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Board Report
Potential Acquisition of Southern
Comfort Corporation
Vineshinee Perumal
CONTENTS
1. Executive Summary...................................................................2
2. Background..............................................................................3
1.1 An Industry Analysis.............................................................3
1.1.1 A Mature Industry...........................................................3
1.1.2 Key Success Factors.......................................................3
1.1.3 Competitor Analysis........................................................5
3 Qualitative Analysis...................................................................7
3.1.1 Strategic Analysis...........................................................7
3.1.2 SWOT Analysis...............................................................7
3.1.3 Strategic Fit...................................................................8
4 Quantitative Analysis.................................................................9
4.1 Comparison of Southern Comfort to its peers*.........................9
4.2 Increasing Shareholder Value...............................................10
4.2.1 Return rate (Gross Profit)..............................................10
4.2.2 The Earnings per share..................................................10
4.2.3 Share Value.................................................................10
4.2.4 Asset/Equity Ratio........................................................10
4.2.5 Cash Flows..................................................................10
4.2.6 Cost of Capital (WACC)..................................................11
5 Recommendations...................................................................11
1|Page
1. Executive Summary
2|Page
economies by minimising the fixed cost per unit as a result of
higher production levels.
2. Background
3|Page
4|Page
Analysis of Demand Analysis of Competition
1.1.3
5|Page
1.1.4 Competitor Analysis
In comparison to its competitors*, Brown Foreman is in a good financial
position demonstrating the highest profitability amongst its peers. The
company has managed to achieve good growth in a slow mature market and
has managed to efficiently utilise its resources, giving its investors good
returns. The company has however not managed to achieve the same level of
economies of scale as some of its competitors but has managed to achieve
some sort of differentiation for the level of growth in their sales. Overall the
company is in a very strong market position and the market generally is
optimistic of the organisations potential.
Assets/ Equity 1.84 1.37 For every rand of equity they have less
assets then their competitor which could be
because the competitors have expanded
internationally. The average industry ratio is
1.84.
Dividend Yield 0.06 .043 This ratio indicates the level of dividends
At 4/14/78 that are distributed as a % of the current
stock price. Brown-Foreman has a below
average dividend yield of 0.043 which in line
with its policy of distributing high levels of
dividends but in comparison to its
competitors is lower. Two competitors are
not paying dividends which are not
necessarily an indicator of profitability; it
could mean that there is investment taking
place for long term growth potential.
Self-sustaining 0.07 .102 Even in a market where there is a slowdown
growth rate in whiskey sales, Brown-Forman has
managed to achieve the highest level of
self-sustained growth indicating that it has a
sustainable competitive advantage
1978 expected 0.06 .09 Brown-Foreman has the highest expected
sales growth sales growth amongst its competitors which
could indicate that the company has plans
to reinvest its retained capital in projects
that will generate high sales growth.
Market Book 0.88 1.26 This ratio looks at how the market values
Value the shares. Only Heubien and Brown-
Foreman have managed to achieve double
digit ratios which indicate a very good level
of the price compared to its underlying
assets and the way it is being used. The
views the company very positively.
*Only the most relevant ratios were analysed, for all the complete list of
ratios refer to appendix 1.
6|Page
3 Qualitative Analysis
Sьѕ > Sь + Ss
Where S= Synergy, B =Brown & S = Southern Comfort
8|Page
2 Quantitative Analysis
*Due to the lack of data, an indicative comparison the 1977 figures of Southern
Comfort were used to compare the company to the industry average figures of
1978.
9|Page
2.2 Increasing Shareholder Value
10 | P a g e
2.2.6 Cost of Capital (WACC)
Using the CAPM model, the cost of equity for this project worked out to
14.27% and the cost of debt 4.31%. Together the cost of capital worked
out to 6.50% which is low compared to their hurdle target rate of either
14% or 12% for new and existing projects. Although this project does
not mean Brown-Forman’s long range financial target goals, it is a
project that has a good strategic fit and could be a strategic acquisition.
3 Recommendations
Brown Foreman is not geared heavily in relation to its peers. The debt
to equity ratio is 24.7%. Industry average is 55%, the company can
afford to take on more debt to finance this acquisition.
