united technologies: dcf parts valuation cost of...
Post on 04-Apr-2020
14 Views
Preview:
TRANSCRIPT
119
UnitedTechnologies:DCFpartsvaluationCostofcapital,bybusiness
Aswath Damodaran
119
Division Unlevered Beta
Debt/Equity Ratio
Levered beta
Cost of equity
After-tax cost of debt
Debt to Capital
Cost of capital
Carrier 0.83 30.44% 0.97 9.32% 2.95% 23.33% 7.84% Pratt & Whitney 0.81 30.44% 0.95 9.17% 2.95% 23.33% 7.72% Otis 1.19 30.44% 1.39 12.07% 2.95% 23.33% 9.94% UTC Fire & Security 0.65 30.44% 0.76 7.95% 2.95% 23.33% 6.78% Hamilton Sundstrand 1.04 30.44% 1.22 10.93% 2.95% 23.33% 9.06% Sikorsky 1.17 30.44% 1.37 11.92% 2.95% 23.33% 9.82%
120
UnitedTechnologies:DCFvaluationFundamentals,bybusiness
Aswath Damodaran
120
Division Total Assets
Capital Invested Cap Ex
Allocated Reinvestment
Operating income after taxes
Return on capital
Reinvestment Rate
Carrier $10,810 $6,014 $191 $353 $816 13.57% 43.28% Pratt & Whitney $9,650 $5,369 $412 $762 $1,316 24.51% 57.90% Otis $7,731 $4,301 $150 $277 $1,536 35.71% 18.06% UTC Fire & Security $10,022 $5,575 $95 $176 $336 6.03% 52.27% Hamilton Sundstrand $8,648 $4,811 $141 $261 $681 14.16% 38.26% Sikorsky $3,985 $2,217 $165 $305 $296 13.37% 102.95%
121
UnitedTechnologies,DCFvaluationGrowthChoices
Aswath Damodaran
121
Division Cost of capital
Return on capital
Reinvestment Rate
Expected growth
Length of growth period
Stable growth rate
Stable ROC
Carrier 7.84% 13.57% 43.28% 5.87% 5 3% 7.84% Pratt & Whitney 7.72% 24.51% 57.90% 14.19% 5 3% 12.00% Otis 9.94% 35.71% 18.06% 6.45% 5 3% 14.00% UTC Fire & Security 6.78% 6.03% 52.27% 3.15% 0 3% 6.78% Hamilton Sundstrand 9.06% 14.16% 38.26% 5.42% 5 3% 9.06% Sikorsky 9.82% 13.37% 102.95% 13.76% 5 3% 9.82%
122
UnitedTechnologies,DCFvaluationValuesoftheparts
Aswath Damodaran
122
Business Cost of capital
PV of FCFF
PV of Terminal Value
Value of Operating Assets
Carrier 7.84% $2,190 $9,498 $11,688 Pratt & Whitney 7.72% $3,310 $27,989 $31,299 Otis 9.94% $5,717 $14,798 $20,515 UTC Fire & Security 6.78% $0 $4,953 $4,953 Hamilton Sundstrand 9.06% $1,902 $6,343 $8,245 Sikorsky 9.82% -$49 $3,598 $3,550 Sum $80,250
123
UnitedTechnologies,DCFvaluationSumoftheParts
Aswath Damodaran
123
Valueoftheparts =$80,250Valueofcorporateexpenses
=$4,587
Valueofoperatingassets(sumofpartsDCF)=$75,663Valueofoperatingassets(sumofpartsRV) =$74,230Valueofoperatingassets(companyDCF) =$71,410Enterprisevalue(basedonmarketprices) =$52,261
=Corporate ExpensesCurrent (1− t)(1+ g)
(Cost of capitalCompany − g)=408(1−.38)(1.03)(.0868−.03)
125
ProcessofValuingPrivateCompanies
¨ Theprocessofvaluingprivatecompaniesisnotdifferentfromtheprocessofvaluingpubliccompanies.Youestimatecashflows,attachadiscountratebasedupontheriskinessofthecashflowsandcomputeapresentvalue.Aswithpubliccompanies,youcaneithervalue¤ Theentirebusiness,bydiscountingcashflowstothefirmatthecostof
capital.¤ Theequityinthebusiness,bydiscountingcashflowstoequityatthe
costofequity.¨ Whenvaluingprivatecompanies,youfacetwostandard
problems:¤ Thereisnotmarketvalueforeitherdebtorequity¤ Thefinancialstatementsforprivatefirmsarelikelytogobackfewer
years,havelessdetailandhavemoreholesinthem.
