RuffCo – Buying And Selling The Troubled Company by Houlihan Lokey
RuffCo, Inc. (“RuffCo” or the “Company”), a Delaware corporation based in Los Angeles, California, designs, manufactures and sells golf clubs. RuffCo was founded in 1990 by Charles Ruff, a local golf professional and renowned trick-shot artist with two children, Charles Junior (known simply as “Son”) and Daughter. Charles Senior (“Father”), who claims an 8 handicap, is now 62 years old and oversees nearly all aspects of daily operations. Son, a recent business school graduate with a 2 handicap, heads the Company’s sales and marketing function. The corporation is family-owned: 75% by Father and 12.5% each by Son and Daughter (who, preferring tennis to golf, plays no active management role in the Company). An old family friend, Frank Numbers, is the Company’s CFO and Controller, but owns no equity in RuffCo. The Board consists of Father (Chairman), Son, Daughter, Numbers and one outside director, John Moneybags. Moneybags, who sports a 7 handicap, is a former senior official at the bank (the “Bank”) where RuffCo has its asset-based debt facilities.
RuffCo distributes its products, principally fairway woods, through a network of more than 25 distributors across the U.S. and Japan. RuffCo buys raw materials (e.g., titanium and other metals) and component parts (e.g., shafts and grips) from select high-quality vendors. The Company’s distributors sell RuffCo’s products to both on- and off-course golf shops and select sporting goods retailers.
Business Description and Historical Results
RuffCo prides itself on its bootstrap beginnings: Father was teaching golf at a local public course and spent his free hours designing a club head with a shallower, harder face and lower center of gravity. This combination produced a fairway wood that allowed the weekend golfer to hit longer, more consistent shots out of the rough. The design also produced higher, straighter shots from the fairway. After conferring with local engineers and patenting the essential design aspects, Father made several dozen test samples of his new club, called the “Ruffhouser,” and started selling the clubs door-to-door at local golf clubs out of the trunk of his car. From these beginnings, the Company’s reputation and sales grew, not from heavy advertising or professional sponsorship, but by word-of-mouth among professionals and players at the local clubs Father had visited and revisited many times.
Despite its $250-plus price tag, the Ruffhouser line of fairway woods was well-positioned by the Company and its advertisers as “the working man’s clubs for the guy in the rough.” The line enjoyed huge popularity at public courses, pro shops and regional specialty stores. Ruffhouser, however, faced problems in larger retail golf outlets because the stores were reluctant to give the relative niche product (fairway woods) much shelf space in favor of companies that provided full sets of clubs.
During the 1990s and early 2000s the popularity of golf surged and Father sought to capitalize on the trend. Father expanded his scope from Southern California across the country by entering into exclusive distributorship agreements with golf club distributors that sold clubs to on- and off-course pro shops. Like many other club manufacturers, the Company experienced strong annual growth in sales and profitability. By 2007, the Company had grown from its humble beginnings to an expected $130 million in annual sales.
Until 2005, the Company engaged in limited manufacturing, relying heavily on contract manufacturers. In 2005, however, Father decided to bring all manufacturing in-house and planned to move to a new, custom-designed headquarters/manufacturing facility that was completed at year-end. Father owns the land and building and leases it to RuffCo, which owns all the manufacturing equipment, financed by an equipment loan from its traditional asset-based lender, the Bank. In 2006, RuffCo purchased the lot adjacent to Father’s and constructed a state-of-the-art packing and distribution warehouse that was integrated with the manufacturing operation. Such expenditures were financed with additional loans provided by the Bank. The Company’s balance sheet, reflecting its new debt facilities, is illustrated in table 2.
In the summer of 2007, Thomas Slick III, an investment banker, took Son out for drinks and a steak dinner to pitch him the idea of an “important transaction” for RuffCo. Slick refused to divulge the specifics of his plan until he met with Father, but outlined for Son the financial ramifications of his proposal.
Slick began by providing a back-of-the-envelope valuation of RuffCo and of Son’s stake in the Company. Assuming RuffCo would meet its budget of $20 million of earnings before interest, taxes, depreciation and amortization (EBITDA) for the full year of 2007, Slick applied a comparable company-based multiple of 7x (approximately 80% of the median of the comparable public company multiples), arriving at an Enterprise Value of $140 million (the market multiples valuation technique is described in more detail later). Slick subtracted the Company’s expected year-end interest-bearing debt of $55.6 million to arrive at an equity valuation of $84.4 million. As the owner of 12.5% of RuffCo, Son’s share of the Company in 2007 was worth approximately $10.6 million. Assuming a 15% annual EBITDA growth rate, Slick suggested that in two years Son’s stake could be expected to grow to almost $14 million. “Not bad,” said Son. “Not bad at all,” replied Slick. However, he reminded Son that his minority stake in the privately held company was extremely illiquid. Slick explained that the best way to achieve liquidity was to establish a public market for the shares of the Company through an initial public offering (IPO) of RuffCo shares. In order to help maximize the value that investors place on an IPO, Slick counseled, RuffCo would need a plan to show both immediate and long-term growth possibilities. Since Son admitted that RuffCo’s internal growth was waning, Slick suggested that the Company use the proceeds of an IPO to grow through acquisition.
At this point, Slick told Son that he could present RuffCo with an opportunity to purchase a compatible golf club manufacturer that, combined with RuffCo, would produce pro forma 2007 sales of $166 million and EBITDA of $27.2 million. Although Slick assured Son that the target company had a new product that would enable its operating cash flow (EBITDA) to grow more than 25% annually over the next few years, Slick said that even if (as a conservative estimate) the combined Company’s EBITDA grew at RuffCo’s projected 15% per year over the next two years, it would produce EBITDA of $36 million in 2009. (Slick focused on 2009 because in 2008 the target’s significant marketing costs associated with its new product would depress the target company’s true profitability.) Slick explained that, given its greater size and liquid publicly traded shares, the combined company could fetch a multiple of approximately 8x its EBITDA for an Enterprise Value of “at least” $288 million in 2009, a mere two years away. Then, Slick subtracted interest-bearing debt of $88.6 million (which he assumed to remain constant following the proposed acquisition and IPO) from the Enterprise Value to arrive at a 2009 equity value of $199.4 million. Although an IPO offering 30% of the Company to the public would decrease Son’s stake to 8.75% of