Valuation of Danisco - PUREpure.au.dk/portal/files/37376894/Valuation_of_Danisco.pdf · Valuation...
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Valuation of Danisco A DCF and Real Option-Based Analysis of the Biofuel Business Master Thesis Author: Kristinn Helgi Guðjónsson Study nr: 402948 Supervisor: Baran Siyahhan Submission: Aarhus, June 1 st 2011
Transcript of Valuation of Danisco - PUREpure.au.dk/portal/files/37376894/Valuation_of_Danisco.pdf · Valuation...
Valuation of Danisco A DCF and Real Option-Based Analysis of the Biofuel Business
Master Thesis Author: Kristinn Helgi Guðjónsson
Study nr: 402948
Supervisor: Baran Siyahhan
Submission: Aarhus, June 1st 2011
Table of Contents
1 Introduction .................................................................................................................. 1 1.1 Problem Statement ........................................................................................................ 1 1.2 Delimitation ..................................................................................................................... 3 1.3 Methodology ..................................................................................................................... 3 1.4 Structure ............................................................................................................................ 5
2 Company Profile .......................................................................................................... 5 2.1 Danisco´s History ............................................................................................................ 5 2.2 Product Range ................................................................................................................. 6 2.3 Food Ingredients ............................................................................................................. 7
2.3.1.1 Bio Activities .................................................................................................................................... 7 2.3.2 Industrial Biotechnology ..................................................................................................... 8 2.3.2.1 Bio Chemicals Projects ................................................................................................................. 8
2.4 DuPont Offer ..................................................................................................................... 9
3 Historical Performance .......................................................................................... 10 3.1 Revenue Growth ........................................................................................................... 13 3.2 NOPLAT ............................................................................................................................ 14 3.3 Invested Capital ............................................................................................................ 15 3.4 Return on Invested Capital ........................................................................................ 15 3.5 Free Cash Flow ............................................................................................................... 17 3.6 Stock Price and Ownership ....................................................................................... 18
4 Strategic Business Analysis .................................................................................. 19 4.1 Market Definition and Revenue Analysis ............................................................. 19 4.1.1 Enablers .................................................................................................................................... 21 4.1.2 Cultures ..................................................................................................................................... 21 4.1.3 Sweeteners .............................................................................................................................. 22 4.1.4 Genencor ................................................................................................................................... 23
4.2 Boston Consulting Group Growth Share Matrix ................................................. 24 4.3 Competiton Analysis .................................................................................................... 25 4.4 Porter´s Five Forces ..................................................................................................... 27 4.4.1 The Threat of Potential New Entrants ......................................................................... 27 4.4.2 The Intensity of Competitive Rivalry ........................................................................... 28 4.4.3 The Thread of Substitute Products ............................................................................... 29
4.4.4 The Bargaining Power of Customers ............................................................................ 29 4.4.5 The Bargaining Power of Suppliers .............................................................................. 29
4.5 PEST Analysis ................................................................................................................. 30 4.5.1 Political Factors ..................................................................................................................... 30 4.5.2 Economic Factors .................................................................................................................. 30 4.5.3 Socio-‐Cultural Factors ......................................................................................................... 31 4.5.4 Technical Factors .................................................................................................................. 31
4.6 SWOT Analysis ............................................................................................................... 32 4.6.1 Strengths ................................................................................................................................... 32 4.6.2 Weaknesses ............................................................................................................................. 33 4.6.3 Opportunities .......................................................................................................................... 34 4.6.4 Threats ....................................................................................................................................... 35
5 Cost of Capital ............................................................................................................ 35 5.1 Cost of Equity ................................................................................................................. 36 5.2 Risk Free Rates .............................................................................................................. 37 5.3 Beta ................................................................................................................................... 38 5.4 Market Premium ........................................................................................................... 40 5.5 Cost of Debt ..................................................................................................................... 40 5.6 Cost of Operating Leases ............................................................................................ 41 5.7 WACC ................................................................................................................................. 42
6 Forecasting Performance ...................................................................................... 43 6.1 Base Case Scenario ....................................................................................................... 43 6.2 Best Case Scenario ........................................................................................................ 44 6.3 Worst Case Scenario .................................................................................................... 45
7 Calculating and Interpreting Results ................................................................ 46 7.1 Value in the Base Case Scenario .............................................................................. 46 7.1.1 Operating Value ..................................................................................................................... 46 7.1.2 Enterprise Value .................................................................................................................... 46 7.1.3 Equity Value ............................................................................................................................ 47
7.2 Additional Scenarios ................................................................................................... 47 7.3 Sensitivity Analysis ...................................................................................................... 48 7.4 Multiples Analysis ........................................................................................................ 49
8 Real Option Approach ............................................................................................ 50 8.1 Identifying a Real Option ........................................................................................... 50
8.1.1 Cellulosic Ethanol ................................................................................................................. 50 8.1.2 Political Support .................................................................................................................... 53 8.1.3 DuPont Danisco Cellulosic Ethanol ............................................................................... 54
8.2 Static Financial Model Development ..................................................................... 55 8.3 Cost of Capital ................................................................................................................ 55 8.4 Volatility Estimation .................................................................................................... 56 8.4.1 Ethanol Price ........................................................................................................................... 58 8.4.2 Production Price .................................................................................................................... 58 8.4.3 Monte Carlo Simulation ...................................................................................................... 59
8.5 Framing the Real Option ............................................................................................ 60 8.6 Option Analytics, Simulation and Optimization ................................................. 61 8.6.1 Option to Abandon ............................................................................................................... 61 8.6.2 Option to Expand .................................................................................................................. 62
9 Conclusion .................................................................................................................. 64
Bibliography ..................................................................................................................... 67
Appendix A – Historical Performances ................... Error! Bookmark not defined.
Appendix B – Forecasted Performance .................. Error! Bookmark not defined.
Appendix C -‐ Financial Ratios .................................... Error! Bookmark not defined.
Appendix D – WACC ....................................................... Error! Bookmark not defined.
Appendix E – Scenarios ................................................ Error! Bookmark not defined.
Appendix F – Real Option ............................................ Error! Bookmark not defined.
List of Figures
List of Tables
List of Equations Equation 1 – Return on Invested Capital .................................................................... 10
Equation 2 - Free Cash Flow ....................................................................................... 10
Equation 3 - Operating lease asset value ..................................................................... 11
Equation 4 – Weighted Average Cost of Capital ........................................................ 36
Equation 5 – The Sharpe-Lintner CAPM model ......................................................... 37
Equation 6 – The Market Model ................................................................................. 38
Equation 7 - Geometric Brownian Motion .................................................................. 57
Equation 8 - Natuarl Logarithm of the Cash Flow ...................................................... 59
Equation 9 - Natural Logarithmic Present Value Returns ........................................... 59
Equation 10 - Real Option Up Movement .................................................................. 60
Equation 11 - Real Option Down Movement ............................................................. 60
Equation 12 - Risk Neutral Probability ....................................................................... 60
Equation 13 - Abandonment Option ........................................................................... 62
Equation 14 - Risk Neutral Value of Node ................................................................. 62
Equation 15 - Expansion Option ................................................................................. 63
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1 Introduction
In this paper an evaluation of the Danish food ingredients company Danisco will be
performed. Danisco has been going through a period of considerable changes since
2005. The company has among others things acquired the biotechnology company
Genencor as well as selling of the Flavour and Sugar divisions, divisions that
represented a big share of Danisco´s revenue. Danisco is currently in the process of
being taken over by DuPont for DKK 700 per share. The objective of this paper will
be to evaluate Danisco´s business and estimated if the value of DKK 700 per share
represents a fair value of Danisco.
Valuing a company is an important analytical tool and is relevant for all stakeholders.
Unlike accounting earnings, which only show short-term performance for the
shareholders, value is better and more thorough measurement on companies past
performance and future prospects.
The market value of a company does not always have to represent the company´s fair
value, given that the market is less than perfectly informed. Market bubbles often
occur because investors forget about how to measure value properly. A good example
of that is the Internet Bubble that burst in 2000, where dot-com companies were
largely overvalued. In that case expectations for Internet companies were out of the
ordinary and Internet companies got overvalued as a result.
A good company doesn’t always represent a good investing cost at the stock market.
A company that has performed well historically might have future great performance
built in its market value. That is why many investors choose to invest in companies
that have performed worse and therefore often have less expectation built in their
share price. Those companies have more upside potential and are already expected to
turn in bad or mediocre performance. In many ways Danisco fit´s that bill perfectly,
being an underachiever and therefore might be a good investment cost.
1.1 Problem Statement
The objective of this paper is to evaluate Danisco in order to find out its fair price. In
the beginning of the year an offer was made from DuPont for all existing shares of
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Danisco. The first offer made was 665 DKK but that offer was then increased to 700,
due to good results in 2nd and 3rd quarter of Danisco´s 2010/11 financial year. A great
majority accepted the improved offer and Danisco is now in its takeover process.
