Appreciating Value
Issue 1
Welcome to the first issue of
Appreciating Value.
6 October 2008
Contents
Economic volatility has impacted your value
1
Like it or not
This publication has been
developed by PwC’s
Corporate Value Advisory
team to provide you with
insight into valuation issues
and their implications within
the broader economic
environment.
Marginal times
2
Things that were recently out of fashion are starting to look
good again
The topics covered in each
issue will be selected based
on issues and questions
raised by you, as well as
regular coverage of the
markets and the Australian
economy more broadly.
When will debt be cheap again?
3
Economics in brief
4
A ‘macro’ point of view and key metrics
In this issue we focus on the
current debt crisis and
consider what impact this will
have on value.
ASX Industry Market Multiples
6
As of 24 September 2008
If you have any comments or
would like us to cover a
particular topic in future
issues, please contact us at:
appreciatingvalue@au.pwc.com

About PwC Corporate Value Advisory
7

Economic volatility has impacted your value
Like it or not
“Analysis indicates
WACC increased
by 0.8%pa over the last
18 months. If you factor
into the analysis an
overall reduction in
leverage, then the
increase is even larger.”
The widely publicised ‘credit crunch’ has severely
impacted both the cost and availability of debt.
Over the 18 months to 30 July 2008, the cost of
long dated corporate debt (10 year BBB
Corporate) increased by 1.9% to just under 9%.
This represents a margin of almost 2.6% over the
corresponding Australian Government 10 Year
bond – widely used as the proxy for a risk free rate
in the Australian market.
The graph below highlights the recent divergence
in this regard.
The deterioration in corporate profitability driven by
debt market volatility has clearly been evidenced in
recent months, particularly in the financial sector.
The impact on corporate value has also been
evident, with a number of household name banks
(Lehman Brothers, Bear Sterns, HBOS, etc) all
either collapsing or being forced into quick sales
for greatly reduced prices. While other major
financial institutions have suffered from major
write-downs and impairment of their assets
resulting in steep falls in their share prices.
Notwithstanding the US Government’s TARB fund,
losses have principally stemmed from exposures
to so called ‘US sub prime’ debt and principally
due to impairment write downs following debt
repayment defaults.
The prospect of future impairment charges looks to
be almost certain. Companies subject to annual
impairment tests under AASB 136 will appreciate
the increases in debt costs has directly impacted
their weighted average cost of capital (WACC).
For most Australian companies, our high level
analysis (shown in table 1 below) indicates a ‘plain
vanilla’ WACC increased by roughly 0.8%, from
9.8% in December 2006 to 10.6% in June 2008, an
increase of just under 10% in real terms. If you
factor into the analysis an overall reduction in
leverage, then the increase is even larger.
Australian Government 10 Year Bonds (Rf) and BBB Corporate Debt Yields (Kd)
9.5
9
8.5
8
7.5
7
6.5
6
5.5
5
Aug 06
Oct 06
Dec 06
Feb 07
Apr 07
Jun 07
Source: Bloomberg and PwC Analysis
Aug 07
Oct 07
Dec 07
Feb 08
10 Year Aust Govt Bond (Rf)
Apr 08
Jun 08
Aust Corporate BBB Bond
Table 1: Calculation of vanilla WACC
WACC Variable
31/12/2006
30/06/2007
31/12/2007
30/06/2008
5.9%
6.3%
6.4%
6.4%
0.7
0.7
0.7
0.7
Debt/Equity Ratio (D/E)
42.9%
42.9%
42.9%
42.9%
Target Gearing (D/(D+E))
30.0%
30.0%
30.0%
30.0%
Risk Free Rate (Rf)
Asset Beta (Ba)
Equity Beta (Be)
Appreciating Value
1
1.0
1.0
1.0
1.0
Equity Market Risk Premium (EMRP)
6.0%
6.0%
6.0%
6.0%
Cost of Equity (Ke)
11.9%
12.3%
12.4%
12.4%
Debt Margin
1.0%
1.1%
2.0%
2.6%
Pre Tax Cost of Debt
6.9%
7.4%
8.4%
9.0%
Tax Shield
30.0%
30.0%
30.0%
30.0%
Post Tax Cost of Debt (Kd)
4.84%
5.18%
5.85%
6.32%
Post Tax WACC
9.8%
10.1%
10.4%
10.6%
Source: Bloomberg and PwC Analysis

