IS Valuation Methods IS Valuation Methods - Insights from Capital Markets Theory and - Insights from Capital Markets Theory and Practice – Practice – Institut für Wirtschaftsinformatik J. W. Goethe University Institute of Information Systems J. W. Goethe University Mertonstraße 17, D-60054 Frankfurt am Main [email protected]http://www.wiwi.uni-frankfurt.de/~tweitzel Tim Weitzel, Cornelia Gellings, Daniel Beimborn, Wolfgang König
38
Embed
IS Valuation Methods - Insights from Capital Markets Theory and Practice – Institut für Wirtschaftsinformatik J. W. Goethe University Institute of Information.
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
IS Valuation MethodsIS Valuation Methods- Insights from Capital Markets Theory and Practice –- Insights from Capital Markets Theory and Practice –
Institut für WirtschaftsinformatikJ. W. Goethe University
Institute of Information SystemsJ. W. Goethe University
Advantages and Disadvantages Advantages and Disadvantages of Valuation Methodsof Valuation Methods
Approach Advantages Disadvantages
DCF
- theoretically sound
- not influenced by temperamental market conditions
- appropriate for mature businesses with strong and stable cash flows
- highly sensitive to underlying assumptions for cash flow, terminal value, and discount rate
- terminal value significant part of total value
Comparable
Companies
- based on public information
- market efficiency ensures that results reflect industry trends, risks, growth potential
- value obtained does not include a control premium
- difficult to find truly comparable companies
- trading valuation may be affected by thin trading activities or small capitalization
- stock prices influenced by M&A activity
- result reflects what the market “tells” no matter if it is right or wrong
Valuing IT investments
ROA to the rescue?
How do capital market professionals valuate?
Real options to the rescue?Real options to the rescue?
„challenge of an uncertain future“
business strategy of a company resembles a series of options rather than a single projected cash flow [Trejo 2000]
disregarding management flexibility leads to a systematic undervaluation of companies [Hommel 2000]
survey on IT portfolio of global enterprise finds 27 of 31 projects to contain at least one option [Kennealy/Lichtenstein 2002]
DCF values do not differentiate between possible scenarios (e.g. successful product launch, development of an innovative technology, failure of an innovation)
esp. software design and sourcing strategies are largely processes of decision-making under uncertainty [Sullivan et al. 1999] making ROAs well suited for valuing IS strategies
Applying ROAApplying ROA
idea: include option premium for uncertainty and flexibility
total value of a company NPV (using DCF method) plus option premium (determined using ROA)
examples
option to learn (delay project) option to grow (pilot projects, new markets) option to quit (e.g. source back)
without flexibility
Cash Flows
pro
b
with flexibility
option value
Tiscali valuation using ROATiscali valuation using ROA
Tiscali is valued using the ROA
IPO was priced using trad. methods in October 1999 at €46
theoretical IPO price calculated by the Real Options Group €309
0
100
200
300
400
Net present value of
Fixed-voice line business
plus value of the option to
enter eCommerce
plus value of the option to
expand to Europe
plus value of the option to enter UMTS
Total estimated
value
~80%
€
Status quo of ROA in practiseStatus quo of ROA in practise
extensive personal interviews with investment bankers from Merrill Lynch, Morgan Stanley, Deutsche Bank, Commerzbank
ROA not (yet) applied
complexity problems estimating the underlying parameters lower acceptance analysts lack necessary knowledge clients do not accept this approach as they lack understanding for it
In most cases, a company is valued using the DCF and CC approach
DCF result is often used to check the value based on the CC approach for plausibility
Status quo of ROA in practiseStatus quo of ROA in practise
tendencies to apply the ROA in the field of Equity Research when valuing new emerging technologies, for example in the semiconductor industry
ROA is quite popular within the oil industry
Advantages and shortcomings of ROAAdvantages and shortcomings of ROA
Advantages
incorporates (value of) flexibility, contingency, or volatility
standard finance: higher volatility higher discount rates lower NPV
ROA: higher volatility higher implicit option due to the asymmetry of payoff schemes [Copeland/Koller/Murrin 2000, 428] [Mauboussin 1999]
Shortcomings
practical knowledge not yet widespread
very time-consuming approach
cannot „bargain“ with ROA model
underlying assumptions of the Black-Scholes formula (e.g. known volatility, fixed interest rates, zero dividends) very strict and typically cannot be assumed in reality.
readiness to adapt this method is currently relatively small.
