Contrasting Equity and Enterprise

Value

MBA - Lecture 3
Elective: Financial Analysis & Valuation

Monday 12 September 2016

9:00-12:00 hours

Dr. Solomon Zori

Department of Accounting & Control
zori@rsm.nl
 LEARNING OBJECTIVES

• Refresher on approaches to valuation

• Valuation multiples

• Challenges in enterprise value

• Valuation multiples- and Sum-of-the parts- LVMH

• Sum-of the-parts- valuation of Yahoo

• Concluding remarks

2
 REFRESHER ON VALUATION

• Defining Value
• Enterprise versus Equity Value Multiples

• Deriving Value
• Discounted Cash Flow, Residual Income and Valuation Multiples

• Identifying Value
• Market, Book and Target Value

3
 OVERVIEW OF VALUATION METHODOLOGIES

Discounted Residual Income Valuation

Cash Flow Model* Multiples

Enterprise value INDIRECT WAY TO VALUE EQUITY

Equity value DIRECT WAY TO VALUE EQUITY

* Residual Income Model is also known as Abnormal Earnings or Economic Profit Approach

4
 INTRODUCING VALUATION MULTIPLES

• “A valuation multiple is simply an expression of market value relative to a key

statistic that is assumed to relate to that value”

• Basically: the value of asset A is compared with the value of a very similar
asset B

• Hereby you assume the market has valued asset A correctly, therefore your
business should be worth the same

5
 MULTIPLE VALUATION AS RELATIVE VALUATION

• When using a multiple, you assume the market is correct and has valued a
comparable company correctly

• Thus, the company you are doing a valuation for should be worth the same as
the other company, controlled for size

• That means that if Company X has EBITDA of $1 million and was recently sold
for $23 million, the buyer ( = market) has paid 23x EBITDA for the target
company

• Company Y is perfectly comparable and has a EBITDA of $2 million

– Based on this Enterprise Value/EBITDA multiple your company should be
worth $46 million
• Relevative valuation: you look at comparable companies and assume a value
relative to that comparable firm

6
 POPULARITY OF VALUATION MULTIPLES

• Valuation across the world are by far done via Multiple valuation*

• Almost 85% of equity research reports are based upon a multiple and
comparables

• More than 50% of all acquisition valuations are based upon multiples

• Rule of thumb based on multiples are not only common but are often the basis
for final valuation judgments

* Aswath Damodaran from Stern NYU

7
 DERIVING VALUATION MULTIPLES

Key steps to deriving multiples:

• Identify a measure of performance or value with which to compare (i.e earnings,
sales, cash flows, book equity, book assets)

• Compute price multiples for comparable firms

• Use multiples to compare selected firms performance or value across time and
industry

To improve comparability developed industry averages or time horizons to

compare with eg. Last 12 months multiples

8
 VARIATIONS OF VALUATION MULTIPLES

Valuation Multiples

Equity Enterprise Value

Price Earnings Price to Book

EV/Sales EV/EBIT(DA) EV/NOPAT
Ratio value

9
 APPLYING ENTERPRISE VALUE MULTIPLES

• Use of enterprise value is based on the idea that the entire company is bought

• Buying the company gives us 100% of sales/EBIT(DA)/NOPAT

• To achieve this we need to buy all financial claims at market value

• Results metric should exclude income/expenses related to financial claims

The challenge is to obtain an apples-to-apples EV multiple

10
 ENTERPRISE VALUE VERSUS EQUITY VALUE

Enterprise value Equity value

Value of the whole business Value of the shareholders’ stake in

Price which would have to be paid to
acquire all enterprise profit or cash
flow
Sum of the market values of the
various claims on the business
the business
Represented by market
capitalisation or share price

11
 ENTERPRISE VERSUS EQUITY MULTIPLES

• Enterprise multiples express the value of an entire enterprise – the value of all
claims on a business – relative to a statistic that relates to the entire enterprise,
such as sales or EBIT

• Equity multiples express the value of shareholders’ claims on the assets and
cash flow of the business. An equity multiple therefore expresses the value of this
claim relative to a statistic that applies to shareholders only, such as earnings (the
residual left after payments to creditors, minority shareholders and other non-
equity claimants)

12
 ENTERPRISE VERSUS EQUITY VALUES MULTIPLES CONT’

Enterprise value multiples Equity value multiples

More comprehensive (apply to the entire More relevant to equity valuation

enterprise)

