Briefing

Methods of Corporate Valuation

Prof. Ian H. Giddy, New York University

What is my company worth? What are the ratios used by analysts to determine
whether a stock is undervalued or overvalued? How valid is the discounted present
value approach? How can one value a company as a going concern, and how does this
change in the context of a potential acquisition, or when the company faces financial
stress?

Finding a value for a company is no easy task -- but doing so is an essential component of
effective management. The reason: it's easy to destroy value with ill-judged acquisitions,
investments or financing methods. This article will take readers through the process of valuing a
company, starting with simple financial statements and the use of ratios, and going on to
discounted free cash flow and option-based methods.

How a business is valued depends on the purpose, so the most interesting part of implementing
these methods will be to see how they work in different contexts -- such as valuing a private
company, valuing an acquisition target, and valuing a company in distress. We'll learn how using
the tools of valuation analysis can inform management choices.

Outline

 Asset-Based Methods
 Using Comparables
 Free Cash Flow Methods
 Option-Based Valuation
 Special Applications

Asset-Based Methods
Asset-based methods start with the "book value" of a company's equity. This is simply the value
of all the company's assets, less its debt. Whether it's tangible things like cash, current assets,
working capital and shareholder's equity, or intangible qualities like management or brand name,
equity is everything that a company has if it were to suddenly stop selling products and stop
making money tomorrow, and pay off all its creditors.

The Balance Sheet: Cash & Working Capital

Like to buy a dollar of assets for a dollar in market value? Ben Graham did. He developed one of
the premier screens for ferreting out companies with more cash on hand than their current market
value. First, Graham would look at a company's cash and equivalents and short-term
investments. Dividing this number by the number of shares outstanding gives a quick measure
that tells you how much of the current share price consists of just the cash that the company has
on hand. Buying a company with a lot of cash can yield a lot of benefits -- cash can fund product
development and strategic acquisitions and can pay high-caliber executives. Even a company
that might seem to have limited future prospects can offer tremendous promise if it has enough
cash on hand.

Another measure of value is a company's current working capital relative to its market
capitalization. Working capital is what is left after you subtract a company's current liabilities
from its current assets . Working capital represents the funds that a company has ready access to
for use in conducting its everyday business. If you buy a company for close to its working
capital, you have essentially bought a dollar of assets for a dollar of stock price -- not a bad deal,
either. Just as cash funds all sorts of good things, so does working capital.

Shareholder's Equity & Book Value

Shareholder's equity is an accounting convention that includes a company's liquid assets like
cash, hard assets like real estate, as well as retained earnings. This is an overall measure of how
much liquidation value a company has if all of its assets were sold off -- whether those assets are
office buildings, desks, old T-shirts in inventory or replacement vacuum tubes for ENIAC
systems.

Shareholder equity helps you value a company when you use it to figure out book value. Book
value is literally the value of a company that can be found on the accounting ledger. To calculate
book value per share, take a company's shareholder's equity and divide it by the current number
of shares outstanding. If you then take the stock's current price and divide by the current book
value, you have the price-to-book ratio .

Book value is a relatively straightforward concept. The closer to book value you can buy
something at, the better it is. Book value is actually somewhat skeptically viewed in this day and
age, since most companies have latitude in valuing their inventory, as well as inflation or
deflation of real estate depending on what tax consequences the company is trying to avoid.
However, with financial companies like banks, consumer loan concerns, brokerages and credit
card companies, the book value is extremely relevant. For instance, in the banking industry,
takeovers are often priced based on book value, with banks or savings & loans being taken over
at multiples of between 1.7 to 2.0 times book value.

Another use of shareholder's equity is to determine return on equity , or ROE. Return on equity
is a measure of how much in earnings a company generates in four quarters compared to its
shareholder's equity. It is measured as a percentage. For instance, if XYZ Corp. made a million
dollars in the past year and has a shareholder's equity of ten million, then the ROE is 10%. Some
use ROE as a screen to find companies that can generate large profits with little in the way of
capital investment. Coca Cola, for instance, does not require constant spending to upgrade
equipment -- the syrup-making process does not regularly move ahead by technological leaps
and bounds. In fact, high ROE companies are so attractive to some investors that they will take
the ROE and average it with the expected earnings growth in order to figure out a fair multiple.
This is why a pharmaceutical company like Merck can grow at 10% or so every year but
consistently trade at 20 times earnings or more.

Intangibles
Brand is the most intangible element to a company, but quite possibly the one most important to
a company's ability as an ongoing concern. If every single McDonald's restaurant were to
suddenly disappear tomorrow, the company could simply go out and get a few loans and be built
back up into a world power within a few months. What is it about McDonald's that would allow
it to do this? It is McDonald's presence in our collective minds -- the fact that nine out of ten
people forced to name a fast food restaurant would name McDonald's without hesitating. The
company has a well-known brand and this adds tremendous economic value despite the fact that
it cannot be quantified.

Some investors are preoccupied by brands, particularly brands emerging in industries that have
traditionally been without them. The genius of Ebay and Intel is that they have built their
company names into brands that give them an incredible edge over their competition. A brand is
also transferable to other products -- the reason Microsoft can contemplate becoming a power in
online banking, for instance, is because it already has incredible brand equity in applications and
operating systems. It is as simple as Reese's Peanut Butter cups transferring their brand onto
Reese's Pieces, creating a new product that requires minimum advertising to build up.

The real trick with brands, though, is that it takes at least competent management to unlock the
value. If a brand is forced to suffer through incompetence, such as American Express in the early
1990s or Coca-Cola in the early 1980s, then many can become skeptical about the value of the
brand, leading them to doubt whether or not the brand value remains intact. The major buying
opportunities for brands ironically comes when people stop believing in them for a few
moments, forgetting that brands normally survive even the most difficult of short-term traumas.

Intangibles can also sometimes mean that a company's shares can trade at a premium to its
growth rate. Thus a company with fat profit margins, a dominant market share, consistent
estimate-beating performance or a debt-free balance sheet can trade at a slightly higher multiple
than its growth rate would otherwise suggest. Although intangibles are difficult to quantify, it
does not mean that they do not have a tremendous power over a company's share price. The only
problem with a company that has a lot of intangible assets is that one danger sign can make the
premium completely disappear

IBM Balance Sheet

Assets $Mil Liabilities and Equity $Mil

Cash 5,216.6 Current Liabilities 30,239.0
Other Current Assets 32,099.4 Long-Term Liabilities 31,625.0
Long-Term Assets 46,640.0 Shareholders' Equity 22,092.0
Total 83,956.0 Total 83,956.0

The Piecemeal Company

Finally, a company can sometimes be worth more divided up rather than all in one piece. This
can happen because there is a hidden asset that most people are not aware of, like land purchased
in the 1980s that has been kept on the books at cost despite dramatic appreciation of the land
around it, or simply because a diversified company does not produce any synergies. Sears, Dean
Witter Discover and Allstate are all worth a heck of a lot more broken apart as separate
companies than they ever were when they were all together. Keeping an eye out for a company
that can be broken into parts worth more than the whole makes sense, especially in this day and
age when so many conglomerates are crumbling into their component parts.

