Specialty Fashion Group Executive Summary

Executive Summary
Specialty Fashion Group (SFG) is an Australian clothing retailer which functions primarily in the Women’s market. The company first came into operation under the name “Millers” in 1993 and hence since grown to house 5 additional brands under the group portfolio. This report was structured to first discuss the firms’ strategy in navigating the ever changing retail environment, before evaluating its’ current valuation. Following which a credit analysis was performed to determine if additional debt could be taken on to fund future strategic goals. With the results of the credit analysis, a proposed acquisition deal was structured and finally a final recommendation on what SFG should do was made.
For the valuation of SFG,
a combination of 2 techniques were used which were the comparable companies and discounted cash flow analysis techniques. Analysis of the comparable companies data was used to arrive at an initial valuation range using trading multiples. Following which, FCF was forecasted for SFG and the values discounted back at the appropriate discount rates to arrive at an implied equity value. This coupled with a sensitivity analysis based on forecasted growth rates allowed for a comparison with the range obtained from the comparable companies method.
A credit analysis was performed to determine the creditworthiness of the company based on past historical financials and ratios. This was performed with the purpose of obtaining a higher loan facility than the current one for future strategic purposes such as a potential acquisition. Based on the forecasted EBITDA numbers, a sensitivity analysis was performed and found that the new loan amount requested did not place the company at any high risk of default.
With the approval of the new loan facility, a potential acquisition was proposed based on the firms’ future strategic goals. Valuation was performed to evaluate if the acquisition was beneficial and to determine what price should be offered. Following which, a teaser document was generated summarising the highlights of the proposed acquisition.
Finally the recommendation was made that SFG should proceed with the proposed acquisition in view of the analysis performed above.
Table of Contents

1.0 Introduction 1
1.1 Company overview (Specialty Fashion Group) 1
1.2 Clothing and retailing industry 2
2.0 Valuation techniques 4
2.1 Comparable companies (transaction multiples) 4
2.2 Discounted cash flow (adjusted present value) 6
2.2.1 Assumptions 6
2.2.2 Forecasting free cash flow (FCF) 7
2.2.3 Derivation of an implied share price for SFG 8
2.2.4 Sensitivity analysis 9
3.0 Credit analysis 10
3.1 Financial statement analysis 10
3.2 Industry analysis 11
3.3 Board and management Analysis 12
3.4 Sensitivity analysis 13
3.5 Increased loan facility 14
4.0 Merger and acquisition (M&A) 15
4.1 The future of SFG in the clothing retailing industry 15
4.2 Target firm: Noni B Limited (NBL) 16
4.2.1 Strategic fit 16
4.2.2 Market position and regulatory concerns 17
4.2.3 Financial capacity 17
4.2.4 Valuation of NBL 17
4.2.5 Valuation of synergies 18
4.3 Acquisition proceedings 19
5.0 Teaser document 20
6.0 Recommendation 22
References 23
Appendices 25

Appendix 1: Calculation of transaction multiples 25
Appendix 2: Benchmarking of transaction multiples 25
Appendix 3: Derivation of implied valuation range from transaction multiples 26
Appendix 4: Explanation of line items for the derivation of forecasted FCF 26
Appendix 5: Line item forecast for FCF calculations 28
Appendix 6: Interest tax shield calculations 28
Appendix 7: Equity value and implied share price calculation 29
Appendix 8: Sensitivity analysis using growth rate as a variable 29
Appendix 9: Key management and board of directors qualifications 29
Appendix 10: 2014-2019 EBITDA forecast (in $ millions) 32
Appendix 11: KVM graphical output for the probability of default on the loan 32
Appendix 12: Additional covenants attached to the increase in loan facility 33
Appendix 13: Calculation of implied share price for NBL 33
Appendix 14: Synergistic benefit from NBL adopting SFG’s online platform 34
Appendix 15: Cost saving synergies from NBL utilising cheaper overseas suppliers 34

List of figures
Figure 1: Industry concentration and market share of major players 7
Figure 2: Valuation range of SFG derived from comparison of EV/gross profit and EV/EBITDAR 11
Figure 3: Probability plot for the EBITDA sensitivity analysis 18

List of tables
Table 1: Comparable companies profile 9
Table 2: Enterprise value derivation for SFG 13
Table 3: Key financials for the previous 5 years 15
Table 4: Key financial ratio analysis for the past 5 years 16
Table 5: Enterprise value derivation for NBL 23
List of abbreviations
APV – Adjusted present value
CapEx – Capital expenditure
COGS – Cost of goods sold
CRM – Customer Relationship Management
CTY – Country Road Limited
GFC – Global Financial Crisis
M&A – Merger and acquisition
NBL – Noni B Limited
NOPAT – Net operating profit after tax
NWC – Net working capital
ORL – OrotonGroup Limited
PMV – Premier Investments Limited
PV – Present value
SFG – Specialty Fashion Group
SGA – Selling, general and administrative

