Southern Comfort Corporation Case Summary
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Brown-Forman Board Report | Potential Acquisition of Southern Comfort Corporation | | This board report summarizes the arguments for why it is believed that the acquisition of Southern Comfort Corporation (including Caligrapo Inc.) is a strategic fit that will increase shareholder value through increased sales and profitability | | Vinny Perumal | 3/7/2011 | |
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 …show more content…
(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. Executive Summary
In 1978, Brown-Foreman Corporation was a successful producer and marketer of alcoholic beverages operating mainly in the United States market. The company through the acquisition of brands such as Jack Daniels, Bolla and Canadian Mist expanded its premium product lines. The company spent large sums of money advertising premium brands and significantly less on low profit brands. In the late 1970’s, the whiskey market declined and this presented Brown Foreman with growth challenges in a mature dwindling market.
Brown-Foreman’s response to market pressures and competition was to aggressively move into other faster growing segments of the alcohol beverage market which required it to expand its product lines. The company also intended to increase its advertising spend to $86 million to aggressively promote its alcoholic product lines. The company also realised that future growth was very dependent on it gaining access to foreign markets quickly.
The company was presented with an interesting offer to purchase Southern Comfort for an amount of $94.6m. This report supports the view that Southern Comfort is an attractive horizontal acquisition for Brown-Foreman and provides the following value if acquired; * One fifth of the Southern Comfort sales were overseas. Its exports market also had the highest 5 year compound growth rate of 37.8% than its other channel markets * Much like the Jack Daniels brand, the company developed a distinctive brand with loyal customers * Southern Comfort being a liqueur does not need to age and can be produced and sold much faster than the traditional whiskey line * Southern Comfort is a profitable company with a profit/sales ratio as high as 7% on par with Brown-Foreman * With an acquisition, shareholders value will increase with the earnings per share earnings per share will increase 16% from 2.45 to 2.82 and the share value increases increase from $16.9 to $18.2. * Southern Comfort has a higher than average sales/assets ratio of 2.49. This may be an indication of efficiency and could be impacted by factors such as economies of scale where much larger sales of a single line product may be able to gain the economies by minimising the fixed cost per unit as a result of higher production levels. 2. Background
An Industry Analysis
A Mature Industry
The distiller industry is in the maturity phase of its industry life cycle (which is the supply side equivalent of the product life cycle model). The increasing market saturation has caused tapered demand, replacement products and fierce competition in the industry. As there is limited market growth, the increase in demand for one product line is at the expense of others. Cost efficiencies are increasingly being sort through capital intensity, scale efficiencies and lower input costs.
Increased market saturation in developed markets has caused the Distiller industry to focus its attention on developing markets. As price competition increases in the saturated mass market, there is also increased focus on attempts to differentiate through branding, quality and increased brand loyalty to encourage repeat purchases.
Key Success Factors
According to Grant (2010), in order to proposer and survive organisations must meet two important criteria that is, supply what customers want to buy and survive competition by constantly evolving and adapting the organisation to meet the dynamic external changes. Applying this model to the distiller industry, we can identify the key success factors required in order to survive and prosper in this industry.
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.
| Industry Average | Brown-Foreman | Comments | 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. | Sales/Assets | 1.43 | 1.46 | The sales to assets indicate the level of sales that are generated by the use of assets and can be seen as a measure of efficiency. This indicator for Brown Foreman slightly over the industry average of 1.43 indicating an average level of efficiency when compared to its competitors. | Profit/Sales | 0.04 | .073 | Brown-Foreman has the highest ratio of profit to sales which indicates an excellent performance with only Hirman Walker coming close with a ratio of 0.069. The industry average is 0.04. By converting the most sales into profit Brown-Foreman is the most profitable amongst its peers. | Price/Earnings | 8.37 | 8.2 | Generally all competitors are creating good value for their shareholders. | Dividend YieldAt 4/14/78 | 0.06 | .043 | This ratio indicates the level of dividends 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 growth rate | 0.07 | .102 | Even in a market where there is a slowdown 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 sales growth | 0.06 | .09 | Brown-Foreman has the highest expected 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 Value | 0.88 | 1.26 | This ratio looks at how the market values 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.
