hewlett packard (hpq) equity valuation
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7/30/2019 Hewlett Packard (HPQ) Equity Valuation
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Mada Arslan
HP Valuation
A. DCF modelFCFF
Characteristics of HP:
Winding Down company: decliningrevenues and earnings, acquisitions thusgrowing inorganically, divestures
Multinational company: operating in USA,Americas, EMEA, and Asia Pacific.
BUY RECOMMENDATION
Target Price $ 22.75
Market Price $ 20.35
Upside Potential 11.81%
Listed on NYSE
Bloomberg Ticker HPQ:US
Enterprise Value (million) $ 34,358
MV Debt (million) $ 20,453Market Capitalization $ 47,065
Outstanding shares (million) 1,974
Bloomberg Industry Computers
Bloomberg Sector Technology
(20,000)
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20,000
40,000
60,000
80,000
100,000
120,000
140,000
2005 2006 2007 2008 2009 2010 2011 2012
HPQ
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7/30/2019 Hewlett Packard (HPQ) Equity Valuation
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Mada Arslan
Tax rates:
Effective Tax rate = 23.5% (from Q2_2013 report)Marginal Tax rate = 35% (from 10K_2012 report)
Incorporating the fact that HP is a multinational, we can take the highest marginal tax rate acrossthe countries & according to Damodaran: While some would push for an average tax rate,weighted by the income in each country, I think it makes far more sense to use the marginal taxrate of the country the company is domiciled in as a floor.
Damodaran Tax rate
Africa average 29.02%
North America average 33.00%
Asia average 22.89%
Europe average 20.50%
Latin America average 28.30%
Oceania average 28.60%
Middle east average 12.00%
Caribbean average 20.00%Source: emergcompfirm.xlshttp://pages.stern.nyu.edu/~adamodar/
Beta:Regression Beta = 0.97 (v/s Yahoo beta 1.52 & Reuters 1.15)Since its a distressed company, using a bottom-up beta is no longer relevant and we deemed thestart of the crisis in 2001.We regressed HPs result since 2001 against a global index since its a multinational: S&P
Global Tech(http://finance.yahoo.com/q/hp?s=IXN&a=00&b=1&c=2001&d=04&e=22&f=2013&g=w).No debt beta was added since HP is not a junk bond. Minimum bond rating is BBB.
http://pages.stern.nyu.edu/~adamodar/http://pages.stern.nyu.edu/~adamodar/http://pages.stern.nyu.edu/~adamodar/http://finance.yahoo.com/q/hp?s=IXN&a=00&b=1&c=2001&d=04&e=22&f=2013&g=whttp://finance.yahoo.com/q/hp?s=IXN&a=00&b=1&c=2001&d=04&e=22&f=2013&g=whttp://finance.yahoo.com/q/hp?s=IXN&a=00&b=1&c=2001&d=04&e=22&f=2013&g=whttp://finance.yahoo.com/q/hp?s=IXN&a=00&b=1&c=2001&d=04&e=22&f=2013&g=whttp://pages.stern.nyu.edu/~adamodar/ -
7/30/2019 Hewlett Packard (HPQ) Equity Valuation
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Mada Arslan
Cost of Equity:
Risk-free: 10 Year Treasury Yield 2.02%
Equity Risk Premium 6.06%
Beta equity: regression 0.97
Country Risk Premium 4.57%
Cost of Equity (Re) 12.44%
The Equity Risk Premium is derived from Damodarans 5.8% that is based on a risk-free rate of
1.76%.
Country Risk Premium is based on regional weighted averages according to GDP as perDamodaran, multiplied by the percentage of revenues earned by HP in the regions:
RevenuesQ2_2013
Weightedregional CRP
WeightedCRP
USA 35% - 0.00%
Canada & Latin America 10% 10.19% 1.02%EMEA: Europe, Middle East, Africa 36% 0.08 3.02%
Asia Pacific, and Japan 19% 2.82% 0.53%
Total Weighted CRP 4.57%
Cost of Debt:Since its not a junk bond, we can take YTM of the latest issued long-term bond:
$1,200 issued at discount to par at a price of 99.863% in September 2011 at6.0%, due September 2041 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,198
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7/30/2019 Hewlett Packard (HPQ) Equity Valuation
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Mada Arslan
Operating Lease:We will capitalize OL.
