CASE STUDY: All Numbers are in $ Canada…You do not have to translate into US $.
ID: 2798468 • Letter: C
Question
CASE STUDY:
All Numbers are in $ Canada…You do not have to translate into US $. However, all principals of finance and accounting in the US are the same in Canada.
Mr. Lube Canada Limited Partnership ("Mr. Lube") is a privately held company that manages a complete automotive maintenance services provider and Canada's largest quick lube brand. Founded in 1976, Mr. Lube pioneered the Canadian quick lube industry, a category of automotive servicing focused on convenience with no appointment necessary. Mr. Lube's network of 170 stores are operated by a national network of franchisees.
Each store must be open a minimum of six (6) days a week. Some are open seven (7) days a week. The stores, on average, are open 338 days per year. Each store has approximately 10 appointments per day and each appointment produces, on average, $ 100 of revenue per customer per visit. Before the franchisees get to pay any of their bills, including employee salaries, they must pay 10% of gross revenue to the parent company, “Mr. Lube”, who is the franchisor.
In early 2015, our Corporate Finance Deals team was retained by Mr Lube as its exclusive financial advisor to maximize value for the owners. After looking at the alternatives, including going public, we concluded that the company should sell control or the whole company to an acquirer.
Our approach
We led all aspects of the deal process, which included:
Pricing the enterprise.
identifying potential acquirers;
marketing the business;
advising on negotiations and structuring;
assisting with definitive agreements; and
ultimately closing the transaction.
How we add value
Mr. Lube attracted significant interest from both local and international acquirers that we had identified and contacted. On August 19, 2015, Diversified Royalty Corp. acquired the trademarks and certain other intellectual property of Mr Lube for approximately $138.9 million. This transaction, defined as an asset sale, in effect sold
the whole company, as we advised. The trust that owned the assets received 75% cash and 25% debt, secured by the assets of the company.
Please answer the following questions:
What is your opinion regarding a valuation for the assets of Mr. Lube, and, therefore, was this a fair price for the transaction?
What issues beyond a pure mathematical calculation may influence your thinking on valuation and the acceptability of the price paid?
List as many of the assets that were sold as possible. (Do NOT answer by just repeating what is in the case study).
Are there any remaining risks to the Trust (the seller) ??? And if there are risks, what are they?
Would you have done anything differently regarding this sale then what was done?
Explanation / Answer
Annual Revenue of the business:
$(338*10*100*170) = $57.46 million
Valuation of the company is done by taking a 10 year period of future cash flow.
The first five years would give an enterprise value and the 6th to the 10th year would be taken as a terminal value for the business. All the cash flows would be discounted to their present values. Normally businesses have a discount rate in the range of 12 - 20%. Figures being largely dictated by the riskiness of the business.
Mr. Lube's business for its size and nature of business would be more riskier than stable companies like utilities and others which have plant and machinery. It would be safe to assume a beta of 1.4 for this business. Market returns are around 12%. Thus using the CAPM, the required discount rate would be around 14% (the risk free rate would be the rate of return of a treasury bond - around 8%). So, with a bit of allowance, the discount rate can be assumed to be 15%.
The PV of the cash flows from year 1 to 5 is $192.61 million. The terminal value computed from the cash flows of year 6 to 10 and then discounted back to today's PV is $ 95.76 mill. Thus the enterprise value is much more than what it was sold for.
Beyond the mathematical calculation, one has to view Mr. Lube as a brand by himself - the brand equity is because of this person. Hence, the value of the company has to recognize this beyond figures computed.
The business has been there for years and that has to be reflected in the riskiness of the company. The beta value may be modified downwards to reflect this stability. The enterprise value would increase through this recognition.
Assets would have been sold beyond trademarks and IPR. There would be inventory, machinery and tools. Physical assets of the company which would have been sold through this transaction. Moreover, in the owner's equity apart from the financial figures therein would also see a transfer of the equity holding to the new owner.
The new owner run the risk of losing market share in the absence of Mr. Lube who had tremendous brand equity. Competitors would seize this opportunity to grab more market share.
Mr. Lube might have done better than to secure 25% of the sale proceeds in debt backed by assets of the company. This being a service oriented company may not have assets to back around $ 35 million in debt. With Mr. Lube's departure the future cash flows may be affected negatively and thus this secured debt given to Mr. Lube would be riskier than one would want to have.
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