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Capital Markets Logic. Jo Whitehead, Director Ashridge Strategic Management Centre. Pre-read. Chapter 5 of Strategy for the Corporate Level. United Business Media (UBM). Industry sectors. Jewellery Forest products Footwear Primary care medical staff Pharmacy - PowerPoint PPT Presentation
Citation preview
Industry sectors
Events Magazines
News services Data services
Marketing services
• Jewellery• Forest products• Footwear• Primary care medical staff• Pharmacy• Global trade and
transportation• Electronics• Medical device design• Technology based
manufacturing• Aviation
United Business Media (UBM)
PV of the Standalone business (Business
logic)
Added PV from your parenting (Added value logic)
PV of the business
under your
ownership
Sell if PV of the business when owned by another
owner is higher
£, $, Euros
Buy if PV of the business when owned by other owners is lower
Capital markets logic
Value under your ownership Value under another’s ownership
Capital markets logic
Capital markets may over or under valueExample: Volatile Schiller p/E ratios
1860 1880 1900 1920 1940 1960 1980 2000 20200.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
40.00
45.00
50.00
“Black Monday
”
“Black Tuesday
”
Dotcom bust
Lehman goes bust
You need to have special information to outguess the market
• Studies suggest:– Insiders (senior managers) do better than the
average investor when buying their companies shares
– Companies also do better than the market when buying or issuing their own equity
• …although these finding are still debated by finance academics
Three challenges to capital markets logic
1. Are there good reasons why the capital markets might misprice this business? – Default position should be that the market has it about right
2. Do you have the superior insight and capabilities required to take advantage of any mispricing?– You need to have superior information, and be a superior
analyst and deal-maker
3. Does the financial analysis suggest that the level of mispricing is significant?– Small gaps may simply be due to over-optimistic
assumptions
Reasons why the capital markets might get it wrong
1. Volatile capital markets (equity and debt)2. Sector or deal-specific characteristics
– Imbalance in number of buyers and sellers– Characteristics of buyers and sellers– Differences in the information available to
buyers and sellers– Deal process
Applying Capital markets logic
11
Market price
NPV of owning the business
Better to be a seller• If you own; Sell• If you don’t own;
Don’t buy
No compelling Capital Markets logic for buying or selling
Better to be an owner• If you own; Hold• If you don’t own; Buy
HIgh
HIgh
Low
Low
13
Implications for E.ON?
Market price
NPV of owning the business
•German Nuclear
•German Fossil
•Eastern Europe
•Sweden
•Russian generation
•Spanish generation
•Italian generation
•Ruhrgas
•Renewables
•UK•US
E.ON strategy shaped by capital markets logic
• Capital markets offer potential challenges…– Thin market for unwanted Spanish generation assets...
• Few buyers• Risky to put assets onto the market if buyers are not already secured• Significant write down unattractive to management team
– Pressures to reduce or sell edge of heartland businesses in hot sectors• …but also potential opportunities
– Buying in potentially undervalued markets e.g., Russia– Selling highly prized assets such as Ruhrgas to Nationalised utilities
e.g., EdF, GdF/Suez
Capital market logic used in different ways
• As a check on analysis based on business or capital markets logic– Many examples
• As a primary logic driving corporate strategy e.g.,– Warren Buffett– Barry Diller– Private equity companies and banks
Alternative tacticsPotential tactics Example: When a desirable
acquisition is too expensiveE.ON Example - Renewables
Wait for capital markets to stabilise – then follow other logics
Announce the deal is too expensive - hope to buy later
Yes
Change your corporate strategy to become consistent with capital market logic
Sell all your businesses in that sector for a high price – even if it is a heartland business
Possible but tough for management
Hedge the risk of over/under-payment when markets seem over/under-valued
Buy with, or issue, equity or fund with cheap debt
Yes
Educate, Communicate and Signal to influence market prices
Try and talk down the value of the target
Yes – but only if stock is doing well
Structure the deal to bring PV up or price down
Buy the business based on an earn-out formula for the current owners
Yes
Improve parenting performance Raise your parenting ambitions Yes
Your examples?
Which Alternative depends on the answer to the three questions…
• What is reason for the mis-valuation?– E.g., if selling, and there are too few buyers, seek
out more!• Do you or your advisors have the skills,
experience and capabilities to pull off the strategy?
• How big is the valuation gap?
Key messages
• Capital markets logic is always important to apply, often after having evaluated the other two logics:1. Evaluate whether Capital market logic is strong
enough to force reconsideration of portfolio decisions2. Consider if there are any alternative tactics which
might deal with the specific situation• Some companies use capital markets logic more
proactively to drive their acquisition or divestment strategy
Application to Own business
19
1. Consider if there are any businesses outside the middle diagonal2. For one business, evaluate the reasons for the over or under valuation (see over for
list of options)3. Consider whether you can employ any of the alternative tactics (see over for table)4. Summarise the options worth pursuing
Market price
NPV of owning the business
Better to be a seller• If you own; Sell• If you don’t own;
Don’t buy
No compelling Capital Markets logic for buying or selling
Better to be an owner• If you own; Hold• If you don’t own; Buy
High
High
Low
Low
Reasons why the capital markets might get it wrong
1. Volatile capital markets (equity and debt)2. Sector or deal-specific characteristics
– Imbalance in number of buyers and sellers– Characteristics of buyers and sellers– Differences in the information available to
buyers and sellers– Deal process
Alternative tactics (examples)Potential tactics Example: When a desirable
acquisition is too expensiveExample: When a desirable divestment is too cheap
Wait for capital markets to stabilise – then follow other logics
Announce the deal is too expensive - hope to buy later
Announce the business is undervalued – hope to sell later
Change your corporate strategy to become consistent with capital market logic
Sell all your businesses in that sector for a high price – even if it is a heartland business
Sell the business regardless, accepting that the market price is all you can get
Hedge the risk of over/under-payment when markets seem over/under-valued
Buy with, or issue, equity or fund with cheap debt
Use the proceeds to buy up equity (or debt)
Educate, Communicate and Signal to influence market prices
Try and talk down the value of the target
Take the business on a road show, spin off or float a portion of the business
Structure the deal to bring PV up or price down
Buy the business based on an earn-out formula for the current owners
Split the business up into more saleable chunks
Improve parenting performance Raise your parenting ambitions Restructure the business, add more value or bring in a more value adding partner to take a share