MEDICA casestudy byfranck IMBERT

Transcription

1 MEDICA casestudy byfranck IMBERT

2 MEDICA case study 1. Carry out a financial analysis of Medica Medica is a fast growing company (sales rose by 25% over the last 2 years), this growth being both organic (creation of new establishments) and external. This growth is well managed as it comes along with a gradual increase in margins (+1% for EBITDA margin); Same comment for EBIT margin. Medicatakes advantage of its increasing size to obtain better conditions in terms of working capital that keeps on decreasing from -37 day of sales in 2007 to -49 day of sales in Fixed assets which constitute bulk of economic assets are increasing at a lower rate than the turnover, which shows its effectiveness. 2

3 MEDICA case study Because of its LBO situation leading to a huge gearing ratio (386% in 2007), Medica does not generate significant cashflows from operations ( 9.9m in 2008 and 2009) in spite of a negative working capital. Therefore, investments it proceeds, which are much more important than depreciation, are financed by an increase in net debt ( 94.2m of investments in 2008 leading to an increased gearing ratio of 504%). Debt ratios are heavy but specific to the situation of LBO and are gradually improving: net debt / EBITDA accounted for 10.3x in 2007 and 9.2x in

4 MEDICA case study However, as the company does not generate significant cashflows from operations after financial expenses, debt can not be repaid except by a restructuring of the financial structure or by divestitures of assets. Economic profitability is extremely low (ROCE of 4% in 2007), although it is slightly improving (ROCE of 4.9% in 2009). It is artificially low because of massive intangible assets (goodwill resulting from the external growth policy and concessions/administrative authorizations to operate establishments). The Return On Equity (ROE) excluding non recurring items is negative (-2.2% in 2007) = > negative leverage effect(roce < Cost of debt). 4

5 MEDICA case study 2. Among Medica scomparable peers listed in appendix 2, which, in your view, is the most comparable to Medica? Why? The company which is the more comparable to Medica is Korian as Medica s growth rate is 8.5%, and Korian, amongst the other three, is the one that has the lowest rate at 10.1% and therefore the most comparable to that of Medica. Calculate the 2009 EBITDA, EBIT and P/E multiple for it. Enterprise value of Korian= 627m + 542m = 1,169m 2009 EBITDA multiple: 1,169m / 92m = 12.7x 2009 EBIT multiple: 1,169m / 63m = 18.5x 2009 P/E multiple of Korian: 627m / 24m = 26.1x 5

6 MEDICA case study 3. Work out a valuation bracket for the Medicashare, knowing that there are 14.2m issued shares. On the basis of the 2009 KorianEBITDA multiple, value of the Medicashare is: Enterprise value = 12.7 x 83m = 1,054m Equity value = 1,054m - 766m = 288m Value of the Medicashare = 288m / 14.2m = 20.3 On the basis of the 2009 KorianEBIT multiple, value of the Medicashare is: Enterprise value = 18.5 x 64m = 1,184m Equity value = 1,184m - 766m = 418m Value of the Medicashare = 418m / 14.2m =

7 MEDICA case study It is not possible to use the P/E of Korian to value the MEDICA share as Medica made losses in This illustrates the fact that for a given P/E to be used, it is necessary that not only the industry and size are similar but that the financial structure is close. Indeed, the P/E, applying to net income (after financial expenses) takes into account the financial structure. 7

8 Some considerations on P/E Price Earning Ratio = Value of the share Earning Per Share(EPS) For the determination of EPS, one should consider the recurrent income (that is to say excluding non-recurrent items), group share (otherwise it gives value to minority shareholders) after tax. The number of shares to take into account is the number of shares currently outstanding (after elimination of treasury shares). As the case may be, this number can be increased by shares that do not yet exist but which can be potentially created by exercise of convertible bonds, bonds redeemable in shares, share subscription warrants... 8

9 Some considerations on P/E (cont d) P/E is the most widely used multiple because it is easy to use and implement. This is also the most dangerous because: It is based on the most volatile indicator (net result) and can rarely be used without adjustments(non recurrent charges); It is affected by the tax rate (in different countries), different rules / depreciation periods of assets and provisioning policy between peers and the company to value; It normalizes the financial structure of the company to value on that of its comparable peers and can lead to respectively over-value or under-value equity of the firm (high gearing ratio or strong positive cash position). 9

10 Some considerations on P/E (cont d) Indeed, the P/E multiple normalizes the financial structure of the company to evaluate on the average of comparable peers: Applying a P/E of 15x to the net result of a firm that has a net cash situation of 100m remunerated at 4% after-tax leads to value not only 15 times operating profit after tax but also after-tax financial products, i.e. 60m (15 x 4) for a cash situation of 100m => undervaluation of the cash situation and therefore of the share. Conversely, applying a P/E of 15x to the net result of a firm which has net debt of 100m with a cost of 5% after-tax leads to value the economic assets to 15 times the economic result after tax and debt (which is deducted from the enterprise value to get the value of equity) to 15 times interest expenses after tax, i.e. 75m => undervaluation of the debt and therefore an overstatement of the share. 10