Aswath Damodaran
125
126
1.NoMarketValue?
¨ Marketvaluesasinputs:Sinceneitherthedebtnorequityofaprivatebusinessistraded,anyinputsthatrequirethemcannotbeestimated.1. Debtratiosforgoingfromunleveredtoleveredbetasandfor
computingcostofcapital.2. Marketpricestocomputethevalueofoptionsandwarrants
grantedtoemployees.¨ Marketvalueasoutput:Whenvaluingpubliclytradedfirms,themarketvalueoperatesasameasureofreasonableness.Inprivatecompanyvaluation,thevaluestandsalone.
¨ Marketpricebasedriskmeasures,suchasbetaandbondratings,willnotbeavailableforprivatebusinesses.
Aswath Damodaran
126
127
2.CashFlowEstimationIssues
¨ Shorterhistory:Privatefirmsoftenhavebeenaroundformuchshortertimeperiodsthanmostpubliclytradedfirms.Thereisthereforelesshistoricalinformationavailableonthem.
¨ DifferentAccountingStandards:Theaccountingstatementsforprivatefirmsareoftenbasedupondifferentaccountingstandardsthanpublicfirms,whichoperateundermuchtighterconstraintsonwhattoreportandwhentoreport.
¨ Interminglingofpersonalandbusinessexpenses:Inthecaseofprivatefirms,somepersonalexpensesmaybereportedasbusinessexpenses.
¨ Separating“Salaries” from“Dividends”:Itisdifficulttotellwheresalariesendanddividendsbegininaprivatefirm,sincetheybothendupwiththeowner.
Aswath Damodaran
127
128
PrivateCompanyValuation:Motivematters
¨ Youcanvalueaprivatecompanyfor¤ ‘Show’ valuations
n Curiosity:Howmuchismybusinessreallyworth?n Legalpurposes:Estatetaxanddivorcecourt
¤ Transactionvaluationsn Saleorprospectivesaletoanotherindividualorprivateentity.n Saleofonepartner’sinteresttoanothern Saletoapubliclytradedfirm
¤ Aspreludetosettingtheofferingpriceinaninitialpublicoffering¨ Youcanvalueadivisionordivisionsofapubliclytradedfirm
¤ Aspreludetoaspinoff¤ Forsaletoanotherentity¤ Todoasum-of-the-partsvaluationtodeterminewhetherafirmwillbe
worthmorebrokenuporifitisbeingefficientlyrun.
Aswath Damodaran
128
129
Privatecompanyvaluations:Fourbroadscenarios
¨ Privatetoprivatetransactions:Youcanvalueaprivatebusinessforsalebyoneindividualtoanother.
¨ Privatetopublictransactions:Youcanvalueaprivatefirmforsaletoapubliclytradedfirm.
¨ PrivatetoIPO:Youcanvalueaprivatefirmforaninitialpublicoffering.
¨ PrivatetoVCtoPublic:Youcanvalueaprivatefirmthatisexpectedtoraiseventurecapitalalongthewayonitspathtogoingpublic.
Aswath Damodaran
129
130
I.PrivatetoPrivatetransaction
¨ Inprivatetoprivatetransactions,aprivatebusinessissoldbyoneindividualtoanother.Therearethreekeyissuesthatweneedtoconfrontinsuchtransactions:¨ Neitherthebuyernorthesellerisdiversified.Consequently,risk
andreturnmodelsthatfocusonjusttheriskthatcannotbediversifiedawaywillseriouslyunderestimatethediscountrates.
¨ Theinvestmentisilliquid.Consequently,thebuyerofthebusinesswillhavetofactorinan“illiquiditydiscount” toestimatethevalueofthebusiness.
¨ Keypersonvalue:Theremaybeasignificantpersonalcomponenttothevalue.Inotherwords,therevenuesandoperatingprofitofthebusinessreflectnotjustthepotentialofthebusinessbutthepresenceofthecurrentowner.
