Appreciating Value
Issue 5
November 2009
Contents
Welcome to Issue 5 of
Appreciating Value.
As the Australian economy
emerges from the downturn our
thoughts turn to profiting from the
next growth cycle.
In this issue the team investigates
how Management can best
analyse profitable growth
opportunities. A key lesson from
the Global Financial Crisis is that a
project’s risk must be priced
effectively when considering
opportunities to deploy capital.
The resurgence of Value Based
Management and particularly
Economic Profit is considered in
our first article.
Value based management – Simple truth
1–2
Valuation models – just a point in time,
or performance enhancing as well?
3–4
Learning the lessons of ABC
5–7
Economics in brief
A ‘macro’ point of view and key metrics
The second article investigates
how the humble DCF can be an
effective Management tool to
enhance a company’s
performance.
ASX Industry Market Multiples
As of 9 November 2009
Lastly, we introduce the first of our
case studies – in this issue we take
a look back at ABC Learning
Centres and the lessons that can
be learnt by all from its demise.

As always, we welcome feedback
and suggestions from our readers.
If you have any comments or
would like us to cover a particular
topic in future, please contact us
at:
appreciatingvalue@au.pwc.com
Mark Reading
Editor
About PwC Corporate Value Advisory
8–9
10
11

Value based management – Simple truth?
The global financial crisis has caused Boards
and Executive Teams to keep a closer eye on
the capital that is employed in the business.
Unsurprisingly, various forms of Value Based
Management are gaining in popularity again.
Time to revisit an old friend: Economic Profit.
The GFC has reminded us of two fundamental
business principles:
“
This disconnect between
‘value’ and ‘accounting’
has left companies
puzzled with poor
shareholder returns while
accounting profits have
been improved.
”
a. Capital both in the form of equity and debt is
the origin of any business activity; and
b. Capital commands a level of return
appropriate to compensate for the level of
risk to which it is exposed.
Both principles are reflected in the concept of
the Weighted Average Cost of Capital (WACC).
This cost of capital rate is a blended rate of both
the cost of debt and the cost of equity. It is
widely accepted and has been used in practice
for decades when it comes to decision making:
the WACC is the discount rate in free cash flow
valuations.
However, the cost of equity as reflected in the
WACC is an opportunity cost and therefore can’t
be found in Income Statements. This disconnect
between ‘value’ and ‘accounting’ has left
companies puzzled with poor shareholder
returns while accounting profits have been
improved. At times this disconnect can become
a threat to a company’s existence when
impairments force the ‘value’ perspective back
into the equation. Impairments can lead to debt
covenant violations or generally reduced
creditworthiness and difficulties in refinancing
maturing debt.
Let’s have a look at a prominent example:
$ million
NPAT
The difference between the two graphs lies in
the opportunity cost of equity. NPAT is already
reflective of the cost of debt (interest), but it
ignores the opportunity cost of equity.
Economic Profit = NPAT – Opportunity Cost of
Equity
This is the one big thing about Value Based
Management and metrics like Economic Profit or
Economic Value Added (EVA): they go beyond
accounting in that they consider the opportunity
cost of equity. This is a small extra step and
simple enough to calculate but it has far
reaching consequences for corporate objectives,
strategy development, decision making,
performance measurement, balanced
scorecards and driver trees, and very
importantly, incentive remuneration. Profit
metrics ignorant of the opportunity cost of equity
(e.g. EBIT, NPAT, EPS…) should not be part of
executive incentive plans, at least not if you
want to properly align shareholder and
management interests.
The perception that Economic Profit is a
complex matter and not easily understood by
general management has its origin in the past.
Previously, numerous adjustments to the
accounting numbers were applied to measure
performance more accurately. Firstly, this is not
a defining element or specific to Economic Profit
(e.g. analysts would calculate an ‘underlying’
EBIT, too). Secondly, accounting has come a
long way over the past decades towards a true
and fair view. Today, most companies choose to
keep it as simple as possible, and don’t apply
any adjustments at all.
Let’s have a glimpse at the power of the
framework in a management context.
200
150
100
50
0
Economic Profit is usually calculated as:
Economic Profit = NOPAT – (WACC x Capital
Employed)
2003 2004 2005 2006 2007 2008
Economic Profit
$ million
This is the data for ABC Learning Centres (ABC)
and of course it all ended in tears. But what
actually is it that the graphs reveal?
