Now that its over, I think I will miss these sleepless night
|Vent Cap & Fnce Innovat
|Advanced Seminar: Corporate Restructuring
|Corp Dev: Merg & Acquis
|Venture Cap & Ent Mgmt
Put yourself in the shoes of Japonica Partners considering an investment in Sunbeam Oster:
- What is Smith Barney’s valuation of Sunbeam Oster.
Smith Barney valued the company at $510M to $570M. He used the 1991 EBIT projection of the Debtor’s plan of $72.9M, build an arbitrary range of $68M to $76M (-$4.9M / +$3.1M) and then multiplied this number with 7.5. He determined the 7.5 multiplier by calculating the ratio of EBIT to market value of various assets in the industry.
For us, this approach is highly questionable. Taking the 1991 EBIT number out of an multiyear projection is arbitrary and easy to manipulate. According to the projection, the EBIT is supposed to rise y-o-y. Taking just one EBIT number doesn’t take this into account.
He should have rather used the DCF methodology to come up with a value estimation. After accomplishing this task, he should have carefully selected comparable firms (not all the firms in the list have similar portfolios as Sunbeam) and calculated their EBITDA (EBITDA is a good measure of core profit trends because it eliminates some of the extraneous factors) to value ration. By doing this, he should have taken into account that the other firms value might have been inflated due to the nature of the stock market. Sunbeam situation is different: they are not in a stable condition and have to win consumer confidence back.
What are the key sources of additional value that you see in the company that are not captured in this estimate?
- SG&A cost cut by combining the administrative functions of Sunbeam and Osters, and by changing the focus focus of the sales force
- Valuation of the Latin American Operations might be to low and should be re-assessed
- Accounting methodology needs to be re-implemented to assure correct accrual/depreciation of CAPEX.
- Risk allowances could be lowered e.g for disputed claims
- Sunbeam might have off balance sheet assets, such as land and escrow accounts. This should be checked.
- Re-assess number/ value/ scope of insurance policies. Some might not be needed any more.
- There might be a tax loss carry forward as reorganized entity
- What is the enterprise value of Sunbeam Oster based on a DCF model with the projections in Exhibit 9 (and possibly some of your own assumptions) as inputs?
Our DCF valuation is based on the following facts and assumptions:
- Market Risk Premium of 7.0% (Rm =15%);
- Cost of debt: 8% (based on 30 y US treasury bond rate 8.3%)
- Asset beta (sunbeam): 0.72
- Tax rate: 40%
- Unlevered cost of equity: 13.3%
- WACC :8.2%
- There might be a tax loss and a NOL carry forward of $18.8M/year as reorganized entity
- Terminal (or perpetual) growth rate (g) = 3.0%
We also assume that the planning horizon is 5 years or more, which is common in the private equity space and allows sufficient time to stabilize the target acquisition company and implement the new business plan (including any cost reductions, synergies, bringing new products to market, and new marketing campaigns).
Based on these assumptions, we valued the enterprise at $725.7M:
We also ran a Monte Carlo simulation to assess the sensitivity to our assumptions of β, market risk and growth rate.
There are certainly other methods and assumptions that could be employed to do the DCF. However, we feel that our approach was reasonable, straight-forward and introduced the least amount of risk.
- Propose a plan of reorganization that allows you to capture the value you see in Sunbeam.
- How much equity would you raise to fund your plan? How much debt?
Using our enterprise value of $725M, we propose a capital structure of $400M in new debt and ~$325M in equity. This does achieve an IRR of 28.3%, even by conservative estimates. However, achieving this requires 55.1% of the equity to go to debt, which violates the requirements under IRS section 382 (l)(5), which limits the use of the NOLs in the manner shown above. The alternative would be to apply the NOLs under 382(l)(6), which would severely limit the use of NOLs, reducing the IRR below the 25% level.
Additionally, it is important to note the multiples associated with this enterprise value and level of debt. And enterprise value of $725M corresponds to an EBITDA multiple of about 7x. That is in line with exhibits 13A and 13B in the case. However, an equity value of $325M is less than a 6.5x EBITDA multiple. These are not monumental differences, but it is worth noting that the equity is undervalued, and this may effect of the cost of equity going forward. It may also result in rapidly rising stock prices after the first 4-6 quarters of financial performance are released, should the company meet or beat expectations.
- Can you deliver projected returns of 25-35% on an equity investment in Sunbeam? Why or why not?
A 5 year IRR of 28.3% is feasible at a Debt to Equity ratio of 55.1%. Please see the attached table for details.