Whitetracks Design, Inc

1042-2587 © 2011 Baylor University

E T&P

Whitetracks Design, Inc. Hugh Grove Tom Cook

Whitetracks Design, Inc. is one of the leading U.S. manufacturers of snowshoes. The business is owned by three individuals who are contemplating whether it should be sold now or continue to be operated for a later sale at a potentially enhanced business value. All the Whitetracks owners are now in their early 60s and are hoping for a comfortable retirement. Whether they retire sooner or later is dependent upon the proceeds from selling the business. Prior to selling, the owners want an accurate determination of the firm’s value to ensure proper returns for years of hard work and personal investment. From an entrepreneurial standpoint, this case raises the issues of how private companies can be valued so that they can be subsequently managed for value creation. This is important as a 2005 survey found that only 60% of private company managers had at least some idea of their firms’ value, and two thirds of these managers said that such firms’ value was based upon management estimates or wishful thinking. To assist with determining the value of their business, the Whitetracks owners hired a merger and acquisition consultant, who is a coauthor of this case. The consultant will assist the owners in valuing the business and in making the decision to sell now or continue to operate the business.

Whitetracks Design, Inc. In mid-2005, Jay Gruber, Betty Boyd, and Doug Jones, the owners of Whitetracks Design, and Bob Moore, the company’s chief executive officer (CEO), were meeting with Gary Grange, executive vice president of International Business Group (IBG), whom they had hired to advise them about valuing their company. Located in Denver, Colorado, IBG was the third-largest merger and acquisition sell-side consulting firm in the United States. All four Whitetracks owners/managers were in their early 60s and were thinking about retirement. The owners had wanted to sell their company in 2001, but its sales flattened, and its earnings declined following the terrorist attacks on September 11. At that time, Mr. Grange had persuaded the owners to wait because Whitetracks’ financial performance was declining. In 2005, the company’s financial performance was improving, and the owners once again asked Mr. Grange if they should sell. Had the last 4 years of his free consulting made the company ready for sale, or should they continue to operate Whitetracks for a subsequent sale at a potentially higher business value? Betty Boyd worried about having most of her assets and income tied up in the company. She thought that if they waited too long to sell, she might miss the opportunity to spend her retirement years traveling the world. She also worried about the owners’ personal guarantees of the corporate debt. Jay Gruber was anxious to sell and move on to other ventures. He noted that industry experts were very positive about the future of the snowshoe industry and so concluded that now would be a good time to sell. Please send correspondence to: Hugh Grove, tel.: (303) 871-2026; e-mail: [email protected].

July, 2011 DOI: 10.1111/j.1540-6520.2011.00478.x etap_478

831..852

831

Gary Grange explained how IBG, one of the leading merger and acquisition advisory firms for privately owned companies, could help in the decision. IBG’s extensive network of potential buyers would be able to review the Whitetracks’ prospectus that Mr. Grange put together and indicate possible interest in buying the company now. Mr. Grange would recast the financial statements to enhance the business value and selling price of the company. Doug Jones was against using IBG. He thought that its fees were too high, and that Gary Grange had a conflict of interest. Mr. Jones wanted the owners to sell the company on their own. Mr. Gruber reminded the others that Mr. Grange had not recommended selling the company 4 years earlier and argued that if Mr. Grange had been interested only in his fee, he could have recommended a sale then. Based on their discussion, the owners decided to continue working with Mr. Grange. It was now up to him to get back to the owners quickly with a recommendation on whether to sell now or continue to operate the business. Although IBG did not offer formal company valuations, Gary Grange knew that the owners needed an idea of what the company was worth in 2005.

Whitetracks Design, Inc. Background History and Ownership In 1988, Whitetracks Design, Inc. was founded in Denver by John Brown, a triathlete looking for a way to exercise during his snowbound winter months. In the same year, the company introduced a unique, V-shaped tail on its first five models as the industry’s first lightweight running and racing snowshoe. The V-shaped tail created a more streamlined design than its competitors’ snowshoes and made the Whitetracks’ shoes less awkward for walking or running (see Figure 1). The three current owners bought Whitetracks from Mr. Brown in 1994. Whitetracks continued to improve existing models and create new snowshoes for a variety of users. In 1996, the U.S. Army Research, Development, and Engineering Center chose Whitetracks to introduce “new concepts and equipment improvements that will help the soldiers’ ground mobility.” Also, Whitetracks’ Blackhawk model was designated as the official snowshoe of the Austrian, German, and Belgian armies. Unit sales in 2004 exceeded 41,000 pairs sold primarily in the United States but also in Canada, Europe, Japan, and Korea. Based on estimated unit snowshoe sales as reported by the Snowsports Industry Association and the Whitetracks selling memorandum, in 2005, Whitetracks held 15% of the U.S. market. Jay Gruber, a venture capitalist who owned 52.6% of the company and served on its board of directors, was an avid outdoorsman. In 1994, he had seen his investment in Whitetracks as a chance to combine his passion for winter sports with an opportunity to make some money. His investment had not turned out to be as profitable as he had expected, and now he was ready to sell. In a conversation with one of the case authors, Mr. Gruber said, “I want to get my money out while the spotlight is still on the growing market (for snowshoes). I am hungry to cash in my chips and move on to greener pastures.” Betty Boyd owned 33.76% of Whitetracks and served awhile as the senior vice president of marketing. After graduating from the University of Texas, Ms. Boyd moved to Denver and worked for Qwest Communications as a marketing manager, but she always wanted to work for a smaller firm. In 1994, she took early retirement from Qwest and invested a sizable portion of her retirement fund in Whitetracks. In 2002, she started to cut back her time at Whitetracks. “Whatever business you are into, you have to have a passion for it. Small business can have a lot of ups and downs, and you have to be willing to ride 832

ENTREPRENEURSHIP THEORY and PRACTICE

Figure 1 Whitetracks Design Inc. Product Images (A) V-tail Adult Snowshoe; (B) V-tail Youth Snowshoe

A

B them out. I lost that passion some time ago and have stepped back from an active role in the company. Also, we have not able to arrange a succession within the business so I don’t know what else we can do but sell,” she said to one of the case authors. Doug Jones owned 13.76% and became the CEO, upon investing in the company in 1994. Mr. Jones brought senior management experience with other small companies to his July, 2011