Allow the user to focus on statistics where More reliable (estimating enterprise value
accounting policy differences can be involves more subjectivity, especially in the
minimised (EBITDA, OpFCF) valuation of non-core assets)

Avoid the influence of capital structure on More familiar to investors

equity value multiples

Wider range of multiples possible

Easier to apply to cash flow

13
 INTRODUCING ENTERPRISE VALUES
What do we mean by enterprise value?
• The price the market is putting on a business irrespective of the capital mix in financing

• Allowing for decomposition into "core" operating assets and "non-core" operating
assets

• EVs help investors gauge the operating performance of the firm regardless of capital
sources

• EVs are more useful than equity values as it presents the true nature of the firms
performce

• EVs are a more useful comparable measure

What drives the value of firm? Does sources of financing matter?

14
 STEPS IN ESTIMATING ENTERPRISE VALUES
Step 1: Identify all sources of equity capital. Use observed market prices of stock to
derive market capitalization

Step 2: Measure the other componets of claims on firm sources of financing

- Market value of debt (including hybrid debt)
- Market value of all provisions eg. Pensions, customer advances
- Market value of non-core assets

Step 3: Estimate the total value of firm’s cash and cash equivalents

Step 4: Sum step 1 and 2 and take out cash & cash equivalnets to arrive at Total
Enterprise Value

Step 5: Deduct the value of non-core assets from Total Enterprise value to arrive at
Core Enterprise values

Note the difference between Total Enterprise Value and Core Enterprise Value. Use
Core Enterprise Value in deriving EV multiples. Use Total EV for leverage
15
 BUILDING BLOCKS FOR ENTERPRISE VALUE

Off-
balance
sheet
items

Pension
deficit Non-Core
Assets
Non- including
Controlling Associates
Interest

Net Debt Total

Enterprise
Value

Equity
Value/Market
Core
Capitalization
enterprise
Value

16
 APPLE VERSUS ALPHABET

17
 APPLE VERSUS ALPHABET IN JANUARY 2016

Source: Financial Times

18
 VALUATION CONUNDRUM? (H1 2016,$USB)

Apple Alphabet
Market Capitalization 580.50 547.67
Total Debt 84.94 6.27
Net Income 47.80 17.99
Cash and Cash Equivalents 62.62 76.94
Total Enterprise Value 597.43 477.00
EV/Sales 2.7x 5.8x
EV/EBIT 6.3x 10.2x
EV/EBITDA 8.1x 17.7x

Source: Yahoo Finance; calculations.

19
 USE OF ENTERPRISE VALUE

Source: Financial Times

20
 PROBLEMS IN USING ENTERPRISE VALUES

• Completeness: EV Calculation should include all claims to the firms profit

• Market Values Not Book Values: Include market value of all claims. Estimate value of
other claims if market values are unobservable

• Seasonality: Avoid seasonlity in estimating EV. Use annual averages or claims on firm
profits

• Distinguish between core-operating and non-core operating assets

21
 BUT’S in USING ENTERPRISE VALUES

• Deriving equity value is easy whereas getting enterprise value is challenging

• Enterprise value should include all financing type liabilities (and assets)

• This should include on – and off balance sheet liabilities

• These financing claims should be included at market value

We believe most mistakes in equity valuation relate to the choice and

valuation of components of enterprise value

22
 DERIVING ARCELOR MITTAL’S ENTERPRISE VALUE (2012, €M)

Absolute Relative

Market capitalization 17.443 40%

Debt 16.192 37%

Minority interest 2.724 6%

Pension deficit 7.180 16%

Total Enterprise Value 43.539 100%

Financing assets (7.033)

Core Enterprise Value 36.506

Source: Datastream

23
 VALUATION MULTIPLES FOR EUROPEAN STEEL (2012E)

Price to Book
Company EV/Sales EV/EBITDA EV/NOPAT P/E Multiple Value

ArcelorMittal 0.4 3.8 8.0 7.0 0.5

ThyssenKrupp 0.5 8.4 29.5 22.9 1.0

Salzgitter AG 0.3 4.8 20.5 14.3 0.5

Voestalpine AG 0.7 5.4 11.6 9.7 0.8

Klöckner 0.2 3.7 7.4 11.3 0.4

Average 0.4 5.2 15.4 13.0 0.7

Median 0.4 4.8 11.6 11.3 0.5

Source: Datastream

24
 DERIVING ARCELOR MITTAL’S ENTERPRISE VALUE (2012, €M)

Core Enterprise Value 36.506

EBITDA 2012E 9.596
Current EV/EBITDA 2012E 3,8
Target EV/EBITDA 2012E 4,5
Target Core Enterprise Value 43.181
Debt (16.192)
Minority interest (2.724)
Pension deficit (7.180)
Financing asset (7.033)
Target equity value 24.118
Current equity value 17.443
Upside/(downside) to current share price 38%

