Applying Relative, Asset Oriented, and Real Option Valuation Methods to Mergers and AcquisitionsChapter 81Learning Objectives! "ri#ary learning objective$ %o provide students &ith 'no&ledge o( alternatives to discounted cash (lo& valuation #ethods, including) Market Approach Similar to real estate valuations ! Co#parable co#panies! Co#parable transactions! *a#e industry or co#parable industry) Asset oriented approach! %angible boo' value! Liquidation value! +rea',up value) Cost approach) Weighted average method *ee -ebsite, Chapter 8, Alternate Valuation Ratios, Table 7, &hich discusses several alternate .quity Valuation and .nterprise Valuation Ratios/0Applying Mar'et,+ased 1Relative Valuation2 Methods1MV% 3 1MVC 4 5C2 6 5%-hereMVC3 Mar'et value o( the co#parable co#pany C5C3 Measure o( value (or co#parable co#pany C5% 3 Measure o( value (or co#pany %1MVC45C23 Mar'et value #ultiple (or the co#parable co#pany1Co#parable co#panies #ay include those &ith pro(itability, ris', and gro&th characteristics si#ilar to the target (ir#/7Relative Valuation!Value o( asset is co#pared to values assessed by the #ar'et (or si#ilar or co#parable asset/!Require#ents$)5denti(y co#parable assets and #ar'et values)Convert #ar'et values to standardi8ed values creating price #ultiples/)Co#pare relative values controlling (or any di((erences/ 9a#odoran, Corporate Finance, :e& ;or' Relative valuation is pervasive!Most valuations on -all *treet are relative valuations/ )Al#ost 85% of equity research reports are based upon a #ultiple and co#parables/)More than 5!% of all acquisition valuations are based upon #ultiples)Rules o( thu#b based on #ultiples are not only co##on but are o(ten the basis (or final valuation "udgments/ Another study indicates #!$# in favor of relative comps/ ?Relative valuation is pervasive!-hile there are #ore discounted cash (lo& valuations in consulting and corporate (inance, they are o(ten relative valuations masquerading as discounted cash (lo& valuations/)%he objective in #any discounted cash (lo& valuations is to bac' into a nu#ber that has been obtained by using a #ultiple/)%he ter#inal value in a signi(icant nu#ber o( discounted cash (lo& valuations is esti#ated using a #ultiple/=Valuation Ratios versus 9C@!9o both!+oth entail use o( value esti#ates, pro(essional judg#ent, quality o( in(or#ation and purpose o( valuation/ !Acquisition o( specific% kno&n asset or company% and good data, Co#ps #ay be better/!Acquisition o( general% non'specific or unkno&n asset or company% (C) may *e *etter/*ee %it#an, Valuation-The Art and Science of Corporate Investment ecisions, AB11, pgs/ AC1,A/8Mar'et,+ased Methods$ Co#parable Co#pany .6a#ple.6hibit 8,1/ +aluing ,epsol ;"@ /?7 1/>11 A0/>C9o& Che#ical 7=/7B 7/7B1 1B/==9u"ont 71/BB A/>=A 1>/C7.ast#an Che#ical >1/?C >/=> 8/CC@MC >C/>A >/=AC 1B/0CRoh# F Gass 7>/BA A/?=8 1?/81 Average #234811Mar'et Cap and ". Ratios-1/ ,atio Market Cap 56illions7+A*@ 10/77 E 08/A>+ayer A0/>C A>/?09o& Che#ical 1B/== 7>/A>9u"ont 1>/C7 7B/?1.ast#an Che#ical I 8/CC 7/1B@MC I 1B/0C A/ABRoh# F Gass I 1?/81 1B/B1Average 56ig 27 #5382 9:;322Average 1*#all 02I1A/B? >/771AVariation o( ". RatioShare -rice Current/-SCurrent1 /A70 10/77E =/A= C/?C+ayer 0>/?7 1/>11 A0/>C A/?C 10/A=9o& 7=/7B 7/7B1 1B/== >/=1 8/0B9u"ont 71/BB A/>=A 1>/C7 0/B7 10/78.ast#an >1/?C >/=> 8/CC >/C0 8/=1@MC >C/>A >/=AC 1B/0C >/?? 1B/>1Roh# F Gass7>/BA A/?=8 1?/81 0/1A 17/77Average #2348 ##34!10Valuation o( .66onMobil!+aseline valuation).arnings E0/7A8+ D "4. Ratio 17/A8 3 E78/C7 +!Modi(ication to re(lect relative si8e).arnings E0/7A8+ D "4. Ratio 1>/C73 E>7/?0 +!@urther #odi(ication)*ubstantial dispersion 11B/== ) A0/>C2 in "4. Ratios even a#ong top 7 (ir#s indicate ris' and gro&th potential #ust be considered/17Mar'et,+ased Methods$Recent %ransactionsJ Method1!Calculation si#ilar to co#parable co#paniesJ #ethod, e6cept #ultiples used to esti#ate targetJs value based on purchase prices o( recently acquired co#parable co#panies/!Most accurate #ethod &henever the transaction is truly co#parable and recent/ 6oston 6eer =->!Major li#itation is that truly co#parable recent transactions are rare/1Also called precedent #ethod/1>+oston +eer Co#pany!