Valuation

1
Session 8

• Valuation

EMBA Fall 2002
2
Methods

• Asset value
• Liquidation value
• Relative value (Multipliers)
• Discounted cash flow value
• Dividend discount models
• Free cash flow models

3
Equity versus Entity Value

• Assets Liabilities

Fixed Assets Debt Working Capital Equity
Current Assets Less Current Liabilities
Entity Value Debt Value
Equity Value
4
Asset and Liquidation Value

• Segment value
• Availability of secondary markets
• Appraised value

5
Multiplier Methods

• Price-to-earnings (P/E)
• Price-to-earnings-before-interest-tax-depreciation
  and amortization (P/EBITDA).
• Price-to-book (P/B)
• Price-to-sales (P/S)
• Price-to-cash flow (P/CF).

6
Multiplier Value

• Value Item value x Multiplier
• For example Using the P/E method
• Value EPS forecast x Predicted P/E
  multiple

7
Choosing Multiplier Level

• 1) Examine historic P/Es for the company. Pay
  special attention to trends.
• 2) Use historic 5 to 10 year average to get
  base multiple level.
• 2) Examine P/Es and trends for several
  comparable companies.
• 3) Determine if the company has historically
  traded at a premium or a discount to its
  competitors. If at a premium, can it maintain
  that premium? Why? If a discount, can it move
  to the industry level? How?

8
Example Knight-Ridder

• Basic Data
• Stock price 68.31
• Net Income 177.3 million
• Shares Outstanding 84 million
• EPS 177.3 / 84 2.11
• P/E 68.31 / 2.11 32.4

9
Knight-Ridder Evaluation 1

• Historic trading range for P/E
• 12 to 23 over last five years
• At current level of 32 KRI looks fully valued.
• Need to evaluate competitive position and
  multiples of similar companies

10
Knight-Ridder Comparables

• Company P/E P/Bk P/Sales
• Gannett 25 3.5 3.2
• NY Times 37 6.3 2.5
• Average 31 4.9 2.8
• KRI Item 2.11 20.3 35.0
• KRI Value 65.4 99.5 98.0
• KRI Multiples 32 3.4 2.0

11
Other Comparables

• Company P/E P/Bk P/Sales
• Gannett 25 3.5 3.2
• NY Times 37 6.3 2.5
• Tribune 185 2.5 2.7
• Dow Jones 51 118 2.8
• Average 99 33 2.8
• Trimmed Avg 44 4.9 2.75
• KRI Multiples 32 3.4 2.0

12
Example 2 ND Enterprises

• Basic Data for ND Enterprises
• Sales 142 million
• EBITDA 20 million
• EBIT 13 million
• Capex 5 million
• Tax Rate 40

13
ND Enterprises Comps

• Company P/E P/Ebitda P/Revenue
• BWAY Corp 13.3 7.5 0.8
• Greif Bros 19.3 10.1 1.1
• Rotonics 9.0 4.7 0.7
• Sonoco Prods 17.0 7.7 1.3

14
ND Enterprises Recent Acquisitions

• Target/Acquirer P/Ebitda P/Revenue
• CFI/ Ivex Packaging 7.3 0.7
• Davies Can/BWAY NM 0.8
• Milton Can/BWAY 12.9 0.7
• Mobil Plastics/Tenneco 8.3 1.1
• Van Dorn/Crown Cork 12.1 0.7 .

15
ND Enterprises Valuation

• Estimate a value for ND enterprises

16
Discounted Cash Flow Models

• Many companies do not pay dividends.
• Also, many firms are choosing to repurchase stock
  rather than increase current dividends.
• For these reasons free cash flow models have
  become increasingly popular.
• Free cash flow represents the cash flow generated
  by the company that is available for dividends
  and interest payments (but may also be used to
  grow the business or repurchase stock).