Using Comparables

The most common way to value a company is to use its earnings. Earnings, also called net
income or net profit, is the money that is left over after a company pays all of its bills. To allow
for apples-to-apples comparisons, most people who look at earnings measure them according
to earnings per share (EPS).

You arrive at the earnings per share by simply dividing the dollar amount of the earnings a
company reports by the number of shares it currently has outstanding. Thus, if XYZ Corp. has
one million shares outstanding and has earned one million dollars in the past 12 months, it has a
trailing EPS of $1.00. (The reason it is called a trailing EPS is because it looks at the last four
quarters reported -- the quarters that trail behind the most recent quarter reported.

$1,000,000
-------------- = $1.00 in earnings per share (EPS)
1,000,000 shares

The earnings per share alone means absolutely nothing, though. To look at a company's earnings
relative to its price, most investors employ the price/earnings (P/E) ratio. The P/E ratio takes
the stock price and divides it by the last four quarters' worth of earnings. For instance, if, in our
example above, XYZ Corp. was currently trading at $15 a share, it would have a P/E of 15.

$15 share price

---------------------------= 15 P/E
$1.00 in trailing EPS

Is the P/E the Holy Grail?

There is a large population of individual investors who stop their entire analysis of a company
after they figure out the trailing P/E ratio. With no regard to any other form of valuation, this
group of unFoolish investors blindly plunge ahead armed with this one ratio, purposefully
ignoring the vagaries of equity analysis. Popularized by Ben Graham (who used a number of
other techniques as well as low P/E to isolate value), the P/E has been oversimplified by those
who only look at this number. Such investors look for "low P/E" stocks. These are companies
that have a very low price relative to their trailing earnings.

Also called a "multiple", the P/E is most often used in comparison with the current rate of growth
in earnings per share. The Foolish assumption is that for a growth company, in a fairly valued
situation the price/earnings ratio is about equal to the rate of EPS growth.

In our example of XYZ Corp., for instance, we find out that XYZ Corp. grew its earnings per
share at a 13% over the past year, suggesting that at a P/E of 15 the company is pretty fairly
valued. Fools believe that P/E only makes sense for growth companies relative to the earnings
growth. If a company has lost money in the past year or has suffered a decrease in earnings per
share over the past twelve months, the P/E becomes less useful than other valuation methods we
will talk about later in this series. In the end, P/E has to be viewed in the context of growth and
cannot be simply isolated without taking on some significant potential for error.

Are Low P/E Stocks Really a Bargain?

With the advent of computerized screening of stock databases, low P/E stocks that have been
mispriced have become more and more rare. When Ben Graham formulated many of his
principles for investing, one had to search manually through pages of stock tables in order to
ferret out companies that had extremely low P/Es. Today, all you have to do is punch a few
buttons on an online database and you have a list as long as your arm.

This screening has added efficiency to the market. When you see a low P/E stock these days,
more often than not it deserves to have a low P/E because of its questionable future prospects. As
intelligent investors value companies based on future prospects and not past performance, stocks
with low P/Es often have dark clouds looming in the months ahead. This is not to say that you
cannot still find some great low P/E stocks that for some reason the market has simple
overlooked -- you still can and it happens all the time. Rather, you need to confirm the value in
these companies by applying some other valuation techniques.

The Price-to-Sales Ratio

Every time a company sells a customer something, it is generating revenues. Revenues are the
sales generated by a company for peddling goods or services. Whether or not a company has
made money in the last year, there are always revenues. Even companies that may be temporarily
losing money, have earnings depressed due to short-term circumstances (like product
development or higher taxes), or are relatively new in a high-growth industry are often valued off
of their revenues and not their earnings. Revenue-based valuations are achieved using the
price/sales ratio, often simply abbreviated PSR.

The price/sales ratio takes the current market capitalization of a company and divides it by the
last 12 months trailing revenues. The market capitalization is the current market value of a
company, arrived at by multiplying the current share price times the shares outstanding. This is
the current price at which the market is valuing the company. For instance, if our example
company XYZ Corp. has ten million shares outstanding, priced at $10 a share, then the market
capitalization is $100 million.

Some investors are even more conservative and add the current long-term debt of the company to
the total current market value of its stock to get the market capitalization. The logic here is that if
you were to acquire the company, you would acquire its debt as well, effectively paying that
much more. This avoids comparing PSRs between two companies where one has taken out
enormous debt that it has used to boast sales and one that has lower sales but has not added any
nasty debt either.

Market Capitalization = (Shares Outstanding * Current Share Price) + Current Long-term

Debt
The next step in calculating the PSR is to add up the revenues from the last four quarters and
divide this number into the market capitalization. Say XYZ Corp. had $200 million in sales over
the last four quarters and currently has no long-term debt. The PSR would be:

(10,000,000 shares * $10/share) + $0 debt

PSR = ----------------------------------------- = 0.5
$200 million revenues

The PSR is a measurement that companies often consider when making an acquisition. If you
have ever heard of a deal being done based on a certain "multiple of sales," you have seen the
PSR in use. As this is a perfectly legitimate way for a company to value an acquisition, many
simply expropriate it for the stock market and use it to value a company as an ongoing concern.

Uses of the PSR

The PSR is often used when a company has not made money in the last year. Unless the
corporation is going out of business, the PSR can tell you whether or not the concern's sales are
being valued at a discount to its peers. If XYZ Corp. lost money in the past year, but has a PSR
of 0.50 when many companies in the same industry have PSRs of 2.0 or higher, you can assume
that, if it can turn itself around and start making money again, it will have a substantial upside as
it increases that PSR to be more in line with its peers. There are some years during recessions,
for example, when none of the auto companies make money. Does this mean they are all
worthless and there is no way to compare them? Nope, not at all. You just need to use the PSR
instead of the P/E to measure how much you are paying for a dollar of sales instead of a dollar of
earnings.

Another common use of the PSR is to compare companies in the same line of business with each
other, using the PSR in conjunction with the P/E in order to confirm value. If a company has a
low P/E but a high PSR, it can warn an investor that there are potentially some one-time gains in
the last four quarters that are pumping up earnings per share. Finally, new companies in hot
industries are often priced based on multiples of revenues and not multiples of earnings.

What Level of the Multiple is Right?

Multiples may be helpful for comparing two compnies, but which multiples is right? Many look
at estimated earnings and estimate what "fair" multiple someone might pay for the stock. For
example, if XYZ Corp. has historically traded at about 10 times earnings and is currently down
to 7 times earnings because it missed estimates one quarter, it would be reasonable to buy the
stock with the expectation that it will return to its historic 10 times multiple if the missed quarter
was only a short-term anomaly.

