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1
Agenda
2
Introduction
3
Introduction
4
Introduction
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Introduction
EQUITY VALUE:
• Value of shareholders’ interest
• After interest expense, preferred dividends and
minority interest expense
• Multiples of net income, book value, EPS
• Other common terms:
• Market Value, Market Capitalization,
Offer Value (in an acquisition context)
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Introduction
ENTERPRISE VALUE:
• Includes all forms of capital
• Market value of equity, debt, preferred stock,
minority interest
• Before interest expense, preferred dividends and
minority interest expense
• Multiples of sales, EBITDA, EBIT or any other
applicable metric (per subscriber, per bed, etc.)
• Other common terms:
• Aggregate Value, Firm Value, Total Capitalization,
Adjusted Market Value, Transaction Value
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Introduction
Preferred Stock
Minority Interest
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Introduction
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Equity Valuation Process
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Valuation Process
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Valuation Process Example
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Economic Cycles
R E C E S S IO N : R E C O V E R Y : E a r ly s ta g e E X P A N S I O N : L a te S ta g e
C o n s u m e r s ta p le s (fo o d , C o n s u m e r C y c lic a ls (a u to s , B a s ic M a te r ia ls (c h e m ic a ls ,
d ru g s , c o s m e tic s , to b a c c o ), a p p a r e l, m e d ia , re ta ile r s ), p la s tic s , p a p e r, w o o d ,
u tilitie s , s o ftw a re , a n d C o n s u m e r C re d it (s a v in g s a n d m e ta ls ), C a p ita l G o o d s
b io te c h n o lo g y f ir m s lo a n s ), a n d T r a n s p o r ta tio n (e q u ip m e n t a n d m a c h in e ry
(a irlin e s , tr u c k in g , r a ilro a d s ) m a n u fa c tu re rs )
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Industry Analysis
Forecast Sales
• An insightful analysis when predicting industry sales is to view the
industry over time and divide its development into stages.
• Pioneering development - A
• Rapid accelerating growth - B
• Mature growth - C
• Stabilization and market maturity - D
• Deceleration of growth and decline - E
Rate of
Sales D
Growth C
E
Time
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Porter’s Five Forces
POTENTIAL
ENTRANTS
INDUSTRY
SUPPLIERS COMPETITORS BUYERS
SUBSTITUTES
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Valuation Approach – Intrinsic Value
Valuation Approaches – Intrinsic Value
V = $8 / 0.09 = $88.89
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Valuation Approaches – Intrinsic Value
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Valuation Approaches – Intrinsic Value
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Valuation Approaches – Intrinsic Value
Assume an investor wants to buy a stock, hold it for one year, and then sell
it. We must evaluate the dividend cash flows as well as the terminal value
in one year. These cash flows are then discounted at the investor’s
required rate of return.
A company earned $2.50 a share last year and paid a $1 dividend (40%
dividend payout). The firm has a consistent record regarding payout and
we expect it to earn $2.75 per share during the coming year. We expect
the stock to trade at $22 at the end of the coming year. Further, the risk-
free rate is 5%, the market return is 10%, and the stock’s beta is 1.2.
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Valuation Approaches – Intrinsic Value
V = D1/(ke - g)
For instance, in our previous example let’s assume that the holding
period is infinite and the firm’s dividends are growing at 6% per
year perpetually. The dividend in one year was $1.10 and the
required rate of return was 11%.
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Valuation Approaches – Intrinsic Value
We can employ the same technique for firm’s that have varying
rates of growth by assuming that the growth rate becomes
constant, at some point.
For instance, suppose we have a firm experiencing rapid growth
due to its position in the product cycle. At some point the growth
rate has to slow or the firm will become the market!
We can accommodate this scenario with a multistage model by
discounting the rapid growth phase dividends individually and then
determining the terminal value using the constant growth
methodology.
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Valuation Approaches – Intrinsic Value
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Valuation Approach – Intrinsic Value
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Discounted Cash Flow Analysis
Using the DCF technique, BAC constructed a valuation for the Company by adding the present
value of the Company's projected after-tax cash flows to the present value of the Company's
terminal value.
-Tax Basis Depreciation & Amortization 14.1 16.2 17.8 19.6 21.9
Operating Income 85.9 77.8 82.1 86.6 91.2
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Free Cash Flow Analysis
… ∞
FCF1 FCF2 FCF3 FCF4 FCF5 FCFn
How do we account for
the remaining cash flows
of the firm?
