Valuation Project
BAFI 403
12/08/2007
Johannes Albrecht
Ryan Arlia
Jim Reese
Siddharth Sharma
Peter Zale
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
Executive Summary
Goodyear Tire and Rubber Company has gone through great change in the last
ten years, barely skirting bankruptcy as it dealt with recession, labor difficulties
and changing demand in the tire market. Avoiding default by mere days, it has
rebounded to become a “buy” in most analyst’s portfolios.
Goodyear began its transformation by realizing the growth market for tires
was moving away from the commodity-based low margin tires it had featured to
higher margin differentiated tires for targeted markets. The strategy requires
Goodyear be less leveraged and more equity financed as the risk of selling
differentiated tires is greater than that of cheaper commodity tires. Goodyear’s
excessive level of debt could not allow for any more risk.
Goodyear is changing from being a highly leveraged high dividend producing
company to being a no to low dividend growth company, featuring differentiated
tires given value by Goodyear’s superior R&D capability and its worldwide
brand equity.
Based on our assessment of Goodyear’s current financial and market
structure, have set a price target of $40 for Goodyear’s common stock.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
2
Summary Slide
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Company Background
Executive Summary
Industry Information
Goodyear Positioning
Goodyear Strategy
Competitive Analysis
Financial Analysis
Cash Flow Analysis
Valuation Analysis
3 Economic Scenarios and Assumptions
Best Estimates
Appendix
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
3
Company Background
The Goodyear Tire and Rubber Company was founded in 1898 by F. A. Seiberling
in Akron, OH. Goodyear specializes in the design, manufacture and distribution of
tires for automotive and industrial applications. They operate 60 plants in 26
countries for distribution to 185 countries around the globe. Revenues are
generated through five operating units based on geographic regions – North America,
Latin America, European Union, Asia Pacific, and Eastern Europe (which includes the
Middle East and Africa).
Goodyear had 2006 revenues of $20.3 billion on the sale of 215 million tire units.
In 2007, Goodyear sold off its Engineered Products division, which accounted for
approximately $1.5 billion in sales for 2006
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
4
Industry Information
The tire industry sells through two basic channels:
 Original Equipment auto manufacturers (OE)
 Replacement
The original equipment market has traditionally been an outlet where
manufacturers could sell many units of guaranteed business while minimizing
SKU’s. In addition, the fitments on popular vehicles would result in replacement
sets of the same brand when the originals wore out.
Today, with the popularity of leases and higher vehicle turnover, this logic no
longer holds true. The OE business is still a good source of high volume but most
fitments are either provided at a financial loss or a very small margin.
The replacement market has become a much more profitable segment for tire
makers. The popularity of large diameter aftermarket wheels has created a
sweet spot in the industry for manufacturers who can produce large bead
diameter tires – margins on these units can be well over $100 per tire.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
5
Goodyear Positioning
In 2003 Goodyear was on the brink of bankruptcy. They were overloaded
with debt and suffering from years of mis-management. In 1998 Goodyear
had net income of nearly $700 million, by 2002, they were loosing nearly $1
billion per year.
Goodyear had sought a growth strategy that involved acquiring
businesses to grow market share. Many smaller tire companies were
purchased around the globe. This strategy culminated in the purchase of 75%
of Dunlop Tires from SRI in 1999 for $125 billion. All of this consolidation
activity put Goodyear deep in debt. The weak economy that followed
combined with Goodyear’s failure to capitalize on the newly acquired brands
lead to a string of financial losses for the years 2001-2003.
Goodyear is now in the 4th year of their turnaround plan. Much attention
has been put on improvement in leadership, products, quality, cost and
finances. Steady improvement has been achieved and the Goodyear
management team believes that they have turned the corner and are gaining
momentum towards profitability.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
6
Goodyear Strategy
Goodyear has stated the following strategies to
achieve their long and short term goals:
 Improved Product Mix
 De-leveraging of the firm
 Cost Saving
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
7
Goodyear Strategy
Improved Product Mix
 Revitalize brand image and position brands for greater market
differentiation
 Goodyear, Dunlop, and Kelly brands
 Focus development on premium branded products
 Recent activity includes launches of highly successful “ICON”
products including Assurance, Wrangler, Fortera, and Eagle
products
 Reduce unit volume on value-line tires that have low profitability
 Exited 8 million units of private brand tires in 2006
 Invest in capacity for larger rim diameter tires
Source: Goodyear 3Q2007 Earnings Presentation, Goodyear.com
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
8
Goodyear Strategy
Cost Saving


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

Continuous improvement/USWA union contract
Footprint reduction
Asia sourcing
SAG reduction
VEBA Insurance Deal
Gross Anticipated Savings: $1.8 - $2.0 Billion Over 4 Years
Source: Goodyear 3Q2007 Earnings Presentation, Goodyear.com
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
9
Goodyear Strategy
De-leveraging/Improved Balance Sheet
 Reduce long term debt*
 2006 sold Farm Business Unit
 2007 sold Engineered Products Unit ($1.4 billion)
 2007 equity offering ($833 million)
*Reduced LT debt from $7.2B in Dec ‘06 to $5.0B in Sept. ‘07
Source: Goodyear 3Q2007 Earnings Presentation, Goodyear.com
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
10
Competitive and Financial Analyses
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
Competitive Analysis
 Business Analysis
In the first part of this section, current industry conditions as well as
historical developments in the industry are described in order to establish
a qualitative framework for the subsequent financial analysis.
