Anish GuptaCase Study 2Elinda KissEskimo Pie Corporation: Case SummaryReynolds Metals owns most of Eskimo Pie Corporation, which was on of the first ice cream novelty. Management has decided to discontinue its operations and sell out its holdings. Goldman Sachs prepared an auction style, in which Nestle gave the highest offer of $61 million, but David Clark, president of Eskimo Pie Corporation, considers an initial public offering proposal. Our main focus is to address the value of Eskimo Pie as a stand-alone company, and the reasons why Nestle wishes to acquire this company. I propose thatthe company takes the company to an initial public offering because they will be ableto value the company more, while still retaining a majority stake in the company. In this case, Goldman Sachs, a New York investment firm, gave a stand-alone value of $57 million. In order to determine the stand-alone value, one must look at the firm’s assets and a projected future income. A discounted cash flow model is the
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Introduction Reynolds Metals is the majority owner of the ice scream company Eskimo Pie Corporation and has decided to sell this company. Nestle Foods provided the highest offer of $ 61 Million. Due to delays of the Nestle'e's purchase, Reynolds Metals has take into consideration the IPO proposal of David Clark, president of Eskimo Pie Corporation, rather than selling the company to Nestle Foods (Case Study, 2001). This analysis will identify the current value of the company at a stand-alone value and explain why Nestle Food would want to buy this company and the synergies involved for their reasoning. We will also discuss who will benefit if Reynolds Metals were to sell to Nestle or were to create an IPO. Finally we will provide a recommendation for Reynolds Metals that will be most beneficial to the company financial needs.
Stand-Alone Value There are many valuation methods that could be used to evaluate this company. Finding a method that valuates the stand-alone value is difficult. The stand-alone value should be dependent upon the firm's own assets and projected future income. We decided to evaluate this company based upon two methods: The Discounted Cash Flow Method and the Comparable Companies Method.
Discounted Cash Flow Method takes the forecast free cash flows during forecasted horizon. Then we estimate the cost of capital (weighted average cost of capital) and estimate continuing value (value after forecast horizon). The future value is discounted to the present value. We than add back cash ($ 13 Million) and non-current assets and deduct total debt.
With the information provided several assumptions had to be made to obtain reasonable values (life period of 30 -years, Capital expenditures not to exceed $ 1 million dollars, depreciation to stay constant at $ 1. 15 Million and a discounted rate of 10 %). Based on our analysis, the company has a stand-alone value of $ 51 Million at the end of fiscal year end 1990 with a net present value of cash flows of $ 33 million that does not include the cash and non-current assets a cash of and non-current assets. The greatest risk using Discounted Cash Flow Method is all the assumptions that were made. Without knowing and having complete information this method could report underestimated or overstatement figures. The second method we used to analyze the firm's value was the Comparable Companies Method. As shown in Table 1, we used the historical figures as of 1990 and Goldman's Sach's Projections.
With an average of 22. 8 times the value, Eskimo Pie has a value of $ 57 million at the fiscal year end of 1990. The Comparable Companies Method is more accurate then the Discounted Cash Flow Method because assumptions are not being used and the company's value is compared to industry values. The risk of using this method is that the value is subject to short-term fluctuations and assumes all companies can generate the same growth. Table 1 Other methods not considered are the Book Value Method and Economic Method.
Book Value Method does not take in to consideration the market value of the company. Eskimo Pie true value is based on the name of the product and not the historical value of assets. Eskimo Pie generates high cash and does not need to invest in fixed assets to create growth. Nestle Foods The purpose of Nestle'e's proposal of $ 61 Million is to consolidate its current operation Drumstick with Eskimo Pie operations.
