Michael H.

Moffett
Lena Booth

PENG PLASMA SOLUTIONS 1

Known as the "Fourth State of Matter", a plasma is a substance in which many of the atoms or molecules are
effectively ionized, allowing charges to flow freely. Since some 99% of the known universe is in the plasma state
and has been since the Big Bang, plasmas might be considered the First State of Matter. Plasmas have unique
physics compared to solids, liquids, and gases; although plasmas are often treated as extremely hot gases, this
is often incorrect. Examples of plasmas include the sun, fluorescent light bulbs and other gas-discharge tubes,
very hot flames, ... and plasmas produced for magnetic confinement fusion.
– The Plasma Dictionary

The 2008-2009 recession accompanying the global credit crisis had been tough on many companies, Peng
Plasma Solutions (PPS) included. Charlie Peng’s father Jerry had started Peng Plasma Solutions in 1988 with
a partner, Wai Seng Leng. Leng had always been a silent partner, a partner in principle, given that the plasma
cutting torch product line was based on patents held by Leng. In 1995 Jerry Peng had bought Leng out, and
the business had been a Peng family business ever since.

Charlie had replaced his father at the helm in 2004. The business had grown under Charlie, hitting a peak
in 2008 before falling in 2009. Although sales and profits had revived in 2010, hitting Rmb 1,940 million
(US$288.7 million) and Rmb 82 million (US$12.2 million), respectively, he was now thinking of selling the
business. His Hong Kong-based bankers, just over the border from Guangdong where Peng was located, had
been highly critical of the way the company was being run, both financially and strategically. It had been
nearly four years since it had launched a new product. Charlie Peng wanted to reassess the business’s
fundamentals and decide upon a course of action – or exit.

Metal Cutting and Plasma Solutions

Peng Plasma’s people always introduced themselves as metal cutters – not welders, not blood thinners – metal
cutters. It was a source of pride. But Peng Plasma wasn’t your average metal cutter.

There are four primary methods for the cutting or separation of metal: 1) manual technologies: saw,
chisel, shear or snips; 2) machine technologies: turning, milling, drilling, grinding, sawing; 3)
welding/burning technologies: burning by laser, oxygen-fuel burning, plasma; and 4) erosion technologies:
water jet or electric discharge. Plasma cutting, Peng’s technology, was preferred for thick stainless steel and
aluminum applications.

Regardless of method, all cutting results in the creation of two separate components, the finished product
– the cut metal pieces, and the excess material, the swarf (shavings or chips of metal). Plasma cutting
improved the performance in both areas. The cut pieces were sharper and cleaner often requiring no additional
finishing. And just as importantly, it produced near-zero swarf in the process.

Metal cutting technology had evolved dramatically over the past 30 years. As Peng and a few small
competitors had engineered new models, they moved increasingly smaller. New torches with smaller nozzles
and ever-thinner plasma arc streams produced cut edges nearing laser precision. This, combined with smaller

1
Copyright ©2013 Thunderbird School of Global Management. All rights reserved. This case was prepared by
Professors Michael H. Moffett and Lena Booth for the purpose of classroom discussion only, and not to indicate either
effective or ineffective management. The case is based on a private company, and all names and values have been
changed to preserve confidentiality.
2

and smaller portability, allowed the use of plasma cutting on a multitude of fabrication and cutting
applications which had traditionally been beyond reach.

Peng’s Profitability

Peng was profitable. As illustrated by Exhibit 1, the company had made a profit over the past six years, and
that included 2009 when many firms in many markets suffered losses with the global financial crisis. Sales
in 2010 had returned to the growth path seen prior to 2009, but profitability, for example return on sales, was
still below levels seen in prior years.

One area of specific concern

Exhibit 1. Peng Plasma Solutions, Sales and Profitability
was cost – direct cost (cost of
sales). Charlie Peng was Sales (million Rmb) Return on Sales (%)
2,000 10%
notoriously ‘lean’ when it came
to overhead expenses, general 9%
Return on Sales = Net Income
and administration expenses, 1,900 Sales
8%
G&A, which he believed caused
many promising companies to 1,800
7%

