Valuation

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Valuation

• Creation of value
• Valuation of a stock listed company
• Valuation of a non listed company
• Net Asset
• Price-earning Ratio
• Present Value of Dividends
• Present Value of Free Cash flow

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Creation of value

• The goal of any company to create value
• This means increase the value of the company
  for the shareholders
• With full respect for the legal framework
• social, fiscal, environmental regulations
• And for all the other stakeholders
• employees
• customers
• suppliers
• neighbors

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Creation of value

• How can the value be increased ?
• by buying assets at a price lower than their
  economic value
• real estate buying during a depression
  (crisis)
• by selling assets at a price higher than their
  economic value
• real estate selling during a boom

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Creation of value

• The best way to create value Innovation
• introducing new products
• Microsoft
• Cellular phones
• introducing new production processes
• Car manufacturers
• improving the productivity of labor
• improving the quality of products
• etc.

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Market capitalization of a stock listed company

• For listed companies the share price is known
  daily
• the value of the company is equal to the price
  share multiplied by the number of shares
• V pshare.nshares
• V Market capitalization (market cap)
• If the market is efficient the Market Cap is
  always the true value of the company
• Efficient market means that at any time all the
  market has all the information on the company

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Fair value of a stock listed company

• There is often a difference between the share
  price and the true value
• unequal distribution of the information
• good or bad news for the future not known by the
  market
• from inside information
• to ... inside trading
• booming or bubble effect (psychology)
• misinterpretation of the facts by the market

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Fair value of a stock listed company

• Even for a stock listed company it is useful to
  calculate a fair value based on
• All the information available on the company
• Comparison of the share price and of the
  financial ratios with similar listed companies
• It is interesting to buy
• When the share price is lower than the fair value
• It is interesting to sell
• When the share price is higher than the fair
  value

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Valuation of a non listed company

• A valuation of a non listed company can only be
  known when
• Shares of the company are sold
• The sale price is known
• But it is possible to estimate the value of a
  non-listed company by using different methods
• Based on the book value
• Based on comparison with similar listed companies
• Based on the present value of the future
  financial flows of the company

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Net Asset

• Is the book-value of the equity a correct
  valuation of a company ?
• No difference between book-value and market
  price of the assets liabilities
• It is possible to replace in the Balance Sheet
  all the book-values by the market prices
• and to calculate a revised value of the equity
• Net Asset Assets (at market prices) -
  Liabilities (at market prices)
• The Net Asset is a valuation of the company

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Saigon Hotel - Net Asset (000 US)
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Saigon Hotel - Net Asset

• Additional information
• The company owns the hotel building
• The book-value is 6.045 and the market price
  estimation 9.055
• The director is an art collector and the company
  owns art pieces
• The book value is 125 and the market price 850
• There are bad receivables for a book-value of 45
• In the cash placement the company owns Microsoft
  shares bought in 1992 for 10 and whose present
  stock price is 100
• The tax rate on all profits is 40
• What is the Net Asset of the Saigon Hotel ?

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Price-earning Ratio

• A second valuation method for a company is the
  Price-Earning Ratio (PER)
• The Price-earning Ratio is equal to the value of
  the company divided by the net result
• PER ? V / EAT
• For listed companies it can be calculated
  directly by dividing the share price by the net
  result per share
• eps EAT / nshares
• PER pshare / eps

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Price-earning Ratio

• The PER is higher for a company
• with higher growth prospects for the earnings
• the risks being equal
• with lower risks
• the growth prospects being equal
• The PER is published daily
• in the financial papers
• on the financial Websites (cfr bourses)

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Price-earning ratios Examples (Oct 30, 2001)
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Price-earning ratios Examples (Oct 30, 2001)
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Price-earning ratios Historic (Nov 2, 2000)
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Price-earning ratios - exercises

• What is the value of the Saigon Hotel in 2002
• EAT 432.000
• PER 15
• High level due to excellent location and future
  prospects
• Explain the difference between the PER
• Coca-cola Pepsico
• Compaq IBM
• Which industry should have the higher PER
• electricity or telecom
• classical telecom or cellular companies

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Present Value of Dividends

• Let us start from a very simple approach
• Suppose that we know
• that the expected value of the share of a company
  one year from now is v1
• that a dividend div1 will be paid at that time
• that the Cost of the Capital for this company is
  r
• Then we can write the equation for the Present
  Value of the share

v0 (div1 v1) / (1r)
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Present Value of Dividends