833

position. After 7 years of working hard to get Whitetracks in a solid financial and competitive position, he got tired of being the CEO and stepped aside for Bob Moore in 2001. Mr. Jones was eager to sell but did not see why the owners needed IBG. He said to Mr. Grange, “Why should we pay a large selling fee if we can sell the business on our own? If we wait, we can increase profits and attract our own buyers. Why pay IBG to package what we already know to be a pretty good thing?” Bob Moore, a retired U.S. Air Force colonel, had headed a logistics command. After his retirement, Mr. Moore moved to Denver and began looking for a job that would enable him to use the management skills he developed in the Air Force. He joined the company as a production manager in 1998 and became the general manager in 2000. In 2003, he married Betty Boyd. Mr. Moore supported his wife’s decision to sell and was also ready to retire. He said to Mr. Grange, “All the actual detail in managing a small business is a tough thing to do with no resources. You’ve got to make many things work. While Whitetracks is a fantastic brand, an icon in the industry, we thought that we could make it stronger, but it’s tough without deep pockets. Besides, Betty wants to move back to Texas, so this is a good time for us to sell.” Mr. Moore thought that Whitetracks’ reputation for quality, excellent customer service, and good market penetration offered a lot of value to a buyer. He thought the highest value for Whitetracks would probably come from a strategic buyer. Aligning Whitetracks with a large sporting goods company, one looking to add a snowshoe line, could provide the investments in working capital, marketing, and research and development (R&D) necessary to increase the market share of the Whitetracks brand and to make it more competitive with the other larger snowshoe manufacturers.

Operations Whitetracks was a seasonal business, shipping 90% of its orders between October and February. Snowshoe models were designed by various consultants with great familiarity with the snowshoe industry, and all materials were obtained from local suppliers. All assembly and quality control took place at Whitetracks’ manufacturing plant, a leased, 12,000 square foot, one-story building in an industrial park in Denver. Whitetracks had an option to terminate the lease if the company were sold. The manufacturing of snowshoes involved a four-stage process: (1) bending and cutting the frame tubing; (2) die cutting the decking and hinge material; (3) assembling and mounting the bindings; and (4) final inspection and packaging. The company purchased precut lengths of seamless, aluminum alloy tubing and used a machine called a bender to create the frame of the shoe. The benders were designed for the specific finished shape and diameter of the snowshoe frame. The bender tightly locked around the tubing and exerted force to make the bend. When removed from the bender, the tubing was shaped exactly as needed for the snowshoe frame. Whitetracks owned and operated two bending machines. Powder coating of the frames was outsourced to a local company. The aluminum frames were electrically charged and then sprayed with dry, finely powdered plastic that clung to the charged frame. The frames were then heated, and the plastic melted onto the frame. Once the frames returned from the powder-coating shop, they were ready for final assembly. Decks (the main part of the shoe) and bindings were cut from large rolls of material. Workers unrolled the material and fed it into Whitetracks’ die press. The press contained razors mounted in the outline of the deck shape and cut a finished deck in one motion. Silk screening of the decks was outsourced to a local company. 834

ENTREPRENEURSHIP THEORY and PRACTICE

The last steps in manufacturing the shoe were to attach the deck to the frame, to install cleats on the bottom of the shoe, and to fit the bindings and heel strap. All these parts were riveted together through the deck with a single rivet. The shoes were then ready to be boxed and sent to retailers. Whitetracks’ managers were pleased with the quality control they achieved by producing locally. All raw materials for the snowshoes were inspected as they came into the plant, and workers checked for problems at each step of the manufacturing process. Because snowshoe components fit so precisely, any fault in the process was usually noticed immediately. For example, an incorrectly cut deck could not be fastened to the frame. Manufacturing snowshoes was also a slow process, thus allowing for visual inspection throughout. The worker who tagged the completed snowshoes and prepared them for shipping acted as the final inspector. Customer service set Whitetracks apart from its competitors, its owners believed. Managers also thought that their high-quality products enabled the company to be the first to offer original purchasers a limited lifetime warranty against defects in materials and workmanship on all of its snowshoes and accessories. Competitors had only recently begun offering similar warranties on their own products. Whitetracks’ managers were uncertain that they could maintain this tight quality control if production were outsourced to China, as competitors had done.

Marketing Whitetracks had limited funds for direct advertising and promotion but did place occasional advertisements in sports publications and on the Resort Sports Network (RSN).1 Other avenues of marketing consisted of providing a newsletter to dealers, engaging a public relations firm to generate media coverage, setting up meetings between sales representatives and store-level buyers, and participating annually in several trade shows. Whitetracks also sponsored approximately 20–30 promotional events each year. Many of these events had a charitable emphasis such as supporting the Special Olympics by providing snowshoes for athletes and coaches. Whitetracks partnered with the National Center for Disabled Skiers and donated equipment to enable individuals with disabilities to participate in snowshoeing. Whitetracks also used the Internet as part of their marketing strategy. The web gave them cheap and quick advertising by simply taking a picture of a new product and posting it to the company website. Funding for promotional budgets was small, making it difficult to compete with larger competitors.

Innovation Whitetracks was known as a cutting-edge firm with a long-established, formal R&D program. The company was recognized as a leader in the design and distribution of high-tech, lightweight snowshoes. It held two design patents (a snowshoe binding and a snowshoe hinge) and had a long record of being the first company in the industry to offer innovations. For example, Whitetracks had introduced children’s snowshoes, V-shaped tails, easy-on-and-off bindings, and a hinge that reduced fatigue by allowing people to walk with a normal stride. The R&D program used independent product developers and design consultants that specialized in the snowshoe industry. The time from initial product 1. RSN was created in 1986 and creates and distributes outdoor lifestyle programming in 105 resorts and in nine markets across the United States. Source: http://en.wikipedia.org, accessed 12 December 2008.

July, 2011

835

design to manufacturing and distribution was about 2 or 3 years. Whitetracks’ limited funding contributed to a longer product development cycle. Managers believed that failure to continue new product development would be a severe blow to Whitetracks’ competitive position.

Products Of all the brands in the market, Whitetracks’ snowshoes were the sportiest.2 They were known as the shoe of choice by winter runners, athletes, and outdoor enthusiasts.3 Their unique V-shaped tail created less stress on the knees and ankles than did similar models made by competitors. In 2005, the company sold 11 models and 31 combinations of snowshoes and bindings. Whitetracks increased revenues by offering high-margin accessories such as snowshoe poles, talon kits, carry bags, t-shirts, and hats. But in spite of its multiple models and the accessories it offered, Whitetracks was still essentially a single-product enterprise that depended for success on snowy winters around the globe.