Buying Eskimo Pie will lower overhead cost by eliminating Eskimo Pie management, utilizing existing facilities, and eliminating sublicensing costs (Case Study, 2001). The purchase price is larger then the both of our stand-alone analysis because Nestle Foods is most likely projecting the value at discounted rate based on combined cash flows from both Drumstick and Eskimo Pie operations. Nestle is valuing the company based on acquisition synergy (Case Study, 2001). By combining the company value on a stand-alone basis of future cash flow (non-synergistic buyer) with the cash flows related to the apparent synergistic benefits (related to Drumstick), Nestle determined its purchase price. By creating a synergy value can creates a risk that the purchase price might be overstated because it tends to overestimate the magnitude of timing of synergistic cash flows while underestimating their associated risks. It may also inadequately evaluate an appropriate split of synergistic value between buyer and seller.
The benefit of doing a synergy acquisition is that it can evaluate the sensitivity of their value to changes in both the timing of projected cash flows and the key variables affecting cash flow magnitude (Jaffe, Jeffrey; Ross, Stephen A. ; and Westerfield, Randolph, 2001). Example of synergy is when GM bought a foreign car automotive called Daewoo. Combining GM with Daewoo created a global synergy and allowed GM to enter a foreign market and be more profitable. Most of the profits are not expected for a few years down the road, however GM expects to take 26 % of South Korea's market in the near future. Like all acquired synergies, only time after the acquisition will provide if the synergy value was benefit to the company (Unknown, 2002).
Who will benefit Reynolds Metals will benefit more financially by not selling to Nestle Foods. Both estimated stand-alone values are less then the purchase price, but Reynolds Metals will have to pay significantly high capital gains by selling to Nestle. Capital gain taxes will take a large sum of the cash. On the other hand, Nestle will benefit from the purchase because it will get a tax break from borrowing money to the purchase company and as mention above, buying Eskimo Pie will lower overhead cost by eliminating Eskimo Pie management and Nestle utilizing existing facilities and eliminating sublicensing costs creating greater cash flows. Based on the projections, Eskimo Pie Company is expecting sales growth estimated at 15 %. It is also undervalued compared to its industry average.
Doing the IPO will create higher market value of the company and generate enough cash to finance the IPO. In addition, the IPO will benefit senior management, employees, and the community. If Reynolds Metals is concerned about receiving cash, they will receive upfront of 84 % of $ 15 Million dollars of dividends and the value of the stock would increase because it will be valued based on the market. Wheat First will benefit as a banker that could provide additional debt needs to Eskimo Pie. Other With the IPO, there could be a potential conflict between shareholders (management) and debt holders. The IPO will create additional debt that may cause potential conflicts between parties.
Debt holders may require specific structure of the IPO to decrease their risk while management would want to take the greater risk that might provide greater profits not agree. The agency of the company may have other parties monitoring their business decision. If Nestle acquires Eskimo Pie, a conflict may occur between management and new owners. With management being eliminated with the new acquisition, they may not cooperate with Nestle in transferring business assets in the most efficient manner. With negotiations still in place, Reynolds Metals may be concerned in losing its agency, which may be delaying the transaction.
Recommendation We recommend that Reynolds Metals chose the IPO. The IPO will distribute all of excess cash out of the company to provide adequate financing for the IPO. As mentioned above, the majority Eskimo Pie cash will be distributed to Reynolds Metals. The Nestle purchase is a good value according the present value based on a future value, although the price is undervalued according to the Company Comparison Valuation Method. Reference Case Study (2001). Eskimo Pie Case Analysis.
Corporate Finance [University of Phoenix Custom Edition e-text]. McGraw-Hill Companies. Retrieved June 4, 2005 from University of Phoenix, Resource, FIN/ 545 -Finance for Managerial Decision Making Web site: ttp's: //my campus. phoenix. -edu / secure /resource / reason rce. asp Jaffe, Jeffrey; Ross, Stephen A. ; and Westerfield, Randolph (2001).
Corporate Finance: Fifth edition, Custom Electronic Text for the University of Phoenix, McGraw- Hill. Unknown (2002). Newsweek. Retrieved June 19, 2005 from Website web
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