Title: Applying Relative, Asset Oriented, and Real Option Valuation Methods to Mergers and Acquisitions
1Applying Relative, Asset Oriented, and Real
Option Valuation Methods to Mergers and
Acquisitions
2You earn a living by what you get, but you build
a life by what you give. Winston Churchill
3Cross-Border Transactions
4Learning Objectives
- Primary learning objective To provide students
with knowledge of alternatives to discounted cash
flow valuation methods, including - Market Approach
- Comparable companies
- Comparable transactions
- Same industry or comparable industry
- Asset oriented approach
- Tangible book value
- Liquidation value
- Break-up value
- Cost approach
- Weighted average method
- Secondary learning objective Enable students to
understand how real options apply to MAs
5Applying Market-Based (Relative Valuation)
Methods1
- MVT (MVC / IC) x IT
- Where
- MVT Market value of target company
- MVC Market value of the comparable
company C - IC Measure of value for comparable
company C - IT Measure of value for company T
- (MVC/IC) Market value multiple for the
comparable - company
- 1Comparable companies may include those with
profitability, risk, and growth characteristics
similar to the target firm.
6Market-Based Methods Comparable Company Example
Exhibit 8-1. Valuing Repsol YPF Using Comparable Integrated Oil Companies Exhibit 8-1. Valuing Repsol YPF Using Comparable Integrated Oil Companies Exhibit 8-1. Valuing Repsol YPF Using Comparable Integrated Oil Companies Exhibit 8-1. Valuing Repsol YPF Using Comparable Integrated Oil Companies Exhibit 8-1. Valuing Repsol YPF Using Comparable Integrated Oil Companies Exhibit 8-1. Valuing Repsol YPF Using Comparable Integrated Oil Companies
Target Valuation Based on Following Multiples (MVC/VIC) Target Valuation Based on Following Multiples (MVC/VIC) Target Valuation Based on Following Multiples (MVC/VIC) Target Valuation Based on Following Multiples (MVC/VIC) Target Valuation Based on Following Multiples (MVC/VIC)
Comparable Company Trailing P/E1 Forward P/E2 Price/Sales Price/Book Average
Col. 1 Col. 2 Col. 3 Col. 4 Col. 1-4
Exxon Mobil Corp (XOM) 11.25 8.73 1.17 3.71
British Petroleum (BP) 9.18 7.68 0.69 2.17
Chevron Corp (CVX) 10.79 8.05 0.91 2.54
Royal Dutch Shell (RDS-B) 7.36 8.35 0.61 1.86
ConocoPhillips (COP) 11.92 6.89 0.77 1.59
Total SA (TOT) 8.75 8.73 0.80 2.53
Eni SpA (E) 3.17 7.91 0.36 0.81
PetroChina Co. (PTR) 11.96 10.75 1.75 2.10
Average Multiple (MVC/VIC) Times 9.30 8.39 0.88 2.16
Repsol YPF Projections (VIT)3 4.38 3.27 92.66 26.49
Equals Estimated Mkt. Value of Target3 40.72 27.42 81.77 57.32 51.81
1Trailing 52 week average. 2Projected 52 week average. 3Billions of Dollars. Key Points 1. Firm valuation differs significantly depending on valuation multiple used. 2. Valuation estimates require addition of a purchase price premium. 1Trailing 52 week average. 2Projected 52 week average. 3Billions of Dollars. Key Points 1. Firm valuation differs significantly depending on valuation multiple used. 2. Valuation estimates require addition of a purchase price premium. 1Trailing 52 week average. 2Projected 52 week average. 3Billions of Dollars. Key Points 1. Firm valuation differs significantly depending on valuation multiple used. 2. Valuation estimates require addition of a purchase price premium. 1Trailing 52 week average. 2Projected 52 week average. 3Billions of Dollars. Key Points 1. Firm valuation differs significantly depending on valuation multiple used. 2. Valuation estimates require addition of a purchase price premium. 1Trailing 52 week average. 2Projected 52 week average. 3Billions of Dollars. Key Points 1. Firm valuation differs significantly depending on valuation multiple used. 2. Valuation estimates require addition of a purchase price premium. 1Trailing 52 week average. 2Projected 52 week average. 3Billions of Dollars. Key Points 1. Firm valuation differs significantly depending on valuation multiple used. 2. Valuation estimates require addition of a purchase price premium.
