The Empire Company Limited: The Oshawa Group Limited Proposal

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In the Empire Company Limited Case, James Vaux, the associate director at Scotia Capital is the main decision maker. It is his job in September of 1998 to decide on a price at which The Oshawa Group Limited will sell their company/accept a takeover offer at. The Oshawa Group Limited (Oshawa) is a food retail, wholesale, and distribution firm. The Empire Company wants to expand beyond their Atlantic Canada roots; however, there are a few catches. The Wolfe family owns 100% of the voting shares of the company, and not only know the value of their company and expect to receive at least that much, but also a premium on top of that.
Greg Rudka is the Managing Director at Scotia Capital; he has extensive background in the history of the grocery industry and was the one who noticed this opportunity as well as the person who assigned James Vaux to his assignment of the value of Oshawa.


There are two main issues at hand. First, Vaux needs to determine a value for both classes of shares that Empire would be willing to pay to the Wolfe family and Oshawa equity holders to acquire a position in the Oshawa Company without starting a bidding war. The second issue is that Vaux needs to find a way to finance the deal.
There are a few minor issues in this case, starting with competition. The grocery industry is very competitive. There are only a few large firms involved in the industry. Of course, there are mom and pop stores all over North America, but they only make enough to live themselves and they are not bringing in the same profits as the major chains, so they are not legitimate threats to Empire. Next, the Oshawa Company’s entire voting shares are owned by the Wolfe family as mentioned above. This will add to the level of difficulty in the purchase or acquisition of Oshawa. Finally, the last issue is that in the grocery industry, it is cheaper to acquire a competitor’s company and chains than it is to open a new store. In other words, horizontal acquisitions were the primary source of growth on the revenue side for the grocery business. People don’t like change and because of this, creating or changing the name of their “local grocery store” may upset or disrupt their previous shopping experiences.

There are three alternatives for Empire when deciding how to go about the takeover offer. First, as always, they could remain the status quo and continue to have a large profitable business with no expansion, but since Empire is looking toward the future, to the new wave of large wholesalers, (ie. Wal-Mart now selling groceries) they feel the need to acquire and grow their business to stay competitive in Canada. Empire’s second option is they can make a competitive bid either at market value or below. This poses a huge risk for Empire as mentioned above since Empire sees new competition from Wal-Mart and other large department stores, which makes this bid incredibly risky should Empire truly feel the need for growth in their company to remain a dominant player in the grocery industry. Also, by bidding at or below market value, Empire is opening the door up for a bidding war which the company wants to avoid at all costs if possible. Empire’s final option is to offer a premium for the stock. Finding a value for the company is one issue, but figuring out what price others may value the company at in order to beat competitors in offering the Wolfe family a premium for their well maintained and efficient chain of stores is another issue.
There are four alternatives for dealing with the issue of financing the takeover. First, Vaux could recommend to Empire the selling off of its investment portfolio which is valued at approximately $1 billion at current market prices, but the Sobey family views the investment portfolio as a vital part of a diversified asset base and may not approve of this option. Second, Vaux could look into debt financing, but the company already has a huge debt portion in comparison to its competitors, so any new debt could be very costly and threaten their debt rating. Third, the company is publicly traded and could issue additional equity to finance an acquisition, but the Sobey family wants to maintain control over Empire and already feels as though the stock is trading at a substantial discount to its true value, so this option may not be feasible. Lastly, another option is that the food business that Empire owns could be spun off into a separate entity where Oshawa shareholders would receive equity in the new company, but new shares would not be traded publicly until after the transaction was complete, so there was a chance that shareholders may not react well to this.

There are four main decision criteria used in the Empire case. First, was just how many potential buyers there could possibly be for the large family chain. Second and third, were the facts that Empire needs to retain majority equity interest and voting control over all its businesses, and that partial financing using equity is attractive to the Wolfe family as it allows to defer some capital gains taxes. Lastly, the Oshawa Company has been looking to enhance shareholder value in the past few years, so any offer made to Oshawa will need to be viewed by Oshawa as resulting in an increase in an appreciation in value for shareholders. By looking at the numbers, we decide who could actually afford to buy the company, who was able to support such a large acquisition, and where/how they would get their funding from based upon their sales and revenues from the past. Out of the five major firms we analyzed, we felt that only Loblaws, Metro-Richelieu, and Provigo would even consider placing bids. We choose these three companies because they have the most to gain from an acquisition of Oshawa. Loblaws is the only company in the running that really operates on a national level. They could increase their stores across the country with the acquisition and become the top dog in the grocery industry in Canada. Metro-Richelieu is a large food retailer, but is only currently in Quebec, so an acquisition of this size would be beneficial to the company as it would give them a national scope. Provigo, another large food distributor, has an advantage over Metro-Richelieu because they already have stores in Ontario. This is an advantage over others in the industry as they have set down roots in two out of the three largest populated provinces in Canada. A large acquisition of a company like Oshawa would put Provigo at the top of the grocery industry in Quebec, improve their Ontario presence and expand their scope nationally.