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Terminal Value Calculation
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The Present Value of the Terminal Value
Discounted Cash Flow Analysis
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Terminal Value as % of Enterprise Value
Discounted Cash Flow Analysis
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Terminal Value as % of Enterprise Value
Discounted Cash Flow Analysis
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Terminal Value Calculation
31
Discounted Cash Flow Analysis
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Perpetuity Growth Formula
Discounted Cash Flow Analysis
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Relative Value Analysis
34
How do we use relative value?
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Comparing PE Ratios across a Sector
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Comparing PE Ratios across a Sector
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Relative Value
P0 = D1/(ke - g)
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Relative Value
The value of the stock today is based on the P/E1 and estimate
of E1.
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Relative Value
The best known measure of relative value for common stock is the
P/E ratio or the earnings multiplier.
Analysts have also turned their attention to other measures of
relative value:
• Price/book value (P/BV) : market value of the company divided
by its book value. This metric is used a great deal with financial
stocks since many of their assets are carried at values very
close to market value. This metric can be used for firms with
negative earnings or cash flows. Several studies have
indicated that P/BV is a good indicator of future performance.
• Price/cash flow (P/CF) : market value of the company divided
by its cash flow.
• Price/sales (P/S) : market value of the company divided by its
sales.
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Expected Growth Rate
When a firm retains earnings and acquires assets, if it earns some positive
rate of return on these additional assets, the total earnings of the firm will
increase.
The rate of earnings growth depends on the proportion of earnings retained
and the rate of return it earns on the new assets acquired.
Specifically, the growth rate (g) of equity earnings without external financing
is equal to the percentage of net earnings retained (retention rate, b) times
the rate of return on equity capital (ROE).
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Pulling it all together
Firm XYZ is trading at $18 currently. Last year’s earnings were $2.00 per
share. The firm’s ROE is 10% and you expect it to stay that way for the
foreseeable future. The firm has a stable dividend payout policy of 40%.
The current nominal risk-free rate is 7%, the expected market return is
12% and XYZ’s beta is 1.2. Value XYZ and indicate what you should do
based on your estimate.
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Valuation Analysis
2. Overview of
Conrail Inc.
Conrail Inc.
Company Description
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CSX and Norfolk Southern
Analysis of Potential Acquirers
45
Financial Overview of Conrail
The Conrail Case Study
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3. Comparable Public
Company Analysis
“Analysis of Selected Publicly Traded Companies”
“Public Comparables”
“Trading Comparables”
“Comp Co’s”
“Common Stock Comparisons”
Comparable Public Company Analysis
Determining the Appropriate Universe
48
Comparable Public Company Analysis
Public Information Checklist
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Valuation Analysis
What comparables
should be used to
value Conrail?
Summary of the Railroad Industry
Canadian National C$4,100 C$4,100 100% Canadian National was owned by the
(CNI) government until late 1995 when it was
privatized. As a result of this transaction,
as well as previous governmental
ownership, its financial statements are
rather messy—eg., there are significant
NOLS, and the capital structure is strange.
Although no longer owned by the Canadian
government, CNI, as all Canadian
railroads, operates under government
regulation. CNI has some lines that
overlap with Conrail in the northeastern
US.
Canadian Pacific (CP) C$7,946 C$3,757 47% CP Ships (12%) Obviously another Canadian railroad. Note
Energy (34%) the rail and non-rail revenue percentages
Real estate (12%) exclude inter-company eliminations.
Conrail (CRR) $3,686 $3,686 100% Do you include the company you are trying
to value in the list of comparable
companies?
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Summary of the Railroad Industry
Florida East Coast $201 $149 74% Real estate (14%) FLA’s rail operations run the length of
(FLA) Mtr carrier (12%) Florida, along the Atlantic coast. FLA has
a unique ownership structure. It is owned
54% by St. Joe Paper Company, which is
in turn 69% owned by the DuPont family.
The DuPonts’ chief interest in FLA is its
extensive land holdings.
Illinois Central (IC) $644 $644 100% IC is a “single track” line that runs up and
down the Mississippi River. Unlike the
other large US railways, IC principally
hauls agriculture commodities, rather than
freight.