The fair value found in the report will shed a light on whether the takeover bid is
reasonable for Danisco´s shareholders. To find its intrinsic value, Danisco´s historical
performance will be analysed to prove insights into the company´s future
performance.
In a discounted cash flow model (DCF) valuation, managerial flexibility is not
considered. Flexibility can be important if outlook changes, especially in new
industries, so that managers can make decision, whether to continue or not,
depending on information arising. In emerging businesses like the biofuel business a
real option valuation could be more appropriate than DCF analysis. A real option
analysis will be conducted based on the future of biofuel business (2G), This process
will reveal the value of flexibility that comes along with the development of a new
product which cannot be determined with a common and static net present value
(NPV) analysis. The main research questions may therefore be formulated as:
- What is the fair value of the company?
- Should shareholders have rejected the DuPont offer?
- How valuable is the flexibility of the biofuel project?
- What are the differences between DCF and real option valuation in the
case of biofuel industry?
A fair value of a company is mainly driven by its ability to generate cash and future
growth potentials. To be able to understand the developing and growing industry in
which Danisco operates, the industry has to be examined in order to estimate the
future growth potentials. To understand the industry, in which the company operates,
a strategic analysis will be carried out, the main questions that the strategic analysis
will answer are:
-‐ What external factors are influencing the growth and profitability of
Danisco´s industries and which are the most important for future
growth?
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-‐ How is the competitive environment in the industry and what are the
main competitive forces?
-‐ What are the strengths and the weaknesses of Danisco and what
opportunities and threats does the food ingredient and biotechnology
industry pose for the future?
-‐ How are the future growth prospects of Danisco´s industries?
-‐ What are Danisco´s the main growth drivers?
1.2 Delimitation
Defining and writing a paper like this inevitably requires some delimitation due to
irrelevance and limited resources. The valuation of Danisco is performed externally
so no internal information was available other than disclosed in official reports.
Furthermore, due to lack of information, many assumptions, regarding the net present
value (NPV) and volatility estimation in the real option analysis had to be made.
It is unrealistic to demand an absolute certainty in valuation, all assumption made
during the valuation process are made in the best of knowledge and are deemed
reasonable and largely approximate reality in a satisfying manner
Inflation and exchange rates issues limit the scope of the study and the forecast is
made given a steady state. More precise assumption about inflation and exchange
rates would maybe give a better forecast of the company´s future revenue and
competitive advantages but were regarded to complex to involve.
At the time this paper was written Danisco was sold to DuPont. All assumptions
made in the paper for the future however are based on Danisco alone, not the merged
company of DuPont/Danisco.
1.3 Methodology
In order to find fair value of Danisco the historical performance have to be analysed
and future performances forecasted. The financial statements from previous years are
reformulated to disaggregate the three main components of the business, operating,
non-operating and financing. The method that will be used is the DCF model and as
the name suggests it discounts future cash flow in order to find the present value. The
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discounted factors are gathered by finding weighted average cost of capital (WACC),
which is supposed to represent cost of capital for the company, both cost of debt and
equity.
When valuating companies there are several different models available, for example
economic profit model, adjusted present value model (APV) and equity DCF. When
correctly applied, those methods all should all have the same outcome.
The DCF has the advantage that it focuses on ROIC and growth, the things that drive
value, and relies solely on the cash flow in an out of the company rather than on
accounting based earnings. For that reason the DCF model remains the favourite of
practitioners (Koller, Goedhart, & Wessels, 2010). In Danisco´s case the DCF is also
a good choice because of its long-term growth potential and the absence of
meaningful valuation peer group.
A special notice will also been given to the DuPont Danisco Cellulosic Ethanol
(DDCE) joint venture with DuPont. In order to capture the value of this great
potential venture, a real option approach (ROA) will be used to put a value on the
flexibility that is so important in a high uncertainty project like this.
A project like the DDCE is filled with uncertainty, with passage of time these
uncertainties often become resolved and managers can take the appropriate decision
regarding the project. Those decisions might be to abandon, expand or even just let
things go on unchanged. The reason that ROA is needed is because it adds a dynamic
perspective to the traditional valuation approach by incorporating the value of
flexibility and growth opportunities in an uncertain environment. In the DCF model
decisions are made now, and cash flow streams are fixed for the future. The ROA can
be described by the formula (Boyer, Christoffersen, Lasserre, & Pavlov, 2001):
!"#$"%&'( !"# = !"#"$% !"# + !"#$%& !"#$%&$ !"#$ !"#$%& !"#"$%&%#'
However, not all projects can be valued by ROA. The following five requirements
have to be satisfied in order to perform ROA (Mun, 2006, p.38):
- A financial model must exist
- Uncertainty must exist
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- Uncertainties must affect decisions when the firm is actively managing
the project and these uncertainties must affect the results of the financial
model
- Management must have strategic flexibility or options to make mid-
course corrections when actively managing the projects
- Management must be smart enough and credible enough to execute the
options when it becomes optimal to do so.
There are multiple methodologies that are used to calculate option’s value. In this
paper the binominal lattices method will be used. The binomial lattices method is the
most mainstream one, mostly because it’s easy to implement and easy to explain.
Further introduction on the ROA will be made in chapter 8.
To analyse Danisco´s business strategy the following frameworks will be used: PEST
analysis, Porters Five Forces, Boston Consulting Group Growth Share Model and
SWOT analysis. In order to perform external analysis a PEST and Porters Five
Forces analysis will be used, to perform internal analysis the Growth Share Model
will be used along with Danisco´s divisions revenue analysis. The SWOT analysis
will then be used to conclude the analysis with overall view of the strengths,
weaknesses, opportunities and threats that possesses Danisco at the present time.
1.4 Structure
The thesis structure consists of introduction in chapter 1 which is followed by a
company profile in chapter 2. In chapter 3 historical performances will be analysed
and then in chapter 4 a strategic business analysis will be performed. In chapter 5
there will be a cost of capital calculation after which the forecast is made. In chapter
7 results will be calculated and analysed. In chapter 8 ROA will be performed and
then the conclusions will be made in chapter 9.
2 Company Profile
2.1 Danisco´s History
Danisco is among world leaders in food ingredients and biotechnology market,
having a first or second position in every sector they operate in. The company was
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formed in 1989 when the two old C.F. Tietgen companies Danish Sugar and Danish
Distillers merged with Dansk Handels- og industry Company. The newly formed
company was immediately listed on Copenhagen Stock Exchange.
In light of CEO changes in 1997, with Ald Dutch-Pedersen as the new CEO, Danisco
decided to change its focus. Danisco decided to focus on becoming global food
ingredients company instead of being regional conglomerate on a wide range of
consumer products.
In 1999 Danisco acquired the Finnish
ingredient company Cultor. The acquisition
was a stepping stone for Danisco in their quest
of becoming a global player in the food
ingredient business. With the acquisition of
Danisco they also received 42% ownership in
Genencor, which then became fully owned in
2005. With the full acquisition of Genencor,
Danisco also became a large force in the
biotechnology market.
In order to sharpen its focus Danisco has also
been divesting divisions that they don’t see as
a core division or have not been performing well enough. In 2007 Danisco divested
the Flavour division for DKK 3.36 billion , corresponding to 2.2 times revenue in
2006/07. In 2009 they then sold of one of its larger divisions when they sold Danisco
Sugar for DKK 5.45 billion to the German Nordzucker AG. (Danisco, 2011)
2.2 Product Range
Danisco delivers bio-based food ingredients to thousands of customers worldwide,
including the world’s leading food manufacturers. With the acquisition of Genencor
in 2005 Danisco also became the second-largest developer and manufacturer in
industrial enzymes. In the industrial enzyme market Genencor and Novozymes
occupy around 70% of the total market, Novozymes being the larger of the two by
some margin (Novozymes, 2011, p. 12).
Source: Danisco Annual report, 2010
Figure 1 – Danisco´s Guidelines
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Figure 2 - Organizational structure
2.3 Food Ingredients
Danisco´s structure is based on food ingredients and industrial biotechnology. Within
the food ingredients part of Danisco the divisions are three:
Enablers: The enablers division has three main production platforms they are
emulsifiers, gums and stabilizers. Emulsifiers are used bind oil and water. Often used
in bread, cakes, margarine and ice cream and to reduce fat and salt or remove trans
fat. Gums and stabilizers are used as thickening, gelling and stabilizing agents and to
bind water, making it viscous or gel-like. They are also used to reduce sugar, fats and
carbohydrates. Gums and stabilizers are used in chocolate milk, drinking yoghurt and
jam (Danisco, 2011).
2.3.1.1 Bio Activities
The Cultures and Sweeteners division make a health and nutrition cluster called Bio
Activities. The cluster was made because of Danisco´s vision to be recognized as a
leading edge company in health and nutrition. Danisco decided to enhance their focus
on health and nutrition as they see it as a key market driver for the future.
