Case Study No.

1:

INTERCO

Alfonso, Eric

Basilio, Leo
Deinla, Dennis
Lapat, George
Magpantay, Mark
Silfavan, John
Talaugon, Danilo
Villaroman, Ramil

INTERCO Case Background

Interco started out as a Shoe Company founded on December 1911

Its business has spread to other consumer products/services through acquisitions

It is fairly conservative financially, debt level is relatively low
Interco has moved away from apparel and general retail (went from 59 % to 40 % of total
sales)
Placed more emphasis on the footwear division (acquired Converse in 1986)
Placed much more emphasis on the furniture division (sales rose from 20-33% of Intercos
total sales)
Highly liquid as the current ratios are consistently over 3.5, showing that it has a plenty of
cash to cover any of its current liabilities

Intercos Business Climate in 1988

Cheap imports hurting profitability of U.S. apparel manufacturers

Retailing industry profits reduced due to drop-off in consumer spending and deep discounting
programs being offered by retailers in 1987
Apparel business are struggling, dropped in earnings from $6.7M in 1986 to $2.0M in 1988
Furniture and home furnishings prospects appear bright given favorable demographic trends in
family formations
Footwear have been flourishing
October 1987 stock market crash still in rear-view mirror
Intercos sales is growing from 4.04 % in 1987 to 13.39 % growth in 1988. Earnings is also
growing from 4.51 % growth in 1987 to 13.97 % in 1988
Overall performance of the company is improving, although some divisions are not pulling their
weight

Intercos Business Operation & Goal

Interco have four major divisions:
Apparel (e.g., London Fog)
General retail merchandising (Central Hardware)
Footwear (Converse, Florsheim)
Furniture and home furnishings (Ethan Allen)

Intercos Goal
Improve long- term sales and earnings growth
Earn increased return on assets and equity

Intercos Management Concern

Interco management is concerned that their stock price is undervalued
Management felt that bad performance in apparel group is unduly dragging down Intercos stock
price.
Because of this undervaluation, Intercos management is afraid for possible unsolicited takeover
bid.

Interco engage the services of Wasserstein, Parella & Co. to amended the Shareholder Rights Plan
and adopted the golden parachute severance agreement for their senior executives making any
hostile takeover of the company prohibitively expensive

The Takeover Bid

On July 27, 1988, City Capital proposed a merger with Interco
City Capital Associates Limited Partnership was led by the Rales brothers
The Rales brothers has been involved in multiple acquisitions of undervalued companies

City Capital offered to buy Intercos common shares at USD64 per share
Intercos Board expanded the role of their financial advisor, Wasserstein, Perella, & Co. to
evaluate City Capitals offer
The offer was raised to USD70 per share in the morning of August 8, 1988

Solution Discounted Cash Flow Valuation

Computation of beta ()
We utilize daily Interco stock price in Exhibit 3 and the daily S&P500 stock price - same dates
Through regression, we get a of 1

Computation of the Required Rate of Return k

k = RFR + (Rm -RFR)
RFR = 9.01%, 10 year treasury bonds from exhibit 14
Rm = 12.4%, internet data: 1988 S&P500 stock price
RFR
9.01%

Rm
12.40%

(Rm -RFR)
3.39%

k
12.40%

Solution Discounted Cash Flow Valuation

Furniture

1988

Sales Growth

1989

Earnings from Operation

1,105,563

1991

1992

1993

1994

1995

1996

1997

1998

7.70%

7.70%

7.70%

7.70%

7.70%

7.70%

7.70%

7.70%

7.70%

7.70% Exhibit 12

13.1

13.21

13.32

13.43

13.54

13.66

13.77

13.88

13.99

14.10 Exhibit 12

Operating Margin in %
Net sales

1990

1,190,691

1,282,375

1,381,117

1,487,463

1,601,998

1,725,352

1,858,204

2,001,286

2,155,385

2,321,349

155,981

169,416

183,996

199,816

216,982

235,606

255,813

277,734

301,514

327,310

Less: Depreciation & Interest

Exhibit 8

Our assumption: 155,981

Above169,416
operating
margin
in216,982
% is 235,606
already255,813
inclusive
of interest
and
Earnings Before Tax
183,996
199,816
277,734
301,514
327,310
depreciation
Less: Income Tax at42.8%
66,760
72,510
78,750
85,521
92,868
100,840
109,488
118,870
129,048
140,089
Net Income

