Acova Case EM The purpose of this executive memo is to evaluate the justification to invest in a potential LBO candidate, Acova Radiateurs, and estimate the possible bidding price, keeping the minimum annual return required by Baring Capital’s investors at 30%-35%. 1. Justification of the Potential Transaction We evaluate the prospects of Acova LBO transaction for Barings and come into a conclusion that Acova is a good potential LBO candidate is justified. a. Strong Cash Flow Generation Ability: Radiators manufacturing market in France is a mature market, with fast growth in a few new types of radiators.
According to Acova’s financial history and the cash generating ability of the whole market, we expect steady and increasing cash flow in the future. Cash flow generated could help support the capital structure in the potential LBO deal. b. Leading and Defensible Market Position: Acova is the leader in decorative radiator market, especially the fast growing towel-dryer radiator segment. Success in the decorative radiator market depends heavily on branding and the ability to customize products, and Acova enjoys dominant advantage in these two aspects.
Acova was also strengthening its market position by a shift to exclusive wholesale distribution. c. Growth Opportunities: We believe that Acova has promising growth opportunities in the future. As the leader in the fast growing towel dryers segment, Acova also opened up a product in the dramatically growing electric radiator segment. Besides, we expect Hot-water radiators, which takes up half of Acova’s sales, will growth steadily in the next five years. d. Expansion and Efficiency Improvement Opportunities: Because other European markets are not that developed than the French market, Acova has the option to expand its revenue in the future.
Acova has opportunities to reach out to other European countries only if the management could make the agreement with Zehnder. However, we consider the possibility to come into an agreement in the LBO period to be low. Efficiency improvements in production, however, are highly possible. e. Management Team: Acova’s management are very experienced and dedicated to the company’s operations and developments. The current CEO has a strong sales and marketing background. We consider it a promising team to cooperate with in further improving Acova’s operation fter the potential transaction. 2. Valuation of the LBO Transaction We value the company at about FFr390mm as of July 1990 using both APV and ECF methods, given the transaction structure of FFr 10mm in fees, 190mm in senior debt, 65mm in mezzanine financing, and 80mm in Bearing’s equity investment. We assume the required rate of return on equity to be 30%-35%, given the high risk of an LBO transaction. The result is well above the 340mm bidding price under consideration, yielding FFr50mm NPV. 3. Recommendations
We recommend Barings to take this LBO opportunity, given the strong cash generation ability, leading market position and professional management team. The bidding range is set to be FFr340mm to 390mm. On one hand, given the fact that strong rivals such as Zehnder have potential synergy with Acova, we consider 340mm to be the lowest possible range. On the other hand, a price higher than FFr 390mm will not meet the required rate of return of Barings. Using APV method, we discounted unlevered cash flow with cost of asset to arrive at NPV of an unlevered firm.
The terminal value is the exit value 608,100 thousand in 1993. Then we adjusted the value with tax shield effect of each type of debt. The total value of Acova is the sum of unlevered firm value and tax-shield-added value, equal to 392,085 thousand FFr. Using ECF method, we determined the value of Acova to be 393,846 thousand FFr. We started from 1993 year end exit value of the firm. We need a constant asset beta for all the years to calculate equity beta, return on equity and previous year equity value, but 1993 year end asset beta had to come from the other variables.
We first assigned a value to 1993 cost of equity, and later used Solver to get the true value under the condition that the holding period return of equity value equals hurdle rate of Acova (assumed 32. 5%). Therefore, we had a good approximation of target cost of equity at exit in 1993. The cost of equity from 1990 to 1992 is derived from the asset beta. After that, we discounted 1990 year end equity and debt value with 1990 WACC by half years to arrive at the present value of Acova on acquisition date July 1, 1990.