Company Valuation: DCF and Multiples; APV; Equity Cash Flow Course Module in Corporate Financial Management I. Overview of suggested content (HBS cases unless otherwise noted) Title Valuation Overview 1. What's It Worth?: A General Manager's Guide to Valuation (HBR Article) And Note on Mergers and Acquisitions and Valuation (Ivey Note) Discounted Cash Flow (DCF) and Multiples 2. Radio One, Inc. Amtelecom Group Inc. (Ivey case) 3. Spyder Active Sports— 2004 Alternative: Kohler Alternative: Kohler Co. Supplement: Corporate Valuation and Market Multiples (HBS Note) Adjusted Present Value (APV) 4. Sampa Video, Inc.
Alternative 1: Seagate 1: Seagate Technology Buyout Alternative 2: Kmart, 2: Kmart, Inc. and Builders Square Supplement: Using APV: A Better Tool for Valuing Operations (HBR Article) Equity Cash Flow 5. Acova Radiateurs Alternative 1: Philip 1: Philip Morris
Author
Product Number
Publication Pages Year
Teaching Note
Luehrman
97305
1997
11p
---
Foerster
95B023
1995 (Rev. 2000)
14p
--
Ruback Dunbar
201025 904N14
2000 2004
15p 32p
201027 804N14
Villalonga
206027
2005
23p
---
Villalonga Luehrman
205034 206039
2005 2005
20p 9p
205093 ---
Andrade
201094
3p
204125
Andrade
201063
19p
204160
Meulbroek
200044
25p
202083
Luehrman
97306
2001 (Rev. 2003) 2001 (Rev. 2002) 2000 (Rev. 2002) 1997
8p
---
Meulbroek
295150
12p
200003
Ruback
289045
21p
289046
1995 (Rev. 1999) 1989 (Rev.
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Company Valuation: An HBSP Course Module
Companies and Kraft Alternative 2: BW/IP International, Inc.
Luehrman
293058
1994) 1992
16p
295147
II. Rationale for selecting and sequencing the items in this module The module starts with the bestselling Harvard Business Review article “What’s It Worth? A General Manager’s Guide to Valuation.” 1 The article first describes the limitations of the standard WACC (Weighted Average Cost of Capital) version of DCF (Discounted Cash Flow) valuation of companies. As an alternative, the article then proposes the Adjusted Present Value, Options, and Equity Cash Flow methods as better suited for valuing operations, opportunities, and ownership claims. The Ivey note, Note on Mergers and Acquisitions and Valuation, demonstrates the DCF, multiples (comparable companies), and break-up value methods for valuing companies in the mergers and acquisitions context.
The next two segments contrast the traditional DCF and multiples techniques to value public (segment 2) and private (segment 3) companies. Segment 2 recommends Radio One, a standard bestseller used over two days at Harvard Business School, both at introductory MBA and executive levels. It concerns the acquisition of a series of urban radio stations across the United States. The alternative Amtelecom Group case, which can be covered in a single session, explores valuation of a Canadian telecommunications subsidiary for sale to a buyer or for an initial public offering (IPO). The Amtelecom case includes a sumof-parts valuation. Segment 3 offers two new cases on valuing privately held companies and shareholder conflicts in family firms. Both cases have worked well in HBS executive programs on valuation. Spyder Active Sports—2004 concerns exit options for the founder and private equity partner of a high-end ski apparel manufacturer. The complementary case, Kohler Co., focuses on valuing a minority stake and issues of control premiums in a plumbing fixtures company. The supplementary technical note “Corporate Valuation and Market Multiples” reviews the implementation and limits of the multiples valuation m ethod. The last two segments explore the alternative valuation techniques mentioned in the lead HBR article. In Segment 4, about Adjusted Present Value (APV), Sampa Video, concerning the expansion of a video chain, is a short case that highlights the impact of a project’s debt capacity on valuation. Students are required to value a project using APV, WACC, and Capital Cash Flow (CCF) methods. The two alternative cases illustrate valuation in a more in-depth buyout context—Seagate (a two-session case) focuses on the volatile technology sector, while Kmart focuses on the traditional retail sector. The supplementary HBR article “Using APV: A Better Tool for Valuing Operations (HBR Article)” describes an APV analysis in clear step-by-step fashion using a hypothetical company example. Segment 5, on the equity cash flow (ECF) method, closes the module with Acova Radiators, a candidate that students must value for a leveraged buyout (LBO) in an international setting. The teaching note provides one- and two-day teaching plans and ECF and CCF valuations of Acova. The first alternative, 1
This module assumes students are familiar with the discounted cash flow ( DCF) and Weighted Average Cost of Capital (WACC) concepts.
