2009 ACG Cup Finals Buy Side Recommendations SOX Group

Aggarwal, Siddharth Betha, Samuel Dasgupta, Subhojit Gaurav, Ananya Kaushik, Ravi
2/9/2009

Executive Summary
FashionCo: Purchase valuation
– Enterprise Value – $80-92Mn – Debt Financing of Deal – $25Mn

Exit scenarios: (3 years)
– Base Scenario – Upside Scenario – Downside Scenario – EV $194Mn, IRR 35% – EV $199Mn, IRR 37% – EV $124Mn, IRR 12%

Recommendation: Purchase FashionCo. with exit horizon of 3years Exit strategies: IPO, strategic sale, secondary placement Risks and mitigation

FashionCo. – Is it a good buy for Sox Group?
FashionCo: 40yrs+ history, low cost apparel – better prospects despite economic downturn Financial strength and low debt levels (details in Appendix 1a) Owned by passive investors not interested in apparels business Sox Group: Previous apparel industry experience Better cost management: reduction of COGS by 2% and SG&A by 15% Current Valuation: Equity Value Asking price – $68-80Mn (inclusive of 29% control premium) – $90Mn Enterprise Value – $80-92Mn Debt financing upto $37Mn (4x EBITDA) at LIBOR plus 400-500bps
Further details in Appendix 1b

Valuations: Assumptions and Base Case
Constants for all scenarios: Purchase Price assumed at $90Mn Debt Financing of $25Mn (3xEBITDA) Exit EBITDA multiple (7.6) is 0.5x less than Entry EBITDA multiple (more info in Appendix 5) IRR calculated excluding intermediate cash flows from FashionCo
Base Case Assumptions Revenue growth COGS savings SG&A savings 2009 0% 0% 0.0% 2010 1% 1% 7.5% 2011 2% 2% 15.0%

Base Case Exit Valuation (after 3 years):
– EBITDA – Equity value – IRR – $25Mn – $160Mn – 35% or 2.5x cash returns
Further details in Appendix 2a

– Enterprise value – $194Mn

Valuation Scenarios: Upside and Downside
Base Case Assumptions Upside Assumptions 2009 0% 0% 0.0% 2010 2009 2011 2010 2% 2%

2011 4% 2% 15.0%

Downside Assumptions Revenue growth COGS savings SG&A savings

2009 0% 0% 0.0%

2010 0% 0% 0.0%

2011 0% 0% 0.0%

Revenue growth
COGS savings

Revenue growth

0%

1%

1%

2%

COGSsavings SG&A savings SG&A savings

2% 7.5% 15.0%

2% 15.0% 15.0%

Upside Exit Valuation (after 3 years):
– EBITDA – Equity value – IRR – $26Mn – $166Mn – 37% or 2.6x cash returns – Enterprise value – $199Mn

Downside Exit Valuation (after 3 years):
– EBITDA – Equity value – IRR – $16Mn – $91Mn – 12% or 1.4x cash returns – Enterprise value – $124Mn

Further details in Appendix 2b

Further details in Appendix 2c

Valuation Scenarios: IRR in different scenarios
Revenue Growth -6% -4% 22% 25% 28% 31% 35% 41% -2% 24% 26% 29% 33% 37% 43% 0% 25% 28% 31% 34% 39% 45% 2% 26% 29% 32% 36% 41% 47% 4% 28% 31% 34% 38% 43% 49% 6% 29% 32% 35% 39% 45% 51%

Growth Rates vs. Leverage
Leverage

0% 10% 20% 30% 40% 50%

21% 23% 26% 29% 34% 39%

Expected IRR: 34-41% Debt Financing of 30-40% Revenue Growth 0-2%

Purchase Price vs. Leverage Expected IRR: 36-56% Debt Financing of 30-40% Purchase Price of $70-90Mn
Leverage 0% 10% 20% 30% 40% 50% 50 54% 58% 63% 69% 76% 86% 60 45% 48% 53% 58% 65% 73% Purchase Price ($Mn) 70 37% 41% 45% 50% 56% 63% 80 31% 34% 38% 42% 48% 55% 90 26% 29% 32% 36% 41% 47% 100 22% 24% 27% 31% 35% 41% 110 18% 20% 23% 26% 30% 35%

Exit multiple of 7.6x

Exit Strategies
Strategy 1: IPO Merits
– Highest potential payoff – Motivation for management (with ESOPs)

Demerits
– Open to public scrutiny/analysts

Strategy 2: Strategic Sale Merits
– Many potential buyers – competing companies

Demerits
– M&A deals have high failure rates

Exit Strategies

Strategy 3: Sale to another PE / financial institution (Secondaries) Merits
– Source of liquidity for private equity investments

Demerits
– Suppressed valuation if no other bidders

Risks and mitigation
Risks Execution risk - management attrition Macro-economic risk Interest rate risk Liquidity risk Delayed exit Competitive bids & price war Mitigation Earnout structure, ESOPs Insurance, recourse clauses Swaps, refinance debt, see appendix 3 for impact on IRR Exit scenarios, synergies from existing portfolio companies Partial sell-out, see appendix 4 for impact on IRR Due-diligence, competitive intelligence

Final Considerations

Quality of management of FashionCo Long term and short term strategies Competitive landscape Sustainable competitive advantages Organizational culture and leadership issues PE firm strategy

Recommendation
Purchase FashionCo
– Start negotiating at $70Mn with a ZOPA of $70-90Mn – Use maximum debt financing feasible (upto $37.2Mn)

Retain Management
– Use ESOPs to motivate management team

Exit Planning
– 3year horizon with $150-160Mn price – IRR of 30-40%

Other Bargaining Chips
– Earn-out clause

THANK YOU!

