ENTREPRENEURIAL FINANCE
Countrywide PLC case study
Select one IPO, with available prospectus, and answer the following questions
- I) what is the most reliable method of valuing new companies in primary (i.e. IPO) markets?
Comparable transaction analysis (Deal Comps) _ deal comps mostly relies on transaction multiples rather than trading multiples which is from several comparable business enterprises in the industry. Moreover, the goodness with this method is that in the process of valuing new business which have entered in the primary, for instance the IPO, market, it makes use of premiums and multiples which were to be paid in comparable transactions so as to value the company (Castillo & Mcaniff, 2006 P. 148). In the act of using this approach to value the company, several attributes had to be taken into consideration. These include; size of the company i.e. (market cap, assets, and revenues), the geographic location of the company, business mix i.e. (its distribution network, market served, products, and so on), timing i.e. (transaction ought to be recent), and industry group (Rosenbaum & Pearl, 2013 P. 4)
Contrary to that, although the deal comps is similar to the assembling trading comps, the information to be collect can be relatively difficult to locate. The ultimate reason for that is because the main source for the data to be computed with the aid of this method is contained in internal resources of the firm (Rosenbaum & Pearl, 2013 P. 4). Conversely, the available metrics for valuing the firm are absolutely tied on the sales and profit gained. Since the precedent transactions are not easily comparable, it means that not all aspects of the firm’s transactions can be captured.
On the other hand, it should be noted that in the process of using this evaluation technique, there is the need of comparing other business organization which have publicly traded securities in the stock market (Geddes, 2003 P. 76). The reason for that is to ensure that the value regarding the comparable firms has been properly estimated. Moreover, this model works best when non-controlling and small stake contained in the company, with respect to the standards of the stock market, is readily acquired or just the newer issuance of its equity is taken into consideration (Rosenbaum & Pearl, 2013 P. 4). Although this doesn’t have the capacity of causing any significant change in control, the fact is that there will be no control premium to be perceived by the company. This is to imply that there will be no value which will accrue as a result of the change in control whenever a newer entity owns all of the company’s voting interests which offers the capacity of having full control of the business (Castillo & Mcaniff, 2006 P. 148). Consequently, since there is no change in business control occurring, it means that this method is the most efficient or reliable technique for valuating new corporations in primary that is initial public offering (IPO) market.
- II) How should the selected company go about valuing the company?
With respect to the various evaluation methods available, typically the evaluation of a company entails the determination of its worthiness. The determination of the worthiness as well as acknowledging what drives its prevailing value remains to be a prerequisite in deciding the appropriate prices to be met or receiving to be used in corporate restructuring, taxable events and so (Rosenbaum & Pearl, 2013 P. 4).
Nonetheless, in valuing the company, its management authority should ensure that they have found a true intrinsic value of its assets as well as other associated resources which are used to run its day-to-day economic activities. This involves a series of computations and assumptions which are based on the specific statistics of the company and the industry. This obviously will include key or effective planning, adjustments of the financial statement as well as applying the suitable valuation method/s (Geddes, 2003 P. 76). On the other hand, in the act of valuing the company, perceived risks, operational history, operational and management control, difficulty of quantifying cash flows and earnings, as well as the capital structure of the company are the main factors which should be considered (Beaton, 2010 P. 46).
Conversely, it should be acknowledged that although there existence of multiple acceptable valuation methodology, the result which is obtained from each one of them should be based on the company’s sensitivity of inputs (Geddes, 2003 P. 76). Usually, the cost of capital for the majority of privately held business organizations differs greatly. The reason for that is because a large percentage of them do not have the opportunity of accessing capital through equity financial institutions. Therefore, since not all valuation techniques are applicable to all business organization, the management authority of the company should ultimately depend on suitable evaluation model i.e. comparable valuations, which enable it to underwrite its shares or stock in the public in advance to the initial public offering (Castillo & Mcaniff, 2006 P. 146). Therefore, in valuing the company, the following should be taken into consideration;
1) Finding the total shares of the common stock which will be outstanding just after the offering
2) Finding the existing and outstanding options _ due to the fact that there are several means of accounting the outstanding options, there is the need of simplifying the valuation technique. It should be acknowledged, therefore, that in the process of valuing the company, its shares are essential since they correspond to the strike prices (Geddes, 2003 P. 77).
3) Computing fully diluted common outstanding shares through the use of a suitable evaluation model.
4) Determining fully diluted common shares via summing all types of outstanding shares.
5) Calculating equity value via multiplying the diluted common shares with the offering price.
6) Calculating enterprise value through the general adjustment of cash and debt of the company. This is achieved through taking primary shares provided and then multiplying it with the offering price so as to find how much the public funding is raised by the company less the IPO costs (Beaton, 2010 P. 46). Conversely, there is tallying of the net cash which is contained in the balance sheet of the company (cash – debt). Therefore;
Value of the enterprise = value of equity – (net cash + IPO proceeds)
III) Estimate the value of the company (i.e. offer price) using at least two valuation methods. At what price should the stock be offered?
