Advising Reynolds: Sale to Nestle or IPO? Analysis of Eskimo Pie’s Valuation Methods.

 Part 1

“As an advisor to Reynolds, would you recommend the sale to Nestle or the proposed IPO? ” Subpoints:

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1. The managers of Eskimo Pie wanted to find an alternative to Nestle’s acquisition offer for one main reason: Eskimo pie would lose its independence. If Nestle went through with the acquisition, Eskimo would not continue its tradition of being a stand-alone company in Richmond with this meaning that its headquarters and management staff would probably be replaced too. Fundamentally, Eskimo was reluctant to being acquired by Nestle because it felt it would be an aggressive takeover of the company. It would ruin a 70-year long business to take advantage of its tax conditions and it would probably transform the business similar to a traditional integrated manufacturing and marketing approach.
2.  David Clark knew that Goldman Sachs had a long-standing relationship with both Reynolds and Nestle. This meant that GS had a conflict of interest in this acquisition. The solution that would best satisfy GS’s interests would be to sell Eskimo to Nestle but this might not be the best solution for Eskimo. So David Clark is dealing with Wheat First Securities instead of Goldman Sachs because he wanted to find an alternative to Nestle’s offer. Since Wheat First Securities had no long-standing relationship with neither Reynolds nor Nestle, it had no conflict of interest in this acquisition. It could see with more objectiveness which acquisition is the best for Eskimo. Furthermore David had personal interest in dealing with WFS because his own position could be put at risk by a Nestle acquisition.

Also the proceeds from the IPO proposed by the management and Wheat First Securities are able to adequately compensate Reynolds. Assuming a price range within $14 - $16, the net proceeds for Reynolds would be $51. 652 and $57. 230 respectively, still higher than the considered equity value. As a matter of fact the private sale to Nestle is still the most convenient to Reynolds. 2. To value Eskimo Pie using multiples method we should decide whether to use the transaction multiple, available from the Drumstick deal, or business and market based multiples. The implied value on sales from Drumstick transaction can be used to assess the value of the company only if the two companies and deals are significantly comparable. In this case accurate information are not available and the peculiar business model of Eskimo Pie, based on licensing, makes this method not highly reliable. * Multiples based on business and market data imply the use of realized or projected values. The management of Eskimo Pie forecasts higher sales in the future years, thus using realized data to calculate the value of the company could lead to mispricing.

Therefore the information of 1991 is used to implement the method. * Looking at comparable companies, two firms are operating in the same business, Empire of Carolina, Inc. and Steve's Homemade Ice Cream. Since multiples based on operating measures such as EBIT or EBITDA depend less on firm leverage and cash than those based on Earnings and we have relevant information available from those two companies, multiples like EV/EBITDA or Firm Value/EBIT seems to be most accurate. Considering the calculations in Exhibit 7 based on the Firm Value/EBIT multiple, Reynolds should sell Eskimo Pie for an amount not less than $56. 68 million. The offer from Nestle is consistent with this valuation of the company, whilst the proceeds from the IPO are sufficient to adequately compensate Reynolds only if the share price is higher than $15. 66. Notwithstanding, if we take into account the implied price using the P/E multiple or transaction multiple, the threshold to sell the company is even higher ($82. 891 and $73. 200 respectively). Thus, neither the IPO option nor the Nestle offer are appealing to Reynolds. 3. The theory says that multiples only work if the comparison group is sufficiently comparable in all other respects.

In order to know if we could use other companies’ multiples or the average of them we must see if they are sufficiently comparable to Eskimo, in other words we must see if the value drivers of the firms are approximately the same. The eligible companies in terms of business model and structure are Empire of Carolina, Inc. and Steve’s Homemade because they both market ice cream and license their formula. All the other companies having a different business model and structure will not be taken into consideration as comparable companies.

As a first comparable driver we will use the operating profit margin. Eskimo has a 6,83% operating profit margin calculated on data of 1990 (exhibit 1). Carolina and Steve instead have respectively 15,38% and 11,11% operating profit margins. This tells us that… The tax rate is the same for all companies therefore it is not a relevant driver in making a choice on which comparable company to use. Since we don’t have the cost of capital and the cost of debt, we will compare the risk class and leverage among the considered companies.

We can see that Carolina and Steve have very different risk classes, one is a C and the other is a BBB, Eskimo on the other hand is a BBB because to calculate the WACC we used a cost of debt correspondent to long-term bond in the BBB risk class. So this means that… The leverage of the three companies are 0,07 (Eskimo), 0,08 (Steve) and 1,747 (Carolina). Carolina has a very high leverage because its debt is more than 1,5 times its equity, instead the other two have a debt which is inferior to their equity.

So even if the two companies have similar business models, through a deeper analysis we found that Eskimo is effectively similar to Steve but very different respect to Carolina. Steve has a closer operating margin to Eskimo’s than Carolina. It also is in the same risk class, and its leverage is alligned with Eskimo’s. Carolina on the other hand has more than double of Eskimo’s operating margin. Its in a riskier class and its leverage is much higher than Eskimo’s. Therefore it was correct to use Steve’s Homemade Ice Cream as a comparable company.

The only case in which we would use an average, instead, would be if the two companies were both very similar to Eskimo. 4. The fact that DFCF approach gives a lower value for the company than multiples-based approaches depends on market drivers. In particular, the case can be that the DFCF model implies a WACC that does not reflect the cost of capital and implied risk perceived by the market. As a matter of fact the market overvalues future growth opportunities, leading to high multiples on EBIT and Earnings.

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