# Valuation Approaches in BCE Inc. In Play -Finance Case Solution Sample

QUESTION

1. What are the different valuation approaches listed in the case?  For each approach, what are the major assumptions, what are the limitations to this approach, and what is the value per share of BCE?
2. For the discounted cash flow valuation, compute the following: (a) the valuation cash flows for each of the projection years, (b) the discount rate, (c) the terminal value, and (d) the net value per share of BCE stock.  What is your assessment of the cash flow assumptions given in the case?  What would you do differently?  What is the DCF value if revenues grow by 4% per year beginning in 2008 instead of the assumptions in the case?
3.  Which of the bidders is likely to submit the highest bid?  Why?
4.  What factors should be considered by the BCE board in evaluating the different bids?

Case: BCE INC. In Play

# Methods of Valuation

The above case talks about three methods of valuation, Discounted Cash Flow method, Relative Method and Comparable Transaction Method. Generally, when we do the valuation of any company there are two approaches that we use, the first one being the absolute valuation and the second one being relative valuation.

Absolute valuation is that method which uses discounted cash flow technique to arrive at the value of the company. This cash flow can be any such as Free Cash Flow to the Firm, Free Cash Flow the Equity and Residual Cash Flow. The discounted cash flow method can also be applied to dividends and earnings of the company (dividend discount model). To get the present value of the cash flows a discounting rate is used which depends on the various rate which could be either cost of equity and weighted average cost of capital. In absolute valuation one cannot proceed with the valuation without making few assumptions about the future. The first and the foremost assumption of absolute valuation is a basic assumption of accounting, the going concern assumption. It does not matter which model of absolute valuation is being used, all the future prediction is done on the basis that the company will go on forever. The next assumption is the assumption of reinvestment. This assumption deals with how the income earned during the life of the company will be used. If the company is growing at a rate which is faster than that which can be financed by internal accruals, then the assumptions regarding from where and at what cost will that money be arranged by the company. The next assumption is about the future incomes or cash flows. Most of the time these future income and cash flow is predicted on the basis of the past trends which may or may not hold true in the future. Absolute valuation is more like company specific, but the performance of the company is dependent on the industry and various other macro factors such as economy, inflation, population size etc. These were the various assumptions that are made in an absolute valuation and these assumptions are the biggest limitation of the absolute method. In this method we predict the future of the company and its financials by taking into account various assumptions but what is the future of the company does not turn out as we predicted in our model.

Coming to the relative valuation, we calculate the worth of the company as compared to its competitors. In the above case we used two different types of relative valuation techniques, first one being the valuation as per the peers in the market and the second one being valuation as per the comparative transactions that occurred in the industry. The most common type of relative valuation technique used is PE multiple approach. In PE multiple approach we compare the PE of the company to its industry, if the PE of the company is less than the PE of the industry than the company in undervalued and vice versa. Another common approach is EV/EBITDA where the EBITDA of the company is multiplied to the multiple of the industry to arrive at the Enterprise Value of the company. The limitation of relative valuation approach are, the first being that the multiple methodologies used are ultimately based on market valuations and if the market is valuing the whole sector wrong, relative valuation can also be inaccurate. While doing relative valuation there may be a case that there is no ‘real’ comparable for the company in the question. Also, no two company are similar, and relative valuation does not take into the consideration the differences among the company. Lastly, the denominator used in the relative valuation methodology are inconsistent across companies.

# DCF Valuation

For the purpose of DCF valuation we used the information given in the case to arrive at the value. First, we calculated the Weighted Average Cost of Capital

 WACC Cost of Equity Risk Free Rate 4.10% Beta 0.85 Market Risk Premium 5% Cost of Equity 8.35% Cost of Debt Before Tax Cost of Borrowing 8% Tax Rate 20% Cost of Debt 6.40% Capital Structure Debt 40% Equity 60% WACC 7.57% Terminal Growth Rate 1%

For the purpose of tax rate, average of the tax over the years were taken.

Next was to calculate the Cash Flows

 Particulars (Amt in \$ million) 2005 2006 2007 2008 2009 2010 2011 2012 Revenue Growth 1.50% 2.40% 2.30% 1.80% 1.90% 1.90% Sales 14462 14541 14759 15113 15461 15739 16038 16343 EBITDA Margin 36.80% 36.30% 37.50% 38.60% 38.60% 38.60% 38.60% 38.60% EBITDA 5322 5278 5535 5834 5968 6075 6191 6308 Depreciation 16.40% 17.10% 17% 17% 17% 17% 17% 17% Depreciation 2372 2487 2509 2569 2628 2676 2726 2778 EBIT 2950 2791 3026 3265 3340 3399 3465 3530 Tax Rate 15% 15% 15% 25% 25% Tax 490 501 510 866 883 EAT 2775 2839 2889 2599 2647 Add: Depreciation 2569 2628 2676 2726 2778 Less: Capex 2646 2707 2755 2808 2862 Less: Change in WC 14 14 11 12 12 Free Cash Flow to the Firm 2684 2746 2799 2505 2551 Terminal Value 39216 Total Cash Flow 2684 2746 2799 2505 41767 Value of the Firm 37986 Value of the Debt 9665 Value of Minority Interest 1100 Value of Preference Shares 1694 Value of Equity 25527 No. of Shares Outstanding 807.6 Value per Share 31.61

As per the DCF valuation the value per share came out to be \$ 31.61.