7Market-Based MethodsRecent Transactions Method1
- Calculation similar to comparable companies
method, except multiples used to estimate
targets value based on purchase prices of recent
transactions of comparable companies. - MVT (MVRT / IRT) x IT
- Where
- MVT Market value of target company
T - MVRT Market value of the recently
acquired comparable company RT - IRT Measure of value for recently
acquired comparable company RT - IT Measure of value for target
company T - (MVRT/IRT) Market value multiple for the
recently acquired comparable company RT - Most accurate method whenever the transaction is
truly comparable and very recent. - Major limitation is that truly comparable recent
transactions are rare. - Valuations based on this method already include a
purchase price premium - 1Also called precedent method.
8Market-Based MethodsSame or Comparable Industry
Method
- Multiply targets earnings or revenues by market
value to earnings or revenue ratios for the
average firm in targets industry or a comparable
industry. - MVT (MVAF / IAF) x IT
- Where
- MVT Market value of target firm
- MVAF Market value of average firm in
target firms or comparable industry - IAF Measure of value for average
firm in target firms or comparable Industry - IT Measure of value for
company T - (MVAF/IAF) Market value multiple for the
average firm in target firms or comparable - industry
- Primary advantage is the ease of use and
availability of data. - Disadvantages include presumption industry
multiples are actually comparable and analysts
projections are unbiased. - Requires addition of purchase price premium
9PEG Ratio
- Used to adjust relative valuation methods for
differences in growth rates among comparable
firms. - Helpful in determining which of a number of
different firms in same industry exhibiting
different growth rates may be the most
attractive. - (MVT/VIT) A and
-
VITGR -
MVT A x VITGR x VIT - Where A Market price to value indicator
relative to the growth rate of - value indicator (e.g.,
(P/E)/ EPS growth rate) - MVT Market value of target
- VIT Value indicator for target
(e.g., EPS)1 - VITGR Projected growth rate in value
indicator (e.g., EPS) - Firms whose PEG ratios gt 1 considered overvalued
PEG ratios lt 1 considered undervalued - 1Valid for VITGR gt 0. For VITGR 0 or lt 0, firm
value will not change or will decline.
10 Applying the PEG Ratio An analyst is asked to
determine whether Basic Energy Service (BAS) or
Composite Production Services (CPS) is more
attractive as an acquisition target. Both firms
provide engineering, construction, and specialty
services to the oil, gas, refinery, and
petrochemical industries. BES and CPS have
projected annual earnings per share growth rates
of 15 percent and 9 percent, respectively. BES
and CPS current earnings per share are 2.05 and
3.15, respectively. The current share prices as
of June 25, 2008 for BAS is 31.48 and for CPX is
26. The industry average price-to-earnings ratio
and growth rate are 12.4 and 11 percent,
respectively. Based on this information, which
firm is a more attractive takeover target as of
the point in time the firms are being compared?
Industry average PEG ratio1 12.4/.11 112.73
BES Implied share price 112.73 x .15 x 2.05
34.66 CPX Implied share price 112.73 x .09
x 3.15 31.96 Answer The difference between
the implied and actual share prices for BES and
CPX is 3.18 (i.e., 34.66 - 31.48) and 5.96
(31.96 - 26.00), respectively. CPX is more
undervalued than BES at that moment in time and
therefore is the more attractive takeover target.
1Solving MVT A x VITGR x VIT using an
individual firms PEG ratio provides the firms
current share price in period T, since this
formula is an identity. An industry average PEG
ratio may be used to provide an estimate of the
firms intrinsic value. This implicitly assumes
that the target firm and the average firm in the
industry exhibit the same relationship between
price-to-earnings ratios and earnings growth
rates.