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Company Valuation: An HBSP Course Module
Philip Morris Companies and Kraft, uses a variety of valuation techniques to assess a merger from both companies’ perspectives. The second alternative, BW/IP International, is an integrative case that values an acquisition candidate using both the adjusted present value and equity cash flow methods. Technical notes for further reading: Note on Capital Cash Flow Valuation (Ruback, 295069, 13p, 1994) Note on Valuing Equity Cash Flows (Luehrman, 295085, 10p, Rev 2005) Note on Valuing Private Businesses (Crane, 201060, 14p, 2001) III. Detailed description of recommended items Valuation Overview 1. What's It Worth?: A General Manager's Guide to Valuation Timothy A. Luehrman (Harvard Business Review) Behind every major resource-allocation decision a company makes lies some calculation of what that move is worth. So it is not surprising that valuation is the financial analytical skill general m anagers want to learn more than any other. What do generalists need in an updated valuation tool kit? In the 1970s, discounted-cash-flow analysis (DCF) emerged as best practice for valuing corporate assets. And one version of DCF--using the weighted-average cost of capital (WACC)--became the standard. Over the years, WACC has been used by most companies as a one-size-fits-all valuation tool. Today the WACC standard is insufficient. Improvements in computers and new theoretical insights have given rise to tools that outperform WACC in the three basic types of valuation problems managers face. Timothy Luehrman presents an overview of the three tools, explaining how they work and when to use them. Subjects: Acquisitions; Capital budgeting; Capital costs; Financial analysis; Joint ventures; Present value; Valuation Length: 11p
Note on Mergers and Acquisitions and Valuation Steve R. Foerster; Dominique Fortier (Richard Ivey School of Business/UWO) The object is to define what is meant by mergers and acquisitions and to understand why they happen. The impact of these deals on shareholders of both the acquiring and acquired companies is investigated, and the reasons why some mergers succeed while other fail are examined. Finally, in order to determine the value of a firm, some valuation frameworks are provided. Subjects Covered: Acquisitions; Mergers; Valuation Length: 14p Discounted Cash Flow (DCF) and Multiples 2. Radio One, Inc. Richard S. Ruback; Pauline Fischer Radio One (NYSE: ROIA and RIOAK), the largest radio group targeting African-Americans in the country, had the opportunity to acquire 12 urban stations in the top 50 m arkets from Clear Channel Communications, Inc. (NYSE: CCU) in the winter of 2000. The stations were being sold by Clear Channel Communications, Inc. to obtain Federal Communications Commission (FCC) approval for its acquisition of AMFM, Inc. (NYSE: AFM). Radio One was also negotiating the acquisition of nine stations in Charlotte, North Carolina, Augusta, Georgia, and Indianapolis, Indiana. The proposed acquisitions would double the
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Company Valuation: An HBSP Course Module
size of Radio One. The case focuses on the strategic and financial evaluation of the proposed acquisitions. Learning Objective: To provide students the opportunity to forecast the cash flows associated with the proposed acquisitions and to value those projections using discounted cash flows as well as transaction and trading multiples. Subjects Covered: Acquisitions; Mergers; Present value; Valuation Setting: District of Columbia; Radio; $81.7 million revenues; 1999 Alternative: Amtelecom Group Inc. Craig Dunbar; Andrew Cogan (Richard Ivey School of Business/UWO) The CEO of Amtelecom Group Inc. (AGI) must make a recommendation to the board of directors regarding the best way to sell its Amtelecom Communications subsidiary. AGI owns and operates ICS Courier, a national fixed-route courier business, and Amtelecom