CASE 2

Eskimo Pie Corporation (Abridged)

Group 3

Max van de Westelaken E10809004

Vivian Limas M10718809
何語萱 M10818012
熊佑恩 M10818018
方翊文 M10818801
林品忻 M10818004
1. What is your estimate of the value of Eskimo Pie Corporation as a stand-alone
company?

Discount Rate: The first task is to estimate the discount rate, or the rate that investors will
require on this type of investment. In 1990, the last year for which we have data, Eskimo Pie
had $744,000 in long-term debt obligations and $19,496,000 in Stockholders’ equity. This
amounts to 3.67588% of their financing coming from debt and 96.32411% of their financing
coming from equity.

Exhibit 9 reflects the corporate borrowing rates as of 1991. Being that Eskimo Pie is a small
operation with fairly thin margins, they would not qualify for an A or AA bond rating. Thus, I
am assuming that any bonds they have issued have a BBB rating. The long-term bond yield
for BBB bonds is 9.56%.

The case does not provide any information regarding the required return on equity. However,
by imputing the data from Exhibit 8c into a spreadsheet we can calculate Beta for comparable
companies. I calculate the average out to 1.253634577, which is the Beta I estimate for
Eskimo Pie.

The S&P 500 index comprises about 500 of America’s largest publicly traded companies and
is considered the benchmark measure for annual returns. When investors say “the market,”
they mean the S&P 500.Measured by the S&P 500 index, stocks return an average of about
10% annually over time.(https://www.nerdwallet.com/blog/investing/average-stock-market-
return/)

Using the risk free rate of 4.56% from Exhibit 9, and an expected market return of 10% , I
calculate the expected return on equity to be 11.38%.

Thus, calculating the Weighted Average Cost of Capital: 11.31%. The applicable discount
rate is 11.31%.

Growth Rate: There are several factors to consider in estimating Eskimo Pie’s growth rate. As
measured by net sales, the growth rate fluctuated greatly between 1987 and 1991. According
to Exhibit 1, half of the growth experienced in 1991 is attributable to increased prices and the
assumption of advertising responsibility. I view this large increase as a one-time event. As
competitors adjust, whatever advantage Eskimo Pie gained from these methods will dissipate.

One advantage that Eskimo Pie has is that they hold patents for various sugar and fat
substitutes. They largely attribute their 3% increase in unit market share over a four year
period to their patent on a sugar free coating. They also have a patent in the works for a fat
substitute. However, any growth they see from the fat substitute will be limited because those
sales will cut into their sales of the sugar-free product.
In Exhibit 6, Goldman Sachs makes very conservative growth estimates. From 1991 to 1992
they project growth, in terms of net sales, of 4.5415%, and from 1992 to 1993 they project
1.2376% growth. These projections are tempered by the fact that they underestimated Eskimo
Pie’s net sales and net income in 1991.

Finally, according to Exhibit 4, the market for frozen novelties has leveled off, so most of
Eskimo Pie’s growth will have to occur by grabbing market share. Eskimo Pie’s growth in the
past is tied, at least to some degree, to their presence in grocery stores. Between 1987 and
1991 the presence of at least one Eskimo product in U.S. Grocery Stores grew from 76.3% to
97.9%. The fact that they are in nearly 98% of all stores in 1991 suggests that they have very
little room for growth in this area, especially when you consider that the percentage change of
their presence in grocery stores is related with the market share of Eskimo products, and is
also related to their net sales. In considering all of these factors, and recognizing this is a low
figure, I estimate that their growth rate in perpetuity, beginning in 1994, will be 5% per year.

Valuation: Valuing the company begins by estimating sales, net income and the free cash
flow. As previously mentioned, net sales will be estimated beginning with the $61 million in
net sales projected for 1991, then relying on Goldman Sach’s projected growth rate for 1992
and 1993, and using a 5% growth rate from that point forward. Net income is estimated for
1992 and 1993 using Goldman Sach’s estimate of the margin.
Thus, I estimate the value of Eskimo Pie, as a stand-alone company, to be $26,840,000. This
is significantly lower than the $61,412,000 or $68,044,000 that Wheat First predicts the IPO
will generate.

Further Analysis: This of course begs the question of why Nestlé would be willing to pay $61
million for Eskimo Pie. The most obvious answer is that they estimate the growth rate to be
much higher than I do. However, such high levels of growth seem unlikely, especially when
you consider that capital expenditures are minimal.

2. Why would Nestle want to acquire Eskimo Pie?

Nestle bid Eskimo Pie with a price of $61 million, which was the highest between the other
bidders. Nestle wants to acquired Eskimo Pie because they have similar types of business,
which also produce frozen novelties.

If Nestle succeeded to acquire Eskimo Pie, Nestle also planned to consolidate its ice cream
novelties by eliminating Eskimo Pie’s headquarters and management staff. By doing this
strategy, Nestle can gain more consumers and expand its market share with decreasing
operating cost.

Besides this, Eskimo Pie is also the pioneer of the ice cream novelties with a lot of licensees
in the US. Because of the licensing that Eskimo Pie does, it would not take a lot of effort for
Nestlé to keep Eskimo Pie profitable.

The fact that Eskimo Pie already sublicences the products of Welch’s and Leaf means that
Nestlé would acquire the licencing rights for many different products in one go. Under Nestlé,
the operations of Eskimo Pie do not have to change much. Therefore, with not a lot of effort,
the addition of Eskimo Pie can bring much profit to Nestlé.