“Decrease in value
potentially large enough
to have brokers re-rate
your stock price”
“Even without any
change to the
underlying cash flows, a
project which had a net
present value (NPV) of
A$100.0 million at a
9.8% WACC, would
have a NPV of $94.4
million if a 10.6%
WACC was adopted.”
The table highlights that due to no fault of their
own, Australian companies must, in most
instances, adopt a higher WACC for project
analysis, valuation and impairment reviews where
a discounted cash flow approach is adopted.
Even without any change to the underlying cash
flows, a project which had a net present value
(NPV) of A$100.0 million at a 9.8% WACC, would
have a NPV of $94.4 million if a 10.6% WACC was
adopted. Not a significant decrease in value,
however potentially large enough to have brokers
re-rate your stock price in the case of listed
companies. Alternatively, in the case of project
assessment and appraisal, increased discount
rates may lead to rejection of projects on the basis
values returned don’t exceed internal rate of return
hurdles.
In cases of impairment testing, for those cash
generating units (CGU) subject to testing, a 5%
reduction in value may require an impairment
expense to be recorded. This is especially true for
CGUs that had limited headroom in prior years,
where current forecasts have not improved
considerably.
David Castles
Brisbane
Marginal times
Things that were recently out of fashion are starting to look
good again
The past twelve months have not been the
friendliest of times for Australian corporates.
High interest rates, high inflation and weakening
corporate bond ratings have caused major
headaches for many companies looking to
refinance or take on additional debt. From a
valuations perspective, the cost of debt is a key
driver in determining the weighted average cost of
capital (WACC) of a company. This is particularly
so in times of high leverage.
“The combination of low
interest rates & strong
global outlook
encouraged companies
to take on more credit”
Between 2003 and 2007 the market was generally
characterised by relatively low global interest rates,
strong economic sentiment, and consequently, a
consumer boom in the western world. At the same
time, commodities were benefiting from rapid
industrialisation in emerging economies.
Throughout this time, inflation remained low. The
combination of low interest rates and strong global
outlook encouraged companies to take on more
credit. Conditions were ideal for private equity and
leveraged buy outs and merger and acquisition
(M&A) activity seemed unstoppable. Many listed
and unlisted companies increased their leverage
during this period to what had historically been
considered high levels.
In the last twelve months credit lenders and
investors have greatly changed their tune on the
outlook for the global economy. With oil and food
costs rising all over the world there are now
inflationary fears and the majority of economists
believe we are set for a slowdown. There is even
fear of a global recession. Interest rates in
Australia have increased and decreased financial
stability has led to a decline in many corporate
bond ratings. These factors have increased the
cost of debt available in Australia.
The rising cost of debt and falling equity prices
have also been accompanied by a decrease in
global M&A activity. Many industries no longer
Appreciating Value
2
have strong inorganic growth prospects supporting
their valuations and those businesses looking to
sell or undergo a liquidity event, such as an initial
public offering (IPO), appear to have put the ideas
on hold.
Indeed, despite lower equity prices, large
Australian companies such as Brambles and
Qantas, which had previously contemplated share
buybacks, appear to have also delayed these
plans in favour of more cash and lower leverage
on their balance sheets.
Current sentiment amongst the majority of lenders
and investors is that the economic situation and
indeed most company outlooks, is uncertain at
best. Investors and lenders are demanding higher
returns for this uncertainty and subsequent
increases in debt margins have resulted. The
increased cost of debt has an immediate
increasing affect on a company’s WACC.
At PricewaterhouseCoopers (PwC) we have
undertaken a fifty five year historic analysis of the
debt margin above the 10-year risk free rate. The
purpose of the exercise is to approximate the
current cost of debt for companies looking to
refinance or take on additional borrowings and
further approximate the cost of similar debt in
several years time. A graph of the margin recorded
for the last fifty five years is shown on the next
page.
The graph indicates an average BBB spread of
1.7% for the fifty five year period and a 2.3%
spread for the last ten years. With the spread
being well over 3% since the beginning of 2008,
we are expecting high costs of debt for the majority
of companies in the short term. However, this
margin should be expected to revert towards the
long run average in the medium to long term.

