equity Transforming Public Stock to Create Value HAROLD BIERMAN, JR. John Wiley & Sons, Inc. equity Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States, With offices in North America, Europe, Aus- tralia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding. The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation, and fi- nancial instrument analysis, as well as much more, For a list of available titles, please visit our web site at www.Wiley Finance.com, equity Transforming Public Stock to Create Value HAROLD BIERMAN, JR. John Wiley & Sons, Inc. Copyright © 2003 by Harold Bierman, Jr. All rights reserved. Published by John Wiley & Sons. Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a. retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act. without either the prior written permission of the Publisher, or authorization through payment or the appropriate per-copy fee to the Copyright Clearance Center. Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-750-4470, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, N] 07030, 201-748-6011, fax 201-748-6008. e-mail: permcoordinator@wiley.coni. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate, Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800- 762-2974, outside the United States at 317-572-3993 or fax 317-572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: Bierman, Harold. Private equity : transforming public stock to create value / Harold Bierman, jr. p. cm. ISBN 0-471-3.9292-8 (cloth : alk. paper) 1. Corporations—Valuation. 2. Private equity. 3. Going private (Securities) 4. Corporations Finance. 5. Leveraged buyouts. 6. Venture capital. I. Title. HG4028.V3 B445 2003 338.6'041--dc21 2002013636 Printed in the United States of America. 10 9 8 7 6 5 4321 [...]... corporation, if the stockholders desire to unload their stock, they may not be able to, because the market is too thin In such a situation the seller might accept the market price or even marginally less than the market price, since the market price does not fairly represent the firm's value Can one obtain the value of the stockholders' equity by using the market value for a few shares traded on the stock market?... firm may have more value Second, two financial decisions (dividends and capital structure) are likely to be different with a private equity firm than with a publicly owned firm The set of financial decisions with the private equity firm is likely to add value to the investors owning the stock QUESTIONS AND PROBLEMS _ 1 What are the advantages of private equity? 2 Of the eight factors listed by DeAngelo... terminal book value V0 = 100,000 18,154 + 50,000 - 54,846 = $77,000 The present values of the economic incomes plus the initial book value plus the present value of the residual value minus the present value of the terminal book value is equal to the firm's value at time 0 The amount is also equal to the present value of the cash flows TABLE 2.1 Four Balance Sheets 1 91,000 91,000 Time 0 Assets Stock Equity... common stock The investors would rather be paid as employees or have their equity investment gains be converted into capital gains and have these gains taxed at the lower capital gains tax rate in the future CAPITAL STRUCTURE _ The normal public corporation has managers and owners While the managers may also be stockholders, the total value of their stock investment in the corporation tends to. .. drafts of this book xi The Many Virtues of Private Equity For purposes of thisa book the term private equity refers to the common stock of corporation where that common stock is held by a relatively few investors and is not traded on any of the conventional stock markets Normally the senior managers of the firm hold a significant percentage of the firm's stock, and we will assume that is the situation... be used to compute the value of the stock M0 applied to after-tax earnings: M0(E) M1 applied to earnings before interest and taxes: M1(EBIT) M2 applied to earnings before interest, taxes, depreciation, and amortization: M2(EBITDA) Determination of M0 Let P be the value now of a share of common stock Then by definition of M0: P = M0E Valuing the Target Firm 13 14 PRIVATE. .. on the stock market? It should be remembered that the entire universe of investors is available as possible purchasers of the stock and that the present owners are not bidding up the stock price to acquire more shares Normally it will not take a large price increase to cause the present investors to sell their shares of stock assuming the price before the bid was set by the market Premiums paid by... for equity, then the changes in capital structure can give rise to an increase in value This potential increase in value is discussed in Chapter 5 EARNINGS VERSUS DIVIDENDS VERSUS CASH FLOWS: PRESENT VALUE CALCULATIONS Assume the objective is to compute the value of a firm using present value calculations Should earnings be used? Since earnings fail to consider the funds necessary to be reinvested to. .. the firm's cash flow (EBITDA) is $20,000,000 Now the firm's estimated value is $120,000,000 If the debt is $40,000,000 this value is consistent with the $80,000,000 value of the stockholders' position obtained previously The value normally obtained using EBITDA is the firm's value (debt plus equity) rather than the stockholders' value Now let us consider the average P/E of 8 for 10 comparable firms... position 10 PRIVATE EQUITY The price-earnings ratio (P/E) that is expected is equal to the dividend payout rate (1 - b) divided by - g The larger the value of the growth rate (g), the larger the value of the P/E ratio that will be justified Assume the P/E of comparable firms is computed to be 8 and the earnings to the stockholders of the target firm are $10,000,000 The valuation of the stock is $80,000,000 . equity Transforming Public Stock to Create Value HAROLD BIERMAN, JR. John Wiley & Sons, Inc. equity Founded in 1807, John Wiley & Sons. please visit our web site at www .Wiley Finance.com, equity Transforming Public Stock to Create Value HAROLD BIERMAN, JR. John Wiley & Sons, Inc. Copyright