Buy ybackofShares

ProfSNRao(SJMSOM,IITB)

Whycompaniesgoforbuybackofshares?

ProfSNRao(SJMSOMIITB)

BuybackTheories
Dividendorpersonaltaxationtheory
Differentialtaxrates Buybackenablessubstitutionofhighertaxrate withlowertaxrate

BuybackTheories
Leveragetheory
BuybackincreasestheD/Eratio TheincreaseinD/Eratioevengreaterifthebuy backisfinancedbyborrowing Higherdebtincreasestaxdeductibleinterest payments Taxsavingsduetohigherdebtmaybetransferred toshareholdersthroughhigherbuybackprice

BuybackTheories
ImproveFinancialPerformanceTheory
Buybackreducesoutstandingnumberofshares EPSimproveswithoutsignificantimprovementin PAT OtherperformanceratioslikeRONWandROAalso improve RecentbuybackannouncementbyHULstatesthis astheobjective

BuybackTheories
Information/SignalingTheory
Buybackisthroughtheuseofcash
signalsthatthefirmhasnoprofitableinvestments

Buybackisatsubstantialpremiumtomarket priceandthepromoterisnotparticipating
signalsundervaluationofstock

BuybackTheories
BondholderExpropriationTheory
BuybackresultsintohigherD/Eratio Financialriskincreases But,theinterestratepaymentstobondholders remainsame Wealthistransferredfrombondholdersto shareholders

BuybackTheories
WealthTransferAmongShareholders
Wealthoftenderingshareholdersistransferredto nontenderingshareholders Postbuybackpricesaregenerallyhigherthan prebuybackprices Ifpostbuybackislessthanbuybackprice,wealth getstransferredfromnontendering g gshareholders totenderingshareholders

BuybackTheories
DefenseAgainstOutsideTakeovers
Tenderofferpricesetsbenchmarkfortakeover bid Buybackincreasesholdingofthepromotersif theydonotparticipateinbuyback Gescosbuybackwasdrivenbythistakeover threatfromDalmias Itreduceditspaidupequitycapitalfrom Rs.258.84ason31March2000toRs.190.34ason 31March2005
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ComputationofFreeCashFlows,Key V l D Value Drivers, i EP andRelatedRatios

ProfSNRao(SJMSOM,IITB)

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ComputationofFreeCashFlows
Components p ofFreeCashFlowstotheFirm(FCF) ( ) 1.FCF=OperatingFCF+Nonope FCF p gProfitLessAdjusted j Tax 2.OFCF=NetOperating (NOPLAT)NetInvestment(NI) 3.NOPLAT=AdjustedEBITATaxonAdjustedEBITA 4.AdjEBITA=PBT+InterestExpense+Loan Amortization+RevexponR&D+Goodwillw/o R&Damortization Interestincome nonoperating incomeOREBITotherincome
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ComputationofFreeCashFlows
5.TaxonAdj j EBITA=Taxp provisionfromincome statement+deferredtax+taxonint.expense tax onint.income taxonnonope income OR Adj EBITA(1T) 6.NetInvestment=Investedcapitalattheendof period(IC1)Investedcapitalatthebeginningofthe period(IC i d(IC0) 7.InvestedCapital=(TotalassetsNoninterestbearing currentliabilities) )+Capex p onR&D+Goodwill Investmentsinmarketablesecurities Revaluation reserves Miscexpnotw/o
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ComputationofFreeCashFlows
8.Non 8 NonOFCF=Posttaxotherincome Changein investmentsinmarketablesecurities Extraordinaryitems

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ComputationofKeyValueDrivers,EPand somerelated l dratios i

1. Investmentrate= NetInvestment/NOPLAT 2.ROIC=NOPLAT/AvgIC 3.Growth=NI/ /AvgIC=InvrateXROIC 4.Posttaxoperatingprofitmargin= NOPLAT/NetSales 5.Capitalturnover=NetSales/AvgIC 6.EP=IC(ROIC WACC) =NOPLAT IC(WACC) =NOPLAT CapitalCharge
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ValuationMethods

