Lockheed Martin has always used acquisitions as a means of expanding their business. In their most current endeavor, they are looking into the benefits of acquiring NationScape Inc. The management at Lockheed Martin is not only interested in valuing NSI as a potential addition to their portfolio of subsidiaries, but also look into the benefits integrating the business into their own network of operations. Lockheed Martin’s management is concerned about the changing business landscape and is hopeful that NSI has capability to mitigate some of the risks that are presented as a result of it.
The analysis of NSI’s business operations must not, therefore, only be limited to their financial aspect. It needs to include the operational as well as strategic value additions that NSI can make. The analysis must also not be standalone, but include the current situation in the picture.
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Is NSI an attractive company compared its competitors?
NationScape Inc. has many advantages over its competitors. The foremost is its financial prowess. Compared to its competitors, NSI has one of the largest revenue turnovers standing at more than half a billion dollars. The company’s growth rate is also very impressive. Unlike its larger competitors, who have reached their mature stage, NSI is still in its growth stage. The company is projected to grow at 10% for the foreseeable future (which in this case is assumed to be up till 2008).
Financial strengths aside, the company’s management practices and organizational structure make NSI a jewel that cannot be ignored. The highly versatile management practices and flat organizational structure make the organization extremely quick to react to changing customer needs. This speedy reaction is something that sets NSI apart from the rest, and is an advantage that could give Lockheed Martin a considerable edge over its competition in the industry. Combined with its portfolio of services, the speed of delivery will be an invaluable asset.
NationScape Inc. also possesses a wide range of available services for its customers. Unlike other companies, NIS does not have a limited scope of operations. The company has the ability to cater to both military and non-military customers. This means that NSI is not exposed to the risk of shrinking business faced by military contractors due to shrinking military funding and expenditure. As a result, the company provides Lockheed Martin with a unique opportunity to expand its current business portfolio to diversify its business risk, and start exploring non-military options. Given the high dependence that Lockheed Martin has on local military contract, this change will certainly be something that will give the company much needed financial stability.
Is NSI a good strategic fit for Lockheed Martin? What are potential synergies from the acquisition?
There are two aspects that need to be looked at in order to decide whether NationScape Inc. is good strategic fit for Lockheed Martin or not. The first is the target company’s organizational and operational policies and structures. If these policies and structures are a match, then the two companies possess the capability to work as a single unit. Looking over the organizational structure of NSI it is clear that the company operates with a flat hierarchy, which is what makes the organization so adaptive. Lockheed Martin, on the other hand, has a very traditional, tall hierarchical strucutre. Also, NSI employees operate under a considerable amount of autonomy, while Lockheed Martin has well defined policies and procedures that govern decision making. The two companies may seem a stark contrast of each other in this regard, but these very different features of NSI are what give the company its high level of adaptability and dynamism. It is, therefore, for these very reasons that NSI is capable of adapting to Lockheed’s organizational environment. Lockheed too will have to undergo certain paradigm shifts, such as allowing more autonomy to its employees; however, there are no changes so significant that will make joint operations for the two companies impossible.
Other than that, most of NSI’s policies and mission statements are in line with those of Lockheed Martin. For example, one of Lockheed Martin’s values was to “perform with excellence” and to “strive to excel in every aspect of business and approach every challenge with a determination to succeed. In line with these values, NSI too had proven track record of meeting its customer set goals with excellent results. Both companies valued corporate social responsibility greatly, and considered it one of the cornerstones of their business strategies. For example, Lockheed Martin believed in the principles of “do what’s right” and “committed to the highest standards of ethical conduct”; whereas, NSI as the family business had instilled a culture of ownership, where employees cared for the achievements and accomplishments of the firm as much as a monetary benefit.
Also, view on leadership was very similar in the two companies. Just as NSI had created a foundation of strong leadership in NSI through familial entrepreneurship, Lockheed Martin believed in creating “full spectrum leadership to shape the future, build effective relationships, energize the team, deliver results and model personal excellence, integrity and accountability.