1 Qualitative Analysis
Strategic Analysis
Brown Foreman has clearly achieved a competitive advantage through a differentiation strategy which places more emphasis on branding, advertising, quality and understanding customer’s needs. The company has managed to create premium brands such as Jack Daniels through aggressive marketing and high advertising spend. The company has also build strong marketing skills to enable the organisation to differentiate its products based on brand positions. A differentiation strategy offers a more secure basis for competitive advantage clearly demonstrated by its strong sales growth than a low cost strategy.
SWOT Analysis
In comparison to its competitors, Brown Foreman’s most outstanding weakness is its lack of a global footprint to achieve economies of scale and entry into new markets. It also needed to expand its product line to cater for the changing consumer preference.
Strategic Fit
The possible acquisition could create a good strategic fit with Southern Comfort addressing some of Brown-Foreman’s immediate market and competitive pressures.
Achieving Economies of Scale
In order for Brown to achieve the economies of scale it needs to improve efficiencies and increase profitability, the company needs to look at international market expansion. In order to achieve this, it needs an extensive global distribution footprint. Southern Comfort has a higher than average sales/assets ratio of 2.49. This may be an indication of efficiency and could be impacted by factors such as economies of scale where much larger sales of a single line product may be able to gain the economies by minimising the fixed cost per unit as a result of higher production levels. It would be easier and quicker for Brown to acquire an international footprint than to build it and to leverage Southern Comfort proven capabilities in this area.
Achieving Synergy
The acquisition could see a duplication of functions which can be reduced by sharing resources such sales staff, buildings and logistics which will bring savings and lower overhead costs. The acquisition will be beneficial to Brown Foreman if the combined organisation has value greater than the sum of the values of the separate organisation.
Sьѕ > Sь + Ss
Sьѕ > Sь + Ss Where S= Synergy, B =Brown & S = Southern Comfort *
Increasing Resources and Capabilities
Southern Comfort has a number of tangible and intangible resources which will address the gaps in Brown Foreman growth strategies through an acquisition. From a tangible resource perspective, its plants is equipped with modern equipment, it has strong financials as indicated by its net profit margin 7% in 1977. Its strong intangible resources and capabilities are its secret recipe to expand Brown Forman’s product line, its strong brand and its management and sales team skills.
Quantitative Analysis
Comparison of Southern Comfort to its peers*
The company is in healthy financial state. Income from operations went up by 15% indicating strong operational performance and the company is able to sell more effectively than its peers. Refer to appendix 2 for details.
*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.
Increasing Shareholder Value
Return rate (Gross Profit)
Currently Southern Comfort is showing a good average gross profit growth rate of 7% which will enhance the shareholder value after the acquisition. The company shows a healthy 5 year forecast but growth slows and then declines in year 10 by -1.15 %( Refer to Appendix 3). This slow down and decline could be attributed to the lifecycle of the product. The product could have reached maturity and will need some form of innovation.
The Earnings per share
The level of value created for shareholders individually is not only dependant on the company’s results, but also the number of shares held. If the acquisition goes ahead, the number of Brown-Foreman shareholders stays the same and as such shares are not diluted. This means that earnings per share will go up from $2.45 to $2.82 that is a 16% increase (assuming the net income growth for Southern Comfort will be the same for 1978 as the growth rate from 1976-1977). Refer to appendix 2
Share
Value
After acquisition share value will increase from $16.9 to $18.2 due the fact that there is no increase in share amounts. The shares are not being diluted so shareholders will be getting more from each share held. Refer to appendix 2
Asset/Equity Ratio
There will be an improvement in the asset/equity ratio from 1.37 to 1.44 after a merger implying the assets have increased in relation to shareholders equity. These increased assets can be used to generate more revenue for the company. Brown-Forman’s ratio pre-merger was below industry average.
Cash Flows
Both Companies show positive cash flow from operations. Southern Comfort Cash flows was done for 1976-1977 and would be indicative of the following year provided nothing drastic occurs. The cash flow for these companies both look strong and this will be good for Brown-Foreman in an acquisition. This also implies that they will be able to finance the $70 million easily from cash flows. Refer to appendix 4
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.
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.