 Industry Analysis
The following Porter analysis provides insights into each major tire
industry player’s profit potential within the industry, given each firm’s
intentions to compete and their specific aims to exploit synergies across
the range of businesses in which they operate.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
12
Competitive Analysis
 5 forces Analysis


The above table shows that each of the major tire companies faces pretty much the same competitive
landscape and industry pressures.
Also the table shows that, from a Porter perspective, the tire industry is relatively unattractive with three areas
scoring “High”.
 Raw material suppliers can exercise high pressure on the prices for their input materials in tire manufacturing
due to strong competition in a rather commoditized market.
 Buyers can exercise high power which keeps prices low.
 Threat of substitutes is low which is favorable for the existing players.
 Threat of new entry is low since new entrants are rather not attracted due to the commodity nature of the
environment. Also initial costs of entry (creating a manufacturing capability) are high.
 However, new competition is seen in growing markets such as China, which already has impacted the threat
of the new entrants-pressure structure.
 That said, each of the major players differentiates itself from its competitors in unique ways relating to
diversification (Continental), footprint (Bridgestone), premium brand (Michelin) and overall reputation and
reputation for new product development (Goodyear).
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
13
Competitive Analysis
 SWOT Analysis
Competitor Analysis: Goodyear (USA), Michelin (FR), Bridgestone (JP), Continental Tire (GE).
In the SWOT analysis we begin to see some of the differentiation occurring between the major
players in the tire industry. We also see the similar threats faced more or less by all of them.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
14
Competitive Analysis
 Market, Segment and Products
 Over the last ten years, Goodyear, Bridgestone, Michelin and
Continental have all faced challenges presented by rising raw
material costs and a global excess in manufacturing capacity.
 Petroleum, steel, and natural rubber are the primary materials
used in tires and prices rose greatly over the last few years.
 Stagnating markets in North America and the European Union,
along with the expansion of manufacturing capacities in Asia means
that more tires can be made than can be sold.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
15
Competitive Analysis
 Market, Segment and Products (Cont.)
 To counteract these conditions, each company has adopted a
different strategy and focused on different segments.
 Until 2003 Goodyear focused its strategy on high volume, low
value tires while it grew its top line.
 Michelin focused on high end-premium tires and followed
a strict branding hierarchy.
 Continental is a much more diversified company
(a good % of its business being in automobile electronics)
and deals in both high and low end tires.
 Bridgestone focused on a rounded product portfolio and
leveraged its vertical integration; mainly its large stake in
rubber raw material production.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
16
Competitive Analysis
 Market, Segment and Products (Cont.)
 Currently, Goodyear is well positioned for future success.
 The brand is strong and well positioned in the market.
 It’s perceived as a quality brand with a good pipeline of
new products.
 It is widely recognizable around the world and is consistently
voted as one of the top and most admired companies.
 Recent product introductions followed by industry
accolades are helping Goodyear move towards a higher
margin product mix and are driving top line growth.
 This growth, coupled with aggressive cost cutting
measures and landmark labor agreements have set the
stage for financial success moving forward.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
17
Competitor Analysis: Michelin
PROFITABILITY
12/31/2006
12/31/2005
12/31/2004
12/31/2003
12/31/2002
Return On Assets
Return On Invested
Capital
Cost of Goods Sold To
Sales
Gross Profit Margin
Operating Profit
Margin
ASSET
UTILIZATION
RATIOS
Assets
Turnover
4.61
6.91
3.94
2.69
4.24
7.61
11.68
6.65
4.57
7.3
65.81
64.35
66.5
67.47
66.75
28.88
30.5
28.19
25.01
27.35
8.03
8.75
4.8
1.49
4.72
12/31/2006
12/31/2005
12/31/2004
12/31/2003
12/31/2002
1.03
1
0.97
0.95
0.96
Inventory Turnover
3.28
3.3
3.71
3.68
3.39
LEVERAGE
12/31/2006
12/31/2005
12/31/2004
12/31/2003
12/31/2002
104.62
105.05
106.02
120.61
117.25
62.09
58.18
60.95
56.55
57.09
30.83
30.27
30.17
32.26
30.9
29.47
28.82
28.46
26.74
26.35
47.47
49.53
46.69
47.3
46.16
33.74
20.39
25.88
41.16
19.53
LIQUIDITY
12/31/2006
12/31/2005
12/31/2004
12/31/2003
12/31/2002
Quick Ratio
0.78
0.89
0.9
0.96
0.92
Current Ratio
1.35
1.49
1.65
1.72
1.78
Inventories Days Held
111.16
110.66
98.44
99.08
107.69
Total Debt Pct
Common Equity
Equity Pct Total
Capital
Total Debt Pct Total
