Creating Value for shareholders- An
Overview
January 6, 2018
A.V. Vedpuriswar
A historical perspective on value creation
In 1900, the stock market was dominated by railroads, which
accounted for 63% of UK market cap and 50% of the UK.
By 2015, railroads represented less than 1% of the US market
and close to nothing of the UK market.
Other industries that have declined in importance are textiles,
iron, coal and steel.
Some industries remain as important today as they were in 1900.
These include banking and insurance, food, beverages, tobacco
and utilities.
In the US, the largest industries today are technology, oil and gas,
banking, healthcare, insurance and retail.
1
The tale of 3 Mobile Sellers
2Ref: Code Halos, by Malcolm Frank, Paul Roehrig, Ben Pring
The Tale of 3 Book Sellers
3Ref: Code Halos, by Malcolm Frank, Paul Roehrig, Ben Pring
4
Strategy and Business
Model
Capital allocation
Financing deciisons
Architecture
Cost mangement
Corporate Riak Mgmt
M&A and Restructuring
Corporate Governance
The Value Octagon
Ref: Prasanna Chandra
Determinants of shareholder value
Sales growth
Operating Profit margin
Income tax rate
Investment in fixed capital
Investment in working capital
Cost of capital
Vale growth duration
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Ref: Alfred Rappaport
The lifecycle of a company
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7
What determines the value of a firm?
The value of a firm can generally be considered a function of
four key inputs:
– Cash flow from assets in place or investments already
made
– Expected growth rate in cash flows during a period of high
growth excess returns
– Time before stable growth sets in and excess returns are
eliminated
– Discount rate which reflects both the risk of the investment
and the financing mix used by the firm
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What can a firm do to increase its value?
Generate more cash flows from existing assets
Grow faster or more efficiently during the high growth phase
Prolong the high growth phase
Lower the cost of capital
Competitive advantage and growth
9Source: Motilal Oswal Wealth creation study
The Competitive Advantage Period
10
Source: Motilal Oswal Wealth creation study, 2017
ACC’s 10 year Competitive Advantage Period
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Source: Motilal Oswal Wealth creation study, 2017
Cipla’s 15 year Competitive Advantage Period
12
Source: Motilal Oswal Wealth creation study, 2017
Porter’s Five Forces Model
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The effect of Rivalry
14
Source: Motilal Oswal Wealth creation study, 2017
The effect of the Threat of new entrants
15
Source: Motilal Oswal Wealth creation study, 2017
The effect of the Bargaining power of customers
16
Source: Motilal Oswal Wealth creation study, 2017
The effect of the Bargaining power of suppliers
17
Source: Motilal Oswal Wealth creation study, 2017
The Structure Strategy Play
18Source: Motilal Oswal Wealth creation study, 2017
Barnes and Noble vs Amazon
19
Source: Motilal Oswal Wealth creation study, 2017
Tata Steel’s acquisition of Corus
20
Source: Motilal Oswal Wealth creation study, 2017
Competitive Advantage Period : The leaders
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Source: Motilal Oswal Wealth creation study, 2017
Growth advantage period
22
Source: Motilal Oswal Wealth creation study, 2017
Infosys’ Growth Advantage Period
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Companies with the longest Growth Advantage Period
24
Source: Motilal Oswal Wealth creation study, 2017
Companies with the largest growth
25Source: Motilal Oswal Wealth creation study, 2017
CAP + GAP
26Source: Motilal Oswal Wealth creation study, 2017
HDFC and HDFC Bank : CAP
27
Source: Motilal Oswal Wealth creation study, 2017
HDFC and HDFC Bank : GAP
28
Source: Motilal Oswal Wealth creation study, 2017
HDFC and HDFC Bank : Creating shareholder value
29
Source: Motilal Oswal Wealth creation study, 2017
The four cornerstones of Finance
30Richard Dobbs, Bill Huyett, Tim Koller, McKinsey
Discounted Cash Flow Valuation
Use DCF technique wherever possible.
Make adjustments for cash flows
Make adjustments for discount rate.
Avoid double counting of risks.
State assumptions clearly.
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Key Principles in Relative valuation
We must look at peers with similar prospects for ROIC and
growth.
Wherever possible, we must use forward looking multiples, i.e.
multiples based on forecasts rather than historical profits.
We should prefer enterprise value multiples rather than P/E.
Enterprise value to EBITA must be suitably adjusted for non-
operating items.
– For example, excess cash should be deducted.
– The value of leased assets must be added to the market value and the
implied interest expenses must be added to EBITA.
– The present value of all employee stock option grants currently outstanding
and pension liabilities must be added to the value.
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The Zen of Finance
Let value the firm = V
V = FCF/ (WACC – g) = (NOPAT – NI )/ (WACC – g)
NOPAT – NI = NOPAT ( 1 – NI/NOPAT)
= NOPAT [ 1 – (NI/IC) / (NOPAT/IC) ]
= NOPAT [ 1 – g /ROIC]
V = NOPAT (1 - g/ROIC)/ (WACC – g)
= [IC x ROIC ( 1 – g/ROIC)] / (WACC –g)
Increasing investment, ROIC, growth and reducing the cost of
capital are the ways of creating value.
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Operating Leverage
Arises from the firm’s fixed operating costs.
Sensitivity of PBIT to changes in sales
DOL =Contribution/ EBIT
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Financial leverage
Arises from the firm’s fixed financing costs such as interest.
Sensitivity of PBT to changes in PBIT
DFL = PBIT/PBT
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Total Leverage
DOL X DFL
(Contribution/ PBIT) x ( PBIT/PBT)
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Strategic cost management
Have a holistic understanding of the value chain.
Use the right methods of costing.
Activity based costing can provide the best outcomes.
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Bata’s Cost cutting strategy
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The relationship between ROI and ROE
ROE = PAT/E
= (PBIT – Int) ( 1 – Tax rate) / E
= (PBIT – i X D)(1 – Tax rate) / E (i = interest rate)
= [(ROI) (A) – i X D] / E X ( 1 – Tax rate)
= [(ROI) (D + E) – i X D] / E X ( 1 – Tax rate)
= [ ROI + (ROI – i) (D/E)] (1- Tax rate)
If ROI > i, leverage boosts ROE
If ROI < i, leverage pulls down ROE
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Sustainable growth rate
Sustainable growth rate = ROE X Retention ratio
= (PAT/Sales) X ( Sales/Total Assets) ( Total Assets/Equity)
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Marakon Model
P = D/(k – g)
= B x r x b/(k – g)
P/B = r x b/(k – g)
But ( 1 – b) (r) = g
or br = r – g
P/B = (r – g) / (k – g)
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P = Market price
B = Book value
b = Dividend payout ratio
g = Growth rate
Why Miller Modigliani does not hold in the real world
Taxes
Cost of distress
Agency costs
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Capital is abundant today
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Profitability vs Growth
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