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Corporate Valuation 248 Executive Summary Interco is comprised of four main business segments, two of which are thriving,

but two of which are struggling. The company has made attempts to restructure the organization to become more profitable, but to date has not been successful. Even despite these struggling business segments, though, the organization as a whole is still growing and still profitable. All of this makes the organization a good target for a takeover attempt. And since Interco does not want to be taken over, and still wants to attempt to restructure on its own, this is likely to be a hostile takeover attempt. On the surface, the data provided by Wasserstein, Perella & Co. seems to support Intercos decision to reject the offer from City Capital; however upon further examination all of the data provided is unconvincing. Wasserstein, Perella & Co. has not provided adequate data or adequate support for its exhibits. Additionally, the Interco board seems to have accepted this data without questioning it, when it should have instead questioned many of the assumptions made by Wasserstein, Perella & Co. Based on our analysis and our calculation of a weighted average cost of capital for use as a discount rate, the discounted cash flow share price calculations come out to a range of $50$60. Therefore both offers by City Capital have surpassed this calculated price, and would have offered Interco a premium above the calculated share price. Even though the Interco board does not want to be taken over, this offer should definitely be considered for acceptance. I. Assess Intercos financial performance. Why is the company a target of a hostile takeover attempt? Interco is a successful organization that has some clear weak parts within the organization. The four business segments within Interco consist of apparel, general retail, footwear, and furniture. As has been stated in the case and can be seen from Intercos financial statements, the footwear and furniture segments have recently been undergoing significant growth, whereas apparel and general retail have both been struggling and hurting the organization. Apparel and general retail were struggling largely due to low consumer spending, increased imports, and an increased emphasis on private-label goods. Even with these struggling business segments, though, Interco still has been performing well, making it a good target for a takeover attempt. Overall, Intercos 1998 sales and net income increased by 13.4% and 15.4%, respectively, over 1997 levels, return on equity increase to 11.7% from 9.7%, and the company had a clean capital structure, with a debt-to-capitalization

ratio of 19.3% and a current ratio of 3.6 to 1. Additionally, Interco has recently been repurchasing company stock, and attempting to enhance shareholder value. Many times, acquiring firms will like to find a target company that can either thrive as part of a larger organization, or will be able to function successful on its own as well. So, from the perspective of an acquiring firm, Interco would appear to be a firm that the acquiring company will be able to quickly increase profitability by restructuring and divesting its underperforming assets. The acquiring firm could help streamline the organization and focus it solely on its profitable divisions. Ultimately, in addition to being a target for a takeover, Interco is likely to be the target of a hostile takeover due to the attitude of management within the organization. The primary difference between a friendly takeover and a hostile takeover is managements attitude, either management will be interested in the takeover and will be willing to work with the acquiring firm to establish a reasonable and fair price, or if management is not interested in the takeover, there is likely to be disagreement about a fair value for the firm. In this situation, Intercos management has made it clear that they do not want to be taken over; management feels that the firm can be turned around by restructuring and selling off the apparel and general retail division. Therefore, in general, management is more likely to have a higher opinion of the value of the firm than the acquiring firm. This appears to be the situation with Interco and the current offer from City Capital Associates. II. As a member of Intercos board are you persuaded by the premiums paid analysis of Exhibit 10 and the comparable transactions analysis of Exhibit 11? Why or why not? By examining exhibits 10 and 11 on a superficial level, it is easy to understand the reasons that Intercos board made the decision to reject City Capitals offer of $70 per share. At a quick glance, it can be seen in Exhibit 10 that the average premiums paid over the stock price in other 1998 tender offers were, for the most part, significantly higher than the offer made by City Capital. Additionally, the purchase price multiples in Exhibit 11 used by City Capital for net income, book value, sales, operating income, and operating cash flow were lower than the averages of the multiples of the firms selected by Wasserstein, Perella & Co. Both of these initial reviews would lead Interco management to feel that the firm should be worth more than the current offer. However, after giving the data a further review, there are several concerns with both exhibits. Exhibit 10: * The footnotes say that it is selected selected tender offers, but we dont know how the tender offers were selected, and what other data may exist. There may be a selection bias in this information. * To one-day premium rate, 4 week, and 52-week low premiums are all below the other data

