Interco Business Case
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1. Assess Intercos financial performance. Why is the company a target of a hostile takeover attempt?
Intercos overall financial health is relatively healthy. It is highly-liquid as the current ratios are consistently over 3.5, showing that it has plenty of cash to cover any of its current liabilities. Its accounts receivable days indicate that in 1987 it took longer to collect on outstanding accounts while this figure would drop in 1988. The same trend follows with its inventory days, increasing in 1987 and decreasing in 1988, which would signal that its turnover was slower in 1987 and faster in 1988. The accounts payable days increased in 1987 while slightly decreasing in 1988. This is a healthy trend as Interco was able to take longer to pay off its current expenses than the past.
When looking at the company collectively, Interco also looks healthy, with sales increasing 4.04% in 1987 and 13.39% in 1988. Its earnings also increased 4.51% in 1987 and 13.97% in 1988. However, if closer examination is undertaken, it is clear to see that the general retail and apparel businesses are struggling while footwear and furniture have been flourishing. Its apparel business has dropped in earnings from $6.7M in 1986 to $2.0M in 1988. This represents a -19.70% drop in earnings as a percentage of total Interco earnings from 1987 to 1988. The general retail business has been stagnant. Its earnings slightly increased while its business has not grown much. Therefore, since the overall performance of the company is improving, although some divisions are not pulling their weight, this means the stock price might be undervalued (due to the inefficiencies). Thus, Interco is a viable target for takeover and restructuring. The takeover could result in divesting the general retail and apparel businesses and focusing on its core business of furniture and footwear, which would yield higher profit margins.
2. As a member of Intercos board, are you persuaded by the premiums paid analysis (Exhibit 10) and the comparables transactions analysis (Exhibit 11)? Why?
Looking at Exhibit 10, which is a summary of the average premiums paid to acquire companies in 1988, we would not be persuaded by the offer for Interco. In particular, if you look at the premiums paid by Rales versus the average premiums paid, you can see that they are significantly lower (refer to appendix A).
Looking at Exhibit 11, which is a summary of comparable transactions by business segment, the offer for Interco once again fails to persuade. Looking at the average purchase price multiples of comparable transactions (refer to appendix B), it is apparent that the Rales proposal multiples are invariably lower than the industry averages. It would be in Intercos interests to divest and realize the higher earnings themselves, rather than allowing City Capital to take over at such a low offer.
3. As a member of Intercos board, which assumptions would you have questioned?
Refer to Appendix B for the Wasserstein, Perella & Co valuation. As with any discounted cash flow analysis, some of the underlying assumptions made could be questioned. The projected sales growth rates and the terminal growth rate used in the analysis could be considered to be low, as Interco is known to be a growing company. The assumption that sales would only grow 7.2% over the projected timeline was a little conservative, considering that sales growth was 13.4% in 1988, even though retailers were facing a slump at the time. A 14 multiple with a 10% discount rate provides a 2.66% growth rate in perpetuity, whilst at $70 per share, the terminal growth rate was approximately 4.77%. These numbers again seem to be low for a growth based company like Interco. The sensitivity analysis provided in Appendix B shows that changes in the projected growth numbers can significantly affect the value of the company.
4. How would you advise the Interco board on the $70 per share offer?
Similar to Wasserstein Perella, we would also advise Interco not to sell. The offer of $70 per share is an insufficient amount and does not reach the price level that is advantageous for Interco to sell. First off, Interco has leverage when it comes to price negotiation with City Capital. The fact that the Rales Brothers formed City Capital with the