This report is a result of my own work which was an integral part of my full time MBAprogram. Prior permission must be tak...
Company Valuations and MergerAssessment ReportFossil Inc Joins Abercrombie & Fitch Co.Author: Deepak Shrivastava (imdshriv...
ContentsIntroduction ........................................................................................................
Figure 1: List of Beneficial Owner ............................................................ Error! Bookmark not define...
IntroductionThe following report will determine the value of a possible merger between two US corporations i.e.Fossil Inc ...
mergers or acquisition. This report will also describe the corporate governance followed bycompanies and possible issues t...
Risk AnalysisFossil IncAny company holds 2 kinds of risk 1) financial risk and business risk. To calculate risk we should ...
Re = Rm + β(Rm-Rf)         (Equation3)Rm = Market return.Market return for the period of calculation is 12.67% which is no...
Currently Fossil has a total debt of $15.24 million which is a mix of debts i.e. short term borrowing of$9.009 million and...
Abercrombie and Fitch Inc (ANF)Using above equations we calculate:1. Levered Beta (βe): 1.365; Yahoo finance value = 1.97R...
Cost of CapitalFormula for cost of capital or weighted average cost of capital (WACC) is:WACC = (E/V) X Re + (Dm/T) X Rd (...
βa(FOSL + ANF) =E(FOSL)/(E(FOSL)+E(ANF)) x βd(FOSL) + E(ANF)/ (E(FOSL)+E(ANF)) x βd(ANF)Substituting the values we getβa(F...
Stand alone valuationIn order to get the merged value of the company, we have to first value individual firms using freeca...
6) The tax rate for FOSL for future is taken as 32% average rate of past 5 years.The growth rate calculation is shown belo...
No outstanding shares = 68370020; Equity Value = $9.07 billion hence share price is $132.77, this isapproximately similar ...
Valuation of Abercrombie & Fitch CoWith similar approach the FCF of ANF is shown below                                    ...
Growth Figures                                2008                2009              2010          2011Depreciation/Net Fix...
Valuation of Merged firmFor merged firm we will simply add the cash flow of both the firm and will calculate the total val...
Value of merged firm including tax and costsEvery firm enjoys some benefit due to its debt i.e. tax benefits and it also b...
Financing OptionsLooking at the share price and individual valuation of the companies and future growth of eachcompany I p...
For example if Fossil raise $3.0 billion as debt (considering interest rate of debt remains the same)and finance the deal6...
Current Price $129.9 right issue offered price10 = $110.415 hence company will be able to raise $3.5billion.Share for Shar...
ConclusionWe have seen various risks associated with each FOSL and ANF and we have seen that ANF has morerisk than FOSL. W...
ReferencesAbercrombie & Fitch Co. (2012) Annual Report 2011, Delware/USAAbercrombie & Fitch Co. (2011) Annual Report 2010,...
TM1031 Exchange (2012) Tenant Credit Ratings – 2012 Q2 Available from:http://www.tm1031exchange.com/tenant-credit-ratings....
AppendixFossil financialsFigure 12: Income statement of FOSL.Source: Adapted from Morning Star (2012) Fossil Inc. FOSL Ava...
Abercrombie & Fitch Co. FinancialsFigure 14: Income statement of ANFSource: Adapted from Morning Star (2012) Abercrombie &...
Upcoming SlideShare
Loading in...5
×

Company valuation and Merger Valuation

1,026

Published on

Report is a detailed valuation of a hypothetical merger between two US firms. I have used FCF method to value both of these companies and then the merged company. This reports in details also calculate various risk associated with each company and later merged company.

Published in: Business
4 Comments
1 Like
Statistics
Notes
No Downloads
Views
Total Views
1,026
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
0
Comments
4
Likes
1
Embeds 0
No embeds

No notes for slide

Transcript of "Company valuation and Merger Valuation"

  1. 1. This report is a result of my own work which was an integral part of my full time MBAprogram. Prior permission must be taken from the author before copying orreproducing this work.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 1
  2. 2. Company Valuations and MergerAssessment ReportFossil Inc Joins Abercrombie & Fitch Co.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 2
  3. 3. ContentsIntroduction ............................................................................................................................................ 5Risk Analysis ............................................................................................................................................ 7 Fossil Inc .............................................................................................................................................. 7 Abercrombie and Fitch Inc (ANF) ...................................................................................................... 10Cost of Capital ....................................................................................................................................... 11 Fossil Inc ............................................................................................................................................ 11 Merged Entity ................................................................................................................................... 