Tiffany Case

The case In July l993 . Tiff some(prenominal)& confederation cereb step an contract with its japanese distributor, Mitsukoshi Ltd. that would fundamentally change its business in lacquer. low the wise agreement, Tiffanys wholly owned subsidiary, Tiffany& social club japan Inc. (Tiffany-Japan), assumed management responsibilities in the operation of 29 Tiffany &Company boutiques previously ope arrayd by Mitsukoshi in its blood lines and other(a) locations in Japan.Tiffany looked forward to the crude locating, as it was like a shot responsible for megs of sawhorses in inventory that it previously commute wholesale to Mitsukoshi, answering in enhanced revenues in Japan derived from higher sell determines. It was also apparent, however, that fluctuations in the hurt/dollar replacement rate would now affect the dollar value of its Nipponese gross revenue, which would be realized in yen. Since Nipponese gross revenue were large and still growing, it seemed evident much(prenominal) fluctuations lusty impact on Tiffanys future pecuniary performance. Company BackgroundFounded in tonic York in 1837,Tiffany Company was an internationally renowned- retail merchant, designer, manufacturer ,and distributor of highlife goods . The renowned blue-box guild found its initial success in fine jewelry, near notably diamonds, but had since expanded its ware line to include timepieces, china, crystal, silverware, and other luxury accessories. In the fiscal year determination January 31, l993 (FY1992), Tiffany earned $15. 7 one gazillion million million on revenues of $486. 4million and had sum summarise assets of$419. 4 million. Recent financial statements are provided in discloses 1and 2.An diachronic summary of operations is provided in Exhibit 3. After more than a century of independence, Tiffany was acquired by Avon Products, Inc. in 1979. For the next several years, Avon, a nationally door-to-door cosmetics marketer, worked to exp and Tiffanys product line to r each(prenominal) beyond its conventional affluent customer base to the larger middle market. While this diversification strategy subjected in enhanced gross revenue for Tiffany from $84million in l979to $124million in l983, operating(a) expenses as a percentage of sales grew inordinately from 34%to 43% in 1978and l983, respectively.Avon soon realized that Tiffanys traditional market niche was good different than its own and, in l984, decided to put the company up for sale. The well-nigh lovely offer came from Tiffanys own management, who agreed to buy pricker Tiffanys fair-mindedness and the Fifth Avenue interpose building for a total of $135. 5 million. In what ultimately took the form of a leveraged buyout (L B O), the ground of the deal distributed virtually all of the equity shares to three key investor bases. management ended up with 20% of total equity shares.Investcorp, the Bahrain-and London-based merchant lodge that backed manag ement in the deal, received 49. 8%of total equity shares. The third player, General Electric Credit Corporation(GECC), ended up with 25. 7%of total equity shares. 1t was by dint of an $85 million credit arrangement with GECC that management was able to refinance a substantial portionof the purchase price. The outcome of the LBO was marked by very tight free currency run away coupled with important growth potential on the horizon.After the company had formerly again become clamsable and realizing that the companys growth prospects demanded more cash than could be generated internally, in 1987,management offered Tiffany stock to the public at roughly $15 a share(ad salutaryed for a subsequent stock split). In l989,Mitsukoshi purchased l. 5 million shares of Tiffanys harsh stock from GECC. As of January31, 1993, Mitsukoshi owned approximately 14% of Tiffany stock, the largest percentage of any single institutional investor.Three other institutional investors collectively owned approximately 26% of the stock, followed by all Tiffany exe clippingive officers and directors as a group at 4. 9%. In l993, Tiffany was tog upd into three distribution transmit U. S. retail, direct marketing, and international retail. U. S. retail included retail sales in Tiffany-operated livestocks in the United States and wholesale sales to independent retailers in newton America. The l6 introduces in this channel accounted for 50% of total sales in FY 1992 forecast marketing, representing the smallest channel of distribution, consisted of corporate and catalog sales .In FY 1992, its sales represented 18% of Tiffanys total sales. International retail, which included retail sales through Tiffany-operated stores and boutiques, corporate sales, and wholesale sales to independent retailers and distributors, primarily in the utmost East and Europe, accounted for 32% of total sales in FY1992. Jewelry sales from all three channels accounted for 65% of 1993 sales, making jewelry the most significant product line. Exhibit 4 provides financial results of Tiffanys municipal and foreign operations.The past several years for Tiffany were marked by a trend of international works out, beginning in1986 when it undefendable a flagship retail store in London. Additional flagship stores were then opened in Munich and Zurich in 1987 and 1988, respectively. In 1990, the Zurich store was expanded. Stores were opened in Hong Kong at the Peninsula Hotel and at the LandmarkCenter