Thalassa Cosmetics Corporation

Reminder of information disclosed in your first assignment:

Flora Diaz and Joel Tanu met in 2008 on Vancouver Island. They were both students. Flora studied computer science. Joel studied marine biology.

Avid kayakers, they admired the richness of marine life. During his studies, Joel discovered algaes amazing properties. Hearing Flora complain about skincare products price and lack of efficiency, Joel decided to research possible applications of algae to cosmetics. After few months of promising tests, Joel developed a moisturizing cream for sensitive skins using a special mix of algae. First users were impressed by the light texture of the cream, as well as the lasting comfort and protection it provided. Realizing the potential of this product, Flora and Joel founded Thalassa Cosmetics Corp.

The success was immediate. The demand for organic skincare products was growing fast, and while most of their competitors focussed on organic plant-based formulas, few proposed organic algae-based products. Thalassa Cosmetics also committed to a socially and environmentally responsible philosophy without compromising a rigorous scientific approach. From the start, Flora and Joel strived to create lasting value and benefits for their clients, build up customers loyalty and brand recognition.

Flora and Joel turned their kitchen into a production lab, and started to sell their products online and at local farmers markets.

In 2009, impressed by the new venture promising debuts, Pine Tree Venture Capital invested $700,000 into Thalassa Cosmetics. This first round of external equity financing allowed the two founders to develop their product line, expand their production facilities, and improve their website and direct sales electronic platform. They opened their first store in Victoria B.C.

In 2017, the firm had 60 stores (company-owned and franchises) in Canada.

In 2017, Gaia International Holding, a global group specialised in investing in cosmetics and specialist-multi and online retails, bought Pine Trees stake in Thalassa Cosmetics and contributed an additional $37 million dollar to Thalassas equity capital. Gaia International became Thalassa Cosmetics main shareholder. Flora and Joel still hold 28% of the voting rights and keep playing a crucial role in the management of the firm.

Based on Thalassa Cosmetics past and expected performance, Gaia Internationals CEO considers that Thalassa Cosmetics could go public (IPO) in less than 5 years.

Intrigued by Thalassa Cosmetics success you researched the firm further and found the following information:

Thalassa Cosmetics success is mainly attributed to its consistency, agility and creativity:

. Strong research and development team

. Effective marketing and sales online-campaigns using Thalassas well-referenced website and products endorsement by star bloggers

. Ability to offer exciting experiences to store-customers, generate top of the industry store traffic and support both store- and online-sales.

	Percentage of total sales (2017)
In-store sales	40%
Online sales	50%
Direct sales (via cosmetics consultants)	5%

These percentages have been stable for the last 5 years.

Gaia International Holding shares Flora and Joels values and their vision for the future development of the firm. Gaia is renowned for its international expertise and its use of innovative technologies (e.g. AI, blockchain ). Gaia also intends to pursue Thalassa omni-channel sales strategy: online sales are expected to grow at a rapid pace in the coming years (40% annual sales growth according to experts). Baby-boomers, the Z-generation as well as teenagers keep enjoying their visits to stores and in-person contact. Surprisingly, online sales growth is not expected to cannibalize in-store sales. Quite the opposite. Key players in the industry are developing integrated online and in-store experiences to create more value for customers.

Financial analysts predict that in spite of an intense competition, Thalassa Cosmetics strategy will keep generating above industry average growth rates in the coming years (30% to 40% annual sales growth rate).

To develop their operations in the US, Thalassa Cosmetics also intends to invest $28,000,000 in new manufacturing equipment, storage and shipping facilities close to the US border. They are also considering the acquisition of a complementary fast growing small American retailer in the coming years.

According to some analysts, the economic outlook for North America is positive, and interest rates are expected to remain low (the yield curve is normal: the spread between short term and long term interest rates is only 0.6%). Other analysts are more cautious and expect a possible interest rate increase in the coming months. Unless told otherwise assume that all numbers in this case study are in Canadian dollars. Assume a world with no pandemic threat.

Question 1 LEASING (12 marks)

For percentages, use 4 decimals: example 0.0562 = 5.62% (to change the number of decimals displayed on your calculator: press 2^nd Format). Round dollars amounts to the nearest dollar (no decimals).