Consolidation in the grocery business has been unchecked in the United States; it looks likely to cover a large area of Canada too, so Empire will need to act fast if they want to use any potential opportunity. The returns on shareholder equity had traditionally been insufficient as the grocery business was in a maturity period. In 1998, grocers faced increasing competition not only from other grocers, but also increasingly from various non-traditional vendors.
The Asian and Russian economic crises of 1998 had resulted from mistakes on corporate and government debt, which led to huge currency devaluations. The Bank of Canada had lowered interest rates nine times since 1996 in an attempt to try to boost the economy and lower unemployment. These low interest rates affect the Canadian dollar against most world currencies.
In order to gauge the potential success of an acquisition, the firm must analyze its competitive landscape. Consolidation, the acquisition of a competitor, was cheaper than opening new stores. Acquisition also reduced risks of entering a new market in terms of lack of local knowledge, difficulty of attracting a qualified work force, and the threat and intensity of competitive response.
Metro-Richelieu was the largest food retailer in Quebec, and it runs an extensive wholesale distribution business. The net income was $66.2 million on revenues of $3.4 billion in the fiscal year 1997. Metro Richelieu was seen as a potential competitor for the acquisition of Oshawa. It would solidify their position as the largest grocer in Quebec, as well as giving them national scope.
Provigo was the largest food distributor in Quebec and had a growing presence in Ontario. Its net income was $68.7 million on revenues of $5.9 billion in the fiscal year 1998. If Provigo were to acquire Oshawa, they would become the largest grocer in Quebec, improve Ontario penetration, and extend their reach nationally. However, Provigo also operated franchised stores; their preferred method of expansion was by building their own corporate network.
The Overwaitea Food Group was based in Langley, B.C. and was privately owned by the Pattison Group. The Pattison Group was seen as a potential competitor for Empire. Whereas, Oshawa had only a small presence in British Columbia, the acquisition would provide national exposure.
The external size-up takes a look at the economy. After we analyzed the history of the industry, we saw that all the big firms were profitable in the last fiscal year. The economy in Canada was strong in 1997 and the Empire stock price had just reached its all time high in July 1998. The grocery market is a relatively stable industry baring natural disasters of produce, or health scares. This is a positive sign for both Vaux and the Wolfe family as they will receive top dollar for their company and Vaux and Rudka know that the industry is not going anywhere; therefore, they can make a strong bid because people need to eat and will always need to eat.
From an industry perspective, the size of the market will continue to grow as our population in Canada increases each year with new birth and immigration. This helps grocery stores earn more money each year by importing exotic foods and charging premium prices for them as some foods may only be available in select stores. As mentioned above, people will always need to eat, so grocery stores will always be needed. Citizens of Canada have money and budget specifically to purchase food. This is common for 98% of Canadians and is a positive reinforcement for Empire as they look to move forward and expand in the future.
The grocery industry is super competitive. Large stores such as “super stores or wholesale” franchises sell larger quantities for cheaper prices. It pays to be big due to economies of scale and this is why this acquisition is an important move for Empire. It is difficult to open a new store in an already developed area as people have already become accustomed to their store; therefore, it take a great deal of time, effort and marketing to get people to convert to your store. Another reason why acquisitions are so important is because it is key to Empire’s growth plans.


