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Case Study
Madras Appliances
Prof. Ian Giddy, New
York University
The proposed acquisition
In mid 2007 a Singapore appliance and furniture company, Island
Shopping, was
considering possible ways to finance the proposed acquisition of Madras
Appliances, a company in the same line of business based in Chennai,
India. The seller, an Indian conglomerate, had decided to focus on its
core manufacturing and export businesses and sell the retail units. The
buyer and the seller had engaged in preliminary discussions, and
reached verbal agreement on the all-cash price, although nothing had
been committted to paper yet.
The company
Madras is the market leader in the home appliances and household
furniture retail sector in south-east India with a market share of 14%
in terms of sales. In terms of the number of outlets, Madras ranks
third; however the others are not strictly comparable to Madras as they
are both retailers of home appliances only.
Being big in its
market, Madras has several competitive advantages over its competitors,
namely:
1. Lower
unit costs, in particular, administrative and advertising;
2. Strong
bargaining position vis-à-vis suppliers and as such, steeper
bulk discounts;
3. More
extensive geographical coverage, and hence better accessibility to
customers; and
4. Ceteris
paribus, price leader in the industry.
Madras
gained a head start in “retail branding” that is still a relatively new
concept in the home appliances and household furniture retail sector in
India. This can be seen in:
1. Madras’
strong brand identity comprising among others, the “Madras in Your
Home” logo and the staff uniform in signature striking blue;
2. Madras’
customer service quality that is a lot more professional and consistent
vis-à-vis competitors thanks to in-house training for employees at Madras
Academy Of Retail Excellence;
3. Madras’
broad product assortment, comprising all key international brands in
the home appliances sector, and key local brands in the household furniture
sector; and
4. Madras’
unique credit scheme
Unique
credit scheme
According
to one Indian retail authority, the single largest driving force behind
Madras’ market leader position in the home appliances and household
furniture retail sector in Tamil Nadu is its credit scheme. The credit
scheme allows customers to settle the payments for their purchases in
up to 48 monthly instalments. The credit scheme
also does not require any downpayments. These substantially reduce the
“entry levels” for the purchases of home appliances and household
furniture. For instance, a 19” Samsung TV that carries a
cash price tag of Rp899, only costs Rp9.92 per week, translating to
Rp43 per month if the customer opts for the credit scheme. Not only did
this give Madras access to a customer base that others could not
penetrate, but it also gave the company a large and lucrative
receivables
position, one that in principle could support secured loans from banks.
Summary financials
| Income Statement |
| FY March (Rp millions) |
2002 |
2003 |
2004 |
2005 |
2006 |
| |
|
|
|
|
|
| Revenue
(A+B) |
498.4 |
497.6 |
580.6 |
609.3 |
635.5 |
| Tamil
Nadu (A) |
498.4 |
497.6 |
560.1 |
523.9 |
510.2 |
| Other
India (B) |
0.0 |
0.0 |
20.5 |
85.4 |
125.3 |
| |
|
|
|
|
|
| Cost
of Goods sold (C+D) |
230.2 |
233.0 |
272.2 |
286.4 |
296.1 |
| Purchases
[C] |
227.1 |
246.0 |
271.9 |
295.1 |
301.8 |
| Change
in Inventory [D] |
3.1 |
(13.0) |
0.3 |
(8.7) |
(5.7) |
| |
|
|
|
|
|
| Gross
Profit |
268.2 |
264.6 |
308.4 |
322.9 |
339.4 |
| Other
Expenses |
120.8 |
132.8 |
166.2 |
189.2 |
210.6 |
| Earnings before Int, Tax, Dep & Amort
(Excl. Bad Debts) |
147.4 |
131.8 |
142.2 |
133.7 |
128.8 |
| Bad
Debts |
32.8 |
48.4 |
54.1 |
59.7 |
76.0 |
| Provision
for Doubtful Debts |
12.5 |
(0.3) |
4.0 |
9.5 |
11.5 |
| Earnings before Int, Tax, Dep & Amortz.
