A Case Analysis on The T.Eaton Company Initial Public Offering

Formed in 1869, Eaton was one of the extremely respected and recognized trade names in the Canadian retailing sector. However, through the early 1990 ‘s, Eaton ‘s fiscal public presentation suffered due to internal and external factors. It incurred losingss ( 1996, $ 128 million & A ; 1995, $ 80 million ) and declined in grosss ( 1996, $ 1.7 billion, which is down $ 2.3 billion from 5 old ages ago ) . Given its leveraged place and cut downing runing net incomes, Eaton ‘s direction had filed for bankruptcy protection in early 1997 and proceeded for a restructuring program which was proposed subsequently in the twelvemonth. The new direction construction and board of managers comprised of persons from noteworthy retails organisations. After implementing a fully fledged restructuring program in November 1997, it covered up some of its losingss and posted a net income of $ 58 million. Since, its capital demands exceeded the operating line of recognition extended from its current loaner i.e. Bear Sterns & A ; Co, it decided to raise equity through IPO issue. It chose Scotia Capital Markets, the investing bank as a co-lead director for easing the IPO procedure. Now, the issue in forepart of the bank is to make up one’s mind the rightness of the timing of this IPO, value this IPO, and cipher the portion monetary value scope and no. of post-IPO portions outstanding.

Present State Analysis

Economic Environment: Economic conditions in North America were favourable for growing, even in the retail sector. Strong addition in retail disbursement and highest consumer assurance in North America, low involvement rates and high disposable incomes had been a characteristic of the market in this decennary. Companies in retail industries continuously rallied frontward on the stock exchange. However, factors such as 1997 economic crises in Southeast Asia and banking crisis in Japan, federal modesty ‘s disposition towards raising involvements to avoid inflationary tendencies which might be caused by low unemployment and nest eggs rates in US and Canada, had some perceivers concerned about the sustainability of North American equity markets at their current degrees.

Appropriateness of Eaton ‘s IPO: Buoyed by the fresh restructuring programs in direction and operations and the fact that the economic system was in a bullish-state, an IPO launch for Eaton seemed to be a favourable option. Besides, Eaton has a competitory advantage of over 100 old ages of good will and repute in Canadian retail sector which extended to providers and creditors which few rivals could tout of. Investors would purchase in portions of a 100 twelvemonth old Canadian retail icon which apparently is in a turnaround phase and holds promise of growing in a healthy economic system. Having said that, the investment bankers need to be highly careful, if equity markets fall shortly after the IPO ( given the sustainability concern with the North American bull-run ) , Eaton ‘s ability to raise equity in the hereafter might be adversely effected. Firms whose economic public presentation has been lacklustre but who expect betterments in the future net incomes, frequently prefer a comparatively little IPO followed by larger seasoned equity offerings when net incomes have improved and seems sustainable. However, urgency of capital demand to implement operational restructuring and capital investings is an inducement for Eaton ‘s direction to raise the full sum required at the IPO phase. The more professionally managed section shops are making better, nevertheless, as they move out of low-margin difficult goods and focal point on supplying soft-goods to the more flush client for whom better service and shopping atmosphere are of import.

Eaton ‘s, by shifting itself in the “ moderate-better ” market section, is aiming a portion of the more flush client section.

The increased competition and force per unit area on borders in the industry have meant that shops in underperforming locations can no longer be supported.

Retailers that are siting out the new competitory environment are those that have consolidated, shut down less profitable shops, and managed to cut down operating expenses.

IPO Valuation Methodology

A company ‘s equity at market value is measured by its chances to turn and ability to bring forth future net incomes. Assorted fiscal techniques can be utilized for Equity rating of a company. Choosing the most appropriate method depends upon the specific industry and province of the company being evaluated. In Eaton ‘s instance, following particulars need to be noted:

Eaton had merely emerged out of Bankruptcy Protection act, the CCAA

The organisation is re-structuring its direction and more significantly its operating schemes

Therefore, recent historic gross growing, gross revenues figures, net income borders or hard currency flow statements will non give an accurate image of future hard currency flows. The DCF theoretical account to value equity and therefore endeavor value is every bit accurate as the truth of the hereafter hard currency flow watercourse. DCF method works best for houses that are mature and stable but renders inaccurate consequences for houses late formed or emerging from insolvency. Therefore, for a turnaround company like Eaton ‘s, the DCF theoretical account is an inappropriate method to gauge the house value for an IPO. Then, there is the Asset-based pricing attack. This method is utile in neutralizing the house, but is non recommended when valuing a house based on future growing chances.