89,221

96,906

105,245

114,295

124,114

134,767

146,325

158,864

172,466

187,221

Less: Net FC Inv (Capex-Dep)

Less: Working Capital Inv

FCFE

89,221

96,906

105,245

114,295

124,114

119,348

129,718

140,979

153,204

166,476

PV of FCFE at 12.4%

79,378

76,704

74,115

71,608

69,181

59,186

57,232

55,338

53,502

51,724

15,419

16,607

17,885

19,262

20,746

Exhibit 12
Exhibit 12

Solution Discounted Cash Flow Valuation

Footwear

1988

Sales Growth

1989

Earnings from Operation

890,411

1992

1993

1994

1995

1996

1997

1998

6.30%

6.30%

6.30%

6.30%

6.30%

6.30%

6.30%

6.30%

6.30% Exhibit 12

9.10

9.24

9.39

9.53

9.68

9.82

9.97

10.11

10.26

10.40 Exhibit 12

946,507

1,006,137

1,069,523

1,136,903

1,208,528

1,284,666

1,365,600

1,451,632

1,543,085

1,640,300

86,132

93,012

100,416

108,385

116,959

126,183

136,105

146,776

158,252

170,591

Less: Dep & Int

1991

6.30%

Operating Margin in %
Net sales

1990

Earnings Before Tax

86,132

93,012

100,416

108,385

116,959

126,183

136,105

146,776

158,252

170,591

Less: Income Tax at42.8%

36,865

39,809

42,978

46,389

50,058

54,006

58,253

62,820

67,732

73,013

Net Income

49,268

53,203

57,438

61,996

66,900

72,177

77,852

83,956

90,520

97,578

Less: Net FC Inv (Capex-Dep)

Less: Working Capital Inv

9,517

FCFE

49,268

53,203

57,438

61,996

66,900

62,659

67,735

73,202

79,089

85,426

PV of FCFE at 12.4%

43,832

42,112

40,448

38,842

37,290

31,073

29,885

28,734

27,620

26,542

10,117

10,754

11,432

Exhibit 8

12,152

Exhibit 12
Exhibit 12

Solution Discounted Cash Flow Valuation

Apparel

1988

Sales Growth

1989

Earnings from Operation

813,198

1992

1993

1994

1995

1996

1997

1998

7.10%

7.10%

7.10%

7.10%

7.10%

7.10%

7.10%

7.10%

7.10% Exhibit 12

6.40

6.47

6.53

6.60

6.67

6.73

6.80

6.87

6.93

7.00 Exhibit 12

870,935

932,771

998,998

1,069,927

1,145,892

1,227,250

1,314,385

1,407,706

1,507,653

1,614,697

55,740

60,319

65,268

70,615

76,393

82,635

89,378

96,663

104,531

113,029

Less: Dep & Int

10

1991

7.10%

Operating Margin in %
Net sales

1990

Earnings Before Tax

55,740

60,319

65,268

70,615

76,393

82,635

89,378

96,663

104,531

113,029

Less: Income Tax at42.8%

23,857

25,817

27,935

30,223

32,696

35,368

38,254

41,372

44,739

48,376

Net Income

31,883

34,503

37,333

40,392

43,697

47,267

51,124

55,291

59,792

64,652

Less: Net FC Inv (Capex-Dep)

