Kohler& Co

Multiples Approach
Which period needs to be considered?
- Taking the same period for comparison i.e 3103-1998
1. In that case, American Woodmark needs to be
excluded from our analysis [ need for revised
set of averages in multiples]
- Why?????
2. The actual numbers for Kohler for the year
1998 [ given for 4 months] need to be
converted into 3 months ending on 31-03-1998

Trading Multiples for comparable cos

[ American woodmark is removed]
Particul
ars

MV
of
Equit
y

Total
Debt

Total
firm
value

S
EBITD CF
EBIAT
Multip A
Multip Multip
le
Multip le
le
le

AM.STD

3,502

2,404

5,906

0.96

8.45

12.77

20.18

MASCO

9,838. 1,187.
8
9

11,026
.7

2.80

13.15

19.93

25.22

B&S

1,109. 259.6
3

1,368.
9

1.03

7.68

10.76

17.03

Cummin
s

2,285. 1,250
7

3,535.
7

0.61

7.26

9.06

15.77

Det.Dis

568.1

675.5

0.30

6.40

8.16

16.48

107.4

Trading Multiples for comparable

cos
Particulars

S Multiple EBITDA
multiple

CF
multiple

EBIAT
multiple

Avg of K&B 1.88

cos

10.80

16.35

22.7

Median ,,
do ,,

1.88

10.80

16.35

22.7

Avg of
Power sys
cos

0.65

7.11

9.33

16.42

Median ,,
do,,

0.61

7.26

9.06

16.48

Avg of all 5 1.14

cos

8.59

12.14

18.94

Median ,,
do,,

0.96

7.68

10.76

17.03

Weighted
average

1.634

10.06

14.95

21.44

Numbers for Kohler

[ For the year ending 31-03-1998]
Parameter

1997[ 9
months]

1998[ 3
months]

Total [ for the

year ending
31-03-1998]

Net Sales

16,60,052

5,68,105

22,28,157

EBIT

1,30,732

43,075

1,73,817

EBITDA

1,46,946

48,147

1,95,093

EBIAT[ AT T=
43.88% and
43.08%]

82,466

24,518

1,06,984

CF[ EBIAT +
depreciation]

98,680

29,590

1,28,270

Value of K&CO based on Multiples

comparable
cosAvg of Media
Particulars S forEBITDA
CF mult EBIAT
Mult

mult

2228

195

128

107

Avg of K&G 4189

cos

2106

2093

2429

2704

2268

Median ,,
do ,,

4189

2106

2093

2429

2704

2268

Avg of
Power sys
cos

1448

1386

1194

1757

1446

1417

Median ,,
do,,

1359

1416

1160

1763

1425

1388

Avg of all 5 2540

1675

1554

2027

1949

1851

For 12
months
Ending
31.03.98[0
00]

mult

4
n
multip Of 4
le
mul

What is the growth rate?

As per the calculation, g= 7.72%
i.e ROIC * Reinvestment rate
ROIC [ mean for 4 years is 8.37% and median
is 8.30%]
Reinvestment rate [ = {Capex-Depr+Ch in
NWC}/ EBIT(1-t) ]
Mean for 4 years is 113%
So g= 9.38%
But the working is based on a conservative
estimate of 3% as growth rate

Methodology for valuing control and

liquidity in a Pvt.Ltd.Company
In a closely held company, the share
price is not pro-rata value arrived
simply by dividing the firm value by
the no. of outstanding share
Different share prices applied for the
controlling and minority
shareholders- they have different
rights-priced in the markets
K had 2 types of stocks common
and -restricted

Methodology for valuing control and

liquidity
All common stock-1 vote per share
HK control 90%
Minority shareholders de facto no
voting rights
Minority sh.holders can exercise their
rights to receive dividends, other
distributions or capital gain

HKs Voting power

-

What businesses to enter or exit?

What companies to acquire?
What assets to sell?
How much to invest?
How much dividends to pay?
Who are to be selected as officers/ executives?
How much to pay them ?
How much will be the cashflow available
to the sh.holders? And so on..