The two firms were also eye to eye on the benefits of employee training and vision alignment. Both Lockheed Martin and NSI believed that in order to run a successful operation the employees must be aware of the company’s ultimate objectives and work towards it.
Similarly, quality of products and services provided was also of utmost importance to both the firms. Both Lockheed Martin and NSI had developed reputation in the market for providing highest standards in quality to its customers. NSI had a history of retaining contracts and had never defaulted on a contract in over fifty years of its business.
All of the mentioned goals, objective, policies and strategies adopted by the two firms show that they are compatible enough with each other to be able to run joint operations. This leads to the second aspect of determining whether the two are a strategic fit, and that is the scope of business operations and future expansions. In other words, what does the new firm have to offer in terms of the acquiring firm’s future?
In this case, Lockheed Martin is looking to expand not only the scale of its operations but also their scope. NSI has customers in both the military spectrum as well as the non-military. This means that the company can help Lockheed Martin increase the scale of its operations by selling existing Lockheed Martin services and products to NSI customers, and increase the scope of its operations by pursuing clientele in the non-military sector, as well. Other than the client base, NSI also offers a wide variety of services that are not military specific and are not offered by Lockheed Martin. This gives Lockheed Martin the unique opportunity to diversify its services portfolio to mitigate some of the risks of high dependence on the Department of Defense and its shrinking budget allocation. Such diversification is something that Lockheed Martin has been looking into for quite some time, but did not have the expertise to accomplish on its own. Therefore, NSI provides an extremely valuable strategic platform for a change in business operations that Lockheed Martin has been trying to achieve.
Also, NSI has presence and operational setups in many countries Lockheed Martin does not. The logistical framework in place and the expertise of NSI employees can prove to be invaluable to Lockheed Martin in its global operations. They also represent an opportunity for Lockheed Martin to increase their international business thereby reducing local market risks. This is another thing that has been on the table of Lockheed Martin executives; therefore, NSI fits right into their international expansion strategies.
All in all, NSI has the ability to fit right into Lockheed Martin’s strategic requirements and enable the company to achieve many of the goals that it will find very difficult to achieve on its own.
How would you characterize the strategic goal of such an acquisition: consolidation, market expansion, adding volume/scale, or as an R&D play?
It is difficult to categorize the goal of this acquisition in any single category because the end results of the acquisition are of many different categories. NSI offers a vertical, as well as horizontal, consolidation of services, expansion in current as well as new markets, increasing both the scope and scale of operations and new technology that is not yet available to Lockheed Martin.
The larger strategic goal, however, can be summed up into increasing shareholder value through expansion. The main reason behind the acquisition of NSI and all previous acquisitions is for Lockheed Martin to expand into new markets, both geographically and products and service wise. Such an expansion takes into account all of the major benefits that Lockheed Martin plans on gaining from the acquisition, which include reduction of business risk, reduction in dependence on a single form of contract, enhanced services portfolio and improved logistics network. Therefore, in the overall sense, the acquisition can be categorized as a bid for market expansion.
If NSI is acquired, how should it be integrated into Lockheed Martin? Should NSI continue as a standalone company with little to no integration into Lockheed Martin’s operations? Or should it be fully integrated into Lockheed Martin?
The key characteristics that make NSI such an attractive investment opportunity are its organizational structure and management policies. A high level of employee autonomy allowed and the relatively flat organizational hierarchy allow NSI to be extremely adaptive to any dynamics that may be at play in the market and respond very effectively and efficiently to customer requirements. Lockheed Martin, on the other hand, has a much taller organizational structure and rigid management policies regarding decision making authority. This means that completely integrating NSI into Lockheed Martin will make the firm lose one of the key advantages that the company has to offer.
However, NSI also offers a vast and well established supply chain network, as well as employee expertise and business knowhow of services that Lockheed Martin wishes to adapt. If NSI is left as a standalone entity, all of the possible synergies to be gained from its operational network and the benefits of being able to expand into new markets will be left untapped. Lockheed Martin will also not be able to use NSI’s staff for their expertise in the local markets and its sales and customer support team to work on Lockheed Martin’s contract renewals.