Communications, a regional telecommunications, cable television, and Internet business. Amtelecom Communication's capital requirements are not being satisfied because cash is being diverted to ICS Courier to cover its losses. In addition, AGI's stock has been performing poorly. To alleviate these problems, the board has decided to sell off Amtelecom Communications. The three sales alternatives being considered are: selling to a strategic buyer, IPO via a common share offering, and IPO via an income trust offering. Learning Objective: To teach valuation in a strategic setting and provide an opportunity to apply sum of parts valuation to value a diversified firm, apply discounted cash flow, conduct a transactions analysis to determine the standalone value of a firm, and gain a basic understanding of income trusts. Subjects Covered: Financial strategy; IPO; Mergers & Acquisitions; Subsidiaries; Valuation Setting: Canada; Communications industry; 2002 Length: 32p 3. Spyder Active Sports—2004 Belen Villalonga; Dwight Crane; James Quinn David Jacobs founded a high-end ski apparel company in 1978. He successfully built and grew the company, establishing a major international brand that appealed to ski racers and other active skiers. In 1995, he sought external financing to support further growth of the company and structured a financial deal with CHB Capital Partners, a private equity firm in Denver. By 2004, Jacobs was ready to consider alternative types of equity transactions that would provide a source of liquidity to him and his family, including sale of Spyder to another apparel company and sale of a large block of stock to a private equity firm. Poses issues of valuation of a privately owned company and presents alternative ways to harvest wealth from a private company. Also brings up family business issues because the transaction would have a significant effect on two of his children who are involved in the business. Includes color exhibits. Learning Objective: To provide an opportunity to study valuation of a private company and the process of harvesting wealth, along with its impact on the owner and his family. Subjects Covered: Financing, Growth strategy, Private equity, Valuation. Setting: Colorado; Apparel i ndustry; $61 million revenues ; 50 employees; 2004 Length: 23p Alternative: Kohler Co. Belen Villalonga; Raphael Amit Kohler Co., best known for its plumbing fixtures, is a large, private family firm. As part of a recapitalization aimed at preserving family ownership of Kohler Co., non-family shareholders, who held 4% of common stock, were required to sell their shares to the company. A group of dissenting shareholders filed a lawsuit claiming that the buyout price undervalued their shares by a factor of five. In April 2000, Herbert V. Kohler, Jr., chairman and CEO, has to decide whether to settle with the dissenters and, if so, at what
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Company Valuation: An HBSP Course Module
share price. The decision calls for a detailed valuation of the company at the time of the recapitalization. Provides the necessary data for students to value the company using both a discounted cash flow approach and a multiples (comparable companies) approach. Students must identify and understand the different valuation assumptions that can lead to a wide range in price, including the applicability of discounts for lack of marketability and lack of control. Exhibits are available in electronic form to facilitate analysis of the data (HBS courseware 9-205-707). Learning Objective: To examine the valuation of privately held firms from the perspectives of the controlling shareholder(s) and minority shareholders. Subjects Covered: Family owned businesses; Legal aspects of business; Recapitalization; Shareholder relations; Stockholders; Valuation Length: 20p • •
Downloadable, spreadsheet exhibits If both cases are used, then Kohler, which requires a more advanced valuation, should follow Spyder.
