Mercury Athletic Footwear Valuing the Opportunity

Student Instructions, Required Analysis, and Questions

Your team is to place themselves in the role of John Liedtke, head of business development for Active Gear, Inc. (AGI). As such, you are to assess your level of interest in pursuing the acquisition of Mercury Athletic Footwear (MAF), which is being divested by West Coast Fashions, Inc. (WCF).

John Liedtke needs to consider the opportunities and risks associated with the possible acquisition of MAF, including strategic and shareholder value implications. MAF has underperformed during WCF’s ownership, for multiple reasons, leading to WCF’s desire to divest the business. The information provided thus far is limited. Nonetheless, John needs to consider the possible investment thesis and more detailed due diligence issues in order to provide AGI’s board of directors with a preliminary assessment of AGI’s desire to pursue this investment opportunity. Your analysis should include the following elements.

1) Financial Model (30 points for the preliminary model, 15 points for the final model, 45 total)

• Construct financial models to value the proposed MAF acquisition using DCF analysis under two scenarios: a) base case and b) with synergies case.
• Each team is to forecast the present value of free cash flow for five years (using a year-end discounting convention), calculate the terminal value (using the exit multiple method), determine the weighted average cost of capital, and estimate the equity value of the acquisition target (under both scenarios).
• Additional assumptions:
o Base case assumptions: use Liedtke’s assumptions, as well as a 6% pre-tax cost of debt, 4.93% risk free rate, Beta of 1.6 and market risk premium of 5%.
o With synergies case: a) MAF’s inventory turns can be improved to AGI’s historical levels beginning in 2007, and b) MAF’s women’s casual footwear will be continued (folded into AGI’s similar business unit) with sales growing 3% annually starting in 2007, reaching a 9% EBIT margin by 2011 (1% in 2007, 3% on 2008, 4% in 2009, 6% in 2010 and 9% in 2011).

2) Why might WCF be considering divesting MAF (offer at least 8 reasons, 16 points total, 2 points each)?

3) What are the likely pros and cons associated with AGI’s potential acquisition of MAF (offer at least 16 total pros and cons, 32 points total, 2 points each)?

4) Make a recommendation to AGI’s board of directors to either continue pursuing the acquisition or pass on the opportunity (15 points total, citing at least five key factors influencing your recommendation, 3 points each)? If you choose to pursue the acquisition, include a recommended price range.