1. What is the value of Calaveras Vineyards? Is the proposed purchase price for Calaveras Vineyards appropriate?
The current management of Calaveras Vineyards is looking to acquire the company from its current owner Stouts PLC. To do so, the proponents are seeking a $4.5 million loan and a revolving credit. Goldengate Capital was asked by NationalBank Investments to participate in the syndicated loan, providing $2 million in debt and a revolving credit amounting to $2.5 million.
Stout PLC’s books indicates a value of $ 7 million for Calaveras Vineyard and a fair market appraisal has put the company’s asset value somewhere between 5 to 7 million. Stout is offering willing to sell Calaveras at $4.5 million. If liquidated, the asset value of the company is estimated to be $ 3.8 million.
The case facts indicate that Calaveras is a growing company, despite the loss of marketing support in 1992. It has done so through quality control, market segmentation and capital improvements. Its current leadership is capable and experienced and has demonstrated commitment by wanting to purchase the business from Stouts PLC. Demand for wine is also noticeably increasing, despite the slowing down of other alcoholic beverages and spirits. Qualitatively, Calaveras Vineyards represents an already profitable organization, that with a few minor adjustments and a major overhaul in terms of shareholder focus (i.e. through a final change of ownership), might prove to be more profitable.
One way of assessing profitability is by estimating current value. This is normally done by calculating the present value of the company’s future cash flows. To calculate the value of Calaveras based on the Discounted Cash Flow (DCF) technique, the following were computed:
a. Weighted Average Cost of Capital (WACC) - was computed using the following:
Cost of Equity
i. Risk free rate of 5.85%
ii. Market rate (average for small companies over T-bills) of 13.80%
iii. Unlevered beta of 1.169. This was derived using the beta of “pureplay” companies relative to Calavera’s operations. Using the weighted average removes any “bias” towards approximating Calavera as any of the mentioned pureplay companies.
Product line / Comparable
Calaveras %
Comparable Unlevered beta
Premium/Finn & Sawyer
Generic/Canandaigua
Specialty/Frogg's Jump
Weighted average unlevered beta
Cost of Debt
i. Interest rate of 9.5%
ii. Tax rate of 37%
WACC was computed every year since the D/E ratio changes as the long-term loan is being repaid. The calculation for WACC for each year is shown below.
Enterprise Value (V)
D/V
WACC
Discounted cash flows are computed as shown below.
Tax rate
Provision for tax
Amortization of organizational costs
Net working capital
Free cash flow (123.75)
WACC per year
Small Firm Premium
Discount rate
Present value of FCF
(113.33)
Total PV of FCF
Interest payments
Tax shield
Present value of tax shields
Total PV of tax shields
Total Present Value of Cash Flows
$ 1,256
The DCF calculations show that Calaveras will be able to service debt and gain a Net Present Value of $1.256 million. Three cases of sensitivities were examined that were considered plausible in the real world. These are the decline in growth of revenues, approximately equal to the inflation growth of 5%, the offering of debt at the current rate of 9.75% and a combination of the two. The results are as follows:
PV of Cash flows
Original
EBIT growing at 5% average, instead of projected 11% p.a
Debt interest rate at 9.75% (current interest rate)
Combination of 1 and 2
2. Would Calaveras be a creditworthy borrower?
Calaveras would be a credit worthy borrower. Historically, the company has been able to service its debt. Operationally, the company has a credit relieve of any receivables left unpaid after 90 days, which makes its revenue side robust. Calavera’s current ratio is at the lower quartile of the industry and is also at the lower quartile in terms of collection period (shortest is an average of 28 days). The company’s cash flows indicate good returns, with increasing returns on assets (from 9% to 14%) and return on net worth (76%).
Ratios
Calaveras Vineyard
Upper Quartile
Median
Lower Quartile
Quick ratio (×)
Current ratio (×)
Curr. liab. to net worth (%)
Total liab. to net worth (%)
Collection period (days)
Sales to inventory (×)
Assets to sales (%)
Acct. payable to sales (%)
Return on sales (%) (0.20)
Return on assets (%) (0.10)
Return on net worth (%)
If the company defaults on its loan obligations, it can salvage value by selling receivables at 85% of face value, inventories at 75% of face value and other capital assets at 40% of book value.
3. What should Anne Clemens do?
The only decision Anne Clemens should take is to participate in the syndicated loan. However, she should insist that Calavares do the following:
a. Do not obtain additional long-term debt from any other source. Calavares cannot sustain additional debt financing and will almost definitely default on payments due to its limited production capacity. Any future cash requirements should be generated internally.
b. Retain the zero-dividends policy until debt is fully serviced. Current management does not dispense dividends, instead plows-back the earnings to the company.
c. Improve on agricultural productivity, since there is a noted drop in productivity in the last year. The decrease in productivity affects possible revenues and maintaining a high farm productivity level not only improves revenues, it also protects debt repayment.
d. Improve the marketing and collections structure, to have a repayment rate of at least median quartile vis-à-vis the industry, to provide greater assurance on revenue generation. Calaveras has one of the longest repayment periods in the industry. Negotiating a shorter repayment period improves the liquidity position of the company.
e. Insist on a periodic review of the financial performance of the company, given that there will be ownership transition which may affect how current management will deploy its operating strategies during the initial phase of the take-over. Currently, Calaveras ranks at the lower quartile of the industry, having low solvency ratios and efficiency ratios. However despite that, the profitability ratios of Calaveras are on the median quartile of the industry. This indicates that its use of its resources provide adequate cash returns and that it is the managerial aspect of the business that requires work. Financial performance may be reviewed by both the company and the lending banks, with the lending banks appointing a “defacto” Chief Financial Officer (CFO) to assist the new owners in managing the company based on financial metrics.
f. Negotiate with the new owners on a possible debt-to-equity swap, in case the company does not meet financial obligations. This again highlights the fact that new management are well versed in producing wine, but may not be as expert in running the company. Possible ownership of the company by converting some of the debt to equity will pay the syndicated term holders additional cash and will provide additional management support for Calaveras.
