When Wayne concocted his cleaning compound some 20 years ago, all that his wife, Corrine, and he were trying to do was to come up with a sweeter, gentler yet tougher, cleaning product. Little did he realize that someday he would be the proud owner of a multimillion-dollar firm debating whether or not to sell stock to the public?

After having peddled vacuum cleaners and floor wax products at state fairs and trade shows throughout the Midwest, Wayne and Corrine Goodman realized that there was a dire need for a cleaning and polishing product that was free from harsh chemicals, environmentally friendly, and tough on dirt and grime. Wayne spent many hours in his garage at their country home in Chesterton, Indiana, experimenting with various oils, cleansing agents, and extracts until he finally came up with what he proudly calls The perfect cleaner and polish. It was the pure citrus oil made from the peels of Valencia oranges that did the trick. Not only was the mixture sweet smelling, it was an effective solvent and degreaser that worked wonders on their kitchen cabinets at home.

Spurred on by their close friends, the Goodmans formed their company, Orange Brite (which they later changed to Orange Brite International) in December 1995, and took their dog-and-pony show on the road. Initially they sold their products mainly through word-of-mouth advertising at state fairs, and home and garden shows, but later, with the help of their three children, Kelly, Billy, and Joey, they used direct response television, direct mail, and e-commerce channels to help grow the companys revenues at a phenomenal rate. When the Home Shopping Network agreed to let them promote their merchandise about five years ago, major retailers like Wal-Mart

39

and Costco took notice and started stocking Orange Brite products on their shelves.

Within 20 years, sales had grown to over $500 million and their production facilities were beginning to feel the strain. Their product line had expanded to include air fresheners, soap bars, liquid soaps, spot removers, and a variety of cleaning tools. Through all this success, the Goodmans always focused on customer needs and satisfaction, always encouraging their customers to provide them with feedback and testimonials. Their latest addition, an industrial-strength cleanser and wood protector, seemed to be gaining wide acceptance both in the United States and overseas.

Wayne, who was nearing 75 years of age, knew that they would need to raise significant capital if they wanted to keep growing and expanding their product line. Still actively involved in the business, he had asked the rest of his family for their suggestions regarding the possibility of going public by issuing an initial public offering (IPO). Kelly and Joey strongly supported the idea because they felt that with competitors coming up with substitute products, they needed to stay ahead of the game. Billy, on the other hand, disagreed and recommended that they outsource production and concentrate on their marketing efforts. He preferred that the firm stay private, relying less on external capital and retaining control.

After carefully weighing all the factors, Wayne decided to explore the possibility of raising the money via an IPO. Billy, Kelly, and Joey, he said, the three of you have MBAs from some of the most prestigious business schools in the country. Im sure you guys can figure out what were really worth! I hate to depend totally on investment bankers to come up with the right price. Why dont the three of you put your heads together and figure out what is the minimum price that we should sell our stock for if we were to go public. Lets say we sell 30 million shares. Im sure we can find a way of retaining control of a large portion of the shareholding and still raise the much-needed cash. Billys point of loss of control is a good one, but I am not in favor of outsourcing production. Our success has come from our quality and that would likely be jeopardized if we let others produce the product.

Kelly, Billy, and Joey got to work. They realized that they would need industry and competitors financial data. Table 1 presents key valuation data for 3 of their major publicly traded competitors in the personal and household products industry sector. Tables 2 and 3 present Orange Brite Internationals five-year income statements and balance sheets, respectively.

Kelly preferred to use the corporate value model, whereby the firms value was estimated as the sum of its discounted free-cash flows. Free cash

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flows were estimated by subtracting the firms net capital investment from the years net operating profits after taxes (NOPAT) and were discounted at a suitable risk-adjusted discount rate (weighted average cost of capital). Kelly assumed that the firms free cash flows would grow at a rate of 20% during the first year, 10% during the second year, and finally settle down to a long-term growth rate of 6% thereafter. The firms equity value was calculated by subtracting out the firms outstanding debt owed to creditors from the overall value. Kelly used a risk-free rate of 4%, a market risk premium of 8%, and the average beta of the three competitors when determining the firms cost of equity.

Having worked on various valuation projects for a major consulting firm, Billy was a strong advocate of the use of price-ratio models for valuing common stock. His method involved using suitable price-earnings, price-sales, price-book value, and price-cash flow multiples in conjunction with forecasted values for the firms earnings, sales, book value, and cash flows respectively. Billy used the four-year average compounded growth rate when forecasting the relevant variables and then discounted the year-ahead price forecasts by the required rate of return on equity (based on the capital asset pricing model using the same inputs that Kelly used).

Joeys finance professor, Dr. Alex Hexter, on the other hand, had indoctrinated him in the art of common stock valuation via the discounting of future dividends. Always use a realistic required rate of return and various growth rate scenarios in conjunction with industry benchmarks, when valuing growth companies, was Dr. Hexters advice. Accordingly, Joey decided to use a variable growth rate model to value the firms equity. What will we do if our three estimates are totally different? Asked Kelly looking rather concerned. Well have to go back to the drawing table and examine our inputs, said the ever-resourceful Billy, Well each have to be within a reasonable ballpark, or Dads going to flip!

Table 1

Key Valuation Ratios for Top 3 Competitors

Shine Brite

ChemScape

Ultra Clean

Price/Earnings

23.6

24.6

22.8

Price/Book

7.7

12.1

4.2

Price/Sales

2.9

2.8

2.9

Price/Cash Flow Dividend

13

16.7

14.7

Yield %

1.8

1.6

1.7

Beta

1.2

1.3

1.15

Recent Price

Table 2

Orange Brite Internationals 5-year Income Statements

2011

2012

2013

2014

2015

Revenue

100,700,000

225,000,000

300,250,000

400,150,000

500,000,000

COGS (excluding depreciation)

45,315,000

108,000,000

147,122,500

184,069,000

255,000,000

Gross Profit

55,385,000

117,000,000

153,127,500

216,081,000

245,000,000

Depreciation

3,061,646

3,600,000

4,206,746

7,042,640

9,703,125

Operating Expenses

33,231,000

72,000,000

87,072,500

141,653,100

140,000,000

Earnings Before Interest & Taxes

19,092,354

41,400,000

61,848,254

67,385,260

95,296,875

Interest Expense

1,743,025

2,760,000

1,876,865

5,165,760

8,006,250

Earnings Before Taxes

17,349,328

38,640,000

59,971,389

62,219,500

87,290,625

Income Taxes

6,939,731

15,456,000

23,988,556

24,887,800

34,916,250

Net Income

Table 3

Orange Brite Internationals 5-year Income Statements

	2011	2012	2013	2014	2015
Current Assets	25,049,832	39,000,000	45,573,081	57,621,600	64,687,500
Fixed Assets	30,616,462	36,000,000	42,067,459	70,426,400	97,031,250
Total Assets	55,666,294	75,000,000	87,640,541	128,048,000	161,718,750
Current Liabilities	4,329,601	4,600,000	3,128,108	8,609,600	13,343,750
Long-Term Debt (#14% per year)	26,336,694	18,400,000	12,512,432	34,438,400	53,375,000
Owners Equity	25,000,000	52,000,000	72,000,000	85,000,000	95,000,000
Total Liabilities and Owners Equity	55,666,294	75,000,000	87,640,541	128,048,000	161,718,750 How does Kellys price estimate compare with Billys price estimate based on the price-ratio models? What are the pros and cons of Billys preferred approach?

10,409,597.0

23,184,000.0

35,982,833.5

37,331,700.0

52,374,375.0

$ 62.47

$ 57.29

$ 57.30