Another option to value houses is the comparable houses approach, i.e. by utilizing multiples of comparable houses, capitalising ( seting ) those multiples to Eaton ‘s scenario and gauging the house value for Eaton. The key in utilizing comparable house multiples is to choose the appropriate comparable houses and so choosing the appropriate multiples. Based on Eaton ‘s market place, hard currency flow features, hazards and growing, the comparable houses selected were: Hudson ‘s Bay Company, Sears Canada and Canadian Tire.

To find Eaton ‘s Equity value or Firm value through comparable house ‘s multiples attack, the options available are: P/E ratio, EV/EBITDA ratio, Market Value/EBIT ratio, Market Value/Sales ratio and Market Value/Book Value ratio.

The P/E ratio ( Price/EPS ) is the most widely used ratio, but it takes into history the capital construction the houses and is non accurate with companies where recent net incomes have been negative ( Exhibit 1 ) . Using ratios affecting Gross saless will stand for an accurate image of the house value, merely if the cost constructions for the comparable houses are similar ( Exhibit 2 & A ; 3 ) . On the other manus, EV includes the cost of paying off debt and EBITDA measures net incomes before involvement disbursal, unusual disbursals and D & A ; A. Therefore, to find the true value of the house, the EV/EBITDA ratio is selected as the most representative multiple.

Eaton ‘s Equity Valuation

Eaton ‘s pre-IPO Enterprise value scope utilizing the EV/EBITDA method is calculated as $ 530.4-634.4 Million ( Exhibit 4 ) . By April, 1998 entire debt outstanding was $ 274.4 million. Therefore, pre-IPO equity would lie in the $ 256- $ 360 million scope. Historically, IPOs are underpriced at around 15 % of their value, but due to Eaton ‘s state of affairs compared to its rivals, and to pull more investors Eaton ‘s portion would be underpriced at 30 % of its mathematical value. Since, Eaton is raising $ 175 million equity, post-IPO equity ranges between $ 354.2-427 million.

Share Price and No. of Shares to be issued at IPO Launch

Determining portion monetary value during IPO process is where the Investment Bankers genuinely add value. The procedure takes into history the equity value of the house, the market demand for its portions and investor assurance in the growing of the company. Here we have calculated the post-IPO portion monetary value scope, which is post-IPO value of equity divided by no. of portions outstanding pre-IPO. Harmonizing to our analysis, Mary Vitug must describe a monetary value scope of $ 15.4- $ 18.48 per portion to Sandra Schumacher. The statement for this would be that normally investing Bankss tend to under-price the stock to ask for as many investors as possible. The investors through competitory command procedure reveal batch of information and finally make to the true monetary value of portion. Investors are compensated for their dearly-won analysis due to underpriced stock. Assuming the higher terminal of this portion monetary value scope is the concluding offer monetary value i.e. $ 18.48, no. of portions issued would be 10,371,711. Normally investment bankers exercise “ Greenshoe ” option in which instance the entire figure of portions to be issued is 11,721,143. Since an optimum distribution ratio of 70:30 is chosen for institutional and retail investors, therefore no. of portions to be issued to institutional investors are 8,204,800 while portions issued to retail investors are 3,516,343.

Concluding Recommendations

Given the demand for capital to pay the operating line of recognition and to finance the restructuring procedure, Eaton ‘s direction determination to publish an IPO to raise equity via the market was appropriate. As investment bankers in the IPO procedure, Mary Vitug should follow a conservative attack in valuing a turnaround company like Eaton. Investors would non be incentivized to put in Eaton if the portion monetary value is non at a price reduction to comparable companies in the retail sector.

The recommendation is hence to establish an IPO with the undermentioned monetary value on securities:

Price/Share= $ 15.40 to $ 18.48 and No. of Shares Issued = 10,371,711 ( Greenshoe: 11,721,143 ) .


Exhibit 1: P/E Analysis

Exhibit 2: Market Value to Gross saless Ratio

Exhibit 3: Market Value to EBIT Analysis

Exhibit 4: EV/EBITDA Analysis