11Stand alone valuation ........................................................................................................................... 13 Valuation of Fossil ............................................................................................................................. 13 Valuation of Abercrombie & Fitch Co ............................................................................................... 16 Valuation of Merged firm ................................................................................................................. 18 Value of merged firm including tax and costs .............................................................................. 19Financing Options ................................................................................................................................. 20 Cash Financing .................................................................................................................................. 20 Share for Share offer ......................................................................................................................... 22Conclusion ............................................................................................................................................. 23References ............................................................................................................................................ 24Appendix ............................................................................................................................................... 26Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 3
  4. 4. Figure 1: List of Beneficial Owner ............................................................ Error! Bookmark not defined.Figure 2: List of Beneficial Owner ............................................................ Error! Bookmark not defined.Figure 3: CEO Compensation breaks up................................................... Error! Bookmark not defined.Figure 4: Beta values compared with market benchmark ...................................................................... 7Figure 5: Calculated entities ................................................................................................................. 12Figure 6: Free Cash Flow of Fossil Inc ................................................................................................... 13Figure 7: Growth Rate calculation of Fossil Inc ..................................................................................... 14Figure 8: Company Value calculation.................................................................................................... 14Figure 9: Free Cash flow calculation of ANF ......................................................................................... 16Figure 10: Growth Rate calculation for ANF ......................................................................................... 17Figure 11: Firm Value calcualtions ........................................................................................................ 17Figure 12: Free cash flow calculation of the merged firm .................................................................... 18Figure 13: Firm value of merged entity................................................................................................. 18Figure 14: Few Entities recalculated after debt structure change........................................................ 21Figure 15: Income statement of FOSL. .................................................................................................. 26Figure 16: Balance Sheet of FOSL.......................................................................................................... 26Figure 17: Income statement of ANF .................................................................................................... 27Figure 18: Balance sheet of ANF ........................................................................................................... 27Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 4
  5. 5. IntroductionThe following report will determine the value of a possible merger between two US corporations i.e.Fossil Inc (FOSL) and Abercrombie & Fitch Co. (ANF). The report will describe the associated risk ofboth the companies and will evaluate individual companies using free cash flow method takingvarious risks and cost involved. The report will also evaluate the value of the merged company andlater it will describe the possible financing options and their corresponding benefits and issues.Fossil IncFossil Inc is a well known brand in consumer fashion accessories industry and has multiple offeringsfor Men and women. The company principle offerings involve fashion watches and jewellery,handbags, small leather goods, belts, sunglasses, shoes, soft accessories and clothing. Company alsohave diverse portfolio of branded and licenses products. Company uses various channels fordistribution including owned store, online retailing, and licensed store in 120 countries.Company has a market capitalization of $ 8.46 billion and has shown 26% growth y-o-y basis.Company also has shown an average growth of 30% growth in it net income. More details about canbe seen in Appendix.Abercrombie & Fitch Co.Abercrombie & Fitch Co. ("A&F"), is a known apparel retailer incorporated in Delaware in 1996. TheCompany sells: casual sportswear apparel, including knit and woven shirts, graphic t-shirts, fleece,jeans and woven pants, shorts, sweaters, and