1.0 Introduction
1.1 Company overview (Specialty Fashion Group)
Founded in 1993, Specialty Fashion Group (SFG) first opened its’ “Millers” stores in the Australian state of New South Wales (NSW). Since then it has transformed into the largest women’s fashion retailer in Australasia, with 1091 stores in Australia, New Zealand and the United States (Specialty Fashion Group, 2013). Brands under the company include Millers, City Chic, Crossroads, Katies, Autograph and Rivers. With the exception of Rivers, the 5 other brands sell apparel catered exclusively for women.
Business revenues for the past 4 years have been stagnant, with an average change of -0.2%. Expenses such as rental and employee benefits have been increasing over the same period at an average of 4.3% and 4.5% respectively. The poor performance over the period has been attributed to discounting tactics employed to attract customers and the bad conditions facing the Australian retail market (IBISWorld, 2013).
The core strategies of the company include optimising the supply chain, developing and enhancing customer interaction and increasing sales via different channels. To optimise the supply chain, the company increased the proportion of products sourced directly from overseas suppliers. This coupled with closer relationships and a favourable exchange rate resulted in a 3.76% increase in the gross margin for the financial year 2013 (Specialty Fashion Group, 2013). Online sales accounted for 3.8% of total revenue which was 50% up from the previous year, representing the firms’ ongoing efforts to improve sales from their online channels.
With the recent acquisition of Rivers, the company reinforces their strategy of increasing their presence in the clothing retailing industry (Chanthadavong, 2013). The acquisition also represented SFG’s entry into the men’s footwear market, and the investment is expected to contribute $77.4m to group revenue in the 2013-2014FY (IBISWorld, 2013).

1.2 Clothing and retailing industry
SFG operates within this industry, which excludes online-based retailers and departmental stores. The industry is noticeable for the intense competition between companies and a low market concentration (Magner, 2014). From Figure 1, the top 4 players in the industry capture only 20% of the market while the remaining 80% is shared among a large number of smaller players. It is of note that most players in the industry choose serve only one customer segment instead of targeting the entire market.

Figure 1: Industry concentration and market share of major players

Key economic drivers that affect companies in the industry include real household disposable income, consumer sentiment, exchange rate of the Australian dollar and indirectly, consumer savings (Australian National Retailers Association, 2011). Other factors that have a huge impact on Australian retailers include international retailers entering the domestic market and the high rate at which Australians are embracing technology to aid in product search, price comparisons and to complete the purchase. This has led to overseas retailers such as London based ASOS actively targeting online shoppers in Australia (Pearson, 2013).
Besides online shopping, another significant factor that affects companies in the industry include the arrival of big name international retailers (Zara, H&M and Uniqlo) into Australia (Magner, 2014). With experience and efficiency in managing the supply chain along with streamlining other operational processes, the international retailers have made competition tighter within the industry.
Regulation and policy within this industry varies between states in Australia, with the Australian National Retailers Association (ANRA) highlighting that consumers bear the costs of the discrepancy (Australian National Retailers Association, 2014a). Regulation regarding trading hours has caused domestic retailers to suffer competitively against online retailers (which do not face such regulations). Hence ANRA is pushing towards complete deregulation of trading hours in all states (2014b). This move is expected to increase consumer demand for clothing and apparel (Magner, 2014).

2.0 Valuation techniques
In the following sections, the valuation techniques used to derive the valuation of SFG was elaborated upon. Acknowledging that each valuation technique is accompanied by its own strengths and weaknesses, a combination of discounted cash flow and comparable companies was used to arrive at a valuation of SFG.
2.1 Comparable companies (transaction multiples)
This method was chosen as it provided a fast and convenient method to derive a valuation for SFG. The information required was readily obtained from public data which provided a valuation that was current, based on market perception and sentiment (Rosenbaum & Pearl, 2009).
However as the method relies heavily on market data, the valuation derived can be biased during periods of unwarranted market optimism or bearishness. Some feel that by concentrating company information to derive a set of multiples, effect of different drivers on valuation can be hard to discern (Suozzo, Cooper, Sutherland & Deng, 2001).
The following four Australian companies were chosen from the clothing retailing industry as comparable companies for SFG:
Table 1: Comparable companies profile
Comparable companies
Core business
Adjusted
EBITDA margin
Adjusted
gross profit margin
Premier Investments Limited (PMV)
Women 's fashion
12.7%
61.6%
Noni B Limited (NBL)
Women 's fashion
4.2%
59.7%
OrotonGroup Limited (OGL)
Women 's fashion
13.5%
63.1%
Country Road Limited (CTY)
Women 's fashion
9.2%
64.2%

From Table 1, companies were chosen based on their business profile being players in the Australian women’s fashion market as well as employing a multi-channel approach to obtain sales. The financial profiles (EBITDA and gross profit margin) were also considered when making the selection for the comparables.
These companies are likely to experience the same economic drivers as SFG, along with the adverse effects that could impact business performance such as revenues and costs.
Financial information was analysed up to and including the 2013/2014 interim reports. Calendarization was performed for Premier Investments Limited and OrotonGroup as both had financial years that ended a month after the rest of the companies. Care was taken to remove the effects of any non-recurring from the financials of the companies under analysis.
The multiples for gross profit, EBITDAR and revenue were computed for the 4 comparables and the results are displayed in Appendix 1. Rental expense was added back to EBITDA, as companies in the retail industry have rent as a significant cost in their operations expense. Doing so would result in a multiple value that best represents the companies in the industries. The decision was made to focus on enterprise value based multiples as they are independent of capital structure. This eliminated any differences brought about by differing capital structures between the comparables.
From the results of the multiples calculations, the comparables were benchmarked to the actual multiples of SFG. From the benchmarking of the 3 chosen multiples, NBL and CTY were observed to be the closest comparables to SFG (Appendix 2). This provided a narrower range for analysis, from which the valuation range could be derived.
From Appendix 3, the implied share prices were derived for each of the transaction multiples considered. A tighter valuation range was obtained by comparing the implied valuations from the 3 transaction multiples.