Kansas City Southern $775 $502 65% Asset mgt (31%) The rail operations run through MO, AR,
(KSU) Other (4%) TX, LA, MS, AL. The Asset Management
segment is comprised of two prominent
investment operations: the Janus and
Berger funds.
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Summary of the Railroad Industry
Union Pacific (UNP) $11,100 $9,874 90% Trucking (9%) The country’s largest railroad operating
Logistics (1%) throughout the western US. Recently
acquired Southern Pacific.
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Valuation Analysis
Required Analytical
Adjustments
One-Time Non-Recurring Items
Subjectivity of the Analysis
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Conrail’s 1995 Income Statement
CONRAIL INC.
CONSOLIDATED STATEMENTS OF INCOME
[CAPTION]
Years ended December 31,
----------------------------
($ In Millions Except Per Share Data) 1995 1994 1993
------ ------ ------
[S] [C] [C] [C]
Revenues $3,686 $3,733 $3,453
------ ------ ------
Operating expenses
Way and structures 485 499 492
Equipment 766 815 703
Transportation 1,324 1,379 1,283
General and administrative 370 350 384
Asset disposition charge (Note 2) 285
Early retirement program (Note 9) 84
------ ------ ------
Total operating expenses 3,230 3,127 2,862
------ ------ ------
Income from operations 456 606 591
Interest expense (194) (192) (185)
Loss on disposition of subsidiary
(Note 10) (80)
Other income, net (Note 11) 130 118 114
------ ------ ------
Income before income taxes
and the cumulative effect of
changes in accounting principles 392 532 440
Income taxes (Note 6) 128 208 206
------ ------ ------
Income before the cumulative
effect of changes in accounting
principles 264 324 234
Cumulative effect of changes in
accounting principles (Notes 1, 6 and 7) (74)
------ ------ ------
Net income $ 264 $ 324 $ 160
====== ====== ======
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Note 2: Asset Disposition Charge
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4. Comparable
Acquisition Analysis
“Analysis of Selected Acquisitions”
“Acquisition Comparables”
“Acq Comps”
“Deal Comps”
Comparable Acquisition Analysis
Determining the Appropriate Universe
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Comparable Acquisition Analysis
Information Checklist
Financial information
• SEC filed documents if possible
SDC M&A summary
• Summary description of the transaction, key dates,
premiums paid
News run
Merger documents (if applicable)
• Form 8-K, Proxy/S-4 for pro forma financial info
Research & EPS estimates (if applicable)
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Comparable Acquisition Analysis
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Comparable Acquisition Analysis
Comparable Acquisition Analysis - Multiples Summary
(Dollars in Millions)
Enterprise Value as a
Effective Transaction Multiple of:
Date Target Acquiror Enterprise Value Sales EBITDA
Comparable
Industry Jun-96 CCP Holdings, Inc. Illinois Central Corp. $157 2.06x 5.3x
Transactions
Comments: CCP was a small railroad owned by three individuals.
May-95 Chicago & North West. Union Pacific Corp. $2,611 2.25x 8.3x
Comments: Union Pacific had owned 32% of CNW, and completed the purchase of the remaining 68%. The statistics in
the chart reflect the transaction as if the entire 100% were purchased.
Cancelled Kansas City Southern Illinois Central Corp. $1,625 3.25x 9.0x
Comments: The transaction from mid-1994 was cancelled since the parties could not agree on how to value the asset
management businesses.
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Comparable Acquisition Analysis
Comparable Acquisition Analysis - Multiples Summary
(Dollars in Millions)
Enterprise Value as a
Effective Transaction Multiple of:
Date Target Acquiror Enterprise Value Sales EBITDA
Comparable
Industry Sep-92 Midsouth Corp. Kansas City Southern $347 3.39x 8.8x
Transactions
Comments: The target operates rail lines in La, Miss, Ala.
Apr-90 Soo Line Corp. Canadian Pacific Ltd. $528 0.98x 7.4x
Comments: The target operates principally in the upper Midwest---Minn and Wisc.
Jul-89 Illinois Central Rail. The Prospect Group $672 1.22x 5.8x
Comments: Another very successful LBO, this time by another prominent financial buyer, the Prospect group.
