coleco industries, inc
TRANSCRIPT
Case 2
Coleco Industries, Inc.
Fifth largest toy manufacturer in the United States.
Head quarter is located in West HartFord, Connecticut
production line includes
• Cabbage Patch Kids
• plush Alf dolls and puppets
• Couch Potato Pals
• play sets
The Flintstones
Sesame Street
Sylvanian Families
INTRODUCTION
Annual sales were two third of what they had been only two years earlier
Its negative equity position of $84 million
INTRODUCTION (Contd.)
ECONOMY ANALYSIS
In the mid 1980s the economy tended to favor toy industry. In 1988, the economy was entering its sixth year of overall strength, and unemployment and interest rates at their lowest in years. As interest rate is decreasing, debt is becoming cheaper.
INDUSTRY ANALYSIS
Toy companies depended on several factors for success:
• The economy
• Demographic factors
• Seasonality
• Successful product introduction on a
regular basis
• In 1988, the economy was entering its sixth year of overall
strength
• Unemployment and interest rates at their lowest in years.
• Demographic factors also were favorable
• Attempt To reduce seasonality
• Importance successful product introductions
• Approximately 800 toy companies in the United States
• Only the largest were able to minimize sales and profit
volatility through diversification
• Attempt to reduce volatility through diversification
INDUSTRY ANALYSIS (Contd.)
Sales growth of selected toy companies
1983 1984 1985 1986 1987
Coleco 16.87 % 29.91 % 0.14 % (35.48 %) 0.76 %
Hasbro 63.45 218.99 71.54 9.02 0.03
Kenner Parker NA 20.17 (1.51) (21.23) NA
Mattel (52.80) 39.07 19.30 0.74 (3.65)
Tonka 8.26 58.31 75.83 20.05 30.40
INDUSTRY ANALYSIS (Contd.)
COMPANY ANALYSIS
known as the “high-wire act of the toy industry”
It had two notable success of recovery in the past.
the situation was skeptical of Coleco’s ability to recover for the third time.
Coleco's sales growth
1983 1984 1985 1986 1987
Coleco 16.87% 29.91% 0.14% -35.48% 0.76%
Coleco's Sales Growth
-40.00%
-30.00%
-20.00%
-10.00%
0.00%
10.00%
20.00%
30.00%
40.00%
1983 1984 1985 1986 1987
Year
Gro
wth
(%
)
sales has been decreasing since 1984. Although the sales began to rise after 1986, it is not a fascinating sign for the company because they could not realize profit out of that increased sales.
COMPANY ANALYSIS (contd.)
1981 1982 1983 1984 1985 1986 1987
Current ratio 2.2124 2.0684 1.3601 1.3331 2.5835 1.3676 1.0752
Debt ratio 0.5224 0.6759 0.8127 0.9730 0.7425 1.0130 1.1574
Long term debt to totalCapitalization 0.7049 0.8256 0.8373 0.8933 0.9007 0.9489 0.9464
Time interest earned ratio 4.0121 9.8026 (0.2681) (1.2756) 4.5110 (1.7516) (0.7689)
Net profit margin 0.0433 0.0880 (0.0125) (0.1030) 0.1068 (0.2222) (0.2088)
Return on equity 0.1780 0.6408 (0.0816) (1.5976) 1.4694 (2.3498) 2.2919
Return on asset 0.0863 0.2331 (0.0195) (0.1842) 0.2108 (0.2250) (0.1870)
COMPANY ANALYSIS (contd.)
Current ratio
0.0000
0.5000
1.0000
1.5000
2.0000
2.5000
3.0000
1981 1982 1983 1984 1985 1986 1987
Year
Va
lue
s
Although Coleco’s current ratio is satisfactory it is fluctuating and another important observation is that the major portion of current asset is accounts receivable.
COMPANY ANALYSIS (contd.)
Debt ratio
0.0000
0.2000
0.4000
0.6000
0.8000
1.0000
1.2000
1.4000
1981 1982 1983 1984 1985 1986 1987
Year
Val
ues
The debt ratio shows a high degree of dependency of the company on borrowing.
COMPANY ANALYSIS (contd.)
Longterm debt to total capitalization
0.0000
0.1000
0.2000
0.3000
0.4000
0.5000
0.6000
0.7000
0.8000
0.9000
1.0000
1981 1982 1983 1984 1985 1986 1987
Year
Val
ues
On the firm’s capital, relative importance of long-term debt is increasing.