Customers and Markets Customers were primarily outdoor recreational products dealers located in the snowy regions of the United States, Canada, Europe, Japan, and Korea. The company sold to over 400 dealers using sales representatives and commissioned sales agents. The three largest customers were Sierra Trading Post (22% of total sales), Recreational Equipment Incorporated (REI) (13%), and The Sports Authority (13%). No other customer accounted for more than 9% of sales. Other customers were ski rental shops. For example, Whitetracks snowshoes were the only brand available at the Winter Park Ski Area, Copper Mountain, and Smuggler’s Notch resort ski shops. A portion of sales came from institutional and governmental customers such as armed forces and schools. The company’s three largest customers had a history of stretching their payments to Whitetracks well beyond the net 30 days policy, causing the company to scramble to meet working capital requirements during its peak season. In contrast, the ski rental shops typically paid on time. Because these three customers represented such a large proportion of its sales, Whitetracks had accepted their behavior as a cost of doing business. Bob Moore, the CEO, expressed his frustration: “It makes me mad as hell that they don’t pay on time. We make calls and send letters to them, but they pay when they want to anyway. We just have to put up with it.” Whitetracks had a significant user base with strong brand loyalty. For instance, user comments included: “I liked the sport snowshoe with the V-tail which made for a lighter and faster hike.” “Weight, shape and size: I love them. The best pair of snowshoes I have owned thus far—the best, hands down.” “They are a great price, have a great appearance and features and have a very cool name!” “I like the women’s design and sizing.”

Competition Whitetracks’ largest competitors for mid- and high-end snowshoes were located in the United States. The Tubbs and Atlas brands, both manufactured by K2, had a combined 2. “Whitetracks Confidential Business Report: IBG Strategic Acquisition Candidate #6709,” IBG Business Services, Inc., p. 11, May 24, 2005. 3. “Whitetracks Confidential Business Report: IBG Strategic Acquisition Candidate #6709,” IBG Business Services, Inc., p. 11, May 24, 2005.

836

ENTREPRENEURSHIP THEORY and PRACTICE

50% share of the domestic snowshoe market while Cascade Designs had a 20% share. These competitors outsourced the manufacturing of their snowshoes to China, leaving Whitetracks as the only remaining major U.S. manufacturer of snowshoes with a 15% market share. The industry was characterized by price cutting, which reduced profit margins for all firms. Also, Whitetracks competed directly with a smaller competitor, Yukon Charlie, for low-priced shoes. Management believed that snowshoes made in the United States had a special appeal but knew that features and service closed the sale. Serving customers quickly and efficiently was much easier to do when employees and facilities were in the United States. The downside to local, small-scale manufacturing was that Whitetracks had to produce snowshoes well ahead of the winter season, which could leave unsold inventory when demand was lower than expected. “Last year the snowfall in Europe was below average and several buyers canceled or reduced their orders,” said Bob Moore.

Employees Due to the seasonality of the snowshoe business, Whitetracks’ employment varied from a seasonal high of 25 to a year-round staff of 10 nonunion factory employees and 6 sales and administrative personnel. Factory employees were paid an average of $8.50 per hour and received paid vacation time and health-care benefits. The full-time factory workers had an average tenure with the company of approximately 4 years. Some of the seasonal employees returned each year to work and ski during the winter months. The owners of Whitetracks had decided to try to help the full-time employees keep their jobs in the event of a sale, but layoffs would not be a deal breaker. The Colorado economy was rebounding from 3 years of job losses following the “dot.com” bubble of 2001. Employment grew by 1.4% in 2004 and was projected to grow by 2.5–3.0% in 2005. Approximately 40% of all new jobs state-wide were in the Denver– Aurora metro area. Also, the winter sports industry throughout the state was expected to continue to grow. Six of the top 10 U.S. ski resorts listed in Ski magazine in 2004 were located in Colorado.

Financial Information In 2001, Whitetracks sales and pretax earnings were $2.5 million and $264,000, respectively, but in 2002, they fell to $2.1 million and $165,000. In 2003, one large account did not place an order, and sales fell to $1.8 million with pretax earnings below $20,000. In 2004, the company replaced the lost order with larger orders from several other accounts and sales, and pretax earnings recovered to $2.2 million and $79,000. Whitetracks struggled to fund necessary advertising, marketing, design, and product development because of insufficient working capital. However, in 2004, the company obtained and used a $200,000 short-term line of credit and a $425,000 long-term bank loan. Historical income statements and balance sheets are shown in Tables 1 and 2.

The Snowshoe Industry Snowshoes allow people to walk on deep snow by distributing the walker’s weight across a large surface area. People have been snowshoeing for over 6,000 years (the practice probably originated in Central Asia), and as early as the eighteenth century, July, 2011

837

Table 1 Whitetracks Design, Inc. Income Statements for Years 2002–2004 — Sales Units sold Cost of goods sold Material Direct labor Rent allocation Depreciation allocation Other Total cost of goods sold Gross profit Operating expenses Owners/management compensation CEO bonus compensation Salaries and wages Professional fees Rent allocation Commissions Bad debts Advertising and promotion Trade shows Research Depreciation allocation Amortization—purchase debt Interest Other expense Total operating expenses Operating profit

2004

2003

2002

$2,248,511 41,300

$1,789,429 30,172

$2,050,742 31,800

771,007 251,120 25,719 11,131 77,157 1,136,134 $1,112,377

596,194 185,736 26,921 12,434 62,723 884,008 $905,421

693,945 207,823 18,374 19,110 95,798 1,035,050 $1,015,692

138,238 23,900 22,331 47,422 23,912 122,089 32,551 104,310 25,162 4,008 1,995 12,600 107,534 367,186 1,033,238 $79,139

151,000 4,270 29,395 99,177 24,447 154,430 0 74,302 25,184 24,582 2,814 12,600 19,517 264,125 885,843 $19,578

133,000 20,327 139,523 45,131 20,793 71,815 14,000 94,304 29,021 14,224 3,901 12,600 42,310 210,169 851,118 $164,574

CEO, chief executive officer.

snowshoeing had become a recreational and fitness sport.4 In the late 1950s, a Canadian company, Magline, used magnesium to construct the first metal frame, with webbing made from airplane cable encased in nylon.5 At about the same time, a Vermont-based company, Tubbs, created the first modern snowshoe, using a shorter length and narrower width than the traditional wooden shoe design. In 1972, Gene and Bill Prater created the aluminum snowshoe as it is known today, with a short frame made of aluminum tubing, a nylon decking (the portion of the shoe that holds the foot), hinged binding, and cleats on the bottom of the shoe.6 The Sherpa Snowshoe Company began manufacturing these “Western” shoes, and the “short and narrow” design became the industry standard. Figure 2 shows photographs of traditional wooden snowshoes and the modern design. The total number of snowshoe participants in the United States was 5.5 million in 2005, compared with the marquee winter sports of skiing and snowboarding with 4. http:ww.madehow.com/Volume-6/Snowshoe.html, accessed 5 December 2007. 5. http:ww.madehow.com/Volume-6/Snowshoe.html, accessed 5 December 2007. 6. http://en.wikipedia.org/wiki/Snowshoe, accessed 5 December 2007.

