Appendix 1

FLINDER VALVES AND CONTROLS INC.

Confidential Supplementary Information for Management of Flinder Valves and Controls

As Bill Flinder neared retirement, the idea of selling FVC to a bigger firm seemed almost
necessary. He had a good top-management team, but he didnt think any one of them could step in and
run the show alone. He found stability in the RSE International combination that was worth something to
him. In the increasingly global market place with more costly development, FVC needed a deep-pocketed
partner to expand and to bankroll more research. Flinder believed that the company would also benefit
from gaining access to a large marketing and distribution network. As the company continued to grow, it
would need to gain production know-how for high-volume manufacturing. Flinder Valves did not have
this kind of expertise. Finally, there had been an increasing trend of consolidation in Flinder Valves
industry over the last year. Flinder feared that without a well-financed partner, the company would be
swamped by competition. He was intrigued with the possibility that Flinder Valves might be more fully
valued if it were part of a larger, more diversified enterprise. Thus, when the merger opportunity with
RSE International Corporation came along in 2007, Flinder determined to make it work as best as he
could.

Flinder believed that FVC had alternatives to this deal. Rockheed-Marlin Corporation, a large
defense contractor (or any of a number of others), might be induced to make an offer for Flinder Valves,
though Flinder preferred RSE International Corporation as a merger partner. FVC and RSE might
establish a joint venture of some sort, though Flinder suspected that joint ventures faced the same kinds of
integration problems as did acquisitions; as a result, he thought joint ventures were an inferior alternative.
FVC could move forward alone, but that would require raising large sums of new debt and equity to
finance the rapid expansion of the firms widening gyre program. Flinder was concerned that he might
lose voting control of the firm regardless. It seemed to him that doing a deal with a known and friendly
partner today would prepare the way for an orderly transition for himself and the firm.

Flinder expected the merger to generate significant cost gains. RSEs greater purchasing power
would lower the cost of materials and components for FVC. RSEs new resource-management system
could be expected to reduce FVCs in-process costs. Estimates from FVCs accounting group had
identified pretax constant-dollar cost savings of $2 million in the first year of operation and $4 million
thereafter. He also recognized other synergy gains that arose from RSEs stronger marketing clout, cross-
selling with other RSE products, and its deep financial pockets. He believed that the widening-gyre
project could have a broad application in nautical, aerospace, and automotive products. Based on the
investment required to bring such technology to market, he estimated the economic value at between $10
and $18 million

Bill Flinder had known Tom Eliot for several years, having been introduced at an industry
conference where they were both speakers. As founders and significant stockholders in their respective
firms, they liked and respected each other. Flinder hoped that RSE would recognize the fair value of his
company.
 Appendix 2
FLINDER VALVES AND CONTROLS INC.
Confidential Supplementary Information for Management of RSE International

Flinder Valves was the first among several potential targets identified by Catherine MacAvity,
RSEs vice president of Business Development, and the architect of the acquisition program. Eliot
approved the choice and believed a smooth and successful acquisition of FVC was critical to RSEs
expansion plans. Recent news in the U.S. credit markets had been grim. MacAvity worried that the news
in the financial markets might chill the ongoing talks. If the merger fell through after going this far, Eliot
feared his board might become discouraged. On the other hand, if FVC was acquired at too high a price or
failed to produce adequate returns, the RSE board would be unlikely to give its full support to future
mergers.

In planning RSEs expansion, Eliot had considered several companies as possible acquisition
candidates. Eliot was seeking a small, well-managed manufacturer that could offer RSE strong growth
opportunities and bring it more specialized, higher-technology products that would be less susceptible to
succumbing to the competition. Although RSE had done well, Eliot felt the company lacked the ability to
be innovative. No new products had been developed over the past two years, and Eliot personally felt that
the research and development (R&D) group at RSE International had fallen behind its competitors. FVC,
with its proven management and engineering skills, seemed to offer the R&D capabilities and growth
prospects that Eliot sought. Eliot realized that time was of the essence, especially since other competitors
were also interested in Flinder Valves. Nonetheless, he wanted to be certain that acquiring it would truly
place RSE in a better competitive position. One concern was how well FVCs employees would handle
the transition from working in a small, entrepreneurial company to a much bigger place like RSE. The
two companies possessed quite different cultures. Another concern was about the earnings dilution that
RSE might incur from the acquisition. In fact, two directors had cautioned Eliot against impairing the
firms forecasted growth in earnings per share.

