DUCATI CASE STUDY Anastasia Karpova Ekaterina Nere8na Ali Baris Sahin Sena Secilmis Alﬁo Shkreta (equal contribu8on)
Agenda Company snapshot 3 SWOT Analysis 4 Beneﬁts for the seller 5 Turnaround 6 Valua?on summary 7 Exit op?ons 9 Recommenda?on 11
Company Snapshot Global Brand Recogni8on Company is in ﬁnancial distress 1 – Race winner in World Championships 5 – 32.7% decrease in volume growth – 31.7% decrease in revenue – 15 models in 4 motorcycle families – 102% decrease in EBIT Eﬃcient Produc8on – Debt/Equity is 100% 2 – 85% of components are outsourced – High level of standardiza?on World Market Share in Sports Niche Delivering High Margins 3 – EBITDA Margin is 21% – ROA is 30% 5% 6% 4% Duca? Honda 25% Kawasaki Compe88ve Landscape 19% Suzuki Yamaha – 4% share in World 4 – 5% share in Europe 24% 17% BMW Harley – 30% share in Tour Motorcycle 3
SWOT Analysis STRENGHTS OPPORTUNITIES – High barriers to entry – Capacity to expand its market share – Market segmenta?on – Capitalize on diversiﬁed product lines – Top-‐?er technology, top-‐notch engineers – Geographical beneﬁts – Great consumer franchise WEAKNESSES THREATS – Poor Management – On the verge of bankruptcy – Financially intertwined with Cagiva’s – Low switching cost for the customers troubled subsidiaries – Higher produc?on eﬃciency from rivals – Manufacturing boclenecks 4
Beneﬁts and costs for Cas8glioni Brothers With current management Duca8 will bankrupt in 1997 Presale forecast – $130-‐170 Million for 51% of the stake sold to TPG with possible earn out of $65 million Total debt payments EBIT based on EBITDA target – Addi?onal ﬁnancing for Cagiva core division – Lower cost of capital (Deutche) 20,2 16,9 18,7 17,2 The “Lollipop” eﬀect 12,8 16,6 12,1 – Chairman with limited competencies 34,9 15,9 45,8 47,3 52,3 51,4 0,0 – Front page in newspapers – Retain of control in “public eyes” Loss of control – Limited nego?a?on power due to bankruptcy and no-‐shop Revenue Growth % EBITDA marging – Realloca?on of Duca? cash ﬂows to Cagiva 15% 15% 13% 12% 12% 12% 11% – Use Duca? assets as a collateral – Presence in luxury motorcycles niche 24% 14% 11% 7% 5% 4% 50% – R&D team and developments 1997 1998 1999 2000 2001 2002 2003 5
Turnaround Methods Assump8ons Brand awareness Base / Low case – “the Ferrari on two wheels” Long term revenue growth – Duca? experience 9% / 6% Sales Distribu?on system Revenue growth in 1997 100% / 80% Introduce apparel and non-‐motorcycle products Working capital management Base / Low case Accounts receivable – Increase inventory turnover 60 / 90 days Opera?ng – Improve collec?on policy Inventory 40 / 70 days eﬃciency Supplier rela?onships Accounts payable – Payments schedule 50 / 60 days Materials / Revenue – Outsourcing 48% / 53% Develop new products Base / Low case R&D Retain leader posi?on in racing R&D / Revenue 2% / 1% Implement racing technology to street motorcycles 6
Exit op8ons Possible Exit Rationale for IPO Borsa Italiana NYSE – Sale to a strategic buyer Market Capitalization $192.2 bln $7,277 bln – Secondary LBO (sale to another PE ﬁrm) Underpricing premium +20.4% +17.6% – Ini?al Public Oﬀering( IPO) Expected returns +1.5% +0.34% Underwriter’s fee 1.5-2% large cap 7% Method 4-5% small cap – Book Building (99.3% of deals in 1995-‐2004) Listing requirements No book value Book and MC >10 bln lira market – Auc?on 25% equity float requirements No + profitability – Fixed Price Public Oﬀer 3y balance sheets – Hybrid Methods Tax Income tax 27% reduction 19% Lock-up period Voluntarily 180 days Other Op8ons – Full exit 60 Numbers of IPO 48 8 50 Capital raised, bl. EUR 6 – Par?al exit 40 33 30 21 4 IPO op8ons 20 12 15 13 2 10 – Stock Exchange: Borsa Italiana, NYSE, Other 0 0 1995 1996 1997 1998 1999 2000 Source: Arosio, 2000; Gajewski, 2006; Ricer, 2003; 9