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ValuationMethods
1. RelativeValuationMethods/PriceMultiples 1 2. DiscountedValuationMethods

ProfSNRao(SJMSOM,IITB)

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RelativeValuationMethods
RelativeValuation
Anassetisvaluedbasedonhowsimilarassetsare pricedinthemarket Itinvolves
Findingcomparableassetsthatarepricedbythe marketinrecenttimes Scalingthemarketpricestoacommonvariableto generatestandardizedpricesthatarecomparable Adjustingfordifferencesacrossassetswhencomparing theirstandardizedvalues
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RelativeValuationMethods
Commonscalingvariablesusedforstandardizing thevalues: EBITDA BVorReplacementValueofAssets SalesRevenue

ProfSNRao(SJMSOM,IITB)

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RelativeValuationMethods
Sectorspecificvariables InternetCos:noofhitsgeneratedbytheweb site CableCos:Noofcablesubscribers TelecomCos:Noofsubscribers

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RelativeValuationMethods
Someprecautions p Ensurethateveryoneisusingsamedefinitionforthe selectedpricemultiple Numeratoranddenominatorofthepricemultiple shouldbedefinedconsistently In I relative l ti valuation, l ti multiple lti l f forafi firmi iscompared d withthatofindustry meaningful,themultiple Tomakethecomparisonmeaningful hastobedefineduniformlyacrossallthefirmsinthe industry
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RelativeValuationMethods
TataSteelCorusDeal InJan2007TataSteelacquiredentirestockof CorusSteelatapriceof608pencepershare ThisputsvalueofCorusatabout$12b Whichis9times EBITDAforrecent12months Ittranslatesinto$ $700p pertonneofoutput p

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RelativeValuationMethods
VodafoneBhartiTeleventuresDeal On28Oct2005Vodafone,theworldsleadingmobilefirm, acquired10%stakeinBhartiTeleventuresforRs.6700cr($1.5 b),whichvaluesBhartiTeleventuresatRs.67000cr($15b) EBITDAofBhartiTeleventureswas$660m Pricingofthedealisdoneat22.72times EBITDA EBITDAfromotherbusinesseslikelongdistance,landline,and broadbandisabout$222m Price cemultiple u t p efor o co combined b edEBITDAis sabout17t times es Thevaluationgives$1000pricepersubscriber

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RelativeValuationMethods
EssarMaxTelecomDeal On14Oct2005EssarboughtMaxTelecomsremaining3.16% stakeinHutchEssarforRs.657cr,whichvaluesHutchEssarat Rs.21000cr($4.7b) EBITDAofHutchEssarwas$540m Pricingofthedealisdoneat8.7times EBITDA HutchBPLMobileDeal InJuly2005HutchEssarboughtoutBPLMobileatapriceof $570 $5 0pe persubsc subscriber be ,which c implies p est the evalue a ueo ofe entire t eHutch utc Essar(includingBPL),with12millioncustomers,being Rs.31000cr(excludingBPLwhichhas2millioncustomers,the valueisRs.26000cr)
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RelativeValuationMethods
Vodafoneacquired67%stakeinHutchEssarby payingUSD10.9billioninMay2007 ThedealvaluesHutchEssaratUSD18.8 USD18 8b HutchEssarhassubscriberbaseofaround24 million illi ,valuation l i at$454persubscriber b ib

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RelativeValuationMethods
ThefollowinginformationisavailableforCo.A,abulk drugmfr.
EBDIT:Rs.20Cr.,BVofAssets:Rs.100Cr.Sales:Rs.150Cr. Basedoncomparableco co.thefollowingmultiplesappear reasonableforCo.A;

MV/EBDIT=18:MV/BV=3.5;MV/Sales=2.5 EstimatethevalueofCo.A

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RelativeValuationMethods
PopularityofRelativeValuationMethods
LesstimeandresourceintensivethanDCF methods Easiertosell Easiertodefend Reflectsmarketmood

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RelativeValuationMethods
LimitationsofRelativeValuationMethods
Ignoresrisk,growth,andcashflowpotential Resultsintoovervaluation(inbullishmarket)and undervaluation(inbearishmarket) Difficulttogetcomparablefirm/benchmark multiple