Figure 2: Valuation range of SFG derived from comparison of EV/gross profit and EV/EBITDAR
From Figure 2, the implied share price of SFG was narrowed down to $0.26 - $1.31.
2.2 Discounted cash flow (adjusted present value)
The adjusted present value (APV) technique is useful when valuing companies that have shifting Debt to Equity ratios and also provides more avenues to account for indirect debt costs. If the costs are not accurately reflected in the pre-tax cost of debt, APV would provide a more conservative valuation than the weighted average cost of capital (WACC) method (Damodaran, 2005).
However one of the potential drawbacks of using APV is the effect of understating or ignoring of the costs of financial distress, which could lead to an overvaluation if the firm in question has high amounts of debt.
With SFG presenting shifting capital structure for the past 5 years, a shifting beta should be used to reflect the dynamic change in risk structure. However due to the constraints faced, the data from the last 3 years was used to determine a fixed beta.

2.2.1 Assumptions
Historical period analysed (2011 to 2013) financial year, as it best reflects the current business cycle post global financial crisis (GFC)
Future growth rates obtained from IBIS world industry reports
Standard deviation of future growth rates used to determine optimistic and pessimistic scenarios was 1.2%
Terminal growth rate used for the company was 0.5% to reflect increasing competition from global competitors entering the Australian market
An average cost of debt of 6.47% was derived from the average of 2011 to 2013 borrowing facilities
From the sliding capital structure over the analysed years and prior, it is clear that SFG has a very low preference of debt. This behaviour was assumed to continue into the years ahead and appropriately factored into the valuation in the form of quick repayment (within 2 years) of any debt
borrowed
Based on the above assumption and the ability to honour its’ payables via cashflows, the expected bankruptcy cost for the firm was assumed to be negligible
5 year bond rate of 3.43% (Bloomberg, 2014) was used as a proxy for the risk free rate as it best reflected the period over which the forecast was generated for
Beta of 1.57 and the market risk premium of 7% was used to calculate the cost of equity of 13.403% using CAPM
Forecasts of financial performance were made based on key performance drivers of the firm (expanded on in the next section)

2.2.2 Forecasting free cash flow (FCF)
As retail companies often focus on sales (revenues) as a driver of growth, it would thus be expected that any forecasted growth should be supported by other related line items. Detailed explanations for each key line item forecasted can be found in Appendix 4. Items such as cost of goods sold (COGS), selling, general and administrative (SGA) along with capital expenditure (CapEx) and rental expense are related to sales, and hence projected margin rates were projected based on a trend line of historical figures. An average of the individual margins was calculated and used to forecast the individual items (Appendix 5). This process was in line with the assumption that business performance was expected to be similar throughout the projection years.

2.2.3 Derivation of an implied share price for SFG
Once the individual line items were forecasted, FCF for the respective years were calculated as represented in Table 2 below. For alignment with the company’s practices with regards to debt, the new debt absorbed from the acquisition of Rivers was assumed to be paid back within the immediate 2 years. This resulted in an interest tax shield of $4.3m when discounted back at the cost of debt of 6.47% (Appendix 6).

Table 2: Enterprise value derivation for SFG
(in $ millions)
2014
2015
2016
2017
2018
Terminal Value
EBIAT (NOPAT)
14.197
14.551
14.914
15.14
14.838
14.5
Plus: Depreciation and amortisation
26.9
27.5
28.2
28.6
28.1
28.1
Less: Capital Expenditure
23.3
23.9
24.5
24.9
24.4
24.5
Less: Changes in NWC
0.495
-0.772
-0.794
-0.486
0.66
0.161
FCF
17.2
18.9
19.4
19.4
17.9
139.0
PV of FCFs
157.2
Plus: PV of interest tax shield
4.3
Enterprise value
161.5

From Table 2, FCF for the respective years were discounted back at the cost of equity of 13.403%. This resulted in a PV of FCFs of $157.2 m, following which the effect of tax shields from debt were added back in to give an enterprise value of $161.5m.
From Appendix 7, the equity value of SFG was then derived by adding cash and deducting debt to give $184.1m. Divided by the number of shares outstanding, this resulted in an implied share price of $0.90, which was within the range calculated of the transaction multiples result and identical to the current market price.

2.2.4 Sensitivity analysis
The sensitivity range was selected based off historic standard deviation of growth which was +/- 1.2%. The calculations can be found in Appendix 8, and the range of share prices derived for SFG was $0.76 - $1.07.
The results of the DCF analysis was within the valuation range obtained from the comparable companies method. This together with the exact value calculated via DCF ($0.90) being identical to the current market price indicates that SFG is fairly priced.
3.0 Credit analysis
SFG has a current revolving credit loan facility of $48 million which functions as the company’s core secured borrowings. Historically the company has used such debt facilities to aid in acquisitions and improvements for their various brands (brand re-investment).
The recent acquisition of Rivers highlights this whereby the company drew $26.33 million from its’ financing facility. These funds were prepared for use in improving Rivers’ supply chain and other operational activities.
To aid in the corporations’ acquisition strategy, the request was submitted to determine if the current revolving credit facility could be increased to $75.23 million from the existing $48 million.

3.1 Financial statement analysis
The financials for the last 5 years were analysed and a summary of key items can be found in Table 3 below.

