FINANCE CASE JEUX DU COMMERCE 2012 UNIVERSITÉ LAVAL

Transcription

1 FINANCE CASE JEUX DU COMMERCE 2012 UNIVERSITÉ LAVAL

2 TEE OFF TIME 1 Written by : Philippe Grégoire, professeur agrégé, département de finance, assurance et immobilier Faculté des sciences de l administration Université Laval On a hot and humid Monday morning of July 2005, Pierre H. Lessard, CEO of Metro Inc., was feeding Tom and Jerry, the two goldfish he received for his sixtieth birthday two years ago. Looking at the two fish going back and forth in their aquarium, Pierre thought to himself: These fish need a bigger bowl. He then walked toward the window of his office and, looking at the busy Montreal streets, he murmured Metro also needs a bigger bowl. Maybe it is time for an acquisition! As of July 2005, Metro Inc. was operating 343 grocery stores in Quebec and Ontario, 281 of which were fresh food banners offering a comfortable shopping environment (Metro Plus, Metro and Loeb), and 62 of which were discount stores (Super C). Metro also operated 179 pharmacies under the Brunet and the Clini Plus banners. Second in the Province of Quebec with a 35% market share, the presence of a few scattered Metro stores in Ontario gave the firm a meager 3% market share in that province (see Exhibit 1). It had come to Lessard s attention that The Great Atlantic & Pacific Tea Company of Canada (A&P), the second largest grocery retailer in Ontario with a 21% market share (see Exhibit 1), was up for sale. Operating 133 fresh stores, 103 discount stores as well as 75 corporate-owned full-service pharmacies within stores, A&P had generated revenues of $4.4 billion in the twelve (12) months ended June 18, With a business model similar to Metro s (see Exhibit 2), A&P seemed a strategic fit. Moreover, 1 We would like to thank BMO Capital Markets for their collaboration and open-mindedness with regards to the elaboration of this case. The present document should not be considered as reflecting the opinion or position of BMO Capital Markets or the author, with regards to parts or the totality of the issues (including products, services, practices and other elements of the case, implicit or explicit) addressed or presented whatsoever. The statements included do not consist in recommendations, neither are formulated to prompt or dissuade from an investment, whatsoever. Moreover, this case does not represent a reliable source of data on the company, its activity sector or the general business environment. Indeed, several elements included have been altered, partly developed or otherwise modified to meet the goals of the present situation. Besides, some data might come from secondary sources, and may have been treated or transformed for practical or competitive reasons. This case does not constitute an example of good or bad management practices. It was written in an entirely pedagogical objective: to stimulate discussion and analysis in an academic context 2

3 A&P s integration appeared straightforward to Lessard, who handled two acquisitions with very satisfying results in the past, namely Steinberg in 1992 and Loeb in Mr Lessard needs your advice on a potential acquisition of A&P by Metro. More specifically, you are asked to provide guidance regarding the points described below. Market Share The acquisition of A&P would greatly enhance Metro s position in Ontario, raising its market share to 24% in that province. This would give the grocer a number two position in Canada s two largest provinces. With an overall 16% market share of the entire Canadian market (3 rd position overall, as shown in Exhibit 3), Metro would be well positioned for future growth and consolidation. Discuss the benefits of an acquisition in Ontario in terms of market share, market power and geographic diversification. Valuation Using the information in Exhibit 4, compute the (expected) value of A&P, as a stand-alone firm, as of September Assume that the company s free cash flow will grow at a constant rate from 2011 on. Compute values for a weighted average cost of capital ranging from 7.0% to 8.0% and a range of longterm growth rate from 1.0% to 2.0%. On top of the discounted cash flow analysis, consider the summary of analysts views displayed in Exhibit 5, the comparable trading analysis in Exhibit 6 and the comparable transaction analysis in Exhibit 7. Based on the discounted cash flow analysis, the summary of analyst views, the comparable company trading analysis and the comparable transaction analysis, what is the fair value of A&P s equity and how much should Metro pay to acquire it? 3