fail. And he would not allow 6%

Peng Plasma to join that list, 1,700 5%

particularly in these tougher
times. He worked continually to 4%

1,600
keep both overhead and G&A 3%

below 10% of sales. The cause Sales

2%
of cost increases had been his 1,500

two major direct costs, labor and 1%

materials. 1,400 0%
2005 2006 2007 2008 2009 2010

Labor costs were at the top

of the list. Labor costs had been
rising very rapidly for all coastal Chinese manufacturers, and Peng was no different. What the company had
avoided, at least until recently, was high turnover. Although many companies in Guangdong had suffered
losses upwards of 25% quarter-to-quarter from workers moving across the street for 10 more yuan, Peng had
been raising wages ahead of the curve to try and preempt losses.2 Although retention had not yet been a
problem, the rising wage costs were. The second source of cost increases, material costs, was a reflection of
the run-up in all types of metal and rare earth element prices in recent years. Copper costs alone had risen
dramatically, but almost every component, including steel and tungsten, had seen continual price increases.

Markets, Margins, and Competitiveness

Charlie Peng had recently completed a review of the company sales with the help of his staff. Charlie believed
in having a strategic plan in place to be used both as a barometer and a benchmark before evaluating
operational performance and financial needs for future success.

Peng offered four major categories of products: handheld cutting systems, mechanized cutting systems,
consumables used to ensure optimal plasma cutting performance, and control products designed to deliver
flexibility in plasma cutting. The first two product lines, handheld and mechanized cutting systems, together
accounted for about 84% of global sales.

2
The People’s Republic of China officially recognizes the terms renminbi (RMB) and yuan (CNY) as the name of its
official currency. Formally, the term yuan is used in reference to the unit of account, while the physical currency itself
is termed the renminbi.
 3

In recent years, healthy growth had been observed in the mechanized systems market, due to the strong
demand from the shipbuilding industry in South Korea, Singapore, and Indonesia, and the heavy equipment
and machinery industries in China. Sales rebounded rapidly after the recession, and in 2010 mechanized
cutting systems accounted for 49% of total sales. Gross margin for the product line, though decreasing, was
still above 30%.

Handheld cutting systems, on the other hand, had not fared well. Peng’s market share of handheld
systems had been falling slowly and steadily. Europe and North America were the main markets for this
product line. The declining manufacturing activities in these big industrial countries had substantially lowered
the demand. Additionally, Peng had not introduced any new product in the handheld market since launching
PT350 three years ago. The increasingly obsolete technology and stiff competition in this market (partly due
to the unfavorable exchange rates that made Peng’s products more expensive than others) had resulted in a
big decline in sales. In 2010, the handheld cutting systems accounted for only about 35% of total sales. Gross
margin fell from 33.5% in 2008 to less than 20% in 2010.

Peng’s consumables accounted for about 11% of total sales and had the lowest margin of all products.
It was to be honest, a product line which Peng had to carry, but was not and would not ever be a profit driver.
The market segment had many low-price generic brands, forcing Peng to price its products very
competitively; consumables were a commodity. The consumables were sold worldwide, with China being
the fastest growth market for this product line. Sales in Europe and North America declined as the global
recession prompted many customers in these regions to switch to generic brands.

The control products in Peng were primarily computer numeric controls and torch height controls used
in mechanized cutting systems. The healthy demand in mechanized systems had resulted in strong sales for
this product line. However, the increased labor costs had lowered the gross margin substantially, from 27%
in 2008 to about 21% in 2010. This product line accounted for about 5% of total sales. Appendix 3 provides
a breakdown of sales by region, and Appendix 4 a decomposition of product sales, costs, and inventories.

Charlie therefore began where he always began, decomposing the revenue growth of the company into
three categories: customer churn, core market growth, and new markets growth.

C Customer churn was the state of current market share and sales. This segment combined the sales growth
each year that arose from sales taken from competitors with that lost to competitors. Depending on the
company, this was often the entire focus of leadership, if it considered itself operating within a mature
market, or nearly totally ignored, if the company’s culture and strategy focused nearly exclusively on
innovative growth.

C Core market growth was the growth in annual sales that arose from the company’s market positioning
– its existing share – of a growing market. In other words, it was the growth in sales that arose from
getting the same sized slice of a growing pie. Corporate leadership often viewed this category passively;
regardless of whether market growth was good or bad, it was viewed as out of the company’s hands.
Charlie was not sure that was really the case.

C New products/markets growth was the growth in annual sales achieved through entering adjacent
markets and new markets through new products or services. Sales in these new markets could be achieved
through either organic growth (expansion from within) or inorganic growth (via acquisition).

