Gr-ii-team 11-2018

BERKSHIRE PARTNERS: BIDDING FOR CARTER’S Submission by Group 11  MITHUN  SAGAR NADKARNI  SHIVANGI TEWARI  SACHIN PANDE  AKASH TRIPATHI

I002 H038 H062 H040 G060

1. How do financial buyers like Berkshire Partners create value? Given the opportunity, would you invest in Berkshire as a limited partner? Berkshire partners in the capacity of Private equity firm, after taking a position in other company plays a dual role of both an investor and managing the acquired company. When a PE firm like Berkshire invests in a company, they do so because they believe they can enhance the value of the asset. The traditional model is acquiring a company experiencing financial distress due to poor management, lack of investment or other factors. In these cases, a private equity firm can restructure the company’s debt, install a new management team, and/or make other operational improvements to enhance operations. In some invest cases investment is made in companies that exhibit strong growth prospects. For these companies, teaming with a PE firm provides access not only to capital but also a wealth of invaluable resources, such as operational executives, industry experts, new suppliers, economies of scale and access to new markets. A private equity sponsor can leverage its extensive network to improve management, logistics, infrastructure and other essential components of a business that can take years to develop separately As a limited partner the main criteria for making an investment is the reliability of getting a proposed return on investment. For such an assessment, limited partners looks at various factors like PE firms management team, their asset under management and screening process for selecting prospective firms. Berkshire partners have a very granular screening process of selecting a firm. Berkshire reviews more than 1200 potential deals and invests in only 5-6 firms after doing a complete due diligence. This drastically reduces chances of selecting a wrong company. As far as Berkshire's management team (as mentioned in exhibit 2) is concerned they have experts from various sectors such as business services, retailing, manufacturing, communication, food processing, distribution, and IT services. So Limited partners would know that their money is in safe hands. Finally AUM of Berkshire partners have increased from $59 mn to $985 mn in a period of 16 years at a CAGR of 19%. Since Berkshire has shown good performance on all three counts a limited partner would consider investing in Berkshire as a good opportunity. 2. Is Carter's an attractive LBO candidate for Berkshire? Why is Investcorp selling? Berkshire’s focus when analyzing an investment is on “building strong, growth-oriented companies in conjunction with strong, equity-incented management teams”.1 If we look at Carter’s Growth Strategy (Exhibit 5), we can see that Carter’s is planning to capitalize on its market leader position in the children’s apparel segment by diversifying both products and distribution channels. More tie-ups with wholesalers like Target, entering into the discount market and new product lines like playware segments show that the company has a clear vision of how it will grow its customer base and top line. Hence, it is growth oriented and has definite plans of how to achieve this. It has also maintained its focus on improving supply chain, reducing cost by offshoring manufacturing and expanding distribution channel which will ensure that the company has a strong base as it expands. The management team of Carter’s is highly experienced, and has already turned around the company since 1992, when Rowan was made CEO.

1

HBS: “Berkshire Partners: Bidding for Carter’s”, Exhibit 1a

Hence, Carter’s satisfies the elements of Berkshire’s investment philosophy. The case also states that despite the slump in IPO market, there is a favorable outlook for Carter’s IPO, with pricing around 16 to 18 times 2002 earnings.2 So if and when Berkshire chooses to exit, it should make a profit. Also, as the interest rates in the US are falling, an LBO will be cheaper for Berkshire at this stage. Investcorp’s investment philosophy is to “inject patient capital” into a company, waiting for the business to improve and then selling it or taking it public.3 Typically, a private equity firm exits an investment within 5-7 years. Investcorp acquired Carter’s in 1996, just as its performance had started to turnaround. By 2000, the company’s revenue had increased at CAGR of 9.5%4, and Investcorp was looking to exit the investment as it had achieved its purpose. Since the IPO markets were near a standstill5, that exit route would have taken them at least another year or two. Hence, they are selling Carter’s as they want liquidity.

3. How much cash flow will Carters generate in the next five years (2002-06) based on management estimates?

Complete calculations are shown in the attached excel sheet. 2001E

2002P

2003P

2004P

2005P

2006P

(in thousands of dollars)

EBIT Tax rate EBIT x (1 - t) Depreciation CAPEX Change in Working Capital FCFF

55,100 35% 35815 20000 20500 26567 8,748

67,600 35% 43940 21100 19500 9127

87,300 35% 56745 21800 21000 17379

36,413

40,166

1,09,800 35% 71370 24400 21500 24275

1,33,500 35% 86775 28100 22500 21351

1,40,175 35% 91113.8 29505 22500 9478

49,995

71,024

88,641

4. How realistic are the management forecasts in light of Carters’ historical performance? From the facts presented in the case it is deduced that the management has made optimistic projections for the coming years as compared to the historical performance, however the assumption seems reasonable, because: 

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Purely based on historical performance and considering other factors to remain constant, the revenue would grow at around 13%, but the factors like business expansion into discount channel and strong brand name would add into the top line growth in the coming years that supports 15% assumption. The Gross Profit margin growth of around 42% looks highly optimistic as compared to the historical performance of the company. The company is positive on the Tyke’s but still the numbers in the recent years does not support the assumptions. Lower cost structure and efficient operations would help to reduce the Selling and Administrative Expenses over the years due to economies of scale.

HBS: “Berkshire Partners: Bidding for Carter’s”, p 6 HBS: “Berkshire Partners: Bidding for Carter’s”, p 2 4 Ibid 5 HBS: “Berkshire Partners: Bidding for Carter’s”, p 3 2 3

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Management’s Capital Expenditure assumptions are reasonable, considering the fact that relatively new operational site would not require significant Capital expenditure in near term. The optimism is justified with the growth strategy of Carter’s including diversifying distribution channels, continuing with existing product offerings and complete outsourcing of manufacturing.

5. What should the Berkshire team bid? In order to determine bid value, we have to take into account comparable transactions in order to arrive at bidding price for Berkshire. Target Name

Value of Transaction

EBITDA

Transaction Date

Too Inc McNaughto n Apparel

581.1

39.0

24-Aug-99

TV/EBITDA 14.89

565.4

80.3

19-Jun-01

7.04

Unitog Co Donna Karan Koret of CA (Levi

370.8

42.7

24-Mar-99

8.68

247.2

28.7

27-Nov-01

8.61

141.6

15.4

29-Apr-99

9.19

Happy Kids Inc

119.6

20.4

17-Dec-99

5.85 9.04

Mean Expected EBITDA for Carter's (2001) (in millions) Average TV/EBITDA Multiple Bidding price (in millions)

75.1 9.04 678.904