akua acheampong jody grewal kieng iv rhea rasquinha
TRANSCRIPT
Akua AcheampongJody Grewal
Kieng IvRhea Rasquinha
Background and Current Issues Terminal Value Estimators of Terminal Value Forecast Horizon Quantitative Analysis Recommendations
Arcadian: • Gene diagnostics industry
Investment Opportunity:• Original Offer: 60% equity interest in
Arcadian for $40M
Value of the Investment: • Determined through estimating terminal
value
It is the lump sum of cash flows at the end of a stream of cash flows, which represent:• The proceeds from exiting an investment;• The present value of all cash flows beyond the
forecast horizon
Terminal values are important because:• They are present in the valuation of almost
every asset• They measure the “continuing value” derived
from the going concern of the business.
Importance of Terminal ValueImportance of Terminal Value
Approach Advantages
Disadvantages When to use approach
Book value Simple •Ignores some assets and liabilities •Historical cost: backward looking •Subject to accounting manipulation
Appropriate when the minimum value of a company needs to be determined.
Replacement Value
Current •Subjective estimates •Value may be difficult to come by
Appropriate when a company is deciding whether to buy another company or build a new one from scratch.
Liquidation Value
Conservative
•Ignores going concern value •Uncertainty about value of assets in the market
Appropriate when assets are marketable
Multiples •Simple•Widely used
•“Earnings” subject to accounting manipulation•“Snapshot” estimate: may ignore cyclical, secular changes •Provides relative value, not absolute value
The approach is used as a business valuation benchmark
Constant Growth Method
•Reflects the time value of money
•Errors in growth rate and/or discount rate can provide improper value •Easy to abuse or misuse•Requires estimate on when firm will grow at stable rate
Appropriate when cash flows are strong and relatively consistent
Terminal Value
Forecast Horizon Cash Flows beyond the Forecast Horizon
Going Concern Timeline
Importance: All future cash flows, not only the ones that you can forecast, determine value
PV of future cash flows beyond the forecast horizon
As far into the future as CFs can be forecasted
• KEY: When Stable Growth Begins…• Set the forecast horizon • Stop Forecasting Cash Flows• Estimate a Terminal Value
1
Projected Cash Flows by Investment
($150)
($100)
($50)
$0
$50
$100
$150
$200
$250
$300
$350
3 5 7 9 11 13 15 17 19 21 23 25 27 29Year
$Mill
ion
s
MovieStudioBottlingPlantToll Road
Stable growth of 2% begins in year 27:-Production capacity reached-Estimate TV at yr 27
Stable growth of 2% begins in year 12:-Plant reaches capacity-Estimate TV at yr 12
Stable growth of 2% begins in year 3: -Operational capacity reached-Estimate TV at yr 3
Arcadian Growth Rate vs. Cash Flows
-100
0
100
200
300
400
500
1 2 3 4 5 6 7 8 9 10 11 12
Year
Gro
wth
Rat
e
-100
-50
0
50
100
150
200
Cash Flow
s ($M U
SD
)
Growth Rate
Cash FlowForecast
Very unstable growth
Resembles Bottling Plant
Limitations:• Forecasts for 10 and 11 years, but neither attains stable
growth• Ideally, we should continue forecasting until stable growth
begins Difficult due to the company being in its early stages
When should TV be estimated?
