Jide Wintoki From: Richard Smith, Scott Mitchell, Zack Gregory Re: Mercury Athletic Acquisition Based on our analysis of Mr. Liedtke’s base case projections for a potential acquisition of Mercury Athletic, we have concluded that this is a positive net present value project, and that AGI should proceed with the acquisition. Under Mr. Liedtke’s operating assumptions, we calculate the value of Mercury’s discounted cash flows to be $624. 446 million, and the acquisition price to be $156. 43 million, yielding a net present value of $467,804 for AGI. Our calculations indicate that this project becomes even more attractive financially when potential favorable synergies between AGI and Mercury are taken into account. A real options valuation (details below) involving inventory management and the women’s casual line indicates that an additional $22. 365 million of value would be created by the successful implementation of fairly simple operating synergies in those two areas alone.
Considering that far more possible synergies and savings are a possibility for AGI and Mercury post-acquisition, we believe this acquisition would be an appropriate strategic move for AGI to improve its own performance and to compete on a more level playing field with the larger companies in the industry. Methodology/Supporting Assumptions To estimate the price of acquiring Mercury, we averaged the P/E multiples of comparable companies in the industry and applied that multiple to Mercury’s 2006 net income to arrive at a likely purchase price.
P/E was used because we believe it is the most accurate reflection of the market’s view of Mercury’s recent performance and value. Kinsley Coulter and Templeton Athletic were used as the two comparable companies because, along with AGI and Mercury, they are the only other companies in the industry with annual revenue of less than $1 billion (Marina Wilderness also has revenue less than $1 billion, but because it is the fastest- growing company in the industry it commands a multiple dramatically different from what Mercury could expect, therefore we excluded it).
To discount the cash flows, we first had to estimate Mercury’s WACC. We did this by calculating the average asset beta for companies in this industry, and then applied it to Mercury’s assumed leverage ratio to find the cost of equity. Combining that information with the cost of debt and tax rate assumptions provided by Mr. Liedtke, we arrived at a WACC of 10. 9%. To calculate the terminal value of the project, we assumed a growth rate roughly equal to historical inflation in the U. S. , which is 3%.
Though Mr. Liedtke’s projections have Mercury’s cash flows growing much more rapidly (8. 5%) in the near term, we didn’t believe that figure was sustainable in the long run, and thus used that more conservative inflation figure. Valuation of Potential Synergies To analyze the potential value that would be added by cooperation between AGI and Mercury, we conducted a real options valuation involving some of the operating synergies that Mr. Liedtke thought could be realized post-acquisition.
The two scenarios we analyzed were: Optimistic Scenario – All synergy benefits realized (50% probability): Mercury women’s casual line turns around; 3% revenue growth, 9% EBIT Adoption of AGI inventory system reduces Mercury’s DSI to margin Discounted present value under this scenario: $685. 479 million Pessimistic Scenario – No synergy benefits realized (50% probability): Women’s casual line maintained, but continues losing money (-2. 3% Adoption of AGI inventory system has no effect onEBIT) indefinitely Discounted present value under thisMercury’s inventory levels scenario: $608. 43 million Sensitivity Analysis A sensitivity analysis of our results indicates that this project would remain a positive NPV project for AGI, even given dramatically different assumptions regarding Mercury’s debt level and future revenue growth. Even using 100% debt or 0% debt in its capital structure, Mercury’s NPV would remain positive. Additionally, discounted cash flows over the first five years (2007- 2011) are sufficient to cover our estimated purchase price, so changes in our terminal value revenue growth figure make no difference in whether this is a positive- or negative-NPV project.