Archivo de septiembre/2009

How to calculate a exit value? or how to do an easy valuation of the equity of a firm?

If you value all the cash flows of a company, but as a shareholder you assume that you sell your equity after 5 years (that cash coming from that sale is the so called “terminal value”).

The easiest way to calculate an exit value (terminal value) is to use a ratio to produce a quick calculation.

Depending on the industry, ratios do differ.

This example will be appreciated by all of you that want to pursue a career in marketing (P&G, Unilever, L’Oreal, etc).

Once you master the discounted cash flows techniques is always good to remember that the most used procedures are much more simple -> Comparable Firm Ratios.

For example… Companies like Unilever, Loreal, P&G tend to use the ratio: Firm Value to Sales, not to be confused by Price to Earnings (PER).

Firm Value = Debt + Equity, but these type of companies do not have much debt, so the ratio is often confused with Equity to Sales.
This blog refers to the acquisition of the Soap´s unit of Sara Lee Corp by Unilever.

If you read this article (Source: Bloomberg) you will realize that… Unilever’s offer price values Sara Lee’s body-care operations at 1.7 times annual revenue. In 2006, L’Oreal SA bought Body Shop International Plc for 1.5 times its sales.

So you see… that the ratio “equity price to sales” is the most used in that industry because its a «revenue-driven» industry.

So if you want to value a firm like Loreal, just multiply their revenues by a ratio (1.5x – 2x) and you will obtain a pretty accurate “back of the envelope” calculation of the value of the shares (= equity value = Market Capitalisation).

As I said if that company has financial debt, you need to subtract that debt to achieve the value of the equity. Because the ratio should be Firm Value / Sales.
See below for the article:

Unilever, the maker of Dove soap, agreed to buy Sara Lee Corp.’s personal-care and European detergent unit for 1.28 billion euros ($1.88 billion), gaining Sanex shower gel in its biggest purchase in nine years.

Unilever, based in London and Rotterdam, will pay cash for the business, which makes Duschdas and Radox soap and had sales of more than 750 million euros for the year ending June 2009, according to a statement today. Sara Lee, which has been shedding units to focus on coffee and food, said the proceeds would help it buy back up to $1 billion in stock.

The purchase is the largest by Chief Executive Officer Paul Polman since he took the reins at Unilever at the start of the year. He focused the company on winning back cash-strapped shoppers and boosting sales volumes by cutting prices, and was rewarded as the company unexpectedly posted volume growth in western Europe in the second quarter.

“We’re not convinced that this is the greatest collection of assets, but another acquisition shows Unilever is still moving from the back foot — cost cutting, disposals — to the front foot — volume growth, acquisitions,” Credit Suisse analysts said in an e-mailed note.

The deal is Unilever’s biggest acquisition since buying SlimFast Foods Co. and Ben & Jerry’s Homemade Inc. for a combined $2.6 billion in April 2000. Unilever’s brands besides food include Vaseline and Axe deodorants.

Comparable Valuations

“This transaction builds on our portfolio in Western Europe and also in Asia,” Polman said in the statement. “The Sara Lee brands enjoy strong consumer recognition, offer significant growth potential and are an excellent fit with Unilever’s existing business.”

Unilever dropped 10 cents to 19.19 euros in Amsterdam trading at 11 a.m. local time. The shares have added 11 percent this year. Sara Lee, based in Downers Grove, Illinois, rose 40 cents, or 3.7 percent, to $10.94 in German trading.

Unilever’s offer price values Sara Lee’s body-care operations, which also include Zwitsal baby shampoo and Zendium toothpaste, at 1.7 times annual revenue. In 2006, L’Oreal SA bought Body Shop International Plc for 1.5 times its sales.

The transaction needs regulatory approval and the companies will consult with European employee works councils, Unilever said today.

To entice cash-strapped European consumers, Polman has also increased ad spending, boosted promotions and accelerated new product introductions since he took over as CEO.

Unilever is taking “quicker actions where we’re feeling that our brands are out-positioned or at a disadvantage, where we’re losing share,” Polman said in May. He said he’s fighting an “inherited assumption that the company will not grow.”

“This is a show of confidence” by Polman, said Julian Hardwick, a Royal Bank of Scotland analyst in London who recommends investors hold Unilever stock. “It fits very well with their personal-care categories.”

Sara Lee Chief Executive Officer Brenda Barnes, a former PepsiCo Inc. executive who took over as CEO in 2005, has sold off clothing lines in the U.S. and Europe, as well as a U.S. coffee unit.