## If the Revenues Grew by 4% instead of given in the Case

 Particulars (Amt in \$ million) 2005 2006 2007 2008 2009 2010 2011 2012 Revenue Growth 1.50% 4.00% 4.00% 4.00% 4.00% 4.00% Sales 14462 14541 14759 15349 15963 16602 17266 17957 EBITDA Margin 36.80% 36.30% 37.50% 38.60% 38.60% 38.60% 38.60% 38.60% EBITDA 5322 5278 5535 5925 6162 6408 6665 6931 Depreciation 16.40% 17.10% 17% 17% 17% 17% 17% 17% Depreciation 2372 2487 2509 2609 2714 2822 2935 3053 EBIT 2950 2791 3026 3316 3448 3586 3730 3878 Tax Rate 15% 15% 15% 25% 25% Tax 497 517 538 933 970 EAT 2819 2931 3048 2797 2908 Add: Depreciation 2609 2714 2822 2935 3053 Less: Capex 2646 2707 2755 2808 2862 Less: Change in WC 24 25 26 27 28 Free Cash Flow to the Firm 2758 2913 3089 2897 3071 Terminal Value 47210 Total Cash Flow 2758 2913 3089 2897 50281 Value of the Firm 44637 Value of the Debt 9665 Value of Minority Interest 1100 Value of Preference Shares 1694 Value of Equity 32178 No. of Shares Outstanding 807.6 Value per Share 39.84

If the Revenue grew by 4% from the 2008 onwards the share price would increase by 26% to \$ 39.84.

## Assessment

I agree to an extent with the assumption made by the case. But in one particular aspect I do not agree with the assumption made in the case and that is the method of calculation of depreciation. In question the depreciation as been taken ass a percentage of the sales and this is not correct as whatever the sales may be the depreciation would be calculated on the basis of fixed assets employed by the company.

# IRR Approach

A lot of assumption were made while calculating the IRR approach. This approach was calculated by keeping in mind that this would be LBO deal in which the acquiring company will take onto a lot of debt to restructure the company and will exist after a period of 5 years. The equity investment at the beginning of the LBO deal would be \$ 7315 million which will grow to \$22278 million at the end of 5 years period. This will give a return of 24.95% year on year.

 2007 2012 EBITDA 5535 6308 Enterprise Value Multiple 7.5x 7.0x Enterprise Value 41735 44195 Proceeds from Asset Sale 6747 0 Value of Debt 27673 21917 Value of Equity 7315 22278 IRR 24.95%

# Relative Valuation

Relative valuation was done on the basis of taking into account the multiple of two of the closet competitors of BCE. The average EV/EBITDA of two of the competitors of BCE is 7.9x.

 EV/EBITDA 2007E Rogers 9.2 Telus 6.6 Mean 7.9 EBITDA 5535 Enterprise Value 43727 Value of the Debt 9665 Value of Minority Interest 1100 Value of Preference Shares 1694 Value of Equity 31268 No. of Shares Outstanding 807.6 Value per Share 38.72

As per the relative valuation method the price per share is coming around \$38.72 per share.

# Precedent Transaction

As per the case the EV/EBITDA multiple varies from 7.0x to 8.0x, therefore for the purpose of this case the EV/EBITDA multiple is been assumed to be 7.5x.

 EV/EBITDA 2007E Mean 7.5 EBITDA 5535 Enterprise Value 41513 Value of the Debt 9665 Value of Minority Interest 1100 Value of Preference Shares 1694 Value of Equity 29054 No. of Shares Outstanding 807.6 Value per Share 35.98

As per the precedent transaction method the price per share is coming around \$35.98 per share.

# Bid Price

Based on the analysis done above, I conclude that the price of \$ 44.41 is an adequate acquisition price for BCE Inc. This value was arrived by taking into the consideration three methods and different weights were given to each of the method. Also, 31% acquisition premium, medium of the acquisition premium payed on the past transactions was assumed.

 Method Value per Share Weightage Value per Share DCF 31.61 60% 18.97 Relative Valuation 38.72 20% 7.74 Precedent Transaction 35.98 20% 7.20 Value per Share 33.90 Acquisition Premium 31% Bid Price 44.41

# Bidders

They are two types of bidders in the fray for acquiring BCE, first the financial buyers and second the strategic buyers. Financial Buyers include the three PE consortiums, Canada Pension Plan Investment Board (CPPIB), Ontario Teacherâ€™s Pension Plan and Cerberus Capital Management. The benefits of the PE consortium is that all three consortium have members that possess the knowledge and experience relevant to the industry which will help the company to improve its operations but the main problem would be applicable regulations on such acquisition.