outerwear; personal care products; and accessories formen, women and kids under the Abercrombie & Fitch, Abercrombie kids, and Hollister brands. TheCompany also operates stores and direct-to-consumer operations offering bras, underwear,personal care products, sleepwear and at-home products for women under the Gilly Hicks brand. Asof January 28, 2012, the Company operated 946 stores in the United States (“U.S.”) and 99 storesoutside of the U.S.ANF has market cap of $4.5 billion and has shown a growth of 20% in sales y-o-y basis. The companyfive average growth rates have been negative due its poor performance during recession. Moredetail on company can be found in appendix.Mergers and acquisition can impact the corporate governance followed by companies and caninfluence the decision. Hence it should also be taken into account while evaluating the merger andacquisition. The companies with strong corporate governance faces less challenges related toAuthor: Deepak Shrivastava (imdshrivastava@gmail.com) Page 5
  6. 6. mergers or acquisition. This report will also describe the corporate governance followed bycompanies and possible issues that can arise due to merger.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 6
  7. 7. Risk AnalysisFossil IncAny company holds 2 kinds of risk 1) financial risk and business risk. To calculate risk we should haveBetas1) Levered Beta (βe): This is a measure of combine risk company has due to its operation (uniquerisk) and financial obligations. This risk is generally reflected in the stock price of the company’s. Thisis also referred as levered beta or equity beta. Fossil Inc has 1.376 as equity beta based on the 2years market and Fossil return values. Calculated Beta 1.38 Yahoo Beta 1.56Figure 1: Beta values compared with market benchmarkSource: Complied by author using http://finance.yahoo.com/q/hp?s=FOSL+Historical+Prices [accessed 19th April 2012]The beta is calculated using Company’s shares daily return which is calculated using followingequation:- = I/V0 +(V1-V0)/V0 (Equation 1) Where I=Income received by investors in terms of dividend payout. = 0 (As Fossil Inc has not paid any dividend to the investors in past 5 years) V0= Value of stock at the start of the period V1= Value of stock at the end of the periodTaking daily adjusted1 share close price of company from stock exchange, however this price shouldalso be adjusted with respect to the inflation rate. I have taken inflation into account whilecalculating the market return.Market daily return: Similarly market return is calculated using equation1.Beta is defined as belowEquity Beta βe= Cov(Rc,Rs)/Var(Rs) (Equation 2)Using this equation2 βe for Fossil is 1.376Return on equity: This is calculated using Capital Asset Pricing Model (CAPM).1 Adjusted with any stock splits or dividendsAuthor: Deepak Shrivastava (imdshrivastava@gmail.com) Page 7
  8. 8. Re = Rm + β(Rm-Rf) (Equation3)Rm = Market return.Market return for the period of calculation is 12.67% which is nominal rate. Using fisher equation toget real market return.1+rNominal = (1+rReal) x (1+i) (Equation4)i= average inflation rate for the period is 2.25%Substituting the value we have Rm =10.19%Rf = risk free rate. Assuming 52 weeks traded US Treasury bill rate which is 0.17%βe= Beta =1.376Re using Levered = 13.96%2) Unlevered Beta (βa): - Business risk or unique risk or sometime called as diversifiable risk. This riskis unique to the business by virtue of its operations. This is measured using Beta of assets orunlevered Beta (βa). Debt is the main factor which introduces financial risk and if we remove thedebt from company than company is only exposed to its own business risk.The equation for calculating unlevered beta =βa = [βe + βd X (1-Tc)Dm/E] / [1+(1-Tc)Dm/E] (Equation5)Whereβd = Beta of Debt (using CAPM equation2) = 0.29Tc= Corporate tax rate = 35% (US registered company hence tax rate of US)Dm = Market Value of debt (see below calculation)2 CAPM = Rd = Rf +β(Rm-Rf)Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 8
  9. 9. Currently Fossil has a total debt of $15.24 million which is a mix of debts i.e. short term borrowing of$9.009 million and long term borrowing $6.236 million. Below table show the details about thedebts. Fossils Inc Weighted Cost of debt calculation FOSL - Debts Amount ($m) Rate Weighted interest rate Maturity Short Term 1 2.8 1.475 0.271068522 0.25 Short Term 2 6.2 4.75 1.932922027 0.25 Long Term 6.236 2 0.818587556 3 Total Debt 15.236 Rd= FOSL 3.022578104 1.35Using the following formula for market value debt:IE X 1-[1/(1+r)^t]/r + Db/(1+r)^t (Equation63)Where IE = Interest expenser= interest rate, t= maturity time in year, Db = book value of debtMarket Value of debt is = $17.76 millionBox 1: Market Value of debt calculationE =market value of the equity = number of outstanding shares X share price.Number of outstanding shares of Fossil Inc = 68370020Share price as of 19th April = $129.92 per shareE = $8.88 billionInserting the values in equation5 we get βa=1.374Corresponding Re (unlevered) = 13.94%We currently see unlevered beta of Fossil is similar to the levered beta, which is common for acompany with less net debt. Hence we can deduce that company has more of business risk thanfinancial.3 DePamphilis 2010, pp263Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 9