When you project fair multiples for a company based on forward earnings estimates, you start to
make a heck of a lot of assumptions about what is going to happen in the future. Although one
can do enough research to make the risk of being wrong as marginal as possible, it will always
still exist. Should one of your assumptions turn out to be incorrect, the stock will probably not go
where you expect it to go. That said, most of the other investors and companies out there are
using this same approach, making their own assumptions as well, so, in the worst-case scenario,
at least you won't be alone.

A modification to the multiple approach is to determine the relationship between the company's
P/E and the average P/E of the S&P 500. If XYZ Corp. has historically traded at 150% of the
S&P 500 and the S&P is currently at 10, many investors believe that XYZ Corp. should
eventually hit a fair P/E of 15, assuming that nothing changes. The trouble is, things do change.

Key Valuation Ratios for IBM (April 2003)

Price Ratios Company Industry S&P 500

Current P/E Ratio 38.2 116.7 34.9
P/E Ratio 5-Year High 61.4 184.5 64.2
P/E Ratio 5-Year Low 14.5 9.6 25.7
Price/Sales Ratio 1.67 1.28 1.29
Price/Book Value 5.95 2.83 2.67
Price/Cash

Free Cash Flows Methods

Despite the fact that most individual investors are completely ignorant of cash flow, it is
probably the most common measurement for valuing public and private companies used by
investment bankers. Cash flow is literally the cash that flows through a company during the
course of a quarter or the year after taking out all fixed expenses. Cash flow is normally defined
as earnings before interest, taxes, depreciation and amortization (EBITDA).

Why look at earnings before interest, taxes, depreciation and amortization? Interest income and
expense, as well as taxes, are all tossed aside because cash flow is designed to focus on the
operating business and not secondary costs or profits. Taxes especially depend on the vagaries of
the laws in a given year and actually can cause dramatic fluctuations in earnings power. For
instance, Cyberoptics enjoyed a 15% tax rate in 1996, but in 1997 that rate more than doubled.
This situation overstates CyberOptics' current earnings and understates its forward earnings,
masking the company's real operating situation. Thus, a canny analyst would use the growth rate
ofearnings before interest and taxes (EBIT) instead of net income in order to evaluate the
company's growth. EBIT is also adjusted for any one-time charges or benefits.

As for depreciation and amortization, these are called non-cash charges, as the company is not
actually spending any money on them. Rather, depreciation is an accounting convention for tax
purposes that allows companies to get a break on capital expenditures as plant and equipment
ages and becomes less useful. Amortization normally comes in when a company acquires
another company at a premium to its shareholder's equity -- a number that it account for on its
balance sheet as goodwill and is forced to amortize over a set period of time, according to
generally accepted accounting principles (GAAP). When looking at a company's operating cash
flow, it makes sense to toss aside accounting conventions that might mask cash strength.

In a private or public market acquisition, the price-to-cash flow multiple is normally in the 6.0 to
7.0 range. When this multiple reaches the 8.0 to 9.0 range, the acquisition is normally considered
to be expensive. Some counsel selling companies when their cash flow multiple extends beyond
10.0. In a leveraged buyout (LBO), the buyer normally tries not to pay more than 5.0 times cash
flow because so much of the acquisition is funded by debt. A LBO also looks to pay back all the
cash used for the buyout within six years, have an EBITDA of 2.0 or more times the interest
payments, and have total debt of only 4.5 to 5.0 times the EBITDA.

IBM's Income Statement

Annual Income Statement (Values in Millions) 12/2002 12/2001
Sales 81,186.0 85,866.0
Cost of Sales 46,523.0 49,264.0
Gross Operating Profit 34,663.0 36,602.0
Selling, General & Admin. Expense 23,488.0 22,487.0
Other Taxes 0.0 0.0
EBITDA 11,175.0 14,115.0
Depreciation & Amortization 4,379.0 4,820.0
EBIT 6,796.0 9,295.0
Other Income, Net 873.0 1,896.0
Total Income Avail for Interest Exp. 7,669.0 11,191.0
Interest Expense 145.0 238.0
Pre-tax Income 7,524.0 10,953.0
Income Taxes 2,190.0 3,230.0

Total Net Income 3,579.0 7,723.0

Free Cash Flow goes one step further. A company cannot drain all its cash flow -- to survive
and grow is must invest in capital and hold enough inventory and receivables to support its
customers. So after adding back in the non-cash items, we subtract out new capital expenditures
and additions to working capital. A bare-bones view of IBM's free cash flows is given below.

IBM: Free Cash Flows

Fiscal year-end: December TTM = Trailing 12 Months
1999 2000 2001 TTM
Operating Cash Flow 10,111 9,274 14,265 14,615
- Capital Spending 5,959 5,616 5,660 5,083
 = Free Cash Flow 4,152 3,658 8,605 9,532

How to Use Cash Flow

Cash flow is the only method that makes sense in many situations. For example, it is commonly
used to value industries that involve tremendous up-front capital expenditures and companies
that have large amortization burdens. Cable TV companies like Time-Warner Cable and
TeleCommunications have reported negative earnings for years due to the huge capital expense
of building their cable networks, even though their cash flow has actually grown. This is because
huge depreciation and amortization charges have masked their ability to generate cash.
Sophisticated buyers of these properties use cash flow as one way of pricing an acquisition, thus
it makes sense for investors to use it as well. It is also commonly used method in venture capital
financings because it focuses on what the venture investor is actually buying, a piece of the
future operations of the company. Its focus on future cash flows also coincides nicely with a
critical concern of all venture investors, the company's ability to sustain its future operations
through internally generated cash flow.

The premise of the discounted free cash flow method is that company value can be estimated by
forecasting future performance of the business and measuring the surplus cash flow generated by
the company. The surplus cash flows and cash flow shortfalls are discounted back to a present
value and added together to arrive at a valuation. The discount factor used is adjusted for the
financial risk of investing in the company. The mechanics of the method focus investors on the
internal operations of the company and its future.

The discounted cash flow method can be applied in six distinct steps. Since the method is based
on forecasts, a good understanding of the business, its market and its past operations is a must.
The steps in the discounted cash flow method are as follows:

 Develop debt free projections of the company's future operations. This is clearly the
critical element in the valuation. The more closely the projections reflect a good
understanding of the business and its realistic prospects, the more confident investors will
be with the valuation its supports.

 Quantify positive and negative cash flow in each year of the projections. The cash flow
being measured is the surplus cash generated by the business each year. In years when the
company does not generate surplus cash, the cash shortfall is measured. So that
borrowings will not distort the valuation, cash flow is calculated as if the company had no
debt. In other words, interest charges are backed out of the projections before cash flows
are measured.

