Case

Amalgam Electronics

Difficulty: Intermediate

Type: Candidate-led

Topics:

Case prompt

Our client, Amalgam Electronics, is a large electronics company which manufactures a wide range of electronics for home and office use. They are evaluating an investment into a company called Chipset Inc., which manufactures Printed Circuit Boards (PCBs).

They have hired us to help them with this investment decision. How would you approach this?

Detailed solution

Paragraphs highlighted in orange indicate hints for you on how to guide the interviewee through the case.

Paragraphs highlighted in blue can be verbally communicated to the interviewee.

Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section.

Suggested case structure

Key question: Would an investment into Chipset Inc. make sense for our client?

Brainstorm with the interviewee on what approach he would take. The case structure given below need not be shared with the interviewee; but it should be used to guide him during the initial brainstorming.

Diagram 1 – Case Structure

Below would be the steps to solve the case:

1. Context: The interviewee should attempt to understand the investment drivers like amount of investment required, ROI threshold for investment, availability of funds, broad industry metrics, etc.

2. Company: The interviewee should then attempt to understand the specifics of the investee company – their top line, assets, profitability, future plans etc.

3. Synergies: The interviewee should also indicate that he would try to understand synergies if any from the investment.

4. Recommendation: Based on the analysis of the investment driver, profitability of the Investee Company and synergies if any, the interviewee must give a conclusive recommendation to the client.

1. Context

The interviewee should try to establish the investment drivers and understand the broad contours of the industry.

Allow the interviewee time to list out the factors that she/he would like to know about and which would help her/him define the investment decision.

Information that can be shared if inquired:

Chipset Inc.’s current valuation is $300m. They are looking for an equity injection of $100m. This investment will be used to set up a new production line with 8m per year capacity for 3-layer PCBs at their Philippines plant
Amalgam has enough funds for the investment
Amalgam Electronics has an internal hurdle rate of 12% ROI for an investment decision to be passed
The PCB market has two kinds of technologies - the 2-layer PCBs and the latest 3-layer PCBs
The older generation 2-layer PCB market is declining globally, as most electronic manufacturers are shifting to the newer technology
The 3-layer PCB market is growing rapidly at an average of 15% per annum; all the new generation mobiles, tablets, laptops use the 3-layer PCBs as the 2-layer PCB is not suited for the advanced features
The market for PCBs is extremely competitive. The competition in more intense in the 2-layer technology segment
Japanese manufacturers hold the lion’s share of the PCB market; however of late, they have been facing stiff competition from low-cost manufacturers from the rest of Asia

Key Insights:

Amalgam Electronics would get a 25% stake in Chipset Inc. The $100m fund injection would take the post -money valuation of Chipset Inc. to $400m and allow Amalgam to take a 25% ($100m/$400m) equity stake.
The PCB market has two key segments – the 2-layer chip technology and the new generation 3-layer chip technology. The 2-layer market is declining but the new 3-layer chip segment is growing on the back of the boom in smartphones, tablets, laptops etc.
The market is competitive and dominated by Japanese manufacturers; the cost of manufacturing in other Asian countries is lower than the cost in Japan and hence other Asian manufacturers are challenging the Japanese manufacturers.
Given the market for 3-layer PCBs is increasing and the investment in Chipset is primarily to set up a line for this technology, it is worth evaluating the company and its financials.

Allow the interviewee to come up with key insights from the information shared on his own. If required, prompt him to form these conclusions.

2. Company

The interviewee should now try to understand the specifics about the investee company – sales, profitability, production capacity, future plans, etc.

Allow the interviewee time to list out the factors that she/he would like to know about and which would help the interviewee understand the profitability of Chipset Inc.

Information that can be shared if enquired:

Chipset Inc. has three manufacturing plants – Philippines, China and France. All three plants are profitable.
The production capacity of the three plants is as follows: Philippines – 6m boards, China – 7m boards, and France – 6m boards per annum
The capacity utilisation of the three plants is as follows: Philippines – 100%, China – 70%, and France – 50%
All the three plants manufacture 2-layer PCBs; the production is done on demand

Share Exhibit 1 with the interviewee if he enquires about the production costs.

