Valuation of Long Term Securities Joint MBA Shanghai Week 邦保罗

What has Mickey Mouse got to do with this? In february 2004 Comcast put a hostile take over bid on DisneyIn february 2004 Comcast put a hostile take over bid on Disney Comcast offered about $ 54 billion for DisneyComcast offered about $ 54 billion for Disney Many professionals said the bid was far too low and therefore could not be successfulMany professionals said the bid was far too low and therefore could not be successful Comcast claimed it offered a 10% premium for the shareholdersComcast claimed it offered a 10% premium for the shareholders But since it was a share for share deal Comcast paid for it with its own sharesBut since it was a share for share deal Comcast paid for it with its own shares After the bid Disney shares raised 10% and Comcast shares fell about 10% at that time the premium evaporated and Comcast actually offered a price for Disney at a discount…After the bid Disney shares raised 10% and Comcast shares fell about 10% at that time the premium evaporated and Comcast actually offered a price for Disney at a discount… The deal did not effectuate as you imagineThe deal did not effectuate as you imagine The board of Disney refused to accept it and the shareholders of course also refused…The board of Disney refused to accept it and the shareholders of course also refused… In the meantime a fight at the top was taking place between the cousin of Walt Disney and the CEO Michael Eisner…(see the picture)In the meantime a fight at the top was taking place between the cousin of Walt Disney and the CEO Michael Eisner…(see the picture) Eisner won then but had agreed to leave Disney per 2006 for early retirement…goodbye Mr. Eisner…who saved Disney when it was about to go bankrupt…Eisner won then but had agreed to leave Disney per 2006 for early retirement…goodbye Mr. Eisner…who saved Disney when it was about to go bankrupt… Bye bye Mr. Eisner…

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And has Disney bonds outstanding? TypeIssuePriceCoupon(%)YTM(%) Current RatingCallable Yield(%) Corp DISNEY WALT CO Mar BBBNo Corp DISNEY WALT CO MTNS BE Dec BBBNo Corp DISNEY WALT CO MTNS BE Jun BBBNo Corp DISNEY WALT CO MTNS BE Mar BBBNo Corp DISNEY WALT CO MTNS BE Jun BBBNo Corp DISNEY WALT CO MTNS BE Mar BBBNo Maturity

Valuation Liquidation value: Sell as separated asset from ongoing operations (low) for instance when a company is bankruptLiquidation value: Sell as separated asset from ongoing operations (low) for instance when a company is bankrupt Book Value: Shareholders equity in the balance sheet of a companyBook Value: Shareholders equity in the balance sheet of a company Market Value: Share Price * number of (common) shares outstandingMarket Value: Share Price * number of (common) shares outstanding Intrinsic Value: Long Term Free Cash Flow/Cost of CapitalIntrinsic Value: Long Term Free Cash Flow/Cost of Capital

Valuation of Bonds A Bond is a confession of debt paper from the government or a companyA Bond is a confession of debt paper from the government or a company Each Bond has :Each Bond has : –A face value (say $ 1,000) –A Coupon rate (say 10% per year) –A maturity ( for example 9 years) –A cost of capital (return that the investor wants for this specific paper (say 12%) This is called the cost of debt (Kd) Calculating the value of a bond means calculating the cash flows that the bond will generate over its life and discounting at 12%Calculating the value of a bond means calculating the cash flows that the bond will generate over its life and discounting at 12% Put a value on mickey?

So the value is: V=$100/(1+12%)+$100/(1+12%)^2+… +$100/(1+12%)^9+$1000/(1+12%)^9= $ 893,80V=$100/(1+12%)+$100/(1+12%)^2+… +$100/(1+12%)^9+$1000/(1+12%)^9= $ 893,80 So an investor should pay not more then $ 893,80 to buy this bondSo an investor should pay not more then $ 893,80 to buy this bond The bond is sold at a discount (lower then its face value of $ 1000)The bond is sold at a discount (lower then its face value of $ 1000) Note that all the coupons are discounted at 12% and at the end of the life time the amount of the “debt” ($ 1000) will be paid backNote that all the coupons are discounted at 12% and at the end of the life time the amount of the “debt” ($ 1000) will be paid back Thanks!

