Finance Simulation: M&A in Wine country

International Beverage
Report submitted
To
Dr. Marcus Braga

Prepared
By
Ahmed Elghriany

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Nagasai Kavuri

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Ahmed Hammoudeh

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05/10/2016

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 1. Rationale for Business Combinations
Finance simulation: M&A in wine country is a simulation that can use of three publicly
traded wine producers: Starshine, Bel Vino, and International Beverage to evaluate merger and/or
acquisition opportunities among the three companies. Then we, International Beverage,
determine the reservation prices, values targets, and negotiate over deal terms before deciding
whether to accept or reject final offers to purchase each other.
1.1 Industry Structure
The American wine industry has become the 4th largest producer of wine behind the old
world giants of France and Italy. The industry has experienced a steady growth of consumption
over the last 10 years of a compound annual rate of just less than 4% and it is expected to
continue to experience long-term growth close to 3%. The wine industry performance as a
whole has been not strong during the last few years because of excess supply, low demand, and
higher cost of production. The decrease in demand of wine consumption and the import from
France and Italy lowers the growth domestic industry. This slows in growth drives the American
producer to think again about their growth strategy. Therefore, one of the ways that can help in

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their growth strategy is Mergers and/or Acquisitions (M&A) with different existing companies.

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Few companies that build the U.S wine industry name. The two largest companies include

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International Beverage and Power Beverage, their combined market shore the U.S. market was

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31%. Midsized publically traded wineries were Bel Vino Corporation, Starshine Vineyards,
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Bellini Winemakers, and a division of Le Dutrec Enterprises, which combined held and
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additional 6% market share. The rest of the market consisted of a number privately held wineries
that varied in size from midsized to small.
1.2 Motivation for Acquisition
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International Beverage Holdings Limited (IB) offers beers, spirits, whiskies, wines, non-
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alcoholic drinks, and other alcoholic drinks. It is one of the industry's most dynamic global
drinks businesses. The company has a broad portfolio across wine, imported beer, and soft
drinks; with net sales over $3 billion and a net income of about $100 million. IB considers as
one of a competitor company in wine industry; it owns vineyards and bottling capacity, and
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boasts distribution channels in the United States and abroad which provide IB with a strong
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competitive advantage.
IB’s organic revenue growth has been below 1%, but over the past 10 years, revenues grew at
a rate of 10% per year, driven primarily through acquisitions, although recently this growth has
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stalled because no recent acquisitions have been made. With the desire to grow profits and
potentially move into the faster-growing popular premium and super premium market segments,
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IB is seeking to expand through acquisition.

1.3 International Beverage SWOT Analysis
 Strengths
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- Strong infrastructure facilities and mastery technologies to cater target market demand
- Full control over distribution chain and ability to innovate new value for the customer
- Clear strategic vision about segmentation, target market, and positioning
- Successful marketing and advertising campaigns

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  Weaknesses
- Inability to grow organically with organic revenue growth less than 1%
- Have leadership in price value vector, but struggling to obtain parity at performance
value vector.
- High debt level due to acquisition
2. Setting Reservation Prices
2.1 Confidential Information
International Beverage Company is the leader between the three companies in the wine
industry and it is clear that the IB is going to acquire either Bel Vino or Starshine Company. By
using the confidential information available to us, we did our calculation to see which company
will add more value to IB Company. We used the average values in this confidential information
as the inputs to modify the assumptions for each company.
By following the Adjusted Present Value (APV) model, we were able to evaluate both

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companies Bel Vino and Starshine as the model was more flexible to use than other valuations
models since the undervalued cost of equity can be used even while the capital structure is

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changing. Since the Acquisition for either company will be made by cash, so that will push us to
issue more debt to make the deal. Therefore, our capital structure will be changed after the