4 Financing Given the price tag in the previous question, how should A&P s acquisition be financed (% Cash, % Debt, % Equity)? Use the information provided in Exhibit 8 and Exhibit 9 to answer this question. Synergies and Earnings per Share (EPS) Assume that the synergies realized through the integration of A&P by Metro will be $38 million in 2006 and $60 million per year thereafter. Discuss these projections in light of the information in Exhibit 10. Assume that these synergies will add to the combined firm s EBITDA. Assume also that the combined firm s depreciation will correspond to the sum of the separate firms depreciation, and that the average interest rate paid on the combined firm s debt will be 5.5%. What will the combined firm s earnings per share (EPS) look like given the firm s tax rate and the debt-equity financing decision? Compare the combined firm s EPS to Metro s actual and historical EPS. Repayment of Debt If debt is used to finance the acquisition, how fast will Metro be able to repay it? To answer this question, compute the free cash flow of the combined firm after dividends are paid. Assume that the projected dividend per share of the combined firm will be as projected for Metro in Exhibit 9, and assume that the combined firm s additions to net working capital and capital expenditures will be equal to the sum of the two separate firms projected additions to net working capital and capital expenditures. How to approach A&P How should A&P s management be contacted? Should Pierre Lessard go with a hostile takeover or should he first try to reach a friendly agreement with A&P s management? 4

5 Buy a Third Fish If Pierre buys Tom and Jerry a new aquarium, should he also buy a third fish to keep them company? 5

6 EXHIBIT 1. ONTARIO MARKET SHARE OF GROCERY RETAILERS. 6

7 # of Stores Metro A&P Food Banners Fresh Discount Total Food Pharmacy EXHIBIT 2. FRESH FOOD AND PHARMACY BANNERS FOR METRO AND A&P. METRO'S FRESH FOOD BANNERS ARE METRO, METRO PLUS, LOEB AND LOEB PLUS. METRO'S DISCOUNT FOOD BANNER IS SUPER C. METRO'S PHARMACIES ARE BRUNET AND CLINI PLUS. A&P'S FRESH FOOD BANNERS ARE A&P, DOMINION, ULTRA FOOD & DRUG AND THE BARN MARKETS. A&P'S DISCOUNT FOOD BANNER IS FOOD BASICS. A&P'S PHARMACY IS FOOD BASICS PHARMACY. 7

8 EXHIBIT 3. CANADIAN GROCERY SALES. THE METRO, INC., BAR INDICATES THE LEVEL OF SALES OF THE COMBINATION OF METRO AND A&P. 8

9 Discounted Cash Flow Analysis Based on Management Forecast (C$ Millions) Revenue EBIT EBITDA EBITDA % Less: depreciation EBIT Less: 35% Net Operating Profit after Tax (NOPAT) Add: depreciation Less: additions to net working capital Less: capital expenditures Free Cash Flow Forecast Year-End September (Fiscal) CAGR 2005E 2006E 2007E 2008E 2009E 2010E 05E-10E 4,486 4,624 4,809 5,011 5,226 5, % % % 3.5% 3.7% 4.0% 4.2% 4.3% 4.5% % % Assumptions for 2011: EBITDA = 266, Tax rate = 35%, Depreciation = 88, Additions to net working capital = 0 and Capital expenditures = 120 EXHIBIT 4. DISCOUNTED CASH FLOW ANALYSIS OF A&P PROJECTED FOR SEPTEMBER 2005 AS OF JULY