shown in exhibit 10, but the 52-week high premium is above the average and higher than all except Q2 1998. In this case of Interco, by judging its stock price, the stock price has been rising significantly recently. There must have been some information leaked about a possible acquisition to the market, which caused the stock price to go up dramatically (for example, on July 5, 1998 the stock price was 45.375, but on August 5, 1988, even before the offer had been submitted, the stock price was $68.25. So, the premium that is being offered in the offer is a premium over an already significant increase price. This might not have been the case with the other offers that are being evaluated. As further evidence with this, in the Rales offer the oneday premium is 17.9%, and the 52 week high premium is 17.2%. This means that the one-day stock price for Interco was essentially at its 52-week high because there is very little difference in these premiums. On the other hand, looking at the aggregated 1998, the one-day rate is 56% compared to a 52-week high of 15.8%. This means there is a significant premium over the current stock price, but only a moderate premium over where the company was at its high. This implies these other companies had peaked earlier in the year and are now declining their stock price. This is different than Interco. Exhibit 11: * The same selection bias as before may exist. We dont know how those other comparable firms were selected, or why they were used. We also have very limited data about the other firms. It would be helpful to be able to compare some of the data of the comparable firms to Interco, such as net income, book value, sales, operating income, and operating cash flow. But we are not given this data, we are only given the multiple. So, overall, both Exhibit 10 and Exhibit 11 would lead to persuade Intercos board to decline the offer at $70 per share because both exhibits prepared by Wasserstein, Perella & Co. lead the reader to believe that the firm should be valued higher than Rales offer. However, upon further investigation, the board should not have reached this conclusion because as they stand right now, these exhibits do not present sufficient evidence to make an educated decision. More background information on how the firms for both exhibits were chosen would be needed, as well as more firms to choose from, and more data on the comparable firms. By analyzing this additional data, it would then be possible to determine the validity of this offer. III. Wasserstein, Perella & Co. established a valuation range of $68-$80 per common share for Interco. Show that this valuation range can follow from the assumptions described in the discounted cash flow analysis section of Exhibit 12. As a member of Intercos board, which assumptions would you have questioned? Why? Discounted Cash Flow (DCF) analysis for the valuation of Interco can be seen in Appendix 2. In order to determine these calculations, data from Exhibit 12 was used, along with some additional assumptions. First, the total operating margin was given as a range from 9.2%-

10.1%. To take this range in to account, our calculations began 1989 with a 9.2% operating margin, and increased by 0.1% every year until reaching the 10.1% in 1998. Additionally, it assumes that the net income will equal the cash flow for the first five years. Given the data and these assumptions, the stock price calculations are confirmed, however the following questions should have been raised: * Why is cash flow assumed to be the same figure as net income for the first five years? In reality, the actual cash flow would likely be different from the net income. * Where did the growth rates come from? Wasserstein, Perella & Co. estimated growth rate figures for sales, operating margin, capital expenditures, and working investment, but the details of how these numbers were calculated are not disclosed. In particular, the apparel group and retail group show strong sales growth, even though these groups have actually been struggling recently. * Where did those discount rates come from? Discount rates of 10%, 11%, 12%, and 13% were used for discounting the cash flows, however the logic behind these particular rates is not disclosed. These discount rates seem somewhat arbitrary. * Where did the multiples come from? Year 10 cash flow multiples of 14, 15, and 16 were used to determine the terminal value, but the logic behind these particular multiples is not disclosed. * Why doesnt the tax rate change in the future? This model assumes a static tax rate of 41%, however given changing income and changing tax laws, this rate would be likely to change in the future. * Why is there an increase in working investment from 1994 forward? The logic for why this amount is projected to begin in the year 1994 is not closed. IV. How would you advise the Interco board on the $70 per share offer? Based on our calculations, the major difference in value will come due to a difference in the discount rate. Our calculated discount rate was 15.1% (please see Appendix 3 for discount rate calculations). Many of the other assumptions made in prior calculations could not be verified on our own due to a lack of data. But with this discount rate, the new valuation for the share price drops down to a range of $50-$60 per share given cash flow multiples of 14, 15, and 16. Therefore, the $70 per share offer from City Capital is well above the current DCF valuation, and the Interco board should accept the offer. The only reason for Interco to not accept the offer is if the company truly feels that it can turn the restructure the organization on its own to cause it to be profitable enough to surpass this share price. However, given that the organization has been unsuccessful in divesting the underperforming assets to date, it seems unlikely that the organization will do so on its own. V. How would you assess the actions of Intercos board up to August 8, 1988? Wasserstein, Perella & Co.s? The Rales brothers?

