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Re: Privatization
Posted: Fri May 24, 2019 5:46 am
by beamthegreat
David wrote: Mon May 20, 2019 10:52 am
A better way to indicate the likelihood of success rather than showing a percentage will be to display that in words including "low", "moderate", "high", "very high".
Let's say that we calculate a premium price that has an absolute chance of acceptance by the shareholders. If the offer price >= that price, the privatization will definitely go through. But if it is owner than that, then it is based on the percentage of shares held by other shareholders.
How is the "ideal" premium price calculated?
Re: Privatization
Posted: Fri May 24, 2019 6:06 am
by jckceric
I think you make a good argument and I understand the point of not paying a premium for the cash that a company holds. I just have a few points I think should be considered:
When the company is valued off of a P/E basis, generally between a 10 and 20 P/E ratio, firms typically have a lot higher P/B ratio in the early stages of the game and that P/B ratio generally gravitates towards 1 as the company matures and starts to accumulate cash. I believe this in itself lowers the premium paid on cash.
Another problem I can see is for very profitable firms with very little physical assets, like internet and software companies. Since most AI firms don't take on debt anyways, isn't it a little unfair to assign a lower acceptable premium to a highly profitable firm just because it has cash? For example, a firm that makes $100 profit/year and is valued at 10x earnings, $1000, but has $800 cash and no debt. If an acceptable premium is 30% under the EV method you would only have to pay $1060 for the firm, pocket the $800, and basically get assets producing $100 a year at 2.6x earnings for $260... Now lets say we have the same exact company making $100 a year valued at 10x earnings, but it now has $400 in debt and only $200 in cash. Now a 30% premium on EV brings your purchasing price to $1360. So now you have to pay $1360, pay down $400 in debt, and pocket only $200 after acquiring the firm. Suddenly, you are now paying $1560 instead of $260, a 15.6x multiple on the assets producing $100 a year, just because the company happens to have a shittier capital structure..
Thirdly, I don't believe sellers would value their firm based off the enterprise value but rather the earnings or sales multiple other firms in its industry are being acquired for.
Does that make sense?
Re: Privatization
Posted: Thu May 30, 2019 11:51 pm
by buells
To level set, let me state my assumptions picking up on your example:
Public market value of assets is 10x operating earnings
Acquisition premium on those assets should be 30% (implies 13x multiple of operating earnings for take private to succeed)
Operating earnings are $100 for Firm 1 and Firm 2
No interest income
Firm 1 has cash of $800
Firm 2 has debt of $400 and cash of $200 (net debt of $200)
Firm 1 Scenario: You are assuming that company is being valued by the game at 10x P/E regardless of its cash position. I think the game is assigning it a public multiple of 10x earnings (so $1,000) PLUS the $800 of cash. Its market cap should be $1,800. The enterprise value would be calculated as Public Market Cap + Net Debt, so in this case it would be $1,000 ($1,800-$800). To acquire the firm, you should have to pay $1,300 + $800 or $2,100 in total. You could net the balance sheet cash against your purchase price to put up $1,300 to acquire 100% of the assets (and for completeness, note you get no cash from the acquired company).
Firm 2 Scenario: In your second example, you would expect the Firm 2's market cap to be 8x lower than its enterprise value because it has net debt. Enterprise value would still be $1,000, but market cap would be $800 because of the $200 of net debt ($400 debt - $200 cash). Note that while the market cap would be 8x operating earnings, it would not be 8x net income because of the interest expense. If we are getting very precise, debt might impact public market valuation in some real life circumstances but that is unusual. You should have to pay 13x operating earnings to acquire the assets, which means you would pay $1100 to acquire the equity. With the equity, you would get $200 of cash you can use to pay off $200 of debt. You would then assume or refinance the $200 in debt. If you pay off the $200 in debt with cash, the total cash you spent to acquire the operating assets of Firm 2 is $1,300. Same as Firm 1!
Premium should be applied to enterprise value only. I have been an M&A banker and work in corporate M&A now. I can assure you that in most industries companies are valued based on an Enterprise Value / EBITDA multiple, particularly for M&A purposes. From enterprise value you back out net debt to see what proceeds are to the seller. Obviously they care about equity value, but equity value is best calculated from enterprise value when using a multiple based valuation approach.
Re: Privatization
Posted: Fri May 31, 2019 12:46 am
by buells
beamthegreat wrote: Fri May 24, 2019 5:46 am
David wrote: Mon May 20, 2019 10:52 am
A better way to indicate the likelihood of success rather than showing a percentage will be to display that in words including "low", "moderate", "high", "very high".
Let's say that we calculate a premium price that has an absolute chance of acceptance by the shareholders. If the offer price >= that price, the privatization will definitely go through. But if it is owner than that, then it is based on the percentage of shares held by other shareholders.
How is the "ideal" premium price calculated?
This is a good question. I would propose a few factors can come into play. These apply to M&A deals in general, not just management buy-outs:
Premiums can be based on average prices over a period of time... not just the current price. Most companies do not like to sell out at a discount to a 52 week high, for example (unless events have happened that make that datapoint no longer relevant)
Companies may not want to sell out at a big discount to book value unless ROE has been consistently low for a long period of time (better to turn it around internally if possible)
Companies in financial distress may accept lower multiples (better than going bankrupt or raising equity at a big discount)
Companies with concentrated ownership often want a bigger premium than public shareholders
The larger a share of the company the acquirer owns the lower premium usually is
Basically the seller's reserve price should be based on the highest of P/B, P/E, and public market reference points (52 week and maybe 2 yr high... hard to go back much farther without taking into account qualitative evaluation of continuities). Some % modifiers could be thrown in for the other factors.
