Lincoln Electric

Team

What is the Best Way to Enter India?

• By acquisition• By Joint venture• Building a new plant on its own

Operation Red Elephant:Entering India

The Ador Welding Joint Venture

Outline

• PEST• Strengths and Weaknesses• Organizational Structure• Culture• Strategy• Recommendations

PEST

STRENGTHS & WEAKNESSES

Key Points• Core Competencies

– Product mix– Technical Developments

• innovation,• technology.

– Customer Relations & Marketing• Quality• Service

– Operations• speed• Productivity• efficiency

– Logistics• Financials• Culture & Leadership

– Management– Organization– Decision-making abilities

Product Mix

• Lincoln could solve customers’ process problems and improve process productivity with its ability to combine both equipment and consumables development needs into one integrated package.

Tech Development

Strengths• Technological innovation allows the company

to earn a price premium for many of its products.– Industry leader in new market introductions and

quality performance.– The most aggressive, comprehensive, and

successful R&D program in the welding industry

Tech Development

– More than 50% of Lincoln Electric’s equipment sales in 2005 were generated by welding machines introduced in the previous five years.

– Known as “The Welding Experts,” vs. its leading competitors who chose to diversify their resources far away from welding.

– In 2004 began building regional engineering development centers worldwide.

Costumer Relations

Strengths• Product support and guarantees, allows the

company to earn a price premium for many of its products.– Customer support– Training– Consultation– Guaranteed Cost Reduction Program

Costumer Relations

Weaknesses• Geographical distance; logistics

Marketing

Strengths• Strong brand identityWeakness• Strong brand identity

Operations

Strengths• Efficiency– Solutions oriented– Supply chain and FANUC Robotics– Harris Colorific acquisition

Weaknesses– Maintaining operational efficiency internationally– Incompatible power source

Logistics

Weaknesses• Local production presence

Is Your Unique Competency aSound Basis for an Effective Strategy?

Inimitability

Product mixTechnical DevelopmentsCustomer Relations & MarketingOperationsLogistics

54332

Durability

Product mixTechnical DevelopmentsCustomer Relations & MarketingOperationsLogistics

34544

Appropriability

Product mixTechnical DevelopmentsCustomer Relations & MarketingOperationsLogistics

55544

Sustainability

Product mixTechnical DevelopmentsCustomer Relations & MarketingOperationsLogistics

33432

COMPETITION

Ador Welding Ltd.

• $50 million in sales in 2005 with a 15% operating margin, and a portion of its shares traded on the local stock exchange.

• Cost-adjusted annual revenue growth rate at 20% over the next two years, which should continue with a return on capital employed at over 40%.

Ador Welding Ltd.

• The company has shifted some production to Silvassa, a government-created tax-free zone, and by concentrating production at a smaller number of facilities Ador had realized both economies of scale as well as tax savings.

• In July 2006 the company’s publicly traded shares were valued at 10.9x FY07 estimated net earnings per share, and EBITDA per share was predicted by the same local analyst to grow at a CAGR of 29% and net earnings per share to grow at a CAGR of 23% over the next two years.

Ador Welding Ltd.

• Ador had annual sales of 241.6 crore (large values of India’s currency, the rupee, are counted in terms of crore, with one crore the same as 10,000,000 rupees).

• The company had produced 17,217 MT of consumable welding products in FY06, and Ador had previously constructed plant lines that could produce far more than that should the market continue to grow. Ador had in FY06 paid a dividend of 15 rupees, equal to a 4% yield on the stock.

ESAB India

• Over $50 million in sales in 2005.• 18% operating margin in 2004• Newly Restructured• New $4.6 million, 50,000 square foot,

greenfield manufacturing plant

EWOC Allows Ltd.

• $30 million in revenues in 2005

Smaller Competitors

• D & H Sécheron– $3.5 million in sales in 2005

• Indo Matsushita• Anand Arc– Manufactures full range of welding consumables– Claims that it produces the highest-quality

electrodes in India

Competitive SuperiorityLincoln Electric

Ador Welding

Ltd.

