Caso Clarck

MERCURY ATHLETIC FOOTWEAR

Problem statement:

West Coast Fashions, Inc a large business of men’s and women’s apparel decided to dispose of one of their segments; Mercury Athletic. John Liedtke, head of the business development for Active Gear, Inc saw it has a possible opportunity for them to acquire it. The footwear industry is very competitive, with low growth and stable profit margins. AGI is very profitable but it is smaller than its competitors, which is becoming a disadvantage. Therefore, Liedtke believes that if they takeover Mercury will double AGI’s revenue, increase it’s leverage with contract manufactures and expand its presence with key retailers and distributions. Liedtke is evaluating the company in order to find out whether the future benefits justify or surpass the present value of the investment in Mercury.

Analysis:

In order for Liedtke to get a broader picture on the acquisition of Mercury, he needs to compare and analyze a list of financial data from 2006 to 2011; projected balance sheet accounts, operating results and free cash flows, and cost of capital calculations. This data will enable him to identify the strengths and weaknesses of this acquisition.

First lets look a summary of the operations of both AGI and Mercury Athletics’ actual operations based on the last year given 2006 before AGI plans of acquiring Mercury.

| Active Gear, Inc | Mercury Athletic |

Revenues | $470, 286 m | $431,121 m |

% Of Revenue Product | 42 % athletic / 58 % casual | 79 % athletic / 21 % casual |

Operating Income | $60.4 m | $42,299 m |

Revenue Growth | $2-6% | 12.5 % |

By looking at this table superficially and keeping in mind that Active Gear is one of the most profitable firms in the footwear industry, Mercury seems to be an attractive investment because they have almost the same revenues as AGI while being smaller in the market. Then we can see that the % revenue product compensates for the lack in both companies. The revenue for the athletic shoes in AGI is low therefore taking Mercury under their wing would increase that revenue and vice versa for the casual shoes as well. Finally when looking at revenue growth the industry average is 10 % and AGI is below it putting the company at risk while Mercury is above it by 2.5 % more, it would be good to acquire the company to stay on top of the market.

Free cash Flow of Mercury

| 2006 | 2007 | 2008 | 2009 | 2010 | 2011 |

Revenue | 431,121.00 | 479,329.00 | 489,028.00 | 532,137.00 | 570,319.00 | 597,717.00 |

Less: divisional operating expenses | 423,837.00 | 427,333.00 | 465,110.00 | 498,535.00 | 522,522.00 |

Less: corporate overhead | | 8,487.00 | 8,659.00 | 9,422.00 | 10,098.00 | 10,583.00 |

EBIT | 42,299.00 | 47,005.00 | 53,036.00 | 57,605.00 | 61,686.00 | 64,612.00 |

Less: taxes | 16,919.60 | 18,802.00 | 21,214.40 | 23,042.00 | 24,674.40 | 25,844.80 |

NOPAT (EBIT (1-t) | 25,379.40 | 28,203.00 | 31,821.60 | 34,563.00 | 37,011.60 | 38,767.20 |

Plus: depreciation | 9,506.00 | 9,587.00 | 9,781.00 | 10,643.00 | 11,406.00 | 11,954.00 |

Net working capital | 104,116.00 | 108,685.00 | 111,333.00 | 121,138.00 | 129,825.00 | 136,059.00 |

Less: changes in working capital | | 4,569.00 | 2,648.00 | 9,805.00 | 8,687.00 | 6,234.00 |

Less: capital expenditures | | 11,983.00 | 12,226.00 | 13,303.00 | 14,258.00 | 14,943.00 |

Less: changes in other assets | | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 |

Plus: changes in other liabilities | | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 |

Free cash Flow | | 21,238.00 | 26,728.60 | 22,098.00 | 25,472.60 | 29,544.20 |

Terminal Value | | | | | | 522,906.19 |

| | | | | | |

Discount Rate | 7.65% | | | | | |

Growth rate | 2.00% | | | | | |

Discount cash flow | | 19,728.75 | 23,064.72 | 17,713.76 | 18,967.81 | 382,140.54 |

The total discount cash flow | 461,615.58 | | | | | |

| | | | | | |

Acquisition price | 186,215.80 | | | | | |

NPV | 275,399.78 | | | | | |

Quantitative valuation:

In the Mercury Segment Data 2004-2006 exhibit the EBIT margin is 9.8 % that means knowing that the industry average is 10 % it shows us Mercury’s profitability after removing all expenses but excluding taxes and interest. It is important to look at it because it is a measure that investors can use to evaluate the financial health of the company. However Liedkte being more conservative he says that the combined businesses could achieve and EBIT of 9 % and when looking at the projections for Mercury from 2007-2011 we can see a growth in earnings. So then what are the cash flows if Liedtke thinks the combined businesses will have a revenue growth of 2% in year 2011 considering we discounting back to 2006. We need to calculate the Free Cash Flow (FCF) in order to determine if the Net profit Value is positive or negative. Knowing that we will know if the acquisition should be undertaken. When looking at the excel sheet we can see that the NVP using the discount rate given by the case 7.65 % with a growth rate of 3 % gives us an NVP= $ 275,399.78. Therefore the NVP’s value compares the value of the investment made today to the same value of the amount in the future. So that is the amount AGI needs to pay up front. The free cash flows are made from the financial statement given in the case and were determined using the FCF method; EBIT (1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure. If AGI pays the acquisition price of $186,215.80, the will get in 5 years $ 461,615.58 as a total discounted cash flow.

Taking the Total Discounted cash flow minus the acquisition price will gives us the NVP, which as mentioned above will be the amount that needs to be paid up front.

The discount rate is an interest rate that is used for calculating the present value of future cash flows. It shows us what our money is worth in the future. The importance of using the discount rate is that it will show the risk that comes with future income. In this case we are using three different discount rates, one as shown in the book, one with less risk, and one with more risk. In the process of using discount rate we believe we utilize the time value of money; this concept is used, when (for example) a company makes an investment. The idea (and importance) of this concept is that your money is worth more in the present than in the future, and allows you to see your income stream in the future. The process that occurs is that the money you make now will earn you interest, the interest earned on that money will also gain interest in the

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