Business valuations, plans, dividends and growth Flashcards
What are the 4 methods of divestment?
- management buy-out
- management buy-in
- spin off (de merger)
- Trade sale
What is management buy-out?
- existing management purchase either the trade and assets or the shares of the company
- funded by mixture of debt and equity
- equity from managers
- mixture of debt and equity from VCs
- debt from other financiers
What is management buy-in?
- external management team purchase
- same as buy-out
What is a spin off?
- shares of company ‘given’ to shareholders of parent
- group of companies split into separate entities, no cash changes hands
- used to avoid the conglomerate discount
- sometimes used as a defence against takeover of entire business
What is a trade sale?
Standard sale of a sub to another company
Why would a company choose to adopt a high dividend policy?
- due to the existence of limited investment opportunities
- traditionally marks strong CFs made by business
- signals confidence, raises stock market rating
- ‘bird in the hand theory’ - market values more highly a firm that pays dividends and issues shares to finance new investment rather than retention
- manager discipline - would need to seek out investment from the market for new investment, thus having to justify to potential investors rather than using internal funds
What is the traditional viewpoint on dividends?
- constant stream is important
- cutting dividends may reduce shareholder wealth
- shareholders may prefer the certainty of a cash dividend now rather than the promise of higher dividends in the future
What is MM;s dividend irrelevance hypothesis?
- pattern of dividends does not affect shareholder wealth
- as long as directors focus on investing in projects with a positive NPV, the increased dividend in the future will compensate for the cut now
- if shareholders need money, the can manufacture dividends by selling a few shares
What are the assumptions of the MM hypothesis / real world problems?
- shareholders have perfect information, i.e. the dividend does not change their view on the company
- investors are indifferent between dividends and capital growth and if investors really needed money they would just sell shares. In practice, tax and transaction costs mean this is not the case
- company must have enough distributable profits to pay dividends
What are the risks of changing dividend policy?
- investors favour dividends for tax, cash flow and other reasons. Change could cause disposal of shares and therefore drop in share price
- dividends resolve uncertainty and investors are traditionally not rational and prefer bigger dividends now
- dividends are a signal of the company’s performance in the absence of perfect information
- changes may adversely affect the shareholder (tax) and the company (share price)
What is a scrip dividend?
- shareholders have a choice of taking dividend as shares
- not the same as a bonus issue
- shareholder can increase shareholding without broker fees or stamp duty
- company does not need to find the cash to pay, save tax
Key considerations for dividend policy?
- dividend signalling
- preference for current income
- clientele effect
- cash
How should companies address the issue of differing shareholder preferences on dividend policy?
- company must remain aware of the mix of shareholders they have
- make clear to shareholders what the dividend policy is and the effect of any changes being made
Describe the relationship between dividend policy and the ‘agency problem’?
- managers and directors are not always acting in the best interests of the shareholders (although they should be)
- high dividend pay outs would leave less surplus cash for management to use. This means they would need to raise funds and therefore justify the projects they are looking to invest in
What are the issues with the asset based valuation approach?
- does not include intangibles not on the balance sheet
- future earnings potential is ignored
What are the issues with the dividend based valuation approach?
- estimating future dividends
- finding similar listed companies
- uncertainty in the discount applied for unmarketability if company is private
- simple method ignores dividend growth
What are the issues with the earnings based valuation approach?
- erratic earnings may give misleading figure
- earnings can be manipulated
- PE EBITDA coming from similar listed company
- based on historic EPS
- difficult to estimate profit going forward
What is SVA?
Concentrates on a company’s ability to generate value and thereby increase shareholder wealth. SVA is based on the premise that the value of a business is equal to
the sum of the present values of all of its activities.
How is the value of the business calculated using SVA?
The value of the business is calculated from the cash flows generated by drivers 1-6 which are then discounted at the company’s cost of capital (driver 7). SVA links a business’ value to its strategy (via the value drivers).
What are the 7 value drivers for SVA?
(1) Life of projected cash flows
(2) Sales growth rate
(3) Operating profit margin
(4) Corporate tax rate
(5) Investment in non-current assets
(6) Investment in working capital
(7) Cost of capital
Problems with SVA (residual value)?
Company projections tend to show cash flows growing steadily upwards into an indefinite future. In the real world, economies falter, competition increases and margins decline.
The majority of a DCF value estimate comes from the ‘residual value’, the worth of the company at the end of the projection period. That, naturally, depends heavily on the cash flows estimate in the final year modelled – a result, logically, of the trend in the early years.
Factors to consider with a rights issue
Issue costs – these are high compared for equity with debt.
Shareholder reactions – they may react badly if the firm regularly makes rights issues. They may sell their shares as a result, which will adversely affect the share price.
Control – should not be affected by a rights issue unless a considerable number of existing shareholders sell their rights.
Unlisted companies – shareholders may not be able to sell their rights (if unlisted) and so a rights issue would not be practical.
Traditional view on gearing
- Low levels - risk relatively unchanged
High levels
- increased volatility of equity returns as debt paid first
- bankruptcy risk
- Ke, Kd and therefore WACC rises
M&M no tax theory
- gearing and Ke increase proportionally
- increase in Ke offsets benefit of cheaper debt finance
- WACC remain unchanged
Assumptions of M&M no tax theory
Perfect capital market no transaction costs no individual dominates the market full information efficiency all investors are rational and risk averse no tax
M&M with tax
debt interest is tax deductible so the kd is lower than before
The increase in ke does not offset the benefit of the cheaper debt finance
therefore the WACC falls as gearing increases.
What is convertible loan stock?
Fixed return securities which may at the discretion of the holder be converted into ordinary shares of the same company.
What are loan stocks with warrants?
Loan stocks which give the holder the right to subscribe at a fixed future date for ordinary shares at a predetermined price. Debt is not converted, but remains as such.
Advantage of SVA
Values free cash flows of company, not distorted by accounting policies
Advantage of P/E valuation
- Market measure valuing shares in comparison to other company takeovers
- looks at potential earnings and growth value of company
How do you calculate the valuation of company using the EBITDA method?
(EBITDA x EBITDA multiple) - MV of debt + cash
How do you do the dividend approach?
Dividend / yield
Method for present value of cash flow valuation
- do an NPV using the cash flows provided
- add on any potential sell on value (make sure you discount)
- add together and divide by # of shares
Disadvantages of discounted cash flow
Best method, however:
- estimating cash flows not easy - synergy benefits from two businesses
- acceptable discount rate
- time period of calculation
Different methods of being remunerated for shareholding
Cash
Share-for-share
Loan stock-for-share
Merits and issues of cash remuneration for shareholding
- certain amount
- tax
Merits and issues of S-F-S remuneration for shareholding
- no tax issues
- uncertain amount received
- dealing costs
Merits and issues of LS-F-S remuneration for shareholding
- more assured return than shares
- shareholders may prefer equity
Advantages of asset based valuations
- minimum valuation, very little risk of over valuation
- good starting point as figures are easily available
- revalued version takes into account latest cost
Advantages of dividend yield approach?
Good for a minority shareholding