Esab India

Product mix

Technical

Developments

Customer Relations & Marketing

Operations

Logistics

----------

----------

----------

FINANCIALS

Cashflow

• Long-term company financial targets included sales growth at double the rate of growth in worldwide industrial production

• Operating margins over 15%• Earnings growth of 10% annually• Return on equity exceeding 20%

Cashflow

86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

(60.0)

(40.0)

(20.0)

-

20.0

40.0

60.0

80.0

100.0

120.0

140.0

Net Income

Access to Outside Capital

• India market booming so credit may be easily accessible.

• Still, any significant welding acquisition would likely require paying an acquisition premium greater than Lincoln Electric had been used to paying in the past

Other Scheduled Plans

• As of 2005 the company spent approximately two-thirds of free cash flow for international expansion

Hurdle Rate

• A minimum internal rate of return, based upon total investment, of an initial 10% increasing to a minimum of 18% over the first 3–4 years (with synergy credits)

• The acquisition price was less than 8x EBITDA

Other Data

• 2005: operating income was $153.5 million and net income was $122 million on sales of $1.6 billion.

Other Data

• Domestic Reliance• Over-forecast and spending• Extensive resources required– Human capital– Manufacturing

Regional Performance

Region Year ROATotal Sales

(USD millions)Total Assets

(USD millions)

USA and Canada 2005 0.28 1077.5 652.5

Mexico and Latin America 2005 0.16 121.4 83.0

Europe 2005 0.07 426.3 313.3

Asia and Astrailia 2005 0.05 125.0 98.1

Acquisition Feasibility of Ador Welding, India

# of Publicly Traded Shares 5,995,933.00% of shareholding 44.09%Total Number of Shares 13,599,303.70

Earnings Per Share (in Rupees) 29.45CAGR for Net EPS (2007 projected) 23%Projected FY07 Net EPS (in Rupees) 36.2235

Ador's public share valuation (P/E)* 10.7 *-Based on Ador's FY07 projected EarningsAdor's Price per Share 387.59145

Acquisition Strategies

Total # of Shares

% Ownership Required

Price Per Share

Acquisition Premium

Total Acquisition Cost in Indian

RupeesTotal Acquisition Cost in US Dollars

Leveraged Buyout Options

80% - Commercial

Funding @8.5%20% -LE

Financing via cash

Interest Expense

Total Acquisition 13,599,303.70 100% 387.59145 10% 5,798,071,222.79 $127,557,566.90

$102,046,053.52 $8,673,914.55

$25,511,513.38 Majority ownership 13,599,303.70 51% 387.59145 10% 2,957,016,323.63 $65,054,359.12 $52,043,487.30 $4,423,696.42

$13,010,871.82

Joint Venture 13,599,303.70 50% 387.59145 10% 2,899,035,611.40 $63,778,783.45 $51,023,026.76 $4,336,957.27

$12,755,756.69

Public Takeover (Purchase all Public Shares) 13,599,303.70 44% 387.59145 10% 2,556,369,602.13 $56,240,131.25 $44,992,105.00 $3,824,328.92

$11,248,026.25

Strategic Alliance 13,599,303.70 30% 387.59145 10% 1,739,421,366.84 $38,267,270.07 $30,613,816.06 $2,602,174.36

$7,653,454.01

2005 Revenue for Largest Competitors in $13 Billion Welding Market

• Lincoln Electric’s main competitors are ESAB (European based company) and ITW (Illinois Tool Works).

• Lincoln Electric also owns assets in Air Liquide, the fourth largest competitor in the market.• Total revenue is important, but the total net income far more important.

Linco

ln Elect

ricES

AB

ITW W

elding

Air Liquide

Kobelco

Therm

yadyn

e

Boher-Th

yssen

Fronius

Daihen

/OTC

Panaso

nic

Sichuan

Atlantic

Hyundai

0200400600800

1,0001,2001,4001,6001,800

In $ Millions

In $ Millions

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

Lincoln Electric's Profit Margin

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 20050.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

Lincoln Electric's Return on Assets

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 20050.00%

5.00%

10.00%

15.00%

20.00%

25.00%

Lincoln Electric's Return on Equity

1998 1999 2000 2001 2002 2003 2004 20050.00%

5.00%

10.00%

15.00%

20.00%

25.00%

Lincoln Electric's Debt Ratio

Industry Benchmarkand Competitors

• Note: ITW and EASB India earned $1.3 billion, while Lincoln Electric earned $1.6 billion.• In 2005, ESAB India gain more capital from investor causing higher ROE. A huge increase of £123.6 million.

