6.3 Formalización de los conceptos del producto y el ingreso
6.3.4 El ingreso desde el punto de vista de su utilización
Equation 10: Weighted average risk of economic assets
𝑉𝑢 𝑉𝑢+𝑉𝑡𝑥𝑎𝛽𝑢+ 𝑉𝑡𝑥𝑎 𝑉𝑢+𝑉𝑡𝑥𝑎𝛽𝑡𝑥𝑎 = 𝐷 𝐷+𝐸𝛽𝑑+ 𝐸 𝐷+𝐸𝛽𝑒
Source: Koller et al., 2010, p 255
The above equation relates operating and tax assets, the first parts of the equation, with debt and equity. Give the assumption about fixed future capital structure along with an assumed beta of debt equal to zero, equation 9 can be rearranged to provide the following estimation of beta equity:
Equation 11: Equity Beta
𝛽𝑒 = 𝛽𝑢(1 +
𝐷 𝐸) Top competitors Beta(s)
Mattel 0.98 Hasbro 0.95 BANDAI NAMCO 0.75 Takara Tomy Co Ltd 0.93 The Walt-Disney Co 1.21 Average 0.9644
Page 62 of 84 Source: Koller et al. 2010
Under the assumption that unleveraged companies within the industry, face similar operating risks, the operating betas should also be alike. By dethatching the betas from the capital structure, making the all equity financed, we arrive at a unlevered industry average beta on 0.7, calculated through equation 11:
Table 13: Unlevered beta for representative companies, aggregated averages and debt to market capitalization.
Unlevered Calculation Mattel Hasbro
Bandai Namco Takara Tomy Walt- Disney Average
Regression based beta 0.98 0.95 0.75 0.93 1.21 0.96
Debt to equity 2012 0.11 0.30 0.55 1.48 0.18 0.52
Unlevered beta 0.88 0.73 0.49 0.38 1.03 0.70
Source: Own calculations, see: LEGO.Bachelor.xlxs
With the unlevered industry average in mind, usually practitioners would leverage the company to its specific debt-equity ratio, where equity is measured by market capitalization (Koller et al. 2010). Given the private firm structure of LEGO, we cannot observe the market capitalization, restricting this approach. Instead we relay on the average debt equity ratio for Mattel and Hasbro, the two most similar competitors of LEGO, to use as a proxy instead. This amounted to an average debt to equity ratio of 0.2 ((0.11+0.3)/2) in 2012; applying equation 11 this gives a corresponding leveraged beta for LEGO on 0.84. To this value an additionally beta increases has been added, given that LEGO do not reflect the marginal investor, and hence not is fully diversified. Together with the rapid expansion in terms of assets in the near future, they must be assumed to be additionally susceptible to the market environment; as a result we have chosen to add an additional premium to the beta of 0.26 arriving at a total beta of 1.1. This amount reflects the slightly higher volatility to the market, based on that above arguments, that we deem associated with the future for LEGO and its financial performance. Therefore with these estimations in place regarding beta, through equation 6 a cost of equity of 9.02% is calculated (see appendix).
Page 63 of 84
5.4.4 WACC
Now that all the components regarding the weighted average cost of capital are estimated, showed in equation 11, we are ready to estimate the cost of capital for LEGO:
Equation 12: WACC
𝑊𝐴𝐶𝐶 =𝐷
𝑉𝑘𝑑(1 − 𝑇𝑚) +
𝐸
𝑉𝑘𝑒
Source: Koller et. al., 2010
Given our assumption that the market value of both debt and equity equals the book value, we arrive at a WACC equal to 6.61 % for 2013. Due to the recent political decision regarding company tax discussed in the strategic analysis, this rate changes slightly to 6.65 % in 2016.
5.5 Explicit and Continuing value period valuation
Given the complexity and difficulty to correctly estimate future performance, growth in the continuing value period is difficult to assert. Although LEGO currently remains a dominant player in the market, based on the strategic analysis, along with our own subjective opinions, growth premiums above average GDP growth are assumed unreasonable.
Given these uncertainties the average GDP growth are assumed a reasonable approximation for revenue growth beyond the explicit period (Koller et al. 2010). Using the historical values a growth rate of 2.16 % is therefore chosen (Own calculations from Eurostats, 2013).
