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Valuation: Mergers, Buyouts and Restructuring, 2nd Edition
by
Arzac, Enrique R.
Publisher: John Wiley & Sons
Publishing Date: 2007/11/09
eText ISBN-10
0-470-28296-7
eText ISBN-13
978-0-470-28296-0
Print ISBN-10
0-470-12889-5
Print ISBN-13
978-0-470-12889-3
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Valuation: Mergers, Buyouts and Restructuring, 2nd Edition
by
Arzac, Enrique R.
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Copyright, iv
Preface, vii
About the Author, xi
Part One. The Tools of Va...
Part Two. Mergers, Acquis...
Part Three. Recapitalizat...
Technical Notes, 396
References, 430
Index, 443
Table of Contents
Copyright, iv
Preface, vii
About the Author, xi
Part One. The Tools of Valuation, 1
1. A User’s Guide, 3
1.1. Valuation of Stand-Alone Firms and Business Units, 3
1.1.1. Free Cash-flow Valuation, 3
1.1.2. Cost of Capital, 3
1.1.3. Valuation Multiples, 4
1.2. Economic Value Added, 4
1.3. Valuation with Changing Capital Structure, 4
1.4. Valuation in Developed and Emerging Markets, 4
1.5. Mergers and Acquisitions, 5
1.6. Deal Design and Special Offer Structures, 5
1.7. Leveraged Buyouts, 5
1.8. Recapitalization of Troubled Companies, 5
1.9. Asset Restructuring, 6
1.10. Real Options: Valuing Entry and Exit Options, 6
1.10.1. Financial Options, 6
1.11. Technical Notes and Problems, 6
1.12. Valuation Aids and DealModeler
®
Software, 6
2. Forecasting and Valuation of Free Cash Flows, 8
2.1. Free Cash Flows, 8
2.2. Building a Financial Model, 8
2.3. Enterprise Valuation, 13
2.4. Continuation Value, 16
2.4.1. Forecast Consistency, 16
2.4.2. Forecasting FCF
T
, 17
2.4.3. A Wrong Way to Forecast Continuation Value, 18
2.4.4. Sensitivity to Parameter Estimates, 19
2.4.5. Competitive Advantage Period, 19
2.4.6. EBITDA Multiples, 20
2.5. An Equivalent Approach: Valuing the Cash Flow to Equity, 21
2.5.1. Decomposition of Free Cash Flows: Cash Flows to Equity and Debt, 21
2.5.2. Equity Valuation, 21
2.5.3. Debt Valuation, 22
2.5.4. Financial Policy and Dividends, 23
2.6. Some Practical Aspects, 24
2.6.1. Choosing the Valuation Method, 24
2.6.2. Personal Taxes and Enterprise Value, 25
2.6.3. Enterprise Value in Tax-imputation Countries, 26
2.6.4. Balance Sheet Adjustments, 27
2.6.5. Cash and Marketable Securities, 28
2.6.6. Mid-year Discounting, 28
2.6.7. Dealing with Equity-linked and Other Securities in the Capital Structure, 28
2.6.8. Restructuring Expenses, 29
2.7. Analysis of Results: The Value of Franchise and Growth, 29
2.8. Summary, 32
Problems, 32
3. The Equity Premium and the Cost of Capital, 36
3.1. Estimating the Cost of Capital, 36
3.2. The Cost of Equity, 37
3.2.1. The Capital Asset Pricing Model Approach, 37
3.2.2. Choosing the Riskless Rate, 37
3.2.3. Estimating the Equity Premium: Historical Analyses, 39
3.2.4. Time Varying Equity Premium, 42
3.2.5. Prospective Equity Premium, 43
3.3. The Cost of Equity of Large Capitalization Companies, 48
3.4. The Cost of Equity and Leverage, 48
3.5. Beyond the Capital Asset Pricing Model, 50
3.5.1. The Original CAPM, 50
3.5.2. The Fama-French Three-factor Model, 52
3.5.3. Arbitrage Pricing Theory, 54
3.5.4. Liquidity and Expected Returns, 55
3.6. The Cost of Equity of Small Capitalization Companies, 56
3.7. Estimating the Cost of Equity: A Detailed Example, 58
3.8. The Cost of Debt and Other Components of the Capital Structure, 58
3.8.1. Investment-grade Debt, 60
3.8.2. High-yield Debt and Preferred Stock, 60
3.8.3. Convertible Securities, Warrants, and Other Options, 61
3.9. Estimation of the Cost of Capital in Practice, 62
3.10. Summary, 62
Problems, 63
4. Metrics and Multiples, 66
4.1. The Use of Multiples in Valuation, 66
4.2. Using Comparables: An Example, 68
4.3. Multiples and Continuation Value, 70
4.4. Relationships Among Valuation Multiples, 71
4.5. Adjusting Multiples for Leverage and Growth, 74
4.6. The Franchise Factor in Valuation Multiples, 76
4.7. Normalizing P/E Ratios by the Growth Rate, 79