Cultures: Cultures are used to acidify milk in the production of cheese, set milk and
yoghurt, probiotics for gut, immune respiratory and digestive health. They are also
used as a feed protection (Danisco, 2011).
Sweeteners: Sweeteners are used to replace sugar and add or enhance the taste of
dairy products, ice cream and low-calorie products. Sweeteners are often used for
Source: Danisco Annual report, 2010
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oral health or prebiotics and fibres for improved gut health and digestion. Danisco´s
main product within this division is xylitol, which is among others used in sugar free
gum (Danisco, 2011)
In order to improve efficiency within the food ingredients Danisco added a new
organisational unit in 2010 called Logistic Food Ingredients (LOGFI). It is supposed
to handle the logistics of finished goods and supply in food ingredients.
Sales division called Sales and Application Food Ingredients (SAFI) handles sales for
the food ingredients. But it does not only serve as a sales division but it also is
suppose to serve as a link between customers and Danisco. SAFI is supposed to work
with customers in order to give consumer insight, which can lead to product
innovation specifically made with the customers needs in mind.
2.3.2 Industrial Biotechnology
Within the industrial biotechnology part of Danisco is a one division, Genencor.
Genencor was fully acquired in 2005 and has since then been growing rapidly.
Within the Genencor Division there are also two Bio Chemicals Projects, DDCE and
BioIsoprene, who are both have a high growth opportunity if development will be
successful.
Genencor: The division designs and operates cell factories that produce enzymes
and other functional proteins that provide customer solutions for a range of
industries. They for example make enzymes for detergents and dishwashing, make
enzymes for bioethanol and carbohydrate processing along with making enzymes for
bred, feed and brewing applications.
2.3.2.1 Bio Chemicals Projects
DuPont Danisco Cellulosic Ethanol: In 2008 Danisco and DuPont formed a 50/50
joint venture in the biofuel business, when the two companies founded DDCE. With
this new company Danisco and DuPont were joining forces to take a lead in a
business that is expected to be high growing for the next few years. The joint venture
was expected to cost USD 140 million in investment over the first 3 years. The aim
was to have commercial demonstration facility by 2012.
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BioIsoprene: In 2008 Danisco also joined forces with Goodyear, when the two
companies announced plans to make BioIsoprene. BioIsoprene is a bio-based,
renewable alternative to petroleum-based isoprene, a key component of rubber. The
aim of the project is to manufacture BioIsoprene at industrial scale by 2013. For the
first three years the project was expected to cost approximately USD 50 million and
additional investment was expected for pilot plant operations and manufacturing
infrastructure. There is a great market potential for high purity BioIsoprene, Danisco
estimated it is about 1.7bn. lbs/yr ≈ USD 1-2 bn and could possible increase up to up
to 11 bn. lbs/yr (LaDuca & Roeck, 2008).
2.4 DuPont Offer
On January 10, 2011 it was announced that DuPont had made a binding offer for
Danisco. The offer price was DKK 665 per share, which was a 25% premium to
Danisco´s closing price on January 7, 2011. The board recommended that the offer
would be accepted. For the offer to go through 90% of shareholders had to accept it.
Danisco´s biggest shareholder at that time was ATP with 5.1% of the total share
capital. It was also announced in the wake of the offer that one of Danisco´s main
competitor DSM owned a 4.95% stake in Danisco (Westervelt, 2011). DSM
announced that they had no intentions to make a competing offer with DuPont.
DuPont’s offer was not expected to be challenged by another company because of the
risk of competing with Danisco´s most important strategic partner1.
As soon as the offer was made, voices of disappointment started to be heard amongst
Danisco´s institutional shareholders that thought the offer did not represent a fair
value. U.S. Financial investor Elliott International L.P. raised its stake in Danisco to
more than 10% and demanded the offer to be improved (Hansegard & Hansen, 2011).
The voices of discontent then got even louder when Danisco announced impressive
3Q results in the middle of March. As DuPont had no other option than to improve
their initial offer, given that Elliot International L.P. would reject their initial offer,
DuPont decide on April 29th to increase the offer by 5% to DKK 700 per share. While
1 As DuPont and Danisco are working together in the DDCE joint venture.
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they improved the offer they also lowered the amount of votes that had to accept
from 90% to 80%.
On May 16, it was announced that DuPont had successfully completed the tender
offer for Danisco. The offer had been accepted by 92.2%, which was well above the
required acceptance (DuPont, 2011). With the merger a leader in industrial
biosciences and nutrition and health has been created.
3 Historical Performance
Before the future prospects of the company can be forecasted it is important to take a
good look at historical performances. To analyse the future accurately a
reformulation of past financial statements is needed. The reason for the reformulation
is that traditional measures of performance, such as return on equity (ROE) and
return on assets (ROA) do include non-operating items and financial structure that
impair their usefulness.
The DCF method however is based on finding return on invested capital (ROIC) and
free cash flow (FCF), both of which represent only the operating part of the company
and are independent of the company´s financial structure. To find ROIC, which
shows the return from operations on invested capital from all investors, the net
operating profit less adjusted tax (NOPLAT) is divided by invested capital.
Equation 1 – Return on Invested Capital
!"#$ =!"#$%&
!"#$%&$' !"#$%"&
NOPLAT represents profit from operations available to all investors and invested
capital is the required capital from all investors to fund operations. The FCF shows
the cash flow gained through operations after the investment in new capital has been
deducted.
Equation 2 - Free Cash Flow
!"! = !"#$!" + !"#$%&ℎ !"#$%&'() !"#$%&$& − !"# !"#$%&'% !" !"#$%&$' !"#$%"&
To reformulate the annual reports, the notes in the annual reports were used
extensively to get as accurate solutions as possible. The period that was reformulated
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thoroughly was chosen to be from 2004/05 to current financial year 2009/10. The
reason for this specific period is that analysis further back would give limited
information because of the frequent changes in Danisco´s business for the past
decade, such as acquisition of Genencor and divestment of the Sugar and Flavour
division.
In the analysis of Danisco there are several accounting issues that require special
attention. These are:
Operating lease: When a company leases an asset, they don’t have to record it as an
asset or a liability. Instead they add the rental charges to the income statement.
Therefore a company that leases assets instead of buying them will seem to be
“capital light”. In order to make up for that in our reformulation we have to capitalize
the leased asset. The value of the leased assets is estimated using the following
equation:
Equation 3 - Operating Lease Asset Value
!""#$ !"#$%!!! =!"#$%& !"#!$%!!
!! +1
!""#$ !"#$
Where !! represents cost of debt. As lease obligations are considered to be less risky
than the company’s unsecured debt, since operating leases are secured by the
underlying asset, a different risk premium was estimated for operating lease than
other debt. Operating leases are estimated to have less risk premium than Danisco´s
other debts. The fair risk premium was found to be 0.65% (AA rated)2, which is
0.45% lower than risk premium on Danisco´s other debt. The leased assets are mainly
buildings and production plants and for that reason an estimated asset life of 20 years
was found to be appropriate.
This action will influence ROIC and leverage ratios, for instance invested capital will
increase and because of that ROIC will decrease. This should however not have
impact on valuation as the drop in ROIC will be accompanied by a drop in the cost of
capital and increase in debt equivalents. (Koller, Goedhart, & Wessels, 2010, p. 577)
2 The debt rating table can be seen in table 10 on page 40.
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Capitalized R&D: For an innovative company like Danisco, that has large amount of
intangible assets, failure to recognize the R&D asset can lead to a significant
underestimation of the companies invested capital. And thus overestimate the
companies ROIC.
In order to recognize this asset, a capitalization of R&D is needed. Capitalization of
R&D is recommended for three reasons (Koller, Goedhart, & Wessels, 2010, p. 593):
- To represent historical investment more accurately
- To prevent manipulation of short-term earnings
- To improve performance assessments of long-term investment
When capitalizing, the historical R&D expense is added to each other and then
amortized accordingly. In the amortization, a lifetime of 12 years is considered
reasonable as an average asset´s lifetime. The amortization is 8.33% of the preceding
year´s ending balance.
Because of many acquisitions and divestments over the last few years, especially the
sale of the Flavour and Sugar divisions and the acquisition of Genencor, historical
R&D cost perhaps does not represent the true amount that has been spent in R&D.
For that reason capitalized R&D cost can be under- or overestimated but as there is
no better measurement historical R&D expense is the closest estimate and is expected
to be the best proxy.
Operating cash taxes/operating taxes: Reported taxes are affected by non-operating
items such as interest expense. For valuating purpose adjustments have to be made to
calculate operating taxes. The first adjustment made is to eliminate one-time and non-
operating taxes from reported taxes. The next adjustment is to adjust taxes for each
non-operating item the company reports on its income statement between EBITA and
earnings before taxes. The final step is then to convert operating taxes to operating
cash taxes by adding the changes in net operating deferred taxes.
