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The Valuation and Financing of Lady M Confections
A：Questions/Considerations for Lady M Confections:
1. What is important to succeed in the foodservice industry?
2. How unique is their model? Could it be replicated?
3. What are the barriers to entry? What is the limit on growth?
4. How many cakes would Lady M need to sell in a year in order to break even?
5. Assuming sales in year-one are break-even, how quickly would sales need to grow after the first year to pay for the start-up costs within five years? Is this growth rate feasible?
6. What is your recommendation? Should Romaniszyn open the new location in the World Trade Center?
7. What is Lady M’s enterprise value? Does it matter if one uses an EBITDA multiple or a perpetuity growth formula for a terminal value? How much of an equity stake should they be giving up to the Chinese investors?
8. What do you think of Romaniszyn’s and Tom’s baseline assumptions? Are they realistic?
9. Do you think they should take the Chinese investor’s offer? Why or why not?
B: Provide a bibliography and reference all facts/quotes
ANSWER PREVIEW FOR The Valuation and Financing of Lady M Confections Case Study
The valuation and Financing of Lady M Confections
Lady M Confections is a leading wholesale business started in 2001. The company deals with the sale of cakes in restaurants and luxuries hotels. Over a decade the company has grown to one of the best in the industry attracting the attention of the investors all over the world. Some reasons have facilitated the success of the Lady M confections in the food industry. The products of lady M cakes are different from those of other companies who are main competitors. Instead, of serving the sugar-laden cakes that most of the American are used to lady M confections tend to copy Japan bakeries making its products unique. Therefore, the lady M bakery positioning is vital to its success. Another thing which has enabled the company to succeed is the designing of the cakes. Individuals could not resist the temptation of talking about lady M shop also referred to as cake ‘boutique’ due to its sensitive, tastefully satisfying product that is smooth and has a stylistic layout (Desai & Elizabeth, n.p).
The study of the case has taught me a lot of lessons. One of the things I have learnt is the appropriate way of handling a case. Like in the above case Lady M is on the verge of taking the shortcut to achieve success. The Chinese offer seems so lucrative since it is going to enable rapid growth of the company and open new branches. Another thing is being open minded on how to enable the growth, and increase the sales of a firm. I feel that the EBITDA method should be used to calculate the enterprise value of the firm. The formula is not complex and easy to compute. Also, I feel that investors are driven by own ambitions so as to achieve what they desire. In the above case, the Chinese investor wants to change the company culture to fit one of his own liking.
The unique model that lady M confections use is differentiating its products to those other bakeries in the religion. Instead of serving sugar-laden cakes the company has emulated Japan and France. Japanese and French bakeries produce products that have less sugar, delicate and gives attention to aesthetics. Dessert served at lady M confections is called ‘Mille Crepe,’ and it consists not less than 20 layers of the French crepes which are layered using pastry cream. The sales of the Mille-crepe increases each year and other bakeries have attempted to copy bearing no fruits. The Mille-crepe made uniquely, and that makes the brand special. Romaniszyn once said no one will ever be able to replicate their scale or produce their quality because Crepe is formed uniquely. Hence, Lady M Confections uses a particular model of manufacturing products are unique to the consumers. Also, it cannot be replicated by any other bakery.
Using porter five force the following the barrier to the entry facing Lady M confection. One of the barriers is the capital to develop investment and increase the stock to be as competitive as another firm (Porter, 25). Competitive rivalry from other firms in the market who are established. Another is legal barriers from the state where an enterprise is supposed to give a specific amount before venturing into the market. High level of customer loyalty is making it difficult for the new entrant to become established and build a customer base. Also, it is limiting the growth of the firm.
Lady M was not making sales as expected in Bryant Park and wanted to improve. The sales pattern was not as expected and the company decided to move to world trade center. Bryant park location made a total transaction of $1,152,001 in 2013 and had an average price of $80 per piece. In total, the number of cakes that were sold in the financial year was a total of 14,400 pieces which gives 40 cakes each day. The figure is the lower total number of the cakes that can be sold in the world trade center that is in New York. The value makes the company have an even number that can be generated from the sales. From, calculation the number of cakes that are supposed to be sold in world trade center is 23600. The figure will be likely because of the environment that is surrounding world trade center and continuous building as it will become the focal point of the business people who are outside to expand their enterprise. Also, the world trade center hosts the New York newest neighborhood. In the regions, there is world class dining, shops, recreational options, hotels, and other attractions. Hence, the environment can attract elite people to live in the area which will indirectly increase the number of customers who can purchase a cake at the Lady M. Hence, Lady M will increase the total number of cakes sold each day due to the neighborhood.
Total sales targeted at world trade center is $1,887,988. The cost of one cake is $80 so, to achieve such value targeted for break-even sales the total number of cakes than needs to be sold that year is 23600 pieces.
