Implementation
Prof. Ian Giddy New York University Valuing a Business II NYU
Copyright ©2003 Ian H. Giddy Valuation 3 What’s a Company Worth? Acquisition LBOs Restructuring Flexics
Equity Valuation: Application to M&A Prof. Ian Giddy New York University
Copyright ©2003 Ian H. Giddy Valuation 5 What's It Worth? Valuation Methods Book value approach Market value approach Ratios (like P/E ratio) Break-up value Cash flow value -- present value of future cash flows
Copyright ©2003 Ian H. Giddy Valuation 6 How Much Should We Pay? Applying the discounted cash flow approach, we need to know: 1.The incremental cash flows to be generated from the acquisition, adjusted for debt servicing and taxes 2.The rate at which to discount the cash flows (required rate of return) 3.The deadweight costs of making the acquisition (investment banks' fees, etc)
Copyright ©2003 Ian H. Giddy Valuation 7 Equity Valuation in Practice Estimating synergies Estimating business restructuring Estimating financial restructuring Application to Basix Valuation in a bidding context
Copyright ©2003 Ian H. Giddy Valuation 8 The Gains From an Acquisition Gains from merger SynergiesControl Top lineFinancial restructuring Business Restructuring (M&A) Bottom line
Copyright ©2003 Ian H. Giddy Valuation 9 The Basics IBM is considering the acquisition of Basix, Inc. The shares are trading at a P/E of 11, far below IBM’s P/E of 18. Based on past performance the company is expected to earn $2 per share next year, an increase from the current EPS of $1.93. If IBM acquires Basix, the long-run EPS growth rate could be raised to 5.5%. The Treasury bond yield is 4.5%, the company’s beta is 1.3 and the long run market return is 11.5%. Is the company worth buying at a P/E of 12? At how much of a premium should we say fugedaboudit?
Copyright ©2003 Ian H. Giddy Valuation 10 Basix Source: basix.xls
Copyright ©2003 Ian H. Giddy Valuation 11 The Network
Copyright ©2003 Ian H. Giddy Valuation 12 How Much Premium Can a Buyer Pay? Applying the discounted cash flow approach, we need to know: The incremental cash flows to be generated from the acquisition, adjusted for debt servicing and taxes The rate at which to discount the cash flows (required rate of return on equity) The deadweight costs of making the acquisition (investment banks' fees, etc) Cost of losing out!
Copyright ©2003 Ian H. Giddy Valuation 13 What is Conrail Worth? Stand-alone value Market value: $71.00 Comparables Discounted present value Value to acquirer Value in bidding-war context
Copyright ©2003 Ian H. Giddy Valuation 14 What is Conrail Worth?
Copyright ©2003 Ian H. Giddy Valuation 15 But Where Are the Profits? January 2001
Copyright ©2003 Ian H. Giddy Valuation 16 But Where Are the Profits? CSX S&P500 NSC
Prof. Ian Giddy New York University Leveraged Buyouts
Copyright ©2003 Ian H. Giddy Valuation 18 M&A and Leverage Leveraged buyout? Company has unused debt capacity Leveraged recapitalization? Takeover?
Copyright ©2003 Ian H. Giddy Valuation 19 Sources: biz.yahoo.com, businessweek.com InterActiveCorp Company has unused debt capacity?
Copyright ©2003 Ian H. Giddy Valuation 20 Private Pitfalls Methods: same Problems: No market price No history of reported information Data provided can be distorted
Copyright ©2003 Ian H. Giddy Valuation 21 Private Pitfalls Revenue overstated? Costs understated? Overstated? New costs that will be incurred? Intangible value?