Control Premium or Minority

Discount
Control prerogatives are of high
value
Per share value of HKs holdings will
be greater than that of the minority
sh.holders
- Known as Control Premium
- Or Minority Discount
- Or discount for lack of control

Limited Marketability
Marketability vs Liquidity
Marketability- ability to sell a share
Liquidity- speed at which an asset
can be converted into cash without
adversely affecting its value

Whether these discounts can be

applied?
Firm value on the basis of DCF method is on a
control basis
- Minority discount should be applied before
arriving at the per share value
- Discount for lack of marketability should be
applied
Multiples approach
- No need to apply the minority discount[ value is
arrived based on minority trades]
- Discount for lack of marketability should be
applied

Valuation of a Minority Share in

Kohler co. using DCF analysis
Assumptions required
1. Minority Discount
2. Discount for lack of Marketability

Minority Discount @ what

rate?
What did you do you in your interns?
If you had relied on rules of thumb,
where those rules of thumb comes
from?
What explains the variance in
discounts?
How to choose discounts for a
specific company like Kohler?

Importance of Control premium /

Minority Discount
often there is more money at stake in
determining what discounts or
premiums are applicable to some
business valuations than there is in
arriving at the base value[ pre
discount valuation]itself
-Shannon Pratt [2001]

Empirical estimates of the control

premium
Two types of premium
1. Acquisition Premium
2. Voting Premium
-. Mergerstat Review has been publishing quarterly
data on control premium in its control premium study
-. Some studies on Block Premium[for controlling
block of shares relative to the prices paid in minority
trades before or after the transaction ] [ Barclay and
Holderness , 1989: Dyck and Zingales,2004]

Variation in Acquisition
Premiums
Mergerstat Review
- aggregate premium in the range 36% and
49% during the 5 year period 1996-2000
- Premium for individual transactions [ range
from negative figures to above 100%]
Common Practice
- Use the average or median premium
from a sample of transactions as an
estimate of the control premium

Explanation for variation in

acquisition premium
- Synergies
- Under exploited investment
opportunities
- Strategic flexibility
- Foreseeable post-merger integration
costs
- Corporate Governance in both
acquirer and target firms
- Period of study and so on

Valuing Kohler
Should be done on a stand alone
basis
Minority discount to be applied
here should be free from any
effect of synergies
Select the MD from Mergerstats
sample [ close to the recapitalization
period]and eliminate those with
strategic acquirors

Voting Premium
In dual class companies
Premium is the difference in stock
price between two classes of shares
that have identical CF rights but with
different voting rights [ Levy, 1983]
Wide variations in voting premium
-5-10% in US [Lease, McConnell, and
Mikkelson,1983,1984; Zingales,1995]to
80% in Italy

Explanation for variation

Degree of shareholder protection
[Nenova,2003]
Likelihood of a change in control in
the company [Zingales, 1995]
Formula for MD
= 1 [ 1/ {1+ CP} ]
E-g If CP= 30%, then MD= 23.08%

Discounts for lack of

Marketability
Two types of discounts reported by empirical studies
1. Discounts on sales of restricted stock of
publicly traded companies [ relative to the price of
unrestricted stock] and
2. Discounts on private transactions [ private
placements and repurchases] prior to public offerings [
relative to the post-IPO price]
- Reviews by Pratt[2001], Pratt et al.[2007],
Bruner[2004], Bruner and Palacios[2004], and Hitchner
et al.[2006]
- The discount range b/w 25 and 45%
- Some studies report higher discounts

Explanation for variation in

discounts
1.The extent to [or time during] which
marketability is limited
2. The nature and inherent risk of the
business
3. The size of the share block
transacted
4. The companys revenues, earnings
and growth prospects

Liquidity and Control

Are not independent
In a private company, controlling
shareholders have exit options
Exit options not available to minority
shareholders
Exit options are
- IPO merging or selling controlling stock to
another company/investor- leveraging the
company as a means of withdrawing capital