  10. 10. Abercrombie and Fitch Inc (ANF)Using above equations we calculate:1. Levered Beta (βe): 1.365; Yahoo finance value = 1.97Return on equity: Levered Beta = 13.85%,2. Unlevered beta (βa):βd = Beta of Debt (Using CAPM Equation) = 0.22Tc= Coporate tax rate = 35% (US registered company hence tax rate of US)Dm = see below calculationCurrently Fossil has a total debt of $57.85 million which is a long term borrowing. With a averageinterest rate as 2.4% with a maturity of 5 years.Using the formula for market value debt: i.e. equation 6.Where IE = 3.577 million, r= 2.4 , t= 5, Vbd = $57.85 millionMarket Value of debt is Vmd = $68.048 millionBox 2: Market value of Debt calculationE= number of outstanding shares X share price. => 84723859 x $48.4 (as of 19th April 2012) = $4.09billionInserting the values in equation5 we get βa=1.353Return on equity (unlevered) =13.85%Similar to FOSL, ANF unlevered beta is approximately same as levered beta. However this as this firmhas high net debt hence the difference between equity beta and unlevered beta is higher than Fossil.Risk profile of this company shows more financial risk than Fossil Inc.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 10
  11. 11. Cost of CapitalFormula for cost of capital or weighted average cost of capital (WACC) is:WACC = (E/V) X Re + (Dm/T) X Rd (1-Tc)+(P/V)Rp (Equation7)WhereP = value of preferred stocksV = D+E+PRe = return on equity, Rd = return on debt, Rp = return on preferred stocks.Tc = Corporate tax = 35%Fossil IncReturn on Debt:Fossil Inc only has bank debts which are not publicly traded and the weighted average cost of debt is3.02% (see the calculation in Box 1).Company has not issued any preferred stock to the investor hence the P and Rp will be 0 in this case.E=$8.88 billion, Dm = $17.74 million,WACC (Levered) = 13.93% andWACC (unlevered) = 13.92%Abercrombie & FitchThe values for ANF are:-Rd= 2.4% (Only long term debt no Bonds or traded debt), Rp = 0 (No preferred stocks were offered)E= $4.08 billion, Dm = $57.85 million, P = 0 (No preferred stocks were offered).WACC (levered) = 13.65% and WACC unlevered = 13.5%Merged EntityFor cost of capital of merged entity let us.Step 1: Calculate Unlevered Beta or Asset beta of merged company using following equationAuthor: Deepak Shrivastava (imdshrivastava@gmail.com) Page 11
  12. 12. βa(FOSL + ANF) =E(FOSL)/(E(FOSL)+E(ANF)) x βd(FOSL) + E(ANF)/ (E(FOSL)+E(ANF)) x βd(ANF)Substituting the values we getβa(FOSL + ANF) = 1.36, this value shows combine business risk of both the firms.Step 2: Calculate R(FOSL +ANF) using CAPM equation3.R(FOSL +ANF) = 13.87% (Unlevered)Step 3: Calculate Return on Debt (FOSL+ANF)Weighted average Cost of Debt =2.52%Step 4: Equity Beta:As the capital structure has changed so the risk associated with firm. Hence we will calculate theBeta for equity.We already have the Asset beta of merged firm = 1.36Using Return of debt value in CAPM equation we have Beta of debt of merged firm = 0.235Re-levering the beta using following equation.βe = βa + (Dm/E) x (βa- βd) x (1-Tc)We get equity beta of merged firm = 1.37 (Levered Beta)Step 5: Cost of Capital (WACC) using equation7WACC (Unlevered) = 13.80%, WACC (Levered) = 13.85%Summary of the values calculated are shown in below figure. Entities FOSL ANF Merged Firm Cost of Capital (U) 13.921 13.530 13.800 Cost of Capital (L) 13.935 13.651 13.850 Return on Equity (U) 13.945 13.730 13.880 Return on Equity (L) 13.959 13.852 13.930 Return on Debt 3.023 2.400 2.530 Equity Beta 1.376 1.365 1.373 Asset Beta 1.375 1.353 1.368 Debt Beta 0.285 0.223 0.235Figure 2: Calculated entitiesAuthor: Deepak Shrivastava (imdshrivastava@gmail.com) Page 12
  13. 13. Stand alone valuationIn order to get the merged value of the company, we have to first value individual firms using freecash flow method.Valuation of FossilFossil Inc is a growing company with a annual growth rate of 16% (Based on 5 years of trend) in salesand 29% growth in Net Income (Based on 5 year trend). The forecasted free cash flow of fossil isshown below. The complete calculation can be found in excel provided with report. Historical Forecasted Fossil, Inc. (FOSL) Amounts in USD Thousands 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Revenue 1432984 1583242 1548093 2030690 2567302 Net income 123261 138097 144294 264890 307402 356586 413640 479823 556594 645649 748953 Depreciation 32796 37642 41334 40560 51925 58714.49 65463.23 72987.69 81377.02 90730.64 101159.4 Receviable 227481 205973 209784 263218 302467 327252.3 354068.7 383082.4 414473.7 448437.3 485184 Inventory 248448 291955 245714 371935 488983 592295.6 717436.1 869016.3 1052623 1275021 1544408 Payables 111015 91027 103591 122266 157883 174838.1 193614 214406.3 237431.4 262929.2 291165.2 Other Liabilities 32833 30306 29618 50779 56122 66224.21 78144.86 92211.29 108809.7 128396 151507.8 Net Fixed Assets 186042 207328 212367 217424 282050 314469.3 350615 390915.3 435847.7 485944.8 541800.2 Interest Expense 890 555 235 1119 2391 2630.1 2893.11 3182.421 3500.663 3850.729 4235.802 Change In Receviable NA -21508 3811 53434 39249 24785.33 26816.33 29013.77 31391.27 33963.59 36746.7 Change in Inventory NA 43507 -46241 126221 117048 103312.6 125140.5 151580.2 183606.2 222398.6 269387.1 Change in payables NA -19988 12564 18675 35617 16955.09 18775.91 20792.26 23025.14 25497.82 28236.03 Change in other liabilities NA -2527 -688 21161 5343 10102.21 11920.65 14066.42 16598.44 19586.24 23111.85 Change in NFA NA 21286 5039 5057 64626 32419.32 36145.65 40300.29 44932.48 50097.1 55855.34 Effective Coporate tax (percentage) 34.7 27.1 34.4 31.1 31.9 32 32 32 32 32 32 After tax interest expense NA 404.595 154.16 770.991 1628.271 1788.468 1967.315 2164.046 2380.451 2618.496 2880.346 FCF 115397.595 236425.16 119023 170306.3 263424.9 299823.4 340805.8 386848.4 438450.6 496127.9Figure 3: Free Cash Flow of Fossil IncSource: Complied by author using Fossil Inc Annual Report 2011, 2010, 2009, 2008, 2007. Delaware/USAFollowing assumption has been made while calculating cash flow: 1) In majority of cases except (net income and interest expense) the forecasted value is based on the last 4 years growth rate. 2) Net Income growth figure was 29% based on 5 years trend. I have taken a conservative figure of 16% to calculate the future net income. 