Case: Congoleum: LBO
Date: January 25, 2012
Group Members: GANPAA Gayatri, HONG Sung Uk, LU Jianning, MUNZER Gabrielle
Is Congoleum a good LBO candidate? In other words, does this company have a lot of debt capacity?
Congoleum is a good LBO candidate for the following reasons:
1. It has low levels of debt and a low debt to equity ratio
| 1977 | 1978 |
Long Term Debt | 16,067 | 14,949 |
Equity | 153,068 | 187,485 |
LTD/E | 9.5% | 7.4% |
2. It has excess cash and a high current ratio
| 1977 | 1978 |
Cash | 55,053 | 40,424 |
Current Assets | 165,355 | 220,505 |
Current Liabilities | 87,359 | ...view middle of the document...
Radaker and Nicholson would be allowed 7% and 5% respectively)
1. To calculate the Terminal Value of the ITS, we assumed that the amount of debt Congoleum has in 1984 remains constant in the years that follow.
2. Post 1984, we have assumed that CAPEX is equal to depreciation. Note that this depreciation is based on the post LBO asset base, which we believe reflects the maintenance CapEx more accurately due to the high inflation environment in 1980s.
3. We used the APV method of valuation since the capital structure of Congoleum is changing. In order to do so, we calculated an unlevered WACC (cost of equity) to discount the unlevered Free Cashflows.
4. We assumed the following discount rates:
Item | Discount Rate | Rationale |
Unlevered FCFs (1980 – 1984) | Unlevered WACC | APV Method |
Terminal Value (1984) | Unlevered WACC | APV Method |
Interest Tax Shield | Unlevered WACC | Value of the tax shield will track the value of the operating assets |
Depreciation Tax Shield | Unlevered WACC | DTS is as risky as the assets |
Savings from LBO ($5m per annum) | Unlevered WACC | Given the high degree of leverage, the savings are as risky as the assets |
5. An IPO is expected for Congoleum at the end of 1984
6. To calculate bankruptcy costs, we assumed that the rating of Congoleum in LBO format was ‘CCC’ due to the high ratio of Debt to Total Capital.
To value Congoleum we used the following steps:
1. Calculate the Equity beta
2. Calculate the unlevered WACC
3. Calculate the free cash flows assuming all equity financed firm and terminal value by using unlevered WACC
4. Calculate the ITS after LBO
5. Calculate the LBO effect which is the sum of ITS, DTS, and benefits from going private by doing LBO
6. Calculate the “total Equity value before LBO” by subtracting “LBO effect” from “Enterprise value after LBO” and add back “Cash” and deduct “Debt and pension liabilities”
Step 1: Calculate the betas of debt and equity
* Take average unlevered equity betas from industry peers of the three industries, home furnishings, shipbuilding, and automotive and industrial distribution in exhibit 9.
* Calculate an arithmetic average of the unlevered beta of the industry based on the weighted identifiable assets of Congoleum.
Company | ß(L) | D/(D+E) | D/E | D*/E | ß(U) |
Home Furnishing | | | | | |
Amstrong Cork | 1.00 | 0.18 | 0.22 | 0.12 | 0.90 |
GAF Corp | 1.15 | 0.35 | 0.54 | 0.28 | 0.90 |
Average | | | | | 0.90 |
| | | | | |
Shipbuilding | | | | | |
Todd Shipyards | 1.00 | 0.69 | 2.23 | 1.16 | 0.46 |
| | | | | |
Automotive | | | | | |
Genuine Parts | 0.95 | 0.05 | 0.05 | 0.03 | 0.92 |
General Automotive Parts | 0.75 | 0.07 | 0.08 | 0.04 | 0.72 |
Barnes Group | 0.85 | 0.18 | 0.22 | 0.11 | 0.76 |
Average | | | | | 0.80 |
| | | | |...