BBB Spread
4.5
Margin above risk free rate (%)
4
3.5
3
2.5
2
1.5
1
0.5
12/2006
08/2004
04/2002
12/1999
08/1997
04/1995
12/1992
08/1990
04/1988
12/1985
08/1983
04/1981
12/1978
08/1976
04/1974
12/1971
08/1969
04/1967
12/1964
08/1962
04/1960
12/1957
08/1955
04/1953
0
Source: Bloomberg and PwC analysis
“Investment focus
shifted from desire for
company expansion
to stability”
In conclusion, the investment focus for lenders and
shareholders alike has shifted from desire for
company expansion to stability. In the current
times of uncertain credit, this means investors
prefer less debt on company balance sheets. The
observed increased cost of debt means companies
are likely to have their cash flows discounted at
higher rates by investors than previously.
Adam Cadwallader
Sydney
When will debt be cheap again?
The question “when will debt be cheap again?” is
often asked with regard to the current high credit
spreads in the aftermath of the US sub-prime
mortgage crisis. One way to attempt to respond to
this question is to assume that credit spreads are
mean reverting. Mean reversion refers to a
process whereby the variable has a tendency to
return to long term average values; a trait
frequently seen in interest rates. A mean
reversion analysis of credit spreads applies
statistical methods to determine the expected
length of time required for credit spreads to return
to around long term averages from current
historically high levels in the absence of any
exogenous shocks. We have undertaken such an
analysis of credit spreads based on the spread to
$US LIBOR of A rated 10 year maturity debt, as
shown below.
Mean Reversion Analysis of Spreads to $US LIBOR for A Rated Issuers of 10 year
Maturity Debt
180
Simulated Path
Reversion Path
95% CI
95% CI
160
Credit Spread (Basis Points)
140
120
100
80
60
40
20
Appreciating Value
3
0
0 Months
20 Months
Source: Bloomberg and PwC Analysis
40 Months
60 Months
80 Months
100 Months
120 Months

“In 20 months time the
credit spread averages
is expected to decline to
approximately 97 basis
points over $US LIBOR”
Initially, the expected reversion path (the dotted
line) displays a steady downward trajectory before
the slope assumes a flatter structure as long term
credit spread averages are approached. This
analysis suggests that in 20 months time the credit
spread for A rated 10 year maturity debt is
expected to have declined to approximately 97
basis points over $US LIBOR from the current
spread of around 145 basis points (in the absence
of any additional shocks). The spread is then
expected to approach the long term average of
around 60 basis points over $US LIBOR in 80-100
months.
The chart also contains upper and lower risk
boundaries, established at a 95% significance level
to show projected variance surrounding the future
path of credit spreads during the forecast period.
As is the case with most analyses in finance, this
result is subject to many assumptions, however it
is a useful perspective as it provides an insight into
what history suggests regarding when debt will be
cheap again.
James Johnston
Melbourne
Economics in brief
A ‘macro’ point of view
“Business investment
surging by 2.9%”
The economic outlook has darkened significantly
since last quarter. On the domestic front we have
seen the spectacular depreciation of the $A, a
decline in economic growth, the peaking of the
interest rate cycle and some wild swings in both
consumer and business confidence. However in
the months ahead it will be the international
developments being most keenly watched.
The turmoil within major US financial institutions is
currently playing havoc with world markets and the
stability of the finance sector, while a very close
eye is being kept on the economic health of our
major trading partners and their demand for our
resources.
The reduction signals a policy shift by the RBA
away from targeting the increasing rate of inflation
(currently 4.5% y-o-y), towards protecting against a
more sustained downturn in economic growth.
Chart 2: Interest rate peak and forecast
Business investment driving growth
The Australian economy grew by 0.3% in Q2 2008
relative to Q1 2008 (see Chart 1 below). Business
investment and exports drove this growth, surging
by 2.9% and 2.7% quarter-on-quarter respectively.
However consumer spending, which accounts for
roughly two thirds of GDP activity, experienced
negative growth for the first time since 1993, down
0.1% q-o-q.
Chart 1: Quarter-on-quarter growth rates
The rate cut has been welcomed by consumers
who contributed a 0.1% decline to GDP growth
during Q2. Record oil prices, inflated food prices
and higher margins on commercial lending drove
the Q2 result. Consumer confidence subsequently
dropped to a 17 year low, reflecting the pressure
these forces were exerting on households.
However interest rate relief and moderating food
and oil prices, combined with tax cuts to the value
of $31 billion delivered on 1 July, will hopefully
improve consumer spending during the second
half of 2008. This would be good news for the
embattled retail sector who, according to the
Australian Bureau of Statistics, have experienced
four months of declining turnover during the first
half of the year.
Australian dollar tailspin
“First reduction in rates
for six years”
Appreciating Value
4
Interest rates start to fall
The interest rate cycle has peaked with the
Reserve Bank of Australia (RBA) reducing the
official cash rate by 25 basis points to 7.0%. This is
the first reduction in rates for over six years, with
the market factoring in a second 25 basis point cut
before Christmas (see Chart 2).
The Australian dollar has plunged off recent highs
of US98.5c to a low of approximately US80c (see
Chart 3 below). The recent strength of the dollar
has allowed the mining and resources sectors to
cash in on record high international commodity
prices. This is reflected in the Q2 export growth, up
2.7% q-o-q, which has helped Australia’s terms of
trade leap 13.1% q-o-q.

