Opel/Vauxhall Automotive: A Back-ofthe-Envelope

Transcription

1 Opel/Vauxhall Automotive: A Back-ofthe-Envelope Valuation Ralf Hafner, HTW Berlin 1 Input Data and Assumptions This is what I draw for the automotive business from the 8-K filed by GM 1, the GM Investor Presentation 2 and GM s latest 10-K 3 : 17.7 billion sales in billion operating loss in billion expected synergies from purchasing, manufacturing and research & development to be realized by 2026, leading to an operating margin of 6% in 2026 and 2% in Positive cash flow 4 by 2020, which I will interpret as just about break even. Purchase price of 1.1 billion. No interest-bearing debt assumed by the acquirer. Let s look at this through the eyes of the acquirer. To derive a time line of future free cash flows, I will make the following assumptions: The EBIT margins for the years between 2016 and 2020 as well as 2020 and 2026 can be projected by a linear interpolation. The tax rate is 25%. 5 If I trust the 1.7 billion synergies, EBIT 2026 should be 1.2 billion ( 0.5 billion negative EBIT in 2016 plus 1.7 billion synergies). At an operating margin of 6%, sales 2026 must be 20 billion in 2026 to get to 1.2 billion EBIT. This translates into a compound annual growth rate of 1.23%. Setting the free cash flow in 2020 to zero, I back out 279 million net reinvestment in 2020, corresponding to 1.5% of sales. I will use this percentage rate for all other years. 1 Available here: Go for the March 6, 2017, document. 2 Available here: Click on Chart Set Download at the top on the right. 3 /10-K.pdf. 4 As defined in footnote 4 on page 2 of the 8-K it appears to be close to the free cash flow definition we use in DCF valuations, but before taxes. 5 The marginal tax rate for Germany is about 30%, for the United Kingdom it is 20%. 1

2 The following table summarizes the assumptions and shows the calculation of future free cash flows to the firm (FCFF) until 2026: 2 Consistency Checks The sales growth rate of 1.23% is reasonable to me. European car sales are expected to be flat, and Opel/Vauxhall is certainly not the frontrunner in potential disruptive industry trends. Taken into consideration the recent developments of sales (flat in 2016 compared to 2015, minus 15% in 2015 compared to 2014) at the company, the forecast is certainly not pessimistic. An operating margin of 6% as a target is also realistic. You can check peers on databases or on the web, and if you disagree with the assumptions, please feel free to run your own valuation with your numbers. 2

3 Since this is a company in a turnaround situation, I estimate the reinvestment as a percentage of sales and not as a percentage of the after-tax operating income. The rate I back out of the 2020 figures based on the announcement that in this year there will be a positive cash flow, is 1.5%. This is also in line with what you find as industry averages. 6 Finally, we should look at the relation between EBIT growth, reinvestment rate and ROC: If this company would not be in a turnaround situation, we would have to adjust here as the implied return on capital is a bit far off from industry averages. But for a restructuring to be successful, this is what must be achieved. Nevertheless, this is where I as an outsider lack most information there could be large investments necessary to achieve the 6% operating margin by Everyone with some practical experience knows how hard this it is to get there from minus 3%. However, I trust the statement that the cash flow will be positive from 2020 onwards and the definition provided for the cash flow. For the perpetuity, I will assume that the company will earn its cost of capital on the reinvestments made, so that the reinvestment rate will not affect the terminal value. At a discount rate (weighted average cost of capital, WACC) of 5.7%, this is what I get for the perpetuity: 6 See for example Damodaran s files margineurope, capexeurope and fundgrebeurope, providing industry averages of 7.28% for the operating margin, 1.57% for net capital expenditures as a percentage of sales and 41.28% for reinvestments as a percentage of after-tax operating income, i.e. the reinvestment rate, see 3

4 3 DCF Valuation If the projections we made come true, this will certainly be a nice company in 2026, no matter what discount rate we agree upon. But let s have a look at what we get in a DCF valuation. We have the free cash flows. The transaction is expected to close by the end of 2017, so we will take this as t=0, i.e. relevant are all free cash flows starting from 2018 onwards. The transaction was announced in early March 2017 and I will use the information available at that time on risk-free rates and equity risk premiums. As we perform the analysis in Euros, we need a Euro risk-free rate. At the beginning of March 2017, the 10-year yield of German government bonds was 0.3%. 7 For the equity risk premium, I will use 6%. Most of the sales are in Germany and in the United Kingdom, so that country risk premiums will not be a major issue here. I will further assume that the company will be fully equity-financed. This is probably realistic as of today, given the negative operating margin. For 2026, you may argue that the company should and would have debt, leading to a lower cost of capital. However, since this is supposed to be a back-of-the-envelope valuation, I will stay with my assumption of zero debt and instead of elaborating on the proper mix of debt and equity, the correct perpetuity growth rate and a potential differentiation between 7 Kapitalmaerkte/Zinssaetze_Renditen/stat_urendite_wpart.pdf? blob=publicationfile. 4

5 the WACC for the detailed planning period and the WACC for the perpetuity, I will run a sensitivity analysis varying the discount rate. For the beta, I will work with an unlevered beta of 0.9 based on industry averages. 8 This is the result: And this the sensitivity analysis: Compared to the purchase price of 1.1 billion, this appears to be a good deal for the buyer, if the future free cash flows will come as projected. The largest part of the enterprise value though comes from the terminal value. Whether the management will be able to turn this into a business generating an operating margin of 6% by 2026 is the decisive question. Given the long history of losses the GM Investor Presentation shows negative EBIT figures back to the year 2000, a failure can t be excluded. There is a probability of default that must be factored in. I will do this via a scenario analysis. 8 See for example the file betaeurope on Damodaran s website (for the link please see footnote 6). 5

6 4 Scenario Analysis I will look at two scenarios: [1] Failure by 2022, where I assume that the free cash flow of minus 487 million projected for 2017 will remain stable with additional costs of winding down the operation in 2022 of 2 billion. 9 [2] 3% operating margin by 2026 instead of the 6% announced in the media. This is what I get for the first alternative scenario: Bottom line, I see a risk of up to roughly 5 billion (negative enterprise value plus purchase price paid) in case this does not work out for the buyer. In the second alternative scenario, the long and winding road to a below industry-average operating margin, the cash flow break-even will be postponed until I kept the sales as in the base case scenario. If you disagree, please feel free to change them. The enterprise value I get at a discount rate of 5.70% is 3.5 billion and well above the 1.1 billion purchase price. As the discount rate approaches 8.5%, the net present value of the project acquisition of the Opel/Vauxhall automotive business will approach zero. Bottom line, even in this suboptimal scenario, there is only a limited probability to destroy shareholder value. 9 40,000 50,000; sale of assets will cover any additional costs (I know it s a rough estimate use your own guess in case you are uncomfortable with it). 6

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8 5 Conclusion I will leave it up to you to assign probabilities to the three scenarios. Peugeot s management demonstrated in the recent past that it does have the ability to successfully restructure automotive operations. Let s wish them luck! If they come close to the 6% by 2026, this will be a transaction that generates shareholder value. Even if they only achieve an operating margin of 3%, they will not destroy shareholder value. But there is a probability that they will fail the Western European automotive market is tough. My opinion based on the analysis is that opportunities outweigh risks in this transaction. Looking at this transaction through the eyes of the seller is much easier, at least for me. If you have a history of almost 20 years of operating losses, it s time to realize that you are not the right owner of this business. Any consideration that you will receive for the business should create value for your shareholders. This could be a deal that makes sense to both the buyer and the seller. 8