Interco Group Case Write-Up
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Interco Group Case Write-UpMark Magaro, Prateek Mittal, Carson Moore, Alex WaltersAssess Interco’s financial performance. Why is the company a target of a hostile takeover attempt? Interco’s recent financial performance was mixed. On one hand, its sales and net income increased 13.4% and 15.4% respectively over the past year, while its effective tax rate decreased by 4.3%. Moreover, its return on equity increased from 9.7% to 11.7% over the past year. Among the operating groups, the furniture and home furnishings group achieved an outstanding year by increasing its sales by $43.7 million and its operating profit by $25.3 million due to favorable demographic trends. Finally, sales for the footwear group increased 34.2% and operating profits increased by 77%. In sum, revenue was growing and it was using cash more effectively. However, the negative aspects of Interco’s recent financial performance also made it look attractive. The apparel manufacturing and general retail divisions experienced a change in the nature of the businesses and their performances suffered. Consumer spending was lower than anticipated, low-cost imported goods became more prevalent, and department stores began preferring private-label goods to branded apparel. Therefore, investors believed that the apparel group’s performance would weaken Interco’s operations and cause equity markets to undervalue its common stock. Additionally, the market crash of October 1987 further lowered Interco’s stock price. Finally, Interco accelerated a share repurchase program, which illustrated confidence in the company and showed that management likely believed that the company was undervalued. The Rales brothers likely saw a company that was undervalued and believed that they could continue their successful acquisition strategy of buying undervalued targets with strong market niches. They already owned 8.7% of the company and likely thought that they could return higher profit margins by selling off some of the business units and either restructuring or acquiring others. Moreover, Interco may have also looked attractive because it was overcapitalized, which gave it the financial flexibility to keep implementing its long-standing growth by acquisition strategy. As a member of Interco’s board are you persuaded by the premiums paid analysis (Exhibit 10) and the comparables transactions analysis (Exhibit 11)? Why? As a member of Interco’s board, I’m initially elated by Wasserstein, Parella & Co’s analyses detailed in Exhibits 10 and 11, as they explain how the Rales offer significantly undervalues my firm. However, in order to be persuaded by either analysis, I need to understand the strength of the underlying assumptions of each.The premiums paid analysis shows how the premium that the Rales brothers are willing to pay for Interco are significantly lower than the average day, 4 week, and 52 week low premiums of selected tender offers. As a board member, I am optimistic that Interco should garner a higher premium than the one being offered to us. However, the premiums paid analysis is weak in terms of detailing the tender offers analyzed. I assume that these are transactions for firms of similar industries, size, and market share, but that is not explicitly stated. Additionally, as these transactions occurred across the 3 quarters thus far in 1988, market conditions could have been different during the time of those transactions than they are now. For example, Exhibit 14 shows how the S&P 500 fluctuated after the market crash of October 19, 1987. I’d like to know whether the market fully recovered by the start of 1988 when these comparable transactions were conducted, or were these firms over or undervalued at that time, thus impacting the Wasserstein, Perella & Co. premiums paid analysis? Without an answer to that question, I am not persuaded by the premiums paid analysis of Exhibit 10 even though it values my firm higher than the Rales offer.
The comparable transaction analysis in Exhibit 11b shows that the median multiples for sales, operating income, and operating cash flow for comparable transactions are higher than Rales offer accounts for in Exhibit 9. The chart below, compiled from data in Exhibits 9 and 11, shows how Rales’ offer undercuts the price per share based on comparable transaction multiples for sales, operating income, and operating cash flow (by $17.44, $38.39, and $4.55, respectively). Assuming the multiples calculated in comparable transactions are indicative of the market, I am pleased with these valuation numbers.[pic 1]However, on the opposite side, these previous transactions that Wasserstein, Perella & Co. are using to drive the multiples calculations are based on previous market data and are no indication for the current market for any of Interco’s lines of business. As stated in the question above, Interco’s financial performance is quite variable at the time of this potential transaction. This variability would not be captured a comparables analysis as no two firms are identical. Additionally, it is impossible to determine the assumptions used in the multiples calculations of previous transactions. The acquired firms involved in the comparable transactions may have demanded a higher premium based on projected synergies between the two companies or the intangible value of intellectual property such as patents. Because of the contingencies involved in calculating the multiples for the comparables analysis, I am not persuaded by it.Wasserstein, Perella & Co, established a valuation range of $68-80 per common share for Interco. Show that this valuation range can follow from the assumptions described in the discounted cash flow analysis of Exhibit 12. As a member of Interco’s board, which assumptions would you have questioned? Why?The valuation range of $68-80 per common share can follow from the assumptions described in Exhibit 12 of the case. The calculations shown in Exhibit 1 of the appendix shows the projected cash flows for the next 10 years and subsequent valuation using a discounted cash flow method. A sensitivity analysis, shown in Exhibit 2 was performed using a varying discount rate from 10-13% as well as a multiplier varying from 14x-16x. Varying these factors supports Wasserstein, Parella & Co’s established range.As a member of Interco’s board it is their responsibility to question the validity of Wasserstein, Parella & Co’s valuation before making a decision based on the results. Some assumptions they should question would be:Sales growth: The 7.2% growth is a questionable assumption. First, the growth rate of the furniture units is influenced by demographic trends and cyclical, which have been favorable lately. Second, the footwear group is growing at a higher rate due in part to the recent acquisition of Converse. In addition, these two groups together accounted for 19% more of the corporate sales in 1988 than they did in 1984, as illustrated in Table A. If this trend continues, perhaps a higher sales growth assumption is warranted.