Source: Datastream

25
 CONCLUSION

• Valuation multiples provides an alternative measure of value to traditional

valuation models

• They are popular for their simplicity and easy of use

• Enterprise Values and Equity Value multiples provides a chance to value

companies from the angle of providers of capital

• Beware of significant accounting adjustments in deriving valuation multiples

26
 .

BREAK-15 MIN
27
 APPLYING EQUITY VALUATION- A CLOSER LOOK AT LVMH

Introducing….

Mr. Bernard Arnault

Chairman and CEO of LVMH

28
 INTRODUCING LVMH

€ 35,000.00 23%

22%
€ 30,000.00

22%

€ 25,000.00
21%

Margin (% of Revenue)
€ 20,000.00
21%
EUR 1,000

20%
€ 15,000.00

20%
€ 10,000.00

19%

€ 5,000.00
19%

€- 18%
2009 2010 2011 2012 2013

Revenue Operating Income Net Operating Cash Flow Operating Margin

29
 LVMH’S STRATEGY

In the first half of 2009, LVMH’s CEO Bernard Arnault wrote in the company’s
interim report, regarding the firm’s position to face the difficult economic
times…

“The diversity of our business

activities is, of course, still a
fundamental advantage” – Bernard
Arnault

30
 PROGRESS ON THE ROAD TO LUXURY LEADERSHIP

How well has it worked?

(EUR m, %) 2003 2013 Change

Net sales 11,962 29,149 144%

Income from operations 2,182 6,021 176%

Net Income 723 3,947 446%

Stockholders'equity 8,769 27,723 216%

31
 GROWTH THROUGH ACQUISITIONS

32
 CONTRIBUTION OF DIFFERENT SEGMENTS

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2009 2010 2011 2012 2013

Wi nes a nd Spi ri ts Fa s hi on a nd l ea ther goods Perfumes a nd Cos metics

Wa tches a nd Jewel ery Sel ective Retai l i ng

Source: LVMH
33
 PERFORMANCE AND GROWTH OF DIFFERENT SEGMENTS

Revenue growth 2009 2010 2011 2012 2013

Wines and Spirits 22% 18% 14% 9%

Fashion and leather goods 29% 20% 6% -4%

Perfumes and Cosmetics 14% 5% 17% 1%

Watches and Jewelery 103% 107% 26% 12%

Selective Retailing 38% 34% 19% 6%

Operating margins 2009 2010 2011 2012 2013

Wines and Spirits 28% 29% 31% 30% 33%

Fashion and leather goods 32% 34% 35% 33% 32%

Perfumes and Cosmetics 11% 11% 11% 11% 11%

Watches and Jewelery 8% 13% 14% 12% 13%

Selective Retailing 9% 10% 11% 11% 10%

Source: LVMH
34
 VALUING AN OCTOPUS?

• How do you value LVMH?

35
 VALUING CONGLOMERATES – SUM OF THE PARTS

• Valuing a diversified company

– It is better to value the separate businesses rather than the firm as a whole

• Absolute valuation methods (DCF and RIM)

– Use of business specific assumptions to determine earnings, investments, cash flows and discount
rates for separate activities

• Relative valuation methods

– Identify peer group and derive valuation multiples

36
 DERIVE ENTERPRISE VALUE BY USING MARKET VALUES
Multiply Target
Multiple with Forecast
EBIT(DA)
Analytical balance sheet

Operating assets Equity

Operating liabilities
Compare with peer
group to derive Target Target Enterprise
Multiple Value
Financing liabilities
(Financing Liabilities)

(Financing assets)

Financing Assets

Derive Market Value Of Net Target Equity Value

Financing Liabilities and Equity
(Enterprise Value)
Observed EV/EBIT(DA)
= multiple

Forecast EBIT(DA)

37
 CHALLENGES IN VALUATING CONGLOMERATES

• Understanding corporate structure

– Ownership by parent company can be full or partial, and such difference in ownership and control, determines
the accounting treatment.

