QUESTION
- 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?
- 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?
- Which of the bidders is likely to submit the highest bid? Why?
- What factors should be considered by the BCE board in evaluating the different bids?
ANSWER
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 Teacher’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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