Excerpt
Table of Content
1. Introduction
2. Value delivery over the past 5 years
3. Development of the equity value over the last 12 months
4. Equity valuation
4.1. Net Asset Value
4.2. Price/Earnings Ratio
4.3. Discounted Cash Flow
5. Critical Appraisal & Conclusion
Appendix 1 – Assumptions
Appendix 2 – Figures
References
1. Introduction
The valuation of a company is fundamental for financial and strategic decision making. One of the first structured approaches to assess the value of a company was the so-called Shareholder Value Analysis developed by Rappaport (1986). As shown in the following figure, he identified value drivers in three different areas, namely Finance, Investment and Business. The theory says that improvement of these value drivers leads directly to an increase in shareholder value (Spencer and Francis 1998).
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Figure 1: The Shareholder Value Analysis.
Following: Rappaport (1986).
Abbildung in dieser Leseprobe nicht enthalten
In this assignment, the company to be evaluated, namely adidas, will be presented and then analysed concerning the value delivery in recent years. After that, different methods of company valuation will be explained and applied to adidas. The assignment will finish with a critical appraisal of the findings. Assumptions for the calculations done in this assignment can be found – if not otherwise stated – in appendix 1.
adidas (ADS, ISIN De005003404) is one of the leading sporting goods producers. Effective 31 January 2006, it acquired Reebok and therewith increased its sales to more than € 10bn p.a. The purchase price for Reebok was circa € 3.0bn (adidas 2007c).[1] Another major event in the recent past was a share split with a ratio of 1:4 on 6 June 2006, where the registered nominal capital of € 203,268,220 was divided into 203,268,220 no-par-value bearer shares (adidas 2006). ‘per share’ information given in this assignment is adjusted to this number.
2. Value delivery over the past 5 years
Shareholders of a company are rewarded in 2 forms:
1) Dividends, which are dependent on a company’s dividend policy and
2) Capital appreciation, which depends on the investment policy.
As a result, the Total Shareholder Return (TSR) for adidas from January 2002 to December 2006[2] can be calculated with the help of the following formula:
TSR = Dividends + Capital appreciation (Pike and Neale 2006)
The dividends paid by adidas in the years under evaluation were as following:
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Figure 2: Dividends paid by adidas (2002-2006).
Own illustration. Data from adidas (2007b).
The second factor in the TSR calculation is the share price development, which is illustrated in the following figure:
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Figure 3: Share price development of adidas (2002-2007).
Own illustration. Data from adidas (2007a).
Taking both factors into consideration, the following calculation of the TSR for adidas is the following:
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Figure 4: Total Shareholder Return of adidas (2002-2006).
Own illustration.
As a result, it can be said that over the analysed period, adidas was able to deliver a TSR of circa 86% (78,6% without dividends). This equals an average annual return of 17,2%. In comparison to a reference index such as the DAX[3] (+21,8%, i.e. on average 4,356% p.a.), this shows an extraordinary performance and value delivery to shareholders (Onvista 2007a).
However, it has to be noted that the mentioned value delivery of adidas was not continuous. Rather, two extraordinary years (2004 & 2005) accounted for the biggest part of this development. In 2002 and 2006, the company was not able to deliver value at all. This generally implies that investors will seek a high return to compensate for those volatility risks. However, the specific reasons for these low returns have to be considered (Pike and Neale 2006): In 2002, the weak performance was due to general market conditions. Actually, the delivered performance of adidas was above the market, with the DAX losing about 44% during the year 2002 (Onvista 2007a). The specific reasons for the development in 2006 will be further explained in the next part of this assignment.
To further assess the given information, the data has to be compared to the return expected by adidas shareholders. This can be done with the help of the Gordon Growth Model in form of the following formula:
ke = D1 / P0 + g
with ke = cost of equity (=shareholder’s required return), D1 = next year’s dividend, P0 = share price (ex dividend) and g = expected rate of dividend growth (Pike and Neale 2006).[4] As shown in figure 13 in the appendix, the expected shareholder return in the years 2002-2006 was between approximately 10 and 13%.
Another possibility to compare the delivered to the required return is the CAPM module. It considers the risk-free rate of interest as well as the risk of the company in relation to the market as following:
ERj = Rf + Betaj (ERm – Rf)
with ERj = shareholder’s required return, Rf = risk-free rate of return, Betaj = correlation coefficient to market risk and ERm = expected return on market portfolio. ERm - Rf = risk premium on market portfolio.
To give an indication, the ERj for adidas in 2005 should be calculated. The assumptions for this calculation are:
- Rf = 2.5%, which equals the end 2005 EUR LIBOR[5] (British Bankers’ Association 2007)
- Betaj = 0.708[6] (Yahoo Finance 2007)
- ERm = 13.67% market average ROE[7] in 2005 (Damodaran 2007)
Following, the expected return 2005 was: ERj = 2.5% + 0.708(13.67% – 2.5%) = 10.41%. This is in line with the already calculated cost of equity ke.[8]
As a result of those two calculations, it can be said that adidas was not only able to outperform comparable indices, but also fulfil shareholder’s requirements in terms of the expected return.
3. Development of the equity value over the last 12 months
To explain how and why the equity value of adidas has changed in recent months, following the share price development of adidas will be analysed. In particular, the period from January 2006 to March 2007 will be considered. The period analysed will be expanded in this assignment from 12 to about 15 months, because the acquisition of Reebok – finished in the first half of 2006 – had huge impacts on the equity value of adidas and also on the share price development during the year 2006 and should therefore be included (BBC 2005).
[...]
[1] For further information on the acquisition, refer to figure 12 in the appendix.
[2] In order to guarantee consistency in the calculation (e.g. concerning the dividend payments, only full fiscal years will be regarded.
[3] It has to be noted that the DAX is know as a technology driven index. Therefore, it may not be 100% representative for the adidas share. Still, it should be used as an indication for the development of German blue-chips (Deutsche Börse 2007).
[4] The specific drawbacks of this approach (e.g. the problem of using past growth rates for estimations of the future development) should not be explained in more detail in this assignment. For further information see Pike and Neale 2006.
[5] The LIBOR can be used as an approximation of the risk-free rate (Pike and Neale2006).
[6] A comparable figure of 0.783 is given by Thomson One (2007). As the figure from Yahoo Finance (2007) is calculated based on information of the last year, it should be used in this assignment because of the major changes after the Reebok acquisition. Generally it can be said that a Beta smaller than 1 makes sense for adidas (compare part 3 of this assignment).
[7] The ROE can be used as an approximation of ERm (Dimson et al. 2000, Pike and Neale 2006). Generally, all items one could invest in would have to be taken into account (e.g. gold, wine, stamps etc.). Due to the complexity of this, the use of approximations such as the ROE has to be accepted as a limitation of the CAPM.
[8] It has to be mentioned that the resulting risk premium of 11.17% seems to be a bit too high for a DAX company, as the German market risk premium after a empirical study by Dimson et al. (2002) is 6.7%, which would reduce ERj.