Less: Working Capital Inv

0
10,170

0
10,892

0
11,665

0
12,493

Exhibit 8

0
13,380

FCFE

31,883

34,503

37,333

40,392

43,697

37,097

40,232

43,626

47,298

51,272

PV of FCFE at 12.4%

28,366

27,310

26,290

25,306

24,357

18,397

17,751

17,124

16,518

15,930

Exhibit 12
Exhibit 12

Solution Discounted Cash Flow Valuation

Retail

1988

Sales Growth

1989

Earnings from Operation

532,251

1992

1993

1994

1995

1996

1997

1998

7.60%

7.60%

7.60%

7.60%

7.60%

7.60%

7.60%

7.60%

7.60% Exhibit 12

6.5

6.61

6.72

6.83

6.94

7.06

7.17

7.28

7.39

7.50 Exhibit 12

572,702

616,227

663,061

713,453

767,676

826,019

888,797

956,345

1,029,027

1,107,233

37,226

40,739

44,572

48,753

53,311

58,280

63,697

69,601

76,034

83,043

Less: Dep & Int

11

1991

7.60%

Operating Margin in %
Net sales

1990

Exhibit 8

Earnings Before Tax

37,226

40,739

44,572

48,753

53,311

58,280

63,697

69,601

76,034

83,043

Less: Income Tax at42.8%

15,933

17,436

19,077

20,866

22,817

24,944

27,262

29,789

32,542

35,542

Net Income

21,293

23,303

25,495

27,887

30,494

33,336

36,435

39,812

43,491

47,500

Less: Net FC Inv (Capex-Dep)

Exhibit 12

Less: Working Capital Inv

4,376

4,708

5,066

5,451

5,865

Exhibit 12

FCFE

21,293

23,303

25,495

27,887

30,494

28,961

31,726

34,745

38,040

41,635

PV of FCFE at 12.4%

18,944

18,445

17,954

17,471

16,997

14,362

13,998

13,639

13,284

12,936

Solution Discounted Cash Flow Valuation

Interco
Sales Growth
Operating Margin in %
Net sales
Earnings from Operation
Earnings Before Tax
Less: Income Tax at 42.8%
Net Income
Less: Working Capital Inv
FCFE
PV of FCFE at 12.4%

1988

3,341,423

1989
7.20%
9.2
3,580,835
335,078
335,078
143,413
191,665
0
191,665
170,520

TV11 @ 14 multiple
TV11 @ 15 multiple
TV11 @ 16 multiple

1990
7.20%
9.30
3,837,510
363,486
363,486
155,572
207,914
0
207,914
164,570

1991
7.20%
9.40
4,112,700
394,252
394,252
168,740
225,512
0
225,512
158,808

4,771,705
5,112,541
5,453,377

1992
7.20%
9.50
4,407,747
427,569
427,569
182,999
244,569
0
244,569
153,227

1993
7.20%
9.60
4,724,094
463,644
463,644
198,440
265,204
0
265,204
147,825

1994
7.20%
9.70
5,063,287
502,704
502,704
215,157
287,547
42,517
245,030
121,513

PV of TV11 @ 14 m = 1,482,554
PV of TV11 @ 15 m = 1,588,450
PV of TV11 @ 16 m = 1,694,347

Present Value of the Firm = P1 + P2 + P3 + P4 + P5 +P6 + P7 + P8 + P9 + P10 + TV11

12

Value of Firm @ TV14

2,845,445

Stock Price @41,356,847 shares =

68.80

Value of Firm @ TV15

2,951,342

Stock Price @41,356,847 shares =

71.36

Value of Firm @ TV16

3,057,238

Stock Price @41,356,847 shares =

73.92

1995
7.20%
9.80
5,426,985
544,993
544,993
233,257
311,736
45,570
266,166
117,433

1996
7.20%
9.90
5,816,970
590,773
590,773
252,851
337,922
48,843
289,079
113,471

1997
7.20%
10.00
6,235,151
640,331
640,331
274,062
366,269
52,353
313,916
109,627

1998
7.20%
10.10
6,683,579
693,973
693,973
297,020
396,952
56,116
340,836
105,897

Solution DCF at different Discount Rates

Interco

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

FCFE

191,665

207,914

225,512

244,569

265,204

245,030

266,166

289,079

313,916

340,836 4,771,705 5,112,541 5,453,377

PV of FCFE at 10% Discount Rate

174,241

171,830

169,431

167,044

164,671

138,313

136,585

134,858

133,131

131,407 1,839,699 1,971,106 2,102,513

(1+k)

(1+k)2

(1+k)3

(1+k)4

(1+k)5

(1+k)6

(1+k)7

(1+k)8

(1+k)9

1.100

1.210

1.331

Value of Firm @ TV14 =

Value of Firm @ TV15 =
Value of Firm @ TV16 =

1.464

3,361,209
3,492,616
3,624,024

1.772

1.949

2.144

2.358

@ 10% Rd
, Stock Price @41,356,847 shares =
81
, Stock Price @41,356,847 shares =
84
, Stock Price @41,356,847 shares =
88