COMPANY ANALYSIS (contd.)
Timeinterest earned ratio
(4.0000)
(2.0000)
0.0000
2.0000
4.0000
6.0000
8.0000
10.0000
12.0000
1981 1982 1983 1984 1985 1986 1987
Year
Val
ue
s
The time interest earned ratio is frustrating in the last years.
COMPANY ANALYSIS (contd.)
Net profit margin
(0.2500)
(0.2000)
(0.1500)
(0.1000)
(0.0500)
0.0000
0.0500
0.1000
0.1500
1981 1982 1983 1984 1985 1986 1987
Year
Val
ues
The ratio infers the company’s overall net loss in last years.
COMPANY ANALYSIS (contd.)
Return on equity
(3.0000)
(2.0000)
(1.0000)
0.0000
1.0000
2.0000
3.0000
1981 1982 1983 1984 1985 1986 1987
Year
Val
ues
ROE is decreasing except 1985.
COMPANY ANALYSIS (contd.)
Return on asset
(0.3000)
(0.2000)
(0.1000)
0.0000
0.1000
0.2000
0.3000
1981
1982
1983
1984
1985
1986
1987
Year
Val
ues
ROA is showing volatility over the years.
COMPANY ANALYSIS (contd.)
SWOT ANALYSIS
Strength (S):
1. Two notable success of recovery in the past.
2. Current ratio is satisfactory.
Weakness (W):
1. Sales reduction has resulted in losses that contributed to its negative equity position.
2. Negative or near zero sales growth in recent years.
3. Escalating dependency on debt.
4. Coleco’s capital position was precarious.
5. Huge reduction in stock price.
SWOT ANALYSIS (Contd.)
Opportunities (O):
1. The economy was entering its sixth year of overall strength.
2. Unemployment and interest rates at their lowest in years.
3. Demographic factors also were favorable; birth rates were increasing.
4. The toy industry had begun to consolidate.
5. Basic and technology-enhanced toys did well.
SWOT ANALYSIS (Contd.)
Threats (T):
1. Of the approximately 800 toy companies in the United States, only the largest were able to minimize sales and profit volatility through diversification.
2. Each companies fortune rose and fell with the strength of its new products
3. Lack of exciting new toy introductions
SWOT ANALYSIS (Contd.)
STATEMENTMENT OF THE PROBLEM
Capital position was precarious,
Creditors were wary of lending any more to
the firm and
New equity from outsiders was virtually out of
the question.
The problem is to determine whether the company’s capital could be restructured in a way that would satisfy its creditors without diluting the stock any further than was necessary.
STATEMENTMENT OF THE PROBLEM
ALTERNATIVE COURSES OF ACTION
1. To go on with the business in the hope that one or more of its product would do well.
2. To merge with another firm with the hope that there might be some latent value in the company’s assets
3. To issue more equity at right market price.
4. To restructure or renegotiate debts, either through a debt/equity swap or the issuance of common stock or warrants.
5. To go for liquidation.
Analysis of the Alternatives
Alternative 1: To go on with the business
• The company’s sales became weak from 1986.
• Recovery is skeptical (no exciting new toy
introduction)
• prospects for increasing the company’s sales
based on its current product line were limited.
• Net income for Coleco is negative ($105.4m in
1987)
• Net worth is also negative.
• Creditors became impatient and were wary of
ending any more to the firm.
• The company was going into default on its loans.
• New equity from outsiders was virtually out of
question.
Alternative 1: To go on with the business (Contd.)
But to achieve the expected sales the firm needs additional fund of $205.15 million (Appendix 9):
AFN = (A / S) S – (L / S) S – MS1 (1 – d)
Here,
A / S = 475180000 / 504483000 = 0.942
S1 = 625m
S = 625m – 504.5m = 120.5m
(L / S) = 162798000 / 504483000 = 0.3227
M = (105351000) / 504483000 = (0.2088)
d = 0
Hence, AFN = 205.15 million
Alternative 1: To go on with the business (Contd.)
So we can conclude that going on with the business will be an inappropriate decision for Coleco.
Alternative 1: To go on with the business (Contd.)
Alternative 2: To merge with another firm
Merger is beneficial only when a synergy will take place.
But the value of total assets is less than the total value of liabilities. Moreover the firm’s sales are not adequate to cover the relevant costs.
So no firm will be interested to acquire it.