Assets
Common Equity Pct
Total Assets
Total Capital Pct Total
Assets
Dividend Payout
WSOM
BAFI
BAFI
403403
– Goodyear
– Goodyear
Tire
Tire
&Rubber
& Rubber
Company
Company
Valuation
Valuation
18
Competitor Analysis: Bridgestone
PROFITABILITY
12/31/2006
12/31/2005
12/31/2004
12/31/2003
12/31/2002
Return On Assets
Return On Invested
Capital
Cost of Goods Sold
To Sales
Gross Profit M argin
Operating Profit
M argin
AS S ET
UTILIZATION
Assets Turnover
Inventory Turnover
3.65
7.98
5.56
4.59
2.45
5.43
12.05
8.52
7.04
3.57
62.81
60.96
59.48
58.75
57.93
32.33
34.3
35.91
36.72
36.76
6.38
7.95
8.18
7.96
8.18
12/31/2006
12/31/2005
12/31/2004
12/31/2003
12/31/2002
1.03
3.7
1.05
3.91
1.07
3.98
1.08
4.02
1.11
3.91
12/31/2006
12/31/2005
12/31/2004
12/31/2003
12/31/2002
59.78
51.37
51.29
54.87
59.07
73.72
74.5
73.32
67.07
70.84
24.39
22.54
21.33
22.83
23.19
40.8
43.88
41.58
41.6
39.26
55.35
58.9
56.71
62.03
55.42
23.86
9.28
11.58
15.21
30.33
LIQUIDITY
12/31/2006
12/31/2005
12/31/2004
12/31/2003
12/31/2002
Quick Ratio
Current Ratio
Inventories Days
Held
0.76
1.48
0.84
1.54
0.98
1.67
1.22
2.06
0.94
1.68
98.54
93.26
91.79
90.86
93.3
LEVERAGE
Total Debt Pct
Common Equity
Equity Pct Total
Capital
Total Debt Pct Total
Assets
Common Equity Pct
Total Assets
Total Capital Pct
Total Assets
Dividend Payout
WSOM
BAFI
BAFI
403403
– Goodyear
– Goodyear
Tire
Tire
&Rubber
& Rubber
Company
Company
Valuation
Valuation
19
Financial Analysis
 This section assesses Goodyear’s current and past performance as
well as its expected future financial prospects.
 First, the product market performance is considered using
ratio-analysis.
 Second, cash-flow analysis is used to determine the firm’s liquidity
and financial flexibility and discusses business risk.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
20
Financial Analysis
 Goodyear 10 year historical strategy & performance
 The years from 1997 to 2007 can be divided off into two sections to
tell an effective story about Goodyear.
 2001-2002 should be considered the turning point for
the company.
 At this point, the previous strategic direction the firm had
adopted nearly put them into bankruptcy.
 This was avoided by days and now the firm is on what
should be considered a sounder footing and direction.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
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Financial Analysis
 Goodyear 10 year historical strategy & performance
 The new President and CEO Robert J. Keegan took over the office
at Goodyear in 2002 and announced “the future begins now” with a
solid turnaround strategy of restoring profitability and growth for
the troubled company.
 The period from 1997-2002 was dominated by a more
commodity based sales strategy, as Goodyear strove to grow its
market share selling OE and private branded “value” tires to
please its shareholders with average dividend payouts of 30% of
cash flow provided by operating activities.
 The company’s stock grew impressively during this time
reaching a height of $75 per share.
 Likewise during this time Goodyear leveraged itself quite
aggressively. In fact, we noticed that there was very possibly
a strategy being employed by the shareholders to, in effect,
“milk” the company as its increased leverage led to an
escalating stock price and returns for shareholders.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
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Financial Analysis
 Goodyear 10 year historical strategy & performance (Cont.)
 In 2000, when the stock market fell, the company began a slide
towards financial distress.
 In 2002, enforced by a non-cash charge of $1.2 billion in tax
provisions, the firm reported a net loss of $1.22 billion.
 The troubles culminated in the firm facing bankruptcy in early 2003
when it issued $1.3 billion long-term debt securities.
 The company however was supported by its continued strong
R&D capability, focus on innovation, leadership, and brand
building which allowed it to launch several successful new
products just at the right time to help it skirt the most severe
financial troubles and buoy it for restructuring which continues
to the present.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
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Financial Analysis
 Goodyear 10 year historical strategy & performance (Cont.)
 The focus in 2004 and 2005 was on higher margin products and
increased market and customer focus which successfully
drove sales.
 In 2006, Goodyear announced that it would exit about half of its
private branded value-line business, reducing it by approximately 8
MM units. Also, it has begun outsourcing some of the remaining
value-line production to Chinese suppliers.
 This strategy allowed Goodyear to close down high cost plants
in North America and lower the costs associated with producing
low margin products.
 The strategy involves some risk however as the manufacturers
sourcing the product are outfitted to produce higher value
added products (the various sized tires spoken of earlier).