50
0
-50
-100
2003 2004 2005 2006 2007 2008
In this case Net Operating Profit after Tax
(NOPAT) can be defined as NPAT without
interest expenses. Interest expenses together
with the opportunity cost of equity are captured
by the WACC applied to the capital employed
(equity plus debt or total assets less non interest
bearing liabilities).
With Return on Capital Employed (ROCE)
defined as NOPAT/ Capital Employed, the
above equation can be restated as
Economic Profit = (ROCE – WACC) x Capital
Employed
Table 1
Appreciating Value
1
What would you like to change
?

Value based management – Simple truth?
Excess Return (ROCE – WACC) is a strategic
measure of competitive advantage or attractive
markets. Capital Employed puts the advantage
to a dollar scale. The two factors can be mapped
out on the following graph:
The Iso EP Map is useful to understand the
historic journey of a company, compare
performance and strategic direction to peers, or
map the strategic plan going forward. It was
originally developed for holding companies and
portfolio management purposes.
Iso EP Map
10.0%
”
7.5%
growth
EP = 150
5.0%
2
2.5%
profitability
Excess Return (ROCE – WACC)
“
Economic Profit is where
strategy meets numbers.
EP = 200
3
EP = 100
EP = 50
Economic Profit is where strategy meets
numbers. Hence, a successful implementation
and application usually takes a CFO with a
strategic view, a CEO who is not ignorant of the
numbers or a good cooperation between the two.
0.0%
EP = -50
-2.5%
EP = -100
-5.0%
EP = -150
-7.5%
1 consolidation
EP = -200
-10.0%
0
500
1,000
1,500
2,000
2,500
Capital Employed
Economic Profit multiplies profitability with
growth, solves the trade-off and provides a
single objective - improve EP!
Each dot on the Iso EP Map represents
Economic Profit as a product of Excess Return
and Capital Employed. The same level of
Economic Profit can be achieved through
different combinations of Excess Return and
Capital Employed. For example, an EP of $50
can be achieved through an Excess Return of
10% on Capital Employed of $500 or 5% on
Capital Employed of $1,000. The graph above
shows Economic Profit levels as iso-lines in
steps of $50. The blue arrows indicate directions
to improve EP and can be categorised in three
general directions:
1. Consolidation
• Optimise net working capital
•
Dispose of non-core or unproductive
assets
2. Profitability
• Cost reduction
•
Revenue enhancement
3. Growth
• Leverage existing core competencies into
adjacencies
•
Geography, products & services, value
chain coverage, etc
Guido Gadomsky
Perth
Appreciating Value
2
What would you like to change
?

“
If the valuation model was
so important in making
the initial decision why
not use it going forward to
measure the performance
of the business?
”
Valuation models – just a point in time, or
performance enhancing as well?
Discounted Cash Flow (DCF) analysis is one of
the most commonly used approaches to
estimating the intrinsic value of a business.
Part of its appeal is that it draws together
consideration of competitive advantage,
operations, capital requirements, and the
opportunity cost of capital. That’s why when
considering whether to buy, or invest in, a
business many people will turn to a DCF
approach. However, after the acquisition the
DCF model’s prominence often fades, and
performance reporting turns to accounting
measures. If the valuation model was so
important in making the initial decision why not
use it going forward to measure the
performance of the business?
At first thought the initial objection to this
question will be that the DCF model provided a
view of the business only at a point in time.
However, there is a relatively simple method of
using the DCF model to track performance,
thereby creating a measure which provides
insight and better alignment to investors.
Consider the simplified company DCF shown
in Figure 1 which we’ll assume was prepared
at the commencement of 2010. For the
purpose of this simple example the forecast
horizon is only 5 years, but in practice this
approach can be used with a longer forecast
horizon and a terminal value. This makes it
suitable for the performance measurement of
indefinite life assets, like companies. Note that
in Figure 1 the forecast free cash flows have
been discounted with a rate of 10% to yield a
present value of $500 (insert billion if you like
to think big).
Start of year
Year 2F
2011
Year 3F
2012
Year 4F
2013
Year 5F
2014
Forecast free cash
flow
$120
$126
$133
$139
$146
Present value
factor
0.91
0.83
0.75
0.68
0.62
Present value of
forecast
$110
$105
$100
$95
$91
Total present value
of forecast
$500
End of year
Actual
2010
Year 1F
2011
Year 2F
2012
Year 3F
2013
Year 4F
2014
Forecast free cash
flow
$120
$138
$133
$139
$146
Present value
factor
1.00
0.91
0.83
0.75
0.68
Present value of
forecast
$120
$125
$110
$105
$100
Total present value
of forecast
$440
Forecast
Figure 2
The DCF at the end of the year in Figure 2
changes in two other respects, that is the year
2010 has become “Actual”, and since we have
moved forward in time the present value factors
have been adjusted accordingly. The present
value of the remaining cash flows is now $440.
