Domain: Finance
Question:
Walmart is evaluating the acquisition of a regional grocery and pharmacy chain with about 80 stores. Analysts disagree on how to value the business and how to align its reporting with Walmart’s disclosures. The target disclosed revenues of ~$2.05B–$2.15B, so assume $2.1B as a base, growing at 6% annually. EBITDA margin is cited as “8%+ trending toward 9.5%,” though it is unclear whether pharmacy operations (35% of sales) should be included in EBITDA or treated separately as lower-margin healthcare services. For modeling, assume a linear ramp from 8.5% in Year 1 to 9.5% in Year 3. Capex is $100M in Year 1 and $30M annually thereafter. Depreciation is 3% of revenues. Tax rate is 25%. Net Working capital is 1% of revenues. Assume Walmart pays $1.3B in cash. Analysts further note that Walmart maintains a minimum $2B cash floor on its balance sheet, so incremental funding must come from debt if cash falls below this threshold. Debt carries a 6% interest rate, creating a recursive loop where interest expense depends on debt drawdowns each year. Assume a WACC of 8% and a 2.5% terminal growth rate in a Gordon Growth model. Additionally, assume for integration costs $40M in Year 1, $20M in Year 2 and $0m in Year 3. Lastly, assume Pre-Tax EBITDA synergies of $0m in Year 1, $30m in Year 2, and $60m in Year 3.

Walmart’s FY2025 disclosures show $648.1B revenue, $29.3B operating income, $11.9B D&A, and $41.2B EBITDA (~6.4% margin). Note that Walmart’s EBITDA margin is not directly comparable because membership fees and “other income” may be placed differently in its reporting. Walmart also reports an internal “ROI” (13.9% in FY2025), which differs slightly from ROIC but is broadly similar and serves as a capital allocation hurdle rate. Comparable grocery/pharmacy chains trade at 7x–9x EV/EBITDA, but accounting for pharmacy treatment and leases is debated.

Based on this, estimate the valuation range from comps and assess whether $1.3B is justified. Compare the deal’s projected ROIC to Walmart’s 13.9% ROI benchmark, for both a scenario with Pre-Tax EBITDA synergies and a scenario without Pre-Tax EBITDA synergies, and evaluate whether the acquisition is accretive to Walmart’s EBITDA margin. 

For both a scenario including Pre-Tax EBITDA synergies and another scenario without including Pre-Tax EBITDA synergies, build a three-year DCF incorporating the recursive debt/interest loop and cash floor constraint. Additionally, for both scenarios, derive the enterprise value, compare to purchase price, and provide a final recommendation on whether Walmart should proceed.

Expected points in a correct answer:
Identifies a 60% weight assigned to food retail comps.
Identifies a 40% weight assigned to pharmacy comps.
Calculates a weighted blended multiple of ~8.1x.
Calculates Year 1 EBITDA of ~$178M.
Calculates an implied EV from comps of approximately $1.4–$1.5B.
Concludes the $1.3B purchase sits below the weighted midpoint.
States the ROIC definition used is EBIT after tax ÷ Invested Capital.
Identifies the Invested Capital proxy as $1.3B.
Calculates stand-alone Year 1 NOPAT as $56.63M assuming no synergies
Calculates stand-alone Year 2 NOPAT as $85.17M assuming no synergies
Calculates stand-alone Year 3 NOPAT as $115.03M assuming no synergies
Calculates the stand-alone Year 1 ROIC as 4.36%.
Calculates the stand-alone Year 2 ROIC as 6.55%.
Calculates the stand-alone Year 3 ROIC as 8.85%.
Concludes the stand-alone ROIC is below the 13.9% hurdle.
Calculates synergy-adjusted Year 2 NOPAT as $107.67M.
Calculates synergy-adjusted Year 3 NOPAT as $160.03M.
Calculates the synergy-adjusted Year 2 ROIC as 8.28%.
Calculates the synergy-adjusted Year 3 ROIC as 12.31%.
Concludes the synergy-adjusted ROIC is still short of 13.9% by Y3.
Calculates the required NOPAT to hit the 13.9% hurdle as $180.7M.
Calculates the required EBITDA to hit the hurdle as approximately $311.72M.
Concludes adding the target moves Walmart's EBITDA margin only a few basis points higher.
Calculates stand-alone Year 1 FCF as −$1.38M assuming no synergies
Calculates stand-alone Year 2 FCF as $120.69M assuming no synergies
Calculates stand-alone Year 3 FCF as $154.48M assuming no synergies
Calculates the stand-alone Terminal Value as $2,878.94M assuming no synergies
Calculates the stand-alone Enterprise Value from the DCF as $2,510.23M assuming no synergies
Calculates the synergy-adjusted Enterprise Value from the DCF as $3,230.98M.
Concludes the DCF takeaway is that EV of approximately $2.51B stand-alone exceeds the $1.3B price materially.
Calculates the ending cash balance for Year 1 as $7,698.62M assuming no synergies
Calculates the ending cash balance for Year 3 as $7,973.79M assuming no synergies
Concludes that no debt is needed for the transaction.
Concludes the cash-floor recursive loop does not bind.
Concludes from the DCF that there is a large value cushion.
Concludes the ROIC is sub-hurdle stand-alone.
Recommends to proceed at $1.3B.
States a contingency for the recommendation is executing a quantified synergy plan.
States a contingency for the recommendation is tight capex discipline.