Edcon: Going shopping in South Africa Case Solution

1. What are the opportunities and risks to consider in the proposed Edcon bid? What are the key sources of value creation?

The Edcon bid comes with a number of opportunities as well as risks, making the bid a difficult decision. The Edgars Consolidated Stores operating in South Africa provide a lucrative opportunity to materialize gains from growing retail economy. Since the political situation in South Africa has changed in the last decade, it has had a positive impact on the economy as a whole. Black Africans of South Africa not only got voting rights, but their incomes also increased. With this increase in income, the middle class black population spent more on clothes and footwear which was the main segment of Edgars.

On the contrary, the liberalization of races also posits a threat for private equity firm in the form of governmental restrictions for promoting equality of races. On a more serious note, investing in Edgars posed a serious and significant currency risk. While the Bain Capital is going to invest dollars, the returns of Edgars are in Rands, which has been deteriorating for the past couple of years.

The key sources of value creation for Bain Capital from Edgars are growth in the retail market, growth of discount stores, decrease in corporate cost by cost management, change in supplier sources and finally the exit strategy. Bain Capital had to consider all of these factors in the valuation of Edgars before making a bid.

2. Why may it not be feasible to use only bank debt to leverage Edcon? Would it be better to use all bond financing or a combination of bank and bond debt? Explain the advantages and disadvantages of each approach.

Bank debt usually comes with covenants that restrict the operations of the business. Banks place these covenants to ensure that the borrower maintains a good profile and hence, makes due payments on the debt. However, from the perspective of the corporate borrower, such covenants restrict the operating and financing activities of the business. Due to the economic conditions of South Africa, the covenants placed by African banks are stricter than those placed by US or European banks which reduce the flexibility of the company.

Nevertheless, foreign bond financing, on the other hand, exposes the firm to currency risk. However, since bond financing involves lenient covenants and does not involve any principal repayments, it will result in lesser cash disbursement and hence, the company can operate and grow more flexibility. Another approach would be to use a mix of both the approaches. While diversifying the financing risk seems a suitable option (in leverage), it is not always the case.

In the light of the above mentioned discussion, it is better to go for USD denominated or Euro denominated debt as it will allow greater managerial and financial flexibility. Flexibility is one of the key variables that determine growth potential, which in turn determine the value of the firm.