But if Kd= 8% instead of 12% V=$100/(1+8%)+$100/(1+8% )^2+… +$100/(1+8%)^9+$1000/(1+8 %)^9= $ 1124,79V=$100/(1+8%)+$100/(1+8% )^2+… +$100/(1+8%)^9+$1000/(1+8 %)^9= $ 1124,79 The bond is sold at a premium: So now the bond has a value higher then its face value…The bond is sold at a premium: So now the bond has a value higher then its face value… Donald’s Uncle

“When will this bond sell at face value (at par)?” If the coupon rate offered by the issuer of the bond (10%) is equal to the return (Kd) the investor demands; so if Kd=10%If the coupon rate offered by the issuer of the bond (10%) is equal to the return (Kd) the investor demands; so if Kd=10% The return offered (coupon rate) is equal to the required Kd so the investor is willing to pay the full amount of $ 1000The return offered (coupon rate) is equal to the required Kd so the investor is willing to pay the full amount of $ 1000 Check it out!Check it out!

Perpetual bonds Perpetual means that they will give coupon income forever…Perpetual means that they will give coupon income forever… If the coupon is 10% and Kd=12%If the coupon is 10% and Kd=12% The value of such a bond is:V= I/Kd with I=the amount of the couponThe value of such a bond is:V= I/Kd with I=the amount of the coupon Value= $100/12%= $ 833,33Value= $100/12%= $ 833,33 Investor: Have lunch or be lunch!

Zero coupon bond Some bonds do not pay a couponSome bonds do not pay a coupon They simply mature after several yearsThey simply mature after several years What is the value of such a bond?What is the value of such a bond? Say Kd=12% and maturity is 10 yrs.Say Kd=12% and maturity is 10 yrs. Value= $1000/(1+12%)^10= $ 322Value= $1000/(1+12%)^10= $ 322 You should pay only pay $ 322 for such a bondYou should pay only pay $ 322 for such a bond Zero Coupon Bond ?

Most bonds issued in the US Pay coupon interest twice a year (semi annually)Pay coupon interest twice a year (semi annually) –A 10% bond with half year coupons and 12 years maturity with Kd=14% and a face value of $ 1000 can be valued at: –V=$50/(1+ 14%/2)^1 +50/(1+14%/2)^2+…..+… …. +$50/(1+14%/2)^24+$100 0/(1+14%/2)^24= $ 770,45 Demo; 2 coupons per year!

Preferred stock valuation Preferred stock offers preferred dividendPreferred stock offers preferred dividend A perpetual stream of fixed dividends will make the valuation look like a perp[etual bond:A perpetual stream of fixed dividends will make the valuation look like a perp[etual bond: Value= Dp (yearly amount of dividends)/Kp ( the return the investor wants on this preferred stock)Value= Dp (yearly amount of dividends)/Kp ( the return the investor wants on this preferred stock) So if the dividend is $ 9 per share of $1000 and Kp= 14% then Value per preferred share= Dp/Kp=$9/14%=$ 64,29So if the dividend is $ 9 per share of $1000 and Kp= 14% then Value per preferred share= Dp/Kp=$9/14%=$ 64,29

The most important valuation is the one for common stock If a share will be hold forever the value is the DCF of all future dividendsIf a share will be hold forever the value is the DCF of all future dividends Assumed that the yearly dividends are the same and that Ke= the return that an investor wants on these common shares:Assumed that the yearly dividends are the same and that Ke= the return that an investor wants on these common shares: Value per share= D1/(1+Ke)+D2/(1+Ke)^2…+Dn/(1+K e)^nValue per share= D1/(1+Ke)+D2/(1+Ke)^2…+Dn/(1+K e)^n So if D1=D2=D3=…=Dn= $10So if D1=D2=D3=…=Dn= $10 And Ke is 10% Value/share= $10/10%=$ 100And Ke is 10% Value/share= $10/10%=$ 100

But in reality Companies pay different dividends every yearCompanies pay different dividends every year Shareholders hold shares for a short time (not forever)Shareholders hold shares for a short time (not forever) –In this case value/share is (assume the shareholder hold the shares 2 years : –Value/share=D1/(1+Ke)+D2/(1+ Ke)^2+ P2/(1+Ke)^2 where P2= the value of the share at the end of the second year Be bullish!

