A Valuation of an IPO - Scandinavian Tobacco Group Page numbers: 113 standard pages Character numbers: 272.069 (119,5 standard pages) 15th of September 2016. Copenhagen Business School MSc. Accounting, Strategy & Control Master Thesis Name of Students: Mads Dalgaard Hansen Rasmus Nørgaard Lüthgens Name of Supervisor: Ole Vagn Sørensen ABSTRACT This thesis answers the question “What is the estimated Fair Value of Scandinavian Tobacco Group per 08.04.2016, and to what extent did market conditions and underwriting bodies affect the aftermarket of the IPO”. Analyses of the strategic- and financial environment led to a fair value of DKK 128,2 per share. It was also found that market conditions changed considerably towards a cold market leading up to the offering. The thesis argues that the conditions affected the first day return of the company and finds significant evidence that the underwriter and stabilising manager, Nordea, performed price support to affect the stock price in the aftermarket. By applying a modified PEST analysis, Porter’s Five Forces, the VRIO-model and analysing financial statements, the thesis gained insight in to the financial performance and the environments in which the company operate. The thesis found that strong regulatory requirements are one of the primary threats, while the biggest opportunities stem from loyal- and price-insensitive consumers, along with increasing volumes in the U.S. market. Furthermore, the company is able to leverage a strong portfolio of brands but faces ineffective operations with a low utilisation of capital. These analyses led to an estimate of the company’s future cash flows and risk, represented in a forecast and an estimated cost of capital, which were the two main components of the applied DCF-valuation. The components exhibited a terminal growth rate of 0,5% and a WACC of 6,15%. The value of the underlying business was estimated at fair value to DKK 112,3, while an initiated efficiency programme was estimated at DKK 15,9, yielding a total share price of DKK 128,2. Subsequently, the components of growth and risk were, among others, stress-tested in a sensitivity analysis to determine the resilience in share price. Findings included a somewhat high sensitivity to changes in risk, while demonstrating a tolerance to changes in growth rates. In addition, a scenario-analysis on the removal of the Cuban Trade Embargo was performed, which indicated a significant downside and low upside in the event of an embargo-lift. Finally, the thesis used investor’s sentiment along with index movements to analyse the market conditions leading up to the IPO. These indicated a change from positive to negative sentiment and considerable drops in the Danish C20-index, leading to a climate change in market conditions, from hot to cold. Analyses suggest that the offering did not adjust the offer price to the market climate, which led to a first-day return of 0,0%. Because of abnormal market movements and a lack of first-day return, the thesis investigated intra-day tick data to test if price support were applied to keep the stock afloat at the offer price. It was found that the stabilising manager, Nordea, bought an abnormal amount of shares at the offer price and was building up inventory of the stock in order to decrease the supply of shares in market. Referring to Lewellen (2006), these findings are clear indicators of underwriters affecting the aftermarket through price support. 1 Contents 2 Introduction ................................................................................................................................................. 3 2.1 Problem Formulation .......................................................................................................................... 4 2.2 Research Questions ............................................................................................................................. 4 2.3 Delimitations and Constraints ............................................................................................................. 4 3 Methodology ............................................................................................................................................... 6 3.1 Theory of Science ............................................................................................................................... 6 3.2 Collection of Empirical Data .............................................................................................................. 6 3.3 Application of Theory ......................................................................................................................... 7 4 Company and Market Description ............................................................................................................ 10 4.1 Products and Segments ..................................................................................................................... 10 4.2 Strategy ............................................................................................................................................. 11 4.3 Market ............................................................................................................................................... 12 5 Strategic Analysis ..................................................................................................................................... 14 5.1 PESEL – External Analysis .............................................................................................................. 14 5.2 Industry Analysis – Porter’s Five Forces .......................................................................................... 23 5.3 Analysis of internal resources ........................................................................................................... 32 6 Financial Statement Analysis .................................................................................................................... 36 6.1 Accounting Quality ........................................................................................................................... 36 6.2 Reorganising the Financial Statement ............................................................................................... 40 6.3 Profitability- and Credit Analysis ..................................................................................................... 44 6.4 Peer Group Analysis ......................................................................................................................... 55 7 SWOT ....................................................................................................................................................... 57 7.1 Strengths ........................................................................................................................................... 57 7.2 Weaknesses ....................................................................................................................................... 58 7.3 Opportunities ..................................................................................................................................... 58 7.4 Threats ............................................................................................................................................... 59 8 Valuation of Scandinavian Tobacco Group .............................................................................................. 60 8.1 Forecasting ........................................................................................................................................ 60 8.2 Weighted Average of Cost of Capital ............................................................................................... 70 8.3 DCF Valuation .................................................................................................................................. 80 8.4 Peer Valuation (multiples) ................................................................................................................ 83 9 Sensitivity Analysis .................................................................................................................................. 85 1 10 Scenario Analysis .................................................................................................................................. 88 10.1 Lift of the Cuban Trade Embargo ..................................................................................................... 88 11 Discussion of IPO and Market Pricing .................................................................................................. 91 11.1 IPO Timing ....................................................................................................................................... 91 11.2 Underpricing in Theory ..................................................................................................................... 95 11.3 Underpricing for Scandinavian Tobacco Group ............................................................................... 97 11.4 Price Support ..................................................................................................................................... 98 12 Conclusion .......................................................................................................................................... 105 13 Bibliography ......................................................................................................................................