• Identifying peer group

– Determining criteria and identifying companies for the peer group

• Benefits/costs of a conglomerate structure

– Identify the costs and benefits of the subsidiaries of being part of the group.

38
 CONSOLIDATION AND NON-CONTROLLING INTEREST

• Applying full consolidation

– Recognize 100% of assets, liabilities and equity of subsidiary if fully owned.

• Non-controlling interest – balance sheet

– Control over subsidiary but less that 100% ownership gives rise to non-controlling interest. This reflects
an outside shareholder in the parent’s subsidiary and is a source of equity capital. This is reflected in the
balance sheet under group equity.

• Non-controlling interest – income statement

– Parent company reports 100% of revenues, EBITDA but deducts share of net income that belongs to
non-controlling interest.

39
 UNDERSTANDING LVMH’S CORPORATE STRUCTURE

• Moet Hennessy is jointly owned by LVMH and Diageo

• LVMH owns 66% and hence applies full consolidation

• Diageo is 34% shareholder in one of LVMH’s subsidiaries

• Diageo share reflects a non-controlling interest

40
 UNDERSTANDING LVMH’S CORPORATE STUCTURE

Source: LVMH

41
 UNDERSTANDING LVMH’S CORPORATE STUCTURE

Source: LVMH

42
 OTHER INVESTMENTS

• Investments in associates (equity method – balance sheet)

– Initially, the investment is accounted for at ; historical cost, and over the course of the investment
horizon, profit/loss incurred by investee adjusts the recorded investment total.

• Investments in associates (equity method – income statement)

– The net income share of investee that corresponds to the parent company is reported in the income
statement. Dividends received are not treated as income, but as a reduction of the investment’s carrying
value.

• Investment in associates (equity method – cash flow statement)

– Dividends received are considered as positive cash flow.

43
 UNDERSTANDING LVMH’S CORPORATE STRUCTURE

• LVMH has also investments in other entities such as Hermes and Tod’s

Source: LVMH

44
 UNDERSTANDING LVMH’S CORPORATE STRUCTURE

Source: LVMH

45
 IDENTIFYING PEER GROUP

• Wines & Spirits

– Diageo, Pernod Ricard & Remy Cointreau
• Perfumes & Cosmetics
– Estee Lauder, L’Oreal & Beiersdorf
• Selective Retail
– Dufry
• Watches & Jewelry
– Richemont & Swatch

46
 SUM OF THE PARTS VALUATION FOR LVMH (EUR m)
2014E 2014E EBITDA Multiple
Sales EBITDA (x) Value
Champagne 2,132 677 11.5 7,786
Cognac 2,606 976 12.5 12,200
Wines & Spirits 4,738 1,653 12.1 19,986
Louis Vuitton 8,260 3,735 10.5 39,218
Other brands 3,540 566 9.5 5,377
Fashion & Leather 11,800 4,301 10.4 44,595
Christian Dior 2,786 493 12.5 6,163
Other brands 1,194 100 12.0 1,200
Perfumes & Cosmetics 3,980 593 12.4 7,363
Bulgari 1,522 265 9.0 2,385
Tag Heuer 761 179 10.0 1,790
Other brands 761 67 7.0 469
Watches & Jewellry 3,044 511 9.1 4,644
Séphora 5,285 732 6.5 4,758
DFS 3,775 452 9.0 4,068
Other brands 1,007 215 7.5 1,613
Specialist Retailing 10,067 1,399 7.5 10,439
Source: UBS Other -363 -193 8.5 -1,641

47 Total LVMH 33,266 8,264 10.3 85,385

 SUM OF THE PARTS VALUATION FOR LVMH (EUR m)

2014E Sales 2014E EBITDA EBITDA Multiple (x) Value

Total LVMH 33,266 8,264 10.3 85,385
Net debt (2014E) -2,265
Minority interests -6,568
Valuation of investments
Hermes 6,100
Tod's 130
Hengdeli 58
Total value of non-core (financial)
assets 6,288
Total Equity Value 82,840
Number of shares 502.2
Value per share 165

Source: UBS

48
 IS TOTAL VALUE EQUAL TO SUM OF THE PARTS?

> Market
Sum of the parts <
VS. Capitalization of
Parent Firm
= (whole)