This means that any post acquisition integration needs to keep the benefits to be reaped in mind before implementation. The best way forward would be to integrate NSI into Lockheed Martin’s operations but adapt some of their management policies to retain the speed of response. Lockheed Martin must start by giving more autonomy to their employees and adopting a more flat organizational structure in the departments that will be dealing directly with NSI. For example, when Lockheed Martin integrates NSI’s consulate consultancy services department and creates one in its own structure, the policies to be implemented should be in line with those at NSI, while it can continue to operate other departments as aircraft manufacturing as they were. This will allow Lockheed Martin to maximize its potential gains from NSI.
What is the value of NSI based on a discounted cash flow valuation, including the calculation of an appropriate weighted average cost of capital?
NSI’s cash flows were calculated based on certain assumptions. The first assumption was that come 2008 the company’s revenue growth will slow down to 5%, from the 10% growth it is expected to experience in years 2007 and 2008. This will be the case since the company is entering a more stabilized growth stage and a growth rate of 10% is not realistically possible indefinitely. All direct costs involved are expected to grow at the same rate; therefore, resulting in a 5% growth in gross profit. Cash flow calculations also included a change in total assets and liabilities adjustments to net income. These are expected to grow at the same rate as operations grow to complement the revenue growth. As a result, they will grow by 10% up till 2008 and 5% thereon. This leaves an end cash growth of 10% for the estimation for years 2007 and 2008 and 5% for all subsequent years.
The weighted average cost of capital has been estimated based on the relative proportions of long term debt and equity in the firm. The cost of equity was obtained using the capital asset pricing model. Using the treasury rate of 4.4% and average market risk premium of 3.84% (calculated using historical S&P500 data taken from yahoo finance); NSI’s beta of 1.50 (calculated as the industry’s average beta value weighted using company incomes) yielded a cost of capital of 10.16%.
Cost of debt was also obtained using market data. Since the case mentioned that NSI’s bonds were rated A-, a cost of debt of 5.32% was obtained assuming the bonds were of 10 year maturities. Using the costs of debt and equity, and adjusting for the proportions of debt and equity on the balance sheet, the average cost of capital turned out to be 7.06%.
With a terminal growth rate of 5% and weighted average cost of capital of 7.06%, the terminal value of the firm came out to be $ 1,513,119,000. This translates to a value of the firm of $ 1,295,591,000 or $1.3 billion.
What is the value of NSI using a multiples valuation?
Multiples valuation is done by using the average price earnings ratio of all comparable companies to determine the value of NSI. Using this method, the average price earnings ratio of all comparable companies turns out to be 30.77. Using this multiple, the value of NSI stands at $1.28 billion (using the latest total earnings value from NSI’s financial statements). It can be seen that the value using the multiples approach is quite similar to the one using the discounted cash flow method. On the whole, the discounted cash flow method is preferred as a method of valuation because it is more company specific; whereas, the multiple's approach only looks at industry averages.
What price should Lockheed Martin offer for NSI if it decides to proceed with the acquisition?
As mentioned, the discounted cash flow method is more intuitive for valuation. This means that it is given more weightage in any decision making. In this case, NSI was valued at $1.3 billion. This means that Lockheed Martin should not bid more than the amount mentioned for the company. NSI in its current operation is not worth more than that. Any additional value that can potentially be created by the company will have to be tapped by Lockheed by implementing new managerial and operational strategies to integrate the two companies. Therefore, Lockheed Martin should bid a maximum of $1.05 billion for NSI.
What is the value of the potential synergies that could result from the acquisition?
As mentioned in the case, that under Lockheed Martin’s management and operational umbrella, NSI has the potential to grow at a much higher rate indefinitely (for the foreseeable future). This means that whatever value that can potentially be generated, will be through an increased growth rate. We know that, at the current estimated growth rate of 5%, NSI is worth $1.3 billion. If we use the same model but increase the growth rate to 5.7% (realistic indefinite growth gained by integration cannot be any higher than that), the value increases to $1.93 billion. This means that even a 1% (realistic) increase in growth rate due to improved synergies will result in an almost $600 million increase in value.
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