R A Hill Corporate Valuation and Takeover 2 Download free eBooks at bookboon.com Corporate Valuation and Takeover © 2011 R A Hill & bookboon.com ISBN 978-87-7681-830-2 3 Download free eBooks at bookboon.com Corporate Valuation and Takeover Contents Contents About the Author 9 Part I: An Introduction 10 1 An Overview 11 Introduction 11 1.1 Some Observations on Traditional Finance Theory 11 1.2 Some Observations on Stock Market Volatility 12 Summary and Conclusions 15 Selected References 17 Part II: Share Valuation Theories 18 2 How to Value a Share 19 Introduction 19 2.1 The Capitalisation Concept 19 2.2 The Capitalisation of Dividends and Earnings 20 2.3 The Capitalisation of Current Maintainable Yield 23 Free eBook on Learning & Development By the Chief Learning Officer of McKinsey Download Now 4 Click on the ad to read more Download free eBooks at bookboon.com Corporate Valuation and Takeover Contents 2.4 The Capitalisation of Earnings 23 Summary and Conclusions 26 Selected References 27 3 The Role of Dividend Policy 28 Introduction 28 3.1 The Gordon Growth Model 28 3.2 Gordon’s ‘Bird in the Hand’ Model 31 Summary and Conclusions 34 Selected References 34 4 Dividend Irrelevancy 35 360° Introduction 35 4.1 The MM Dividend Irrelevancy Hypothesis 35 4.2 The MM Hypothesis and Shareholder Reaction 37 thinking 4.3 The MM Hypothesis: A Corporate Perspective360° 39 . Summary and Conclusions 41 Selected References thinking. 42 Part III: A Guide to Stock Market Investment 43 5 How to Read Stock Exchange Listings 44 360° thinking . 360° thinking. Discover the truth at www.deloitte.ca/careers Discover the truth at www.deloitte.ca/careers © Deloitte & Touche LLP and affiliated entities. Discover the truth at www.deloitte.ca/careers © Deloitte & Touche LLP and affiliated entities. © Deloitte & Touche LLP and affiliated entities. 5 Discover the truth at www.deloitte.ca/careersClick on the ad to read more Download free eBooks at bookboon.com © Deloitte & Touche LLP and affiliated entities. Corporate Valuation and Takeover Contents Introduction 44 5.1 Stock Exchange Listings 44 Summary and Conclusions 49 Selected References 50 6 Strategies for Investment (I) 51 Introduction 51 6.1 Dividends as Income 53 6.2 Dividends for Growth 55 6.3 The Price-Earnings Ratio: Past and Future 56 Summary and Conclusions 58 Selected References 59 7TMP PRODUCTIONStrategies for Investment (II) NY026057B 4 12/13/201360 Introduction 60 6 x 4 PSTANKIE ACCCTR0005 7.1 Corporate Information 60 gl/rv/rv/baf Bookboon Ad Creative 7.2 “Beating” the Market 63 Summary and Conclusions 66 Selected References 66 Part IV: Valuation and Takeover 67 © All rights reserved. 2013 Accenture. Accenture. 2013 Bring your talent and passion to a global organization at the forefront of business, technology and innovation. Discover how great you can be. Visit accenture.com/bookboon 6 Click on the ad to read more Download free eBooks at bookboon.com Corporate Valuation and Takeover Contents 8 A Stock Exchange Valuation 68 Introduction 68 8.1 Coming to the Market 69 8.2 Calculations and Assumptions 71 8.3 A Total Market Valuation 73 8.4 An Aggregate Flotation Value 74 8.5 The Number and Denomination of Shares 74 8.6 A Valuation per Share 74 Summary and Conclusions 75 9 Managerial Motivation and Corporate Takeover 77 Introduction 77 9.1 Objective Motivational Factors 77 9.2 Subjective Motivational Factors 80 Summary and Conclusions 83 Selected References 83 10 Acquisition Pricing and Accounting Data 84 Introduction 84 10.1 Takeover Valuation: The Case for Net Assets 86 10.2 Valuing the Assets 86 10.3 How to Value Goodwill 88 The Wake the only emission we want to leave behind " #$% &'())%*+ , - . 7 Click on the ad to read more Download free eBooks at bookboon.com Corporate Valuation and Takeover Contents Summary and Conclusions 92 11 Acquisition Pricing-Profitability, Dividend Policy and Cash Flow 94 Introduction 94 11.1 Takeover Valuation: The Profitability Basis 94 11.2 Takeover Valuation: Dividend Policy 98 11.3 Takeover Valuation: The Cash Flow Basis 103 Summary and Conclusions 106 Selected References 107 12 Takeover Activity, Investor Behaviour and Stock Market Data 108 Introduction 108 12.1 The Current Takeover Scene 109 12.2 Investor Behaviour 110 12.3 The “Golden Rules” of Investment 112 12.4 Acquisition Strategy and Stock Market Data 114 Summary and Conclusions 121 Selected References 122 Appendix: Stock Market Ratios 123 30 daysFREE trial! SMS from your computer ...Sync'd with your Android phone & number Go to BrowserTexting.com and start texting from your computer! ... BrowserTexting 8 Click on the ad to read more Download free eBooks at bookboon.com Corporate Valuation and Takeover About the Author About the Author With an eclectic record of University teaching, research, publication, consultancy and curricula development, underpinned by running a successful business, Alan has been a member of national academic validation bodies and held senior external examinerships and lectureships at both undergraduate and postgraduate level