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5. Discounted Cash Flow
Analysis
Discounted Cash Flow Analysis
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Discounted Cash Flow Analysis
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Discounted Cash Flow Analysis
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Discounted Cash Flow Analysis
-Tax Basis Depr eciat ion & Am or tization 276.2 294.9 307.6
Oper atin g In com e 690.6 740.9 763.2 5.1%
Op eratin g In come Margin 18.5% 20.1% 20.1%
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Discounted Cash Flow Analysis - BASE CASE
The discounted cash flow ("DCF") analysis is based on Conrail's historical performance and Wall Street research expectations.
* Sales are projected to reach $4,401 million by FY 2001 through organic growth.
Sales figures for 1997-2001 assumed 3% growth per year.
* Rail Operating Ratio falls from 79.9% in 1996E to 77.9% in 1997 and by an additional 1% per year for 1998-2001, hitting
73.9% in 2001. This operating improvement is based on Conrail's stated goal of achieving an operating ratio of 75%.
* All working capital needs are projected to support the annual growth.
* Capital expenditures are estimated to be 11.5% of revenues in 1997 and 11% for 1998-2001, in line with historical levels.
Depreciation is a reasonable estimate from the capital expenditures and existing PP&E base.
* The following table compares Conrail's historical operating results to the projections:
Historical Projected
1994 1995 1996E 1997 1998 1999 2000 2001
Revenue Growth 8.1% (1.3%) 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
Rail Operating Ratio (1) 81.5% 79.9% 79.9% 77.9% 76.9% 75.9% 74.9% 73.9%
EBITDA Margin 25.9% 28.1% 28.2% 30.2% 31.3% 32.3% 33.3% 34.3%
Operating Inc. Margin 18.5% 20.1% 20.1% 22.1% 23.1% 24.1% 25.1% 26.1%
(1) Rail Operating Ratio = Rail Operating Expenses (including depreciation) divided by Rail Revenues
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Discounted Cash Flow Analysis
Additional assumptions:
• Taxes are assumed to be 38.5% of operating income.
• Working capital will be:
• -$34.0 million 1997
• -$22.1 million 1998
• -$23.1 million 1999
• -$24.3 million 2000
• -$25.6 million 2001
• Cost of capital is 11% for Conrail based on the stability of the firm’s
cash flows.
• We will use an exit multiple of 8x EBITDA in 2001 to value the sale
of Conrail. This multiple compares to an average 8.3x EV/LTM
EBITDA multiple using Comparable Acquisition Analysis.
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Terminal Value
A. The Exit Multiple
Method
The Present Value of the Terminal Value
Discounted Cash Flow Analysis
Note: Does not match the $7,177.2 on the previous page due to rounding.
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Terminal Value as % of Enterprise Value
Discounted Cash Flow Analysis
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Terminal Value as % of Enterprise Value
Discounted Cash Flow Analysis
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B. The Perpetuity
Growth Method
Discounted Cash Flow Analysis
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Synergies Valuation
Discounted Cash Flow Analysis
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Synergies Valuation
Discounted Cash Flow Analysis
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Perpetuity Growth Formula
Discounted Cash Flow Analysis
where:
FCFN+1 = steady-state free cash flow in period N+1
g = nominal perpetual growth rate
r = discount rate
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Discounted Cash Flow Analysis - SYNERGIES
The Synergies valuation analysis was created to calculate the present value of the expected
net sales and operating savings benefits from a possible Norfolk Southern or CSX acquisition
of Conrail.
*Incremental revenue synergies from single line service, new coal traffic and
highway-to-railway transfers, less of losses from enhanced competition
*Operating cost savings from reduction in general and administrative, transportation, and
equipment expenses.
*Additional capital expenditures are assumed for roadway, equipment and terminals,
plus cash severance costs. Net investments avoided are assumed in years 2000 and 2001.
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Discounted Cash Flow Analysis - SYNERGIES
Using the DCF technique, Bank of America constructed a valuation for the estimated syneriges of a possible Norfolk
Southern or CSX merger with Conrail.
-Merger Outlays & Costs / Investments Avoided (551.7) (439.7) (262.1) 34.5 34.5
Net Operating Cash Flow (476.4) (189.4) 161.0 470.3 483.3
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Terminal Value of the Synergies
Discounted Cash Flow Analysis
Note: Does not match the $2,702 on the previous page due to rounding.
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What is the Total DCF
for Conrail?
What is the Total DCF Valuation?
Discounted Cash Flow Analysis
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