Discounted Cash Flow (DCF) = (5.28/21.5) + (5.94/21.5) + (5.90/21.5) + (6.49/21.5) + (8.80/21.5) + (10.97/21.5)
= 0.2456 +0.2762 + 0.2744 + 0.3018 + 0.4093 + 0.5102
=2.0175 %
Enterprise value = equity (market cap) + debt - cash
= 1129 + 64001313-308
= 64002134
With respect to the above computations, it essential to understand that the value ascribed has the potential of controlling the business rather than merely owning a percentage of the company’s equity in it (Wyatt, 2009 P. 89). Basically, the offering price refers to the price of the securities which are publicly traded and readily made available for purchase by the general public. The offering price of the publicly traded securities comprises of the management fee and the underwriters fee which is highly applicable to this context. This is because most of the time underwriters do consider several factors whenever trying to determine the offering price of the securities. Preferably, the above result indicates that the company should efficiently do an assessment of the securities, raise sufficient funds, as well as sell them to potential investors at a fair offering price (Marsh, 2012 P. 171).
On the other hand, the selling of the company’s stock is perceived as the means of generating funding which is used for the purpose of growing the business. Despite of that, the prices of the stocks has the potential of fluctuating whenever they are publicly traded or offered. Therefore, the management authority should bear in mind that the corporations which undertake the issuing of new stocks has the possibility of diluting the shares hence causing the ultimate drop of their value (A.I.C.P.A, 2013 P. 104). As a result of that, what is acknowledged from these assumptions is that although stock offering is mainly used for funding the operations of the company, the truth is that they has the capacity of spurring corporate growth as well improving earning hence fostering long-term profits to the shareholders (Geddes, 2003 P. 78).
- IV) Compare your estimated offer price with the price disclosed in the IPO prospectus. Explain the difference.
With respect to the above computations, the fact is that what were taken into are the four main key portions of the prospects. The result obtained light on the issuer as well as that of the underwriter objectives. Since this was also aimed at predicting the magnitude of the first day initial public offering (IPO) return and the long-run post IPO performance of the company, the fact is the litigation risks associated in the industry performs an essential determining the main pricing of IPO as well as the strategic disclosure of prospects’ information (Smith, 2006 P. 304). The result obtained clearly supports the conventional theories regarding book-building or disclosure with other interesting exceptions.
The issuing manager of the company plays a crucial role in the book-building processes. In return, greater management disclosure ends up generating relatively higher prices or superior long-term performance (A.I.C.P.A, 2013 P. 104). The disclosure obtained from the response information is perceived as being systematic; therefore, prospectus revision usually occurs whenever that data is negative.
In connection to that, since it not relatively easily to find firms which are similar as compared to the targeted company, it essential, therefore, for the appraiser to be able to make use of the available information more creatively. Due to the fact that comparing the ratios is more useful unlike the absolute amount of the sales, it easier to have a clear picture of the weaknesses and strengths of the firm as compared to those in the same industry (Chechile, 2004 P. 9). In return, once arriving at the preliminary range of the valuation values using the suitable evaluation technique, it is important to make adjustments on the prices for any situation which are typical to the company (Marsh, 2012 P. 171).
Additionally, there is the need of backing up the prices or subsequent adjustments so as to account for its competitive advantage in the industry. This has the ability of making investors and buyers to examine and understand any justification for any valuation which might be higher than the apparent comparables. Thus, the values computed above tend to be a good indicator of the business risks, industry trends, and market growth (Chechile, 2004 P. 9).
- VI) Compare the offer price disclosed in the IPO prospectus with the stock’s closing price on the first trading day. Explain the difference.
Due to the fact that the majority of the private companies have the capacity of changing their balance sheets as well as earnings for some alternative purposes, there is the need of recognizing or modifying its capital structure and earnings accordingly. For private companies, it should be noted the some of the non-traditional may not be applicable for such an analysis of the capital invested, assets appraisal, capitalization of earnings, and replacement cost (A.I.C.P.A, 2013 P. 104).
Likewise, in the act of comparing the revealed offer price contained in the IPO prospectus with the closing price of the stock on the first day, it was noted that stock has a greater potential of reflecting both the performance as well as the general potential selling of the company as compared to others in the industry. The reason for that is becomes it assist in coming up with an easier means of arriving at a value i.e. the stock price. Therefore, the appraisal used in this technique will be examining other companies which not only operate in the same industry but also offering similar services or products (Chechile, 2004 P. 9). The justification with this technique is that it provides the potential customers with the possibility of considering buying it or with which to compare.