Bloomberg has just announced that John Mack, who struggled to return Morgan Stanley toprofitability after surviving the worst financial crisis since the Great Depression, will turn over his chief executive officer title to Co-President James Gorman.

Mack, 64, will step down at the end of the year and remain chairman of the New York-based bank for at least two years, he said in an interview yesterday. Gorman, 51, will become CEO and Walid Chammah, 55, co-president with Gorman since 2007, will relinquish that role and remain chairman of Morgan Stanley International in London. The changes take effect Jan. 1.

In more than four years leading the firm, Mack sought to improve profits and repair divisions that appeared under former CEO Philip Purcell. Mack’s strategy of boosting trading risks backfired in 2007 when bad bets led to the firm’s first quarterly loss. While the company survived the financial crisis that devastated some rivals, Morgan Stanley has lost money since the third quarter of 2008 and reined in trading even as Goldman Sachs Group Inc. earnings hit an all-time high.

“Mack has been beaten up a little for not taking as much risk in the capital markets as Goldman,” said Matt McCormick, a banking industry analyst at Bahl & Gaynor Inc. in Cincinnati, which manages $2.3 billion. “He was given a tough job, I think he handled it above average and history will judge him a solid leader on Wall Street.”

Morgan Stanley slashed the assets on its balance sheet by almost a third to $677 billion at the end of June from $987 billion at the end of August to cut its reliance on leverage, or borrowed money. The firm’s average value-at-risk, a measure of how much the company estimates it might lose in a day’s trading, was $154 million in the second quarter compared with $245 million at Goldman Sachs.

Missed Opportunities

Led by Chief Executive Officer Lloyd Blankfein, Goldman Sachs set a new Wall Street record for fixed-income and equities trading revenue during the second quarter. Colm Kelleher, Morgan Stanley’s chief financial officer, said in July that the firm’s fixed-income team “didn’t pursue the opportunities we could have” in the second quarter.

Gorman, born in Australia, was recruited by Mack in August 2005, less than two months after Mack became CEO, to run the retail brokerage division. Gorman previously worked at Merrill Lynch & Co., now part of Bank of America Corp.,which is Morgan Stanley’s biggest competitor in providing financial advice to individual investors.

Brokerage Business

Earlier this year, Gorman increased Morgan Stanley’s investment in its brokerage business when he formed a joint venture with Citigroup Inc.’s Smith Barney. Morgan Stanley paid $2.75 billion in cash to Citigroup to gain a 51 percent stake in the venture, dubbed Morgan Stanley Smith Barney, which had 18,444 financial advisers as of June 30.

Gorman said in an interview that he doesn’t expect to change Morgan Stanley’s strategy.

“We’re pretty clear about what kind of company we’re going to be,” Gorman said yesterday. “A lot of what has to happen now is to really focus on day-to-day execution.”

Morgan Stanley in July reported its third consecutive quarterly loss, weighed down by accounting charges and costs as well as fixed-income trading and asset-management revenue that Mack said was unsatisfactory.

The company’s stock, at $28.64 in New York Stock Exchange trading yesterday, is down 34 percent from its closing level on June 30, 2005, the day Mack was named chairman and CEO. Goldman Sachs shares are up 71 percent and JPMorgan Chase & Co. shares climbed 22 percent over the same period. Morgan Stanley’s shares slipped to $28.39 as of 11:15 a.m. in Frankfurt trading today.

‘Bigger-than-life’

“Mack is a bigger-than-life individual” who has had both negative and positive effects on the firm, said Brad Hintz, an analyst at Sanford C. Bernstein & Co. and a former treasurer at Morgan Stanley. “Mack’s leadership stabilized the firm after Purcell left and he pulled the firm back from failure in 2008.”

Mack’s decision to step down was unrelated to the firm’s recent performance or the stress of last year’s financial crisis, Mack said. He said he told the board 18 months ago that he would like to hand off the CEO title after he turns 65 in November.

“I’ll stay as chairman at least for two years working with James, working with clients,” Mack said. “I’m not leaving this firm. This firm is part of my DNA.”

Mack, the youngest of six boys born to Lebanese immigrants, entered the securities industry by accident, according to a biography posted on the Horatio Alger Association’s Web site. In his junior year at Duke University, a cracked neck vertebra ended the football scholarship that had paid his way, forcing him to take a clerking job at a North Carolina brokerage.

Bond Salesman

He graduated from Duke in 1968 and joined Morgan Stanley as a bond salesman four years later. He spent most of his career at the firm, working his way up in fixed-income sales and trading before becoming president under CEO Richard Fisher in 1993. He encouraged Fisher to sell the firm to Dean Witter Discover & Co., the brokerage firm led by Purcell, only to leave in 2001 after Purcell refused to relinquish power.

