DCF valuation explained using case of Walt Disney along with relative valuation using multiples

1. EQUITY VALUATION: THE WALT DISNEY
COMPANY
INVESTMENT MANAGEMENT
GROUP - 8
RUSHAB - 19DM170
HIMANSHU - 19DM240
SIDDHARTHA -19DM213
ANVI KAPOOR - 19DM043
PRASHANTH - 19DM138
KASTURI RANGA -19DM093

2. OBJECTIVE OF TECHNICAL NOTE
● GIVES VIEWPOINT AND PRACTICES OF EQUITY ANALYST
● HELPS US UNDERSTAND PROCESS OF VALUATION OF COMPANIES.
● BRIEF OVERVIEW OF DIFFERENT VALUATION METHODS.
● DEEP DIVES INTO VALUATION PROCESS TAKING WALT DISNEY AS A CASE-
STUDY.
● STATED PURPOSE IS TO MAKE A REPORT FOR STOCK MARKET INVESTORS.
● ASSUMPTIONS TAKEN ARE CLEARLY MENTIONED ALONG WITH THE
ALTERNATIVES POSSIBLE.
THIS TECHNICAL NOTE IS PREPARED BY MAX HOLVIK AND JAMES PENISTON AND PROF. MARC BADIA, FEBRUARY 2012. 2

3. ● VALUATION METHODS DEPEND ON THE PURPOSE AND THE INDUSTRY
TYPE OF THE COMPANY WE ARE VALUING.
● MOST COMMON VALUATION METHODS ARE DISCOUNTED CASH FLOWS
(DCF) AND VALUATION USING MULTIPLES.
● DIFFERENT METHOD IS USED TO VALUE DIFFERENT BUSINESS PART
BASED ON ITS NATURE AND VALUE DRIVER.
● THE CALCULATED VALUE IS COMPARED WITH PRICE ON ANY EXCHANGE
TO MAKE INVESTMENT DECISION.
● MAIN AIM IS TO BUY AN UNDERVALUED STOCK (PRICE < VALUE).
3
VALUATION METHODS

4. ● SUM-OF-PARTS VALUATION: DISNEY’S DIVERSIFIED BUSINESS LINES ARE
SPLIT INTO PARTS TO APPLY APPROPRIATE METHOD.
● FIRST WE HAVE COLLECTED HISTORICAL DATA OF LAST 10 ACCOUNTING
YEARS AND CREATE A MODEL SEPARATING 5 BUSINESS LINES. ( DISNEY
PUBLISHES ITS REPORTS SEPARATELY)
● SEGMENTATION OF BUSINESS LINES IS IMPORTANT TO DO A DETAILED
ANALYSIS.
● MEDIA NETWORKS, PARKS AND RESORTS, STUDIO ENTERTAINMENT,
CONSUMER PRODUCTS AND INTERACTIVE MEDIA ARE THE 5 LINES IN
DISNEY
4
VALUATION OF DISNEY

5. 5
STEPS IN VALUATION OF DISNEY.
2
ESTIMATING
CASH FLOWS
4
COMPARISON AND
REALITY CHECK
1
FORECASTING
EARNINGS
5
VALUATION
BASED ON
MULTIPLES
3
ESTIMATING THE
DISCOUNT RATE

6. FORECASTING EARNINGS
LOOKING FORWARD FIVE YEARS (2011-15)
6
1.

7. “AN ANALYST WOULD TYPICALLY FORECAST THE REVENUES
BASED ON GUIDANCE FROM MANAGEMENT ALONG WITH
IN-DEPTH INSIGHT INTO FIRM, PERSONAL EXPERIENCE
AND JUDGMENT, ADJUSTED FOR ANY TRENDS
/CIRCUMSTANCES THAT ANALYST CONSIDERS
IMPORTANT.
7

8. FORECASTING EARNINGS
8
● REVENUE CONSENSUS FIGURES FORECASTED BY BLOOMBERG ARE UTILISED
FOR THE PURPOSE OF THIS VALUATION.
● THESE FORECASTED REVENUES ARE USED AS A BASE FURTHER FOR
FORECASTING MANY INCOME STATEMENT ITEMS.
● COMMON SIZE INCOME STATEMENT IS PREPARED USING HISTORICAL DATA
WHICH SHOWS ALL THE ITEMS AS A PERCENT-OF-SALE.
● THREE YEAR AVERAGE PERCENTAGE IS USED AS THE ANALYST BELIEVES THIS
WILL PORTRAY THE TREND AND IMPACT OF RECENT TECHNOLOGICAL
CHANGE.
○ CORPORATE-LEVEL EXPENSES (IN ALL BUSINESS LINES).
○ OPERATING EXPENSES (EXCEPT FOR INTERACTIVE MEDIA).

