Article Reviews, Valuation

Damodaran: How to Enhance Firm Value and the Value of Control

I came across this presentation by Aswath Damodaran on the value of control (link here).

It wrote about the different ways to optimize the value of a company, as well as propose a framework to think about the value of control embedded in market prices, transaction prices, and the prices of voting/non-voting shares. Quick summary below:

Four Ways to Enhance the Value of a Firm (under DCF)

  1. Increase cash flows from existing assets
    • Increase after-tax earnings
      • Improve margins by cutting costs or improving efficiency
      • Divest assets with negative EBIT
      • Reduce tax rate
    • Reduce re-investment needs
      • Reduce working capital needs by tightening credit policies and improving inventory management
      • Live off past over-investment
  2. Increase growth rates of the cash flows
    • Improve the return on capital on re-invested capital
      • Increase operating margins
      • Increase capital turnover ratio
    • Increase the rate of re-investment
      • Re-invest more in projects
      • Do acquisitions
  3. Extend the length of the high growth period
    • Find new competitive advantages
    • Build on existing competitive advantages
  4. Reduce the cost of capital
    • Change financing mix
      • Use more debt
    • Reduce default risk (i.e. cost of debt)
      • Match debt to assets (i.e. collateral)
    • Reduce operating risk (i.e. cost of equity)
      • Reduce operating leverage (e.g. lower fixed costs, convert fixed to variable costs)
      • Make products more sticky

Value of Control

  • Market price of every publicly traded firm should incorporate an expected value of control
    • Market value
    • = Status quo value + value of control
    • = Status quo value + (Optimal value – Status quo value) * Probability of management changing

Minority Discount

  • Minority discount should reflect the value of control
    • A controlling stake should be measured as a proportion of Optimal value, e.g. 51% * optimal value
    • A minority stake should be measured as a proportion of Status quo value, e.g. 49% * status quo value
  • Evidence
    • In private company transactions, a control premium of 15-20% is applied for a majority stake over a minority stake.
    • Hanouna, Sarin and Shapiro (2001) found that minority transactions are valued at a a discount of 20-30% on majority transactions in “market oriented” economies like the UK and US but the discount is smaller in “bank oriented” economies like Germany, Japan, France, and Italy.

Value of Voting Rights

  • Value per non-voting share = Status quo value / (# voting shares + # non-voting shares)
  • Value per voting share = Status quo value + (Optimal value – Status quo value) * Probability of management change



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