11 Some considerations on P/E (cont d) In summary, when a company has a significant net debt or positive cash situation: If 1 / P/E > cost of debt after tax => net debt is undervalued If 1 / P/E > return of cash after tax => net cash is undervalued If 1 / P/E < cost of debt after tax => net debt is over-valued If 1 / P/E < return of cash after tax => net cash is over-valued 11

12 Some considerations on P/E (cont d) Example: consider two companies X and Y that are active in the same business sector. Try to estimate the equity value of Y from multiples of X. Company X Company Y EBIT Financial expenses Tax (30%) = Net income 320 1,377 Equity value 4,500? Debt value 2,400 5,400 12

13 Some considerations on P/E (cont d) P/E of X = / 320 = 14x The two firms being comparable, one might be tempted to apply the P/E of X to net income of Y to obtain the equity value of Y, i.e. 14 x 1,377 = 19,280. This reasoning, apparently just is wrong! 13

14 Some considerations on P/E (cont d) Applying a P/E of 14x to net income of Y, is like applying a P/E of 14x to EBIT after tax of Y (2,246 x (1-30%) = 1,572), less a P/E of 14x applied to financial expenses after tax of Y (279 x (1-30%) = 195). Indeed, the net result is equal to EBIT after tax less net financial expenses after taxes. The first term (14 x EBIT after tax) represents the economic value of the assets of Y, i.e. 14 x 1,572 = 22,000. The second term (14 x the financial expenses after tax) should represent the value of debt and is deducted from the value of capital employed to give the equity value that we want to calculate. However, 14 x financial expenses after tax is worth 2,730, which is not the value of debt ( 5,400). 14

15 Some considerations on P/E (cont d) The correct reasoning is as follows: we use the multiple of EBIT after tax of X to value economic assets of Y. If the market capitalisation of X is 4,500 and the value of its debt is 2,400, economic assets of X = 4, ,400 = 6,900.Since the EBIT after tax of X is 581 x (1-30%) = 407, multiple of EBIT after tax of X is 6,900 / 407 = 17x. The economic assets of Y is therefore 17 times its EBIT after tax, or 17 x 1,572 = 26,720. Then when deducting the value of debt (5,400) to obtain the value of equity, we get 21,320. And this is different from the first figure calculated from 19,280! If the company has to evaluate a financial structure different from that of the sample, we must focus on the EBIT multiple instead of P/E. 15

16 Some considerations on P/E (cont d) To use the P/E wisely, one must understand the parameters that underlie it. Assuming, for simplicity, that the benefit of the company will grow at a constant rate (g), on an infinite period. The price of a stock can then be estimated by the dividend discount model with constant growth rate: t= t= 1 Div (1 + g) Div0 (1 + g = t 0 ) t ( 1 + Ke) ( Ke g) ( Ke g) Since dividend of Year1 equals EPS of Year0 payout ratio ( ) Div1 = EPS0, we can thus write: = Div 1 EPS 0 (1+g) P/E 0 = P 0 = EPS 0 K e -g EPS 0 (1+g) = Ke g 16

17 Some considerations on P/E (cont d) Even if the assumption of constant growth to infinity of the dividend is not verified, this decomposition of the P/E outlines the basic parameters of its estimation: the anticipated growth of EPS: the more it increases, the more the investor will be willing to pay the company on high multiples of its current net profit knowing that it should grow strongly in the future; perceived risk on EPS: the more EPS is volatile (low visibility), the greater the risk is and therefore the lower is the P/E; the required rate of return:the higher it is, the lower the P/E the payout ratio. The P/E is even higher than the payout is high, risk and rate of return is low and growth is strong. 17

18 MEDICA case study 4. Without redoing the calculations, look carefully at the discounted cash flows in appendix 3, taken from the four different brokers notes. Which valuation(s) seem(s) to be free from any major methodological error? What are the mistakes made by the other analysts? Why have these errors occurred? Only the DCF valuation made by the analyst 4 is correct. The analyst 1 does not discount the free cashflows at WACC but only at cost of equity (K e ) regardless of the cost of debt. He also forgets to discount the terminal value in The analyst 2 does not subtract the value of financial indebtedness and minority interests of the value of economic assets (enterprise value) to find value of equity. 18

