1 / 19

Multibusiness Company

Multibusiness Company. Many firms are diversified. In 1997: 20% of public companies listed on major exchanges had 2 or more reported segments (1,541 or 7,956 firms). 154 firms had 5 or more reported segments. Most segments are in different industries.

inga-summers
Download Presentation

Multibusiness Company

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Multibusiness Company • Many firms are diversified. In 1997: • 20% of public companies listed on major exchanges had 2 or more reported segments (1,541 or 7,956 firms). • 154 firms had 5 or more reported segments. • Most segments are in different industries. • Firms buy and sell divisions therefore changing the composition of the firm. • In 1996, public firms sold off or divested over 2,500 divisions. • Between 1983 and 1996, approximately 150 firms spun-off divisions. • In 1995, 5,000 mergers and acquisitions occurred. F409 - Valuing Multi-business Firms

  2. Focusing Events • Firms may refocus the firm by divesting unrelated segments. • Sell-off: Sell division or assets to another firm • Spin-off: Distribute stock of subsidiary to existing shareholders. • Carve-out: Issue stock in subsidiary to public. • Each of these events are value increasing. • On average, the announcement of a spin-off leads to a 3% abnormal return. F409 - Valuing Multi-business Firms

  3. Multibusiness Company • Recent Breakups • AT&T will divide into 4 units in 2001 to save its falling stock price. • Lucent spun-off Avarya (10/00) and will sell off power systems unit (11/00) • Laporte PLC (British industrial conglomerate) will sell off 55% of its operations to specialize in organic chemical business (9/00) • Laporte’s stock price increases 20% • Less Recent Breakups • AT&T spins off NCR and Lucent technologies in 1996 • AT&T’s stock price increased 7.8%. • Samsonite spins off Culligan Water in 1995 • Samsonite’s stock price increased 5.5%. • Sears and Roebuck spin off Allstate in 1995 • Sears’ stock price increase 4.4%. F409 - Valuing Multi-business Firms

  4. How do you value a Multibusiness Segment? F409 - Valuing Multi-business Firms

  5. General Electric Divisions: 1997 F409 - Valuing Multi-business Firms

  6. Multibusiness Company • How do you determine if a firm should divest a segment. • Is the sum of the pieces (if stand-alone firms) > Conglomerate value • Comparing the value of the firm as a set of stand-alone entities to aggregate value to the value of the firm is useful to: • Determine if firm should divest unrelated segments. • Value acquisition candidates • Estimate the cost/benefit to diversification • Each segment will be valued individually with their own FCF, discount rate and growth rate. F409 - Valuing Multi-business Firms

  7. Difficulties Valuing Multibusiness Companies • Different units have different: • Cash flows • Growth Rates • Risk: Discount rates • Segment level data limited. • Accounting data reports only a few items • No market price to calculate cost of equity • No capital structure to calculate cost of debt or WACC. • Need to estimate the above items for the firm as a stand-alone firm, so may need to use single-segment comparables. • Headquarter expenses/income apply to all segments. • Based on conglomerate organizational structure. • Need the stand-alone firm’s administrative expenses and income. F409 - Valuing Multi-business Firms

  8. Steps to Value Multibusiness Company • Define the business units. • Collect business unit data. • Perform Business Unit Valuations • Aggregate values and compare to total company discounted cash flow. F409 - Valuing Multi-business Firms

  9. Step 1: Defining the Business Unit • A business unit = a separable entity with no significant synergies, such as shared production. • Define Business Units • Company’s description and segment data • SIC codes • A complete separation of business units is difficult • Headquarter may operate an internal capital market and allocate excess funds across divisions. • It is difficult to determine if there are “significant synergies” • Firms can be in same SIC code and be separable or be in different SIC codes and have shared facilities. • A division as defined by the company is not always the same as a segment reported on accounting statements. F409 - Valuing Multi-business Firms

  10. Step 2: Collect Business Unit Data • Finding a comparable • Use single segment firms since valuing stand-alone firm. • If you find a comparable, you may use this for identifying ratios to project statements and cash flows. • Segment level data • Firms financial statements must report business segments that accounts for 10% of sales (up to 10). • Great flexibility in reporting standards. • Data available limited so difficult to create full proforma statements • operating income • sales • depreciation • assets • capital expenditures F409 - Valuing Multi-business Firms

