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M&A Buyside Advising project involving valuation and financial modeling of a textile firm and pitching the purchase to a private equity firm. Includes sensitivity analysis with respect to price, cost of capital, debt leveraging of purchase, and IRR calculations with changing exit scenarios.
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2/9/2009
2009 ACG Cup FinalsBuy Side Recommendations
SOX GroupAggarwal, Siddharth
Betha, SamuelDasgupta, Subhojit
Gaurav, AnanyaKaushik, Ravi
Executive Summary
FashionCo: Purchase valuation
– Enterprise Value – $80-92Mn
– Debt Financing of Deal – $25Mn
Exit scenarios: (3 years)
– Base Scenario – EV $194Mn, IRR 35%
– Upside Scenario – EV $199Mn, IRR 37%
– Downside Scenario – EV $124Mn, IRR 12%
Recommendation: Purchase FashionCo. with exit horizon of 3years
Exit strategies: IPO, strategic sale, secondary placement
Risks and mitigation
FashionCo. – Is it a good buy for Sox Group?
FashionCo:
40yrs+ history, low cost apparel – better prospects despite economic downturn
Financial strength and low debt levels (details in Appendix 1a)
Owned by passive investors not interested in apparels business
Sox Group:
Previous apparel industry experience
Better cost management: reduction of COGS by 2% and SG&A by 15%
Current Valuation:
Equity Value – $68-80Mn (inclusive of 29% control premium)
Enterprise Value – $80-92Mn
Asking price – $90Mn
Debt financing upto $37Mn (4x EBITDA) at LIBOR plus 400-500bps
Further details in Appendix 1b
Valuations: Assumptions and Base Case
Constants for all scenarios:
Purchase Price assumed at $90Mn
Debt Financing of $25Mn (3xEBITDA)
Exit EBITDA multiple (7.6) is 0.5x less than Entry EBITDA multiple (more info in Appendix 5)
IRR calculated excluding intermediate cash flows from FashionCo
Base Case
Exit Valuation (after 3 years):
– EBITDA – $25Mn
– Enterprise value – $194Mn
– Equity value – $160Mn
– IRR – 35% or 2.5x cash returns
Base Case Assumptions 2009 2010 2011
Revenue growth 0% 1% 2%
COGS savings 0% 1% 2%
SG&A savings 0.0% 7.5% 15.0%
Further details in Appendix 2a
Valuation Scenarios: Upside and Downside
Upside
Exit Valuation (after 3 years):
– EBITDA – $26Mn
– Enterprise value – $199Mn
– Equity value – $166Mn
– IRR – 37% or 2.6x cash returns
Base Case Assumptions 2009 2010 2011
Revenue growth 0% 1% 2%
COGS savings 0% 1% 2%
SG&A savings 0.0% 7.5% 15.0%
Upside Assumptions 2009 2010 2011
Revenue growth 0% 2% 4%
COGS savings 2% 2% 2%
SG&A savings 15.0% 15.0% 15.0%
Downside Assumptions 2009 2010 2011
Revenue growth 0% 0% 0%
COGS savings 0% 0% 0%
SG&A savings 0.0% 0.0% 0.0%
Downside
Exit Valuation (after 3 years):
– EBITDA – $16Mn
– Enterprise value – $124Mn
– Equity value – $91Mn
– IRR – 12% or 1.4x cash returns
Further details in Appendix 2b Further details in Appendix 2c
Valuation Scenarios: IRR in different scenarios
Growth Rates vs. Leverage
Expected IRR: 34-41%
Debt Financing of 30-40%
Revenue Growth 0-2%
-6% -4% -2% 0% 2% 4% 6%
0% 21% 22% 24% 25% 26% 28% 29%
10% 23% 25% 26% 28% 29% 31% 32%
20% 26% 28% 29% 31% 32% 34% 35%
30% 29% 31% 33% 34% 36% 38% 39%
40% 34% 35% 37% 39% 41% 43% 45%
50% 39% 41% 43% 45% 47% 49% 51%
Revenue Growth
Lev
erag
e
50 60 70 80 90 100 110
0% 54% 45% 37% 31% 26% 22% 18%
10% 58% 48% 41% 34% 29% 24% 20%
20% 63% 53% 45% 38% 32% 27% 23%
30% 69% 58% 50% 42% 36% 31% 26%
40% 76% 65% 56% 48% 41% 35% 30%
50% 86% 73% 63% 55% 47% 41% 35%
Lev
erag
e
Purchase Price ($Mn)
Purchase Price vs. Leverage
Expected IRR: 36-56%
Debt Financing of 30-40%
Purchase Price of $70-90Mn
Exit multiple of 7.6x
Exit Strategies
Strategy 1: IPO
Merits
– Highest potential payoff
– Motivation for management (with ESOPs)
Demerits
– Open to public scrutiny/analysts
Strategy 2: Strategic Sale
Merits
– Many potential buyers – competing companies
Demerits
– M&A deals have high failure rates
Exit Strategies
Strategy 3: Sale to another PE / financial institution (Secondaries)
Merits
– Source of liquidity for private equity investments
Demerits
– Suppressed valuation if no other bidders
Risks and mitigation
Risks Mitigation
Execution risk - management attrition Earnout structure, ESOPs
Macro-economic risk Insurance, recourse clauses
Interest rate risk Swaps, refinance debt, see appendix 3 for impact on IRR
Liquidity risk Exit scenarios, synergies from existing portfolio companies
Delayed exit Partial sell-out, see appendix 4 for impact on IRR
Competitive bids & price war Due-diligence, competitive intelligence
Final Considerations
Quality of management of FashionCo
Long term and short term strategies
Competitive landscape
Sustainable competitive advantages
Organizational culture and leadership issues
PE firm strategy
Recommendation
Purchase FashionCo– Start negotiating at $70Mn with a ZOPA of $70-90Mn
– Use maximum debt financing feasible (upto $37.2Mn)
Retain Management– Use ESOPs to motivate management team
Exit Planning– 3year horizon with $150-160Mn price
– IRR of 30-40%
Other Bargaining Chips– Earn-out clause
THANK YOU!
