Mette I. Wikborg
24.02.05

Focus on Value Creation = raider economics?
1980s
1990s onw.
Hostile takeover activity and leveraged buyouts
• The market for corporate control exerted strong external pressure on management, esp. in the US
• “Raider economics” was an easy theme and an obvious reason for wanting to manage for value creation
Focus on value creation for stakeholders
• Creating value for shareholders
• Even with other stakeholders than the shareholders (e.g.
Europe), the optimisation of stakeholders interests can best be realized by maximizing shareholder value long term
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Finance and Strategy – no longer separate
Corporate Finance
- exclusive area of financiers
Corporate Strategy
- a separate realm ruled by CEOs
Have come together; – a very close and clear link:
– Participants in the financial markets involved in business operations through
• leveraged buyouts,
• hostile takeovers
• comparisons
– Chief executives brought their companies to be active players in the financial markets through
• Self-generated restructurings
• Leveraged recapitalizations
• Leveraged buyouts
• Share repurchases
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- And along has the focus on value increased
This link between finance and strategy presents a challenge to managers: the need to manage value
Must consider radical alternatives
• Selling the “crown jewels” (e.g. Storebrand)
• Completely restructuring operations (e.g.
Dagens Nyheter 90s)
Focus on the value their strategies are creating
Need more systematic and reliable ways to look for opportunities
• acquire assets and businesses that may be worth more to them than to their original owners, as a result of restructurings (Orkla acquiring beer-brands like Carlsberg)
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When is Valuation important?
Whenever the goal is to improve your ability to create value for the stakeholders in your business, e.g. to
Estimate the value of alternative strategies
New product introductions (Sonys mini-disks)
Capital expenditures (Norske Skogs plant in the far east)
Joint venture agreements (Nordea)
New market entries (the Hakon group)
Assess major transactions
Use value-based management
Communicate with key stakeholders
E.g. mergers, acquisitions, divestitures, recapitalizations, share repurchases
To review and target the performance of business operations o Is Norsk Hydro creating value today?
Key stakeholders, esp. stockholders, about the value of the business. o does Orkla have a communication problem?
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Theoretical Foundations
Valuation is an old methodology in finance
Intellectual origin:
– Present value method of capital budgeting
– Valuation approach developed by Prof Merton Miller and Franco
Modigliani (both Nobel laureates), in the 1961 Journal of Business article “Dividend Policy, Growth and the Valuation of Shares”.
– Later applications/popularisations, along with spreadsheets
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What is it?
Discounted cash flows Requires complete information
3 steps:
1. Input historical income statement and balance sheet information. Based on this, calculate NOPLAT, invested capital, ROIC, economic profit, free cash flow
• Free cash flow is cash flows generated by the company available to all providers of capital.
2. Input forecast assumptions: sales growth rates, margins etc.
Based on this, calculate projected income statements and balance sheets.
3. Based on this, calculate projected free cash flow etc, and discount to estimate the value of the company.
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Economic value = present value of future cashflows
Free cash flows
(pre-interest, post tax, NOK)
Yr.1
Yr.2
Yr.3 Yr.4
Yr.5
Yr.6
Terminal value
Business entity value
Discount at weighted average cost of capital (WACC)
1.5
1.4
1.3
1 bill.
.
1.2
-0.2
-0.4
0.9 bill.
A B C Corporate assets
Corporate center
Total Market corporate Value of
Market
Value of costs value debt equity
Business values
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Corporate value building on present values, discounted at WACC business

How do you discount your cash flows?
• Convert expected future cash flow into present value for all investors, using the weighted average cost of capital (WACC)
• Creditors and shareholders expect to be compensated for the opportunity cost of investing their funds in one particular business instead of others with equivalent risk
Ke Cost of equity
Kd Cost of debt
ME Market value of equity
MD Market value of debt
V Total market value t Marginal tax rate
V = ME + MD
WACC =
Ke (ME/V) + Kd(1-t) (MD/V)
E.g: Ke=14%, Kd=10%, ME/V=0,4,
MD/V = 0,6, t=0,3 => WACC = 9,8
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Estimating the WACC
– What is the cost of Equity?
Ke
Inflation
Real
Long term risk free government bond yield
Expected market risk premium
Effect of relative company risk (ß)
Estimated opportunity cost of capital
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Example 1:
Merger between two P&C Insurers
• Significant value creation for shareholders, short & long term
– Solid synergies and restructuring potential
– The two companies is a good match
• A new business plan focused on:
– Extracting synergies and restructuring potential
– Attracting and restructuring new players
– Continuing to build world class P&C capabilities
P/NAV
*B
1
0
*D
*C
*JW
*A
NAV
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Structure of the deal is set
• Valuation of the units implies that C<D
• Deal will be executed by setting up a new holding company in which the mother companies own a 50-50 share
• An agreement is signed ensuring ….
– Mother companies role will be …
– Dividend policy will by ….
– Exit/evolution provisions are ….
– As CEO will be…
–
–
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Example 2:
50/50 JV in Chemicals
(to avoid hostile takeover?)
Player Abacon
• The leading global player, with strong asset position outside of
Europe
• A weak production base in Europe
• Ambition to strengthen position in
Europe and improving developing capabilities
Player Buffalo
• Major European player, with valuable production site and strategic capabilities in developing and marketing new fuels
JV between A & B?
• gives marginal synergies;
– 30% cost reduction on sales, marketing and admin,
– 2% cost reduction on ongoing costs,
– some potential for local transport optimisation
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Abacon is prone to hostile takeover
– What should Buffalo do?
• Abacon has a stable ownership structure today
• However, the company has a substantial positive cash balance
• Thus it is exposed to the risk of a hostile takeover
• To secure its position and protect its industrial interests in Abacon, Buffalo can respond in 3 ways:
– Shareholder agreement with
Abacons major ownergroup
– Acquire control over
Abacon
– Do nothing and accept the risk
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Issues of considering to acquire control over Abacon
• Potentially undervalued; NPV calculations exceed market value
• Is Abacon significantly undervalued and what is the likely acquisition cost?
• Can Buffalo generate significant additional value by restructuring assets and realizing synergies?
• Marginal value; Buffalo is already focused and streamlined as stand-alone business
• How can Buffalo acquire control over Abacon and what is a viable financing?
• What are the risk exposure and strategic consequences of acquiring Abacon?
• Combination of asset merger, cash purchase and special dividends; major part of financial investors willing to sell at good price
• Increased product margin exposure and higher risk due to increased debt
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