Statement of Situation Berkshire Partners, a private equity firm based in Boston, was invited to bid for Carter’s, the largest branded manufacturer of toddler and baby apparel in the United States. The invitation came from Goldman Sachs (GS), the investment bank who was running the auction. GS was also offering staple-on financing to expedite the bid. Berkshire decided to place a bid for Carter’s, and intended to use a mix of equity and debt financing to conduct the purchase. This paper advises Berkshire on the bid amount, as well as the appropriate debt and equity ratios to maximize Berkshire’s rate of return on this investment.
Economic and Industry Analysis The end of 2000 saw the culmination of a decade of rapid economic expansion. U.S. GDP growth was 4.1% in 2000, down from 4.8% in 1999. Throughout the year, there were signs of an economic slowdown, manifested in Congress passing a major tax cut, with the hopes of stimulating consumer and business spending. Moreover, the Federal Reserve cut interest rates 10 times in 2000. This led analysts to believe that the Fed had sufficient information to foresee an economic slowdown.
Changes in economic perceptions are of high interest to apparel companies like Carter’s. The apparel industry is very cost sensitive: fluctuations in the prices of raw materials, cost of energy and transportation directly impact the bottom line. In slowing economic times, consumers are extremely price sensitive, meaning manufacturers cannot easily pass down increasing costs to consumers. Financial Analysis Looking at Carter’s competitors, we found that The Children’s Place, Oshkosh B’Gosh and Gymboree more closely resemble Carter’s in terms of asset size, sales volume and EBITDA. Per our analysis, Enterprise value to EBITDA ratio is the most appropriate to use in order to establish our exit multiple. We consider management’s sales growth projections adequate when taking into account the
current economic environment, as well as strategies undertaken by Carter’s management to grow the company and make it more efficient. Based on the DCF projections, the enterprise value gives us a reasonable assessment of Carter’s intrinsic value. Carter’s has reduced its costs over the last few years and has formed strategic partnerships with major retailers like Target. Therefore, we anticipate an increase in inventory and receivables for the next few years, manifested in our projections for changes in NWC.
With our proposed financing structure, we anticipate to generate enough cash flows to pay the senior debt in full in the first three years of ownership. We then intend to use all available cash flows to pay off the senior subordinated notes. The company will be able to generate free cash flows beginning in 2005. This generates a compound annual growth rate (IRR) of 33.41%.
Carter’s represents an attractive LBO candidate because it is projected to generate increasing cash flows, it has incredible growth opportunities both in the U.S. and overseas markets and strong assets. Our LBO analysis shows Carter’s maximum purchase price at $539 million, financed with 56.9% of debt and 43.1% of equity. We recommend that Berkshire Partners purchase Carter’s for that price. The reason being is that Carter’s is projected to reach an enterprise value of $1018.5MM in 2006. This creates $479.6MM in profit for Berkshire Partners if they choose to sell it in 2006. The results would be negatively affected by a higher cost structure due to movement of some manufacturing operations offshore. We believe our recommendation will be achieved through an efficient and strong management team leading Carter’ to success.