My Vale missteps illuminated for me some of the risks of going where it is darkest, but I will not let them stop me from trying again. This time, my focus is Volkswagen, a company that has, over the course of a month, gone from being just another mature company in a bad business (automobiles) to one beset on all sides by governments, lawyers and investors. In this case, though, unlike Vale and Lukoil, much of the uncertainty comes from self-inflicted wounds and as its stock price drops, it is worth looking at whether the market reaction has been overdone.
The setting
For the last decade, Volkswagen has worked hard to make itself a global automobile giant. Last year, the company was the leading auto company in the world, in terms of revenues, and second only to Toyota in units sold. In the US, it has a much lower profile, with a market share in the low single digits.
The company has been able to weather the 2008 crisis well, and has seen revenues and earnings climb, albeit at the moderate levels that befit a mature automobile company.
The company's operating margin of 6.07% in the last twelve months (ending June 30, 2015) was higher than its historical average margin of 4.21%. During the period, the Volkswagen auto offerings have expanded to include not only Audi and Skoda but also luxury brands including Bentley, Lamborghini, Porsche and Bugatti.
The company has been able to weather the 2008 crisis well, and has seen revenues and earnings climb, albeit at the moderate levels that befit a mature automobile company.
 |
| Source: S&P Capital IQ, Data |
The Scandal, The Stock Price and Knee Jerk Contrarianism
In the last few weeks, the wheels have come off the Volkswagen bus. The trigger was a revelation that VW had designed the computer software on its diesel automobiles to fool the EPA, when it was testing for emissions; this BBC story explains it well. Once the story became public, Volkswagen admitted that it had screwed up big time, its CEO resigned, a whole host of top managers lost their jobs and Volkswagen's stock price collapsed, losing almost 40% of its value in the last month.
While both the ordinary and preferred shares have collapsed, the preferred shares seem to have taken more of a beating; the ordinary shares that used to trade at par with the preferred now trade at a premium of about 8% (and I will take more about this later in this post)
There is no doubt that this is more than a tempest in a teapot, and that that there will be consequences, but are the consequences dire enough to cause a loss of more than 30 billion Euros in market capitalization? That remains the key question, as investors who are attracted to beaten up stocks look at Volkswagen. A knee jerk contrarian strategy may argue that history and empirical evidence is on your side and push for investment in Volkswagen now, but I am wary of using average returns from past studies, often based upon large samples of companies, to justify investing in one company that meets the criteria.
While both the ordinary and preferred shares have collapsed, the preferred shares seem to have taken more of a beating; the ordinary shares that used to trade at par with the preferred now trade at a premium of about 8% (and I will take more about this later in this post)
There is no doubt that this is more than a tempest in a teapot, and that that there will be consequences, but are the consequences dire enough to cause a loss of more than 30 billion Euros in market capitalization? That remains the key question, as investors who are attracted to beaten up stocks look at Volkswagen. A knee jerk contrarian strategy may argue that history and empirical evidence is on your side and push for investment in Volkswagen now, but I am wary of using average returns from past studies, often based upon large samples of companies, to justify investing in one company that meets the criteria.
The Costs
In the aftermath of Volkwagen's revelations, the news media have turned their full attention to the company's foibles, real and made up, with a skew towards putting the worst possible spin on the company's actions. Thus, the fact that the company has close ties to German lawmakers is viewed as a sign of the company's moral turpitude, as if other auto makers do not have their own stables of legislators pushing for preferential treatment. Thus, the first step in assessing the impact of this scandal on Volkswagen is separating the wheat from the chaff, or in Nate Silver's words, the signal from the noise. It is quite clear that this scandal is going to cost Volkswagen, in many different arenas, starting with penalties being imposed by governments and regulators for the deception, continuing with the costs of recalling and fixing the cars and expanding to cover lost sales, as potential customers switch to competing car companies.