 These suppliers could be tempted to leave the partnership with
Goodyear if another “suitor”, more closely aligned with their
best capabilities, approached them for tire supply.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
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Financial Analysis
 Goodyear 10 year historical strategy & performance (Cont.)
 In addition to product mix, Goodyear also is expanding capacity in Asia
and Eastern Europe to serve those growing markets.
 Investment in its own facilities in countries like China presents a risk in
that the Chinese government cannot be completely trusted to not
“nationalize” foreign industry.
 Similar threats have been carried out in Venezuela.
 We don’t consider this a high or even medium threat presently, but the
regime in China is such that we cannot completely dismiss this
possibility, particularly with the nation’s extraordinarily rapid growth
and what could well be concomitant social, economic and
environmental turbulence.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
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Financial Analysis
 Goodyear 10 year historical strategy & performance (Cont.)
 In 2007, Goodyear extended an equity offering of 23 million shares of
common stock, earning the company about $850 million.
 This is being put towards refitting its manufacturing capability so
that it may address the changing needs of the tire market which
now requires a wide variety of different sized tires
(13”-22”) for various standard cars and light and heavy trucks. Also
Goodyear is interested in the growing airline tire market.
 Also, Goodyear recently sold its Engineered Products Division for
roughly $1.4 billion and used the money to restructure its debt.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
26
Financial Analysis
 10-year overview of net sales, gross profit and net income
Net Sales
Gross Profit
Net Income
25,000.00
20,000.00
15,000.00
10,000.00
5,000.00
0.00
12/31/97
12/31/98
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
12/31/99
12/31/00
12/31/01
12/31/02
12/31/03
12/31/04
12/31/05
12/31/06
-5,000.00
Figure 1: Profitability
27
Financial Analysis
 The margins
 It is interesting to observe that between 2003 and 2006, sales
increased about 30% from $15 billion to $20 billion dollars per year
indicating that the turnaround efforts were gaining momentum
from a sales volume perspective.
 At the same time though gross-profit declined which indicates that
Goodyear’s ability to turn sales dollars into profits was impaired.
 This stems from increasingly more expensive raw materials
such as rubber, oil, and steel.
 The price for natural rubber had doubled during 2006 and
remains at high level. According to the 2006 annual report,
overall a 17% increase in all raw materials was pressuring on
Goodyear’s margins.
 In addition, Goodyear appears to have had difficulties passing along
price increases through sales to customers, which could be related
to strong competition in a rather commoditized product market,
where low cost is an important driver of overall performance.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
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Financial Analysis
 Current Profitability and comparison with Competition
 Goodyear vs. Michelin
 Looking at Michelin’s asset management, Michelin consistently
reports a lower Inventory Turnover Ratio than Goodyear due to
maintaining higher levels of inventory.
 Goodyear is also performing better in regards to managing its
accounts receivable, beating out Michelin by 30 days in 2006 in
its Accounts Receivable Days Ratio.
 This of course reflects Goodyear’s value tire strategy of
greater sales of less expensive tires.
 One might almost consider this a “Wal-mart like” strategy
of beating the competition with quicker turnover leading
to faster sales, smaller inventory and handling costs and
buyer power with suppliers from whom you can possibly
command smaller charges because you are paying them
faster and thus lessening their own need to finance.
 Goodyear also maintains higher liquidity ratios than its
competitor Michelin.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
29
Financial Analysis
 Current Profitability and comparison with Competition (Cont.)
 Goodyear vs. Michelin
 In the past four years, Goodyear has kept its Quick Ratio above
a 1.0, whereas Michelin has failed reach this level of liquidity
in the past five.
 Decision makers should also note that Michelin’s liquidity level
has been on the decline year after year, while Goodyear has
shown improved liquidity over the same given time frame.
 Overall Goodyear is showing good working capital management
along with a stable cash flow position as illustrated in Figure 5.
 Turning to profitability performance, Michelin seems to be
operating more efficiently in relation to Goodyear, reporting a
higher Operating Profit Margin for the past three years.
 Michelin’s ROA and Gross Profit Margin have also been higher
than Goodyear’s in the past five years.
 Goodyear’s poor profitability performance seems to be
attributable to the company’s higher costs directly related to
costs of goods sold as seen in Figure 3.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
30
Financial Analysis
 Current Profitability and comparison with Competition (Cont.)
 Bridgestone Analysis
 Bridgestone’s Inventory Ratio falls just short of Goodyear’s
figures every year for the past five years.
 Bridgestone’s Asset Turnover ratio has decreased every year
for the past five years.
 On the other hand, Bridgestone’s asset management earns
high marks for gradually reducing its Accounts Receivable
Days Ratio 14% over the last five years.
 However, this ratio still does not compare to the low
levels of Goodyear’s receivables.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
31
Financial Analysis
 Current Profitability and comparison with Competition (Cont.)
 Taking a look at Bridgestone’s financial management ratios,
one can see significant decreases in company liquidity.