Because of acquisitions and divesments, changes in operating deferred taxes were not
only organic. For that reason a clean measure of cash taxes was impossible and
operating taxes were used rather than operating cash taxes.
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Other receivables: In the annual reports, other receivables are reported as non-current
and current. For valuating purposes, adjustment has to be made to separate operating
and non-operating receivables.
Goodwill and acquired intangibles: In order to be able to evaluate ROIC with and
without goodwill, adjustments have to be made on goodwill and acquired intangibles.
Reported goodwill and acquired intangibles have to be adjusted upward in order to
capture historical amortization and impairment cost.
Deferred tax: Deferred taxes arise from differences in how investors and the
government account for taxes. As they are both operating and non-operating they
have to be divided into three groups:
- Tax loss carry-forwards, which is treated as non-operating asset
- Operating deferred tax assets and liabilities, which is treated as equity
equivalent
- Non-operating deferred tax assets and liabilities, are treated as an debt
Other payables: In the annual reports, other payables are reported as non-current and
current. Adjustment has to be made to separate operating and non-operating payables.
Cash and cash equivalents: When reformulating the balance sheet it is important to
exclude excess cash from invested capital, as excess cash is unnecessary for core
operations. In order to find out how much is working cash a rule of 2% of revenue is
used. (Koller, Goedhart, & Wessels, 2010, p. 145)
Pension: No adjustments were made on pension assets and liabilities. But it is worth
mentioning that Danisco has a pension liability at a fair value of DKK 946 million
but pension asset only at a fair value of DKK 835 million which means that there is
about DKK 107 million gap, rising from DKK 63 million the year before.
3.1 Revenue Growth
When looking at historical revenue and revenue growth, it is visible that the revenue
has been unstable and decreasing for the last 11 years. One of the reasons for that is
the constant change that has been on Danisco´s business during that period.
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In 2005/06 revenue
growth was 17%,
majority of it being
attributable to the
acquisition of
Genencor, although
food ingredients had
organic growth of 5%
whilst sugar sales recorded a 3% decline. At this time there were difficult trading
conditions because of pending EU sugar reform that eventually lead Danisco to the
decision to divest the sugar division. In 2006/07 revenue decreased 3% plus a
negative impact of 7% because of the divestment of flavours division. Although total
revenue decreased by 3%, food ingredient had an organic growth of 5% while sugar
sales recorded a 11% decline. The 2007/08 drop in revenue is mainly because of the
divestment of the sugar division. The food ingredients had a organic growth of 5%
that financial year.
Looking at the last three years, since the sale of the sugar division, there is a steady
growth, 5.9% compounded annual growth rate (CACR), and according to the first
three quarters of the 2010/11 that growth trend seems to be continuing. Further
revenue analysis will be made in the next chapter.
3.2 NOPLAT
NOPLAT represents the
income generated from the
company’s operations that is
available to all investors.
Like revenue growth,
NOPLAT has been rather
unstable for the last six years
going from DKK 2.504 million DK in 2005/06 to being only DKK 1.036 million in
2008/09. This was caused by the divestments made during that time. The financial
year 2008/09 was a bad one, but followed by an impressive 79% increase between
2008/09 and 2009/10.
Figure 4 - NOPLAT
Figure 3 – Historical Revenue
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3.3 Invested Capital
Invested capital
represents the total
capital needed from
all investors to fund
operations. Invested
capital with and
without goodwill has
been decreasing for
the last six years. The divestments made at the period are well noticeable in the years
2007/08 and 2008/09 in figure 5.
3.4 Return on Invested Capital
ROIC is a good
measurement on how well a
company has been
performing, it shows the
ratio between operating
income in relation to
invested capital. ROIC
without goodwill is a good
measurement to compare the company with it´s peers, while ROIC with goodwill
shows the company´s ability to create value from it´s acquisitions (Koller, Goedhart,
& Wessels, 2010, p. 165).
As mentioned earlier, R&D cost and operating leases were capitalized. The effects of
the capitalizations of R&D and operating leases is that invested capital increases and
hence ROIC decreases.3
3 Even though ROIC and leverage ratios changes when R&D and Operating Leases
are capitalized the company´s valuation should not be affected. “A drop in ROIC will
be accompanied by a corresponding drop in the cost of capital and increase in debt
Figure 5 - Invested Capital
Figure 6 - Return on Invested Capital
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Since profit is measured over the entire year, whereas invested capital only at one
point per year, an average of starting period and ending period invested capital is
applied.
Because of the divestments of the Flavour and Sugar division adjustments, the ROIC
in 2005/06 and 2006/07 is underestimated. The reason for the underestimation is that
in the financial year 2006/07 the revenue from the Flavours division is recognized as
profit from discontinued operations and therefore is not included in NOPLAT.
However the invested capital for that year still has assets that are a part of the
Flavours division and therefore those two financial years are underestimated, 2006/07
more so than 2005/06 because the Sugar division was considerably larger.
Figure 7 – ROIC Tree
For the last five years, ROIC with goodwill and acquired intangibles has been 10%
on average. In figure 7 a comparison can be made on ROIC and its main drivers.
Until last year ROIC had steadily been falling. The reason for the decrease in ROIC
is because of decrease in capital turnover, which suggest lower efficiency, and in
profit margin. The restructuring of the company with the acquisition of Genencor and
divestments of the Sugar and Flavour division has taken its toll. The on going
struggle with unprecedented volatility in raw materials and worldwide economical
crisis has not helped either. Volatility on raw materials is among things that have had
a negative impact on the profit margin. In 2009/10 Danisco were able to increase
both profit margin end capital turnover impressively.
equivalents. The net effect will leave the equity valuation unchanged.” (Koller,
Goedhart, & Wessels, 2010, p. 577)
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3.5 Free Cash Flow
As mentioned earlier free cash flow is defined as:
!"! = !"#$%& + !"#$%&ℎ !"#$%&'!" !"#$%&$& − !"#$%&'$"&% !" !"#$%&$' !"#$%"&
As the equation above shows, FCF is the after tax cash flow generated by operations
available to debt and equity holders. Figure 8 shows the FCF after goodwill for the
past five years. However, years 2007/08 and 2008/09 are only estimated numbers but
not actual numbers. The reason for that is that the divestments of the sugar and
flavour division caused
an artificial drop in
many items on the
balance sheet. That
artificial drop needs to
be adjusted so that the
FCF after goodwill only
shows changes in the
operating part of the
company. An adjustment was made for capital expenditures for both financial years
because sufficient information was at hand. An adjustment in the amount of DKK -
576 million in 2007/08 and DKK -2894 million in 2008/09 was made and the
numbers moved to “cash flow from discontinued operations”. However, sufficient
information was not available to adjust “investment in operating working capital”.
For that reason the investment was estimated to be 0 and the calculated investment
was added to “cash flow from discontinued operations”.
Although NOPLAT was higher during the financial years 2005/06 and 2006/07 than
in 2009/10, the financial year 2009/10 showed a much higher FCF. That is mainly
because of lower rate of investment. In 2009/10 Danisco sold off operating working
capital instead of investing like in previous years. The capital expenditure was also
DKK 576 million in 2009/10, which is lower than usual.
Figure 8 - Free Cash Flow
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3.6 Stock Price and Ownership
The last seven years have been an experience of mixed emotions for Danisco´s
shareholders. In figure 9 the total share return is presented by comparing start and
end of the year prices.
In order to compare
the return with its
competitors Danisco´s
peers have been split
into two groups
Biotechnology (DSM,
Novozymes and ABF)
and Food Ingredient
(Tate & Lyle, Kerry
Group and McCormick & Co). Danisco had three straight years of negative return for
their shareholders but the stock price has since then been increasing rapidly. In
comparison with the peer group averages, Danisco´s fluctuations are much deeper.
The only year Danisco does not go in the same direction as the peer groups, is in
2006 where Danisco´s share price declined by 1% while the peer groups increased its
share price by 16-21%. The influences of the financial crisis in 2008 are obvious and
in that year the deepest decreases are visible.
It is also interesting to compare
changes in the share price since
the DuPont offer was first
submitted. The first offer from
Danisco of DKK 665 million had
a 25% premium over the current
market price that had been rising
rapidly over the past two years. The second offer of DKK 700 million was a 5%
increase of the first offer and had a firm deadline on the 13.05.2011. When looking at
peer companies share changes, in the time since the first offer was submitted and
until the second offers deadline, it can be said that the 5% improvement of the second
Figure 9 - Shareholders Return
Table 1 - Stock Returns in 2011
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offer was only the bare minimum given the good results from the 3Q and increases in
peer companies’ shares.
4 Strategic Business Analysis
In this chapter an external and internal analysis will be made on Danisco´s strategic
business environment. To perform internal analysis a growth share matrix developed
by Boston Consulting Group (BCG) will be used. Historical revenue analysis will
also be performed.