Internal size-up shows an increase in Empire’s property, plant, and equipment. This is a positive sign for a company that is able to create cash flows of eighty-eight million while expanding their operations
Empire was established in 1907. The company grew into a holding company, with a variety of interests including food distribution, real estate, and corporate investment activities. The major objective of the corporation was the support and operation of the Sobeys retail grocery business. The food distribution business consisted of five operating groups, which are retail, wholesale, foodservice, drug, and industries. The retail group operated 112 stores under the Sobeys name. Sobeys was the largest food retail and distribution company in Atlantic Canada. The wholesale division includes three companies, TRA Maritimes, TRA Newfoundland in Atlantic Canada, and Lumsden Brothers in Ontario. The Sobeys Group was the largest foodservice operator in Atlantic Canada. It also operated 11 distribution centres and serviced institutional clients, as well as independent and chain restaurant businesses. The drug group was comprised of the Lawton’s Drugs chain. The industry group provided ancillary services primarily to the food distribution group. The main businesses were a private label soft-drink maker, a printing company, and a video distribution business. The primary focus of the real estate group was the acquisition, development, and management of property portfolios, which supported or complemented Empire’s retail operations. The investment group comprised of equity investments in other corporations, both long and short term. The main purpose of the investments group was to supply both geographic and industry diversification to Empire. Empire had 17.4 million Class B common shares and 19.5 million Class A non-voting shares outstanding. The Class B shares were not publicly traded and were held entirely by members of the Sobey family. Class B were convertible to Class A at any time on a one-for one basis. Under certain circumstances, if an offer was made to purchase the Class B shares, Class A shareholders had the right to receive a follow up offer at the highest per share price paid to Class B shareholders. The corporation also had several series of preferred shares outstanding.
Oshawa was a food retail, wholesale, and distribution firm, and was founded in 1951. Before unusual items, the earnings after tax from continuing operations were $40.1 million on revenue of $6.8 billion in fiscal 1998, but after tax, earnings from continuing operations were $54.6 million on revenue of 6.0 billion in 1997. The corporation was separated into a grocery division, Agora Food Merchants, and a food service division, SERCA Foodservice. Agora was Canada’s second largest food retailer and was responsible for 82 per cent of Oshawa’s revenues in 1998. SERCA Foodservice was Canada’s largest foodservice business.
The current ratio for Empire is 0.74. Which means that the company has $0.74 in assets for every $1 in liabilities. Empire has a quick ratio 0.44 which means that the company has poorer liquidity due to higher debt levels. The activity ratio for Empire is 1.8. The debt ratio is 12.7. The debt ratio measures total debt to total assets which means that the firm has a lower borrowing capacity and thus, lower financial flexibility. An equity multiplier of 1 means that the firm is fully financed by equity and the larger the equity multiplier, the more the firm is financed by debt. For Empire, the equity multiplier for the firm is 0.87 meaning that the firm is highly financed by debt. The interest coverage ratio is 2.2 which means that although the firm is heavily financed by debt, they are sufficiently able to meet their interest expenses. The firm’s net profit margin is 2.6% which means that for every $1 of sales, the firm makes 26 cents in net income. The return on assets is 5%. The return on equity is 17%.

To come up with an assessment of Oshawa’s value, we used two discounted cash flow analyses (DCF), the precedent transactions analysis, the capitalized earnings analysis, and the comparable transactions analysis. Using as many approaches as possible to value a company will give us the best idea as to the closest true value of Oshawa.
In the first discounted cash flow analysis (DCF), which included our future projections of Oshawa’s cash flows over a five year period, we took a look at their terminal value based upon EBITDA and their cost of equity and cost of debt in an attempt to reach an accurate value of Oshawa (see Exhibits 1 and 2) . We performed this first DCF analysis based on Oshawa as a stand-alone entity in order to assist in finding an intrinsic value of Oshawa relative to its current market value; we did not take into account any synergies that Empire’s acquisition of Oshawa would result in. In order to reach our final DCF, we needed to evaluate the Evaluation Period, Valuation Data, Terminal Multiple, Terminal growth rate in perpetuity, WACC, and cash taxes. After calculating all of this, the enterprise value of Oshawa, not including synergies, was found to be $1355.31 million or a price per share of $31.2 (see Exhibits 4 and 5).
In the second discounted cash flow analysis (DCF), we did the same process to project Oshawa’s cash flows five years into the future except this time, we took into account projected synergies that could result with the merging of Oshawa and Empire (see Exhibit 3). There were two specific kinds of potential synergies that we took into account: those related to margin enhancements and cost reductions. We also were conservative with the realization of these potential synergies by taking into account in our estimates that no cost synergies would occur in the first year, 37.5% of cost synergies would occur in the second year, and 75% of cost synergies would occur in year three and onwards. After taking these synergies into account when doing our DCF analysis, we obtained a firm value of $5135.23 million and a price per share of $117.6 (see Exhibits 4 and 5).
Next we used the precedent transaction analysis to give us a better understanding of the grocery market (see Exhibit 6). This helped us realize just how competitive the grocery market is and how it really is a big-player game. In the last three years, there had been ten large grocery store mergers. After analyzing this chart and computing the industry average of enterprise value (EV) to earnings before interest, tax, and depreciation (EBITDA) we found an enterprise value of $1,277.10 and a price per share of $33.61
Fourth, we used the capitalized earnings approach to find the value of the equity of the company on a per share basis by taking the industry price-earnings ratio (18.3) and multiplying this number by Oshawa’s earnings per share (1.42). We arrived at a price per share of $26.01 (see Exhibit 7).
Finally, we performed a comparable trading analysis in which we took the industries multiples of price earnings for 1998 and averaged them and then took Oshawa’s revenues for 1998 and divided the revenues by the industry average price earnings ratio to obtain a value of the firm of $2,888.75 million dollars or a price per share of $76.02 (see Exhibit 8).