 Bridgestone’s Current Ratio declines every year for the
past four years for a combined 28% drop, while
Bridgestone’s Quick Ratio declines every year for the past
four years as well for a combined 38% drop.
 Despite these apparent changes in company liquidity, there is
little need for concern as the current level of these ratios
remains relatively safe.
 Approaching 2006, Bridgestone, and the entire tire industry,
appear to be slowly losing profit margins.
 However, Bridgestone has still managed to consistently
produce higher Gross Profit Margins and Operating Profit
Margins than Goodyear over the past five years.
 The resulting depressed profitability figures for Goodyear
resonates in the company’s high cost of goods sold
(see Figure 3).
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
32
Financial Analysis
 Gross-Profit Margin Comparison
Gross-Profit Margin
40.00
35.00
30.00
%
25.00
20.00
15.00
10.00
5.00
0.00
12/31/06
12/31/05
12/31/04
12/31/03
12/31/02
Year
Goodyear Tire & Rubber Company
Bridgestone Corporation
Michelin
Figure 2: Gross-Profit Margin comparison
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
33
Financial Analysis
 Operating Profit Margin Comparison
Operating Profit Margin
10.00
9.00
8.00
7.00
%
6.00
5.00
4.00
3.00
2.00
1.00
0.00
12/31/06
12/31/05
12/31/04
Goodyear Tire & Rubber Company
12/31/03
Bridgestone Corporation
12/31/02
Michelin
Figure 3: Operating Profit Margi
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
34
Financial Analysis
 Net Profit Margin Comparison
Net Profit Margin
8.00
6.00
4.00
2.00
0.00
%
12/31/06
12/31/05
12/31/04
12/31/03
12/31/02
-2.00
-4.00
-6.00
-8.00
-10.00
Goodyear Tire & Rubber Company
Bridgestone Corporation
Michelin
Figure 4: Net Profit Margin
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
35
Financial Analysis
 Current Profitability and comparison with Competition (Cont.)
 The overall lower operating profit margin of Goodyear compared to
Bridgestone could indicate that the firm pursued a differentiation
strategy which requires overall higher SG&A costs, more R&D, more
frequent new product introductions, high-end products, branding
activities, support and full service activities.
 However, the overall lower gross-margins contradict the
differentiation strategy and suggest rather a low-cost approach.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
36
Financial Analysis
 Current Profitability and comparison with Competition (Cont.)
 Michelin has been able to improve its operating management
between 2003 and 2005 significantly and outperformed both
Goodyear as well as Bridgestone in 2005 and 2006.
 What business activities cause Goodyear to under perform at the
operating margin? Goodyear’s strategy through the 1990’s focused
on high-volume, value-line tires with small margins. Michelin has
focused on the premium, high-margin segment. As raw material
prices have increased, the margins on the value-line products have
been reduced by a higher percentage. This has resulted in much
lower operating margin for Goodyear when compared to Michelin
and even Bridgestone.
 Goodyear’s strategy moving forward is to focus on reducing their
share of the value-line business and increasing their share of the
premium, high-margin business. They are also aggressively pursuing
cost reductions in materials, manufacturing and other operations.
These strategies should help Goodyear command more dollars per
tire in price and reduce the cost per tire to manufacture. The
coupling of these strategies will result in higher operating margins
and more flexibility to compete for shelf space with competitors.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
37
Cash Flow Analysis
 Cash Flows
 Despite a 300 million loss in 2006, Goodyear was able to generate
positive cash flow from operating activities during the year.
 Overall, the firm has had positive cash flow from operating
activities throughout all ten years with exception of 2003.
 Cash flows from operating activities appear to be quite
volatile though.
 Significant investments in property plant and equipment have
been made in 1999 and 1998 and at a smaller scale
continuously throughout the remaining years.
 Three major financing events occurred.
 In 1999, the firm increased borrowings by $1.4 billion.
 In 2003 it added $1.4 billion in debt.
 In 2006, the firm issued $1.7 billion debt.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
38
Cash Flow Analysis
 Cash Flows
 As discussed earlier the 2003 debt issuance had to do with the
turnaround and refinancing activities in the face of distress.
 The fact, that the company yet again issued significant portion
of debt in 2006, indicates that it still faces
significant difficulties.
 The 2006 annual report discloses that Goodyear has sold off
several non-core businesses and continuous with this
divestment strategy.
 Change in cash has been positive and increasing; the strongest peak
being in 2006, when the firm was able to increase cash by 80%
compared to the beginning of the year.