Alternative 3: To issue more equity
Appendix-1: Stock and bond price data
Stock price
S&P 500
Closing Bond PricesS&P Long-Term Govt. Bond Index High Low Close 11.13% 14.38%
1984 $22.250 $9. 625 12.125 167.24 - $90.125 40.29
1985 21.500 10.125 16.000 211.28 - 101.875 48.93
1986 20.500 8.125 8.375 242.17 $81.875 100.875 58.04
1987 Apr 11.625 10.000 10.375 288.36 82.000 99.500 60.69
May 10.750 9.875 10.500 290.10 77.750 96.500 51.55
June 11.625 10.250 10.625 304.00 76.000 95.000 52.42
July 11.000 9.750 9.750 318.66 94.000 95.000 51.89
Aug 10.375 9.125 9.375 329.80 75.625 98.625 50.40
Sept 10.250 8.500 9.125 321.83 76.125 96.000 47.39
Oct 9.125 4.250 5.500 251.79 72.000 94.375 47.17
Nov 6.000 4.375 4.625 230.3 55.250 68.875 50.31
Dec 4.625 3.625 3.875 247.08 50.000 63.500 49.89
1988 Jan 4.250 3.125 3.500 257.07 41.500 50.000 51.28
Feb 3.500 2.625 3.000 267.82 41.750 54.125 53.67
14-Mar 2.500 266.37 27.000 34.250 52.50
• The company is facing loss in the last years
• The value of equity is ($84) million. In this
situation
New equity from outsiders was virtually out of question.
Alternative 3: To issue more equity (Contd.)
Alternative 4: Renegotiation of debt
• It has announced that it might miss interest payments of $10
million due on debentures on April1, 1987 and another $4
million due on May 1 1987.
• At the same time the company has failed to comply with
most of the covenants of revolver’s credit agreement
regarding
maintenance of working capital,
net worth and pre tax income,
ratio of debt to net worth,
restrictions on unsecured indebtedness and
a prohibition of payment of cash dividends.
• The creditor banks had amended the
agreement to eliminate the violations at that
date and to take into consideration the
projected financial condition of the company.
• The annual volatility of the 11.25% debenture was 41.1%
the annual volatility of the 14.375% was 43.1%.
So under this situation, renegotiation of debt will not be possible to Coleco.
Alternative 4: Renegotiation of debt (Contd.)
Alternative 5: To liquidate
Coleco is now in both stock based and flow based insolvency.
D
E
B
T
ASSETS
Negative Equity $84.3m
Stock based Insolvency
Contractual obligation
$
Flow based insolvency
Cash flow shortfall
Insolvency
Alternative 5: To liquidate (Contd.)
To justify whether the company should be liquidated or not we took the help of distress analysis. We have calculate the Zi scores of the company using the following revised multivariate model of Altman.Zi = 0.717X1i + 0.847X2i + 3.107X3i + 0.420X4i + 0.998X5i
Where
X1i = (Current assets – Current liabilities) / Total assets
X2i = Retained earnings / Total assets
X3i = Earning before interest and taxes / Total assets
X4i = Book value of preferred and common equity / Book value
of total liabilities
X5i = Sales / Total assets
Zi = Index of bankruptcy
Alternative 5: To liquidate (Contd.)
The cutoff points Altman reported were
Assign to nonbankrupt group if Z > 2.90
Assign to bankrupt group if Z < 1.20
Gray area if 1.20 ≤ Z ≤ 2.90
According to this formula any firm with a Z-score below 1.20 is considered to be a prime candidate for bankruptcy, and the lower the score, the higher the failure probability.
Alternative 5: To liquidate (Contd.)
Year 1980 1981 1982 1983 1984 1985 1986 1987
Zi score 4.04781862 3.25805175 3.5526636 1.58343312 1.7081271 3.497728 0.50546 0.410293
Zi = 0.717X1i + 0.847X2i + 3.107X3i + 0.420X4i + 0.998X5i
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
1980 1981 1982 1983 1984 1985 1986 1987
Year
Val
ue
s
Nonbankrupt
Gray area
Bankrupt
Alternative 5: To liquidate (Contd.)
Since the Zi score is far below from 1.2, the firm can be considered as a prime candidate for bankruptcy and it has a higher probability of being bankrupt.
Recommendation
The firm should be liquidated.
Ways of Liquidation:
1. Informal liquidation.
• Reorganization.
• Assignment.
2. Formal liquidation.
So Coleco should go for formal liquidation.
Question answer session.