There seasonal items and the store network (over
There can be a number of reasons for a company to go public or private. There are benefits, as well as disadvantages that go along with either course of action (Exhibit 1 for details).
When firms decide to go private, they are no longer listed on any stock exchange market. The pressure of keeping accounting regularity and reporting to the public is no longer an issue. Instead, firms can be more flexible to reorganize the business profile as well as the management team. In many cases, shareholders and board members receive very rewarding financial benefits from this transaction.However, in some situations, public firms do not have a choice in the matter, as is the case in a “hostile takeover”. In assessing Dollar General’s performance, we first must conduct an internal comparison, in which the Statement of Income shows both production and period cost had increased greatly which resulted in lower income; meanwhile, Ratio Analysis also points out relatively lower growth in revenues and profit margin.
For external comparison, the Income Statement Comparison chart proves (Although DG still lead in net sales) its growth in sales dropped 43. %, while its peers had significant growth. Refer to ratios analysis in Exhibit 2.
In the fiscal year ending Feb. 2, 2007, there was a performance decline caused by 1) ineffective inventory management, 2) real estate profile, and 3) increased SG&A. Inventory amassed due to unsold seasonal items and the store network (over 8000 stores) experienced problems due to its sheer size. Management took challenging steps to resolve #1 and #2 by offering markdown sales and restructuring the shops network.Even so, the profit loss from the markdowns, the additional depreciation expense caused by the store closures and rising SG&A costs of opening new stores all led to a lower net income (Exhibit 2). Mrs. Sadayo’s decision on whether or not to sell her shares depends on two major factors 1) Her financial goals in respect to KKR’s offer and 2) her evaluation of KKR’s offer vs.
her vision of DG’s future growth. She may also take into consideration the legal expenses and other risks that come along with renegotiating the price.Based on the analysis of the retail Industry as well as analysis of the company performance and strategic initiatives (Exhibit 2), the offer from KKR can be described as fair and reasonable (high Offer/EBIDTA ratio, 10. 9 against industry avg. 8. 9). Available documents contain no traces of malicious intent of the management.
The recovery of the earnings seems to be possible, however the future growth potential of DG is difficult to estimate because of its size and tough competition. Our recommendation: sell DG and accept KKR offer.Refer to Exhibit 3 for the possible evaluation algorithm.
Exhibit 1 For company owners/shareholders: can be + or – depending on the premium and investment goals. | Benefits or “ +”| Negative sides or “-“| | For current investors/shareholders| For management of the company| Company| For current investors/shareholders| Management of the company| Company| Public company going private| New owner pays premium, high enough to trigger the immediate sale, and sacrifice long-term goals. Usually up to 40% premium. May be a good solution, if company experience difficulties or they are expected. Acquirer has built the relationship and offers financial bonus, good enough for retirement, or guarantees future employment. So called “golden parachutes”| Avoid regulatory, administrative and financial reporting burden. No risks of stock market speculations and dependency.
Avoid bankruptcy and responsibility due to current market and financial position. Growth potential if acquirer is “growth investor”| The offered value may seem to be or is unfair. Thus current shareholders are l forced in the deal, which they don’t like. Hostile acquisition.Need for expensive lawsuits to protect the interest. Risks or loosing the trial and being in the minority camp.
No more a liquid asset| The risks of being sued and suspected in fraud, need to search the new employment and possible negative effects on CV. | Company may cease to exist, if the new owner bankrupts it and uses the assets. No more prestige of being listed on the stock exchangeDifferent financial and investment algorithms. | For the comparison a reversed process is given| Private company going public| Stocks are a liquid asset, easy to buy and sell.High profits it stocks go up| Higher wages and bonuses, Prestige of running a public company. | Growth potential, ability to attract public funds. Access to the public funds | Risks, the stock price may go down| More “paperwork” and responsibilities, business processes could be subject to more control and adjustment.
| The risks of becoming a victim of hostile acquisition and stocks speculations, causing problems with financing. | Exhibit 2 The following markers could be used to measure DG performance: Profit margin, ROA, ROE, EBIDTA.To tackle company’s specific problems and estimate proposed solutions: inventory turnover, days in inventory and Sales/Employee. The most important is Enterprise value/EBIDTA.
Helps to estimate the offer of KKR, inc and gives the answer to Question N4. (See the following table) DG experienced difficulties with inventories and real estate portfolio, due to its size and nature of business, however it recognized the problem, implemented the effective and adequate steps towards it resolution (some of these steps are made the results better than of competitors, see days in Inventory).As the result this was reflected in financial statement, in declining N/I, EBITDA, profit margin and return on assets.