 Estimate a terminal value for the last year of the projections. Since it is impractical to
project company operations out beyond three to five years in most cases, some
assumptions must be made to estimate how much value will be contributed to the
company by the cash flows generated after the last year in the projections. Without
making such assumptions, the value generated by the discounted cash flow method would
 approximate the value of the company as if it ceased operations at the end of the
projection period. One common and conservative assumption is the perpetuity
assumption. This assumption assumes that the cash flow of the last projected year will
continue forever and then discounts that cash flow back to the last year of the projections.

 Determine the discount factor to be applied to the cash flows. One of the key elements
affecting the valuation generated by this method is the discount factor chosen. The larger
the factor is, the lower the valuation it will generate. This discount factor should reflect
the business and investment risk involved. The less likely the company is to meet its
projections, the higher the factor should be. Discount factors used most often are a
compromise between the cost of borrowing and the cost of equity investment. If the cost
of borrowed money is 10% and equity investors want 30% for their funds, the discount
factor would be somewhere in between -- in fact, the weighted-average cost of capital.

 Apply the discount factor to the cash flow surplus and shortfall of each year and to the
terminal value. The amount generated by each of these calculations will estimate the
present value contribution of each year's future cash flow. Adding these values together
estimates the company's present value assuming it is debt free.

 Subtract present long term and short term borrowings from the present value of future
cash flows to estimate the company's present value.

The following table illustrates the computations made in the discounted cash flow method. The
chart assumes a discount factor of 13% (IBM's estimated weighted-average cost of capital) and
uses the growing perpetuity assumption to generate a residual value for the cash flows after the
fifth year.

Valuation for IBM

2-stage growth model

Stage 1 10% growth

Stage 2 5.7% growth

End of year 2002 2003 2004 2005 2006 2007 2008

Revenue 81.2 89.32 98.252 108.0772 118.8849 130.7734 138.2275
-Expenses -67.99 -74.789 -82.2679 -90.4947 -99.5442 -109.499 -115.74
-Depreciation -4.95 -5.445 -5.9895 -6.58845 -7.2473 -7.97202 -6.9413
EBIT 8.26 9.086 9.9946 10.99406 12.09347 13.30281 15.5462
EBIT(1-t) 5.9 6.49 7.139 7.8529 8.63819 9.502009 11.10443
+Depreciation 4.95 5.445 5.9895 6.58845 7.247295 7.972025 6.941298
-CapEx -4.31 -4.741 -5.2151 -5.73661 -6.31027 -6.9413 -6.9413
-Change in WC -0.9 -0.99 -1.089 -1.1979 -1.31769 -1.44946 -1.53208
FCFF 5.64 6.204 6.8244 7.50684 8.257524 9.083276 9.572354
235.2537
Total 6.204 6.8244 7.50684 8.257524 244.3369
PV 5.651872 5.663768 5.67569 5.687636 153.3175
Total PV 175.9964
less debt -61.864billion
Equity value 114.1324billion divided by 1.69gives 67.53397per share

Option-Based Methods

Executives continue to grapple with issues of risk and uncertainty in evaluating investments and
acquisitions. Despite the use of net present value (NPV) and other valuation techniques,
executives are often forced to rely on instinct when finalizing risky investment decisions. Given
the shortcomings of NPV, real options analysis has been suggested as an alternative approach,
one that considers the risks associated with an investment while recognizing the ability of
corporations to defer an investment until a later period or to make a partial investment instead. In
short, investment decisions are often made in a way that leaves some options open. The simple
NPV rule does not give the correct conclusion if uncertainty can be “managed.” In acquisitions
and other business decisions, flexibility is essential -- more so the more volatile the environment
-- and the value of flexibility can be taken into account explicitly, by using the real-options
approach.

Financial options are extensively used for risk management in banks and firms. Real or
embedded options are analogs of these financial options and can be used for evaluating
investment decisions made under significant uncertainty. Real options can be identified in the
form of opportunity to invest in a currently available innovative project with an additional
consideration of the strategic value associated with the possibility of future and follow-up
investments due to emergence of another related innovation in future, or the possibility of
abandoning the project.

The option is worth something because the future value of the asset is uncertain. Uncertainty
increases the value of the option, because if the uncertainty is interpreted as the variance, there
are possibilities to higher profits. The loss on the option is equal to the cost of acquiring it. If the
project turns out to be non-profitable, you always have the choice of non-exercising. More and
more, the real options approach is finding its place in corporate valuation.

Assignment: Special Applications

What adjustments to the valuation approaches discussed above would have to me made in the
following special situations?

 Valuation in an M&A context

 Valuation of a company in distress
 Valuation of a company facing corporate financial restructuring.
Premiums Paid AnalysisTax-Efficient Sale Strategies

Sum-of-the-parts ("SOTP") or "break-up" analysis provides a range of values for a company's equity by
summing the value of its individual business segments to arrive at the total enterprise value (EV). Equity
value is then calculated by deducting net debt and other non-operating adjustments.

For a company with different business segments, each segment is valued using ranges of trading and
transaction multiples appropriate for that particular segment. Relevant multiples used for valuation,
depending on the individual segment's growth and profitability, may include revenue, EBITDA, EBIT, and
net income. A DCF analysis for certain segments may also be a useful tool when forecasted segment
results are available or estimable.

Applications

SOTP analysis is used to value a company with business segments in different industries that have
different valuation characteristics. Below are two situations in which a SOTP analysis would be useful:

 Defending a company that is trading at a discount to the sum of its parts from a hostile takeover

 Restructuring a company to unlock the value of a business segment that is not getting credit for
its value through a spin-off, split-off, tracking stock, or equity (IPO) carve-out

This analysis is a useful methodology to gain a quick overview of a company by providing a detailed
breakdown of each business segment's contribution to earnings, cash flow, and value. many companies
can be viewed as a candidate for break-up valuation. The table below provides a number of examples:

Exhibit 5.19 – Candidates for SOTP Analysis

Company Operating Divisions

Cablevision Cable TV, retail electronics, theaters, sports team, cable network

Disney Theme parks, broadcast network, film studio, retail stores

United Technologies HVAC systems, elevators, aerospace, fire and security, energy

Fortune Brands Home/hardware, golf equipment, office products, spirits and wines

Tyco Telecom, electronics, fire and security, healthcare

Sara Lee Food, beverages, household products, intimates and underwear

Methodology

(1) Gather segment-level data from any of the following sources:

 Investor presentations

 Corporate web sites

 Research reports

 Latest annual report, 10-K, or 10-Q

 Moody's company profiles, S&P tearsheets

(2) Spread LTM and, to the extent possible, projected financial data for each business segment

 Typical financial metrics used include EBITDA, EBIT, and net income

 The SOTP financial information should equal the consolidated financial information for the
entire company

 As necessary, an "other" category may be used, but care should be taken to determine the
nature of this category in order to assess multiples, value, etc.