The company’s performance for the year can
now be judged by comparing the end of year to
the start of the year, as shown below in Figure 3.
Calculation of performance
Cost of Capital
10%
A
Value as at end of year
$440
–B
Value as at start of year
$500
=C
Change in Value
($60)
+D
Actual cash flow realised during year
$120
=E
Total Return
$60
–F
Expected Return
$50
Forecast
=G
New Value Created
$10
Year 1F Year 2F Year 3F Year 4F Year 5F
2010
2011
2012
2013
2014
Figure 3
Forecast free cash
flow
$120
$126
$133
$139
$146
Present value
factor
0.91
0.83
0.75
0.68
0.62
Present value of
forecast
$110
$105
$100
$95
$91
Total present
value of forecast
$500
Figure 1
In the example let’s now move ourselves
forward 12 months to the end of 2010 (wow,
what a year!). We can now compare the
original forecast to the updated version at the
end of the year, as shown in Figure 2. Let’s
suppose that at the end of 2010 the business
has exactly performed as forecast, with the
exception that the forecast free cash flow in
2011 has now increased from $126 to $138
(perhaps due to anticipated cost saving, or
additional revenue).
Appreciating Value
3
Forecast
Year 1F
2010
Start of year
The first step is to calculate the change in the
value of the forecast, yielding a negative change
in value of $60 (i.e. in Figure 3, A-B=C). To this
we now add the $120 cash actually realised
during the year, so the total return was $60 (i.e.
C+D=E). We compare this to investor
expectations, the ‘Expected Return’, by
multiplying the starting value of $500 by the 10%
cost of capital. New Value Created is now $60 –
$50 = $10.
This $10 is significant because it is value which
has been created over and above the
expectations of investors, as quantified in the
10% cost of capital. Had the 2011 forecast free
cash flow not increased the result would have
been zero, signifying that investors’ expectations
had been met exactly. Of course the opposite
could also have occurred, with a negative result
showing value had been lost.
What would you like to change
?

Valuation models – just a point in time, or
performance enhancing as well?
To continue to use this approach the
management team merely add a year to the
end of their forecast, perhaps as part of an
annual planning process, and ‘lock it in’ for the
same comparison in 12 months time. Other
time frames, such as quarterly or semiannually, are also feasible.
“
This approach gets
management focused on
the value of the business
using the same approach
that investors use.
”
But what’s to stop someone from arbitrarily
increasing the forecast, in order to make their
performance look good? Well, there are two
main reasons:
1. Behaviour like that becomes a ‘one shot
game’ as the ending value becomes the
new starting value used to judge the
following year’s performance, i.e. they’ve
raised the subsequent benchmark. As a
further deterrent, if this measure is linked to
an incentive scheme then deferral of
payments would be recommended.
2. The time value of money means that to
spuriously affect performance the changes
either need to be close in time to the
present or very large, either of which would
be noticeable to directors and other
managers.
What would you need to get started?
1. Develop a robust corporate value model
which you believe captures the true
underlying economic drivers of the
business.
2. Build the use of the value model and this
measure into the firm’s planning and
management processes. This should
include some training.
3. Include people from other functional teams,
not just finance, as they can make valuable
contributions to discerning the core
economic drivers of the business.
4. Consider the use of the measure in your
company’s dialogue with investors.
Building and enhancing these capabilities
ensures that management’s efforts are more
directly linked to value creation. The more
people there are looking at the business
through a value lens, the more likely it is that
shareholders will be delighted.
This approach gets management focused on
the value of the business using the same
approach that investors use. Surely that’s an
important outcome since managers are
custodians of capital and trying to deliver
returns at least equal to expected returns.
Other benefits include:
1. As for traditional measures there is still
recognition of current performance, via
‘actual cash flows realised during year’.
2. But this measure is also forward looking.
This is a key distinction given that
managers are paid to worry about the
future, not what’s just happened.
