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IAFF6198 Special Topics In International Trade And Investment Policy

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  • Course Code: IAFF6198
  • University: The George Washington University
  • Country: United States

Question:

Multi Products, Inc. (MPI) was founded 53 years ago and sold snack foods such as potato chips and pretzels as its main products. Through acquisitions, MPI has grown into a conglomerate with major divisions in the snack food industry, home security systems, cosmetics, and plastics. Additionally, the company has several smaller divisions. In recent years, the company has been underperforming, but the company’s management doesn’t seem to be aggressively pursuing opportunities to improve operations (or the stock price). You are a financial analyst and management expert working for a firm specializing in identifying potential buyout targets. You believe that two major changes are needed at Multi. First, you think that the company would be better off if it sold several divisions and concentrated on its core products in snack foods and home security systems only. Second, MPI is financed entirely with equity.

Because the cash flows of the company are relatively steady, you think the company’s debt-to-equity ratio should be at least 0.25. According to your analysis, these changes would significantly enhance shareholder wealth, but you also believe that the current board and company management are unlikely to take these necessary actions. As a result, you think the company is a good candidate for a leveraged buyout. A leveraged buyout (LBO) is the acquisition by a small group of equity investors of a public or private company. Generally, an LBO is financed primarily with debt. The new shareholders service the heavy interest and principal payments with cash from operations and/or asset sales. Shareholders generally hope to reverse the LBO within three to seven years by way of a public offering or sale of the company to another firm. A buyout is therefore likely to be successful only if the firm generates enough cash to service the debt in the early years and if the company is attractive to other buyers a few years down the road. You have suggested to your firm the potential LBO ad your firm asked you to provide projections of the cash flows for the company. You have provided the following estimates (in millions):

 

 

2016

2017

2018

2019

2020

Sales

$ 2,749

$ 3,083

$ 3,322

$ 3,400

$ 3,539

Costs

$ 731

$ 959

$ 1,009

$ 1,091

$ 1,149

Depreciation

 $ 485

 $ 516

 $ 537

 $ 564

 $ 575

EBT

$ 1,533

$ 1,608

$ 1,776

$ 1,745

$ 1,815

Capital expenditures

$ 279

$ 242

$ 304

$ 308

$ 304

Change in NWC

($122)

($186)

$101

$95

$108

Asset Sales

$ 1,419

$ 1,028

 

 

 

 

At the end of five years, you estimate that the growth rate in cash flows will be 3.5 percent per year. The capital expenditures are for new projects and the replacement of equipment that wears out.

Additionally, the company would realize cash flow from the sale of several divisions. Even though the company will sell these divisions, overall sales should increase because of a more concentrated effort on the remaining divisions. After plowing through the company’s financials and various pro forma scenarios, your firm feels that in five years the company can be sold to another party or taken public again. Your firm is also aware that a considerable amount of money must be borrowed for the purchase price. The interest payments on the debt for each of the next five years if the LBO is undertaken will be these (in millions):

 

 

2016

2017

2018

2019

2020

Interests Payments

$ 1,927

$ 1,859

$ 2,592

$ 2,526

$ 2,614

 

The company currently has a required return on assets of 14 percent. Because of the high debt level, the debt will carry a yield to maturity of 12.5 percent for the next five years. When the debt is refinanced in five years, they believe the new yield to maturity will be 8 percent. MPI currently has 425 million shares of stock outstanding that sell for $29 per share. The corporate tax rate is 40 percent.

Question:

If your firm decides to undertake the LBO, what is the most they should offer per share?

Explain the reasoning behind your approach and show all your math. It would preferable to, first, explain your understanding of the approach to calculate the price, then to follow with the calculation of the stock price.

 
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