Interco

Interco (Assignment)

Your assignment in this case is to put yourself in the role of an outside (non-executive) director of the firm. In class we will discuss the appropriateness of the Rales brorther's offer. For your assignment I would like you to specifically answer the following:

1. What would Wasserstein-Perella like to conclude from premium paid analysis (Exhibit 10)? Any problems with their conclusion?

2. I would like you to re-construct from basics the stock price table obtained in the lower right corner of exhibit 12 under various assumptions on discount rate and terminal multiple. Let me define terminal multiple below:

Value in 1998 of Future cash flows (1999 onwards) = FCF in 1998 * Terminal Multiple

To help you in the task, the spreadsheet for the case, interco.xls, provides a bit more detailed version of Exhibit 12, the discounted cash flow analysis. This should start you up on completing exhibit 12.

3. Continuing value can also be obtained from assuming that FCF will grow at a constant rate from 1999 onwards. Assume that the firms' cash flows will grow at a rate g. Given the discount rates in exhibit 12, what growth rates (1999 onwards) are implied by the various terminal multiples. [You will need to use the formula CV(t)=FCF(t+1)/(WACC-g)].

4. Assume that the beta of existing equity is 1.2 and the firm will not undergo any major operational restruturing.; How would you go about calculating the WACC that should have been used in exhibit 12?; You'll need to assume some unavailable data. Any problems in using WACC here?

5. Examine the appropriateness of the assumptions underlying 12. The second item in the spreadsheet might be useful here. It is a comparison of the assumptions in Exhibit 12 with historical operating results. These results are described in Exhibits 6-8.

Market Place; Almost Everyone Is Faulted In Interco Bankruptcy Case

A bankruptcy examiner said yesterday that Interco Inc., whose brands include Converse and Florsheim shoes and Lane and Broyhill furniture, had been forced into bankruptcy in part because company officials breached their fiduciary duties.

The examiner, Sandra E. Mayerson, who has investigated the company's collapse, is the head of the bankruptcy practice at the law firm of Kelley Drye & Warren. She was critical of almost everyone involved in Interco's 1988 defense against a hostile takeover, which ended in the company going deeply into debt. That debt, she concluded, left the St. Louis-based company insolvent and led to its bankruptcy filing earlier this year.

The harshest criticism was directed at American Appraisal Associates, which gave Interco an opinion that it was solvent after its recapitalization was completed. That opinion, she said, was possible only because American Appraisal breached its own rules, ignored some liabilities and overstated some assets.

Ms. Mayerson said Interco had "a very strong case for negligence, malpractice and breach of contract against American Appraisal," and recommended that one be brought.

A spokeswoman for American Appraisal said the company had not seen Ms. Mayerson's report and would not comment. An Interco spokesman said his company had not had time to study the report, but emphasized that it had relied on outside experts.

Ms. Mayerson concluded that a "fraudulent conveyance" suit against the banks that financed the deal was justified, but said such a suit would only drag out the bankruptcy and run up legal bills. She recommended that the banks reach a settlement that reduced their claims. Her conclusion was based in part on a provision of the financing that, she asserted, violated the rights of bondholders.

Interco's investment banker, Wasserstein, Perella & Company, was exonerated, Ms. Mayerson said in an interview, because company officials had misled it.

"They performed their services at a level that was acceptable by investment banking industry standards, which I have come to learn are abysmally low," Ms. Mayerson said. "Their real problem was that they were not given complete information from the company."

In her 556-page report, Ms. Mayerson painted a portrait of two investment bankers jealously refusing to share information with one another, although both were working for Interco, and of two top law firms telling diametrically opposite stories about an important aspect of the financing, one that Ms. Mayerson concluded was probably illegal.

The biggest winners as a result of her report may be holders of one bond issue, Interco's 8.875 percent medium-term notes due in 1993, and Interco's trade creditors. She called them "the true victims" and recommended that a settlement be reached for eventual full payment of their claims, unlike those of banks and other bondholders.

Ms. Mayerson concluded that Interco was insolvent when it completed the leveraged restructuring to fend off a hostile takeover offer from two brothers, Steven and Michael Rales of Washington. They were backed by Drexel Burnham Lambert Inc., which had promised to sell junk bonds to finance their offer. Interco prevailed by borrowing $1.9 billion from banks, paying out most of it to shareholders, along with a package of securities.

Ms. Mayerson's report traces an amateurish and at times outlandish sequence of events. Goldman, Sachs & Company, which had been hired by Interco to find buyers for the company's apparel group, refused to tell Wasserstein, Perella how the sale was going, although the latter firm had been hired by Interco to put a value on the company.

Goldman did tell Interco's vice chairman, Ronald L. Aylward, that Wasserstein's figure was far too high, but that information was not given to Wasserstein.

Ms. Mayerson concluded that a number of inside directors, including Mr. Aylward, had breached their fiduciary duty. The report exonerated the company's outside directors, who it said were kept in the dark on important facts.

Wasserstein,