Corporate Valuation: Endesa

Corporate Valuation - Endesa ^. Executive Summary

The European energy power markets continue to be one of the major topics of political, industrial and financial discussions and meetings. Prices of the energy products are increasing due to declining reserves and the emerging countries like China and India are fueling a constant growth in world-wide demand. The right energy mix for the utility companies is becoming more and more important as well as the investments in a ‘cleaner’ energy due to ecological issues are necessary. 1

For a utility company a powerful standing is essential to secure these supply issues for short and long-term supply. This is maybe one reason for the upcoming consolidation in the energy market. E.ON is also trying to play this game. Its strategic and financial goals through the merger with Endesa are to create the world’s leading power and gas company and therefore, a stronger presence in the European and American market as well as to create an advanced financial value for the shareholders. 2

Generally for mergers it is important that both, investors in shares and managers of companies seeking to make acquisitions, need to know how much a company is worth and how much they are willing to pay for their investment. Therefore, the au-thors outline the theoretical background of valuating companies and will show how different valuation techniques can be used in different contexts. As for every acquisition, on the one hand the possible buyer should always bear in mind that: “Price is what you pay, value is what you get” ³ . On the other hand it is also important to keep in mind that: “A thing is worth whatever the buyer will pay for it”. ⁴ These are two statements which are also important beside the valuated company values.

For that reason, the authors valuate Endesa with two different valuation methods including their different approaches. First of all the Discounted Cash Flow (DCF) method will be applied. Herewith the authors will use the three different approaches:

¹ Cf. Capgemini 2006, p. 2.

² Cf. E.ON presentation 2007, p. 5.

³ Ernst/Schneider/Thielen 2006, p. VI.

⁴ Publilius Syrus, cf. Forbes.com 2007.

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Corporate Valuation - Endesa

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entity, equity and the adjusted present value technique. Afterwards these results are validated with three different multipliers by using the multiplier method.

The average result - without the result of the Discounted Cash Flow method / equity approach - of these calculation is an estimated share price of 41,81 €/share or a corporate value of about € 44,262 billion for Endesa. The last bid of E.ON was placed on 02. February 2007 with a value of 38,75 €/share this means a corporate value of € 41,027 billion. 5

⁵ Cf. Tagesschau.de 2007.

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  Corporate Valuation - Endesa  

Table of  Contents  

  Executive Summary  II

  List of Figures  VI

  List of Abbreviations  VIII

1  Introduction  1

2  Problem Description  3

2.1  Objective  3

2.2  Methodology  3

3  Methods of Corporate Valuation  4

3.1  Background of Corporate Valuation  4

3.2  Valuation Methods  7

3.2.1  Net Asset Value Method  9

3.2.2  Liquidation Value Method  10

3.2.3  Real Options Method  11

3.2.4  Multiplier Method  12

3.2.5  Discounted Cash Flow Method  14

3.2.5.1  Parameters of the DCF Methods  16

3.2.5.2  Entity Approach  18

3.2.5.3  Equity Approach  19

3.2.5.4  Adjusted Present Value Approach  21

3.2.6  Earnings Value Method  22

4  Overview of Endesa  24

4.1  Company profile of Endesa  24

4.1.1  Business Activities of Endesa  24

4.1.2  The Financial View of Endesa  25

4.2  Deals and Developments in the Energy Market  26

4.3  The deal between E ON and Endesa  27

5  Corporate Valuation of Endesa  31

5.1  Assumptions for the corporate valuation  31

5.2  Discounted Cash Flow Methods  34

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  Corporate Valuation - Endesa  

5.2.1  Different Variables for the DCF Valuation  34

5.2.2  Entity Approach  37

5.2.3  Equity Approach  39

5.2.4  Adjusted Present Value  40

5.3  Multiplier Method  41

5.3.1  Peer-Group composition  41

5.3.2  Price-Earnings Ratio  43

5.3.3  Price-Bookvalue Ratio  44

5.3.4  Price-Cash Flow-Ratio  44

5.4  Wrap-up of Corporate Valuations  46

6  Conclusion and Outlook  50

Appendixes VII   

  Bibliography  X

Internet  Sources  XIV

IT-MChecklist:  360 degree analysis  XVI

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  Corporate Valuation - Endesa  

