BRANDEIS UNIVERSITY

PRADA
Case Write-Up
Finance 202a International Corporate Finance
Nam Pham
Kien Phi
Duc Tran

Executive Summary
Prada S.p.A., founded in 1913, is an Italian fashion label specializing luxury goods for men
and women. Through a turbulent period of brand acquisitions during 2000-2005, Prada has both
acquired and sold many of its subsidiary brands like Helmut Lang, Jil Sanders, Amy Fairclough, and
Fendi. The Global Luxury Fashion Industry is expecting a more organic steady growth in the future,
while noticing a new shift in the Luxury Fashion Industry dynamic towards Asia, hoping that this
new change the global environment will drive its growth. In January 2011, Prada had to decide on
how to pay the large portion of its long-term debt and to expand into Asia. The Board hired
investment bank Grupo Capo Milano to prepare different alternatives for raising over 1 billion euros
within the next six to 12 months.
Grupo Capo Milano came up with three different alternatives for Prada to consider: Prada can
raise money by an initial public offering (IPO), strategic partnership, or debt. Each of these options
presents different opportunities and drawbacks for Prada, with respect to its future sustainability.
Given the situation at Prada and projection of future cash flows, Prada should proceed with an IPO in
Hong Kong. This option would help pay back part of its debt, lower the financial distress, and further
strengthen its brand image in Asia.

1.

The Luxury good market (LGM) segment is considered to be a very good growth market.

The market contains some very special and interesting characteristics that distinguish itself from
other traditional markets that have been exposed to traditional financial analysts. One of the first
characteristics of the LGM is that throughout the recent years, data have shown that the market
suffers from little to no economical cyclical downturns; for instance from 9/11 to the global financial
crisis in 2008 and 2009, the LGM has proved its potential as it continued to attain a positive growth
rates in those years.
Traditionally the LGM sales around the world mainly stem from highly developed regions.
Europe and the America consisted of the main proportion of sales, respectively these regions
accounted for 37 percent and 31 percent of the LGM. During most recent years, however, there
seems to be a shift in the paradigm of the LGM, as the new worldwide spending on luxury market
seems to have a growing focus on emerging markets. The main drive of the LGMs growth mainly
comes from the Asian market and Chinas economic growth. The market share of the Asian-Pacific
market excluding Japan started from 11% of the global market in 2007, and already reached 18% of
the global market share in 2011.
It is expected that the Chinese market for luxury good is rapidly growing and may surpass the
U.S as the biggest luxury good market with an estimated CAGR of the Luxury Market Value in
China from 2008-11 of 25%. Although throughout the world there are other emerging markets that
experience high level of economic growth, for example Indias and Brazils LGM growths have been
hindered by regulatory issues and high import duties.
As Asia is becoming one of the main markets for the LGM after Europe, it is important for
Prada to realize this in its upcoming decision in its IPO and position itself to utilize the rapid growth
factors that are in the Asia-Pacific region. Due to these circumstances in the outlook of the LGM,
Prada should position itself corporate prominence prominently in the Asian market. As retail is

confirmed to be the best performing channel in the LGM, as the numbers show that from 2010 to
2011 alone the percentage increase of the retail distribution channel alone was 22.8%. Pradas
positioning is consistent with the changing dynamic of the LGM. In 2009, retail accounted for 54.3%
sales of Prada, while in 2011 the percentage of retail composed of 70.8% of Pradas sales.
2.

In order to raise 1 billion euros over the time frame of 12 months, Prada has to consider

between different sources of capital, and between different tradeoffs. The top priority for them is to
weigh the cost of different alternatives. For instance, going public entails direct costs, which include
underwriting, audit, listing and other fees, and indirect costs, such as preparation time, roadshow, and
responsibilities. Using debt, on the other hand, raises company financial distress cost and places
company to a riskier situation. Prada managers need to carefully weigh the cost and benefits between
different options. Using equity enables the investors and business owners the opportunity to develop
a long term relationship throughout their joint business endeavor. The cash flow generated can be
used for follow-on investments rather than towards the loan debt. In using debt, lender does not gain
ownership; therefore, the entrepreneur is able to maintain maximum control over their business. The
interest on debt financing is also tax deductible. The second priority they need to consider is their
brand image going forward. Unfavorable news about their debt level or failure in launching another
IPO could significantly hamper their reputation and especially their expansion plan to Asia. For
example, using debt provides a strong signaling effect to investors than using equity; however, in the
Asian culture, the investors value highly the stock of a fashion company, thus further strengthen the
image of Prada in this market. Finally, Prada also needs to think about their level of control that after
the strategic move. Bertelli, CEO of Prada, believed that the success of the firm today was a result of
his familys collaborative efforts; therefore, they disfavored the option of going public. The company
needs to think about the future of the brand Prada after paying off all the current debts.