- The Legal Penalties: There is no question that there are legal penalties coming, with Volkswagen already setting aside $7.3 billion (6.5 billion Euros) to cover the costs (fines/penalties, recall costs and other legal costs) that it will face, and the EPA's potential fines could expand to $18 billion. There is talk in Europe of similar penalties being meted out by European governments, which will add to the cost. (Update: A reader sent me the link to this article that provides some perspective on the potential fine size being closer to $11 billion, rather than $18 billion.)
- Auto Recall Costs/ Legal Costs: It is estimated that Volkswagen has about 11 million vehicles that it might have to recall and refit, and that will be costly. Not surprisingly, talk of lawsuits fill the air, with both European and American shareholders considering suing the company for damages; even if the company wins all of these suits, it will be paying hefty legal fees along the way.
- Lost Sales/Operating Income: There is also talk of lost trust and tarnished brand names, but these remain PR buzzwords until they start showing up in lost sales/profits. Unlike the BP or GM scandals, where lives were lost, the impact of this scandal is more diffuse, though the New York Times segued into this argument (a little far fetched) that the cheating could have cost lives.
At the moment, the magnitude of these costs is still murky, but waiting for them to be clearer, as some investors seem to be doing, is an investment cop out. The market is already imputing a cost , and investors who want to invest in Volkswagen have no choice but to make their own judgments on whether the market imputed cost is too high (in which case Volkswagen becomes a buy), just right or too low (Volkswagen will be over valued).
I know that the cases are dissimilar, but to get a measure of what a scandal can cost an auto company, I looked at Toyota's experiences in 2010 with faulty gas pedals, the press coverage and controversy and the subsequent costs to the company.
I know that the cases are dissimilar, but to get a measure of what a scandal can cost an auto company, I looked at Toyota's experiences in 2010 with faulty gas pedals, the press coverage and controversy and the subsequent costs to the company.
| Toyota | Volkswagen | |
|---|---|---|
| The Scandal | Gas pedals stuck, causing acceleration & accidents. | Computer software fooled EPA on emissions tests, reporting emissions at lower than actual level. |
| Deaths/Fatalities | 37* (NHSTA) | None |
| Number of cars affected | 9 million | 11 million |
| EPA fines/ Government Penalties | $1.2 billion | VW set aside $7.3 billion |
| EPA maximum fine $18 billion | ||
| Auto Recall Costs & Car Owner lawsuits | $1.1 billion | If proportional to number of cars, $1.34 billion. |
| Shareholder lawsuits | $25.5 million | Lawsuits being considering in both US and Europe. |
| Effect on Revenues/Operations | Revenues dropped from $19.1 billion in 2009 to $17.8 billion in 2010 and stayed about that level through 2011 and 2012, before rebounding to $21 billion in 2013. | Not known yet |
| Effect on stock price | Market Cap dropped 20% between 2009 and 2012, but rebounded in 2013. | Market capitalization down 40% in month since story broke |
The Valuation
To evaluate how this scandal affects Volkswagen's value as a company, I will adopt a two-step process. In the first, I will go back a month and value Volkswagen before the revelations, but to isolate the effect of the scandal, I will assume that the market capitalization a month ago (on August 31) was right and back out the operating income that the market was imputing in the stock price. In the second, I will make judgments on the extent of the costs, with a bias towards over estimating, rather than under estimating them, and revalue Volkswagen.
The Pre-Scandal Volkswagen
To value the company prior to the scandal, I drew on Volkwagen's financial history, which is summarized here. If you truly want to numb yourself, try reading Volkswagen's annual report, a model of opacity and bulk. Once I had those numbers and examined the landscape of the auto business, my initial narrative for Volkswagen was a boring one: it is a mature firm that I expect to grow barely (at the same rate as the economy), earn no excess returns and an established capital structure and regional exposure. Rather than try to value the company, I took the market capitalization of 82 billion Euros that the company was trading at then, and solved for the operating income that the firm would need to generate to be trading at the prevailing market value, arriving at 7,683 million Euros in operating income, well below the 12,886 million Euros that the company earned in the trailing 12 months, and about 25% below the average operating income generated over the last five years.