  List of Figures  

  Figure 1 Share price of Endesa from September 2005 up to January  

  Figure 2 The Eight Paradigm of Corporate Valuation according to T. S. Kuhn  

  Figure 3 Evaluation Causes  

  Figure 4 Overview of Corporate Valuation Methods  

  Figure 5 Current Corporate Valuation Methods in the Context of international M As  

  Figure 6 Calculation of the Net Asset Value  

  Figure 7 Calculation of the Liquidation Value  

  Figure 8 Flowchart for the Multiplier Method  

  Figure 9 Formation of a Multiplier  

  Figure 10 DCF Valuation Steps  

  Figure 11 Different Cash Flows  

  Figure 12 CAPM Formula  

  Figure 13 WACC Formula  

  Figure 14 DCF - Entity Approach  

  Figure 15 DCF - Equity Approach  

  Figure 16 DCF - Adjusted Present Value Approach  

  Figure 17 World Primary Energy Demand  

  Figure 18 Global scale of Endesa and E ON  

  Figure 19 Free cash flow projections  

  Figure 20 WACC assumptions  

  Figure 21 Market rate  

  Figure 22 Betas and Capital Quotes  

  Figure 23 WACC result of Endesa and of the market comparison  

  Figure 24 DCF Entity Value Calculation - Assumptions  

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  Corporate Valuation - Endesa  

  Figure 25 DCF Entity Value Calculation - Terminal Value  

  Figure 26 DCF Entity Value Calculation - Entity Value  

  Figure 27 DCF Equity Value Calculation - Assumptions  

  Figure 28 DCF Equity Value Calculation - Terminal Value  

  Figure 29 DCF Equity Value Calculation - Equity Value  

  Figure 30 DCF Adjusted Present Value Calculation - Assumptions  

  Figure 31 DCF Adjusted Present Value Calculation - Terminal Value  

  Figure 32 Peer Group for Endesa  

  Figure 33 P/E-Ratio  

  Figure 34 P/B-Ratio  

  Figure 35 P/CF-Ratio  

  Figure 36 Results of the Different Valuation Methods  

  Figure 37 Offer/Demands for Endesa  

  Figure 38 Self evaluated values in relation to E ON´s last bid  

  Figure 39 Brokers’ fair values to E ON´s last bid  

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Corporate Valuation - Endesa .

List of Abbreviations

APV - Adjusted Present Value CAPM - Capital Asset Pricing Model CEO - Chief Executive Officer Cf. - Confer CNE - National Energy Commission CNMV - Comisión Nacional del Mercado de Valores COGS - Costs of Goods Sold DCF - Discounted Cash Flow DJ - Dow Jones DrKW - Dresdner Kleinwort e - estimated e.g. - exempli gratia; for example EBIT - Earnings before interest and taxes EBITDA - Earnings before interest, taxes, depreciation and amortization EBT - Earnings before taxes Ed. - Editor EdF - Electricté de France Et seq. - And the following etc. - et cetera FCF - Free Cash Flow GAAP - Generally Accepted Accounting Principles GdF - Gaz de France IEA - International Energy Agency IFRS - International Financial Reporting Standards IPO - Initial Public Offering M&A - Merger and Acquisitions MBO - Management Buy Out Mgt. - Management MRP - Market Risk Premium MW - Mega-watt MWh - Mega-watt-hour NCF - Net Cash Flow P/B - Price-Bookvalue P/CF - Price-Cash-Flow P/E - Price-Earnings

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Corporate Valuation - Endesa ^. R&D - Research & Development SGA TWh USA - United States of America WACC - Weighted Average Cost of Capital

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1 Introduction .

1 Introduction

Regarding the issue of corporate valuation this assignment took a look on the possible acquisition ⁶ of the Spanish energy company Endesa S.A. ⁷ by the German company E.ON AG ⁸ .

E.ON started his bid in February of 2006 with an offer of over € 29 billion. Today, one year and many problems later E.ON submitted putative its last bid of about 38,75 €/share this means a corporate value of € 41,027 billion. This one year was paved with bids, accusations, lamentations, new teammates and different other problems. However, the share value of Endesa boomed enormously like figure 1 shows and it seems that Endesa´s share value is driven by E.ON´s offers. Then it is astonishing

why E.ON bids so much money for their shares.

