In this case study, I will value Galen Holdings PLC, a medium-sized biotechnology company listed in London Stock Exchange (LSE), base on the various valuation methods, and explain the differences in valuation. For the purpose of providing a better understanding of these methods, another three biotechnology companies are used as a comparison. They are Acambis PLC, Celltech PLC, and Skyepharma PLC. Consider the comparability, all these four companies are listed in FT-SE 250.
What is the business value? Before a business is valued the purpose of the valuation must be determined. Different purpose results in different values. There are a lot of purposes to value a business, such as buying or selling a business, transfer shares, employee stock option plan, going public. By the EMH, the business value is determined by the market, which provides a fair value of the business. Simply, a listed company's value is how much you can sell or buy the share in the open market. Thus, this case study will try to estimate the share value of Galen Holdings PLC. What the investors really want to know is why and how the share traded at the real market price, are there any clues about whether the share price will go up or down in the future. In other words, whether there is a fundamental value of a share? Unfortunately, as Crockett (2002) said 'It's not obviously clear'. Theoretically, the fundamental value of a share is estimable. Generally agreed there are three main methods that can be used to valuing a share, that is dividend-discount model (DDM), price/earnings ratio (PE ratio), and the net assets value model (NAV). In the following parts, each of these three methods will be used to test the value of Galen PLC, comparing with the competitors, and the methods employed will be estimated.
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The dividend discount model approach:
First of all, the dividend discount model will be employed to value the company. This model provides a classic formula that explains the underlying value of a share, which believes that the share is worth the sum of all its prospective dividend payments, discounted back to their net present value. There are two formulas can be used, P0=Div/r and P0=Div1/(r-g), where P0 is the present price of the share, Div is the dividend per share, Div1 is the dividend per share at year 1, r is the required rate of return or the cost of capital, and the g represents annual constant percentage growth in dividend per share. The first formula assumed that the company would distribute a fixed figure of dividend per share in the foreseeable following years; the second assumption that the future dividend will grow in the fixed rate per year, which also called the dividend growth model (DGM), and the growth rate is less than the cost of capital. Look at Galen's history dividend; the final dividend was 1.66 pence per share at 25th-Jan-2002, final dividend at 2 pence per share at 24th-Jan-2003, and interim dividend at 1.2 pence per share at 25th-Jul-2003. If it is assumed that the final dividend at 1.2 pence per share at the first of 2004, then it can find that dividend has a growth of around 20% per year (g=0.2). For the required rate of return (r) can be calculated by the CAPM, r=rf + ï¿½(rm-rf), where rf is the return of risk-free, which can be seen as the rate of 3-month treasury bills, according to Financial Times the rate is around 3.8%; rm-rf is the market risk premium which usually assumed as 6%, and according to Yahoo Finance the company's beta is estimated at 1.79. Then the required rate of return is 14.54%.
Also, there is an alternative formula to get the r, r=DIV1/P0 + (1-DIV/EPS) X ROE, where ROE means the return of equity, DIV/EPS is the payout ratio and 1-DIV/EPS equal the plow back ratio. Use the figure collected from the annual report, r=2.4/495 + (1-2/32) X 92042/671959, r=12.90%. Compare both two required rate of return (14.54% and 12.90%) with the rate of dividend growth (20%), one of the assumptions is conflicted, the r should be more than g, so the dividend-discount model is not suitable to value this company. The problems with the dividend-discount model are not that it is wrong; indeed, most economists agree that the theory is fine. The problem is the uncertainty surrounding both its components: the future stream of dividends and the appropriate discount rate. For example, does the zero dividend policy mean the company is no value? Of course, wrong. Look at the other three competitors, zero dividend policy are adopted by all of them, but they are still traded in the market. Furthermore, whether the company can insist on the fixed dividend or growing rate forever? Impossible. Since no one can ensure there always have enough net NPV projects in the future. If no more valuable projects, dividends cannot be maintained. Thirdly, will the required rate of return always exceed the growth rate of dividends? Not always. The Galen group is a good example of this problem. All in one, if shares change in the value, that must be the result of a change in either the prospective dividend flow or the right discount rate, or both.
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