3. Although this approach could be used for
any business, public or private, it will have
particular attraction for management teams
focused on making long term strategic
decisions. Are you a manager making
decisions which will have impact far into the
future?
4. This approach can also be applied to large
capital investments using the Net Present
Value (NPV) model as the basis and
following the same logic.
James O’Brien
Sydney
Appreciating Value
4
What would you like to change
?

Learning the lessons of ABC
By understanding value, boards and
managers can sidestep the issues that
brought one of the fastest growing
companies in Australia to its knees.
“
To uncover some
answers … we opened
our toolbox of value tools
and analysed publically
available information … to
see if we could find
anything that might
provide a hint of what was
to follow.
”
While the financial press has been full of
stories of corporate collapse, the collapse of
ABC Learning has been one of the more
emotional. Widespread reporting of parents
concerned by the impending closure of their
ABC Learning Centre has focused community
attention on what went wrong with this
erstwhile darling of corporate Australia.
Not only have children, parents, shareholders
and creditors been affected but the founders
also saw a concerted run on their (highly
leveraged) holdings by short sellers, leading to
a significant loss of personal wealth.
Were there any early warning signs that senior
managers and boards could look to so they
short circuit these types of calamitous
outcomes in their own businesses?
To uncover some answers, we travelled back
in time – to a time when ABC Learning was at
its zenith, in 2006. We opened our toolbox of
value tools and analysed publically available
information from 2006 and 2007 to see if we
could find anything that might provide a hint of
what was to follow.
Clearly, the context of the rapid growth and
share price appreciation that ABC Learning
experienced should not be ignored; it is often
easy to pinpoint issues in hindsight. However,
disciplined financial management is like driving
in that it requires us all to look for potential
accidents, even when the traffic is running
smoothly. Accordingly, we’ve unapologetically
sought to find a glimpse of the oil on ABC
Learning’s road even as it was racing ahead.
A brief primer on ABC Learning
ABC Learning operated childcare centres or
nurseries in Australia, NZ, the UK and the USA,
as well as some schools in the USA. By 2007,
it had revenues of almost $1.8 billion, across
almost 1,200 outlets in Australia and New
Zealand and more than 1,000 in the Northern
Hemisphere, employing thousands. It grew
from annual revenues of $40 million in 2003 –
a phenomenal growth trajectory by any
standards. Chart 1 plots the trend of revenue
growth and share price over this period.
Appreciating Value
5
Chart 1: Revenue and average share price 20032008
ABC’s growth came from three sources; most
significantly acquisitions, green-field
developments and organic growth. Because of
the sensitivity of childcare operations,
regulation and government funding were
substantial considerations in how it ran its
business, with increased funding of childcare
places being a substantial driver of organic
growth.
Revenue was largely dictated by the number of
places filled in the centres and costs were
predominantly labour and premises, the
number and condition of which were largely
regulated, making the costs fixed within quite
large ranges of child numbers.
Margin expansion was to some extent
achievable by initiatives such as tailoring child
place mix, increasing administrative leverage,
developing procurement/property efficiencies
and promoting wage restraint.
From a market perspective, ABC Learning
experienced dizzying growth in value touching
a high of $8.80 per share, which placed its
founders in many lists of Australia’s most
wealthy.
Even into 2008, ABC Learning continued to
grow. Unfortunately, it didn’t last. Short sellers
targeted the stock leading to precipitous
declines in value, creating nervousness around
the company’s survival. On 6th November
2008, matters came to a head with the group
being placed into voluntary administration.
ABC Learning was not a particularly complex
business, nor did it engage in extensive
financial engineering. Essentially, it was a good
business that got itself into trouble. The key
question is, could trouble have been spotted
earlier?
What would you like to change
?

Learning the lessons of ABC
In using our value toolkit, we took into account
three perspectives to see what warnings were
available – a market perspective, an
accounting perspective and a value
governance perspective.
“
Economic profitability was
negative in both periods
we reviewed. This implied
that the business was not
generating the returns
that justified the capital
invested in it.
”
We have not adjusted for any of the
restatements that occurred in 2008. To do so
would distort the information available in 2007,
but clearly if the restatements had been
included, the picture would not have been
better than what is explored below.
A market perspective
Firstly, the market perspective provided some
insight. We took four key measures from our
corporate value model that summarises the
way the market looks at a company. The four
measures we chose were: the z-score, volatility,
economic profitability and economic leverage.
