Cumberland Entertainment Summary of the case: Cumberland Entertainment is a Canadian-based company that had done very well for itself by finding and exploiting a niche market in North American music distribution. But major US clients had started producing their own titles, and were now direct competitors. What was worse, distributors had also started focusing on lower-end products from other suppliers and Cumberland’s modus operandi became unsustainable.
CEO Tom Smith felt the only sensible course of action was for Cumberland to take over the distribution of its own products, both in order to defend its market position and to ensure higher margins. This movement has been very successful and they have grown a lot. But despite such tremendous expansion, there seemed to be yet more opportunity for growth for Cumberland, so in summer 1999 they are evaluating the possibility to move toward private equity to finance this growth.
What do you think of the Cumberland opportunity? As a private equity financier, would you invest in it – why or why not? Positive points: * Management Team: competent and committed * Up to now it’s a successful project * Good business model: they control the distribution, maintain direct relationship with its retailers and are able to know customers’ preferences and adapt their product to it * Opportunity to grow: Organically: new product lines, new distributions channels, increase US market penetration, international markets and internet development * By acquisitions: Cumberland could acquire some of its international distributors, its competitors or some niche production companies whose products would complement those of Cumberland * Forecasts are very positive (but maybe not so realistic? ) Negative Points: It is a business that has had a tremendous and fast expansion exploiting a niche in the market. That may attract competitors to this niche, and it seems that there are not many barriers of entry to go for this niche * Exit strategy: if the project fails, the investors will be able to get back very little money * The forecast seems to be too optimistic: Net earnings are supposed to grow 50% approx. along the next 4 years, but last year has decreased.
It is quite attractive: the business model is good, the management team is performing well and there seem to be opportunities to grow, but this opportunity has also its drawbacks (see negative points). For me it is not a bad opportunity but if I were the investor I wouldn’t consider it as a good enough opportunity to put my money on it. 2. Now shift gear and adopt the Cumberland perspective: To whom should Tom Smith turn for funds: Delvie? Canadian Capital Partners? Others (explain)?
The alternatives would be: bank financing (too expensive, 17%), organic growth (can’t reach their goals) or private equity: Regarding the private equity alternatives in exhibit 7: * Canada Bank is less flexible in its role in financing and its type of financing and is a company this opportunity does not seem to fit their usual portfolio * Maple Partners is smaller than the others, there is less info available * Alberta Capital: it could be a possibility, we should investigate whether they are interested Between Delvie and Canadian Capital Partners: Financial terms are quite similar * CCP’s structuring fee is higher (5% vs 3%) * Delvie seems to be less interested * Delvie wants to have 2 members in the board of directors, while CCP wants 3 The conditions of Delvie may be slightly better than the ones of CCP, but I would go for CCP because I think they are more committed and professional.