News and Articles

Littelfuse Announces Acquisition of Cole Hersee Company

December 22, 2010

CHICAGO -- Littelfuse, Inc. (NASDAQ:LFUS) today announced that it has purchased all the outstanding stock of Cole Hersee Co. Cole Hersee, which is based in Boston, Massachusetts, is a recognized leader in the off-road, truck and bus (OTB) market with annual revenues of approximately $43 million. Shields and Company acted as financial advisor to Cole Hersee in connection with the transaction.

"The acquisition of Cole Hersee is a significant step in our strategy to expand our OTB business," said Dieter Röder, Vice President and General Manager of Littelfuse's Automotive Business Unit. "We expect the Cole Hersee acquisition to strengthen key customer relationships, expand our distribution network and extend our product offering. Their focus on power management products and heavy duty electromechanical and solid-state switches for DC electrical systems expands our offering to this diverse OTB customer base."

Donald Mayer, Vice President of Cole Hersee, added, "This is a great fit. We think the combination with Littelfuse will allow us to bring new products and capabilities to our customers and enable new opportunities to grow the business."

Terms of the transaction included cash consideration of $50 million, which was paid out of cash on hand and existing credit facilities. This acquisition is expected to be accretive to earnings in 2011.

About Cole Hersee

Since its founding in 1924, Cole Hersee has been a pioneer and leader in the development of heavy-duty electrical products for the vehicle industry and has earned a reputation for quality and value. Cole Hersee collaborated on many basic industry standards and today is a preferred supplier of over 2,000 dependable products and accessories for construction, agriculture, military and commercial vehicles. Cole Hersee products are available as standard or custom designed products to meet customer needs. Cole Hersee is ISO 9001-certified. The company is headquartered in Boston, Mass. with manufacturing in Muzquiz, Mexico, and distribution in Schertz, Texas.

About Littelfuse

Littelfuse is the worldwide leader in circuit protection, offering the industry's broadest and deepest portfolio of circuit protection products and solutions. Backed by industry-leading technical support, design and manufacturing expertise, Littelfuse products are vital components in virtually every product that uses electrical energy, including portable and consumer electronics, automobiles, industrial equipment and telecom/datacom circuits. In addition to its Chicago, Illinois, world headquarters, Littelfuse has over 20 sales, distribution, manufacturing and engineering facilities in the Americas, Europe and Asia. Technologies offered by Littelfuse include Fuses; Gas Discharge Tubes (GDTs); Positive Temperature Coefficient Devices (PTCs); Protection Relays; PulseGuard® ESD Suppressors; SIDACtor® Devices; Silicon Protection Arrays (SPA™); Switching Thyristors; TVS Diodes and Varistors.

For more information, please visit Littelfuse's Web site at www.littelfuse.com.

“Reduced Capital Gains Tax Rates Expire 12/31/2010 – Should Business Owners Sell Now Or Wait?”

Laura M. Moruzzi
August 18, 2010

The 2001 and 2003 tax rate reductions that reduced capital gains tax rates are currently scheduled to expire at the end of this calendar year. Based on extensive research and many conversations with tax advisors, I believe that capital gains tax rates will not be allowed to expire altogether. However, speculation is that rates may end up at higher levels than they are now. As we wrap up the summer, the expectation that Congress will get to this topic before the mid-term elections in November is unlikely. Thus, the future capital gains tax rates will depend on how Congress will shape up after the November elections.

Regardless of one’s political views, many business owners are asking if they should sell their business now because of uncertainty surrounding the future capital gains tax rates. As an M&A advisor and a fiduciary, I am reluctant to let one variable impact such a significant life-altering decision as this. Instead, one should look at the many other variables in evaluating a decision to sell one’s business, which presumably is their largest asset. A few questions I would ask include: What are the future prospects for your business? Is consolidation taking place in your industry? What impact does the economy have on your business? What are the valuation trends in your industry?

The latter question leads me to a more quantitative perspective. Today, with the federal capital gains tax rate at 15%, profitable businesses are achieving valuation multiples of between 4-5x EBITDA. (Please note that this is not industry specific.) Basic mathematics tells us that by assuming a federal capital gains tax rate increase of some percentage, we can determine what the transaction value needs to be or, more specifically, what the EBITDA multiple needs to be for one to be monetarily indifferent to an increase in the capital gains tax rate. Assuming no change in EBITDA and including no assumptions for the time value of money, debt, or transaction costs, what would be the required EBITDA multiple necessary to achieve the same after-tax net proceeds as capital gains tax rates increase?