Aswath Damodaran
130
131
Anexample:Valuingarestaurant
¨ AssumethatyouhavebeenaskedtovalueaupscaleFrenchrestaurantforsalebytheowner(whoalsohappenstobethechef).Boththerestaurantandthechefarewellregarded,andbusinesshasbeengoodforthelast3years.
¨ Thepotentialbuyerisaformerinvestmentbanker,whotiredoftheratrace,hasdecidetocashoutallofhissavingsandusetheentireamounttoinvestintherestaurant.
¨ Youhaveaccesstothefinancialstatementsforthelast3yearsfortherestaurant.Inthemostrecentyear,therestaurantreported$1.2millioninrevenuesand$400,000inpre-taxoperatingprofit.Whilethefirmhasnoconventionaldebtoutstanding,ithasaleasecommitmentof$120,000eachyearforthenext12years.
Aswath Damodaran
131
132
Pastincomestatements…
3 years ago
2 years ago Last year
Revenues $800 $1,100 $1,200 Operating at full capacity- Operating lease expense $120 $120 $120 (12 years left on the lease)
- Wages $180 $200 $200(Owner/chef does not draw salary)
- Material $200 $275 $300 (25% of revenues)- Other operating expenses $120 $165 $180 (15% of revenues)Operating income $180 $340 $400- Taxes $72 $136 $160 (40% tax rate)Net Income $108 $204 $240
All numbers are in thousands
Aswath Damodaran
132
133
Step1:Estimatingdiscountrates
¨ Conventionalriskandreturnmodelsinfinancearebuiltonthepresumptionthatthemarginalinvestorsinthecompanyarediversifiedandthattheythereforecareonlyabouttheriskthatcannotbediversified.Thatriskismeasuredwithabetaorbetas,usuallyestimatedbylookingatpastpricesorreturns.
¨ Inthisvaluation,bothassumptionsarelikelytobeviolated:¤ Asaprivatebusiness,thisrestauranthasnomarketpricesorreturnstouseinestimation.
¤ Thebuyerisnotdiversified.Infact,hewillhavehisentirewealthtiedupintherestaurantafterthepurchase.
Aswath Damodaran
133
134
Nomarketprice,noproblem…Usebottom-upbetastogettheunleveredbeta
¨ Theaverageunleveredbetaacross75publiclytradedrestaurantsintheUSis0.86.
¨ Acaveat:Mostofthepubliclytradedrestaurantsonthislistarefast-foodchains(McDonald’s,BurgerKing)ormassrestaurants(Applebee’s,TGIF…)Thereisanargumenttobemadethatthebetaforanupscalerestaurantismorelikelytobereflecthigh-endspecialtyretailersthanitisrestaurants.Theunleveredbetafor45high-endretailersis1.18.
Aswath Damodaran
134
80 unitsof firm specificrisk
20 units of market risk
Private owner of businesswith 100% of your weatlthinvested in the business
Publicly traded companywith investors who are diversified
Is exposedto all the riskin the firm
Demands acost of equitythat reflects thisrisk
Eliminates firm-specific risk in portfolio
Demands acost of equitythat reflects only market risk
Market Beta measures justmarket risk
Total Beta measures all risk= Market Beta/ (Portion of the total risk that is market risk)
Private Owner versus Publicly Traded Company Perceptions of Risk in an Investment
Aswath Damodaran135
136
Estimatingatotalbeta
¨ Togetfromthemarketbetatothetotalbeta,weneedameasureofhowmuchoftheriskinthefirmcomesfromthemarketandhowmuchisfirm-specific.
¨ Lookingattheregressionsofpubliclytradedfirmsthatyieldthebottom-upbetashouldprovideananswer.¤ TheaverageR-squaredacrossthehigh-endretailerregressionsis25%.¤ Sincebetasarebasedonstandarddeviations(ratherthanvariances),
wewilltakethecorrelationcoefficient(thesquarerootoftheR-squared)asourmeasureoftheproportionoftheriskthatismarketrisk.