Table 3: Key financials for the previous 5 years
Financial Statement Item (in $ millions)
2009
2010
2011
2012
2013
Cash
8.04
2.70
5.59
10.58
38.57
EBITDA
48.20
56.80
39.30
17.30
43.30
Rental expense
(98.20)
(93.20)
(106.20)
(113.60)
(110.80)
Employee expense
(127.60)
(132.20)
(138.70)
(146.00)
(149.80)
Capital expense
(23.59)
(22.30)
(34.20)
(15.93)
(13.49)

The strong cash generation ability of the company resulted in the strengthening of its’ balance sheet, this enabled SFG to make the acquisition of Rivers’. Due to stable sales revenue, and increase in rental costs as well as material costs, EBITDA faced a decline from 2010 to 2012 (Specialty Fashion Group, 2012). The company recognised the issues it faced with regards to costs and started implementing cost control initiatives such as cotton price derivatives, more intensive rent analysis.
To further aid in the analysis of the company to determine its’ creditworthiness, financial ratios were analysed as shown in Table 4 below.

Table 4: Key financial ratio analysis for the past 5 years
Category
Ratio
2009
2010
2011
2012
2013
Operating performance
EBITDA Margin
8.60%
9.90%
6.90%
3.00%
7.60%
Debt service coverage
EBITDA /Interest
17.27
48.73
28.54
12.06
133.9
Financial leverage
Long term debt / Capitalization
4.94
2.43
3.23
2.96
2.59
Liquidity
Current ratio
0.58
0.84
0.76
0.75
1.08

Quick ratio
0.17
0.15
0.14
0.19
0.61

From Table 4, the EBITDA margin for financial year 2013 improved in response to the cost control measures adopted by the company. The margins in general also imply that the company was profitable with regards to its operations, and that there is room for expansion and re-investment to increase profits even further. The sharp increase in debt service coverage ratio, indicates that SFG has sufficient amount of cash to meet interest and principal obligations. The high figure also implies that there is a possibility for more debt should the need ever arise. The decrease in financial leverage reflects the company’s reluctance to rely too much on debt unless it needs to. This historical practice of the firm has led to it being exposed to low levels of default risk. The liquidity ratios (current and quick ratio) rose steadily for the period analysed, they show that that the company has the ability to re-pay its’ short term liabilities.
The financial data and ratios indicates that SFG has had steady financial performances, strong asset base along with stability of earnings and profitability. Therefore SFG has the traits that are representative of an ideal borrower.

3.2 Industry analysis
The clothing retailing industry is one that has been negatively impacted by the recent GFC. As consumers regain confidence in the market, many analysts expect the industry to experience moderate growth between 1.1 – 2.5% (IBISworld, 2014).
A form of uncertainty that this industry faces is foreign exchange. The strength of the Australian dollar is expected to play an important role in the outcome of the industry. This is primarily due to the reliance on overseas countries such as China and Bangladesh for manufacturing needs (Weller, 2007). In recent years, the Australian dollar has been high and this has benefitted retailers who import a majority of their products. A less direct factor that could impact the performance of companies in the industry is the cost of wage or inflation in the foreign countries mentioned earlier.
However the uncertainty can be navigated with the appropriate decisions made by a competent management team, either via hedging strategies with derivatives or business plans that minimise the negative impacts should they occur.

3.3 Board and management Analysis
As mentioned in the section above, the decisions made by management can determine whether a company becomes successful or files for bankruptcy. Hence the experience and qualifications for each of the management team were analysed and listed in Appendix 9.
From the list, it is apparent that the board is comprised of individuals who are proven individuals be it in the fields of corporate finance, accounting or retail experience. The expertise that each member brings to the table would allow them to manage the company efficiently, as well as ensuring that strategies planned for future performances are the right ones to take the company to the next level.
The audit committee comprised of 3 non-executive directors, is tasked with a range of responsibilities from board appointment, appointment of independent auditors (currently Deloitte), ensuring adequate risk management policies are in place. Operation of risk management and compliance falls under the responsibility of the risk management committee which is chaired by Alison Henriksen (Chief Financial Officer). The 2 committees work in tandem to ensure that risks of any form faced by the company are identified and effectively managed in order to achieve the company’s business goals.

3.4 Sensitivity analysis
Based on the increased amount of the loan requested of $75.23 million, a sensitivity analysis was performed with EBITDA chosen as the variable used to assess the impact on debt repayment. EBITDA was chosen due its’ historical standard deviation ($16.388m) being higher than the rest of the other impactful items considered (eg. Revenue, rent and COGS).
In performing the analysis, 2 standard deviations from the expected EBITDA were considered for the optimistic and pessimistic outcomes. These outcomes were used to determine the EBITDA values for the years 2014 to 2019 and PV of EBITDA was calculated using the cost of capital of 13% (same discount rate used in DCF analysis). The period was used for the analysis, as the new loan if approved would be applicable to the same term. The results are presented in Appendix 10.
From the optimistic ($296.9m) and pessimistic ($92.8m) values derived for PV of EBITDA, a probability plot was obtained as shown in Figure 3 below.

Figure 3: Probability plot for the EBITDA sensitivity analysis
Based on Figure 3, the probability of SFG defaulting on the proposed new loan is very low at 0.951%. This result was derived using the “Normal distribution” function in excel.
As a control check, the KVM tool was used as another form of determining the default value and the outcome as represented in Appendix 11 shows no probability of SFG defaulting on the same loan.

