San Diego State University Mercury Athletic Footwear & AGI Case Study Single Spaced – 3 pages Write a summary and draw a timeline as well Is Mercury Athlet

San Diego State University Mercury Athletic Footwear & AGI Case Study Single Spaced – 3 pages Write a summary and draw a timeline as well Is Mercury Athletic an appropriate target for AGI? Why or why not?Review the projections formulated by Ledtke. Are they appropriate? How would you recommend modifying them?Estimate the value of Mercury using a DCF approach and Liedtke’s base case projections. Be prepared to defend additional assumptions you make.Do you consider the value you obtained as conservative or aggressive? Why?How would you analyze possible synergies or other sources of value not reflected in Ledtke’s base case assumptions?I included the case solution if it helps. Do not plagarize. For the exclusive use of S. Brikho, 2020.
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REV: JUNE 20, 2011
TIMOTHY A. LUEHRMAN
JOEL L. HEILPRIN
Mercury Athletic Footwear:
Valuing the Opportunity
In March 2007, John Liedtke, the head of business development for Active Gear, Inc., a privately
held footwear company, was contemplating an acquisition opportunity. West Coast Fashions, Inc.
(WCF), a large designer and marketer of men’s and women’s branded apparel had recently
announced plans for a strategic reorganization. The plan called for a divestiture of certain non-core
assets and a renewed focus on WCF’s higher-end business, business-casual, and formal-wear apparel
businesses. One of the divisions WCF intended to shed was Mercury Athletic, its footwear division.
Liedtke knew that acquiring Mercury would roughly double Active Gear’s revenue, increase its
leverage with contract manufacturers, and expand its presence with key retailers and distributors.
He also expected that Active Gear’s bankers would quickly approach the company about a possible
bid for Mercury; consequently, he wanted to complete his own rough evaluation of the opportunity
before hearing the bankers’ pitch.
Athletic and Casual Footwear Industry
Footwear was a mature, highly competitive industry marked by low growth, but fairly stable
profit margins. Despite the industry’s overall stability, the performance of individual firms could be
quite volatile as they vied with one another to anticipate and exploit fashion trends. The market for
athletic and casual shoes remained fragmented, despite the presence of a small number of global
footwear brands. In the casual segment, companies competed on the basis of style, price, and general
quality. In the athletic segment, competition revolved around brand image, specialized engineering
for performance, and price.
Within the fashion-sensitive part of the industry, product lifecycles tended to be short, sometimes
lasting only a season. Consequently, active management of inventory and production lead times
were critical success factors. Although a few firms sold their products in company-owned retail
stores, the large majority of athletic and casual footwear was sold through department stores,
independent specialty retailers, sporting goods stores, boutiques, and wholesalers. In 2007, many
________________________________________________________________________________________________________________
HBS Professor Timothy A. Luehrman and Illinois Institute of Technology Adjunct Finance Professor Joel L. Heilprin prepared this case
specifically for the Harvard Business School Brief Case Collection. Though inspired by real events, the case does not represent a specific
situation at an existing company, and any resemblance to actual persons or entities is unintended. Cases are developed solely as the basis for
class discussion and are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.
Copyright © 2009 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
This document is authorized for use only by Sandra Brikho in FIN 423 Spring 2020 taught by Yaoyi Xi, San Diego State University from Jan 2020 to May 2020.
For the exclusive use of S. Brikho, 2020.
4050 | Mercury Athletic Footwear: Valuing the Opportunity
companies were actively engaged in attempts to sell directly to customers via web-based e-commerce
platforms. So far, successes in this venue had been small in both size and number.
New footwear was produced on a cycle that required 8 to 10 months to complete a new design,
associated samples, and production specifications. Another 4 to 6 months were required for
manufacturing start-up before new orders could be filled. Despite significant import taxes and tariffs
in the United States and European Union, the great majority of North American and European
footwear companies used independent contract manufacturers to produce their shoes. Most of these
independent manufacturers were located in China.1
Active Gear, Inc.