The z-score is a credit scoring model, which
estimates the risk of credit default in a similar
way to credit markets. Volatility is a measure of
the variability in share price, which provides a
market-based measure of uncertainty of value.
Economic profitability compares the return on
capital with the cost of capital, which is an
indicator of capital efficiency. Economic
leverage highlights the degree to which the
business value is debt funded.
ABC Learning’s scores in the two years were
studied were as follows:
Measure
2007
Z-score 1
-0.4
2006
5.1
Volatility 2
33%
29%
Economic profit % 3
-3%
-4%
Economic leverage % 4
43%
4%
In 2007, ABC’s z-score and economic leverage
took a battering, largely as a result of
substantially debt funded offshore acquisitions.
The high degree of debt funding was
exacerbated by the currency and short tenor of
funding. This left ABC highly exposed to
refinancing risk and with the added leverage
implied by margin loans (as signalled by
unanticipated disposals of management owned
shares) made the company highly exposed to
the eventual short-selling raid on the shares.
From where we sit today, it can only be
speculated about the rationale for the
aggressive financing of the US acquisition that
generated this exposure, and indeed the
company sought to reduce this risk in 2008, as
discussed opposite.
Appreciating Value
6
Volatility in the two periods increased slightly,
but ABC Learning only just made it into the top
half of the ASX 300 in terms of observed risk.
This measure became more of a problem for
the company in 2008 but in this period of
ABC’s life did not highlight major challenges.
However, it was significant to note that the
share price trajectory flattened and started to
decline in this period, implying a perception
that more downside risk existed than
previously.
Economic profitability was negative in both
periods we reviewed. This implied that the
business was not generating the returns that
justified the capital invested in it. On its face,
this would be of some concern, but against the
background of extremely rapid growth this may
have been a timing issue of when full year
earnings were attributable against capital
invested. During the period under review, this
wouldn’t have set an alarm sounding, but it
would have remained an area to watch for the
board and senior managers.
Accounting indicators
Accounting indicators also provided some
warnings during 2006 and 2007. We looked at
three key indicators – EBIT interest cover
which is a measure of the buffer that exists for
servicing of debt holders, the current ratio,
which highlights a company’s liquidity, and free
cash flow as a percentage of revenue, which
reveals how much of the company’s revenue is
converted to cash.
On the first two measures, the aggressive
offshore acquisition financing plan made ABC
Learning appear much riskier than it had in the
past. In fact, the second measure, the current
ratio was an immediate indicator of either an
impending liquidity crisis or major refinancing
risk. The company did notice this risk, and
early in the new financial year conducted a
major refinancing, with a substantial equity
raising and extending the term of debt facilities.
However, with hindsight, this refinancing was
not enough to stem the tide that was turning for
ABC Learning.
In terms of free cash flow generation, very little
of ABC Learning’s stellar revenue growth was
being converted to cash. This raises questions
about whether the level of growth was
sustainable or whether ABC Learning was in
fact over extending in its quest for rapid growth.
2007
2006
Interest cover 5
Measure
3
5
Current ratio 6
0.25
2
FCF % of revenue 7
1%
-4%
What would you like to change
?

Learning the lessons of ABC
Value governance
From a value governance perspective, we
considered four aspects.
“
ABC was on a growth
binge, fuelled in part by
its systems of governance
pertaining to value. The
growth binge failed to fully
take account of the
capital consumed or the
dramatic risk profile that
the sources of that capital
created for the group.
”
First, we looked at the incentive plan in place
for senior management. We noted that this was
largely driven by increases in EBITDA.
Inherent in the structure of this incentive plan
was that the capital invested in delivering this
EBITDA growth was not accounted for. This
created a structural deficiency in accountability
for capital employed, a fundamental aspect of
value governance. In 2008, the company
sought to address this shortcoming, if belatedly.
Another issue of value governance is the
incentives implied by related party transactions
with members of the board. The impact of any
board member deriving related party fees as a
result of capital raisings, property transactions
and acquisitions is a relevant consideration for
investors. Without access to non-public
information relating to these transactions, of
course, no conclusions can be drawn around
the nature of the advice provided. However, on
its face, any financially sophisticated member
of a board who may have an incentive, through
related party transactions, to accelerate growth
velocity at rates that may be difficult to sustain
is a sign of potentially increased risk for
investors.
ABC Learning’s investor base provided
interesting value governance challenges.
