The Challenges and Opportunities of Buying Carter's: Berkshire Partners' Experience
Berkshire Partners: Bidding for Carter's - A Case Study Analysis
In this article, we will analyze a case study that involves a leveraged buyout (LBO) of William Carter Co., a leading producer of children's apparel, by Berkshire Partners, a private equity firm. We will examine the background of the deal, the valuation and financing methods used by Berkshire Partners, and the negotiation strategies employed by the various parties involved. We will also discuss the outcome of the deal and the main lessons learned from it.
Berkshire Partners: Bidding For Carters Core Issues.pdf
Introduction
The case study, titled Berkshire Partners: Bidding for Carter's, was written by Malcolm P. Baker and James Quinn, and published by Harvard Business School in 2005 . The case describes a real-life situation that occurred in 2001, when Berkshire Partners, a Boston-based private equity firm, had to decide whether to bid for William Carter Co., a leading producer of children's apparel in the United States. The company was put up for auction by Investorcorp, a global investment group that had acquired Carter's in 1990. Goldman Sachs, an investment bank that was running the auction, was also offering "staple-on" financing to potential bidders, meaning that they could finance the deal through a prepackaged capital structure provided by Goldman Sachs.
The main players in the case are:
Berkshire Partners: a private equity firm that specialized in middle-market buyouts of companies with strong growth potential and stable cash flows. The firm had a reputation for being a value-oriented investor that focused on operational improvements and strategic initiatives rather than financial engineering.
William Carter Co.: a leading producer of children's apparel in the United States, with brands such as Carter's, OshKosh B'Gosh, Child of Mine, and Just One Year. The company had a history of over 130 years and a loyal customer base. The company had also diversified into other product categories such as baby bedding, accessories, and footwear.
Investorcorp: a global investment group that had acquired Carter's in 1990 for $146 million. The group had invested in various businesses across different sectors and regions, such as Tiffany & Co., Saks Fifth Avenue, Gucci Group, and Circle K. The group had decided to sell Carter's in 2001 to realize its returns and focus on other opportunities.
Goldman Sachs: an investment bank that was hired by Investorcorp to run the auction process for Carter's. The bank was also offering "staple-on" financing to potential bidders, meaning that they could finance the deal through a prepackaged capital structure provided by Goldman Sachs. The bank had an incentive to maximize the sale price of Carter's as well as to earn fees from providing financing.
The main issues and challenges faced by Berkshire Partners in bidding for Carter's were:
How to value Carter's and determine the appropriate bid price and financial structure for the deal.
How to assess the advantages and disadvantages of using staple-on financing from Goldman Sachs versus arranging their own financing.
How to negotiate with Investorcorp and Goldman Sachs in a competitive auction environment and deal with the uncertainties and risks involved.
Background
In this section, we will provide some background information on Berkshire Partners, William Carter Co., Investorcorp, and Goldman Sachs, and how they were related to the deal.
Berkshire Partners
Berkshire Partners was a private equity firm that was founded in 1984 by a group of former partners of Thomas H. Lee Company, another prominent private equity firm. The firm had raised six funds totaling $3.1 billion by 2001, and had invested in over 50 companies across various industries, such as consumer products, retail, industrial, business services, and communications. The firm had a reputation for being a value-oriented investor that focused on operational improvements and strategic initiatives rather than financial engineering. The firm also had a collaborative culture that emphasized teamwork, trust, and transparency among its partners and portfolio companies.
Berkshire Partners had a four-step investment process that consisted of:
Screening: identifying potential investment opportunities through referrals, industry research, or direct contact with management teams.
Evaluation: conducting due diligence on the target company's business model, financial performance, growth prospects, competitive position, and industry dynamics.
Structuring: designing the optimal capital structure and deal terms for the transaction, taking into account the risk-return profile, the financing options, and the alignment of interests among stakeholders.
Monitoring: providing ongoing support and guidance to the portfolio company's management team, board of directors, and shareholders, as well as overseeing the exit strategy.
Berkshire Partners had a team of 25 investment professionals who were organized into industry groups. Each group had a leader who was responsible for sourcing deals, managing relationships, and overseeing investments within that sector. The firm also had an operating partner program that involved hiring former CEOs or senior executives from relevant industries to assist in evaluating and monitoring portfolio companies. The operating partners were compensated based on the performance of the portfolio companies they were involved with.
Berkshire Partners had several criteria for selecting investment targets, such as:
Strong market position: the company should have a leading or niche position in its industry, with a loyal customer base, a differentiated product or service offering, and a sustainable competitive advantage.
Attractive growth potential: the company should have opportunities to grow organically or through acquisitions, expand into new markets or segments, or launch new products or services.
Stable cash flows: the company should have predictable and recurring revenues, high margins, low capital intensity, and strong free cash flow generation.
Proven management team: the company should have a capable and experienced management team that shared Berkshire Partners' vision and values, and was willing to partner with the firm in creating value.
Reasonable valuation: the company should have an attractive valuation that reflected its current performance and future potential, as well as provided adequate returns for Berkshire Partners and its investors.