838

ENTREPRENEURSHIP THEORY and PRACTICE

Table 2 Whitetracks Design, Inc. Balance Sheets for Years 2003–2004 — Current assets Cash Accounts receivable (net 5,000) Inventory Prepaid expenses Total current assets Property, plant, and equipment Leasehold improvements Furniture and fixtures Machinery and equipment Vehicles Total PPE Accumulated depreciation Net PPE Other assets Patent and trademark costs Non-compete agreement Loan fees Accumulated amortization Total other assets Total assets Current liabilities Accounts payable Sales tax payable Accrued commissions Accrued interest Line of credit payable Total current liabilities Long-term liabilities Note payable-bank Shareholder loans Total long-term liabilities Total stockholders equity Total liabilities and equity

12/31/2004

12/31/2003

$503,443 613,485 852,343 0 $1,969,271

$391,347 610,525 654,684 33,035 $1,689,591

5,120 33,075 263,045 24,109 325,349 -305,296 20,053

5,120 73,138 254,681 24,109 357,048 -323,812 33,236

15,262 189,000 4,375 -80,850 127,787 $2,117,111

15,262 189,000 0 -68,250 136,012 $1,858,839

$80,937 17,972 21,639 90,156 200,000 410,704

$71,367 10,639 18,404 163,310 21,500 285,220

425,000 637,193 1,062,193 644,214 $2,117,111

129,685 837,478 967,163 606,456 $1,858,839

PPE, property, plant, and equipment.

approximately 12.5 million participants.7 More than 30 firms manufactured snowshoes, but the industry was dominated by K2 (which owned both Tubbs and Atlas) and Cascade Designs with total market shares of 50% and 20%, respectively. Firms in the industry competed by either adopting a niche strategy or pursuing a mass merchandising strategy. Niche producers sold a small number of high-quality shoes and focused on experienced users such as racers, avid snowshoers, and others who spent time

7. Snowshoe information from Snowsports Industries Association on the National Ski Area Association website: http://www.nsaa.org/nsaa/press/0506/facts-about-skiing-and-snowboarding.asp, accessed 2 December 2008.

July, 2011

839

Figure 2 Whitetracks Design, Inc. Traditional and Modern Snowshoe Images (A) Traditional Snowshoe; (B) Modern Snowshoe Clow Toe bar Toe hole

Toe

Located beneath binding Toe cord Pivot rod Traction device (fastened to bottom) Heel bar

Strike plate Heel strop

Frame

A

Webbing

Tail

Step-in binding

Inside edge (left snow shoe)

Decking

Pull strap

Outside frame B

Tail area

in deep snow. Manufacturers from mass merchandisers to specialty companies sold a wide range of snowshoe models at prices between $20 and $300. Although demand in most of the snowsports industry was flat in 2005, snowshoeing was booming. Participation grew by 15% between 2004 and 2005, and between 8% and 24% annually over the period from 2001 to 2004.8 Unit sales of snowshoes grew 9.2%, 21.3%, and 10.2% over the years 2003, 2004, and 2005, respectively.9 Dollar sales grew at comparable rates, and the average retail price for a pair of snowshoes over the same period varied between $142.30 and $148.95. One of the biggest draws to the sport was the ease of mastering it. No fancy techniques were required, and snowshoes could be used in many different types of snow conditions, regardless of the weather. The saying in the industry was, “If you can hike, you can snowshoe.” Snowshoeing was a crossover sport that offered a low-impact, aerobic workout that also included strength training and muscle endurance. Research showed that adults burnt up to 700 calories an hour snowshoeing. People who substituted snowshoeing for running during the winter improved their overall fitness.10 Snowshoeing exercised similar muscles to those used in walking and hiking. Carry Porter of Mountain Safety Research pointed out, “It’s the number one growing winter sport. Kids love it, women love it, it’s easy to get into, it’s relatively inexpensive . . . why wouldn’t you want a pair of snowshoes?”11 8. http://www.winterfeelsgood.com/winterfeelsgood.php?section=news&page=basic_stats__06, 27 October 2007. 9. “SIA Resort Shop Abstracts, March 2003-March 2004”, Snowsports Industry Association. 10. http://www.winterfeelsgood.com/winterfeelsgood.php?section=news&page=fact_snow-shoe, 27 October 2007. 11. Mandel, P. “American Made: Does it Matter?,” Snowshoe Magazine, March 22, 2005.

840

accessed accessed

ENTREPRENEURSHIP THEORY and PRACTICE

The industry was going through some fundamental changes because of a period of consolidation, and outsourcing manufacturing to China. Several small manufacturers shut down, and others were acquired by larger competitors. Many industry experts believed that the consolidation was driven by consumer and retailer demands for lower priced snowshoes. But others like Jake Thamm, president of Crescent Moon, a small high-end snowshoe company in Boulder, Colorado, thought that the shakeout of small companies stemmed from their failure to offer uniquely designed snowshoes or otherwise differentiate themselves from competitors. According to Mr. Thamm, to stay in business, smaller U.S. companies had to offer innovative designs and superior customer service. In the mid-1990s, Yukon Charlie became the first snowshoe company to move a large part of its manufacturing to China. As in other industries, the trend toward offshoring in China accelerated over time. All of Atlas’ snowshoes were made in China in 2005, and Tubbs planned to import all of its snowshoes from China in 2006. Much of the pressure to move overseas came from consumers demanding lower priced snowshoes and retailers pushing that demand back onto the manufacturers. Snowshoe manufacturing was expensive, said Richard Havlick of Havlick Snowshoes in Mayfield, New York: “Take a kid’s shoe. It costs the same to make as a full size shoe but you can’t sell it for the same price.” According to Karen Rightland of Tubbs, the advantages of outsourcing to China were clear: “A lower-cost product is just a reality. Lower-cost manufacturing makes it possible for Tubbs to offer discounted family pricing on their snowshoes. Also, we can hurl resources at quality assurance problems, we can dedicate ourselves to making fixes and improvements in a way we just couldn’t do when we were in the United States.” The R&D of new products was done in the United States, and then the products were manufactured offshore. Lead times for offshore manufacturing of 4 or 5 months combined with the logistics of shipping large quantities through limited port facilities to require that snowshoe production for the next season start early each year. The minimum efficient order size from China was approximately 10,000 units.12 Some consumers were concerned about the quality and performance of snowshoes made in China. Chinese snowshoes had a reputation for being heavy but cheap. However, although American shoppers might ask where a shoe was manufactured, the answer did not seem to be critical to most of them. According to Bob Dion of Dion Snowshoes in Readsboro, Vermont, “Consumers say they want a U.S.-made product, but come shopping time, that’s not what happens. They do all their homework in their local stores and shopping malls, then go to the Internet and see where they can get the product for the lowest price.”13 However, Whitetracks’ managers thought that competitors’ overseas outsourcing gave Whitetracks’ “Made in USA” products a certain cachet that increased sales. For many years, women and children were offered only unisex products that did not fit properly. By 2005, all manufacturers had age- and gender-specific products. Mel Janaes, a sales associate with Eastern Mountain Sports said, “Gender, weight, versatility are now factors in how snowshoes are made.”14 Whitetracks, for example, was offering new V-tail models designed for a woman’s walking and running strides that were light and easy to handle. Their bindings used quick release buckles with easy-to-use strap systems that were designed to form to a woman’s foot. Other snowshoes were designed specifically for children.