Active Gear (AGI) was founded in 1965 to produce and market high-quality specialty shoes for
golf and tennis players. The company’s products were among the first to incorporate sculpted
cushioned insoles and a selection of high-performance tread patterns designed for specific surfaces
and/or playing conditions. AGI began selling its shoes primarily in golf and tennis pro shops and a
few specialty sporting goods stores. As its products became more established, AGI moved into larger
department and retail stores. The company also exported its shoes to Europe and, to a lesser extent,
Japan. Sales outside the United States were made through a network of wholesalers, which the
company still employed in 2007.
Beginning in the 1970s, Active Gear moved into casual and recreational footwear aimed at what
had become its core customer demographic: affluent urban and suburban family members aged 25 to
45. AGI was among the first companies to offer fashionable walking, hiking, and boating footwear.
By the early 1980s, the Active Gear brand and logo were associated with a lifestyle that was
prosperous, active, and fashion-conscious.
After years of steady if unspectacular growth, AGI’s 2006 revenue and operating income were
$470.3 million and $60.4 million, respectively, with 42% of revenue from athletic shoes and the
balance from casual footwear. [Historical income statements and balance sheets for AGI are
presented in Exhibits 1 and 2.] The firm’s athletic shoes had evolved from high-performance
footwear to athletic fashion wear with a classic image. The company’s traditional casual shoes also
offered classic styling, but were aimed at a broader, more mainstream market.
AGI’s casual footwear was sold by more than 5,700 North American department, specialty, and
general retail stores via a network of wholesalers and independent distributors. Sales of athletic
footwear were made through independent sales representatives to a limited number of sporting
goods stores, pro shops, and specialty athletic footwear retailers. A small percentage of both casual
and athletic shoes were sold through Active Gear’s website.
By focusing on a smaller portfolio of classic products with longer lifecycles, Active Gear was able
to maintain relatively simple production and supply chains. This in turn allowed the firm to avoid
the worst of the industry’s cycles of inventory write-downs and missed profit opportunities. AGI’s
simplified approach to brand and inventory management also contributed to its strong operating
margins. Table 1 shows AGI’s Days Sales in Inventory compared to Mercury and other selected
footwear producers.
1 U.S. import taxes ranged from 8.5% to 10.0% for leather footwear, and 6.0% to 20.0% for synthetic footwear. Duties in the EU
averaged 7.0% to 8.0% for leather and 16.5% for synthetic footwear.
2
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Mercury Athletic Footwear: Valuing the Opportunity | 4050
Table 1
Casual & Athletic Shoe Companies
Days Sales
in Inventory
D&B Shoe Company
Marina Wilderness
General Shoe Corp.
Kinsley Coulter Products
Victory Athletic
Surfside Footwear
Alpine Company
Heartland Outdoor Footwear
Templeton Athletic
Average
61.3
39.5
73.2
31.1
50.0
60.0
42.9
58.1
42.5
50.9
Active Gear
Mercury Athletic
42.5
61.1
Like most footwear makers, AGI outsourced production to a network of contract manufacturers
located in China. To ensure quality and on-time delivery, AGI conducted a rigorous screening and
certification program for all of its manufacturers. The company also maintained a staff of 85 full-time
professionals who monitored contract manufacturing on-site from the initial sourcing of materials all
the way through final inspection.
Financial Policy & Performance
Active Gear was among the most profitable firms in the footwear industry (Exhibit 3 presents
recent data for selected publicly traded footwear producers). However, the company was much
smaller than many competitors, and AGI’s executives felt its small size was becoming a competitive
disadvantage. A recent wave of consolidation among Chinese contract manufacturers created
pressure to boost capacity utilization; this was expected to favor larger firms who could offer the
manufacturers longer production runs.
Active Gear had recently increased its supplier
concentration—reducing the number of its contract manufacturers—in an effort to improve its
negotiating position. Until recently, AGI’s largest supplier accounted for no more than 12% of its
volume; by 2006 this figure was approximately 20%, and the two next-largest firms together
accounted for 22%.