2 types of studies on discount for

liquidity
1. Studies of the difference in deal
values or in abnormal returns for
acquisitions of private and public
companies, and
2. Studies of the costs of going public

Standards of value and adjustments required

to value Kohler Co. shares
Business appraisers, attorneys, and courts
often distinguish between 2 Standards of
Value i.e Fair Value and Fair Market
Value
Fair Market Value: the net amount that a
willing purchaser would pay for the
interest to a willing seller , neither being
under any compulsion to buy or to sell and
both having reasonable knowledge of
relevant facts
- Is the statutory value for tax cases,
bankruptcy proceedings, and other legal
cases but not the standard of value in

Fair value

is the value of the shares immediately

before effectuation of the corporate action
to which the dissenter objects, excluding
any appreciation or depreciation in
anticipation of the corporate action unless
exclusion will be inequitable- Model
Business Corporation Act
Amendments in 1999 fair value not to
include discounts for either lack of
marketability or lack of control
Under the standard of fair market value,
both discounts are applicable to the
valuation of minority interests in closely

During K s recapitalization
1998
Legal ambiguity as to whether these
discounts would be applied or not
Disagreement on basis for the
valuation of minority shareholdings
Kohler- non marketable minority
basis
Dissenters- marketable and control
basis
- Calls for adjustment in valuation

Valuation adjustment and legal standards of

value applicable to the valuation of Ks
minority shares
METHOD

Kohlers
Dissenters
agreement
agreement
[Fair market value : [Fair Value:
non-marketable ,
Marketable,
minority basis]
Control basis]

DCF
[Marketable , Control
Basis]

Applying MD and
DLOM

No Discount is applied

Multiples
[Marketable , minority Apply DLOM only
basis]

Apply Control
Premium only

K may have the desire to settle

down with dissenters
As the amendment in the Model
Business Corporation Act seem to
work in favour of the dissenters
Alternatively Push him to increase
the offer price

What have we discussed so

far?
Empirical studies relevant to control
premium
Empirical studies relevant to lack of
marketability discount

What to be done?
Reverse engineer the $ 54,000 and $
2,73,000 share prices suggested by
K&CO and Dissenters
Perform a break even analysis of the
price at which HK should settle

Discounts and Premium in the

valuation of Ks minority shares
How could HK justify a share price of
$55,400?
How would Sogen Fund argue for a
share price of $2,73,000?

Other Methods
Book value of a share was $1,00,000 at the end of
1997, or $1,04,000 as of April ,1998[ exhibit 3 a]
Can also value the company using the DDM
-Forecasted dividend for 1999 is $54,03,000[ exhibit 6-c]
or $712 per share
- Wacc =12.28% and g @3%
- Discounted dividends = 712/[ 0.1228-0.03]
= $7672 per share
- Would you pay $55,500 for an investment which would
yield $712, in perpetuity, growing at 3% forever
- ???????????????????????????

KOHLER (B) CASE

What Happened on April

2000?
HK settled $1,53,000 [ including
interest and legal fees]
Why???

Forecasts vs actuals
Sales and Net Income numbers
forecasted for the year 2002 were
reached in 1999
Sales at $2.4 billion [1998] and $2.6
billion [1999]
NI at $95.3 million[1998] and $107.8
million in1999
Actual no. far exceeded the forecast
behind the settlement price

Case-B
FKs estate paid tax on the valuation
of $48,215 per share while the IRS
claiming a valuation of $1,48,205
The estate took the matter to US Tax
Court

Qs??????????
1. What was different in the IRS trial
relative to the dissenters rights
lawsuit?
2. If you were the appraiser for the IRS,
what would you have argued to
justify your valuation?

What was different in the

IRS trial?
No legal ambiguity as in the first one
-important takeaway
The value of a share may be very
different not just across
- Controlling and minority shareholders
- Also for a given group of sh.holders
depending on the purpose of the
valuation

If you were the appraiser for

IRS
Arguments on discount ratesforecasts-valuation method
- Small discount for marketability
- More weight to the multiples
valuation
- $1,35,000 ceiling for the estate but
floor for the IRS

What Happened?
On July 25, 2006, the Judge dictated that
the FMV of FKs 975 shares were $47
million or $ 48,215 per share
Highly critical about the appraiser of IRS
- Ignored the DDM
- No weight to managements projections
but used his own weights
Concluded that the appraiser did not
understand the business.

