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Corporate Finance

Share holder value creation Credit Rating Equity Valuation & buy back Treasury management Term Debt management Corporate Liabilities and Hedging risks
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Shareholder value creation


The objective of any Company is to maximise its shareholders value. SVC may be defined as the excess of market value over its book value.

SVC could be analysed as follows :


Market-to-book value per share approach (MV/ BV)

Economic value added approach (EVA)


DCF approach
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The Value Creation Matrix


Improve management or replace inefficient one

Managerial Dimension

Redeploy capital Increase RoI

Financial Dimension

Risk Dimension
Cost-of-capital reduction

VALUE CREATION

Operational Dimension
Scale Economies Improve margins

Market Valuation
Release value
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MV/ BV Approach

Value creation

MV ---- > 1 BV MV ---- =1 BV MV ----< 1 BV

Value maintenance

Value destruction

Economic value added approach


It is a concept based on economic profit and not accounting profit. In EVA approach, the comparison is between ROCE and COCE. It is the ratio of the net operating profit less adjusted tax (NOPLAT) to capital employed (CE)

NOPLAT is profit after depreciation and taxes but before interest


NOPLAT = PBIT (I-T) = PAT + INT (I-T)

Return on capital employed = PBIT I CE

Economic value is added when ROCE > WACOC

Economic value is destroyed when ROCE < WACOC EVA = net operating profit after tax cost charges of capital employed

It is the net earnings in excess of the cost of capital supplied by lenders and share holders. It represents the excess return to shareholders over and above the minimum required return. It is net value added to shareholders.
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DCF approach
The true economic (present) value of a firm, or a project or a strategy depends on the cash flows and the appropriate discount rate (adjusted if required). Economic value =PV of net operating cash flows + PV of terminal value

Value creation strategies


Revenue enhancement

Cost reduction
Optimal Asset utilisation Cost of capital reduction
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Relevance of Shareholder value creation


Private sector / Funds allowed in banking and mutual funds in addition to FIIs are allowed to invest in Indian debt and equity. Indian corporates allowed to raise funds offshore Greater freedom to financial intermediatries. Capital issue controls abolished.

Credit Rating
Bond rating Equity rating Commercial paper rating Sovereign rating Project/ company rating

Credit Rating agencies


CRISIL

CARE

ICRA

S TAN DAR D AN D PO O R

M O O DYS

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Rating Methodology
Industry Risk Operating Efficiency Market Position

Business Risk Overall Risk Rating

Management Risk

Existing Risk

Project Risk

Financial Risk

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Rating methodology for Corporates


Completion of Business Risk 1. Industry 2. Market Position 3. Operations 4. ongoing projects 5. Management

OVERALL RISK

Financial Risk 1. Accounting Quality 3. Financial Resources/ Flexibility

2. Existing Financial Position 4. Cash Flow Adequacy


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Industry Risk
Industry Characteristics
Importance to the economy Stage of Business cycle Industry size Government policies Cyclical/seasonal factors Entry Barriers
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Industry Risk......
Extent of Competition
Nature and basis of competition Threat from imports Unorganised players Substitutes

Technological risk

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Products

2. MARKET POSITION

Markets

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Products

2. MARKET POSITION Customer Preferences / Brand Loyalty Product Range Competitive advantages Pricing flexibility Brand Equity
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Market size Market share Marketing set-up


Selling & Distribution arrangements

2. MARKET POSITION

Markets

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Supply Chain Efficiency

Labour relations /Productivity

3. OPERATIONS

Environmental Technological Location Factors

Cost structure

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Project Risk
Number and size of projects Means of financing the projects Funding tie up Extent of completion of projects Ability and track record in executing projects Analysis of time and cost overruns, if any

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FINANCIAL RISK EVALUATION

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Return on Capital Employed Analysis of receivables Coverage Ratios

2. EXISTING FINANCIAL POSITION

Profitability Ratios Liquidity Mgmt.

Capitalization Ratios
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Ability to raise alternative financing

Liquid assets available with the company

3. FINANCIAL RESOURCES & FINANCIAL FLEXIBILITY Flexibility in deferring capital expenditure programmes

Support from Promoters / Group companies

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Future earnings in relation to working capital needs and capital spending

4. CASH FLOW ADEQUACY Assumptions underlying the cash flows

Projected key financial parameters

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Crisil Rating Symbols


Easily comprehensible to lay investors Distinctive symbols for different debt securities differentiated on the degree of safety, viz. investment and non-investment grades. Securities with the same rating are of similar but NOT identical investment quality.
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CRISILs Long Term Rating symbols


Investment Grades AAA : Highest safety AA : High safety A : Adequate safety
- Change in circumstances can adversely effect such issues

BBB : Moderate safety


- Change in circumstances are more likely to lead to weakened capacity
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CRISILs Long Term Rating symbols


Speculative Grades BB : Inadequate safety - Uncertainties could lead to inadequate capacity B : High risk
- Currently being met but adverse conditions could lead to lack of ability or willingness

: Substantial Risk
- Payment possible only if favourable circumstances continue

: Default
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CRISIL Rating Symbols


Grades Investment Highest Safety High Safety Adequate Safety Moderate Safety Speculative Inadequate Safety High Risk Substantial Risk Default Debenture Fixed Deposit Commercial Paper FAAA FAA FA P1 P2 P3