After reviewing Peng’s sales growth over recent years, Charlie Peng quickly concluded that there was
trouble in all three categories. Customer churn had been high for a variety of reasons, and pricing in both
North America and Europe was a growing problem. Core market growth, again the traditional North
American and European markets, had been flat at best. Most of that was a result of both declining
manufacturing activity in the big industrial countries and the 2009 recession.
4

New markets and products was a more fundamental problem. Peng was a technology company, yet they
had been unable to launch a truly new competitive product in the last three years. The last new product, the
PT350, a micro-plasma cutter, had done well enough, but it was time for a new power cutter and the company
just didn’t have the capital to develop a commercially competitive product now.

Peng’s target customers had never really changed: Shipbuilding, heavy equipment and machinery,
industrial construction projects of all kinds, all were the pillars of Peng’s sales and profitability for years. But
where those companies were was changing. It was increasingly local, China itself.

The shipbuilding industry, much of it surrounding the South Korean and Singapore/Indonesia markets,
had been a segment of healthy growth for Peng’s plasma cutting systems for a number of years. The ship
building needs of the global oil and gas industry had been behind a lot of it as the offshore industry had
grown, including offshore platforms of all kinds, floating production and storage vessels, and supertankers.
The growth of the liquified natural gas market (LNG), requiring a new fleet of refrigerated ocean-going
tankers, had helped as well. And the industry had seemingly only blinked briefly with the 2009 global
downturn. Oil and gas prices had remained relatively high in 2009 and into 2010, so the market was
seemingly solid.

But it was the growth of China itself which had been behind a lot of the recent sales growth. Although
the traditional residential and commercial construction segments did not drive much demand for Peng’s high-
end mechanized systems, there were enough infrastructure projects underway to make China the growth
engine.

Outside of shipbuilding, Peng was faced with a highly dispersed industrial market, with many niche
players and a few dominant companies. This was particularly the case with North American and European
sales. Markets which historically had been the core of company sales were quite anemic in recent years. These
were typically specialty sales, small machine part manufacturers and electronic component integrators, who
were not volume buyers. The only way Peng had been able to reach most of them was through sales reps who
carried a lot of different company products, and increasingly, Internet sales.

Pricing

Another part of the problem which Charlie continually struggled with was price. Peng’s products were priced
in U.S. dollars in most markets, and the creeping revaluation of the renminbi against the dollar had been
steadily working against the company.

For example the PT350 (plasma torch model 350) was introduced in 2007 at Rmb 18,000. The average
exchange rate for 2007 was about Rmb 7.60/US$, so the dollar price as it retailed through distributors in
North America was:

The reception for the product had been good and initial sales promising. But over the following years its
price continued to creep upwards as the Rmb rose against the dollar. Charlie was worried. The historical role
of exports as being the primary driver for Chinese business, had him pondering the path of the renminbi (see
Appendix 5), and listening to announcements by the Chinese government. Charlie had seen the problems
coming, but they were difficult to stop. He had held the line on the home-country price, but that had not been
enough.
 5

Looking at the cumulative impact

and assuming that the current year Exhibit 2. Pricing of the PT350 Since Introduction
would average about Rmb 6.55/US$,
Average Rate Percent
as illustrated in Exhibit 2, the PT350's Year Price (Rmb) (Rmb/US$) Price (US$) Change
price had risen a cumulative 16% in the 2007 18,000 7.60 2,368.42 ---
dollar markets since its introduction. 2008 18,000 6.94 2,593.66 9.51%
Many of the international sales reps 2009 18,000 6.84 2,631.58 1.46%
were starting to complain more and 2010 18,000 6.76 2,662.72 1.18%
more that the dollar price was too high. 2011 18,000 6.55 2,748.09 3.21%
Cumulative 16.03%
Investment and Debt

Charlie Peng knew the company

needed to broaden its product offerings to include laser cutting technology and control equipment for
automation applications, but he estimated that would require an investment of Rmb 200 million over a series
of years. He had started the process, investing Rmb 56 million in 2009 and another Rmb 72.5 million in 2010.
But it had come at a cost: a growing debt load.

The company had acquired much of its long-term debt back in 2006 and 2007 at a moderate cost of
9.75%. It had used short-term debt sparingly over the years, but the capital outlays in 2009 and 2010 had to
be funded, and short-term debt had been the only choice. But short-term debt costs during the crisis had
skyrocketed, averaging 16.50% in 2009, dropping slightly to 14.80% in 2010.