Southern Comfort is not listed, the brothers want $94.6m for the
company but the book value in 1977 was $16.7m. It is recommended
that this acquisition be further investigated more as a strategic
acquisition rather than a pure financial one.
Brown- Forman wants to use finance and debt to fund this acquisition
($20 m cash and $70m debt); it is recommended that company
considers financing a higher debt than $70m to get the additional tax
shield benefits. Currently tax is very high is this industry at 50%.
Brown-Forman’s hurdle rate is too high implying that the company is
very conservative in their choosing of projects. It is recommended
that the company revise this hurdle rate as they could miss out on
important strategic opportunities such as Southern Comfort.
It is recommended that the company proportions a significant amount
of its planned advertising spend to market the Southern Comfort
brand more aggressively.
It is recommended that the company considers carefully the culture,
systems and processes of the Southern Comfort in the acquisition.
The people aspects are especially important post-merger to ensure
that skills and capabilities are not lost. The management team is
especially valuable as they have shown that they are able to run an
efficient profitable business with no shareholder involvement and
should be returned to ensure a successful merger.
11 | P a g e
Appendix 2: Key Ratios
Industry Analysis: Southern Comfort 1977
Profit/Sales 6.81%
Appendix 1: Competitor Analysis
Sales/Assets 2.49
Book Value 15m
Debt/Equity 0.539
BROWN-FORMAN DISTILLERS Debt/Total Assets
CORPORATION 0.35
Comparative Financial
Data, 1978
Earnings Per Share for Brown Foreman 1978
America
Projected net income for Southern Comfort** 5 245 754
n Brown- National Publicker Hiram Average Comments
Net income of BF for 1978 31 247 000
Distilling Forman Heublein Distilling Industries Seagram Walker
No of Shares 12 908 739
-------- -------- -------- -------- -------- -------- --------
Net Income* of BF + Net Income of SC**/no of
Beta 1.41 1.10 1.71 0.79 1.63 1.04 0.65 1.19 Lower volatility than average
shares 2.826981
Marginal tax rate 0.30 0.50 0.49 0.47 0.40 0.46 0.50 0.45 Tax Rate higher than average
Debt/equity 1.14 0.247 0.55 0.34 0.84 0.53 0.20 0.55 Much lower Debt to equity
*Divided the earnings by EPS to get the no of shares
Debt-cash/total
capital 0.50
** Net income 0.11
growth bet0.28 0.16 is 20% based
1976 and 1977 0.44 on this0.32
we assume0.12 0.28 Debt to total capital is the lowest
Assets/equity 2.46 1.37 2.16 1.65 2.04
that it will have the same growth rate bet 1977 to 1978 1.76 1.43 1.84 Lowest Assets to Equity of its peers
Sales/assets 1.66 1.46 1.80 1.35 1.49 1.22 1.04 1.43 Asset utilization used to create sales is average
Profit/sales Assets/Equity
0.012 0.073Ratio after merger 0.052
0.035 0.005 0.038 1979
0.069 0.04 Highest Net profit ratio
Price/earnings SC9.4assets forecast
8.2 growth9.6
at 5.52% for 1979
6.5 NMF 8.8 28 668 651
7.7 8.37 Creating good value for their shareholders
Dividend yield at BF assets forecast growth at7.2% for 1979 352 339 000
4/14/78 NIL 0.043 0.056 0.080 NIL 0.042 0.062 0.06 Lower than competitors
Combined Assets of BF+ SC 381 007 651
Self-sustaining
growth rate SC equity forecast
0.049 0.102 growth at 23% for0.079
0.053 1979 0.015 0.041 25 4530.054
654 0.07 Highest rate amongst its peers
1978 expected sales BF equity forecast growth at 9.72% for 1979 239 436 000
growth 0.02
Combined 0.09 of BF +0.06
Equity SC 0.08 0.04 0.07264 889 654
0.06 0.06 The market has good expectations of sales growth
Market value/book
Assets/Equity after Merger 1.4
value 0.46 1.26 1.53 0.79 0.63 0.75 0.77 0.88 Relatively higher market to book value.
