Restore Medical, Inc. Restore Medical, Inc. manufactured and marketed its patented Pillar, a palatal implant system. The system was a minimally invasive medical device which was used to treat the soft palate component of sleep-disordered breathing, including obstructive sleep apnea (OSA) and snoring. In the Pillar system, a physician implanted three small polyester inserts into the muscle of the soft palate. The implants added structural support to stiffen the soft palate, thereby minimizing or eliminating the palatal tissue vibration and obstruction of the upper airway that could cause snoring or sleep apnea. There was a large market for the device. A 2018 American Medical Association study found that one in five adults, or about 44 million people suffer from mild OSA and that 1 in 15 adults, or about 15 million people, suffered from moderate to severe OSA OSA sulferers experienced frequent interruptions in sleep, which could result in excessive daytime sleepiness, memory loss, lack of concentration, depression and irritability. OSA was linked to more serious health consequences, including cardiovascular disease, high blood pressure, stroke, and Type II diabetes. In addition to the U.S. market, there were an estimated 20 million with OSA in western Europe, 57 million in China and 47 million in India, A report of the American Academy of Otolaryngology estimated that 1 in four adults, of 55 million people, suffer from habitual snoring. (There is overlap between people suffering from OSA and snoring) The Company The Pillar system was approved by the FDA for snoring in 2002 and form mild to moderate OSA in 2004. The system received certification from the European Commission for snoring in 2003 and for OSA in 2004. Restore Medical products were marketed in 20 countries through independent distributors in North and South America, Asia, Europe and the Middle East. Most recently, Restore focused on the higher margin U.S. business, reducing international initiatives. The international independent distributors could market other devices, as well as the Pillar system, but they were not permitted to simultaneously market competing devices. The Pillar system was Restore's only product, providing all of its revenues. Competition Restore's primary competitors were producers of CPAP and other sleep apnea therapeutic devices. Respironics, a subsidiary of Philips Healthcare, and ResMed, were the primary manufacturers of CPAP devices, with a combined 80% market share. Other CPAP competitors include Fisher \&. Paykel Healthcare Corp., Nelicor Puritan Bennett, a subsidiary of Tyco, and Vital Signs, Inc. The industry beta was 1.65 , which reflected an average debt/equity ratio of 10% and a tax rate of 30%. Restore's Prospects Restore aimed for a steady 20% growth in sales for the next five years, then 10% growth for the following five years. Restore had received an offer of $60 million for its equity, In other words, the firm's long term debt and current portion of long-term debt would need to be paid first, and then the buyer would purchase Restore. A typical cost of debt was 5%. The buyer realized that Restore had negative income, primarily due to his high expenses in the past. The buyer expected to make Restore more efficient, achieving a cost of goods sold, not including depreciation, would be 25% of sales in the future and selling. general and administrative expenses 43% of sales, Depreciation was 4% of sales, and the firm's tax rate was 24%. Restore had an unusually large amount of cash on its balance sheet which was considered to be excess cash, and not necessary to ongoing operations. Current assets, without cash, were 40% of sales and current liabilities, without debt due in one year, were 32% of sales, both Restore's historical averages. Plant, property and equipment was 22.2% of sales, also Restore's historical average. The long-term Treasury bond rate was 2.5%. A typical market risk premium was 6%. Restore's current share price was $5.44. Additional financial information needed for the analysis is contained in the Excel exhibits, as is information about Restore's competitors. 1. What is an appropriate discount rate for Restore/Pillar, assuming a 10 -year time period? Assume that Restore's capital structure weights and tax rate will remain the same after it is purchased and that the beta of debt is 0 . 2. What is the value per share of Restore assuming the project will last for 10 years? Determine the appropriate free cash flows and discount by weighted average cost of capital. Calculate the price per share under these assumptions? 3. Suppose the Pillar system can be produced beyond 10 years. What is the value of Restore assuming an infinite time horizon? Use a 2% perpetual growth for sales in year 11 in your base case. 4. What would be the value of Restore using comparable multiples analysis? Submit questions 5&6 in section 6.3 Assignments after this case: 5. To which factors should you show sensitivity? What range of values would you get if you performed a sensitivity analysis? 6. Restore was offered $60 million to purchase the firm, net of debt. In other words, a firm was willing to pay $60 million for Restore's equity. Is this a reasonable price? Before reviewing your response, consider under what assumptions in your model would you be happy with this price. 1. To which factors should you show sensitivity? What range of values would you get if you performed a sensitivity analysis? Choose 3 factors to which to show sensitivity, and perform the analysis. Your deliverable will be a spreadsheet with 1 tab for each sensitivity analysis. 2. First, briefly explain (a sentence or two) why you chose the factors that you did in question 1. Second, in the same word doc, determine an appropriate price for Restore. Restore was offered $60 million to purchase the firm, net of debt. In other words, a firm was willing to pay $60 million for Restore's equity. Is this a reasonable price? Before reviewing your response, consider under what assumptions in your model would you be happy with this price. Use both your DCF and comparables valuation to answer this question. Your deliverable will be a word doc with the answers to question 2. Assumptions needed for Analysis Base case assumptions 1. Sales growth will be at rates stated in case Years 1-5 20% Years 610 10% 2. Terminal year (year 11 ) sales growth will be 2% 3. Cost of goods sold will be 25%. 4. SG\&A will be 43%. 5. Depreciation is 4% of sales, the average from Restore's income statement 6. Taxes are 24%. Medtronics average tax rate 7. Current assets without cash are 40% sales, Restore's historical average 8. Current liabilities (without long term debt due in one year) are 32% of sales, Restore's historical average 9. Plant, property and equipment is 22.2% of sales, Restore's historical average Read Only - This is an older file format. Changes can only be saved to a copy of the file. Enter text or formula here \begin{tabular}{|c|c|c|c|} \hline A & B & C & D \\ \hline \multicolumn{4}{|c|}{ Restore Medical Competitors } \\ \hline & 2018 & 2019 & \\ \hline \multicolumn{4}{|l|}{ Covidien COV } \\ \hline Sales & 8318 & 8895 & \\ \hline Assets & 14108 & 18328 & \\ \hline Book Value equity & 8621 & 6742 & \\ \hline Stock price & NA & 44.29 & \\ \hline Number of shares & 495.07 & 497.53 & \\ \hline EPS & 2.33 & -0.69 & \\ \hline Net Income & 1155 & -342 & \\ \hline \end{tabular} \begin{tabular}{|l|r|r|} \hline RedMed Corp. RMD & & \\ \hline Sales & 607 & 716 \\ \hline Assets & 1012.92 & 1252.04 \\ \hline Book Value equity & 738.15 & 931.22 \\ \hline Stock price & 49.22 & 52.53 \\ \hline Number of shares & 75.67 & 77.62 \\ \hline EPS & 1.18 & 0.85 \\ \hline Net Income & 88.21 & 66.3 \\ \hline \end{tabular} \begin{tabular}{|l|r|r|} \hline ArthroCare Corp. ARTC & & \\ \hline Sales & 263 & 319.24 \\ \hline Assets & 375.05 & 450.07 \\ \hline Book Value equity & 228.89 & 322.5 \\ \hline Stock price & 39.92 & 48.05 \\ \hline Number of shares & 25.25 & 27.39 \\ \hline EPS & 1.25 & 1.58 \\ \hline Net Income & 31.68 & 43.18 \\ \hline \end{tabular} fx19.568000793457