1. Corporate Finance -2 Topic 1. Introduction. Corporate Finance and Corporate Analysis thru the Organization’s Life Cycle (LCO) Irina Ivashkovskaya, Ordinary professor, Head of finance academic department, Head of Corporate finance research center National Research University – Higher school of economics, Moscow, Russia

2. Outline What is corporate finance about? How does corporate finance contribute to corporate decision – making? Financial model of analytical framework versus accounting model of corporate decisions’ analysis Financial dimensions of the firm thru its OVERALL life cycle: liquidity, risk and fundamental value. Financial dimensions of the firm: ANNUAL approach. How to identify the LCO stage with financial measures? The challenges for financial analytical framework

3. CORPORATION AS A FRAMEWORK ATTRACTING CAPITAL CREATING FINANCE’ PRODUCTS CAPITAL MARKET TOOLKIT: -the variety -the costs -the mix FINANCIAL DECISIONS OF ANY FIRM AND CORPORATE FINANCE APPROACH CAPITAL MARKET PRODUCTS CREATION : - benefit stream - risks - innovations - packing the firm Minimizing costs Maximizing prices

4. CORPORATE FINANCE VISION THE PRINCIPLES IMPERFECT MARKETPERFECT MARKET  VALUE IS CREATED ONLY BY INVESTMENTS  NO ARBITRAGE  INVESTOR IS IRRELEVANT -Capital structure -Payout policies  INVESTORS IS NOT IRRELEVANT  capital structure and payout policies matter  interactions of investing and financing  Financial innovations Capital market efficiency

5. MODELLING CORPORATE FINANCIAL DECISIONS ATTRACTING CAPITAL CREATING PRODUCTS AGENCY/ MOTIVES INFORMATION ASSYMETRY EQUITY VERSUS DEBTHOLDERS CONTRACTS CHANGE IN VALUE KNOWING WHAT DOES NOT MATTER IN A PERFECT WORLD WE’LL KNOW WHAT DOES MATTER BEYOND IT BY IMPLICATIONS RATIONAL EXPECTATIONS investors managers

6. CORPORATE FINANCE CONTRIBUTION TO DECISION-MAKING THE CONCEPTUAL FRAMEWORK TO CORPORATE DECISION’S ANALYSIS: THE ELEMENTS  The criteria for performance analysis  The measures of performance  The measures for corporate goals and strategies’ perfromance

7. WHAT IS CORPORATE FINANCE? The conceptual framework to corporate decision’s analysis: the elements  THE CRITERIA FOR PERFORMANCE ANALYSIS  THE MEASURES OF PERFORMANCE  Opportunity cost of capital  Risk-return trade-off and cost of capital (WACC)  Economic profit  Economic profit metrics  Economic spread (over the required returns)

8. WHAT IS CORPORATE FINANCE? The conceptual framework to corporate decision’s analysis: the elements  THE MEASUREMENT OF CORPORATE GOALS AND STRATEGIC RESULTS Market value creation Agency conflicts Information asymmetry Value creationValue Destruction?Value Extraction True value creation

9. К Е (%) Accounting model Financial model 012 ROE (%) ROE<0ROE>0 Income and capital gains Loss and capital losses Loss and capital losses Income and capital gains + - ROE<К Е ROE>К Е -2 Cumulative data Backward looking Static Flows Forward looking Dynamic

10. LIFE CYCLE STAGES OF ORGANIZATION I.INTRODUCT ORY STAGE, ENTRY II.GROWTHIII.MATURITYIV.DECLINE Time Activity

11. FINANCIAL DIMENSIONS OF THE FIRM WITHIN ITS LIFE CYCLE LIQUIDITY INVESTMENT RISK FUNDAMENTAL VALUE

12. Transactions affecting directly net income Transactions affecting asset's structure Transactions affecting the totals Net income + non-cash charges -net increase in current assets +net increase in current liabilities + Proceeds from sale of assets - Capital expenditure +Increase in short term &long term debt +Owners investments - Debt repayment (principal) - Dividends CASH FLOWS CASH FLOW FROM OPERATING ACTIVITY CF FROM INVESTING ACTIVITY CF FROM FINANCING ACTIVITY NET CASH FLOW

