Readings This session equity valuation class will be taped starting September 9,and the lectures are accessible in multiple ways. You can get the supporting lecture notes by clicking on the pdf files below - the pages covered by each lecture are provided next to each lecture.
My not-so-profound thoughts about valuation, corporate finance and the news of the day! Bataan Death March or Turnaround Play? The quintessential conglomerate, with a presence in almost every part of the global economy, it seemed to have been built to withstand economic shocks and was the choice for conservative Damodran country risk analysis, scared of the short life cycles and the volatile fortunes of its tech challengers.
Unlike other aging companies like Sears that have decayed gradually over decades, GE's fall from grace has been precipitouswith the rate of decline accelerating the in the last two years. As a new CEO is brought in, with hopes that he will be a savior, it is the right time to both look back and look forward at one of the globe's most iconic companies.
The company that Edison founded inEdison General Electric, was combined with two other electric companies to create General Electric in The company established its first industrial lab in and it would not be an exaggeration to say that it revolutionized not just the American home, with its appliances, but changed the way Americans live.
For much of of the twentieth century, though, GE remained an appliance company, though it made forays into other businesses. It was inwhen Jack Welch became the CEO of the company, that the company started its march towards what it has become today. The Market History The first place to start, when looking at GE, is to see how markets have viewed it, over its life.
Skipping over the first half of GE's life, the graph below looks at the growth and recent decline of GE's market capitalization over time: As you can see, GE was a solid but unspectacular investment from toand exploded in value in the s and s, with Jack Welch at its helm, and reached its most valuable company in the world status in Under Jeff Immelt, his successor, the stock continued to do well, but it dropped with the rest of the market as the dot com bubble burst, but then recovered leaving into the crisis.
That crisis was devastating for the company and while it did recover somewhat in the years after, the bottom has clearly dropped out in the last two years, with Jeff Flannery at the top of the company. In keeping with our earlier market cap assessment, between andGE was a good but not exceptional company, delivering solid revenue growth and decent margins.
Jones helped the company navigate through the turbulent period of high inflation and oil prices, holding margins steady and delivering double digit revenue growth. Welch made himself the stuff of legendby doubling margins and pushing the company to the top of the market cap ranks by the time he left the firm.
His successor Jeff Immelt faced the unenviable task of following Welch, but managed to keep revenues growing and delivered high margins untilwhen the bottom fell out for the company.
The Business Mix Shift To understand GE's current plight, we have to go back to Welch's tenure as CEO, when he remade the firm, by moving it away from its domestic and manufacturing roots and giving it a global and multi-business focus. GE's biggest leap during that period was into the financial services business, and one reason Welch was attracted to the financial services business was its capacity to generate high profits with relatively little investment.
Inwhen the crisis hit financial service firms had, GE was significantly exposed, and in the years since, GE has retreated not just from the financial services business but also from its entertainment bets with the sale of NBC to Comcast and from the appliance business now owned by Haier.
GE's current business mix, broken down into more detail, is shown in the pie chart below: Replacing income in each business with a normalized value computed using the average margins in each business between and improves the return on capital at the power and renewable energy businesses, but the overall conclusion remains the same.
GE, as a company, does not look good, but it does have significant value creating businesses. Corporate Life Cycle While there are different ways of framing GE's current standing, I will use the corporate life cycle, since it encapsulates the challenges facing the company.
GE's light bulb moment might have been in Thomas Edison's lab inbut at an official corporate age of years, GE is an ancient company and its problems reflect its age.
Other than renewable energy, all of GE's businesses are mature or declining, and by the laws of mathematics, GE itself is a mature to declining company. Any story that you tell about GE going forward has to reflect this reality, and there are three possible ones that can lead to different values.
If GE at its peak represented the glory of conglomerates, its current plight is a sign of how far conglomerates have fallen in the world. Across the world, multi business companies are finding themselves under pressure to break up and in many cases, their stockholders will be better off if they do.
To gain from a break up, though, here are some of the things that have to be true. The different businesses have to be separable, since leakages and synergies across businesses can make it more difficult to cleave off pieces to sell or spin off.
On this count, GE is probably on safe ground, since its businesses other than GE Capital are self standing, for the most part, with little in terms of cross business effects. There have to be potential buyers who are willing to pay prices for the pieces that exceed what they will generate as value for the holding company, as going concerns, and those higher prices either have to come from potential synergies or changed management.
None of GE's businesses seem alluring enough to attract multiple bidders, willing to pay premium prices, and given GE's shaky bargaining position, it is more likely than not that a rush to unload businesses will do more harm than good.
Corporate Waste at HQ: A large chunk of the corporate overhead has to viewed as wasteful, with a big drop in corporate expenses accompanying the breakup. Since GE will be trying to sell these businesses to buyers today, this is a pricing and not a valuation exercise, and I have estimate a pricing for GE's businesses below, using an EBITDA recomputed using the average operating margin in each business over the last five years to compute operating income and allocating corporate expenses to the divisions, based upon revenues.
The problem, though, is that fire sales of entire companies almost never deliver the expected proceeds, as buyers, recognizing desperation, hold back. In fact, GE's attempts to extricate itself from a portion of its Baker-Hughes investment in the last few days show that these sales will occur at a discount.
The second choice for GE is to retrench and perhaps renew itself, not as a growth company, but as a stable, high margin company in businesses where it has a competitive advantage.
To get a better sense of what the businesses would be worth, as continuing operations, I valued each of GE's business, using simplistic assumptions: I used the sector cost of capital for each business, set growth in the next five years equal to revenue growth in each of GE's businesses in the last five years and normalized operating income based upon the average operating margin that each of GE's businesses have delivered over the last five years:In this paper we want to perform a systematic analysis and critical discussion of his CRP concept.
It will turn out that Damodaran’s concept of a country risk premium (CRP) is of no relevance in academic circles, has no theoretical basis neither is the CRP concept empirically supported.
For the regional averages, I use a simple average of the total and country risk premiums by region For the weighted averages, I use the World Bank GDP estimates from the most recent year.
prefer not to scale the default spread. feelthefish.com provides free access to a comprehensive and transparent country risk framework and country risk analysis. Thus, the risk premium for Argentina would be: Risk Premium = U.S.
premium + % Country ratings measure default risk. While default risk premiums and equity risk premiums are highly correlated, one would expect equity spreads to be higher than debt spreads.4/4(1). (Updated for Fall class). Part II: Relative Valuation and Private Company Valuation: This is a pdf file and works well if you have an iPad or tablet to read it on If you have trouble printing this file, download the powerpoint file.
Aswath Damodaran is a professor of finance and David Margolis teaching fellow at the Stern School of Business at New York University.
He teaches the corporate finance .