PBP; Xiang Yang

0
7240AFE Advanced Corporate Finance
[This report represents the results,
findings and recommendations of the
analysis conducted using historical
data and annual reports of Probiotec
Ltd from year 2009 to 2013]
Consultant
Project
Probiotec Limited
Xiang Yang S2873075

7240AFE Consultant Project – Probiotec Limited
EXECUTIVE SUMMERY
In this consultant project, Probiotec Limited (PBP.AX)’s historical data and annual reports (from
2009 to 2013) will be analysed to provide shareholders and company’s governing body an insight of
Probiotec Limited’s corporate governance, operating performance, and business practises. Also,
recommendations will be presented at the end of this report, in order to improve company’s
performances in different aspects under current financial and market situation.
This report is separated into 3 parts. In the first part, Probiotec’s corporate governance will be
reviewed to ensure that management’s decision making and business practices are acted in the
shareholders’ best interest and within the code of conduct. Further, the Probiotec’s operating
performance will be analysed through company’s accounting performance, market performance,
investment decision, financial decision and dividend decision. The valuation and risk management for
Probiotec will be precisely performed in this part as well. In the last part of this report, appropriate
recommendations will be provided based on the calculation and analysis above.
As the summary provided below, it briefly presents the major issues of Probiotec, which will be
analysed in this report:
1. Corporate governance review, mainly focus on the changes of director’s remuneration related
to the changes of company’s return on equity (ROE);
2. Over expansion of its business into multiple offshore destination simultaneously;
3. Sluggish international retail economy and slow domestic retail environment;
4. Lack of risk management (hedging policy) regarding to the rapid increase in the value of
Australian dollar;
5. Significant decreases in Company’s liquidity.
Depend on the issues above, several recommendations for the purpose of improving Probiotec’s
business practices are summarised as below:
1. Decrease its debt to equity ratio from 61.93% to 40%;
2. Restructure the company by selling some parts of its oversea assets (non-profitable Plants and
Sales Companies), and some brands (bearing losses) as well;
3. Improve the performances in Nutritional products segment, or abandon it;
4. Introduce hedging policy to company to avoid the risks of the increases in interest rates and
dramatic changes in currency exchange rates.

As consequence of following above suggestions, it is reasonable to expect that Probiotec Limited may
still be able to turn its business loss to profit, and return its profitability to previous level in 2009.

Content
INTRODUCTION....................................................................................................................1
CORPORATE GOVERNANCE............................................................................................2
Organizational Structure..................................................................................................................2
Mission Statement............................................................................................................................2
New Share Issues.............................................................................................................................2
Directors’ Remuneration..................................................................................................................3
ACCOUNTING PERFORMANCE........................................................................................4
Du-Pont Model Analysis..................................................................................................................4
Major Financial Ratio Analysis........................................................................................................5
Segment Report........................................................................................................................6
Geographic Segment........................................................................................................................6
Business Product Segment...............................................................................................................6
MARKET PERFORMANCE.................................................................................................8
INVESTMENT DECISION..................................................................................................11
FINANCING DECISION......................................................................................................12
DIVIDEND DECISION.........................................................................................................13
Free Cash Flow Analysis................................................................................................................13
Operating activities........................................................................................................................13
Investing activities..........................................................................................................................14
VALUATION.........................................................................................................................15
Discounted cash flow approach (DCF)..........................................................................................15
P/E ratio approach..........................................................................................................................16
MERGERS AND ACQUISITIONS.....................................................................................17
RISK MANAGEMENT.........................................................................................................18
Market risk (Foreign exchange risk)..............................................................................................18
Market risk (Interest risk)...............................................................................................................18
Liquidity risk..................................................................................................................................19
Credit risk.......................................................................................................................................20
RECOMMENDATION.........................................................................................................21
REFERENCE.........................................................................................................................22