(Multiple x EBITDA) x (1 – Capital Gains Tax Rate) = After-tax Net Proceeds

The results of this simple back-solving analysis are summarized below:

Thus, if the federal capital gains tax rates increased 100% to 30%, then a 4x EBITDA multiple today would equate to a 4.9x multiple indifference point, an increase of 21.4%.  Similarly, an EBITDA multiple of 5x today would equate to a 6.1x multiple if the federal capital gains tax rate increased 100% to 30% (again, assuming no change in EBITDA, and no assumptions for the time value of money, debt, or transaction costs).

However, if you think that the economy is improving and valuations will increase after the most recent market corrections, then you may want to consider waiting to sell your business, despite the risks of increased capital gains tax rates. As a business owner you already understand the risks of ownership – an increased competitive landscape, capital expenditure requirements to maintain or grow, potential increased industry regulation – and the bottom line is that a good advisor will evaluate all of these topics with you and help you understand the pros and cons of selling now as opposed to selling later. At a time when private equity firms are still on the sidelines and strategic buyers are actively seeking opportunistic acquisition targets, being a well informed and knowledgeable business owner can only help you make a well informed methodical decision.

“Stock Option Appraisals: When is it appropriate to use one allocation method over the others?”

Laura M. Moruzzi
February 20, 2010

The original AICPA Practice Aid established for SFAS 123R/ IRC 409a business appraisers discussed the following three methods as appropriate approaches to allocate the enterprise value of an entity among the different classes of equity securities: i) the option-pricing method (“OPM”); ii) the probability-weighted expected return method (“PWERM”); and iii) the current value method (“CVM”).  Experience has demonstrated that specific facts and circumstances surrounding the company being valued need to be understood and considered when selecting the most appropriate method of allocating value. In some cases, appraisers will look at more than one method, as no single method takes into account all the characteristics of varying classes of securities, especially those of the preferred securities. In selecting an appropriate allocation method, an appraiser should have a strong understanding of the terms of the related stockholder agreements and whether or not the entity is a going concern or in liquidation.

The first two methods are typically employed by business appraisers when allocating value among varying classes of securities. Both the OPM and the PWERM methods are forward-looking approaches that take into consideration claims on future value of a company’s equity.  Despite this very significant similarity, these methods have many differences.  For example, the OPM uses the Black-Scholes or lattice model to calculate future claims of equity value, while the PWERM uses a variety of selected, discrete liquidity events, such as an IPO and a sale transaction.  The OPM is used to value an infinite number of values at one future point in time, while the PWERM estimates multiple values at various times depending on future outcomes across a range of different exit scenarios. Both of these methods have flaws; however, it is up to the appraiser to use his or her judgment based on the facts and circumstances, specifically the characteristic (rights and preferences) of the various classes of stock established for the company being valued to determine which method is most appropriate or if it warrants developing a hybrid approach.

An appraiser may utilize the OPM method specifically if the company recently completed a round of financing. As a result, an implied equity value can be derived. In this situation, it is typical to use the OPM model to back-solve for the per-share value of the common stock given the most recent per share value of the preferred capital raised. Note that understanding the financing round is pivotal to utilizing the back-solving technique. For example, was the new capital raised from an outside source or was it an internal round? This may determine if the implied value is truly fair value or fair market value. Alternatively, the PWERM may be more appropriate when addressing an early stage company that needs to achieve significant technological milestones.  This type of company theoretically may have equal probability of achieving these technology hurdles as not achieving them. History has demonstrated that failure to achieve technological milestones results in zero value to the common stockholders, a specific scenario that appraisers need to address when valuing early stage technology companies.

The third method, the current value method, is just that: “current”. It does not take into consideration the future value or potential future growth of the entity being valued.  The Practice Aid outlines two specific circumstances under which the current value method should be employed: (i) when a liquidity event is imminent where the preferred securities are not forced to convert into common securities, and (ii) when the entity is at such an early stage of development that no significant common equity value has been created, and there is no reasonable basis for estimating a probable future common value.

Although the data are limited because few cases have been contested to date by the Internal Revenue Service, we have found that valuation practitioners, accounting firms, and the SEC have taken a preference (no pun intended) to the use of the OPM. We believe this is due to the fact that the OPM employs far fewer subjective assumptions than those employed by the PWERM. The OPM uses five specific assumptions, some of which are significantly less subjective than others, while the PWERM is fraught with a variety of subjective scenarios and related scenario-specific underlying assumptions. It is difficult to capture all possible potential outcomes using the PWERM. However, more and more practitioners are recognizing that the OPM may not be appropriate for early stage companies. Time will tell where the IRS will come out on this evolving topic, so please stay tuned.