Peng’s bankers had been anxious

about the growing use of short-term Exhibit 3. Comparables for Peng Plasma
debt over the past two years. Charlie
was certainly aware of the issue, and Company Company Company
Working Capital A B C
those growing costs, but cash flow was
Days Sales Outstanding 38 41 40
a bit of a problem and short-term bank Days Inventory 44 39 38
loans was the customary way to deal Days Payables 36 34 35
with that.
Capital Structure
Part of the problem had been the Debt / Total Assets 0.26 0.21 0.25
Debt / Invested Capital 0.31 0.35 0.29
Chinese market itself. Many of Peng’s
Debt / Equity 0.65 0.59 0.52
Chinese customers, since the onset of
the financial crisis, had been paying for Profitability
product with Chinese Paper. This Gross Profit Margin 28.0% 24.6% 25.3%
paper which was nothing other than an Return on Sales 14.2% 7.7% 12.1%
IOU, a promise to pay in cash (finally), Aftertax ROIC 23.2% 17.3% 21.9%
in another 60 to 90 days. If Peng Return on Assets 14.3% 10.1% 15.9%
ROE 29.5% 22.5% 27.4%
wanted its money now it could sell the
notes for cash, but this typically
resulted in the company taking a
discount of 8% to 10% on the receivable.

When Charlie had asked his bankers for some benchmarks on business performance including working
capital management, they had only been able to provide three comparable companies, labeled A, B, and C
in Exhibit 3. If nothing else, all three companies were making much higher returns on capital than Peng
Plasma had been able to generate recently. Regardless, Charlie’s bankers set his borrowing limit as Rmb 200
million, and that was it.
6

Jerry Peng’s Rules

What Charlie Peng knew about financial performance and management he had learned from his father. His
father had a few principles – Jerry Peng’s Six Rules – which Charlie had tried to follow over time.

Rule #1:“Collect your receivables, its your money.” Charlie’s father had continually reminded him that when
you made a sale the business was not over. You needed to deliver the product, support the customer, and
collect your money. Not necessarily in that order.

Rule #2: “Bankers are only interested in your ability to repay their loans – with interest.” The senior Peng
had always emphasized what a bad thing debt was, but Charlie struggled with this. The company needed to
occasionally borrow if it were to make the investments and purchases needed for growth. But Charlie’s banks
were now arguing that his debt levels were too high, doubting his ability to sustain the rising interest costs.

Rule #3: “The worst noise to hear on the shop floor is silence.” This is the slogan that the senior Peng had
always used to emphasize that the company needed to maintain adequate inventories at all times to avoid
stock-out shutdowns or delays.

Rule #4: “Accounting is a practice; cash flow is real.” Needless to say, the elder Peng had never held the
accounting profession in high esteem. He also believed that the only way you could tell how well a business
was doing was to look closely at its cash flows.

Rule #5: “We are a private business. We don’t care what others think.” Charlie’s father constantly
reminded him that they had a strong advantage over publicly traded companies. They could run the business
as they chose, and weren’t accountable for other investor attitudes toward what margins were adequate or
what actions had to be taken to create accounting results.

Rule #6: “Growth is overrated. What counts is sustaining the family.” Not surprisingly, under senior Peng’s
leadership the company had grown very slowly for many years. Charlie had succeeded in growing it at a more
rapid rate, but his father thought he was sacrificing the sustainability of the business.

Charlie Peng’s bankers had heard the six rules many times over the years, and they were not great fans
of some of the principles. But Charlie had been talking to two different sets of bankers, those that provided
Peng Plasma its debt, and a couple of investment banking houses on the prospects of selling the company.
The latter had focused on something which wasn’t in Jerry’s Rules or on the banker’s list, return on capital.
The I-bankers said Peng needed to get return on invested capital up over 20% to make the company attractive.
But when Charlie had discussed it with his father, his father had simply remarked “I used to get 3% on my
savings, and averaged 10% on my stocks. Since the company is more risky than a stock, for us, then 15%
should be the minimum.”

