Version 1.7 Brown-Forman Distillers Corporation In early July 1978, W. L. Lyons Brown, Jr., president and chief executive officer of Brown-Forman Distillers Corporation, faced an important acquisition decision. The principal owners of Southern Comfort Corporation had approached Brown in May with an offer to sell the company at a price of $94.6 million. In preparing his response, Brown was evaluating the reasonableness of the asking price and the likely effects of the acquisition on Brown-Forman’s share price. As a leading producer, marketer, and importer of wines and distilled spirits (including the well-known Jack Daniel’s brand), Brown-Forman ($457 million net sales) was the fifth-largest distiller in the United States, after National Distillers ($586 million), Seagram ($2,018 million), Heublein ($839 million), and Hiram Walker ($875 million).1 How Brown had chosen to position Brown-Forman among its competitors would affect the appraisal of Southern Comfort. Brown-Forman: Financial Goals and Performance In 1977, Brown-Forman’s management adopted new long-range financial goals regarding (1) hurdle rates for investment, (2) size of the capital budget through 1980, (3) target capital structure, and (4) dividend payout. The primary objective of these goals was to “increase the value of the stockholders’ investment.”2 The dividend payout ratio (all dividends paid divided by net income) was targeted at a range of 30 percent to 35 percent. Planned investment during the 1978–80 period included $86 million for advertising and promotion, $39 million in barreled whiskey inventory, and $19 million in new plant and equipment. Regarding capital structure, the ratio of total debt to total 1 Net sales figures for all firms were from wine and distilled-spirits business lines only. 1978 Annual Report, 3. 2 This case was prepared by Professor Robert F. Bruner. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright © 1983 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to dardencases@virginia.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Rev. 4/02. -2tangible capital,3 26.6 percent at the end of 1977, was viewed as offering “considerable flexibility in financing investment opportunities with either debt or equity.”4 Finally, the target hurdle rate, calculated as the return on total capital employed,5 was set at 14 percent for new capital projects in the distilling industry and 12 percent for investments in projects already in place. The 1977 Annual Report declared: While we are pleased with our 1977 results, in order to improve our return on total capital employed, we will be selective in pursuing new capital projects and will concentrate our efforts on improving the profitability of our present business. Management will actively pursue investments in new capital projects that have an anticipated return of at least 14 percent after taxes on the capital employed. At the same time, we will continue our efforts to expand the most profitable operations of the company. With respect to other areas of our business, your management is taking steps through price increases and closer attention to asset management to improve profitability. If the returns of these operations do not attain a higher level, management will consider channeling the capital supporting them into more-profitable projects, products, and acquisitions. Exhibit 1 compares the financial performance of Brown-Forman with its largest competitors. The company had a relatively larger profit margin, higher growth rates, and stronger balance sheet than its major competitors. The 1978 Annual Report noted: The Company’s balance sheet is strong due to continued close attention to asset management. Our low debt/equity ratio and the excellent financial performance in recent years place the Company in a favorable position to assume higher levels of debt to finance acquisitions and other investment opportunities. Value Line identified Brown-Forman as the “premier liquor company in the United States” and noted that the firm’s major brands continued to grow despite a flat industry growth trend.6 The company was expected to earn $2.45 per share in 1978 and to add another 15 percent to earnings per share in 1979. Brown-Forman’s income statement and balance sheet for the year ended April 30, 1978, are given in Exhibits 2 and 3. In 1978, two classes of stock existed for the company: Class A 3 “Total tangible capital” was defined as the sum of all interest-bearing debt, deferred income taxes, preferred equity, and common equity less intangible assets. 