Walk away or complete? Possibility to walk away Lecer of Intent: “Agreement to make an agreement” – Binding provisions: walk away fee, break up fee, no shop clause etc. – Pre Contractual Liability in European Law – Breach of exclusivity clause by Duca? – Cagiva cannot demand walk away fee and should reimburse the cost incurred by TPG Complete the deal Since internal value received from valua?on is higher than the deal price TPG should proceed with the deal Threats – Possible bankruptcy – Op?mis?c projec?ons – Vola?le equity market in unstable economy 10
Recommenda8on Recommenda8on – TPG should close the deal – Pay $140 million with earn-‐out provision – IPO in 3 years Terms of deal – No shop agreement – Walk away/break up fee: redeem $7-‐8 mln due diligence cost. – Working Capital Adjustments Term: $30mln – Earn out term: $65 mln if EBITDA in 1997 exceeds 90bln lira – Pre-‐emp?ve right to purchase – Control of Board – Covenant with legal en?ty to avoid bankruptcy – Management op?on: 10% op?on granted in case of IPO 10
Actual Facts – 1996 TPG purchased 51% stake of Duca? for $325 ml*. – 1998 TPG purchased most of the remaining shares – 1999 Listed on Borsa Italiana and NYSE, TPG sold 65% of its shares s?ll remaining majority shareholder – 2005 TPG sold remaining shares to Inves?ndustrial Firms (Italian Private Equity Firm) 11
Appendix – Turnaround Cont’d • Financial Restructuring The issue of the working capital is a major problem for Duca?. The fact that the accounts payable have been “mushroomed” to 100 days was a relief for the short term goal’s of the ﬁrm. Yet because suppliers were not being paid and the major ﬁnancial distress that the enterprise was facing would result ul?mately in 0 supplies. These would ruin the company. In order to avoid such a scenario TPG would need to inject capital star?ng in the year 1996 and that would recapitalize the ﬁrm and allow it to operate normally. • Stronger product name The best racing bikes were manufactured by Duca? aﬃrming it-‐self as superior ﬁrm with edge-‐cuqng engines. Being so widely exposed to the media will further increase the customer base . It will help the new management launch a more eﬃcient marke?ng campaign that would adver?se the new products introduce to the market. Another strategic change is the seqng-‐up on complementary products such as motorcycle helmets, accessories and clothes.
Appendix – Turnaround Cont’d • Re-‐vitalize the rela?onship with sellers The rela?onship with sellers is to be much becer managed and the result would be a stable rela?on. Nurturing trust among the two par?es, by fulﬁlling payments on due ?me, will increase Duca?’s eﬃciency and lower the number of motorcycles laying around in the produc?on plant. • Energe?c and close-‐knit R&D team The engineers of the R&D team of Duca?, especially the racing one, are praised for the high quality of the products that they deliver. The very compe??ve environment that exists in the racing industry pushes for constant innova?on. Ul?mately the fana?cs, loyal and prospec?ve customers of Duca? will beneﬁt from the edge-‐cuqng technologies that will be made available to street motorcycles.