Supplement: Corporate Valuation and Market Multiples Timothy A. Luehrman (Harvard Business School Technical Note) Provides a basic introduction to the use of market multiples for business valuation. Explains the method's reliance on the Law of One Price, sets forth the basic steps for using the method, and reviews some practical issues arising in its application. Learning Objective: To introduce the use of market multiples to estimate the value of a business. Subjects Covered: Acquisitions, Mergers, Stocks, Valuation. Length: 9p Adjusted Present Value (APV) 4. Sampa Video, Inc. Gregor Andrade A video rental store is considering offering home delivery service. Management must value the project under different financing strategies and methods, specifically adj usted present value (APV) and weighted average cost of capital (WACC). Learning Objective: To explain how to implement APV and W ACC, and when each is appropriate. Subjects: Capital budgeting; Capital investments; Cash flow; Debt management; Financial strategy; Financing; Present value; Valuation Setting: 2001 Length: 3p
Alternative 1: Seagate Technology Buyout Gregor Andrade; Todd Pulvino; Stuart C. Gilson In March 2000, a group of private investors and senior managers were negotiating a deal to acquire the disk drive operations of Seagate Technology. The motivating factor for the buyout was the apparently anomalous market value of Seagate's equity: Seagate's equity value was just a fraction of the value of its minority stake in Veritas Software Corp., a software maker. The investor group had to decide how much to offer for the operating assets, as well as how to finance the transaction. Further complicating the analysis was the fact that, unlike in traditional buyout settings, the target company was in a highly cyclical, volatile, and capital--intensive industry. Learning Objective: To illustrate cash flow valuation (adjusted present value and WACC), including estimating the cost of capital from comparables, as well as the impact of financing decisions on value; to discuss leveraged buyouts, both in traditional settings within mature industries, as well as in the more volatile technology sector; to discuss tax implications associated with corporate divestitures; and to
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Company Valuation: An HBSP Course Module
qualitatively evaluate potential costs of financial distress in a capital-intensive technology-driven setting. Capital structure; Financial strategy; Leveraged buyouts; Mergers & Acquisitions; Present value; Software; Valuation Setting: Silicon Valley; Computer hardware; $6.8 billion revenues Length: 19p •
Two-session comprehensive case
Alternative 2: Kmart, Inc. and Builders Square Lisa Meulbroek; Jonathan Barnett In 1997, Kmart received an offer from retail buyout specialists Leonard Green & Partners for the purchase of its ailing 162-store home improvement chain, Builders Square. Green's offer included a $10 million cash payment, a warrant to purchase a 28% stake in the new entity in the future, and the assumption of approximately $1.5 billion in noncancelable Builders Square lease obligations. Kmart would remain contingently liable for the lease payments if the new entity were to fail. In the midst of the fiercely competitive home improvement retail industry, the questions posed include (1) what is the value of the Builders Square subsidiary?,(2) is the Green offer a good deal for Kmart?, and (3) should Kmart accept the offer or hold out for a higher offer or more offers? Learning Objective: To incorporate off-balance-sheet financing of operating lease guarantees into a valuation exercise (using multiples and the APV approach) focused on a money-losing subsidiary. Subjects: Capital structure; Corporate reorganization; Debt management; Discount department stores; Divestiture; Leasing; Liability; Options; Restructuring; Valuation Setting: Building materials industries; Retail industry; $2.5 billion revenues; 1997 Supplement: Using APV: A Better Tool for Valuing Operations Timothy A. Luehrman (Harvard Business Review) For the past 25 years, managers have been taught that the best practice for valuing assets--that is, an existing business, factory, product line, or market position--is to use a discounted-cash-flow (DCF) methodology. That is still true. But the particular version of DCF that has been accepted as the standard-using the weighted-average cost of capital (WACC)--is now obsolete. Today's better alternative, adjusted present value (APV), is especially versatile and reliable. It will likely replace WACC as the DCF methodology of choice among generalists. Like WACC, APV is used to value operations, or assets-inplace. Timothy Luehrman explains APV and walks readers through a case example designed to teach them how to use it. Subjects: Acquisitions; Capital budgeting; Capital