Appendix 1a – FashionCo: Financial Highlights
Revenue 10% 4% 3% 4%Earnings 2% 4% 3% 1%ROS 6% 8% 6% 5%ROE 23% 28% 20% 9%Debt Ratio 24% 17% 10% 50%Times Interest Earned 2.2x 3.7x 4.2x 1.9x
Cash Flows Free Cash Flow ($Mn) 0.8 16.3 12.8 NA
Leverage
Financial Highlights 2008Industry
Avg. 2008
Growth
Profitability
2006 2007
Appendix 1b – Purchase Valuation
Comparable Companies Summary of Valuations
Sales EBITDA EBIT Earnings Minimum 28.40 Fashion Co 195.00 12.20 11.40 5.76 Maximum 183.08 Multiple 0.38 4.61 6.48 8.47 Median 61.80 EV 73.62 56.26 73.83 48.77 Mean without outliers 59.36 Equity 64.62 47.26 64.83 39.77 Mean 69.67
Comparable Transactions Valuations - Range Median 40th % 60th %Selected Equity Value 61.80 53.23 64.06
Sales EBITDA Control Premium 29% 29% 29%Fashion Co 195.00 12.20 Equity with Cont Prem 79.51 68.48 82.41Multiple 0.99 7.80 Debt 11.60 11.60 11.60EV 1.00 1.00 Less Cash (2.60) (2.60) (2.60)EV 192.08 95.16 EV 88.51 77.48 91.41Equity 183.08 86.16
NAV 28.40DCF-WACC 61.80
DCF-CAPM 51.09
Appendix 2a – Base Case Income StatementIncome Statement(In $ millions)
2008 2009 2010 2011Actual Projected Projected Projected
Revenue 195.0$ 195.0$ 197.0$ 200.9$ % Growth 2.6% 0.0% 1.0% 2.0%
Cost of Goods Sold 153.6$ 150.2$ 149.7$ 148.7$ Gross Profit 41.4$ 44.9$ 47.3$ 52.2$
Gross Margin 21.2% 23.0% 24.0% 26.0%SG&A 28.4$ 28.30$ 26.52$ 26.52$ Dep & Amrt 0.8$ 0.7$ 0.6$ 1.0$ Oth Exp (Inc) 0.8$ 1.2$ 1.4$ 0.3$
Operating Income (EBIT) 11.4$ 14.6$ 18.7$ 24.4$ Operating Margin 5.8% 7.5% 9.5% 12.2%Addn Interest Exp 2.12 2.01 1.91Interest Exp (Net) 1.8$ 1.0$ 1.1$ 1.2$ Oth (Inc) Exp -$ -$ -$ -$ EBT 9.6$ 11.5$ 15.6$ 21.3$
40% Taxes 3.8$ 4.6$ 6.3$ 8.5$ Net Income avbl to Common 5.8$ 6.9$ 9.4$ 12.8$
3.0% 4.0% 4.1% 4.1%Add: Taxes 3.8$ 4.6$ 6.3$ 8.5$ Add: Interest Exp 1.8$ 3.1$ 3.1$ 3.1$ Add: Oth (Inc) Exp -$ -$ -$ -$ Plus: Dep & Amrt 0.8$ 0.7$ 0.6$ 1.0$
Adjusted EBITDA 12.2$ 15.3$ 19.3$ 25.4$ EBITDA Margin 6.3% 7.4% 7.7% 7.9%
Free Cash Flow to Firm 12.8$ 3.6$ 11.8$ 15.4$ Free Cash Flow to Equity 11.0$ (0.7)$ 7.4$ 11.0$
Fiscal Year Ended December,
Appendix 2b – Upside Case Income StatementIncome Statement(In $ millions)
2008 2009 2010 2011Actual Projected Projected Projected
Revenue 195.0$ 195.0$ 198.9$ 206.9$ % Growth 2.6% 0.0% 2.0% 4.0%
Cost of Goods Sold 153.6$ 146.3$ 149.2$ 153.1$ Gross Profit 41.4$ 48.8$ 49.7$ 53.8$
Gross Margin 21.2% 25.0% 25.0% 26.0%SG&A 28.4$ 24.06$ 24.61$ 27.30$ Dep & Amrt 0.8$ 0.7$ 0.6$ 1.0$ Oth Exp (Inc) 0.8$ 1.2$ 1.4$ 0.3$
Operating Income (EBIT) 11.4$ 22.8$ 23.1$ 25.2$ Operating Margin 5.8% 11.7% 11.6% 12.2%Addn Interest Exp 1.99 1.89 1.79Interest Exp (Net) 1.8$ 1.0$ 1.1$ 1.2$ Oth (Inc) Exp -$ -$ -$ -$ EBT 9.6$ 19.8$ 20.1$ 22.2$