Appendix 1a – FashionCo: Financial Highlights

Financial Highlights Growth Profitability Leverage Cash Flows Revenue Earnings ROS ROE Debt Ratio Times Interest Earned Free Cash Flow ($Mn)

2006 10% 2% 6% 23% 24% 2.2x 0.8

2007 4% 4% 8% 28% 17% 3.7x 16.3

2008 3% 3% 6% 20% 10% 4.2x 12.8

Industry Avg. 2008 4% 1% 5% 9% 50% 1.9x NA

Appendix 1b – Purchase Valuation
Comparable Companies Sales 195.00 0.38 73.62 64.62 EBITDA 12.20 4.61 56.26 47.26 EBIT 11.40 6.48 73.83 64.83 Earnings 5.76 8.47 48.77 39.77 Summary of Valuations Minimum Maximum Median Mean without outliers Mean Valuations - Range Selected Equity Value Control Premium Equity with Cont Prem Debt Less Cash EV 28.40 183.08 61.80 59.36 69.67 Median 61.80 29% 79.51 11.60 (2.60) 88.51 40th % 53.23 29% 68.48 11.60 (2.60) 77.48 60th % 64.06 29% 82.41 11.60 (2.60) 91.41

Fashion Co Multiple EV Equity

Comparable Transactions Sales 195.00 0.99 1.00 192.08 183.08 28.40 61.80 51.09 EBITDA 12.20 7.80 1.00 95.16 86.16

Fashion Co Multiple EV EV Equity NAV DCF-WACC DCF-CAPM

Appendix 2a – Base Case Income Statement
Income Statement (In $ millions) Fiscal Year Ended December, 2008 2009 2010 2011 Actual Projected Projected Projected Revenue % Growth Cost of Goods Sold Gross Profit Gross Margin SG&A Dep & Amrt Oth Exp (Inc) Operating Income (EBIT) Operating Margin Addn Interest Exp Interest Exp (Net) Oth (Inc) Exp EBT 40% Taxes Net Income avbl to Common Add: Taxes Add: Interest Exp Add: Oth (Inc) Exp Plus: Dep & Amrt Adjusted EBITDA EBITDA Margin Free Cash Flow to Firm Free Cash Flow to Equity $ $ $ $ $ $ $ 195.0 2.6% 153.6 41.4 21.2% 28.4 0.8 0.8 11.4 5.8% 1.8 9.6 3.8 5.8 3.0% 3.8 1.8 0.8 12.2 6.3% $ 195.0 0.0% $ 150.2 $ 44.9 23.0% $ 28.30 $ 0.7 $ 1.2 $ 14.6 7.5% 2.12 $ 1.0 $ $ 11.5 $ 4.6 $ 6.9 4.0% $ 4.6 $ 3.1 $ $ 0.7 $ 15.3 7.4% $ 197.0 1.0% $ 149.7 $ 47.3 24.0% $ 26.52 $ 0.6 $ 1.4 $ 18.7 9.5% 2.01 $ 1.1 $ $ 15.6 $ 6.3 $ 9.4 4.1% $ 6.3 $ 3.1 $ $ 0.6 $ 19.3 7.7% $ 200.9 2.0% $ 148.7 $ 52.2 26.0% $ 26.52 $ 1.0 $ 0.3 $ 24.4 12.2% 1.91 $ 1.2 $ $ 21.3 $ 8.5 $ 12.8 4.1% $ 8.5 $ 3.1 $ $ 1.0 $ 25.4 7.9% 15.4 11.0