ORGANIZATIONAL STRUCTURE

Introduction

Structural Dimension Divisional Functional Matrix Network

Efficiency of resource utilization

Poor Excellent Moderate Good

Efficiency of time utilization

Good Poor Moderate Excellent

Responsiveness to the environment

Moderate Poor Good Excellent

Adaptability over time

Good Poor Moderate Excellent

Ability to hold people accountable

Excellent Good Poor Moderate

Environment for which best suited

Heterogeneous Stable Complex Volatile

Strategy for which best suited

Diversified Focus/low cost

Responsive-ness

Innovative

Lincoln Electric

Structural Dimension Divisional

Efficiency of resource utilization Poor

Efficiency of time utilization Good

Responsiveness to the environment Moderate

Adaptability over time Good

Ability to hold people accountable Excellent

Environment for which best suited Heterogeneous

Strategy for which best suited Diversified

Functional Divisional Matrix Network

Division of Labor

By inputs By outputs By inputs & outputs

By knowledge

Coordination of Mechanisms

Hierarchicalplans &

procedures

Division Gen. Mgr. &

corporate staff

Dual reporting relationships

Cross-functional

teamsDecision Rights Highly

centralizedSeparation of

strategy &execution

Shared Highly decentralized

Boundaries Core/periphery Internal/external markets

Multiple interfaces

Porous & changing

Importance of Informal Structure

Low Modest Considerable High

Politics Inter-functional Corporate-division &

Interdivisional

Along matrix dimensions

Shifting coalitions

Basis of Authority

Positional & functionalexpertise

Gen. Mngt.responsibility &

resources

Negotiating skills &

resources

Knowledge & resources

Lincoln ElectricCentral Issues Divisional

Division of Labor By outputs

Coordination of Mechanisms Division General Manager &corporate staff

Decision Rights Separation of strategy & execution

Boundaries Internal/external markets

Importance of Informal Structure Modest

Politics Corporate-division & Interdivisional

Basis of Authority General management responsibility & resources

CULTURE

Culture

Strengths• Industry-leading productivity advances

through innovative human resource and incentive systems.– stock ownership– incentive bonuses via merit ratings– Employee Advisory Board– employee suggestion system

Culture

– annuities for retired employees– group life insurance.– No lay-off policy

• The entrepreneurial spirit– Piecework– Work days– Merit ratings

• Trusting relationships

Culture

Weaknesses• Competent executive management• Synergies of acquisitions• Competent operational/functional

management• Incentive and bonuses

Culture

• Trust issues

STRATEGY

Introduction

• Many executives argue that brilliant execution is more important than brilliant strategy. The reason is simple: doing is harder than dreaming, and poorly executed strategy is merely a vision of what could be. Effective implementation can prove difficult, as it requires the coordinated and appropriate efforts of individuals throughout an organization. Thus the critical task for senior managers is to define the key success activities for their organization's strategy and develop an organizational system that promotes those same activities.

Structure and Strategy

The Joint Venture

NEGOTIATION STAGE

Equity Structure

• Control of a joint venture is not something surrendered easily

Technology Transfer

• Important aspects include defining precisely what technologies (possibly including technologies not yet developed by either side) are to be covered in the agreement and the terms under which they are to be made available to the venture.

• The developing country partners hope to set bounds on the royalties and fees they will have to pay providers, especially as the technology becomes older, and to broaden the joint venture’s control over its use.

Valuation problems

• Each partner brings financial and other assets to the joint venture, and it is often not easy to determine what these assets are worth.

Transparency.

• Getting accurate data upon which to base valuations and other decisions can be very difficult in some countries, especially where accounting standards are quite different from international standards.

Conflict resolution.

• Disputes are virtually inevitable in a relationship as complex and dynamic as a joint venture.

• Spell out how disputes are to be resolved

Division of management responsibilityand degree of management

independence

• Attempts by parent companies to micromanage an enterprise that may be thousands of miles away are doomed to failure.

• A better strategy is for them to set up clear operational parameters and then let the venture’s management succeed or fail on its own.

Changes in ownership shares

• How should the ownership structure be changed as a joint venture matures?

Dividend policy and other financialmatters

• Dividend policy goes to the heart of why companies enter into joint ventures, with some companies hoping to expand and gain market share rapidly while others are striving to achieve quick increases in cash flows that they can use to support other operations.

