This is my analysis, it is NOT for investment purposes.  It is only an example of my scholastic ability.

Pitt Des Moines

2-17-2002

Finance 425

Michael J. Bootsma

I suggest that we sell Pitt Des Moines because I feel the stock is currently overvalued and is strategically positioned for an acquisition. Further, I feel that the recent offer by Ironbridge Holding LLC, provides an excellent opportunity for us to liquidate our shares.

Pitt Des Moines Inc. is a publicly traded construction-engineering and manufacturing company. Their headquarters are in Woodlands, Texas and at last count they employed 1024 employees. Phone is 281-765-4600 and their website www.pdm.com, is restricted. Pitt Des Moines was incorporated on February 14, 1919 as Pittsburgh - Des Moines Steel Co. They are currently traded on the American stock exchange and their ticker symbol is PDM. PDM’s institutional ownership consists of 41.6% institutional shareholders, while insiders and the top 5% hold 72% percent of the common stock. PDM operates into two segments; the heavy construction segment, which specializes in the engineering and fabrication of steel bridges, and the steel distribution segment, which processes and distributes a full line of heavy carbon steel products. The Chairman of the board is P. Elbert, the President, CEO, and Director is William McKee, and the Vice-President is R. Byers. The 52-week stock price range is 26.82 – 38.45. The current price is 33.41 with a market cap of 254.4 million. During the past year we have seen numerous amounts of buy transactions by insiders, and we have also seen a recent increase in stock price after the announcement of a planned sale to the Iron Bridge Holding company. PDM is a thinly traded company, and therefor, there are not a lot of news articles printed about them. The articles I have been able to find, have dealt with the planned sale to Iron Bridge Holding Company and past sales of operations.

In the financial statements, management says their objective is to increase shareholder value by repositioning the company and streamlining its operations. They have also relinquished all debt and our currently toting a large amount of cash in order to meet any short-term financing needs . It is my opinion that they have now restructured themselves in order to make a sell of assets or the whole company, attractive and easy. This is the main reason I think we should sell PDM. They have set themselves up for an acquisition by relinquishing all debt and I believe this causing an inflated stock price. When a company like Iron Bridge Holding tries to purchase another company they will offer a sweetener, which is a price that includes a premium. Iron Bridge Holding LLC has made an offer of 33.90 and has now included a one point five million penalty in case either company backs out. The price of 33.90 is probably an amount, which both companies feel is larger than the real intrinsic value of a share. This is not a hostile take over. Management of PDM is not planning any action to prevent sale of their company. I feel this deal in immanent and if it does not go through then stock price will decrease dramatically. Then we may have to wait for another offer in order to see a price of at least $33.40 again.

From what I have read in both Value Line Investment Survey and on various Internet sights, I feel we will see some recovery during 2002. The fed has decided to cease with the cutting of rates, which is sure sign that they believe the economy is in the early stages of recovery. This recovery will probably be highly cyclical. I feel that construction and engineering should benefit from increased government spending, which we will most likely see in 2002 due to our stagnant economy. Manufacturing will probably also benefit from the same proposed spending increases, but not as directly. Manufacturing will most likely benefit more from producing stainless steel and other metals used for the storage of petroleum products. However, long-term growth is not a factor according to the Standard and Poor’s Industry Reviews, because of the use of alternate substitutes. I read in Value Line Investment Survey that 2004 and 2005 have the potential to be profitable years for both manufacturing and especially construction.

