In the previous section, a short-term shareholder value creation has been investigated based on multiple divestment announcements. In this section, the value effect behind one specific
divestment will be evaluated by the use of a case study in a longer time perspective. The fertilizer company, Yara, has announced a carve-out of its industrial nitrogen business, known as one of Norway’s largest equity carve-outs. The objective in the case study is to evaluate whether the remaining company and the new carved-out company together yields a higher value than Yara as a consolidated firm. This evaluation raises the opportunity to test the phenomenon behind the conglomerate discount. It is worth mentioning that at first glance, Yara may not be regarded as a fully conglomerate. However, the company has developed a diverse operation in various business areas and may therefore somehow be considered a conglomerate. In order to answer the section’s two sub-questions, a profitability-, liquidity- and strategic analysis will be conducted to better understand the industry and the value drivers of Yara, for the purpose of creating a proper
valuation. These analyses, in addition to the findings in Section 2, will support the investigation of the possible motivation behind Yara’s carve-out decision. In addition, these analyses will be used as a basis for the forecasting assumptions that subsequently builds the valuation process.
4.1.1 Scope and limitations
The scope of this section involves answering the two sub-questions regarding the possible motives behind Yara’s carve-out decision and find the fair value of each company in order to examine whether Yara is traded at a conglomerate discount. Although there might be several benefits of being a conglomerate, this thesis will discuss the theory behind the conglomerate discount and therefore the benefits will not be the main focus in this study. Further, the case study will apply the information, literature, and valuation methods the authors find relevant. Information brought to use in the calculations of this section is based on financial data as of December 31, 2019 retrieved from the annual reports 2012-2019. The thesis has not taken any qualitative information published after mid-February (February 14, 2020) into account. This date is therefore the information stop date for this study. However, even though the annual report of 2019 was published after the information stop date, only the financial data and the information concerning these figures are included. Hence, information in the 2019 report regarding future expectations after mid-February is excluded. The reason behind this relatively early information stop date is the ongoing Covid-19 pandemic that has significantly impacted the economy and businesses worldwide. As the world is currently in the midst of an economic crisis, with uncertain and unpredictable prospects that not even the most acknowledged economists can predict, the effects of the virus are excluded in the valuation. Thus, a calculation of the enterprise value (EV) of each company will be conducted at the information stop date (February 14, 2020). The market value (EV) of Yara of this date seems to be undisrupted and not affected by the virus, as the value is in line with the average EV in
February and YTM. After all, the authors of this thesis consider it valuable to include such an important topical event. Therefore, a valuation of the two companies including the impact of the coronavirus, with information stop date as of March 31, 2020 will be conducted in a scenario analysis at the end of this section.
Similar to Section 3, the scope in this section is narrowed down to only include Norwegian divestments. However, unlike the other sections, this section focuses solely on one specific divestment type, namely a carve-out, and investigates its value effects for the vendor company as well as the divested part. Further, the valuation is based on publicly available information, and information regarding the scope of the ongoing carve-out is especially limited due to its
confidentiality. Yara gives partly “abbreviated” financial information, meaning that the allocation of accounting items to the segments in the annual reports is limited. Therefore, the valuation in this thesis is based on a number of conditions and assumptions, making the estimates more uncertain.
A justification of these assumptions will be discussed in detail throughout the section.
4.1.2 Methodology
A case study research method is preferred for understanding the how and when questions to gain insight into unexamined phenomena in a real-life context. A case study can test a theory and includes both quantitative and qualitative data (Yin, 2009). In this section, a case study will be used to describe and explore the theory of conglomerate discount and investigate potential value of conducting a carve-out. Besides, this section will also include aspects related to the understanding and interpreting of the reason behind Yara’s carve-out decision by exploring potential motives. A case study is therefore ideal for answering parts of the problem statement, as the carve-out of Yara is a real-life and unexamined case.
To determine the value of a firm, several valuation models- and methods can be applied. There are various present value approaches which estimate the value of a company or investment, such as the dividend discount model and the economic value-added model. These models are based on analysts’ projections of the future cash flow and discount factors, that reflect the future risk and the time value of money (Petersen & Plenborg, 2012). Since all the present value approaches yield exactly the same value, only the discounted cash flow (DCF) model is applied, as this is the most frequently applied present value approach and widely used by practitioners (Petersen & Plenborg, 2012). This model will be the primary valuation approach brought to use to answer the last sub-question of this section. The combined value of the separate company will be obtained through a
“sum-of-the-parts”-valuation (Petersen et al., 2017), and consequently compared with the market value of Yara as a consolidated company. In order to create higher validity, A DCF-model of Yara as a consolidated company will also be conducted for comparison of the combined DCF value and the market value. The valuation process, including a determination of the forecasted free cash flows and the Weighted Cost of Capital (WACC), will mainly follow the theories from Petersen &
Plenborg (2012), Petersen et al. (2017), and Sørensen (2012).
