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MGMT S-2720

Assignment 1: Mercury Athletic Footwear

Questions:
1. Is Mercury an appropriate target for AGI? Why or why not?
2. Review the projections by Liedtke. Are they appropriate? How would you
recommend modifying them?
3. Estimate the value of Mercury using a discounted cash flow approach and Liedtkes
base case projections.
4. Do you regard the value you obtained as conservative or aggressive? Why?
5. How would you analyze possible synergies or other sources of value not reflected
in Liedtkes base assumption?

1. Is Mercury an appropriate target for AGI? Why or why not?


Yes, we believe Mercury is an appropriate M&A target for AGI and should be pursued.

The Footwear Industry is a competitive business. We can analyze the industry and summarize
some of the critical characteristics below:

It is a highly competitive industry. There are many competitions in the field, thus
growing the market share is difficult. However, brand loyalty leads customers to repeat
sales, thus producing a stable sales numbers, and stable profit margin.
Fashion is changing at a very high pace. A company must produce the latest fashion
trend that caters to the customers taste and lead the market. Individual companys
performance depends on their fashion design to reach out to as wide a customer base as
possible.
Footwear brands, styles, and specialty use (athletic, casual, dress, etc) have their own
customer base. A company specializing in one type of footwear would have a market
characteristic particular to that footwears performance. A shift in footwear trends might
have a dramatic effect on a companys performance. A unified company with multiple
footwear brands and styles will yield a more stable performance results, even during
dramatic shifts in footwear trends.
Brand image that has characteristics of footwear design, engineering, performance and
price affects the market share.
Fashion trends have a dramatically short life cycle. Thus production lead time, logistics,
and inventory management are critical for the success.

Sale channels are important to the success of the brand. Department stores, independent
specialty retailers, sporting goods stores, boutiques and wholesalers are possible sales
channels.
Production are mostly in Asian countries, with major production outsourced to China.

AGI has some problems The AGI faces these problems:

AGI is a small company, with relatively low competitive advantage.


Consolidation of manufacturers has created problems with steady production, prices and
logistics.
AGI sells its brands through certain retail stores, but does not sale through discount
retailers. Furthermore, with relatively little discount price, this further reduces sales
growth.
Price cuts and promotion in apparel line hurts operating margins but helped to the growth
in sales.
The industry is very competitive, tastes changes, and suppliers and competitors continues
to pressure the company.
The company has pressure to grow to new market, increase market share, and increase
profits.
While AGI is smaller, revenue is almost the same as Mercury. There could be
opportunities to double revenue while finding synergy in the two brands.

Mercury has some characteristics that should be considered:

Mercury, is a footwear company that aim at urban and youth market, one of the most
lucrative customer target in the industry. Target customers are urban and suburban
family members aged 25 to 45. Youth market, mainly 15 to 25.
Among one of the most profitable business in the industry, Mercury products offer
fashionable walking, hiking and boating footwear. Mercurys parent company then
branched out to complementary line of apparel products. With poor performance,
Mercury is being sold off.
Mercury does not discriminate its sales channels. It is sold in department stores, specialty
retailers, wholesalers and independent distributors. A small percentage is sold through
website and other sources
Mercury manufacturers the footwear in China.

Possible synergies from the acquisition of Mercury:

Increase in sales by using the same sales channels, offering more styles, and increase
presence in new markets for AGI products.
Increase production efficiency by consolidation in manufacturing facilities. With a
higher production volume, the new AGI might be able to negotiate for lower cost from
different suppliers and manufacturers.
Increase in logistics efficiency. The combined company would be able to combined the
logistics for both company, decreasing overhead and possibly offer more efficient
distribution and logistic support.
AGI has a higher profitability margin, and can thus potentially increase Mercurys
financial performance.
AGI and Mercurys respective brands target different customers markets. The combined
company would have opportunities to gain new customer segments to the combined
products.

2. Review the projections by Liedtke. Are they appropriate? How would you
recommend modifying them?
Liedtke used historical averages to assume the future revenue projections. However, with the
combined companies synergies, future projections should be more robust with higher revenue
projections and decrease in costs due to efficiencies in the system.
Smaller firms and the competitive footwear industry tends to be more volatile, and various
projections can dramatically shift. It is difficult to maintain historical growth rates as firms
double or triple in size, so future projections rarely follows historical performance. Future
projections could use other analysis information to provide future projections: firm-specific
information, macroeconomic information, information revealed by competitors on future
prospects, private information about the firm and public information other than earnings.

3. Estimate the value of Mercury using a DCF approach using the base case
projections. Be prepared to make additional assumptions.
Assumptions
Sales Growth
CGS
SGA

Values
12.75%
57.02%
31.42%

Depreciation/NET ppe t-1


Cash
A?R
Inventory
PPE/sales
AP/sales
accruals/sales
Tax Rate
Long-run growth

27.26%
3.90%
9.99%
17.48%
8.67%
3.94%
4.77%
40%
3%

Cost of Capital Estimation


Debt/Value
Cost of Debt(Rd)
Debt/Equity
10 yr treasury(Risk Free Rate)
Risk Premium
Ba(beta asset)
Be(beta Equity)
Required return on equity(Re)
WACC

20%
6%
0.25
4.73%
5%
1.37
1.57
12.60%
10.80%

Valuation Based on Case Projections


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

94,211

96,566

105,069

112,603

118,010

WC

93,944

Investment in WC

267

2,355

8,503

7,534

5,407

Free Cash Flow

25,540

27,021

23,399

26,626

30,371

401,037

431,409

Terminal Value
Net FCF

25,540
1

Discount Rate

7.65%

Growth Rate

3.00%

Acquisition Price

$186,216

NPV

$338,263

27,021
2

23,399
3

26,626
4

We used the assumption and summarize in the above assumption table


To calculate the Cost of Capital, we use the debt ration of 20%, and cost of debt at 6%.
We assume cost of equity equal to the return on equity at 12.6%. Calculating WACC
yields 10.8%

Our assumption the growth of rate of net income, and free cash flow steadies after 5th
year. We also assume reinvestment of 23%, based on reinvestment rate of 15.5% to
37.1%. Our growth rate is calculate at 3%.
Our terminal value is calculated at $401,037
Cash flows from years 2007 2011, and terminal value in 2011 estimate at $401,037,
using WACC at 10.8%, we calculated the NPV of Mercury at $338,263

4. Do you regard the value you obtained as conservative or aggressive? Why?


It is probably conservative. The above value estimated from case projection is based on AGI
historical data. Liedtke assumed a higher debt to equity ratio, leading to a higher WACC, and
thus a lower terminal value. Alternative calculation methods could yield a higher terminal value.

5. How would you analyze possible synergies or other sources of value not reflected
in Liedtkes base assumption?
A combined company can yield synergies of the companies through efficiencies in processes and
other areas. Some possible synergies to recalculate the values:

Merge Mercury & AGI womens casual footwear line to increase EBIT margin of 9%
and revenue growth of 3%. Assume that Mercurys womens casual footwear line can
be merged into AGIs line , calculate the revenue of the Mercury, compare the revenue
with the original revenue to evaluate the new value.
More efficient inventory and logistics system can be used for the combined operation to
reduce DSI. Assume that Mercury has the same DSI as AGI does, calculate the new
Mercury revenue and compare the revenue with the original revenue to evaluate the new
revenue value.