 Allocate corporate overhead to divisions based on percent of revenues, EBIT, or industry norms
for each segment. It is also acceptable to value overhead as a standalone item

 If depreciation and amortization are not provided by segment, allocate to divisions using
methodologies that may include percent of assets, revenues, EBIT, or industry norms for each
segment

 Use your judgment to the extent necessary

(3) Determine an appropriate range of multiples for each business segment by applying metrics and
multiples which are most relevant for each business segment

 Use either trading or transaction comps, as appropriate, for each industry to determine the
appropriate range

 Use a range of multiples, not point estimates

 To the extent overhead was not allocated, apply blended multiples to determine the "negative
value" of overhead. Since this may create misleading values for the individual segments,
allocating overhead is preferable, assuming there is sufficient data

 DCF valuations may be useful for certain business segments

(4) Sum the values of each business segment, offset by corporate overhead, if appropriate. The result is
an aggregate EV range for the consolidated company.

(5) Deduct net debt and add/subtract other non-operating/financial items from the EV range to
determine a range of equity values.

(6) Divide by the sum of diluted shares outstanding to arrive at a range of equity values per diluted
share. Be sure to include any in-the-money options and convertible securities.

(7) Other considerations:

 Minority interest could be attributable to a single segment or may have components from all
segments. If attributable to a single segment, be sure to make note of it in the valuation analysis

 Similarly, certain liabilities may be attributable to one or more segments, or may be entirely
separate

Interpreting the Analysis

Compare the range of results to current trading levels and ask: "At the current share price, is the
company being undervalued or overvalued compared to the SOTP equity value per share?" Also,
compare results to any of the following metrics and look for consistency with the calculated range:

 52-week high and low

 Comparable companies analysis

 Wall Street research

It is also important to "sanity check" the results. To do so, ask yourself what the key value drivers are
and whether or not one segment is driving/distorting the overall company value.

Exhibit 5.20 – SOTP Analysis

The following spreadsheet demonstrates how to set up the sum-of-the-parts analysis for a publicly
traded company. Note that the analysis will typically calculate the premium/discount to the current
share price to suggest whether or not the public company is worth more or less when separated into its
individual businesses.

Enterpri
Valuati Multip se
on le Value
Statist
Segment Method ic Low High Low High

2008
EBITD $3,400
Segment A A $400.0 7.5x 8.5x $3,000.0 .0
Segment B 2008 200.0 9.0x 11.5 1,800.0 2,300.
 EBITD x 0
A
2008
Revenu 1,100. 1.00 1,100.
Segment C e 0 0.50x x 550.0 0

$6,800
Total Firm Value $5,350.0 .0
(1,250.0 (1,250.
Less: Net Debt ) 0)
Plus: Options Proceeds from
In-the-Money Options 150.0 150.0
$5,700
Total Equity Value $4,250.0 .0
Fully Diluted Shares 115.00
Outstanding 115.000 0

SOTP Equity Value $36.96 $49.57

Current Share Price $37.05 $37.05
Premium/(Discount) to
Market (0.3%) 33.8%

Sponsored Spin-Off
Monetizing Spin-OffMorris Trust

 The sponsored spin-off has drawn increasing attention from the private equity community as a tax-
efficient technique to acquire a substantial interest in a division or subsidiary of a public company
 For Sellers, the structure can deliver tax-free cash proceeds in excess of those available in a traditional
spin-off or reverse Morris Trust transaction, while providing a "smart money" valuation benchmark for
the newly public subsidiary
 Sponsors can utilize the structure to acquire a large stake in a business at an attractive valuation and
with full transaction leverage (constrained only by the limitiations of having a significant public investor
base)
 The end result of the structure is for the Sponsor to own up to 49.9% of the divested company with the
remaining greater than 50% of the shares owned by the public shareholders of Seller
 There are three principal variations on the structure insofar as it would be relevant to a non-core asset
spin: (i) Sponsor invests pre-spin; (ii) Sponsor invests post-spin; and (iii) Sponsor invests as part of the
spin, through debt/equity and/or equity/equity swaps
 All three variations allow for the Seller to receive tax-free proceeds (through de-leveraging) up to the full
leverage capacity of the spun entity and avoid any corporate tax on the sponsor equity proceeds
 The sponsor equity proceeds will be either utilized to repay debt, pay dividends to shareholders, or
repurchase Seller shares, depending on the particular facts and the structure chosen
 All three structures should receive an IRS ruling confirming tax-free treatment
 Transaction could also be structured as a Sponsored Split-Off, where the 51% to be received by Seller
shareholders is distributed via an exchange ofefr where shareholders tender their ParentCo stock for
SplitCo stock
 In a "going private" version of the structure, the split-off could be done on a targeted basis to a discrete
subset of ParentCo shareholders who seek to enter into a private JV with the financial sponsor
 Precedent transactions: Marshall & Ilsley/Metavante, Alberto-Culver/Sally Beauty

Exhibit A – Benefits to Parties

Structural Benefits to Parent and Shareholders Benefits to Target

 Captures 100% of enterprise value at a premium  Creates strategically and financially

valuation independent public entity
 No tax leakage o Optimal access to capital
 Substantial up-front proceeds - enhanced beyond o Direct access to capital markets
typical upstream dividend o New acquisition currency
 Retains significant upside in Target for Parent o "Dry powder" provided by Sponsor
shareholders  Benefits of Sponsor as investor
 Removes risk associated with one-step spin-offs o Sets premium valuation as a floor
o Provides value benchmark without need for an IPO o Investors will react positively to Sponsor
o Mitigates significant downside from shareholder churn participation
post-spin o Stable, long-term shareholder under lockup
o Active and experienced board presence

Exhibit B – Other Considerations

Size of  Can be up to 49.9%
Sponsor
Interest

Form of  Can be structured as common, potentially convertible preferred, or combination

Sponsor  Convert offers Sponsor downside protection and potential coupon, but raises
Interest incremental tax complexity

Governance  Sponsor will enter into governance arrangements with SplitCo

 As a large stockholder, Sponsor can have significant governance rights and
influence, though tax requirements will provide some limitations
 Potential rights could include initial Board seats (up to 49.9% of inital Board
should be permissible)

Management  Agreement as to inital management

 Subsequent management changes subject to approval of Board
Standstill  Sellers will want to require Sponsor to sign initial standstill
o Protect tax treatment
o Need to discuss ability of Sponsor to acquire additional shares without offer for
entire company (relates to value paid)
 Sponsor may request poison pill or excess share provision to protect it during
stanstill period