11Asset-Based MethodsTangible Book Value
- Tangible book value (TBV) (total assets - total
liabilities - goodwill) - MVT (MVC /
ICTBV) x ITTBV - Where
- MVT Market value of target
company - MVC Market value of the comparable
company C - ICTBV Tangible book value for
comparable company C - ITTBV Tangible book value for
target company - (MVC/ICTBV) Market value multiple for the
comparable company - Often used for valuing
- Financial services firms where tangible book
value is primarily cash or liquid assets - Distribution firms where current assets
constitute a large percentage of total assets
12Valuing Companies Using Asset Based Methods
Ingram Micro distributes information technology products worldwide. The firms share price on 8/21/08 was 19.30. Projected 5-year annual net income growth is 9.5 and the firms beta is .89. Shareholders equity is 3.4 billion and goodwill is .7 billion. Ingram has 172 million (.172 billion) shares outstanding. The following firms represent Ingrams primary competitors. Ingram Micro distributes information technology products worldwide. The firms share price on 8/21/08 was 19.30. Projected 5-year annual net income growth is 9.5 and the firms beta is .89. Shareholders equity is 3.4 billion and goodwill is .7 billion. Ingram has 172 million (.172 billion) shares outstanding. The following firms represent Ingrams primary competitors. Ingram Micro distributes information technology products worldwide. The firms share price on 8/21/08 was 19.30. Projected 5-year annual net income growth is 9.5 and the firms beta is .89. Shareholders equity is 3.4 billion and goodwill is .7 billion. Ingram has 172 million (.172 billion) shares outstanding. The following firms represent Ingrams primary competitors. Ingram Micro distributes information technology products worldwide. The firms share price on 8/21/08 was 19.30. Projected 5-year annual net income growth is 9.5 and the firms beta is .89. Shareholders equity is 3.4 billion and goodwill is .7 billion. Ingram has 172 million (.172 billion) shares outstanding. The following firms represent Ingrams primary competitors.
Market Value/ Tangible Book Value Beta Projected 5-Year Net Income Growth Rate ()
Tech Data .91 .90 11.6
Synnex Corporation .70 .40 6.9
Avnet 1.01 1.09 12.1
Arrow .93 .97 13.2
Based on this information, what is Ingrams tangible book value per share (VIT)? What is the appropriate industry average market value to tangible book value ratio (MVIND/VIIND)? Estimate the implied market value per share for Ingram (MVT) using tangible book value as a value indicator. Based on this analysis, is Ingram under-or-overvalued compared to it 8/21/08 share price? Based on this information, what is Ingrams tangible book value per share (VIT)? What is the appropriate industry average market value to tangible book value ratio (MVIND/VIIND)? Estimate the implied market value per share for Ingram (MVT) using tangible book value as a value indicator. Based on this analysis, is Ingram under-or-overvalued compared to it 8/21/08 share price? Based on this information, what is Ingrams tangible book value per share (VIT)? What is the appropriate industry average market value to tangible book value ratio (MVIND/VIIND)? Estimate the implied market value per share for Ingram (MVT) using tangible book value as a value indicator. Based on this analysis, is Ingram under-or-overvalued compared to it 8/21/08 share price? Based on this information, what is Ingrams tangible book value per share (VIT)? What is the appropriate industry average market value to tangible book value ratio (MVIND/VIIND)? Estimate the implied market value per share for Ingram (MVT) using tangible book value as a value indicator. Based on this analysis, is Ingram under-or-overvalued compared to it 8/21/08 share price?
13Solution to Ingram Problem
- Ingrams net tangible book value per share (VIT)
(3.4 -.7)/.172 15.70 - Based on risk as measured by the firm beta and
the 5-year projected earnings growth rate, Synnex
is believed to exhibit significantly different
risk and growth characteristics and is excluded
from the calculation of the industry average
market value to tangible book value ratio.
Therefore, the appropriate industry average ratio
is as follows - MVIND/VIIND .95 i.e., (.911.01.93)/3
- Ingrams implied value per share MVT
(MVIND/VIIND) x VIT .95 x 15.70 14.92 - Based on the implied value per share, Ingram was
over-valued on 8/21/08 when its actual share
price was 19.30
14Asset-Based Methods Liquidation Method
- Value assets as if sold in an orderly fashion
(e.g., 9-12 months) and deduct value of
liabilities and expenses associated with asset
disposition. - While varies with industry,
- Receivables often sold for 80-90 of book value
- Inventories might realize 80-90 of book book
value depending on degree of obsolescence and
condition - Equipment values vary widely depending on age and
condition and purpose (e.g., special purpose) - Book value of land may understate market value
- Prepaid assets such as insurance can be
liquidated with a portion of the premium
recovered.