3) Interest expanse growth rate was 98% as company has increased its debt in past 2 years. For future I have taken a moderate of 10% growth in interest expense. Also the majority of debt (approx 11 million out of 15 million) will be paid in 2012 and rest in next 5 years. 4) The future depreciation will increase in proportion (based on the average ratio of past depreciation over net asset of 4 years) to the net asset. 5) The terminal value of the firm is calculating growing perpetuity formula. Here growth rate of the firm is assumed to be 11% y-o-y basis. However the growth rate of sales is 16% based on historical data.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 13
  14. 14. 6) The tax rate for FOSL for future is taken as 32% average rate of past 5 years.The growth rate calculation is shown below. Growth Figures 2008 2009 2010 2011 Depreciation/Net Fixed Assets 0.181558 0.194635 0.186548 0.184099 Average Depreciation/ NFA 0.18671 Growth Rate of Revenue 0.104857 -0.0222 0.311736 0.264251 Average Growth Rate 0.164661 Growth Rate of Income 0.120362 0.044874 0.835766 0.160489 Average Growth Rate 0.290373 Assuming 0.16 Growth Rate of Receviable -0.09455 0.018502 0.25471 0.149112 Average Growth Rate 0.081944 Growth Rate of Inventory 0.175115 -0.15838 0.513691 0.3147 Average Growth Rate 0.21128 Growth Rate of Payables -0.18005 0.138025 0.180276 0.291307 Average Growth Rate 0.10739 Growth Rate of Other Liabilities -0.07697 -0.0227 0.714464 0.105221 Average Growth Rate 0.180004 Growth Rate of Net Assets 0.114415 0.024304 0.023813 0.297235 Average Growth Rate 0.114942 Growth Rate of Interest Expense -0.3764 -0.57658 3.761702 1.136729 Average Growth Rate 0.986363 Assuming 0.1Figure 4: Growth Rate calculation of Fossil IncSource: Complied by author using Fossil Inc Annual Report 2011, 2010, 2009, 2008, 2007. Delaware/USAThe weighted average cost of capital (unlevered) is used to determine the discount factor. Belowfigure shows the calculated value. WACC (Unlevered) 13.92 Discount Factor 0.88 PV Value with 2011-16 1321278.95 Value after 2016 (Using Growing Perpetuity) 16986948.54 PV value of firm after 2016 7771428.21 Enterprise vale 9092707.17 9092707167 Equity Value of the firm 9077462.17 9.07 billionFigure 5: Company Value calculationFossil Inc values $9.092 billion and the equity value of the firm is (Enterprise value – net debt) i.e.$9.077 billion. Currently market value the company is $7.88 billion (yahoo finance) as enterprisevalue and this shows that company is little undervalued4.Ratio of value of firm over outstanding share will give us expected share price.4 Keep is mind we have calculated the enterprise value with a conservative growth rate.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 14
  15. 15. No outstanding shares = 68370020; Equity Value = $9.07 billion hence share price is $132.77, this isapproximately similar to the share price as of 19th April 2012 i.e. $129.9.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 15
  16. 16. Valuation of Abercrombie & Fitch CoWith similar approach the FCF of ANF is shown below Historical ForecastAbercrombie and Fitch, Inc. (ANF) Amounts in USD Thousands 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017Revenue 3699656.00 3484058.00 2928626.00 3468777.00 4158058.00 4330048.08 4509152.20 4695664.62 4889891.77 5092152.75 5302779.87Net income 475697.00 272255.00 254.00 150283.00 127658.00 153189.60 183827.52 220593.02 264711.63 317653.95 381184.75Depreciation 183716.00 225334.00 238752.00 229153.00 232956.00 225536.74 227792.11 230070.03 232370.73 234694.43 237041.38Receviable 53801.00 53110.00 90865.00 74777.00 89350.00 100072.00 112080.64 125530.32 140593.95 157465.23 176361.06Inventory 333153.00 372422.00 310645.00 385857.00 569818.00 665386.00 776982.36 907295.29 1059463.87 1237153.67 1444645.02Payables 108437.00 92814.00 110212.00 137235.00 211368.00 236732.16 265140.02 296956.82 332591.64 372502.64 417202.95Other Liabilities 434676.00 356983.00 339160.00 415129.00 493985.00 516866.70 540808.30 565858.89 592069.83 619494.89 648190.29Net Fixed Assets 1318291.00 1398655.00 1244019.00 1154759.00 1197271.00 1209243.71 1221336.15 1233549.51 1245885.00 1258343.85 1270927.29Interest Expense -18827.00 -11328.00 -1598.00 3362.00 3577.00 3805.75 4049.13 4308.07 4583.57 4876.69 5188.55Change In Receviable -691.00 37755.00 -16088.00 14573.00 10722.00 12008.64 13449.68 15063.64 16871.27 18895.83Change in Inventory 39269.00 -61777.00 75212.00 183961.00 95568.00 111596.35 130312.93 152168.59 177689.80 207491.35Change in payables -15623.00 17398.00 27023.00 74133.00 25364.16 28407.86 31816.80 35634.82 39911.00 44700.32Change in other liabilities -77693.00 -17823.00 75969.00 78856.00 22881.70 23941.60 25050.59 26210.95 27425.05 28695.40Change in NFA 80364.00 -154636.00 -89260.00 42512.00 11972.71 12092.44 12213.36 12335.50 12458.85 12583.44Effective Coporate tax (percentage) 37.40 39.50 33.90 34.30 32.00 35.00 35.00 35.00 35.00 35.00 35.00After tax interest expense -6853.44 -1056.28 2208.83 2432.36 2473.74 2631.93 2800.24 2979.32 3169.85 3372.56FCF 433863.56 451828.72 362834.83 117277.36 265419.82 283020.39 304253.54 329917.83 360984.25 398632.98Figure 6: Free Cash flow calculation of ANFSource: Complied by author using Fossil Inc Annual Report 2011, 2010, 2009, 2008, 2007. Delaware/USAFollowing assumption were made while calculating the FCF for ANF 1) Average Net income growth rate of last 4 years was very high i.e. 147% due very high fluctuation in the sales in during recession (2008-2009). Hence I have taken a rate of 20%. 