4 1977 Annual Report, 15. 5 “Return” was defined as the sum of net income (excluding extraordinary items), the after-tax cost of interest, the increase in deferred income taxes, and the amortization of intangible assets during the year. “Average total capital employed” was defined as the sum of all interest-bearing debt, deferred income taxes, and preferred and common equity averaged at year-end. 6 This and following quotes are from Value Line (April 14, 1978): 350. -3stock had the exclusive voting right and was listed on the American Stock Exchange, while Class B common had no voting rights but was also listed. The Brown family held 74 percent of the Class A stock and 40 percent of the Class B, and also provided some of the senior officers and directors of the company some of the Class A stock. Brown-Forman: Product-Market Strategy and Performance “The production of distilled spirits is a relatively straightforward task. It is marketing skill that is critically important to the survival and growth of firms in this industry,” said William Street, senior vice-president. Brown succinctly stated Brown-Forman’s product-market strategy in a presentation to the New York Society of Security Analysts on June 29, 1978: The company’s marketing philosophy is to produce and sell high-quality products which retail at prices generally at the upper end of the price scale within whatever category the product is sold. The company is a strong believer in heavy advertising support in order to build brands that have long life cycles with generally higher margins than are found on brands whose consumer appeal is based on price and shorter life cycles. Brown-Forman’s product line included many well-known brands, which were categorized into three groups (see Exhibit 4). Outside observers suggested that Brown-Forman’s special competence was in building brand franchises. For example, the company purchased the Canadian Mist Brand from Barton Brands, Inc., in 1971, “Because we had no significant brand in the Canadian Whiskey market and perceived significant growth in that market,” said Brown. By 1978, it was Brown-Forman’s largest brand and grew 11.5 percent during 1977 versus 3.1 percent for all Canadian whiskeys. A second example would be the company’s investment in the Bolla and Cella brands of Italian wines. The preeminent example of the firm’s ability to build premium brand franchises was, however, Jack Daniel’s Tennessee whiskey. Brown said, Jack Daniel’s’ compounded annual growth rate over the last five years has been between 10 and 15 percent and yet we know from tests in certain markets where we’ve allowed free supply both this year and last, that the growth has jumped to between 25 percent to 40 percent. I believe we can state without equivocation that Jack Daniel’s has the strongest and most loyal consumer franchise of any product in the industry. What are the reasons for this phenomenal success? Number one, it has been our long-term marketing philosophy that top quality deserves the highest price, and over many years, Jack Daniel’s has been the highest priced American whiskey of any significant volume on the market. The brand is probably the only one that by -4policy has never granted quantity discounts of any kind. The fact that there has been a supply shortage from time to time has added to the mystique surrounding the label and no doubt has been a factor contributing to long-term sales growth. . . Jack Daniel’s is a unique product. . . . Our advertising over the years has emphasized the character of the distillery and the whiskey it produces. . . . Finally, the most exciting thing for us for the long term is that the big increase in demand, which is on the top of the normal 10-15 percent compounded annual growth, is coming primarily from the youth market . . . the corporation sees a very healthy, long life cycle ahead for this brand. A new marketing thrust on the Jack Daniel’s brand had been to increase penetration of foreign markets. This campaign would require an expanded marketing organization overseas. Whereas skillful branding and product positioning could improve the sales performance of a particular product or product group, another factor, product-line mix, would also affect the sales growth of the company in the long run. Exhibit 5 suggests how demand for distilled spirits had changed during the previous ten years. Regarding