Multibusiness Company

1. Multibusiness Company • Many firms are diversified. In 1997: • 20% of public companies listed on major exchanges had 2 or more reported segments (1,541 or 7,956 firms). • 154 firms had 5 or more reported segments. • Most segments are in different industries. • Firms buy and sell divisions therefore changing the composition of the firm. • In 1996, public firms sold off or divested over 2,500 divisions. • Between 1983 and 1996, approximately 150 firms spun-off divisions. • In 1995, 5,000 mergers and acquisitions occurred. F409 - Valuing Multi-business Firms

2. Focusing Events • Firms may refocus the firm by divesting unrelated segments. • Sell-off: Sell division or assets to another firm • Spin-off: Distribute stock of subsidiary to existing shareholders. • Carve-out: Issue stock in subsidiary to public. • Each of these events are value increasing. • On average, the announcement of a spin-off leads to a 3% abnormal return. F409 - Valuing Multi-business Firms

3. Multibusiness Company • Recent Breakups • AT&T will divide into 4 units in 2001 to save its falling stock price. • Lucent spun-off Avarya (10/00) and will sell off power systems unit (11/00) • Laporte PLC (British industrial conglomerate) will sell off 55% of its operations to specialize in organic chemical business (9/00) • Laporte’s stock price increases 20% • Less Recent Breakups • AT&T spins off NCR and Lucent technologies in 1996 • AT&T’s stock price increased 7.8%. • Samsonite spins off Culligan Water in 1995 • Samsonite’s stock price increased 5.5%. • Sears and Roebuck spin off Allstate in 1995 • Sears’ stock price increase 4.4%. F409 - Valuing Multi-business Firms

4. How do you value a Multibusiness Segment? F409 - Valuing Multi-business Firms

5. General Electric Divisions: 1997 F409 - Valuing Multi-business Firms

6. Multibusiness Company • How do you determine if a firm should divest a segment. • Is the sum of the pieces (if stand-alone firms) > Conglomerate value • Comparing the value of the firm as a set of stand-alone entities to aggregate value to the value of the firm is useful to: • Determine if firm should divest unrelated segments. • Value acquisition candidates • Estimate the cost/benefit to diversification • Each segment will be valued individually with their own FCF, discount rate and growth rate. F409 - Valuing Multi-business Firms

7. Difficulties Valuing Multibusiness Companies • Different units have different: • Cash flows • Growth Rates • Risk: Discount rates • Segment level data limited. • Accounting data reports only a few items • No market price to calculate cost of equity • No capital structure to calculate cost of debt or WACC. • Need to estimate the above items for the firm as a stand-alone firm, so may need to use single-segment comparables. • Headquarter expenses/income apply to all segments. • Based on conglomerate organizational structure. • Need the stand-alone firm’s administrative expenses and income. F409 - Valuing Multi-business Firms

8. Steps to Value Multibusiness Company • Define the business units. • Collect business unit data. • Perform Business Unit Valuations • Aggregate values and compare to total company discounted cash flow. F409 - Valuing Multi-business Firms

9. Step 1: Defining the Business Unit • A business unit = a separable entity with no significant synergies, such as shared production. • Define Business Units • Company’s description and segment data • SIC codes • A complete separation of business units is difficult • Headquarter may operate an internal capital market and allocate excess funds across divisions. • It is difficult to determine if there are “significant synergies” • Firms can be in same SIC code and be separable or be in different SIC codes and have shared facilities. • A division as defined by the company is not always the same as a segment reported on accounting statements. F409 - Valuing Multi-business Firms

10. Step 2: Collect Business Unit Data • Finding a comparable • Use single segment firms since valuing stand-alone firm. • If you find a comparable, you may use this for identifying ratios to project statements and cash flows. • Segment level data • Firms financial statements must report business segments that accounts for 10% of sales (up to 10). • Great flexibility in reporting standards. • Data available limited so difficult to create full proforma statements • operating income • sales • depreciation • assets • capital expenditures F409 - Valuing Multi-business Firms