@ounded 1C87 ?th generation bre&er 1G+*2!9ra&n by .uropean, #ore bitterbre&s/!:ot loo'ing to co#pete &ith +ud&eiser etc/!+y 1CC7, largest cra(t bre&er, gre& >=K/!= year round and seasonal beers/!+oston Lager ?0K o( sales/!.uropean standards and ra& #aterials/16+oston +eer Co#pany! #asters, Ldate passed, beer goesM)Contract bre&ing ) "ros and consH)5ntensive #ar'eting F sales ) 7B N o( each E) "roduct innovations , seasonal F private labeling!Outloo')Current gro&th ) stagnant but cra(t beersgre&):iche #ar'eting and develop#entH 17+oston +eer Co#pany!Co#petitors , *-O%)Majors ) A+ +evO Coors, Miller)And %ier ) *trohs, Geile#an, Penessee etc/! %ough (or the# to (ight the +ig 0!Loss o( #ar'et share!.6cess capacity ) Go& did this help ++CH)5#ports ) Per#an, Golland, Canada, Me6ico/ *ubsequent changes due to MFA ie/ Molson4Coors)Cra(t bre&eries ) (ar and a&ay, the s#allest18+oston +eer Co#pany!Cra(t +re&ing ) s#allestO rapid gro&th ,7BK)Very co#petitive, proprietary recipes)Catered to upscale #ar'et there(ore e6pensive)@our types! +re&pubs 11AK2 , product consu#ed on site! Micro 1AAK2 ) li#ited distribution Q 1>,BBB bbls !Regional 10BK2, li#ited distribution, capital intensive, li#ited #ar'eting, brand recognition! Custo# 10?K2 ) %ypically contract, less capital intensive there(ore #ore #ar'eting E19+oston +eer Co#pany! Recent 5"Os$) Redhoo' ) t&o plants, planning a third, allied &ith +ud in :G using distribution net&or'/ 71K gro&th :o& Cra(t +re&ers Alliance/ E?/87 share price 1B4>411) "eteJs ) Contract bre&er, allied &ith *trohs, planned to build bre&ery/ :o& "eteJs -ic'ed +re&ing/ "rivate/ A((iliated &ith Pa#brinus, i#porters Moosehead, Corona) @urther characteristics ) *ee previous slides) Ruestions and 5ssues (ro# the LMar'etM$ ! "ositive reception ) ho& &ell4ho& longH Gula hoopH!Age old question o( sustainable gro&th/! 9ependence on And tier bre&eriesH20+oston +eer 5"O CalculationA1+oston +eer 5"O!:ove#ber A1, 1CC> , ++C issues A/C #illion shares at EAB each/!"rice by end o( day rose >BK to E0B/=>/ !%odayJs "rice E8B/7C/.arlier this year, E1BB/C0/ AAMar'et,+ased Methods$*a#e or Co#parable 5ndustry Method!Multiply targetJs earnings or revenues by #ar'et value to earnings or revenue ratios (or the average (ir# in target?s industry or a compara*le industry/!"ri#ary advantage is the ease o( use and availability o( data/!9isadvantages include presumption industry multiples are actually compara*le and analystsJ projections are unbiased/A0".P Ratio 3 ". Ratio4.arnings Pro&th! 6 EA/B> 3 9:23DD #!3#% undervaluedC"D$ 5#plied share price 3 11A/=0 6 /BC 6 E0/1> 3 9:#38D 4438% undervaluedAns&er$ %he di((erence bet&een the i#plied and actual share prices (or +.* and C"D is E0/18 1i/e/, E07/?? , E01/782 and E>/C? 1E01/C? , EA?/BB2, respectively/C"D is #ore undervalued than +.* at that #o#ent in ti#e/ 1*olving MV% 3 A 6 V5%PR 6 V5% using an individual (ir#Js ".P ratio provides the (ir#Js current or share price in period %, since this (or#ula is an identity/ An industry average ".P ratio #ay be used to provide an esti#ate o( the (ir#Js intrinsic value/ %his i#plicitly assu#es that both (ir#s e6hibit the sa#e relationship bet&een price,to,earnings ratios and earnings gro&th rates/ A>Asset,+ased Methods$%angible +oo' Value!%angible boo' value 1%+V2 3 1total assets , total liabilities , good&ill2!