AAA AA A BBB

BB BB C D

FB FC FD

P4 P5

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Advantages of credit rating


Provide superior information Offer low cost information Serve as a basis for a proper risk-return trade off. Impose healthy discipline on corporate borrowers Lend greater credence to financial and other representations Formulation of policy guidelines on institutional investors
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Moodys rating analysis pyramid


Qualitative Analysis Management Strategic direction Financial Flexibility Quantitative Analysis Finaancial Statements Past Performance Future Projections

Market Position

Competitive Trends in Sector Global / Domestic

Regulatory Enviornment Global / Domestic

Sectoral Industry Analysis Global / Domestic

Sovereign Macro Economic Analysis

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Equity buy back


Allowed as per the provisions of sec 77a of the companies act. Special resolution to be passed Complete disclosure of all material fact Maximum 25% of paid up capital during a year.

Debt: equity ratio after proposed buy back not to exceed 2:1 Consent of Lenders No fresh issue allowed for a period of 24 months post buyback

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General Motivations for Share Buyback


Improve Shareholder Value
Surplus funds with few attractive alternative investment options Reduction in capital base normally results in higher EPS That the stock of the company is undervalued and/or that investing in its own stock is the best bargain around

Information Signalling by Management

Signaling believed to be based on legitimate inside information


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General Motivations for Share Buyback


A US research study reveals that repurchase plans have a larger impact on shareholder wealth than special dividends In India, depends on period of holding, capital gains tax rate, and dividend tax rate

Tax effective return of cash

Defence Mechanism

Promoter group can improve percentage holding


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Target Companies for Buyback


Low growth plans
Cash Surplus ( Internal accruals / extraordinary receipts ) Take over threat Promoter controlling interest Undervalued stocks
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Success of a Buyback
Pricing :
Premium / discount to market price

Timing :
Economic and political conditions Market phases ( Bearish / Bullish )

Funding :
Debt Preference shares Cash reserves
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Modes of Buy back


Open market operations by way of book building / stock exchange
Odd lot Tender offer with or without negative mandate If buyback results in public holding falling before 10% resulting in de listing open offer for the balance through book building will have to be done.

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Benefits of allowing buy back . Enhanced liquidity for small investor . Enhancing shareholders wealth

. Increase in EPS
. Better servicing of equity

. Signal of under valuation of stock


Drawbacks of buy back . Insider trading . Increase in promoter stake . Affecting companys fund-flow/ financial positions
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Treasury management
- Resource mobilisation - Resource deployment - Risk management

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- Risk management helps in minimising cost fluctuations for the funds mobilised and in case of forex borrowings helps in minimising losses possible due to any exchange rates fluctuations.

-Treasury management will become more complex as constant monitoring of interest rates will be essential due to severe volatility and falling of interest rates. - Risk profiles change over the life of a company thereby necessitating a continous correction of interest rates on borrowings. ( Infra Projects ) - Corelation between forex market and the domestic money market and Integration of domestic and international markets.
- Parking of mobilised funds till deployment
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Investment Objectives
Time Horizon Income Head : Income head under which returns to be realised to have efficient tax management Risk Profile : Acceptable level of risk or volatility Liquidity Geographic and performance benchmark : Is asset / liability matching an important consideration and against which benchmark index should the portfolio performance be evaluated
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Creating Portfolios
Short term / money market index : Call ( Overnight ) money rates,short term treasury bills and commercial paper,basket of money market mutual funds as an index Government Securities :Short term interest rates Co relation to bond prices basket of G-sec mutual funds as an index.
Corporate Bonds : Co-relation to G-secs, Low liquidity and basket of fixed income mutual funds as index
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Investing Procedure
Need Analysis : Cash flow analysis and Bucketing
Recommendation : Investment policy creation , Different portfolios for different buckets, Product selection

Execution
Predefined methods of tracking portfolio

Support
Reporting
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Treasury Products
Rupee Dollar swaps : offers flexibility to convert FC liability to rupee liability
Swaps between fixed to floating across currencies possible Interest rate swaps linked to MIBOR,T-bill yield etc. Provides hedge against anticipated interest rate volatility and reduces costs Easy documentation and procedures
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Avenues for investing funds


Fixed income securities

Mutual funds close ended / open ended


Ready forwarded deal with banks for securities

Treasury bills / bank deposits


Certificate of deposits with banks Commercial paper Inter corporate deposits Bill discounting
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Term debt management


What determines general level of interest rates

Difference between long / medium / short term interest rates


Difference between cupon rates on rated Corporate paper and G-sec securities. Effect of inflation on interest rates

Liquidity preference theory which indicate that a back to back maturity of a bond will not increase the cost but in the event of a maturity mismatch cost would increase
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Inverse Floater Bonds


Interest rate would be the differential between benchmark ( say 14% ) and SBI plr / G-Sec. Back hedged with borrowing which is PLR +
Provides natural hedge

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Corporate Liabilities risk management


Interest rate volatility on outstanding debt Forex change rate risk Raw material prices (Commodities ) Selling prices volatility Investments (Treasury ) Capital purchases Business contracts / performance guarantees

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