In order to perform external analysis a PEST and Porters Five Forces analysis will be
used. PEST stands for Political, Economic, Social and Technical. The model provides
a useful framework for analyzing the external pressures on Danisco. Porter´s Five
Forces was formed by Michael Porter in 1979. The framework uses five micro-
environment forces in order to determine the competitive intensity and therefore
attractiveness of the market. The five forces used are the threat of an entry from new
competitors, the threat of substitute products or services, the bargaining power of
customers, the bargaining power of suppliers and the intensity of competitive rivalry.
To finish the strategic business analysis a SWOT analysis will be performed. SWOT
analysis is used to evaluate Strengths, Weaknesses, Opportunities and Threats of the
company. The SWOT analysis is supposed to sum up the main advantages and
drawbacks in Danisco´s business.
4.1 Market Definition and Revenue Analysis
Danisco is competing in two main markets,
the food ingredients and industrial enzymes.
Danisco has a strong market position in
every field it is competing on with first or
second positions in all of them. The
estimated size of the food ingredients market
is around USD 24 billion (DKK150 billion)
and has been growing at a rate of 3-5% annually. The area that Danisco operates
within has a total market share of around USD 10 billion (DKK 60 billion) with
Table 2 - Danisco´s Ambitions
Source: Danisco 3Q report, 2011
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Danisco being the largest within that space (Danisco, 2010, p. 21). Danisco´s
competitors in the food industry include Cargill, Kerry Group, Huber, Cognis, Chr.
Hansen and ABF. Three of four divisions in Danisco are in food ingredients,
Enablers, Cultures and Sweeteners.
Table 3 - Danisco´s Competitive Position
The industrial enzyme market is a fairly consolidated one, with Danisco (21%) and
Novozymes (47%) sharing around 70% of the market. (Novozymes, 2011, p. 12)
Other competitors include DSM, AB Enzymes, BASF and a range of niche players.
In 2010 the total market value was approximately USD 2.9 billion (DKK 18 billion)
growing at an average of 6-8% annually.
Growth rates tend to be relatively higher in
emerging markets. Danisco is well positioned to
capitalize on that as Danisco is a global company
and gets it´s revenue from all over the world.
Europe and North America are Danisco´s largest
market as they represent approximately 77% of its
revenue. Asia Pacific is also a large market with
about 17% of Danisco revenue coming from
there. Since the financial year 2004/05 sales from Northern and Latin America have
increased the most but that increase is by large part because of the acquisition of
Genencor, which was an American company.
Figure 10 - Revenue by Region
Source: Danisco Annual report, 2010
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4.1.1 Enablers
Table 4 - Enablers Revenue Analysis
The Enablers division is the largest segment of Danisco´s business, representing
around 41% of its total revenue. The segment has shown steady organic growth
between 2-6% for the past few years. In 2009/10 Danisco had only 2% organic
growth which is below its target of 3-5% but at the same time increased its EBIT
margin impressively from 11,7% in 2008/09 to 16,2%. The impressive increase in
margin was mainly due to combination of a better product mix, internal cost
containment measures and favourable external factors. On top of that, the previous
year had been negatively affected by volatile and sharply increased input costs.
The first three quarters of the new financial year are looking very promising with
organic revenue growth of 7% and EBIT margin of 17%, which is an 1,4% increase
from the same period last year and 0,8% increase from the financial year 2009/10.
According to Danisco´s management it is believed that Enablers are currently having
a peak performance period (2010/11) and those margins are not sustainable in the
long term.
4.1.2 Cultures
Table 5 - Cultures Revenue Analysis
In Cultures Danisco is the second largest player with Chr. Hansen being the leader.
The Cultures segment account for approximately 15% of Danisco´s total revenue.
This division has been improving every year for the last 4 years and the financial year
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2009/10 was the most impressive so far, surpassing its targets with 10% organic
growth and an EBIT margin of 19%. The impressive EBIT margin increase was
driven by positive production mix and faster than expected conversion of part of
Genencor´s Rochester site into cultures production. (Danisco, 2010, p. 12)
This impressive development has continued for the first three quarters of 2010/11,
where organic growth has decreased a little, or to 7%, but EBIT margin has continued
its grow and is now 21,6%.
The Cultures division is currently increasing its capacity in order to support the
continuing strong demand. In addition to the Rochester conversion there are more
expansion plans in the making in both Europe and America. Cultures have an
estimated market growth of 5-7 % (Saadane-Oaks, 2010).
4.1.3 Sweeteners
Table 6 - Sweeteners Revenue Analysis
The Sweeteners division has not performing well for the past few years. After a solid
year in 2006/07, revenue sharply decreased and in 2009/10 the division is thought to
have hit rock bottom with 6% organic decrease in revenue and only 1,4% EBIT
margin before special items. One of the main reasons for this downfall is the
significant drop in the segments main product, xylitol, which dropped both in volume
and price. In 2008/09 it declined by more than 20% year over year (YOY).
Xylitol is a core product having a global market of around DKK 1 billion. Most of
Xylitol usage is in chewing gum, but it is also used in bakery, dairy and oral care.
Due to Chinese low-cost producers, the Xylitol market went from being insufficiently
supplied to being intensely competitive in only couple of years.
In order to try to stop this decline, Danisco decided to replace the segments top
management in March 2009. Significant impairment charge of DKK 460 million was
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made on goodwill that year and followed by another DKK 700 million goodwill
impairment charge the year after, which leaves no goodwill left for the segment.
With 9% organic growth in revenue and 8,1% EBIT margin in the first three quarters
of the financial year 2010/11, the recovery seems to be well on way. Danisco´s
management is encouraged by this turnaround and is positive for its future prospects.
4.1.4 Genencor
Table 7 - Genencor Revenue Analysis
As mentioned before, Danisco acquired Genencor in 2005, setting in motion period
of changes for Danisco that lead to the sale of the Flavour and Sugar division.
Genencor accounts for around 33% of Danisco´s total revenue. As for most other
divisions, last year was the most impressive one with organic growth of 12% and an
EBIT margin of 13,5%, which was an improvement from the last year but still far
from the 17% target. The high growth percentage was among others because of high
growth in bioethanol production and animal nutrition.
The first three quarters do look good for Genencor with 9% organic growth and EBIT
margin of 17,3% that is according to target set by Danisco. For the first three quarters
all major products areas were contributing to organic growth.
Genencor is also
involved in two bio
chemical projects with
Goodyear and DuPont
who are still on early
stages but have both
high growth potentials.
Those projects are Source: Danisco annual report, 2010
Figure 11 - Industrial Enzyme Market Growth
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decreasing the EBIT margin, without BCP the EBIT margin for Genencor so far in
2010/11 would be 18,6%.
Within the industrial enzymes market the highest growth is in the fuel ethanol where
the market growth has been around 15-20% per annum. Novozymes and Genencor
are by far the biggest players on the 1st generation biofuel market as Novozymes has
60% share and Genencor 30% share (UBS, 2010). The largest sectors within
industrial enzymes are food, animal nutrition and fuel ethanol.
4.2 Boston Consulting Group Growth Share Matrix
The Boston Consulting Group (BCG) developed a matrix where company´s products
were categorised into four groups, cash cow, star, problem child and a dog.
The cash cow is represented as a product with high market share but with low market
growth. Therefore the product generates high cash flow but does not require much
cash to keep it´s market share.
The dog is on the other hand a product with low market share and a low market
growth. BCG recommended that this group is divested to cut losses.
The problem child is defined as a product with low market share but high market
growth. This product requires far more cash than it generates. If the cash is not
supplied then the product will not keep up with the market, fall behind and eventually
fade out. The problem child needs a large amount of cash in order to increase its
market share.
The star is a product that has high market share and high market growth. The product
should turn profit and may or may not generate all the cash it needs. When market
growth slows down the star will be a cash cow and generate cash.
According to BCG no product can grow indefinitely so every product becomes either
a cash cow or a dog. The BCG also states that every company needs a mixture of
products with different kind of growth rates and different market shares (Mintzberg,
Ahlstrand, & Lampel, 1998).
Danisco´s divisions placement in the matrix:
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Enablers: By using the matrix on Danisco´s divisions and trying to place them in
some of the groups the Enablers divisions can be defined as a cash cow. The reason
being that growth is fairly low and Danisco has a leading position within that sector.
Cultures: The Cultures division is defined as a star with a high growing market and a
leading market share.
Sweeteners: The Sweeteners division is defined as cash cow because it is the market
leader and the market is growing at a low pace. However there are also arguments for
defining them as a dog because though Danisco has a leading market position within
the Sweeteners market, it has struggled to keep a high profit.
Genencor: Genencor is a division in a high growing market and has the second best
market share. In the growth share matrix Genencor is defined as a star, however there
are also arguments for defining the division as a problem child as the division is
currently far behind the leader Novozymes and therefore the competition with them
about market share will be difficult.