2) Interest expense growth rate of company is assumed as per last year (i.e. 2011) as company has long term loan for next 5 years. 3) Depreciation is again adjusted in similar fashion as of Fossil. 4) I have assumed a moderate of growth for account receivables, payables, and net assets. (see assume rates below). 5) Terminal value of the company is calculate using growing perpetuity with a growth rate of 5% as average sales growth of company is 4.1% y-o-y basis. 6) Tax rate is assumed to be 35%.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 16
  17. 17. Growth Figures 2008 2009 2010 2011Depreciation/Net Fixed Assets 0.161 0.192 0.198 0.195Average Depreciation/ NFA 0.187Growth Rate of Revenue -0.058 -0.159 0.184 0.199Average Growth Rate 0.041Growth Rate of Income -0.428 -0.999 590.665 -0.151Average Growth Rate 147.272 Assuming 0.200Growth Rate of Receviable -0.013 0.711 -0.177 0.195Average Growth Rate 0.179 Assuming 0.120Growth Rate of Inventory 0.118 -0.166 0.242 0.477Average Growth Rate 0.168 0.168Growth Rate of Payables -0.144 0.187 0.245 0.540Average Growth Rate 0.207 Assuming 0.120Growth Rate of Other Liabilities -0.179 -0.050 0.224 0.190Average Growth Rate 0.046Growth Rate of Net Assets 0.061 -0.111 -0.072 0.037Average Growth Rate -0.021 Assuming 0.010Growth Rate of Interest Expense -0.398 -0.859 -3.104 0.064Average Growth Rate -1.074 Assuming 0.064Figure 7: Growth Rate calculation for ANFThe WACC unlevered is used to calculate the discount factor. Below are the calculations.WACC (Unlevered) 13.53Discount Factor 0.88PV Value with 2011-16 1168550.07Value after 2016 (Using Growing Perpetuity) 4673088.60PV value of firm after 2016 2182383.60Enterprise vale 3350933.67Equity Value of the firm 3293082.67 3.29 billionFigure 8: Firm Value calcualtionsThe market benchmark for this firm is $3.78 billion (yahoo finance). The firm currently looksovervalued which is also shown in the share price with it current outstanding shares the estimatedshare price should be $38.87 per share, where as it was traded on 19th April 2012 at $48.24.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 17
  18. 18. Valuation of Merged firmFor merged firm we will simply add the cash flow of both the firm and will calculate the total value. Current ForecastAmount in $ thousands 2011 2012 2013 2014 2015 2016 2017FCF FOSL 170306.3 263424.9 299823.4 340805.8 386848.4 438450.6 496127.9FCF ANF 117277.4 265419.8 283020.4 304253.5 329917.8 360984.3 398633Total Cash 287583.6 528844.8 582843.8 645059.4 716766.2 799434.9 894760.9Figure 9: Free cash flow calculation of the merged firmTerminal value is calculated assuming a moderate growth rate of 9%. This rate is assumedconsidering Fossil contribution in the merged firm hence growth is more adjusted toward Fossilgrowth rate of 11% rather than 5% of Abercrombie and Fitch.Using the WACC (Unlevered) = 13.80% calculated earlier we can see the total value of the firm. Dis Fac 0.878762114 NPV 2486491.29 Value after 2016 growing Perpetuity 18654687.43 PV after 2016 8590450.23 Enterprise value 11076941.52 11.08 billion Equity Value 10991132.89 10.99 billionFigure 10: Firm value of merged entityThe merged firm will have total of $85.08 million of total debt (combined market value of both firm)and similarly merged firm will have total equity of $12.97 billion. The D/E ratio of this firm will be0.0066 which more the individual firms D/E ratio.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 18
  19. 19. Value of merged firm including tax and costsEvery firm enjoys some benefit due to its debt i.e. tax benefits and it also bear a cost i.e. bankruptcycost. Let us see how much benefit or cost this firm will have after this merger. This is calculation isalso important for the deciding the future capital structure.Hence overall firm value can be seen as:Firm Value = Value of Firm (unlevered) + Tax benefit (due to debt) – bankruptcy cost (due to debtfinancing)Tax Shield (Benefit):Currently the merged firm has total of $73.10 million of debt (book value) and has tax rate 35%. Thecombined interest expense of firm is $5.968 million ($2.391 million from FOSL and $3.577millionANF)Hence the tax shield is => 5.968 *0.35 = $2.09 million,Bankruptcy Cost:Debt also brings a risk of default or also known as Bankruptcy cost. This bankruptcy cost has 2components:1) Default cost: This is a combination of direct and indirect cost. I will assume this to be constantwith respect to the debt level (as this will remain same even if the debt will increase). Let us assumeit to be 6.5 %( average costs)52) Probability of default: This is directly related to the debt level the company has. There is noinformation on the companies (FOSL & ANF) default probability as their debts are not publiclytraded. However at this stage I will take default probability rate of a competitor in this industry i.eThe Ralph Lauren Corporation (RL), as the probability rate i.e. 0.144% (A3 rate by Moody’s).Expected Bankruptcy cost will be = 0.065 x 11.07 x 0.00144 = $1.04 millionOverall Value of firm = $11076 (m) + $2.09 (m) - $1.04 (m) = $11078 million5 Direct Cost: Legal and Administrative only 1% of market value 7 year prior (Warner 1977); Indirect costs: 12%of market value 3 years prior (Altman1984)Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 19