Eliot and MacAvity expected the merger to generate significant cost gains. RSEs greater
purchasing power would lower the cost of materials and components for FVC. RSEs new resource
management system could be expected to reduce FVCs in-process costs. Estimates from RSEs due-
diligence process had identified pretax constant-dollar cost savings of $1.5 million in the first year of
operation and $3 million thereafter. They also recognized other synergy gains that arose from RSEs
stronger marketing clout, cross-selling with other RSE products, and its deep financial pockets. But for
the sake of conservatism, they chose not to include these in the valuation. They believed that the
widening-gyre project could have a broad application in nautical, aerospace, and automotive products.
Based on the investment required to bring such technology to market, they estimated the economic value
at between $5 and $15 million

Tom Eliot had known Bill Flinder for several years, having been introduced at an industry
conference where they were both speakers. As founders and significant stockholders in their respective
firms, they liked and respected each other. Eliot hoped that RSE could put together a deal that not only
worked for the two founders but made broad economic sense.
 Exhibit 1
FLINDER VALVES AND CONTROLS INC.
Supplemental Technical Note: Valuation and Merger Negotiation

Experienced financial decision-makers know that valuation is imprecise. Too many

parameters are uncertain, which renders any particular point estimate uncertain. This situation
leads to two important questions for negotiators of mergers and acquisitions: (1) What role can
quantitative analysis play? (2) How can one negotiate rationally and advantageously amidst this
uncertainty?

The Role of Quantitative Analysis

Two classic naive responses are made to the uncertainty of valuation: (1) to assert (with a
straight face) that the point estimate is the true value of the company, and (2) to chuck the
quantitative analysis out the window and to rely on some other method of guidance. 1 The more
sophisticated response is to embrace the uncertainty and focus not on point estimates of value but
on a range of value. Quantitative analysis is essential for determining this range. The classic
ways of setting the range include:

Sensitivity analysis: Here, one identifies the key value drivers of a firm and determines
the variation in value as the drivers vary. One must take care to do this sensibly because
quickly generating a blizzard of numbers is easy.
Scenario analysis: This analysis is similar to the sensitivity analysis, but acknowledges
that many assumptions will tend to vary together. In this approach, one estimates values
of a company associated with different views of the future. These scenarios could simply
be based on a general sense of how things will turn out (i.e., optimistic, pessimistic, etc.)
or could be tied to specific events that have a competitive foundation (e.g., a major
foreign competitor enters your domestic market) or a political/economic foundation (e.g.,
Britain endures a long recession). Here also one must take care to do the analysis sensibly
because as the saying goes, garbage in, garbage out. Also, almost any scenario may be
framed in such a way as to produce the results that one wants.
Break-even analysis: At the least, knowing what assumptions are necessary to produce a
target value will be extremely useful. This approach explicitly solves the valuation in
reverse and leaves it to the decision maker to judge whether the break-even assumptions
are reasonable.

11 Investing folklore is replete with success stories in which the critical insights were obtained from
sources as varied as astrology, gossip, and charting the height of womens hemlines.
 Using these methods to produce a negotiating range, bounded on one side by the opening
price and on the other by the walk-away price, provides vital discipline for a negotiating team
and may help the team in its assessment of new information that could appear in the negotiations.

In short, quantitative analysis serves an important role in merger negotiations. The

sophisticated user acknowledges the uncertainty of value estimates and can use the insights
derived from careful analysis as a foundation for negotiation strategy.

Negotiating Well

Research on merger negotiations conducted in laboratory experiments suggests that 30% to 50%
of merger outcomes represent a significant adverse deviation from what the negotiators actually
wantedwalking away from negotiations where a satisfactory outcome was feasible or closing a
deal beyond the walk-away price. This finding is attributable to a significant psychological
influence on what, in theory, is a simple economic event. The psychological phenomena include
the following, adapted from Negotiating Rationally:2

1. Irrationally escalating to an initial course of action, even when it is no longer the most
beneficial choice
2. Assuming your gain must come at the expense of the other party and missing
opportunities for trade-offs that benefit both sides
3. Anchoring your judgments on such irrelevant information as the initial offer
4. Being overly affected by the way that information is presented to you.
5. Relying too much on readily available information, while ignoring more relevant data
6. Failing to consider what you can learn by focusing on the other sides perspective
7. Being overconfident about attaining outcomes that favor you

The lessons of most studies of financial negotiation include the following:

Know thyself. Know thy counterparty. Risk aversion, optimism (or pessimism) about the
future, the desire to settle, and an expectation of settling are influential on bargaining
outcomes.
Do not abandon sound quantitative analysis. Do your homework before negotiating.
Estimate bargaining ranges; set walk-away prices.
Be disciplined in negotiating. Stick to predetermined walk-away prices unless you have
significant new information or other sound reasons for abandoning them.

22 Max H. Bazerman and Margaret A. Neale, Negotiating Rationally, (New York: Free Press, 1992).
 Mastery of negotiating tactics pays. Anchoring or framing the other partys expectations,
the number of proposals, the pattern of concessions, the use of time, the use of
interruptionsall these affect outcomes.
Negotiate based on several attributes, such as price and terms, rather than one. One-
attribute negotiation often leads to deadlock.