West Coast Fashions, Inc. (WCF), a large designer and marketer of men’s and women’s branded apparel recently announced plans for a strategic reorganization. Active Gear, Inc. (AG), a privately held footwear company, was contemplating an acquisition opportunity. John Liedtke, the head of business development for AG, was interested in a WCF subsidiary. The subsidiary that Liedtke and AG intended to acquire was Mercury Athletic (MA), a footwear company. Liedtke thought acquiring Mercury would roughly double AG’s revenue, increase its leverage with contract manufacturers and expand its presence with key retailers and distributors. In order to provide a solid recommendation to Liedtke, further analysis must be performed.
The apparel or footwear industry is highly competitive with low growth. The market is influenced by fashion trends, price, quality and style. Companies can reduce risk factors by not following fashion trends which equates to efficient and effective inventory management and missed profit opportunities.
AG is a relatively small athletic and casual footwear company. It has annual revenues of $470.3M (42% of revenues came from athletic shoes), and $60.4M of operating income. Casting a shadow over these numbers are AG’s typical competitors. AG’s typical competitor has annual sales over $1.0B. Because of Chinese manufacturing contract consolidations, AG’s size was becoming a disadvantage due to low buying power vs. competitors. AG’s initial focus was to produce and market high-quality specialty shoes for golf and tennis players. AG was among the first companies to offer fashionable, walking, hiking and boating footwear. Over the years, the firm’s athletic shoes had evolved from high-performance footwear to athletic fashion wear with a classic image.
The firm’s traditional casual shoes also offered classic styling, but were aimed at a broader, more mainstream market. AG’s target demographic was urban and suburbanites, ranging from 25-45 in age. AG’s distribution channels consisted of independent retailers, departmental stores, and wholesalers. AG excluded big box retailers and discount stores. AG focused on products that didn’t follow fashion trends, resulting in a lengthened product lifecycle. This business model led to more efficient and effective supply chain and operating management. However, because they opted for the safe route it halted the company’s sales and growth opportunity.
Mercury Athletic was purchased by WCF from its founder Daniel Fiore. Fiore was forced to sell the company after running it for over 35 years, due to health problems. Due to a strategic reorganization, the plan called for the divestiture of MA and other “non-core” WCF assets. MA had revenues of $431.1M and an EBITDA of $51.8M
Products were distributed to departmental and discount stores
It had two product lines- athletic and casual footwear
Target market of both men and women
Shoes popularity grew in the extreme sports market
MA developed an operating infrastructure, allowing management to quickly adapt to changes in customer tastes with product specifications. 1. Is Mercury an appropriate target for AG? Why or why not?
Let me walk you through some qualitative considerations before making my recommendation.
AG and MA are both competing in the athletic and casual footwear industry. Acquiring MA could lead to economies of scale and scope through manufacturing and distribution networks, respectively. Acquiring MA- AG would be less affected by the Chinese manufacturing contract consolidation, due to increased buying powers. AG could potentially revive and profit from acquiring Mercury’s women’s product line. Acquiring MA will double AG’s annual revenue.
AG and MA target demographics could not produce company synergies MA is fashion trendy, therefore prone to risks outside of AG’s steady business model Company cultures could not match
2. Review the projections by Liedtke. Are they appropriate? How would you recommend modifying them? In order to find if the projections are reasonable, you need a starting point. Using projected growth rates and EBIT should indicate if Liedtke’s data is solid. Referencing the Free Cash Flow and Terminal Value tables (found below), I will be able to generate an opinion of Liedtke’s projections. Year to year growth rates are extremely volatile, normalizing in 2010.
The negative rate could signify that in 2007 they are projecting to discontinue a product line. The swing back to a positive growth rate could be indication of AG leveraging its economies of scale and scope, while distributing their product lines through big box retailers. EBIT has been projected to gradually increase, which looks to be on par with industry norms. It is reasonable to say that Liedtke’s projections properly reflect AG’s business model, post-acquisition.
3. See tables and calculations below
4. Do you regard the value you obtained as conservative or aggressive? Why? From my analysis, the value I obtained seemed to be aggressive against the information provided. Referencing the tables below:
Terminal or Enterprise Value is High
Synergies are excluded from financial analysis
Declining revenue growth
5. How would you analyze possible synergies or other sources of value not reflected in Liedtke’s base assumption? In order to analyze possible synergies, I would look at both companies’ operations. Starting from where they source their materials to distributing their final product are all possibilities of operational synergies (buying power, distribution channels, inventory management, etc…). Financial synergies would include combining revenues and cost benefits, which translate to increasing bottom line.
Company culture matching could also become problematic.
Net Working Capital
Free Cash Flow
NPV, IRR and Payback Period
Net present value of future cash flows equates to a positive $0.2M. Internal rate of return or IRR is the interest rate at which the net present value of all the cash flows from a project or investment equal zero. The IRR of this acquisition is 28%. Having a positive NPV and an IRR that considerably outweighs the discount and risk free rate- suggests that this acquisition should be pursued. In conclusion, AG should acquire MA.