Adjusted Present Value

For Discussion
Limitations of WACC
APV
Case Discussion

INTRODUCTION
HISTORY :
-The best way for valuing operating
assets [ an existing business, factory,
product line, or market position] was
to use a DCF approach
- DCF using WACC as the discount rate
is outdated
- Alternative : APV

Drawbacks of using WACC

Requires more number of restrictive

assumptions [ like premium for
market risk in computing COE, book
value of debt]
Does not talk about the sources of
value [ operating, incremental
operations, tax shield, reduced
working capital requirements and so
on]
Does not provide managerially
relevant information [ whether to buy
a busiess or not]

Adjusted Present Value

APV= Base Case Value + Value of all
financing side effects
- Base case value : value of the project as if
it were financed entirely with equity
- Value of all financing side effects: interest
tax shields + costs of financial distress+
subsidies + hedges+ issue costs +other
costs
- Unbundles components of value and
analyzes each one separately

Steps in a basic APV

Analysis
1. Prepare performance forecasts and
base-case incremental cash flows
for the business
2. Discount base-case CFs and TV to
present value
3. Evaluate financing side effects
4. Add the pieces together to get an
initial APV
5. Tailor the analysis to fit managers
needs

Case Study
ABC wants to acquire XYZ , a division of PQR
XYZ is a mature business that has
underperformed in its industry for the past 6
years
After an internal campaign to improve
performance fell short of senior executives
expectations, PQR decided to sell XYZ
The MD of ABC had formulated strategies for
value creation

Strategies for Value

Creation
XYZs product line will be
rationalized, and some components
will be outsourced to improve the
cos operating margins by 3%
The same changes will reduce
inventory and increase payables,
resulting in onetime reductions in
NWC
Xyzs some of the non-productive
assets will be sold

Strategies for Value

Creation
Distribution will be streamlined and
new sales incentives introduced to
raise Acmes sales growth from 2%
to 3% annually to the industry
average of 5%
Some taxes will be saved mostly
through the interest tax shields
associated with borrowing

Additional Data
PQR is not willing to accept not less than
INR 307 million for XYZ
The finance manager of ABC feels that a
deal at book value could be financed with
about 80% debt [ senior bank debt,
privately placed subordinated debt, and a
revolving credit facility]
The MD wants to have a DER of 1 within 5
years [ reducing the interest expenses to
INR 15 million]

Additional data
XYZ does not have publicly traded shares
-one of the competitors with a historical debt
to capital ratio of 45-50% has COE of 24%
-another with no debt in its capital structure
has COE of 13.5%
-ABCs equity investors ROR is 30-35%
-Return on long term government bonds is 5%
- CF to grow at 5% after the fifth year in
perpetuity

How to find the APV?

Evaluate the business as if it were
financed entirely with equity
Add or subtract value associated with
the financing program
The net effect should be positive ;
otherwise, he should use only equity
financing
Step 1 : Prepare Performance Forecasts

1.1 Pro forma Income

Statements

Particular
s

Year 1

Year 2

Year 3

Year 4

Year 5

EBIT [ in
million]

22.7

29.8

37.1

40.1

42.1

EBT

1.1

10.7

19.3

23.3

26.3

Taxes@34
%

0.4

3.6

6.6

7.9

8.9

Net Income 0.7

7.1

12.7

15.4

17.3

Depreciatio 21.5
n

13.5

11.5

12.1

12.7

Capex

10.1

10.4

11.5

13.1

Interest

OTHER

Ch.in NWC
Ch. In

DETAILS

10.7

1.2 Pro forma Balance

Sheets
Particulars
Year
Year
1 Year 2 Year 3 Year 4 Year 5
0

NCA[in mill]