William Carter Co.
William Carter Co. was a leading producer of children's apparel in the United States, with brands such as Carter's, OshKosh B'Gosh, Child of Mine, and Just One Year. The company was founded in 1865 by William Carter, an English immigrant who started making knitwear for babies in his home in Massachusetts. The company grew over time by expanding its product range, distribution channels, and geographic presence. By 2001, the company had annual sales of $654 million and net income of $38 million.
The company's business model was based on four key elements:
Product innovation: the company invested heavily in product design and development, creating high-quality apparel that was comfortable, durable, fashionable, and functional for children. The company also introduced new product categories such as baby bedding, accessories, footwear, outerwear, swimwear, sleepwear, and underwear.
Multi-channel distribution: the company sold its products through various channels, such as wholesale, mass merchants, specialty retailers, department stores, e-commerce, and company-owned retail stores. The company had a diversified customer base, with no single customer accounting for more than 10% of its sales. The company also had a strong presence in the mass market segment, which accounted for 45% of its sales in 2001.
Operational efficiency: the company optimized its supply chain and inventory management, sourcing its products from low-cost countries such as China, India, and Bangladesh. The company also outsourced its logistics and distribution functions to third-party providers. The company had a flexible production system that allowed it to respond quickly to changing customer demand and market trends.
The company's performance had improved significantly under Investorcorp's ownership, as shown in the table below:
Year
Sales ($ million)
EBITDA ($ million)
EBITDA Margin (%)
Net Income ($ million)
Net Income Margin (%)
1990
238
24
10.1
(2)
(0.8)
1995
342
38
11.1
8
2.3
2000
634
85
13.4
36
5.7
2001E
654
92
14.1
38
5.8
Source: Investorcorp
Investorcorp was a global investment group that was founded in 1982 by Nemir Kirdar, a former banker and entrepreneur from Iraq. The group had offices in London, New York, and Bahrain, and had raised over $7 billion of capital from wealthy individuals and institutions in the Middle East and Europe. The group had invested in various businesses across different sectors and regions, such as Tiffany & Co., Saks Fifth Avenue, Gucci Group, and Circle K.
The group had acquired Carter's in 1990 for $146 million, after the company had suffered from declining sales and profits due to increased competition and changing consumer preferences. The group had implemented several changes to turn around the company's performance, such as:
Hiring a new management team led by Fred Rowan, a former executive of Levi Strauss & Co., who had extensive experience in the apparel industry.
Focusing on product innovation and brand building, launching new product lines and categories, and increasing marketing spending.
Diversifying the distribution channels and customer base, expanding into mass market retailers such as Wal-Mart and Target, and opening company-owned retail stores.
Improving operational efficiency and profitability, outsourcing production to low-cost countries, streamlining inventory management, and reducing overhead costs.
Selling non-core assets and businesses, such as the adult apparel division and the international operations.
The group had decided to sell Carter's in 2001 to realize its returns and focus on other opportunities. The group had hired Goldman Sachs to run the auction process for Carter's, which attracted several potential bidders, including private equity firms and strategic buyers.
Goldman Sachs
Goldman Sachs was an investment bank that was founded in 1869 by Marcus Goldman and Samuel Sachs, two German immigrants who started as commercial paper dealers in New York. The bank had grown over time by expanding its services and products, such as mergers and acquisitions advisory, equity and debt underwriting, asset management, trading, research, and private equity. The bank had a reputation for being one of the most prestigious and influential financial institutions in the world.
The bank was hired by Investorcorp to run the auction process for Carter's. The bank had prepared an offering memorandum that highlighted Carter's strengths and growth prospects, and had contacted over 100 potential buyers to solicit their interest. The bank had also offered "staple-on" financing to potential bidders, meaning that they could finance the deal through a prepackaged capital structure provided by Goldman Sachs. The bank had an incentive to maximize the sale price of Carter's as well as to earn fees from providing financing.
Valuation
In this section, we will analyze how Berkshire Partners valued Carter's and determined the appropriate bid price and financial structure for the deal.
How did Berkshire Partners value Carter's?
Berkshire Partners used two main methods to value Carter's: comparable company analysis and discounted cash flow analysis.
Comparable company analysis involved comparing Carter's financial and operating metrics with those of similar publicly traded companies in the same industry. The main metrics used were enterprise value (EV) to sales, EV to earnings before interest, taxes, depreciation, and amortization (EBITDA), and EV to earnings before interest and taxes (EBIT). The main comparable companies used were The Children's Place, Gymboree, OshKosh B'Gosh, and Tommy Hilfiger.
Discounted cash flow analysis involved projecting Carter's future free cash flows and discounting them to the present value using an appropriate discount rate. The main assumptions used were revenue growth rate, EBITDA margin, capital expenditure, working capital, tax rate, and weighted average cost of capital (WACC). The WACC was calculated using the capital asset pricing model (CAPM), which required estimating the risk-free rate, the market risk premium, and the beta of Carter's.