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acquisition operation.
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The reservation price that we calculate for each company is representing the highest price that
IB company is willing to pay to acquire one of these target companies, and these prices was our
reference value during the bidding and negotiations. For Starshine Company, we calculated the
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reservation price for each share $57.48 and (the assumed value/number of outstanding shares
was equal to 440,800,000 /8,000,000). While for Bel Vino Company, we estimated the
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reservation price per share $44.80 (the assumed value/number of outstanding shares was equal to
443,000,000/10,000,000).
2.2 Value Creation Opportunities
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The industry is quite capital intensive. Therefore, in order to be an industry leader, one must
have sufficient capital to acquire new lands to develop into vineyards and vineyard development
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is quite expensive. The industry also requires holding a high inventory due aging the wine and
storing it during the aging process. Competition has been fierce lately due to consolidation of the
industry. Distribution channels are becoming more consolidated, stiffening the competition. The
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wine industry is definitely one that can benefit from both mergers and acquisitions. Large
corporations can help differentiate themselves in the market by acquiring small vineyards to meet
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their added needs such as expanding into super premium brand wines. At the same time, different
size wineries may merge with one another to intensify their distribution tactics or channels and
differentiate their product lines. Bel Vino Corp. and Starshine Vineyards are both two very
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different companies both having different strengths and weaknesses.

2.3 Updating valuation analysis and avoided loss
Starshine Vineyards is a midsize company that focuses in on lower price segments in the
industry. Starshine has a superior national distribution network compared to most companies and
capitalizes on it. The company is boasting revenues of $525 million per year. Based on this, their

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 wines have low margins and have trouble competing with imported brands. Starshine is also not
very well recognized on Wall Street as a strong, well-run company. Looking ahead, Starshine has
forecasted sales growth in the United States of 4% and International sales growth of 8.3%. This
totals out to a 6.3% total sales growth rate into perpetuity. Costs of goods sold are also expected
to grow at 6.3%, with Net Income growing rapidly at 103% and remaining steady at 6.3% into
perpetuity. Cash as a percent of sales plans to remain constant at 4% while Receivables (Days of
Sales) go from 134.5 down to 126 showing an increase in collections. Inventory (Days of COGS)
are also slated to improve going from 456.3 to 430.1 while Accounts Payable (Days of COGS)
also improve from 151.5 to 136.4. On the other hand, Bel Vino Corporation is a smaller firm than
Starshine with $370 million in annual revenues. Bel Vino sells high-end California wines and
strong brands, such as the coveted UVA Del Sole brand. Bel Vino also owns many of the prized
vineyard properties in California making it a quite coveted acquisition. Bel Vino also possesses
one of the lowest COGS for its size in the industry and is a reliably profitable company,
according to Wall Street analysts, due to their strong SG&A. On the negative end, Bel Vinos
sales have been lagging behind its competitors recently as they lack a good national distribution
network due to high competition. Bel Vino also does not have any real relationships with

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international distributors, making its international sales weak. Due to its poor distribution
network, U.S. sales are only projected to increase by. 5% into perpetuity, while international

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sales are slated to increase only 12.5%. This provides a total sales increase of only 2.9% in the
year 2013, which is quite low. Bel Vinos COGS will also increase steadily to 2.9% while it is Net