60

47.7

49.6

53.7

59

65.1

NFA

221

210.3

206.9

205.7

205.1

205.5

Other Assets

26

17

10.1

6.7

6.7

6.7

Total Assets

307

275

266.5

266.2

270.8

277.3

Subord
debt@9.5%

150

150

150

150

150

Revolver @7.5%

13

0.2

4.8

11.7

20.9

20

Bank Loan@8%

80

60

40

20

Long Term
debentures at
9%

140

Total Debt

243

210.2

194.8

181.7

170.9

160

Equity

64

64.7

71.8

84.5

99.9

117.2

Total L& E

307

275

266.5

266.2

270.8

277.3

Expected BENEFITS through the value

creation initiatives& baseline EBIT
Particula Y 1
rs

Y2

Increment 2.3
al EBIT

3.7

4.2

Benefits
16.3
of
improvem
ent in
NWC

2.1

Incre.CF
9
from
Asset Sale

6.9

3.4

EBIT
[ BASELIN
E]

26.8

33.4

36.1

37.9

20.4

Y3

Y4

Y5

Find out FCFF

Base-case Cash Flows

Particula Year 1
rs

Year 2

Year 3

Year 4

Year 5

EBIT

22.7

29.8

37.1

40.1

42.1

- Taxes
@34%

7.7

10.1

12.6

13.6

14.3

=EBIT{1T}

15

19.6

24.5

26.4

27.8

+Depreci
a

21.5

13.5

11.5

12.1

12.7

Op.cashfl
ow

36.5

33.1

36

38.5

40.4

-Ch. In
NWC

12.3

-1.9

-4.2

-5.2

-6.1

- Capex

-10.7

-10.1

-10.4

-11.5

-13.1

- Ch.in
other

6.9

3.4

Step 2:Discount Base-case FCFF

and terminal value to Present Value

PV of FCFF and TV
[ it is lower than the BV sought by the seller]
Base-Case
Value

Year Year 1
0

Year 2

Year 3

Year 4

Year 5

FCFFassets[in
million]

28.1

24.8

21.8

21.3

47

TV of assets

263.4

{21.3*1.05
}/
{ 0.1350.05}
PV Factor at
13.5%

PV of
FCFF&TV
Base-case

244.

.8811

.7763

.6839

.6026

.5309

41.4

21.8

17

13.1

151.1

Step 3: Evaluate the financing side

effects
Only interest tax shield
Why is it a side effect?
-the projected tax payments in the base case are
too high
-the hypothetical all equity financed co. pays no
interest and receives no tax deduction
- The capital structure proposed by the MD of
ABC usage of Debt-interest payment-taxshield
- reduce tax payments by the amount tax
shield = 7.4 million [= 21.6 million*0.34] in the
first year and so on

Step 3: Evaluate the financing side

effects
As with the base case, we need TV and a discount
rate
Academics : Tax shield should be discounted at an
appropriate risk-adjusted rate
- No agreement on how risky tax shields are?
- Common method : use COD as a discount rate on
the assumption that tax shields are as uncertain as
principal and interest payments
- Practitioners argue that managers may increase /
decrease the % of debt employed in the Capital
structure of their cos- discount rate to be higher
than COD [ let us take 9.5%]

Step 3: Evaluate the financing side

effects
Particul
ars

Year 0

Interest
Tax
Shield

Year 1

Year 2

Year 3

Year 4

Year 5

7.4

6.5

6.1

5.6

5.4

TV of tax
shield
Discount
factor@9
.5%

122
1

PV
Total PV
of tax
shields

101.8

0.9132

0.8340

.7617

.6956

.6352

6.7

5.4

4.6

3.9

81.2

Step 4 : Add the pieces together to

get an initial APV
= Base-case Value+ Effect of financial
side effect[ tax shield]
= [244.5+101.8] = 346.3 million
-ignored the other financing sideeffects
-buying the business for 307 million is
a NPV positive decision with a NPV of
39 million