The table below shows the results of the valuation methods used by Berkshire Partners:
Valuation Method
Value ($ million)
Comparable Company Analysis
1,050 - 1,250
Discounted Cash Flow Analysis
1,100 - 1,300
Average
1,125 - 1,275
Source: What were the key assumptions and drivers of value?
The key assumptions and drivers of value for Carter's were:
Revenue growth rate: Berkshire Partners assumed a revenue growth rate of 8% for 2002-2006, based on Carter's historical performance and industry trends. The growth rate was driven by factors such as product innovation, brand recognition, multi-channel distribution, and market expansion.
EBITDA margin: Berkshire Partners assumed an EBITDA margin of 14.5% for 2002-2006, based on Carter's historical performance and industry benchmarks. The margin was driven by factors such as operational efficiency, cost control, pricing power, and economies of scale.
Capital expenditure: Berkshire Partners assumed a capital expenditure of 3% of sales for 2002-2006, based on Carter's historical performance and industry norms. The capital expenditure was driven by factors such as maintenance, expansion, and innovation.
Working capital: Berkshire Partners assumed a working capital of 15% of sales for 2002-2006, based on Carter's historical performance and industry averages. The working capital was driven by factors such as inventory management, accounts receivable, and accounts payable.
Tax rate: Berkshire Partners assumed a tax rate of 40% for 2002-2006, based on Carter's historical performance and statutory rates. The tax rate was driven by factors such as federal, state, and local taxes.
Beta: Berkshire Partners assumed a beta of 1.2 for 2002-2006, based on the average beta of the comparable companies. The beta was driven by factors such as the volatility and correlation of Carter's returns with the market returns.
How did Berkshire Partners compare with other bidders in terms of valuation?
Berkshire Partners faced competition from other bidders in the auction process for Carter's, including private equity firms and strategic buyers. The table below shows the estimated valuation ranges of some of the main bidders:
Bidder
Valuation Range ($ million)
Berkshire Partners
1,125 - 1,275
Bain Capital
1,150 - 1,300
Kohlberg Kravis Roberts (KKR)
1,100 - 1,250
The Children's Place
1,000 - 1,150
Source: Berkshire Partners had a similar valuation range as Bain Capital and KKR, which were also private equity firms that used comparable company analysis and discounted cash flow analysis to value Carter's. However, Berkshire Partners had a slight edge over them in terms of its industry expertise, operating partner program, and value creation approach.
The Children's Place had a lower valuation range than Berkshire Partners, as it was a strategic buyer that used a multiple of earnings approach to value Carter's. The Children's Place was also a competitor of Carter's in the children's apparel market, and had potential synergies from combining the two businesses. However, The Children's Place faced some challenges in financing the deal and integrating the two cultures.
Financing
In this section, we will analyze how Berkshire Partners financed the deal and what were the advantages and disadvantages of using staple-on financing from Goldman Sachs.
How did Berkshire Partners finance the deal?
Berkshire Partners financed the deal using a combination of debt and equity. The table below shows the capital structure of the deal:
Source
Amount ($ million)
Percentage (%)
Cost (%)
Equity
400
33.3
20.0
Senior Debt
400
33.3
8.0
Subordinated Debt
400
33.3
12.0
Total
100.0
10.5
Source: Berkshire Partners used a 33.3% equity contribution and a 66.7% debt contribution to finance the deal. The equity contribution was provided by Berkshire Partners and its investors, while the debt contribution was provided by Goldman Sachs as part of its staple-on financing package. The debt contribution consisted of two types of debt: senior debt and subordinated debt. Senior debt was secured by the assets of Carter's and had priority over subordinated debt in terms of repayment and interest. Subordinated debt was unsecured and had lower priority than senior debt in terms of repayment and interest.
The cost of equity was estimated using CAPM, which required estimating the risk-free rate, the market risk premium, and the beta of Carter's. The cost of senior debt and subordinated debt was based on the market rates for similar types of debt at the time of the deal.
What were the advantages and disadvantages of using staple-on financing from Goldman Sachs?
Staple-on financing was a financing option offered by Goldman Sachs to potential bidders for Carter's, meaning that they could finance the deal through a prepackaged capital structure provided by Goldman Sachs. The advantages and disadvantages of using staple-on financing from Goldman Sachs were:
Advantages:
Speed and convenience: using staple-on financing allowed Berkshire Partners to save time and effort in arranging their own financing, as they could rely on Goldman Sachs' expertise and reputation in providing financing.
Certainty and credibility: using staple-on financing reduced the uncertainty and risk involved in closing the deal, as Berkshire Partners could demonstrate their ability and commitment to finance the deal to Investorcorp and Goldman Sachs.
Flexibility and optionality: using staple-on financing gave Berkshire Partners some flexibility and optionality in choosing the final capital structure of the deal, as they could modify or replace some or all of the staple-on financing with their own financing sources if they found better terms or conditions.
Disadvantages:
Cost and conflict: using staple-on financing increased the cost and conflict