$ $ $ $ $ $ $ $ $ $

$ $

12.8 $ 11.0 $

3.6 $ (0.7) $

11.8 $ 7.4 $

Appendix 2b – Upside Case Income Statement
Income Statement (In $ millions) Fiscal Year Ended December, 2008 2009 2010 2011 Actual Projected Projected Projected Revenue % Growth Cost of Goods Sold Gross Profit Gross Margin SG&A Dep & Amrt Oth Exp (Inc) Operating Income (EBIT) Operating Margin Addn Interest Exp Interest Exp (Net) Oth (Inc) Exp EBT 40% Taxes Net Income avbl to Common Add: Taxes Add: Interest Exp Add: Oth (Inc) Exp Plus: Dep & Amrt Adjusted EBITDA EBITDA Margin Free Cash Flow to Firm Free Cash Flow to Equity $ $ $ $ $ $ $ 195.0 2.6% 153.6 41.4 21.2% 28.4 0.8 0.8 11.4 5.8% 1.8 9.6 3.8 5.8 3.0% 3.8 1.8 0.8 12.2 6.3% $ 195.0 0.0% $ 146.3 $ 48.8 25.0% $ 24.06 $ 0.7 $ 1.2 $ 22.8 11.7% 1.99 $ 1.0 $ $ 19.8 $ 7.9 $ 11.9 4.0% $ 7.9 $ 3.0 $ $ 0.7 $ 23.5 7.4% $ 198.9 2.0% $ 149.2 $ 49.7 25.0% $ 24.61 $ 0.6 $ 1.4 $ 23.1 11.6% 1.89 $ 1.1 $ $ 20.1 $ 8.0 $ 12.1 4.1% $ 8.0 $ 3.0 $ $ 0.6 $ 23.7 7.7% $ 206.9 4.0% $ 153.1 $ 53.8 26.0% $ 27.30 $ 1.0 $ 0.3 $ 25.2 12.2% 1.79 $ 1.2 $ $ 22.2 $ 8.9 $ 13.3 4.1% $ 8.9 $ 3.0 $ $ 1.0 $ 26.2 7.9% 15.8 11.6

$ $ $ $ $ $ $ $ $ $

$ $

12.8 $ 11.0 $

8.5 $ 4.2 $

14.3 $ 10.1 $

Appendix 2c – Downside Case Income Statement
Income Statement (In $ millions) Fiscal Year Ended December, 2008 2009 2010 2011 Actual Projected Projected Projected Revenue % Growth Cost of Goods Sold Gross Profit Gross Margin SG&A Dep & Amrt Oth Exp (Inc) Operating Income (EBIT) Operating Margin Addn Interest Exp Interest Exp (Net) Oth (Inc) Exp EBT 40% Taxes Net Income avbl to Common Add: Taxes Add: Interest Exp Add: Oth (Inc) Exp Plus: Dep & Amrt Adjusted EBITDA EBITDA Margin Free Cash Flow to Firm Free Cash Flow to Equity $ $ $ $ $ $ $ 195.0 2.6% 153.6 41.4 21.2% 28.4 0.8 0.8 11.4 5.8% 1.8 9.6 3.8 5.8 3.0% 3.8 1.8 0.8 12.2 6.3% $ 195.0 0.0% $ 150.2 $ 44.9 23.0% $ 28.30 $ 0.7 $ 1.2 $ 14.6 7.5% 2.24 $ 1.0 $ $ 11.4 $ 4.6 $ 6.8 4.0% $ 4.6 $ 3.2 $ $ 0.7 $ 15.3 7.4% $ 195.0 0.0% $ 150.2 $ 44.9 23.0% $ 28.39 $ 0.6 $ 1.4 $ 14.5 7.4% 2.13 $ 1.1 $ $ 11.2 $ 4.5 $ 6.7 4.1% $ 4.5 $ 3.2 $ $ 0.6 $ 15.1 7.7% $ 195.0 0.0% $ 148.2 $ 46.8 24.0% $ 30.28 $ 1.0 $ 0.3 $ 15.2 7.8% 2.02 $ 1.2 $ $ 12.0 $ 4.8 $ 7.2 4.1% $ 4.8 $ 3.2 $ $ 1.0 $ 16.2 7.9% 9.9 5.4

$ $ $ $ $ $ $ $ $ $

$ $

12.8 $ 11.0 $

3.7 $ (0.8) $

9.2 $ 4.8 $

Appendix 3 – Valuation Scenarios: Interest Rate Risk
Base Case Assumptions Revenue growth COGS savings SG&A savings 2009 0% 0% 0.0% 2010 1% 1% 7.5% 2011 2% 2% 15.0%

LIBOR Decreases LIBOR – 300bps, Cost of debt – 750bps Exit Valuation (after 3 years):
– EBITDA – Equity value – IRR – $26Mn – $166Mn – 37% or 2.6x cash returns – Enterprise value – $199Mn

LIBOR Increases LIBOR – 500bps, Cost of debt – 950bps Exit Valuation (after 3 years):
– EBITDA – Equity value – IRR – $26Mn – $166Mn – 37% or 2.6x cash returns – Enterprise value – $199Mn

Appendix 4 – Valuation Scenario: Delayed Exits
IRR in different cases with delayed exit

Time to Exit 3yrs Scenario Best Upside Downside 37% 35% 12% 4yrs 26% 25% 9% 5yrs 21% 20% 7%

Appendix 5 – IRRs at different Exit EBITDA Multiple
Entry at 8.1x EBITDA Positive returns at or above:
– Base: 4x EBITDA – Upside: 4x EBITDA – Downside: 6.5x EBITDA
45% 40% 35% 30% IRR 25% 20% 15% 10% 5% 0%
8. 00 7. 50 7. 00 6. 50 6. 00 5. 50 5. 00 4. 50 4. 00 3. 50 3. 00 2. 50 2. 00

Base Upside Downside

Exit EBITDA x

Sign up to vote on this title
UsefulNot useful