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Income will slow to a mere 5.3% increase in 2013. Cash as a percent of sales, Receivables (Days
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of Sales), Inventory (Days of COGS), and Accounts Payable (Days of COGS) look to remain
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constant at 2.79%, 100, 708 and 90 respectively. If a merger or acquisition were to take place
between International Beverage, Starshine Vineyards, or Bel Vino Corp., I feel the outcome
could only be positive, unless an absurdly unreasonable price was agreed upon. In this
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simulation, I play the role of International Beverage. This being said, I see value added to my
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company regardless of whether I acquire Bel Vino or Starshine. In the case of acquiring Bel
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Vino, the company really has no distribution network and therefore its sales suffer. It also has
little international presence while producing only the highest quality wines. In my opinion, this is
a perfect fit for International Beverage. International Beverages main competitive advantages are
its diverse product lines and it’s well developed distribution networks (especially
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internationally). If the acquisition took place, International Beverage could bring Bel Vino to the
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next level. International Beverage would expose Bel Vinos products overseas finally make them
successful there as well as funnel Bel Vinos products through its well-developed distribution
network. Acquiring Bel Vino would also enhance International Beverages high product line,
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which is where the company wants to focus its future. If International Beverage acquired
Starshine, it would be acquiring a midsize company that is stable and ready to grow.
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International Beverages well-developed distribution network will help take Starshines well
developed network to the next level by gaining more of a share in the national channels of the
market. This acquisition would also enhance International Beverages product line; however, it
would still have not many high-end wines. If Starshine and Bel Vino were to merge, I think this
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would actually be the best outcome (regardless of myself representing International Beverage).
Each of these companies possesses strengths, which are weaknesses of the other. Therefore, this
merger would be very well balanced. Starshine has a solid distribution network both nationally
and abroad but they suffer from competition of high-end imported wines. However, they are a
financially stable company and ready to grow. Bel Vino, on the other hand, is a steady company

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 with reliable low growth. Bel Vinos high-end wines would go great with Starshines distribution
network making it a perfect match for both companies. In addition, neither of the companies is
too big so they would end up forming a respectable sized company to run operations through.
Acting as International Beverage, I must acquire either Bel Vino or Starshine.
- Avoided loss: Bel Vino was the left out firm and it got harm since the company’s stock price
dropped badly to 34$. Bel Vino is the smallest market capitalization firm, which has its sales
not growing rapidly because the company would have issues to reach both domestic and
international customers.
3. Stock Price Reactions
Figure 2 shows the analysis of the stock price and stock price reactions to a bid as described
below in the following sections.

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Figure 1: Analysis of the Stock Price and Stock Price Reactions

 Target's stock price reaction and analysis
International Beverage (IB) started the biding to buy Bel Vino; Bel Vino’s stock price was
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increased. This incremental in the stock price is reasonable since the potential acquisition would
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create synergy and investors expect that. Nevertheless, IB made another offer to purchase SS for
$45.00 per share and its share stock was decreased. This reaction was expected since SS’s price
and IB’s bids were far below its fair market value.
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Soon after BV rejected SS's bid, IB offered to purchase SS for $45.00 per share. The offer
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was rejected and, stock price of the target increased. The reason was that investor thought the
bidder’s price did not show the really value of the target when the offer was rejected.
 Bidder's stock price reaction and analysis
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Every time IB made a bid, IB’s stock price increased because of higher value would be
created after acquisition. IB offered to purchase BV for $41.00 per share because we think the
reason was that this bid is too close to our reservation price of Bel Vino. Investors became
concerned that the company might pay too much for the target.

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 In the scenario of the bid was rejected by the target company, stock price of the bidder
decreased. Since the acquisition was failed, the synergy could not be created and investor might
have less confidence in the bidder. If so, the target company accepted the bid, stock price of the
bidder increased since the synergy was created.
 Third firm's stock price reaction and analysis
The third firm in each bid activity, its stock went down when offer was made. This decrement
was because of the possibility of other two companies might marge or one acquire the other. In
the scenario of this bid was rejected by the target company, stock price of the third firm
increased. Since the prior offer did not work out, the third firm regained the opportunity to get
value from acquisition or merge, so its stock price increased. In the scenario of this bid was
accepted by the target company, stock price of third firm decreased. Therefore, based on the
results and analysis above, the stock price reactions are expected and they have relative
changing.
- The effects of stock bids on IB's decisions

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Whenever both of BV and/or SS offered stock bid to purchase each other, there was a chance

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of IB loss the opportunity to get value from acquisition. Therefore, we had to try to keep biding

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within or under reservation price to purchase either BV or SS. We paid attention on stock bids

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and tried to make our bids more competitive and reasonable. In addition, when we found the

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target company was hesitated after a bid, we engaged in further negotiation to convince it accept
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- The effects of cash bids on BV's and SS's decisions
A like with the situation that IB would face as explained above, BV or SS might be in
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pressure situation when IB made cash bids to its merger target. They had to increase the cash
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bids and made offers more attractive than the IB to make the merger successful to get synergy.
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4. Negotiation Narratives
In this simulation, we are representing International Beverage (IB) and we decided to acquire
either one of the companies: Bel Vino, or Starshine. We closed the deal by acquiring SS
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successfully with price of 53.1, which was under our reservation price that we had determined
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for the company.