13. CASH FLOWS AT THRU LCO INTRODUCTORY STAGE GROWTHMATURITYDECLINE OPERATING CASH FLOW INVESTING CASH FLOW FINANCING CASH FLOW

14. ЭТАП СТАНОВЛЕНИЯ 14 Компания “Российские навигационные технологии” Чистая прибыль (NI) = 78,1 млн. руб. Долг/собственный капитал = 0,01 Доходность собственного капитала (ROE) = 20,5 % Рыночная капитализация = 1,6 млрд. руб. Div = 0 Возраст = 6 лет

15. ЭТАП СТАНОВЛЕНИЯ Российские Навигационные Технологии 201020092008 Поток от осн.деятельности (CF Operating), млн. руб. (116.6)(49.2)(37.8) Поток от инвет.деят. (CF Investment), млн. руб. (176.2)15.7(82.6) Поток от финансирования (CF Financing), млн. руб. 299.147.8125.6 15

16. ДВИЖЕНИЕ ПОТОКОВ ДЕНЕЖНЫХ СРЕДСТВ НА СТАДИЯХ ЖЦО ЭТАП СТАНОВЛЕНИЯ ЭТАП РОСТА ЭТАП ЗРЕЛОСТИ ЭТАП СТАРЕНИЯ РНТ 16

17. ЭТАП РОСТА 17 Компания розничная сеть “Магнит” Чистая при быль (NI) = 320,3 млн. долл. Долг/собственный капитал = 0,49 Доходность собственного капитала (ROE) = 18,6 % Рыночная капитализация = 8,7 млрд. долл. Дивиденды к чистой прибыли = 3,5 % Возраст = 17 лет

18. ЭТАП РОСТА Розничная сеть “Магнит” 2010200920082007 CF Operating, млн. долл. 428.7376.2420.1242.4 CF Investment, млн. долл. -1230.0-448.1-575.4-568.7 CF Financing, млн. долл. 565.2339.2200.2354.8 18

19. ЭТАП СТАНОВЛЕНИЯ ЭТАП РОСТА ЭТАП ЗРЕЛОСТИ ЭТАП СТАРЕНИЯ Магнит ДВИЖЕНИЕ ПОТОКОВ ДЕНЕЖНЫХ СРЕДСТВ НА СТАДИЯХ ЖЦО 19

20. ЭТАП ЗРЕЛОСТЬ “Аэрофлот” российские авиалинии 2010200920082007 CF Operating, млн. руб. 739.3228.5472.5216.5 CF Investment, млн. руб. -193.5-299.3-439.3-417.3 CF Financing, млн. руб. 13.948.344.6100.9 20

21. Чистая прибыль (NI) = 12,1 млрд. руб. Долг/собственный капитал = 0,69 ROE = 10,7 % Рыночная капитализация = 2,89 млрд. долл. Дивиденды к чистой прибыли= 10 % Возраст = 17 лет ЭТАП ЗРЕЛОСТИ: ЭТАП ЗРЕЛОСТИ: КОМПАНИЯ “АЭРОФЛОТ” 21

22. ЭТАП СТАНОВЛЕНИЯ ЭТАП РОСТА ЭТАП ЗРЕЛОСТИ ЭТАП СТАРЕНИЯ Аэрофлот ДВИЖЕНИЕ ПОТОКОВ ДЕНЕЖНЫХ СРЕДСТВ НА СТАДИЯХ ЖЦО 22

23. NI = -276,3 млн. руб. Долг/собственный капитал = 2,18 ROE = 15,3 % Рыночная капитализация = 0,34 млрд. руб. Div = 0 % Возраст = 95 лет Отношение рыночной цены акции к ее бухгалтерской оценке = 0,01 ЭТАП СТАРЕНИЯ: ЭТАП СТАРЕНИЯ: АМО “ЗИЛ” 23