 Net income and net cash from operations are moving closely
together, particularly in the last 3 years. This indicates no unusual
events for Goodyear’s accounting policies or practices. The Cash
flow from operations to sales ratio declined in 2006 to 30% which
indicates that the firm struggles increasingly to translate sales
dollars into cash compared to 2005 and 2004, when 40% of sales
manifested in cash flow from operations.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
39
Cash Flow Analysis
 Cash Flows
Cash Flows
2,000.00
1,500.00
1,000.00
500.00
0.00
12/31/06
12/31/05
12/31/04
12/31/03
12/31/02
12/31/01
12/31/00
12/31/99
12/31/98
12/31/97
-500.00
-1,000.00
-1,500.00
-2,000.00
Cash Flow Provided By Operating Activity
Cash Flow Provided By Investing Activity
Cash Flow Provide By Financing Activity
Net Change in Cash or Equivalents
Figure 5: Cash Flows
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
40
Cash Flow Analysis
 Income and CFO
1,500.00
1,000.00
500.00
0.00
12/31/06
12/31/05
12/31/04
12/31/03
12/31/02
12/31/01
12/31/00
12/31/99
12/31/98
12/31/97
-500.00
-1,000.00
-1,500.00
Net Income(Loss)
Net Cash Provision (Used) By Operations
Figure 6: Income and CFO
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
41
Cash Flow Analysis
 Future prospects, growth potential, and business risk
for Goodyear
 Goodyear’s results of operations, financial position and liquidity
could be adversely affected in future periods by loss of market
share or lower demand in the replacement market or the OE
industry, which would result in lower levels of plant utilization and
an increase in unit costs.
 Also, the firm could experience higher raw material and energy
costs in future periods.
 These costs, if incurred, may not be recoverable due to pricing
pressures present in today’s highly competitive market and
Goodyear may not be able to continue improving its product mix.
 Future results of operations are also dependent on the firm’s
ability to successfully implement cost reduction programs and
address increasing competition from low-cost manufacturers.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
42
Cash Flow Analysis
 Future prospects, growth potential, and business risk
for Goodyear (Cont.)
 With this, the major drivers of ROE are strongly limited as asset
turnover is expected to remain stable or otherwise decrease if demand
slows down and utilization decreases, profit margins will be crucial.
 However, the firm has had as discussed earlier much lower margins than
its competitors Michelin and Bridgestone and will struggle with these
due to environmental cost conditions pertaining to raw materials and
consumer unwillingness and inability to pay premium prices.
 The currently extreme high leverage most likely must be reduced in the
future and recent equity offerings confirm this trend, which in return
will impact ROE negatively.
 The overall growth rate is expected to align with averages in the US due
to the effect of mean reverting.
 Industry structure and competitive environment will also constitute
limitations to ROE.
 As a matter of fact, Goodyear has achieved high ROE’s solely due to
financial leverage and as this must decline in the future, ROE is
expected to be lower.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
43
Cash Flow Analysis
 Key Data
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
44
Cash Flow Analysis
 Future prospects, growth potential, and business risk
for Goodyear (Cont.)
 Comparing Goodyear to its competitors in a couple of key margins
provides insight into the future business risk which must be
considered highest among the three compared companies.
 The key drivers of ROE indicate various strategies toward
return generation.
 While Goodyear shows low margins compared to the competitors, it
has higher asset turnover.
 In an environment with dominating market share and stable
demand for products, this position of Goodyear might be
sustainable.
 However, industry structure and future expected developments as
described, indicate that weak margins cannot be compensated
which results in an overall low return on assets for Goodyear versus
Bridgestone and Michelin.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
45
Cash Flow Analysis
 Future prospects, growth potential, and business risk
for Goodyear (Cont.)
 The other key driver for ROE is financial leverage and it is obvious
that Goodyear, in contrast to its competitors, is pursuing a
different financial policy with a highly levered balance sheet.
 This can result in excessive shareholder returns during stable
business environments, however, in unstable environments it can
pose a major business risk.
 The high beta for Goodyear of 2.6 indicates that investors
internalize these circumstances as they reflect a higher volatility of
stock prices compared to the market.
 Bridgestone has the lowest beta of 0.9 followed by Michelin with
beta of 1.59, and 1.78 for the industry benchmark.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
46
Valuation Analysis
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
Purpose
 Based on preceding




Business and Industry Analysis of Goodyear
Historical and Financial Analysis
Competitor Comparison in the industry
Future economic prospect for the firm and the industry
 Conducting Valuation Analysis of Goodyear Rubber & Tire
 Over a 10 year time frame
 With the goal to determine ultimately the best estimate of
current stock price per share
 Based on 3 economic scenarios
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
48
Methodology for Valuation (DCF-Analysis)
 Using the Discounted Cash Flow Valuation
Technique
 Forecast essential financial statements
 Income Statement
 Balance Sheet
 Cash Flows
 Based on
 Percentage of Sales method
 And Assumptions about




Operational future performance of the firm
Expected capital structure policy changes
Expected cost of capital
3 General economic scenarios
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
49
Objectives
 Establish best estimate of Present Value:
 Of the Firm
 The Value of the Firm is obtained by discounting expected cash-flows to
the firm
 Cash flow to firm: the residual cash-flows after meeting all operating
expenses and taxes, but prior to debt payments and without the benefit
of tax-shelter
 Discount rate: weighted average cost of capital (WACC)
 Of Common Equity
 The Value of Equity is obtained by discounting expected cash-flows to
equity
 Cash flow to equity: the residual cash-flows after meeting expensed,
meeting all tax obligations and interest and principal payments
 Discount rate: rate of required return by equity investors (CAPM)
 Determine stock-price per share
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
50
Variable Forecasting Control Parameters
 Incremental Sales Growth Rate for each year
 Gross-Profit Margin
 Indicating the company’s ability to charge premium prices
 Lowering their costs of goods sold
 Operating-Profit Margin
 Operational efficiencies and ability to manage firm effectively
 Total Asset-Turnover
 Proxy for the ability of the firm to utilize assets and their
infrastructure. The need for further investment in property, plant
and equipment
 Debt / Equity
 How much leverage will the firm use in the future? What capital
structure policy changes might influence the return of the firm?
