Statement of Purpose: The purpose of this analysis is to determine if Reynolds Metals (“Reynolds”) should accept Nestlé’s offer of $61 million for its holdings of Eskimo Pie. The crux of the issue is whether or not the projected income from a proposed Initial Public Offering (“IPO”) by Wheat First Securities (“Wheat First”) is reasonable and will actually result in proceeds between $61 and $68 million to Reynolds, the Reynolds family and the Reynolds foundation, as projected. To get at this question, this paper will seek to value Eskimo Pie as a stand-alone company, if the IPO option is selected.
Discount Rate: The first task is to estimate the discount rate, or the rate that investors will require on this type of investment. In 1990, the last year for which we have data, Eskimo Pie had $744,000 in long-term debt obligations and $19,496,000 in Stockholders’ equity. This amounts to 3.67588% of their financing coming from debt and 96.32411% of their financing coming from equity.
Exhibit 9 reflects the corporate borrowing rates as of 1991. Being that Eskimo Pie is a small operation with fairly thin margins, they would not qualify for an A or AA bond rating. Thus, I am assuming that any bonds they have issued have a BB rating. The long-term bond yield for BB bonds is 11.44%.
The case does not provide any information regarding the required return on equity. However, by imputing the data from Exhibit 8c into a spreadsheet we can calculate Beta for comparable companies. I calculate the Beta for Ben & Jerry’s to be 1.5994. I calculate Beta for Dreyer’s to be 1.2524. This averages out to 1.4259, which is the Beta I estimate for Eskimo Pie.
Using the risk free rate of 4.56% from Exhibit 9, and an expected market return of 13.99% , I calculate the expected return on equity to be 17.9968%.
Thus, calculating the Weighted Average Cost of Capital: (.0367588)(11.44%) + (.9632411)(17.9968%) = 17.7558%. The applicable discount rate is 17.7558%.
Growth Rate: There are several factors to consider in estimating Eskimo Pie’s growth rate. As measured by net sales, the growth rate fluctuated greatly between 1987 and 1991. According to Exhibit 1, half of the growth experienced in 1991 is attributable to increased prices and the assumption of advertising responsibility. I view this large increase as a one-time event. As competitors adjust, whatever advantage Eskimo Pie gained from these methods will dissipate.
One advantage that Eskimo Pie has is that they hold patents for various sugar and fat substitutes. They largely attribute their 3% increase in unit market share over a four year period to their patent on a sugar free coating. They also have a patent in the works for a fat substitute. However, any growth they see from the fat substitute will be limited because those sales will cut into their sales of the sugar-free product.
In Exhibit 6, Goldman Sachs makes very conservative growth estimates. From 1991 to 1992 they project growth, in terms of net sales, of 4.5415%, and from 1992 to 1993 they project 1.2376% growth. These projections are tempered by the fact that they underestimated Eskimo Pie’s net sales and net income in 1991.
Finally, according to Exhibit 4, the market for frozen novelties has leveled off, so most of Eskimo Pie’s growth will have to occur by grabbing market share. Eskimo Pie’s growth in the past is tied, at least to some degree, to their presence in grocery stores. Between 1987 and 1991 the presence of at least one Eskimo product in U.S. Grocery Stores grew from 76.3% to 97.9%. The fact that they are in nearly 98% of all stores in 1991 suggests that they have very little room for growth in this area, especially when you consider that the percentage change of their presence in grocery stores is related with the market share of Eskimo products, and is also related to their net sales. In considering all of these factors, and recognizing this is a low figure, I...
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