Alegra N HorneMGMT 2720 – Mergers, Acquisitions, and Restructurings March 2, 2016 Mercury Athletic Footwear: Valuing the Opportunity Case Analysis 1. Please answer the following questions: a. Is Mercury an appropriate target for AGI? Why or Why not? Mercury’s business strategy involves designing and distributing branded athletic and casual footwear to global youth extreme sport enthusiasts (focused and differentiated market leadership), which is the firm’s core competitive advantage relative to its peers. In addition, Mercury prides itself as a trailblazer (a form of differentiation) within the extreme sports and X-Games culture, which is generally not seen in the traditional footwear industry. The company is able to offer low- to med- to high-prices through achieving iconoclastic nonconformist cultural status, as well as achieving influence in alternative music, television, film, and clothing. In addition, the company has utilized its resources in athletic and cultural events in skateboarding, snowboarding, and BMX competitions, as well as alternative music festivals and concerts garnering appeal to its target customer. It successfully competes in women and men’s athletic and casual segments on the basis of simple design styles and general quality through competitive marketing, distribution, and cost management strategies. Additionally, Mercury successfully developed an operational infrastructure to quickly adapt to changes in consumer taste and product specifications, reducing product cycle time. Mercury also shoulders a low CAPEX (limited capital intensive investments) position, and rather focuses its capital utilization efforts on product innovation, market research, and product design. Overall, Mercury is an appropriate target for AGI. However, the speed at which Mercury is able to discontinue its pricing concessions and underperforming women’s casual footwear line is a concern, as the company is presently experiencing a strain in its infrastructure and eroding operating efficiency. b. Review the projections by Liedtke. Are they appropriate? How would you recommend modifying them? Growth Rate Analysis of Exhibits 6 and 7 Alegra N Horne MGMT 2720 – Mergers, Acquisitions, and Restructurings March 2, 2016 MERCURY ATHLETIC Forecast Data YOY Growth Rate Changes Men's Athletic: Revenue Less: Operating Expenses* Operating Income 2007 251,957 218,435 33,522 2008 282,192 244,647 37,545 2009 310,411 269,112 41,299 2010 335,244 290,641 44,603 2011 352,006 305,173 46,834 2008 12.00% 12.00% 12.00% 2009 10.00% 10.00% 10.00% 2010 8.00% 8.00% 8.00% 2011 5.00% 5.00% 5.00% 5-year Average 8.75% 8.75% 8.75% Men's Casual: Revenue Less: Operating Expenses* Operating Income 52,179 43,834 8,345 53,223 44,711 8,512 54,287 45,605 8,682 55,916 46,973 8,943 57,594 48,382 9,211 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 2.50% 2.50% 2.50% Women's Athletic: Revenue Less: Operating Expenses* Operating Income 138,390 124,302 14,088 153,613 137,976 15,638 167,438 150,393 17,045 179,159 160,921 18,238 188,117 168,967 19,150 11.00% 11.00% 11.00% 9.00% 9.00% 9.00% 7.00% 7.00% 7.00% 5.00% 5.00% 5.00% 8.00% 8.00% 8.00% Women's Casual: Revenue Less: Operating Expenses* Operating Income 36,802 37,265 (463) 0 0 0 0 0 0 0 0 0 0 0 0 479,329 423,836 8,487 47,006 489,028 427,333 8,659 53,036 532,137 465,110 9,422 57,605 570,319 498,535 10,098 61,686 597,717 522,522 10,583 64,612 2.02% 0.83% 2.02% 12.83% 8.82% 8.84% 8.82% 8.61% 7.18% 7.19% 7.18% 7.09% 4.80% 4.81% 4.80% 4.74% 5.70% 5.42% 5.70% 8.32% 11,983 9,587 12,226 9,781 13,303 10,643 14,258 11,406 14,943 11,954 2.02% 2.02% 8.82% 8.82% 7.18% 7.18% 4.80% 4.80% 5.70% 5.70% Consolidated Revenue Less: Operating Expenses* Less: Corporate Overhead Consolidated Operating Income Estimated Capital Expenditures Estimated Depreciation MERCURY ATHLETIC Select Forecasted Balance Sheet Data Select Balance Sheet Accounts Cash Used in Operations Accounts Receivable Inventory Prepaid Expenses 2007 4,161 47,888 83,770 14,474 2008 4,195 48,857 85,465 14,767 2009 4,566 53,164 92,999 16,069 2010 4,894 56,978 99,672 17,222 