Carlton Polish Company

Overview

Our aim is to deliver an analysis regarding to the leveraged buyout in Carlton Polish Company (“the Company”) from Charlie Carlton’s Perspective. The deal is either a partner accepts $250M cash and leaves the management by giving up all his 50% shares of The Company. The repurchased shares will be cancelled, and the remaining partner will own 100% of The Company. Based on our valuation, we suggest that Carlton should conduct this leveraged buyout and we will provide our assumption validation, analysis and associated recommendations.

Assumptions

A Proforma financial statement is attached in this case however we have determined and adjusted several assumptions, so our model will be better fit in the realistic scenarios. The valuation method is “Adjusted Present Value” (APV).

1. The applied corporate tax rate is 56.9% and it is identical in all forecasting periods.

1. The Company beta () is based on the averaged unlevered beta of three comparable public companies with significant compound growth rates in net sales. We believe that intra-industry businesses have very similar systematic risks. The result is as follows:[pic 1]

1. KPMG (2016) reported that the US long term government bond yield and equity market risk premium at 31-Dec 2014 are at 3% and 6% respectively. Thus, the Company cost of equity is estimated as 6.89%, according to CAPM. It is assumed to be unchangeable in our analysis.

1. The perpetuity growth rate is targeting to US GDP annual growth rate in 2014, which is 2.4% (Source: World Bank).

1. We agree the net sales is forecasted to be increasing at 10% annually after analysing the Company financial statements in 2008 – 2014 and the stable market condition .

1. The IRS settlement is realized in 2015 since it is a payable incurred in 2015. Therefore, the net working capital in 2014 and 2015 are adjusted.

1. For simplicity, we assume COGS and administrative expense are increasing over time at 11% and 10% respectively. The rates are estimated based on current cost structures & accounting policy. We do not expect any significant productivity improvements in foreseeable periods due to the bank loan covenants.

1. We assume initial capital expenditure is at $100,000 in 2015 in response to the growing sales. Additionally, depreciation is calculated by adopting straight-line method. Both components grow at an identical rate as net sales per year.

1. In terms of net working capital in Exhibit 4, we generally agree on the assumptions related to current assets and current liabilities multiples. We do not expect structural changes in assets since the buyout debt is not a type of productive debt.

1. The Company is assumed to avoid any external debt financing or any kinds of leasing in future. Thus, the growth rate of debt in set to be 0.

Analysis

Instead of calculating the enterprise value, the focus is to identify the present value of all leveraged free cashflows (Appendix 1). The purpose is to see whether the Company is able to cover the cost of buyout. Essentially, the NPV of this deal is:

[pic 2]

Given the positive NPV, Carlton should carry out this buyout.

However, the model is vastly sensitive to discount rate and growth rate due to its strong exposure to terminal values. If the cost of equity increases to 7.13%, Carlton is indifferent in choosing between buyout or receiving cash. Similar scenario happens if the terminal growth rate drops to 2.16%. It is worth mentioning that corporate tax rate is important in our valuation. A change in tax rate may causes a remarkable shift in enterprise value due to the greater magnitude of change in EBIT. For instance, if we selected the real US tax rate at 39.1% (Deloitte 2017), the buyout would be more favourable because the FCF value increases by almost double.