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17 Cards in this Set
- Front
- Back
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Valuation of a takeover target
(some aimed at estimating market prices when there is no market price - ie shares not traded) |
stock market methods - P/E approach & dividend yield approach
cash flow and dividend based methods - FCFs & dividend valuation method asset-based methods - historic cost approach & market value approach |
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Price-earnings (P/E) ratio approach
(stock market method) |
market share price = EPS x P/E ratio
(or earnings x P/E = val of co rather than share price) Matter of judgement what P/E is used – factors: MICROBEAMS Market sentiment If co is currently quoted Comparable companies in same sector – their P/E ratio Reputation of co & mngt – security of CFs & earnings – affected by business & financial risks (gearing, dependent on small no of key inds) Org’s business & its prospects Business sector & its prospects Economic conditions Asset backing Make-up of shareholdings & financial standing of main /shs Size of co |
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Advantages & disadvantages of P/E ratio approach
(stock market approach) |
Advs: PUT
Profit on of objs of business & this approach incorporates profit per share (EPS) Uses info that is readily available Terminology involved mngrs accustomed to dealing Disadvs: PEAS Projected improvement in earnings is a matter of judgement (value potential acqu in terms of earnings & effect on their own EPS – ‘earnings enhancing’ – estimate improvements in profitability by achieving synergies – subjective) EPS-based estimates how shares are/might be valued by market rather than what they are worth to the acquirer – useful for negotiating but not whether acq worthwile Accounting principles applied & judgement exercised effects earnings – not absolute figure. Could discount future profits to find value of T-co but same drawbacks as EPS. Similar listed business needed to undertake valuation |
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Dividend yield approach
(stock market approach) |
Share price = target dividend per share / dividend yield
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Advantages & disadvantages of dividend yield approach
(stock market approach) |
Advs: CUP
Cash rather than earnings used – less influence by a/cing policies Uses stock market ratio (relates valuation to the market) Dividend imp to s/hs Disadvs: Divs only part of s/h return & amount depends on div policy Similar listed business needed to provide div yield for valuation of unlisted co’s (like P/E) |
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FCFs & SVA
(cash flow and dividend-based methods) |
FCFs – surplus cash generated by co after payment of int, divs, tax + allowing for capital investement needed to maintain FAs & increase investment (FA or CA) to support growth of bus.
Value of T-co = PV (calc using co’s WACC) of the projected future CFs Accuracy depends on accuracy of CF projections and value of discount rate used. SVA – focuses on optimising value drivers – provides stimulus to FMs to take actions to max s/h value. Requires judgements re what improvements bidder might be able to make in value drivers. |
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Advantages & disadvantages of FCFs & SVA
(cash flow and dividend-based methods) |
Advs: IQ
Info needed can be obtained/estimated from published FS predominantly Quick & simple way of estimating value of co, taking a/c of future prospects Disadvs: UPS Uncertainty & error issues – e.g. in estimating time horizon up to which growth in CFs can be projected, business value, or estimated values of this time horizon & cost of capital Profit margin is starting point of calcs, not CFs, so no NPV produced Separate inclusion of depreciation & FA investment CFs involves some double-counting |
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Dividend valuation model
(cash flow and dividend-based methods) |
Value of a shares = PV of divs expected to be received from the share
Need to know current div & expected rate of growth of the div & appropriate discount rate (should reflect risk of business). Valuation of future dividend stream: PV = d1/(1+k) + d2/(1+k)2 + d3/(1+k)3 + dn/(1+k)n d1,d2... = dividend for next yr, yr after + so on n = no. of yrs k = discount rate used in the valuation |
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Advantages & disadvantages of dividend valuation model
(cash flow and dividend-based methods) |
Advs: CARS
Clear & cash-based Appropriate if no aim to gain mngt control & if no expectation of change in earnings & div policy (e.g. portfolio investors) Risk can be incorporated into discount rate used in valuation process Shares valuation will be diff from market price if investor believes risk associated w co’s shares or rate at which divs expected to grow is diff to market assumptions – indicate if shares undervalued/overvalued. Disadvs: FUR Forecast future div payments diff – 1 to 2 years ahead max Understated total returns – divs rep annual cash returns (after-tax EPS, also reflected in share price – part of total s/h wealth) Rate of return calc (discount rate) diff as should relate to risk implicit in T-co’s bus/financial structure |
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Historic cost approach
(asset-based methods) |
Values a co using figures from stmnt of FP.
