Mercury Athletic Footwear: Valuing the Opportunity

Mercury Athletic Footwear:  Valuing the Opportunity

Terran Knox

Measurements II MBA-634

Northwood University DEVOS Program

Dr. Adam Guerrero

4 March, 2015

Problem Statement        

Mercury Athletic is the footwear division of West Coast Fashions (WCF), a designer and marketer of men’s and women’s apparel.  Due to unspectacular financial reports, the division was going to be sold.  John Liedtke, the head of business development for Active Gear, Inc., (AGI) looked to acquire Mercury from WCF, believing that the purchase would double their revenue and provide greater leverage with manufacturers and distributors.  Would Liedtke’s evaluation of Mercury prove that the future benefits of the acquisition will exceed the present value of the company?

 Analysis

        While Mercury Athletics was an owned subsidiary of WCF, they were allowed to operate with a rather large amount of autonomy.  They maintained their own financial statements, databases, resource management systems, and distribution facilities (Luehrman & Heilprin, 2009).  This could have attributed to the various profitability problems that plagued Mercury.  A main contributor to these problems was that the company has to discount many of its lines to be allowed to be sold in large discount retailers.  As shown in the table below,   Mercury dropped from a 21% return on net assets in 2004 to 13% in 2006.  That a significant drop from the 20% group average indicated in the article.  

Mercury Operating Metrics         2004         2005         2006

Return on net assets                         21.1%         10.8%         12.9%

Return on equity                         18.5%         9.6%         12.1%

Asset turnover                         3.58x         2.00x         2.12x                 (Luehrman & Heilprin, 2009)

        Mercury also had an issue with their operational efficiency as they maintained a backlog of inventory for greater periods of time.  In fact, Mercury average a Days Sale Inventory (DSI) that was over ten days more than that of the group.  AGI, on the other hand, sat comfortably at eight days below the group average.  During the acquisition, AGI could take strip the autonomy that Mercury had with WCF and implement several of the practices and policy that they have set in place.  This could greatly improve Mercury’s return on assets, returning it back to the group average of 20%.  AGI could also introduce the practice of focusing on smaller portfolios of products with longer lifecycles to maintain simple production and supply chains.  It would be very beneficial to AGI to have two companies with DSI well beneath the group average of 51 days.  

Days Sales

Casual & Athletic Shoe Companies                 in Inventory

D&B Shoe Company                                         61.3

Marina Wilderness                                         39.5

General Shoe Corp.                                         73.2

Kinsley Coulter Products                                 31.1

Victory Athletic                                         50.0

Surfside Footwear                                         60.0

Alpine Company                                         42.9

Heartland Outdoor Footwear                                 58.1

Templeton Athletic                                         42.5

Average                                                 50.9

Active Gear                                                 42.5

Mercury Athletic                                         61.1                (Luehrman & Heilprin, 2009)

To gain a wider idea of the purchase of Mercury, Liedtke needed to evaluate the strengths and weaknesses of the acquisition.  To do that, he would have to review financial data to produce a projected balance sheet that would range from 2006 to 2011.  The following table illustrates the two companies’ revenues, percentage of revenue product, operating income, and revenue growth in 2006, prior to the decision to purchase Mercury:

 [pic 1]

What can be seen here is that initially, the purchase of Mercury would a very lucrative investment as the revenues of the acquisition nearly mirror than on the AGI.  It should also be noted that the percentage of revenue product would allow for both companies to pick up the slack in each other’s product lines.  Mercury would provide a boost in AGI’s athletic line.  AGI’s casual footwear would benefit Mercury.  Also, although AGI is well below the average growth percentage of 10% for its group, Mercury stands above the average with 12.5% revenue growth.  Having reviewed the initial financial data on the companies, it is easy to see Liedtke’s interest in obtaining Mercury Athletic.  

        To start off, Liedtke would need to determine the Free Cash Flows (FCF) for a five year period after the acquisition.  FCF is the amount of funds available to all investors in a firm after the firm pays taxes and meets investment needs.  The importance of it is that FCF does not distinguish between debt or equity investors, allowing for the focus to be on the firm finance entirely by equity (Greenwood & Scharfstein, 2006).  The formula for FCF is EBIT X (1-Tax Rate) + Depreciation – Capital Expenditures – Increases in Net Working Capital.  With values included, it is displayed as 42299(1-.4) +9506-4645-11560 to see the FCF for 2006.  It comes out to be $28956m in 2006 and ends as $29544m in 2011.  Throughout the time range there is consistent growth with a small dip in 2009.  It should be noted that revenues for Mercury display a pattern of growth during this period, as well.  That can be seen in the spreadsheet below.