the near future, Value Line expected sluggish industry growth overall, although “mystique” brands such as Jack Daniel’s would continue to grow: The spirits companies are beset with a number of problems. While the shift to non-whiskeys is firmly entrenched, the white goods (vodka, gin, rum, and tequila) aren’t as profitable. . . . Since the overall liquor market hasn’t gotten significantly larger, sales penetration by any one product type has come at the expense of another category. . . . Retail liquor prices have advanced about 15 percent over the last decade while the consumer price index rose 75 percent. Plainly, the industry has been reluctant to raise prices and has preferred to absorb cost increases because of the sluggish volume. Southern Comfort The object of Brown-Forman’s acquisition interest was Southern Comfort Corporation (Consolidated) and Caligrapo, Inc., producers of Southern Comfort, a unique liqueur. By industry definition, a liqueur is a distilled spirit that contains more than 2½ percent sugar by volume. Generally, a liqueur is produced by adding a syrup or concentrate to an alcohol base. The concentrate gives the liqueur its distinctive flavor. Southern Comfort’s concentrate was mixed by a secret formula owned by Caligrapo, Inc. Caligrapo sold the concentrate to Southern Comfort, which purchased alcohol and mixed, bottled, and marketed the liqueur. Southern Comfort employed 22 salesmen; its sales in 1977 were about $64 million (see Exhibits 6 and 7). -5Southern Comfort was owned by the estate of Francis E. Fowler, Jr., while Caligrapo was owned directly by his heirs, principally his sons, Francis G. Fowler, III, and Philip F. Fowler. Francis E. Fowler, Jr., had owned Southern Comfort for many years until his death in 1975.7 His sons managed the St. Louis company largely from California, where they and their father had chosen to live in recent years. Despite absentee management, the company was regarded as well run and efficient. Plant visits by Brown-Forman employees revealed modern equipment. Southern Comfort had enjoyed above-average growth in shipments (see Exhibit 8), which was consistent with the general rise in the consumption of liqueurs shown in Exhibit 5 but surprising in light of market surveys that over half of Southern Comfort’s consumers viewed it as a whiskey. Thus, compared with the slow growth of whiskey as a class, Southern Comfort’s performance was arresting. It was attributed in part to rock-and-roll singer Janis Joplin, who preferred Southern Comfort. Strengthened channels of foreign distribution also accounted for growth in export sales. Among marketing professionals, it was considered a very strong brand. Southern Comfort had never been sold at a discount by its manufacturer. Its performance notwithstanding, Brown believed that the brand had not been aggressively marketed. Through an intermediary, the Fowler brothers had approached Brown-Forman to solicit their interest in buying Southern Comfort Corporation and Caligrapo, Inc, for $94.6 million. Subsequently, Brown-Forman learned that, in recent years, two other major distillers had entertained the possible acquisition of Southern Comfort and had rejected it at that price. At the time of approaching Brown-Forman, the Fowlers were discussing acquisition with no other potential buyers. They seemed sincerely interested in selling to Brown-Forman, primarily because of a perceived fit of Southern Comfort with the Brown-Forman product line. Also, Brown-Forman resembled Southern Comfort in broad outline: a family-run business with a Southern heritage and a record of superior performance. The Fowlers indicated a willingness to accept cash for the two companies. Through an intermediary, they also suggested two other features of the acquisition. First, Southern Comfort Corporation owned some real property unrelated to the operations of the company. The Fowlers offered to repurchase that property at book value, about $5.9 million, after the acquisition. Second, they proposed that the acquisition be consummated after January 1979, when they expected Congress to lower the tax rate on capital gains. Brown contemplated financing $20 million of the purchase price with cash and financing the balance with bank debt. He estimated that up to $70 million could be borrowed at a nominal rate of 8 3/4 percent repayable over 7 years semiannually starting the following year. The company would be required to maintain an average compensating balancing of 7 percent on the amount borrowed. 