7240AFE Consultant Project – Probiotec Limited Page 1
INTRODUCTION
Probiotec Limited (PBP.AX) is a leading emerging pharmaceutical company listed on Australian
Stock Exchange (ASX). It mainly focuses on developing, manufacturing, and selling pharmaceuticals,
foods, and nutraceutical products in Australia and other countries, such as New Zealand, Europe, and
China. There are five segments in Probiotec Limited, include Branded Pharmaceuticals, Contract
Manufacture, Weight Loss and Sports Nutrition, Europe, and Specialty Products. It provides owned
and licensed branded prescription and over-the-counter pharmaceutical products,
complementary medicines, and specialty ingredients (Yahoo Finance, 2014). The company is
also involved in the contract manufacturing of pharmaceutical, food, and animal nutrition
products for pharmaceutical and food companies; manufacture and sale of a range of weight
loss and sports nutrition products in various channels, including FMCG, pharmacy, health
food stores, and online; and provision of Celebrity Slim and Impromy weight loss programs.
In addition, it sells human and animal nutrition products, incorporating the sale of ingredients
and additives for use in the pharmaceutical and food industries (Probiotec Limited, 2013).
In this report, the Probiotec Limited’s corporate governance, accounting performance, market
performance will be analysed in details. Further, the decisions made in investments, finances, and
dividends will be discussed as well. Finally, based on the analyses of company’s valuation, mergers
and acquisitions, and risk management, several appropriate recommendations will be provided at the
end of this report.

CORPORATE GOVERNANCE
Organizational Structure
As the main governing body of Probiotec, board of directors has responsibilities to monitor, review
and improve company’s corporate governance in a high standard. Relied on Commonwealth
Government’s CLERP 9 legislation and the Australian Standard AS8000 Good Governance Principles,
board of directors in Probiotec Limited is responsible for the best interests of stakeholders, and must
fully comply with the principles, practices and legal requirements (Probiotec Limited, 2013).
According to Probiotec Limited’s annual report in 2013, the board’s responsibilities are summarised
as:
• “providing strategic direction and approving corporate strategic initiatives;
• selecting and evaluating future Directors, the Chief Executive Officer (‘CEO’) and the Chief
Financial Officer (‘CFO’);
• planning for Board and executive succession;
• setting CEO and Directors’ remuneration within shareholder approved limits;
• approving Probiotec’s budget and monitoring management and financial performance;
• considering and approving Probiotec’s Annual Financial Report and the interim and final financial
statements;
• approving Probiotec’s risk management strategy, monitoring its effectiveness and maintaining a
direct and ongoing dialogue with Probiotec’s auditors and regulators; and
• considering and reviewing the social and ethical impact of Probiotec’s activities, setting standards
for social and ethical practices and monitoring compliance with Probiotec’s social responsibility
policies and practices” (Probiotec Limited, 2013)
Mission Statement
Probiotec’s mission stated in annual reports is to create long-term shareholder value by:
• “leading in the innovative development of consumer health products;
• growing revenues while improving margins; and
• increasing distribution levels in both domestic and international markets” (Probiotec Limited, 2009).
NewShare Issues
Probiotec issued 4,533,403 new shares in 2010. Then, 1,587,272 and 37,866 new shares were issued
over the next two years, respectively. Compared with its most similar peer company - Vita Life
Sciences Ltd (VSC.AX), Probiotec issued much more shares in 2010 than Vita Life Sciences did.
Even though Vita Life Sciences issues 3,559,753 shares in 2011, which are more than double of
shares issued by Probiotec, VSC repurchased almost half of the shares issued in 2011, during the next
two years. However, based on the great performance in 2009, Probiotec planned to expand its

business in offshore markets rapidly in 2010. Thus, Probiotec issued a large number of shares
(4,533,403 in 2011) to raise more than 11 million and did not buyback any shares during the next 3
years,in order to support its expansions in Europe and Asia markets.
Share outstanding 2013 2012 2011 2010
PBP.AX 0 37,866 1,587,272 4,533,403
VSC.AX -223,988 -1,370,422 3,559,753 0
Directors’ Remuneration
2013 2012 2011 2010 2009 VSC (2013)
Total Directors
Remunerations 1,475,514 1,487,875 1,424,003 1,491,338 875,970 215,627
Sales 67,342,884 66,046,188 71,770,144 74,842,141 87,133,035 35,411,000
Directors
Remuneration /
Sales (%) 2.19% 2.25% 1.98% 1.99% 1.01% 0.61%
Directors
Remuneration /
Total assets
(%) 1.34% 1.47% 1.34% 1.18% 0.86% 0.98%
ROE 1.70% 2.51% -1.98% 10.69% 16.13% 23.73%
As clearly showed in the table above, Probiotec Limited’s percentage of directors remuneration over
sales was almost doubled to 1.99% in 2010 (1.01% in 2009). Then, this percentage further grew to
peak at 2.25% in 2012 while its return on equity (ROE) kept dropping continuously from 16.13% in
2009 to -1.98% in 2011, 2.51% in 2012, and 1.70% in 2013. Although the annual reports of Probiotec
Limited clearly states that “The Remuneration and Nominations Committee has structured the
Group’s executive remuneration policies to ensure:
• the policy motivates executives to pursue the long term growth and success of Probiotec within an
appropriate control framework;
• the policy demonstrates a clear relationship between individual performance and remuneration; and
• the policy involves an appropriate balance between fixed and variable remuneration, reflecting the
short and long term performance objectives appropriate to Probiotec’s circumstances and goals”
(Probiotec Limited, 2011), the directors’ remunerations still unreasonably rose while Probiotec
Limited made a loss of $11,303,166 in 2011. Compared to its competitor (VSC), the percentage of
directors remuneration over sales in Probiotec Limited (2.19%) in 2013 is more than triple of the