Ability to Increase  Ability for Sponsor to increase ownership will be related to standstill negotiation
Ownership  Sponsor cannot have a plan or intention to increase ownership to 50% or above
 Any increase could result in trigger of corporate level taxes under Section 355(e)
 Safe harbors would permit purchases by Sponsor to 50% or above after 1-2 years
so long as there was no plan or intention

Exhibit C – Possible Transaction Structures

Key Facts Seller Proceeds Sponsor Investment Execution Complexity

 Sponsor invests in  Debt and equity  Convertible preferred 

Sponsor Simple to execute,
Invests SpinCo representing up funded proceeds can representing up to 49% although breaks some
Post- to 49% value, <= 20% be utilized to de- value, <= 20% vote new ground from IRS
Spin vote lever Seller, pay o SpinCo tax deconsolidated perspective
 Leverage placed in dividend, or o Potential to recap into "full
SpinCo through repurchase shares vote" security post-spin,
debt/debt swap or cash subject to IRS ruling
"boot" in
reorganization

 Sponsor invests in 
Sponsor Debt-funded  Common or convertible  Simple to execute and
Invests SpinCo immediately proceeds can be preferred consistent with prior
Post- post-spin, up to 49% used to de-lever IRS rulings
Spin vote and value Seller or pay
 Leverage placed on dividend to
SpinCo through shareholders
debt/debt swap or  Equity-funded
post-spin leveraged proceeds distributed
dividend to shareholders

 Sponsor invests
Sponsor  Debt-funded  Common or convertible  Meaningful execution
Invests through exchanging proceeds used to de- preferred complexity within
as Seller debt and/or lever Seller likely IRS
Part of equity securities forup Equity-funded requirements,
Spin to 49% SpinCo vote andproceeds used to although doable
value buy-back Seller debt
  Leverage placed on and/or equity
SpinCo through
debt/debt swap

Transaction Structure - Sponsor Invests Pre-Spin

Step 1 Transaction Steps

 Seller contributes Sub to NewCo in exchange for 100%

NewCo common stock and cash funded by leverage and
sponsor equity
 Sponsor invests in NewCo convertible preferred
representing less that or equal to 20% NewCo vote and
greater than or equal to 20% NewCo value
o Can convert into >20% of NewCo vote, subject to IRS
ruling
o Accomplishes tax deconsolidation

Step 2 Transaction Steps

 Seller distributes shares of NewCo to its shareholders

 Seller uses (i) cash up to NewCo basis to retire debt or
pay dividend/repurchase shares and (ii) cash in excess of
basis to pay dividend/repurchase shares

Transaction Structure - Sponsor Invests Post-Spin

Step 1 Transaction Steps
  Seller contributes Sub to NewCo and spins NewCo to its
shareholders

Step 2 Transaction Steps

 Immediately post-spin, Sponsor invests for up to 49.9% of

NewCo equity concurrent with NewCo being levered up to
capacity
 Proceeds of debt and equity immediately distributed to
Seller shareholders

Transaction Structure - Sponsor Invests Concurrent with Spin

Step 1 Transaction Steps

 Seller annouces plans to spin off Sub

Step 2 Transaction Steps

  Sub borrows money and distributes the proceeds tax-free
to the Seller (up to the amount of the Seller's tax basis in
the stock of Sub)

Step 3 Transaction Steps

 Seller contributes Sub to NewCo in exchange for (i) 100%

of NewCo equity, and (ii) a NewCo Note with at least a 7-
year maturity

Step 4 Transaction Steps

 Sponsor buys Seller debt and/or equity for cash

o Sponsor "debt-equity swap" limited to 20% SpinCo vote;
top up through equity-equity swap
 Investment bank buys debt of Seller equal to the value of
the NewCo Note

Step 5 Transaction Steps

  Seller spins off NewCo
o 49.9% NewCo equity to sponsor in retirement of the Seller
debt and/or equity
o 50.1% to the public as a dividend
o NewCo Note to investment bank to retire the Seller debt

Step 6 Transaction Steps

 Investment bank sells NewCo Note to bond investors

Monetizing Spin-Off
Morris Trust

A properly executed multiples analysis can make financial forecasts more accurate.

Senior executives know that not all valuation methods are created equal. In
our experience, managers dedicated to maximizing shareholder value gravitate
toward discounted-cash-flow (DCF) analyses as the most accurate and flexible
method for valuing projects, divisions, and companies. Any analysis, however, is
only as accurate as the forecasts it relies on. Errors in estimating the key
ingredients of corporate value—ingredients such as a company’s return on
invested capital (ROIC), its growth rate, and its weighted average cost of capital—
can lead to mistakes in valuation and, ultimately, to strategic errors.
We believe that a careful analysis comparing a company’s multiples with those of
other companies can be useful in making such forecasts, and the DCF valuations
they inform, more accurate. Properly executed, such an analysis can help a
company to stress-test its cash flow forecasts, to understand mismatches between
its performance and that of its competitors, and to hold useful discussions about
whether it is strategically positioned to create more value than other industry
players are. As a company’s executives seek to understand why its multiples are
higher or lower than those of the competition, a multiples analysis can also
generate insights into the key factors creating value in an industry.

Yet multiples are often misunderstood and, even more often, misapplied. Many
financial analysts, for example, calculate an industry-average price-to-earnings
ratio and multiply it by a company’s earnings to establish a “fair” valuation. The
use of the industry average, however, overlooks the fact that companies, even in
the same industry, can have drastically different expected growth rates, returns
on invested capital, and capital structures. Even when companies with identical
prospects are compared, the P/E ratio itself is subject to problems, since net
income commingles operating and nonoperating items. By contrast, a
company can design an accurate multiples analysis that provides valuable
insights about itself and its competitors.

When multiples mislead

Every week, research analysts at Credit Suisse First Boston (CSFB) report the
stock market performance of US retailers by creating a valuation table of
comparable companies (exhibit). To build the weekly valuation summary, CSFB
tracks each company’s weekend closing price and market capitalization. The table
also reports the projections by CSFB’s staff for each company’s future earnings
per share (EPS). To compare valuations across companies, the share price of each
of them is divided by its projected EPS to obtain a forward-looking P/E ratio. To
derive The Home Depot’s forward-looking P/E of 13.3, for instance, you would
divide the company’s weekend closing price of $33 by its projected 2005 EPS of
$2.48.
Exhibit

Valuation table of comparable companies

But which companies are truly comparable? For the period covered in the exhibit,
Home Depot and its primary competitor, Lowe’s, traded at nearly identical
multiples. Their P/E ratios differed by only 8 percent, and their enterprise-value-
to-EBITDA (earnings before interest, taxes, depreciation, and amortization)
ratios1by only 3 percent. But this similarity doesn’t extend to a larger set of hard-
lines retailers, whose enterprise multiples vary from 4.4 to 9.9. Why such a wide
range? Investors have different expectations about each company’s ability to
create value going forward, so not every hard-lines retailer is truly comparable. To
choose the right companies, you have to match those with similar expectations for
growth and ROIC.

