Discuss why ESPRIT might be an attractive candidate for an LBO/MBO transaction.
ESPRIT is a prime target for a LBO transaction from our private equity firm for several reasons.
The current economic environment has been quite dismal, which has produced low interest rates to promote lending. Our private equity firm can use this to our advantage and borrow large to finance the buyout. Most mergers and acquisitions happen because of “shocks” to the economy, and we are currently in one.
ESPRIT has been underperforming against it rivals in the clothing retailing industry. Analysts in recent years have summarized ESPRIT as “lost its soul”. This is a chance to time the market and buy when the asset or potential target is low, revamp, and sell when market and valuation of company is higher. Currently, equity is relatively cheap as the price to sales ratio is at 0.32, compared to the industrial average of 1.33.
ESPRIT as a brand has been criticised by the media has having “lost its soul”, which could be the fault of management. Management will most likely be evaluated and replaced as necessary.
The company currently has the opportunity to gain new debt as it has low debt to equity ratio. This new debt can lead to increased tax savings as the increased debt can increase interest expenses and subsequently the tax shield of the company.
The company is in dire need of extreme measures to revamp the revenues or be forgotten in retailing history. By privatizing ESPRIT it will allow management to make more efficient decision processes under our private equity ownership.
The brand in it of itself is worth much more than its book value. Furthermore, it has the opportunity to make a comeback to create new value and rejuvenate the brand into new markets. The emerging market of Asia also provides a possible new high growth sector if properly executed by management.
2. Discuss how going private can improve ESPRIT’s operating margin. Be as specific as you can in the discussion of potential restructuring measures.
By going private, ESPRIT can improve its operating margin summarized by the following reasons:
Entering new markets with more opportunities
Esprit can increase its operating margin by entering and expanding in new territories, such as Eastern Europe, China and rest of Asia. The company will benefit from those fast growing markets, comparing to nearly stagnating North America and Western Europe. The sales growth in those regions will be much higher. Which is very important for textile industry, as they have high fixed costs, such as maintaining shop and their employees. Higher sales growth will therefore mean better profit margin.
Rejuvenating the brand
Management has to be careful about preserving and creating the value of the brand, which is very important for the customers. A marketing campaign must focus on the new markets and attracting new customers from the growing middle class in those countries. The company must focus on making their brand different from H&M and ZARA, so the customer will understand the reasons for shopping at Esprit shops.
Private equity firms are known for their expertise in various industries, they usually put their own members on the Board of Directors and hire the best managers on the market. They are focused on the goal of creating value, because their compensation is aligned with the profits from selling the company after restructuring and the investment period, usually after 5-10 years. The management can therefore focus on the long-term strategy for the firm, since the focus is put not on short-term results, but the value of the company.
Private equity firms usually align managerial compensation with the performance by increasing the managers ownership stake in the overall company. Management here has the incentive to realize big gains from enhanced performance, and as a result will submit more effort to their work.
The new high