24. Business riskFinancing risk Commercial risks Currency Exchange risks Management depth ■ key person ■ transparency and disclosure Investment risk ■Diversification by product by channel by segment ■Power of supplier ■ Market position ■ Expense structure operating leverage Solvency (short term) Financial leverage Coverage: ■ income coverage ratios ■ cash flow coverage ratios ■ assets coverage ratios

25. LCO AND INVESTMENT RISKS INVESTMENT FLEXIBILITY MANAGERIAL FLEXIBILITY FINANCING FLEXIBILITY TERMS OF FINANCING AMOUNTS OF FINANCING DECREASE IN REQUIRED RATES OF RETURN INCREASE IN THE VARIETY OF EFFICIENT PROJECTS

26. WHAT IS VALUE? DISCOUNTED FUTURE BENEFITS STREAM  KEY STRATEGIC AND OPERATIONAL DRIVERS  REQUIRED RATES AT THE CAPITAL MARKETS KEY DRIVERS

27. VALUE Income + Non cash charges -Capex -Net working capital investment = FREE CASH FLOW COST OF CAPITAL INVESTMENT RISKCORE COMPENTENCIES STRATEGIC (PLANNING) HORIZON INVESTED CAPITAL (CAPITAL EMPLOYED)

28. CORPORATE VALUE COMPONENTS CORPORATE VALUE DISCOUNTED CASH FLOWS WHITHIN STRATEGIC HORIZON TERMINAL CASH FLOW BEYOND HORIZON CASH FLOWSRISK EXPECTED CF FROM GROWTH OPPORTUNITIES RISK IN GROWTH OPPORTUNITIES CURRENT OPERATIONS VALUE COV FUTURE GROWTH OPPORTUITIES VALUE (VFGO) Assets in place, AIP Growth opportunities, GO + + FINANCIAL APPROACH STRATEGIC APPROACH

29. VALUE COMPONENTS AND LCO INTRODUCTORY STAGE  ASSETS IN PLACE?  VALUE BASE?  FUNCTIONING ASSETS RISKS?  GROWTH OPPORTUNITY RISKS? RATIO = (ASSETS IN PLACE )/ (GROWTH OPPORTUNITIES)?

30. VALUE COMPONENTS AND LCO GROWTH ASSETS IN PLACE? VALUE BASE? FUNCTIONING ASSETS RISKS? GROWTH OPPORTUNITY RISKS? RATIO = (ASSETS IN PLACE )/ (GROWTH OPPORTUNITIES)?

31. VALUE COMPONENTS AND LCO MATURITY ASSETS IN PLACE? VALUE BASE? FUNCTIONING ASSETS RISKS? GROWTH OPPORTUNITY RISKS? RATIO = (ASSETS IN PLACE )/ (GROWTH OPPORTUNITIES)?

32. VALUE COMPONENTS AND LCO DECLINE ASSETS IN PLACE? VALUE BASE? FUNCTIONING ASSETS RISKS? GROWTH OPPORTUNITY RISKS? RATIO = (ASSETS IN PLACE )/ (GROWTH OPPORTUNITIES)?

33. FINANCIAL DIMENSIONS OF THE FIRM: WITHIN THE YEAR FREE CF COST OF CAPITALECONOMIC PROFIT (RESIDUAL INCOME)

34. CASH FLOWS FREE FOR INVESTORS AFTER ALL INVESTMENTS NEEDED FOR CORPORATE MARKET STRATEGY ARE CONSIDERED FCFF EBIAT D NWCI Capex = + -- Earnings before interest but after tax Depreciation Net working capital investment Capital expenditure FINANCIAL DIMENSIONS OF THE FIRM: FREE CASH FLOWS TO THE FIRM (FCFF)

35. FINANCIAL DIMENSIONS: HURDLE RATE COST OF CAPITAL  RATE OF RETURN REQUIRED BY RATIONAL RISK AVERSE INVESTOR DEPENDS ON:  INVESTMENT RISK  OPPORTUNITY COST OF CAPITAL OF INVESTORS