¨ TotalUnleveredBeta=MarketBeta/Correlationwiththemarket=1.18/0.5=2.36
Aswath Damodaran
136
137
Thefinalstepinthebetacomputation:EstimateaDebttoequityratioandcostofequity
¨ Withpubliclytradedfirms,were-leverthebetausingthemarketD/Eratioforthefirm.Withprivatefirms,thisoptionisnotfeasible.Wehavetwoalternatives:¤ Assumethatthedebttoequityratioforthefirmissimilartotheaverage
marketdebttoequityratioforpubliclytradedfirmsinthesector.¤ Useyourestimatesofthevalueofdebtandequityastheweightsinthe
computation.(Therewillbeacircularreasoningproblem:youneedthecostofcapitaltogetthevaluesandthevaluestogetthecostofcapital.)
¨ Wewillassumethatthisprivatelyownedrestaurantwillhaveadebttoequityratio(14.33%)similartotheaveragepubliclytradedrestaurant(eventhoughweusedretailerstotheunleveredbeta).¤ Leveredbeta=2.36(1+(1-.4)(.1433))=2.56¤ Costofequity=4.25%+2.56(4%)=14.50%(TBondratewas4.25%atthetime;4%istheequityriskpremium)
Aswath Damodaran
137
138
Estimatingacostofdebtandcapital
¨ Whilethefirmdoesnothavearatingoranyrecentbankloanstouseasreference,itdoeshaveareportedoperatingincomeandleaseexpenses(treatedasinterestexpenses)CoverageRatio=OperatingIncome/Interest(Lease)Expense
=400,000/120,000=3.33Ratingbasedoncoverageratio=BB+ Defaultspread=3.25%After-taxCostofdebt=(Riskfree rate+Defaultspread)(1– taxrate)
=(4.25%+3.25%)(1- .40)=4.50%¨ Tocomputethecostofcapital,wewillusethesameindustry
averagedebtratiothatweusedtoleverthebetas.¤Costofcapital=14.50%(100/114.33)+4.50%(14.33/114.33)=13.25%¤(Thedebttoequityratiois14.33%;thecostofcapitalisbasedonthedebttocapitalratio)
Aswath Damodaran
138
139
Step2:Cleanupthefinancialstatements
Stated AdjustedRevenues $1,200 $1,200- Operating lease expenses $120 Leases are financial expenses- Wages $200 $350 ! Hire a chef for $150,000/year- Material $300 $300- Other operating expenses $180 $180Operating income $400 $370- Interest expnses $0 $69.62 7.5% of $928.23 (see below)Taxable income $400 $300.38- Taxes $160 $120.15Net Income $240 $180.23
Debt 0 $928.23 ! PV of $120 million for 12 years @7.5%
Aswath Damodaran
139
140
Step3:Assesstheimpactofthe“key” person
¨ Partofthedrawoftherestaurantcomesfromthecurrentchef.Itispossible(andprobable)thatifhesellsandmoveson,therewillbeadropoffinrevenues.Ifyouarebuyingtherestaurant,youshouldconsiderthisdropoffwhenvaluingtherestaurant.Thus,if20%ofthepatronsaredrawntotherestaurantbecauseofthechef’sreputation,theexpectedoperatingincomewillbelowerifthechefleaves.¤ Adjustedoperatingincome(existingchef)=$370,000¤ Operatingincome(adjustedforchefdeparture)=$296,000
¨ Astheowner/chefoftherestaurant,whatmightyoubeabletodotomitigatethislossinvalue?
Aswath Damodaran
140
141
Step4:Don’tforgetvaluationfundamentals
¨ Tocompletethevaluation,youneedtoassumeanexpectedgrowthrate.Aswithanybusiness,assumptionsaboutgrowthhavetobeconsistentwithreinvestmentassumptions.Inthelongterm,Reinvestmentrate=Expectedgrowthrate/Returnoncapital
¨ Inthiscase,wewillassumea2%growthrateinperpetuityanda20%returnoncapital.
Reinvestmentrate=g/ROC=2%/20%=10%¨ Eveniftherestaurantdoesnotgrowinsize,thisreinvestment
iswhatyouneedtomaketokeeptherestaurantbothlookinggood(remodeling)andworkingwell(newovensandappliances).