Copyright ©2003 Ian H. Giddy Valuation 22 Typical LBO Sequence Company gets bloated or slack and stock price falls LBO offer made LBO completed Restructuring Efficiencies Divestitures Financial ? years3-9 months5-7 years IPO or sale of company LBO financing lined up
Copyright ©2003 Ian H. Giddy Valuation 23 LBO: A Temporary Capital Structure COST OF CAPITAL DEBT RATIO Stage 1: Pre-LBO Stage 4: Debt paydown Stage 2: LBO financing Stage 3: LBO refinancing
Copyright ©2003 Ian H. Giddy Valuation Step Method Evaluating cost of deal Estimating borrowing capacity Estimating cash costs of funding Estimating growth rates of sales, expenses, etc Projecting cash flows (FCFF and FCFE) Projecting debt amortization Calculating terminal value of FCFE and FCFF Estimating costs of capital to find PV Making sense of the deal
Copyright ©2003 Ian H. Giddy Valuation 25 What Would it Cost to Buy Kodak? Source: biz.yahoo.com
Copyright ©2003 Ian H. Giddy Valuation 26 Cost of the Deal lbocapacity.xls
Copyright ©2003 Ian H. Giddy Valuation 27 Borrowing Capacity From table lbocapacity.xls
Copyright ©2003 Ian H. Giddy Valuation 28 Capital Structure lbocapacity.xls
Copyright ©2003 Ian H. Giddy Valuation 29 LBO Financing NEWCO Cost of purchasing the business Equity $25 Senior debt $457 What securities? What returns? What investors? Mezzanine
Copyright ©2003 Ian H. Giddy Valuation 30 Cash Flows and Debt Repayment
Copyright ©2003 Ian H. Giddy Valuation 31 Exit Company gets bloated or slack and stock price falls LBO offer made LBO completed Restructuring Efficiencies Divestitures Financial ? years3-9 months5-7 years IPO or sale of company LBO financing lined up
Equity Valuation: Application to Restructuring Prof. Ian Giddy New York University
Copyright ©2003 Ian H. Giddy Valuation 33 Corporate Financial Restructuring Why Restructure? Proactive Example: Sealed Air Distress Example: Loewen 1999 Defensive Example: Loewen 1996 n Management acts to preserve or enhance shareholder value n Management acts to protect company, stakeholders and management from change in control n Lenders and shareholders lose, but try to work out best way to minimize loss
Copyright ©2003 Ian H. Giddy Valuation 34 Restructuring Restructuring: Any substantial change in a operational structure, business portfolio, financial structure, or ownership and control. Designed to increase the value of the firm Restructuring OperationalFinancialBusiness Portfolio
Copyright ©2003 Ian H. Giddy Valuation 35 Average Impact of Restructuring on Company Performance Source: Bowman et al, “When Does Restructuring Improve Economic Performance?”
Copyright ©2003 Ian H. Giddy Valuation 36 Novartis: Financial Restructuring Fixed Assets Debt Equity AssetsLiabilities Fixed the cash and working capital Fixed the capital structure Cash Divested Non-core business
Copyright ©2003 Ian H. Giddy Valuation 37 Case Study: Flexics MANAGERS PHOTRONICS SELLER
Copyright ©2003 Ian H. Giddy Valuation 38 Corporate Restructuring: It’s All About Value How can corporate and financial restructuring create value? Operating Cash Flows Debt Equity AssetsLiabilities Fix the business Or fix the financing
Copyright ©2003 Ian H. Giddy Valuation 39 Restructuring Checklist Figure out what the business is worth now Use valuation model – present value of free cash flows Fix the business mix – divestituresValue assets to be sold Fix the business – strategic partner or merger Value the merged firm with synergies Fix the financing – improve D/E structure Revalue firm under different leverage assumptions – lowest WACC Fix the kind of equityWhat can be done to make the equity more valuable to investors? Fix the kind of debt or hybrid financing What mix of debt is best suited to this business? Fix management or controlValue the changes new control would produce
Valuation: Conclusions & Summary Prof. Ian Giddy New York University
Copyright ©2003 Ian H. Giddy Valuation 41 Valuation is a Key to Unlock Value Value with and without restructuring Consider means and obstacles Who gets what? Minimum is liquidation value Valuation Going ConcernLiquidationAfter Restructuring
Copyright ©2003 Ian H. Giddy Valuation 42 Summary: What’s It Worth?
Copyright ©2003 Ian H. Giddy Valuation 43 Conclusion? Valuation techniques force the recognition of assumptions – cost of capital, risk, growth rates, and which numbers matter Valuation is an essential management tool Can these approaches be used to change the way your company evaluates its investment decisions? How?
Copyright ©2003 Ian H. Giddy Valuation 44 Further Reading Books: Damodaran on Valuation DePamphilis: Mergers, Acquisitions, and Other Restructuring Activities Web Site: Damodaran Online: ~adamodar Cheat sheets: