Novell's 'Buy-Out' price - A Case Study in Valuation
If you were a suitor for Novell the question arises as to how you would arrive at a fair market valuation for the company. There are several approaches an analyst can perform to determine a 'buy-out' price for the company. I have completed a "Case Study In Valuation" using the approach IBM did when they purchased Lotus in June 1995.
The basic approach for this study assumes the price to sales ratio. It is commonly
agreeded that software companies are best valued based on the price to sales ratio. For example Microsoft is valued by the market at a 9 price to sales ratio. This is at the higher end of the spectrum. Sybase has a price to sales ratio of 2.5 ( this company has
little or even negative assets if one includes their debt) and is at the lower end . The reason analyst use the price to sales ratio valuation model is that many of these companies have little debt and few fixed capital assets. Book value is NOT (usually) material. The value in the company is the software franchise (ie. customer base) , the dollar sales generated from site licenses (ie.current sales) and potential sales generated from future upgrade releases going forward.
When IBM agreeded to buy out Lotus Corp. for $64/share or $3.52 Billion many analysts on the street believed they had over paid for this company. However, if one adjusted the buy-out price by the book value of the company, IBM really obtained a bargain. At the time of the transaction, Lotus had a book value of $11.52/share (according to Prudential `s company report). 1995 Lotus sales hit $928 million with
1996 estimates of $1 Billion. Lotus had 47.4 million shares outstanding . The total price of $3.53 Billion when adjusted for the tangible assets of $1.03 Billion as defined by their book value ($11.52/share x 47.4 million shares) equals the "Software Franchise" premium. This amount was $2.488 Billion.
To calculate the adjusted price to sales ratio paid for the "Software Franchise" using current 1995 Lotus sales was 2.681 ($2.488/$928 million ). If you use the 1996 analyst earning of $1 Billion the Price to Sales ratio was 2.488. Therefore the average price to sales ratio paid by IBM when adjusted by tangible assets was 2.585. The point of this analysis is you want to look at the price to sales ratio when adjusted for current 'liquid' assets.
Using a similar approach in valuation for Novell:
If one uses the same ratios for Novell based on the adjusted price to sales ratio for Lotus, you arrive at the minimum fair market valuation for the company. To arrive at a fair value for book value for the company, you really have to go through the balance sheet to determine what assets are carried at cost and those that are carried at market. All land and other capital assets are carried at cost. Stock and other equity investments are carried at cost and need to be adjusted to reflect current market prices. Buildings and other longer term capital assets are depreciated at straight line or accelerated basis and for this analysis were adjusted to reflect 80 percent of market.
The major assets carried on the Novell books which are understated are (1) Land and Buildings and (2) stock and other equity investments.
Based on my review, the current adjusted book value of the company including cash and other adjusted to market assets is $6 per share. From my estimate, the current balance sheet understates actual assets by almost $1 per share.
For purposes of this analysis, I assumed current 1996 sales at $1.4 Billion (or $350 million /quarter) and 1997 sales at $1.6 Billion (or $400 million/quarter). One can make arguments for higher or lower numbers based on marketing, site license upgrades,new product releases etc..
The Calculation:
The adjusted price to sales valuation for Novell based on 352 million shares outstanding (as of Q3) would be calculated as follows:
(1) $1.4 Billion x 2.585 = $3.619 Billion/353 million shares = $10.281/share + $6.00 Book Value = $16.281. <<<<<
(2) $1.6 Billion x 2.585 = $ 4.136 Billion/353 million shares= $11.72/share + $6.00 Book Value = $17.717. <<<<<
The valuation range is between $16.25 and $ 17 3/4. As one can see the adjusted price to sales ratio which reflects the premium for the "Software Franchise" affects the valuation significantly. The capital assets are additive. If this company was priced similar to Microsoft it would be valued at $ 46 5/8 per share ($1.6 Billion x 9.00 = $14.4 Billion/353 million = $40.79/share + $6.00 Book Value = $46.79).
Therefore, I hope this provides another way in viewing the Novell asset and at current levels IMO it remains significantly undervalued!
Comments and refinements to the analysis are welcomed. Salah, Joe, Jack, Eric , Jean, Barry, and all....
EKS |