11. Step 3: Valuing Business Units • General Principles: • Each unit is treated as a separate stand-alone entity. • Each business unit has its own operating cash flows. Shared corporate services, such as accounting and other administration, must be applied to each business. • The effective tax rate for each unit is different than if the unit was considered part of the larger organization. • Each unit has its own target capital structure which may differ from the conglomerate. • Each unit has its own cost of capital which may differ from the conglomerate. F409 - Valuing Multi-business Firms

12. Step 3: Valuing Business Units • Cash flows of business units • Estimate as if firm is stand alone entity • Adjust costs and revenues for transfer pricing • Transfer pricing occurs when one unit supplies goods at a reduced price to another unit. • Allocate corporate overhead based on usage basis • Relative to the units operating income or revenue • Cash flows of corporate headquarters • Costs that should not be allocated to units such as nonallocatable executive salaries, office space, consulting, charity, and other nonallocatable expenses. • Benefits include tax advantages and greater debt capacity. • Costs and especially benefits are difficult to identify • Often defined as difference in sum of stand alone and conglomerate value. F409 - Valuing Multi-business Firms

13. Step 3: Valuing Business Units • Business unit tax rates • Taxes the firm would pay if it was not under corporate umbrella • Use comparable or get estimate from tax advisor. • Capital structure and cost of capital • Each business unit will have little debt and no stock equity. • Should be consistent with comparable companies and with parent’s philosophy. • Cost of capital will derive from: • Capital structure assumed for unit • Estimated cost of debt and cost of equity from comparables. • May need to unlever cost of equity of comparables and then relever the cost of equtiy using the segment’s target capital structure if this target differs from comparables. F409 - Valuing Multi-business Firms

14. Step 3: Valuing Business Units • Estimate Beta or cost of equity using comparable firms and adjust for different capital structures (similar to private firm example). • Collect a group of comparable single-segment firms • Estimate the average beta or cost of equity • Estimate the average debt-equity ratio (using market values) • Unlever the cost of equity or beta • Estimate the debt to equity ratio for the segment as a stand-alone firm and re-lever beta or return. • Problem the debt to equity ratio must use market values, which are not available. • Solution: assume the firm will go to the industry average or determine the firm’s optimal leverage ratio by adjusting industry average F409 - Valuing Multi-business Firms

15. Step 3: Valuing Business Units • Estimate the cost of debt equal by using • The rate for comparable single-segment similar firms in the industry • Estimate an appropriate bond rating and use rate for similar rated firms. • Estimate WACC • Using cost of equity and cost of debt from above. • Assume capital structure same as above. F409 - Valuing Multi-business Firms

16. Step 4: Aggregate Business Units • Add up the values of each unit • Compare the sum of cash flows to total company cash flows • Compare the sum of debt to total company debt • Unconsolidated subsidiaries exist if the company owns less than 50% of the subsidiary. You must consider the percentage of value or cash flows owned by the parent. • Compare aggregate value with the market value of the firm and the estimated total value of the firm if the units are not treated on a stand-alone basis. F409 - Valuing Multi-business Firms

17. Value to Diversification • On average diversified firms trade at a discount: • The value of the segments as stand-alone entities is approximately 13% to 15% more than the actual firm value for firms with more than one division. • The discount exists in the U.S., U.K., Germany, and Japan. • Discounts in 1998 • Baxter Intl’s value is 51% of its stand-alone value. • Eastman Kodak’s value is 79% of its stand-alone value • Kraft Foods’ value is 62% of its stand-alone value • Time Warner’s value is 59% of its stand-alone value • Premiums in 1998 • Hershey’s value is 106% of its stand-alone value. • Disney’s value is 106% of its stand-alone value. F409 - Valuing Multi-business Firms

18. Why is diversification bad? • Assuming that the discount is correct, the costs of diversification outweigh benefits. • Benefits: • More efficient resource allocation due to internal capital market. • Greater debt capacity and more tax shields due to less risk. • Costs: • Agency problems may lead to inefficient internal capital markets (invest too much in poor growth segments and/or not enough in high growth segments) • Information asymmetry between headquarters and division managers • Difficult to provide incentives to division managers F409 - Valuing Multi-business Firms

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