Analysis of Acquisition of Mercury

Athletic by Active Gear

Vedantam Gupta
20152095
BBA-MBA 2015
Corporate Valuation and Restructuring
 Analysis of Acquisition of Mercury Athletic by
Active Gear

Industry Overview

The casual footwear industry is mature, but highly competitive industry. There has been low growth, with stable
profit margins. The competition has been competing to anticipate and exploit fashion trends. The casual segment
is mainly based on style, price and general quality. The Athletic segment focuses on brand image, specialized
Engineering for performance and price.

Company Profile

 Active Gear
o Demographics

Active Gear is in broad and mainstream market. The company is originally affluent urban and suburban family
members ages between 25 and 45. The product image is prosperous, active and fashion conscious.

o Products

The products of Active Gear have a good brand image. The athletic shoes have a classic image. Also, the casual
shoes have a classic styling. The company has a small portfolio of products with longer lifecycles.

o Distribution

Let us divide this into the 2 segments of the market

Casual Footwear: The company has 5700 department, specialty and general retail stores. This is via a network of
wholesalers and independent distributors.

Athletic Footwear: The company here follows a different distribution channel. Here they have independent sales
representatives to a limited number of sporting goods stores, pro shops and specialty footwear retailers.

The company also gets its small part of sale from its website.

o Revenue

2006

$470.3 Million- Revenue

$60.4 Million – Operating Income

Revenue breakup – Athletic footwear- 42%

Casual Footwear- 58%

 Mercury Athletic
o Demographics

Mercury Athletic is quite a established company in the footwear industry. The image of the company is
iconoclastic and nonconformist. They target the global youth culture of alternative music, TV and clothing.
 o Products

So Mercury Athletic has 4 product ranges. They are as follows:

1. Men’s athletic footwear- These products are inexpensive to produce with basic materials used. The
customers pay medium to high prices.
2. Men’s Casual footwear: This segment has products with promising designs but have external forces that
impact this product mainly due to bad weather and strikes, cannibalization of products.
3. Women’s Athletic footwear: This segment has high cost of building brand image and awareness. This
leads to higher marketing and advertising expenses.
4. Women’s Casual footwear: In this segment, the more advertising and marketing is required otherwise the
company will lose its sales volume from this segment.
o Distribution

The main drawback for this company is that there is no one single market that generates a significant amount of
sales, this leads to higher marketing, advertising and distribution cost which in turn hampers the bottom line.

o Revenues

In 2006

$431.1 Million – Revenue

$58.1 Million- EBITDA

If we compare both the companies, we can see that both of them have many differentiating points, which
leads to conclude that they are fundamentally different.

ACQUISITION RATIONALE

Let us analyse weakness/opportunities that Active Gear has and what it aims to generate out of this acquisition.

Weakness of Active Gear

The firm is small which creates a competitive disadvantage because of the recent consolidation of contract
manufacturers. Also, currently the manufacturers favour the firms that can offer longer production runs.

Since Active Gear is a small brand comparative to its competitors, they cannot use discount retailers due to the
company’s brand image, but this do have consequences which is in this case is the lower sales growth and the
company grew at a rate of 2.2% for the last 3 years.

Weakness of Mercury Athletic Footwear

The first weakness of this company is the lack of reliable manufacturers, which was mentioned above that the
manufacturers stopped production due to bad weather and strikes.

Mercury Athletic has a very poor inventory management. The current daily sales of inventory is 10 days longer
than the industry average. Also, Active Gear has a DSI better than Mercury Athletic.

The third weakness for Mercury is that the company has been facing a decline in operating margins. This is
because of the tradeoff for increase in growth through discounted retailers.
Now if these 2 companies are combined,

Active Gear’s Large Size + Growth Rate and Mercury’s Manufacturer Scrutiny + Inventory System Adoption +
Better Operating Margins.