36. FINANCIAL DIMENSIONS: ECONOMIC PROFIT NOPAT CAPITAL CHARGE RESIDUAL INCOME - = COST OF CAPITAL ROCE - return on capital employed WACC - weighted average cost of capital – CE – capital employed RI - Residual income NOPAT- Net operating profit after tax

37. LCO FINANCIAL CURVE RESIDUAL INCOME COST OF CAPITAL TIME Return on capital employed, ROCE INTRODUCTORY STAGE GROWTH MATURITY DECLINE

38. LCO ANALYSIS  SALES GROWTH RATE Miller, Friesen (1984)  AGE GROWTH ABOVE 15% ; MATURITY BELW 15%; BELOW 10 YEARS - ENTRY  EXPERT ‘ ESTIMATES 6 YEARS AT EACH STAGE ON AVERAGE

39. 5 STAGES: GROWTH,STABLE GROWTH,MATURITY, BEGINNING OF DECLINE,DECLINE 5 YEARS MEAN: Revenue growth rate, Dividends Capital expenditure RATING BY METRIC SUM OF RATINGS INDUSTRY FACTORS Age IDENTIFICATION OF LCO STAGE BY FINANCIAL MEASURES: RATING APPROACH Metrics Anthony,Ramesh (1992 ) Pashley,Phillippatos (1990)  FINANCIAL RATIOS  CLUSTERS SIMPLE APPROACH EXTENDED APPROACH

40. RATING APPROACH (Black,1998) INTRODUCTORY STAGE (START-UP) SALES REVENUE NO LONGER THAN 1 YEAR NO RESTRUCTURING GROWTH 20% highest ratings by growth rates and capex 20% lowest ratings by dividends &age MATURITY STAGE AVERAGERATINGS BY GROWTH RATES AND CAPEX HIGHEST RATINGS BY DIVIDENDS DECLINE 20% LOWEST RATINGS BY CAPEX AND GROWTH RATES HIGHESTRATINGS BY AGE ABOVE AVERAGE RATINGS BY DIVIDENDS

41. STUDY OF LCO OF AMERICAN FIRMS BY RATINGS Black,1998 Public firms 1977-1995, COMPUSTAT 22082 annual observations Introductory stage : 75 firms Growth : 2905 Maturity : 2384 Decline : 3961 Firms in decline are concentrated within the periods of macro shocks (1980-1983,1989-1992)

42. FINANCIAL MEASURES AT THE LCO STAGES GROWTH RATE142%38%8%-13%10% Debt-to-equity7%42%50%16%39% Net income (mln doll.)- 0.360.6616.15-0.541.90 Return on equity 7%6%13%-12%7% Capex to total assets1.760.140.070.020.06 R&D mln )0.180.414.530.511.26 Age(years)2.416.237.457.642.8 Dividends payout (%)0036%00 Equity market cap (mln doll.)16.5221.95208.4710.91 46.11 START UPGROWTHMATURITYDECLINE MEAN Black

43. CONTRIBUTION TO THE MARKET CAPITALIZATION AT DIFFERENT STAGES OF LCO INTRODUCTORY STAGE, START UP earnings&operating cash flows not significant Investing cash flows significant at 5%, financing cash flows at 10% all cash flows significant at 5% earnings not significant earnings, operating and financing cash flows AT 5% FINANCING CASH FLOW NEGATIVE ALL TYPES OF CASJ FLOWS AT 5% уровнеearnings not significant GROWTH MATURITY DECLINE

44. CASH FLOWS AND MARKET CAPITALIZATION AT DIFFERENT STAGES OF LCO Black: OPERATING CF: significant except start ups all components significant payments to suppliers&personnel not significant at maturity FINANCING CF: siginificant, high correlation at growth & maturity INVESTING CF: significant, high correlation at growth & start up

45. CASH FLOW APPROACH : DICKINSON  500 FIRMS COMPUSTAT  THE CASH FLOW PATTERNS (+/-)  MONITORING THRU TIME  COMPARISON TO THE PRECEEDING PATTERNS AND SEARCH FOR BREAK-EVEN IN THE PATTERNS

