Valuation of Lego DCF, Fourier analysis and Monte Carlo Simulation 38000 16000 33000 14000 28000 12000 23000 10000 18000 8000 DKK mn DKK 13000 6000 Avg # FTE # Avg 8000 4000 3000 2000 -2000 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Net pr ofits Revenue Avg # FTE MASTER THESIS Per Elsted Hansen Copenhagen Business School cand.merc. Finance and Strategic Management Submitted: May 6, 2016 Thesis advisor dr. merc. Finn Østrup Pages Characters 79.2 180.112 ABSTRACT This thesis aims at estimating a fair value of Lego. The discounted cash flow model serves as the overall guideline in relation to the computational valuation. Thirty financial statements from 2006 to 2015 are reformulated and analyzed – ten statements from Lego and a sum of twenty from Lego’s largest competitors Hasbro and Mattel. The case of Lego is interesting because in just ten years, the firm went from near-bankruptcy to becoming the second largest toy-manufacturing firm in the world measured by revenue. In addition, Lego is an unlisted firm and having no access to the inner workings in the research of Lego proves to be a challenge during the process. The research relies heavily on historical public record data and information asymmetry is therefor expected, which may yield a ‘less true’ valuation than otherwise possible. Lego’s famous product, the Lego Brick, is today the single most sold toy product across the global toy and games industry. A strategic analysis is conducted on macro and micro levels, while meso level analysis in general is avoided due to the sheer scale and scope of Lego. In the practical part of forecasting time series data (10-year government bond interest rates, revenue and NOPLAT), the data was first checked to rule out randomness by using Fisher’s Kappa test statistic, as well as Bartlett’s Kolmogorov-Smirnov test statistic. Depending on results, Fourier analysis is employed to reveal any periodicity, and later benchmarked against various regression models. However, for the data at hand, and although only in a minor degree, Fourier transformation proves to be inferior compared to the regression model. In accordance with the research design chosen, regression modeling takes the precedence over Fourier analysis. After benchmarking, forecasting and calculating the final valuation, it is put into perspective against peer firms. In addition, to try simulating “what if scenarios” of possible enterprise values, the thesis incorporates Monte Carlo modeling on one and two dimensions. The resulting valuation is found to be DKK ~460bn using 10 year budget from 2016-2025. The strategical analysis indicates an exciting future for Lego, which gives credit to the valuation, and as such, it is assumed that the valuation is fair given the limitations of thesis. 1 Index 1 Index .................................................................................................................................. 1 1.1 List of tables ................................................................................................................. 4 1.2 List of figures ................................................................................................................ 5 2 Introduction and research design ................................................................................... 8 2.1 Background ................................................................................................................... 8 2.2 Motivation and research question ............................................................................... 10 2.3 Structure ...................................................................................................................... 10 2.4 Methodology and delimitation .................................................................................... 10 2.5 Scientific framework .................................................................................................. 12 2.5.1 Science theory ................................................................................................... 12 2.5.2 Reflection on models for strategic analysis ...................................................... 18 2.5.3 Time Series Analysis ........................................................................................ 20 2.5.3.1 Fourier analysis in brief ........................................................................ 21 2.5.3.1.1 Wave, frequency, amplitude and phase ................................. 21 2.5.3.1.2 Fourier Transform applied on constructed data .................... 25 2.5.3.1.3 Testing for randomness ......................................................... 26 2.5.3.1.4 Inverse Fourier Transform ..................................................... 28 2.5.4 Monte Carlo Simulation in brief ....................................................................... 29 3 Strategic Analysis ........................................................................................................... 31 3.1 Firm introduction ........................................................................................................ 31 3.1.1 History of firm in strategic perspective ............................................................. 31 3.1.2 Products ............................................................................................................. 41 3.2 Market environment .................................................................................................... 43 3.2.1 Market outlook and competitive situation ........................................................ 43 3.2.2 Macro environment ........................................................................................... 47 3.2.2.1 Socio-cultural ........................................................................................ 48 3.2.2.1.1 Short product life cycles, digitization/mediatization of toys . 48 3.2.2.2 Legal ..................................................................................................... 49 3.2.2.2.1 Safety and product recalls ..................................................... 49 3.2.2.2.2 Intellectual Property Rights ................................................... 50 3.2.2.3 Technology ........................................................................................... 52 3.2.2.3.1 Oil .......................................................................................... 52 3.2.3 Micro environment ............................................................................................ 54 3.2.3.1 System of Play ...................................................................................... 54 3.2.3.2 Brand .................................................................................................... 56 3.2.3.3 Stores + ambassadors ............................................................................ 57 3.2.3.4 Production capabilities ......................................................................... 58 1 3.3 Summary ..................................................................................................................... 59 4 Financial Analysis ........................................................................................................... 59 4.1 Accounting policies and reformulation notes ............................................................. 59 4.2 Reformulation of balance sheets ................................................................................. 61 4.2.1 Operating cash ................................................................................................... 62 4.2.2 Operating leases ................................................................................................ 62 4.3 Reformulation of income statements .......................................................................... 64 4.4 Profitability analysis ................................................................................................... 64 4.4.1 Peer performance comparison ........................................................................... 65 4.4.2 Profitability drivers ........................................................................................... 66 4.4.2.1 Invested Capital, IC .............................................................................. 68 4.4.2.2 Return on Invested Capital ................................................................... 69 4.4.2.3 Net operating profit less adjusted taxes, NOPLAT .............................. 70 4.4.2.4 Asset turnover ratio and inverse ........................................................... 71 4.4.2.5 Net operating profit margin, NOPM ..................................................... 72 4.5 Summary ..................................................................................................................... 72 5 Valuation of Lego ........................................................................................................... 75 5.1 Discounted Cash flow model ...................................................................................... 75 5.1.1 Weighted Average Cost of Capital, WACC ..................................................... 76 5.1.1.1 Corporate tax rate ................................................................................. 77 5.1.1.2 Risk-free interest rate ............................................................................ 77 5.1.1.2.1 Results of white noise test for risk-free interest