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Arcadian Microarray Technologies, Inc: The Power of Terminal Value

Arcadian Microarray Technologies, Inc: The Power of Terminal Value. Akua Acheampong Jody Grewal Kieng Iv Rhea Rasquinha. Agenda. Background and Current Issues Terminal Value Estimators of Terminal Value Forecast Horizon Quantitative Analysis Recommendations.

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Arcadian Microarray Technologies, Inc: The Power of Terminal Value

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  1. Arcadian Microarray Technologies, Inc:The Power of Terminal Value Akua Acheampong Jody Grewal Kieng Iv Rhea Rasquinha

  2. Agenda Background and Current Issues Terminal Value Estimators of Terminal Value Forecast Horizon Quantitative Analysis Recommendations

  3. Background and Current Issues • Arcadian: • Gene diagnostics industry • Investment Opportunity: • Original Offer: 60% equity interest in Arcadian for $40M • Value of the Investment: • Determined through estimating terminal value

  4. Terminal Value • It is the lump sum of cash flows at the end of a stream of cash flows, which represent: • The proceeds from exiting an investment; • The present value of all cash flows beyond the forecast horizon • Terminal values are important because: • They are present in the valuation of almost every asset • They measure the “continuing value” derived from the going concern of the business.

  5. Importance of Terminal Value

  6. Assumptions and Methods: Estimating Terminal Value

  7. Key Terminal Value Estimators

  8. Setting the Forecast Horizon Going Concern Timeline Forecast Horizon Cash Flows beyond the Forecast Horizon Terminal Value Importance: All future cash flows, not only the ones that you can forecast, determine value As far into the future as CFs can be forecasted PV of future cash flows beyond the forecast horizon • KEY: When Stable Growth Begins… • Set the forecast horizon • Stop Forecasting Cash Flows • Estimate a Terminal Value

  9. Projected Cash Flows by Investment $350 $300 $250 Movie $200 Studio Bottling $150 Plant $Millions $100 Toll Road $50 $0 3 5 7 9 11 13 15 17 19 21 23 25 27 29 ($50) Year Stable growth of 2% begins in year 27: -Production capacity reached -Estimate TV at yr 27 ($100) ($150) Stable growth of 2% begins in year 12: -Plant reaches capacity -Estimate TV at yr 12 Stable growth of 2% begins in year 3: -Operational capacity reached -Estimate TV at yr 3 Setting the Forecast Horizon: An Illustration 1

  10. Resembles Bottling Plant Very unstable growth Setting the Forecast Horizon

  11. Forecast Horizon for Arcadian • Limitations: • Forecasts for 10 and 11 years, but neither attains stable growth • Ideally, we should continue forecasting until stable growth begins • Difficult due to the company being in its early stages • When should TV be estimated? At end of 2013? • Cash flow growth is volatile after 2013 At end of the Forecasted Cash Flow period? • Cash Flow growth has declined and will further decline until 5% is reached It is reasonable to assume that growth will fall to 5% by 2016 given the pattern of decline since 2013 Use the End of the Forecasting Period to Estimate TV

  12. Estimating Terminal Value Best Options: Price/Earnings Ratio Price/Book Value Ratio Constant Growth Rate Assumptions: WACC – 20% At end of forecast horizon Arcadian is a mature company

  13. Price to Earnings Ratio

  14. Price to Book Ratio

  15. Constant Growth Rate Options: Real growth rate in the economy = 3% Real growth rate in the Pharmaceutical Industry = 5% USA Population growth = 1% Inflation=2% Nominal Rates Nominal growth rate in the economy ~ 5% Nominal growth rate in the Pharmaceutical Industry ~ 7% USA Population growth = 1% Best Rate: Nominal growth rate in the economy ~ 5%

  16. Constant Growth Rate High Range Low Range

  17. Summary of PV Calculations

  18. Difference - Terminal Value

  19. Qualitative Analysis • Option on Future Opportunities • Further financing needed • 40M barely covers 2005 projected cash deficit • Debt financing • High debt financing costs: low current earnings -> low interest coverage, low operating income margin -> high cost of debt • Impact on WAcc • IPO/Early Exit • Distribute shares to clients tax-free • Compare with • Affymetrix (P/E 50.09, P/B 8.56,P/FCF 97.5, P/SALES 7.49) • Illumina (PB 8.46, P/SALES 8.82) • Current Average Investment weighting: $31.25M

  20. Counteroffer and Conditions Counteroffer: $21M Abandonment Point: $31M Management Bonus If management hits forecast in years 2013-2014, 5% incentive $2M present value

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