Update: I added a worksheet to the spreadsheet to explain how I came up with the net asset value for the financial services company. Put simply, rather than let its numbers drown out and distract me from valuing Volkswagen, I separate all of the assets and liabilities that VW reported for its financial services business and estimated a net book value. My estimate is significantly lower than VW's own book value of equity estimate for its financial service firm, reflecting what I chose to include in the financial service firm's assets and liabilities. I also fixed the post-scandal spreadsheet to let you change the operating income to any of the pre-specified choices and fixed an error in the total debt number.
The Pre-Scandal Volkswagen
To value the company prior to the scandal, I drew on Volkwagen's financial history, which is summarized here. If you truly want to numb yourself, try reading Volkswagen's annual report, a model of opacity and bulk. Once I had those numbers and examined the landscape of the auto business, my initial narrative for Volkswagen was a boring one: it is a mature firm that I expect to grow barely (at the same rate as the economy), earn no excess returns and an established capital structure and regional exposure. Rather than try to value the company, I took the market capitalization of 82 billion Euros that the company was trading at then, and solved for the operating income that the firm would need to generate to be trading at the prevailing market value, arriving at 7,683 million Euros in operating income, well below the 12,886 million Euros that the company earned in the trailing 12 months, and about 25% below the average operating income generated over the last five years.
 |
| Spreadsheet |
The Post-Scandal Valuation
There have been no major financial reports from the company over the last month and the macro environment has changed little, with the German 10-year Euro bond rate stuck at 0.60%. In effect, the only thing that has changed is that the company has revealed its deception and the costs are starting to be tallied. Using the structure that I described in the last section, I brought in the effects of the scandal in three layers.
- Government and Regulatory Fines/Penalties: In this layer, I look at the fines and penalties that Volkwagen has to pay, and it seems reasonable that the lower bound on this number would be the $7.3 billion that VW has already set aside, but the upper bound may be much higher, ranging to include the $18 billion (16.07 billion Euros) that would be the maximum fine (for the EPA) and other fines that may come from European governments that have also been deceived. In my assessment, I added 10 billion Euros, reflecting the tendency of governments to pile on, to the 16.07 billion Euros to arrive at a total penalty of 26.07 billion Euros.
- Auto recalls & Lawsuits: To estimate the costs that Volkswagen might face, as a result of this scandal, note that 11 million vehicles may need to be recalled and "fixed" and the costs will be high. Scaling up the $1.1 billion that Toyota spent recalling 9 million cars to fix gas pedals, adjusting for inflation and adding a buffer, I estimate a recall cost of $1.6 billion. In addition, a big company in the midst of a self-inflicted scandal is a ripe target for lawsuits, from both shareholders and affected customers, and while the end judgment may not be huge, the legal costs will accumulate along the way. With Toyota, these lawsuits created more noise than consequences, with the final settlement being only $25.5 million, but I am sure that the legal costs to the company were a multiple of this number. With Volkswagen, I will take the conservative tack and estimate a cost of $2.4 billion, matching the largest judgment ever in a shareholder suit,
- Reputation Loss: Will customers stop buying Volkswagen cars as a result of this fiasco? Again, using the Toyota gas-pedal problem as an illustrative example, the company saw its revenues drop by about 7% in 2010 and stay low until 2012, though other factors may have contributed to the decline as well. Volkswagen will lose sales, especially in its diesel car segment, because of this scandal, but the effect will fade over time, just as it has for Toyota, GM and Ford, each of whom has had a scandal (or two) in the past. In fact, the car business is full of fallen sinners and soon-to-be sinners, and it seems unlikely that any company will be tarred for life. Again, in the interests of being conservative, I will assume that Volkswagen will lose 20% of its (imputed) operating income each year for the next 5 years; the present value of these lost profts amounts to $5.17 billion.
