Dressen Case Study Essay

Custom Student Mr. Teacher ENG 1001-04 30 April 2016

Dressen Case Study

#1)I believe one major factor was how appealing Dressen had become during 1995, as opposed to previous years. It appeared that new management had turned the company around. Management stated Dressen was looking good for future growth during the end of 1995. I think management felt it was the opportune time to sell. They wanted to sell Dressen while they were making money and being successful, as opposed to hemorrhaging money from Westinghouse.

Dressen was Westinghouse’s star performer in the Q3 of 1995. Sales increased 10% over the year-prior quarter. EBIT reached 12% of sales as well. Their growth strategy as well as technology and work processes lead management to believe that there was even greater growth potential. Dressen was now headed in the right direction. Management was trying to strike while the iron was hot.

Another factor was the cash acquisition of CBS in August 1995 for $5.4 billion. The large purchase price had strained an already weakened balance sheet. There was also a $2 billion bridge loan that was due in February 1996.

Businesses are meant to earn economic profit and mitigate the cost associated with them. Without effective and timely cost strategy, a business cannot climb the stairs of economic prosperity. Organizations have to be aware of how much cost they are incurring over a certain period of time, as most of the time, high operational costs can devastate the entire financial structure of an entity.

Apart from the cost, it is also important for a company to be consistent in their earnings momentum because it is something that shareholders, as well as analysts, are looking for in a company. There are certain ratios that can be taken into account to analyze why Westinghouse would want to sell Dressen. Mentioned below are some calculations that justify why Westinghouse was intending to sell Dressen at the end of the fiscal year 1995:

1991
1992
1993
1994
1995
Net Sales
671
577
508
563
621
% Change

-14.01
-11.96
10.83
10.30
Gross Profit
200
151
122
153
203
Gross profit margin
29.81
26.17
24.02
27.18
32.69
Net Income

-40
-60
29
Net Profit Margin

-7.87
-10.66
4.67

Dressen recorded a net profit of $29 in 1995, as compared to the net loss of $60 a year before, but the net profit margin of the company in 1995 was only 4.67%, which is still very low. The Gross Profit Margin in the same year was 10.30%, which shows that around 90% of the sales come under the net Cost of Goods Sold. This is a very high figure that businesses cannot sustain for a long period of time. Total assets of Dressen also showed a net decrease from fiscal year 1994 to 1995:

Year

1994
1995
Assets $ in Million
705
657
Proportion

-6.809

A decrease in the operational assets would not be acceptable for the company as a whole. Therefore, Westinghouse was willing to sell Dressen because the company was not doing well in its jurisdiction.

#2)There are a number of valuation tools which could be used for the purpose of analyzing the effectiveness of a company as a whole. Warburg is considering paying $585 million for Dressen and we must analyze if this is a fair price for Warburg to pay.

Price to Earnings is a ratio that is usually applied by investors on the entire investment in order to anticipate the expected dividend. Specifically, it refers to the ratio evaluation of an entity’s price of shares in relation to earnings for each share.

Price to Earnings ratio is generally symbolized as an earning multiplier or investment multiplier. However, there are some probability flaws in the P/E ratio, but it is still the most widely accepted technique to measure potential speculations. Market price to earnings is one of the most vital tools used to analyze the stance of investors while investing in the company. Five-year period analysis has been taken into consideration for Dressen: Question-2

1991
1992
1993
1994
1995
Share Price Average
32
32
15
15
15
Earnings Per Share
0
0.00
-0.87
-1.31
0.60
Market Value to Earnings
0
0
-17.175
-11.45
24.88

The computation of Dressen’s Market Price to Earnings is showing that the company did a good job in the fiscal year 1995, as its Price to Earning (P/E) or Market Value to Earning (MV/E) ratio had increased tremendously to a level of $24.88. The higher the P/E, then the higher the net worth of the company. Enterprise Value to Sales is a valuation method that is applied to assess the ratio of enterprise value to its market share price.

The Enterprise Value to Price ratio allows investors to make a decision on whether the market share of the company is expensive or cheap. The ratio has also considerable influence on the company’s sales as it is utilized by many market analysts to avoid any manipulation over the turnover of an entity. The Enterprise Value to Sales analysis is mentioned below:

1994
1995
Market Capitalization $ in Million

458
481
Total Debt in $ million

247
176
Total Worth in $ Million

705
657
Less: Cash in $ Million

5
2
Net Worth in $ Million

700
655
Annual Sales in $ Million

563
621
EV/Sales

124.33
105.48

The Enterprise Value to Sales is high in both years 1994 and 1995. This shows me that the net worth of the company is high. EBIAT is a financial appraisal technique which is used to figure out the operating performance of a company. It refers to how much resources have been utilized to generate revenue within a given span of time. The financial evaluators are most likely to consider this ratio as an indicator of a company’s performance within a defined accounting cycle. This will allow them to set a point of time within the operating cycle that they can focus on.