When looking at ROE, PDM is well behind the rest of the construction industry and the companies in its prospective sectors. In 2001, they provided about a 3.5% return on equity. While the construction and manufacturing industries provided at least a 14.35% return. The one area in which PDM has the highest numbers is P/E. Their P/E ratio of almost 40, catches ones attention especially in an industry in which manufacturing companies have P/E ratio of 24 and construction companies’ range from 12 – 22. I feel the high P/E ratio is a product of being overvalued. Pitt Des Moines is a small company and has sold most of its revenue producing assets. Thus, a high price for safe earnings was the high explanation for the high P/E ratio, but due to their strategic management, I feel this logic may be reversed and the stock price will drop if the acquisition falls through. In order for PDM to increase earnings they will either have to increase their Capex and obtain more revenue producing assets or cut costs. I feel that cutting costs is somewhat of an unlikely possibility because they are in a mature industry and innovations will only cause more expenses in the short run. PDM has not debt to equity ratio because they have not debt. A higher debt/equity ratio is not necessarily a bad thing, especially when we take into consideration, market risk. PDM is assuming a lot more risk by not having any debt. The riskiness of projects is now shifted directly towards the stockholders. Even more discerning if they plan to keep operating with no debt, all financing will need to come directly from either cash or issuance of stock. I feel this will limit their ability to increase revenues to the needed level in order to sustain their current stock price. The Ebitda/ev is currently six percent, but has been decreasing over the last few quarters, which is discerning because its competitor’s URS and CBI have been improving their Ebitda/ev ratios over the past year. PDM’s Ebitda/eb is forecasted to increase dramatically in 2004 and 2005. This assumes substantial growth rates in sales and a constant decrease in costs in the future. PDM could possibly reach these projected growth rates, but this would have to involve an expansion of operations, which is the exact opposite of what they have done in the past fifteen months. Using thirty-day T-bill rates I have come up with a capm rate of 10.328 and when using the RADR approach I came up with a required return of 10.56. Using 10.328 and a long-term growth rate of seven percent I came up with a dividend discount value of 24.70. This assumes that long-term growth of dividends PDM will remain constant at 7 percent, which is highly unlikely because if long-term growth at GDP is assumed, PDM would eventually cannibalize its assets by paying higher dividends than they could generate. I then recalculated the dividend discount model using a long-term growth rate of 5 percent and came up with a value of 19.45 for PDM’s common stock. I realize that most stocks are not held with the belief that dividends will not be the only form of return on investment. The FCF method was used next. I projected the FCF using a sales growth as high as nine percent in the following three years. I then forecasted a number for shares outstanding using past regression and the assumption that PDM would eventually acquire debt if they continued to operate until 2005. I then found a terminal value for the company using a stock price of thirty-four dollars. The result of my FCF was a price of 31.32 assuming a perpetuity rate of 10.57%. I then used the financial evaluator on the website quicken and found that PDM would need to sustain a growth level of sales around 15% to justify their current stock price. This growth rate seems highly unlikely given PDM’s limited operating status and the fact that 2002 will probably prove to show mild improvement in the economy. It is my opinion that PDM is overvalued right now mainly due to the possible buyout proposed by Ironbridge Holdings LLC.

I propose that we sell PDM for about 33.50. If we can sell PDM within the next few days for this amount we will position ourselves against the risk of the acquisition falling through. Things that might cause the acquisition to fall through include regulatory constraints and anti-trust regulations. The main risk we face in selling is that the merger will go through and we have passed up the option to sell for 33.90 dollars per share. However if we hold onto the stock and the merger falls through, I am almost certain that the stock price will drop due to the limited value of the stocks FCF’s. PDM’s stock price did not move much in the last few months until the announcement of the planned acquisition, the announcement reversed the stock price and has since set it on an upward trend. Another risk I feel we face if we do not sell is the fact that if the merger falls through and the stock price drops it may take another acquisition proposal to bring the price back up. How can we be certain there will be another proposal and now that PDM has agreed to a price of 33.90 how do we know that the next company will not offer even less?

One of the main benefits of PDM was the fact that its beta is below 1.0. Its beta is however not incredibly low at .94. The riskiness of the portfolio will increase, but I feel the beta of PDM is likely to change given the reduction in its operations and its limited ability at the present time to provide returns. Another implication would be the reduction in the percentage of Iowa stocks, but given the long list of stocks with Iowa interest, I feel we will be able to find a better potential substitute. Holding PDM for the chance at another thirty cents seems foolish to me especially when we look at the fact that we bought it for $22.31 a share about 2.3 years ago. This is a yearly return of about roughly 24%.

Key assumptions I have made include the projected growth rates of nine percent for the end of 2002, and then about eight percent the next two years. To reach these levels I fell PDM will have to make major purchases of PPE and inventory. I figure these increases will start in 2003, if the company would somehow still be operating independently. I gave PDM the benefit of the doubt and figured they could continue to decrease costs, which were a direct percentage of sales. Depreciation was also a direct percentage, but this was a percentage of PPE. I decided that the shares outstanding would increase at a .75 percent, while treasury stock would decrease until 2003. If the company continues to operate until 2003 they will probably have to issue more stock. My first plug for the balance sheet was cash. In the financial statements, management said they would avoid debt by using their cash reserves. I used this plug until 2003, when I decided to use debt under the assumption they were now operating for the long-term. Finally, I figured the tax rate to be a constant 38%. I have tried to give PDM the benefit of the doubt and make their FCF almost a best-case scenario. This helps to justify my claim that PDM is overvalued and that we should sell now. If we hold onto the stock we run the risk of seeing the merger fall through, and then the price declining. It is my assumption that the stock price we see today is highly dependant on the acquisition offer and not future potential earnings.