ROA in IS researchROA in IS research
growing ROA community for IS valuation problem
esp. valuing IS flexibility and the associated problem of optimal IT investment time and scope are focused [Taudes/Feurstein/Mild 2000] [Gaynor/ Bradner 2001]
ROA for overcoming deficiencies of controlling theory when applied to network problems (e.g. fair prices for the future production of IS services) [Kargl 2000] [Krcmar 2000] [Emigh 2001] [Riepl 1998] [Wiese 2000]
We will use the ROA as part of a network analysis framework supporting sourcing decisions for financial service providers by modeling the cash flow implications of different IS infrastructures and choice of sourcing partners.
„When NPV was introduced in the mid 1960’s,
it was rejected for having unrealistic assumptions and for being overly complex.”
[Tallon et al. 2002]
AppendixAppendix
examplesexamples
when outsourcing ISIS elements...
...what happens if I reduce my ISIS investments by 20%?
...or increase by 20%?
...what price should I be ready to pay for ISIS services?
...what service levels should I demand from my provider?
what about influence of provider attributes like size, market share, etc.?
What is the “true” underlying value What is the “true” underlying value to new technologies?to new technologies?
Cash) - Debt of ValueMarket Equity of Value(MarketRatioSalestoValueEnterpise
EBIT(DA)
Cash) - Debt of ValueMarket Equity of Value(MarketRatio EBIT(DA) to ValueEnterprise
advantages and disadvantages of multiplesadvantages and disadvantages of multiples
Multiple Advantages Disadvantages
P/E- Simple- Most often applied multiple
- Sensitive to corporate tax rate- Sensitive to capital structure
PEG - Considers future earnings expectations
- Limited applicability if growth ratios low
EV/Sales
- Simple- applicable if no or negative earnings- Facilitates cross-border comparisons
- Ignores financial structures- Does not consider profitability
EV/EBIT(DA)
- Avoids bias caused by different taxation rates, capital structure- Facilitates cross-border comparisons
- Equity value is very sensitive to net debt for highly leveraged companies
CCCC
Empirical evidence:
precision increases using companies with similar historic earnings growth rates (instead of same industry classification)
no improvement from adjustments in risk, growth differences, leverage
better results when using forecasted (not historic) earnings
ROA definedROA defined
ROA employs the financial option theory based on the Black-Scholes formula
idea: option provides the holder with the right, but not the obligation, to sell or buy a specified quantity of an underlying asset at a fixed price, called the strike price.
15
2 64 10 128 14 16 2018 222
10
5
20
25
30 Base case:expected average revenues
Breakeven
„Intrinsic“ value
Real options value
Curve of distribution ofpossible final outcome
In this area, outcomes arepotentially negative, thereforecompany abandons venture,and outcome becomes zero
Equity Value
Expected future revenues
ROA in IS research ROA in IS research
lowhigh
high
flexibility
unce
rtai
nty sensitivity analysis,
simulation
statistical net presentvalue methods(DCF, NPV)
option price methods
dynamic net present value methods,option price methods
low
Applying ROAApplying ROA
1. NPV has to be determined, using the DCF approach
2. build an event tree, based on the set of combined uncertainties that drive the volatility of the company’s value
3. put the decisions that management may make into the nodes of the event tree to turn it into a decision tree
4. valuation of the payoffs in the decision tree using the method of replicating portfolios applying the Black-Scholes formula