The first year is a break-even and lady M generate a gross sale of $1,887,988 by the margin of the sales to that of the cost is zero. From the figure above growth rate of the company needs to be maintained to be in a position to pay the starting capital after the period of five years. Referring to the figure above one can see that after five years the starting cost had turned on the left side and the value is $-1,112.95 which means the company has completed paying the starting cost. Hence, the company needs to maintain the growth rate to achieve paying starting cost after five years. Yes, the growth rate is feasible because of several factors. One is the excellent name Lady M has established in the market due to their famous Mille-crepe which is unique. Another is only some initiative is going to be used to boost the number of customers which will directly improve sales. Another is the space in the food hall which is 560 sq. ft. and can take up to 1000 customers. Hence, the store has a vast space which can hold a lot of customers. Another is the location of the WTC which is set in an elite area and suitable for business. Also, from 2010, Lady M has experienced growth which has prompted to increase the sales in 2013 by 81% percent.
The only recommendation that I would give to Lady M is on the market strategy where they need to do the following;
1. Offering the client coupons or rewards as a show of gratitude after purchasing in lady m.
2. Publicize of the products using different media and platform to create awareness.
3. Designing an app where consumers can place an order instead of forming a line.
4. Making the consumers be able to order their favorite cake anytime they want.
Romaniszyn should open a new location at the WTC. One of the reason is the strategic position of the site. New York is one of the biggest city in the United States and has a lot of people making it an excellent place to open a business. Another is that it would attract more people to come and thus increase sales. Also, the market would become bigger giving the company the likely hood of achieving its target.
The enterprise value of Lady M Company differs depending on the formula used to calculate. The values are $56, 100, 701.46 or $73, 925, 393.19. There is a difference if one uses EBITDA multiple or the perpetuity growth formula to calculate the terminal value. The enterprise value (EV) is equal to NPV + PV of TV (Ohlson & Zhan 5). Using perpetuity growth formula (PM) = (1+ Terminal growth rate / (WACC –terminal growth rate). The terminal value is calculated as cash flow of 2019 x PM. The terminal value is $77, 705,329.65.
EBITDA gives a different value than of the PM. Terminal value is calculated using EBITDA as follows; terminal value= EBITDA of 2019 x 12. The terminal value is equal to $109, 118, and 352.82. The following values are the one that are going to be given to the investor depending in the method used 17.9% or 13.5 % percent of the stake is given to investors.
Tom and Romaniszyn decided to figure out some baseline assumptions to value Lady M confection in 2014. The two the Chief Financial officers of the Lady M. The assumptions were made on WACC (Weighted Average cost of Capital) of 12% percent to the capital expenditure. A hypothesis on WACC of 12% percent is low as it may and may fail and lead to low activity. There is a high level of uncertainty as one invest in world trade center, and they seem to have overvalued the company. A lower value of WACC makes the enterprise value to rise, which results in underestimating of the WACC value to 12 % percent. The amount of the enterprise appears to be high while the value that is given to investors is low leading to investing WTC (World Trade center) attractive. The WACC value was then to be changed to 20% percent as the enterprise value of the company.
The increase of WACC results directly in an increase of cash flow which is discounted at a higher rate and the enterprise of the company decreases. It lowers the originality value of the company making increasing that of investors. By the use, if perpetuity method the originality value of the firm drops by $27.6 million while that of investors would increase by $36.2 million. A double of the equity stake is given to investors. A change of WACC does not affect EBITDA multiple methods that much since the enterprise value drops from $74 million up to $56 million, meaning that 17.9% or 13.5 % percent of the stake is given to investors. The percentage is the value that is going to be given to the Chinese investors. I do not think that the sales growth assumption of 5 % percent is realistic. The increase is going to change the WACC which will alter the cash flow in the organization.
Lady M is a big company that needs funds to keep on developing on its route to success. The Chinese investor offer is a good one since the funds provided will help in running the business smoothly and efficiently venture into the new market. But I do not think that Lady M needs to take the offer of investment. The company should be worried about the fact that an investor can change the culture of the business and design it to his or her liking. For instance, Lady M has established a brand in the market by copying Japan and French bakeries. The Investor may decide and change the recipe off to fit the interest of the people of China. The change of recipe will make Lady M lose it identity and originality which it has maintained from 2001. Also, the investor is offering $10 million, and if the company accepts that value, it is like giving the company with an amount of 13.53% and 17.83% of the enterprise value. The percentage is an apparent loss to the company if they take investors offer.
Instead of the offer, Lady M should open a new boutique at the WTC. But, to open a new boutique, the company is going to require cash to start and finish the set up I would recommend to the Lady M to make a wise move and borrow a loan from the bank that has low interest. With the bank loan interest low, it will be an advantage to the company than taking the funds of an investor. Also, opening of a new boutique will increase sales and enable the company to complete paying loan. Hence, Lady M will stand firm without the fear of losing franchising to China.
Desai, Mihir A., and Elizabeth A. Meyer. “The Valuation and Financing of Lady M Confections.” Harvard Business School Case 215-047, June 2015.
Porter, Michael E. “The five competitive forces that shape strategy.” Harvard business review 86.1 (2008): 25-40.
Ohlson, James, and Zhan Gao. “Earnings, earnings growth and value.” Foundations and Trends® in Accounting 1.1 (2006): 1-70.
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