Note that some of these costs will create tax savings, insofar as they are tax deductible. (Update: A reader notes that US tax law generally does not allow government fines to be tax deductible, but there is some give in the provision.) In my assessment, in keeping with the conservative estimation, I will assume that only half of the costs on the first two items (fines and legal costs) are tax deductible. Finally, note that if Volkswagen pays the fines and incurs recall/legal costs, they will show up as expenses in the near years, and that you should expect to see reported losses in the mega-billions.
There is one more potential cost, which is that the management of Volkswagen will be focused on managing the scandal so much that they will not be able to direct their attention towards managing the company. If this were a creative company in a good business, I would be calculating the cost of lost investments and foregone growth and reducing my value. With Volkswagen, a not-that-imaginative company in a bad business (at least based on my narrative), I am less concerned, since an auto management's effort to grow faster (by acquiring other companies, expanding market share, entering new markets) is just as likely to destroy value, as it is to add value. In a perverse way, Volkswagen's stockholders may be better served by managers doing too little rather than trying to do too much.
There is one more potential cost, which is that the management of Volkswagen will be focused on managing the scandal so much that they will not be able to direct their attention towards managing the company. If this were a creative company in a good business, I would be calculating the cost of lost investments and foregone growth and reducing my value. With Volkswagen, a not-that-imaginative company in a bad business (at least based on my narrative), I am less concerned, since an auto management's effort to grow faster (by acquiring other companies, expanding market share, entering new markets) is just as likely to destroy value, as it is to add value. In a perverse way, Volkswagen's stockholders may be better served by managers doing too little rather than trying to do too much.
With these conservative (almost worst-case numbers), I revalued Volkswagen's equity at 52.5 billion Euros, about 10% higher than the market capitalization of 48 billion Euros at the time of this assessment. While that may not seem impressive, that is with an extremely conservative assessment of costs. Incorporating the full tax benefit from the government penalties and auto recall increases the value to 56.7 billion Euros, and assuming a smaller penalty or less in legal costs will push the value up even further. (Negative numbers in the last column indicate under valued.)
Updated the likely case to make the costs only 50% deductible since readers who are much better versed than I on the tax law indicate that it is unlikely that VW will be able to deduce a large portion of their government fines.
For the final question of whether to buy the ordinary or preferred shares, here is the trade off. The preferred shares have dropped by more than the ordinary shares and have historically been more liquid, but in times when you want a say in who runs the company and how it is run, it is better to own the ordinary shares. In fact, I would argue that the reason the common shares are trading at an 8% premium over the preferred shares now, as opposed to trading at par just a month ago, can be traced to the reawakening of interest in control and corporate governance that comes out of every scandal.
| Assumptions | Value of Equity (billions of Euros) | % under or over valued | |
|---|---|---|---|
| Worst Case | Maximum EPA Penalty + 10 billon in Other Government Fines, 4 bilion Euros in recall/legal costs, 20% loss in operating income forever, Fines and Legal costs not deductible. | 32.04 € | 59.47% |
| Base Case | Maximum EPA Penalty + 10 billon in Other Government Fines, 4 billion Euros in recall/legal costs, 20% loss in operating income for 5 years, Fines and Legal costs only 50% deductible | 52.50 € | -8.05% |
| Better Case | Maximum EPA Penalty + 10 billon in Other Government Fines, 4 bilion Euros in recall/legal costs, 20% loss in operating income for 3 years, Fines and Legal costs 100% deductible | 58.75 € | -17.95% |
| Likely Case | Half of maximum EPA Penalty + 5 billon in Other Government Fines, 2 bilion Euros in recall/legal costs, 20% loss in operating income for 3 years, Fines and Legal costs 50% deductible | 65.91 € | -30.54% |
| Best Case | Penalties proportionate to Toyota, 20% loss in operating income for 3 years, Fines and Legal costs 100% deductible | 73.60 € | -34.78% |
Updated the likely case to make the costs only 50% deductible since readers who are much better versed than I on the tax law indicate that it is unlikely that VW will be able to deduce a large portion of their government fines.