7 Following the death of Francis E. Fowler, Jr., an independent appraisal in 1977 deemed the fair market value of the common stock of Southern Comfort to be $120 per share for estate- and inheritance-tax purposes. -6Because the proposed transaction would be taxable to the Fowlers, Brown-Forman could write up the value of the assets to the purchase price paid. Brown-Forman’s finance department estimated that the purchase price could be allocated as follows: $55.0 million 12.2 27.4 $94.6 million Intangible assets (amortized over 40 years) Property, plant and equipment (depreciated over 20 years) Current assets Asking price Fundamentally, however, the attractiveness of the acquisition would rely on the strength of the cash flow from operations. A small team of executives developed a series of revenue, cost, and volume assumptions, which are summarized in Exhibit 9. The recent price history of Brown-Forman’s common stock is given in Exhibit 10. -7Exhibit 1 BROWN-FORMAN DISTILLERS CORPORATION Comparative Financial Data, 1978 American Distilling BrownForman Heublein 1.41 1.10 1.71 .79 1.63 1.04 .65 .30 .50 .49 .47 .40 .46 .50 Debt/Equity 1.14 .247 .55 .34 .84 .53 .20 Debt - Cash Total capital .50 .11 .28 .16 .44 .32 .12 Assets/Equity 2.46 1.37 2.16 1.65 2.04 1.76 1.43 Sales/Assets 1.66 1.46 1.80 1.35 1.49 1.22 1.04 Beta Marginal tax rate Profit/Sales Price/Earnings .012 9.4 .073 8.2 .035 9.6 National Distillers .052 6.5 Publicker Industries .005 NMF Seagram .038 8.8 Hiram Walker .069 7.7 Dividend Yield at 4/14/78 NIL .043 .056 .08 NIL .042 .062 Self-sustaining growth rate .049 .102 .053 .079 .015 .041 .054 1978 expected sales growth .02 .09 .06 .08 .04 .07 .06 Market value Book value .46 1.26 1.53 .79 .63 .75 .77 Notes: (1) The long-term geometric mean risk premium (calculated as the difference between the return on the market portfolio and the long-term return on government bonds) was 5.7 percent. The arithmetic mean risk premium was 8.7 percent. (2) The yield to maturity of 10-year U.S. Treasury bonds (a proxy for the ex ante risk-free rate) was 8 percent. The yield on 90-day U.S. Treasury bills was 7.08 percent. Source of market premium: R. G. Ibbotson and R. A. Sinquefield, Stocks, Bonds, Bills, and Inflation: The Past (1926-1978) and the Future (1978-2000) (Charlottesville, Va.: Financial Analysts Research Foundation, 1977), Exhibit 28. Source of financial ratios: Value Line (April 14, 1978). Source of betas: “Security Risk Evaluation,” Merrill Lynch Pierce Fenner & Smith, Inc., April 1978. -8Exhibit 2 BROWN-FORMAN DISTILLERS CORPORATION Consolidated Statements of Income (in thousands except per-share amounts) Years Ended April 30, Net sales Cost of sales Gross profit Selling, advertising, administrative, and general expenses 1977 1978 $396,176 $457,071 274,733 310,539 121,443 146,532 69,714 76,395 - (2,300) 1,760 1,314 53,489 69,151 6,249 5,804 47,240 63,347 23,500 32,100 $ 23,740 $ 31,247 $ 1.85 $ 2.45 Other income (expense): Write-off of intangible asset Miscellaneous, net Earnings before interest and taxes Interest expense Income before taxes Taxes on income Net income Earnings per common share Source: 1978 Annual Report. -9Exhibit 3 BROWN-FORMAN DISTILLERS CORPORATION Consolidated Balance Sheets (in thousands of dollars) April 30 Assets Cash Short-term money market investments Accounts receivable, trade Inventories Other current assets Total current assets Investments in associated companies Property, plant, and equipment, at cost: Less accumulated depreciation Net property, plant, and equipment Other assets Goodwill, franchises, brands, and trademarks Total Assets Liabilities and Stockholders' Equity Current portion of long-term debt Accounts payable and accrued expenses Accrued taxes Deferred income taxes Total current liabilities 9.3% serial notes, less current portion, $5,000 due each September 1, 1979-1988 Deferred income taxes Total liabilities Stockholders' Equity Capital stock: Preferred 40¢ cumulative, 1,177,948 shares authorized and outstanding Class A common stock, voting, issued shares, 4,020,634 Class B common stock, non-voting, issued shares, 8,888,105 Capital surplus Retained earnings Less common treasury stock, at cost (Class A, 61,742 shares; Class B, 261,377 shares) Total stockholders' equity Total liabilities and stockholders' equity Source: 1978 Annual Report. 