Appendix 1: Competitor Analysis | | | | | | | | | | | | BROWN-FORMAN DISTILLERS CORPORATION | | | | | | | | | | | | Comparative Financial Data, 1978 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | American | Brown- | | National | Publicker | | Hiram | Average | Comments | | | | | | | Distilling | Forman | Heublein | Distilling | Industries | Seagram | Walker | | | | | | | | | -------- | -------- | -------- | -------- | -------- | -------- | -------- | | | | | | | | Beta | 1.41 | 1.10 | 1.71 | 0.79 | 1.63 | 1.04 | 0.65 | 1.19 | Lower volatility than average | | | | 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 | | Debt-cash/total capital | 0.50 | 0.11 | 0.28 | 0.16 | 0.44 | 0.32 | 0.12 | 0.28 | Debt to total capital is the lowest | Assets/equity | 2.46 | 1.37 | 2.16 | 1.65 | 2.04 | 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 | 0.012 | 0.073 | 0.035 | 0.052 | 0.005 | 0.038 | 0.069 | 0.04 | Highest Net profit ratio | | | | | Price/earnings | 9.4 | 8.2 | 9.6 | 6.5 | NMF | 8.8 | 7.7 | 8.37 | Creating good value for their shareholders | | | Dividend yield at 4/14/78 | NIL | 0.043 | 0.056 | 0.080 | NIL | 0.042 | 0.062 | 0.06 | Lower than competitors | | | | | Self-sustaining growth rate | 0.049 | 0.102 | 0.053 | 0.079 | 0.015 | 0.041 | 0.054 | 0.07 | Highest rate amongst its peers | | | | 1978 expected sales growth | 0.02 | 0.09 | 0.06 | 0.08 | 0.04 | 0.07 | 0.06 | 0.06 | The market has good expectations of sales growth | | Market value/book value | 0.46 | 1.26 | 1.53 | 0.79 | 0.63 | 0.75 | 0.77 | 0.88 | Relatively higher market to book value. | | | | | | | | | | | | | | | |
| Appendix 2: Key Ratios | | | Industry Analysis: Southern Comfort | 1977 | | Profit/Sales | 6.81% | | Sales/Assets | 2.49 | | Book Value | 15m | | Debt/Equity | 0.539 | | Debt/Total Assets | 0.35 | | | | | Earnings Per Share for Brown Foreman | 1978 | | Projected net income for Southern Comfort** | 5 245 754 | | Net income of BF for 1978 | 31 247 000 | | No of Shares | 12 908 739 | | Net Income* of BF + Net Income of SC**/no of shares | 2.826981 | | | | | *Divided the earnings by EPS to get the no of shares | | ** Net income growth bet 1976 and 1977 is 20% based on this we assume that it will have the same growth rate bet 1977 to 1978 | Assets/Equity Ratio after merger | 1979 | | SC assets forecast growth at 5.52% for 1979 | 28 668 651 | | BF assets forecast growth at7.2% for 1979 | 352 339 000 | | Combined Assets of BF+ SC | 381 007 651 | | SC equity forecast growth at 23% for 1979 | 25 453 654 | | BF equity forecast growth at 9.72% for 1979 | 239 436 000 | | Combined Equity of BF + SC | 264 889 654 | | Assets/Equity after Merger | 1.4 | | Share Value | 1978 | | Share Value for Brown Foreman before acquisition | 16.9 | | Share Value for Brown Foreman after acquisition | 18.2 |
Appendix 5: Cost of Capital | | | | | | Using CAPM | | | | | | | | | | | | Cost of Equity | | | | | | Rf rate = | 8.00% | | | | | Beta = | 1.1 | | | | | Rpm*= | 5.70% | | | | | | | | | | | Re = | 14.27% | | | | | | | | | | | | | | | | | Cost of Debt | | | | | | Tax rate = | 50.70% | | | | | | (1-.507) | | | | | Interest rate | 8.75% | | | | | Cost of Debt | 4.31% | | | | | | | | | | | WACC | | | | | | Percentage of equity cost | 22.00% | | | | | Percentage of debt cost | 78.00% | | | | | WACC | 6.50% | | | | | | | | | | | *The 10 year treasury bond was used as the risk free rate and the geometric mean for the risk premium | | Retained earnings is a component of cost of equity | | | | |
Brown-Forman Board Report | Potential Acquisition of Southern Comfort Corporation | | This board report summarizes the arguments for why it is believed that the acquisition of Southern Comfort Corporation (including Caligrapo Inc.) is a strategic fit that will increase shareholder value through increased sales and profitability | | Vinny Perumal | 3/7/2011 | |
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 …show more content…
(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. Executive Summary
In 1978, Brown-Foreman Corporation was a successful producer and marketer of alcoholic beverages operating mainly in the United States market. The company through the acquisition of brands such as Jack Daniels, Bolla and Canadian Mist expanded its premium product lines. The company spent large sums of money advertising premium brands and significantly less on low profit brands. In the late 1970’s, the whiskey market declined and this presented Brown Foreman with growth challenges in a mature dwindling market.