Figure 12 –Growth Share Matrix
4.3 Competiton Analysis
It´s not easy to compare Danisco with its competitors because even though it has
many competitors it lacks peers. The reason for that is how wide Danisco´s business
divisions are ranging, from sweeteners in chewing gum to developing cellulosic
ethanol and detergents.
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Here is a quick introduction on Danisco´s main competitors:
- Novozymes: World leader in industrial enzymes with approximately 47% market share (Novozymes, 2010). Almost all its revenue comes from enzyme sales, with Detergent and Technical Enzymes divisions being the largest.
- DSM: DSM is a global manufacture of nutritional and pharmaceutical products, performance materials and industrial chemicals. The company is the third largest player in the industrial enzymes market with approximately 6% market share (Novozymes, 2010). It does also compete in the cultures and sweeteners divisions.
- Kerry Group: Kerry Group is a global food, ingredients and flavors producer. Around 67% of its revenue is generated from the sales of food ingredients and flavors (Kerry Group, 2011). The rest is generated from the sale of consumer foods.
- Chr. Hansen: Chr. Hansen is the leader in the Cultures division with approximately 62% of its revenue generated from cultures and enzymes, and the remaining 38% from Health & nutrition as well as Colors & Blends (Chr. Hansen, 2010).
- BASF: BASF is one of the largest chemical companies in the world and is competing amongst other in the food enzymes market. In 2009, BASF acquired one of Danisco´s competitor when it acquired Cognis. The unified company is also a competitor in the enablers market.
As can be seen from the descriptions above, Danisco´s competitors are involved in a
wide market and have many different concentration areas. For that reason it is
difficult to compare for example the profit margin for Danisco and Novozymes, the
reason being that Danisco operates in areas where the margins are thinner, such as in
the Sweeteners and the Enablers division. It would be more appropriate to compare
Novozymes profit margins with Genencor´s. In table 7 Genencors profit margins are
shown in order to compare them with its main competitors Novozymes and DSM.
Novozymes is an outstanding company and has performed exceptionally for the last 5
years, always being able to show a high level of organic growth, except in 2009,
where it had only 2% organic growth but kept high profit margins. By the looks of
the profit margins, it seems that market share is the key for higher margins, which
can be expected given that they get economies of scale in terms of distribution and
production price. Novozymes also has by far the highest percentage of R&D, which
is reasonable given that the biotechnology demands more innovation than the food
ingredients market in which both Danisco and DSM operate.
When comparing Danisco with other food ingredients companies like Kerry group,
BASF/Cognis and DSM, the companies seem to be similar. In 2009 whilst DSM and
Kerry group had decreasing revenues, Danisco had an impressive 12% organic
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growth. The profit margin is similar between the companies and Danisco has the
highest R&D as a percentage of revenue.
When comparing the companies from a value perspective the enterprise value
(EV)/EBITDA ratio was used rather than P/E ratio. The reason for that is because P/E
ratio is influenced by non-operating gains and losses as well as capital structure,
while EV/EBITDA ratio uses only operating performance and is not affected by
capital structure. EBITDA is used rather than EBIT or EBITA because companies
depreciation methods may vary between companies and therefore give biased result.
Novozymes has, like in other ratios, by far the highest EV/EBITDA ratio with
average about 14.5. Daniso on the other hand has a ratio of about 9 on average. The
EV/EBITDA ratio is driven by four main factors growth rate, ROIC, operating tax
rate and cost of capital. The ratio therefore differs both by companies from different
countries because of the tax rate and also companies in different industries because of
different profitability and growth rate. As a both food ingredients company and
biotechnology company, Danisco´s EV/EBITDA ratio should be somewhere between
Kerry Group´s ratio and Novozymes.
Table 8 - Competitors Comparison
4.4 Porter´s Five Forces
4.4.1 The Threat of Potential New Entrants
The possible threat of newcomers to Danisco´s markets appears to be insignificant. In
Danisco´s markets, food ingredients and biotechnology, it’s difficult to enter because
they have relatively high barriers to entry due to the need for technical expertise,
reliability, innovation time and quality that is not easy to collect.
That is especially appropriate when looked at the industrial enzymes market where
Danisco and Novozymes command 70% of the market share. That makes it difficult
for remaining players and newcomers to enter as the two companies have years of
Source: www.infinancials.com
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experience and a high degree of R&D. Developed enzymes will also only be
commercialized if they can be produced and distributed cost efficiently from an entire
value-chain perspective. Given the size of Danisco and Novozymes and the critical
mass, it makes it even more difficult for new competitors to enter an existing enzyme
application with a competitive edge in terms of product offering or cost.
4.4.2 The Intensity of Competitive Rivalry
The food ingredient market as a whole is estimated at a DKK 150 billion. Within that
the food ingredient market, Danisco operates in an area which has a market size of
DKK 60 billion and they are the largest player having the leading position in almost
every field as can be seen in table 3 (Danisco, 2010, p. 21). The food ingredients
market is fairly diversified but has a high degree of competitiveness driven by
innovation.
The industrial enzyme market is an
oligopolistic market where two
giants, Novozymes and Danisco,
have around 70% market share.
The rest of the market consists of a
number of much smaller
participants that face a big
challenge keeping up with the two
giants. Between the two big firms
there is an intense competition that is driven by innovation and technology
developments.
There is always the threat of competition from producers based in low-cost countries
like China. In order to remain competitive, product development and cost efficiency
has to be constantly monitored. Danisco have already suffered because of
competition from China in the Xylitol market. Three years ago, the market suffered
from undersupply due to the lack of raw materials. Two years later, the market had
shifted completely and there was an excess capacity in the market due to Chinese
low-cost producers.
Source: Novozymes annual report, 2010
Figure 13 - Industrial Enzyme Market
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4.4.3 The Thread of Substitute Products
In industries like the one Danisco is operating in, driven by innovation and technical
development, there is always a great thread of substitute products. Since Danisco´s
market place is highly dependent on innovations and advancements in product
offerings, a major breakthrough from one of its rivals could possible decrease
Danisco´s market share considerably. In a competitive environment there is also the
threat of a market driven price reduction that would decrease Danisco´s profit
margin. (Datamonitor, 2011)
For DDCE, who are developing bioethanol, there is also a great threat of substitutes.
The possibility always exist, that alternative technologies would be more cost
efficient and could replace fossil fuel.
4.4.4 The Bargaining Power of Customers
The industrial enzyme market is highly concentrated which often leads majority of
the production yield improvements to be passed on to customers. In the food
ingredients market the buyer power is high because there is a high level of
competition and profit margins are low. The Sweeteners market is a good example of
highly competitive market within the food ingredients.
4.4.5 The Bargaining Power of Suppliers
Bargaining power of Danisco´s suppliers is high because most of Danisco´s supplies
are raw materials. Danisco´s key raw materials include vegetable oils, citrus peel,
carrageenan, locust bean, alginates, guar seeds, wood pulp and sugars. Being
dependent on raw materials can be difficult as raw materials are very volatile, the
volatility stems from high demand and unpredictability regarding harvests.
Within the biotechnical industry there is also a fierce competition for the most
talented people. Danisco is working in a high tech industry and needs people with
high degree of education, in the fast growing market the demand and competition for
talent is high.
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4.5 PEST Analysis
4.5.1 Political Factors
Policy makers can influence the market through the control of licensing and granting
patents. Where length of patent period has a large impact on monopolistic position of
companies.
Legislative changes constitute both threat and advantage for certain sectors of
Danisco. The advantage for Danisco is the growing awareness of food ingredients
and most legislations aim at a better and healthier food, which is exactly what
Danisco is aiming at.
The threat is that the development of the biofuel business is to a large extent
dependent upon the national policies in the company´s market. For example in the US
there are laws that force biofuel to be blended with fossil fuel, if it wasn´t for the laws
about biofuel blending then its almost certain that the fuel ethanol market wouldn’t
be as large as it is today. Political commitment to 2nd generation biofuel is a crucial
factor for success of DDCE.
4.5.2 Economic Factors
Like most other industries the food sector is affected by macroeconomic
developments, however it is less sensitive to cyclical fluctuations. Danisco is an
international company with revenue coming from all over the world so they are
highly exposed to exchange rate risk. Favorable currency fluctuation magnified
revenue growth significantly for the first three quarters of the current financial year
2010/11.
Another economical factor affecting Danisco, are the global capital markets. Before
the economical crisis in and around 2007 companies had almost unlimited access to
financing. In the wake of the crisis almost all capital borrowing stopped for a while
but has now reached somewhat a steady state. Danisco has a conservative capital
structure and used part of the money from the Sugar division sale to decrease debt, so
they were not highly affected by this. However, if the biofuel commercialization
turns out to be successful, then there could be a need for a high degree of capital
expenditures.
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4.5.3 Socio-‐Cultural Factors
Business organizations have an important role to play towards ensuring
environmental sustainability. Danisco has taken a leading role in recognizing the
environmental challenges that lie ahead. Danisco has not only realized that as a food
ingredients and biotechnical company they have huge responsibilities regarding
environmental issues, but also see it as an opportunity for future growth.
