Suburban Electronics Company

A Case in equity valuation in a public stock offering

PGP 2009-11 2nd Term - Session 17

Submitted by: Group 9

Saurabh Kumar Sinha -49
Saurabh Patawari – 50
Sidharth Shankar Prasad – 51
 Sourjyo Das – 52
Sreethala Ganapathy – 53
Shubhangi Shree – 54
Case summary:

Suburban Electronics is an electronics company founded in 1979 by John Marris who is an

electrical engineer with hands on experience on designing of electronic equipments. To fulfil
his dream he started Suburban Electronics thereby manufacturing electronic warning devices
and burglar alarms. He then partnered with H.J. Mack who was a mechanical engineer.

Suburban electronics sales and earnings have been increasing and the owners desire to
expand the size and scale of business. They are thinking to take the company public and in
this regard they had approached Sandra Tracy, a principal in small investment banking firm,
for stock valuation. Sandra Tracy is exploring different methods of company valuation but is
relying heavily on the method of comparison with similar firms. She also wishes to make
Marris and Mark understand the whole process so that they are clear about it. She finds out
following statistics regarding similar firms:

Particulars Numbers
Price –earnings multiple 12-14
Market value to book value ratio per share 3-5
Payout percentage 15-25%
Total return offered to equity shareholders 20-22%

Marris owning 270000 shares and Mack owning 30000 have an emotional attachment with
the company and wish to retain ownership and control after public offering.
1)

Final amount = Initial amount (1+r/100) ^n

Where, n= number of years

And, r= growth rate

Sales:
Sales in 1982 = 1,292,000$
Sales in 1992 = 8,000,000$
n=10 years
This gives compounded growth rate for sales, r = 20%

Net-income after tax:

Net income after tax in 1982 = 155,400$
Net income after tax in 1992 = 811,448$
n= 10 years
This gives compounded growth rate for net income after tax, r = 18%

Earnings per share:

EPS in 1982 = 0.52$
EPS in 1992 = 2.70$
N=10 years
This gives compounded growth rate for EPS, r = 17.9%

2). From the given conditions, three basic assumptions can be made for calculating the range
of values of Suburban Electronics’ Common Stock
i) Using Industry Market Value/ Book value

Assume Return on equity (25%) is the same as that of industry values

Common stock shares =300,000
Market Value / Book value lies between 3-5(industry values)

This gives us Common stock per share values as

Net income after Tax = 811448

Book Value of Common stock (Return on equity is 25%) = 3245792
Using Market Values / Book value from 3-5
We get, Common stock per share = (32.5 – 54.1) $

ii) Using Industry P/E ratio

P/E for the company is between 12-14 (industry values)

EPS 1992 = 2.7

Using P/E ratios between 12-14
Common stock per share = (32.4 – 37.8) $

iii) Using Industry debt ratio

Assume Debt ratio (25%) is the same as that of industry values

Market Value / Book value lies between 3-5 (industry values)

Total Assets = 2900000

Book Value of Common Stock = 2175000
Common Stock per share = (21.75 -36.25) $

3). It is given in the case that the Market Value of Common Shares is between $15 to $25
Thus, the Range of Common stock per share calculated using the Industry Debt Ratio of
25%
Which gives common stock per share in the range 21.75 to 36.25 the most reasonable.

4)

Use of similar firms in the Suburban Electronics for the valuation of Suburban electronics has
a trade off. There are certain advantages and disadvantages in using such an approach:
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5)
Additional information required for valuation:

 NPV of the car alarm project it is going to undertake

 Projected sales and net earnings growth
 Planned retention ratios
 Number of shares to be issued to public
 Percentage of stake to be issued to public
 Name and reputation of clients of Suburban Electronics
 Electronics industry specifics variables
  Valuation of any publicly listed electronics firm similar in size to Suburban
Electronics

6)
Table 2 contains data related only to yearly incomes and earnings per share which is very
insufficient for assigning a value to a firm’s stock. This is so because of the following
reasons:-

 It says nothing about the financial health of the company

 Ratio analysis is not possible by only using Table 2
 Many important parameters like Return-on- equity and Return-on-assets can neither
be calculated
 Suburban’s liabilities cannot be estimated using only Table 2
 Working capital requirements of Suburban cannot be calculated, which is considered
to be very important for valuation
 -Moreover, total number of shares cannot be known
 Lastly the capital structure is invisible in Table 2

7)
Morris and Mack had invested in the firm at the cost of their home and inherited farm. So it is
natural for Marris and Mack to desire ownership and control of the firm. But at the same time
public offering of the stock was needed for future growth and prosperity. It is a situation
essentially faced by many entrepreneurs once the business reaches a certain size and aims for
expansion to next scale.
One possible solution in this regard is to maintain a 51-55% stake in the company and issue
IPO for only 45-49% of ownership. In this way Suburban will be able to gain capital that can
be invested in future projects and Marris & Mack will retain the control.

Currently:
Marris number of shares: 2, 70,000
Mack number of shares: 30,000
Total equity: 300000$

Therefore, value of one share = 1$

Suburban can issue share’s at a face value of 1$ to raise any amount less than 300000.
Even if they receive more than 3000000, they would be able to maintain more than 50% of
ownership. Afterwards as their profits increase from future projects they can go for debt
financing of the capital requirements.

8)
Without having prior knowledge of the organizational structure of Suburban Electronics it is
difficult to comment on the future roles of Marris and Mock. They could expect more of
strategic responsibilities rather than being involved in day to day operations of the firm.
These roles may include collaborating with new clients, deciding upon business
diversification, expanding the presence in major cities, establishing long term partnerships,
etc

9)
The owners should not consider an outright sale of the company because of the following
reasons:
-The company is performing good – sales and earnings are increasing in addition to a
good reputation in the market
-Because of good performance and huge retained earnings then can go for debt
financing whenever required
-Growth rate and earnings per share has been increasing for a decade
-Currently there is no immediate requirement of huge cash by the owners for the
personal usage
-They have invested a lot of their time, energy and money in bringing the company to
this level
-IPO can serve the capital requirements for future projects

10)
Every company, be it private or public survives under constant influence from larger
economy. Suburban Electronics Company is also no exception to this. Being in the
electronics manufacturing industry it experiences influence from larger economy in the
following manner:
Products like car burglar alarms and electronic warning devices are not of immediate need of
people so when economy is in recession with people becoming unemployed, the demand for
such devices will fall down
If average income rises with more inclusive growth then crime rate will be low which in turn
would decrease demand for Suburban’s company products.

11)
Remaining inside the purview of information and data provided the performance of Suburban
Electronics seems promising for the next 5-10 year period. It has been growing consistently
with increasing EPS which is a positive sign of good efficiency. Also it has a good brand
reputation which will be helpful in crisis situations, if any. The company is also bagging huge
projects which speaks about its ability to bag opportunities and deliver on time.