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Butler Capital Partners and Autodistribution

business

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Butler Capital Partners and Autodistribution

The deal became feasible because of a failed takeover battle for Autodistribution’s parent company. Private equity investor Butler Capital Partners must make an investment decision within three weeks. Other private equity firms compete with Butler for the deal. Butler must assess the potential for margin improvement and expansion within France and to other European countries. Furthermore, since the price for the deal is set, Butler must focus on finding an advantageous structure for all parties to secure the deal. Teaching Purpose: assessing the feasibility of a private equity transaction in France, valuation of a car parts distributor, structuring executive compensation.

Questions:
What industry and strategic factors must be considered in the decision to invest in a components supplier?
What local investment factors should be of concern in the decision to invest in Autodistribution?

Should Walter Butler submit a proposal for Autodistribution? What rate of return do you expect for this investment? Please consider the assumptions for margin improvements and growth in Exhibit 18 of the case.

What is your assessment of Autodistribution’s chances for pan-European expansion? In your opinion, what are the major risks associated with this investment? What can Walter Butler and his team do to mitigate these risks?

Paul-Marie Chavanne is interested in joining Autodistribution as CEO, but he has not signed on yet. What kind of incentives should Walter Butler offer to Chavanne? How should these incentives be structured? What should Walter Butler's strategy be in negotiating the deal?

Answers:

Question 1:

Since the pricing level of the deal has been fixed, and the growth opportunities have been determined with certain, Butler Capital is only left with overcoming the future execution risks. Though the time is limited, and there are many constraints to the deal, Butler should focus their valuation process on the potential liabilities and the profit margin, which is required to be over 30% for the fund. What Walter Butler can be sure of is that the Autodistribution is destined to have a successful prospect in the European markets, due to the reasons following:

1.      With the future consolidation of independent wholesalers, and non-affiliated wholesalers, the sales will grow substantially. Synergies can be exploited from this because more subsidiaries mean more purchasing bargaining power.

2.      The European markets are ripe for consolidation. The acquisition opportunities are very profitable in the current fragmented European auto-parts markets.

3.      Efficiency can be improved internally in Autodistribution because the main three departments can be better-organized and centralized. 

4.      E-commerce can be another driver of business in the future.

Of course, there are also

Ex-ante risks and hurdles:

1.      Butler is not sure of the potential liabilities due to the limited time and data.

2.      The deal seems to be “fully priced”

3.      BNP has very stringent terms on the debt.

4.      Many other competitive contenders who also want to acquire Autodistribution.

Ex-post risks

1.      AD and its management team do not have a lot of international business experience (execution risk). New people are also needed.

2.      Corporate culture needs to be modified from entrepreneur-encouraging to more centralized.

3.      Chavanne has not signed as the CEO yet.

All of the ex-post risks can be avoided by a well-organized transition management. Therefore, they should not be a big concern for Butler Capital. Though the ex-ante risks seem problematic due to limited time and information, Walter should not be too worried because the fact that many private equity firms bidding for AD is already a sign that acquisition of AD is an extremely attractive deal. Therefore, they should definitely submit the proposal for AD.

The answer to this question is not a clear one. In order to reach a conclusion we have to analyze the decision from different angles.

As Butler argued, some problems might appear:

-          no flexibility on price as AD Shareholders want the same condition. In this case Butler bargain powers are limited and in this way he may lose some future benefits.

-          time constraint , they have only two weeks not only to evaluate properly the business but also to complete the transaction. Autodistribution is not a small company is a big one and in order to come up with a very good expertise.

-          In the evaluation they should have also a proper view over the Autodistribution’s agreement with Strafor Facom, because this transaction may give some answers about the AD.-But time constraint is a problem again.

-          On the other hand, they need to secure finance in this short time, which can also be a problem.

-          Another important aspect related with the time constraint is that after the acquisition they have to come with a restructuring plan in order to create value. But this plan should be made accordingly with the previous analyses made before(time constraint problem).

-          AD doesn’t have  big international reputation as they did business only in France until now. Their poor international experience may affect their futures business outside France and may be a weak point for them regarding in their relationship with their local competitors.

Pros:

-          The French private equity market was increasing very much during that period. So if they decide to submit the proposal and this afterwards accepted, the private equity market can assure them good outcomes.

-          Even if AD has a very strong position on the French market they do not make business outside France and this may be  a good  opportunity for Butler after the transaction is done.