“Understanding the Option-Pricing Method (“OPM”) Allocation Method: Implications Inherent in the Underlying Assumptions”

Laura M. Moruzzi
November 3, 2009

Accounting firms and the SEC have generally taken a preference to the use of the OPM to allocate the equity value of an entity among the different classes of equity securities. This allocation method has also been adopted by most valuation practitioners, ourselves included. However, we challenge practitioners and other professionals as to their actual understanding of the OPM and the implications inherent in the underlying assumptions employed in the OPM model.

In simplest terms, the OPM is a forward-looking methodology that takes into consideration claims on future values of a company’s equity. Specifically, the OPM typically employs the use of a Black-Scholes model to distribute an infinite number of future values at one future point in time, or the assumed liquidation date, log-normally. What does that mean, “log-normally distributed”? A Google search resulted in the following definition: “Lognormal is a probability distribution in which the log of the random variable is normally distributed.” For these purposes, the future value of the Company’s equity is normally distributed based on the underlying assumptions employed.

There are five key underlying assumptions used in an OPM. These assumptions include: i) an underlying asset value or the equity value of the company; ii) time; iii) volatility; iv) a risk-free rate; and v) an exercise price of the security.  Any intelligent financial professional can estimate these assumptions, but do they truly understand the impact of the underlying assumptions on the resulting per-share value?  Although not inclusive, the table below summarizes these fundamental assumptions and attempts to comment on their respective implications on value or the fundamental issue as it relates to the use of the Black-Scholes OPM for venture-backed companies:

Key Underlying Assumption	Description	Comments/ Implications
The Underlying Asset Value or the Equity Value of the Company	Market price of the underlying security on which the option is based. The implied value of 100% of Company equity determined using traditional valuation methodologies or based on the equity capital raised on or close to the Valuation Date.	Potentially fraught with a variety of subjective assumptions unless a recent financing round is used to estimate value. However, was this round an internal round or true market value based on a market test? A high valuation for enterprise may or may not result in a high per-share value for the common stock. A thorough understanding of the company's capitalization table and Articles of Incorporation is pivotal when modeling the OPM for allocation purposes.
Time or Time to Liquidity	The date by which the option must be exercised, or it will be forfeited. Estimated liquidity event window based on the earliest exit date as determined through discussions with management and the Company's financial partners.	Holding period is very subjective and management's vision of time to liquidity may differ from that of the investors. We encourage board involvement and discussions. Generally speaking, the longer the time period, the increased probability of the option coming in-the-money and the higher the resulting value.  Another consideration: the Black-Scholes model was originally developed to value options on a term of nine months or less. This is in stark contrast to venture capitalists' typical holding period of 5 years or more.
Volatility	Measurement of how the price of the underlying security fluctuates about its mean value for a given period. Comparable public company sample observed median volatility.	Assumes the same volatility for all companies and each class of equity securities. Originally, the Black-Scholes model was developed to value public-company options, thus using that company's specific volatility.
Risk-free Rate	The rate of return on a riskless security. Based upon the yield of the United States Treasury bonds as of the Valuation Date, as quoted by US Treasury Department.	Implies a riskless security; however, VC-backed companies are anything but riskless. This despite the fact that much of the risk in the OPM is theoretically captured in the volatility assumption. Many VCs have a required rate of return of 40% or higher depending on the company's stage. Failure for VC-backed companies is highly probable. Statistical studies of venture-backed businesses show that nine out of ten investments fail.
Exercise Price of the Security	The amount at which an investor is indifferent between exercising the option or not, based on the liquidation preferences and conversion values as described in the Company stockholders’ agreements.	It is critical for practitioners to understand the unique and sometimes complicated liquidation characteristics designed by sophisticated investors. Participating or not? If so, is the participation capped? Are there accrued dividends? Etc.

The old phrase ‘garbage in, garbage out’ is forever true with the Black-Scholes OPM like any other financial model.  When using the OPM, it is imperative that practitioners not only understand the key underlying assumptions used, but also understand their respective impact or influence on the resulting per-share value in addition to all other macro and micro facts and circumstances related to the company being valued.

Erroneous data or inputs can have a drastic impact on value. Recent studies and articles written by practitioners imply that the OPM using the Black-Scholes model overstates value. This can easily occur when one misunderstands the assumptions or limitations of the model.  This is true specifically when using the OPM to allocate value within certain industries with exit values that have a high rate of failure, such as the biopharmaceutical industry. Understanding the company one is valuing, its industry, its financial profile, its capitalization table, and all other pertinent facts and circumstances is critical when using any allocation methodology, but even more so when applying a Black-Scholes OPM.