Summary Advanced Corporate finance and Strategy (FEM11006)

Summary
Advanced
Corporate
Finance
and
Strategy

Week
1:
Introduction


§   Introduction:
Improving
your
decision
making

-­‐   When
valuing
potential
investments,
you
should
not
only
look
at
their
value
today,
but
also
at

the
future
growth
opportunities.
Only
when
you
value
strategies
instead
of
standalone

projects,
you
get
the
complete
picture
of
a
potential
investment's
value.








-­‐   Static
valuation
need
to
be
extended
with:



•   Real
options:
to
value
intertemporal
synergies
(a
first
investment
leads
to
new

opportunities),
flexibility
of
venture
capital
investments,
high-­‐tech
growth
firms,
etc.

•   Games:
pricing
in
bidding
situation

-­‐   In
which
situations
do
we
need
to
go
beyond
DCF
valuation?







1.   Platform
acquisitions:
A
platform
acquisition
may
strengthen
a
company’s
core

capabilities
or
provide
access
to
new
geographical
locations,
creating
a
path
for
future

growth
opportunities.
The
value
of
a
platform
acquisition
is
therefore
not
only
the

standalone
value
of
the
platform,
but
also
the
many
opportunities
it
provides
access
to.

5.   Follow-­‐on
Acquisitions:
The
future
acquisition
opportunities
are
simple
options
and
can

be
taken
in
the
future
if
conditions
turn
out
to
be
favorable.
These
acquisitions
offer

benefits
primarily
through
synergies
or
an
expected
stream
of
earnings
(or
operating

cash-­‐flows)
to
the
company.

-­‐   Explanations
when
rival’s
bid
is
exceedingly
high

i.   Rational
Explanations:
The
value
of
future
opportunities
(real
options)
justifies
the
bid

ii.   Irrational
Explanations:
Price
exceeds
expected
value


→
Confirmation
Bias:
you
didn’t
look
enough
to
information
that
rejects
the
things

you
want
to
do.



→
Over
commitment
(and
you
forget
about
sunk
costs)




1


,§   Corporate
Strategy

-­‐   Value
of
assets
in
place:


→
DCF
analysis
estimates
the
value
of
the
assets
currently
in
place.

-­‐   Growth
option
value

→
The
PVGO
reflects
a
company's
future
options
on
real
assets.

-­‐   Strategic
value


→
Future
opportunities
are
vulnerable
to
rivals'
actions.
Therefore,
we

combine
the
DCF
and
real
options
approach
with
game
theory.

-­‐   Expanded
strategic
present
value
=
NPV
+
PVGO







Market
value
firm

Value
drivers





Valuation
methods



§   Real
options

-­‐   Basic
idea:
you
pay
a
little
bit
for
the
right
to
buy
the
underlying
asset
and
later
on
you
can

decide
whether
to
exercise
the
right
and
pay
the
exercise
price
and
get
the
underlying
value.


-­‐   Real
option
valuation
is
valuable
when
there
is:


1.   Uncertainty

The
conditions
in
the
future
are
likely
to
be
different
than
today’s
conditions.

2.   Flexibility

Wait
and
see
and
only
after
we
know
the
outcome,
or
when
uncertainty
is
resolved,
we

make
a
decision.
This
way
we
can
limit
downward
losses
and
keep
our
upward
potential.

Higher
volatility
is
a
positive
thing.


→
More
skewed
distribution:
active
management
under
uncertainty
where
you
can
limit

the
downward
losses
and
increase
upward
potential
by
future
growth
options.


3.   Irreversibility

Irreversible:
when
the
decision
is
impossible
or
costly
to
reverse.


Irreversibility
under
uncertainty
gives
you
incentive
to
wait
till
the
investment
is
clearly

valuable.



-­‐   Example:
For
a
small
deposit,
Thales
acquired
options
to
rent
out
olive
presses
months
before

the
olive
harvest
season,
when
uncertainty
about
the
harvest's
quality
was
still
high.
His

options
expired
at
the
start
of
the
harvest
season,
at
which
time
he
had
to
decide
whether
or

not
to
exercise
them.
If
the
harvest
had
been
bad,
he
would
not
rent
out
the
presses
and
all
he

would
lose
would
be
his
deposit.
But,
the
harvest
turned
out
to
be
fruitful,
so
Thales
rented
out

the
olive
presses
for
high
prices,
allowing
him
to
gain
high
profits.
By
acquiring
the
options,
he

gained
a
high
upside
potential
and
the
only
downside
risk
was
the
loss
of
his
deposit.





2


, -­‐   With
real
options
analysis
companies
can
estimate
what
an
option
is
worth
by
looking
at
the

future
and
then
reason
back
to
decide
whether
to
invest
in
an
option
today,
or
not.