49
?
 0
50
100
150
200
250
300
350
01/02/07

50
01/04/07
01/06/07
01/08/07
01/10/07
01/12/07

LVMH Index
01/02/08
01/04/08
01/06/08

SWATCH Group Index

01/08/08
01/10/08

Sa l va tore Ferra ga mo SpA Index

01/12/08
01/02/09
01/04/09
01/06/09
01/08/09
01/10/09
01/12/09
01/02/10
01/04/10
01/06/10

Hermes Index
01/08/10

Burberry Group Index

01/10/10

Pernod-Ri ca rd SA Index
01/12/10
01/02/11
01/04/11
01/06/11
01/08/11
01/10/11
01/12/11
01/02/12
01/04/12
01/06/12
01/08/12
Pra da i ndex

01/10/12
Tod's SPA Index

01/12/12
01/02/13
01/04/13
Remy Interna tiona l , Inc. Index

01/06/13
01/08/13
01/10/13
01/12/13
01/02/14
PERFORMANCE OF LVMH VERSUS PEER GROUP

01/04/14
01/06/14
01/08/14
 .

BREAK-15 MIN
51
 INTRODUCING YAHOO!

• Founded in 1995 by Jerry Yang and David Filo, both Stanford graduates at the time

• Yahoo! offers search, content and communication tools

• Best known is Yahoo! site providing Yahoo! Search, Mail and Finance

• Provided in 45 languages, 60 different countries, regions and territories

52
 STOCK PRICE DEVELOPMENT
• Yahoo! went public in 1996, 1 year after incorporation

• Much of growth came from acquisitions and joint ventures

• Revenues soared and crashed as a result from dot-com bubble

Revenue dried up, many advertisers

IPO proceedings used for expansion
phase, some organic growth but
mostly acquisitions and joint ventures
scaled back on online advertising.
Yahoo! lost more than 95% of its
market value!

CEO Tim Koogle replaced by media and

entertainment executive Terry Semel in 2001

53
 STOCK PRICE DEVELOPMENT

• The new CEO succeeded at pulling Yahoo! back up after the buble

• Yahoo! expanded into a more robust media and advertising firm

• Unfortunately, market share kept detoriating against Google’s share

Revenue dried up, many advertisers

scaled back on online advertising.
Yahoo! lost more than 95% of its
IPO proceedings used for expansion market value!
phase, some organic growth but
From 2000-2004, Yahoo! licenced
mostly acquisitions and joint ventures Competitive pressure, mainly from
technology from Google, to switch back Google, eroded Yahoo!’s market share.
on it’s own tech in 2004. Unfortunately for CEO Semel was replaced by co-founder
CEO Tim Koogle replaced by media and
Yahoo, this did not prove successfull. Jerry Yang
entertainment executive Terry Semel in 2001

54
 MICROSOFT MAKES A US$ 45 BILLION OFFER FOR YAHOO

55
 YAHOO DECLINES MICROSOFT BID

• Co-founder David Filo: “Five years from now, we’ll be in a much stronger
position. There is a lot of value here.”

• Over the next quarters, Yahoo stock price fell to $12

• This was a 63% decline relative to Microsoft’s offer

(Monetary wise a $20 billion loss..!)

• Shareholders were furious about the failed deal with Microsoft

• Lawsuits and threat of a proxy battle by activists investors

“Yahoo!’s CEO and board have failed to act in the best interest of
shareholders in rejecting Microsoft’s bid.”

56
 MICROSOFT TALKS CONTINUE

• After the rejected bid and subsequent discussions, Jerry Yang resigned as
CEO and Carol Bartz was appointed new CEO
– 3rd CEO in 2 years time!

• After just 6 months on the job, Carol Bartz announced a deal with
Microsoft
• 10 year search partnership, powered by Microsoft’s search algorithm..
• Yahoo!’s revenues would be shared with Microsoft
• Estimated increase of operating income by $500M annually and a
reduction of $200M capital expenditures yearly

• Some argued that this shift fundamentally changed Yahoo! from a

technology company to strictly an advertising and media firm

57
 RELATIVE PERFORMANCE AFTER MICROSOFT DEAL
• Nearly two years after the signing of the Microsoft deal, Yahoo!’s share price
had remained essentially flat, despite a rebounding stock market
• The board decided to fire CEO Carol Bartz after a 30 months tenure

58
 ACTIVIST CAMPAIGN ON YAHOO!

• During 2011, hedge fund Third Point acquired 65M shares and call options,
giving the fund 5.15% ownership in Yahoo!