9. ● INTERACTIVE MEDIA IS FAIRLY NEW LINE CURRENTLY IN LOSSES BUT THE
ANALYST EXPECTS TO SEE IMPROVED MARGINS AS BUSINESS MATURES AND
DISNEY ACHIEVES SCALABILITY.
● SO, HISTORICAL AVERAGES IS NOT A GOOD INDICATOR.WE ASSUME GRADUAL
MOVEMENT OF OPERATING MARGINS TOWARDS INDUSTRY AVERAGE OF 10.6%
BY 2015.
● CHANGES OVER TIME DUE TO CYCLES AND TRENDS ARE CRUCIAL AND ANALYST
MUST USE HIS/HER BEST JUDGEMENT IN FORECASTING.
● NON-RECURRING ITEMS ARE TREATED AS ONE TIME AND WE WILL FORECAST
THEM AS ZERO UNLESS WE KNOW THAT RECURS.
● INTEREST EXPENSES ARE TAKEN AS A PERCENT-OF-SALES.
● TAX IS TAKEN AS 35% SIMILAR TO WHAT IS BEING PAID IN PREVIOUS YEARS.
FORECASTING EARNINGS
9

10. ESTIMATING CASH FLOWS
LOOKING FORWARD FIVE YEARS (2011-15)
10
2.

11. “WE CAN EITHER DIRECTLY DISCOUNT FUTURE CASH FLOWS
AVAILABLE TO SHAREHOLDERS i.e. AFTER PAYING OF DEBT AND
INTEREST ON DEBT OR DISCOUNT THE THE CASH FLOWS FOR
ENTERPRISE (DEBT+EQUITY) AND SUBTRACT VALUE OF DEBT TO
ARRIVE AT VALUE OF EQUITY i.e. DISCOUNTING OF FREE CASH
FLOWS (FCFs). LATER IS USED IN THIS NOTE.
11

12. ● FUTURE CASH FLOWS (FCF) ARE CALCULATED ADJUSTING THE OPERATING
PROFIT (EBIT) FOR TAXES, DEPRECIATION AND AMORTIZATION, INCREASE IN
WORKING CAPITAL REQUIREMENTS (WCR) AND CAPITAL EXPENDITURE (CAPEX).
FCF = [EBIT*(1-TAX-RATE)]+DEPRECIATION AND AMORTIZATION+EFFECT OF WCR-
CAPEX
● DEPRECIATION IS A FUNCTION OF FIRM’S CAPEX - IT IS ESTIMATED AS A
AVERAGE RATIO OF DEPRECIATION-TO-CAPEX.
● WCR ARE ESTIMATED BASED ON THREE YEARS AVERAGE RATIO TO SALES -
HIGHER ARE THE SALES THE MORE WILL BE REQUIREMENT OF WC.
● CAPEX IS CALCULATED AS THREE YEARS AVERAGE OF CAPEX-SALES SAME AS
WCR. ANALYST MAY TRY TO FORECAST ACTUAL FUTURE INVESTMENTS WITH IN-
DEPTH ANALYSIS CONSIDERING MANAGEMENTS FUTURE INTENTIONS.
ESTIMATING CASH FLOWS
12

13. ESTIMATING DISCOUNT RATE
USING WEIGHTED AVERAGE COST OF CAPITAL (WACC)
13
3.

14. “
DISCOUNT/HURDLE/REQUIRED RATE IS USED TO DISCOUNT THE
CALCULATED FUTURE CASH FLOWS TO ARRIVE AT THE PRESENT
VALUE CONSIDERING THE OPPORTUNITY COST OF INVESTING IN
AN EQUALLY RISKY ASSET.
14

15. ● CAPITAL ASSETS PRICING MODEL (CAPM) IS WIDELY USED METHOD BY
ANALYSTS TO ARRIVE AT THE DISCOUNTING RATE (Re) FOR EQUITY.
● IT USES THREE INPUTS - RISK-FREE RATE (Rf), RISK PREMIUM (Rp) AND BETA
(β)
Re = Rf+β*Rp
● RISK-FREE RATE IS TAKEN AS AVERAGE OF 10-YEAR U.S. TREASURY BOND.
● BETA IS MEASURE OF HOW RETURNS OF COMPANY VARY WITH THOSE OF
MARKET.
● RISK PREMIUM(Rp) IS THE AVERAGE HISTORICAL PREMIUM (Rm) OF MARKET
RETURN OVER RISK-FREE RATE (Rf) - TAKEN AS 5.5% WHICH IS COMMON
AMONG ANALYSTS.
ESTIMATING DISCOUNT RATE
15