3.

There are three differences sources of capital that Prada should consider: Initial Public

Offering, Debt, and Strategic Partnership. We discuss each source and give the valuation of the firm
and equity for each source below.
-

Initial Public Offering (IPO)

Given Pradas financial position, an IPO would help Prada raise the fund to pay off its debts

which are maturing in the next 6 to 12 months. Thus, an IPO would improve Pradas debt to asset
ratio and lower the financial distress of the company. Moreover, an IPO would enhance Pradas
liquidity and cash position, enabling it to finance its expansionary business plans in Asia. Another
advantage of an IPO is that it can boost the brand image of Prada in the market. By opting for an
IPO, Prada would be able to increase customer and investor confidence in the company due to strict
listing and disclosure requirements. Thus, Prada could improve its sales and receive healthy boost
for future plans, such as a strategic merger and acquisition or a subsequent initial public offering.
However, a disadvantage of IPO is that it dilutes the control of the existing owners of the
company. Pradas shares would be traded publicly and part of its ownership would be distributed to
new investors. Being a leading luxury brand, Prada would want to retain as much control as much as
possible to preserve its authenticity. Therefore, an IPO might hinder Pradas future decision making
process. Another disadvantage of IPO is that it takes from 6 months to a year to file an IPO. Also,
opting for an IPO would require Prada to disclose certain confidential information, which might
benefit its competitors.
DCF Valuation for IPO: (see Table 3)
For the valuation, we assume Pradas expected growth rate in sales in each region in 2012 is
equal to the CAGR, leading to total sales of 2,376.41 million in 2012. In addition, we assume the
growth rate for Prada to normalize to the similar level of overall regional growth rate from 2013
(p.3), and assume growth rate in other countries equal to that of Japan. Hence, Pradas total sales will
reach 3092.43 million by 2016, with an annual growth rate of 6.65% from 2013 to 2016. We also
4

assume that the long run overall sales will grow at a 5% rate per annum after 2016, giving premium
for the expected inflation rate of China of roughly 3.2% in 2013. Subsequently, we assume that the
free cash flow (FCF) of Prada will grow at the same pace as its sales. (See Tables 1 & 2)
For the beta of Prada, we use the average beta of 1.02, of comparable luxury firms (p.19).
Then, we use the geometric average return of 10.58% for the Hang Seng Index in Hong Kong from
1991 to 2011 as a proxy for the market return. The risk free rate is 3% as of January 2011, based on
the yield of 10-year Hong Kong government bond. Hence, the required return of Pradas equity is
10.73%. Prada SpAs current Debt/Asset ratio is 1155.9/2366 = 48.85% and this would drop to
35.86% if we assume 200 million out of the 1.5 billion proceeds from the IPO would be used to
reduce debt, and 300 million will be injected to Prada SpA. Pradas cost of debt is estimated to be
LIBOR plus 2.50, which is 4.074% based on the 12-months Euro LIBOR rate of 1.574% at the end
of January 2011. Tax rate is 34.7%. Thus we have WACC and value of the firm as in table 3.
-

Strategic partnership:
Another option for Prada is strategic partnership with other private equity firms, who demand

a reasonable return for their investment. Private equity and financial partner funding is different from
a public offering as the shares are not traded in the market and the agreement is made exclusively to
relevant parties. The private equity firms usually sell their stakes after they have turned the company
around.
In order to find the equity value of Prada under strategic partnership, first we will compute
the Enterprise Value. We would use the Bulgaris Enterprise Value to Sales ratio of three times; the
2011 sales of Prada equals 2017.1 million euros (exhibit 3), therefore, the Enterprise Value is 6051.3
million. Then we use the following formula:
Equity value = Enterprise Value + Cash and equivalents - Debts - Preferred stocks - Minority Interest
= 6051.3 + 96.6 - 1150 - 0 - 0 = 4,997.9 million euros.