Despite the stellar growth described above,
ABC Learning’s analyst following remained
relatively limited, the institutional investor base
remained narrow and general shareholdings
remained closely held. These challenges may
have muted the feedback of the market to the
company, and almost certainly exacerbated
valuation downside when positive momentum
waned.
The final issue of value governance was
around disclosure of quality of earnings. By
any measure, ABC’s growth was stellar. It also
engaged in some innovative property finance
transactions. In circumstances like this, it was
difficult to truly tell what the underlying
earnings from operating its centres were –
there were challenges around the clarity of
presentation of revenue and margins of
franchised centres, half periods of earnings
from new acquisitions, restructuring costs, and
one-off profits of centre redevelopment. Given
the complexity of these phenomena, greater
transparency would have provided investors
and creditors much more certainty and perhaps
alleviated many concerns that were emerging.
Allied with this opacity, the earnings
restatements that emerged in 2008, with the
appointment of a new auditor heaped more
market scepticism on the quality of earnings.
Furthermore, the lack of continuity in the CFO
over this period may have restricted the
company’s ability to have necessary market
dialogue to develop clarity in earnings
reportage.
Conclusions
Boiling down all of the above analysis, there
were warning signs about ABC Learning even
in its heyday.
Fundamentally, ABC was on a growth binge,
fuelled in part by its systems of governance
pertaining to value. The growth binge failed to
fully take account of the capital consumed or
the dramatic risk profile that the sources of that
capital created for the group.
The good news is that lessons can be drawn
from this sad outcome which will enable boards
and senior managers to avoid or prevent the
difficulties that ABC Learning has been through
in the last year or two.
To summarise these lessons:
•
Understand how debt and equity markets
view your business, particularly in terms of
your risk profile
•
Check out what your value governance
says about your company –
−
what behaviours are incentives likely
to generate,
−
what could related party transactions
say about the likely stance of the
board,
−
how does your investor base
influence value outcomes and
−
how transparent are your reported
earnings.
These sound like simple lessons, but they are
lessons that are very costly if ignored.
Richard J Stewart
Sydney
Appreciating Value
7
What would you like to change
?

Economics in brief
A ‘macro’ point of view
The global economy is growing again after
contracting sharply late last year and in the early
part of 2009. The risk aversion that was so
evident earlier in the year, particularly in
financial markets, has abated and confidence is
gradually returning.
GDP growth would have been stronger had
exports not been tempered by the sharp drop in
global prices for agriculture commodities and
lower coal and iron ore contract prices which
came into effect during the quarter.
Chart 1: Quarter-on-quarter growth rates
“
The risk aversion that
was so evident earlier in
the year, particularly in
financial markets, has
abated and confidence is
gradually returning.
”
Interestingly, this turn around in global economic
fortunes has not been driven by the traditional
economic powerhouses – the USA and the EU –
but by the emerging Asian economies. The
Asian region’s financial systems have not
experienced the same dislocation as elsewhere
in part due to the substantial reforms which
resulted from the turmoil of the Asian Financial
Crisis in 1997-98. The Asian economies are also
benefiting from a recovery in domestic demand,
as these traditionally high saving populations are
encouraged to increase consumption. Growth in
China and India has been particularly strong.
Economic conditions in Australia have also been
stronger than expected. In contrast to other
developed economies, the Australian economy
is estimated to have expanded, albeit modestly,
over the first half of the year and recent data
suggest that this expansion has continued into
the second half. Confidence has improved and
spending has been supported by stimulatory
settings for both monetary and fiscal policy.
The challenge that now faces those at the
controls of fiscal and monetary policy is to
determine an appropriate pace to roll back the
expansionary settings of both forms of stimulus
without stymieing the recovery of the Australian
economy.
GDP
Consumers
Gov
Investment
Exports
Imports
2%
0%
-2%
-4%
-6%
-8%
2008 Q3
2008 Q4
2009 Q1
2009 Q2
Source: Australian Bureau of Statistics (ABS)
Stimulus measures drive the economy
The Government cash handouts continue to
prop up consumer confidence. This was
reflected in the performance of industries with
direct exposure to discretionary spending.
Retail trade grew by 1.7% q-o-q, restaurants and
cafes by 0.9% q-o-q and recreational services
by 3.7% q-o-q, its strongest growth since Q3
2007. Consumer confidence has also hit its
highest level since December 2007 with the
Westpac-Melbourne Institute Consumer
Sentiment reaching 119.3 in September 2009
(see chart 2).