12. Mandel, P. “American Made: Does it Matter? Part II,” Snowshoe Magazine, April 21, 2005. 13. Mandel, P. “American Made: Does it Matter? Part II,” Snowshoe Magazine, April 21, 2005. 14. Allford, R. “The Changing Landscape of the Snowshoe Industry: A Conversation with Mel Janaes,” Snowshoe Magazine, March 15, 2004.

July, 2011

841

Growth Opportunities for the Snowshoe Industry The 2004 Outdoor Participation Study (The Study) published by the Outdoor Industry Foundation suggested several future growth opportunities for aggressive, wellfinanced companies. 1. The market for snowshoes would be increasing.15 The Study reported a total U.S. outdoor recreation population of 145.7 million. Participants were younger (median age 35), slightly more diverse (20% non-White), and consisted of more families (50% of households have a child under 18) than in 1998. Snowshoeing was one of four activities showing the largest percentage increase in “participants” since 1998, with 3 million new participants, a 203.4% increase. Respondents were looking for activities that were easy to access and to learn, could be done in a day, and did not require specialized technical gear. Snowshoe industry experts recognized that this group was critical for growth in the sport. 2. Young adults was a rapidly growing market segment.16 According to The Study, among young adults aged 16–24, snowshoeing had greater participation rates in 2005 than in 1998, and a third of all snowshoers were between 16 and 24. The challenge with this overall age-group was changing their perception that snowshoeing was an “uncool” activity for young people and suited only to older people. In the words of a New York Times reporter, To understand the problem facing snowshoe makers today, look no further than the snowboarding prodigy Shaun White. He wows. His wild orange hair flops beneath a sticker-bedecked helmet. He has an acrobatic repertoire of 360s, McTwists and Method Airs that children instinctively want to ape. It’s enough to make the snowshoe industry scream. After the under-18 crowd has admired the jumps, twists and turns of the talented Mr. White, why would they be satisfied to simply plod through snow?17 None of the firms spent much on advertising to the under-18 group. Even the industry leader Tubbs only spent $25,000 on advertising to this market segment in 2004. 3. Young Hispanics and African/Americans were a new market segment.18 The Study also found that Hispanics and African Americans represented a new generation of outdoor participants. Over 60% of the males in each group, and over 40% aged 16–24 in each group participated in outdoor activities during the sample period. 4. Women are a growing market segment. The Study also found that over 74 million women participated in outdoor activities, and the growth of female participation in snowshoeing increased substantially from 2004 to 2005. 5. Snowshoeing is a low-impact aerobic exercise. A final growth opportunity was to increase the awareness of snowshoeing as a means of improving physical fitness. Poor diet and sedentary lifestyles were contributing to almost two thirds of American adults

15. “2006 Outdoor Recreation Participation Study,” Outdoor Industry Foundation. http://www. outdoorindustryfoundation.org. 16. Allford, R. “Dude, Snowshoeing Kicks A**! How the Youth Make a Difference,” Snowshoe Magazine, November 15, 2004. 17. Melekian, B., “Thank You for Snowshoeing,” The New York Times, December 14, 2006. 18. “2006 Outdoor Recreation Participation Study,” Outdoor Industry Foundation. http://www. outdoorindustryfoundation.org.

842

ENTREPRENEURSHIP THEORY and PRACTICE

or more than 123 million people being overweight or obese.19 Dr. William Klish of the Baylor College of Medicine noted that for the first time in over 100 years, children had a shorter life expectancy than their parents.20 The winter months contributed to inactivity as well as to poor eating habits. Snowshoeing could improve fitness levels by offering a noncompetitive, social activity for all members of the family.

Recast Financial Statements for Whitetracks Design, Inc. Gary Grange told the owners that Whitetracks’ financial statements should be recast, or “normalized,” to prepare the company for sale. Because privately owned companies tended to minimize reported profits for income tax purposes, he said that financial recasting was important for understanding a company’s earning capacity and cash flow and making meaningful comparisons with other companies. Mr. Grange told the owners that financial recasting eliminated such items as excessive or discretionary expenses (especially personal expenses) and nonrecurring revenues and expenses. He said that recasting also removed debt and interest expense because they reflect the financing decisions of the current owner, not of a new owner. Furthermore, recasting the financial statements often identified off-balance sheet assets and liabilities. Mr. Grange pointed out that the Whitetracks balance sheet did not recognize product liability for snowshoes already sold, a liability that the company’s owners had ignored. He told them, “We need to unwind your income statements to get at the real economic earning power of the company. Every dollar that we can add to your earnings will increase your business value by $5 (using the typical “EBITDA times 5” approach).” Mr. Grange also told the three owners that all recasting adjustments must be legitimate, to pass review by the buyers’ Certified Public Accountants (CPAs) during their due diligence process. With his coaching, the owners volunteered the information that is shown in panel A of Table 3. Panel B shows Mr. Grange’s recast income statements for 2004 and 2003 based on the first seven proposed adjustments listed in panel A. For 2004, recast operating profit increased 127% from $79,139 to $179,429 and in 2003 by 559% from $19,578 to $128,996. Panel C of Table 3 shows the recast balance sheet for 2004 based on the last four proposed adjustments in panel A. The net effect of these balance sheet adjustments was to increase the stockholders’ equity by 116% from $644,214 to $1,392,621.

Setting the Value of Whitetracks Design, Inc. When valuing private companies for sale, Mr. Grange typically followed the industry practice of using a multiple of 5 times the most recent historical earnings before interest, taxes, depreciation, and amortization (EBITDA) on a recast basis. As one check on this EBITDA approach, he considered information from the John Wiley subscription database, Mid-Market Comps, for the sale of similar private companies in Whitetracks’ Standard Industry Classification (SIC) code. This database was organized by industry and contained the actual selling price as well as partial income statement and balance sheet information 19. Tarallo, M.J., “Take Another Look at Winter—Snowshoe Programs Work at Fitness Issues,” Perspective, July, 2004. 20. Tarallo, M.J., “Take Another Look at Winter—Snowshoe Programs Work at Fitness Issues,” Perspective, July 2004, p. 29.