percentage in VSC (0.61%). Consequently, the increases in the director remuneration indicate that the
management of Probiotec did not act in accordance with the guidelines stated in the annual reports. A
potential agency cost was created against its shareholders’ interests.

ACCOUNTING PERFORMANCE
On the perspective of accounting performance, both of company’s return on equity (ROE) and return
on asset (ROA) decreased dramatically during last 5 years and reached the bottom at -1.98% and 0.36%
respectively in 2011. Compared to its peer company, the ROE (1.70%) and ROA (2.00%) of
Probiotec are much lower than the percentages in VSC (23.73% and 17.53%, respectively). It clearly
indicates that Probiotec Limited’s resources were failed to be allocated during these periods, which
leaded to a lower income generated from its investments.
Du-Pont Model Analysis
Year ROE ROA PM AT EM
2009 16.13% 9.67% 9.68% 0.85 1.96
2010 10.69% 7.21% 10.49% 0.59 1.92
2011 -1.98% 0.36% -1.69% 0.67 1.74
2012 2.51% 2.94% 2.37% 0.65 1.62
2013 1.70% 2.00% 1.61% 0.61 1.73
5-year Average 5.81% 4.43% 4.49% 0.67 1.79
VSC (2013) 23.73% 17.53% 10.90% 1.61 1.35
As illustrated in the table above, by using Du-Pont Model, ROE can be broken down into three
components: profit margin, asset turnover, and equity multiplier. Firstly, the profit margin (PM)
presents the profits generated by the company out of its revenue. Probiotec’s profit margin after a
slight increase in 2010, this figure jumped from 10.49% to -1.69% in 2011. Then, it returned to
positive at 2.37% in 2012 and 1.61% in 2013. Compared to VSC’s profit margin (10.90%) in 2013, it
indicates that the worse profitability of Probiotec after 2010. Company can only generate very limited
return related to its sales due to the dramatic strengthening in Australian dollar.
Further, asset turnover represents (AT) whether the company effectively uses its assets or not. As can
be seen from the table, Probiotec’s asset turnover dropped from 0.85 in 2009 to 0.61 in 2013 (0.67 for
5-year average), which is much lower than the figure in VSC (1.61 in 2013). It is obviously that
Probiotec Limited’s performance on sales for every unit of assets owned was much poorer than its
peer company, under a sluggish domestic and global retail environment.
In the equity multiplier (EM), it is used to measure the level of leverage used by the company.
Probiotec reduced its leverage from 1.96 in 2009 to 1.62 in 2012. However, its equity multiplier (1.79)
is still much higher than VSC’s (1.35) in 2013. The higher leverage indicates that the company is
more risky and less future financial flexibility than its competitor, and also brought more pressure to

company and its management while the more expensive interest payments and greater returns were
requested by shareholders for bearing extra risks.
Major Financial Ratio Analysis
Year Current
Ratio
Days A/R Days Inventory Days A/P Required
Financing
Period
2011 0.67 56.62 179.88 110.34 126.16
2012 0.71 51.66 144.18 107.57 88.28
2013 0.64 53.32 131.35 114.67 99.21
In order to maintain adequate cash flows for company’s normal operations, company had better
shorten the days for collecting account receivables and delay the account payables. In the table above,
Probiotec’s days account receivable slightly decreased from to 56.62 days in 2011 to 51.66 days in
2012 based on the recovery of global economy after the influences of global financial crisis. With the
same reason, the days inventory dropped from 179.88 days in 2011 to 144.18 days in 2012 and further
reduced to 131.35 days in 2013. As stated in Probiotec’s annual report 2013, under the unexpectedly
difficult economic situations, the days account receivable rose again, to 53.32 days. However,
fortunately, most of the suppliers extended the due dates, in order to avoid bad debts being written off
from books, the days account payable increased to 114.67 days, which gave Probiotec more days to
maintain adequate cash flows for its business operations. Consequently, Probiotec’s required
financing period reduced from 126.16 days in 2011 to 99.21 days in 2013, which implies that
company’s cash management is essential especially with the global economic downturn.