1977 1978 $ 9,354 36,171 40,446 148,794 1,380 236,145 6,494 74,229 38,384 35,845 4,716 $ 8,875 20,797 59,759 167,142 1,030 257,603 6,554 81,010 41,709 39,301 6,360 21,671 $304,871 18,787 $328,605 $ 5,000 32,213 6,659 2,759 46,631 $ 5,000 39,361 11,475 1,650 57,486 60,000 1,226 107,857 50,000 2,894 110,380 11,779 11,779 1,206 1,206 2,667 91,146 94,138 2,667 91,146 115,349 (3,922) (3,922) 197,014 $304,871 218,225 $328,605 -10Exhibit 4 BROWN-FORMAN DISTILLERS CORPORATION Product-Line Information Share of Market American Spirits (53% Brown Forman sales) 1977 Industry % Sales Growth 1977 NA 3% NA 7.2% Jack Daniel’s Tennessee Whiskey Old Forester Bottled in Bond Bourbon Whiskey Old Forester Kentucky Straight Bourbon Whiskey Early Times Kentucky Straight Bourbon Whiskey NA +4.4% NA 2.0% NA 2.9% 2.9% 2.9% +11.5% NA NA NA NA NA +3.1% +0.2% +0.2% NA NA NA +32.5% +77% NA NA NA NA 11% NA NA +37% +37% NA NA NA NA NA +15.2%1 +9.0% Sales Growth Imported Spirits (24% B-F sales) 10.5% NA NA NA NA NA Canadian Mist Canadian Whiskey Ambassador Scotch Whiskeys Usher’s Green Stripe Scotch Whiskey Pepe Lopez Tequila Old Bushmill’s Irish Whiskey Martell Cognacs Wines & Specialties (23% B-F sales) 4.6% 3.3% NA NA NA NA 3.2% 6.1% NA Bolla Italian Wines Cella Italian Wines Cruse French Wines Veuve Clicquot French Champagnes Noilly Prat Vermouths Anheuser German Wines Korbel California Champagnes Korbel California Brandy Bols Liqueurs and Brandies 1 5-year percentage increase, 1971–76. Sources: Company estimates and Liquor Handbook (New York: Gavin-Johnson Associates, 1982), 74. -11Exhibit 5 BROWN-FORMAN DISTILLERS CORPORATION Consumption Changes by Types of Distilled Spirits Case Shipments Product type 1966–71 % Change Total distilled spirits American whiskeys Blends Straights Bonds Other Scotch Canadian Gin Rum Brandy Cordials, liqueurs Vodka Prepared cocktails Other +22.2 −4.6 −7.3 + 0.9 −29.1 −26.2 +54.5 +70.6 +18.9 +77.1 +41.3 +44.1 +51.6 +30.3 +328.9 Source: Liquor Handbook, 44 and 74. 1971–76 % Change + 9.8 −21.9 −29.2 −14.7 −36.4 +106.7 + 8.2 +31.5 + 4.3 +43.2 +15.2 +45.5 +55.1 +116.5 +97.7 -12Exhibit 6 BROWN-FORMAN DISTILLERS CORPORATION Southern Comfort Corporation and Subsidiary Income Statement (for the years ended December 31) 1977 1976 Net sales $ 57,308,426 $ 64,183,392 40,909,265 45,814,353 16,399,161 18,369,039 9,446,120 10,193,517 6,953,041 8,175,522 329,804 (186,210) (141,457) (5,237) (3,100) 6,949,941 355,940 (62,283) 111,329 2,466 407,452 8,582,974 3,453,400 4,211,512 3,496,541 4,371,462 Cost of sales Gross profit Selling, administrative, and general expenses Income from operations Other income (expense): Royalties on Canadian sales Interest Rental property, net Other, net Income before income taxes Provision for income taxes Net income Earnings per common share Source: Annual reports. $ 59.67 $ 79.95 -13Exhibit 7 BROWN-FORMAN DISTILLERS CORPORATION Southern Comfort Corporation and Subsidiary Consolidated Balance Sheets, December 31 Assets Current Assets: Cash Accounts receivable Inventories Prepaid expenses Total current assets Property, at cost: Less: Accumulated depreciation Investment in rental property, less accumulated depreciation of $171,996 and $106,878 Total property, net Display Silver, at cost Liabilities and Stockholders' Equity Current Liabilities Notes payable to bank, unsecured Current portion of long-term notes payable Federal spirits and rectification taxes payable Accounts payable and accrued expenses Dividends payable Income taxes Total current liabilities Long-Term Notes Payable, less current portion Deferred Compensation Payable, less current portion Stockholders’ Equity: Preferred stock, no par redeemable at $10, $.50 cumulative outstanding 33,374 and 33,974 shares Common stock, $1 par, authorized 170,000 shares, issued 120,000 shares Retained earnings Less: treasury stock, at cost, 66,214 and 65,437 common shares Source: Annual reports. 