On the customer side, the rise of “big box” retailers threatened AGI’s growth. To protect the
company’s brand image, Active Gear did not sell through discount retailers. While this policy helped
preserve operating margins, it was believed to have hurt sales growth. During 2000–2006 AGI grew
its revenue at a compound average rate of only 6% per year compared with nearly 10% for the group
shown in Exhibit 3. During the past three years AGI grew even more slowly—at an average annual
rate of only 2.2%. Continuing pressure from suppliers and competitors caused some deterioration of
basic performance metrics, such as return on net operating assets, return on equity, and asset
turnover, during 2004–2006 (see Exhibit 1).
Mercury Athletic Footwear
Mercury Athletic Footwear designed and distributed branded athletic and casual footwear,
principally to the youth market. Its 2006 revenue and EBITDA were $431.1 million and $51.8 million,
respectively. Exhibit 4 presents recent income statements and balance sheets for Mercury.
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4050 | Mercury Athletic Footwear: Valuing the Opportunity
West Coast Fashions had purchased Mercury from its founder, Daniel Fiore, in late 2003. Fiore
had started Mercury 35 years earlier, but developed health problems that forced him to sell the
business. At the time of the transaction, WCF was in a period of rapid expansion, driven by an
aggressive acquisition strategy; it planned to extend the Mercury brand by creating a complementary
line of apparel. WCF executives also believed that its larger, more established network of distributors
would substantially widen Mercury’s distribution with department stores and large discount retailers
and boost sales for both shoes and apparel.
Mercury’s performance since the acquisition was mixed, but disappointing on the whole. WCF
did exploit its own distribution network to expand Mercury’s sales. However, the new Mercury
Athletic line of branded apparel never gained much traction with consumers. The most loyal
purchasers of Mercury’s footwear were 15 to 25 years old, with an active interest in extreme sports.
These customers were either uninterested in branded apparel, or the specific apparel offered by
Mercury simply did not appeal to their tastes. Further, WCF’s efforts to establish the apparel line
included price cuts and promotions that hurt operating margins. In late 2006, WCF’s board
concluded that Mercury’s size, customers, and brand image did not fit with WCF’s and had
determined to sell the business in the context of a broader reorganization. Mercury’s managers were
eager to abandon the apparel line and return to an exclusive focus on footwear.
Mercury Products
Mercury competed in four main segments: men’s and women’s athletic and casual footwear.
During the 1990s, Mercury’s athletic shoes became popular among extreme sports enthusiasts and
within the associated X-Games subculture. As a result, the company’s brand acquired an iconoclastic
nonconformist image that the company tried to exploit by adding a line of active casual footwear
targeted at the same demographic.
Traditionally the company had promoted the Mercury brand without emphasizing individual
products. In support of this strategy, Mercury closely monitored styles and images that evolved from
a global youth culture that included alternative music, television, film, and clothing. The company
also sponsored, or co-sponsored, certain athletic and cultural events with demonstrated appeal to its
target demographic. Such events included skateboarding, snowboarding, and BMX competitions, as
well as alternative music festivals and concerts.
Mercury’s price points were predominantly mid-range, but the company also had a few brands in
higher and lower price ranges. Mercury’s shoes were sold throughout North America in a wide
range of retail, athletic, department, and specialty stores, and via catalogs and the Internet. No single
geographic region accounted for more than 10% of sales.
Production & Operations
Mercury sourced substantially all of its production from independent contractors in Asia. The
company had developed an operational infrastructure intended to help it adapt quickly to changes in
customer tastes and corresponding product specifications. The company had relatively little capital
spending and focused its resources instead on market research and product design. It sourced the
majority of its raw materials from foreign suppliers, and had 73 professional and technical personnel
in China alone to oversee the quality, production, packaging, and shipping of all its footwear.
Although Mercury was a wholly owned subsidiary of WCF, it operated with considerable
autonomy. It maintained its own financial statements, databases, resource management systems, and
distribution facilities. As of December 31, 2006, the company had 1,123 full- and part-time
employees.
4
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Mercury Athletic Footwear: Valuing the Opportunity | 4050
Financial Performance
Following the acquisition by WCF, Mercury’s financial performance had been disappointing. The
growing popularity of extreme sports, along with WCF’s large distribution network, supported top
line growth of 20% during 2006 and at a compounded annual rate of 10.5% from the date of the
acquisition. However, when Fiore sold the company to WCF, Mercury’s EBITDA margin had been
steady for years between 14.0–14.5%. In contrast, during 2004–2006 Mercury’s EBITDA margin
averaged 11.6%.