40% Taxes 3.8$ 7.9$ 8.0$ 8.9$ Net Income avbl to Common 5.8$ 11.9$ 12.1$ 13.3$
3.0% 4.0% 4.1% 4.1%Add: Taxes 3.8$ 7.9$ 8.0$ 8.9$ Add: Interest Exp 1.8$ 3.0$ 3.0$ 3.0$ Add: Oth (Inc) Exp -$ -$ -$ -$ Plus: Dep & Amrt 0.8$ 0.7$ 0.6$ 1.0$
Adjusted EBITDA 12.2$ 23.5$ 23.7$ 26.2$ EBITDA Margin 6.3% 7.4% 7.7% 7.9%
Free Cash Flow to Firm 12.8$ 8.5$ 14.3$ 15.8$ Free Cash Flow to Equity 11.0$ 4.2$ 10.1$ 11.6$
Fiscal Year Ended December,
Appendix 2c – Downside Case Income StatementIncome Statement(In $ millions)
2008 2009 2010 2011Actual Projected Projected Projected
Revenue 195.0$ 195.0$ 195.0$ 195.0$ % Growth 2.6% 0.0% 0.0% 0.0%
Cost of Goods Sold 153.6$ 150.2$ 150.2$ 148.2$ Gross Profit 41.4$ 44.9$ 44.9$ 46.8$
Gross Margin 21.2% 23.0% 23.0% 24.0%SG&A 28.4$ 28.30$ 28.39$ 30.28$ Dep & Amrt 0.8$ 0.7$ 0.6$ 1.0$ Oth Exp (Inc) 0.8$ 1.2$ 1.4$ 0.3$
Operating Income (EBIT) 11.4$ 14.6$ 14.5$ 15.2$ Operating Margin 5.8% 7.5% 7.4% 7.8%Addn Interest Exp 2.24 2.13 2.02Interest Exp (Net) 1.8$ 1.0$ 1.1$ 1.2$ Oth (Inc) Exp -$ -$ -$ -$ EBT 9.6$ 11.4$ 11.2$ 12.0$
40% Taxes 3.8$ 4.6$ 4.5$ 4.8$ Net Income avbl to Common 5.8$ 6.8$ 6.7$ 7.2$
3.0% 4.0% 4.1% 4.1%Add: Taxes 3.8$ 4.6$ 4.5$ 4.8$ Add: Interest Exp 1.8$ 3.2$ 3.2$ 3.2$ Add: Oth (Inc) Exp -$ -$ -$ -$ Plus: Dep & Amrt 0.8$ 0.7$ 0.6$ 1.0$
Adjusted EBITDA 12.2$ 15.3$ 15.1$ 16.2$ EBITDA Margin 6.3% 7.4% 7.7% 7.9%
Free Cash Flow to Firm 12.8$ 3.7$ 9.2$ 9.9$ Free Cash Flow to Equity 11.0$ (0.8)$ 4.8$ 5.4$
Fiscal Year Ended December,
Appendix 3 – Valuation Scenarios: Interest Rate Risk
LIBOR Decreases
LIBOR – 300bps, Cost of debt – 750bps
Exit Valuation (after 3 years):
– EBITDA – $26Mn
– Enterprise value – $199Mn
– Equity value – $166Mn
– IRR – 37% or 2.6x cash returns
Base Case Assumptions 2009 2010 2011
Revenue growth 0% 1% 2%
COGS savings 0% 1% 2%
SG&A savings 0.0% 7.5% 15.0%
LIBOR Increases
LIBOR – 500bps, Cost of debt – 950bps
Exit Valuation (after 3 years):
– EBITDA – $26Mn
– Enterprise value – $199Mn
– Equity value – $166Mn
– IRR – 37% or 2.6x cash returns
Appendix 4 – Valuation Scenario: Delayed Exits
IRR in different cases with delayed exit
3yrs 4yrs 5yrs
Best 37% 26% 21%
Upside 35% 25% 20%
Downside 12% 9% 7%
Time to Exit
Sce
nar
io
Appendix 5 – IRRs at different Exit EBITDA Multiple
Entry at 8.1x EBITDA
Positive returns at or above:
– Base: 4x EBITDA
– Upside: 4x EBITDA
– Downside: 6.5x EBITDA
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
8.0
0 7
.50
7.0
0 6
.50
6.0
0 5
.50
5.0
0 4
.50
4.0
0 3
.50
3.0
0 2
.50
2.0
0
Exit EBITDA x
IRR
Base
Upside
Downside