The strategic buyer is Telus, a competitor of BCE. This merger would result in increase synergies which will yield direct benefit to the revenues and income. But this might get struck in regulatory issues regarding competition in the industry.

BCE should go ahead with Telus offer.

# Factors to be Evaluated

There are lot of things should be kept in mind before evaluating various bids. The first and the most important being the bid should be selected that maximizes the shareholders values. Second, the board must keep in mind the regulatory issues. A transaction of this size will definitely require regulatory approval. Thirdly, the board should compare an all cash deal versus cash plus stock deal. Lastly, the legacy of the company should be kept in mind before accepting the bid.

DCF

 Particulars (Amt in \$ million) 2005 2006 2007 2008 2009 2010 2011 2012 Revenue Growth 1.50% 2.40% 2.30% 1.80% 1.90% 1.90% Sales 14462 14541 14759 15113 15461 15739 16038 16343 EBITDA Margin 36.80% 36.30% 37.50% 38.60% 38.60% 38.60% 38.60% 38.60% EBITDA 5322 5278 5535 5834 5968 6075 6191 6308 Depreciation 16.40% 17.10% 17% 17% 17% 17% 17% 17% Depreciation 2372 2487 2509 2569 2628 2676 2726 2778 EBIT 2950 2791 3026 3265 3340 3399 3465 3530 Tax Rate 15% 15% 15% 25% 25% Tax 490 501 510 866 883 EAT 2775 2839 2889 2599 2647 Add: Dedpreciation 2569 2628 2676 2726 2778 Less: Capex 2646 2707 2755 2808 2862 Less: Change in WC 14 14 11 12 12 Free Cash Flow to the Firm 2684 2746 2799 2505 2551 Terminal Value 39216 Total Cash Flow 2684 2746 2799 2505 41767 Enterprice Value 37986 Value of the Debt 9665 Vaue of Minorit Interest 1100 Value of Preference Shares 1694 Value of Equity 25527 No. of Shares Outstanding 807.6 Value per Share 31.61

WACC

 WACC Cost of Equity Risk Free Rate 4.10% Beta 0.85 Market Risk Premium 5% Cost of Equity 8.35% Cost of Debt Before Tax Cost of Borrowing 8% Tax Rate 20% (Average Rate over the years) Cost of Debt 6.40% Capital Structure Debt 40% Equity 60% WACC 7.57% Terminal Growth Rate 1%

DCF 4%

 Particulars (Amt in \$ million) 2005 2006 2007 2008 2009 2010 2011 2012 Revenue Growth 1.50% 4.00% 4.00% 4.00% 4.00% 4.00% Sales 14462 14541 14759 15349 15963 16602 17266 17957 EBITDA Margin 36.80% 36.30% 37.50% 38.60% 38.60% 38.60% 38.60% 38.60% EBITDA 5322 5278 5535 5925 6162 6408 6665 6931 Depreciation 16.40% 17.10% 17% 17% 17% 17% 17% 17% Depreciation 2372 2487 2509 2609 2714 2822 2935 3053 EBIT 2950 2791 3026 3316 3448 3586 3730 3878 Tax Rate 15% 15% 15% 25% 25% Tax 497 517 538 933 970 EAT 2819 2931 3048 2797 2908 Add: Dedpreciation 2609 2714 2822 2935 3053 Less: Capex 2646 2707 2755 2808 2862 Less: Change in WC 24 25 26 27 28 Free Cash Flow to the Firm 2758 2913 3089 2897 3071 Terminal Value 47210 Total Cash Flow 2758 2913 3089 2897 50281 Enterprice Vallue 44637 Value of the Debt 9665 Vaue of Minorit Interest 1100 Value of Preference Shares 1694 Value of Equity 32178 No. of Shares Outstanding 807.6 Value per Share 39.84 26.05%

IRR

 2007 2012 EBITDA 5535 6308 Enterprice Value Multiple 7.5x 7.0x Enterprice Value 41735 44195 Proceeds from Asset Sale 6747 0 Value of Debt 27673 21917 Value of Equity 7315 22278 IRR 24.95%

Relative Valuation

 EV/EBITDA 2007E Rogers 9.2 Telus 6.6 Mean 7.9 EBITDA 5535 Enterprice Value 43727 Value of the Debt 9665 Vaue of Minorit Interest 1100 Value of Preference Shares 1694 Value of Equity 31268 No. of Shares Outstanding 807.6 Value per Share 38.72

Precedent Transaction

 EV/EBITDA 2007E Mean 7.5 EBITDA 5535 Enterprise Value 41513 Value of the Debt 9665 Vaue of Minorit Interest 1100 Value of Preference Shares 1694 Value of Equity 29054 No. of Shares Outstanding 807.6 Value per Share 35.98

Bid Price

 Method Value per Share Weightage Value per Share DCF 31.61 60% 18.97 Relative Valuation 38.72 20% 7.74 Precedent Trasacction 35.98 20% 7.20 Value per Share 33.90 Acquisition Premium 31% Bid Price 44.41

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