Danisco are looking to solve the problem that will emerge if forecasts about
increasing population will become a reality4. Increased sustainability is what will be
needed with growing population. Danisco has identified challenges ahead in four
main areas, food, health, energy and chemicals, that are especially critical and
Danisco is ideally positioned to help address. Affordable and healthy food along with
the Bio Chemicals Projects, DDCE and Biolsoprene, is among things that Danisco is
hoping for will provide solutions for some of the problems that will arise.
In September 2009 Danisco was added to the Dow Jones Sustainability Indexes as
the company signed Copenhagen Communiqué on Climate Change. By signing it
Danisco showed its support of a low carbon future and progressive regulatory
mandates that hopefully will impact climate change in a tangible manner.
(Datamonitor, 2011)
4.5.4 Technical Factors
Technical developments are obviously a critical factor for Danisco. The businesses
that Danisco operates in, food ingredients and biotechnology, depend heavily on
technological advancement and turning innovation into revenue and profit is the core
of their business. A large part of Danisco´s innovation is in the food ingredients.
Danisco´s focus areas within food ingredients are taste and texture, health & nutrition
and food protection. In the biotechnical part, Genencor is constantly working on
product development, processing aids for increased efficiency as well as helping
reducing customer´s environmental footprints.
4 Growing from 7 billion in 2010 to 9 billion in 2050 (Danisco, 2010).
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In order to maximize technological advancement Danisco is involved in co-
operations with a number of other companies in development of products. An
example of this are the Bio Chemicals Projects, DDCE and Biolsprene, were Danisco
is working with DuPont and Goodyear. Co-operations like those can be very fruitful
as companies from different fields combine their strengths in order to advance more
quickly.
As an evidence of an impressive performance in research and development, Danisco
filed patent applications grew by 13% in the financial year 2009/10 compared with
the previous year and it´s patent portfolio stood at more than 9300 patents at the end
of that financial year. (Danisco, 2010)
4.6 SWOT Analysis
Figure 14 - SWOT Analysis
4.6.1 Strengths
Strong market positions (first to second position in every section)
As mentioned earlier Danisco has a strong market position in every area in which
they work in both in the food and biotechnology industry as shown in table 3.
Large patent portfolio
Danisco has a patent portfolio of 9300 patents, increasing 13% from the previous
year. Portfolio that big offers a risk reduction, with such a scope and range of
products that a single product loosing its competitive position does not impose a large
threat.
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Large customer base
Danisco has over 10.000 customers worldwide. Danisco´s long-term dependence on a
single customer is limited as the 10 biggest customers only represent about 20% of
revenue.
4.6.2 Weaknesses
Dependence on raw material and energy
Danisco´s products are highly dependent on raw materials and energy, especially
Enablers. Price fluctuations in raw materials can be unfavorable for cost of goods
sold and result in decreased earnings for a period, as the competitive environment
does not always allow Danisco to raise prices accordingly. Danisco´s key raw
materials include vegetable oils, citrus peel, carrageenan, locust bean, alginates, guar
seeds, wood pulp and sugars. Raw materials were extremely volatile in 2007/08,
where many key raw materials such as vegetable oils and energy more than doubled
in price.
Danisco should be able, to some extent, to hedge their contracts so that they won´t be
as affected by raw materials price volatility. But given the problems in 2007 and
2008 where cost of goods sold was much higher, as a percentage of revenue, than it
was for 2009/10, there may be some mismatch in contract length or the price changes
were to severe to pass on to customers.
Lack of focus
Danisco has through the years been very active in acquisitions and divestments,
though there has been less action the past few years. Danisco has a broad production
base and is working both in food and the biotechnology industry. Even though they
have an impressive market position in every area of their business, their EBIT margin
hasn´t been constant and perhaps can be improved if compared to peers like
Novozymes. By focusing on more efficiency, improving the current corporate
structure or even divesting some of their lower margin divisions could be a vise move
in order to improve business.
To be fair, that is a part of what current CEO Tom Knutzen has been doing since he
arrived in 2006 by selling the Flavors and Sugar divisions. Current improvements on
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the financial year 2009/10 and the first three quarters of the financial year 2010/11
are impressive but there is still some room for improvements if compared to
Novozymes and other peers.
4.6.3 Opportunities
High growth potentials in the Bio Chemicals Projects
The BCP, DDCE and BioIsoprene, have high growth potentials if the development of
those projects turns out successfully. The cellulosic ethanol project is further
advanced than the BioIsoprene project, that is still in its development stages, while
DDCE opened demonstration plant in 2010 and are looking to build commercial plant
that will be ready in 2014.
Focus on health, nutrition and sustainability for the future
In order to meet all the side effects that a growing population will bring, more
sustainability in the future is vital. There is an increasing awareness about the need
for a change in a more sustainable direction, which represents a great market
potential. Danisco is using their technical knowledge to develop breakthrough
innovations in biotechnology that replaces petrochemicals and protects the
environment.
The market for health and nutrition products is growing and in 2004 it was estimated
that ingredients potential for the health and nutrition market was around USD 4
billion (DKK 24 billion) (Danisco, 2009). There is increasing awareness amongst
people in health and nutrition as well as there is a growing number of legislations that
aim at a better and healthier food.
Focus on health and nutrition along with sustainability could be a key growth drivers
for Danisco for the future.
Bolt-on-acquisitions and strategic partnerships
There is a clear first mover advantage in Danisco´s market, especially in
biotechnology. In order to fight for their market share and try to increase it,
companies have to do their utmost in order to keep up with the competition. A part of
that can be strategic partnerships like the ones Danisco has with the likes of DuPont
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and Goodyear. Partnerships like those, when companies combine their strengths, can
be very productive.
One of Danisco´s strategies is to have both organic growth and acquisitive growth.
Bolt-on-acquisitions can be very useful to make incremental changes on the business.
But companies do always have to be careful with the premium paid on acquisitions,
because acquisitions don´t create value if the premium is too high.
4.6.4 Threats
Intense competition/Slowdown in product innovation
In the food ingredients market there is a constant need to be aware of what the
competition is doing, as the Sweeteners development for the past few years has
shown.
In the biotechnology market, where the first mover advantage is extremely high, there
is a constant innovation race. Danisco has to keep a high R&D base to try keep up
with Novozymes, who are in a prime position having by far the largest market share.
Significant translation risk
Danisco is a global company and has its revenue coming from all over the world.
According to the financial year 2009/10 Danisco´s main exposures are in EUR and
USD. At 30 April 2010 a 1% change in EUR and 10% in USD would have impact on
equity by DKK 74 million and DKK 230 million.
5 Cost of Capital
When using the DCF method, forecasted free cash flow is discounted using weighted
average cost of capital (WACC).
The WACC represent the opportunity cost that investors face for investing
their funds in one particular business instead of others with similar risk.
(Koller, Goedhart, & Wessels, 2010, p. 235)
It is important when using the DCF method, that there remains consistency between
the different components of WACC and free cash flow because, since free cash flow
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is available to all investors, the WACC needs to incorporate the required return for
each investor. In its simplest form, the weighted average cost of capital equals the
weighted average of the after-tax cost of debt and cost of equity. However in
Danisco´s case operating leases are a part of it´s funding so the WACC equation
looks like this:
Equation 4 – Weighted Average Cost of Capital
!"## =!
! + ! + !" !! 1− !! + !
! + ! + !" !! +!"
(! + ! + !")
Where,
-‐ D: value of debt -‐ E: market value of equity -‐ OL: Value of operating lease -‐ (D+E+OL): market value of enterprise -‐ Kd: cost of debt -‐ Ke: cost of equity -‐ (1-Tm): tax shield
5.1 Cost of Equity
The cost of equity was determined by using the Capital Asset Pricing Model
(CAPM). The CAPM model was first proposed by William Sharpe in a 1964 paper
and has since then become the most important model of the relationship between risk
and return (Berk & DeMarzo, 2007). The model however has been widely criticized
because of simplified assumptions about how the real world works. The CAPM
models considers a simplified world where (Elton, Gruber, Brown, & Goetzman,
2011):
- There is no transaction cost - Assets infinitely divisible (can be bought for any amount) - There are no personal transaction or taxation cost - Investors are price takers, i.e., the cannot influence prices - Investors are broadly diversified across a range of investments - All investors are equally rational and have same idea of return - There is unlimited short sales allowed - There is unlimited lending and borrowing - All assets are marketable
There have been other models used to estimate cost of equity, the most common ones
are Fama-French three-factor model and the arbitrage pricing theory model (APT).
The three models differ most in how they define risk, while the CAPM model defines
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the stock risk as it´s sensitivity to the stock market. The Fama-French model however
defines risk as the stock’s sensitivity to three portfolios (Koller, Goedhart, &
Wessels, 2010, p. 239)
- the stock market, - a portfolio based on firm size - a portfolio based on book-to-market ratios.