A second problem with multiples is that different ones can suggest conflicting
conclusions. Best Buy, for instance, trades at a premium to Circuit City Stores
when measured using their respective enterprise-value multiples (6.3 versus 4.4)
but at a discount according to their P/E ratios (13.8 versus 22.3). Which is right—
the premium or the discount? It turns out that Circuit City’s P/E multiple isn’t
meaningful. In July 2004, the total equity value of this company was
approximately $2.7 billion, but it held nearly $1 billion in cash. Since cash
generates very little income, its P/E ratio is high; a 2 percent after-tax return on
cash translates into a P/E of 50. So the extremely high P/E of cash artificially
increases the company’s aggregate P/E. When you remove cash from the equity
value ($2.7 billion – $1 billion) and divide by earnings less after-tax interest
income ($122 – $8), the P/E drops from 22.3 to 14.9.

Finally, different multiples are meaningful in different contexts. Many corporate

managers believe that growth alone drives multiples. In reality, growth rates and
multiples don’t move in lockstep.2Growth increases the P/E multiple only when
combined with healthy returns on invested capital, and both can vary
dramatically across companies. Executives and investors must pay attention to
growth and to returns on capital or a company might achieve its growth
objectives but forfeit the benefits of a higher P/E.

The well-tempered multiple

Four basic principles can help companies apply multiples properly: the use of
peers with similar ROIC and growth projections, of forward-looking multiples,
and of enterprise-value multiples, as well as the adjustment of enterprise-value
multiples for nonoperating items.

1. Use peers with similar prospects for ROIC and growth

Finding the right companies for the comparable set is challenging; indeed, the
ability to choose appropriate comparables distinguishes sophisticated veterans
from newcomers. Most financial analysts start by examining a company’s
industry—but industries are often loosely defined. The company might list its
competitors in its annual report. An alternative is to use the Standard Industrial
Classification codes published by the US government. A slightly better (but
proprietary) system is the Global Industry Classification Standard (GICS) recently
developed by Morgan Stanley Capital International and Standard & Poor’s.

With an initial list of comparables in hand, the real digging begins. You must
examine each company on the list and answer some critical questions: why are
the multiples different across the peer group? Do certain companies in it have
superior products, better access to customers, recurring revenues, or economies
of scale? If these strategic advantages translate into superior ROICs and growth
rates, the companies that have an edge within an industry will trade at higher
multiples. You must become an expert on the operating and financial specifics of
each of the companies: what products they sell, how they generate revenue and
profits, and how they grow. Not until you have that expertise will a company’s
multiple appear in the appropriate context with other companies. In the end, you
will have a more appropriate peer group, which may be as small as one. In order
to evaluate Home Depot, for instance, only Lowe’s remains in our final analysis,
because both are pure-play companies earning the vast majority of their revenues
and profits from just a single business.

2. Use forward-looking multiples

Both the principles of valuation and the empirical evidence lead us to recommend
that multiples be based on forecast rather than historical profits.3If no reliable
forecasts are available and you must rely on historical data, make sure to use the
latest data possible—for the most recent four quarters, not the most recent fiscal
year—and eliminate one-time events.

Empirical evidence shows that forward-looking multiples are more accurate

predictors of value. Jing Liu, Doron Nissim, and Jacob Thomas, for example,
compared the characteristics and performance of historical and forward industry
multiples for a subset of companies trading on the NYSE, the American Stock
Exchange, and Nasdaq.4When they compared individual companies against their
industry mean, the dispersion of historical earnings-to-price (E/P) ratios was
nearly twice that of one-year forward E/P ratios. The three also found that
forward-looking multiples promoted greater accuracy in pricing. They examined
the median pricing error for each multiple to measure that accuracy.5The error
was 23 percent for historical multiples and to 18 percent for one-year forecasted
earnings. Two-year forecasts cut the median pricing error to 16 percent.

Similarly, when Moonchul Kim and Jay Ritter compared the pricing power of
historical and forecast earnings for 142 initial public offerings, they found that the
latter had better results.6When the analysis moved from multiples based on
historical earnings to multiples based on one- and two-year forecasts, the average
prediction error fell from 55.0 percent, to 43.7 percent, to 28.5 percent,
respectively, and the percentage of companies valued within 15 percent of their
actual trading multiple increased from 15.4 percent, to 18.9 percent, to 36.4
percent, respectively.

3. Use enterprise-value multiples

Although widely used, P/E multiples have two major flaws. First, they are
systematically affected by capital structure. For companies whose unlevered P/E
(the ratio they would have if entirely financed by equity) is greater than one over
the cost of debt, P/E ratios rise with leverage. Thus, a company with a relatively
high all-equity P/E can artificially increase its P/E ratio by swapping debt for
equity. Second, the P/E ratio is based on earnings, which include many
nonoperating items, such as restructuring charges and write-offs. Since these are
often one-time events, multiples based on P/Es can be misleading. In 2002, for
instance, what was then called AOL Time Warner wrote off nearly $100 billion in
goodwill and other intangibles. Even though the EBITA (earnings before interest,
taxes, and amortization) of the company equaled $6.4 billion, it recorded a $98
billion loss. Since earnings were negative, its P/E ratio wasn’t meaningful.

One alternative to the P/E ratio is the ratio of enterprise value to EBITA. In
general, this ratio is less susceptible to manipulation by changes in capital
structure. Since enterprise value includes both debt and equity, and EBITA is the
profit available to investors, a change in capital structure will have no systematic
effect. Only when such a change lowers the cost of capital will changes lead to a
higher multiple. Even so, don’t forget that enterprise-value-to-EBITA multiples
still depend on ROIC and growth.

4. Adjust the enterprise-value-to-EBITA multiple for nonoperating

items

Although the one-time nonoperating items in net income make EBITA superior to
earnings for calculating multiples, even enterprise-value-to-EBITA multiples
must be adjusted for nonoperating items hidden within enterprise value and
 EBITA, both of which must be adjusted for these nonoperating items, such as
excess cash and operating leases. Failing to do so can generate misleading results.
(Despite the common perception that multiples are easy to calculate, calculating
them correctly takes time and effort.) Here are the most common adjustments.

 Excess cash and other nonoperating assets. Since EBITA excludes interest income
from excess cash, the enterprise value shouldn’t include excess cash. Nonoperating
assets must be evaluated separately.
 Operating leases. Companies with significant operating leases have an artificially low

enterprise value (because the value of lease-based debt is ignored) and an artificially
low EBITA (because rental expenses include interest costs). Although both affect the
ratio in the same direction, they are not of the same magnitude. To calculate an
enterprise-value multiple, add the value of leased assets to the market value of debt and
equity. Add the implied interest expense to EBITA.
 Employee stock options. To determine the enterprise value, add the present value of all

employee grants currently outstanding. Since the EBITAs of companies that don’t
expense stock options are artificially high, subtract new employee option grants (as
reported in the footnotes of the company’s annual report) from EBITA.
 Pensions. To determine the enterprise value, add the present value of pension liabilities.

