Interco was extended a $70 per share offer for the company. However, Wasserstein Perella advised the company to reject the said offer. This case study looks into the factors that Wasserstein Perella has to consider in coming up with his recommendation.

Susan L. Roth

Harvard Business Review (291033-PDF-ENG)

March 12, 1991

### Case questions answered:

We have uploaded two case solutions, which both answer the following questions:

- Assess Interco’s financial performance. Why is the company a target of a hostile takeover attempt?
- As a member of the company’s board, are you persuaded by the premiums paid analysis and the comparable transactions analysis? Why?
- Wasserstein, Perella & Co. established a valuation range of $68-$80 per common share for the company. Show that this valuation range can follow the assumptions described in the discounted cash flow analysis. As a member of the company’s board, which assumptions would you have questioned? Why?
- How would you advise the Interco board on the $70 per share offer?

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## Interco Case Answers

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#### Part 1: Background

Interco is a conservative company with high liquidity. Sufficient capital brings Interco financial flexibility, allowing Interco to repurchase its common stock and acquire other companies at the right time. The company’s primary strategy is to acquire companies in related fields and incentivize the acquired companies to expand their business.

When Interco finds a company that meets the standards, such as some companies with highly skilled managers or development potential products, Interco will acquire this company. Interco will also focus on evaluating already acquired companies, divesting underperforming companies, and re-searching for markets with potential for development. This approach has brought Interco stable growth, and nearly half of its growth has come from acquisitions.

In 1987, there were many problems in the clothing manufacturing industry in the United States. For example, consumer spending is lower than expected, imported goods from countries with lower labor costs continue to flow into the United States, and significant U.S. department stores continue to focus on private-label products, and so on.

Various problems have forced retailers to implement promotional and discount programs. Nevertheless, this does not solve the fundamental problem, and retailers’ revenues are still declining. Based on this situation, Interco decided to implement a restructuring plan. The plan includes the sale of the apparel division and stock repurchase. Saligman, chairman of Interco, stated that its restructuring plan is mainly achieved by narrowing the focus of Interco’s business and increasing the stock price.

Interco’s furniture and footwear groups have outstanding performance; only the apparel manufacturing and retail departments still have problems. Also, the data shows that Interco’s overall performance in 1988 was on the rise.

Compared with the performance in 1987, sales and net income in 1988 increased by 13.4% and 15.4%, respectively， which means that Interco’s stock price is likely to be undervalued. Therefore, the investment community generally believes that Interco is a potential acquisition target, and Capital City wants to acquire Interco.

#### Part 2: Overview of Valuations

As indicated in the article, the person responsible for carrying out the valuation of Interco’s stock price for Interco is Wasserstein Perella or Wasserstein, Perella & Co.

Additionally, according to Wasserstein Perella, the discounted cash flow analysis, comparable transaction analysis, and premiums paid analysis that he performed showed that the valuation of Interco’s stock should sit between $68 and $80 per share.

Even though the advisory fee agreement was not explicitly stated in the article, it is reasonable to expect that as the financial advisor of Interco, Wasserstein, Perella & Co. is incentivized to put together analyses that would maximize Interco’s stock price valuation.

Because in doing so, Wasserstein, Perella & Co. can be better compensated when the M&A proposal goes through and takes place. In other words, there is the reason for us to believe that the valuation analyses delivered by Wasserstein, Perella & Co. may be biased.

#### Part 3: Free Cash Flow Valuation

Based on exhibit 12, we calculate the future ten years’ sales by the given rate. We use two different methods to calculate the total amount: the first is called the sum method, which calculates sales by departments and sums them up; the second is called the direct method, which is calculated directly by total sales with average rate.

Then, we can directly use the operating margin to calculate EBIT. Hence, we could get free cash flow with the formula FCF = EBIT + Other Income – Corporate Expense – tax – (CAPEX – DP) – NWC. After using Year 10 free cash flow times the multiplier in exhibit 12, we found that the direct method has the more accurate value.

To calculate implied enterprise value, we use share price times the total number of shares plus net debt. We then use the value divided by the net value of terminal value to calculate the fraction of enterprise value.

To calculate the share price, we first calculate the operating income by using EBIT minus other income. Then we use Year 10 operating income to obtain the net present value of terminal value with an adjusted discount rate of 15.04%. Then we could get the share price by using terminal value divided total number of shares.

As for the implied growth rate corresponding to the different discount rates and multiple combinations, we could easily derive the number through Excel Solver. To begin with, we calculate the free cash flow for Year 10 by dividing the multiple implied terminal value by the given multiple.

Next, we try to find the growth implied terminal value by using the…

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MBA student, Boston