2011 5,130 59,715 104,460 18,049 2008 0.82% 2.02% 2.02% 2.02% 2009 8.84% 8.82% 8.82% 8.82% 2010 7.19% 7.18% 7.18% 7.18% 2011 4.81% 4.80% 4.80% 4.80% 5-year Avg 5.42% 5.70% 5.70% 5.70% Property, Plant & Equipment Trademarks & Other Intangibles Goodwill Other Assets 35,015 43,853 43,051 11,162 37,460 43,853 43,051 11,162 40,120 43,853 43,051 11,162 42,972 43,853 43,051 11,162 45,961 43,853 43,051 11,162 6.98% 0.00% 0.00% 0.00% 7.10% 0.00% 0.00% 0.00% 7.11% 0.00% 0.00% 0.00% 6.95% 0.00% 0.00% 0.00% 7.04% Liabilities Accounts Payable Accrued Expenses 18,830 22,778 18,985 22,966 20,664 24,996 22,149 26,792 23,214 28,081 0.82% 0.82% 8.84% 8.84% 7.19% 7.19% 4.81% 4.81% 4.81% 5.42% Deferred Taxes Pension Obligation 11,654 9,080 11,654 9,080 11,654 9,080 11,654 9,080 11,654 9,080 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% No, Liedtke’s base case and balance sheet projections are not appropriate to perform an equity valuation analysis. Liedtke must perform an analysis which includes an in-depth view of the footwear retail industry, the economy, and the company relative to its peers. Exhibits 6 and 7 are classified as partial pro forma projections in part to missing data on financing methods and cost and working capital requirements. Generally, this type of financial analysis is utilized in longrange planning and long-term credit decisions. The exhibits only provide a set of unsubstantiated growth rates lacking meaning in to an investor seeking an equity valuation for Mercury. Mercury’s Consolidated Balance Sheets, Income Statements, Statement of Retained Earnings, and Cash Flow Statements were not provided for analysis to determine whether the company is a Alegra N Horne MGMT 2720 – Mergers, Acquisitions, and Restructurings March 2, 2016 sound investment. The projections need to be modified to incorporate the information based on the recommended steps provided below. I. II. III. IV. V. List the objectives of the analysis Study the footwear retail industry and relate industry trends and its climate to current and projected economic developments. Generate in depth knowledge of Mercury’s financial health, operations, and the quality of its management team Evaluate financial statements Summarize findings based upon the analysis and reach valuation conclusions about Mercury’s future potential growth and earnings relative to the established objectives. An understanding of Mercury’s short-term liquidity position, operating efficiency, capital structure and long-term solvency, and profitability are required to establish company performance, future expectations, risks, expected returns, and competitive position. c. Estimate the value of Mercury using a discounted cash flow approach and Liedtke’s base case projections. Business Valuation - Discounted Cash Flow The estimated Net Present Value (NPV) of your business is $3,554,139. Your cash flow was estimated in two parts. First from your cash flow statement, and secondly from projecting future cash flows assuming a growth of 8.75%. We first calculated your estimated cash flow for year one from your inputs. An additional 49 years of cash flows were calculated assuming an 8.75% annual growth (for a total of 50). Each year's estimated cash flow was then discounted by 6% (your weighted average cost of capital) for the number of years until the cash flow would be realized. The sum of all of your future discounted cash flows is the net present value of your business. How Growth Affects Business Valuation What else can I do to increase my valuation? Increase your operating profits: You can directly impact your valuation by becoming more profitable. Increased efficiency and lower operating expenses can have a dramatic impact on your business' valuation. Even relatively small increases in profitability can have a dramatic impact on your valuation. Reduce inventory and accounts receivable: By reducing your inventory and accounts receivable, you can decrease the amount of capital that is tied up in your business. The net change directly affects your valuation. Reduce your taxes: Alegra N Horne MGMT 