3.5 Increased loan facility
From the analysis of the company, SFG has proven that it has strong performance and financials to support the request for an increase in its’ current loan facility. Therefore upon the company’s acceptance of the new covenants attached, the loan facility will be raised from $48 million to $75.23 million effective 1st of June 2014. This new arrangement would super-cede the previous facility in place and the interest rate would remain unchanged at 6.47%. Pre-existing covenants would still apply for this facility with additional covenants pertaining to acquisitions and sale of assets listed in Appendix 12.

4.0 Merger and acquisition (M&A)
SFG has a proven track record in acquiring stable mature companies since inception as a single brand Millers till now with its’ portfolio of 6 main brands. The company utilises acquisitions as a way of establishing itself in new markets, or increasing market share in pre-existing ones. Taking the recent acquisition of River’s in December 2013 as an example, the company gained entry into the men’s and footwear markets (Chanthadavong, 2013) and the deal is expected to bring in an additional $77.4 million in revenues for the financial year 2013-2014 (IBISworld, 2013). The deal was structured with the view that management expertise of SFG would be able to improve River’s performance and extract synergistic benefits from the year 2015 onwards (Specialty Fashion Group, 2014). From the results from past acquisitions, this acquisition strategy does work to meet the goals of the organisation. In light of this, the firm has been constantly studying the market in the hope of discovering another potential takeover target.

4.1 The future of SFG in the clothing retailing industry
Previously, products of foreign retailers such as Zara and Topshop were only available to the Australian market through online sales channels. With the arrival of actual brick and mortar stores in Australia, the competition for the Australian consumers spending dollar is expected to intensify. With these foreign retailers bringing along their brand power as well as their efficiency in supply chain management (Nagurney & Yu, 2011), domestic retailers have to be ready or risk being marginalised. In anticipation of this, SFG has committed to improving their multi-channel sales distribution, customer service provided as well as the product lines and brands that they offer to the consumer. Cost control initiatives taken over the past 2 years have allowed the company to improve its’ margins. These cost control measures along with other strategic plans have prepared the company for the challenges ahead within the industry.

4.2 Target firm: Noni B Limited (NBL)
Founded in 1977, NBL is another player within the women’s fashion market and has 2 main brands Noni B and Liz Jordan. NBL currently operates over 200 stores throughout Australia.
4.2.1 Strategic fit
As NBL targets similar niche groups as SFG (mature and plus-sized female customers), the horizontal acquisition would allow SFG to incorporate the 2 brands under its’ wings. Although the acquisition would initially just be increasing the number of brands under SFG, the key justification is for SFG to be able to improve the performances of the 2 NBL brands. This could be done mainly by utilising well established online platforms or by optimising their supply chain to be in line with the rest of the brands under SFG. The proposed acquisition would also allow SFG to tap onto NBL’s customer relationship management (CRM) processes which is well known for. Improving on its’ current CRM is one of the groups’ long term strategies going forward.
As NBL has an online platform that has only been functional for a year, currently only 1% of total sales were attributable to it. As for SFG, their platform has been operational since 2010 and till date attributes to 4% of total sales. Hence by acquiring and incorporating the products of NBL into the system, revenues would increase. In the long run, a potential restructuring might be required if cross cannibalisation was occurring. This would further enable the management team of SFG to focus their efforts on improving the performances of the brands
Another avenue of potential synergies is the cost savings brought about by NBL moving away from its’ current arrangement of local suppliers and sourcing directly from cheaper overseas countries such as China and Bangladesh. This would allow NBL to lower its’ COGS and bring its gross margins in line with that of SFG.

4.2.2 Market position and regulatory concerns
As NBL is not one of the larger players in the clothing retail industry, the potential acquisition is not going to create a monopoly or provide for any opportunity to increase the prices of goods sold. However as a precaution and to safeguard the company from any future legal complications, an informal merger review should be sought after from the Australian Competition & Consumer Commission (ACCC). This would allow ACCC to access the deal, and to ensure that there is no breach of s.50 of the Competition and Consumer Act (Australian Competition & Consumer Commission, 2008).
4.2.3 Financial capacity
Based on the market capitalisation alone of NBL ($13m), SFG does possess enough cash on hand ($38.57m) to make the offer. However, some of the cash approximate $26 million was held in reserve to make improvements to Rivers’. Therefore taking that and the historical cash reserve of $6 million. The available cash for the acquisition would only be around $6.57m.
SFG would then have to draw upon its’ credit facility which has just recently been increased. The total sum available from the credit facility would be $48.9m, which would give a total of $55.47m available for the purchase if required.

4.2.4 Valuation of NBL
DCF analysis was performed to arrive at a valuation for NLB. The risk-free rate used was 3.43%, market risk premium used was 7%, terminal growth rate was 0.50% and the beta was 1.34 (retrieved from DatAnalysis Premium) which gave us a cost of equity at 12.81%. Following which, FCF was forecasted by using industry expected numbers to forecast the line items. From there on out, the enterprise value was calculated and the results are presented in Table 5 below.