At end of 2013? Cash flow growth is volatile after 2013
At end of the Forecasted Cash Flow period? Cash Flow growth has declined and will further decline until 5% is
reached
It is reasonable to assume that growth will fall to 5% by 2016 given the pattern of decline since 2013
Use the End of the Forecasting Period to Estimate TV
Best Options:1. Price/Earnings Ratio2. Price/Book Value Ratio3. Constant Growth Rate
Assumptions:1. WACC – 20%2. At end of forecast horizon Arcadian is a
mature company
Arcadian SierraP/E 15 20 P/E 15 202014 Net Income 203$ 203$ 2015 Net Income 162$ 162$ Terminal Value 3,045$ 4,060$ Terminal Value 2,430$ 3,240$ PV Terminal Value 492$ 656$ PV Terminal Value 327$ 436$ PV 05-14 CF (151)$ (151)$ PV 05-15 CF (118)$ (118)$ PV 341$ 505$ PV 209$ 318$ 60% Ownership 204$ 303$ 60% Ownership 125$ 191$
Terminal Value ExplanationPE 15 20 PE 15 20Arcadian 144% 130% Sierra 157% 137%
Arcadian SierraPrice to Book Ratio 8.5 Price to Book Ratio 8.5BV of Equity $672 BV of Equity $199Terminal Value $5,708 Terminal Value $1,691PV Terminal Value $922 PV Terminal Value $228PV 05-14 CF ($151) PV 05-15 CF ($118)PV $771 PV $10960% Ownership $462 60% Ownership $66
Terminal Value ExplanationArcadian 120% Sierra 208%
1)1()1( Remin InflationalalNo gxgg
EquationFisher
Options:1.Real growth rate in the economy = 3%2.Real growth rate in the Pharmaceutical Industry = 5%3.USA Population growth = 1%
Nominal Rates1.Nominal growth rate in the economy ~ 5%2.Nominal growth rate in the Pharmaceutical Industry ~ 7%3.USA Population growth = 1%
Best Rate: Nominal growth rate in the economy ~ 5%
Inflation=2%
Arcadian's View
Annual growth rate to infinity 2% 3% 4% 5% 6% 7%
Weighted average cost of capital 20% 20% 20% 20% 20% 20%Adjusted free cash flow 2015 202 194 185 180 174 165 Terminal value 2014 1,142 1,173 1,200 1,257 1,314 1,355 PV of terminal value 2014 185 189 194 203 212 219PV free cash flows 2005-2014 ($151) ($151) ($151) ($151) ($151) ($151)
Total Present Value $33 $38 $43 $52 $61 $6860% Ownership $20 $23 $26 $31 $37 $41Terminal Value Explanation 554% 495% 455% 392% 347% 324%
Sierra Capital's View
Annual growth rate to infinity 2% 3% 4% 5% 6% 7%
Weighted average cost of capital 20% 20% 20% 20% 20% 20%Adjusted free cash flow 2016 185 177 168 163 157 148 Terminal value 2015 1,049 1,073 1,093 1,142 1,189 1,219 PV of terminal value 2015 141 144 147 154 160 164PV free cash flows 2005-2015 ($118) ($118) ($118) ($118) ($118) ($118)Total Present Value $23 $26 $29 $35 $42 $4660% Ownership $14 $16 $17 $21 $25 $27Terminal Value Explanation 619% 555% 513% 436% 384% 359%
Low Range
High Range
Arcadian
Sierra Difference Applicable
Price/Earnings RatioLow End: 15
High End: 20
204
303
125
191
79
112
No
No
Price/Book Ratio 462 66 396 No
Constant Growth Rate
31 21 10 Yes
Arcadian
Sierra Difference
Constant Growth Rate 122 92 30
Option on Future Opportunities
Further financing needed• 40M barely covers 2005 projected cash deficit• Debt financing
High debt financing costs: low current earnings -> low interest coverage, low operating income margin -> high cost of debt
Impact on WAcc
IPO/Early Exit• Distribute shares to clients tax-free• Compare with
Affymetrix (P/E 50.09, P/B 8.56,P/FCF 97.5, P/SALES 7.49) Illumina (PB 8.46, P/SALES 8.82)
Current Average Investment weighting: $31.25M
Counteroffer: $21MAbandonment Point: $31M
Management Bonus If management hits forecast in years
2013-2014, 5% incentive $2M present value 2013 2014
Arcadian's Forecast $134 $231Sierra'sForecast $28 $98
Difference $106 $1325% $5 $7PV $2