1976 $ 750,108 12,305,064 6,554,342 59,218 19,668,732 1977 $ 1,341,190 12,118,758 7,365,841 35,952 20,861,741 4,933,708 2,105,195 2,828,513 5,556,624 2,439,268 3,117,356 1,673,585 4,502,098 152,297 $ 24,323,127 1,614,633 4,731,989 152,297 $ 25,746,027 $ 2,350,000 858,461 4,933,465 1,489,093 8,493 572,571 10,212,083 1,297,894 $ -62,067 7,096,549 1,076,973 8,343 738,279 8,982,211 35,827 51,200 -- 169,870 166,870 120,000 19,011,274 19,301,144 120,000 23,363,049 23,649,919 6,539,194 12,761,950 $ 24,323,127 6,921,930 16,727,989 $ 25,746,027 -14Exhibit 8 BROWN-FORMAN DISTILLERS CORPORATION Historical Data: Case Shipments of Southern Comfort Corporation Calendar Years 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 20-year compound growth 5-year compound growth U.S. Domestic Export 109,347 123,928 145,667 149,998 168,063 182,220 210,331 269,687 332,719 381,457 443,993 524,171 541,832 617,201 684,115 716,798 829,341 850,778 904,993 1,047,896 2,380 2,528 2,621 2,778 3,409 4,746 5,569 9,662 8,937 12,253 16,024 15,945 20,784 39,031 61,184 190,678 232,795 189,123 291,185 303,916 11.9% 8.8% 27.44% 37.8% Source: Southern Comfort Corporation records. Canada Total 5,635 117,362 6,000 132,456 6,707 154,995 7,166 159,942 7,505 178,977 8,225 195,191 9,600 225,500 12,540 291,889 15,518 357,174 18,408 412,118 19,484 479,501 23,334 563,450 26,923 589,539 36,129 692,361 48,478 793,777 61,828 969,304 70,407 1,132,543 85,141 1,125,042 95,070 1,291,248 111,566 1,463,378 16% 18.2% 13.45% 13% -15Exhibit 9 BROWN-FORMAN DISTILLERS CORPORATION Assumptions Used in Southern Comfort Cash-Flow Forecast (in dollars except for case volumes [in units] and expenses [in $000]) 1978 Profit per case U.S. domestic Revenue Cost of goods Advertising Selling Regular Transition Export Revenue Cost of goods Advertising Brokerage Selling exp. Canada Royalty Concentrate profit 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 $49.62 33.52 4.07 $50.62 34.10 4.01 $51.42 34.75 3.80 $52.42 35.41 3.68 $52.92 36.14 3.83 $53.92 36.93 3.89 $54.92 37.78 3.92 $55.92 38.70 3.97 $56.92 39.70 3.33 $57.92 40.77 3.18 $58.92 41.93 3.37 .55 .71 .58 .34 .59 .15 .60 .61 .62 .63 .63 .65 .67 .70 19.21 20.32 21.50 22.55 7.08 and increases at 8% annually thereafter. 1.44 1.38 1.37 1.37 2.75 2.76 2.75 2.85 .05 .05 .05 .06 23.21 23.80 25.16 26.15 27.15 28.15 29.15 1.37 2.72 .06 1.36 2.69 .06 1.37 2.68 .06 1.37 2.67 .06 1.37 2.67 .07 1.37 2.67 .07 1.37 2.67 .08 3.48 3.48 3.48 3.48 3.48 3.48 4.00 4.00 4.00 4.00 4.00 1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55 Case volumes (in thousands) U.S. Export Canada 1,140 325 115 1,225 350 125 1,315 380 138 1,410 405 150 1,510 425 160 1,615 445 170 1,725 463 180 1,835 480 190 1,923 490 200 1,984 500 210 2,015 500 220 Corporate level1 G&A Expense Transition Settlements Interest expense2 1,665 430 400 113 1,800 380 400 122 1,944 180 400 132 2,100 2,268 2,449 2645 2,857 3,086 3,332 3,599 400 142 154 166 179 194 209 226 244 1 For forecasting purposes, investment to maintain plant and equipment could be expected to be offset by depreciation expense, but there would be some additional investment in working capital as sales grew. 2 On seasonal borrowings for working-capital financing. Analysts at Brown-Forman viewed this item as virtually an operating expense and considered including it in their forecast of free cash flows. Source: Brown-Forman Distillers Corporation estimates. -16Exhibit 10 BROWN-FORMAN DISTILLERS CORPORATION Stock-Price Data Brown Forman Class A Class B S&P 500 Index 1/3/78 2/1/78 3/1/78 4/3/78 5/1/78 6/1/78 19.875 19.750 20.500 21.875 23.500 24.750 20.000 19.375 20.500 21.250 23.750 24.875 93.82 89.93 87.19 88.46 97.67 97.35 6/2/78 6/9/78 6/16/78 6/23/78 6/30/78 24.875 25.625 26.375 26.000 25.625 25.000 26.375 27.000 26.500 24.875 98.14 99.93 97.42 95.85 95.53 Source: ISL Daily Stock Price Record, Standard & Poor’s Corporation. Dr. FINApril 30, 2020 1. Assume the managers role a. Understand the environment in which the company operates: Worldwide socioeconomic and political environment The domestic environment The industry situation b. Know the companies history, current condition, and the future prospects Identify the problem Brown-Forman’s management had long-term financial goals regarding hurdle rates for investment, size of the capital budget through 1980, target capital structure, and dividend payout and the reason for all this was to be able to “increase the value of the stockholders; investment.” The dividend payout ratio was targeted at a range of 30 percent to 35 percent. Brown-Forman was the fifth-largest distiller in the United States. Its investment during 1978-1980 included $86 million for advertising and promotion, $39 million in barreled whiskey inventory, and $19 million in new plant and equipment. The ratio of total debt to total tangible capital was 26.6 percent at the end of 1977 and that was viewed as considerable flexibility in financing investment opportunities with either debt or equity. The 1977 Annual report stated that they wanted to increase their return on total capital. Management would only