Calaveras Case Study

1. Please refer to the Excel Spreadsheet.
2. Would you advise Dr. Martinez to purchase Calaveras’ at the proposed price? Why or why not?

Recommendation

The purchase price of the firm is $4.122 million. I would advise Dr Martinez to purchase Calaveras’ at the proposed price because the equity value of the firm we have calculated is $5.463 million. Therefore, it is true that the purchase price for the assets of the firm of $4.122 million represented a discount and Dr Martinez should seize this opportunity to buy Calaveras. After all, the sales trend of Calaveras and the wine industry in general are optimistic partially due to heightened awareness on the health benefits of wine products. Furthermore, as Calaveras regularly replace top management, Dr. Martinez would have strong equity incentives to buy up Calaveras so that her position in the company will be very stable.

It only makes sense for her to buy this company if she can produce according to her forecasts, and there is no better investment than this. Have a range of valuation for the company using different methods: DCF 3.2 – 6.3, Comparables 4.2- 5.8, other methods (liquidation, book value, venture cap) 3.9 - 7

Assumptions

However, there are many underlying assumptions that result in this conclusion, and those assumptions could be challenged. Firstly, the discount rate we use to calculate the final equity value is pre-tax cost of debt. We choose to use APV method because Calaveras might receive a massive loan from Goldengate which would significantly alter its capital structure in the future years, rendering WACC inappropriate. However, if this loan did not go through and the capital structure remains roughly constant, WACC method could be used. The use of WACC will lead to a different valuation of Calaveras. Nonetheless, the valuation based on WACC would still be higher than the purchase price as WACC is even smaller than Cost of Debt.

The terminal growth rate of the company could be lower than our estimated 1% because it is hard for a company to grow forever. Therefore, the terminal value and the equity value of Calaveras might be lower than what we have calculated.

We used Anne Clemens’ estimate for the actual cost of debt. However, it could differ from 9.5% on both the revolver and term loan since this is just a rough initial assumption by Anne and the prime rate was 6.75%. The interest rate on the revolving loan was prime plus 2.0% and on the term loan was prime plus 3.0%.

1. Does Dr Martinez have any particular competitive advantage in running Calaveras relative to others, including the current owners?

Dr. Martinez has some particular competitive advantages in running Calaveras relative to others such as Peter Newsome and current owners, because:

1. Dr Martinez was the vice president and general manager of the property for Stout PLC, and Calaveras would assume two long-term supply contracts with Stout PLC so Dr. Martinez would be in good position to oversee these deals.
2. Dr Martinez could help Calaveras to sustain real price growth as shown by her strong past success in enhancing brand image, improving market position, and developing premium products. By having her to run the company, Anne Clemens, a senior vice president at Goldengate Capital, could feel reassured that long-term real price growth would be good and be more willing to offer financing to Calaveras.
3. Dr Martinez has been an insider in the winery industry since 1980 and has worked in many different winery firms. Her extensive connections in the winery industry could help her to establish more suppliers and business partners. She also has attended training in winery and distillery and related technology. Her past experience in other winery companies and depth of knowledge about winery could help her form better strategic plans for Calaveras. In contrast, her Operation Manager Peter Newsome does not have as much experience as she has.
4. Dr Martinez aims to purchase 85 percent of the equity of the new company, which is much more significant than the 15 percent equity that would be purchased by Peter Newsome. Due to her substantial decision-making power, Dr Martinez would have a comparative advantage in running the company compared to Peter Newsome.

1. If Dr. Martinez buys the company, how would her incentives change? Does that impact your answer to c) above?

Before

Dr. Martinez’s incentives before she bought the company might just be that she wants to gain significant decision-making power to decide on company strategies, and utilize her past experience in enhancing brand image, improving market position, and developing premium products to improve the profitability of Calaveras (below median for ratios such as Return on sales (%),  Return on assets (%) and Return on net worth (%), refer to Supplemental Calculations sheet) and develop Calaveras further in the premium market.