Interco is a shoe company founded in 1911. Its business has spread to other product through acquisitions. Equity analysts saw Interco as a conservative company that was not highly leveraged leading to high financial flexibility. This allowed the firm to repurchase share and make acquisitions when the opportunities were there. Interco has four major divisions; Apparel Manufacturing, General Retail Merchandising, Footwear Manufacturing and Retailing and Furniture and Home Furnishings. Within these divisions were independent companies. Interco’s goals were long-term sales and growth of earnings, higher return on corporate assets and improved return on equity. To achieve these goals, Interco’s approach was to improve the profitability of existing operations and divesting underperforming assets. Besides that it had to make acquisitions with expected higher returns and growth.
During the fiscal year 1988 the overall performance of Interco was positive, with increasing sales and net income. This was mainly due to the furniture and home furnishings group and the footwear group. Despite restructuring efforts, the apparel manufacturing and general retail division had problems with declining earnings and sales only advancing at a moderate rate.
Interco management believed that the bad performance of the apparel group would lead to a weakening of overall operations and cause the equity market to undervalue its shares. Due to this situation, Interco was seen as a potential takeover target. Despite restructuring efforts, City Capital owning already 8,7% of Interco’s stock proposed a merger with Interco. It offered to buy all of Interco’s shares at a price of $64 per share. Interco’s reaction was to mandate Wasserstein Perella’s as financial advisor to see how much Interco was worth. In August 1988 City Capital raised its offer for Interco to $70 per share, stating its willingness to increase the price offered if a review of the company would lead to a higher value of the company.
Before taking any decision on the City Capital’s offer it is important to assess Interco’s value. Wasserstein Parella’s analysis resulted in a valuation range between $68-$80 per share. They determined that the offer of $70 per share was inadequate. In this report we will analyze the value of Interco year-end to see whether the takeover bid of $70 per share is justified.
To formulate an advice about the takeover bid, we made use of the discounted cash flow analysis and multiples.
Concerning the discounted cash flow method, we first calculated the net operating profit after tax (NOPAT) by subtracting the tax from the earnings before interest and taxes (EBIT). Than we subtracted, if present, the total operating capital from the NOPAT, resulting in the free cash flow (FCF). In order to determine Interco’s value, we divided the FCF by the cost of capital (WACC) minus the growth rate (g), Interco’s equity value is determined by subtracting the debt from the total capitalization. As a last step we divided Interco’s equity by the amount of outstanding shares. We made use of year-end data of 1988, a constant growth rate (g) of 7,2% and the total operating capital rate first applied in 1994 with a constant rate of 11,6%. The cost of capital (WACC) is determined with the use of the: average market return of the S&P 500 index of the year 1988, beta which volatile with the market and a risk-free rate which is equal to the 10 year treasury bond (USA).
Discounted cash flow:
| Most likelyWACC 12%| scenario 1 WACC 11%| scenario 2 WACC 13%| Interco company: (year 1988)| | | |
EBIT| 286995| 286995| 286995|
Tax| 122834| 122834| 122834|
NOPAT| 164161| 164161| 164161|
Total operating capital| 0| 0| 0|
FCF| 164161| 164161| 164161|
PV of FCF| 3434931| 4320030| 2830364|
Value equity| 2771989| 3486264| 2284104|
Value per share| 67,03| 84,30| 55,23|...