Interco Summary of the Case Even before we go into the specifics of the case, we can point out a few important pieces of information from the case: 1) Interco management and Wall Street analysts believed that the apparel group’s performance would continue to weaken Interco’s overall operations and cause the equity markets to undervalue its common stock. Case Page 4. 2) To deter any unwanted third- party acquisition, the board voted on July 11, 1988, to amend Interco’s shareholder rights plan, making any hostile takeover of the company prohibitively expensive. Case Page 4. 3) Interco had retained Wasserstein Perella pursuant to a unique compensation contract that offered a substantial contingency fee of $3.7 million payable to Wasserstein Perella once City Capital rescinded their offer and only if a recapitalization was completed. Wasserstein Perella would receive $1.8 million for its services with or without this contingency fee. See George Anders and Francine Schwadel, "Wall Streeters Helped Interco Defeat Raiders But at a Heavy Price," The Wall Street Journal, July 7, 1990, p. A1. Case Page 4, footnote 2. What appears from the above information is that the management was not amenable to a prospective takeover offer. Case Discussion As the case reports, Interco’s goals included Long-term sales growth Earnings growth Increased return on assets Improved return on equity To meet these goals Interco began a strategic repositioning Program to Improve the profitability of existing assets Divest underperforming assets Make high-return, high-growth acquisitions Repurchase shares Prudently use borrowing capacity
Laundry lists of goals and strategies may sound logical but in fact can be problematic. For example growth in sales, return on equity, a target capital structure, and a share repurchase program are not independent of one another. How has Interco done? Exhibit 1 Interco and Business Segment Performance Data Business Segments Interco Overall Growth Net Sales FY 1987 FY 1988 FY 1989 Q1 Operating Margin FY 1986 FY 1987 FY 1988 FY 1988 Q1 FY 1989 Q1 Operating Earnings/ Average Identifiable Assets FY 1987 15.3% 10.2% 16.8% 13.2% 19.7% 22.4% FY 1988 15.8% 4.5% 15.6% 16.9% *All numbers are calculated using information from Exhibits 6, 7, and 8 Exhibit 2 PAT/Average Equity Total Long Term Liabilities/Total Equity Effective Tax Rate Cap. Expense/Depreciation NA 17.7% 47.6% 1.11 Interco Financial Data FY 1986 FY 1987 9.7% 18.2% 47.1% 0.92 FY 1988 11.3% 28.8% 42.8% 1.06 8.9% 9.0% 9.0% 8.6% 8.2% 7.3% 5.8% 2.5% -0.4% -0.2% 6.9% 8.1% 7.3% 9.5% 8.4% 8.7% 7.9% 10.4% 7.5% 8.7% 11.6% 12.8% 13.5% 14.5% 12.2% 4.0% 13.4% -0.4% -9.9% -0.6% -13.4% 7.9% 6.8% 0.7% 18.9% 34.2% 8.2% 7.0% 14.3% 0.0% Apparel Retail Footwear Furniture
Change in NWC as % of change in net sales NA -303% 686% *All numbers are calculated using information from Exhibits 6, 7, and 8
Converse Inc. accounted for a large part of the sales growth in the footwear business segment and that the athletic-shoe business is noted for its boom or bust cycles. It is also interesting that first-quarter FY 1989 results are flat against FY 1988. Overall, Exhibit 1 would suggest that Interco’s strategic repositioning plan is working as measured against sales growth, operating margin, and return on assets. According to Exhibit 2, return on equity is also up, but this could be due, in part, to increased leverage and decreased effective tax rate. Various valuations of Interco as described in Exhibits 10-13. Using FY 1988 financial information contained in Exhibits 7 and 8, we can reconstruct the data in Exhibit 9: Adjusted Aggregate Value (Firm Value) of $2,941.3 divided by Sales: $2,941.3/$3,341.4=0.9X
Operating Cash Flows: $2,941.3/($253.3+$33.5-$29.2+$61.5) = 9.2X OCF= operating income + depreciation = earnings before taxes plus interest expense minus other income + depreciation Operating Income: $2,941.3/($253.5+$33.5-$29.2) = 11.4X
Aggregate Value ($2,622.8), or...
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