Terminal Multiple

Discount Rate

13

1.611

14

15

16

10%

81

84

88

11%

76

79

82

12%

71

73

76

13%

66

69

71

(1+k)10
2.594

@14

@15

@16

Solution Relative Valuation

Aquirer/Target
Furniture Manufacturing Companies
Masco/Henredon
Chicago Pacific/General Mill Furniture
Interco/Lane
La-Z-Boy/Kincaid
Hostorical Average
City Capital offer

Announcement Adj Aggregate

Date
Price ($million)

June 3,1986
Aug 12,1986
Nov 17,1986
Dec 14,1987
Aug 8,1988

Footwear Manufacturing Companies

Interco/Converse
July 31,1986
Reebok/Rockport
Sept 18,1986
Reebok/Avia
March 10,1987
Moacq/Morse Shoe
June 3,1987
Nike/Cole Haan
Apr 25,1988
Hostorical Average
City Capital offer

14

Aug 8,1988

$260.90
89.3
523.7
63.5

Net
Income

Purchase Price as Multiple of

Book
Operating Operating
Sales
Value
Income Cash Flow

2,941.30

31.6
14.1
2.8
22
17.6
18.1

2.6
1.8
2.8
2.1
2.3
2.2

2.1
1
1.6
0.8
1.4
0.9

20.3
12
11.1
11.7
13.8
11.4

15.8
9.9
9.6
8.1
10.9
9.2

$202.70
146.1
191
312.5
95

37.1
30.7
40.6
2.5
36.2

1.8
0
6.7
1.8
0

0.9
1.7
2.1
0.5
1.5

24.7
26
24.6
13
12.2

18.2
23.9
23.3
9.2
8.1

2,941.30

29.42
18.1

3.43
2.2

1.34
0.9

20.1
11.4

16.54
9.2

Average

9.2
8.4

14.2
8.4

Solution Relative Valuation

Aquirer/Target
Apparel Companies
West Point Pepperall/Cluett, Peabody
W.Acquisition/Warnco
Salant/Manhataan Indus
Wesray/Wm Carter
Hostorical Average
City Capital offer
Central Hardware Division
Management Group/Payless Cashways
City Capital offer

Announcement
Date

Adj Aggregate
Price ($million)

Nov 4,1985
Mar 17,1986
Feb 2,1988
Apr 28,2988
Aug 8,1988

$551.90
504.7
129.7
157.4
335.93
2,941.30

June 24,1988
Aug 8,1988

$1,189.40
2,941.30

Purchase Price as Multiple of

Operating
Net Income Book Value
Sales
Income
19.6
21

Operating
Cash Flow

0.6
0.9
0.4
0.8
0.68
0.9

10.6
10.6

0.2
9.2

20.30
18.1

1.5
2.5
1.4
1.6
1.75
2.2

24
15.07
11.4

13.7
7.70
9.2

9.1
8.4

22
18.1

2.3
2.2

0.6
0.9

13.1
11.4

9.2
9.2

9.4
8.4

Average

15

Average

10.47375

Our Decision as the Board of Interco

Findings
Relative Valuation
The offer of City Capital, as compared to historical acquisition of the same business, is lower with an
average of 10.5 vs. 8.4

Discounted Cash Flow Valuation

USD 66 per share

- @ 13.0% discount rate and Terminal Value of 14 multiple

USD 74 per share

- @ 12.4% discount rate and Terminal Value of 16 multiple

USD 88 per share

- @ 10.0% discount rate and Terminal Value of 16 multiple

Our Decision
Decline the offer of City Capital and challenge them to submit their best proposal given above
valuation report from the consultant
An Offer of USD 74 per Share will be considered

16

Our Decision as the Board of Interco

Why shall we consider an offer of USD 74 per Share
The stock has been undervalued. In fact the value of Interco shares is always below USD50 in the
last 3 years
It only reaches 68 a share in July when City Capital tendered their unsolicited merger proposal in
July 27, 1988.

The USD 74 per share seemed fair (+) since it is base from the prevailing S&P500 return of equity
of 12.4% and at maximum assumed TV of 16 multiple.
Selling less profitable division also poses greater risk of undervaluation.

17