Home Accounting Corporate Valuation and Takeover: Exercises

IV: Valuation and Takeover

A Stock Exchange Listing

Introduction

In Part Three we explained how share price listings based on valuation theories that encompass dividends (the yield and cover) and earnings (the P/E ratio) are analyzed by private investors and financial institutions to implement their trading decisions (i.e." buy, sell or hold").

We shall now apply these dynamics to the corporate sector and the specific case of a firm seeking a stock exchange listing and hence a market valuation for the first time. In Chapter Seven we shall develop this corporate theme with an analysis of the most important trading decision subsequently undertaken by corporate management: namely the takeover of one firm by another.

Exercise 6: Coming to the Market

At Board meetings of the privately owned Bowie Company, the recurrent question is how to finance future growth. The rational solution would appear to go public with a listing on the London Stock Exchange. Mr. David, the company chairman, produces the following information recently obtained from a Manhattan consultancy concerning two listed companies, Eno plc and Ronson plc. Both firms are similar to Bowie in respect to size, asset composition, financial structure and product mix.

On the basis of this information, Mr. David asks what you think the Bowie Company was worth in 2012. The only other data that you have available at the moment are the company's final accounts, which disclose the following (\$ million)

From memory, you also recall that the post-tax earnings and dividends for 2012 were one third higher than the average for the previous four years.

Required:

As a basis for more detailed analysis;

1. Calculate valuation multipliers for Bowie based on those for Eno and Ronson.

2. Produce a range of values for Bowie using these multipliers.

3. Evaluate your results and advise the Chairman on the feasibility of going public.

An Indicative Outline Solution

The key to answering these questions is an understanding of the term valuation multiplier, which should be familiar, given our detailed discussion of the P/E ratio elsewhere in this text and its CVT companion. Using the concept of the capitalisation of a perpetual annuity (maintainable yield):

Value (price) is simply a multiple of earnings that may be interpreted as the number of years required to recoup your investment. Likewise, value can also be defined as a multiple of dividends, the price-dividend (P/D) ratio.

1. The Valuation Multipliers

The competitors' P/E and P/D ratios (past, present or future) provide multipliers that can be applied to a company's earnings and dividends per share to determine a possible range of share prices if it is to go public. With the information available we can also use an asset valuation ratio (market value of assets over book value) to determine a benchmark price. Our over-arching objective is the derivation of a share price that ensures the successful launch of Bowie on the market as a going-concern. Ths two stage process can be summarized as follows:

Earnings and dividends per share for Bowie (\$million)

This data has been derived as follows:

Valuation Multipliers

2. A Range of Share Prices for Bowie: based on multiples for Eno and Ronson (\$)

3. A Data Evaluation

Any discussion of your results should initially highlight the following points:.

- Price per share varies widely from \$12.00 to \$38.50.

- The lower price range reflects trailing low dividend payout ratios.

- Prices still vary from \$24.00 to \$38.50, if we ignore dividend policy.

- Using the earnings multipliers (P/E ratios), price ranges narrow from \$24.00 to \$32.00 with an average of \$28.00 for 2012.

- The highest price of \$38.50 is defined by an asset valuation ratio (market value of assets over book value). Bowie therefore has two problems that must be resolved before coming to the market.

Can you explain them?

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