FINA 5470 Mergers, Acquisitions and Restructuring Case 3: Eskimo Pie

Submitted by Group 3: LIU Zheng 09962873 Wu Yilin 09963451 Liu Sisi 20070180

CHEN Yifan 20076419 LI Jie 20078003

1. What is your estimate of the value of Eskimo Pie Corporation as a stand-alone company? Be specific about the assumptions and the data as well as its source. Since the actual performance of Eskimo Pie in year 1991 was different from Goldmans forecast, our valuation will be based on both the Goldmans forecast and actual data with adjustments for comparison. Besides, since the deal lasted from early 1991 to end of 1991, the valuations as at the beginning and at the end of year 1991 are presented for reference. iDiscounted Cash Flow Model Based on Goldmans forecast, the share value of Eskimo Pie was about $10.03 (at the beginning of 1991) or $10.38 (at the end of 1991) as a stand-alone company. The offer price $18.40 (i.e. $61million/3,316,000shares) by Nestle and the IPO proceeds (i.e. $18.52-$20.52) were both higher than the share value as a stand-alone company. Based on actual performance of the company in 1991 and adjusted forecast, the share value of Eskimo Pie was about $17.27 (at beginning of 1991) or $18.18 (at the end of 1991). The offer price $18.4 by Nestle and the IPO proceeds (i.e. $18.52-$20.52) were both higher than the share value as a stand-alone company. In particular, we used a WACC of 12.43% as the discounting factor, which could have been lower by choosing a higher long-term risk-free rate and a higher risk premium (currently we assume the market risk premium to be 7%). That is, the share value as a stand-alone company could have been even lower under the DCF model. To conclude, under the DCF model, the value of Eskimo Pie as a stand-alone company is estimated to be lower than the offer price of the Nestls buyout. Please refer to Table 1 for detailed calculation and key assumptions made. ii) Comparable Approach Based on Goldmans forecast, the share value of Eskimo Pie was about $19.89 (at the beginning of 1991) or $21.97 (at the end of 1991). The offer price $18.4 by Nestle was below the share value. While the IPO proceeds ($18.52-$20.52) might overlap with the share value if the IPO offer price reached the upper limit of $16. Based on the actual performance of the company in 1991 and adjusted forecast, the share value of Eskimo Pie Corporation was about $27.5 (at beginning of 1991) or $30.25 (at the end of 1991). The offer price $18.4 by Nestle and the IPO proceeds ($18.52-$20.52) were both below the share value. Please refer to Table 2 for detailed calculation and key assumptions made.

2. Nestle is considering the acquisition of Eskimo Pie: a. What are Nestls motives? Are there potential synergies? Explain. Market position strengthening The intended acquisition of Eskimo Pie will further strengthen the market position of Nestl in the frozen novelty industry. As the third leading frozen novelty brands in terms of market share, Eskimo Pie's products were recognized in 98% of all US grocery stores. The distribution and market share of Eskimo Pie from 1987 to 1991 both kept growing steadily. These factors would give Nestl competitive edge in better market presence. Synergies from manufacturing, licensing, and product innovation First, the horizontal acquisition would consolidate Nestls Carnation and Drumstick units with Eskimo Pie operations. The overhead cost per unit will be lower by eliminating Eskimo Pies management, leveraging on existing facilities/ distribution channels, and eliminating the licensing costs. Second, by taking over Eskimo Pies licensing and sublicensing business, Nestl might gain more control over some of its competitors. Third, Eskimo Pie was very active in product innovation and sensitive to the market demand as evidenced by the ten products being actively sold since their introduction and the increased market share. Nestl would utilize Eskimo Pies innovation engine for product development in the future. Operating efficiency Eskimo Pies recent operation margins had improved consistently from 1987 to 1990 in terms of net sales, net income, and gross/ net profit margin, (calculated by using Exhibit 1), which also makes Eskimo Pie an attractive target. b. Is Eskimo Pie worth more to Nestle than it is worth as a stand-alone company? In Question 1 we concluded that the buyout offer price were greater than our estimated value of Eskimo Pie as a stand-alone company using the DCF approach, and were equal to or below our estimated value of Eskimo Pie as a stand-alone company under the multiple approach. As Exhibit 5 shows, the IPO market was promising and might generate more liquidity and upward price potential to shareholders. Such liquidity and market optimism might bring more value to shareholders as compared to a private buyout. This may explain why Eskimo Pies PE was lower than its comparables and why the valuations were higher using market comparables multiples. However, by using forecasted cash flows and WACC that are particular to Eskimo Pie, we can observe that the synergy effects illustrated in part a) above would make Eskimo Pie worth more to Nestl than it was worth as a stand-along company.

