Jay Risher worked at Printcomm as the vice president and control manager. Printcomm is a communication firm that provides back-to-back printing service by merging production capabilities to generate finished copies and dispense the printed materials. Risher initiated plans to acquire Digitech Company because he discovered that the firm has huge profit potential. He also negotiated to have Buckingham and Greene as part of the management team because the two were the driving force behind the excellent performance by Digitech. The two individuals were needed to not only manage the Digitech operations but also facilitate the merging of the two firms. During negotiation, Risher presented two earnout proposals to hasten the conclusion of the deal. The first earnout plan promised to endow payments to Buckingham and Greene in the next five years on the condition that Digitech achieves specified income goals. The second earnout plan offered contingent compensations over the next three years. Risher used a simulation-based value model to estimate the future projected sales growth and profit margins. However, he failed to include the inflation component in his simulation model since inflation has a direct effect on projected sales growth and profit margins.
Printcomm’s proposed acquisition of Digitech
Jay Risher worked at Printcomm as the vice president and control manager. Printcomm is a communication firm that provides back-to-back printing service by merging production capabilities to generate finished copies and dispense the printed materials. Risher had discovered that Digitech was a profitable acquisition project and initiated negotiations that conferred Printcomm two weeks of exclusive rights to bargain for the purchase of Digitech. Risher also learned that the exceptional performance of Digitech was attributed to the excellent managerial skills of the two leaders of the company. He thus acquired a contract of these two leaders to stay at Printcomm and manage Digitech business for a period of five years (Stiegler 1).
The negotiation for the acquisition of Digitech focused mainly on establishing a fixed sales price for the firm. A fixed price agreement was definitely the easiest to achieve since it needed only a normal purchase and sale agreement that emphasized the full consideration in form and amount. However, the two parties held divergent views with respect to their perception of a rational valuation for Digitech’s business. Risher was also worried that Digitech management would not be motivated to stay on at Digitech if Printcomm agreed to pay a premium price to acquire the company. He believed that Buckingham and Greene should be retained as they possessed vital managerial skills and experience needed to integrate the firms and transmit business knowledge between the two firms (Stiegler 8).
Risher presented two different proposals to conclude the deal as soon as possible. He proposed the use of an earnout-an acquisition payment system where a certain percentage of the purchase price of Digitech is paid by Printcomm on the condition that Digitech realizes certain business goals after its closure. The first earnout plan would endow payments to Buckingham and Greene in the next five years on the condition that Digitech achieves specified income goals. Risher wanted to include high earnout targets into the five-year plan because Printcomm was exposed for an extended period of time. His targets were: 1999 ($2.5 million); 2000 ($3 million); 2001($3million); 2002($3.5million); and 2003($3.5million). Risher set these targets close to Printicomm’s estimated profit margins for Digitech. Under this structure, Printicomm would only pay for extra money if the actual performance surpassed the anticipated outcome. Risher also was convinced that the money to be paid at the conclusion of the deal should be set at a low value ($20million) on the basis of the prospective future value granted to Digitech with a five-year earnout period (Stiegler 9).
The second proposal (earnout plan) only offered contingent compensations over the next three years. Risher believed that the earnout targets needed to be lower under this plan since the anticipated future performance could be estimated with a high level of certainty. Thus, the targets set by Risher under the second proposal were as follows: 1999 ($2million); 2000 ($2.5million); and 2001($2.5). Digitech was thus offered a chance to earn extra income in the second earnout structure since the targets set were lower and achievable. The second earnout plan presented a win-win situation for both firms since Printicomm too would incur less cost to implement. Under the second proposal, Risher proposed to set the fixed price offer at $28 million at a closing-a figure that was already under consideration.
Both Printicomm and Digitech valued each earnout in a different way on the basis of their respective perception about the future. For instance, Risher opted to employ a simulation model that would utilize estimated distribution for key-value determinants. According to him, sales growth and profit margins were the key determinants of future value for Digitech (Stiegler 9). Consequently, he estimated a 5% growth in sales every year. He also projected that the future sales growth would reach 10%. Richer used the same simulation model to forecast the future profit margins for Digitech. Risher opted to replicate the analysis in order to predict the manner in which Digitech might view his earnout proposal. He used the distribution that Digitech would most likely employ for the key determinants in their analysis. Risher assessed the estimates done by Digitech and concluded that 10% was the minimum projected sales growth by Digitech while 30% was the maximum projected sales growth. He also anticipated the distribution for estimated income earnings to be somewhat tighter- fluctuating between 15% and 25%-with 20% as the most probable margin (Stiegler 10).
Risher must consider the impact of the projected inflation on the estimated profit margins of the two proposals. For example, the total population in the US was expected to hit the 280 million mark in 2003. This growth was to be accompanied by rising income levels and aggregate demand. A growing economy accompanied by an increase in the aggregate demand for print adverts was projected to increase the inflation-adjusted yearly growth rate of 2% in the next 5 years. Also, the stiff competition was expected from electronic media in the US which would further diminish the demand for printed products. Moreover, the printer’s profit margins were expected to shrink as a result of the rising cost of paper, which is the principal raw material for Printicomm (Stiegler 7). I would recommend introducing the inflation component in his simulation model to project future sales growth and profit margins.
Stiegler, Scott. Printicomm’s Proposed Acquisition of Digitech: Negotiating Price and Form of Payment. Charlottesville, VA: University of Virginia Darden School Foundation, 1999.