For the final question of whether to buy the ordinary or preferred shares, here is the trade off. The preferred shares have dropped by more than the ordinary shares and have historically been more liquid, but in times when you want a say in who runs the company and how it is run, it is better to own the ordinary shares. In fact, I would argue that the reason the common shares are trading at an 8% premium over the preferred shares now, as opposed to trading at par just a month ago, can be traced to the reawakening of interest in control and corporate governance that comes out of every scandal.
The End Game
This may be a reflection on my moral compass, but I find it difficult to muster the outrage that some people seem to feel about Volkswagen's deception. I think that the company's acts were stupid, short-sighted and greed-driven, but there have been far more appalling acts in corporate history, that are more deserving of my outrage. Volkswagen should be punished and the market has already meted out a hefty penalty, but looking at the possible costs of this scandal, I think that the market has over reacted. My market order for ordinary shares in Volkswagen went through yesterday, as my desire to have a say in management (with the ordinary shares) overwhelmed the bargain hunter in me (which was attracted to the preferred shares). I am investing in Volkswagen, but this will be a bumpy ride, for quite a while. This is the scandal du jour, of the moment, but there will be other news stories that draw the rubber necking crowd away. I have neither the desire, nor the inclination, to talk you into buying the stock. If you work through the numbers and come to the same conclusion that I did, I will be glad to have your company, but if your judgment leads you to a different assessment, I have no quarrels with you. To each, his (or her) own!
YouTube
Data
Spreadsheets
YouTube
Data
Spreadsheets
I also purchased 100K worth. Great write-up.
ReplyDeleteThank you for another excellent article.
ReplyDeleteI have two questions:
1. Since all German car-makers stocks got beaten with VW, what is your opinion on BMW at its current price? I think their management is far superior to VW and they can now profit from VW loses.
2. What you think about Audi (NSU) shares in relation to the scandal?
Thank you
Greetings from Europe.
Hi Mr. Damodaran,
ReplyDeleteCan you explain why did you decide to go with voting shares when State of Lower Saxony, Hanover and Qatar Holding control over 37% of the voting distribution? I am sure I missed something obvious so I apologies in advance.
Thanks
Tim
Tim,
ReplyDeleteYou are right and it is one reason that control has been worth very little in the past. I have a feeling that this scandal might shake the status quo a lot and that the states in question may be willing to push for change. I may be over optimistic, but no harm hoping.
Iraya,
I do think that BMW and Audi look intriguing, but I have not done a full valuation of either. Until I do so, it would not be right for me to make judgments on these companies as investments.
Prof, There seems to be a typo in both pre and post worksheets, wherein debt deducted from value of operating assets includes financial services assets. It appears that net financial assets are both added and deducted.
ReplyDeleteThat is one of the best valuation exercise, which might have been done for this VW episode.
ReplyDeleteBut coming from you, its not a surprise for me. :-)
Not sure if you track Indian markets, but Nestle went through a fiasco recently - Maggi. The company already traded at expensive valuations before the crisis, it was surprising to see that it continued doing so even after the crisis. It will be great if we could use a similar analysis for Indian investors of Nestle. It might be late now - but it will be a good academic exercise to better understand valuing companies facing temporary problems.
Prof. Damodaran,
ReplyDeleteIt's always a pleasure to listen to you. In this VW case, I didn't see you assign any probability associated with various cases (best, likely, etc.)
Shouldn't they be considered at all? How likely is 'likely', for example.
Another issue I have with your VW valuation is even with the best-case scenario, the stock is not attractive enough: only 34% undervalued and one would have to wait years to find out if that's correct. There are bigger fish to fry, I think.
Robert J.