Valuation

Valuation Based on Case Projections:

Valuation Based on Case Projections

Line Item 2006 2007 2008 2009 2010 2011
Revenues $ 479,328 $ 489,028 $ 532,136 $ 570,319 $ 597,717
EBIT $ 47,005 $ 53,035 $ 57,604 $ 61,686 $ 64,612
EBIT(1-T) $ 28,203 $ 31,821 $ 34,562 $ 37,012 $ 38,767
Op Cash Flows $ 37,790 $ 41,602 $ 45,205 $ 48,418 $ 50,721
CAPEX $ 11,983 $ 12,226 $ 13,303 $ 14,258 $ 14,943
WC $ 93,944 $ 94,211 $ 96,566 $ 105,069 $ 112,603 $ 118,010
Investment in WC $ 267 $ 2,355 $ 8,503 $ 7,534 $ 5,407
FCF $ 25,540 $ 27,021 $ 23,399 $ 26,626 $ 30,371
TV $ 401,037
Net FCF $ 25,540 $ 27,021 $ 23,399 $ 26,626 $ 431,409
Enterprise Value $338,263

Valuation Based on Historical Information:

Valuation based on Historical Information

Line Item Actual Projected
2006 2007 2008 2009 2010 2011
EBIT $ 47,268 $ 51,831 $ 58,441 $ 65,895 $ 74,300
EBIT(1-T) $ 28,361 $ 31,098 $ 35,065 $ 39,537 $ 44,580
Op Cash Flows $ 37,252 $ 42,589 $ 48,021 $ 54,146 $ 61,052
CAPEX $ 9,537 $ 5,377 $ 6,062 $ 6,836 $ 7,707
WC $ 93,944 $ 110,116 $ 124,160 $ 139,996 $ 157,852 $ 177,985
Investment in WC $ 16,172 $ 14,045 $ 15,836 $ 17,856 $ 20,133
FCF $ 11,543 $ 23,168 $ 26,123 $ 29,455 $ 33,212
TV $ 429,063
Net FCF $ 11,543 $ 23,168 $ 26,123 $ 29,455 $ 462,275
Enterprise Value $344,855

Valuation Based on Case Projection and Synergy:

Valuation based on Case Projections Plus Synergy

Line Item 2006 2007 2008 2009 2010 2011
EBIT $ 47,005 $ 53,035 $ 57,604 $ 61,686 $ 64,612
EBIT(1-T) $ 28,203 $ 31,821 $ 34,562 $ 37,012 $ 38,767
Op Cash Flows $ 37,790 $ 41,602 $ 45,205 $ 48,418 $ 50,721
CAPEX $ 11,983 $ 12,226 $ 13,303 $ 14,258 $ 14,943

Invetory Projections $ 55,287 $ 56,406 $ 61,378 $ 65,782 $ 68,942

WC $ 93,944 $ 65,728 $ 67,507 $ 73,448 $ 78,713 $ 82,492
Investment in WC $ (28,216) $ 1,779 $ 5,941 $ 5,265 $ 3,779
FCF $ 54,023 $ 27,597 $ 25,961 $ 28,894 $ 31,999
TV $ 413,397
Net FCF $ 54,023 $ 27,597 $ 25,961 $ 28,894 $ 445,396
Enterprise Value $376,204
Assumptions of Synergy

Some of the assumption that were taken as this synergy happens is as follows: -

 No cannibalization of products after the merger. There also cannot be significant synergy on the revenues
also.
 Further pointing out the revenue synergy. Active Gear can provide Mercury Athletic with a 40% increase
in inventory efficiency. This is based on the previous point mentioned in the company profile. This will
increase the revenue of Mercury by mere 6.7%.
 There will be a huge impact on the COGS synergies. This is mainly due to better economies of scale,
better bargaining positions, increased specialization of infrastructure and long production runs
benchmarked at 10%.

COGS Synergy Explanation

So as mentioned in the above point that there will be significant impact on the COGS for mentioned regions. Let
us see in detail

1. Manufacturing and Distribution Synergies

After the merger of these 2 companies’ economies of scale is created in manufacturing due to larger size, this will
additional savings by providing larger production runs to the manufacturers. In the distribution also economies of
scope are created by increasing size of the distribution network and resilience as well as reaching larger target
audience.