Step 5: Tailor the analysis to fit

Managers needs
5.1: Baseline Performance
5.2: Increments: Value Creation
initiatives
5.2.1: Margin Improvement
5.2.2: Improvement in NWC
5.2.3: Incremental CF from asset sales
5.2.4: Incremental Terminal Value
5.3: Sum of Baseline and increments

5.1
Baseline
Performance
Particulars
Y1
Y 2
Y3
Y4
Y5
EBIT

20.4

26.8

33.4

36.1

37.9

- Taxes @34%

9.1

11.4

12.3

12.9

=EBIT{1-T}

13.5

17.7

22

23.8

25

+Deprecia

21.5

13.5

11.5

12.1

12.7

Op.cashflow

35

31.1

33.5

35.9

37.7

-Ch. In NWC

-4

-4

-4.2

-5.2

-6.1

- Capex

-10.7

-10.1

-10.4

-11.5

-13.1

FCFF

20.2

17

19

19.2

18.5

TV

172.8

Discount
factor@13.5

.8811

.7763

.6839

.6026

.5309

PV of FCFF
and TV

17.8

13.2

13

11.5

101.6

Baseline
Business
value[ in

157.2

5.2.1: Margin Improvement

Particular
s

Y1

Y2

Y3

Y4

Y5

Incr.EBIT

2.3

3.7

4.2

-taxes
@34%

0.8

1.3

1.4

1.4

= cash
increment

1.5

2.4

2.6

2.8

Incr. to TV

25.9

Discount
Factor

0.8811

0.7763

0.6839

0.6026

0.5309

PV of
CF&TV

1.3

1.5

1.7

1.6

15.2

Value of
margin
improvem
ent

21.3

5.2.2: Improvement in NWC

Particulars

Y1

Y2

Incremental Cashflow

16.3

2.1

Discount
factor@13.5%

0.8811

0.7763

PV of incr.CF

14.4

1.7

Value of NWC
improvement

16

5.2.3: Incre. CF from sale of

assets
Particulars

Y1

Y2

Y3

Incremental Cashflow

6.9

3.4

Discount
factor@13.5%

0.8811

0.7763

0.6839

PV of incr.CF

7.9

5.4

2.3

Value of NWC
improvement

15.6

5.2.4: Incremental TV
Incremental TV = 64.7
Discount factor at 0.5309
PV of incremental TV = 34.3

5.3: Sum of Baseline and

incremental Cash flows
Base line = 244.5 million
Incremental = 101.8 million
Total CF = 346.3 million

Sources of APV[ 346 million]

Higher Growth
at
34 million
Asset Sales
at
16 million
Improvement in NWC at
million
Margin improvement at
million
Interest tax shields
at
102 million

16
21

Distribution of APV[346
million]
Purchase price [ retained by seller]=
307 million
Net Present Value [ captured by
buyer] = 39 million

WACC Calculations
1. Computation of WACC
2. DCF using WACC as the discount
rate

1. Computation of WACC
Source of
funds

Amount

Proportion
[%]

After-tax
cost

Weighted
cost

Debt:
-Revolving
credit
@7.5%

13

4.2

0.050

0.2%

-Bank
debt@8%

80

26.1

0.053

1.4%

subordinate
d
debt@9.5%

150

48.9

0.063

3.1%

Equity

64

20.8

0.240

5.0%

Total funds

307

100

9.7%=
WACC

2. DCF at WACC
Particula Y1
rs

Y2

Y3

Y4

Y5

FCFF

28.1

24.8

21.8

21.3

47

TV of
assets

481.2

Discount
factor@
WACC at
9.7%

0.9120

0.8317

0.7585

0.6917

0.6308

PV of
FCFF

42.9

23.3

18.8

15.1

317

Value of
the Firm

417.1

Limitations of APV
1.Overestimate of the net advantage
associated with interest tax
shields[ when looking at the personal
tax to be paid by an equity investor
for the return from his stock
investments]
2. Neglects cost of financial distress
associated with corporate leverage
3. Not suitable for valuing options