As an advisor to Reynolds, would you recommend the sale to Nestle or the proposed initial public offering? Why? We would recommend Reynolds to accept the IPO for the following reasons: Price: First, Nestls buyout offer would provide a lower value to Reynolds. Nestls offer price was equal to $18.40 per share (i.e. $61m/ 3316 shares), whereas the IPO would offer shareholders with both shares and special cash dividend that would be worth either $18.52 or $20.52 per share (i.e. $4.52 + $14/ + $16 = $18.52 / $20.52). Second, to address Reynolds concern on the price uncertainty after the IPO, we could demonstrate that the implied PE multiple was 12.38/ 14.15 as per Exhibit 7, which was much lower than the comparables average PE of 22.8 (i.e. using Exhibit 8, we divided the net income by the market value of equity to get PE). That is, the IPO was not overpriced comparatively and the growth potential in share price would be high. IPO offering structure: The IPO was designed to be a two-phased deal, which would pay out $15 million in cash (i.e. more than 20% out of the whole proceeds). The Reynolds would thus be compensated in part for the uncertainty associated with the IPO market, the share price as well as potential loss in time value of money due to a relatively prolonged IPO process. Sale in future: As discussed in Question 2b, an IPO could bring liquidity and potential growth potential in share price to shareholders, which could not be given by a private buyout. The case indicated that there were only six bidders and many other potential buyers were concerned that Eskimo Pies licensing approach diverged from their traditional manufacturing and marketing approach. In other words, there would not be many potential buyers that could offer a private buyout with attractive prices in the near future. By contrast, with successful IPO, the Reynolds could sell their share more easily in a secondary market. Other considerations: From a social economic perspective, IPO would save Eskimo Pie as an independent company and thus save local jobs. Moreover, an IPO does not require complicated negotiations and compromises as compared to a buyout.

Table 1: Discounted Cash Flow Approach a) Valuation based on Goldmans forecast Tax rate=40% rf=4.64% U=1.14((assume equals mean of U(comparable)) E=1.15 Assume market risk premium = 7% Assume r D=9.56% (corporate bond with BBB rating) Assume market value of equity is the same as the book value Assume free cash flow grow at 4% per year after 1993. Assume capital expenditure is equal to average of capex in year 1989 and year 1990 Assume NWC is equal to that of year 1990 Assume Depreciation and Amortization etc remains at the average of 1989 and 1990: ((1006+175+250-154)+(1352+118-58-156))/2 = 1267 Assume debt and cash amount at the end of year 1991 remains the same as at the end of year 1990 Year Ended December 31, 1991 NI Plus Interest *(1-Tax Rate) Plus Depreciation& Amortization etc (Data from Exhinit 2 cash flow summary) Minus CapEx Minus NWC FCF Terminal Value WACC NPV at the beginning of year 1991 Sum of NPV Minus Debt Plus Cash Equity Value No. of Shares Share value at beginning of year 1991 NPV Sum of NPV Minus Debt Plus Cash Equity Value No. of Shares Share value at the end of year 1991 $21,958 $744 $13,191 $34,405 3316 $10.38 12.43% $1,291 $20,821 $744 $13,191 $33,268 3316 $10.03 $1,552 $20,407 $1,380 $18,150 $1,267 $1,835 $905 $1,451 $1,267 $1,835 $905 $1,745 $1,267 $1,835 $905 $1,935 $23,862 $2,893 $32 1992 $3,195 $23 1993 $3,394 $15

Table 1: Discounted Cash Flow Approach (Continued) b) Valuation based on actual performance of year 1991 and adjustment Adjustment on net income forecast and capex is made according actual outcome of year 1991 Base on the actual net income data, adjust the net income forcast in year 1992 and 1993. Assume net income grow at 10% in year 1992 and 1993 Capital expenditure is expected to be about $1million since year 1992 Other assumptions remain unchanged Year Ended December 31, 1991 NI Plus Interest *(1-Tax Rate) $4,000 $32 1992 $4,400 $23 1993 $4,840 $15

Plus Depreciation& Amortization Minus CapEx Minus NWC FCF Terminal Value WACC NPV at the beginning of year 1991 Sum of NPV Minus Debt Plus Cash Equity Value No. of Shares Share value at beginning of year 1991 NPV at the end of year 1991 Sum of NPV Minus Debt Plus Cash Equity Value No. of Shares Share value at the end of year 1991

$1,267 $1,835 $905 $2,558 12.43% $2,275 $44,812 $744 $13,191 $57,259 3316 $17.27

$1,267 $1,000 $905 $3,785

$1,267 $1,000 $905 $4,216 $51,988

$2,994

$39,543

$3,366 $47,826 $744 $13,191 $60,273 3316 $18.18

$44,460

Table 2: Multiple Approach Valuation based on Goldman Sachs Forecast PE of Comparable companies EPS(year 1991) Price at the beginning of year 1991 EPS(year 1992) Price at the end of year 1991 22.8x $0.87 $19.89 $0.96 $21.97

Valuation based on actual performance of year 1991 and adjustment PE of Comparable companies EPS(year 1991) Price at the beginning of year 1991 EPS(year 1992) Price at the end of year 1991 Market Net Company Ben & Jerry's Dreyer's Grand Ice Cream Empire of Carolina, Inc. Steve's Homemade Ice Cream Hershey Foods Corp. Tootsie Roll Inds. $207.9 $25.5 $728.8 $0.0 1.0 1.00 Average 1.00 1.14 28.58 22.80 $2,899.2 $219.5 $4,002.5 $282.9 1.0 1.07 0.93 18.23 $35.1 $1.8 $37.4 $3.1 2.5 1.08 2.31 20.78 $243.1 $8.8 $51.4 $89.8 0.3 2.75 0.11 5.84 $354.9 $15.9 $534.0 $44.3 1.4 1.08 1.29 33.58 $97.0 $3.7 $110.1 $2.8 1.2 1.03 1.17 29.76 Sales Income Value of Equity Total Debt Beta Levering Factor Unlevered Beta P/E 22.8x $1.21 $27.50 $1.33 $30.25