Cogito

Idea Generation 1: Value Creation and Sustainability

Posted in Uncategorized by qmarks on December 18, 2010

Lately I am obsessed with the “value creation”. The source of this interest is that book Valuation:Measuring and Managing the Value of Companies, from McKinsey.

Even though my exams are over, I could not help myself to head Rotman Finance Lab to search companies that has consistently created values. The first factor flashed on my mind was Return on Equity, which is calculated as Net Income over Total Shareholder’s Equity. But we all know that net income becomes a dirty approach as we move lower in the income statement. It is affected by capital structure decisions, country of domicile where tax rates are different, etc. Instead I will use NOPAT as a proxy. So formula will look like NOPAT/(Total Debt + Shareholder’s Equity) is my ROIC, and WACC adjusted for industry leader’s capital structure and LT cost of capital as yields in 2007.

Assuming ROIC-WACC as a proxy for value creation, The Dun & Brandstreet Corp. was on the top of the list from the SP500 index for the FY2009 with 116%. However for the reasons listed below it does not seem to me that it is sustainable.

Over the last 168 years, DNB database collected 150 million records, it obtains much of the data that they use from third parties, including public record sources. The raise of internet and the availability of information will erode the competitive advantage. Furthermore, In North America, DNB is the market leader in their Risk Management Solutions business (64% of the total revenue in FY09) in terms of market share and revenue. But DNB competes with its own customers’ own internal business practices. So only chance for the company is to offer differentiated product to their  customers. However, once the customer uses that service it may also learn how it was built. That will also erode the core strength of their business model. Going forward I think this value creation is not sustainable. Am I right? I don’t know yet.

DNB: $81.56

My DCF target $125

assumptions:

  • 7.6%, 6%, 5% growth for the next 5 year periods
  • 8.5% WACC
  • 3% LT Growth
  • EV $7,374.37 millions
  • Sensitivity to WACC; 10% -> $93.4, and 11% ->$79.14
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