• We can repeat this calculation by writing the
  value of the share at time 1 based upon the value
  and dividend at time 2
• v1 (div2 v2) / (1r)
• and so on . . .
• v2 (div3 v3) / (1r)
• We can then write
• v0 (div1 (div2 v2) / (1r))/(1r)
• v0 div1/(1r) div2/(1r)2 pT/(1r)T

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Present Value of Dividends

• If we consider that the company lives in
  perpetuity we can write
• v0 div1/(1r) div2/(1r)2 divt/(1r)t
• V0 DIV1/(1r) DIV2/(1r)2 DIVt/(1r)t
• Or
• v0 ?t1? divt/(1r)t
• V0 ?t1? DIVt/(1r)t

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Present Value of Dividends

• If we consider that
• the company will live in perpetuity
• the growth rate of the dividend is constant and
  equal to g
• Then
• divt div1.(1g)t-1
• Gordon Shapiro proved mathematically that
• v0 div1 / (r-g)
• V0 DIV1 / (r-g)
• of course one must have rgtg
• The lower the Cost of Capital the higher the
  value
• The higher the growth rate the higher the value

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PV of Dividends - Examples

• What is the Present Value of the Quiz Company ?
• the next dividend will be 12.000.000
• the Cost of Capital is 14
• the growth rate of dividend (perpetual) is 2
• What is the Cost of capital of company B ?
• the next dividend will be 100.000
• the present value is 1.000.000
• the growth rate of dividend (perpetual) is 4

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DCF modelPresent Value of Free Cash Flow

• An improved approach is to use the prospected
  Cash Flows from the Business Plan to estimate the
  value
• The Total Entreprise Value is equal to the PV of
  all FCF
• Entreprise Value Equity Financial Debt
• Free Cash Flow before Interest
• FCF Net Operating Earning After Tax
  Depreciation
• Net Operating Earning After Tax (NOPAT) EBIT.(1
  - Tc)

• EV0 ?t1? FCFt/(1r)t

The Enterprise Value is equal to the PV of all
Free Cash Flows  Discounted Cash Flow Model 
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DCF ModelHow to use it ?

• Using the Business Plan one can calculate the EV
• Calculating the NOPAT and the FCF
• Problem The Business Plan is made for a limited
  period of time
• 5, 10 or 20 years
• We need to estimate the value of the Cash Flows
  after the Business Plan period

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DCF ModelTerminal Value

• The Terminal Value represents the EV for the
  perpetuity after the end of the Business Plan
  period
• Based on the Gordon-Shapiro formula
• VT DIVT1 / (r-g) or
• EVT FCFT1 / (r-g)
• T last year of the Financial Plan
•  Normalized  FCF for the perpetuity FCFT1
  NOPATT1
• Future capex Future depreciation (keep the
  production capacity)
• g perpetual growth rate
• To be estimated cautiously (2 to 4)
• Total Enterprise Value is then

• EV0 ?t1T FCFt/(1r)t (NOPATT1/(r-g))/(1r)T

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DCF modelEquity Value

• The Value of the Equity is equal to
• The Enterprise Value (EV)
• Less
• The Financial Debt (Dfin)
• All interest bearing debts
• Long term
• Short term
• Eventually others (if bearing interest)
• Less Financial placement

V0 EV0 - Dfin,0
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DCF - The Quiz Company
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DCF - The Quiz Company

• Calculate the best estimation of the present
  value of company C
• if the Cost of capital is 14
• if the Cost of capital is 12

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Saigon Hotel DCF valuation

• We will apply the DCF model to the Base Case
• Using a set of assumptions
• Cost of Capital (r)
• From 8 to 12
• Perpetual growth
• From2 to 4
• Example The Base Case

BPcons.xls - VALO!A2
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Saigon Hotel ValuationSensibilities Studies
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DCF Decision tool

• In order to choose the best scenario
• Maximize the value

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SummaryThe Values of Saigon Hotel
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Conclusions of the lesson

• Creation of value is the goal of any company
• For a stock listed company the market value can
  be observed through the stock price
• the fair value can differ from the market value
• For non listed companies there are different
  methods to estimate the value
• Net Asset
• PER
• PV of Dividends
• DCF Model (PV of FCF)
• The different methods can give different values

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Synthesis of the course

• Begin with the strategy
• Build a Business Plan based on the strategy
• With different strategic scenarios
• and sensibilities studies
• The Financial Plan must be balanced
• Measure and improve the financial structure
• Optimize the investments decisions
• Net Present Value maximization
• In order to create value
• Valuation methods
• Optimize your Business Plan