets.com (accessed June 11, 2018). This document is authorized for use only by Georgeta Stan (
[email protected]). Copying or posting is an infringement of copyright. Please contact
[email protected] or 800-988-0886 for additional copies. Burton Sensors, Inc. | 918-539 HARVARD BUSINESS SCHOOL | BRIEFCASES 3 defense, chemical, semiconductor, utilities, metals, medical, construction, and consumer electronics industries had the greatest demand for fiber-optic sensors. The Bank’s Request Burton’s bank lender and suppliers supported the company’s growth between 2013 and 2016. At the end of 2016, its revolving credit line was $4.58 million. It could also borrow at just 2% above the prime rate (3.5% as of February 2017). Nonetheless, Burton’s lender had recently expressed concern about the extent to which the company was depending on short-term debt to finance its operations. When Burton’s bank initially agreed to finance Burton’s expansion, it expected the industry would soon experience a shakeout, in which weaker competitors would exit and only stronger firms like Burton would remain. In turn, Burton expected to increase its operating cash flows once competition had decreased. Because Burton had covenanted in its loan agreement not to pay a dividend for several years, any increase in net income would go directly to its retained earnings and reduce the company’s ratio of liabilities to equity. However, Burton’s sales growth outpaced its growth in cash flows. The company had to sustain high levels of working capital to support its growth. At the end of 2016, Burton’s total liabilities were five times its net worth. Its outstanding bank loans were 96% of the total value of its accounts receivable and inventory, far in excess of industry norms. Burton’s bank insisted that the company act to ensure that it would stay safely within the two restrictions that the bank planned to impose on future loans. These restrictions, which would apply as of the end of 2017, specified the following: 1. The outstanding bank loans at any time should not exceed 75% of the company’s accounts receivable and inventory. 2. Total liabilities should not exceed three times the book value of equity. Marshall had her own target leverage ratio in mind. She wanted to hold Burton’s ratio of total interest-bearing debt to the book value of equity at approximately 1 to 1. Purchasing New Thermowell Machines The thermowell was a major part of the RTD. There were many advantages to installing a thermowell with the sensor. First, in providing a physical barrier between the production process and the sensing element, the thermowell protected production from corrosive processes, extremely high temperatures, and high pressure. Second, it allowed the RTD to be removed and serviced without interfering with the production process. Because the temperature had to travel through the metal of the thermowell before reaching the RTD, however, the RTD sensor’s response time was reduced. The thermowell’s quality and design thus affected the RTD’s quality. Most thermowells were made from carbon steel, stainless steel, nickel, and brass. Other chemical compounds such as silicon carbide and silicon nitride were sometimes used to produce thermowells. The cost of thermowells was a major component of the production cost of sensors. Burton’s thermowell equipment allowed it to fulfill only