-          As is said in exhibit 6 Spain market was not very well developed but was showing very high growth recently. The perspectives for this market were high. Another thing that might be attractive for Butler is that this market mirrors French but 15 years ago. This can be an important advantage for AD because they were very good in doing business on the French market and according to the upper assumption.



-          Italian market may also be a good opportunity for AD after the restructuration especially in the North part and in the big cities.

-          The British market may offer some good possibilities as many smaller wholesales disappeared and been replaced by bigger companies. The tradition of the small wholesales started to be replaced by big companies 

-          The recent deregulation on the European Legislation

-          The French market will continue to increase due to: growth number of cars , the increased technical complexity of car parts, more compulsory vehicle inspections.  

Question 2: Valuation

In order to find out the beta of the company, we will look at comparable firms, since AD is not traded. In Exhibit 19a, we have several companies to choose from, but we will pick O’Reilly, Partco and Fine List, as they are comparable with AD, given the revenues.

Calculating the WACC:

-          Cost of debt is the weighted average of the coupons from the proposed debt structure

-          Cost of equity – will be obtained with the use of CAPM

-          Risk free rate is 4.88% (French Government bond – Exhibit 17)

-          Equity premium is 7.5% (assumption made by Raj in the last case also)

-          For obtaining the equity beta, we look at other firms that operate in the same industry: from exhibit 19a, we choose the companies that have similar revenues

-          Starting from their equity beta, we obtain their asset beta, considering that each of them has a different capital structure

-          We calculate an average asset beta for the 3 companies chosen and based on this value we calculate the equity beta for AD

-          We plug everything into the CAMP and we obtain the cost of equity

-          We calculate the WACC

Working Capital Turnover: Sales divided by Net Working Capital (current assets minus current liabilities). Ratios higher than industry norms may indicate a strain on available liquid assets, while low ratios may suggest too much liquidity. Target: at or above industry level.

Days Working Capital: 365/(working capital turnover): Expresses the coverage in number of days of available working capital.

A warrant is a call option written by the company itself on new stock (whereas the regular call option is written on existing stock).

Reprises & transferts de charges - reversal (transfer) of a provision / shifting; write-backs of provisions and transfers of expenditure.

Extraordinary items

n      Unusual for the company and infrequent

n      Losses due to natural disasters

n      Expropriations

n      Exception

n      Material gains/losses from extinguishment of debt (to be reported as extraordinary item)

Extraordinary events can also be mergers, new production systems.

Goodwill can be thought as a premium for buying a business

Question 3:

AD stands good chances to succeed in the European market for several reasons:

-          Since every of the European markets was very fragmented, with no company holding a significant share, AD strategy of consolidation has good prospectives there as well

-          AD already has prospective targets, that is the European wholesalers affiliated with the ADI network

-          Early to mid 1990 – steady growth of the auto parts market

-          The rest of Europe had more permissive legislation than France: they can sell body parts there (and in France in 2002)

-          A possible drawback could be AD’s management lack of international experience; however, since the markets are all similar in structure, that shouldn’t constitute a major problem. Moreover, no other players (in other countries) benefit from international experience either.

-          Last but maybe more important: first mover’s advantage (maybe they shouldn’t wait for 3 years before starting consolidating beyond French borders)

Question 4:

There is a wide range of incentives that can be offered to Mr. Chavanne, the problem is to see what exactly is being asked from the new CEO.

As seen above, when we limit the discussion to the execution risk, the CEO should be aware of the new generation issue in AD. Since the old management of AD will become shareholders of the new entity, they will want a person in charge who can best represent their interest and view of this business. In this case, Mr. Chavanne should smoothly handle this “delicate and slow process” of passing on to a new generation and Mr. Butler has to include an incentive in this sense, maybe a clause that Pierre Farsy can still vote to key decisions.

Since the remuneration of the CEO is a key factor in Mr. Chavanne’s decision, this should include a fix salary, most likely higher than 3 FF million (Chavannes’s last salary at SF) plus options on the stock of the company, when it will become public. As Mr. Chavanne has already made a plan for AD to follow, the compensation should include rewards for each objective met.

As for the stock options offered to the CEO, a period of several years before being able to use the options, a vesting period should be specified, namely until the plan of expansion and acquisitions will be completed.

In the exhibit 15 from the case, we can see that the proposed capital structure includes equity to the management, namely an amount of 15 FF millions. This is another way to directly offer the CEO a share in the equity of the company, through this restricted stock.

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