It is important to understand that many assumptions were used in making our calculations. Refer to the next section in the report for a summary of the assumptions used in our analyses. If these assumptions were to vary in reality from what was assumed in our models, the results and outcomes would vary as well. For example, as the cost of debt decreases, the weighted average cost of capital decreases as well and the value of the firm increases. Likewise, as the cost of debt increases, the value of the firm will decrease. In other words, if the cost of debt for Oshawa decreases, this will positively affect the value of the firm by having an upward pressure on the value of the firm. In this case, Oshawa would be worth more, and Empire would need to pay more money per share in order to purchase Oshawa. Growth rate is another important factor in valuing a firm. If the actual growth rate is lower than the projected growth rate, then the firm will be worth less, and the firm acquiring the other firm will have overpaid for their shares in the firm. In other words, if Oshawa grows at a rate slower than projected when calculating the discounted cash flow analysis, intrinsically, Oshawa will be worth less to a potential buyer, Empire, than had it met or exceeded the projected growth rate. A third key assumption was made in terms of the interest rate, market premium, and risk free market rate. At the present time, interest rates are low and if interest rates were to increase, this will affect the cost of debt and thus the value of the firm. Oshawa would benefit most from a lower interest rate as this will keep their cost of debt lower and the value of the firm higher. Finally, an assumption was made in regards to capital expenditures. Capital expenditures were assumed to be static ranging from 1% to 2% of total sales for each year into the future. They were also expected to decrease over time; however, capital expenditures can increase as input costs increase thus decreasing the value of a firm.