“Business is currently
balancing the
pessimistic signs
flowing from US and
European markets with
domestic strength and
the optimism
underpinned by
commodity demand
from China”
However softening commodity prices, the falling
official cash rate and resurgent US dollar have
since led to an 18% fall in the value of the
Australian dollar in the space of six weeks. While a
weaker Australian dollar adds to the risk of
importing inflationary pressures from trading
partners, it is a relief for the domestic
manufacturing sector as Australian goods become
more competitive on the world markets. The
increasing price consumers will have to pay for
imported goods could also act to stem import
demand and help to narrow the current account
deficit.
Not pessimistic or optimistic, just cautious
Business is currently balancing the pessimistic
signs flowing from US and European markets with
domestic strength and the optimism underpinned
by commodity demand from China. Against this
backdrop we expect a continued slowing of GDP
growth during 2008 to 2.6%, with the slowdown
expected stabilise at 2.5% GDP growth during
2009.
Chart 3: Australian dollar against the US
dollar
Key metrics
Indicator
2006
2007
2008f
2009f
GDP growth
2.7%
4.2%
2.6%
2.5%
Consumer spending
3.1%
4.5%
2.5%
2.4%
Government
3.2%
2.4%
3.5%
2.0%
Investment
5.4%
9.1%
7.6%
4.8%
Export
3.3%
3.2%
6.0%
5.9%
Imports
7.2%
10.8%
11.7%
6.3%
3.6%
2.4%
4.4%
3.3%
6.25%
6.75%
6.00% *
↓
Real growth (annual % change)
Inflation
CPI (annual % change, average)
Interest rates
Base interest rate (EOP)
Source: Australian Bureau of Statistics; Reserve Bank of Australia;
PricewaterhouseCoopers forecasts (f)
*Rate as of September 2008 is 7.00%
James Liddy
Sydney
Appreciating Value
5

ASX Industry Market Multiples
As of 24 September 2008
Industry
No. of
companies
EV/EBITDA
Multiple
P/E
Multiple
9
9.5x
12.4x
Consumer Durables and Apparel
Consumer Services
25
31
5.1x
9.3x
9.6x
14.5x
Media
Retailing
39
35
8.2x
7.5x
11.2x
11.2x
7
12.2x
20.6x
40
1
9.7x
7.5x
13.1x
10.6x
189
9.4x
12.2x
Consumer Discretionary
Automobiles and Components
Consumer Staples
Food and Staples Retailing
Food, Beverage and Tobacco
Household and Personal Products
Energy
Energy
Financials
Banks
Diversified Financials
Insurance
Real Estate
Healthcare
Healthcare Equipment and Services
Pharmaceuticals, Biotechnology and Life Sciences
Industrials
Capital Goods
Commercial Services and Supplies
Transportation
Information Technology
Semiconductors and Semiconductor Equipment
Software and Services
Technology Hardware and Equipment
Materials
Materials
15
N/A
12.6x
148
9
8.0x
14.4x
10.1x
20.1x
89
12.0x
10.6x
70
72
9.9x
6.6x
17.3x
14.5x
98
7.2x
11.1x
57
20
7.9x
7.6x
11.4x
10.4x
3
N/A
N/A
69
33
7.4x
9.5x
13.4x
8.9x
568
6.1x
11.4x
Telecommunication Services
Telecommunication Services
28
6.4x
13.0x
Utilities
Utilities
23
13.3x
8.9x
1678
8.1x
12.6x
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
Appreciating Value
6
Sholto Maconochie
Henry Kim
Sydney
Sydney

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 Chartered Financial Analysts.
We work with our clients to improve their
performance by ensuring there is rigorous analysis
underpinning key management decisions.
Our services include:
•
Business value analysis – business unit
performance analysis, employee reward
structuring and cost of capital analysis
•
Investment analysis – pre-investment financial
analysis and post investment financial
evaluation
•
Deal value analysis – transaction value advice
and commercial advocacy.
•
Valuation opinions – financial reporting and tax
values and independent expert reports
Contacts
Perth
Andrew Edwards
 +61 (8) 9238 3318
 andrew.edwards@au.pwc.com
Roger Port
 +61 (8) 9238 3476
 roger.port@au.pwc.com
Brisbane
Andrew Wellington
 +61 (7) 3257 8816
 andrew.wellington@au.pwc.com
Sydney
Mark Reading
Melbourne
Nigel Smythe
Kevin Reeves
 +61 (3) 8603 3970
 +61 (2) 8266 0617
 kevin.reeves@au.pwc.com
 nigel.smythe@au.pwc.com
John Studley
Appreciating Value
7
 +61 (2) 8266 2963
 mark.reading@au.pwc.com
 +61 (3) 8603 3770
 john.w.studley@au.pwc.com