Why knowing a company’s intrinsic value is important in the finance world – Why “Value”?

In Corporate Finance, success is usually judged by value. It is the perceived or calculated value of assets and investments of a company for fundamental analysis of the company’s value and cash flows. While price determines the cost at which the security comes, the value defines a company’s true worth! CEOs and CFOs thus take keen interest to measure, create and Maximize Shareholder Value. More specifically, there are several reasons why you need to “Value”.

Valuation exercise elucidates factors influencing value of a company

Valuation exercise helps you understand What Value Drivers are driving Value up or down in your business concerning Sales Growth, Margins, Cost of Capital or Investment Rate. The Value impact of each driver on the Intrinsic Value of a business highlights where one needs to work on and how to improve.

To know more about Cost of Capital, Investment Rate click here- Valuation FAQs

Identify Opportunities available to you to Increase Value

• Change in Capital Structure Mix. The way a company raises its funds change its valuation metrics significantly. Apple having huge Cash Overseas still raised a Debt. If Apple had chosen to repatriate its cash and liquid assets held overseas using the earlier applicable tax rate, it might have had to shell out taxes at a 35-percent rate. With Apple enjoying a low-risk credit rating, raising funds through bonds could have been a relatively cheaper option. The economics of the debt work out better for Apple when the earlier 35-percent repatriation tax is taken into consideration. Change in Capital Structure Mix can alter the Debt ratio making the Shareholder Value rise significantly.

• Divestitures. These could be divisions or brand that would require Corporate Actions such as Divestitures, Spinoffs etc. Zee Entertainment divested from its Sports Business to Sony for $385 Million as it was losing money for years (Accumulated Losses of about $100Million) and was no way going to get an IPL contract.

• Merger and Acquisitions. HUL acquired GSK consumer for INR 37100 Crores in a Cash and Stock Deal. The transaction was aligned with Unilever’s stated strategy of increasing its presence in health-food categories and high-growth emerging markets. GSK HFD is the undisputed leader in the Health Food Drinks category in India, with iconic brands like Horlicks and Boost. With Horlicks being originally introduced in the 1930s as a popular nutritional supplement, and a portfolio of strong products with nutritional claims, GSK HFD was strong support to HUL’s product strategy. Synergies in terms of top-line and cost are anticipated to grow the business in double digits in the near medium term. The strong distribution network is expected to be used as strength to improve the Sales Growth Rate.

• Share Buyback. Concerning the under-priced market worth, and a motive to return surplus cash to shareholders tax-efficiently, the IT services companies like Tata Consultancy Services, Infosys, etc undertook Share Repurchase programs. The idea of returning excess cash to its shareholders tax-efficiently, particularly when the Management believes its Intrinsic Value is more than the Market Price – unfolded opportunities to increased valuation.

• Business Model Changes. After 6 years of humbly beginning with the fast-food chain McDonald’s, Ray Kroc felt that the ambitions were falling short. He decided to change the business model entirely for the brand to be a promising venture. Instead of making money by selling supplies to franchisees and demanding royalties, McDonald’s Corporation became the landlord of the franchisees. They bought the properties to lease them out to the franchisors’ at large mark-ups in addition to their regular income of a percentage of gross sales from franchisees.

Going Public, Successions or Family Realignment
* One needs to know the Intrinsic Value of the business to understand what they are leaving on the table and what their strategic priorities are. Know your worth even before you step out for a meeting with an Investment Banker. With your homework done, you can be clear with your expectations and finances.

Valuation is the decision maker!
When intending to understand the business model, strategic business options, analysis and decision making for maximizing expected value, Valuation is an important aspect. As you learn, practice and analyze valuation metrics, you get smarter with your decision making.