Peng’s Prospects

Charlie Peng had been educated in engineering, not business. His father had made sure that Charlie knew the
technology, and had introduced his son to the business on the job and over time. But Charlie knew enough
about his business to know that something needed to change, and quickly. He did not know if its current
financial position would allow it to stay independent much longer. Alternatively, Charlie could search out
a new owner, a larger established firm with a wider portfolio and the experience of integrating and growing
smaller businesses.
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Appendix 1. Peng Plasma Solutions, Statement of Income

(millions of Rmb, year ending December 31)

Income Item 2008 2009 2010

Sales 1,861.68 1,560.30 1,940.30
Cost of goods sold 1,255.12 1,160.10 1,456.70
Gross profit margin 606.56 400.20 483.60

Marketing & selling expenses 125.42 128.20 116.84

General and administrative expenses 162.66 158.29 160.82
Earnings before interest, taxes, depreciation 318.48 113.71 205.94
and amortization

Depreciation expenses 50.54 58.17 62.00

Earnings before interest and taxes 267.94 55.54 143.94

Interest expenses 26.10 34.60 47.70

Earnings before taxes 241.84 20.94 96.24

Taxation expenses @ 25% 60.46 5.24 24.06

Net income 181.38 15.71 72.18

Dividends paid 60.00 60.00 60.00

8

Appendix 2. Peng Plasma Solutions, Balance Sheets

(millions of Rmb, year ending December 31)

Assets 2008 2009 2010

Cash 61.20 26.40 17.40
Accounts receivable 201.21 198.78 292.91
Inventory 192.29 183.49 247.84
Prepaid expenses 34.17 38.73 32.59
Current assets 488.88 447.39 590.73

Gross fixed assets 437.24 493.44 565.94

Accumulated depreciation 98.64 156.81 218.81
Net fixed assets 338.60 336.63 347.13

Total Assets 827.48 784.02 937.86

Liabilities & Net Worth 2008 2009 2010

Accounts payable 107.05 105.27 140.48
Accrued expenses 43.71 35.78 44.18
Short-term debt 119.54 137.29 242.74
Current Liabilities 270.30 278.34 427.40

Long-term debt 127.80 120.60 113.20

Equity 429.38 385.09 397.27

Liabilities & Net Worth 827.48 784.02 937.86

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Appendix 3. Sales Decomposition by Region

Sales by Region (millions of Rmb) 2008 2009 2010
China 484.0 530.5 776.1
Europe 279.3 187.2 194.0
Americas 446.8 312.1 310.4
Singapore/Indonesia 502.7 405.7 523.9
South Korea 148.9 124.8 135.8
Global sales, net 1,861.7 1,560.3 1,940.3

Supplementary Data:

Sales by Region (percent) 2008 2009 2010

China 26% 34% 40%
Europe 15% 12% 10%
Americas 24% 20% 16%
Singapore/Indonesia 27% 26% 27%
South Korea 8% 8% 7%
Global sales, net 100% 100% 100%

Average Exchange Rate for the Period 2008 2009 2010

Rmb/€ or RMB/EUR 10.15 9.48 8.96
Rmb/$ or RMB/USD 6.94 6.84 6.76
Rmb/S$ or RMB/SGD 4.90 4.69 4.96
Rmb/Won or RMB/KWN 0.0063 0.0053 0.0058
10

Appendix 4. Sales and Costs by Product Line

(millions of Rmb, year ending December 31)

2008
Product Line Sales Cost of Sales Inventory
Handheld Systems 707.4 470.2 76.3
Mechanized Systems 844.7 542.2 85.2
Consumables 223.4 179.8 21.6
Controls 86.2 62.9 9.2
Total 1,861.7 1,255.1 192.3

2009
Product Line Sales Cost of Sales Inventory
Handheld Systems 570.3 450.2 74.3
Mechanized Systems 725.9 498.1 81.9
Consumables 183.6 149.5 17.9
Controls 80.5 62.3 9.4
Total 1,560.3 1,160.1 183.5

2010
Product Line Sales Cost of Sales Inventory
Handheld Systems 670.8 540.6 96.3
Mechanized Systems 950.1 657.3 114.2
Consumables 219.2 179.5 24.2
Controls 100.2 79.3 13.1
Total 1,940.3 1,456.7 247.8
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Appendix 5. Chinese Renminbi to U.S. Dollar Exchange Rate

RMB = 1.0 USD Daily, January 1994 – December 30, 2010

9.0

8.5

8.0

7.5

7.0

6.5

6.0