Re: Privatization
Posted: Mon Jul 15, 2019 11:31 pm
by jckceric
buells wrote: Thu May 30, 2019 11:51 pm
To level set, let me state my assumptions picking up on your example:
Public market value of assets is 10x operating earnings
Acquisition premium on those assets should be 30% (implies 13x multiple of operating earnings for take private to succeed)
Operating earnings are $100 for Firm 1 and Firm 2
No interest income
Firm 1 has cash of $800
Firm 2 has debt of $400 and cash of $200 (net debt of $200)
Firm 1 Scenario: You are assuming that company is being valued by the game at 10x P/E regardless of its cash position. I think the game is assigning it a public multiple of 10x earnings (so $1,000) PLUS the $800 of cash. Its market cap should be $1,800. The enterprise value would be calculated as Public Market Cap + Net Debt, so in this case it would be $1,000 ($1,800-$800). To acquire the firm, you should have to pay $1,300 + $800 or $2,100 in total. You could net the balance sheet cash against your purchase price to put up $1,300 to acquire 100% of the assets (and for completeness, note you get no cash from the acquired company).
Firm 2 Scenario: In your second example, you would expect the Firm 2's market cap to be 8x lower than its enterprise value because it has net debt. Enterprise value would still be $1,000, but market cap would be $800 because of the $200 of net debt ($400 debt - $200 cash). Note that while the market cap would be 8x operating earnings, it would not be 8x net income because of the interest expense. If we are getting very precise, debt might impact public market valuation in some real life circumstances but that is unusual. You should have to pay 13x operating earnings to acquire the assets, which means you would pay $1100 to acquire the equity. With the equity, you would get $200 of cash you can use to pay off $200 of debt. You would then assume or refinance the $200 in debt. If you pay off the $200 in debt with cash, the total cash you spent to acquire the operating assets of Firm 2 is $1,300. Same as Firm 1!
Premium should be applied to enterprise value only. I have been an M&A banker and work in corporate M&A now. I can assure you that in most industries companies are valued based on an Enterprise Value / EBITDA multiple, particularly for M&A purposes. From enterprise value you back out net debt to see what proceeds are to the seller. Obviously they care about equity value, but equity value is best calculated from enterprise value when using a multiple based valuation approach.
This is wrong on many different levels. like I stated earlier, the PRICE to BOOK ratio of the company lowers as the cash builds up (aka part of the company's BOOK value) and the BOOK value begins to equal the PRICE to EARNINGS based MARKET value. Your beginning assumptions that the market cap would be $1,800 under the P/E valuation is wrong in the game and in real life and would defeat the entire purpose of a P/E valuation. Like I said, if you play the game at all and visit the stock market page, you can easily see this effect play out.
I don't know any other way to explain it other than you wouldn't value two firms with identical capital structures the same if one firm is much more profitable than the other.
Re: Privatization
Posted: Wed Jul 17, 2019 2:59 am
by buells
I don't understand what your objection is. I am not saying the current game mechanic is wrong.
My point is simply that in the game a company's total enterprise value (cash-free, debt-free) should be determined as Operating Earnings x TEV Multiple. The cost to purchase the EQUITY should be the Total Enterprise Value + Cash - Debt.
Assuming the game requires you to pay a premium %, the premium should be a premium to enterprise value.
Pre-merger, trading publicly:
TEV-> $100 operating earnings x 8x multiple = $800
Market Cap-> $800 TEV + $200 Cash - $300 Debt = $700 Market Cap
Cost to Acquire:
TEV-> $100 operating earnings x 10x multiple = $1000
Equity Purchase Price-> $1000 TEV + $200 Cash - $300 Debt = $900
TEV Premium: 25.0%
Equity Purchase Premium: 28.6%
If the company had no net debt, the premium would be 25%. The point is this: the premium an acquirer will pay for an asset depends on the assets themselves, not whether they are currently financed with debt or come with cash. The acquirer will pay $1 more for $1 more of cash (obviously) and deduct $1 from its equity purchase price for each $1 of debt. As an analogy, if you have a house with a mortgage for 80% of what you initially paid for it, the amount a buyer will pay for the house has nothing to do with your equity stake in the house and everything to do with its asset value.
Re: Privatization
Posted: Sat Sep 28, 2019 4:36 pm
by beamthegreat
David, given the overwhelming majority wants this feature, can we expect to see this in the banking/finance dlc?
Re: Privatization
Posted: Sat Sep 28, 2019 5:09 pm
by David
beamthegreat wrote: Sat Sep 28, 2019 4:36 pm
David, given the overwhelming majority wants this feature, can we expect to see this in the banking/finance dlc?
I will remind the dev team about this requested feature and hopefully they will include it in the banking/finance dlc feature implementation list, perhaps not at the release of the banking/finance dlc, but in a post-release update version of the DLC.
Re: Privatization
Posted: Sun Sep 29, 2019 1:04 pm
by beamthegreat
David wrote: Sat Sep 28, 2019 5:09 pm
beamthegreat wrote: Sat Sep 28, 2019 4:36 pm
David, given the overwhelming majority wants this feature, can we expect to see this in the banking/finance dlc?
I will remind the dev team about this requested feature and hopefully they will include it in the banking/finance dlc feature implementation list, perhaps not at the release of the banking/finance dlc, but in a post-release update version of the DLC.
Awesome! Looking forward to it.