10 A&P Canada -- Summary of Analyst Views Firm/Analyst Selected Commentary Estimated A&P Canada Valuation BMO Nesbitt Burns Karim Salamatian CIBC World Markets Perry Caicco National Bank Financial Jim Durran Scotia Capital Ryan Balgopal Desjardins Securities Keith Howlett May 10, 2005 Following some reallocation of costs, lease accounting adjustments and unusual items, A&P Canada today reported EBITDA for the year ended February of C$157 million. At 9-10x EBITDA, this translates into C$ billion. We believe Sobeys has the greatest cost synergies; therefore, this could position them well to bid for A&P Canada. METRO would have more modest cost/purchasing synergies and higher revenue synergy potential in our opinion, but at the new valuation and given the fact that revenue synergies take longer to realize, we believe the chances of it making the acquisition accretive in year one are lower. May 30, 2005 Despite the strategic necessity to pursue A&P Canada aggressively, it is quite possible that METRO s risk-averse history will cause them to be cautious in the bidding. As a result, rival Sobeys may end up paying less than we had originally forecast. The probability of a financial player winning this bid is probably zero. There are systems currently provided by A&P Canada's parent company that a strategic buyer could easily replace, but that a financial buyer would have to develop, buy or lease. Sobeys remains the front-runner for this asset. However, it now appears that the most they will have to pay is 10x EBITDA, which boosts the accretion and projects a share price approaching $60. We have raised our target on Sobeys to $48 in a separate note published today. The immense synergies available to both potential acquirers certainly act as a security blanket as the bids climb. Indeed, either company could make the acquisition accretive at these elevated levels. May 11, 2005 We are now calculating the EPS accretion estimates using A&P Canada LTM EBITDA of US$147 million versus our previous estimate of US$93 million. Based on a valuation range of x EV/EBITDA, the estimated purchase price for A&P Canada increases to CAD$1.5 - CAD$1.9 billion, up from $1.0 - $1.3 billion. Sobeys would be the most likely winner in an all-cash bid; METRO can offer a more meaningful equity stake. As outlined in our report issued yesterday, we believe with its greater synergy potential and financial capacity, Sobeys emerges as the more natural buyer: we estimate the acquisition would be 16 40% accretive to EPS, depending on the debt/equity financing mix and assuming synergies of 90 bps on EBITDA margins. Assuming 45 bps of synergies for METRO, we estimate the transaction would be 10% dilutive to 6% accretive to EPS, depending on the financing of the transaction. We estimate that METRO would need to gain 75 bps in synergies for the acquisition to be non-dilutive under all of the likely financing options. May 11, 2005 We believe a price in the range of C$1.1 billion to C$1.4 billion is likely. We arrive at our valuation range by applying an EV/EBITDA multiple range of 6.5x to 8.0x. Based on its review of the Oshawa Group and Provigo acquisitions, we expect the Bureau will look at market share on a town-by-town and store-by-store basis. If the post-merger market share is less than 35% in a relevant market, the Bureau gives it a green light. May 11, 2005 A&P Canada generates operating EBITDA in Canada of approximately US$108m by our calculation. With the benefit of some accounting rules that recently changed, and some other adjustments, A&P yesterday presented (quite appropriately) EBITDA from Canada as being US$147m. A&P Canada is a solid business in one of the most difficult markets in North America (Ontario has often had the lowest food prices in North America). We would not want to understate the competitive challenges that it faces. Loblaw has opened 15 Real Canadian Superstores in Ontario with eight more to come in A&P Canada s sales in Canadian dollars are stagnant, despite US$225m in capital expenditures over the last three years. Earnings before interest and taxes declined by 12% in US dollars in FY04 and by an even greater amount in Canadian currency. We would not pay over C$1.2b for A&P Canada. Based on a valuation range of x EBITDA, our view is that A&P Canada is fairly valued at between C$1 1.2b. With long-lived assets on the books at under C$600m, there will be considerable increases in the accounting value of the acquired assets (which may increase depreciation expense). LTM EBITDA Multiple Revised Value Range (1) (EBITDA: $176 mm) 9.0x x $1.6B - $1.8B 10.0x $1.8B - $1.9B 8.0x x $1.4B - $1.8B 6.5x - 8.0x $1.1B - $1.4B 7.5x - 8.5x $1.3B - $1.5B EXHIBIT 5. SUMMARY OF ANALYST VIEWS ON A&P. 10

11 Valuation of A&P Canada -- Comparable Trading Analysis Price % of Market Enterprise EV/Sales (1) EV/EBITDA (1) P/E (1) 5Yr. IBES CY 2005E Debt/ Company 15-Jul-05 52W-High Value Value CY 2005E CY 2005E CY 2006E CY 2005E CY 2006E Gr. Rate PEG (1) Cap. (2) Canadian Food Retailers Loblaw C$ % C$20,072 C$24, % % METRO C$ % C$2,682 C$2, % % Sobeys C$ % C$2,677 C$2, % % Mean % % Median % % U.S. Food Retailers Albertson's $ % $7,617 $14, % % Great A&P $ % $1,225 $2, NM NM 2.0% NM 81.5% Kroger $ % $14,253 $21, % % Safeway $ % $10,923 $17, % % Mean % % Median % % METRO (at C$27.66) C$ % C$2,697 C$2, % % Selected Multiple Range Low High (1) Based on First Call estimates. METRO estimates based on management forecast. (2) As of latest balance sheet date. EXHIBIT 6. COMPARABLE TRADING ANALYSIS. 11