in imperious 1988 and March 1989, respectively. Taipei saw the opening of a store in1990, as did Singapore (at the Raffles Hotel), Frankfurt, and Toronto in 199l. Also in l991, the London store was expanded.In l992, Tiffany opened five new boutiques in Japan, and two new boutiques were opened by an independent retailer in Korea. Early 1993 saw keep international growth, with the opening of two more boutiques in Japan, a scrap store in Singapores NgeeAnnCity, two boutiques by independent retai lers in Saipan and the Philippines, and the expansion of the Peninsula Hotel store in Hong Kong. Exhibit 5 shows the growth in the figure of speech of Tiffany stores and boutiques around the world from 31 to 79, implying a 250% increase from 1987 to 1993.These 79 retail locations included l6stores in the United States,56 stores in the Far East,6stores in Europe, and l store in Canada, all of which ranged in size from700 to 13,OOO gross firm feet, with a total of approximately 127,OOO gross square feet devoted to retail purposes. Tiffanys worldwide capital expenditures were $22. 8 million in FY l992. compared with $41. 4 million in FY 1991. These expenditures were primarily for the opening of new stores and boutiques and the expansion of existing stores.Management judge capital expenditures to drop further to $18. O million in FY l993 in the lead rebounding to approximately $25. O million in FY 1994. Management also pass judgment to open four or five new stores per year in the f oreseeable future. To support future expansion plans, and fluctuations in seasonal working capital needs, management planned to rely upon internally generated funds and a $100 million noncollateralized revolving credit facility available at post rates based upon Eurodollar rates, a prime rate, certificate of deposit rates, or money market rates.As in the past, cash dividends were anticipate to be well-kept at a relatively moderate level, which would permit the company to defend a majority of its earnings. Impetus for Change in the Nipponese trading operations While Tiffany found new market potential across the globe, nowhere was let as promising as in Japan, where Tiffanys sales accounted for precisely 1% of the $20 billion Japanese jewelry market. The well-to-do Japanese deliverance of the late l980s and very early 1990s aroused a booming demands for certain types of expensive and glamorous Western goods.Among these were Tiffany products, principally those of the fine jewe lry line marketed toward older women. However, as the Japanese economy finally slowed and Japanese consumers became more cautious in their spending, the demand for Tiffanys luxury items also slumped. In response to soft consumer demand in Japan, Mitsukoshi cut back on Tiffany inventory levels. Mitsukoshis wholesale purchases from Tiffany-Japan declined from 23%of Tiffanys total sales in FY 199l to 15%in FY1992. Declining wholesale shipments were also attended by a small decline in gross security deposit from 49. %in FY1991 t0 48. 7%in FY 1992. Despite lackluster consumer demand in the first half of FY 1993, however, Tiffany continued to believe that Japanese sales had attractive long-run growth potential. It was for this reason that Tiffany sought greater control everywhere its future in Japan and ultimately decided to restructure its Japanese operations. From 1972 through July1993, Mitsukoshi acted as the principal retailer of Tiffany products in Japan, purchasing selected goods from Tiffany-Japan on a wholesale base.Mitsukoshi sold the products on a retail basis to the Japanese consumer, realizing profits in the form of relatively higher retail prices. Since the wholesale transactions were denominated entirely in dollars, fluctuations in the yen/dollar exchange rate did not represent a source of irritability for Tiffanys pass judgment cash flows. Instead, Mitsukoshi bore the risk of any exchange rate fluctuations that took place between the time it purchased the inventory from Tiffany and when it finally made cash settlement.Typically, Tiffany merchandise sold by Mitsukoshi was priced at a substantial amplitude (l00% in some cases) over the domestic U. S. retail price for such merchandise. The new agreement between the two companies, however, fundamentally changed both companies financial situations. In repurchasing the merchandise previously sold by Tiffany to Mitsukoshi, Tiffany-Japan assumed new responsibility for establishing yen retail prices, hol ding inventory in Japan for sale, managing and funding local advertising and publicity chopines, and controlling local Japanese management.Mitsukoshi on the other hand, would no longer be an independent retailer of Tiffany products but would still receive fees disturbing 27% of net retail sales in compensation for providing boutique facilities, sales staff, collection of receivables, and security for store inventory. With greater control over retail sales in its Japanese operations, Tiffany looked forward to long-run improvement in its performance in Japan despite continuing weak local economic conditions. However, increased sales and profits were not the only changes that Tiffany could anticipate as a result of the new agreement.Tiffany now faced the risk of foreign currency fluctuations previously borne by Mitsukoshi. Past history warned Tiffany that the yen/dollar exchange rate could be quite volatile on a year-to-year