Segment Report
Geographic Segment
Geographic
Segment
Australia NewZealand Europe America Others
Sales 61,634,728 1,396,592 5,696,227 68,454 785,960
Sales
percentage 88.58% 2.01% 8.19% 0.10% 1.13%
As illustrated in the table above, due to the dramatic increases in the value of Australian dollar against
the other currencies, Probiotec restructured its export activities by selling some non-profitable entities
in Asia, America, and other countries, all the sales in these countries reduced or eliminated during the
fiscal year 2013. After the disposals in offshore markets, Probiotec’s sales now mainly depended on
the performances in domestic markets, which contributed 88.58% of the company’s total sales in 2013.
Moreover, the Probiotec also continuously focused on the manufacturing and distribution business in
the United Kingdom and Ireland (8.19% of total sales). These retreats from offshore markets reduced
the risks of rapid changes in currency exchange rates by compromising Probiotec’s capabilities of
diversifying the risks of the recession in domestic market and retail environment.
Business Product Segment
Business segment Pharmaceuticals
and consumer
health
Contract
manufacturing
Nutritional
products
Export sales
Sales 35,445,162 23,729,543 3,275,289 7,131,966
Sales Percentage
50.94% 34.10% 4.71% 10.25%
EBIT, operating
P/L 6,067,092 2,977,244 -455,756 202,711
Profit Margin, PM
11.98% 8.78% -9.74% 1.99%
Probiotec’s business can be separate into 4 segments: pharmaceuticals and consumer health, contract
manufacturing, nutritional products, and export sales. As the highest profit margin segment (11.98%),
pharmaceuticals and consumer health products contributed more than half of Probiotec’s sales and
EBIT in 2013, around $35,445,162 and $6,067,092, respectively. However, due to the recession of
economic conditions in the domestic retail environment, and poor performance in the cost control of
weight management products, the profit margin in this segment dropped more than 7%, from 19.02%

in 2012 to 11.98% in 2013. On the contrary, the revenue from contract manufacturing segment
increased from $17,514,134 in 2012 to $23,729,543 in 2013. The profit from this segment rose almost
1 million while the profit margin reduced around 3% over the fiscal year 2013. It is the result of
transferring group’s Biosource brand from Pharmaceuticals to contract manufacturing segment during
the year. Moreover, due to the selling of some non-profitable brands, Nutritional products segment
experienced a loss from discontinued operations, around $455,756. In the export sales segment, as a
result of restructuring its export activities, such as the closure of loss making entities in offshore
market, both the profit and profit margin recovered while the sales decreased slightly in 2013. In
addition, the profitability of all segments mentioned above was also largely influenced by the strength
of the Australian dollar against both the Euro and Great Britain pound (Probiotec Limited, 2013).

MARKET PERFORMANCE
In the market performance, in 2009, based on the great performance in sales, Probiotec’s annual
revenue grew 31.9% to $87.13 million while the profit before tax rose 41.8% to $12.05 million.
Probiotec Limited’s stock price increased significantly from around $1.50 per share to more than
$2.70 per share.
Afterwards, Probiotec Limited brought out its aggressive worldwide expanding plans in fiscal year
2010. It started to increase distribution and sales through Europe and Asia, and leverage its
manufacturing capabilities. Probiotec raised 3 million from debts and more than 21 million from new
shares to acquire brands, manufacturing plants and sales companies globally. After the new company
strategies announced, the share price of Probiotec Limited jumped significantly to $1.60 per share in
April 2010. Then, this figure further dropped around $1 per share to $0.6 per share after the annual
report for fiscal year 2010 published.
As can be seen from the graph below, the historical share price of its peer company - Vita Life
Science (yellow line) will be used to compare with the share price of Probiotec (blue line) while the
SP & ASX 200 (red line) is set as the benchmark.
In fiscal year 2011, the Probiotec’s share price experienced a great decrease. This drop can be
attributed to three reasons:

1. “Probiotec Limited’s expansion of its business into multiple offshore markets simultaneously;
2. Those expansion made at the time of a rapid increase in the value of Australian dollar against
the other currencies;
3. The international retail economy was sluggish at that moment” (Probiotec Limited, 2011).
With the rapid increase in Australian dollar, Probiotec’s export costs increased as well. At the same
time, the sluggish international retail economy further brought Probiotec’s profits down in 2011.