He helped run Zurich-based Credit Suisse Group AG for three years, leaving after a clash with the board. When Morgan Stanley shareholders and employees helped to oust Purcell in 2005, fed up with a lackluster share price and an autocratic management style, they turned to Mack to restore the firm’s former glory in investment banking and trading.

Like Purcell, Gorman worked at consulting firm McKinsey & Co. before running a retail-oriented financial brokerage and has never worked as a trader or banker. That’s led some analysts to question whether he’ll have the same difficulty winning over the institutional-securities side of the business as Purcell did.

‘Lost Decade’

“I am concerned that the Morgan Stanley board of directors is placing an admittedly capable executive with a largely retail brokerage operating background in charge of a global capital markets firm with the second-largest investment banking franchise in the world,” Bernstein’s Hintz said. “It was a similar decision in 1997 that led to the lost decade of Morgan Stanley.”

Mack dismissed the concerns, saying that Gorman is much more accessible to bankers and willing to make client calls than Purcell was. Gorman said that a majority of his recent client meetings have been with customers of the institutional- securities side of the business.

Mack said he considers his own greatest accomplishment to be leading the firm through last year’s crisis, which wiped out Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch. One week after Lehman’s Sept. 15 bankruptcy, Morgan Stanley and Goldman Sachs converted to bank holding companies, ending their history as independent securities firms to win the backing of the Federal Reserve.

Japan Investment

Morgan Stanley shares fell as low as $9.68 on Oct. 10 before the firm won a $9 billion investment from Japan’s Mitsubishi UFJ Financial Group Inc. and $10 billion from the U.S. government on Oct. 13. Mack has since repaid the Treasury and the stock has rebounded. Spreads on the company’s bonds, which widened during the financial crisis, have since narrowed to bring them in line with peers.

“You’ve got to give him some credit for surviving,” said Kenneth Crawford, a senior money manager at Argent Capital Management LLC in St. Louis, which oversees $700 million. “The good thing is there’s an MS ticker on my screen that changes price each day, and there are a fair number of his peers that aren’t on my screen anymore.”

It is widely believed that Spanish banks dodged much of the financial crisis due to better banking regulation. The argument is that Spanish banks were more prepared to handle the financial crisis due to rules introduced by the Bank of Spain like dynamic provisioning, basically having more capital reserves in boom times to pay for losses in down times. There are many articles written about this and how Spanish banks are strong in the face of the crisis, see Forbes: Spanish Banks in Top Form. As the article illustrates, BBVA and Santander beat expectations with considerable increases in interest income and more lending. In more recent news, BBVA acquired Guaranty Bank in the US, a deal arranged by the FDIC showing faith in BBVA´s financial health. BBVA’s expansion into the large US market shows their foresight to invest in a country that is rebounding from the recession. Furthermore, another sign of strength is the fact that Santander’s recent IPO of its Brazilian business, the largest IPO in Brazilian history, raised $4.6 billion making it one of the largest banks in Latin America’s biggest economy.

However, in the latest report published by Variant Perception titled Spain: The Hole in Europe’s Balance Sheet, they accuse investors who support this view of smoking crack! Notwithstanding the parlance used by the authors in this report, the findings are worth mentioning. They make the case that Spain’s crisis is more severe and that Spanish banks are more vulnerable to it than previously understood by investors. The report illustrates the severity of Spain’s economic crisis: Spain accounts for 30% of homes built in the EU since 2000, and only 10% of EU GDP; and it has as many unsold homes as the US, a country seven times its population. Outstanding loans to developers and construction companies are at $470 billion, (almost 50% of Spanish GDP) and most will go unpaid. With unemployment at 17% and growing, while Spain is showing signs of deflation means that this crisis will crush Spanish banks regardless of the extra provisions.

The report also accuses Spanish banks of taking advantage of recent changes in accounting rules to avoid posting losses; not marking loans to market because they own real estate firms and can manipulate appraisal values; and refinancing bad construction loans to 40 years at lower interest rates when it is known that these companies will likely fail. All this is to delay the inevitable effects of an economic meltdown in hopes that a turnaround will pull them out of this mess.

This report presents Spanish banks as risky when many investors and politicians think they are role models. Hopefully people won’t ignore the fact that Spain’s dynamic provisioning is still a good regulation that should be emulated in the rest of the world. However, neither extra provisions nor the banks growth internationally will be enough to save them from Spain’s economic disaster.

Article written by Brendan Quirk (IMBA – April Intake).