If instead, we use the E/V ratio similar to Burberrys (2.7) and Tiffanys (2.3), the Equity value will be
lower at 4,392.77 million and 3,585.93 million, respectively.
By choosing this option, Prada would improve its debt-to-asset ratio similar to an IPO. Also,
since financial partners do not necessarily want to be part of the daily operations, the problem of
control dilution is not severe as in an IPO. If managed well, strategic partnership could turn out to be
a win-win strategy in which the financially distressed Prada would get funding to turnaround and in
return, the private equity investors would get higher returns if Prada did improve its financials and
increase its overall value. However, the decisions made by these private equity firms might be
focusing on short term gains rather than on the benefit of the company in the long run. Furthermore,
similar to IPO, the tax shield will be reduced.
-

Debt:
The final option is to finance its new growth and future strategy is debt. In the past, two of

Prada's competitors Bulgari and LVMH have already issued debt in the Euromarkets. The option was
also viable for Prada S.p.A, as it is stated that there is a 750 Million Euro market for Pradas bond at
Libor plus 2.50 percent for a 5 year bond, One of Pradas other routes to debt could be in the U.S
market that offers a lower LIBOR rate; however, Prada would be faced with the disadvantage of
being the first mover in the U.S bond market at its level. Other option of debt that Prada can issue the
newly popular "dim-sum" bond that many investors expect low yields out from, in return for
anticipation for Yuan appreciation. However, as previously mentioned, there are attractive markets
for Prada to issue new debt into the public. The option itself would not be Prada's best action, due to
the fact that Prada itself already has a dangerous debt level that is due to mature in the future, while
at the same time even though the "dim sum" bonds do offer low yields for Prada, the bonds have
small maturity of only 2-3 years, therefore their purpose would not serve well for Prada's long term
strategies, while it increases greatly the toxic level of the corporation.

Assuming Prada wants to raise 1.5 Billion in upcoming funds it would need to issue Debts in more
than one market, Due to the characteristic of the Dim Sum bond only having short term maturity
from 2-3 years only the U.S market and Euro Market are a Viable option for Prada SpA. To
understand the cost of debt in different markets, see Table 4.
DCF Valuation for Debt: (see Table 5)
Prada SpAs current Debt/Asset ratio is 48.85% and this would increase to 68.7% if we assume the
firm takes on new debt of 1.5 billion. In addition, the tax rate for Prada is 34.7%. Then we
recalculate WACC and firm value as the table 5.
-

For Prada, there should be a preference for equity rather than for debt:
While one main advantage of debt issuance is the additional tax shield that comes with

interest payments, issuing debt would increase the financial distress of the company. Since Prada is
already experiencing serious financial problems, further debt issuance may cost more than
expected. A high level of debt would degrade the rating of Prada in the fashion market. Given
Pradas current financial position, it is likely that the downside of additional debts would offset the
interest tax shield that comes with it. Also, if Prada is issuing the increasingly popular dim sum
bonds, whose an inherent disadvantage is their short-term maturity and low-yield, which may not
attract many investors given the large size of the debt issue and the uncertainty of the appreciation of
the yuan against the dollar in the coming months or years. Another disadvantage of issuing debt is
that, since Prada need more than 1 billion to repay its loan, it would need to issue debt in several
different markets to raise sufficient funds, and therefore be exposed to exchange rate risk.
-

Also, Prada should have preference for different countries regarding the type of capital:
If Prada chooses to raise capital by debt, they should prefer to raise capital in the US over

Europe since the interest rate in US is lower. If they choose to raise capital by equity, Prada should
consider the immediate benefit for public listing in Hong Kong instead of other countries. Hong
Kong is a hot market in IPO, the demand is strong, and their valuation was higher than what Prada
7

could have received in Europe. In terms of an Asian expansion, an IPO in Hong Kong would give
them more than enough exposure to step in this profitable market. In considering between countries,
Prada also needs to take into consideration the complicated tax treatment in different regions.
-