actively pursue investments in new capital projects that have at least an anticipated rate of 14 percent after taxes on the capital employed. If the returns of these operations don’t have a higher level, then management will consider channeling the capital supporting them into more-profitable projects, products, and acquisitions. In July 1978, Southern Comfort Co. approached Brown-Forman with an offer to sell for $94.6M. Define the Alternatives One alternative to this would be buying Southern Comfort Corporation. Brown-Forman is considering buying to be able to increase the value of shareholders’ investment and with the target return of 14%. It also has experience producing, marketing, and importing brand franchises. There are different approaches that can be used in valuing Southern Comfort Corporation, but these amounts would be only a rough idea from where negotiations would start. The actual final amount will be after negotiations are done and terms are agreed on. Gather information on the Alternative The first approach to value Southern Comfort could be the price per earning. The market value of the companies’ shares can be calculated by multiplying the earnings per share of the company by its P/E ratio. The P/E shows what the market is willing to pay today for its stock based on its past or future earnings. The average market value per share/Average Earnings per share shows how good the company is performing compared to its competitors. This approach to value a company wouldn’t be the best choice because it wouldn’t be as accurate as we would want it to be. The second approach that could be used is assets based which mainly captures the value of the business worth only its net assets. This method is used to see at least what the business is worth buying on its lowest terms. It would require the company to sell all its assets, settle all of the liabilities, and the leftover is what shareholders are expected to receive from the buyers. Southern Comfort Corporation has a high sales margin and the shareholders would demand a premium over their share price if to be sold. A third approach is the dividend valuation which tells us the value of the company should be obtained by calculating the present value of the dividends through the required return of equity holders with suggested growth in dividends if there are any. This approach has a weakness since it depends on past dividend growth rates and on Ke for its calculation but the calculation itself uses suggested assumptions of the risk-free rate of return, market-based rate of return, and equity beta. The most appropriate and precise valuating method would be the discounted free cash flow approach. This determines the present value of a company and if the DCF values are higher than the current cost of the investment, the investment is a good consideration. Southern Comfort has both high DCF and a positive NPV which makes it a profitable investment and a good opportunity. Now we can do a ratio comparison with Brown-Forman and Southern Comfort. Debt Management TIE Debt Ratio Brown-Forman 8.56 35% Southern Comfort 38.32 35% Current Quick Brown-Forman 5.06 1.28 Southern Comfort 2.32 1.50 Liquidity Asset Management DSO Fixed Asset Total Assets Turnover Turnover Brown-Forman 36.8 11.05 1.3 Southern Comfort 68.0 13.56 2.5 Profitability Brown-Forman Net Profit Margin ROA ROE 6.0% 7.8% 12.1% Southern Comfort 6.8% 17% 26.1% Analyze the risks and returns of the options Below is the Projected Cash flows for each year after the acquisition Make a decision and develop a plan of action Below is the analysis of the Projected cash flows which leads to a breakdown of the DCF, NPV, and Terminal Value Based upon the DCF valuation approach (present value) Brown Forman SHOULD purchase Southern Comfort for the asking price of $94.6 million since the NPV of this acquisition is positive. Therefore increasing shareholders wealth. First off, Southern Comfort is a small southern family whiskey brand that instills the image of a quality American company that is highly regarded in the world of whiskey. This pairs well with a company that holds its image at the forefront of its marketing strategies. Secondly, Southern Comfort itself will fit in well with the current product line of Brown Foreman. It is important to not have any internal competition between your brands, you do not want to take away from your own profits. Update on the companies 
Purchase answer to see full attachment