  20. 20. Financing OptionsLooking at the share price and individual valuation of the companies and future growth of eachcompany I propose that Fossil Inc should buy Abercrombie & Fitch Co. A merger is more suitable forthe companies having same level of enterprise value. Currently in the merged entity Fossil has morestake than Abercrombie & Fitch Co.From business point of view both companies operates in same sector but Fossil operates in fashionaccessories and watches where as Abercrombie operates in apparel. Fossil recently trying to moveinto the clothing business and buying Abercrombie will give it lot of advantage like established brandvalue, supply chain network, experience management etc. This could be very promising businessdiversification opportunity for Fossil.Now let us consider possible financing options which Fossil have to finance this deal. a) Cash financing: a. Raising cash by debt (Bank Loan) b. Raising cash by issuing shares in secondary market b) Share for share offer.Cash FinancingCash availability:Currently Fossil has $253 million of cash and its equivalent also it has unused credit facilities of totalof $600million approximately from various bank source. This cash might be required by Fossil for itsday to day hence cannot be used for financing.Raising cash by Debt: Debt financing brings couple of simultaneous effects. 1) It changes the financial risk profile of company i.e. D/E, which will have an effect on β of equity. This is will increase the Return on equity i.e. the investors will get the benefit. 2) Debt financing will raise the Tax shield offered to the company and will add the value of the firm. This will have a circular effect on Bankruptcy cost (as it will increase the default cost). 3) Rise in debt level will also increase the probability of default factor, which will increase the bankruptcy cost of the firm, this together with the increase in the default cost will pose a negative effect on the firm’s value.The below example explains the above stated points.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 20
  21. 21. For example if Fossil raise $3.0 billion as debt (considering interest rate of debt remains the same)and finance the deal6 then βe of combined firm will change from 1.37 to 1.757 and thecorresponding return on equity will increase from 13.92% to 17.92%. Below figure shows the changein the values. Beta Unlevered 1.367765333 Old D/E 0.006616078 New D/E 0.225436001 Equity Beta Old 1.372634949 Equity Beta New 1.67610888 Return Equity Old 13.92564297 Return Equity New 17.13222187Figure 11: Few Entities recalculated after debt structure changeThis will also increase the tax shield8 of the company from $2.08 to $83.5 million. And will also giverise to bankruptcy cost from $1 million to $7.2 million9.In this case we have seen that firm value has also increased from $11.07 billion to $11.15 billion.With debt financing we have see 2 benefits 1) Increase in shareholder return 2) Increase in firmvalue. Expert of corporate governance argues that top management will tend to finance the dealusing debt as this will benefit them (short term gain).Raising cash by Equity:The cash can also be raised by issuing shares to stock market. Fossil has 100,000,000 common sharesbut has issued so far 68,370,020. In order to raise it can issue the remaining share either as rightissue. This approach has following advantage:- 1) As company is already listed in the share market it is easy access to gain long term finance and it is the cheapest option to raise fund. 2) The right issue is offered to the existing share holders and over a discount on current market price (to adjust for any market price change) at a pro-rata basis i.e. 1 share for every 2 shares. In past 2 years Fossil share price has shown a growth of 130% hence its shares at discounted price will be accepted by the shareholder.6 Assuming the enterprise value not the premium value on top of enterprise.7 Beta is calculated by unlevering and than relevering it.8 Assuming the rate of interest remains the same as before 2011 calculated as = Interest Expense(FOSL+ANF)/Debt value(FOSL+ANF)9 Assumed double of default rate of THE GAP (.51%, having $1.6 billion as debt with Baa3 rating Moody’s).Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 21
  22. 22. Current Price $129.9 right issue offered price10 = $110.415 hence company will be able to raise $3.5billion.Share for Share offerFossil also have an option to exchange share for share to share holders of Abercrombie and Fitch.This option has few advantages a. The shareholders of Abercrombie will still have equity interest in the Fossil Inc. b. Shareholder of ANF will not incur any brokerage cost of reinvesting in other firm. c. The growth rate of Fossil in far better than the current performance of ANF. Etc.However the biggest disadvantage if this approach is that company has to pay a lot of premium toANF shareholders which make this deal more costly. There is also a threat of devaluation of shareprice soon after the bid is finalized making take over more costly.As we have already seen that entire deal cannot be financed by single approach hence I will proposeto finance the deal by mixed finance i.e. cashed raise by debt, right issue and share for share offer. Inthis majority of deal must be financed by share-for-share offer and rest by debt and right issue.The loss to share holder due to expected decline in share price caused because of issuing right issuesor giving share for share can be offset by raising the debt which will raise the return on shareholderequity. Hence mix financing will be the best option to finance this deal.10 Right issue price is assumed to be 15% discount on market priceAuthor: Deepak Shrivastava (imdshrivastava@gmail.com) Page 22