15Asset-Based Method Break-Up Value
- Target viewed as series of independent operating
units, whose income, cash flow, and balance sheet
statements reflect intra-company sales,
fully-allocated costs, and operating liabilities
specific to each unit - After-tax cash flows are valued using
market-based multiples or discounted cash flows
analysis to determine operating units estimated
enterprise value - The units equity value is determined by
deducting operating/non-operating liabilities
from estimated enterprise value - Aggregate equity value of the business is
determined by summing equity value of each
operating unit less unallocated liabilities held
at corporate level and break-up costs
16Replacement Cost Method
- All target operating assets are assigned a value
based on what it would cost to replace them. - Each asset is treated as if no additional value
is created by operating the assets as part of a
going concern. - Each assets value is summed to determine the
aggregate value of the business. - This approach is limited if the firm is highly
profitable (suggesting a high going concern
value) or if many of the firms assets are
intangible.
17Weighted Average Valuation Method
- An analyst has estimated the value of a company
using multiple valuation methodologies. The
discounted cash flow value is 220 million,
comparable transactions value is 234 million,
the P/E-based value is 224 million and the
liquidation value is 150 million. The analyst
has greater confidence in certain methodologies
than others. Estimate the weighted average value
of the firm using all valuation methodologies and
the weights or relative importance the analyst
gives to each methodology.
Estimated Value (M) Relative Weight Weighted Avg. (M)
220 .30 66.0
234 .40 93.6
224 .20 44.8
150 .10 15.0
1.00 219.4
18Real Options as Applied to MAs
- Real options refer to managements ability to
adopt and later revise corporate investment
decisions (e.g., acquisitions) - Options to expand (i.e., accelerate investment)
- Acquirer accelerates investment in target after
acquisition completed due to better than
anticipated performance of the target - Options to delay (i.e., postpone timing of
initial investment) - Acquirer delays completion of acquisition until a
patent pending receives approval - Options to abandon (i.e., divest or liquidate
initial investment) - Acquirer divests target firm due to
underperformance and recovers a portion of its
initial investment
19Alternative Real Option Valuation Methods
- Develop a decision tree for which the NPV of each
branch represents the value of alternative real
options. The options value is equal to
difference between the NPV including the real
option and the NPV without the real option. - Treat the real options as financial options and
value using the Black-Scholes method. - Option to expand or delay are valued as call
options and added to the NPV of the investment
without the option. - Option to abandon is valued as a put option and
added to the NPV of the investment without the
option. - Key Points Total NPV NPV Without Option
Option Value and - Option Value Total NPV NPV
Without Option
20Microsoft Real Options Decision Tree in Attempted
Takeover of Yahoo
Option to expand contingent on successful Integra
tion of Yahoo MSN
Purchase Yahoo online search only. Buy
Remaining businesses later.
Enter long-term search Partnership with option to
buy
Base Case Microsoft Offers To Buy All Yahoo
Shares
Option to postpone contingent on Yahoos
rejection of offer
Offer revised price for all of Yahoo if
circumstances change
Spin off combined Yahoo and MSN to Microsoft
shareholders
Option to abandon contingent on failure to
integrate Yahoo MSN
Divest combined Yahoo MSN. Use proceeds to pay
dividend or buy back stock.
21Microsoft Yahoo Transaction Outcome
- 2008 offer price for all of Yahoo 38 per share
- Offer rejected by Jerry Yang (founder) and board
of directors - Microsoft withdraws offer and Yahoo share price
drops to 16 per share - Jerry Yang later fired
- Microsoft and Yahoo agree to online search
partnership in 2010 in which MSN and Yahoo
combine search businesses
22Things to Remember
- Alternatives to discounted cash flow analysis
include the following - Market based methods
- Comparable companies
- Recent transactions
- Same or comparable industries
- Asset based methods
- Tangible book value
- Liquidation value
- Break-up value
- Replacement cost method
- Weighted average method
- Firm value must be adjusted for both
non-operating assets and liabilities. - Real options should be considered in MA
valuation when clearly identifiable and when
would add significantly to investments value