Return on incremental invested capital is set equal to WACC in the continuing period. Based on the before mentioned arguments; We do not believe that the LEGO group will be able to sustain their competitive advantage and competition will eventually reduce their ROIC to the level of their WACC (Koller et al. 2010).
5.5.1 Projected company value
With the cost of capital in place, along with the estimates for the future development in the respective drivers that make up the future free cash flows, the overall firm value can be projected. This value consists of the aggregated discounted free cash flows for all the explicit years added to the present value of the continuing period. Equation 13 shows the calculation for the present value of the continuing period, by discounting the continuing value after the explicit period to the present value:
Page 64 of 84 Equation 13: Continuing value in period 7
𝐶𝑜𝑛𝑡𝑖𝑛𝑢𝑖𝑛𝑔 𝑉𝑎𝑙𝑢𝑒7 =
𝑁𝑂𝑃𝐿𝐴𝑇𝐶𝑉(1 −𝑅𝑂𝑁𝐼𝐶)𝑔
𝑊𝐴𝐶𝐶 − 𝐺 Source: Koller et al., 2010
Equation 14: Present value of continuing value
𝐶𝑜𝑛𝑡𝑖𝑛𝑢𝑖𝑛𝑔 𝑉𝑎𝑙𝑢𝑒0 = 𝐶𝑉7
(1 + 𝑊𝐴𝐶𝐶)7
Source: Koller et al., 2010
By combining the present value of the continuing period with those of the explicit period, we arrive at a total value for the LEGO Group at 140,433.06 mia, DKK.
This price is estimated to be a reasonable amount, given the assumption made concerning the LEGO group. However, other financial analysts has also tried to value the LEGO group albeit their firm value are significant lower. Sean MacGowan (in Okkels, 2013), who is a toy analysis, believes that the value of the LEGO group is in the area of 20 billion USD (about 114 billion DKK). Analysist, Gerrick Johnson (in Metcalf & LaFranco, 2013), confirms this lower value and goes all the way down to a value about 15 billion USD (about 85.5 billion DKK) and that is after have discounted the value from 17 billion because of the relatively narrow product portfolio. These estimates from professional could lead to believe that our firm value is overpriced but it is hard to conclude based on numbers where we do not know the underlying assumptions. Another reason why these estimates might have been lower, could be due to extrapolations of ratios and prices from their nearest competitors, thereby neglecting some of the intrinsic values captured within our discounted cash flow.
5.6 Competitor comparison
To get a deeper comprehension of the validity of our value we can compare P/E ratio with their competitors. The P/E tells us how high a price investors are willing to pay for earnings. A high P/E ratio will also tell us that the valuation suggests high growth in the future (Investopedia, 2013).
The LEGO group’s P/E ratio is 21.38, high compared to their main competitors, Mattel and Hasbro, who have a P/E of 17.8 and 16.04 respectively. Whilst the average P/E of Mattel, Hasbro, Disney and Bandai Namco’s arriving at 16.7; putting the LEGO group well over. The high P/E of the LEGO group could suggest that we have valued the organization too high.
Page 65 of 84 However, we do believe that if the LEGO group was available on the stock exchange their price would be high because of the growth potential, above market growth, and strong market position they hold.
Table 14: Competitors P/E ratio
Source: Bloomberg and own calculations, ‘’Beta’’ in LEGO.bachelor.xlsx
5.7 Sensitivity analysis
The sensitivity analysis contains various scenarios and how these affect the firm value. In the scenarios there is assumed that all parameters not indicated are held fixed from original level.
5.7.1 Scenario 1: Change in WACC
The first scenario will contain an overview of what will happen to the firm value if there is a change in the weighted average cost of capital. A change in WACC could happen through a different capital structure, unforeseen change in the risk free rate or in the risk premium. Graph 10 shows what the firm value would be in case of different WACC’s-
Source: Own calculation, ‘’Sensitivity analysis’’ in spreadsheet
Company P/E ratio 2013
Mattel 17,80
Hasbro 16,04
Walt Disney 17,91
Bandai Namco 15,06
Average 16,70
Page 66 of 84 As we can see from the graph, a change in WACC would have serious effect on the firm value. A higher WACC would decrease the value significantly. This emphasizes the importance of cheap cost of equities and debt, as this allows for greater firm value.
