Value

In this class we will discuss• The nature of value• Different methods for arriving at an estimate

of value• The problems of each of the methods

Introduction

“….value, like beauty, is in the eye of the beholder” (Pike and Neale, 2006)

• What is ‘value’?• What influences value?• What are the methods available for

calculating value?• Is there ONE unique value?

How much?

London Lincoln

Company Valuation – why, who?

• Takeover or merger situation • Investors buying shares in a company• Advisers making buy/sell/hold

recommendations to clients• Lenders considering debt issues or reissues• Credit ratings agencies• …

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J. Sainsbury plc – how much is the company worth?

2009 2008Group£m

Comp£m.

Available information

• Published accounts• Share price• Shareholder meetings/other communication• Insider knowledge?

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Approaches to valuing companies

• Stock market valuation– Share price

• Asset based valuation– Balance sheet

• Income based valuation– Income statement– Dividend history

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In practice

• Some combination of all of these approaches will be used

• They will give different ‘answers’• Some judgement has to be used in

interpreting the ‘answers’

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Each method/model

• Comes with ASSUMPTIONS

– How realistic are these assumptions?

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Each method

• has strengths

• and weaknesses

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Example (adapted from Watson and Head)

Simpson plc has distributable earnings of £72.7m, a WACC of 14% and a PE ratio of 18.7. It is in the process of taking over Stant plc whose financial details are as follows:

Stant plcPBIT £66mInterest paid £7.2mCT £17.64mCurrent dividend 16pDividend growth 7.5%EPS 16.7pPE ratio 12.87MP of ordinary shares £2.15Equity beta 1.17

Stant plc balance sheet£m £m

Non-current assets 265Current assets 60Current liabilities 43 17

28210% debentures(2016) 72

210

Ordinary shares (50p) 123Reserves 87

210

Other information

• Distributable earnings are currently £41.16m and are expected to grow by 5% (synergy) per year.

• Risk free rate is 4% and return on the market is 10%

Calculate the net asset value

• = non-current assets + Net current assets –LT liabilities

• = £265m + £17m - £72m = £210m

Net Asset Values

• Should be equivalent to ‘owners equity’• Strengths

– Information is easily available– Objective

• Weaknesses– Use of historic cost (depreciation policies)– Separate asset valuation– Use of balance sheet to reflect value– ‘Backward’ looking– Intangible assets

Stock market valuation

• Number of ordinary shares multiplied by MP• Doesn’t give an estimate of ‘worth to bidder’• Premium will be needed ie current SP will be

the minimum that the target company shareholders would be willing to accept

• Not all shares are traded at any one time• Market Price as a reflector of value is a

function of market efficiency• Not useful for non-listed companies

What is the stock market valuation of Stant plc?

• Number of ordinary shares £123m/£0.5 = 246m shares

• Stock market valuation 246m * £2.15 = £529m

• Compare this with the NAV• Normally stock market value is higher – why?• … and if NAV is higher???

Price/earnings ratio Valuation

• P/E ratio value = Distributable earnings x P/E ratio

• Which P/E ratio to use?– Target company– Bidding company– Weighted average– Proxy company

PER valuation

• Using target company’s (ie Stant) PER– £41.16m * 12.87 = £528m– Proxy could be used for unquoted company

• Using bidding company’s (ie Simpson) PER– £41.16m * 18.7m = £770m– Assumptions

• Strengths/Weaknesses?

Dividend Growth Model

• P0 = D0(1+g)

(r - g)• Where r = required return by shareholders• r can be found using the CAPM

Dividend Growth Model

• Assumptions– Investors in a company receive cash flow in the

form of dividends – A discounted cash flow calculation of the future

dividend payments will represent the market value of a share

– Most companies’ dividends grow from one year to the next

– Assume a constant growth rate, g

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Value using Dividend Growth Model

Total current dividend£0.16 * 246m shares = £39.4m

Return required by ordinary shareholders (r)r = risk free return + (Beta * market risk premium)r = 4% + 1.17 * (10% - 4%) = 11%

Company Value P0 = D0(1+g) = £39.4m * (1 + 0.075) = £1,210m

(r - g) 0.11 – 0.075

Dividend Growth Model

Problems• Use of CAPM• Assumption regarding growth rate of

dividends• A high valuation if cost of equity and dividend

growth rate are close together (as in this case)• Not suitable for zero dividend paying

companies

Discounted Cash flow Valuation

• Use constant growing perpetuity modelCF1 = (£41.16 * 1.05)/(0.14 – 0.05) =

£480.2mKo – g

Assuming that current distributable earnings are a proxy for future cash flow

DCF Valuation

• The maximum that should be paid is the difference between the present values of the acquiror’s pre- and post- acquisition cash flows

• Problems– Quantifying future cash flows (inc synergies)– Appropriate time period and terminal value– Determining cost of capital

Summary• Values for Stant plc range from £210m to

£1210m according to method used!!• How reliable is information used• What assumptions have each of the methods

made?• Have the bidder’s intentions for the target

company been taken into account?• There is no one unique value

‘Valuing a business is part art and part science’ (Warren Buffet)