2. Growth Potential

Since Active gear gains exposure to growing historically in discount retail space through Mercury’s product
line without compromising core Active Gear Product. Mercury Athletic gains improved inventory
management and efficiency but retains autonomous status outside merged production lines and logistics.

Acquisition Risks

Some of the major risks of this merger are as follows

1. Completely different products and market demographics

2. Mercury Athletic has lower EBITDA Margins and also failed in their women casuals’ line.
3. Mercury Athletics market is more prone to fashion cycles.

Conclusion

Active Gear in prime position to acquire Mercury Athletic

 AGI margins stagnant, but above industry averages

 Acquisition to put AGI’s margins even more ahead of competitors
 Easily integrated corporate structures
 AGI’s business strengths compliment Mercury’s
 Mercury: promising men’s casual, women’s athletic lines
 Larger size = Better competition among rival firms
 Expansion of customer base and consumer demographic
 Mercury’s value/size comparable to rival firms
 Synergies add significant value post-acquisition
 Rebranding to revitalize Active Gear’s growth
Merger Analysis- FCF

Merger Analysis- DCF and Cash Flow

Combined Income Statement
Line Item 2007E 2008E 2009E 2010E 2011E
Combined Revenue 959,256 978,793 1,031,943 1,080,371 1,118,225
Revenue Synergies 29,260 29,260 29,260 29,260 29,260
COGS 477,771 487,502 514,038 538,212 557,099
Revenue Synergy COGS 14,360 14,630 14,630 14,630 14,630
Gross Profit 496,114 505,921 532,534 556,788 575,755

Operating Expenses 847,583 859,763 906,991 949,957 983,476

OpEx Synergies 84,758 85,976 90,699 94,996 98,348
Depriciation and Ammortization 17,458 17,813 18,840 19,771 20,490
Depriciation of PPE Write up 326 326 326 326 326
New Intangibles (Ammortization 4,053 4,053 4,053 4,053 4,053
EBITDA 211,061 219,636 230,280 240,039 247,726

Operating Income 189,224 197,444 207,062 215,889 222,856

Interest Income/Expense 5,122 5,122 5,122 5,122 5,122
Less Interest paid on new debt 1,316 1,316 1,316 1,316 1,316
Less Principal Repayment 21,934 21,934 21,934 21,934 21,934
Pre Tax Income 160,852 169,071 178,689 187,516 194,484
Income Tax Provision 64,341 67,629 71,746 75,007 77,793

Net Income 96,511 101,443 107,213 112,510 116,690

Combined FCF Projections

Line Item 2007E 2008E 2009E 2010E 2011E
EBIT 189,224 197,444 207,062 215,889 222,856
EBIT(1-T) 113,535 118,466 124,237 129,533 133,714
Add D&A 21,837 22,192 23,219 24,150 24,869
Less CAPEX 24,276 24,771 26,105 27,323 28,275
Less Increase in WC 15,184 5,118 12,326 11,260 8,859
FCF 95,911 110,769 109,025 115,101 121,448
Cummulative FCF 95,911 206,681 315,705 430,806 552,255

Operating Metrics (After Merger)

Revenue CAGR 3.10%
EBITDA Margin 22.20%
EBIT Margin 20.00%
Net Income Margin 10.30%
Growth Rate Calculation

Growth Rate Calcualtion

EBIT 64612
EBIT(1-T) 38767.2
Total Reinvestments 9223
Reinvestment Rate 23.79%
BV Equity (80% Capital) 259352
BV Debt (20% Debt) 64838
Total Capital 324190

Return on Capital 11.96%

Long Term Growth Rate 2.84%

Assumptions

Assumptions Values
Sales Growth 12.75%
CGS 57.02%
SGA 31.42%
Depreciation/NET ppe t-1 27.26%
Cash 3.90%
A?R 9.99%
Inventory 17.48%
PPE/sales 8.67%
AP/sales 3.94%
accruals/sales 4.77%
Tax Rate 40%
Long-run growth 2.84%

