Valuation and Value Creation in Internet-related Companies
PABLO FERNANDEZ；IESE Business School
Abstract: This paper will analyze the evolution of a number of companies (Terra, Amazon, America Online, Microsoft, B2B companies, online brokers, . . .), although our focus will be the valuation of Amazon. We compare Damodaran's valuation by cash flow discounting ($35/share), Copeland's valuation by scenarios and cash flow discounting ($66/share) and our valuation by simulation and cash flow discounting: $21/share
We claim that in a company such as Amazon, it is necessary to introduce uncertainties in the expectations. We deal with uncertainty (volatility) in the hypotheses doing simulations. In our valuation, the likelihood of bankruptcy or voluntary reorganization is 43.43%. It is very interesting to compare and try to differentiate what Internet may signify in the first years of the 21st century with the revolutionary effect on society that the railways, freeways, airlines, radio, television and the telephone had when they first appeared. We also urge the reader to analyze the history of companies such as Levitz, Home Shopping Network, MCI, LTCM and Boston Chicken.
Internet is no King Midas. Business ideas related with Internet must be analyzed with the same rigor as any other business initiative. On the other hand, it is fairly obvious that Internet will reduce (it is already reducing them) the margins of banks as a whole. Some banks may succeed in benefiting partially from Internet if it manages to increase its customers by taking them from other banks. However, for the industry as a whole, Internet will bring about a decrease in their margins that will not be matched by a parallel decrease in their costs. A website is not necessarily a business. Selling below cost gets you lots of customers, but not much money.
Market Valuations in the New Economy: An Investigation of What has Changed
JOHN E. CORE；University of Pennsylvania
WAYNE R. GUAY；University of Pennsylvania
ANDY VAN BUSKIRK；University of Pennsylvania
Abstract: The acceleration of globalization combined with rapid advances in technology and the growing importance of the Internet have led many researchers and practitioners to suggest that these developments have triggered a "New Economy" that calls for new models of equity valuation. We examine the explanatory power and stability of a traditional model of equity valuation for a broad sample of firms over the past 25 years and investigate how equity valuation has changed in the New Economy. We find that although the explanatory power of our traditional model has declined in the New Economy for subsamples of high-technology firms and young firms, it has not changed for the remainder of the population. For all samples of firms, we find that the structure of our valuation model is surprisingly stable during the New Economy sub-period, as compared to other sub-periods. Overall, our results are consistent with valuations in the New Economy exhibiting greater uncertainty and volatility around a stable fundamental valuation model.
Equivalence between Discounted Cash Flow (DCF) and Residual Income (RI)
J.F.K. School of Government; Fulbright Economics Teaching Program ，February 2001
Fulbright Economics Teaching Program
Abstract: Recently, the residual income (RI) model has become very popular in valuation because it purports to measure "value added" by explicitly taking into account the cost for capital in the income statement. Some proponents of the residual income approach have even suggested that the RI model is superior to the discounted cash flow (DCF) method and consequently, the DCF model should be abandoned in favor of the RI model. The residual income model is seductive because it purports to provide assessments of performance at any given point in time. The claim that the RI model is superior to the DCF model in valuation is puzzling because the RI model is simply an interesting algebraic rearrangement of the DCF model. Since the same information is used in both models, it is not unexpected that both models should give the same valuation results.
In this paper, I examine the idea that the residual income model is superior to the discounted cash flow model. Using a simple numerical example, I show that in a M & M world, the two approaches to valuation are equivalent. In practice, the choice between the two valuation methods will be determined by the ease with which the relevant information is available. Valuing Companies by Cash Flow Discounting: Eight Methods and Six Theories PABLO FERNANDEZ；IESE Business School
Abstract: This paper is a summarized compendium of all the methods and theories on company valuation using cash flow discounting. The paper shows the eight most commonly used methods for valuing companies by cash flow discounting:
1) free cash flow discounted at the WACC;
2) equity cash flows discounted at the required return to equity;
3) Capital cash flows discounted at the WACC before tax;
4) APV (Adjusted Present Value);
5) the business's risk-adjusted free cash flows discounted at the required return to assets; 6) the business's risk-adjusted equity cash flows discounted at the required return to assets; 7) economic profit discounted at the required return to equity; and
8) EVA discounted at the WACC.
All eight methods always give the same value. This result is logical, since all the methods analyze the same reality under the same hypotheses; they only differ in the cash flows taken as starting point for the valuation.
The disagreements in the various theories on the valuation of the firm arise from the calculation of the discounted value of tax shields (DVTS). The paper shows and analyses 6 different theories on the calculation of the DVTS: Modigliani and Miller (1963), Myers (1974), Miller (1977), Miles and Ezzell (1980), Harris and Pringle (1985) and Ruback (1995), Damodaran (1994), and Practitioners method. The paper contains the most important valuation formulas according to these theories, and also shows the changes that take place in the valuation formulas when the debt's market value does not match its book value. F&C International: A Case Study of an IPO Valuation
NIKHIL P. VARAIYA
San Diego State University
Bruno & Mack；ROBERT TAYLOR；Brodshatzer, Wallace, Spoon & Yip
Abstract: SUBJECT AREAS: Valuation of an initial public offering (IPO) using DCF and comparable company valuation approaches; the issue of short-run underpricing and long-run overpricing of IPOs. CASE SETTING: 1991, U.S.A.; manufacturer of flavors and fragrance compositions primarily used in the food, beverage, tobacco, personal care, and pharmaceutical products industries.
REQUESTS FOR COPIES: An inspection copy of this case and teaching note may be obtained from the first author (MAILTO:Nikhil.Varaiya@sdsu.edu). Alternatively, this case may be obtained from Journal of Financial Education (JFEd), Vol. 23, Spring 1997, pp. 114-123. JFEd "both encourages and permits copying of any article, in any quantity, for classroom use."
Pedagogical Objectives and Substantive Issues: This case provides a challenging opportunity to undertake a valuation of a firm seeking to go public. The case study is based on an undisguised real comapny which had a history of operating losses with a rapid growth in revenues over the five-year period prior to going public. This case highlights an interesting dilemma - finance textbooks have advocated the use of DCF-based valuation approaches, yet the application of a DCF approach can be problematic. The difficulties in application stem from the obvious problems in estimating cash flows, specifically, the linkage between revenues and earnings growth rates, to the question of estimating the cost of capital. The operating and financial history of the company from the IPO in December 1991 to its denouement in April 1993 lends a perspective to the accumulated empirical evidence on the short and long-run performance of IPOs - over the short run typified by the two-day, one-week, or one-month period following the IPO announcement, market-adjusted IPO returns are significantly positive; whereas over the long run exceeding three years IPOs perform significantly poorly relative to the shares in a portfolio of size-adjusted seasoned firms.
This case has been successfully used both by finance majors in an MBA program and by senior managers in an Executive MBA program. It has also been successfully-used as a take-home exam for graduate finance majors.