Through our preparation phase, we persue a deep research in order to understand wine
industry which helped us to inderstand the companies strategies and operations in this
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simulation. We were able to use the confidential data provided in the simulation to calculate the
reservation prices for the target companies (SS and BV). Therefore, we determined our
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reservation price for Starshine as $57.48 per share and our reservation price for Bel Vino as
$44.8 per share. With that said, we will be able to pay to acquire SS with any price but not more
than $57.48 and $44.8 for acquiring BV.
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During the negotiation phase, initially, we started to bid on BV by offering $40 and we felt
that its not a wise decision so we withdraw the offer and right away we made a bid on SS and
offered to purchase SS for $45.00 per share, but SS rejected our offer. Then, we made another
offer to purchase SS for $48.00 per share and again SS rejected our offer and they were requiring
price higher than our reservation price. So we made another attempt by offering $52 and they
still rejected our offer. After that we tried to negotiate with BV by going back and forth with

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 multiple rounds of bidding to see the reaction of the market and to test the reflection on the
targeted companies stock prices. We offered BV $40.50 but the company reject our offer, so we
increase our bid on BV to $41 and again they rejected the offer, we hold and waited to see the
market reactions after these rounds of negotiations and then we made another offer to SS
company for $50 after we noted a decrease in their stock price. And again we did not give up and
respond to the market actions and offered again $52 to buy SS shares, and agaon they rejected
the offer and we entered in a talk with SS management and inquired from them about what is the
price vthat they are looking for since we showed them that we are interesting in acquiring the
company and offer them all the facilities that they need to better market their product through the
strong distribution network IB have. And they told us that they are looking for $54 per share, at
that time we felt that we are really close since thier asking prive is below our reservation price
that we determined for them in our calculations. But still we did not go directly to their asking
price, but we offered $53 per share, and they decline the offer again, Finally, we went a little up
in the price and offered $53.1 and with a little negotiations on the side we successfully got our
offer accepted by SS and we were able to close the deal on $53.1 and that was a great deal for
our company since that was below our resrvation price of 57.48 for SS.

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During the process of bidding, our company (IB) stock price as well as the Starshine and

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Bel Vino stock prices were changing due to many factors. When we started our offers to SS and

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BV our stock price increased, as the market may believe that the bidder has more potential to add
value to the company when the bidder attempt to acquire target companies and the synergy could

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lead the bidder to grow more and increase its market share in the market, on the other hand, this
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fluctuations in the stock prices explain the decrease in our company stock price when our offers
get declined by the target companies.When we offered SS a price that was lower than thier fair
value, SS stock price decreased as thet market may think that the company stock price was
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overvalued, and we we made an offer to BV with a price over their fair value, their stock price
increased as the stock market may think that the company stock price was undevalued.
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The acquisition of SS can increase the value of IB and SS as well. both companies stock
prices went up after the deal closed. Our company stock price went up from $66.14 to $67.50
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and SS stock price slightly increased from $53.01 to $53.10

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In addition to that, this deal can extend IB product line and boost the company
efficiency and also increase the sales significantly by adding SS products to its distribution
network in the demostic market and the international market as well. As a result, this will enable
our company to strength its market position as this acquisition can creat economies of scale in
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marketing, Sales, accounting and other functions in the company. Finally, the acquisition will
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help our company to maximize its earnings.

5. Summary
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