To remove the nonoperating gains and losses related to pension plan assets, start with
EBITA, add the pension interest expense, deduct the recognized returns on plan assets,
and adjust for any accounting changes resulting from changed assumptions (as indicated
in the footnotes of the company’s annual report).
Other multiples too can be worthwhile, but only in limited situations. Price-to-
sales multiples, for example, are of limited use for comparing the valuations of
different companies. Like enterprise-value-to-EBITA multiples, they assume that
comparable companies have similar growth rates and returns on incremental
investments, but they also assume that the companies’ existing businesses have
similar operating margins. For most industries, this restriction is overly
burdensome.

PEG ratios7are more flexible than traditional ratios by virtue of allowing the
expected level of growth to vary across companies. It is therefore easier to extend
comparisons across companies in different stages of the life cycle. Yet PEG ratios
do have drawbacks that can lead to errors in valuation. First, there is no standard
time frame for measuring expected growth; should you, for instance, use one-
year, two-year, or long-term growth? Second, these ratios assume a linear relation
between multiples and growth, such that no growth implies zero value. Thus, in a
typical implementation, companies with low growth rates are undervalued by
industry PEG ratios.

For valuing new companies (such as dot-coms in the late 1990s) that have small
sales and negative profits, nonfinancial multiples can help, despite the great
uncertainty surrounding the potential market size and profitability of these
companies or the investments they require. Nonfinancial multiples compare
enterprise value to a nonoperating statistic, such as Web site hits, unique visitors,
or the number of subscribers. Such multiples, however, should be used only when
they lead to better predictions than financial multiples do. If a company can’t
translate visitors, page views, or subscribers into profits and cash flow, the
nonfinancial metric is meaningless, and a multiple based on financial forecasts
will provide a superior result. Also, like all multiples, nonfinancial multiples are
only relative tools; they merely measure one company’s valuation compared with
another’s. As the experience of the late 1990s showed, an entire sector can
become detached from economic fundamentals when investors rely too heavily on
relative-valuation methods.

Of the available valuation tools, a discounted-cash-flow analysis delivers the best

results. Yet a thoughtful analysis of multiples also merits a place in any valuation
tool kit.
About the author(s)

Marc Goedhart is an associate principal in McKinsey’s Amsterdam office, and Tim Koller is a
partner in the New York office. David Wessels, an alumnus of the New York office, is an adjunct
professor of finance at the Wharton School of the University of Pennsylvania. This article is adapted
from the authors’ forthcoming book, Valuation: Measuring and Managing the Value of Companies,
fourth edition, Hoboken, New Jersey: John Wiley & Sons. It also appeared in the Spring 2005 issue
of McKinsey on Finance. Visit McKinsey’s corporate finance site to view the full issue.

Gautam Adani-led diversified industrial conglomerate Adani Group is

restructuring its business which would see the public listed power generation
and ports firm spliced out of the flagship company Adani Enterprises Ltd
while the privately held power transmission unit be listed as a separate firm.
Currently Adani Power and Adani Ports and Special Economic Zone
(APSEZ) are listed subsidiaries of Adani Enterprises. However, Adani
Enterprises also has some separate assets in these domains.
Adani Enterprises would demerge its ports business (Belekeri Port,
Karnataka) to APSEZ; power businesses (solar power unit of 40 MW in
Kutch, Gujarat) to Adani Power and transmission business (Mundra-Zedra
transmission line) to Adani Transmission Ltd, according a stock market
disclosure.
Post restructuring the entire power generation business would be housed
under Adani Power and the entire ports interest would be under APSEZ.
Adani Enterprises would become a mining firm by merging its existing unit
Adani Mining Pvt Ltd with itself.
The power transmission firm would be spun off as a separate listed company,
the fourth under the Adani Group. It would have 5,000 km of transmission
lines, one of the largest in the country.
The restructuring is part of the group’s effort to simplify its corporate
structure and unlock value for the shareholders of Adani Enterprises by
eliminating the holding company discount, it said.
Investors tend to discount the value of cross holdings among listed companies
while ascribing a valuation to them.
“The Scheme of Arrangement will drive next level of value creation,
competency, decision making and would be able to accelerate the business
growth. These developments and positive macro-economic environment re-
affirm our commitment towards securing infrastructure and energy need of
the country,” Gautam Adani, chairman Adani Group, said in the statement.
As part of the restructuring, shareholders of Adani Enterprises will be issued
14,123 shares of APSEZ and 18,596 shares of Adani Power for every 10,000
shares of Adani Enterprises besides 1 share of Adani Transmission for every
one share in Adani Enterprises.
This is based on valuation report by BSR & Associates and fairness opinion
by JM Financials.
Adani promoters who currently own 75 per cent in Adani Enterprises would
own a similar stake in Adani Transmission. However, the free float or public
holding in the other two listed firms would increase post the restructuring.
In Adani Power, which also counts PE firm 3i as a shareholder, they would
own 55 per cent while in APSEZ, where Temasek is an investor they would
hold 56 per cent stake, as per VCCircle estimates.
The restructuring will become effective from April 1, 2015, the company said
in its release.
Post restructuring Adani Enterprises will become a mining firm with
operations in Australia, Indonesia and India.
The Adani Group ventures into Australia in 2010 with the purchase of the
Greenfield Carmichael Coal Mine in the Galilee Basin, Central Queensland,
and the Port of Abbot Point near Bowen in North Queensland. It wants to
operate a vertically integrated model – with the extraction of coal from
Carmichael Mine, transported by rail to Abbot Point, and exported to meet
consumer and business demands in offshore markets.
In Indonesia it got licence in 2007 for coal mining at Bunyu, East
Kalimantan.
Back home in India, it is implementing coal mining projects with total annual
coal production capacity of around 110 MTPA.
Q3
Meanwhile, Adani Enterprises clocked over six-fold increase in consolidated
net profit for the third quarter ended December 31, 2014 to Rs 443.8 crore as
compared to Rs 68.2 crore in the year-ago period. Its total revenues rose to
Rs 18,074.9 crore from Rs 13,954.3 crore in the same period.
“Our overall performance has improved due to higher contribution from coal,
ports & logistics and power businesses. The shareholders would continue to
participate in the growth and progress of Adani with direct shareholding in
the respective listed companies,” Ameet Desai, CFO Adani Group and
executive director, Adani Enterprises, said.
On Friday, shares of Adani Enterprises closed at Rs 629.50, up 7.79 per cent
on the Bombay Stock Exchange in weak Mumbai market.