2012 Leveraged Buy Out of Revco D S Inc. Group - 4 Department of Finance, University of Dhaka 9/9/2012 Leverage Buyout of Revco D S Inc Submitted To: Dr. Md. Sadiqul Islam Professor Department of Finance University of Dhaka Submitted By: Group no. 4 13th batch Department of Finance University of Dhaka Date of Submission: 09 September, 2012 Group Members Name Roll Mohammed Robiul Alam 13-643 ASM Zakariya 13-578 Rokeya Mahzavin 13-588 Md. Shah Naoaj 13-686 Taslima Akter 13-666 Letter of Transmittal Dr. Md. Sadiqul Islam Professor Department of Finance University Of Dhaka Subject: Submission of Case Report. Dear Sir: With great pleasure and honor we are submitting our case report on ―Leverage Buy Out of Revco D S Inc‖. The case study includes analysis of LBO of Revco. We analyzed the LBO from different viewpoints by using various financial tools and software. We have tried our best to accommodate as much information and relevant issues as possible and follow the instructions that you have given. We would like to thank you for providing us with the opportunity to prepare this case report. Sincerely Yours Group -04 13th batch Department of Finance University of Dhaka Table of Contents 1. Introduction .................................................................................................................................................... 1 1.1. The Company ........................................................................................................................................ 1 1.2. Competition ........................................................................................................................................... 1 1.3. Origin and Terms of the Buyout ........................................................................................................... 1 1.4. Management of New Revco .................................................................................................................. 2 1.5. Strategy and Restructuring Plans .......................................................................................................... 2 1.6. Outlook ................................................................................................................................................. 3 1.7. Comparative Analysis ........................................................................................................................... 4 1.8. Capital Adequacy .................................................................................................................................. 5 2. Business Analysis .......................................................................................................................................... 6 2.1. PESTEL ................................................................................................................................................ 6 2.2. HEPTALYSIS ....................................................................................................................................... 8 2.3. SWOT ................................................................................................................................................. 10 2.4. Porter’s Five Forces Model ................................................................................................................. 12 2.5. SCRS ................................................................................................................................................... 14 3. Time Series Ratio Analysis of Revco D.S. Inc. ........................................................................................... 16 3.1. Profitability Ratio: ............................................................................................................................... 16 3.2. Liquidity Ratio: ................................................................................................................................... 17 3.3. Efficiency Ratio .................................................................................................................................. 19 4. Cross Sectional Ratio Analysis of Revco D.S. Inco. ................................................................................... 20 5. Bankruptcy Risk .......................................................................................................................................... 21 5.1. Altman Z-score ................................................................................................................................... 21 5.2. Estimation of the formula .................................................................................................................... 22 5.3. Accuracy and effectiveness ................................................................................................................. 22 5.4. Z-score estimated for private firms ..................................................................................................... 22 6. DuPont Analysis .......................................................................................................................................... 23 ROA and ROE ratio ....................................................................................................................................... 24 7. Case Analysis ............................................................................................................................................... 26 8. Valuation ...................................................................................................................................................... 26 8.1. Assumptions: ....................................................................................................................................... 27 8.2. Calculation WACC: ............................................................................................................................ 28 8.3. Comparative Analysis with Peer Company: ....................................................................................... 31 8.4. Possible Reasons for Going LBO: ...................................................................................................... 33 9. Capital Adequacy: ........................................................................................................................................ 34 9.1. The Variables ...................................................................................................................................... 35 9.2. Results ................................................................................................................................................. 37 9.3. Conclusions and Implications ............................................................................................................. 39 1. Introduction In December 1986 the management of Revco D.S. and a group of investors took the company private in a leveraged buyout (LB0). Revco was the operator of the largest chain of discount drug stores in the United States. The buyers paid a 48 percent premium for the shares compared to the price in January 1986, before the announcement of plans for the buyout. In addition to the large acquisition premium, this buyout arrested\ tj1e attention of investors and analysts because of its unusual financing terms. Goldman Sachs advising the board of directors, had declared that the purchase · price was "fair." Salomon Brothers, advising the buyout group, had designed the transaction and employed its considerable bond-trading muscle to promote it-indeed, this was Salomon's first major "done deal" acting simultaneously as buyout advisor, underwriter, and merchant banker. On the other hand, Moody's and Standard & Poor's, the bond rating agencies, declared Revco's LBO to have a "negative outlook" and downgraded their ratings of Revco's public bonds to "speculative" categories. Analysts noted that debt repayment in the first few years depended significantly on asset sales, an especially uncertain source of cash. More importantly, the operating performance of the firm had been declining over recent quarters. 1.1. The Company In 1986 Revco was the nation's largest discount drugstore chain, operating 2,049 stores in 30 states. Fiscal 1986 sales were $2.7 billion with after-tax profits of $56.9 million. Revco was formed in 1956 and utilized the marketing concept of "every-day, low prices," a concept still in use in 1986. Strip centers in small cities were the primary location of Revco stores, with approximately 70 percent of the company's stores located in cities with a population of less than 25,000. Over the previous 5 years, the number of stores had grown at an annual compound rate of 6.24 percent, from 1,514 stores in 1981. The average cost of opening a new store was approximately $300,000, with inventory comprising approximately $200,000 of this tota1. 1.2. Competition Revco competed with health maintenance organizations, hospital pharmacies, mail-order organizations, discount drugstores, combination food-and-drug stores, mass .merchandisers, and the rapidly emerging "deep discount" drugstores. Deep discounters were large "super" drug stores relying on volume to compensate for the unusually low prices they charged. Consequently, deep discount drugstores were located primarily in cities with populations over 250,000 and were not seen as a major threat to Revco. The drugstore industry exhibited little cyclicality since most sales were necessity items