Brown-Foreman’s response to market pressures and competition was to aggressively move into other faster growing segments of the alcohol beverage market which required it to expand its product lines. The company also intended to increase its advertising spend to $86 million to aggressively promote its alcoholic product lines. The company also realised that future growth was very dependent on it gaining access to foreign markets quickly.
The company was presented with an interesting offer to purchase Southern Comfort for an amount of $94.6m. This report supports the view that Southern Comfort is an attractive horizontal acquisition for Brown-Foreman and provides the following value if acquired; * One fifth of the Southern Comfort sales were overseas. Its exports market also had the highest 5 year compound growth rate of 37.8% than its other channel markets * Much like the Jack Daniels brand, the company developed a distinctive brand with loyal customers * Southern Comfort being a liqueur does not need to age and can be produced and sold much faster than the traditional whiskey line * Southern Comfort is a profitable company with a profit/sales ratio as high as 7% on par with Brown-Foreman * With an acquisition, shareholders value will increase with the earnings per share earnings per share will increase 16% from 2.45 to 2.82 and the share value increases increase from $16.9 to $18.2. * Southern Comfort has a higher than average sales/assets ratio of 2.49. This may be an indication of efficiency and could be impacted by factors such as economies of scale where much larger sales of a single line product may be able to gain the economies by minimising the fixed cost per unit as a result of higher production levels. 2. Background
An Industry Analysis
A Mature Industry
The distiller industry is in the maturity phase of its industry life cycle (which is the supply side equivalent of the product life cycle model). The increasing market saturation has caused tapered demand, replacement products and fierce competition in the industry. As there is limited market growth, the increase in demand for one product line is at the expense of others. Cost efficiencies are increasingly being sort through capital intensity, scale efficiencies and lower input costs.
Increased market saturation in developed markets has caused the Distiller industry to focus its attention on developing markets. As price competition increases in the saturated mass market, there is also increased focus on attempts to differentiate through branding, quality and increased brand loyalty to encourage repeat purchases.
Key Success Factors
According to Grant (2010), in order to proposer and survive organisations must meet two important criteria that is, supply what customers want to buy and survive competition by constantly evolving and adapting the organisation to meet the dynamic external changes. Applying this model to the distiller industry, we can identify the key success factors required in order to survive and prosper in this industry.
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.
| Industry Average | Brown-Foreman | Comments | 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. | Sales/Assets | 1.43 | 1.46 | The sales to assets indicate the level of sales that are generated by the use of assets and can be seen as a measure of efficiency. This indicator for Brown Foreman slightly over the industry average of 1.43 indicating an average level of efficiency when compared to its competitors. | Profit/Sales | 0.04 | .073 | Brown-Foreman has the highest ratio of profit to sales which indicates an excellent performance with only Hirman Walker coming close with a ratio of 0.069. The industry average is 0.04. By converting the most sales into profit Brown-Foreman is the most profitable amongst its peers. | Price/Earnings | 8.37 | 8.2 | Generally all competitors are creating good value for their shareholders. | Dividend YieldAt 4/14/78 | 0.06 | .043 | This ratio indicates the level of dividends 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 growth rate | 0.07 | .102 | Even in a market where there is a slowdown 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 sales growth | 0.06 | .09 | Brown-Foreman has the highest expected 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 Value | 0.88 | 1.26 | This ratio looks at how the market values 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.