Exhibit 1: Production cost overview – Chipset Inc.

Allow the interviewee time to calculate the per unit profitability for each of the plants. The profitability solution can be found in Exhibit 2.

Exhibit 2: Plant wise (per unit) profitability – Chipset Inc.

The interviewee should also note that the per unit profit for the proposed 3-layer chip would be $4.5 instead of the current $1.5 (based on Philippines) for the 2-layer chip.

Key Insights:

All three plants are currently profitable.
The profits of the Philippines plant will increase significantly once the new production line is completed. The investment would be used to create an additional capacity of 8m boards of 3-layer technology PCBs which will have a much higher per unit profitability of $4.5.

3. Synergies

The interviewee should also enquire about the synergies arising from this investment.

This would be the key element to crack the case. A great candidate would immediately ask about synergies as the investment is being done by an electronics manufacturer who would use PCBs as an input in their production set-up.

Information that can be shared if enquired:

Amalgam Electronics manufactures mobile phones and tablets; they purchase PCBs from other suppliers as the PCB is one of the key components of their production set-up. This synergy is the core reason that has made Amalgam Electronics consider this investment.
Amalgam Electronics has its manufacturing plants spread across Europe and has recently set up its largest manufacturing plant in Thailand.
Amalgam Electronics currently purchases 15m 2-layer PCBs at a price of $4 for its plants across Europe.
Amalgam’s Thailand plant uses only the new generation 3-layer PCBs; this plant procures 10m 3-layer PCBs from its suppliers at a price of $7.

The fact that Amalgam Electronics purchases 2-layer and 3-layer PCB’s at the same price as the selling price of Chipset Inc. is a hint that now Amalgam could purchase these chips from Chipset Inc.

A great candidate would also immediately realise that the incremental orders from Amalgam for the 2-layer PCBs would ensure that their plants in China and France would also run at full capacity. If the interviewee does not comment on the potential full capacity production levels, prompt him/her.

Information that can be shared if enquired:

Transportation costs would not be consequential when Amalgam Electronics decides to shift its orders to Chipset Inc. for 2-layer PCBs.
Amalgam Electronics is keen to utilise the proposed capacity creation of 3-layer PCBs exclusively for its Thailand production plant.

Allow the interviewee time to calculate the profits after the proposed investment.

Share Exhibit 3 with the interviewee if he enquires about the profits at 100% capacity utilisation.

Exhibit 3: Profits from the sale of 2 layer PCB at 100% capacity utilisation

Now the interviewee can estimate the total profits of Chipset Inc. after the investment:

Profits from the sale of 2 layer PCBs = $9m + $14m + $6m
Profits from the sale of 2 layer PCBs = $29m
Additional profit from the sale of 3 layer PCBs = Units sold * Profit per unit
Additional profit from the sale of 3 layer PCBs = 8m * $4.5
Additional profit from the sale of 3 layer PCBs = $36m
Total profit of Chipset Inc. = $29m + $36m
Total profit of Chipset Inc. = $65m

The ROI of the investment can be calculated as follows:

Amalgam Electronics would be entitled to a share of 25% of the profits as they would hold a 25% stake after the investment.

Amalgam’s share of profits = 25% * $65m
Amalgam’s share of profits = $16.25m
ROI = Share of profits / Investment Amount
ROI = $16.25m / $100m
ROI = 16.25%

Key Insight:

The ROI from the investment into Chipset Inc. is 16.25% after taking into account the synergies from the investment.

4. Recommendation

The client should invest in Chipset Inc.

The ROI of 16.25% on the investment is higher than the internal hurdle rate of 12%.
Although the market for 2-layer PCBs is declining globally, all three plants manufacturing these chips are profitable. Also, Amalgam Electronics requires 15m 2-layer PCBs. A part of this requirement could be sourced from Chipset Inc.; this would ensure that Chipset’s factories in France and China function at 100% capacity utilisation.
The proposed investment in Chipset Inc. is to set-up an additional line to manufacture 3-layer PCBs. Amalgam Electronics has a requirement of 10m such PCBs. They would procure these chips from the Philippines factory once the new production line is set-up.

Exhibits

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