Case: Hansson Private Label
Q1. HPL, started in 1992, is manufacturer of private label personal care products. Tucker Hanssen bought the company for $42 million to capitalize on the powerful trend of increasing share of private labels in consumer-products sales. The company since then grew steadily to generate revenues of $680.7 million in 2007. HPL now had four plants, all operating at more than 90% of capacity. In February 2008, the company was mulling over a proposal to invest in a $50 million project to expand the production capacity of the company in order to cater to their largest retail customer.
HPL accounted for 28% of the total $2.6 billion wholesale sales of personal care products from manufacturers in 2007. Within the industry, HPL now counted most major national and regional retailers as its customers. The $50 million project, although would double the company’s debt, but would also greatly increase its customer concentration.
Q2. HPL had not initiated a project of such ($50 million) magnitude in over a decade. The expansion of the business will have a significant impact in the company. We can consider three metrics to analyze it: long-term debt, revenue and book value. More than double the company’s long-term debt. The new expansion debt of $57.8 million (at 7.75% per annum) would add to the existing long-term debt. According to the revenue of the current operations and the revenue that the expansion will provide to the company, the new investment will increase the revenue by 21%. Similarly, the new investment will increase the book value of Hansson by up to 15%.
Long term debt
Current operations 2007
New investment 2009
Q3. In 2007, the book Leverage ratio of Hansson, calculated as long-term debt divided by the company equity is 20%. If we consider that the new investment will be financed only by long-term debt, the Leverage ratio of the company will increase to 42%. The interest coverage ratio of the company before the new investment is 20.42, while after the expansion it will drop to 9.23. (The interest expenses of the new investment is the result of the cost of debt (7.75%) times the total investment.)
Both metrics show the significant impact that the expansion will have to the company financial stability. However, the new ratios are still reasonable due to the initial conservative stage. Their initial stage allows them to expand their operations by increasing their debt. Current operations
9.23 Q4. (Please refer to the Excel spreadsheet for detailed calculations)
We believe that the assumptions made are reasonable; however, there are a few items that we think are questionable.
First, the assumption of price increases in-line with recent historical averages could be problematic. The end of the contract after year three will provide the retailer with a large amount of leverage in negotiating prices. This leverage would be neutralized were some of Hansson’s competitors to exit, a scenario discussed by Hansson in the case, but this scenario is out of Hansson’s direct control and thus shouldn’t be the basis of their assumptions. Given greater leverage from the retailer, Hansson may have to reduce prices in order to maintain the sales volume justifying the expansion plan. Halving the price increase from 2% to 1% after year 3 could be a more reasonable assumption.
Second, the assumption of SG & A as a percentage of revenue equal to the average percentage for Hansson as a whole is likely inaccurate. The case for reducing the percentage for the new project is based…