Chart 2: Household consumption and growing
consumer confidence
Household Consumption (LHS)
1.6
120.0
Consumer Confidence Index (RHS)
1.2
Given that the Australian economy is operating
with less spare capacity than earlier thought
likely, and the outlook for the next few years has
improved, the Reserve Bank Board has elected
to lessen the degree of monetary stimulus in
place by increasing the cash rate by 25 basis
points at both its October and November
meetings. The cash rate is still deemed to be at
low levels and it is likely the Board will continue
to raise rates as the economic recovery
strengthens towards a neutral position (thought
to be a cash rate of around 5.0%-6.0%).
The buoyant Australian economy
The Australian economy expanded by 0.6% in
Q2 2009 relative to Q2 2008 (see Chart 1
below). This is the second consecutive quarter
of growth after contracting by 0.6% quarter-onquarter during Q4 2008. Domestic growth, both
household and business, was led by the
Australian Government’s fiscal stimulus flowing
through the economy. Household spending was
up 0.8% q-o-q while business investment grew
1.9% q-o-q.
Appreciating Value
8
100.0
0.8
80.0
0.4
0.0
60.0
Dec-07
Mar-08
Jun-08
Sep-08
Dec-08
Mar-09
Jun-09
Source: Australian Bureau of Statistics (ABS) and Westpac
Melbourne Institute Consumer Sentiment Index
Companies are still showing caution, choosing
to run down inventories as opposed to re-stock
in order to meet the surprisingly strong, stimulus
driven, consumer demand. Despite this caution,
private business investment rose by 1.9% q-o-q
as companies took advantage of the historically
low interest rates and the Government’s tax
incentives designed to bring forward the
purchase of critical machinery and equipment.
The Reserve Bank is now watching carefully for
inflationary pressures resulting from this fiscal
stimulus, with rates having started their rise from
these historically low levels back towards the
long term norm of 5.0% to 6.0%.
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Economics in brief
A ‘macro’ point of view
Treading lightly along the road to
recovery
“
While the cash hand outs,
tax offsets to business
and infrastructure
spending have placed the
budget into deficit, these
measures can be
considered one off, or
temporary in nature.
”
It appears that the Australian economy has
dodged the worst of the global recession and
stabilised, setting the stage for an imminent
recovery. However, there are still obstacles on
the road to recovery, one of which is the
successful winding back of the emergency
stimulus measures.
While the cash hand outs, tax offsets to
business and infrastructure spending have
placed the budget into deficit, these measures
can be considered one off, or temporary in
nature. They appear to have supported the
intended sectors during the global financial crisis
without fundamentally changing or distorting the
markets in which these sectors operate. These
measures therefore pose less risk to
destabilising areas of the economy as they are
wound back.
By contrast, the boost to the first home buyers’
grant and Government bank guarantee have
both had a structural impact upon the markets
they were designed to support. The demand
generated by the boost to the first home buyers’
grant has shored up Australian housing prices
during the crisis.
Key metrics
Indicator
So while Australian prices matched the strong
growth shown in the US and UK in the period
leading up to the crisis, they appear to have
avoided the sharp drop which has been
witnessed overseas (see chart 3). The
Government has signalled the gradual
withdrawal of this measure: however the short
term impact on house prices and longer term
impact on housing affordability remain to be
seen.
Chart 3: House-prices % change in real terms for
2001-2006 and 2007-Q2 2009
65%
45%
25%
5%
-15%
-35%
Australia
Britain
2001 - 2006
US
2007 - 2009 (Q2)
Source: , Standard & Poor’s and US Case Shiller Index
The government bank guarantee has also
influenced the structure of the Australian
banking sector, leading to the consolidation of
the ‘big four’ banks’ positions as smaller
institutions face higher funding costs and non
bank lenders struggle to access capital.
However, the strength of the ‘big four’ has been
one of the reasons behind the relative stability of
Australia’s financial markets during the crisis.
Hence the withdrawal of this guarantee needs to
consider not only the competitive forces within
the Australian market place, but also the nature
and time span of similar such overseas
guarantees so as not to weaken the position of
Australian banks within the global market.
