In order to illustrate the principles treated in the chapters on promotion in a collected form, and to show how they may be applied in practice, it may be well to review briefly the facts as to a small combination of manufacturing plants located in a western city.

The Western Machinery Company was organized in 1900 for the purpose of manufacturing certain patented specialties. The capital stock was $150,000, and first mortgage bonds were issued to the extent of $25,000; $100,000 of the capital stock was given in payment for patents, and $50,000 was given to the first promoter for his services in disposing of the bonds at par. The $25,000 received for the bonds represented the total cash actually invested.

It was quickly found that the business would not prosper with the few specialities that it had been arranged to manufacture, and other specialties intended for the same general market were added. As a result, practically all of the profits which were earned from year to year were spent in securing new patents and in other development. This continued until 1906, in which year a satisfactory profit was made. However, the crisis of 1907 and the depression that followed almost wiped out the business of the company and cut down the profits practically to zero. In the last two years, however, there has been a recovery and net profits are now running at the rate of approximately $20,000 per annum. The character of the business has changed considerably since its inception, but it may now be regarded as established on a reasonably sound basis. The company, however, is considerably handicapped, its location being unfavorable for the kind of business it is now handling.

A few miles distant from the city in which the Western Machinery Company operates is a related, but not competitive, business, owned outright by a gentleman whom we will call James Smith. He has a small plant worth perhaps $60,000, and is earning net profits of about $6,500.

There is also in the immediate neighborhood the plant of a manufacturing company which became bankrupt some years ago. The plant has been closed for over three years. The buildings and other assets, even in their present depreciated condition, are estimated to have a value of well over $100,000, but could be bought for a much smaller consideration.

The following plan for the combination of the three plants above described was recently under consideration:

It is now proposed to combine these three plants under the name and charter of the first-named company, which is now carrying on an active and successful business. It is believed that the same management which has developed this business in the face of unfavorable conditions can at least go ahead with the successful operation of the plant owned by James Smith and can reorganize and successfully conduct the abandoned business of the company which formerly owned the third plant above named. James Smith is willing to remain with the new organization for a short time and then retire, so there are no personal antipathies or jealousies to be overcome. It is proposed to recapitalize the Western Machinery Company as follows:

Authorized Issue

Actual Issue

6% First Mortgage Bonds.............

$500,000

$150,000

6% Cumulative Preferred Stock..........

250,000

180,000

Common Stock..........

250,000

250,000

It is proposed to distribute these securities as follows:

Bonds

Preferred Stock

Common Stock

Western Machinery Company..........

$30,000

$100,000

$250,000

James Smith.......

20,000

Owners of abandoned plant.........

20,000

40,000

To be sold to the public........

100,000

20,000

Total..........

$150,000

$180,000

$250,000

It is anticipated that the bonds, with a 20% bonus of preferred stock, can be sold to an underwriting syndicate at par. The syndicate will probably be able to dispose of the bonds alone at par, leaving its selling expenses and profits to be covered by the bonus of preferred. Thus the company will realize $100,000 in cash.

It is further provided in the financial plan that James Smith shall receive in addition to his $20,000 preferred, $30,000 in cash, thus leaving $70,000 for rehabilitation of the abandoned plant and for working capital.

It is further provided that when earnings on the preferred stock amount to as much as 12%, then the 70% of preferred remaining unissued at the time of organization shall be distributed as a bonus in agreed proportion among the owners of the three plants entering into the combination.

It is estimated that the net profits of the combination should average at least $60,000, or approximately three times the interest and preferred dividend payments, at the outset. The three lines of business, it is stated, fit together splendidly and the combination of the different businesses will provide excellent facilities for manufacturing and shipping which will much improve the efficiency of the two going plants and will make possible the profitable operation of the abandoned plant.

In an independent analysis and criticism of the plan above set forth, it was pointed out that the earnings of the proposed combination appear to be loosely estimated and that a much more thorough investigation of probable markets for the products of the combination, of the selling expenses, and of the actual expenditures required to build up an efficient working organization in the abandoned plant, would be demanded by a conservative investor before putting any of his money into the proposition. Unless it can be demonstrated, not merely as a supposition, but as a reasonable certainty, that the earnings will average $60,000 or more, there will be no real advantage to the Western Machinery Company in carrying through this combination. After all, the plant which they possess is the only one that is now earning a considerable volume of profits, and this plant will presumably be the chief contributor to the profits of the combination.

It is no doubt true, as stated, that the Western Machinery Company could make use of enlarged facilities advantageously, but the question to consider here is whether a small bond or preferred stock issue, based upon the assets of the company, would not provide facilities for enlarging its operations and earning more profits with less risk than would be the case if they carried through the combination. Under the proposed plan, the Western Machinery Company assumes nearly the whole burden of risk, must contribute its own profits to the payment of interest and dividends, and must rely on its ability to develop new business for the other two plants in order to give a satisfactory return to the present owners of the Western Machinery Company. To state the case in slightly different terms, the most successful of the three companies entering into this plan will be giving up the practical certainty of continued, satisfactory profits, for the uncertainty of developing a new enterprise.

It may be stated in general terms, that the wisdom of combining a going, successful concern with an unsuccessful concern may almost always be questioned. If the successful concern desires to acquire the assets of the unsuccessful concern, that may best be done by raising cash upon its own credit and purchasing those assets outright. The situation is entirely different from the one which exists when two or more going and successful corporations are combined on the basis of their earning powers.

On the strength of this criticism, it was agreed that the plan was in all probability faulty, and it is understood to have since been abandoned.*