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Case 2 Coleco Industries, Inc.
INTRODUCTION
Fifth largest toy manufacturer in the United States.
Head quarter is located in West HartFord, Connecticut
production line includes
Cabb Ca bbag age e Patc Patch h Kids Kids
plus plush h Alf Alf dolls dolls an and d pupp puppet etss
Couc Couch h Pota Potato to Pals Pals
play sets
The Flintstones
Sesame Street
Sylvanian Families
INTRODUCTION
Fifth largest toy manufacturer in the United States.
Head quarter is located in West HartFord, Connecticut
production line includes
Cabb Ca bbag age e Patc Patch h Kids Kids
plus plush h Alf Alf dolls dolls an and d pupp puppet etss
Couc Couch h Pota Potato to Pals Pals
play sets
The Flintstones
Sesame Street
Sylvanian Families
INTRODUCTION (Contd.)
Annual sales were two third of what they had been only two years earlier
Its negative equity position of $84 million
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
INDUSTRY ANALYSIS (Contd.) 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
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
Kenner Parker
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 Colecos ability to recover for the third time. Coleco's
Coleco
sales growth
1983
1984
1985
1986
1987
16.87%
29.91%
0.14%
-35.48%
0.76%
COMPANY ANALYSIS (contd.) C o le c o 's S a le s G ro w th 4 0 .0 0 % 3 0 .0 0 % 2 0 .0 0 %
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.) Curr nt r ti 3 .0000 2 . 00 0 2 .0000 s e u
l
1 . 00 0
V
1 .0000 0 . 00 0 0 .0000 1981
1982
1983
1984
Y
1985
1986
1987
r
Although Colecos 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 1 .4000
1 .2000
1 .0000
s e u
0 .8000
l
a
V
0 .6000
0 .4000
0 .2000
0 .0000 1981
1982
1983
1984
1985
1986
1987
Yea r
The debt ratio shows a high degree of dependency of the company on borrowing.
On the firms capital, relative importance of longterm debt is increasing.
COMPANY ANALYSIS (contd.) Timein
er est ea rned r atio
12.0000 10.0000 8.0000 6.0000 s e u l a
4.0000
V
2.0000 0.0000 1981
1982
1983
1984
1985
1986
1987
(2.0000) (4.0000) Yea r
The time interest earned ratio is frustrating in the last years.
COMPANY ANALYSIS (contd.) Net
pr of it margin
0 .1500
0 .1000 0 .0500
0 .0000 s e u
l
a
1981 (0 .0500
1982
1983
1984
1985
1986
1987
V
(0 .1000
(0 .1500 (0 .2000
(0 .2500
Yea r
The ratio infers the companys overall net loss in last years.
COMPANY ANALYSIS (contd.) Return on
equity
3 .0000
2 .0000
1 .0000 s e u
l
a
0 .0000
V
1981 (1 .0000
(2 .0000
(3 .0000
1982
1983
1984
1985
¡
¡
¡
Yea r
ROE is decreasing except 1985.
1986
1987
COMPANY ANALYSIS (contd.) R eturn on
asset
0 .3000
0 .2000
0 .1000 s e u
l
a
0 .0000
V
1
(0 .1000
(0 .2000
(0 .3000
9
81
1
9
82
1
9
83
1
9
84
1
9
85
1
9
86
¢
¢
¢
Yea r
ROA is showing volatility over the years.
1
9
87
SWOT ANALYSIS
Strength (S):
1. Two notable success of recovery in the past.
2. Current ratio is satisfactory.
SWOT ANALYSIS (Contd.) 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. Colecos 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
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.
STATEMENTMENT OF THE PROBLEM
The problem is to determine whether the companys capital could be restructured in a way that would satisfy its creditors without diluting the stock any further than was necessary.
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 companys 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 companys sales became weak from 1986. Recovery is skeptical (no exciting new toy introduction) prospects for increasing the companys sales based on its current product line were limited.
Alternative 1: To go on with the business
(Contd.)
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 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 firms sales are not adequate to cover the relevant costs.
So no firm will be interested to acquire it.
Alternative 3: To issue more equity (Contd.)
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 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 revolvers credit agreement regarding maintenance net
worth and pre tax income,
ratio
of debt to net worth,
restrictions a
of working capital,
on unsecured indebtedness and
prohibition of payment of cash dividends.
Alternative 4: Renegotiation of debt
(Contd.)
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 5: To liquidate Coleco is now in both stoc k based and flow based insolvency. Flow based insolvency
Stock based Insolvency
$
A S
D
S
E T S
Cash flow shortfall
E B T
Contractual obligation
Negative Equity $84.3m
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 = 0.717X 1i + 0.847X 2i + 3.107X 3i + 0.420X 4i + 0.998X 5i Where X 1i = (Current assets Current liabilities) / Total assets X 2i = Retained earnings / Total assets X 3i = Earning before interest and taxes / Total assets X 4i = Book value of preferred and common equity / Boo k value of total liabilities X 5i = 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.
Since the Zi score is far below from 1.2, the firm can be considered as a prime candidate for ban kruptcy and it has a higher probability of being ban krupt.