In our previous assignment, we considered the replacement of Thalassa Cosmetics existing packaging equipment by a new machine, the PACK-2075-XL. In what follows, assume that the projects NPV is positive.

Now, Thalassas CFO is considering two financing alternatives:

(1) Borrow and purchase the new equipment. Thalassa could obtain a 7 year-loan at 6.3% from its bank for 100% of the equipment cost ($1,065,000).

(2) Lease the new equipment from Vancouver Leasing Corporation (VLC).

VLCs tax rate is 35%. Its WACC is equal to 9.2%. VLC could obtain a 7-year loan at 4.2%.

Thalassas WACC is equal to 12.5%, the marginal tax rate is 30%, and the CCA rate is 30%.

The new equipment will have an estimated useful life of 7 years and an estimated salvage value of $275,000 (in 7 years). The annual lease payment would be $163,400 (payment due at the beginning of each of the next 7 years). Under the proposed contract, the lessor will pay for maintenance ($20,000 annual cost, payable at year-end).

Based on the data provided in this question, should Thalassa Cosmetics lease the PACK-2075-XL? Show all calculations needed to support your answer otherwise marks will be deducted. Type you answer hereafter.

Question 2 Capital structure decision no calculations needed maximum 300 words (12 marks)

Based on information provided in the case (pages 1, 2 and 6 from this case study), on material studied in class, assuming that you are a potential investor, identify, and briefly explain two possible concerns regarding Thalassa Cosmetics financial debts.

Then, assume that you are Thalassa Cosmetics Chief Financial Officer and briefly explain how you would address potential investors worries.

Type your answers hereafter.

Question 3 Dividend policy no calculations required maximum 200 words. (12 marks)

Financial analysts predict that in spite of an intensified competition, Thalassa Cosmetics positioning will allow the firm to keep experiencing above industry average growth rates in the coming years (30% to 40% annual sales growth rate). Based information provided in the case (page 1,2 and 6 from this case study) and on the material studied in class, describe two possible advantages and two possible disadvantages of Thalassa Cosmetics distribution policy from investors viewpoint? Assume that the industry average dividend payout ratio is 30%.

Type your answer hereafter.

Question 4 Valuation Capital structure decision maximum 50 words (4 marks)

Thalassa Cosmetics is a private company (not listed). If you wanted to compare Thalassa Cosmetics total equity value to a comparable publicly listed company, which ratio would you use: Price-earning ratio or EBITDA multiple? Briefly explain your choice. No calculations required.

PE ratio = Stock price / EPS = total market value of equity / Net Income

EBITDA multiple = Total market value of equity / EBITDA

Type your answer hereafter.