July, 2011

843

Table 3 Whitetracks Design, Inc. Recast Financial Statements for 2003 and 2004 Panel A: Tentative Recasting Adjustments for Whitetracks Adjustment number 1

2 3 4 5 6 7 8 9 10 11 12 13

Tentative adjustment The total owners/management compensation for both the chief executive officer (CEO) and senior vice president (VP) positions for 2004 and 2003 was $138,238 and $151,000, respectively. The owner doing the senior VP job was just in an oversight role and the same duties were being performed by a VP of sales and marketing who was being compensated normally. The market compensation for the CEO position at similar companies was estimated to be $80,000 per year. The CEO bonus compensation for 2004 and 2003 was $23,900 and $4,270, respectively. This bonus was normally based upon 10% of unadjusted operating profits. Excess or one-time expenses for attorneys and consultants were incurred for $37,000 in 2004 and $89,000 in 2003 for a business acquisition, real estate transactions, and software training. In 2004, excess overtime of $14,000 was incurred due to a new production manager. Bad debt expense could be adjusted to normalize this expense at 1% of sales. Whitetracks carried no product liability insurance, which would cost $35,000 per year. The income tax rate is estimated to be 40%. This adjustment assumes that the new buyer would have to pay corporate income taxes. Whitetracks is currently an S Corporation. To calculate an adjusted EBITDA, depreciation, amortization, interest, and taxes need to be added back to net income. Also, for the adjusted EBITDA, capital expenditures were normally $10,000 per year. In reviewing Whitetracks’ 2004 balance sheet with the owners, $25,000 of scrap inventory still on the books. Accelerated depreciation had been used for income tax purposes but straight-line depreciation would be have been $198,845 less over the years of fixed assets’ ownership. None of the other assets, except the patent and trademark costs (net book value of $10,000), had any future value to potential buyers. All the accrued interest payable related to the shareholder loans that would all be reclassified as stockholders equity if the company was sold.

EBITDA, earnings before interest, taxes, depreciation, and amortization.

Panel B: Whitetracks Design, Inc. Recast Income Statements for 2003–2004 —

2004

2003

Operating profit Recasting adjustments: adjustment no.* 1. Actual owners/management salaries Reasonable managers’ salary 2. Actual CEO bonus Recalc.: 10% operating profit 3. Excess or one-time expense 4. Excess overtime expense 5. Actual bad debt expense Normalized: 1% sales 6. Product liability insurance Earnings before taxes 7. Income taxes (40%) Earnings 8. Interest 8. Income taxes 8. Depreciation 8. Amortization 9. Capital expenditures

$79,139

$19,578

138,238 -80,000 23,900 -7,914 37,000 14,000 32,551 -22,485 -35,000 $179,429 71,772 $107,657 107,534 71,772 13,126 12,600 -10,000

151,000 -80,000 4,270 -1,958 89,000 0 0 -17,894 -35,000 $128,996 51,598 $77,398 19,517 51,598 15,248 12,600 -10,000

844

ENTREPRENEURSHIP THEORY and PRACTICE

Table 3 Continued Panel B: Whitetracks Design, Inc. Recast Income Statements for 2003–2004 — EBITDA: Recast EBITDA: Not recast: Operating profit Interest Depreciation Amortization EBITDA: Not recast

2004

2003

$302,689

$166,361

$79,139 107,534 13,126 12,600 $212,399

$19,578 19,517 15,248 12,600 $66,943

Note: * Adjustment No. corresponds to the adjustment number shown in panel A. CEO, chief executive officer; EBITDA, earnings before interest, taxes, depreciation, and amortization.

Panel C: Whitetracks Design, Inc. Recast Balance Sheets for 2004 Unadjusted — Current assets Cash Accounts receivable Inventory Prepaid expenses Total current assets Property, plant, and equipment Leasehold improvements Furniture and fixtures Machinery and equipment Vehicles Total PPE Accumulated depreciation Net PPE Other assets Patent and trademark costs Non-compete agreement Loan fees Accumulated amortization Total other assets Total assets Current liabilities Accounts payable Sales tax payable Accrued commissions Accrued interest Line of credit payable Product liability Total current liabilities Long-term liabilities Note payable-bank Shareholder loans

July, 2011

12/31/2004

$503,443 613,485 852,343 0 $1,969,27 5,120 33,075 263,045 24,109 325,349 -305,296 20,053 15,262 189,000 4,375 -80,850 127,787 $2,117,111 $80,937 17,972 21,639 90,156 200,000 0 410,704 425,000 637,193

Recast Adjustment*

12/31/2004

(10) -25,000

$503,443 613,485 827,343 0 $1,944,271

(11) 198,845

-5,262 (12) -189,000 -4,375 80,850 $56,058

(13) -90,156 35,000

(13) -637,193

5,120 33,075 263,045 24,109 325,349 -106,451 218,898 10,000 0 0 0 10,000 $2,173,169 $80,937 17,972 21,639 0 200,000 35,000 355,548 425,000 0

845

Table 3 Continued Panel C: Whitetracks Design, Inc. Recast Balance Sheets for 2004 Unadjusted — Total long-term liabilities Total stockholders equity Total liabilities and equity

Recast

12/31/2004

Adjustment*

12/31/2004

1,062,193 644,214 $2,117,111

748,407 $56,058

425,000 $1,392,621 $2,173,169

Note: * The numbers in parentheses correspond to the adjustment numbers shown in panel A. PPE, property, plant, and equipment.

for the company in fiscal year before the sale. Financial statement data and various business valuation multiples for each company sold, such as Price/Earnings, Price/ Revenue, Price/Cash Flow, and Price/EBITDA are shown in Table 4. This historical EBITDA approach assumed no or few capital expenditures or working capital requirements for cash flows. Therefore, Mr. Grange also considered the free cash flow method of business valuation. He estimated revenues by forecasting total market size for the snowshoe industry for each of the next 5 years and assuming a constant market share for Whitetracks. He thought that the average wholesale price of Whitetracks’ snowshoes would keep up with inflation, which he expected to average about 3% per year over the planning period. The owners told him that each year’s capital expenditures would approximate the sum of depreciation and amortization. Mr. Grange also decided to use the build-up method to find a weighted average cost of capital (WACC) for Whitetracks. Table 5 contains financial market data that Mr. Grange would use to find the WACC. To estimate the value of Whitetracks to a C-Corporation, he used a 40% corporate income tax rate. Finally, Mr. Grange knew that strategic buyers would likely come from current manufacturers of winter sports equipment who would add the Whitetracks line to their existing products. Discussions with industry experts and managers at Whitetracks helped him to estimate the cost savings another manufacturer could realize by acquiring Whitetracks. These savings from both economies of scale and scope are shown in Table 6. The major savings would come from reduced wages and salaries, lower rent, and the elimination of subcontracted services. The owners were willing to stay on after the sale to help during the transition to new ownership. Mr. Grange estimated that a buyer would pay upfront for both a $100,000 non-compete agreement and a $50,000 consulting agreement, totaling $150,000 to be divided equally among the three owners. The three owners were anxiously awaiting Mr. Grange’s recommendation on whether to sell the company now or continue to operate it for a future sale at a higher business value. Mr. Grange had gathered all his notes and working papers together and was considering the various tasks that lay before him. He knew that the financial statement recasting was the starting point for a company business valuation. To attract buyers, he 846