19 MEDICA case study The analyst 3 makes a mistake in calculating free cash flows. Indeed, he wrongly includes in the free cashflows calculations, the financial expenses that should not be taken into account as the DCF method is an indirect method based primarily on the estimated present value of operating cash flows (i.e. before taking into account the financial structure). In addition, he also forgets to take into account changes in working capital that should be financed and so integrated in the calculations. 19

20 MEDICA case study 5. Select the cashflowsvaluation model that you consider to be the most relevant from appendix 3, and test the sensitivity of the value calculated to the Medica share price at: a variation of ±0.81% of the cost of capital a variation of ±0.25 % of the growth to infinity state your views. Sensitivity of share price to a change in discount rate is strong. Indeed: if WACC increases from 8.13% to 8.94% (i.e. a 10% increase), share price would decrease from 17.2 to 7.9 (-54%). If WACC decreases from 8.13% to 7.32% (i.e. a 10% decrease), share price would increase from 17.2 to 29.8 (+72%). 20

21 MEDICA case study This strong sensitivity is mainly caused by the leverage effect resulting from the high level of debt of Medica. Increase/decrease of the enterprise value are amplified by the level of debt that is fixed irrespective of the discount rate. 17, ,51% 7,32% 8,13% 8,94% 9,75% 2,00% 38,9 24,3 13,5 5,2-1,3 2,25% 42,8 26,8 15,3 6,5-0,3 2,50% 47,1 29,6 17,2 7,9 0,7 2,75% 52,0 32,8 19,3 9,4 1,8 3,00% 57,6 36,3 21,7 11,1 3,0 21

22 Medica case study 6. On the basis of the various calculations that you have made, what sort of price bracket would you suggest for the MedicaIPO in January 2010? Why? Given that the DCF leads to a value of 17.2 per share and the nearest comparable gives a valuation range of 20 to 29, a reasonable price would be around 20. In reality, analysts, with more information than given in this case, came to between 16 and MEDICA and its bankers have started to meet investors and started the process of IPO in January 2010 on that basis of price. As market conditions deteriorated during this period and to allow the company to reduce its debt through the IPO, the price was lowered to 13, two days before the end of the subscription period. If this decrease in price had not been made, the company would not have found investors willing to buy the company in the initial range. 22

23 Medica case study 7. What impact will the IPO have on Medica sbalance sheet and on its income statement? Since the IPO took place through a capital increase and not by sale of existing shares from current shareholders, the IPO will result in a decrease of financial debt by 260m and an increase of shareholders equity by the same amount. As far as the income statement is concerned, interest expenses will be lowered thanks to a lower level of debt which will enable the company to renegotiate the terms of its credit lines, allowing thus Medica to benefit from a dual effect of lowering capital costs both because of a lower base and a lesser interest rate charged. 23

24 MEDICA case study Would your answer be different if the IPO were to be carried outthrough the sale of existing shares, rather than a capital increase involving the issue of new shares? Why? If the IPO had taken place by sale of existing shares, the transaction would have been completely neutral for MEDICA, which neither the balance sheet nor the income statement would have been affected. 24

25 Case Study Medica IPO on Euronext Paris on Feb General Information Shareholders N 3 Retirement-Home Operator in France and a market leader in Italy in two sectors: nursing homes (medical/welfare sector ) - 37 convalescent and rehabilitation centres and psychiatric clinics (healthcare sector ) Key management - Chairman and CEO: Jacques Bailet - CFO: Mathieu Fabre IPO motivations - Finance Medica s growth in France and northern Italy - Deleveraging the company with pay down up to 212m of mezzanine and tranche C syndicate loans Medica bought by BC Partners mid 2006 after a dual track Shareholders pre IPO Shareholders post IPO Key financials IPO ( m) Revenue EBITDA Multiples at IPO Issuers EV / EBITDA Orpea x 13.6 Medica x10.2 Korian x9.8 IPO date: February 2010 Listing venue: Euronext Paris Market capitalization at offering: 623m (post money) EV/EBITDA 2010: 10.2x Offer price: (initial indicated price: ) Subscription: institutional placement 3x oversubscribed Capital raised: 275m and 314¹m (incl. Green shoes) 100% new money in the company (Cash in) BC Partners Share LBO ( 750m) AXA PE, BC Partners % BC Partners Exit Full exit less than 18 months after IPO IPO Market Cap: 623m Feb ABB 14.6% sold for 96m MC: 660m Mars 2011 ABB 28.1% sold for 216m MC: 770m 30.5% May 2011 <3% 0% Source: NYSE Euronext, Bloomberg, Factiva, ECM Analytics. *Forecast numbers ¹ with the exercise of the overallotment option (and after the reserved capital increase to Predica, a subsidiary of Crédit Agricole Assurances, and after the reserved offering to independent directors and after the employee offering) 25 1