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
51
Variable Forecasting Control Parameters (cont.)
 Current Ratio
 Coverage of short term liabilities with cash and equivalents
 The Cost of Debt
 Depending on economic scenario, inflation, company bond rating
 The After Tax Cost of Debt
 The Cost of Equity
 Depending on risk premium, beta for the firm, and country risk
premium
 Beta for the Firm
 Based on historical movement of Goodyear’s stock vs. market
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
52
Fixed Firm-Specific Parameters
 The corporate tax rate for Goodyear assumed to be 35%
 Depreciation on PPE assumed to be 53%
 Estimated using historic average percentage of PPE
 Depreciation Expense per fiscal year assumed to be 4%
 Estimated using historic average percentage of Sales
 Current Liabilities portion assumed to be 24%
 Approximated using historic average of Sales
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
53
Fixed External Parameters
 Based on Financial-Market Research
 Risk Free Rate assumed to be 4.5%
 Computed based on 10 year average (1997-2007) of 10 Year
Government T-Bonds
 Expected Market Return assumed to be 8.3%
 Historical arithmetic average of S&P 500 since 1928 (80 years).
 Market Risk Premium assumed to be 3.8%
 20-year arithmetic Average
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
54
3 Economic Scenarios and Assumptions
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
Recession:
 Sales are going to decrease
 Margins are decreasing due to price pressure
 Leverage going up due to need for borrowing to cover
liquidity issues having low cf
 Beta estimated to be high due to bond grading, due to
leverage, due to risk
 Cost of debt is high at 9%
 Cost of equity is about 15%
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
56
Recession:
 The market and economy are stagnate or in recession. GT struggles
to grow sales revenue but maintains levels based on execution of
their product mix and cost cutting strategy. Low margins result in
the inability to de-leverage any further but the bad economy keeps
interest rates low.
 The soft economy keeps raw material cost increases lower than in
previous years. GT profit margin is flat via management execution
of strategic plan.
 The cyclical nature of markets see improvements by 2011
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
57
Recession (cont.)
 Cost of Equity = 15.9% (including
2% country related risk)
 WACC for the 10 years
forecasting period (to 2017)
 Beta 2.47
RECESSION
2007
Value of Equity
$
5,386
Stock Price
$
25.51
Value of Firm
$
12,629
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
58
Flat:
 Sales increase initially a little due to positive effect of product mix and
restructuring
 But then remain stable without much growth
 Decline slightly at the bottom of the period and will slight come back
 Margins decline slightly as the effect of products towards higher margin
products do not materialize fully
 Leverage will remain lower as the strategy and policy changes manifest
 Yet borrowing will become necessary again mid of period in order to
support lacking revenue streams
 Beta of 1.7 as rating improves due to restructuring then stable due to
un-levered balance sheet
 Then increasing to 1.9 mid term to reflect the new borrowings
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
59
Flat
 The market and economy are estimated to be relatively
flat. GT maintains a low growth in sales revenue based on
execution of their product mix strategy.
 The soft economy keeps raw material cost increases lower
than in previous years. GT profit margin increases slowly
via management execution of strategic plan
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
60
Flat (cont.)
 Cost of Equity = 13% (including
2% country related risk)
 WACC for the 10 years
forecasting period (to 2017)
 Beta 1.7
FLAT
2007
Value of Equity
$
7,762
Stock Price
$
36.76
Value of Firm
$
18,002
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
61
Boom
 20 B to 28 B B Net Sales is a reasonable assumption based
on
History steady increase rate in sales
Increased prices due to higher raw materials  higher margins
Product mix and strategy objectives fully materializing
Larger customer base
Emerging markets, more infrastructure
More international business
Approaching competitor margins due to high margin products
Un-levering the firm pays off and debt to equity is improved
Mid term new expansion and borrowings in order to benefit taxshelter again and increase ROE
 Cost of debt decreases as bond rating will improve
 Beta at the 10-years historic price fluctuations









WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
62
Boom
 The market and economy continue to grow. GT increases sales revenue
based on execution of their product mix strategy and strong global
presence.
 The growing economy sees raw material costs continue to increase but
they are offset by price increases and product mix. GT profit margin
increases rapidly via management execution of strategic plan
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
63
Boom (cont.)