Dear Prof Damodran,
ReplyDeleteThank you for a very thoughtful analysis. I am curious to know what you think will be the valuation consequences of a criminal indictment against VW? Given that the software was installed precisely to cheat EPA testing there is a more than negligible likelihood that the Justice department might criminally indict VW to make an example out of them. I like that you use the Toyota scandal to infer costs but I think the Toyota scandal was a fundamentally different. Toyota we not willingly cheating a government agency.
Thanks,
Sam
Why do you consider 'automobiles' a bad business?
ReplyDeleteHi again,
ReplyDeletesorry, I'm a bit slow. :) This probably has to do with the financial services?
I'll look more closely.
Great post. It appears that market indeed has overreacted.
ReplyDeleteI have just a thought: What say can you have as a small (presumably) common stock investor in a listed company? Can you change management decisions in any way with your shares?
best wishes
SP
"Computer software fooled EPA on emissions tests, reporting emissions at lower than actual level."
ReplyDeleteThat is not the case. The emissions were right. The software decreased power of the engine and increased fuel consumption to lower emissions when it detects an emission test. The emission is actually measured and not delivered by the VW software.
Another point is the special right of Niedersachsen re Volkswagen: https://en.wikipedia.org/wiki/Volkswagen_Law#cite_note-4
Also it is difficult to value VW as a whole because the financial arm is so big. Did you account for the decreasing value of the collateral (VW cars? In the case of increasing defaults this would be important and is why I avoided to buy shares in the past. Also the sales in China and the even larger profit share of China is a risk. If you assume a shake up better go long Renk. MAN may sell it. MAN is a subidiary of Volkswagen.
Thank you for the excellent writeup.
ReplyDeleteA couple of quick questions, if I may:
1) Why did you subtract the net assets (book value) of the financial services business to get to the enterprise value?
2) In your valuation spreadsheet post-scandal, you get to a value per share by dividing the total equity value by the sum of common shares and preferred shares, but then you compare it with the price of the common (about 100 euros). Why? Shouldn't it be more appropriate to subtract the value of the preferred (I don't know whether they have a liquidation preference, etc) from the total equity value and then divide the result only by the number of common shares?
Thank you in advance for addressing my questions.
Silvio
Another excellent piece, Pr. Damodaran. Please keep them coming!
ReplyDeleteRegarding the potential magnitude of the EPA fine, I thought you would find the following information interesting/ useful:
"Reports that the EPA could impose a fine of up to $18 billion are wrong, according to Mr. Warburton of Bernstein. They were calculated by multiplying a maximum fine of $37,500 with 482,000 affected cars in the U.S.
But the maximum base fine for a 140 horsepower car is $21,775, the analyst wrote, and it declines if more than 10 cars are affected. For the 100,001st car, the base fine is only 3.2% of the fine for the first car. However, other factors such as “egregiousness” drive the fine higher."
http://blogs.wsj.com/moneybeat/2015/09/29/cost-of-volkswagens-emissions-scandal-at-least-11-billion-analysts-say/
Aother great post – I’ve submitted it to the UKFinanceOver30 sub-reddit.
ReplyDeletehttps://www.reddit.com/r/UKFinanceOver30/
I'm thinking about joining you in the shares, too.
Thanks,
Mike
Alex, Thank you for the link to the EPA fine.
ReplyDeleteMike, Glad to see it get out to more people.
Anonymous, The value per share is messy when you have two classes of shares. That is why I focused on equity value.
Martin, Point taken.
Sam, Criminal indictments may come against managers, but the real cost to the stockholders is the financial penalty.
Finally, I know that I will not be able to exercise control with my minuscule holdings of the ordinary shares, but I may be able to piggy back on someone else with more heft doing it.