ENTREPRENEURSHIP THEORY and PRACTICE

July, 2011

847

.00 .00 .00 .00 .00 .00 .00 2.60 1.60 .00 .00 .00 3.61 2.60

Annualized EBITDA

Annualized cash flow .00 .00 .00 .00 6.20 1.40 .00 1.71 1.08 .00 (2.27) (.80) 1.66 1.66

5.33 3.80 .00 11.04 41.80 10.70 17.73 16.00 11.07 17.40 7.20 6.70 38.40 11.04

Annualized revenues

4.00 1.90 .00 9.20 41.80 10.70 13.30 8.00 8.30 17.40 5.40 6.70 9.60 8.00

Revenues

CF, cash flow; E, earnings; EBITDA, earnings before interest, taxes, depreciation, and amortization; P, price.

Nancy Lopez Golf Thermal Snowboards, Inc. Crush Innovative Sports Systems, Inc. Sport Supply Group, Inc. Game Time, Inc.; an S Corporation Grafalloy L.P. (CA) Ride Inc. (WA) JT USA, L.P. (CA) (fka J.T. Racing, L.P.) Torpedo Sports, Inc. (Quebec) Rainfair, Inc. (WI) Westbeach Snowboard Canada Ltd. (Canada) Silverzipper.com, Inc. (NY) and subsidiary Robern Skiwear, Inc. Kubic Marketing, Inc. (CA) and SWI Holdings LLC, the sole stockholder of Kubic Medians

Nancy Lopez Golf Thermal Snowboards, Inc. Crush Innovative Sports Systems, Inc. Sport Supply Group, Inc. Game Time, Inc.; an S Corporation Grafalloy L.P. (CA) Ride Inc. (WA) JT USA, L.P. (CA) (fka J.T. Racing, L.P.) Torpedo Sports, Inc. (Quebec) Rainfair, Inc. (WI) Westbeach Snowboard Canada Ltd. (Canada) Silverzipper.com, Inc. (NY) and subsidiary Robern Skiwear, Inc. Kubic Marketing, Inc. (CA) and SWI Holdings LLC, the sole stockholder of Kubic Medians

Seller

62.73 .00 .00 .00 10.00 10.14 .00 14.55 .00 85.38 .00 .00 52.52 14.55

P/E

End 6/00 End 6/95 End 10/95 End 10/95 End 12/96 End 12/96 End 9/99 End 6/00 End 4/02 End 4/96 End 9/97 End 12/98 End 5/00

Revenue date

Private Company Sales Data for SIC 3949 from the Mid-Market Comps Database

Table 4

.86 3.13 .00 .49 .65 .90 .70 2.00 .00 .64 .54 1.46 1.30 .86

P/revenue

9.00 6.00 .00 10.00 12.00 12.00 9.00 6.00 9.00 12.00 9.00 12.00 3.00

Revenue months

2.00 4.10 .83 .90 1.22 2.91 .36 5.82 .00 .12 .87 6.53 1.79 1.79

P/assets

.07 (.06) (1.09) (.43) 2.70 .95 (6.53) 2.20 .75 .13 (.54) (1.40) .95 .07

Annualized net income

.00 .00 .00 .00 4.35 6.86 .00 18.71 .00 .00 .00 .00 30.19 6.86

P/CF

2.30 2.90 1.20 6.00 22.10 3.30 34.40 5.50 2.70 9.90 4.50 1.50 27.90 4.50

Assets

.00 .00 .00 .00 .00 .00 .00 12.31 .00 .00 .00 .00 13.86 12.31

P/EBITDA

2.20 .18 (.33) .00 4.50 1.30 .54 2.30 .12 .39 .32 (4.60) 14.00 .32

Stockholder equity

Table 5 Financial Market Data Component

Rate

Risk-free interest rate Equity risk premium Industry risk premium (SIC 39) Company-size risk premium

.051 .072 -.033 .098

Source: SBBI Valuation Edition 2004 Yearbook, Chicago: Ibbotson Associates. SIC, Standard Industry Classification.

Table 6 Projected Savings if Whitetracks Merged With Another Snowshoe Manufacturer Estimated annual savings

— 1. Factory (15%) using current production workers already employed 2. Management compensation 3. Reduced rent 4. Utilities (50% of current) 5. Telephone (20% of current) 6. Subcontracted operations Silk screening Injection molding

40,000 185,000 57,000 6,000 2,000 50,000 181,000

thought that Strengths, Weakness, Opportunities, and Threats (SWOT) and Porter’s Five Forces analyses would be helpful as well as ratio analysis. Concerning the business valuation task, he wanted to estimate both what Whitetracks would be worth to a buyer from outside the industry and its value to a strategic buyer. He knew that such a task would be a real challenge since there was little comparable valuation data available from the company’s two major competitors. Also, he thought that forecasting cash flows for business valuation would be challenging but important in presenting a final recommendation to the owners. Hugh Grove is a Professor in the Daniels College of Business at the University of Denver. Tom Cook is a Professor in the Daniels College of Business at the University of Denver.

848

ENTREPRENEURSHIP THEORY and PRACTICE

Note to Instructors: Whitetracks Design, Inc. Introduction Whitetracks Design, Inc. was a leading U.S. manufacturer of snowshoes. Its three owners were deciding whether to sell the company now or to operate it for a later sale at a potentially enhanced business value. All of the Whitetracks owners were in their early 60s and hoping to retire. To assist with determining the value of their business, they hired Gary Grange, a merger and acquisition consultant with International Business Group (IBG) Business Services, who is also a coauthor of this case. Mr. Grange would assist the owners in valuing Whitetracks and in deciding whether to sell the company. The owners had wanted to sell Whitetracks in 2001, but its sales flattened and earnings declined following the terrorist attacks on September 11. At that time, Mr. Grange had persuaded the owners to wait because Whitetracks’ financial performance was declining. In 2005, the company’s financial performance was improving, and the owners once again asked Mr. Grange if they should sell. Some of the owners worried about having most of their assets and income tied up in the company. Others thought that if they waited too long to sell, they might miss the opportunity to spend their retirement years traveling the world. They also worried about the owners’ personal guarantees of Whitetracks’ corporate debt. Whether they could retire sooner or later depended upon the proceeds from selling the company. Prior to selling, the owners wanted an accurate determination of their firm’s value to ensure proper returns for their years of hard work and personal investment.