 Cost of Equity = 12% (including
2% country related risk)
 WACC for the 10 years
forecasting period (to 2017)
 Beta 1.45
BOOM
2007
Value of Equity
$
14,249
Stock Price
$
67.48
Value of Firm
$
41,377
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
64
3 Sales Revenue Projections
Sales Revenue Forecast
30,000.00
28,000.00
26,000.00
$ MM
24,000.00
22,000.00
20,000.00
18,000.00
16,000.00
14,000.00
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Time
Boom
Flat
Recession
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
65
3 Different Stock Prices
Future Economic Outlook 10 years
RECESSION
FLAT
BOOM
2007
2007
2007
Value of Equity
Value of Equity
Value of Equity
$
5,386
$
7,762
$
14,249
Stock Price
Stock Price
Stock Price
$
$
$
25.51
Value of Firm
$
12,629
36.76
Value of Firm
$
18,002
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
67.48
Value of Firm
$
41,377
66
Best Estimate based on Probability
Best Estimate
Probabilities
2007
Boom = 20%
Flat = 50%
Recession = 30%
Value of Equity
$
8,346
Stock Price
$
40
Value of Firm
$
21,065
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
67
Best Estimates

Conclusion
Goodyear Tire and Rubber Company is well positioned to grow in profitability
in the next ten years in either a boom, flat or bust scenario. This is because
Goodyear has taken steps to align its corporate strategy with the changing
competitive landscape for its products and has adjusted its financial strategy to
fit this direction.
Goodyear is changing from being essentially a highly leveraged mass low
margin “cheaper” tire seller paying high dividends to shareholders to a more
equity financed higher margin targeted seller of quality, differentiated tires.
They will grow with this strategy because there is potential in the high margin
differentiated market in the otherwise flat North American and European markets
which comprise 75% of Goodyear’s sales. Goodyear can capture the growth in this
market by leveraging both its brand and its superior R&D capability.
Goodyear is supplementing this with a lower risk maintenance of low margin
tire selling to emerging markets in Eastern Europe, Asia and Latin America. Odds
are these markets will grow to become enamored of Goodyear’s higher margin
tires over time.
While there are risks due to increasing costs of raw materials and ever
increasing competition from rivals, we feel Goodyear is a good buy for investors
looking for a stable growth stock paying less dividends in the next ten years.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
68
Appendix
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
Country Risk


To estimate country risk, find country rating (www.moody.com) and
estimate default spread for rating over a default free government
bond rate.
 Basis: Traded country bonds.
This becomes the added risk for the country and is added to historical risk premium for a
mature equity market (U.S.) to get total risk premium.
 Multiply default spread by relative equity market volatility
(STD DEV. in country equity market/STD DEV. in country bond.)
 Emerging market average = 1.5 (emerging equity markets approx. 1.5 X more volatile
than bond markets.)
 Estimate of country Risk Premium.
 Add this to U.S. Historical Risk Premium of 3.8 to get the total risk premium.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
70
Country Risk
 Making Lambdas



Company has exposure to country risk different from exposure to all other market risk.
Call this Lambda and, like Beta, scale around 1
(>1 = greater country risk; <1 = less country risk)
The cost of equity for a firm in this market is written as:
Expected Return = Rf + Beta (Mature Market Risk) + λ (County Risk)
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
71
Country Risk
 Lambdas



Company’s risk exposure to country risk reflects revenues it derives from the country.
Goodyear can have exposure to country risk because it has revenues from and production
facilities within these markets.
Estimate Lambdas by revenues.
 A company getting a smaller % of its revenues from a market should be less exposed
to country risk than one with a larger %.
 To get Lambda, scale % of revenue company gets from a country, dividing it by % of
revenues all companies in the market get from the country, i.e. its local GDP.
 For example: Goodyear did approximately 0.018 (1.8%) of its business in Brazil
compared to .92 (92%) for the average company (8% of Brazil’s GDP was in
exports and 92% local), so we measure Lambda as 0.018 / 0.92 = 0.02 and we
multiply this by the country risk premium (0.0486) 4.86% which is the difference
between the mature equity risk premium of 0.038 (3.8%) and country premium
of 0.0866 (8.66%).
 0.0486 x .02 = 0.00097 and this is then added to the cost of capital. The
process is repeated for each country Goodyear does business in that has risk
beyond the mature market equity premium.
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
72
Country Risk for Goodyear






Estimate % business done in each country out of approx. $18.5 billion in net revenues.
N.America: $10 billion: US:
6 billion
= 30%
Canada:
2 billion
= 10%
Mexico:
2 billion
= 10%
European Union: $5 billion in sales
Average across 7 countries
$.71 billion EA
= 24.5% (3.5% EA)
Eastern Europe, Mideast, Africa: $1.6 billion
Average across all 3 countries
$.53 billion EA
= 7.2% (2.6% EA)
Latin America: $1.8 billion
Average across all 5 countries
$.36 billion EA
= 9% (1.8% EA)
Asia Pacific: $1.6 billion
Average across all 11 countries
$.145 billion EA
= 8% (.72% EA.)
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
73
Country Risk
(2.1%)
WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation
74