Congoleum Corporation has three product market segments: home furnishings, shipbuilding and automotive and industrial distribution. In 1979, First Boston Corporation bid for an LBO of Congoleum for a price per share of $38. The purpose of this analysis is to assess Congoleum as a LBO candidate and determine whether the offer made by First Boston Corporation is fair. 1. Is Congoleum a good LBO candidate? In other words, does this company have a lot of debt capacity? The company was identified as a good LBO candidate as it had: (i) a minimal outstanding level of debt estimated at 5-7%; (ii) steady cash flows as a result of its operations which would enable it to meet higher debt obligations. The steps below further support this conclusion. Step 1: We calculated debt as a percentage of assets for the Congoleum pre-LBO * We extracted the value of the current portion of long-term debt and long-term debt for 1977 and 1978 from Exhibit 3
Step 2: We calculated Congoleum’s debt capacity
* Based on research papers, the typical debt capacity required for an LBO is between 4 and 5 times EBIT * Using an average of 4.5 times, we calculated the debt capacity for Congoleum to be $ 365.99 Million * As additional measures, we calculated the debt service and debt service ratio
As such, Congoleum is a good LBO candidate as it has sufficient debt capacity 1. How can you explain the 50% premium paid to the shareholders of Congoleum? Step 1: We calculated the free cash flows (FCF) for Congoleum before the LBO based on the data in Exhibit 2. In calculating FCF, it was assumed that no material change would occur to Congroleum’s operations as a result of the capital restricting; more precisely the following two assumptions were made in order to leverage the data in Exhibit 13 in the calculations: * Net working capital remains unchanged
* Capital expenditures are independent of the LBO; the same capex charges will be...