Sir, I am big fan of yours since I first read your book "Investment Fables". I am not that expert in Valuation but having failed miserably so many times trying to attach a value to something which has been hit hard I simply try to stay out of this universe of stocks and dare not to bottom fish and set a value price as that might not be perceived buy major market participants and not realized for very long time leading to opportunity cost loss. The wound in case of Volkswagen is fresh and will take long time to heal. Till then who are already invested they have nothing to do as there is no point in selling the stock in panic and their allocation to the stock is already hitting new recent lows, but fresh buying should wait as there is no triggers for the stock to appreciate in near term. The stock is hitting 5 year lows and so is the moral of long term patient shareholders who are witnessing their money being evaporated. There will be relentless selling, if stock goes higher, by those who couldn't sell earlier. There is no point in bailing out the fearful owners now. Investor will get plenty of opportunity to grab this share may be at slightly higher prices but at least with peace of mind. I also don't have any downward price target as the pendulum can swing to such extremes that people won't believe. If vale can fall 85% from it's 2011 high, a market cap loss of over $130 billion, nothing seems impossible these days. I am very small investor from India and not challenging your view as I have grown up learning value investing from you but just thought of sharing my experience.
ReplyDeletehamza
ReplyDeleteVery interesting analysis Prof...VW share price has indeed been beaten quite badly...
can you please also share your view on VW finance division? given the size of VW financial div, is there a specifc risk here due to ongoing scandal?
thank you
Thanks so much Prof !
ReplyDeleteJust wondering how this scandal has affected the long line DCF value of the group's brand which seems intrinsically reflected on share prices...it could be a little different vs. reputation cost...Thanks !
Prof Damodoran, I have been a casual reader for the last couple of years. I always find your posts insightful yet easy to follow, I wish there had been such clarity in all readings when I studied finance. Thank you for sharing freely!
ReplyDeleteI wonder if you've recently posted the performance vs. market of the entry/exit trades associated with your valuations (say as a basket of stocks over the past 5 years and assuming constant inital investment)? If not, this would be most interesting. Thank you.
Hi Prof,
ReplyDeleteI am just wondering, in general, when you input your growth assumption into your DCF formula, do you take into account of qualitative factors ? For example the strength of the firm business model, its source of competitive advantages and whether such competitive advantage can be sustained in the future. If no, why not ? How much time do you even spend on exploring these qualitative factors?
The long held feeling I get from academic finance professor like yourself is that you guys treat investing in stock market like a number game rather than treating it like a real business. Most of your valuation just input simplistic growth assumption based on industry average, past performance, stage of business etc Just take twitter for example, you just input a growth assumption based on industry average for similar tech company at the same business stage. Have you even consider important issues such as why is twitter so popular among users? Will users continue to use twitter and not switch to other platform? and will the growth of users be sustainable in the future? Will twitter able to translate users growth into earning through monetization?
I would like to emphasize that I have deep respect for your work, and I thoroughly enjoy your books on valuation. Just that I could not help but feel that academic professor just treat investment like a number game (just pluck numbers here and there, be it using past averages or industry comparable without understanding the competitiveness of its good & services) which I really do not agree. I hope you can give me your view on my thoughts, and pls do correct me if I am wrong! Thank you Prof & look forward to your reply.
Jin,
ReplyDeleteI am surprised that you would use Twitter as an example where I am drawing on the sector and past history, since I use neither. You may want to go back and look at the valuation again. With young companies, it is your assessment of the total market that drives valuation. Remember, it does not matter how many people use Twitter, if it is not a good medium for advertising, which is how they expect to make revenues. So, don't be distracted by the story telling. Convert the stories into numbers. That is what I try to do and why my projections almost never match up to historical data for a company.
Hello Professor - Thank you for your wonderful work. I am particularly intrigued by your approach to valuing AAPL. In today's environment have you ever considered using IBM as a project to evaluate since it is mostly generating earnings growth through buybacks with declining revenue growth, it confuses me why someone like Mr. Buffett continues to hold and accumulate large positions. I know this is out of the blue. Using current price with a p/e of 12.1, payout ratio of 47.3 a discount rate for 10 years @10%, I generate about a 150 price value. IBM has generated many strong opposing views.
