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A Valuation of Orkla

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A Valuation of Orkla Master’s Thesis The Conglomerate Discount Phenomenon ̶ A Valuaon of Orkla ASA Copenhagen Business School, 2014 MSc. Applied Economics and Finance Authors: Joakim W. Severinsen & Henrik G. Gundersen Supervisor: Morten Vestengen Date of Submission: May 19th 2014 Number of Pages: 118 (excl. references and appendices) Number of Characters: 272,770 (incl. spaces) Number of Standard Pages: 120 Executive Summary Executive Summary The stock of a company engaged in multiple unrelated business segments is typically traded at a price below the combined value of its separate entities. This phenomenon is commonly known as the ‘conglomerate discount’, pointing to a valuation disadvantage of the conglomerate structure. After being structured as a conglomerate for nearly three decades, Orkla ASA suddenly shifted its business focus, in September 2011, towards becoming a pure-play branded consumer goods (BCG) company. Although several subsidiaries in the company’s wide-spread portfolio have been divested at the time of writing, the restructuring process is not fully completed. The authors found this shift in strategic direction very interesting in relation to the historical discount associated with the company’s stock. Therefore, the overall objective of this thesis has been to combine a thorough analysis of corporate diversification with a ‘sum-of-the-parts’ valuation to assess whether the stock is still traded at a conglomerate discount. Before delving into the specifics, it was necessary to establish the relevance of considering a phenomenon such as the ‘conglomerate discount’. Through a comprehensive literature review, it was revealed that conglomerates first and foremost could be justified from an ‘economic perspective’. This view emphasizes that companies are able to benefit from an internal capital market through easier access to capital and through opportunities to seize profitable investments in different industries. However, both empirical evidence and our own regression-analysis pointed towards a negative effect of corporate diversification on relative firm value. The prevailing reason for this seems to be that investors are not willing to pay for the corporate diversification and rather prefer to assemble their own portfolio of assets. It was thus surprising to observe that there appears to be no common practice among financial analysts as to how a conglomerate discount should be incorporated into the valuation. Through interviews with leading analysts covering the Orkla stock, it was evident that their interpretation of the discount varied. Some argued that there is still a discount of about 10%, another argued it had dissolved, and yet another did not even consider a conglomerate discount. With such varying opinions among experienced practitioners, it could also be expected that market participants vary in their interpretation and approach. Therefore, in order to assess whether there still seemed to be a conglomerate discount associated with the Orkla stock, a valuation of the individual parts of Orkla was conducted. With BCG being the core-business going forward, this segment was valued using a fundamental analysis and discounted cash flow (DCF) approach. The non-core segments were valued using trading-multiples. The analysis yielded a theoretical share price of NOK 52.50, as of March 20th 2014. Compared to the market price of NOK 48.30, the valuation of the underlying assets indicates a discount of 8.7%. The discount is clearly below the historical average of about 25%, and it is reasonable to expect that the discount will continue to gradually disappear when Orkla transitions into a single-business firm. This implies a potential upside for investors, which is unrelated to the general performance of the company. Page 1 of 251 Table of Contents Table of Contents Executive Summary ......................................................................................................................................... 1 Table of Contents ............................................................................................................................................. 2 1. Introduction ................................................................................................................................................. 4 1.1. Context and Motivation .......................................................................................................................... 4 1.2. Problem Statement .................................................................................................................................. 5 1.3. Methodology ........................................................................................................................................... 8 1.4. Delimitation and Assumptions ............................................................................................................. 10 2. Corporate Diversification and the Conglomerate Discount .................................................................. 11 2.1. The Conglomerate Rationale ................................................................................................................ 11 2.2. Assessment of the Effect from Corporate Diversification .................................................................... 13 2.3. Financial Analysts’ Approach to Orkla’s Conglomerate Discount ...................................................... 17 3. Introduction to Orkla ................................................................................................................................ 22 3.1. Orkla’s History ..................................................................................................................................... 22 3.2. Company Description ........................................................................................................................... 25 3.3. Orkla Share Price Development ........................................................................................................... 27 4. The Branded Consumer Goods Industry ................................................................................................ 28 4.1. Supply- and Value Chain for the BCG Industry .................................................................................. 28 4.2. Competition in the BCG Industry ........................................................................................................ 29 4.3. Customers of the BCG Industry .......................................................................................................... 31 4.4. Suppliers of the BCG Industry ............................................................................................................ 32 4.5. Substitutes for BCG Products .............................................................................................................. 32 5. Strategic Analysis ...................................................................................................................................... 33 5.1. PESTEL ................................................................................................................................................ 34 5.2. Porter’s Five Forces .............................................................................................................................. 47 5.3. VRIO Analysis of Firm Specific Factors.............................................................................................. 57 6. Financial Analysis ...................................................................................................................................... 65 6.1. Reclassification of Financial Statements .............................................................................................. 65 6.2. Definition of Peer Group ...................................................................................................................... 68 6.3. International BCG Peer Group ............................................................................................................. 72 6.4. Profitability Analysis ............................................................................................................................ 74 6.5. Risk Analysis ........................................................................................................................................ 78 7. SWOT Analysis .......................................................................................................................................... 82 Page 2 of 251 Table of Contents 8. Forecasting ................................................................................................................................................. 85 8.1. Forecast by Segment ............................................................................................................................. 86 8.2. Quality of the Estimates in the Pro Forma Statements ......................................................................... 93 9. Cost of Capital ........................................................................................................................................... 94 9.1. Weighted Average Cost of Capital ....................................................................................................... 94 10. Valuation ................................................................................................................................................ 101 10.1. Orkla Branded
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