INVESTMENT DECISION
During these 5 year period, Probiotec’s beta (β) can be calculated at 0.57, which indicates that
Probiotec’s share price is not sensitive to fluctuations in the market. The correlation between
Probiotec and ASX 200 is low.
Jenson’s Alpha (α) = -0.06
At the given level of risk, the Jensen Alpha (α) of Probiotec can be computed at -0.06, which indicates
the market performance of Probiotec is worse than the expectations. The actual performance of
Probiotec’s stock over the past five years was 6%, well below the expected market return.
CAPM (Ke) = Rf+ β [Rf + E(Rm)] = 8.80% (based on the data of the last 5 years)
Applying the Capital Asset Pricing Model (CAPM), the expected annual returns (Ke) of Probiotec can
be calculated at 8.80%. However, the actual 5 year average annual return was -0.3%, which was much
lower than the expected return. The R-Squared (R²) of Probiotec was 0.026, which indicates only 2.6%
of the risk in Probiotec was from market sources.
In the economic value added (EVA), after the great performance in 2009, Probiotec’s profits declined
materially and slightly recovered during the past 5 years. As showed in the table below, the economic
value added decreased significantly in 2010. Then, it further dropped to a negative $4,027,909 in 2011,
which presents both the company and shareholders suffered a loss during that year. After the disposals
of non-profitable offshore entities, the economic value added recovered around 2.5 million, but
remained negative $1,509,729 in 2012. However, the figure went down again to $-2,495,060 in 2013,
due to the losses from disposals, and the worse domestic and global retail environment which brought
the profits down during those periods.
EVA (Economic Value Added)
30/06/2009 30/06/2010 30/06/2011 30/06/2012 30/06/2013
4,564,457 2,528,655 -4,027,909 -1,509,729 -2,495,060

FINANCING DECISION
Probiotec
Limited
Interest Coverage Rating Interest rate
Low High
1.94 1.75 1.999999 B+ 7.00%
Based on the great performance in 2009, Probiotec raised large amount of money from new debts and
issuing new shares in 2010, in order to expand in offshore markets. According to the credit rating
issued by Standard & Poor’s,the increases in Probiotec’s leverage lifted its cost of debt as showed
above. The interest coverage ratio of Probiotec was 1.94, which indicates the credit rating should be
B+. According to the coverage ratio, the current credit rating was the same as the current official
rating. Therefore,its debt financing costs exactly equal to the amounts stated.
Current Optimal Change
D/(D+E) Ratio 61.93% 40.00% -21.93%
Beta for the Stock 0.57 0.39 -0.18
Cost ofEquity 8.80% 7.45% -1.35%
AT Interest Rate on Debt 4.90% 4.03% -0.88%
WACC 6.39% 6.08% -0.31%
Implied Growth Rate 4.50%
Market Value ofFirm (C) $43,098,115 $45,262,967 $2,164,851
Market Price/share (C) $0.31 $0.35 $0.04
*Firm Value (C): No growth in savings.New Firm Value=Current Firm value +{(WACC(current)-New
WACC)*Current firm value/New WACC}
As the results of calculation above, the current capital structure of Probiotec maximises neither the
value of the firm nor the share price. Also, it did not minimise the cost of equity and interest rate on
debt. In order to achieve the optimal financial mix, Probiotec should pay off the debt raised in 2010
for the purposes of acquisition and expansion in offshore market. This movement will decrease its
debt ratio from 61.93% to 40%, and also increase the firm’s value by $2,164,851 and share price by
$0.04 per share. With the lower debt ratio, the beta of Probiotec will be improved by 0.18 to 0.39.
Consequently, both the cost of equity and interest rate on debt will go down by 1.35% and 0.88%,
respectively. After this restructure, the interest expense will be reduced, which leads to a potential
greater profitability of Probiotec. In addition, more financial flexibilities will be gained from this
restructure for Probiotec’s future investments.