2720 – Mergers, Acquisitions, and Restructurings March 2, 2016 Very much like reducing your inventory, reducing your tax burden can directly impact the value of your business. A business that creates effective tax shields can be worth substantially more than one that doesn't consider this important variable. Effective capital expenditures: Target your capital expenditures to projects that increase your growth rate, or increase your profitability. While capital expenditures reduce your near-term cash flow, effective investment in your business can have a positive impact in your valuation. Your cash flow statement: Net Cash flow* Year 1 Year 2 Year 3 Year 4 Net cash flow $35,479 $38,583 $41,959 $45,631 Net cash flow NPV $35,479 $36,399 $37,344 $38,313 *Years 2-4 estimates assuming 8.75% annual growth Cash flow from operations: Operating profit $56,789 Interest expense $0 Interest income $0 Income taxes $11,650 Depreciation and amortization $10,640 Net from operations $55,779 Cash flow from change in operating assets & liabilities: Change in accounts payable $1,000 Change in inventory $5,500 Change in accounts receivable $2,500 Other net change $0 Net from change in assets & liabilities -$7,000 Cash flow from investment activities: Capital expenditures $13,300 Additional investment income $0 Net from investment activities ($13,300) Alegra N Horne MGMT 2720 – Mergers, Acquisitions, and Restructurings March 2, 2016 d. Do you regard the value obtained as conservative or aggressive? Why? Conservative. The growth rate projections provided by Liedtke’s are for long-term planning purposes are cannot be used to anticipate Mercury’s future growth and earnings stability. The projections of Exhibits 6 and 7 trail the S&P 500 historical index average of 9-11% in earning growth. However, the firm’s potential has yet to be realized in lighter of the growing popularity of extreme sports across multiple demographics and the company’s success with its men’s casual and the turnaround of its women’s athletic segment. Mercury’s EBITDA margin had trended at 14.0 -14.5% prior to WCF’s acquisition of the firm. With 2004-2006 EBITDA margin diminishing to 11.6%, even with top line growth of 20% but this is attributed to pricing concessions of its niche products. Despite Mercury’s operating efficiencies and strained infrastructure, the company remains significantly profitable in its core business, which grew more than 40% at an average compounded rate of 29% between 2004 and 2006. These growth rates were not factored into Liedtke’s projection analysis. e. How would you analyze possible synergies or other sources of value not reflected in Liedtke’s base assumption? Given the conservative valuation provided on Mercury’s stemming from its operational performance, several synergies may be considered. AGI should carefully consider the individually and collective the implications: The brand is iconoclastic in the global youth culture. The company has an operational infrastructure in place to adjust to changes in consumer taste and product specifications. Limited CAPEX (no capital intensive investments), Innovative and creative in marketing and product design. Materials sourced from international suppliers and professional personnel located in China for QA/QC measures. Simple production and cost strategy Mercury’s product costs are relatively low due to simple designs. Utilization of cost management, product focus and differentiation strategies. As the future earnings potential of Mercury increases in the near term, this will increase the financial synergies and advantages to AGI to acquire Mercury. The synergies listed above and value adds presented by Mercury would assist AGI’s revenue, increase its leverage with contract manufacturers, and expand its presence with key retailers and distributors. In addition, Mercury has operated as a subsidiary with complete autonomy under WCF. This autonomy will ensure a smoother transition to AGI, given Mercury has maintained its own financial statements, databases, resource management systems, and distribution facilities.