The company stays competitive and controls the largest share of the market. n| Name of ratio| Why important| Current value 2007| Inference| I time-series (itself in different time periods). | 1| ROA| how well the company is doing its operations, independently of financial costs| 5. 2% against 13. 0%| Declined due to NI loss due to real estate portfolio restructuring (NI is $137 mil in 2007 against average $350 mil in 2006-2005, I/S).
2| Profit margin of ROA| Shows level of expenses related to sales, how effective sales are and how well expenses are controlled| 1. 5% against 4. 3% average last years| Declined 2x because of the growing inventory, but as seen below in N5 SGA is still good | 3| Days in inventory, inventory turnover| Due to retail nature of business and to explain the declining profit margin of ROA | 78 days against medium of 85 in previous years.
Industry average 84 till 91 days. Inventory turnover above average 4. 7 (4.
3-4. 0). Good result! The company introduced a deep-discounted sale in response to growing inventory. Sales are successful. | 4| Enterprise value / EBITDA| Represents a number of year needed to collect the company value from its earning, assuming company pays no Taxes, Dividends and no Amortization, and maintains the current level of profitability| 12. 1 against medium 8 in previous years. Enterprise value increased relatively insignificantly (+1.
9%). Company was restructuring the stores and opened less new stores than in previous years (300 vs 600). 1) Important integral marker, to grasp the value of the whole company as an investment. Estimate of this investment’s return in years, if the company pays no Taxes, dividends, does not count the amortization. And continue to generate revenue as in the current period. Declined due to the decline of ROA.
2) Important to estimate the KKR offer to buy the company. Compare with | II cross section (other firms) analysis. From Comparable I/S and peers| | marker| situation| Why, inference| 4| Gross profit| Lowest in 2007 amongst other peers, 25. 8%| Old, unsalable inventories| 5| SGA| 23.
% in 2007 against 22. 2 in 2006, but still the best in amongst peers 29. 3% in general| Still quite effective company in managing its operations| 6| Income before taxes| 2. 4 in 2007, 6.
3 in 2006. Decline, but still in the range of the competitors| Inspire of the inventories and real estate restructuring company stay competitive| 7| Profit margin and ROA| 1. 5% in 2007 against 4. 1%, below the average of 2.
5% | Inventories and shops restructuring | 8| Sales per employee| $131 against $155 in the industry | Too many non performing stores.The metric is important as Earning/square meter, which is absent| To support the assessment of Dollar General’s performance excerpted key financial report data as proof. Statement of Income Fiscal Year| 2007| 2006| 2005| Cost of Goods Sold| 74. 2%| 71.
3%| 70. 5%| Selling, General & Administrative Expense| 23. 1%| 22. 2%| 22.
3%| Operating Income7. 3%| 2. 7%| 6. 5%| 7.
3%| Dollar General Ratios Analysis Fiscal Year| 2007| 2006| 2005| 2004| 2003| Growth in Revenues| 6. 8%| 12. 0%| 11. 5%| 12.
6%| –| Profit Margin| 1. 5%| 4. 1%| 4.
5%| 4. 4%| 4. 3%|Comparable Firms’ Common-Size Income Statements and Other Key Financials Fiscal Year 2007| DollarGeneral| Family Dollar| Fred’sInc| DollarTree| 99 CentOnly| Net Sales(millions)| $9,169. 8| 6394. 8$| $1767.
2| $3969. 4| $1080. 9| Growth in Sales| 6. 8%| 9.
8%| 11. 2%| 17. 0%| 5. 6%| *Change Ratio compared to 2006 Growth in Sales| – 43. 3%| – 4. 9%| + 9. 8%| + 97.
7%| + 43. 6%| *The calculation result according to the data shown in the original chart Exhibit 3 Suggested algorithm of Mrs Sadayo thinking, leading to a decision against DG shares DG stock.What is the investment objective? Short-term speculative. Long term growth? Long term.
Mrs Sadayo evaluates offer of KKR against a) her own expectations and future prospect of growth and b) opportunity profits, i. e fixed CDs or trusted securities Short term Buy price < 22. * Yes: sell * No: Hold and try to negotiate the higher price thought trial (if its expenses are affordable) Expectations are met, offer seems fair: sell Can be expected goals be met with other available financial instruments? Yes: sell No: Hold and support Trial