16. ● Re GIVES US THE DISCOUNTING RATE FOR EQUITY.
● FURTHER WE CALCULATE REQUIRED RATE FOR DEBT (Rd) - INTEREST EXPENSES
AFTER TAX AS A PERCENT OF TOTAL BORROWED FUNDS IN RECENT YEAR.
● THE WEIGHTED AVERAGE OF THESE TWO RATES CALCULATED FOR DEBT AND
EQUITY BECOMES OUR DISCOUNT RATE.
● WEIGHTS BEING THE AMOUNT OF FUNDS RAISED USING EQUITY AND DEBT.
WACC = [(D/D+E)*Rd]+[(E/D+E)*Re]
Where; D- TOTAL DEBT
E- TOTAL EQUITY
ESTIMATING DISCOUNT RATE
16

17. ● TERMINAL VALUE (TV) - THE ABOVE CALCULATED Re GIVES THE DISCOUNTED
CASH FLOWS TILL 2015 BUT THE VALUE OF BUSINESS FROM 2015 IS ALSO TO
BE BROUGHT TO PRESENT VALUE AND ADDED TO Re.
● TV IS CALCULATED USING GORDON GROWTH MODEL ASSUMING A CONSTANT
GROWTH RATE (g) OF 1.5% AND APPLYING WACC AS RATE (r)
TV = C/(r-g)
● “C” IS THE CASH FLOWS EXPECTED FOR ONE YEAR WHICH IS TAKEN AS RECENT
CASH FLOWS i.e. CASH FLOW IN 2015.
● ALTERNATIVELY, AVERAGE OF EV/EBITDA OF COMPANY CAN BE MULTIPLIED
WITH EBITDA TO ARRIVE AT TV INSTEAD OF GORDON MODEL.
ESTIMATING DISCOUNT RATE
17

18. “
FINALLY, ADDING DISCOUNTED CASH FLOWS AND TERMINAL
VALUE (TV) THEN SUBTRACTING NET DEBT WE ARRIVE AT
ESTIMATED EQUITY VALUE OF DISNEY. ASSUMED THAT DEBT OF
DISNEY WILL APPROACH 30% OF ENTERPRISE VALUE BY 2015.
18

19. COMPARISON AND REALITY CHECK
19
4.

20. COMPARISON AND REALITY CHECK
20
● IN THIS THE VALUE OF DISNEY CALCULATED IS TURNED INTO A MULTIPLE -
PRICE/EARNINGS OR ENTERPRISE VALUE/EBITDA.
● THESE MULTIPLES CAN BE COMPARED WITH THOSE AVAILABLE FOR INDUSTRY
OR MARKET. ANY SIGNIFICANT VARIATIONS FOUND SHOULD BE BACKED BY
ANALYSTS.
● ANALYSTS CAN ALSO USE DCF TO DO A SENSITIVITY ANALYSIS OF ESTIMATED
SHARE PRICE FOR DIFFERENT DISCOUNTING RATES AND PERPETUAL GROWTH
RATES.

21. VALUATION BASED ON MULTIPLES
21
5.

22. ● IN THIS STEP RELATIVE VALUATION IS DONE USING VARIOUS MULTIPLES OF
SIMILAR FIRMS.
● IN THIS THE ANALYST HAS COMPARED WITH AVERAGE OF THREE OTHER
COMPANIES MULTIPLES TO ARRIVE AT PRICE OF DISNEY
● FIVE MULTIPLES - PRICE/EARNINGS, PRICE/BOOK VALUE, PRICE/SALES,
PRICE/FCF AND EV/EBITDA.
● ALL THE MULTIPLES SHOWED A RANGE FALLING AROUND THE DCF VALUATION.
VALUATION BASED ON MULTIPLES
22

23. ● HOWEVER BEING WIDELY USED METHOD DCF ANALYSTS SHOULD ALSO BE
AWARE OF ITS LIMITATIONS.
● ONE MAJOR LIMITATION BEING HIGHLY SUSCEPTIBLE TO CHANGES IN
ASSUMPTIONS AND FORECASTS MADE.
● THE CHANGES IN ASSUMPTIONS CAN HAVE MAJOR IMPACT ON THE PRESENT
VALUE OR INTRINSIC VALUE THUS ASCERTAINED BY THE ANALYST.
● THE ANALYST MUST HAVE A SOLID UNDERSTANDING OF ASSUMPTIONS MADE
● THERE IS NO ULTIMATE ANSWER AS SUCH AND ANALYST SHOULD BE INTUITIVE
AND ADAPTIVE IN ARRIVING AT THE SHARE PRICE BASED ON THEIR BEST
JUDGEMENTS.
CONCLUSION
23

24. Any questions!
24
THANKS!