2007
2008
2009f
2010f
GDP growth
4.0
2.4
0.4
1.4
Consumer spending
4.4
2.6
1.7
1.7
Government spending
2.4
4.1
2.6
2.3
Real growth (annual % change)
Investment
9.5
9.6
-4.9
-3.2
Export
Imports
3.3
11.8
3.8
11.3
1.4
-11.3
3.4
2.0
2.3
4.4
1.5
2.2
6.75
4.25
3.50 *
↑
Inflation
CPI (annual % change, average)
Interest rates (%)
Base interest rate (EOP)
Source: Australian Bureau of Statistics; Reserve Bank of Australia; PricewaterhouseCoopers Economics’ forecasts (f) Economic
analysis provided by PricewaterhouseCoopers Economics.
* Rate as of 4 November 2009 is 3.50%
James Liddy
Sydney
Appreciating Value
9
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
ASX Industry Market Multiples
As of 9 November 2009
No. of
companies
EV/EBITDA
Multiple
P/E
Multiple
Automobiles and Components
11
6.3x
9.9x
Consumer Durables and Apparel
26
5.7x
11.6x
Consumer Services
30
8.0x
14.0x
Media
34
8.3x
13.4x
Retailing
33
8.1x
15.4x
Industry
Consumer Discretionary
Consumer Staples
Food and Staples Retailing
8
7.1x
20.3x
40
8.8x
16.0x
2
4.3x
10.2x
198
8.4x
13.2x
12
N/A
14.1x
141
7.9x
13.9x
9
11.5x
18.2x
85
12.4x
11.9x
Healthcare Equipment and Services
66
7.2x
15.5x
Pharmaceuticals, Biotechnology and Life
Sciences
75
5.9x
17.0x
Capital Goods
97
6.0x
12.8x
Commercial Services and Supplies
56
7.1x
14.8x
Transportation
22
7.7x
13.6x
3
3.9x
6.4x
Software and Services
65
7.1x
14.0x
Technology Hardware and Equipment
28
4.2x
13.1x
568
6.5x
12.7x
25
4.9x
11.1x
26
12.6x
21.2x
1661
7.5x
11.7x
Food, Beverage and Tobacco
Household and Personal Products
Energy
Energy
Financials
Banks
Diversified Financials
Insurance
Real Estate
Healthcare
Industrials
Information Technology
Semiconductors and Semiconductor Equipment
Materials
Materials
Telecommunication Services
Telecommunication Services
Utilities
Utilities
Total
Source: Data obtained from Bloomberg and Capital IQ
Reported multiples are average ratios in the industry group (excluding negatives, outliers and not meaningful data)
Definitions
• N/A = Data is not available/applicable,
• EV = Market Value of Equity plus Preferred Equity plus Minority Interests plus Book Value of Debt minus Cash
• EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortisation for latest 12 months
• P/E = Price to Earnings Ratio, calculated as the Market Capitalisation divided by the Net Income for the latest 12 months
Casey de Souza
Sydney
Appreciating Value
10
Sholto Maconochie
Sydney
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About PwC Corporate Value Advisory
Understanding the concept of value is fundamental to effective decision making in business,
whether raising or investing capital, driving change, managing performance or satisfying regulatory
requirements.
How Corporate Value Advisory can help you?
Our professionals are drawn from accounting,
corporate finance, tax, law, marketing,
engineering and economic disciplines and
include Chartered Accountants, Masters of
Business Administration and those with the
Chartered Financial Analyst designation.
Our services include:
•
Value measurement – Independent value
measurement and opinion to enhance
management’s value position for
transactions, tax and accounting;
We work with our clients to improve their
performance by ensuring there is rigorous
analysis underpinning key management
decisions.
•
Value enhancement – Portfolio business
reviews, value based management and
insights using value to deliver improved
business performance;
•
Investment analysis – Value analytics,
financial modelling and business case
process to test and better inform key
investment choices.
Contacts
Brisbane
Andrew Wellington
 +61 (7) 3257 8816
 andrew.wellington@au.pwc.com
Sydney
Mark Reading
 +61 (2) 8266 2963
 mark.reading@au.pwc.com
Kevin Reeves
 +61 (2) 8266 0617
 kevin.reeves@au.pwc.com
Richard Stewart
 +61 (2) 8266 8839
 richard.stewart@au.pwc.com
Alastair Pearson
 +61 (2) 8266 5345
 alastair.pearson@au.pwc.com
Perth
Melbourne
Roger Port
Nigel Smythe
 +61 (8) 9238 3476
 roger.port@au.pwc.com
 +61 (3) 8603 3970
 nigel.smythe@au.pwc.com
John Studley
 +61 (3) 8603 3770
 john.w.studley@au.pwc.com
Appreciating Value
11
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