As a supplement to the DCF-model, the value of the two separate companies will be estimated through a relative valuation method, by using multiples. The multiple analysis will calculate
NewCo’s and RemainCo’s EVs from reported earnings with the corresponding multiples of the peer groups (Petersen & Plenborg, 2012). These values will thereby be compared with Yara’s current market value. In addition, a stress-test will be conducted to compare the findings in the multiple analysis and the DCF-models (Koller et al., 2015). The basic idea behind using multiples is that similar assets should be sold for similar prices and various multiples express how much the market values each stock (Koller et al., 2015). This is different from the DCF-model, which to a larger extent relies on the analysts’ own projections and evaluation of the company (Petersen &
Plenborg, 2012). The multiple analysis will mainly be based on theories from Petersen & Plenborg (2012) and Koller et al (2015).
As mentioned, there are several other valuation methods relevant for this thesis. Option based valuation has been considered which, opposed to the DCF-model, takes into account different scenarios arising for a company’s investments (Petersen & Plenborg, 2012). Although there are uncertainties regarding Yara’s fertilizer investment projects, an option based valuation may be more applicable for industries such as biotech or oil that need more flexibility in projects during economic downturns (Petersen & Plenborg, 2012). As the valuation method is resource intensive and requires detailed information which is not available in the financial statements of Yara, it will not be applied in this study.
4.1.3 Literature review
The findings in Section 2 and the overall assessment of Yara in this section will contribute to answering the second last sub-question regarding possible motives behind Yara’s carve-out decision. Additionally, the last sub-question of the problem statement involves testing whether the two separate companies yield a higher value than Yara as a consolidated company. This involves testing the concepts of conglomerate discount. The post-war period experienced a significant increase in M&A and was dominated by the diversification and conglomeration trend (Shleifer &
Vishny, 1991). A conglomerate is defined as “a corporation made up of a number of different, seemingly unrelated businesses”, and diversifies risk by participating in different markets (Chen, 2019a). In the 80s, the diversification process reversed to focusing on greater specialization
through a divestment movement, as companies moved from rigid models of large conglomerates to more flexible business models to better respond to the disruptive environment (Whale, 2015).
The disadvantages of the conglomerate structure are widely discussed, and various studies show evidence of conglomerates being traded at a discount ranging from 5-15%, compared to the sum of its parts (EY, 2019). Although there are benefits of being a conglomerate, the discount can arise from different sources involving complexity, lack of synergies, inefficient allocation, cost of
additional management layer and limited transparency (Wilson, 2015; Kose & Ofek, 1995;
Servaes, 1996), which are many of the motives behind divestments found in Section 2. The Italian conglomerate, Vivendi, is an example of a company that experienced this kind of discount. In fact, due to its complexity, the company was traded at a conglomerate discount of 15%, according to analysts (Credit Suisse, 2017), while the shareholders and the chairman anticipated an even
varies across regions. While the conglomerate discounts are found to vary around 10% in North America and Western Europe, 9% in Asia excluding Japan, and 12% in CEEMA regions, the report found evidence of a premium of 12% in Latin America. This was possibly due to the low number of conglomerates in the latter area.
Historically, there are multiple evidence of successful divestments creating value for shareholders.
The forest company, Weyerhaeuser, has conducted various divestments since 2004 and has ended up producing some of the highest returns in its sector. Other examples are when General Electric successfully divested 117 business units during a period of only four years (Mankins et al., 2002)., and when Fiat Chrysler Automobiles carved-out Ferrari through an IPO in 2014, which later increased shareholder wealth (Sterling, 2016). Further, the large conglomerate of Textron also experienced the success of divestments by building up extensive divestiture expertise through the sale of 41 businesses, resulting in significant dividends to its shareholders (Mankins et al., 2008).
This was also the case, when both Yara and Hydro outperformed the market a couple of years after Yara was carved-out from Hydro in 2004, which will be discussed later in this section.