Table 5: Enterprise value derivation for NBL
(in millions)
2014
2015
2016
2017
2018
Terminal Value
EBIAT (NOPAT)
1.453
1.489
1.511
1.481
1.474
1.481
Plus: Depreciation and amortisation
3.681
3.773
3.830
3.753
3.734
3.753
Less: Capital Expenditure
2.982
3.056
3.102
3.040
3.025
3.040
Less: Changes in NWC
0.905
-0.064
-0.040
0.054
0.013
-0.013
FCF
1.247
2.270
2.279
2.141
2.170
2.207
PV of FCFs
19.0

Plus: PV of interest tax shield
0.2

Enterprise value
19.1

From the enterprise value of $19.1m obtained from Table 5, the equity value of NBL was then calculated as outlined in Appendix 13. The equity value divided by the number of outstanding shares resulted in an implied share price of $0.89, which was close to the $0.87 cents valuation calculated by Thomson Reuters.
The current share price of SFG was $0.41 which implies that NBL is currently undervalued by the market.
4.2.5 Valuation of synergies
The valuation of possible synergies from the acquisition came from 2 aspects, incremental revenue generated from NBL utilising SFG’s online platform and the cost savings derived from NBL switching from local suppliers to cheaper overseas options.
To calculate the synergies from NBL adopting the online platform of SFG, the numbers for 2014 were forecasted assuming that the synergies would be extracted almost immediately (refer to Appendix 14). This would produce a one-time benefit of $3.85m from the increase in revenues generated via the online distribution channels.
Unlike the immediate synergistic benefit above, the cost savings portion would take years as existing contracts would have to be fulfilled with suppliers. Hence the benefits from cost savings were spread out over the immediate 5 years. Thus a simplistic view was taken to compare the COGS from the stand alone NBL and the forecasted post-acquisition COGS (refer to Appendix 15). This PV of cost savings amounted to $17.23m. The total value of synergies and valuation of NBL amounts to $49.8m which is the maximum price to be paid for NBL.
4.3 Acquisition proceedings
From the valuation of the company and the synergies, an initial offering price to be tendered to all existing shareholders of NBL was set at $0.52 cents per share. This includes a 30% control premium over and above the current market price of the shares. The total cost should the deal go through, would be $16.69m.
The deal would be financed with $6m from cash on hand and the remaining $10.69m would be drawn down from the adjusted loan facility. This would leave SFG with enough cash for working capital requirements and improvements for both Rivers’ and NBL. The deal was not funded wholly by debt, as this keeps in line with the company’s debt averse nature.
As the intention would be to replace the existing management of NBL due to their poor performance, the acquisition would be carried out in a hostile manner. The proposed method of sale would be to tender an offer directly to shareholders instead of a book building method. A book build was not chosen, as the valuation of the target firm was already derived.

5.0 Teaser document

Proposed acquisition of Noni B Limited (NBL)

Company overview
Specialty Fashion Group (SFG) has 20 years of experience in the clothing retailing industry, where it specialises in women’s fashion and plus sized clothing. The firm now holds the 2nd largest market share in the industry and prides itself with having one of the best online platforms amongst competitors. The company views its’ online distribution channels as a potential area of growth and significant revenue source in the years to come, hence the continued investment and improvement of existing systems. SFG also keeps a keen eye out to search for potential acquisitions that could complement the business profile and NBL is believed to be one of them.

Investment highlights
Long term strategic goals – The proposed deal would is in line with two of the company’s strategies to invest in opportunities and mature brands, and to improve its’ customer relationship management of which NBL is well known for.
Increased market share – The acquisition of NBL is expected to bring an additional $124m to the groups’ revenue. This would increase the groups’ presence within the industry with the 2 additional brands under the portfolio.
Increased revenue from online sales – By incorporating NBL into the online platforms used by the various existing brands within the group, sales revenues generated via online channels is expected to rise and bring in an additional $3.85m.
Cost savings from adopting overseas suppliers – The cost savings achieved by shifting from more expensive local suppliers to cheaper ones (China, Bangladesh) were calculated to give a PV of $17.23m.

Offering price
Based off the market capitalisation and a control premium which would reflect a portion of the synergistic benefits to be gained, the offering price for NBLs outstanding shares would be $0.52 per share. The management team at SFG believes this to be a fair and just amount over and above the current market price of $0.40 per share.

6.0 Recommendation
From the analysis performed on SFG, the current market valuation is deemed to fairly priced. With the recent changes to its’ supply chain, a mark of improvement has been observed in an increase in gross margins. Their robust online platform have placed the company in a position as one of the market leaders within the clothing retailing industry. From the credit analysis, the company has also been shown to be capable of taking on more debt if needed. With the experience and competence of the management team, the recent poor performances of NBL can be improved. This would translate into benefits for the group as a whole in the future, from the acquisition of brands that complement its’ own as well as potentially allowing it to improve its’ leading market position in women’s fashion.
Therefore the recommendation is that SFG proceed with the acquisition of NBL for the proposed offer price of $0.52 per share.