Cost of Capital Estimation

Debt/Value 20%
Cost of Debt(Rd) 6%
Debt/Equity 0.25
10 yr treasury(Risk Free Rate) 4.73%
Risk Premium 5%
Ba(beta asset) 1.37
Be(beta Equity) 1.57
Required return on equity(Re) 12.60%
WACC 10.80%

Synergy Assumptions
Current Day Sales Inventory 63.79
Target Day Sales Inventory 42.1
$380,000
DCF Valuation Summary
$370,000

$360,000
Valuation as is using
$350,000 Historical Information
Valuation using case
$340,000 projections
Valuation including
$330,000 synergies

$320,000

$310,000
1

$600,000
Valuation Comparison
$500,000

$400,000 Summary of Comparable

Valuation
$300,000 Valuation as is using
Historical Information
$200,000 Valuation using case
projections
$100,000

$-
1

$50,000
$45,000
Premium Comparison
$40,000
$35,000
$30,000 Premium based on
$25,000 historical

$20,000 Premium based on Case

Projections
$15,000
$10,000
$5,000
$0
1
 Net
Equity MV Net Debt D/E Beta E LTM Rev LTM Earnings Revenue CAGR-2000-06 EBITMargin EBITDA Margin Income EBIT Multiple EBITDA Multiple P/E Multiple B/V Multiple Beta Asset
D&B Shoe $ 420,098 $ 125,442 29.90% 2.68 $ 2,545,058 $ 67,679 6.60% 4.40% 6.10% 2.70% 5.5 3.9 6.8 0.9 2.27
Marina Wilderness $ 1,205,795 $ (91,559) -7.60% 1.94 $ 313,556 $ 41,923 17.80% 22.1% 23.10% 13.4% 18 16.9 31.6 6 2.03
General Shoe Corp $ 533,463 $ 171,835 32.20% 1.92 $ 1,322,392 $ 64,567 11.20% 8.8% 11.50% 4.9% 6.8 5.1 9.1 1.6 1.61
Kinseley Couler Products $ 165,560 $ 82,236 49.70% 1.12 $ 552,594 $ 27,568 4.60% 6.9% 8.90% 5.0% 7.3 5.5 6.6 0.7 0.86
Victory Athletic $ 35,303,250 $ 7,653,207 21.70% 0.97 $ 15,403,547 $ 1,433,760 7.90% 14.1% 16.00% 9.3% 22.1 19.2 27.1 6 0.86
Surfside Footwear $ 570,684 $ 195,540 34.30% 2.13 $ 1,241,529 $ 73,124 10.10% 9.3% 10.80% 5.9% 7.4 6.3 8.6 1.4 1.77
Alpine Company $ 1,056,033 $ 300,550 28.50% 1.27 $ 1,614,648 $ 112,015 6.20% 10.4% 12.20% 6.9% 9 7.6 10.4 2 1.08
Heartland Outdoor Footwear $ 1,454,875 $ (97,018) -6.70% 1.01 $ 1,176,144 $ 86,156 8.50% 10.8% 12.60% 7.3% 12 10.1 18.6 3.1 1.05
Templeton Athletic $ 397,709 $ 169,579 42.60% 0.98 $ 516,182 $ 79,170 14.40% 19.9% 20.20% 15.3% 6.2 6 5.5 1.2 0.78
Average 24.90% 9.70% 11.9% 13.50% 7.9% 10.5 9 13.8 2.5 1.37
Mercury 2006 Comparable Metrics
EBITADA $ 51,805 Metric Low Average High
EBIT $ 42,299
Net Income $ 25,999 P/E 5.5 13.8 31.6
EV/EBIT 5.5 10.5 22.1
EV/EBITDA 3.9 9 19.2
Comparable Valuation

Mercury Valuation based on comparables

Mercury Low Average High Average
P/E $ 142,995 $ 358,786 $ 821,568 $ 441,116
EV/EBIT $ 232,645 $ 444,140 $ 934,808 $ 537,197
EV/EBITDA $ 202,040 $ 466,245 $ 994,656 $ 554,314