46. COMPARISON BY GROWTH RATES BREAK-EVEN POINTS 4STAGES: from IPO, quarterly data Growth, maturity, mature growth, decline At minimum 2 years per stage Minimum 2 stages GROWTH RATES: - Adjusted to the industry (it is subtracted) -Moving average for 4 quarters -Р33 and Р67 (percentile) MATURITY: after 9 quarters needs 6 quarters with growth rates LOWER темп выручки than in Р67 DECLINE: after 9 quarters, 6 quarters with growth rates темп выручки LOWER than Р33 Yan,2006 MATURE GROWTH: after 9quarters, 6 quarters growth rates HIGHER than Р67

47. Corporate finance and the challenges for corporate analysis

48. SCALE OF FEASIBLE STATES OF THE MARKET FRACTION OF VOLATILITY THAT IS PRICE-DRIVEN 0%100% ORDER IN THE MARKET TURBULENCE AND CHAOS COMPLEXITY RATIONAL FINANCE BEHAVIORAL FINANCE DEDUCTION and mathematical modeling PREVAILS induction prevails “fly with feathers” : Process, store info and fly in response THE NEW FINANCE  Almost no price effect associated with investor’s interaction Price changes are almost unrelated to changes in real economic information set Market efficiency – special rational case Impact of interactions: -Interpretation of signals -Irrational expectations

49. MODELLING CORPORATE FINANCIAL DECISIONS Irrational expectations INVESTORS’ BIASES:  Market inefficiency (mispricing)  Arbitrage  Follow mispricing – behavior less than fully rational  But managers make unbiased forecasts about the future :  Take for granted prices fully reflect the info about fundamental values  decisions in their best interests BUT GOVERNANCE apply MANAGERIAL BIASES:  Less than fully rational behavior following mispricing  Optimism and overconfidence  Exploit and use mispricing in decision-making

50. FINANCIAL ANALYSIS IN INDUSTRIAL ECONOMY TYPE OF BUSINESS MODELS KEY RESOURCES KEY ANALYTICAL FOCUS CRITERIA FOR PERFORMANCE TANGIBLE AND FINANCIAL ASSETS, LIMITED INTANGIBLES SEEKING FOR ALLOACATIVE EFFICIENCY FINANCIAL STATEMENTS ANALYSIS SHAREHOLDER VALUE (SHV) AND AGENCY INFORMATION MODEL OF THE FIRM ACCOUNTING PROFIT AND CASH FLOWS ACCOUNTING PROFIT BASED

51. FINANCAL ANALYSIS IN THE KNOWLEDGE ECONOMY TYPE OF THE BUSINESS MODELS KEY RESOURCES KEY ANALYTICAL FOCUS CRITERIA INTELLECTUAL CAPITAL DYNAMIC CAPABILITIES TRAMFORMATION EFFICIENCIES CASH FLOWS, INTELLECTUAL CAPITAL SHV VERSUS STAKEHOLDER VALUE :AGENT AND ITS INTELLECTUAL CAPITAL CONTRIBUTION INFORMATION MODEL OF THE FIRM ECONOMIC PROFIT (RISK ADJUSTED APPROACH), KNOWLEDGE EARNINGS VALUE REPORTING NON-FINANCIAL REPORTING

52. КОРПОРАТИВНЫЕ ФИНАНСЫ-2. СТРУКТУРА КУРСА  РАСТУЩИЕ РЫНКИ  НОВЫЕ ГИПОТЕЗЫ, КОНЦЕПЦИИ  СТАТЬИ В МЕЖД ЖУРНАЛАХ 1. ЗАТРАТЫ НА КАПИТАЛ –  РАЗВИТИЕ СИГНАЛЬНЫХ МОДЕЛЕЙ  РАЗВИТИЕ АГЕНТСКИХ МОДЕЛЕЙ  СОЕДИНЕНИЕ АГЕНТСКИХ И СИГНАЛЬНЫХ МОДЕЛЕЙ  ИНТЕЛЛЕКТУАЛЬНЫЙ КАПИТАЛ  СЛОЖНЫЕ СТРУКТУРЫ КАПИТАЛА  РАСТУЩИЕ РЫНКИ: НОВЫЕ МОДЕЛИ, АДАПТАЦИЯ МОДЕЛЕЙ 2. СОВРЕМЕННЫЕ ИССЛЕДОВАНИЯ СТРУКТУРЫ КАПИТАЛА 3. СОВРЕМЕННЫЕ ИССЛЕДОВАНИЯ ПОЛИТИКИ ВЫПЛАТ- 4. ФИНАНСОВАЯ АРХИТЕКТУРА ФИРМЫ ИНТЕГРИРОВАННЫЙ ПОДХОД 5. АНАЛИЗ УПРАВЛЕНЧЕСКОЙ ГИБКОСТИ: МЕТОД РЕАЛЬНЫХ ОПЦИОНОВ  эмпирические исследования классических концепций: - технологии -результаты