4.8. Summary, 80
Problems, 80
5. Economic Value Added, 83
5.1. Measuring Value Creation, 83
5.2. Relation To Free Cash-Flow Valuation, 84
5.3. A Detailed Example of EVA Valuation, 86
5.4. The Sources of Value: Franchise and Growth, 88
5.5. Economic Value-Added and Market Value, 91
5.6. Some Empirical Evidence, 93
5.7. Summary, 93
Problems, 94
6. Valuation with Changing Capital Structure, 96
6.1. Leverage Changes and Enterprise Value, 96
6.2. Adjusted Present Value and The Value of the Tax Shield, 97
6.3. A Detailed Example of APV Valuation, 99
6.4. Valuing an Acquisition with Leverage Above Target, 101
6.5. Recursive WACC Valuation, 102
6.6. Compressed APV, 104
6.7. Uncertain Leverage: A Recursive APV Model, 106
6.8. Valuing Equity as an Option, 109
6.9. Summary, 112
Problems, 112
7. Debt Capacity for Acquisition Financing, 114
7.1. Financial Interdependencies, 114
7.2. Financing Growth, 115
7.3. Growth via Acquisitions, 118
7.4. Sustainable Debt, 118
7.5. The Target Debt Ratio Assumed in WACC Valuation, Debt Capacity, and Interest Coverage, 120
7.6. Debt Capacity in Leveraged Buyouts and Recapitalizations, 121
7.7. The Debt Capacity Multiple in Practice, 126
7.8. Summary, 127
Problems, 127
8. Valuing Entry and Exit Options, 129
8.1. Net Present Value and Options, 129
8.1.1. Accounting for Flexibility, 129
8.1.2. Option Pricing, 131
8.2. A Continuous-Time Model of Free Cash Flows, 132
8.3. Valuation in Discrete and Continuous Times, 136
8.4. Valuing a Going Concern in Continuous Time, 137
8.5. Valuing the Entry Option, 138
8.6. Entry and Exit Options, 140
8.7. Valuing Foothold and Growth Options, 142
8.7.1. Foothold Investment with an Expansion Option, 142
8.7.2. Valuing Foothold and Expansion Options, 143
8.8. Allowing for Uncertain Costs in Foothold Investments, 146
8.9. Sensitivity of DCF Values in the Presence of Real Options, 147
8.10. Summary, 148
Problems, 148
Part Two. Mergers, Acquisitions, and Buyouts, 151
9. Mergers and Acquisitions, 153
9.1. Value Creation and Mergers, 153
9.2. Legal Form of the Transaction and Tax Considerations, 153
9.3. Examples of Tax Consequences, 155
9.4. Tax-Free Reorganizations, 157
9.5. Merger Accounting, 158
9.6. Premiums and the Iron Law of M&A, 160
9.6.1. All-cash Offer, 162
9.6.2. Share Exchange, 163
9.6.3. Cash and Share Offer, 164
9.7. Break-Even Synergies, 167
9.8. Premiums and the Acquirer’s Foothold, 168
9.9. Accretion-Dilution Analysis, 169
9.10. Free Cash-Flow Valuation: Total Versus Incremental Free Cash Flows, 171
9.11. Comprehensive Merger Example, 172
9.11.1. Terms of the Merger, 172
9.11.2. Building the Financial Model of the Merger, 175
9.11.3. Accretion-dilution Analysis, 179
9.11.4. Free Cash-flow Valuation, 179
9.11.5. Sensitivity and Scenario Analysis, 186
9.12. Summary, 190
Problems, 191
10. Deal Making with Difference of Opinion, 198
10.1. Sources of Disagreement in Deal Making, 198
10.2. Risk Shifting, 200
10.3. Staged Financing, 201
10.4. Earnout Agreements, 203
10.5. Valuing Earnout Cash Flows, 204
10.6. Earnouts as Options on Future Cash Flows, 206
10.6.1. Earnouts with Thresholds, 206
10.6.2. Earnouts with Thresholds and Caps, 208
10.6.3. Earnouts Based on Average Performance, 208
10.6.4. Valuing the Seller’s Repurchase Option, 209
10.6.5. Valuing Multiyear Earnouts, 209
10.6.6. Earnouts Based upon Relative Performance, 210
10.7. Perpetual Earnouts and Class Shares with Threshold, 211
10.8. Summary, 214
Problems, 214
11. Special Offer Structures: Price Guarantees and Collars, 223
11.1. Special Offer Structures, 223
11.1.1. Risk Arbitrage, 223
11.1.2. Guarantees, 223
11.2. Valuing Price Guarantees, 225
11.2.1. Commodity Price Guarantees, 227
11.3. Valuing Offers with Price Collars, 228
11.4. Additional Features in Price Collars, 234
11.4.1. Walk-away Rights, 234
11.4.2. Top-up Rights, 235
11.4.3. Fixed Exchange Ratio with Collar, 235
11.4.4. Weighted Average, 235
11.5. Summary, 235
Problems, 235
12. Acquisitions in Developed and Emerging Markets, 239