Dividend constant growth If dividend grows every year by a certain % then D2=D1(1+g%) where g% is the growth percentage and D1=D0(1+g%)If dividend grows every year by a certain % then D2=D1(1+g%) where g% is the growth percentage and D1=D0(1+g%) Now value/share=D0(1+g%)/(1+ke%) +D0(1+g%)^2/(1+Ke%)^2+…+D n(1+g%)^n/(1+Ke)^nNow value/share=D0(1+g%)/(1+ke%) +D0(1+g%)^2/(1+Ke%)^2+…+D n(1+g%)^n/(1+Ke)^n This can be simplified to:This can be simplified to: Value/share=D1/(Ke%-g%) proof!Value/share=D1/(Ke%-g%) proof! Note: assume Ke%>g% and D0(1+g)^n/(1+Ke)^n converges to 0 (nil) for this reasonNote: assume Ke%>g% and D0(1+g)^n/(1+Ke)^n converges to 0 (nil) for this reason Bear market?

Homework assignment Go to Yahoo FinanceGo to Yahoo Finance Find out if your team’s company pays dividend and how much per shareFind out if your team’s company pays dividend and how much per share What are the earnings per share (latest figures)What are the earnings per share (latest figures) What is the pay out ratio (dividends per share/earnings per share)What is the pay out ratio (dividends per share/earnings per share) Find out how much dividend the company has paid in the past per shareFind out how much dividend the company has paid in the past per share Find g% (the dividend growth)Find g% (the dividend growth) Assume that Ke=10%Assume that Ke=10% Use the dividend growth model to calculate the value per share and compare it with today’s share price of your companyUse the dividend growth model to calculate the value per share and compare it with today’s share price of your company Does the share market values your company shares higher or lower then the dividend growth model?Does the share market values your company shares higher or lower then the dividend growth model? Why do you think this is the case?Why do you think this is the case?

Rate of Return (yield) The Yield to Maturity (YTM) for bonds is:The Yield to Maturity (YTM) for bonds is: Say you know today’s price of a bondSay you know today’s price of a bond You know also the coupon rate and how many times the coupon will pay per yearYou know also the coupon rate and how many times the coupon will pay per year But you would like to calculate at which Kd (yield) the present value of all coupons and the $ 1000 at maturity will result in todays price; this Kd is the “Yield “But you would like to calculate at which Kd (yield) the present value of all coupons and the $ 1000 at maturity will result in todays price; this Kd is the “Yield “

Illustration A Bond can be bought today for $ 761A Bond can be bought today for $ 761 The coupon is $80 (8%) per yearThe coupon is $80 (8%) per year Maturity is 12 yearsMaturity is 12 years So we want to find Kd in:So we want to find Kd in: $761=$80/(1+Kd)^1+$80/(1+K d)^2+…+$80/(1+Kd)^12$761=$80/(1+Kd)^1+$80/(1+K d)^2+…+$80/(1+Kd)^12 We can find it with trial and error or with the IRR% function in Excel…(treat $761 as initia; cash out)We can find it with trial and error or with the IRR% function in Excel…(treat $761 as initia; cash out) Kd=11.828%Kd=11.828% Jump!

Note that If interest rates rise bond prices fallIf interest rates rise bond prices fall If interest rates fall bond prices increaseIf interest rates fall bond prices increase So interest rates and bond prices move in opposite directionsSo interest rates and bond prices move in opposite directions Climb!

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