%argetJs esti#ated value 3 %argetJs %+V 6 T1industry average or co#parable (ir# #ar'et value2 4 1industry or co#parable (ir# %+V2U/!O(ten used (or valuing ))inancial services firms &here tangible boo' value is pri#arily cash or liquid assets)(istri*ution firms &here current assets constitute a large percentage o( total assets!Re#e#ber i#pact o( PAA" 3 historical costA?Valuing Co#panies +illion at auction to ,ockstar 6idco/)Consortiu# Apple, .MC, Microso(t, R5M F *ony)Poogle ) de(ensive, stal'ing horse bid to discourage suits over Android F Chro#e/)5ntel ) early bidder but tea#ed &ith Poogle0BAsset,+ased Method$ +rea', deals/ 01McPra& Gill *pin O(( H!August AB11 ) "ublisher F *F" o&ner!"ressure (ro# activist hedge (und Sana "artners and Ontario %eachersJ "ension "lan/ !Meetings bet&een MG 1Pold#an2 F Sana!MG )M#ini conglo#erate o( non related in(or#ation businessesM/ L.ducation ) capital intensive and plodding gro&thMH!La8ard F S"Morgan Chase ) brea'up value E>> per share versus E71 current price/ *ee &ebsite, !c"ra# $ill Faces %rea&up 'ressures, %usiness (ee&, August A, AB11/ 0AReplace#ent Cost Method!All target operating assets are assigned a value based on &hat it &ould cost to replace the#/!.ach asset is treated as i( no additional value is created by operating the assets as part o( a going concern/!.ach assetJs value is su##ed to deter#ine the aggregate value o( the business/!%his approach is li#ited i( the (ir# is highly profita*le 5suggesting a high going concern value7 or if many of the firm?s assets are intangi*le/00-eighted Average Valuation MethodAn analyst has esti#ated the value o( a co#pany using #ultiple valuation #ethodologies/%he discounted cash (lo& value is EAAB #illion, co#parable transactionsJ value is EA07 #illion, the "4.,based value is EAA7 #illion and the liquidation value is E1>B #illion/ %he analyst has greater con(idence in certain #ethodologies than others/.sti#ate the &eighted average value o( the (ir# using all valuation #ethodologies and the &eights or relative i#portance the analyst gives to each #ethodology/.sti#atedValue 1EM2Relative -eight-eightedAvg/ 1EM2AAB /0B ??/BA07 /7B C0/?AA7 /AB 77/81>B /1B 1>/B1/BB A1C/707Real Options as Applied to MFAs! Real options re(er to #anage#entJs ability to adopt and later revise corporate invest#ent decisions 1e/g/, acquisitions2 , Een@yme! Options to e6pand 1i/e/, accelerate invest#ent2) Acquirer accelerates invest#ent in target a(ter acquisition co#pleted due to better than anticipated per(or#ance o( the target ! Options to delay 1i/e/, postpone ti#ing o( initial invest#ent2) Acquirer delays co#pletion o( acquisition until a patent pending receives approval! Options to abandon 1i/e/, divest or liquidate initial invest#ent2) Acquirer divests target (ir# due to underper(or#ance and recovers a portion o( its initial invest#ent0>Alternative Real Option Valuation Methods0?! 9evelop a decision tree (or &hich the :"V o( each LbranchM represents the value o( alternative real options/ %he optionJs value is equal to di((erence bet&een its :"V and the :"V &ithout the real option/Art or scienceL!%reat the real options as (inancial options and value using the 6lack'Scholes method/ ) Option to e6pand or delay are valued as call options and added to the :"V o( the invest#ent &ithout the option/)Option to abandon is valued as a put option and added to the :"V o( the invest#ent &ithout the option/+ase Case$ Microso(t o((ers to buy all outstanding shares o( ;ahoo+ase Case$ Microso(t o((ers to buy all outstanding shares o( ;ahooOption to postpone contingent on ;ahooJs rejection o( o((erOption to postpone contingent on ;ahooJs rejection o( o((erOption to abandon contingent on (ailure to integrate ;ahoo F M*: Option to abandon contingent on (ailure to integrate ;ahoo F M*: Option to e6pand contingent on success(ul integration o( ;ahoo F M*: Option to e6pand contingent on success(ul integration o( ;ahoo F M*: "urchase ;ahoo online search business only/ +uy re#aining businesses later/"urchase ;ahoo online search business only/ +uy re#aining businesses later/O((er sa#e4lo&er price (or all o( ;ahoo i( board co#position changesO((er sa#e4lo&er price (or all o( ;ahoo i( board co#position changes*pin,o(( co#bined ;ahoo F M*: to Microso(t shareholders*pin,o(( co#bined ;ahoo F M*: to Microso(t shareholders9ivest co#bined ;ahoo F M*:/