12.1. The Global Capital Market, 239
12.2. Translating Foreign Currency Cash Flows, 239
12.3. The Cost of Capital in Developed Capital Markets, 240
12.4. Valuing Emerging-Market Companies, 242
12.4.1. Translating Free Cash Flows to the Acquirer’s Currency, 243
12.4.2. Value to the Acquirer, 246
12.4.3. Nominal and Real Cash Flows and the Cost of Capital, 248
12.4.4. Value to the Seller, 248
12.5. On the Nature of the Country Risk Premium, 250
12.6. Post-Emergence Systematic Risk, 252
12.7. Summary, 253
Problems, 253
13. Leveraged Buyouts, 262
13.1. The Rationale for LBOs, 262
13.2. Financing LBOs, 264
13.3. Robust Financial Structures, 265
13.4. Computing the Returns to Investors, 266
13.5. Option Pricing of Warrant Kickers, 268
13.6. Debt Capacity and Affordable Price, 269
13.7. Returns to Investors and The Private-Equity Discount, 271
13.8. A Detailed LBO Example, 273
13.9. Mezzanine Financing, 276
13.10. APV Valuation, 279
13.11. Summary, 280
Problems, 281
Part Three. Recapitalizations and Restructuring, 291
14. Recapitalization of Troubled Companies, 293
14.1. Dealing with Financial Distress, 293
14.2. Framework for Recapitalizations, 293
14.3. Out-Of-Court Workouts and Bankruptcy, 295
14.3.1. Out-of-court Workouts, 295
14.3.2. In-court Reorganization, 295
14.3.3. Prepackaged Bankruptcy, 296
14.3.4. Liquidation, 296
14.4. Accounting Treatment, 297
14.4.1. Troubled Debt Restructuring, 297
14.4.2. Asset Impairment, 297
14.4.3. Fresh-start Accounting, 297
14.5. Tax Considerations, 298
14.6. Valuing Recapitalization Securities, 299
14.6.1. The Southland LBO, 299
14.6.2. The Recapitalization Plans, 300
14.6.3. Valuing the New Debt Securities, 301
14.6.4. Valuing Equity, 304
14.6.5. Recovery, 306
14.7. Valuing Recapitalization Rights and Options, 306
14.8. Summary, 313
Problems, 313
15. Asset Restructuring, 318
15.1. Asset Restructuring and the Value Gap, 318
15.2. Is There a Diversification Discount?, 318
15.3. Share Repurchases, 320
15.4. Asset Disposition, 320
15.5. Tax and Accounting Treatment, 322
15.5.1. Private Sales, IPOs, and Carve-outs, 322
15.5.2. Spin-offs, 323
15.5.3. Tracking Stock, 324
15.6. Sum-of-the-Parts Valuation, 324
15.7. Headquarter Costs and Benefits, 329
15.8. Comprehensive Restructuring Analysis, 332
15.8.1. Sum-of-the-parts Valuation: Multiples, 334
15.8.2. Sum-of-the-parts Valuation: Free Cash Flows, 334
15.8.3. Valuing the Effect of Cost Reduction at Wendy’s Stores, 336
15.8.4. Refranchising Wendy’s-Operated Restaurants, 337
15.8.5. Comparison of Restructuring Actions, 338
15.8.6. Monetizing Real Estate, 340
15.8.7. Share Repurchases, 340
15.8.8. Wendy’s Restructuring Plan, 341
15.9. Summary, 342
Problems, 342
Appendix A. Financial Options, 347
A.1. Financial Options in M&A Valuation, 347
A.2. European Calls and Puts and American Calls, 347
A.3. American Puts, 349
A.4. Warrant Pricing Model, 350
A.5. Asian Options, 351
A.6. Knockout (Barrier) Options, 352
A.7. The Put-Call Parity, 354
A.8. Stock Options Paying A Known Dividend Yield, 354
A.9. Dilution Adjustment in Warrant Valuation, 355
Problems, 356
Appendix B. Valuation Aids Software, 361
Appendix C. Answers to Selected End-of-Chapter Problems, 363
Appendix D. Modeling Mergers and Buyouts with DealModeler
®
: User’s Manual, 376
D.1. Brief Description of Dealmodeler, 376
D.1.1. Financial Modeling, 376
D.1.2. Inputs, 377
D.1.3. Additions, 377
D.1.4. Printing Output, 378
D.1.5. Demo and Blank Copies, 378
D.2. Modeling Mergers and Acquisitions, 378
D.2.1. Setting Up the Financial Model for M&A Transactions, 378
D.2.2. Valuation, 387
D.2.3. Checking the Model, 389
D.2.4. Printing M&A Financials and Valuation Output, 390
D.2.5. Sensitivity and Scenario Analysis, 390
D.3. Modeling Leveraged Buyouts, 390
D.3.1. Setting Up the Financial Model for LBO Transactions, 390
D.3.2. IRR Valuation, 395
D.3.3. Checking the Model and Printing, 395
Technical Notes, 396
References, 430
Index, 443
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