12 Transaction Value to: LTM Comparable Transaction Analysis Announcement Transaction LTM LTM LTM Price/ EBITDA EBIT Sales Target Acquiror Date Value (1) EBITDA EBIT Sales Book Value Margin Margin CAGR Pathmark Yucaipa 28-Feb-05 $ NA 3.7% 1.4% 0.1% Shaw's Supermarkets Albertson's 25-Mar-04 $2, NA 7.8% 4.8% 4.3% Safeway plc William Morrison Supermarkets 9-Jan-03 $6, % 4.8% 5.1% Roundy's (2) Willis Stein 9-Apr-02 $ % 1.7% 7.5% Bruno's Ahold 4-Sep-01 $ NA 3.6% 2.0% 8.4% Hannaford Bros. Delhaize America 18-Aug-99 $3, % 5.5% 9.0% Randall's Safeway 23-Jul-99 $1, % 4.2% 3.0% Richfood (3) SUPERVALU 9-Jun-99 $1, % 4.2% 1.0% Star Markets J. Sainsbury 25-Nov-98 $ % 2.2% 8.7% Oshawa Sobeys 2-Nov-98 C$1, % 1.6% 6.4% Provigo Loblaw 30-Oct-98 C$2, % 2.6% -1.2% Fred Meyer (4) Kroger 19-Oct-98 $12, % 4.3% NA Dominick's Safeway 13-Oct-98 $1, % 4.3% 5.5% Carr-Gottstein Safeway 6-Aug-98 $ % 5.0% 0.7% American Stores Albertson's 3-Aug-98 $11, % 4.0% 1.4% Giant Food Ahold 19-May-98 $2, NA % 3.0% 4.6% Shoppers (5) Richfood 9-Apr-98 $ NA % NA 4.3% Buttrey Albertson's 20-Jan-98 $ % 2.5% -1.4% 3-Year Apple Pie 3.4% 2.2% 1.6% Maximum % 5.5% 9.0% Mean % 3.4% 4.0% Median % 4.0% 4.3% Minimum % 1.4% -1.4% (1) Transaction value equals offer value plus preferred equity at liquidation value (incl. redeemable), short- and long-term debt less cash and exercisable option proceeds. (2) Multiples based on Roundy's LTM results pro forma for the acquisition of Copps in (3) Multiples based on Richfood's FYE May 1999 sales, EBIT and EBITDA, pro forma for the loss of the Giant of Carlisle distribution business. (4) EBIT and EBITDA multiples for Fred Meyer are based on 1998E EBIT and EBITDA (pro forma LTM results for the period ended 8/15/98 are not available). (2) Figures for Shoppers are based on 1998E sales, EBIT and EBITDA. EXHIBIT 7. COMPARABLE TRANSACTION ANALYSIS. 12

13 Financial Projections for A&P Fiscal Year 2005E 2006E 2007E 2008E 2009E 2010E Year Ended Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Revenue 4,466 4,624 4,809 5,011 5,226 5,451 Growth % 3.5% 4.0% 4.2% 4.3% 4.3% EBITDAR Margin % 4.5% 4.7% 4.9% 5.0% 5.2% 5.3% EBITDA Margin % 3.5% 3.7% 4.0% 4.2% 4.3% 4.5% Growth % 7.1% 6.7% 4.5% 3.7% 3.1% Depreciation EBIT Margin % 1.8% 1.9% 2.0% 2.1% 2.2% 2.3% Net Income Growth % 12.8% 11.3% 10.2% 9.2% 11.3% NOPAT: (1-t)EBIT + Depreciation Investment in Working Capital CAPEX Free Cash Flow Cash Working Capital Total Debt Total Capitalization Equity Debt/EBITDA EBITDAR/Adj. Interest EBITDAR: Earnings before interest, taxes, depreciation, amortization and rent. The effective tax rate for A&P is 35%. EXHIBIT 8. FINANCIAL PROJECTIONS FOR A&P FOR SEPTEMBER 2005 AS OF JULY

14 Financial Projections for Metro Fiscal Year 2005E 2006E 2007E 2008E 2009E 2010E Year Ended Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Revenue 6,240 6,614 6,826 7,133 7,454 7,790 Growth % 6.0% 3.2% 4.5% 4.5% 4.5% EBITDAR Margin % 5.8% 5.9% 6.0% 6.0% 6.1% 6.1% EBITDA Margin % 5.1% 5.2% 5.3% 5.4% 5.5% 5.6% Growth % 2.4% 1.9% 1.8% 2.4% 0.8% Depreciation EBIT Margin % 3.9% 4.0% 4.0% 4.1% 4.2% 4.3% Net Income Growth % 10.2% 5.3% 6.5% 7.8% 6.0% EPS Growth % 10.9% 9.4% 11.6% 12.3% 11.0% NOPAT: (1-t)EBIT + Depreciation Investment in Working Capital CAPEX Free Cash Flow Dividend Free Cash Flow after Dividend Cash Working Capital Total Debt Total Capitalization 994 1,049 1,098 1,145 1,188 1,229 Equity 982 1,036 1,086 1,132 1,175 1,216 Price per share as of July 15, 2005: $27.66 Number of shares outstanding as of July 15, 2005: 98.1 million Debt/EBITDA EBITDAR/Adj. Interest EBITDAR: Earnings before interest, taxes, depreciation, amortization and rent. The effective tax rate for Metro is 30%. EXHIBIT 9. FINANCIAL PROJECTIONS FOR METRO FOR SEPTEMBER 2005 AS OF JULY

15 EXHIBIT 10. SYNERGIES AS A PERCENTAGE OF THE TARGET S REVENUES. 15