Appendix – Walk away or complete? • In order to decide whether to walk away or quickly complete the deal, deal terms should be assessed. However, before doing that legal result of walk away should be determined. • In lecer of intent there is an exclusivity clause. It means that Cagiva should not shop the deal. Although it is not provided in the case in return of no-‐shop clause Cagiva might have demanded a walk away fee. It is a fee that obliges buyer to pay the agreed amount if buyer decides not to complete the deal. Diﬀerent from U.S. law, European Law recognizes pre-‐contractual liability. Therefore, as we do not know the applicable law, we have to take that into considera?on. Nevertheless, as Cagiva has been in breach of no-‐shop clause which is also a binding term of lecer of intent, walk away from buyer would be jus?ﬁed and buyer would not be required to pay walk away fee. Buyer even may be rewarded its damages (such as due diligence costs) since seller has been in breach of no-‐shop clause. That is to say, without being held liable TPG can walk away from this deal. • Arer coming to the conclusion that TPG can walk away, it remains to discuss whether TPG should walk away from deal or complete to deal. For that purpose terms of the deals should be analyzed to see how advantageous they are and to what extent they meet the concerns of TPG. • Terms: • No shop clause: Explana?on and deﬁni?on made above. • Walk away fee: Explana?on and deﬁni?on made above. • Break up fee: Break up fee is the reverse of walk away fee. It has to be paid by seller to buyer in case seller decides not to complete the deal. In the case it is not stated that break up fee is determined. If there is it is advantageous. However, even there is not a set break-‐up fee if it is European Law is to be applied to contract. For its break up buyer will be held liable under pre-‐contractual liability. However, if U.S. law will be applied, there is a slight chance based on promissory estoppel to held seller liable for the damages. • Working capital adjustments term: According to deal, not all of the purchase price will be paid to Cagiva. Deal provides that a part of deal price will be paid to company so that it is working capital requirements are met. This is a quite advantageous term as most essen?al problem of Duca? is working capital and it will decrease the probability of Duca? to go bankrupt. In addi?on as Cagiva will have 49% percent of the Duca? arer closing the deal, 49% of this amount shall be deemed to be paid to Cagiva. • Covenant with the legal en8ty selling Duca8 to technically avoid insolvency: It is also a term to avoid insolvency. • Earn out term: This term will allow TPG to pay somewhere between 20-‐25% of the deal price on the condi?on that previously set EBITDA targets are met. This also decrease the probability of TPG facing a loss arising from failure to improve Duca?’s performance. • Control of Board: According to deal TPG will control the board un?l TPG’s interest drop under 10%. It is also a very advantageous term that ensures that TPG will achieve its goals. It especially takes TPG’s par?al exit from the investment. However, it should be noted that it may not bind third par?es but only Cagiva. In addi?on there is a term to avoid bot party to collect majority of public shares in IPO. It also ensures that management will remain at TPG. With all these provisions deal set in a way to make sure that TPG will achieve its goals. Source Balz 2004; Tene, 2006
Appendix – Lis8ng Requirements Lis8ng Standards -‐ United States Round-‐lot Holders 400 U.S. Alterna8ve #3 -‐ Aﬃliated Company Public shares 1,100,00 outstanding For new en??es with a parent or aﬃliated Market Value of Public Shares $40 million company listed on the NYSE IPOs, Spin-‐oﬀs, Carve-‐Outs, Aﬃliates $100 million Global Market Capitaliza0on $500 million Opera0ng History 12 months Financial Criteria Alterna8ve #1 -‐ Earnings test Alterna8ve #4 -‐ Asset and Equity Aggregate pre-‐tax income for last 3 years $10 million Global Market Capitaliza0on $150 million Minimum in each of the most 2 recent Total Assets $75 million years; Third year must be posi0ve $2 million Stockholders Equity $50 million Alterna8ve #2a -‐ Valua8on with Cash Flow REITs Global Market Capitaliza0on $500 million Stockholders Equity $60 million Revenues (most recent 12-‐month period) $100 million Adjusted Cash Flow: Funds and BDCs Aggrehate for the last 3 year Net Assets $60 million All 3 years must be posi0ve $25 million Source: NYSE EURONEXT