2013 2012
Year
Lease (Rent)
Expense in
million
PV of
OLYear
Lease
(Rent)
Expense
in
million
PV of
OL
PV of
OL
1780 736
11,012 955
2665 592
2780 694
3517 434
3665 558
4351 278
4517 409
5218 163
5351 262
thereafter 805 476 6 218 154
Total3,336 2,678
thereafter805 449
Total4,348 3,481 (803)
Refer to excel sheet for details of the calculations.
Research & Development:We will capitalize R&D assuming a 10 year life cycle.
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7/30/2019 Hewlett Packard (HPQ) Equity Valuation
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Mada Arslan
Mergers & Acquisitions:M&A should be smoothed for the last 3-5 years by taking an average & the value of the M&A is
calculated as cash paid or price per share x number of shares offered. The M&As were paid forin cash (includes cash paid for outstanding common stock, convertible bonds, vested-in-the-money stock awards and the estimated fair value of earned unvested stock awards assumed-annual report 2012).
2012$ mill
2011$ mill
2010$ mill
2009$ mill
2008$ mill
Acquisition 141 10,480 8,102 391 11,248
Average 6,072
Return On Capital:ROC = EBIT (1-Tc) / BVCapital
We adjusted EBIT for OL and R&D.We adjusted Book Value of Capital for Cash, Goodwill, PV of OL, unamortized portion ofR&D, and minority interest.
ROC = 5.03% < WACCDestroying Value
FCFF:FCFF = (EBIT + pretax cost of debt*PV of OL) (1-Tc) + R&D expense (current) - Depreciation expense of R&D -
(CAPEX - Depreciation + R&D expense - Depreciation expense of R&D + M&A) - NWC - in PV of OL
Adjusted EBIT 4,371CAPEX, net 279
Depreciation (TTM) 1,548
Current R&D (TTM) 3,372
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7/30/2019 Hewlett Packard (HPQ) Equity Valuation
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Mada Arslan
Terminal Value: Expected Liquidation ValueSince its a distress company we used a liquidation value.
There are 2 ways to estimate ELV:1. Expected Liquidation value = Book Value of AssetsTerm yr(1+ inflation rate)Average life of assets2. Earning Power of the Assets
The limitation of the first approach is that it is based on accounting BV.We estimated the earning power of the assets based on TA2012*TAT2012.
Cash (a):Cash interest income in 2012 was $155 million which is less than 2% but the Daily Treasury
Yield Curve Rates for 1year is 0.12% so we should not discount cash for low returns.
Adjusted Enterprise Value (b):HP falls under Reversible Decline with No or Low Distress since its minimum bonds rating isBBB according to Standard & Poors. Refer to Optimal Enterprise Value Model below fordetails on the calculated value.
Market Value of Debt (c):
Its the market value of interest bearing debt.
Pensions/leases (d):Pension leases are computed as Employee compensation and benefits 4,058 + Pension, post-retirement, and post-employment liabilities 7,780 in other liabilities.
Employee Options (e):We valued the options using the modified Black & Scholes approach. These options are issued inthe US therefore are considered tax deductible. We used time T = 2.5 years since averagematurity of these options is 3 years, but since we are valuing in April 2013 we consider it T=2.5and since those are American options thus they can be exercised anytime T/2=1.25.Rf f 0 2% d t t h th t it f th ti
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7/30/2019 Hewlett Packard (HPQ) Equity Valuation
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Mada Arslan
dividends/y/cs $ 0.50
dividend yields 2.46%C 0.79
Value Options (after tax) 44.63
d1= [ln (S/K) + (rfy + /2) t] / td2= d1 - tC= Se^(-y*t) N(d1)Ke^(-rf*t) N(d2)
Minority Interest (f):No information on number of shares bought in those subsidiaries therefore we used BV.
#Shares (g):We used the basic weighted-average #shares as per the 10K report that was used to compute netearnings per share. There are no different classes of common shares although some employeewere granted restricted shares as stock-based compensations, Restricted stock has the same cashdividend and voting rights as other common stock and is considered to be currently issued and
outstanding.