DIVIDEND DECISION
Free Cash FlowAnalysis
Free Cash Flow
Analysis
2013 2012 2011 2010 2009
EBIT 3,143,002 4,249,601 540,510 12,995,677 14,126,398
NOPAT 2,200,101 2,974,721 378,357 9,096,974 9,888,479
%CH-NOPAT -26.04% 686.22% -95.84% -8.00% -
Operating capital
(OC) 71,407,706 68,203,044 67,013,964 99,896,162 80,971,909
%CH-OC 4.70% 1.77% -32.92% 23.37% -
NOWC -13,701,395 -9,578,658 -13,130,814 11,355,053 13,613,167
Non-cash working
capital -13,747,512 -9,772,046 -14,068,921 8,538,638 11,939,771
Change in Non-
cash Working
Capital (DNWC) -3,975,466 4,296,875 -22,607,559 -3,401,133 -
Net fixed assets 85,109,101 77,781,702 80,144,778 88,541,109 67,358,742
FCFE 2,441,235 -7,863,642 20,887,903 14,217,831 -
FCFF -1,004,561 1,785,641 33,260,555 -9,827,279 -
Current Ratio 0.64 0.71 0.67 1.43 1.64
As we can see from above table, due to the large capital expenditures in acquiring offshore assets, the
free cash flow to firm (FCFF) turned to be a negative $9,827,279 in 2010. Afterwards, as a result of
the increase in current liability in 2011, Probiotec experienced a great change in non-cash working
capital (DNWC), which decreased dramatically by $22,607,559. With the change in non-cash
working capital, the FCFF rose largely from a negative $9,827,279in 2010 to a positive $33,260,555
in 2011. In 2012, due to the disposals of non-profitable entities, the non-cash working capital
increased by $4,296,875, which led to another drop in FCFF. Further, in terms of the strong
Australian dollar against the other currencies and the new acquisitions in Europe, the EBIT declined
around 1 million while net fixed assets increased again, to $85,109,101 in 2013. In addition, the
current ratio kept dropping continuously from 1.64 in 2009 to 0.64 in 2013. It clearly indicates that
Probiotec faced serious liquidity problems after the aggressive expansions.
Operating activities
From the table in the next page, as explained in accounting performance part, it is easily found that
Probiotec improved its cash to cash cycle during the past three years. Even though the days used to

collate account receivable slight increased by almost 2 days, the days used in selling inventories
decreased by 3 days. Also, the suppliers extended the days for account payables to 114.67 days.
Year Days A/R Days Inventory Days A/P Required
Financing Period
2013 53.32 131.35 114.67 70.01
2012 51.66 144.18 107.57 88.28
2011 56.62 179.88 110.34 126.16
Therefore, the days required for financing reduced by 18 days, which indicates Probiotec’s cash to
cash cycle getting more efficient and less working capital was required.
Investing activities
Cash Flows From Investing Activities 2013 2012
Payment for property, plant and equipment (8,034,247) (3,532,926)
Proceeds from sale ofproperty, plant and equipment 32,094 1,048,125
Proceeds from sale ofintangible assets 900,000 6,000,000
Cash payments for investments - (322,046)
Receipts relating to loans receivable 511,496 590,001
Purchase ofintangible assets (1,309,880) (2,596,575)
Net cash used in investing activities (7,900,537) 1,186,579
From Probiotec’s cash flows statement in 2013, due to a large amount of funds used in the
investments (purchasing property, plant and equipment), and less income received from the disposals
of property, plant, equipment, and intangible assets, Probiotec’s net cash used in investing activities
dropped significantly from a positive $1,186,579 in 2012 to a negative $7,900,537 in 2013. It
indicates that Probiotec spent lots of funds into the fixed assets again for the purposes of expansion in
oversea markets. Based on the poor sales performance in 2013 and current sluggish retail conditions,
it is reasonable to assume that Probiotec may experience another recession after this aggressive
expansion (similar to the expansion in 2009).
In terms of the significant decrease in profit in 2011 and aggressive expansion in 2013, it is
reasonable for Probiotec to stop paying dividends from 2011.