  11. Step 3: Valuing Business Units • General Principles: • Each unit is treated as a separate stand-alone entity. • Each business unit has its own operating cash flows. Shared corporate services, such as accounting and other administration, must be applied to each business. • The effective tax rate for each unit is different than if the unit was considered part of the larger organization. • Each unit has its own target capital structure which may differ from the conglomerate. • Each unit has its own cost of capital which may differ from the conglomerate. F409 - Valuing Multi-business Firms

  12. Step 3: Valuing Business Units • Cash flows of business units • Estimate as if firm is stand alone entity • Adjust costs and revenues for transfer pricing • Transfer pricing occurs when one unit supplies goods at a reduced price to another unit. • Allocate corporate overhead based on usage basis • Relative to the units operating income or revenue • Cash flows of corporate headquarters • Costs that should not be allocated to units such as nonallocatable executive salaries, office space, consulting, charity, and other nonallocatable expenses. • Benefits include tax advantages and greater debt capacity. • Costs and especially benefits are difficult to identify • Often defined as difference in sum of stand alone and conglomerate value. F409 - Valuing Multi-business Firms

  13. Step 3: Valuing Business Units • Business unit tax rates • Taxes the firm would pay if it was not under corporate umbrella • Use comparable or get estimate from tax advisor. • Capital structure and cost of capital • Each business unit will have little debt and no stock equity. • Should be consistent with comparable companies and with parent’s philosophy. • Cost of capital will derive from: • Capital structure assumed for unit • Estimated cost of debt and cost of equity from comparables. • May need to unlever cost of equity of comparables and then relever the cost of equtiy using the segment’s target capital structure if this target differs from comparables. F409 - Valuing Multi-business Firms

  14. Step 3: Valuing Business Units • Estimate Beta or cost of equity using comparable firms and adjust for different capital structures (similar to private firm example). • Collect a group of comparable single-segment firms • Estimate the average beta or cost of equity • Estimate the average debt-equity ratio (using market values) • Unlever the cost of equity or beta • Estimate the debt to equity ratio for the segment as a stand-alone firm and re-lever beta or return. • Problem the debt to equity ratio must use market values, which are not available. • Solution: assume the firm will go to the industry average or determine the firm’s optimal leverage ratio by adjusting industry average F409 - Valuing Multi-business Firms

  15. Step 3: Valuing Business Units • Estimate the cost of debt equal by using • The rate for comparable single-segment similar firms in the industry • Estimate an appropriate bond rating and use rate for similar rated firms. • Estimate WACC • Using cost of equity and cost of debt from above. • Assume capital structure same as above. F409 - Valuing Multi-business Firms

  16. Step 4: Aggregate Business Units • Add up the values of each unit • Compare the sum of cash flows to total company cash flows • Compare the sum of debt to total company debt • Unconsolidated subsidiaries exist if the company owns less than 50% of the subsidiary. You must consider the percentage of value or cash flows owned by the parent. • Compare aggregate value with the market value of the firm and the estimated total value of the firm if the units are not treated on a stand-alone basis. F409 - Valuing Multi-business Firms

  17. Value to Diversification • On average diversified firms trade at a discount: • The value of the segments as stand-alone entities is approximately 13% to 15% more than the actual firm value for firms with more than one division. • The discount exists in the U.S., U.K., Germany, and Japan. • Discounts in 1998 • Baxter Intl’s value is 51% of its stand-alone value. • Eastman Kodak’s value is 79% of its stand-alone value • Kraft Foods’ value is 62% of its stand-alone value • Time Warner’s value is 59% of its stand-alone value • Premiums in 1998 • Hershey’s value is 106% of its stand-alone value. • Disney’s value is 106% of its stand-alone value. F409 - Valuing Multi-business Firms

  18. Why is diversification bad? • Assuming that the discount is correct, the costs of diversification outweigh benefits. • Benefits: • More efficient resource allocation due to internal capital market. • Greater debt capacity and more tax shields due to less risk. • Costs: • Agency problems may lead to inefficient internal capital markets (invest too much in poor growth segments and/or not enough in high growth segments) • Information asymmetry between headquarters and division managers • Difficult to provide incentives to division managers F409 - Valuing Multi-business Firms

  19. F409 - Valuing Multi-business Firms

More Related