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DiscountedValuationMethods
EnterpriseDCFModel EquityDCFModel AdjustedPresentValue(APV)Model EconomicProfitModel

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DiscountedValuationMethods
EnterpriseDCFModel
ValueofFirm=PVofTotalFCFduringexplicit forecastperiod+PVofcashflowafterexplicit forecastperiod(orPVofCV) ValueofEquity=ValueofFirm ValueofDebt valueofPrefCap valueofESOPs Valueof Warrants Assumesconstantcapitalstructure UsefulforvaluationofMultibusinessFirms
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DiscountedValuationMethods
Valuescomponentsofthebusinessinsteadofjust theentity Helpsinidentificationofleverageareasforvalue creation Canbeappliedconsistentlyatdifferentlevelsof aggregation Consistentwithcapitalbudgetingprocess Dealswiththecomplexityofsituations

Freecashflowscanbeinfluenced
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Hershey Foods-Free Cash Flow Summary ($m) 1997 EBITA Cash taxes on EBITA NOPLAT Depreciation Gross Cash Flow Ch in WC Cap Exp Inc in net other assets Gross investment Operating FCF 646 (204) 442 137 579 (18) (183) (18) (219) 360 1998 610 (177) 434 142 576 (195) (142) (47) (384) 192 Forecast 1999 648 (227) 420 139 559 35 (275) 12 (228) 331 Forecast 2000 671 (236) 436 151 586 (26) (223) 12 (237) 349 Forecast 2001 700 (246) 454 159 613 (27) (235) 13 (249) 364

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Hershey Foods-Enterprise DCF Valuation Summary Year 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 CV Mid year Adj factor Value of operations Value of non-ope cash flows Total enterprise DCF value Value of debt ProfSNRao(SJMSOM,IITB) Equity value 9 385 FCF($m) 331 349 364 379 395 412 429 447 466 48 485 14 710 DF (7.5%) 0 930 0.930 0.865 0.805 0 709 0.709 0.697 0.648 0 603 0.603 0.561 0.522 0 48 0.485 0.485 PV of FCF ($m) 308 302 293 284 275 267 258 251 243 23 235 7 138 9 855 1 037 1.037 10 217 450 10 667 1 282 32
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Hershey Foods- WACC Summary

Source of Capital Prop of Cost of total capital specific source 12.1 87.9 5.5 8.1 Tax rate 39 After tax rate 3.4 8.1 Contribution to Weighted Average 0.4 7.1 75 7.5

Debt Equity WACC

Hershey Foods- computation of Continuing Value NOPLAT for 2008 ROIC NOPLAT growth rate in perpetuity (g) WAAC 634 21.3% 4.0% 7.5% CV = NOPLATt+1 (1 g/ROIC) WACC - g CV = 14 710 CV = FCFt+1 WACC - g
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ProfSNRao(SJMSOM,IITB)

Value Drivers: ROIC Company A: ROIC 20% ,Growth Growth rate 5% 5%, NI 25% Year 1 NOPLAT Net Inv FCF 100 25 75 Year 2 105 26.2 78.8 Year 3 110.3 27.6 82.7 Year 4 115.8 29 86.8 Year 5 121.6 30.4 91.2

Company B : ROIC 10% 10%,Growth Growth rate 5% 5%, NI 50% NOPLAT Net Inv FCF 100 50 50 105 52.5 52.5 110.3 55.2 55.2 115.8 57.9 57.9 121.6 63.8 63.8
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Value drivers: Growth rate Growth rate 5% & ROIC 20% Year 1 NOPLAT NI FCF 100 25 75 2 105 26 79 3 110 27 83 4 116 29 87 5 122 31 91 6 128 32 96 7 134 33 101 8 141 35 106 9 148 37 111 10 155 39 116 11 163 41 122 12 171 43 128

Growth rate 8% & ROIC 20% NOPLAT NI FCF 100 40 60 108 43 65 117 47 70 126 50 76 136 54 82 147 59 88 159 64 95 171 68 103 185 74 111 200 80 120 216 86 130 233 93 140
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ProfSNRao(SJMSOM,IITB)