VALUATION
The difference between the Probiotec’s intrinsic value and market value can be another important
factor used by shareholders to make investment decision. In the valuation part, there are three main
models normally used to calculate the intrinsic value, including discounted cash flow approach (DCF),
dividend discount model (DDM), and P/E ratio approach. In this report, only DCF and P/E ratio
approaches will be applied, due to the ceases of Probiotec’s dividend payment after 2010. Then, the
calculated intrinsic values will be used to compare with the market value and measure whether its
stock is overpriced or underpriced.
Discounted cash flowmodel
Estimate Free Cash Flow to Firm (FCFF)
Year 0 1 2 3 4 5 6
EBIT'(1-t) 3,184,681 3,212,788 3,241,144 3,269,750 3,298,608 3,327,721 3,477,468
Net Capex = Capex-
Depr
5,073,823
∆W (3,975,466)
Estimate Free Cash
Flow to Firm (FCFF)
Year 0 1 2 3 4 5 6
EBIT'(1-t) 3,184,681 3,212,788 3,241,144 3,269,750 3,298,608 3,327,721 3,477,468
FCFF=EBIT(1-t)(1-d) 2,086,324 2,409,591 2,430,858 2,452,312 2,473,956 2,495,791 1,419,274
Present Value (PV) 2,260,932 2,140,167 2,025,853 1,917,645 1,815,217
Terminal Value (TV) 31,706,649
Compute Intrinsic Value per Share
Sum(PV(FCFF),..,TV) 41,866,462
+ cash 46,117
- Debt 26,690,015
= Equity 15,222,564
Shares Outstanding 52,929,356
Intrinsic Value per
share =
$0.2876 Market share price = $0.31
By using the discounted cash flow approach (DCF), the intrinsic value of Probiotec can be calculated
at $0.2876 per share. Compared to the market value of Probiotec ($0.31), Probiotec’s stock is slightly
overpriced by $0.02 per share.

P/E ratio approach
Intrinsic value per share = Industry P/E × EPS
= 12.27 × $0.011
= $0.135
As the formula above, the industry average P/E ratio in Pharmaceuticals industry (12.27) will be
applied. By using P/E ratio approach, the intrinsic value of Probiotec can be computed at $0.135 per
share, which is much lower than the market share price ($0.31 per share). Therefore, based on the
results calculated above, Probiotec’s stock is well overvalued.

MERGERS AND ACQUISITIONS
Based on the great performance in offshore markets during previous year (2009), Probiotec started its
aggressive expanding plans in oversea market in 2010. It acquired a large number of entities (plant,
brands and sales company), such as a manufacturing facility in Dundalk, the 50% shares in Celebrity
Slim brands (fully own), four sports nutrition brands, the 50% of the Australian Dairy Proteins JV
(fully own), and a China-based sales company in Hong Kong. However, due to the lack of hedging
policy, Probiotec cannot offset the higher expenses from a rapid increase in Australian dollar against
the other currencies. Under the worse global retail environment, Probiotec experienced a great loss
after the aggressive expansion.

RISK MANAGEMENT
The major risks faced by Probiotec include market risk, liquidity risk, and credit risk.
Market risk (Foreign exchange risk)
As mentioned above, Probiotec did not introduce any hedging policies to protect the firm’s profits
from the foreign exchange risk. Company is still exposed to the risk of the rapid changes in the
exchanges rate of foreign currencies. Probiotec only explained and predicted the sensitivity of firm’s
profit to the changes of currencies exchange rates based on the historical data. As stated in Probiotec’s
2013 annual report, the results of 10% strengthening of Australian dollar against Great British pound
(GBP), 15% strengthening of Australian dollar against the New Zealand dollar (NZD), 10%
strengthening of Australian dollar against US dollar (USD) and a 10% strengthening of Australian
Dollar against EUR, are simply presented as below:
2013 Profit
GBP $(72,160)
NZD $(12,139)
USD $33,104
EUR $719
Regarding to the ambition of the directors of Probiotec in offshore expansions in the near future, the
main risk faced by Probiotec should be the foreign exchange risk.
Market risk (Interest risk)
Probiotec’s financial assets and liabilities are also exposed to the variable interest rate risk. As
explained in its 2013 annual report (shown in the table below), a large amount of company’s assets
and liabilities were exposed to the risk of changes in variable interest rates.
2013 Weighted
average
interest rate
%
1 year
or less
$
Over 1 to
5 years
$
More than
5 years
$
Total
$
Financial assets: 2.90
Cash 46,117 - - 46,117
Total financial
assets 46,117 - - 46,117
Financial
Liabilities 5.80