References
Australian Competition & Consumer Commission. (2008). Merger guidelines. Retrieved from http://www.accc.gov.au/system/files/Merger%20guidelines.pdf
Australian National Retailers Association. (2011). Economic structure and performance of the Australia Retail Industry. Retrieved from http://www.pc.gov.au/__data/assets/pdf_file/0003/109776/sub091.pdf
Australian National Retailers Association. (2014a). Regulatory reform – cutting red tape. Retrieved from www.anra.com.au/policies/regulatory-reform.html
Australian National Retailers Association. (2014b). Trading hours – pursuing fairer trading. Retrieved from www.anra.com.au/policies/trading-hours.html
Bloomberg. (2014). Australian government bond yields. Retrieved from http://www.bloomberg.com/markets/rates-bonds/government-bonds/Australia/
Chanthadavong, A. (2013). Specialty Fashion Group buys Rivers to home in on mature, value segment. Retreived from http://www.retailbiz.com.au/2013/11/28/article/Specialty-Fashion-Group-buys-Rivers-to-home-in-on-mature-value-segment/AIHFVZPJBG.html
Damodaran, A. (2005). The adjusted present value approach. Retrieved from http://pages.stern.nyu.edu/~adamodar/New_Home_Page/valquestions/apv.htm
IBISWorld (2013). IBISWorld Company Premium Report: “Specialty Fashion Group Limited”. Retrieved on http://clients1.ibisworld.com.au.ezp.lib.unimelb.edu.au/reports/au/enterprisepremium/default.aspx?entid=6879
Magner, L. (2014). IBISWorld Industry Report G4251: “Clothing Retailing in Australia”. Retrieved from http://clients1.ibisworld.com.au.ezp.lib.unimelb.edu.au/reports/au/industry/default.aspx?entid=407.
Pearson, R. (2013). ASOS poses huge threat to Aussie retailers. Retrieved from http://www.fool.com.au/2013/05/04/asos-poses-huge-threat-to-aussie-retailers/
Rosenbaum, J., & Pearl, J. (2009). Investment Banking: Valuation, Leveraged Buyouts and Mergers and Acquisitions. New York: Wiley-Finance.
Specialty Fashion Group. (2012). 2012 annual report. New South Wales
Specialty Fashion Group. (2013). 2013 annual report. New South Wales.
Specialty Fashion Group. (2014). 2014 half-yearly report. New South Wales.
Suozzo, P., Cooper, S., Sutherland, G., & Deng, Z. (2001). Valuation multiples: A primer. UBS Warburg: Valuation and Accounting (November).

APPENDICES

Appendix 1: Calculation of transaction multiples
(in millions)
PMV
NBL
ORL
CTY
SFG
Enterprise value
$474.70
$4.50
$165.30
$418.90
$152.40
EBITDAR
$292.40
$36.60
$24.10
$255.40
$139.40
revenue
$861.77
$119.74
$107.46
$797.04
$582.76
Gross profit
$532.80
$71.50
$68.90
$502.60
$364.40
Multiples
EV /EBITDAR 1.63x 0.12x 6.87x 1.64x 1.09x
EV/ Revenue 0.55x 0.04x 1.54x 0.53x 0.26x
EV/Gross profit 0.89x 0.06x 2.40x 0.83x 0.42x

Appendix 2: Benchmarking of transaction multiples

Appendix 3: Derivation of implied valuation range from transaction multiples

Appendix 4: Explanation of line items for the derivation of forecasted FCF
Projected line item
Basis of projection
Explanation
Sales (Revenue)
Industry growth revenue COGS
Sales
Directly proportional to sales
SGA
Sales
Growth in sales needs to be supported by SGA
Depreciation and amortisation Sales
Related to firms capital spending to support growth in sales
Rental
Sales
Directly proportional to sales as per annual report
CapEx
Sales
Growth in sales needs to be supported by an increase in the company 's asset base
Tax rate
Historical
Reflects historical tax rates from 2011
NWC
Accounts receivable
No. of days sales outstanding
Estimate of how quickly the firm collects it 's receivables
Inventory
No. of days inventory held
Reflects number of days inventory is held by the firm
Other current assets
Sales
Support of growth in sales
Accounts payable
No. of days payables outstanding Reflects number of days taken for a firm to repay creditors
Other current liabilities
Sales
Support of growth in sales
Appendix 5: Line item forecast for FCF calculations
(in $ millions)
2014
2015
2016
2017
2018
2019
Forecasted Income Statement Items
Operating revenue
692.2
709.5
727.2
738.1
723.4
719.7
COGS
-281.1
-288.1
-295.3
-299.7
-293.8
-292.3
Gross profit
411.1
421.4
431.9
438.4
429.6
427.4
Rental expenses
-128.8
-132.0
-135.3
-137.4
-134.6
-134.0
SGA expense
-235.1
-241.0
-247.0
-250.7
-245.7
-244.7
EBITDA
47.1
48.3
49.5
50.3
49.3
48.8
Depreciation and amortisation
-26.9
-27.5
-28.2
-28.6
-28.1
-28.1
EBIT
20.3
20.8
21.3
21.6
21.2
20.7
Tax
-6.1
-6.2
-6.4
-6.5
-6.4
-6.2
EBIAT (NOPAT)
14.2
14.6
14.9
15.1
14.8
14.5
Forecasted cash flow statement items
Capital Expenditure
23.3
23.9
24.5
24.9
24.4
24.5
Forecasted balance sheet items
Accounts receivable
4.9
5.1
5.2
5.3
5.2
5.1
Inventory
53.9
55.2
56.6
57.5
56.3
56.0
Other current assets
5.8
6.0
6.1
6.2
6.1
6.1
Total current assets
64.6
66.3
67.9
68.9
67.6
67.2
Accounts payable
73.3
75.2
77.1
78.2
76.7
76.3
Other current liabilities
22.2
22.8
23.4
23.7
23.2
23.1
Total current liabilities
95.6
98.0
100.4
101.9
99.9
99.4
Net working capital (NWC)
-30.9
-31.7
-32.5
-33.0
-32.3
-32.2
Change in NWC
0.5
-0.8
-0.8
-0.5
0.7
0.2

Appendix 6: Interest tax shield calculations
(in millions)
2014
2015
2016
2017
2018
Interest Tax shields
2.2
2.2
0.0
0.0
0.0
Discounted at cost of debt (6.47%)
2.2
2.1
0.0
0.0
0.0
PV of Interest tax shields
4.3