DiscountedValuationMethods
EquityDCFModel
EquityValue=Discountedvalueoffreecashflowstothe equityowners DiscountrateisKL(costofequityforleveredfirm) KL=KU+(KU KD)D/E Needscomputation p ofcostofequity q yevery yp period Moresuitableforvaluationoffinancialinstitutions Doesnothelpinidentifyingvaluecreationopportunities

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Hershey Foods-Equity DCF Valuation Summary Year 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 CV Discounted ECF value Mid year Adj factor Value of operations Value of non-ope cash flows Equity value FCF($m) 245 137 644 149 708 162 723 176 738 193 12895 DF (8.1%) (8 1%) 0.925 0.856 0.792 0.733 0.678 0.628 0.581 0.537 0.497 0.460 0.460 PV of ECF ($m) 227 118 512 109 481 102 420 95 367 89 5934 8454 1 0405 1.0405 8454 450 9246

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DiscountedValuationMethods
AdjustedPresentValueModel
ValueofFirm=APVValueofFCFs+PVofTaxbenefit arisingfromtheuseofdebt ValueofLeveredFirm=ValueofUn leveredFirm+ ValueofTaxbenefitsofdebtfinancing WACC=KU KD {D/(D+E)} {D/(D E)}T KU =WACC+KD {D/(D+E)}T

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DiscountedValuationMethods
DiffersfromEnterpriseDCFModelin decomposingvalueofoperationsintotwo components Easiertousewhencapitalstructureisnotstatic UsefulinLBOvaluation

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Hershey Foods-APV Valuation Summary Year 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 CV Discounted FCF value Mid year Adj factor Value of operations Value of non-ope cash flows APV value of FCF Add: PV of Debt tax shield T t l Enterprise Total E t i Value V l Less: Value of Debt Equity value ProfSNRao(SJMSOM,IITB) FCF($m) 331 349 364 379 395 412 429 447 466 485 13526 DF (7.8%) 0.928 0.860 0.798 0.740 0.687 0.637 0.591 0.548 0.508 0.472 0 472 0.472 PV of FCF ($m) 307 301 290 281 271 262 253 245 237 229 6380 9056 1.039 9409 450 9859 642 10501 1282 9299 40
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DiscountedValuationMethods
EconomicProfitModel
Valueofacompanyisequaltotheamountof capitalinvested,plusapremiumequaltothe presentvalueofthevaluecreatedeachyear Usefulmeasureforunderstandingperformancein singleyear Ittranslatestwovaluedriversintoasinglerupee figure

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Hershy Foods-Economic Profit Calculation

Forecast o ecast Forecast o ecast Forecast o ecast 1997 ROIC WACC S Spread d IC (beg) NOPLAT Capital Ch Charge EP 24 3% 24.3% 8.3% 16% 1815 442 151 291 1998 23 0% 23.0% 7.5% 15 5% 15.5% 1885 434 141 293 1999 23 0% 23.0% 7.5% 15 5% 15.5% 1830 420 137 283 2000 22 7% 22.7% 7.5% 15 2% 15.2% 1919 436 144 292 2001 22 6% 22.6% 7.5% 15 1% 15.1% 2005 454 150 304
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Hershey Foods-Economic Profit Valuation Summary Year 1999 2000 2001 2002 2003 2004 2005 005 2006 2007 2008 CV PV of Economic Profit Invested capital (beg of year) Md Adj factor Value of operations Value of non-operating cash flows Total enterprise value Value of debt ProfSNRao(SJMSOM,IITB) Equity value 9 385 EP($m) 283 292 304 316 329 343 357 35 372 387 403 11858 DF (7.5%) 0.930 0.865 0.805 0 709 0.709 0.697 0.648 0.603 0 603 0.561 0.522 0.485 0.485 PV of FCF ($m) 263 252 245 237 229 222 215 5 209 202 196 5754 8024 1830 1 037 1.037 10 217 450 10 667 1 282 43
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LetusapplyEnterpriseDCFValuationModelforACC ltd
Valuation of ACC.xlsx

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