Marketing and staffing issues

• The multinational company (MNC) partner may see the joint venture as only part of a larger strategy to enter the developing country market.

• As a result, insistence by the MNC partner on control of key positions in the joint venture may be seen by the local partner, first, as overly expensive and, second, as an effort to marginalize it.

OPERATIONAL STAGE

Multinationality

Many joint ventures undertaken in developing countries involve large MNCs that participate in a variety of other joint ventures and run wholly owned subsidiaries elsewhere in the world. The developing country firms that are their joint venture partners, though they may be quite large by local standards, are often dwarfed by their MNC partners.

Multinationality• Export rights – Typically, the MNC would prefer not to allow the joint

venture to export products, which may be of inferior quality (compared with those it manufactures elsewhere), into markets already served by other manufacturing points in its own system…

• Tax issues – An MNC generally wishes to minimize its worldwide tax burden. This objective can dramatically affect its relations with a joint venture…

• Dividend and investment policies – The MNC partner may have global investment programs that involve transferring of funds from one region to another. It might, therefore, prefer to receive dividends from the joint venture instead of reinvesting earnings, a position not necessarily compatible with that of its domestic partner…

• Differences in partner size – The local partner is likely to be considerably smaller than the MNC partner, a difference that can have important consequences for operating the joint venture…

Ownership and control problems

One problem that frequently arises in the management of joint ventures occurs when an owner’s attitude changes…

Ownership and control problems

• Product line disputes• Material and component sourcing• Technology utilization• Cultural problems

Changing relationships

Joint ventures involve dynamic relationships, and it is almost impossible to foresee at the time of agreement just how underlying conditions might change. For example, learning takes place, and it can modify how one partner views the contributions of the other. A developing country partner often is seen at the outset as mainly contributing knowledge of local practices, and the perceived value of its contribution can decrease as the MNC partner learns more about the local setting…

RECOMMENDATIONS

Strategic Alliance/Greenfield Investment Hybrid

First Best Strategy

• Creating a strategic alliance with Ador would give Lincoln Electric instant access to the company with the largest market share in India for welding equipment and consumables.

• Projected revenue growth for Ador is 20% per year for the next 2 years, with a Return on capital of 40% over the same period. Shares of the company are available on the market, the company is obviously well run, and getting a minority stake (25%) in the company should allow Lincoln Electric to utilize the excess production Ador has available in their Silvassa facility. This would enable the production of consumables locally while a greenfield facility for research, development, and equipment production is constructed.

Lincoln Electric

Structural Dimension Network

Efficiency of resource utilization Good

Efficiency of time utilization Excellent

Responsiveness to the environment Excellent

Adaptability over time Excellent

Ability to hold people accountable Moderate

Environment for which best suited Volatile

Strategy for which best suited Innovative

Network Structure

• Advances in technology, specifically inverter technology, will be necessary in India, given their limited access to such technology, the efficiency of this technology, and the high cost of electricity in India. This provides a huge opportunity for Lincoln Electric to capitalize on its previous technological achievements in a new market while developing newer technologies for more developed markets.

• Considering the levels of expansion in the countries GDP growth, the projected level of governmental infrastructure projects, and the development of several thousand miles of new oil and gas pipeline, the Indian market will be profitable through at least 2015, and most likely beyond, as these infrastructure improvements encourage further build-out.

Acquisition

Not a First Best Strategy

• An acquisition would prove overly costly for Lincoln Electric, as the enhanced performance of the welding market would push the costs of the acquisition outside of the boundaries commonly used in justifying the acquisition of a target company.

• Even if the rules of acquisition were relaxed, there could be several issues in this method. The only viable acquisition target would be a large scale target, as consolidating enough of the 300 smaller competitors into a force sizable enough to rival ESAB and Ador would take far longer and be more logistically and capital intensive than other more practical strategies. Also, given Ador's organizational structure, there is no guarantee that acquiring this company would result in similar performance under LE's ownership, as the management and HR styles are different.

• It has already been demonstrated, by ESAB India, that entry into the market based solely on acquisitions is not profitable in the short term. Their acquisitions strategy, started in 1988, only turned profitable in 2005 (+17 years from entry) and this was due to massive restructuring, increased capital funding, and accounting write down; for that level of capital investment a greenfield investment would be a better use of capital in both the near- and long-term.