Key Issues and Discussion Points This case raises the issue of how to value privately held companies. This is important because a 2005 survey1 found that only 60% of private company managers had at least some idea of their firms’ value; two thirds of these managers said their idea of the firms’ value was based upon management estimates or wishful thinking. The case also aims to introduce students to the interdisciplinary nature of business valuation through an industry analysis and the recasting of financial statements preceding the valuation. Good business valuations require sound fundamentals in business strategy, accounting, and finance. Among the more interesting aspects of the case are the small size of the company, the lack of comparable companies for the valuation, and the paucity of good financial information on which to make a decision to sell or not. With the emergence of global competition and “world-flattening” technology, even private companies should be managed for value by making decisions with the goal of creating business value and measuring performance by the change in value from 1 year to the next. Eighty percent of a typical private business owner’s net worth is tied up in his or her business.2 As a result, an accurate determination of the firm’s value is essential to ensure proper returns for years of hard work and personal investment. This firm’s value is computed using various business valuation methods with various assumptions about the firm’s operations. The major opportunities for student learning are: 1. Leitner, P., “The Fallacy of Safe Harbors: Managing for Value in the Private Firm,” Strategic Finance, April 2006, p. 32. 2. Good, D. “Business Valuation of Private Firms,” Presentation at the Association of Corporate Growth Annual Meeting, Denver, Colorado, June 2005.

July, 2011

849

1. To understand a company’s strengths, weaknesses, opportunities, threats, and the competitive forces of its industry. 2. To analyze recastings (financial accounting adjustments) for their impacts on reported earnings, financial condition, cash flows, and business valuation. 3. To construct pro forma income statements and free cash flows for business valuation purposes. 4. To apply various business valuation methods to understand their impacts on the value of a business. 5. To consider both financial and nonfinancial factors in making a final recommendation whether to offer a company for sale.

Potential Audiences and Uses Whitetracks Design, Inc. is intended for both senior-level undergraduate and advanced graduate case courses in accounting, finance, and entrepreneurship. It should be used later in these courses after business valuation methods are covered. Students are challenged to analyze the industry, make adjustments to the reported financial statements, and apply several different valuation methods. As such, the case provides an opportunity for students to perform these tasks in a real-world setting where the financial information is far from perfect.

Suggested Teaching Approach This case has been used in an Master’s of Business Administration (MBA) course with finance majors and some accounting students and general MBAs. Instructors will have to be sensitive to the students’ academic preparation and be prepared to offer different background readings tailored to individual students. It is likely that finance students will excel with the business valuation approaches but will have some challenges with the various industry analysis techniques. The opposite results are likely for management or entrepreneurship students. Thus, industry analysis techniques may need emphasis to finance students, and major business valuation methods may need emphasis to management students before the case is assigned. We have found that the finance students needed more lecture information on the industry analysis methods for their impacts on reported earnings, financial condition, cash flows, and business valuation. Both finance and management students did well constructing pro forma income statements and free cash flows for business valuation purposes. But the management students needed more lecture information on the business valuation approaches and methods. Both finance and management students did well evaluating both financial and nonfinancial factors in making a final recommendation. To facilitate a case discussion, the instructor could review major concepts of alternative business valuation methods from any of a number of excellent books on business valuation, such as Damodaran (2002) and Pratt (2001). Whitetracks is very flexible; instructors can tailor it to the needs of their individual courses. The case can be taught as a full analysis of all the key issues and discussion points as we do at the University of Denver, assigning three or four students to each group, giving 1 week for student preparation, and employing a 2-hour class period for discussion. Alternatively, for instructors not wanting to devote as much time to all of the issues in the case, selected issues (or various combinations thereof) could be taught separately as stand-alone sections. For example, solutions to the pro forma free cash flows could be provided to the students to 850

ENTREPRENEURSHIP THEORY and PRACTICE

focus on the business valuation decisions rather than on financial forecasting. Similarly, solutions to the financial statement recastings are already included in the case exhibits. We use the following assignment questions for students: 1. Perform a SWOT analysis for Whitetracks. Use Porter’s Five Forces model to analyze the industry. 2. Perform a financial analysis of Whitetracks using financial ratios and common-size financial statements. 3. Estimate earnings before interest, taxes, depreciation, and amortization (EBITDA), earnings before interest and taxes (EBIT), net operating profit after taxes (NOPAT), and free cash flows for Whitetracks over the next 5 years. 4. Use the build-up method to estimate a cost of equity capital for Whitetracks. Estimate a weighted average cost of capital (WACC) for Whitetracks. 5. Estimate the enterprise value and common stock values for Whitetracks using free cash flows. Estimate the terminal value at the end of year 5 using both a constant growth assumption as well as a multiple of EBITDA. 6. Estimate Whitetracks’ enterprise value and a value for all of its common stock using IBG’s primary private company approach of a multiple times historical recast EBITDA and other methods of comparables or multiples given in the case. Use both trailing and leading year values for EBITDA. Conduct a sensitivity analysis of the value of Whitetracks to different levels of the multiples. 7. Using Excel Data Tables, perform a sensitivity analysis on the value of Whitetracks by: Varying WACC and the Terminal Value EBITDA Multiple Varying the growth rate in total-market size and Whitetracks market share Varying inventory turnover and days sales outstanding 8. Estimate the value of Whitetracks to a strategic buyer who is able to realize the cost savings given in the case and to improve Whitetracks’ working capital position. Assume that a strategic buyer could lower days sales outstanding (DSO) to 60 days and increase inventory turnover to 3.8 times. 9. As Mr. Grange, make a final recommendation to the owners. Should Whitetracks be sold now or should it be developed further to enhance its value for sale at a later date?

• • •

Readings Instructors might assign outside readings to assist students in understanding of business valuation. Here are some suggested readings: Damodaran, A. (2002). Investment valuation. New York: Wiley. Pratt, S. (2001). Market approach to valuing businesses. New York: Wiley.

Role of the Authors The two authors (business professors) have worked with IBG for several years. They have published several case studies with other top executives at IBG. During the early part of 2006, Professors Grove and Cook met with Mr. Grange and obtained a copy of IBG’s selling book for Whitetracks. Following discussions with Mr. Grange, the professors deemed Whitetracks to be an excellent teaching vehicle. Follow-up phone calls, e-mail, and interviews with Mr. Grange and the owners of Whitetracks over the summer of 2006 solidified the issues in the case and provided additional financial information on the company as well as personal information from the owners. July, 2011

851