• Addressing the lack of management quality at Yahoo!, Daniel Loeb (Managing

Partner) demanded changes in the board

• Yahoo! did not follow Daniel Loeb’s advice and appointed Scott Thompson as
the new CEO in January 2012

• On May 3, 2012, Loeb revealed that Scott Thompson did not have a computer
science degree, as had been commonly assumed for many years. Thompson
resigned on May 13, 2012.

59
 YAHOO UNDER MARISSA MAYER

• In summer 2012, Marissa Mayer, the top female executive from Google, was
then appointed as CEO

• Under her leadership Yahoo! invested heavily to enhance its offerings,

engineering talent and user base
– Acquisition of micro-blogging platform Tumblr
– Changes to company culture to improve moral and retain talent

60
 GOOD STRATEGY AND LEADERSHIP? OR SOMETHING ELSE..
• At the end of 2012, Yahoo!’s share price had crossed $27, a level not seen
since 2003
– The stock price gains had occurred despite revenue and profitability projections for 2013 were
down from the year before

61
 INTRODUCTION OF YAHOO’S BUSINESSES (2012, %)

• Display revenues

• Search revenues

• Other revenues

Source: Company statements

62
 YAHOO! REVENUES (2008-2012, US$ M)

Source: Company statements

63
 YAHOO! KEY METRICS (2008-2012, %)

Source: Company statements

64
 ANALYZING THE DIFFERENT MEASURES OF PROFIT (US$ M)

Source: Company statements

65
 BALANCE SHEET – YAHOO! (2012, US$M)

Balance Sheet (2012) US$ m %

Cash and short term investments 4.184 24%

Other current assets 1.469 9%

Property, Plant and Equipment 1.686 10%

Long Term Investments 5.522 32%

Goodwill and other intangibles 3.981 23%

Other non-current assets 262 2%

Total Assets 17.103 100%

Total Liabilities 2.498 15%

Total equity 14.606 85%

Total equity and liabilities 17.103 100%

Source: Company statements

66
 BALANCE SHEET – YAHOO! (2014, US$M)

Balance Sheet (2014) US$ m %

Cash and short term investments 2,744 17%

Other current assets 1,413 9%

Property, Plant and Equipment 1,470 10%

Investment in Equity Interests 4,029 32%

Goodwill and other intangibles 5,058 23%

Other non-current assets 1,742 2%

Total assets 16,457 100%

Total liabilities 3,726 23%

Total equity 12,731 77%

Total equity and liabilities 16,457 100%

Source: Company statements

67
 INVESTMENTS IN THE INCOME STATEMENT (US$, M)

2011 2012

Revenue 4,984 4,987

Total operating expenses 4,184 4,420

Income from operations 800 566

Other income, net 27 4648

Earnings before income taxes and earnings in equity interests 828 5214

Provision for income taxes -242 -1,940

Earnings in equity interests 477 676

Net income 1,063 3,951

Non-controlling interests -14 -5

Net income attributable to Yahoo 1,049 3,945

Source: Company statements

68
 INVESTMENTS IN THE BALANCE SHEET (USD, M)

2011 2012

Long term marketable securities 474 1,838

Alibaba Group preference shares 0 816

Property and equiment, net 1,731 1,686

Goodwill 3,901 3,827

Intangible assets, net 255 154

Other long term assets 221 289

Investments in equity interests 4,749 2,840

Total long term assets 11,330 11,450

Source: Company statements

69
 ANALYZING THE CONTRIBUTION OF INVESTMENTS AT YAHOO

2011 2012

Earnings from investments as % of net income 45% 17%

Investments as % of total assets 32% 19%

Source: Company statements

70
 FINDING THE VALUE IN YAHOO

71
 HISTORY YAHOO! JAPAN

• In 1995, Softbank started investing $2 million in Yahoo! for a 5% stake

• In 1998 Softbank owned 37% of Yahoo!

• Soon parties agreed to start up Yahoo! Japan as a joint venture between

Yahoo! and Softbank

Japanese telecom billionaire Masayoshi Son owner of Softbank

72
 HISTORY YAHOO! AND ALIBABA

• In 1997, Jerry Yang did a tour of the Great Wall of China

• His tour guide: government official mr. Jack Ma

• Few months later that same Jack Ma started his second start up: Alibaba

• 2005, Yahoo! announces a $1 billion dollar investment for 42% of Alibaba

73
 2012 AGREEMENT BETWEEN YAHOO! AND ALIBABA

• Alibaba to buy back 28% ($7.1 B) of its own shares owned by Yahoo!

