The Leveraged Buyout of Cheek Products Finance 620 – Summer 2010 Group 1 Danielle Kaufmann Vivake Persaud Jessica Friedman Loria Mcleod David Lawrence Background: Cheek Products, Inc. began as a snack food company but has since expanded into different types of business through acquisitions, such as home security systems, cosmetics, and plastics. The company has not been performing as expected in recent years, and management has not tried to improve operations in any way. To help improve the company’s financial position, Meg Whalen, a financial analyst has suggested a buyout. A leveraged buyout (LBO) is the acquisition by a small group of equity investors of a public or private company. ” Meg believes that Cheek Products, Inc. could improve its financial position by making two major changes. The first change that Cheek should make is to concentrate mainly on the snack food industry and the home security industry, and sell the other divisions. The second change, Meg would like to make is to Cheek’s debt-equity ratio. Currently, Cheek is financed entirely with equity.
Meg believes that if Cheek’s debt-equity ratio is at least . 25, the company would greatly benefit. Meg has prepared estimated future cash flows to support her idea and shared her idea with her other partners, Ben Feller and Brenton Flynn. After reviewing Meg’s projection and looking through Cheek’s financials, Ben and Brenton believe they could sell the company in five years to another party or go public once again. They also realize that a significant amount of the purchase price will have to be borrowed if the LBO takes place.
The interest payments for the next five years, if the LBO takes place, are presented below (in millions): Reason for case study: If Cheek Products, Inc. undertakes the LBO, “what is the most they should offer per share? ”. As previously mentioned, the case study was undertaken because in recent years the company has been underperforming but Cheek’s management is not being aggressive in pursuing opportunities in order to maximize shareholder wealth (by improving the stock price).
Assumptions: Meg Whalen has estimated that cash flows will grow by 3. 5% each year. Also, Cheek will realize additional cash flows from the sale of several divisions. Sales are expected to increase because Cheek will be more focused on the remaining divisions. Additionally, capital expenditures are for new projects and the replacement of equipment that wears out. Please see the chart below for some additional assumptions. Conclusion:
If Meg, Ben and Brenton decide to undertake the LBO, what is the most they should offer per share? Our results indicate that if Meg, Ben and Brenton should decide to undertake the LBO the most they should offer per share is $92. 79. The LBO partner will purchase the share at a price above the current market, which is $58 per share. With this LBO taking place it would take Cheek Products, Inc private and there’s a likelihood that there would be major changes that would take place with in the company.
There could be changes in the area of change to the CEO, adjustments to the pay of directors and alteration to the structure of the board once the LBO has taken place. The LBO of Cheek Products will be profitable for the potential LBO partners with the sales of the divisions causing there to be a greater focus on the snack division and home security divisions. The management will have to ensure that the changes that take place will increase revenue or decrease the cost. Please see below for our step-by-step analysis in calculating the share price of $92. 79.