Appendix 7: Equity value and implied share price calculation
(in $ millions) Enterprise value
161.5
Plus: Cash
38.6
Less: Debt
26.3
Equity Value
173.8
No. of shares outstanding
192.2
Implied share price (in $)
0.90

Appendix 8: Sensitivity analysis using growth rate as a variable
(in $ millions)
Pessimistic
Optimistic
Enterprise value
133.51
193.38
Plus: Cash
38.58
38.58
Less: Debt
26.33
26.33
Equity Value
145.76
205.63
No. of shares outstanding
192.2
Implied share price (in $)
0.76
1.07

Appendix 9: Key management and board of directors qualifications
Name
Title held
Qualification
Board of directors
Geoffrey Levy, AO

Chairman

Previous executive Chairman and Chief Executive Officer (CEO) of Investec

Held partnership positions in the firms such asClifford Chance LLP, Robert Fleming Holdings, Freehills and Wentworth Associates

20 years experience in corporate advisory dealing with M&A, capital raisings and general corporate commercial law
Gary Perlstein

Chief Executive Officer (CEO)
Executive Director
15 years retailing experience in Australia, previously held managing director position of the apparel division

Has been with SFG since its’ inception and has been key to its’ expansion and growth since
Ian Miller
Non-Executive Director
Co-founder of SFG and its’ managing director until 2003

Executive Director from 1993 -2007

35 years of retail experience
Joel Bloom

Non-Executive Director

Joined the board in 2005

Chartered acountant by training

Co-founder of Go Lo, a national chain of discount variety stores

20 years of retail experience
Anne Mcdonald

Non-Executive Director

Joined the board in 2007

Chartered acountant by training, served as a partner in Ernst & Young, Australia for 15 years (board member for 7 years)

Non-executive director of Westpac 's life and general insurance business, where she is also chair of theaudit committee
Ashley Hardwick
Non-Executive Director
Joined the board in 2012

Director and shareholder of Cotton On Group, where he oversees the property function

20 years of retail experience
Michael Hardwick

Non-Executive Director

Joined the board in 2012

Chartered accountant by training, working in PricewaterhouseCoopers in transaction advisory

Partner for 10 years in the New York based Private Equity firm Hudson valley Capital Partners
Megan Quinn

Non-Executive Director

Joined the board in 2012

Specialist in the luxury end of retailing, advertising, publishing and design for the fashion, jewellery, hotel and airline industries

Held a variety of leadership and senior executive as well as non-executive board roles.
Director of UNICEF Australia
Key management personnel
Alison Henriksen

Chief Financial Officer (CFO)
Company Secretary

CFO since 2009
Company secretary since
2010

Previously served as Vice President of M&A at Boart Longyear Limited

Held a variety of roles including Assistant Director (corporate finance) at Ernst & Young from 1990 to 2002
Kerr Maclean

General Manager, Marketing

Appointed in 2012 to current position

Previously head of market and customer insight at CPP Group PLC

Worked throughout her career in industries such as banking, insurance and F&B, with marketing as a specialty
Mario Matarelli

Senior Operations Co-ordinator

Appointed in 2012 to current position

Previously systems and network administrator at Bushman 's Group Pty Ltd

16 years experience in operations with a specialty in information systems and technology
Sonia Moura
Director of Human Resources
Appointed in 2010 to current position

10 years experience with the company, having held positions such as HR manager and employee relations manager

Appendix 10: 2014-2019 EBITDA forecast (in $ millions)
Year
Pessimistic
Expected EBITDA
Optimistic
2014
47.1
47.1
47.1
2015
15.5
48.3
81.1
2016
16.7
49.5
80.3
2017
17.5
50.3
83.1
2018
16.5
49.3
82.1
2019
16.0
48.8
81.6
PV of EBITDA
92.8
194.86
296.9

Appendix 11: KVM graphical output for the probability of default on the loan

Appendix 12: Additional covenants attached to the increase in loan facility
Additional Covenants
Rationale
Details of acquisitions have to be provided to the bank prior to the deal being made
Allows the bank to determine if the acquisition changes the risk profile of the company
Approval for sale of assets has to be granted by the bank
Ensures that business profile does not change significantly

Appendix 13: Calculation of implied share price for NBL
(in $ millions) Enterprise value
19.1
Plus: Cash
9.84
Less: Debt
0.222
Equity Value
28.718
No. of shares outstanding
32.1
Implied share price (in $)
0.89

Appendix 14: Synergistic benefit from NBL adopting SFG’s online platform
(in $ millions)
2013
% of total revenue
2014
Without acquisition
Online revenues SFG
25.59
3.95%
27.24
Store revenues SFG
647.91
3.80%
662.42
Total
673.50

689.66
Online revenues NBL
1.00
0.84%
1.03
Store revenues NBL
119.71
0.83%
122.57
Total NBL
120.71

123.60
(RA) + (RT)

813.27
With acquisition
Online revenues SFG

3.950%
27.24
Store revenues SFG

662.42
Total

689.66
Online revenues NBL

3.950%
4.88
Store revenues NBL

122.57
Total NBL

127.45
(RA + T)

817.12
Synergistic benefits

3.85

Appendix 15: Cost saving synergies from NBL utilising cheaper overseas suppliers
(in $ millions)
2014
2015
2016
2017
2018
Terminal Value
COGS (stand alone)
50.33
51.59
52.37
51.32
51.06
51.32
COGS (post-acquisition)
48.60
49.82
50.56
49.55
49.30
49.55
Cost saving synergies
1.73
1.78
1.80
1.77
1.76
1.77
PV
17.23