HBS Case: Threshold Sports

Harvard Business School Case : Threshold Sports
Cycling Market
Europe

* Popular as amateur and professional sports
* Well supported

1. Prestigious Tour de France
2. 1 billion viewers

United States

* Growing in popularity as a professional sport
* Lack of community support and organization
* Growing interest due to cycling icon

1. Greg LeMond
2. Lance Armstrong

S.W.O.T Analysis
Strengths
Management experience

* Cycling
* Event planning
* Contacts
* Over 100 professional cycling events

Current sponsorship agreements

• First Union Series, BMC Software Grand Prix, U.S. PRO Cycling Tour

• Event-staging equipment Acquired for less than 1/3 of the value

Weaknesses

* New Company: 3 months old
* Management has limited experience in finance
* Financing needed for first growth phase
* Identification for potential investors/banks
* No tangible assets

Opportunities

* First movers to emerge in the United States
* To become a household name – “branding”
* Growth potential

Interest by spectators – the next “NASCAR”
Expansion across the U.S.

* Selling more sponsorships
* Expansion of TV coverage
* Developing new revenue streams
* Potential profit growth

31.17% in 2001
15.47% in 2002
Threats

* Risk of competitors gaining the advantage
* Loss of market share
* Being taken over by an umbrella organization
* Cycling does not gain popularity

Lack of investors
Lack of marketing

Growth Plans
* Create financing need for Threshold Sports
– Estimated need of $500,000 for upcoming expenses
– Growth plan consists of emerging European style cycling events into the US market

Issues Facing Valuation

* New firm
* No tangible assets
* Limited comparable companies

Possible Valuation Methods
EBITDA

* EBITDA multiplier for private companies = 6.0
* EBITDA multiplier average for comparable companies based on the industry for fiscal yr 1999 = 17.35
* Comparable company with a positive EBITDA

– Cordiant Communications Group
– 15.09
Valuation based on EBITDA
$14,743,000
P/E Multiples of Comparable Companies
Valuation based on P/E multiple
$32,004,000
Discounted Cash Flow
Key assumptions:
Rf = 6.04%
Βeta = 1.2
Rm = 15.04%
Re = 16.84%
Valuation of Threshold based on DCF method
$4,337,000

Financing
FRICTO Analysis of Debt Financing
Flexibility
– Not flexible, but customizable
Risk
– Risk off-set by a higher interest rate by the bank
– It is a risky loan for the bank
Income
– Structured into the loan, coupon payments, lump sum payment, etc.

FRICTO Analysis of Debt Financing
Control
– Founders can keep control
Timing
– Timing can affect the interest rate, not as important as other 2 options
Other
– Can default on loan, bankruptcy, debt restructuring
Valuation of Debt Financing
Tax shield value = $135,511
Value of Threshold Sports = $4,473,000

FRICTO Analysis of Issuing Common Stock
Flexibility
– Liquid – easy to change ownership

Risk
– Higher Risk for investor
– If company goes bankrupt, common stock holders are behind bond holders in line for assets

Income
– Capital appreciation
– Dividend

Control
– Owner of company with voting rights
– Founders will lose some control
– If they wanted to keep control, they can sell 49% of the company as long as they all vote the same

Timing
– Best to offer stock when company has strong financials and positive outlook, this way they can raise the max. capital

Other
– Financial statement implications, looks better than debt


The added value to the company is the equity received from the stock issue
$4,837,300

FRICTO Analysis of Issuing Convertible Preferred Stock
Flexibility
– Pre-established terms state that it could be converted into common stock
– Preferred stock = 1.5 units of common stock executable at the strike price

Risk
– If company fails preferred stock holders may lose some initial investment
– Increase in interest rate
– Company risk

Income
– 10% dividend on par value that will accrue and be payable on a cumulative and noncumulative basis

Control
– Holders of convertible preferred stock do not have voting rights
– Control remains in the hands of the founders
– If the preferred stock holder wants to sell, first must offer to the company for a buy back and then to existing preferred stockholders

Timing
– Interest rate sensitive; not ideal to offer during increasing interest rates
Other
– Tax disadvantage/No tax shield offered
– Taxed as personal income, not as a business expense

Value of the Preferred stock
– $4,176,000
– Deducted discounted dividend payments from the discounted cash flows

Convertible Preferred Stock
Convertible preferred stock has an embedded option that allows the holder to exchange each preferred share for a specified number of common shares. Convertible preferred is usually callable. This allows the issuers to call the stock and force preferred shareholders to choose between accepting either par value or common shares. This is called a conversion-forcing call.

Option #1

* Find a corporate partner to provide capital in the form of a loan
* For collateral on the loan issue the lending company common stock
* This will provide a tax shield to Threshold Sports and allow them to retain majority control of the company

Option #2

* Issue convertible preferred stock

Recommendation
Convertible preferred stock

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