Several factors contributed to the diminished profitability. First, some of Mercury’s sales growth
resulted from lower prices. In particular, Mercury had discounted part of its line to get product on
the shelves of large discount retailers. These pricing concessions explained part of the financial
performance displayed in Table 2. However, a related problem, discussed further below, was
Mercury’s unsuccessful entry into women’s casual footwear. Finally, the firm’s rapid sales increase,
proliferation of brands, and underperforming women’s lines strained its infrastructure and eroded
operating efficiency. In 2006 Mercury’s DSI2 was more than 10 days longer than the industry
average, and the company’s return on net operating assets was only 12.9%, compared with an
industry average of approximately 20%.3
Table 2
Mercury Operating Metrics
Return on net assets
Return on equity
Asset turnover
2004
17.0%
18.5%
2.4x
2005
8.6%
9.6%
1.4x
2006
11.1%
12.1%
1.6x
Performance data for each of Mercury’s product segments are presented in Exhibit 5.
Men’s Athletic Footwear
Men’s athletic footwear was by far the company’s largest segment and constituted its core
business. Revenue for this segment grew more than 40% over the prior year, and at an average
compounded rate of 29% between 2004 and 2006. Mercury’s managers attributed the growth
primarily to increased sales through large discount retailers, which began handling Mercury’s
products nationwide in the second quarter of 2005.
In addition to robust sales growth, men’s athletic footwear enjoyed operating margins that were
consistently higher than rival firms’. On the one hand, loyal customers associated with extreme
sports paid medium to high prices for Mercury footwear. On the other, Mercury’s shoes were
relatively inexpensive to produce: simple designs in combination with basic materials reduced
complexity and cost in manufacturing. Operating margins for men’s athletic footwear had been
approximately 14% historically. A slight decline in 2005 was due to roll-out costs associated with
introducing the line to discount retailers.
Men’s Casual Footwear
Sales of men’s casual footwear peaked in 2004, and had declined since then at an average rate of
6.25% per year. Mercury attributed much of the decline to a combination of cannibalization and
2 DSI or days sales inventory is computed here as end-of-year inventory / (revenue /360).
3 Return on net operating assets equals net operating profit after tax / end-of-period net operating assets. Asset turnover is
computed as revenue divided by end-of-period net operating assets.
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4050 | Mercury Athletic Footwear: Valuing the Opportunity
unfortunate shipping problems. The firm introduced a new fashion line for the 2005 holiday season
that was received enthusiastically by retailers, who placed strong orders. When bad weather and
strikes by dockworkers delayed deliveries, Mercury’s holiday sales were disappointing: stores had
trimmed their orders for Mercury’s existing men’s casual products to make room for the new line,
which showed up late. When sales failed to recover satisfactorily in 2006, Mercury took steps to
upgrade parts of the line and boost support of the casual segment generally. As a result, Mercury
expected 2007 and following years to show steady improvement.
Despite its small size and recent sales declines, the men’s casual segment consistently posted
Mercury’s highest profit margins. High profitability was attributed to a marketing and distribution
strategy in which casual products were sold exclusively through specialty shops with proven ability
to reach the youth demographic. In addition to supporting prices, the exclusivity reinforced the
brand’s image. Finally, this set of retailers tended to be quite fragmented, and most lacked a national
footprint, which allowed Mercury to obtain very favorable terms.
Women’s Athletic Footwear
In contrast to the relative strength of the men’s lines, Mercury’s lines for women had subpar
performance. Women’s athletic footwear turned in solid sales growth, averaging 13.5% per year
during 2004–2006. However, as with the men’s line, much of this growth was due to the recent
introduction of Mercury’s shoes to large discount retailers. An equally important driver was the
growing participation of women in extreme sports.
Operating margins for women’s athletic footwear averaged just over 10%, which was below the
industry mean of 11.9%. Mercury’s managers felt the primary reason for lower margins was the high
cost of building brand image a…
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