in the UK and abroad. With increasing demand for global e-learning, his attention is now focussed on the free provision of a financial textbook series, underpinned by a critique of contemporary capital market theory in volatile markets, published by bookboon.com. To contact Alan, please visit Robert Alan Hill at www.linkedin.com. 9 Download free eBooks at bookboon.com Corporate Valuation and Takeover Part I: An Introduction 10 Download free eBooks at bookboon.com Corporate Valuation and Takeover An Overview 1 An Overview Introduction The 2007 global financial crisis ignited by reckless bankers and their flawed reward structures will be felt for years to come. Emerging from the wreckage, however, is renewed support for the over-arching objective of traditional finance theory, namely the long-run maximisation of shareholder wealth using the current market value of ordinary shares (common stock) as a benchmark. If capitalism is to survive, it is now widely agreed that conflicting managerial aims and short-term incentives, which now seem to characterise every business sector, must become entirely subordinate to the preservation of ownership wealth, future income and capital gains. And as we shall discover, the key to resolving this principle-agency problem begins with a theoretical critique of how shares are valued. This not only underpins the practical measures of current and historical stock market performance published in the financial press (price, yield, cover, and the P/E ratio) used by market participants throughout the world. It also provides private individuals and the companies or financial institutions acting on their behalf with a common framework to analyse all their future investment decisions, whether it is an individual share transaction, a market placement, or corporate takeover activity. 1.1 Some Observations on Traditional Finance Theory Based on the Separation Theorem of Irving Fisher (1930), traditional normative theory explains how corporate management should maximise shareholder wealth by maximising the expected net present value (NPV) of all a firm’s investment projects. According to Fisher, in a world of perfect capital markets, characterised by rational-risk averse investors, with no barriers to trade and a free flow of information, it is also irrelevant whether a company’s future project cash flows are distributed as dividends to match shareholders consumption preferences at any point in time. If a company decides to retain profits for reinvestment, shareholder wealth measured by share price will not fall, providing that: Management’s minimum required return on new projects financed by retention (the discount rate) at least equals the shareholders’ opportunity rate of return (yield) that they can expect to earn on alternative investments of comparable risk, or their the opportunity cost of capital (borrowing rate). If shareholders need to borrow to satisfy their consumption (income) requirements they can do so at the market rate of interest, leaving management to reinvest current earnings (unpaid dividends) on their behalf to finance future investment, growth in earnings and future dividends. Following Fisher’s logic, all market participants should therefore earn a return commensurate with the risk of their investment. And because perfect markets are also efficient markets, shares are immediately and correctly priced at their intrinsic value in response to managerial policy, just like any other information and current events. 11 Download free eBooks at bookboon.com Corporate Valuation and Takeover An Overview Yet, we now know that markets are imperfect. Investors may be irrational, there are barriers to trade and information is limited (particularly if management fail to communicate their true intentions to shareholders) any one of which invalidates Fisher’s theorem. As a consequence, the question subsequent twentieth century academics sought to resolve was whether an imperfect capital market can also be efficient. To which the answer was a resounding “yes”. Based on the pioneering work of Eugene Fama, which began to emerge in the 1960s, modern finance theory now hypothesises that real-world stock markets may not be perfect but are reasonably efficient. Shareholder wealth maximisation is premised on the law of supply and demand. Large numbers of investors are assumed to respond rationally to new public information, good, bad, or indifferent. They buy, sell, or hold shares in a market without too many barriers to trade. A privileged few, with access to insider information, or either the ability, time or money to analyse all public information, may periodically “beat the market” by being among the first to react to events. But share price still reverts quickly if not instantaneously to a new equilibrium value, correctly priced, in response to the technical and fundamental analyses of historical trends and the latest news absorbed by the vast majority of market constituents. Today’s trading decisions are assumed to be independent of tomorrow’s events.