Aswath Damodaran
141
142
Step5:Completethevaluation
¨ Inputstovaluation¤ AdjustedEBIT=$296,000¤ Taxrate=40%¤ Costofcapital=13.25%¤ Expectedgrowthrate=2%¤ Reinvestmentrate(RIR)=10%
¨ ValuationValueoftherestaurant=ExpectedFCFFnextyear/(Costofcapital–g)=ExpectedEBITnextyear(1- taxrate)(1- RIR)/(Costofcapital–g)
=296,000(1.02)(1-.4)(1-.10)/(.1325- .02)=$1.449million
Valueofequityinrestaurant=$1.449million- $0.928million(PVofleases)b=$0.521million
Aswath Damodaran
142
143
Step6:Considertheeffectofilliquidity
¨ Inprivatecompanyvaluation,illiquidityisaconstanttheme.Allthetalk,though,seemstoleadtoaruleofthumb.Theilliquiditydiscountforaprivatefirmisbetween20-30%anddoesnotvaryacrossprivatefirms.
¨ Butilliquidityshouldvaryacross:¤ Companies:Healthierandlargercompanies,withmoreliquidassets,shouldhavesmallerdiscountsthanmoney-losingsmallerbusinesseswithmoreilliquidassets.
¤ Time:Liquidityisworthmorewhentheeconomyisdoingbadlyandcreditistoughtocomebythanwhenmarketsarebooming.
¤ Buyers:Liquidityisworthmoretobuyerswhohaveshortertimehorizonsandgreatercashneedsthanforlongerterminvestorswhodon’tneedthecashandarewillingtoholdtheinvestment.
Aswath Damodaran
143
144
TheStandardApproach:Illiquiditydiscountbasedonilliquidpubliclytradedassets
¨ Restrictedstock:ThesearestockissuedbypubliclytradedcompaniestothemarketthatbypasstheSECregistrationprocessbutthestockcannotbetradedforoneyearaftertheissue.
¨ Pre-IPOtransactions:Thesearetransactionspriortoinitialpublicofferingswhereequityinvestorsintheprivatefirmbuy(sell)eachother’sstakes.
¨ Inbothcases,thediscountisestimatedthebethedifferencebetweenthemarketpriceoftheliquidassetandtheobservedtransactionpriceoftheilliquidasset.¤ DiscountRestrictedstock=Stockprice– Priceonrestrictedstockoffering
¤ DiscountIPO =IPOofferingprice– Priceonpre-IPOtransaction
Aswath Damodaran
144
145
TheRestrictedStockDiscount
¨ Aggregatediscountstudies¤ Maherexaminedrestrictedstockpurchasesmadebyfourmutualfundsinthe
period1969-73andconcludedthattheytradedanaveragediscountof35.43%onpubliclytradedstockinthesamecompanies.
¤ Moroney reportedameandiscountof35%foracquisitionsof146restrictedstockissuesby10investmentcompanies,usingdatafrom1970.
¤ Inastudyofrestrictedstockofferingsfromthe1980s,Silber(1991)findsthatthemediandiscountforrestrictedstockis33.75%.
¨ Silberrelatedthesizeofthediscounttocharacteristicsoftheoffering:LN(RPRS)=4.33+0.036LN(REV)- 0.142LN(RBRT)+0.174DERN+0.332DCUST¤ RPRS=Relativepriceofrestrictedstock(topubliclytradedstock)¤ REV=Revenuesoftheprivatefirm(inmillionsofdollars)¤ RBRT=RestrictedBlockrelativetoTotalCommonStockin%¤ DERN=1ifearningsarepositive;0ifearningsarenegative;¤ DCUST=1ifthereisacustomerrelationshipwiththeinvestor;0otherwise;
Aswath Damodaran
145
146
CrosssectionaldifferencesinIlliquidity:ExtendingtheSilberregression
Figure 24.1: Illiquidity Discounts: Base Discount of 25% for profitable firm with $ 10 million in revenues
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
5 10 15 20 25 30 35 40 45 50 100 200 300 400 500 1000Revenues
Dis
coun
t as %
of V
alue
Profitable firm Unprofitable firm
Aswath Damodaran
146
148
The“sampling” problem
¨ WithbothrestrictedstockandtheIPOstudies,thereisasignificantsamplingbiasproblem.¤ Thecompaniesthatmakerestrictedstockofferingsarelikelytobe
small,troubledfirmsthathaverunoutofconventionalfinancingoptions.