1 Qualitative Analysis
Strategic Analysis
Brown Foreman has clearly achieved a competitive advantage through a differentiation strategy which places more emphasis on branding, advertising, quality and understanding customer’s needs. The company has managed to create premium brands such as Jack Daniels through aggressive marketing and high advertising spend. The company has also build strong marketing skills to enable the organisation to differentiate its products based on brand positions. A differentiation strategy offers a more secure basis for competitive advantage clearly demonstrated by its strong sales growth than a low cost strategy.
SWOT Analysis
In comparison to its competitors, Brown Foreman’s most outstanding weakness is its lack of a global footprint to achieve economies of scale and entry into new markets. It also needed to expand its product line to cater for the changing consumer preference.
Strategic Fit
The possible acquisition could create a good strategic fit with Southern Comfort addressing some of Brown-Foreman’s immediate market and competitive pressures.
Achieving Economies of Scale
In order for Brown to achieve the economies of scale it needs to improve efficiencies and increase profitability, the company needs to look at international market expansion. In order to achieve this, it needs an extensive global distribution footprint. Southern Comfort has a higher than average sales/assets ratio of 2.49. This may be an indication of efficiency and could be impacted by factors such as economies of scale where much larger sales of a single line product may be able to gain the economies by minimising the fixed cost per unit as a result of higher production levels. It would be easier and quicker for Brown to acquire an international footprint than to build it and to leverage Southern Comfort proven capabilities in this area.
Achieving Synergy
The acquisition could see a duplication of functions which can be reduced by sharing resources such sales staff, buildings and logistics which will bring savings and lower overhead costs. The acquisition will be beneficial to Brown Foreman if the combined organisation has value greater than the sum of the values of the separate organisation.
Sьѕ > Sь + Ss
Sьѕ > Sь + Ss Where S= Synergy, B =Brown & S = Southern Comfort *
Increasing Resources and Capabilities
Southern Comfort has a number of tangible and intangible resources which will address the gaps in Brown Foreman growth strategies through an acquisition. From a tangible resource perspective, its plants is equipped with modern equipment, it has strong financials as indicated by its net profit margin 7% in 1977. Its strong intangible resources and capabilities are its secret recipe to expand Brown Forman’s product line, its strong brand and its management and sales team skills.
Quantitative Analysis
Comparison of Southern Comfort to its peers*
The company is in healthy financial state. Income from operations went up by 15% indicating strong operational performance and the company is able to sell more effectively than its peers. Refer to appendix 2 for details.
*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.
Increasing Shareholder Value
Return rate (Gross Profit)
Currently Southern Comfort is showing a good average gross profit growth rate of 7% which will enhance the shareholder value after the acquisition. The company shows a healthy 5 year forecast but growth slows and then declines in year 10 by -1.15 %( Refer to Appendix 3). This slow down and decline could be attributed to the lifecycle of the product. The product could have reached maturity and will need some form of innovation.
The Earnings per share
The level of value created for shareholders individually is not only dependant on the company’s results, but also the number of shares held. If the acquisition goes ahead, the number of Brown-Foreman shareholders stays the same and as such shares are not diluted. This means that earnings per share will go up from $2.45 to $2.82 that is a 16% increase (assuming the net income growth for Southern Comfort will be the same for 1978 as the growth rate from 1976-1977). Refer to appendix 2
Share
Value
After acquisition share value will increase from $16.9 to $18.2 due the fact that there is no increase in share amounts. The shares are not being diluted so shareholders will be getting more from each share held. Refer to appendix 2
Asset/Equity Ratio
There will be an improvement in the asset/equity ratio from 1.37 to 1.44 after a merger implying the assets have increased in relation to shareholders equity. These increased assets can be used to generate more revenue for the company. Brown-Forman’s ratio pre-merger was below industry average.
Cash Flows
Both Companies show positive cash flow from operations. Southern Comfort Cash flows was done for 1976-1977 and would be indicative of the following year provided nothing drastic occurs. The cash flow for these companies both look strong and this will be good for Brown-Foreman in an acquisition. This also implies that they will be able to finance the $70 million easily from cash flows. Refer to appendix 4
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.
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.