ReplyDeleteThank you very much for your enlightening approach and have a great day!
Cheers,
Chet
Chet
Dear Professor,
ReplyDeletewhy in your spreadsheet in the item "Total Debt, including Pension Liabilities" you also include the Net Value of Financial Services (Assets - Liabilities) ?
Luis,
ReplyDeleteYou are absolutely right. I should not have. I have fixed it and the net effect works out to close to zero. The break-even operating income, pre-scandal, now drops to 7.683 million Euros but removing the item from debt compensates for the lower operating income and my value for Volkswagen in the base scenario is 52.5 billion Euros now. Thank you for noticing it (and anonymous as well).
Well written article but I suspect the damage to VW is likely to be more permanent than the simplistic logic of public memory. The issue here is fraud and the nexus with German lawmakers. Fraud is not something people forgive easily. Trust is a currency that must be valued more than any monetary measure. Time will tell. My feeling is that the VW brand is damaged beyond repair.
ReplyDeleteI think that generally, consumers don't really care what is coming out of their tailpipe as long as the car they're buying is 1.) well made 2.) fun to drive 3.) safe (to them) 4.) get good fuel economy. I just don't see consumers shunning VW because it lied to regulators. There will be exceptions to this and no doubt that the media will latch on to anecdotal cases of potential VW buyers choosing a competitor because "trust issues", but by and large I think that if someone would have bought a non-diesel VW in Q4 2016, they're going to do it anyway.
ReplyDeleteWhy is 9.74% used as the average of the last five years ROIC when the third sheet shows the five year average as 18.68%? Isn't the 9.74% too low because is takes an average of operating incomes from 2010-2014 but divides by a snapshot of invested capital in just 2014?
ReplyDeleteVery insightful thoughts. Despite the value offered by any valuation exercise the many assumptions that need to be made render it vulnerable to being off the target by a wide margin at times. The following two assumptions are quite standard - ethical conduct by the company's top management and complete integrity in the reporting of its financial performance. Unfortunately, time and again these assumptions have failed to hold good. There are several examples - Enron earlier and Volkswagen now. Unless market regulators can fix these challenges, valuation results will remain subject to high volatility. That would in turn increase the risk associated with investing, especially in stock markets. A sudden, bad news due to ethical failure can lead to free fall of stock prices and significant erosion (and in the worst case complete wipe out) of the net worth in a matter of few days time.
ReplyDeleteThanks for your post. Very interesting as always. I was wondering if you considered the potential variation in the capital structure of the company and the associated WACC (i.e. % of debt to equity due to capital increases, increase in beta, increase in debt costs linked to rating deterioration...). From the sensitivities I ran in your model, I would say that the value in the company will move a lot depending on these parameters. Thanks.
ReplyDeleteThe cost of capital may move, as a result of everything that you have listed, but it will be a derivative effect of earnings coming in much worse that expected or the top line deteriorating.
ReplyDeleteGreat article.
ReplyDelete-You could also have considered GM, who hide for years a major safety issue, fighting back claims of users who had lost a relative as a consequence, and got a fine lower than Toyota...
-Also, I read somewhere that the difference in preferred vs regular stock could be because a capital increase is expected and that would dilute preferred stock value more than regular. Is that correct?
Greetings from a former student
Dear Professor,
ReplyDeleteGreetings from India. Article is very insightful and detailed.
While going through the spreadsheet, I noticed that unlevered beta has been calculated taking into account the financial services arm of the firm as well, however, the D/E ratio for levering the unlevered beta ignores it. Moreover, net value of assets of this business has been added separately to arrive at total estimated equity value.
My question is should unlevered beta be calculated considering only the automobile and power businesses of the firm;rest of the computation remaining the same?
Thanks,
Akshay
Dear Prof,
ReplyDeleteI've been looking through your valuation. I was wondering how you worked out the Total Debt figure for the automotive division? I have been looking at the annual reports but cannot understand how you came to your figure of 41,840.
Many thanks