On the other hand, the closing price of the stock during the first day of trading indicates that peers in the industry can easily be grouped based on several criteria, such as growth or size of the company, industry focus, and so on. The various multiples which were derived from this kind of analysis indicate that evaluation of stock during its first day of trading were timely but can equally change with time. The point of consideration is that the trading multiples do not have the capacity of reflecting control premiums or synergies (Castillo & Mcaniff, 2006 P. 148)
Typically, there are various a financial ratios which assists in measuring the value of the company based on its gross revenue or net sales. The effectiveness of using any of the valuation methods is that they offer the opportunity of evaluating or measuring the returns of the company. Conversely, the truth is that the obtaining a considerable statistical population offers effective revenue evaluation hence making it to be more reliable. This then means that with stock, there is the provision of a wide range of multiple of revenue and average for the general evaluation. Since the company’s objective is the profit maximization, it then means that growth, revenue size, and revenue model are the main factors which are considered at the end of the first day of its trading as compared to the offer price which is contained in the IPO prospectus. The reason for that is because it has the ability of influencing valuation and comparison of the prevailing value in the industry which is mainly revealed in the initial public offering (IPO) of the prospectus together with the fair price during the start of the trading day (Wyatt, 2009 P. 89)
The reason for that consideration is because the recurring revenue models to be used for the evaluation the company will typically be commanding higher valuation ranges which in return reflect the extent to which the organization has grown in respect to stock (Ogilvie, 2009 P. 598). The value to be obtained after the termination of the first trading period of stock will ultimately indicate the revenues obtained from the same client i.e. on recurring basis or through increasing characteristics. Contrary to that, the truth is that in the process of comparing the offer price which is revealed by the IPO prospectus together with the closing price of the stock on the start of the trading day, the fact is that the maintenance revenues will equally be valued more highly. This will only happen in case the firm has an efficient technological roadmap that will offer realistic value to the clients as well as incentivizing them to be loyal to it and make sound judgment in purchasing the stocks (Wyatt, 2009 P. 89)
VII) Evaluate long term performance of the stock up to 1 year after the listing.
From the above computations, it should be noted that always internal public offering (IPO) underperforms by an average of 1% per month for duration of four years. This indicates that firm will have a positive performance which is reported in the beginning year followed by a negative value in the following 3-years and finally a positive trend in the 4-year. Therefore, this is an important trend to equity assurance or an impressive explanatory power. In hypothesis, in case the company manages to successfully time its offering during the time when equity capital costs are perceived to be relatively low, the probability is that it will subsequently manifest lower returns for its potential investors (Ogilvie, 2009 P. 598).
In addition to that, the probable means of realizing that is through identifying the period when their market is overhauled or when the potential investors have the chances of overpaying for a certain IPO in relative to other companies in their industry (Schön, 2007 P. 6). In the early offering period of stock, their prices will be relatively higher with some huge differentiation of opinions for the anticipated future returns. Despite of that, in the long-run, the possibility is that prices decreases as a result of optimistic investors lowering their appraisals.
In connection to the above considerations, it should be noted that investors are always regularly over-optimistic about the forecast of the companies in entering the stock market. Therefore, IPOs becomes more and more beneficial to the company in case issuers have the ability of timing their flotation/s so as to ensure that they have coincided with the period of energetically high predictions or expectations amongst investors (Sepp & Frear, 2011 P. 96). This equally implies that the heterogeneity of these beliefs has the capacity of supporting the provisional bubble theory and the overvaluation of the initial public offering (IPO) straight away after its issuance.
With respect to the current state of the company, the fact is that the general performance of the company’s stock in the long-run (for duration of one year following its listing) is depended on the expected future performance of IPOs (Sepp & Frear, 2011 P. 96). The reason for that is because always IPOs perform efficiently when stock expects focuses on lower growth projection. Other hypothesis that the firm ought to entails manipulating its financial statements and accounting numbers so as to be able to make its offering to be more appealing to the customers (Schön, 2007 P. 6). This in return has the effect of beguiling investors to pay more than the fair price. The empirical result obtained above, therefore, indicates that the potential investor/s who would be investing in IPOS through direct subscription will be earning a positive stock market adjusted returns via the period of listing (Ogilvie, 2009 P. 598). Contrary to that, investors who will be buying the shares on the IPO listing day will most probably be earning a negative returns for a period of twelve months (1 year) from listing date hence anticipate to be earning positive market adjusted returns thereafter.
References
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ROSENBAUM, J., & PEARL, J. (2013). Investment banking: valuation, leveraged buyouts, and mergers & acquisitions. http://public.eblib.com/choice/publicfullrecord.aspx?p=1204848
GEDDES, R. (2003). IPOs and equity offerings. Oxford, Butterworth-Heinemann. http://www.123library.org/book_details/?id=37452
BEATON, N. J. (2010). Valuing early stage and venture-backed companies. Hoboken, N.J., John Wiley & Sons. http://www.123library.org/book_details/?id=5751
SMITH, D. (2006). Zero-to-IPO & other fun destinations: the essential guide to surviving startup -- & cashing out! [Calif.], Cambridge Manhattan Group.
MARSH, C. (2012). Financial management for non-financial managers. London, Kogan Page.
OGILVIE, J. (2009). F3: financial strategy. Oxford, CIMA/Elsevier.
SCHÖN, D. (2007). The relevance of Discounted Cash Flow (DCF) and Economic Value Added (EVA) for the valuation of banks. München, GRIN Verlag.
CHECHILE, R. A. (2004). The ABCs of IPOs: investment strategies and tactics for new issue securities. Lincoln, NE, iUniverse.
