UVA-F-1353
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This case was prepared from publicly available information by Jessica Chan under the supervision of Professor Robert F. Bruner. The financial support of the Batten Institute is gratefully acknowledged. T
his case was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2001 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenpublishing. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Rev. 10/02. ◊
NIKE, INC.: COST OF CAPITAL
On July 5, 2001, Kimi Ford, a portfolio manager at NorthPoint Group, a mutual fund management firm, pored over analyst write-ups of Nike, Inc., the athletic shoe manufacturer. Nike’s share price had declined significantly from the start of the year. Kimi was considering buying some shares for the fund she managed, the NorthPoint Large-Cap Fund, which invested mostly in Fortune 500 companies with an emphasis on value investing. Its top holdings included ExxonMobil, General Motors, McDonald’s, 3M and other large-cap, generally old-economy stocks. While the stock market declined over the last 18 months, NorthPoint Large-Cap had performed extremely well. In 2000, the fund earned a return of 20.7 percent even as the S&P 500 fell 10.1 percent. The fund’s year-to-date
returns at the end of June, 2001 stood at 6.4 percent versus the S&P 500’s minus 7.3 percent.
Only a week ago, on June 28, 2001, Nike held an analysts’ meeting to disclose its fiscal year 2001 results 1. However, the meeting had another purpose: Nike management wanted to communicate a strategy for revitalizing the company. Since 1997, Nike’s revenues had plateaued at around $9 billion, while net income had fallen from almost $800 million to $580 million (see Exhibit 1). Nike’s market share in U.S. athletic shoes had fallen from 48 percent in 1997 to 42 percent in 2000.2 In addition, recent supply-chain issues and the adverse effect of a strong dollar had negatively affected revenue. At the meeting, management revealed plans to address both top-line growth and operating performance. To boost revenue, the company would develop more athletic shoe products in the mid-priced segment 3 – a segment that it had overlooked in recent years. Nike also planned to push its apparel line, which, under the recent leadership of industry veteran Mindy Grossman 4 had performed extremely well. On the cost side, Nike would exert more
1
Nike’s fiscal year ended in May.
2 Robson, Douglas, “Just Do…Something: Nike’s insularity and foot-dragging have it running in plac
e”, Business Week , July 2, 2001
3
Sneakers in this segment sold for $70-$90 a pair. 4
Mindy Grossman joined Nike in September 2000. She was the former president and chief executive of Jones Apparel Group's Polo Jeans division.
effort on expense control. Finally, company executives reiterated their long-term revenue growth targets of 8-10 percent, and earnings growth targets of above 15 percent.
Analyst reactions were mixed. Some thought the financial targets to be too aggressive; others saw significant growth opportunities in apparel and in Nike’s international businesses.
Kimi Ford read all the analyst reports that she could find about the June 28 meeting, but the reports gave her no clear guidance: a Lehman Brothers report recommended a ‘Strong Buy’ while UBS Warburg and CSFB analysts expressed misgivings about the company and recommended a ‘Hold’. Kimi decided instead to develop her own discounted-cash-flow forecast to come to a clearer conclusion.
Her forecast showed that at a discount rate of 12 percent, Nike was overvalued at its current share price of $42.09 (see Exhibit 2). However, she had done a quick sensitivity analysis that revealed Nike was under valued at discount rates below 11.2 percent. Since she was about to go into a meeting, she requested her new assistant, Joanna Cohen, to estimate Nike’s cost of capital.
Joanna immediately gathered all the data she thought she might need (Exhibits 1 through 4) and set out to work on her analysis. At the end of the day, she submitted her cost of capital estimate and a memo (Exhibit 5) explaining her assumptions to Ms. Ford.
