creating value for shareholders- an overviewvedpuriswar.org/mba/finvalcre/creating value- an...

Creating Value for shareholders- An

Overview

January 6, 2018

A.V. Vedpuriswar

A historical perspective on value creation

In 1900, the stock market was dominated by railroads, which

accounted for 63% of UK market cap and 50% of the UK.

By 2015, railroads represented less than 1% of the US market

and close to nothing of the UK market.

Other industries that have declined in importance are textiles,

iron, coal and steel.

Some industries remain as important today as they were in 1900.

These include banking and insurance, food, beverages, tobacco

and utilities.

In the US, the largest industries today are technology, oil and gas,

banking, healthcare, insurance and retail.

1

The tale of 3 Mobile Sellers

2Ref: Code Halos, by Malcolm Frank, Paul Roehrig, Ben Pring

The Tale of 3 Book Sellers

3Ref: Code Halos, by Malcolm Frank, Paul Roehrig, Ben Pring

4

Strategy and Business

Model

Capital allocation

Financing deciisons

Architecture

Cost mangement

Corporate Riak Mgmt

M&A and Restructuring

Corporate Governance

The Value Octagon

Ref: Prasanna Chandra

Determinants of shareholder value

Sales growth

Operating Profit margin

Income tax rate

Investment in fixed capital

Investment in working capital

Cost of capital

Vale growth duration

5

Ref: Alfred Rappaport

The lifecycle of a company

6

7

What determines the value of a firm?

The value of a firm can generally be considered a function of

four key inputs:

– Cash flow from assets in place or investments already

made

– Expected growth rate in cash flows during a period of high

growth excess returns

– Time before stable growth sets in and excess returns are

eliminated

– Discount rate which reflects both the risk of the investment

and the financing mix used by the firm

8

What can a firm do to increase its value?

Generate more cash flows from existing assets

Grow faster or more efficiently during the high growth phase

Prolong the high growth phase

Lower the cost of capital

Competitive advantage and growth

9Source: Motilal Oswal Wealth creation study

The Competitive Advantage Period

10

Source: Motilal Oswal Wealth creation study, 2017

ACC’s 10 year Competitive Advantage Period

11


Cipla’s 15 year Competitive Advantage Period

12


Porter’s Five Forces Model

13

The effect of Rivalry

14


The effect of the Threat of new entrants

15


The effect of the Bargaining power of customers

16


The effect of the Bargaining power of suppliers

17


The Structure Strategy Play

18Source: Motilal Oswal Wealth creation study, 2017

Barnes and Noble vs Amazon

19


Tata Steel’s acquisition of Corus

20


Competitive Advantage Period : The leaders

21


Growth advantage period

22


Infosys’ Growth Advantage Period

23

Companies with the longest Growth Advantage Period

24


Companies with the largest growth


CAP + GAP


HDFC and HDFC Bank : CAP

27


HDFC and HDFC Bank : GAP

28


HDFC and HDFC Bank : Creating shareholder value

29


The four cornerstones of Finance

30Richard Dobbs, Bill Huyett, Tim Koller, McKinsey

Discounted Cash Flow Valuation

Use DCF technique wherever possible.

Make adjustments for cash flows

Make adjustments for discount rate.

Avoid double counting of risks.

State assumptions clearly.

31

Key Principles in Relative valuation

We must look at peers with similar prospects for ROIC and

growth.

Wherever possible, we must use forward looking multiples, i.e.

multiples based on forecasts rather than historical profits.

We should prefer enterprise value multiples rather than P/E.

Enterprise value to EBITA must be suitably adjusted for non-

operating items.

– For example, excess cash should be deducted.

– The value of leased assets must be added to the market value and the

implied interest expenses must be added to EBITA.

– The present value of all employee stock option grants currently outstanding

and pension liabilities must be added to the value.

32

The Zen of Finance

Let value the firm = V

V = FCF/ (WACC – g) = (NOPAT – NI )/ (WACC – g)

NOPAT – NI = NOPAT ( 1 – NI/NOPAT)

= NOPAT [ 1 – (NI/IC) / (NOPAT/IC) ]

= NOPAT [ 1 – g /ROIC]

V = NOPAT (1 - g/ROIC)/ (WACC – g)

= [IC x ROIC ( 1 – g/ROIC)] / (WACC –g)

Increasing investment, ROIC, growth and reducing the cost of

capital are the ways of creating value.

33

Operating Leverage

Arises from the firm’s fixed operating costs.

Sensitivity of PBIT to changes in sales

DOL =Contribution/ EBIT

34

Financial leverage

Arises from the firm’s fixed financing costs such as interest.

Sensitivity of PBT to changes in PBIT

DFL = PBIT/PBT

35

Total Leverage

DOL X DFL

(Contribution/ PBIT) x ( PBIT/PBT)

36

Strategic cost management

Have a holistic understanding of the value chain.

Use the right methods of costing.

Activity based costing can provide the best outcomes.

37

Bata’s Cost cutting strategy

38

The relationship between ROI and ROE

ROE = PAT/E

= (PBIT – Int) ( 1 – Tax rate) / E

= (PBIT – i X D)(1 – Tax rate) / E (i = interest rate)

= [(ROI) (A) – i X D] / E X ( 1 – Tax rate)

= [(ROI) (D + E) – i X D] / E X ( 1 – Tax rate)

= [ ROI + (ROI – i) (D/E)] (1- Tax rate)

If ROI > i, leverage boosts ROE

If ROI < i, leverage pulls down ROE

39

Sustainable growth rate

Sustainable growth rate = ROE X Retention ratio

= (PAT/Sales) X ( Sales/Total Assets) ( Total Assets/Equity)

40

Marakon Model

P = D/(k – g)

= B x r x b/(k – g)

P/B = r x b/(k – g)

But ( 1 – b) (r) = g

or br = r – g

P/B = (r – g) / (k – g)

41

P = Market price

B = Book value

b = Dividend payout ratio

g = Growth rate

Why Miller Modigliani does not hold in the real world

Taxes

Cost of distress

Agency costs

42

Capital is abundant today

43

Profitability vs Growth

44

creating value for shareholders- an overviewvedpuriswar.org/mba/finvalcre/creating value- an...

Documents