Title: Interco HBS Case Study
1IntercoHBS Case Study
2Interco Case Study
- Background
- Started out as shoe company been around a long
time - Business has spread to other consumer products /
services through acquisitions - Fairly conservative financially, debt level is
relatively low
3Operations
- Currently has four major operating divisions
- 1. Apparel (e.g., London Fog)
- 2. General retail merchandising (Central
Hardware) - 3. Footware (Converse, Florsheim)
- 4. Furniture and home furnishings (Ethan Allen)
4Intercos Goals
- Improve long-term sales and earnings growth
- Earn increased return on assets and equity
5How does Interco plan to achieve these goals?
- Improve profitability of existing assets
- Divest/sell unproductive assets
- Make acquisitions that will improve
growth/returns - Use corporate finance!
- (adjust payout policy and debt policy to
maximize firm value we will discuss this in
depth later in the course)
6Recent Interco History (from 1984-88)
- Interco has moved away from apparel and general
retail (went from 59 to 40 of total sales) -
- Placed more emphasis on the footwear division
- (acquired Converse in 1986)
- Placed much more emphasis on the furniture
division (sales rose from 20-33 of Intercos
total sales)
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8Economic environment in August 1988
- Cheap imports hurting profitability of U.S.
apparel manufacturers - Retailing industry profits reduced due to
drop-off in consumer spending and deep
discounting programs being offered by retailers
in 1987 - Furniture and home furnishings prospects appear
bright given favorable demographic trends in
family formations (success of firms like Home
Depot proved this ex post!) - October 1987 stock market crash still in
rear-view mirror
9Interco concerned stock price may be
undervalued - Why?
- Management felt that bad performance in
apparel group is unduly dragging down Intercos
stock price. - Because of this undervaluation, Intercos
management afraid may be a takeover target.
10What has Interco done to try and improve return
to shareholders (boost its stock price) and thus
deter an unwanted takeover attempt?
- Following 1987 crash, Intercos board authorized
repurchase of 5 million shares (by end of fiscal
1988 over 4 million shares had been repurchased
over 10 of the equity) - 7/15/88 Interco announces reorganization plan
- sell the apparel division that is dragging down
rest of company - take the money raised from this sale and return
it to shareholders (via special dividend or
repurchase)
11Mid 1988 things start to get interesting
- Enter stage left the cowboy(s) with the black
hat - Rales Brothers Washington DC businessmen
- The book on the Rales Brothers
- they buy undervalued companies with strong
brand-names - City Capital (formed by Rales) has Interco in it
sights - Thinks currently that the sum of Intercos parts
exceeds Intercos current stock price - Plans to sell apparel division and also sell part
of footwear division, focus on home furnishing
12Good Guys in Black Hats?
- Corporate raiders as
- Misunderstood heroes
- Unsung protectors of the public shareholders
13- City Capital has accumulated 8.7 of Intercos
stock - Ups the ante on 7/27/88 City Capital proposes a
merger/takeover of Interco and offers to buy
Intercos stock for 64 per share (price was
44.75 on 6/30/88) - Morning of 8/8/88 Offer raised to 70 per share
- Offer is timed well Interco happens to have a
Board meeting scheduled for 8/8/88. - Board wants their financial advisor, Wasserstein,
Perella, Co. to evaluate City Capitals offer.
14The Big Question
- Should Intercos Board accept or reject the
offer of 70 per share that is on the table?
15Premiums Paid Analysis (Exhibit 10)
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17Comparable Firm Analysis
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19Discounted Cash Flow Analysis
20- Given the assumption presented by Wasserstein,
Perella, Co., we can value Interco using a
discounted cash flow methodology. - Value Interco
- discounted first 10 free cash flows TV10 /
(1r)10 - Value Intercos equity
- Value Interco 318.5M of debt
- Price per share of stock
- Value Intercos equity / 37.5M shares
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22Are assumptions implicit in estimates reasonable?
- 1. First ten cash flows
- 2. Discount rate (WACC)
- 3. Long-term growth rate
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262. Discount Rate (WACC)
- What is appropriate discount rate for Intercos
free cash flows? - Exhibit 14
- 10-year Treasury bond returns 9
- 10-year AAA bond returns 9.5
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293. Long-term Growth Rate
- Given multiple applied and discount rate assumed,
can back out the implied long-term growth rate of
free-cash flow. Way to check if value obtained
using market data of competitors can be justified
by DCF analysis. - Value of firm10 FCF11 / (r - g) FCF10 (1g)
/ (r - g) - Value of firm10 14FCF10 (by assumption)
- ? 14 (1g) / (r - g)
- r .10 ? g .027
- r .11 ? g .036
- r .12 ? g .045
- r .13 ? g .055
- r .14 ? g .064
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31Now, the rest of the story . . .
- 8/22/88 Wasserstein, Perella adjust valuation
range to 74-87 - 9/10/88 City Capital raises offer to 72 per
share - 9/19/88 Board adopts restructuring plan and
rejects 72 offer - 10/17/88 City Capital raises offer to 74
- 10/19/88 Board declares large dividend financed
by debt (and anticipation of proceeds from
selling off divisions), rejects 74 offer - 11/16/88 City Capital 74 offer expires, Interco
stock price falls closing at 63.375 - 11/16/88 group of shareholders file lawsuit
against Interco and its Board in connection with
Intercos avoidance of the hostile tender offer
by City Capital (breach of fiduciary
responsibility) - Under 11/88 restructuring, Interco to pay 1.42
billion cash dividend
32Now, the end of the story . . .
- Earnings were less than forecast during 1989-1990
- Proceeds from asset sales less than anticipated
- Spring of 1990, Interco pays 18.5 million to
settle the shareholder lawsuit - Spring of 1990, Interco begins to work with
creditors to restructure its debt - 6/15/90 Interco defaulted on bond payments
- 1/24/91 Interco filed for bankruptcy and sued
Wasserstein, Perella, Co. for negligence - Interesting side note (footnote 2 of the case)
- Wasserstein, Perella, Co. get 1.8 million from
Interco for its advice/services, however get a
3.7 million bonus if City Capital rescinded
their offer to buy Interco and Interco then put
in place its own restructuring plan.