Exhibit 1
NIKE, INC.: COST OF CAPITAL
Consolidated Income Statements
Year Ended May 311995199619971998199920002001 (In millions except per share data)
Revenues4,760.86,470.69,186.59,553.18,776.98,995.19,488.8 Cost of goods sold2,865.33,906.75,503.06,065.55,493.55,403.85,784.9 Gross profit1,895.62,563.93,683.53,487.63,283.43,591.33,703.9 Selling and administrative1,209.81,588.62,
303.72,623.82,426.62,606.42,689.7 Operating income685.8975.31,379.8863.8856.8984.91,014.2 Interest expense24.239.552.360.044.145.058.7 Other expense, net11.736.732.320.921.523.234.1 Restructuring charge, net---129.945.1(2.5)-Income before income taxes649.9899.11,295.2653.0746.1919.2921.4 Income taxes250.2345.9499.4253.4294.7340.1331.7 Net income399.7553.2795.8399.6451.4579.1589.7 Diluted earnings per common share 1.36 1.88 2.68 1.35 1.57 2.07 2.16 Average shares outstanding (diluted)294.0293.6297.0296.0287.5279.8273.3
Growth (%)
Revenue35.942.0 4.0(8.1) 2.5 5.5 Operating income42.241.5(37.4)(0.8)15.0 3.0 Net income38.443.9(49.8)13.028.3 1.8
Margins (%)
Gross margin39.640.136.537.439.939.0 Operating margin15.115.09.09.810.910.7 Net margin8.58.7 4.2 5.1 6.4 6.2
Effective tax rate (%)*38.538.638.839.537.036.0
*The U.S. statutory tax rate was 35%. The state tax varied yearly from 2.5% to 3.5%.
Source: Company's 10-K SEC filing, UBS Warburg
Exhibit 2
NIKE, INC.: COST OF CAPITAL
Discounted Cash Flow Analysis
2002200320042005200620072008200920102011 Assumptions:
Revenue growth (%)7.0 6.5 6.5 6.5 6.0 6.0 6.0 6.0 6.0 6.0 COGS/Sales (%)60.060.059.559.559.059.058.558.558.058.0 S&A/Sales (%)28.027.527.026.526.025.525.025.025.025.0 Tax rate (%)38.038.038.038.038.038.038.038.038.038.0 Current assets/Sales (%)38.038.038.038.038.038.038.038.038.038.0 Current liabilities/Sales (%)11.511.511.511.511.511.511.511.511.511.5 Yearly depreciation and capex equal each other.
Cost of capital (%)12.0
Terminal value growth rate (%) 3.0
Discounted Cash Flow
Operating income1,218.41,351.61,554.61,717.01,950.02,135.92,410.22,554.82,790.12,957.5 Taxes463.0513.6590.8652.5741.0811.7915.9970.81,060.21,123.9 NOPAT755.4838.0963.91,064.51,209.01,324.31,494.31,584.01,729.91,833.7 Capex, net of depreciation----------Change in NWC8.8(174.9)(186.3)(198.4)(195.0)(206.7)(219.1)(232.3)(246.2)(261.0) Free cash flow764.1663.1777.6866.21,014.01,117.61,275.21,351.71,483.71,572.7 Terminal value17,998.7 Total flows764.1663.1777.6866.21,014.01,117.61,275.21,351.71,483.719,571.5 Present value of flows682.3528.6553.5550.5575.4566.2576.8545.9535.06,301.5 Enterprise value11,415.7
Less: current outstanding debt1,296.6
Equity value10,119.1
Current shares outstanding
Equity value per share at 12%Current share price:
Exhibit 3
NIKE, INC.: COST OF CAPITAL
Consolidated Balance Sheets
May 31,
As of20002001 (In millions)
Assets
Current Assets:
margin rateCash and equivalents254.3
$
$ 304.0 Accounts receivable1,569.41,621.4 Inventories1,446.01,424.1 Deferred income taxes111.5113.3 Prepaid expenses215.2162.5 Total current assets3,596.43,625.3 Property, plant and equipment, net1,583.41,618.8 Identifiable intangible assets and goodwill, net410.9397.3 Deferred income taxes and other assets266.2178.2 Total assets5,856.9
$
$ 5,819.6
Liabilities and shareholders' equity
Current Liabilities:
$ 5.4
$
Current portion of long-term debt50.1
Notes payable924.2855.3 Accounts payable543.8432.0 Accrued liabilities621.9472.1 Income taxes payable-21.9 Total current liabilities2,140.01,786.7 Long-term debt470.3435.9 Deferred income taxes and other liabilities110.3102.2 Redeemable preferred stock0.30.3 Shareholders' equity:
Common stock, par 2.8 2.8 Capital in excess of stated value369.0459.4 Unearned stock compensation(11.7)(9.9) Accumulated other comprehensive income(111.1)(152.1) Retained earnings2,887.03,194.3 Total shareholders' equity3,136.03,494.5 Total liabilities and shareholders' equity5,856.9
$
$ 5,819.6 Source: Company 10-K SEC filing.
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