Price per share- after iteration (h):We have used 3 iterations to get the price per share to converge to S, diluted.Refer to excel sheet for calculations details.
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7/30/2019 Hewlett Packard (HPQ) Equity Valuation
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Mada Arslan
The model:
Y0 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10 ELV
g 5.11% 4.49% 3.87% 3.26% 2.64% 2.02% 2.02% 2.02% 2.02% 2.02% 2.02%
EBIT 4,371 4,568 4,745 4,899 5,028 5,130 5,234 5,339 5,447 5,557 5,670
t 24% 24% 24% 24% 24% 24% 35% 35% 35% 35% 35%
EBIT (1-t) 3,344 3,494 3,630 3,748 3,847 3,925 3,402 3,471 3,541 3,612 3,685
RR % 101.71 89.41 77.11 64.80 52.50 40.20 40.20 40.20 40.20 40.20 40.20
WACC 9.93% 9.93% 9.93% 9.93% 9.93% 9.93% 9.93% 9.93% 9.93% 9.93% 9.93%
FCFF 370 831 1,319 1,827 2,347 2,034 2,076 2,118 2,160 2,204 115,569
PV of FCFF 337 688 993 1,251 1,462 1,153 1,070 993 921 855 44,837
PV of Operation 54,559
Non-operating assets:
Cash 11,301 a
Loss Carry Forward 9,142Enterprise Value 75,002
Enterprise Value adjusted 76,232 b
Non-equity Claims:
MV of Debt 20,453 c
Pensions/leases 11,838 d
Employee options 45 e
Minority interests 397 f
Equity Value 43,500
#shares 1,974 g
#options 87
Price per share 22.04 BUYPrice per share- after iteration 22.75 BUY h
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7/30/2019 Hewlett Packard (HPQ) Equity Valuation
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Mada Arslan
Optimal Enterprise Value Model:Expected Value = Status Quo Value (probability of no management change) + Optimum Value
(probability of management change)
Status Quo Enterprise Value 75,002
probability of no management change 0.8
Optimum Enterprise Value 81,155
probability of management change 0.2
Enterprise Value adjusted (b) 76,232
We considered the following changes when we computed the optimal value of HP: Operating margins will increase to the industry average of 7.61% (Reteurs) v/s the
current 5.25%
Divesture of assets that have negative EBIT: Corporate Investments segment Capital expenditures: zero. Live off past overinvestment NWC: based on industry current ratio of 1.56 (Reuters) v/s HPs 1.11. We expect this
difference to double as HP improves its current assets by decreasing inventory on handand speeding-up receivables collections
Treat HP in valuing its DCF in the optimal phase as a mature company Probability of management change
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7/30/2019 Hewlett Packard (HPQ) Equity Valuation
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Mada Arslan
Optimal Enterprise Value Model
Y0 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10Y11-Going
Concern
g 4.06% 3.85% 3.65% 3.44% 3.24% 3.04% 2.83% 2.63% 2.43% 2.22% 2.20% 2.02%EBIT 6,272 6,514 6,751 6,984 7,210 7,429 7,640 7,841 8,031 8,210 8,391 8,560
t % 23.50 23.50 23.50 23.50 23.50 23.50 23.50 23.50 23.50 23.50 23.50 35.00
EBIT (1-t) 4,798 4,983 5,165 5,343 5,516 5,683 5,844 5,998 6,144 6,280 6,419 5,564
RR % 56.24 53.42 50.60 47.78 44.95 42.13 39.31 36.48 33.66 30.84 30.55 28.01%
r (WACC, ROC) 7.71% 7.71% 7.71% 7.71% 7.71% 7.71% 7.71% 7.71% 7.71% 7.71% 7.71% 7.21%
FCFF 2,321 2,551 2,790 3,036 3,289 3,547 3,810 4,076 4,344 4,458 4,005
PV of FCFF 2,155 2,199 2,233 2,256 2,269 2,272 2,266 2,250 2,227 2,122 38,463
PV of Operation 60,712
Non-operating assets:
Cash 11,301
Loss Carry Forward 9,142Enterprise Value 81,155
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