-­‐   You
can
find
numerous
real
options
in
business
settings:


•   The
option
to
defer
gives
you
the
flexibility
to
delay
investment
decisions
until

circumstances
are
favorable.

•   With
growth
options,
you
open
up
future
opportunities,
forming
a
link
in
a
chain
of

interrelated
projects.

•   With
the
option
to
expand
or
contract,
you're
flexible
to
upscale
or
downscale
projects.

•   With
the
option
to
abandon,
you
can
dispose
unprofitable
projects
completely
and

recover
some
resale
value.

•   With
the
option
to
temporarily
shut
down,
you
can
start
up
again
under
favorable

circumstances.

•   With
staged
financing,
investment
risks
can
be
reduced
by
financing
high-­‐risk
projects
in

stages,
rather
than
all
at
once.
This
allows
you
to
stop
when
the
projects'
performances

don't
meet
their
expectations.

-­‐   Call
Option
with
the
Flexibility
to
Wait







•   The
ability
to
defer
a
project
with
an
uncertain
value
(Vt)
creates
valuable
managerial

flexibility.
If
the
market
demand
develops
favorably
and
Vt
>
It
,
the
firm
can
make
the

investment
and
obtain
the
project’s
net
present
value
at
that
time,
NPVt
=
Vt
–
It
.
If
the

project
value
turns
out
to
be
lower
than
originally
expected
(Vt<It),
management
can

decide
not
to
make
the
investment
and
the
firm
only
loses
what
it
has
spent
to
obtain

the
option.


•   The
curve
illustrates
the
current
value
of
the
option.
The
value
can
be
divided
in
two

components,
the
static
NPV
of
cash
inflows
and
the
timing
flexibility
component
of

value.
The
latter
represents
the
option
value
of
deferment.









3


, §   Option
Games
to
measure
strategic
growth
option
value

-­‐   Options
can
be
exclusive,
but
more
often
you
have
to
share
them
with
competitors.
It
may
not

always
be
advisable
to
follow
a
flexible
wait-­‐
and-­‐see
strategy
from
a
competitive
perspective.


-­‐   To
predict
how
others
might
affect
your
shared
options,
we
use
option
games.



→
Option
games
might
seem
contradicting:
while
options
provide
flexibility,
games
are
based

on
commitment.
The
optimal
investment
timing
under
uncertainty
and
competition
often

involves
a
trade-­‐off
between
wait-­‐and-­‐see
flexibility
and
the
“strategic
value”
of
early

commitment.

-­‐   Expanded
NPV
=
static
NPV
+
flexibility
(option)
value
+
strategic
(game-­‐theoretic)
value.


→
The
option
games
framework
helps
you
assess
what
the
value
of
an
option
is
to
you
and
to

others.
This
way,
you
can
determine
the
optimal
price
to
pay
when
competing
for
an
option.

-­‐   Example
Thales:
imagine
that
someone
else
also
acquired
the
options
to
rent
out
olive
presses.

It
is
essential
in
option
games
to
keep
each
other
in
mind
during
investment
decisions.
Let's
say

there
were
100
presses
available.
If
the
harvest
would
be
fruitful,
the
demand
for
presses

would
be
high.
So,
they
would
both
exercise
their
option
and
share
the
market.
If
the
harvest

would
be
mediocre,
the
demand
for
presses
would
be
average.
Then,
Thales
could
win
the
total

market
share
by
exercising
his
option
first.
If
the
harvest
would
be
bad,
no
presses
would
be

needed
and
neither
of
them
would
exercise
their
option.

→
How
could
Thales
have
valued
this
as
an
option
game?










Combining
real
options
with
games
works
as
follows:
the
tree-­‐like
branches
in
the
first
figure

reflect
uncertainty.
The
end
nodes
represent
a
decision
moment
where
you
either
exercise

an
option
or
not.
To
extend
this
figure
from
merely
real
options
to
option
games,
we
replace

the
decision
moments
by
sub-­‐games.
Each
sub-­‐game
represents
a
moment
where
two

competitors
either
exercise
or
wait.
First,
you
must
consider
what
your
options
can
be
worth

in
the
future,
then
anticipate
what
rivals
will
do,
and
finally,
reason
back
to
decide
whether
or

not
to
invest
today.



Week
2:
Corporate
strategy

§   Value
drivers

-­‐   The
table
below
provides
a
summary
of
the
value
drivers
that
can
help
build
a
strategic

position.
Columns
1
and
2
show
that
a
value-­‐creating
strategy
depends
on
opportunities
or

market
imperfections
in
the
external
environment.
The
position
of
the
firm
is
essential
not

only
for
supporting
competitive
advantage
underlying
the
value
of
assets
that
are
currently
in






4