West Coast Fashions, Inc. was planning a reorganization. Such a move would result in divesting the corporation of its hold over Mercury Athletic, a wholly-owned footwear subsidiary. Active Gear, a mid-sized athletic and casual footwear company, is looking into the possible acquisition of Mercury Athletic as it might be the opportunity for the former to expand the size of his business.
Timothy A. Luehrman; Joel L. Heilprin
Harvard Business Review (4050-PDF-ENG)
September 18, 2009
Case questions answered:
Case study question answered in the first solution:
- Provide a valuation of the proposed acquisition based on various valuation techniques.
Case study questions answered in the second solution:
- Synergy and risks of this acquisition: a. What are the potential synergies created by combining Active Gear with Mercury Athletic Footwear? b.What are the risks faced by Active Gear in this deal? c.Comparing your answer in (a) and (b), does it make sense for Active Gear to acquire Mercury Athletic Footwear?
- Estimate the value of Mercury using a discounted cash flow approach using Liedtke’s base case projections. Following the steps listed below. Make necessary additional assumptions and be prepared to defend them.
a.) What is the weighted average cost of capital? Should it be based on Mercury’s own cost of capital or AGI’s?
b.) Estimate the free cash flows from 2007 to 2011.
c.) Develop an estimate for terminal value in 2011. Choose your method (stable growth, multiples, or/and liquidation value) and explain.
d.) What should be the maximum price AGI is willing to pay to acquire Mercury based on your estimates from (a) to (c)? - Review the projections formulated by Liedtke. Are they appropriate? If not, how would you recommend modifying them? How would your modification (if any) change the maximum price AGI is willing to pay for Mercury?
- The Ultimate Question: Do you recommend AGI to acquire Mercury? If so, what price?
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Mercury Athletic: Valuing the Opportunity Case Answers
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Industry Overview – Mercury Athletic and the Footwear Industry
The casual footwear industry (to which Mercury Athletic belongs) is a 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 the 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, casual shoes have a classic styling. The company has a small portfolio of products with longer lifecycles.
o Distribution
Let us divide this into 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 a small part of the 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 an 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:
- Men’s athletic footwear- These products are inexpensive to produce with basic materials used. The customers pay medium to high prices.
- Men’s Casual Footwear: This segment has products with promising designs but has external forces that impact this product mainly due to bad weather and strikes and cannibalization of products.
- Women’s Athletic Footwear: This segment has a high cost of building brand image and awareness. This leads to higher marketing and advertising expenses.
- Women’s Casual Footwear: In this segment, more advertising and marketing are 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 single market that generates a significant amount of sales. This leads to higher marketing, advertising, and distribution costs, which in turn hampers the bottom line.
o Revenues
In 2006
$431.1 Million – Revenue
$58.1 Million- EBITDA
If we compare both companies, we can see that both of them have many differentiating points, which leads us to conclude that they are fundamentally different.
ACQUISITION RATIONALE
Let us analyze the weaknesses/opportunities that Active Gear has and what it aims to generate out of this acquisition.
The 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 favor the firms that can offer longer production runs.
Since Active Gear is a small brand compared to its competitors, it cannot use discount retailers due to the company’s brand image, but this does have consequences, which are, in this case, lower sales growth and the company growth at a rate of 2.2% for the last 3 years.
The weakness of Mercury Athletic Footwear
The first weakness of this company is the…
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