When performing our calculations, we made a number of assumptions:
1) From the historic data in the past 5 years, we got the average of the sales growth rate as 7%; After the discussion with Empire management, we decide to make the forecasting sales growth rate at 6%, both on two separate DCF analysis in order to be conservative.
2) From the historic data in 1997 and 1998, we got the cost of sales and expenses in sales percentage as 97% and 98%, respectively. The EBITDA margins from these two years are 3% and 2%, so we still apply 98% and 2% as the cost of sales percentage and the EBITDA margins in the next 5 years based on the first DCF analysis. For the second DCF analysis, after the merger with Empire, there should have been the benefit in both the enhancement of sales and the reduction of costs, so the Empire management estimates the future EBITDA margins as 2.4%, 2.55%, 2.8%, 3.3%, 3.8%, from 1999 to 2003, respectively.
3) From the historic data in the past 5 years, we get that the depreciation and amortization percentage related to the sales are all 1%, from 1994 to 1998; therefore, we still apply 1% to the depreciation and amortization percentage for the next five years' forecasting, both on two separate DCF analysis.
4) From the financial statement, both on Empire and Oshawa, we can see that the income tax rate is around 40%, so we still use 40% to forecast the next five years' tax expenses, both on two separate DCF analysis.
5) In the first DCF analysis, we average the capital expenditures to the sales ratio in the past 5 years and obtain the answer of 2%, and 1%, in the first 2years (1994, 1995) and 2% in the recent 3 years (1996, 1997, 1998), so we still use 2% as the capital expenditure to the sales ratio in the next 5 years. For the second DCF analysis, because of the benefit from the merger with Empire, the Empire management estimates that the Oshawa's capital expenditure related to the sales will stay at 2% in the first year following the merger (1999), but will gradually decrease to 1% in year 5 (2003). Therefore, we estimate the capital expenditure to the sales ratio for the next 5 years as 2%, 1.8%, 1.5%, 1.2%, 1%, respectively.
6) From the historic data in the past 5 years, we get the average rate of the working capital to the sales is 4%, and we still use this figure to estimate the working capital for next 5 years.
7) After we have done all of the assumptions above and input them to the spreadsheet, now the free cash flow can be calculated, we use the equation as below:
FCF = EBITDA - Tax expense - Capital expenditures - Change in capital
8) We use the 10 year government bonds yield of 5.8% as our risk-free rate and because Oshawa's debt rating is AA, we use 100 basis points (1%) as the risk premium over government yields
9) We assume the beta shown in Exhibit 9 of 0.77 is the levered beta
10) The total outstanding shares of Oshawa are around 38M, and the current stock price is $26, so we can get the equity of 988M. From the balance sheet of the Oshawa, we can see that the long term debt and the bank loans of Oshawa in 1998 are 145.7M and the total interest expense from the income statement is 7.9M. Using this information, we can get the interest rate of 5.4%, but this inappropriate since it is under the government bond yield, so we decide to choose the market rate as our estimation of the cost of debt, which is the risk free rate plus the risk premium, so the after tax cost of debt we estimate is 4.08%.
11) We use the WACC model to get the cost of capital of 6%, and we use it as the discounted rate to calculate the NPV
12) Terminal Value Analysis: After we have done the five years' FCF forecasting, we should get the terminal value to estimate the company value, because we cannot forecast the FCF forever, we just use the long-term economic growth rate as our perpetual cash flow grow rate. From the historic data between 1992 and 1997, the GDP of Canada are in the range of 1.2% and 3.4%, then fall to 2.4% in 1998 due to the financial crisis in Asia and Russia. So, based on the discussion with Empire management, we believe that the long-term GDP growth will remain this percentage; therefore, we use 2.4% as our perpetual cash to calculate the Terminal Value.
According to the equation below:
T= Final year CF (1+ perpetual growth rate)/( Discount rate - perpetual growth rate)
Then, we get the PV of the Terminal Value and add it to all the PVs in the forecasting period, so we arrive at the Enterprise Value.
13) Because the investors do not want to consider the debt in an Enterprise Value to effect their decision, we should take the debt out from the EV. We assume that the total debt at the level of 1998, which is 135, then we can get the Equity Value via the equation below:
Equity Value = Enterprise Value - Total debt
Once we figure out the Equity Value, we can use the number divided by the total shares outstanding and then we can know the fair price per share of the target company which is Oshawa.
Fair price per share = Equity Value / Total shares outstanding

Based on the figures obtained from our calculations, the firm in itself, Oshawa, has a value in the range of $31.00 per share to $33.61 per share with an outlier of $76.02 per share; however, these values do no not taking into account any of the synergies that potentially could occur between Empire and Oshawa and so, these synergies need to be factored in. These figures also do not yet include a premium to market that will be needed in order for the Wolfe family to be willing to sell their shares. Based on our second DCF analysis which took potential synergies into account, the value per share is estimated at $117.6. In other words, Empire could offer the Wolfe Family approximately $117.6 per share to obtain their voting shares and Empire could offer the Class A shareholders anywhere from $31.91 to $33.61 per share plus an additional premium of approximately 20 to 22% in order to obtain majority ownership of Oshawa. This offer should appeal to the Wolfe family and Class A shareholders, and thus, should not start a bidding war.
Finally, there is the issue of how to finance the deal. Based on our calculations, the cost of debt was 6.8%, but after taxes, the cost of debt was 4.08% while the cost of equity was 7%. In other words, it is cheaper for Empire to issue debt than it is to issue equity. However, there is concern about issuing additional debt and the effect that this will have on Empire’s debt rating. Therefore, we believe that the best option for Empire to pursue in financing this deal is to use some debt, but for the most part, use equity capital raised from spinning off the food business into a separate entity and making it publicly traded. The grocery business is currently making up 95% of the company’s revenue, but only 37% of operating income, so by spinning off the grocery business into its own company, Empire can raise equity by issuing shares through this new company to fund the financing of the Oshawa acquisition. Also, Class A shareholders of Oshawa could have the option of receiving shares in the new business Empire creates, or choose to have the cash payout for their shares.

Article name: The Empire Company Limited: The Oshawa Group Limited Proposal essay, research paper, dissertation