⁶ “Possible” therefore because till the finalization of the assignment on the 5 ^th February 2007 it was not clear if E.ON took over Endesa.

⁷ In the following only ‚Endesa‘.

⁸ In the following only ‚E.ON‘.

⁹ E.ON presentation 2007, p. 4.

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1 Introduction ^. Endesa in combination with E.ON is not the only possible merger in these days. Chapter 4.3 describes the deals and developments in the energy market in a deeper way. The trend of this industry is like in some other markets, to get a more consolidated one. Companies merge to expand their business and survive. Therefore, the merger of E.ON and Endesa could be a clever move. Both are in the same business but the advantage is that they complete themselves perfectly in regards to the regional distribution.

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2 Problem Description .

2 Problem Description

Corporate valuations are partly difficult to understand, partly long-winded to perform and partly full of assumptions, but they are necessary. There are some reasons like the initial public offering (IPO) or merger and acquisition (M&A) for which a valuation has been execute.

2.1 Objective

The objectives of this assignment are a literature based overview of the common corporate valuation methods and the valuation of a company by using the described methods. The authors choose the Spanish utility company Endesa for proving the valuation methods.

2.2 Methodology

After an introduction in chapter 1 the problem description respectively the objective of this work and the methodology of this assignment are given in chapter 2. After that, chapter 3 gives an overview about the background of corporate valuation methods. Chapter 3.2 shows then a deeper and more theoretical look on the mainly used valuation methods. Before using these literature based information in the practical example of valuating the utility company Endesa, this company and also the energy market are described in chapter 4. Chapter 5 shows then the corporate evaluation of Endesa. The detailed valuation using the DCF and Multiplier methods deliver the final results. At the end in chapter 6 the conclusion and an outlook are given.

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3 Methods of Corporate Valuation .

3 Methods of Corporate Valuation

The first part of this chapter discusses the theoretical background of corporate valuation. It provides the reader with information about the reason for the existence of different valuation methods and the various areas of usage. The second part takes a look on those different valuation approaches for estimation of a company´s value and the attractiveness of possible investment options.

3.1 Background of Corporate Valuation

The topic of corporate valuation is much transcribed in the business economics. Therefore, it is no miracle that plenty of different valuation methods in the literature could be found. In the course of time, these developed techniques are further fine tuned over and over again and additionally new methods will be developed. ¹⁰ This is caused by a steady knowledge transfer between the business science and the evolution by daily use or necessary because of changes in law or national differences. Another reason for the various corporate valuation techniques is the occasion of valuation. ¹¹ Thomas S. Kuhn the famous science theorist developed eight paradigms of corporate valuation which are listed in figure 1 on the next page.

The figure shows that every corporate valuation method had a golden decade. After the obtainment of new knowledge and information a new method was developed and supplemented or substituted the older one. But some of the most important valuation methods - like the DCF methods - are over 30 years old. They were also adapted to the latest business needs and are still in use for example to supplement newer methods or to get another point of view. 12

¹⁰ Cf. Mandl/Rabel 1997, p. 28.

¹¹ Cf. Ernst/Schneider/Thielen 2006, p. 1.

¹² Cf. Spremann 2002, p. 141.

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3 Methods of Corporate Valuation

has to be asked. As already stated in the executive summary there is a difference between the value and the price of a company. If one company considers buying another one which has only one machine, why should it pay more for that company than the cost of a comparable machine of equivalent age and condition? The answer to that question is that the value is not only based on assets but also on intellectual property or even effort. So the price which has to be paid for a company could be much higher but also less than the real value (net asset value) of a company. It is based on different things and therefore, many different valuation methods could be used.

Sometimes each item needs to be carefully kept in mind when someone wants to evaluate the whole company. And every time it is important to consider the point of view. It is a difference to see things through the buyer´s or through the seller’s eyes. The “final price” is typically the bottom price from the seller’s point of view but the price ceiling of the buyer. 14

Depending on the chosen valuation method and the intended reason (buying/selling/tax/etc.) for valuation it can be stated that different valuation methods conclude almost different values. Therefore, it is important for which reason you have to

¹³ Self created figure, cf. Spremann 2002, p. 140.

¹⁴ Cf. Born 1995, p. 22 et seq.

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