costs; Financial analysis; Present value; Valuation Length: 8p Equity Cash Flow 5. Acova Radiateurs Lisa Meulbroek In March 1990, Baring Capital Investors faced a decision about whether and how much to bid for Acova Radiateurs, a subsidiary of Source Perrier. Source Perrier had decided to sell Acova, and Baring Capital Investors thought it might make a good leveraged buyout candidate. Learning Objective: To give students an opportunity to value Acova using the flows-to-equity technique, as well as to evaluate the merits of this technique relative to the valuation methodologies typically used by buyout firms. Subjects: Acquisitions; Capital structure; Corporate control; Divestiture; International business; International finance; Leveraged buyouts; Mergers & Acquisitions; Project evaluation; V aluation Setting: France; Plumbing & HVAC; 337M FF; 500 Employees; 1990 Length:12p
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Company Valuation: An HBSP Course Module
Alternative 1: Philip Morris Companies and Kraft, Inc. Richard S. Ruback Gives students the opportunity to explore the effect of substantial free cash flow on corporate acquisition and operating strategies. Students are also given the opportunity to extract information from the common stock prices of the participating firms. A variety of valuation techniques are employed to assess the plausibility of a restructuring plan. Subjects: Acquisitions; Cash flow; Food; Restructuring Setting: Food industry; Tobacco industry; Fortune 500 Length: 21p Alternative 2: BW/IP International, Inc. Timothy A. Luehrman; Andrew D. Regan Less than a year after completing a leveraged buyout of their own company, the managers of BW/IP International were presented with an attractive acquisition candidate. To buy the target company, however, BW/IP would have to borrow more money and take on more administrative problems at a time when its managers are already very busy. The case asks students to consider how BW/IP can convince its lenders that the acquisition is a good idea. Presents two straightforward valuation exercises. Also permits a careful comparison of the capital allocation processes at a large, low-leveraged, public company, versus a small, highly-leveraged, private company. Subjects: Capital budgeting; Financial management; Loan evaluation; Machinery; Reorganization; Securities analysis; Valuation Setting: California; Fluid control, pump & seal industries; mid-size; $250 million revenues; 1988 Length: 16p HBS Technical Notes for Supplementary Reading
Note on Capital Cash Flow Valuation Richard S. Ruback Presents the capital cash flow method for valuing risky cash flows. In this method cash flows are calculated to include the benefits of interest tax shields. In a capital structure, with just ordinary debt and common equity, capital cash flows equal the flows available to equity--net income plus depreciation less capital expenditure and the change in working capital--plus the cash interest paid to bondholders. The interest tax shields decrease taxable income and thereby increase cash flows. Since the interest tax shields are included in the cash flows, a before-tax interest rate that corresponds to the riskiness of the assets is appropriate to value the capital cash flows. Subjects: Capital budgeting; Cash flow; Investment management; Valuation Length: 13p Note on Valuing Equity Cash Flows Timothy A. Luehrman A technical note for advanced students on the topic of valuing highl y-levered equity. Introduces the "equity cash flow" valuation methodology, shows how to use it, discusses the sources and signs of its built-in biases, and provides some guidance about when to use it. Subjects: Capital budgeting; Capital costs; Equity financing; Present value; Valuation Length: 10p •
Teaching Note, (295149), 8p, by Timothy A. Luehrman
Note on Valuing Private Businesses Dwight B. Crane; Indra A. Reinbergs This case provides a brief overview of valuation for owners of closely held companies. The focus is on a comparable transactions approach, although rules of thumb and discounted cash flow are mentioned. Earnings multiples and their drivers are discussed. It uses company example and transaction data on
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Company Valuation: An HBSP Course Module
private deals as an exercise in screening for comparable companies and valuation based on multiples. It includes a three-page bibliography with references to further sources on valuation methods, private transaction data, financial databases for company screening, and professional advisors from appraisal and valuation communities. Learning Objective: To teach participants how to value privately owned businesses. Subjects: Financial analysis; Financial ratios; Price earnings ratio; Small business; Valuation Length: 14p
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