The vice president of Deutsche Bank Securities was approached by a private equity fund named Intercontinental Capital. Ltd (ICL) offering to help finance the acquisition of a large hospital-supply distributor. It was a good deal for DB who could work with a private equity firm with a good reputation. As an independent advisor, would you recommend ICL and DB Securities to go ahead with this deal? Would you propose any changes to the capital structure?
Robert F. Bruner; Sean Carr
Harvard Business Review (UV1392-PDF-ENG)
December 09, 2005
Case questions answered:
- Please conduct your evaluation of CSSA, using the information available on the case. Is the buyer paying too much?
- How sensitive is your previous analysis of the buyer’s assumptions on:
a. Future growth;
b. Ebitda margin improvements:
c. Working capital improvements;
d. All the above
- Consider the proposed financing structure and terms. Additionally, assume the following binding covenants to be imposed:
a. Interest coverage ratio (Ebitda / Interest Expense) > 2.0×
b. Leverage Ratio (Total Debt / Ebitda) < 6.75×
Is this company taking excessive leverage? What factors (strategic, operational, economic) should we take into consideration to answer this question?
- Why is Deutsche Bank structuring the financing of this deal as a combination of Senior Secured and High Yield Debt? What determines the maximum amount of senior secured debt that a company may take? Considering its relatively high cost, why is ICL considering such a large issuance of high yield debt to finance the deal (instead of equity)?
- Analyze the CSSA’s ability to repay the loans according to the schedule proposed in Case Exhibit 7. How sensitive is your analysis of the buyers’ assumptions on future operating performance?
- Analyze the CSSA’s ability to comply with the proposed covenants. How sensitive is your analysis of the buyers’ assumptions on future operating performance?
- As an independent advisor, would you recommend ICL and DB Securities to go ahead with this deal? Would you propose any changes to the capital structure?
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Case answers for Deutsche Bank Securities: Financing the Acquisition of Consolidated Supply S.A.
This case solution includes an Excel file with calculations.
Executive Summary – Deutsche Bank Securities: Financing the Acquisition of Consolidated Supply S.A.
In 2003, the Hospital supply industry was fragmented in both the supply and demand side. Europe and the US represented most of the market. A private equity fund named Intercontinental Capital. Ltd (ICL) approached Deutsche Bank Securities to help them finance an LBO of Consolidated Supply SA (CSSA). It was a good deal for DB who could work with a private equity firm with a good reputation.
The DB believed in the ICL’s assumptions for the forecasting period. The APV method was used to account for changes in the cost of debt and in the debt to equity ratios each year. For the discounted rate it was assumed that MRP was 7,1% and that through the comparables it led to an unlevered cost of capital of 9.743%.
The DCF valuation based on the stated assumptions yields an Enterprise Value of about $1.974 billion, resulting in an Equity value of $995 million. According to multiple valuations, CSSA‘s Enterprise Value is about 1.974 billion dollars. Since ICL placed a bid of $1.435 billion (solely the Enterprise Value), the fund is rather underpaying than overpaying as the intrinsic value of CSSA is assessed to be 30% higher.
Four scenarios were created for a sensitivity analysis using from -30% to 30% of the expectations over the following captions: Growth Rate of Revenue, EBITDA margin, and NWC.
Revenue growth’s assumption is important once computing the valuation of the company, as less 30% of expected growth per year will lead to a decrease in EV by 14%.
EBITDA margin will be crucial once calculating the valuation of the company, an improvement of 30% will cause about 32% of the increase in the final EV of the company.
Working Capital improvements of 30% per year will lead to a change of approximately 6,5% of the Enterprise Value. NWC is the less sensible variable when compared to the previous ones.
Once computed together, these three variables have a huge sensibility in the Enterprise value, with these scenarios it can go up to 71% more than expected or decrease by 50% of the expected/originally forecasted one.
For the purpose of maximum value creation and return to the PE fund, the deal will be financed mainly with senior secured debt and high yield debt, being covenants’ compliance that restricts the different use of debt securities. Given the forecast assumed by ICL, the target company conveniently complies with all imposed covenants. Operational, economic, and strategic factors are important indicators for covenants compliance, but it is important to take them into consideration after, on CSSA’s Repayment Schedule.
With a sensitivity analysis, we can conclude that only with high percentage changes in the EBITDA margin (between 15% and 20%), it will lead to the non-compliance of many covenants; when these are not complied with, the bank is allowed to ask for immediate repayment of all the debt, leading to the bankruptcy of CSSA.
Regarding the repayments, CSSA is currently able to fulfill its obligations regarding Debt and Interest payments. Therefore the group believes it could leverage a little bit more, but always considering the costs inherent to debt borrowing.
Taking into account the valuations calculated, the size of the deal for Deutsche Bank Securities, and the risks involved for CSSA if it incurred in more debt, the independent advisory suggests an unchanged capital structure.
Hospital Supply Industry Overview
- Diversified market across regions, products, and end-markets
- North America and Europe represent 41% and 32% of the market respectively
- Thanks to increases in surgical procedures and medical advances, projected industry growth was of 4% to 5%
- Increases in investments in R&D also indicated market growth
- Supply and demand are highly fragmented
- Customers ranged in fields like Hospitals, Surgery Centers, outpatient medical facilities, and medical offices
- The market was lead by 3 main distributors (holding 28% of the market):
- Medical and Scientific Supply (MASS)
- Spa and Hospital Distribution
Hospital Supply market by region (% of global industry Revenue)
The Hospital supply industry was fragmented in both the supply and demand side. Europe and the US represented most of the market.