17
Free Cash Flow Models

• Free cash flow Gross Cash Flow - Investment
• Gross Cash Flow NOPAT Depreciation
• NOPAT EBIT (1-Tax rate)
• Investment Capex ?Net Working Capital
• Capex ?NPPE Depreciation

18
Free Cash Flow Example Nike

• NOPAT 1014 (1 0.35)
• 659
• Gross Cash Flow NOPAT Depreciation
• 659 214
• 873

19
NIKE Investment

• ?Net Working Capital 2699 2430
• 269
• Capex (2195 2261) 214
• -66 214
• 148
• Investment Capex ?Net Working Capital
• 148 269 417

20
NIKE Free Cash Flow

• Free cash flow Gross Cash Flow Investment
• 873 417
• 456

21
FCF No Growth Model

• (a) No Growth Model
• (Note Denominator is the WACC, not
• the return on equity)

22
NIKE No Growth Value

• Value FCF/WACC
• 456/.11
• 4,145
• Value of Equity Entity Value Debt
• 4,145 1,399 2,746
• Shares Outstanding 268 million
• Value per share 2,746/268 10.25
• Mkt price 61

23
Free Cash Flow Constant Growth

• (b) Constant Growth Model

24
NIKE Constant Growth Model

• 1992 2001 Gwth Rate
• Sales 3340 9489 12.3
• EBIT 521 1014 7.7
• Net Income 329 590 6.7
• Assume g 8

25
NIKE CGM (Contd.)

• Entity Value 456 / (.11-.08) 15,200
• Value of Equity Entity Value Debt
• 15,200 1,399 13,801
• Shares Outstanding 268 million
• Value per share 13,801/268 51.50

26
FCF Abnormal Growth Model

• (c) Abnormal Growth Model

27
Continuing Value

• CV is known as the continuing value and is the
  value of the company at the end of the explicit
  forecast period (i.e. at the end of year N).
• There are two common ways to estimate CV
• 1) Constant Growth Method
• 2) Multiplier Method

28
Estimating Continuing Value

• (i) Constant Growth Method
• g is the constant growth rate per year in
  perpetuity after year N.
• In general, g consists of three components
• The first two can be obtained from many
  economic forecasting services.
• The last is the rate at which you believe the
  company can grow above that of the economy as a
  whole.

g Expected Infl Real Growth in Econ Fran
Growth Rate
29
Estimating CV (Contd.)

• (ii) Multiplier Method
• This approach uses the final years pro
  formas to determine either N/Inc, EBITDA, or book
  value at the end of the explicit forecast period.
• The model then assumes that the company will
  trade at an industry average multiplier after
  year N.
• CV Net Inc of year N x (Industry Avg. P/E)

30
Abnormal Growth Model NIKE

• Assumptions
• FCF 2003 600
• FCF 2004 750
• Thereafter g 7
• Value 600 750 750(1.07)/(/11-.07)
• 1 .11 1.112 1.112
• 541 609 20,063/ 1.23
• 541 609 16,283
• 17,432

31
NIKE Abnormal Growth Value

• Entity Value 17,432
• Value of Equity Entity Value Debt
• 17,432 1,399 16,033
• Shares Outstanding 268 million
• Value per share 16,033/268 59.83

32
Equity versus Entity Value

• Company A Company B
• Revenues 400 Revenues 400
• Nopat N/Inc 20 (EBIT40) EBIT 40
• Price 200 Tax rate 50
• P/B 2 Interest rate 10
• P/ Sales 0.5 N/Inc 17.5
• P/E 200/20 10

100 E 100
100 D 50 E50
33
Valuing B Using As Multiples

• Ignoring Entity/Equity Differences
• P/E Value 17.5 10 175
• P/Bk Value 50 2 100
• P/Sales Value 400 .5 200
• Adjusting for Entity/Equity Differences
• Entity Value P/E Nopat P/E 2010 200
• P/Bk Assets P/Bk 100 2 200
• P/Sales Sales P/S 400 0.5 200
• Value of Equity Entity Value Debt
• 200 50 150

34
Entity vs Equity Problems

• Reverse Process and Start with Company B
• Price 150
• P/E 150/17.5 8.57
• P/Bk 150/50 3
• P/Sales 150/400 .375
• Using These to Value A
• P/E 20 8.57 171
• P/Bk 100 3 300
• P/S 4000.375 150

35
Entity vs Equity Adjustments

• Adjust the Multiples for B
• Entity value Equity Debt 150 50 200
• P/Nopat 200/20 10
• P/Bk 200/100 2
• P/Sales 200/400 .5
• Use These Adjusted Multiples to Value A
• P/Nopat 20 10 200
• P/Bk 100 2 200
• P/S 4000.5 200

36
Summary Multiple Adjustments

• P in all Ratios
• Always use entity value (equitydebt) for P
• Note that equity equals sharesshare price
• P/E Use Nopat rather than E
• P/Bk Use total assets for book value
• P/Sales Needs no adjustment
• Note These all then yield the ENTITY value