Bain Capital, a world-leading private equity firm, seeks to invest in a nonfood retail store called Edgar Consolidated Stores in South Africa. Edgar provides a number of opportunities, for example, stable economic and political environment, growing retail and discount stores and rising middle class income of Black South Africans. However, the investment in South Africa also posed serious currency risk and complications concerning the source of leverage. Overall, the key factors for value creation are required rate of return, potential cost reduction, potential for increasing value by increase in leverage and growth rate in the economy. Based on our assumptions of 23% rate of return, 10% growth in retail sector with 1.5% incremental growth in discount stores, cost reduction of 100bp and a P/E multiple of 12x, the proposed bid price for the second round is R53 per share. Furthermore, Thers has been proposed that this should not be the final bid and Bain Capital should retain the flexibility of adjusting the bid should circumstances change favorably or unfavorably. Finally, Bain Capital should bring strategic changes in the management of Edgars and bring better utilization of resources to maximize the return on assets if they win the bid. However, they should retain the current CEO as he has shown good results for the company.
1. What are the opportunities and risks to consider in the proposed Edcon bid? What are the key sources of value creation?
2. Why may it not be feasible to use only bank debt to leverage Edcon? Would it be better to use all bond financing or a combination of bank and bond debt? Explain the advantages and disadvantages of each approach.
3. Using Exhibit 13, calculate what premium to the required rate of return would be needed for an investment in South Africa. Why might Bain Capital use an alternate premium?
4. Restricting yourself to the set of parameters and values in Exhibit 14, justify what price you would be willing to pay for Edcon. Specifically address the rationale behind your base case assumptions that led you to that particular bid price. What degree of confidence do you have in paying this amount?
5. Should Bain Capital make their bid “final”?
6. If Bain Capital wins the bid, should they make changes to the management team?