Share Value 1978
Share Value for Brown Foreman before acquisition 16.9
Share Value for Brown Foreman after acquisition 18.2
13 | P a g e
Appendix 3: Projections
BROWN-FORMAN DISTILLERS CORPORATION
Assumptions Used in Southern Comfort Cash Flow Forecast
1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
PROFIT PER CASE
U.S. domestic
Revenue $49.62 $50.62 $51.42 $52.42 $52.92 $53.92 $54.92 $55.92 $56.92 $57.92 $58.92
Cost of goods 33.52 34.10 34.75 35.41 36.14 36.93 37.78 38.70 39.70 40.77 41.93
Advertising 4.07 4.01 3.80 3.68 3.83 3.89 3.92 3.97 3.33 3.18 3.37
Selling
Regular 0.55 0.58 0.59 0.60 0.61 0.62 0.63 0.63 0.65 0.67 0.70
Transition 0.71 0.34 0.15
PROFIT PER CASE 10.77 11.59 12.13 12.73 12.34 12.48 12.59 12.62 13.24 13.30 12.92
Export
Revenue 19.21 20.32 21.50 22.55 23.21 23.80 25.16 26.15 27.15 28.15 29.15
Cost of goods 7.08 7.65 8.26 8.92 9.63 10.40 11.24 12.13 13.10 14.15 15.29
Advertising 1.44 1.38 1.37 1.37 1.37 1.36 1.37 1.37 1.37 1.37 1.37
Brokerage 2.75 2.76 2.75 2.85 2.72 2.69 2.68 2.67 2.67 2.67 2.67
Selling exp. 0.05 0.05 0.05 0.06 0.06 0.06 0.06 0.06 0.07 0.07 0.08
PROFIT PER CASE 7.89 8.48 9.07 9.35 9.43 9.29 9.81 9.92 9.94 9.89 9.74
Canada
Royalty 3.48 3.48 3.48 3.48 3.48 3.48 4.00 4.00 4.00 4.00 4.00
Concentrate profit 1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55
PROFIT 5.03 5.03 5.03 5.03 5.03 5.03 5.55 5.55 5.55 5.55 5.55
CASE VOLUMES (in thousands)
U.S. 1140 1225 1315 1410 1510 1615 1725 1835 1923 1984 2015
Export 325 350 380 405 425 445 463 480 490 500 500
Canada 115 125 138 150 160 170 180 190 200 210 220
Total Case volumes 1580 1700 1833 1965 2095 2230 2368 2505 2613 2694 2735
CORPORATE LEVEL
G&A Expense 1665 1800 1944 2100 2268 2449 2645 2857 3086 3332 3599
Transition 430 380 180
Settlements 400 400 400 400
Interest expense 113 122 132 142 154 166 179 194 209 226 244
Total Revenue for US Domestic(In 000's) 56566.8 62009.5 67617.3 73912.2 79909.2 87080.8 94737 102613.2 109457.16 114913.28 118723.8
Total Revenue for Export(In 000's) 6243.25 7112 8170 9132.75 9864.25 10591 11649.08 12552 13303.5 14075 14575
Total Revenue for Canada(In 000's) 578.45 628.75 694.14 754.50 804.80 855.10 999.00 1054.50 1110.00 1165.50 1221.00
Total Revenue In Millions 63388.50 69750.25 76481.44 83799.45 90578.25 98526.90 107385.08 116219.70 123870.66 130153.78 134519.80
Costs for US 44289.00 47811.75 51666.35 55962.90 61275.80 66925.60 73019.25 79455.50 83996.64 88526.08 92690.00
Costs for Export 3679.00 4142.74 4722.68 5345.50 5857.46 6458.22 7104.77 7792.26 8435.15 9131.48 9702.59
Cost of Sales 47968.00 51954.49 56389.03 61308.40 67133.26 73383.82 80124.02 87247.76 92431.79 97657.56 102392.59
Gross Profit 15420.50 17795.76 20092.41 22491.05 23444.99 25143.08 27261.06 28971.94 31438.87 32496.22 32127.21
Appendix 4
Indication of cash flow strength