¤ ThetypesofIPOswhereequityinvestorsselltheirstakeinthefivemonthspriortotheIPOatahugediscountarelikelytobeIPOsthathavesignificantpricinguncertaintyassociatedwiththem.
¨ Withrestrictedstock,themagnitudeofthesamplingbiaswasestimatedbycomparingthediscountonallprivateplacementstothediscountonrestrictedstockofferings.Onestudyconcludedthatthe“illiquidity” aloneaccountedforadiscountoflessthan10%(leavingthebalanceof20-25%tobeexplainedbysamplingproblems).
Aswath Damodaran
148
149
Analternativeapproach:Usethewholesample¨ Alltradedassetsareilliquid.Thebidaskspread,measuringthe
differencebetweenthepriceatwhichyoucanbuyandselltheassetatthesamepointintimeistheilliquiditymeasure.
¨ Wecanregressthebid-askspread(asapercentoftheprice)againstvariablesthatcanbemeasuredforaprivatefirm(suchasrevenues,cashflowgeneratingcapacity,typeofassets,varianceinoperatingincome)andarealsoavailableforpubliclytradedfirms.
¨ Usingdatafromtheendof2000,forinstance,weregressedthebid-askspreadagainstannualrevenues,adummyvariableforpositiveearnings(DERN:0ifnegativeand1ifpositive),cashasapercentoffirmvalueandtradingvolume.Spread=0.145– 0.0022ln(AnnualRevenues)-0.015(DERN)– 0.016(Cash/FirmValue)– 0.11($Monthlytradingvolume/FirmValue)Youcouldpluginthevaluesforaprivatefirmintothisregression(withzerotradingvolume)andestimatethespreadforthefirm.
Aswath Damodaran
149
150
EstimatingtheilliquiditydiscountfortherestaurantApproach used Estimated discount Value of restaurantBludgeon (Fixed discount) 25% $0.521 (1- .25) = $0.391
millionRefined Bludgeon (Fixed discount with adjustment for revenue size/ profitability)
28.75% (Silber adjustment for small revenues and positive profits to a base discount of 25%)
$0.521 (1-.2875) = $0.371 million
Bid-ask spread regression = 0.145 – 0.0022 ln (1.2) -0.015 (1) –0.016 (.05) – 0.11 (0)= 12.88%
$0.521 (1-.1288) = $0.454 million
Aswath Damodaran
150
151
II.Privatecompanysoldtopubliclytradedcompany
¨ Thekeydifferencebetweenthisscenarioandthepreviousscenarioisthatthesellerofthebusinessisnotdiversifiedbutthebuyeris(oratleasttheinvestorsinthebuyerare).Consequently,theycanlookatthesamefirmandseeverydifferentamountsofriskinthebusinesswiththesellerseeingmoreriskthanthebuyer.
¨ Thecashflowsmayalsobeaffectedbythefactthatthetaxratesforpubliclytradedcompaniescandivergefromthoseofprivateowners.
¨ Finally,thereshouldbenoilliquiditydiscounttoapublicbuyer,sinceinvestorsinthebuyercanselltheirholdingsinamarket.
Aswath Damodaran
151
152
Revisitingthecostofequityandcapital:RestaurantValuation
Private Public
Unlevred beta 2.36 1.18
Debt to equity ratio 14.33% 14.33%
Tax rate 40% 40%
Pre-tax cost of debt 7.50% 7.50%
Levered beta 2.56 1.28
Riskfree rate 4.25% 4.25%
Equity risk premium 4% 4%
Cost of equity 14.5% 9.38%
After-tax cost of debt 4.50% 4.50%
Cost of capital 13.25% 8.76%
Aswath Damodaran
152
154
So,whatpriceshouldyouaskfor?
¨ Assumethatyourepresentthechef/owneroftherestaurantandthatyouwereaskingfora“reasonable” pricefortherestaurant.Whatwouldyouaskfor?
a. $454,000b. $1.484millionc. Somenumberinthemiddle¨ Ifitis“somenumberinthemiddle”,whatwilldetermine
whatyouwillultimatelygetforyourbusiness?
¨ Howwouldyoualtertheanalysis,ifyourbestpotentialbidderisaprivateequityorVCfundratherthanapubliclytradedfirm?
Aswath Damodaran
154
top related