• Yahoo! to divest another 10% when Alibaba IPO’s in a few years

• Attempt by Yahoo! to raise its share price

74
 VALUING YAHOO! IN 2013

• Late July 2013, Danielle Engle has to make a recommendation about Clairemont
Capital’s investment in Yahoo!

• The firm acquired its stake in Yahoo! In mid-2012 at about US$15.

• Recent events contributed to an increase in the share price to US$28

• Yahoo!’s strong performance triggers a debate at Clairemont Capital

• Should the firms trim its exposure to Yahoo! or is there more room to run?

75
 POTENTIAL VALUATION APPRAOCHES FOR YAHOO!

Discounted Residual Valuation

Cash Flow Income Model* Multiples

Enterprise value INDIRECT WAY TO VALUE EQUITY

Equity value DIRECT WAY TO VALUE EQUITY

* Residual Income Model is also known as Abnormal Earnings or Economic Profit Approach

76
 APPLYING SUM OF THE PARTS VALUATION TO YAHOO!

• Valuation of Yahoo’s Businesses

• Valuation of stake in Yahoo Japan

• Valuation of stake in Alibaba

77
 THE BASIC DISCOUNTED CASH FLOW MODEL

• Value = present value of expected future cash flows

V0 = The intrinsic value of the operations of the firm (Enterprise Value)

r0 = Expected rate of return on the operations of the firm (WACC)
FCFt = After-tax free cash flow from the operations of the firm in period t

Two key assumptions:

• Expected cash flows are the only source of value
• All cash flows are used in a way that is value neutral

78
 STEPS IN DISCOUNTED CASH FLOW VALUATION

Forecasting future performance Enterprise Free Cash Flow

Estimating risk of the business Weighted Average Cost of Capital

Estimating performance
Terminal value
after forecast period

Determine present value of future cash

Enterprise value
flows

Adjust for financial claims that do not

Equity value
accrue to shareholders

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 VALUATION ASSUMPTIONS FOR YAHOO’S OPERATING BUSINESS

Revenues growth (2013-2017) From 0.5% to 4% in five years

Capex = Depreciation

Net Working Capital -4,5% of sales

Tax rate (corporate income) 35%

Tax rate (capital gains) 37%

Discount rate 9,8%

Terminal Value Growth 4,0%

Discount rate 9,8%

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 FORECASTS FOR YAHOO’S OPERATING BUSINESS (US$M)

2012 2013E 2014E 2015E 2016E 2017E 2018E

Revenue 4987 4836 4884 4982 5131 5337 5550

Cost Of Goods Sold 1621 1572 1587 1619 1668 1734 1804

Gross profit 3366 3264 3297 3363 3464 3602 3746

SGA Expenses
1642 1491 1506 1536 1583 1646 1712

R&D Expenses 886 836 844 861 887 922 959

Amortisation of Intangibles
36 42 43 44 45 47 49

Total Operating Expenses 2563 2370 2393 2441 2514 2615 2720

Operating Income 803 895 904 922 949 987 1027

Operating margin 16,1% 18,5% 18,5% 18,5% 18,5% 18,5% 18,5%

Source: Yahoo Case

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 VALUATION OF YAHOO’S OPERATING BUSINESS (US$M)

2013 2014 2015 2016 2017 2018

NOPAT 582 587 599 617 642 667
+ Amort. of Goodwill and Intangibles
42 43 44 45 47 49
+ Depreciation 532 537 548 564 587 610
- CapEx 532 537 548 564 587 610
NWC -218 -220 -224 -231 -240 -250
- Ch in NWC -252 -2 -4 -7 -9 -10
Enterprise Free Cash Flow 876 632 647 669 698 726
Terminal Value 12524
Total Cash Flows 876 632 647 669 13222

PV of EFCFs 2014 onwards at Dec

2013 10.717

Source: Yahoo Case

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 VALUING YAHOO!– SUM OF THE PARTS

Target Enterprise Value for Yahoo Core

+ Cash

+ Value of investments (Yahoo! Japan & Alibaba)

- Debt

Target Equity Value Yahoo

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 VALUATION OF STAKE IN YAHOO! JAPAN (US$M)

Yahoo! Japan stake:

Market Value of Yahoo! Japan 32800
Ownership percentage 35%
Pre-tax value of stake in Yahoo! Japan 11480
Tax Cost Basis (2254)
After-tax value of stake in Yahoo! Japan 8066