  23. 23. ConclusionWe have seen various risks associated with each FOSL and ANF and we have seen that ANF has morerisk than FOSL. We have also seen the impact of these risks (Financial and Business) on cost ofcapital. After valuing both the firms first separately and then as a merged entity, we have seen thatFossil is undervalued and Abercrombie is a overvalued firm. Looking the business benefits associatedwith this merger I have recommended acquisition rather than merger. This merger should befinanced using all three options to balance the risk and benefit to shareholder wealth. The strongcorporate governance already employed by companies will help in offsetting any kind of agency costor agency issues.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 23
  24. 24. ReferencesAbercrombie & Fitch Co. (2012) Annual Report 2011, Delware/USAAbercrombie & Fitch Co. (2011) Annual Report 2010, Delware/USAAbercrombie & Fitch Co. (2010) Annual Report 2009, Delware/USAAbercrombie & Fitch Co. (2009) Annual Report 2008, Delware/USAAbercrombie & Fitch Co. (2008) Annual Report 2007, Delware/USAAbercrombie & Fitch 2011. Def 14A: Definitive proxy statements. Available from: :http://services.corporate-ir.net/SEC/Document.Service?id=P3VybD1odHRwOi8vaXIuaW50Lndlc3RsYXdidXNpbmVzcy5jb20vZG9jdW1lbnQvdjEvMDAwMDk1MDEyMy0xMS0wNTA4NjUvZG9jL0FiZXJjcm9tYmllRml0Y2hDby5wZGYmdHlwZT0yJmZuPUFiZXJjcm9tYmllRml0Y2hDby5wZGY= [Accessed on 19th April 2012]Coinnews Media Group LLC (2012), US Inflation Calculator. Available fromhttp://www.usinflationcalculator.com/inflation/current-inflation-rates/ [Accessed 1st May2012]Corina G., and Roxana S, (2011) Comparative Study on Corporate Governance. Economic ScienceSeries University of Oradea. JEL Classification G30, M10 (Online) Available from:http://anale.steconomiceuoradea.ro/volume/2011/n2/095.pdf [Accessed on 25th April]DePamphilis DM. (2010). Mergers, Acquisitions, and other restricting activites: An integratedapproach to process, tools, cases and solutions 5th Edition. London: ElsevierFossil Inc (2012) Annual Report 2011, Delware/USAFossil Inc (2011) Annual Report 2010, Delware/USAFossil Inc (2010) Annual Report 2009, Delware/USAFossil Inc (2009) Annual Report 2008, Delware/USAFossil Inc (2008) Annual Report 2007, Delware/USAFossil Inc 2012. Schedule 14A: Proxy statement pursuant to section 14(a). Available from :http://www.fossil.com/attachments/en_US/financials/2011/2011_Proxy_Statement.pdf [Accessedon 25th April, 2012]Masulis RW., Wang C., and Xie F. (2007) Corporate Governance and Acquirer Returns. The Journal ofFinance Vol.LXII, No4.pp1851-1889.Quiry P., Dallocchio M., Fur YL. and Salvi A.(2005) Corporate Finance: Theory and Practice 6th Edition.England: John Wiley & Sons Ltd.Taub, B. (2012) Capital Structure (II): Market frictions [Lecture Slide], BUSI49015 Corporate Finance,Full time MBA Program 2011/2012, Durham Business School, Durham University, Durham UK.Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 24
  25. 25. TM1031 Exchange (2012) Tenant Credit Ratings – 2012 Q2 Available from:http://www.tm1031exchange.com/tenant-credit-ratings.html [Accessed on 2nd May 2012]US Department of The Treasury (2012) Resource Center: Daily Treasury Yield Curves Rates. Availablefrom: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield [Accessed on 25th April 2012]Watson D. and Head A. (2004) Corporate Finance: Principles & Practices 3rd Edition. England: PearsonEducation limited.Yahoo Finance (2012) Fossil Inc (FOSL) Available from:http://finance.yahoo.com/q/ks?s=FOSL+Key+Statistics [Accessed on 20th April 2012]Yahoo Finance (2012) Abercrombie & Fitch Co. (ANF) Available from:http://finance.yahoo.com/q/ks?s=ANF+Key+Statistics [Accessed on 20th April 2012]Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 25
  26. 26. AppendixFossil financialsFigure 12: Income statement of FOSL.Source: Adapted from Morning Star (2012) Fossil Inc. FOSL Available from: http://financials.morningstar.com/income-statement/is.html?t=FOSL&region=USA&culture=en-us [Accessed on 19th April 2012]Figure 13: Balance Sheet of FOSLSource: Adapted from Morning Star (2012) Fossil Inc. FOSL Available from: http://financials.morningstar.com/income-statement/is.html?t=FOSL&region=USA&culture=en-us [Accessed on 19th April 2012]Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 26
  27. 27. Abercrombie & Fitch Co. FinancialsFigure 14: Income statement of ANFSource: Adapted from Morning Star (2012) Abercrombie & Fitch Co ANF Available from: http://financials.morningstar.com/income-statement/is.html?t=ANF&region=USA&culture=en-us [Accessed on 19th April 2012]Figure 15: Balance sheet of ANFSource: Adapted from Morning Star (2012) Abercrombie & Fitch Co ANF Available from: http://financials.morningstar.com/income-statement/is.html?t=ANF&region=USA&culture=en-us [Accessed on 19th April 2012]Author: Deepak Shrivastava (imdshrivastava@gmail.com) Page 27

×