Loans and
overdraft 22,288,610 50,000 - 22,338,610
Total financial
liabilities
22,288,610 50,000 - 22,338,610
Net exposure (20,242,493) (50,000) - (22,292,493)
In terms of the sensitivity analysis in Probiotec’s 2013 annual report, the impacts of an increase in
interest rates shown as follow:
2013 Profit $
1% (222,925)
2% (445,850)
Liquidity risk
Another major risk faced by Probiotec is the risks that the company may not be able to raise funds to
continuously maintain the its current operations. The insufficient liquidity in Probiotec may not be
able to meet its liabilities when due, and it also reduces its future financial flexibility. As can be seen
from the table below, there was a great decline in Probiotec’s current ratio after the fiscal year 2010,
from 1.64 in 2009 to 0.64 in 2013. The figure was much lower than its competitor’ (VSC), which
shows the worse liquidity in Probiotec in 2013.
30/06/2009 30/06/2010 30/06/2011 30/06/2012 30/06/2013 VSC(2013)
Current Ratio:
1.64 1.43 0.67 0.71 0.64 3.61
Furthermore, in Probiotec’s annual report (2013), the total carrying amount of its non-derivatives
financial liabilities increased around 6 million during fiscal year 2013. As illustrated in the table
below, a 3 million more non-derivatives financial liabilities got close to maturity date ( less than 6
months), which may further reduce Probiotec’s liquidity.

Carrying
amount
Total
contractual
cash flows
Less than 6
months
6 – 12 months 1 – 5 years
Non-derivatives financial liabilities (2013)
Trade and
other payables 13,767,584 13,767,584 13,446,584 321,000 -
Fixed
borrowings
(including
finance leases) 3,802,111 4,054,144 734,906 734,906 2,584,332
Variable
borrowings 22,338,610 22,338,610 675,000 675,000 20,988,610
Total 39,908,305 40,160,338 14,856,490 1,730,906 23,572,942
Non-derivatives financial liabilities (2012)
Trade and
other payables 10,213,722 10,213,722 9,892,722 321,000 -
Fixed
borrowings
(including
finance leases) 2,763,434 3,046,752 513,075 513,075 2,020,602
Variable
borrowings 21,065,968 22,619,870 1,650,343 4,931,543 16,037,984
Total 34,043,124 35,880,344 12,056,140 5,765,618 18,058,586
Although the company may gain a 4 million dollar financial flexibility in the next 6 to 12 months,
however, in the long-run (1 – 5 years),Probiotec’s liquidity problems are still noteworthy.
Credit risk
2013 2012
(Increase)/decrease in trade and other receivables (2,782,006) 1,803,391
As stated in the notes to the statement of cash flows, the trade and other receivables increased
significantly by $2,782,006 in 2013. It indicates that Probiotec may not be able to collect the
payments from customers and a raise in its bad debts. Even though Probiotec stated in its annual
reports that all the trades were made to the credit-worthy third parties and a credit insurance policy
was applied by the company, the dramatic increase in accounts receivable still worthy to be take into
concerns.

RECOMMENDATION
Based on the analyses performed in the previous parts of this report, some appropriate
recommendations can be provided to the shareholders and Probiotec’s management.
According to the optimal financial mix analysis, Probiotec should lower its leverage from 61.93% to
40%. After company’s financial structure achieve the optimal mix, Probiotec’s firm value will
increase by $2,164,851 while the market share price will rise 13% ($0.04 per share) to $0.35 per share.
Even more important, Probiotec will further decrease its beta from current 0.57 to optimal 0.39,
improve its liquidity and gain the extra financial flexibility for its future investment.
Moreover, for the potential incentives to open the offshore markets, management should employ the
hedging policies (interest rate swaps and forward exchange contracts) to company, which will reduce
the uncertainty of Probiotec’s future profitability and protect company from the risk of rapid increases
in the interest rates and the value of Australian dollar against the other foreign currencies. These
protections will also improve the investors’ confidence in investing Probiotec.
Further, company’s management should review the company’s policies for credit purchases and
reduce the amounts of its account receivables, which may decrease the amount of potential bad debts.
In addition, according to the historical sales data, Probiotec should further dispose some non-
profitable brands and sales companies. Nutritional products may need to be abandoned if the poor
performances in this segment remain disappointed in the near future.

REFERENCE
Probiotec Limited, (2009). Annual Report 2009
Yahoo Finance (2013), graphs retrieved from: http://finance.yahoo.com Accessed 01.09.2014.
Yahoo Finance (2014), retrieved from: https://au.finance.yahoo.com/q/pr?s=PBP.AX

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