Valuation

1. 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

2. 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

3. 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

4. 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.

5. 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

6. 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

7. 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

8. 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

9. 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

10. Saigon Hotel - Net Asset (000 US$)

11. 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 ?

12. 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

13. 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)

14. Price-earning ratios Examples (Oct 30, 2001)

15. Price-earning ratios Examples (Oct 30, 2001)

16. Price-earning ratios Historic (Nov 2, 2000)

17. 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

18. 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) / (1+r)

19. 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) / (1+r) • and so on . . . • v2 = (div3 + v3) / (1+r) • We can then write • v0 = (div1 + (div2 + v2) / (1+r))/(1+r) • v0 = div1/(1+r) + div2/(1+r)2 +…+ pT/(1+r)T

20. Present Value of Dividends • If we consider that the company lives in perpetuity we can write • v0 = div1/(1+r) + div2/(1+r)2 +…+ divt/(1+r)t + … • V0= DIV1/(1+r) + DIV2/(1+r)2 +…+ DIVt/(1+r)t + … • Or • v0 = t=1divt/(1+r)t • V0 = t=1DIVt/(1+r)t

21. 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.(1+g)t-1 • Gordon & Shapiro proved mathematically that • v0 = div1 / (r-g) • V0 = DIV1 / (r-g) • of course one must have r>g • The lower the Cost of Capital the higher the value • The higher the growth rate the higher the value

22. 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%

23. 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 = t=1 FCFt/(1+r)t The Enterprise Value is equal to the PV of all Free Cash Flows « Discounted Cash Flow Model »

24. 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

25. 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 = DIVT+1 / (r-g) or • EVT = FCFT+1 / (r-g) • T = last year of the Financial Plan • « Normalized » FCF for the perpetuity FCFT+1 = NOPATT+1 • 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 = t=1T FCFt/(1+r)t + (NOPATT+1/(r-g))/(1+r)T

26. 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

27. DCF - The Quiz Company

28. 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%

29. 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

30. Saigon Hotel – ValuationSensibilities Studies

31. DCF – Decision tool • In order to choose the best scenario • Maximize the value

32. SummaryThe Values of Saigon Hotel

33. 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

34. 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