For Prada, there should also be a preference regarding the types of investors:
The type of investor is also a very important factor for Prada to consider when it chooses to

conduct its IPO is not. Since IPO belongs to the LMG and is actually one of the largest luxury brands
in the world, Pradas brand identity is also very important for its image. As it sales is directly
dependent on how the public views the value of the brand. That is why it is important for Prada to
find different types of investors that would maximize the brands public perception. Ideally when the
Prada conduct its IPO, it would want its shareholders to not only view the Prada shares as a
commodity, but would value the share in its intrinsic value as well. With investors that have intrinsic
value with the share, they will hold onto to the share longer and would be less likely to sell Pradas
share out in the market. This would maintain the luxury image of the brand as it is not anymore a
commodity than is being freely traded around the market, but an exclusive share that everyone would
want to own. Due to this factor, the types of investor that would be more prone in an emerging
market economy, as the luxury market in these regions carry more prestige, Status recognition and
extravagance and in return Prada shares in these markets would carry more intrinsic and value to
both the investors and the company.
4.

Looking into three different options, debt provides the firm with the highest value; IPO and

strategic partnership come second and third. This is relevant to the pecking order of financing. If one
relies merely on this data, one would conclude debt would be a viable option.
However, if we use realistic assumptions and consider the long-term sustainability of the firm, Prada
should proceed with an IPO. To maximize the value of the company through financing and support
the Asian expansion, Prada needs to conduct an IPO in the Hong Kong market. Difficulties with tax

treatment and dilution at the beginning will gradually disappear due to the effects of better
management and experiences.
The IPO would provide an opportunity for Prada to refresh and strengthen its brand image to
the Asian market. Moreover, Prada would be able to increase customer confidence by opting for an
IPO due to the strict listing and disclosure requirements. With all the advertising efforts for an IPO,
Pradas sales figures could be expected to receive a healthy boost. Furthermore, an IPO would
increase Pradas ability in recruitment and loyalty. The creation of an employee stock option would
be able to lower the agency cost for the company as the employees that hold shares of the company
would tend to be more motivated and have more loyalty towards the company. It would also help
Prada for future need of strategic mergers and acquisition (M&A), as they could be partly financed
with Pradas common shares offering

Table 1. Prada Expected Sales

Note

220.9

Other
countries
11.8

51.1%

8.7%

-28.5%

297.26

975.65

240.12

8.44

Assuming
equals CAGR
2376.41

16.72% 19.26%
4.5%
4.5%

12.51%
4.5%

41.06%
10.5%

10.10% 0.36%
1.5%
1.5%

From page 3

473.71

545.83

354.49

1454.60

254.85

8.95

3092.43

0.75%

0.87%

0.56%

4.31%

0.15%

0.01%

6.65%

2016
286.9

2017
Growth:
5%

Italy
Current sales (
millions)
Expected growth rate
in 2012
Sales by 2012 (
millions)
Percentage of sales
Expected annual
growth 2013-16
Sales by 2016 (
millions)
Normalized annual
growth rate

AsiaPacific
645.7

Japan

393.3

Rest of North
Europe America
450.5
294.9

1.0%

1.6%

0.8%

397.23

457.71

Table 2. Free Cash Flow Projection

Year
FCF ( millions)

2011
191.0

2012
221.8

2013
236.5

2014
252.2

2015
269.0

Table 3. IPO Valuation

Initial Public Offering
rE
rD
Tax rate
D/V
E/V
rWACC
Value of Firm (
millions)
Value of Equity (
millions)

10.73%
4.074%
34.7%
35.86%
64.14%
7.84%
11935.455
7655.401

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Table 4. Estimated Cost of Debt

U.S Market
Funds Raised for Prada SpA
12 month LIBOR
Cost of Issuing Debt
Interest Cost per year
Annual Tax Shield (Tax Rate of
34.7%)

Euro Market
750 Million
1.57%
4.07%
30.555
Million
10.6 Milliion

750 Million
0.83%
3.33%
24.975
Million
8.67 Million

Table 5. Debt Valuation

Debt
rE
rD
Tax rate
D/V
E/V
rWACC
Value of firm ( millions)
Value of equity ( millions)

10.73%
4.074%
34.7%
68.70%
31.30%
5.19%
13260.364
4150.4938

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