Co value = value of assets – value of liabilities (NAV per shares – value of co/no. of ord shares) |
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Advantages & disadvantages to historic cost approach
(asset-based methods) |
vAdvs: IFA
Info readily available from published stmnt of FP & NAV is easily calculated Floor price provided by share valuation figure (doesn’t consider earning potential, NAV only) Assets may act as collateral for additional borrowing by merged co Disadvs: MRI Most co’s worth more than A’s in stmnt – intangible assets Revalued asset (some) costs may be less than their realisable value & t/f understate value of A’s Ignores primary reason for holding NAs – to earn profits More appropriate if identified undervalued assets which purchaser believes can realise at a price higher than value of bus as a going concern (asset-stripping). |
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Market value approach / Realisable value approach
(asset-based methods) |
Asset-stripping led to co’s being more careful to show A’s as realistic values in BS & shares took a/c of this – corporate predators less likely as stripping less worthwhile.
New context – identify undervalued conglomerates (diversified businesses where corp mngt not getting best results from a range of often unrelated businesses) – purchaser sells separate businesses as GCs to other co’s in same industries. Purchasers needs to ensure all A’s properly considered: NCAs have to be valued on a realisable value basis (pref to HCA as gives current market value) – break-up value (does not consider bus a GC) Intangible assets need to be valued – help if purchaser wants to incorporate T-co as GC in own bus. Method usually based on identifying PV of the CFs attributable to the brands (same as for FCF described earlier) |
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Divestment and de-merger activity
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Management buy-outs (next card) – acquisition by existing mngt of all/part of bus from owners. Usually of profitable subsidiaries that don’t match group’s strategic plans.
Management buy-ins – similar to MBO except that team of outside mngrs who mount takeover bid to run co. Spin-offs – creation of 1+ newcos + shares held by s/hs of old co in same proportion as before. A’s of bus separated and transferred to newco, usually under diff mngt. Sell-offs – sale of part of the co to 3rd party, generally for cash. Extreme form is liquidation of entire co. De-mergers – sell part(s) of bus to 3rd party or offer s/hs shares in de-merged parts of bus in place of current shares in ‘merged’ co (e.g. BT & O2). Generally viewed favourably (depending on reason & future profitability of demerged components) – improved visibility & greater choice of shares for investors. Going private – small group purchases all shares & no longer quoted on SE – to prevent takeover bids, reduce costs of meeting listing req’s, limit agency problem, concentrate on LT needs over ST share price volatility. |
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Advantages & disadvantages of MBOs
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Advs: MAPOR
Vendor - more money achievable by sale of GC Vendor - alt to closure + prevents sale to 3rd party (poss competitor) Mngt - purchase operation which they have fully operational K (need to be sure can obtain better return once owners) Mngt – owners rather than e/es, won’t lose job (if bus threatened w/ closure) Financiers – reduced risk compared w/ new venture w/ no track record Problems: CERAMIC Continuity of rels w/ suppliers & customers might be diff E/e redundancies often follow, change to working practices diff to implement, may lose key e/es, previously empt/pension rights to be maintained Resentment by mngt of board rep req’d by suppliers of finance (may influence how bus run) Agreeing fair price to be paid diff Mngrs good at mnging process, not necy got financial/legal K req’d to conduct MBO – rely on costly expert adviser Ind mngrs req’d to be financially committed to venture, this may have –ve impact on personal financial affairs CF problems, esp if FAs need replacing |
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Financing MBOs
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Bank & subordinated debt (‘intermediate debt’ or ‘mezzanine finance’). Ranks after other debt capital & before equity. Often has conversion rights or equity warrants attached allowing for conversion to equity as some predetermined point in future. Rate of interest is higher than other debt, but lower than cost of equity.
Mngt equity (often only minority of shares) Financier equity (banks, accepting house, venture capitalists – LT view). Bus plan necy. Equity stake due to risk. E.g. convertible pref shares w/ VRs should divs become in arrears – allows backers to capitalise on the bus if successful + cover themselves if bus fails. Result is high financial gearing (higher than usually accepted). Makes expansion diff as diff to raise further funds . Financiers may commit to provision at the start w/ stringent perf conditions. Or could float the co (AIM) but involves relinquishing some control over bus. Allows financiers to realise their investment. LT viability is q of careful risk assessment & ability of mngt to plan & develop the bus. Poss success reasons – reduced o/hs, higher levels of mngr motivation, quicker/flexible decision-making, austere action on pricing & debt collection, acquired bus at a good price. |
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Financing MBOs – financiers’ risk should be assessed in relation to:
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CRAPPER
Customer/supplier rel’s w/ mngt team Return projected suff to offset risk ? Additional capital requirements to replace/improve assets? Projections in business plan Reason business is being sold & what is being bought? Expertise/motivation/ability (mix/range of skills) of mnt team & amount will to invest from own funds Price correct level? |
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Advantages & disadvantages of de-mergers
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Advs: RID
Reduced risk of takeover if attractive parts of co divested Improve efficiency & control problems, concentrate on fewer areas, increase cash & earnings Diseconomies of scale could be reduced Disdadvs: RILE Reduce ability to raise finance Increased risk of takeover Lower turnover, less stauts & profits. Economies of scale could be reduced |