Appendix 1: Competitor Analysis | | | | | | | | | | | | BROWN-FORMAN DISTILLERS CORPORATION | | | | | | | | | | | | Comparative Financial Data, 1978 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | American | Brown- | | National | Publicker | | Hiram | Average | Comments | | | | | | | Distilling | Forman | Heublein | Distilling | Industries | Seagram | Walker | | | | | | | | | -------- | -------- | -------- | -------- | -------- | -------- | -------- | | | | | | | | Beta | 1.41 | 1.10 | 1.71 | 0.79 | 1.63 | 1.04 | 0.65 | 1.19 | Lower volatility than average | | | | 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 | | Debt-cash/total capital | 0.50 | 0.11 | 0.28 | 0.16 | 0.44 | 0.32 | 0.12 | 0.28 | Debt to total capital is the lowest | Assets/equity | 2.46 | 1.37 | 2.16 | 1.65 | 2.04 | 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 | 0.012 | 0.073 | 0.035 | 0.052 | 0.005 | 0.038 | 0.069 | 0.04 | Highest Net profit ratio | | | | | Price/earnings | 9.4 | 8.2 | 9.6 | 6.5 | NMF | 8.8 | 7.7 | 8.37 | Creating good value for their shareholders | | | Dividend yield at 4/14/78 | NIL | 0.043 | 0.056 | 0.080 | NIL | 0.042 | 0.062 | 0.06 | Lower than competitors | | | | | Self-sustaining growth rate | 0.049 | 0.102 | 0.053 | 0.079 | 0.015 | 0.041 | 0.054 | 0.07 | Highest rate amongst its peers | | | | 1978 expected sales growth | 0.02 | 0.09 | 0.06 | 0.08 | 0.04 | 0.07 | 0.06 | 0.06 | The market has good expectations of sales growth | | Market value/book value | 0.46 | 1.26 | 1.53 | 0.79 | 0.63 | 0.75 | 0.77 | 0.88 | Relatively higher market to book value. | | | | | | | | | | | | | | | |
| Appendix 2: Key Ratios | | | Industry Analysis: Southern Comfort | 1977 | | Profit/Sales | 6.81% | | Sales/Assets | 2.49 | | Book Value | 15m | | Debt/Equity | 0.539 | | Debt/Total Assets | 0.35 | | | | | Earnings Per Share for Brown Foreman | 1978 | | Projected net income for Southern Comfort** | 5 245 754 | | Net income of BF for 1978 | 31 247 000 | | No of Shares | 12 908 739 | | Net Income* of BF + Net Income of SC**/no of shares | 2.826981 | | | | | *Divided the earnings by EPS to get the no of shares | | ** Net income growth bet 1976 and 1977 is 20% based on this we assume that it will have the same growth rate bet 1977 to 1978 | Assets/Equity Ratio after merger | 1979 | | SC assets forecast growth at 5.52% for 1979 | 28 668 651 | | BF assets forecast growth at7.2% for 1979 | 352 339 000 | | Combined Assets of BF+ SC | 381 007 651 | | SC equity forecast growth at 23% for 1979 | 25 453 654 | | BF equity forecast growth at 9.72% for 1979 | 239 436 000 | | Combined Equity of BF + SC | 264 889 654 | | Assets/Equity after Merger | 1.4 | | Share Value | 1978 | | Share Value for Brown Foreman before acquisition | 16.9 | | Share Value for Brown Foreman after acquisition | 18.2 |
Appendix 5: Cost of Capital | | | | | | Using CAPM | | | | | | | | | | | | Cost of Equity | | | | | | Rf rate = | 8.00% | | | | | Beta = | 1.1 | | | | | Rpm*= | 5.70% | | | | | | | | | | | Re = | 14.27% | | | | | | | | | | | | | | | | | Cost of Debt | | | | | | Tax rate = | 50.70% | | | | | | (1-.507) | | | | | Interest rate | 8.75% | | | | | Cost of Debt | 4.31% | | | | | | | | | | | WACC | | | | | | Percentage of equity cost | 22.00% | | | | | Percentage of debt cost | 78.00% | | | | | WACC | 6.50% | | | | | | | | | | | *The 10 year treasury bond was used as the risk free rate and the geometric mean for the risk premium | | Retained earnings is a component of cost of equity | | | | |