Brown-Forman Southern Comfort Brown-Forman, Southern Comfort Acquisition

Brown-Forman Southern Comfort

Brown-Forman, Southern Comfort Acquisition

The case considers the opportunity for Brown-Forman Distillers of America to acquire the Southern Comfort Corporation (SoCo). The primary concern is of financial matters, but also represents other issues of firm strategy and core competencies.

Price

The asking price of 94.9 million (USD) is evaluated upon a structuring of a mix of cash and debt financing. The initial price includes a real estate holding, unaffiliated with the SoCo product, and is to be sold back to the family shareholders at a price of 5.9 million (USD). It follows that the net price for SoCo is 89 million (USD), with 70 million (USD) borrowed at a rate of 8.75% (Pg. 5). The current debt to equity ratio of 0.247 of Brown Forman is significantly below the average of competitors maintaining a ratio of 0.51. Acquiring SoCo with 70 million (USD) of debt financing implies no issue with the balance of debt to equity, due to the fact that the additional leverage merely aligns the firm with their benchmarked competitors.

Furthermore, the acquisition of SoCo, without any issuance of new equity shares, ensures that current shareholders gain from increased firm value. Increasing assets and cash flow increases the money available for dividends and exerts upward pressure on the stock price.

Hurdle Rate

Brown-Forman is known to adhere to a hurdle rate of 14% for investments within the distilling industry (Pg. 2). Based upon the 14% hurdle, the SoCo acquisition is advisable from a cash flow prospective. The initial outlay of 89.9 million (USD) recaptures 109.7 million utilizing the forecasted sales figures for SoCo 1978 through 1988.

NPV Operating Profits at 14%

$109,667.99

NPV Operating Profits at 12%

$121,046.90

The acquisition of SoCo entails benefits beyond simply cash flows, however the venture does exceed the organization's current investment objective criteria. The product broadens the firm's holdings and diversifies with into another segment that has demonstrated growth.

Strategy and Brand Development

The case notes that Brown-Forman's flagship product, Jack Daniels, has achieved a market leadership position and has experienced occasions of short supply (Pg. 3). The fact that whiskey is a consumable product implies that the current hurdle rate may be set too high for the firm to keep pace with consumer demands, or that an overriding criteria for matters of strategic importance should be implemented. A consumer unable to purchase their preferred brand is likely to purchase another, be it a competitor or alternate beverage. If the firm's products were of both aspirational and of occasional consumption, such as leather handbags or shoes, then intermittent short supply may be of little concern.

Brown-Forman is noted for their core competency of building brand equity; therefore acquiring a product outside of the firm's portfolio enables opportunities to exercise their capabilities (Pg. 3). Southern Comfort's success is noted as attributable, in part, to the fact that Janis Joplin prefers the beverage (Pg. 5). The subtle endorsement of the beverage is evidence that there are opportunities for Brown-Forman to exercise their brand building expertise with Southern Comfort.

The fact that Brown-Forman is able to achieve a self-sustaining growth rate of 10.2%, while competitors hold 7% growth rate in a flat market landscape, is additional evidence that the firm exhibits superior brand management capabilities (Pg. 7).

The acquisition of SoCo and the debt financing that is utilized carries with it a covenant that 7% must be maintained in cash, therefore the financials will show that the additional cash generated for 1978 will be not be free capital (Pg. 7). The 7% "compensating balance" amounts to 6.4 million (USD), which would just exceed the estimated net profits for SoCo operations.

1978 TOTAL GROSS PROFIT

15,421

Less G&A and interest

Operating Profits

13,213

Debt Servicing

0

EBIT

13,213

Taxes

Net Profits

6,738

Debt servicing costs reduce net profits, starting in 1979, through 1986, yet SoCo operations are still projected to produce consistent and increasing profits.

1979

1980

1981

1982

1983

1984

1985

1986

Gross Profit

17,796

20,092

22,491

23,445

25,139

27,261

28,972

31,323

Less G&A&I

Operating Profit

15,094

17,436

19,849

20,623

22,524

24,437

25,921

28,028

Debt Service

-13584

-13584

-13584

-13584

-13584

-13584

-13584

-13584

EBIT

1,510

3,852

6,265

7,039

8,940

10,853

12,337

14,444

Taxes

Net Profit

1,965

3,195

3,590

4,559

5,535

6,292

7,367

Following the full repayment of the debt instrument of 70 million, 1987 and 1988 projections forecasts SoCo performance as follows.

1987

1988

Gross Profit

32,496

32,127

Less G&A&I

Operating Profit

28,938

28,284

Debt Service

0

0

EBIT

28,938

28,284

Taxes

14179.72

13859.26

Net Profit

14,758

14,425

Synergies

The less tangible aspects of the acquisition entail efficiencies from duplication and/or increased market penetration with sales force. Both firms currently have both domestic and international distribution, however it is very unlikely that there is not additional opportunities to extend market penetration with both products.