and even month-10-month, basis. Exhibit 6 illustrates the s ignificant strengthen of the yen against the dollar during the l O years ending in 1993. While a continuation of this strengthening would enhance the dollar value of Tiffanys yen denominated cash inflows, there was the clean-cut possibility that the yen might eventually become overestimated and crash suddenly, just as the U.S dollar in 1985. Indeed,there was some evidence that the yen was overvalue against the dollar in 1993 (see Exhibit 7) Hedging to Manage Foreign central Risk The possibility of sharp, unexpected movements in the yen/dollar exchange rate had prompted Tiffanys management to study the desirability of engaging in a program to manage exchange rate risk. To reduce exchange rate risk on its yen cash flows, Tiffany had two elementary alternatives available to it. One was to enter into forward agreements to sell yen for dollars at a predetermined price in the future.The other was to purchase yen put options. The terms at which Tiffany could purchase forward contracts an d put options, along with other financial market data, are shown in Exhibit 8. in advance committing Tiffany to a hedging program, management wanted to be sure it dumb what the potential risks and rewards were for each of these so-called derivative instruments. Perhaps more importantly, it was inborn to determine whether or not a risk management program was appropriate for Tiffany, what it objectives should be, and how much, if any, exposure should be covered. pic This included a $ 75 million secured revolving credit facility a $10 million, 16% subordinated note cod in 1992 and common stock warrants to purchase approximately 25% of the companys equity on a fully diluted basis. earlier to Mitsukoshis purchase of Tiffanys common stock from GECC, Tiffany and Mitsukoshi entered into an agreement by which Mitsukoshi agreed not purchase in excess of 19. 9% of Tiffanys issued and outstanding common shares. This agreement would expire on September 31, 1994.Due to the significant number of Tiffany boutiques already operating in Japan, future openings there were expected to occur only at very modest rate, if at all, in the near-term future. Tiffanys business was seasonal in nature, with the fourth quarter typically representing a proportionally greater percentage of annual sales, income from operations, and net income. In FY 1992, net sales totaled & 107,238,000, $120,830,000, $105,897,000, and $152,431,000 for the first, second, third, and fourth quarters, respectively. Management expected this pattern to continue in the future.Tiffany management believed that a retail price reduction in Japan of 20% to 25% would likely result in a substantial increase in unit sight of jewelry sales. The repurchase of inventory by Tiffany necessitated the reversal of $115 million in sales and related gross profit previously acknowledge on merchandise sold to Mitsukoshi. Accordingly, Tiffany recorded a gross profit previously recognized $57. 5 million reserve to provide for pr oduct returns. , which reduced the second fiscal quarters (ended July 31, 1993) net income by approximately $32. 7 million, or $2. 7 per share. Of the $115 million of sales being reversed, only $52. 5 million of inventory held in Mitsukoshi boutiques was actually repurchased during the month of July 1993 (Mitsukoshi agreed to accept a deferred payment on $25 million of this repurchased boutique inventory, which was to be repaid in yen on a quarterly basis with interest of 6% per annum over the next 4 1/2 years). Approximately $62. 5 million of Tiffany & Company inventory maintained in Mitsukoshi warehouses would be repurchased throughout the period ending February 28, 1998.Payment for this warehouse inventory was to be made in yen 40 days following actual receipt of the inventory. Fees were reduced to 5% on certain high-value jewelry items repurchased from Mitsukoshi. Tiffany Japan would also pay Mitsukoshi incentive fees equal to 5% of the amount by which boutique sales increas e year-to-year. reckon on a per boutique basis. In Tokyo, Tiffany boutiques could be established only in Mitsukoshis stores, and Tiffany-brand jewelry could be sold only in such boutiques (though Tiffany-Japan reserved the right to open a single flagship store inTokyo). ===============================================================================??? The suggested questions In what way(s) is Tiffany exposed to exchange-rate risk subsequent to its new distribution agreement with Mitsukoshi? How serious are these risks? Should Tiffany actively manage its yen-dollar exchange-rate risk? Why or why not? If Tiffany were to manage exchange-rate risk activity, what should be the objectives of such a program? Specifically, what exposures should be actively managed? How much of these exposures should be covered, and for how long? As instruments for risk management, what are the chief differences of foreign-exchange options and forward or futures contracts? What are the advantages and d isadvantages of each? Which, if either, of these types of instruments would be most appropriate for Tiffany to use if it chose to manage exchange-rate risk? How should Tiffany organize itself to manage its exchange-rate risk? Who should be responsible for executing its hedges? Who should have circumspection responsibility for this activity? What controls should be put in place?