(After. Bad Debts) |
102.1 |
83.7 |
84.1 |
64.5 |
41.3 |
| Depreciation |
5.8 |
6.3 |
8.0 |
10.9 |
30.1 |
| Amortization |
0.0 |
0.0 |
0.1 |
0.4 |
0.0 |
| Earnings before Interest & Tax (EBIT) |
96.3 |
77.4 |
76.0
|
53.2
|
11.2 |
| Finance
costs |
4.9 |
4.0 |
5.3 |
7.8 |
9.6 |
| Exceptional
Items (Income) |
0.0 |
0.0 |
0.0 |
0.0 |
3.4 |
| Profit
before Tax (PBT) |
91.4 |
73.4 |
70.7 |
45.4 |
5.0 |
| Taxation |
25.7 |
20.3 |
20.9 |
13.4 |
3.9 |
| Minority
Interest |
0.0 |
0.0 |
0.1 |
(0.1) |
0.0 |
| Net Profit |
65.7 |
53.1 |
49.9 |
31.9 |
1.1 |
| |
|
|
|
|
|
| Effective
Tax Rate |
28.10% |
27.60% |
29.60% |
29.60% |
77.50% |
| Balance Sheet |
| FY March (Rp millions) |
2002 |
2003 |
2004 |
2005 |
2006 |
| Property,
Plant & Equipment |
54.1 |
51.2 |
69.7 |
74.4 |
72.9 |
| Goodwill |
0.0 |
0.0 |
8.5 |
8.1 |
7.6 |
| Deferred
Tax Asset |
0.0 |
0.0 |
1.7 |
0.0 |
1.1 |
| Long
Term Receivables |
183.8 |
203.3 |
274.6 |
303.2 |
277.6 |
| Total
Fixed Assets |
237.9 |
254.5 |
354.5 |
385.7 |
359.2 |
| |
|
|
|
|
|
| Inventories |
65.8 |
52.8 |
61.1 |
69.7 |
75.4 |
| Tax
Recoverable |
0.0 |
0.0 |
4.2 |
0.5 |
2.8 |
| Receivables |
263.7 |
242.1 |
273.7 |
280.2 |
320.4 |
| Cash
& Deposit |
125.2 |
143.1 |
136.9 |
79.3 |
60.1 |
| Total
Current Assets (a) |
454.7 |
438.0 |
475.9 |
429.7 |
458.7 |
| |
|
|
|
|
|
| Total Assets |
692.6 |
692.5 |
830.4 |
815.4 |
817.9 |
| |
|
|
|
|
|
| Accounts
Payable |
37.2 |
46.8 |
59.7 |
56.5 |
107.8 |
| Short
term Borrowings |
158.3 |
116.8 |
210.0 |
201.4 |
156.9 |
| Taxation |
17.9 |
12.0 |
6.3 |
2.4 |
3.7 |
| Total
Current Liabilities (b) |
213.4
|
175.6
|
276.0 |
260.3
|
268.4
|
| |
|
|
|
|
|
| Working
Capital (a-b) |
241.3 |
262.4 |
199.9 |
169.4 |
190.3 |
| |
|
|
|
|
|
| Share
Capital |
141.0 |
141.0 |
141.0 |
141.0 |
141.0 |
| Share
Premium |
109.2 |
109.2 |
109.2 |
109.2 |
109.2 |
| Revaluation
Reserves |
5.2 |
3.9 |
2.6 |
3.9 |
3.5 |
| Forex |
0.0 |
0.0 |
(0.4) |
(3.5) |
(3.2) |
| Retained
Earnings |
222.7 |
260.5 |
297.1 |
298.7 |
292.7 |
| Total
Shareholder's funds |
478.1 |
514.6 |
549.5 |
549.3 |
543.2 |
| Minority
Interest |
0.0 |
0.0 |
1.4 |
1.3 |
1.3 |
| Long-term
Debt |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
| Deffered
Tax Liability |
1.1 |
2.4 |
3.5 |
4.6 |
5.1 |
| Total Liabilities |
692.6 |
692.6 |
830.4 |
815.5 |
818.0 |
The
proposed financing
The
acquiror, Island Shopping
Singapore, had accumulated a surplus through retained earnings, and was
able to come up with about S$24 million of the proposed S$48 million
purchase price. The rest would have to be funded through bank debt or
other means. Island hoped to finance the whole amount by borrowing in
Singapore, but later to replace this debt with financing at the
subsidiary level. Among other methods, Island was considering senior
secured bank loans, a seller note, some form of subordinated mezzanine
financing, securitization of the receivables, sale-and-leaseback of the
properties, and a transferable loan facility with warrants.
Questions:
1. How
much debt can the target company support?
2. What
form of financing makes sense in this situation?
Supplement: see madras_appliances.xls
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