Eskimo Pie’s products also well-known and actively marketed and sold to the customers and
distributed in 98% of all US grocery stores. By acquiring Eskimo Pie, Nestle get the
advantages from this large distribution channel and its strong brand.

3. Are there potential synergies for Nestle's acquisition of Eskimo Pie?

Drumsticks, which is similar to Eskimo Pie, manufacturer of ice cream novelties will be have
the synergies between each other. By doing the acquisition of Eskimo Pie, Nestle can broaden
its market share in this ice cream novelties business and also cutting costs from the production
process, like the worker or the machine needed. Hence, the decreasing costs with the
increasing production and sales means the increasing of effectivity and productivity of Nestle.
They also can allocate their capital to another of their business or investment.

An example of possible new products created by the synergy with Nestlé would be with the
products of Rowntree Mackintosh Confectionery (acquired by Nestlé in 1988). It contains
brands such as Kit Kat (chocolate bars with wafers) and Aero (aerated chocolate bars). These
could synergize well with a product like Eskimo Pie. A mash-up of a Kit Kat Eskimo Pie,
where there would be Eskimo Pie ice cream inside a Kit Kat, is one example of a possible
synergy. Many of these synergies could be made with other products acquired by Nestlé. This
provides customers with more choice, and Nestlé can benefit with more profits.

4. Is Eskimo Pie worth more to Nestle than it is worth as a stand-alone company?

Yes. There are several other reasons why Eskimo Pie would have more value to a company
such as Nestlé than as a standalone company. The first is that Nestlé could slash operating
expenses, such as the Richmond management, advertising expenses and selling expenses,
which would increase the net profits and the free cash flows. They would also be able to
reduce personnel and possibly consolidate the manufacturing components of each company.
Most importantly, however, is that the acquiring company would also assume ownership of
Eskimo Pie’s patents on the sugar and fat substitutes. The sugar substitute was largely
responsible for Eskimo Pie’s increased market share and is thus a very valuable asset. Nestlé
would be able to use those patents on all of their products and potentially see their market
share grow as Eskimo Pie’s did. These patents, along with Eskimo Pie’s name, may be the
most valuable parts of Eskimo Pie.

A strong mitigating factor remains that would keep Nestlé from increasing their bid. It is the
potential litigation arising from the spill in the New Jersey plant. If Nestlé acquires the
company, then they are acquiring the potential lawsuit as well, exposing their entire company.
While the likelihood of litigation is small, the potential still exists.

5. As an advisor to Reynolds, would you recommend the sale to Nestle or the proposed
public offering?
The estimated stand-alone value is less than the purchase price, but Reynolds Metals will
have to pay significantly higher capital gains by selling to Nestle. Capital gain taxes will take
a large part of the cash. On the other hand, Nestle will benefit from the purchase because it
will get a tax break from borrowing money to purchase the company and as mentioned above,
buying Eskimo Pie will lower overhead cost by eliminating Eskimo Pie management and
Nestle utilizing existing facilities creating greater cash flows.

However, we also see value in going to market with Eskimo Pie. Firstly, let us look at the
numbers. Based on their balance sheet on Dec.31, 1990, 34% debt ratio and 48 times interest
earned showed the company was in good liquidity. The ROE turned out to be 12.95% seemed
to be a profitable company. With such a good financial condition and as one of the leading
brand in the market, if Eskimo Pie went on IPO, investors would see it and not just enjoy the
growing of stock price, but to save the company from acquisition and losing its tradition. This
last point is important, since Eskimo Pie has been a staple of the American frozen novelty
section for many years. Those working for the company are proud and would not like to see
their company go. Currently, there are already over 3 million shares outstanding. In the new
situation, 3.3 million additional shares would be issued at either $14 or $16. As an advisor
within Reynolds, Exhibit 7 shows the results of the public offering. In either situation, the
total for Reynolds would be a significant amount. Though not everything would be received
of course, it is still a significant amount for Reynolds to look at.

Based on these considerations, we recommend to Reynolds to take Eskimo Pie public through
the IPO, because the IPO will create higher market value for the company and will benefit
senior management, employees, and the community.

6. Could you evaluate the public offering markets in Asia? Where would you prefer to
raise money for you company(if you have the authority! ) And why?
From the perspective of valuation, we will choose to be listed on the Shanghai Stock
Exchange.

The top 3 largest stock exchanges in Asia by market capitalization are the Hong Kong Stock
Exchange, the Tokyo Stock Exchange and the Shanghai Stock Exchange. The Hong Kong
and Tokyo markets have great advantages in institutionalization and internationalization, and
so on.

If listing in a given market had quantifiable benefits, we should see evidence for them in the
valuation or liquidity of the companies that list there. Yet when we look at the companies that
executed a second listing in Hong Kong, the evidence doesn't support An economic argument
for a move on the basis of liquidity or valuations. Companies listing in Hong Kong have not,
on average, experienced a significant increase in their shares' liquidity. Many of the
companies listing in Hong Kong had already listed on exchanges in Mainland China, where
they enjoyed basically higher valuations.

Why is the valuation of Shanghai's capital market higher than other Asian markets? There are
two reasons. First, China's economic growth has accumulated huge amounts of capital and
second, the proportion of retail investors is very high. As everyone knows, a lot of Chinese
companies are listed in the US, but many of them are delisting from the US, intended to be
back to China through the VIE structure. An important reason is that the US capital market
does not recognize the valuation of these companies, as long as they return to China's capital
market, the valuation will rise 1-2 times.