Alibaba stake:
Initial stake 42%
Stake sold 18%
Vale of stake sold 7100
Total value of Alibaba at time of sale 39444
Remaining stake 24%
Implied valuation of remaining interest 9467
Tax Cost Basis 617
After-tax value of remaining stake in Alibaba 6192

Source: Company Statements

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 VALUING YAHOO!– SUM OF THE PARTS (US$M)

Fair value of Yahoo! FCFs as of end of June 2013 10.717

+ Non-operating cash 2.629
- Share repurchase (1.164)
+ Long-term marketable securities 1.838
+ After-tax value of equity stake in Yahoo! Japan 8.066
+ After-tax value of equity stake in Alibaba 6.192
Total 28.278
- Long-Term Debt 0

Fair value of equity 28.278

No of shares remaining after repurchase 1.039

Fair value per share 27,2

Source: Yahoo Case

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 TAXES ARE KEY

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 DO TAXES MATTER? (US$M)

Yahoo! Japan stake:

Market Value of Yahoo! Japan 32,800
Ownership percentage 35%
Pre-tax value of stake in Yahoo! Japan 11,480
Tax Cost Basis 2,254
After-tax value of stake in Yahoo! Japan 8,066

Expected IPO value of Alibaba 110,000

Remaining stake 24%
Valuation of remaining interest 26,400
Tax Cost Basis 617
After-tax value of remaining stake in Alibaba 16,860

Source: Company Fillings

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 VALUATION OF YAHOO!
Pretax
Number of shares Yahoo 1,005
Share price Yahoo 41
Market capitalization 41,198
Long term debt 1,140
Enterprise Value Total 42,338
Value of equity stake in Alibaba (35,597)
- Number of shares owned by Yahoo! 384
- Alibaba share price 93
Value of equity stake in Yahoo Japan (11,480)
Long-term marketable securities (1,566)
Short-term marketable securities (1,630)
Enterprise Value Yahoo! (7,935)

Source: Company Fillings

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 YAHOO! – SUM OF THE PARTS AT TIME OF ALIBABA IPO

Source: Bloomberg
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 THE LATEST VIEWS FROM BLOOMBERG

Source: Bloomberg
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 YAHOO SHARE PRICE DEVELOPMENT
60

50

40

30

20

10

0
10-11-05 10-11-07 10-11-09 10-11-11 10-11-13 10-11-15

Source: Data Stream

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 ACTIVIST SHAREHOLDER AT THE GATE

• Starboard Value CEO Jeff Smith rattling the cages of Yahoo!

• Demanding spin off of both Alibaba and Yahoo! Japan

• Taking apart core business of advertising and search

• Ultimately a merger, preferably between Yahoo! and AOL Inc

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 THE LATEST NEWS – JANUARI 2015

• Yahoo! to spin off its 15.4% stake in Alibaba into separate company

• Stake is currently worth $39.5 billion

• Yahoo! current market capitalisation is at $45.5 billion

• No news on Yahoo! Japan stake

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 THE MASTERPLAN OF MARISSA MAYER

• Spin off the 15.4% stake into a new company ‘Spinco’

• Spinco will give back shares to shareholders according to proportion

• Since it is a stock transaction it will be tax-free to Yahoo!

• Saving the company, and thus shareholder, a tax bill of approximately $16
billion

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 UNLOCKING THE VALUE OF YAHOO! WHATS THE FUTURE?

• July 2015 – Filing for Spin Off with the SEC

• Dec 2015 – No Spin Off due to uncertainty on tax treatment

• Feb 2016 – Strategic Plan

• Feb 2016 – Pursuing Strategic Alternatives

• July 2016 – Sales of Yahoo! to Verizon

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 FUTURE OF YAHOO!

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 CONCLUSION

• Many ways of establishinhg value of a firm

• Traditional valuation methods work well in many cases, but beware of complex
businesses with multiple business models

• Unlocking the value of a firm viewing it from an Enterprise angle allows

disaggregation of value drivers. Core versus non-core

• Use relative valuation approach to unlock value drivers.

• Conglomerage valuation using sum-of-the parts can help unlock value

• A sum-of-the-parts can be worth more than a whole.

• One thing is certain in bueinss! Taxes.

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 CONTACT DETAILS

• Dr. Solomon Zori

• Location: T08-20
• Email: zori@rsm.nl
• Telephone: 010-408 1817

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