EV/EBIAT
1994
1995
Market Capitalization $ in Million

458
481
Total Debt in $ million

247
176
Total Worth in $ Million

705
657
Less: Cash in $ Million

5
2
Net Worth in $ Million

700
655
EBIAT in $ Million

-2.5
10.4
EV/EBIAT

(28,000)
6,298

The company recorded a net loss in the year 1994 of $-28,000, but it is a positive figure of $6,298 in the year 1995.
My calculation for the Dividend Discount Model is as follows: P = Dividend / WACC – g
WACC = 12%
G = Growth rate = 4%
= 1.2 / 12 – 8
1.2/ 0.08
P = $15
The average Share Price in the year 1995 was also $15.
Taking all of this analysis into consideration, I believe that $585 million is a fair price to pay for Dessen. The net worth of Dressen in terms of financial value and share valuation are strong. I believe that Warburg is underpaying for Dressen. I believe Warburg got Dressen for a good price. I feel that Warburg should have paid more for Dressen, so with a purchase price of $585 million I believe Warburg got a great value.

#3)Financial Forecasting is an important metric to use because it can estimate the future financial outcomes of a company. Analysts have to forecast the cash flows and debt obligations to analyze the financial competitiveness of a company as a whole. Two different ratios could be used to analyze Dressen’s ability to generate sufficient cash flows to service its debt. The two ratios I used for Dressen are the Cash Flow to Sales Ratio and Debt to Equity.

The Cash Flow to Sales ratio is an important ratio which analyzes what
percentage of the company’s sales are on credit, and how much of the sales are on cash. The computed ratio for the next five years is below:

Operating Cash Flow to Sales

1996
1997
1998
1999
2000
Forecasted Operational Cash Flow
77
83
99
101
95
Forecasted Sales in Million $
658
698
740
784
804
Operating Cash Flow to Sales
11.70
11.89
13.38
12.88
11.82
Average
12.33

The forecasted figure of the cash flow to sales is showing that the company is not efficient in getting their cash sooner as related to sales. The amount of operating cash flow to sales ranges from 11.70% to 13.38%, with an average of 12.33%. This shows that over 80% of Dressen’s sales are on credit, which is not a good sign from the viewpoint of the company. The risk in generating sufficient cash flow will remain with the company for the next five years (1996-2000) as well, because the cash generating cycle of the company is too low and it has to be increased accordingly.

The Debt to Equity ratio of Dressen for the next five years is below: Debt to Equity

1996
1997
1998
1999
2000
Total Debt in $ Million
530
501
455
409
357
Equity in $ Million
178
208
247
294
345
Debt to Equity
2.98
2.41
1.84
1.39
1.03
Average
1.93

The Debt to Equity ratio for Dressen (Forecasted) is showing that the level of debt is twice that of the equity. This is against the restrictive covenants. A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings because of the additional interest expense. Average Debt to Equity of the company is showing that the proportion of debt is nearly 68%, while the proportion of equity is 32%.

This is very near to the restrictive covenants, in which debt should not be higher than 70%. There is a risk that this ratio will increase in the upcoming years. #4)For the Debt Rating analysis I decided to examine the Debt to total Capital and the liabilities to total assets. I wanted to figure out these ratings for 1994 and 1995, before the buyout. Question-4 Debt Rating

1994
1995
Average
Subordinate Debt in $ Million

165

Capital
458
481

Percentage of Debt/Capital
36.03
34.30
35.16
Total Liabilities in $ Million
247
176

Total Assets in $ Million
705
657

Proportion
35.04
26.79
30.91

The Total Debt to Capital of Dressen on average is 35.16%. This would represent a rating category of “A.” Along the same lines, liabilities to assets have a figure of 30.91%. The bond rating in this particular scenario is also “A.”

The coverage ratio is a measure of a company’s ability to meet its financial obligations. The higher the coverage ratio, the better the ability of the company to fulfill its obligations to its lenders. Analysts and investors perform coverage ratios to determine the change in a company’s financial position. The findings of the coverage ratio I performed on Dressen are below:

1994
1995
EBIT
-2.5
10.4
Interest Expense
3
1
Coverage Ratio
-0.83
10.40

This analysis shows that Dressen generates enough cash flow to pay its interest, specifically in the year 1995. Taking all of this information into account, I would assign an “A” rating to Dressen.

#5)In order to analyze the level of business risk for the buyout, I decided to use the current ratio and the gearing ratio. The current ratio is a liquidity ratio that measures a company’s ability to pay short-term obligations. The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. This is an important ratio for Warburg because they need to make sure they can meet their short-term obligations after the buyout.

Current Assets in Million $
183
Current Liabilities in Million $
95
Current Ratio
1.926

Dressen has a current ratio of 1.926. The current ratio can give a sense of the efficiency of a company’s operating cycle and its ability to turn its product into cash. This ratio shows that Dressen is doing a good job as far as meeting its short-term financial obligations and promises. The gearing ratio is a financial ratio that compares some form of owner’s equity to borrowed funds.

It is a measure of financial leverage that demonstrates the degree to which a firm’s activities are funded by owner’s funds versus creditor’s funds. A company with high gearing (high leverage) is more vulnerable to downturns in the business cycle because the company must continue to service its debt regardless of how bad sales are. If a company has more equity, then there would be more of a cushion, which would show financial strength. Debt

420
Equity
160
Assets
705
EBIT
10.4
Interest
1
Debt to Equity
2.625
EBIT/Interest
10.4
Equity/Assets
22.70

From this analysis, it can be determined that the Debt to Equity of the company is still high at 2.62%. Total Equity to Assets is relatively small at only 22.70%. This shows that most of the assets in Dressen have been bought using debt. From this analysis, it is found that the company is not risky when it comes to short-term financial obligations, but it will be in a dangerous situation in the long-term.

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  • University/College: University of Arkansas System

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  • Date: 30 April 2016

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