5.7.2 Scenario 2: Change in revenue growth in the explicit period
The second scenario contains an description of what happens to firm value when there is a change in the revenue growth in the explicit period. There is assumed the same rate of revenue growth through the explicit period.
Source: Own calculation, ‘’Sensitivity analysis’’ in spreadsheet
From graph 11 we can see that an increase in revenue growth would have a large effect on the firm value. This also confirms that a too skeptical view on the revenue growth or to optimistic view would have serious implication, which is why the revenue growth estimation have to be done carefully or else the firm value will be either undervalued or overvalued. In a practical situation the revenue growth should be a bit skeptic because you do not want to pay for unrealistic growth.
Page 67 of 84
5.7.3 Scenario 3: Change in net-profit margin
In our analysis, we have not based our NOPLAT on a net-profit margin ratio but on several ratios, which would give a net-profit margin. In this analysis, it is assumed that NOPLAT is based on net-profit margin and graph 12 displays how a changing market affects the firm value.
Source: Own calculations, ‘’Sensitivity analysis’’ in spreadsheet
It would have been easier to forecast on a net-profit margin instead of several line items, because it would be easier to reduce an over-performing net-profit margin, compared to the market. Along with profits aligning towards the level of competitors. Graph 12 illustrates how a lower net-profit margin would significantly reduce the firm value.
Page 68 of 84
6. Conclusion
The goals throughout this thesis were to analyses the strategic and financial performance of LEGO, so as to arrive at a concrete tangible value. This has been achieved through a variety of acknowledged theoretical framework within strategic analysis, along with valuation
frameworks from within enterprise-discounted cash flow, each of which merits its own strengths and weaknesses discussed in the theory section.
Analyzing the strategic environment highlighted the extend to which LEGO is affected by both the general market externalities along with the internal company specific issues. Here it was found that although difficult global financial performance, LEGO has managed to grow and capture market shares; however facing increasing constraints as further growth are restricted by the economical development on especially their core markets in Europe and America. In relation to growth, the skewed global sales distribution, relaying heavily on cultivated
markets, both acts as a liability and opportunity for future expansions. We further argued that their historical results were achieved through excellent operating performances along with good value added, analyzed via the value chain. This revealed their effective utilization in connection with their production facilities, along with relevant concurrent market strategies allowing them to retain its dominant position with in the construction toy market.
Externally LEGO face increased competition as entrants into the construction toy market, join in on the lucrative market. LEGO has however successfully navigated their competitors, but we still assumed a somewhat pessimistic view, that eventually prices would decline as essentially similar products drive up competition; driven by competitors such as Mattel, Hasbro and Mega Brands.
Further externalities such as demographics along with political and societal factors accounted within the PEST framework, highlighted the future demographic composition of their target audience, painting a somewhat ambiguous picture as fertility rates decline, whilst average income increase. The strategic analysis was sub-concluded by summarizing these individual items within a brief SWOT table.
Page 69 of 84 Within the valuation analysis, the strategic conclusion was extrapolated helping estimate future developments along with the historical financial ratios. Here it we firstly reformulated the financial income statements along with balance sheets, so as to prepare them for the enterprise discounted cash flow model. This involved determining and separating operating and non-operating items within the aforementioned sheets so as to correctly forecast future value only related to LEGO.
Secondly followed an historical analysis, where we uncovered items such as return on invested capital, along with other measures showing impressive growth and superior performance in relation to their competitors. This analysis was continued with accounts regarding invested capital and net operating profit less adjusted tax. Furthermore an
efficiency analysis was conducted showing, that LEGO have managed to generate higher asset and inventory turnovers than their competitors.
Combining these inputs forecasts about the future value was estimated. An explicit period of seven years was chosen, as this was the time period in which we felt that we could give relevant estimations. Most importantly was the estimation of future revenue, as this drives almost every line item. With an expected growth rate around 8 % in 2013, eventually reaching a market growth of 4 % in 2019, this is a major reduction compared to previous years. By calculation the additional line items based on these revenue estimations future free cash flows and net operating profits was determined.
Finally to arrive at the overall firm value, we calculated a weighted average cost of capital equal to 6.61 % changing slightly during the explicit years due to changes from lower corporate taxes. Using this cost of capital to discount free cash flows a total firm value of 140,433,06 billion DKK was estimate, which hypothetically would make the world’ largest toy manufacturer.
Page 70 of 84
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