{in $, thousands) Sales Cost of Goods sold Distribution expense Administrative expense Interest expense Earnings before taxes Taxes (30%) Net Income Thalassa Cosmetics Corp. Income statement for year ended December 31st, pro forma 2020 2019 Sales 2018 Sales 249,175 191,673 150,279 114,629 88,673 46.3% 65,511 43.6% 56,196 41,627 21.7% 35,743 23.8% 32,77 25,136 13.1% 20,443 13.6% 3,467 3,474 2,535 42, 205 32,763 26,047 12,662 9,829 7,814 29,544 22,934 18,233 2017 Sales 109,824 47,880 43.6% 25,697 23.4% 14,310 13.0% 3,076 18,861 5,658 13,203 Cash and equivalent Short-term investments Accounts receivable Inventories Other current assets Net Fixed Assets Total Assets Thalassa Cosmetics Corp. Balance Sheet es at December 31st, pro forma 2020 2019 Sales 2018 Sales 628 0.3% 447 0 0 37,376 34,431 18.0% 23,787 15.8% 49,835 49,994 26.1% 43,529 29.0% 16,184 12,449 6.5% 11,176 7.4% 114,254 76,254 39.8% 59,284 39.4% 218,465 173,756 138,28 2017 Sales 311 0 12,165 11.1% 30,368 27.7% 9,075 8.3% 40,880 37.2% 92,799 (in $, thousands) Accounts payable Short term debt Accruals Other current liabilities Long-term debt Shareholders' equity Total Lishtities and SE* pro form 2020 23,590 46,677 5,824 7,921 6,666 115,329 206,007 2019 Sales 18,146 9.5% 46,677 24.4% 4,480 2.3% 6,093 3.2% 6,666 3.5% 91,694 47.8% 173,756 2018 Sales 12,099 8.1% 25,623 17.1% 3,656 2.4% 5,686 3.8% 4,524 3.0% 86,635 57.6% 138,223 2017 Sales 11,150 10.2% 32,182 29.3% 3,080 2.8% 3,539 3.2% 7,788 7.1% 35,060 31.9% 92,799 2019 27.5% 2018 36.8% 2017 Industry average 38.0% Sales growth rate 20% 20% 20% 31% 22% 43% 42% 0.6 0.8 0.4 1.1 DIV Payout Debt ratio Quick Ratio CR DSO INV T/O F.A.T/O 1.7 1.3 66 1.0 40 1.9 52 58 1.8 1.5 1.6 1.5 2.5 2.5 2.7 1.9 TAT 1.1 1.1 1.2 1.2 PM ROE ROA EBITDA multiple PE ratio 12.0% 25.0% 13.2% 12.1% 21.0% 13.4% 12.0% 37.7% 14.4% 9.7% 20.0% 11.7% 10 to 12 times 17 to 24 times {in $, thousands) Sales Cost of Goods sold Distribution expense Administrative expense Interest expense Earnings before taxes Taxes (30%) Net Income Thalassa Cosmetics Corp. Income statement for year ended December 31st, pro forma 2020 2019 Sales 2018 Sales 249,175 191,673 150,279 114,629 88,673 46.3% 65,511 43.6% 56,196 41,627 21.7% 35,743 23.8% 32,77 25,136 13.1% 20,443 13.6% 3,467 3,474 2,535 42, 205 32,763 26,047 12,662 9,829 7,814 29,544 22,934 18,233 2017 Sales 109,824 47,880 43.6% 25,697 23.4% 14,310 13.0% 3,076 18,861 5,658 13,203 Cash and equivalent Short-term investments Accounts receivable Inventories Other current assets Net Fixed Assets Total Assets Thalassa Cosmetics Corp. Balance Sheet es at December 31st, pro forma 2020 2019 Sales 2018 Sales 628 0.3% 447 0 0 37,376 34,431 18.0% 23,787 15.8% 49,835 49,994 26.1% 43,529 29.0% 16,184 12,449 6.5% 11,176 7.4% 114,254 76,254 39.8% 59,284 39.4% 218,465 173,756 138,28 2017 Sales 311 0 12,165 11.1% 30,368 27.7% 9,075 8.3% 40,880 37.2% 92,799 (in $, thousands) Accounts payable Short term debt Accruals Other current liabilities Long-term debt Shareholders' equity Total Lishtities and SE* pro form 2020 23,590 46,677 5,824 7,921 6,666 115,329 206,007 2019 Sales 18,146 9.5% 46,677 24.4% 4,480 2.3% 6,093 3.2% 6,666 3.5% 91,694 47.8% 173,756 2018 Sales 12,099 8.1% 25,623 17.1% 3,656 2.4% 5,686 3.8% 4,524 3.0% 86,635 57.6% 138,223 2017 Sales 11,150 10.2% 32,182 29.3% 3,080 2.8% 3,539 3.2% 7,788 7.1% 35,060 31.9% 92,799 2019 27.5% 2018 36.8% 2017 Industry average 38.0% Sales growth rate 20% 20% 20% 31% 22% 43% 42% 0.6 0.8 0.4 1.1 DIV Payout Debt ratio Quick Ratio CR DSO INV T/O F.A.T/O 1.7 1.3 66 1.0 40 1.9 52 58 1.8 1.5 1.6 1.5 2.5 2.5 2.7 1.9 TAT 1.1 1.1 1.2 1.2 PM ROE ROA EBITDA multiple PE ratio 12.0% 25.0% 13.2% 12.1% 21.0% 13.4% 12.0% 37.7% 14.4% 9.7% 20.0% 11.7% 10 to 12 times 17 to 24 times