53. ЗАДАНИЕ К СЕМИНАРУ 1: 1. Изучить статьи по методам идентификации стадий ЖЦО С ИСПОЛЬЗОВАНИЕМ ФИНАНСОВЫХ ПОКАЗАТЕЛЕЙ. ПОДГОТОВИТЬ ПРЕЗЕНТАЦИЮ (ОБЗОР) СТАТЕЙ: -КЛАССИФИЦИРОВАТЬ МЕТОДЫ -ВЫДЕЛИТЬ СИЛЬНЫЕ И СЛАБЫЕ СТОРОНЫ -СФОРМУЛИРОВАТЬ СУЖДЕНИЕ О ВОЗМОЖНОСТИ ПРИМЕНЕНИЯ К РОССИЙСКИМ КОМПАНИЯМ -2. ВЫБРАТЬ 4 РОС ПУБЛИЧНЫЕ КОМПАНИИ И РАСПОЛОЖИТЬ ИХ НА КРИВОЙ ЖЦО ТАК, ЧТОБЫ ОНИ ПРЕДСТАВЛЯЛИ РАЗНЫЕ СТАДИИ -ИЗУЧИВ ИХ ФИНАНСОВЫЕ ДАННЫЕ,А ТАКЖЕ КАЧЕСТВЕННУЮ ИНФОРМАЦИЮ О НИХ, ДОКАЗАТЬ, ЧТО ОНИ ПРИНАДЛЕЖАТ ТОЙ ИЛИ ИНОЙ СТАДИИ -В ПОСЛЕДУЮЩИХ ТЕМАХ КОМАНДА ОСТАВИТ ДВЕ ИЗ 4 КОМПАНИЙ ДЛЯ ДРУГИХ ЗАДАНИЙ -ФОРМА ПРЕЗЕНТАЦИИ РЕЗУЛЬТАТОВ: - ПО П 1 И 2 СЛАЙДЫ -ПО П1 РЕФЕРАТ (ДО 5-7 СТР), ССЫЛКИ НА ИСТОЧНИКИ ВЫПОЛНЯТЬ АКАДЕМИЧЕСКИ (СМ СЕРЬЕЗНЫЙ ЗАП ЖУРНАЛ) -ПО П2 АНАЛИТИЧЕСКАЯ ЗАПИСКА 2-3 СТР -РЕЗУЛЬТАТЫ СДАЮТСЯ В ДЕНЬ СЕМИНАРА: В ДЕПАРТАМЕНТ ФИНАНСОВ, КОМАНДА ДЕЛАЕТ ЕДИНУЮ ПАПКУ «СЕМИНАР1 ЖЦО-КОМАНДА №....» -ПАПКА ЗАПИСЫВАЕТСЯ В МОЙ КОМПЬЮТЕР СОТРУДНИКАМИ ДЕПАРТАМЕНТА

54. HOMEASSIGNMENT 1 Make the teams of 4 participants (mixed) Find 4 public firms and look thru their financial annual reports and data for 3 years Identify the LCO stages with the help of financial measures, especially cash flows dynamics Prepare power point presentation with the arguments to prove your opinion on firm’s LCO stages Prepare short analytical report (2-3 pages) with the references on the data sources