Some of the actions of Intercos board are reasonable while others are not. Interco did not want to be taken over, so the defensive actions by the board to amend Intercos shareholder rights plan seems to be reasonable. These amendments would make it much more difficult for a new buyer to takeover the firm. If the ultimate goal of the organization is to avoid being bought, then this is reasonable. However, Intercos board should have done some additional legwork in calculating a fair price for the organization. The board seems to have been persuaded by the data provided by Wasserstein, Perella & Co. without questioning the assumptions or data provided. The board should have questioned the analysis according to some of the questions mentioned earlier. By doing so the board may have thought differently about the offer from City Capital. Mt s cc hnh ng ca hi ng qun tr Interco l hp l trong khi mt s khc khng.Interco khng mun b thm tm, v vy cc hnh ng phng th ca hi ng qun tr l sa i quyn ca c ng nghe c v l hp l. Nhng sa i ny s lm cho cc t chc mun mua interco kh khn hn. Nu mc tiu cui cng ca t chc l trnh b mua, th iu ny l hp l. Tuy nhin, hi ng qun tr Interco cn phi thu thp thm s liu tnh ton tnh ton ra gi tr hp l cho cng ty. Hi ng qun tr dng nh b thuyt phc bi cc d liu c cung cp bi Wasserstein, Perella & Co m khng t cu hi v cc gi nh hoc cung cp d liu. Hi ng qun tr cn phi t cu hi v phn tch theo mt s cu hi cp trc . Bng cch lm nh vy hi ng qun tr c th c suy ngh khc nhau v cung City Capital. Wasserstein, Perella & Co. should have provided additional data in its exhibits, or at the minimum should have given additional explanations for the data. Much of the data provided by Wasserstein, Perella & Co. seems to be somewhat arbitrary, such as the discount rates and cash flow multiples. Furthermore, the logic behind the selection of which tender offers to use and which comparable firms were selected is missing. All of the data provided may in fact be the most accurate and best available, however without knowing additional details about the selection process leaves significant room for doubt. This data may be subject to selection bias, and additional information about the selection process would help to confirm the legitimacy of the data. Wasserstein, Perella & Co cung cp d liu b sung trong cc bng tnh ton, hoc ti cc thng tin b sung. Phn ln cc d liu c cung cp bi Wasserstein, Perella & Co c v hi ty tin, chng hn nh t l chit khu v bi s dng tin. Hn na, logic ng sau la chn c cung cp s dng v so snh cc cng ty c la chn l b thiu. Tt c cc d liu c cung cp trn thc t c th c chnh xc nht v c sn tt nht, tuy nhin ta li khng bit thm chi tit v qu trnh la chn, v cng c nhng iu cn phi nghi ng. D liu ny c th b sai lch chn la, v thm thng tin v qu trnh la chn s gip xc nhn tnh hp php ca d liu.

The Rales brothers seem to have acted reasonably to this point. Based on our calculations of a discount rate, and using some of the assumptions provided in Exhibit 12, both the $64 per share offer and the $70 per share offer were well above our calculated share price range of $50$60. In fact, these offers represent a significant premium above the DCF calculated value. If the Rales brothers do feel strongly that they will be able to divest the underperforming assets and increase profitability in the firm, it will be worthwhile for them to pay a premium for the share price. If the Rales brothers came to these values by doing similar calculations to what we have used, perhaps one thing they should have done was share this information with Interco. The Interco board seems to be strongly influenced by the data provided by Wasserstein, Perella & Co., therefore perhaps if the Rales brothers shared their logic and reasoning with Interco, it may have helped improved the chances of acceptance. Cc anh em Rales dng nh hnh ng hp l n thi im ny. Da trn cc tnh ton ca chng ta v mt t l chit khu, v bng cch s dng mt s cc gi nh c cung cp ti Ph lc 12, c hai u cung cp $ 64 cho mi c phiu v cung cp $ 70 trn mi c phiu cng cao hn mc gi tnh phm vi gi c phiu ca chng ti $ 50 - $ 60. Trong thc t, nhng cung cp i din cho mt bo him ng k trn cc gi tr tnh ton DCF. Nu anh em Rales cm thy mnh m rng h s c th loi b cc ti sn hot ng km hiu qu v tng li nhun trong cng ty, n s ng gi cho h tr thm phn b cho gi c phiu. Nu anh em Rales n nhng gi tr ny bng cch thc hin cc tnh ton tng t nh nhng g chng ta s dng, c l mt trong nhng iu h nn lm l chia s thng tin vi Interco. Ban Interco dng nh c nh hng mnh m bi cc d liu c cung cp bi Wasserstein, Perella & Co, do c l nu anh em Rales chia s logic v l lun vi Interco, n c th gip ci thin c hi chp nhn.

-------------------------------------------[ 1 ]. Page 3 from the case study [ 2 ]. Page 1 from the case study [ 3 ]. The multiples used by Rales were 18.1, 2.2, 0.9, 11.4, and 9.2 compared to 23.4, 2.5, 1.0, 15.6, and 12.0 as the averages of all companies. See Appendix 1 for details.

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