The CAPM was chosen, despite of lack of empirical evidence and simplifying
assumptions, as it is the most widely acknowledged and relatively straightforward to
implement, furthermore because it is widely used by practitioners and academics.
The Sharpe-Lintner CAPM was used:
Equation 5 – The Sharpe-Lintner CAPM model
!(!!) = !! + !(!(!!)− !!)
Where,
- E(Re): expected return
- rf: Risk free rate
- β: stock´s sensitivity to the market
- E(Rm): expected market return
The CAPM model describes the relationship between risk and expected return.
Investors need to be compensated both for the time value of their money and for their
risk, the risk free rate represents time value of money while the other half calculates
how much the investor should be compensated for additional risk.
5.2 Risk Free Rates
The risk free rate is the return on a portfolio that has no covariance with the market.
As there is no such thing as a risk free bond on the market Koller, Goedhart and
Wessels (2010, p 241) recommend using government bonds. Ideally the length of the
government bond would match the maturity of each cash flow, however a
government bond of 10 years is recommended as a good proxy. If the bond has a
longer maturity there might be illiquidity problem that would have an impact on price
and yield so that it does not reflect their current value.
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A 10-year German zero-coupon government bond (STRIPS) is recommended, by
Koller, Goedhart and Wessels (2010, p 241), for European bonds. A zero-coupon
bond is preferred because coupon bonds have interest payments that cause their
effective maturity to be shorter than their stated maturity.
In Danisco´s case, a 10-year Danisco government bond was chosen as a proxy for the
risk free rate. Since Danisco is based in Denmark, the best fit for a proxy was
considered as 10-year Danish government bonds. The rate used was 3.39%
(Danmarks Nationalbank, 2011), which is the yield on Danish government bonds at
the end of March. The yield was compared to 10 year German government bond at
the same time, which had 3.47% yield. (Bloomberg, 2011)
A coupon bond was rather used than STRIPS, mainly cause of availability of data,
both present and historical, which lacked for STRIPS but was available for coupon
bonds.
5.3 Beta
The beta (β) coefficient is a key parameter in the CAPM. It is a measure of how
individual stock returns follow the market in general. The raw beta is estimated using
an OLS linear regression. The most common method to do this is using the market
model, which is depicted in the following:
Equation 6 – The Market Model
!! = ! + β!! + !
In the model the stock´s return (!!) is regressed against the market´s return. The data
used in the regression was a measurement period of 61 monthly data points, which is
approximately 5 years. The reason for the data being calculated on a monthly returns
bases is because a more frequent return periods, such as daily and weekly, leads to a
systematic biases. As for the length of the data period there is no common standard
for the appropriate measurement period, Koller, Goedhart and Wessels (2010, p 250)
recommend that at least 60 data points are used.
As the CAPM assumptions suggest a market portfolio has to equal the value
weighted portfolio of all assets, both traded and untraded (such as private companies
and human capital). Since that market portfolio does not consist in the real world a
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proxy has to be used. A good proxy is suggested to be a well diversified indexes,
such as S&P 500 and MSCI World index. In our regression S&P 500 was chosen to
be a proxy.
F Figure 15 - Regression Plot
The regression resulted in a raw beta of 0.764, the results are shown in table 9 The
coefficient of the market portfolio had a p-value of 0.00096 and hence the null
hypothesis can be rejected and the results are statistically significant. R2 of the
regression is 0.17, which is rather low and means that only 17% of the variance of
Danisco is due to systematic or market risk and about 83% to idiosyncratic or firm-
specific risk.
After estimating the raw beta, a smoothing mechanism, often called the Bloomberg
Beta was used to adjust the beta coefficient towards 1. The reason doing so is that
Marshall Blume observed that beta revert to the mean (Blume, 1975)
!"#$%&'" !"#$ = 0.33+ 0.67 ∗ 0.764 ≈ 0.842
As can be seen on the rolling
beta in figure 16 it is clear
that the structural changes
made by the sale of Flavor
and the Sugar division had
the impact that Danisco´s
beta decreased. The decisive
changes in 2008 can be
Figure 16 - Danisco´s Rolling Beta
Table 9 - Regression Output
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traced to divestments and to the fact that Danisco used revenue gathered from the sale
to lower its debt.
Since the beta estimation is an imprecise process, there are also other ways to
calculate the beta. For instance a good approach is to regress the market with industry
index in order to find the industry beta rather than the company-specific beta. This
approach can be useful as companies in the same industry face similar operating risks
and thus their operating beta should also be similar (Koller, Goedhart, & Wessels,
2010, p. 254). However, when using this approach the beta has to be adjusted for debt
as companies with more debt face a greater risk that should reflect on its beta. In
Danisco´s case this approach was difficult as Danisco has few peers, because of its
wide business operations.
5.4 Market Premium
The market premium is the difference between market´s expected return and the risk
free rate. There are few different ways used to calculate the premium, however none
of today´s models precisely estimate the market risk premium (Koller, Goedhart, &
Wessels, 2010, p. 242). According to Koller, Goedhart and Wessels (2010, p 242) the
market premium ranges from 4,5% to 5,5%, with that in mind the market premium
used to value Danisco will be estimated 5%.
5.5 Cost of Debt
Since Danisco have not issued any actively traded long-term bonds it is impossible to
calculate the yield-to-maturity in order to use it for
estimating the cost of debt. Instead the interest
coverage ratio (Adjusted EBITA/interest expense)
was used to estimate Danisco´s ranking. Danisco
has on average had interest coverage around 5.8 for
the last five years, so a rating of (A-) was used as an
appropriate rating. With (A-) rating a risk premium
of 1.1% is added on risk free rates for cost of debt.
As a comparison Danisco´s competitor DSM has a
credit rating from Standard & Poor´s (A/A1) and Source: Damodaran, (2011)
Table 10 - Debt Rating and Spread
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Moody´s (A3) that reflects an upper medium grade and a good financial security.
The marginal tax rate used is the statutory corporate tax in Denmark, which equals
25%. In the WACC calculations, an after tax cost of debt is used because of the
interest shield. In order to find after tax cost of debt we multiply the cost of debt by
one minus the marginal tax rate.
5.6 Cost of Operating Leases
Since NOPLAT, invested Capital and FCF were adjusted with operating leases cost
of capital also has to be adjusted. Operating leases represents loaned assets that
should be treated as a debt. The operating leases asset value was estimated using
equation 3, now the assets value is used in WACC calculations.
Because operating lease is just as a regular debt, it also has to be given a debt rating.
Operating leases is more secure debt than the company´s unsecured debt because
operating leases is secured by the underlying asset. With that in mind, an appropriate
debt rating of AA was estimated for the operating lease debt. Just as for the cost of
debt, after tax cost of operating leases is used in the WACC calculations
Credit Health
In 2009/10 Danisco was
financed 85% by equity, 14%
by debt and 3% by operating
leases. For the last five years
Danisco´s credit health has
improved significantly. The
improvements are especially
noticeable in the difference
between 2007/08 and 2008/09, because Danisco decided that it would use large
portions of the sale proceeds from divestments in order to decrease leverage. Danisco
has a gearing target that is 1.5-2.5x EBITDA, their gearing in 2009/10 was 2.2x
EBITDA which is within that range. The reason why Danisco has been changing
their capital structure is because their business has been changing from being solely
focused on the food ingredients to being also partially a company in biotechnology
Figure 17 - Danisco´s Capital Structure
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sector. The board of directors has
taken the view that their current mixed
approach, with the biotechnology as
well as the food ingredients business,
is riskier than before and therefore
have lowered their debt dependence.
Danisco is also maintaining low debt
because of uncertainty in the
Biotechnology Chemicals Projects (BCP), which will be capital intensive if that
project turns out to be as successful as they hope.
5.7 WACC
The WACC was calculated as 6.89%. Danisco´s capital structure consists of mainly
equity, 83%, so it had the highest impact on the WACC. Cost of equity is much
higher than debt and operating leases cost because Debt has first priority on claims
while equity is a residual claimant. The items that contribute to the WACC are
showed in figure 19, historical WACC and further WACC calculations are in
Appendix D.
Figure 19 - WACC Tree
Figure 18 - Total Debt
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6 Forecasting Performance
Now that Danisco´s business has been analyzed, both internally and externally, a
forecast will be developed based on the analyses. The forecast period will be 12
years, which is divided into explicit forecast for six years and then key driver forecast
for six years. In the explicit forecast, all items in the income statement, NOPLAT,
invested capital and the FCF will be forecasted. However in the key driver forecast,
the focus will be on the key drivers such as revenue, NOPLAT, invested capital and
FCF. The concept of continuing value was used to estimate the value of expected
cash flow beyond the 12 year forecast period.
Three scenarios will be developed for the forecast, the base case scenario, worst case
scenario and best case scenario. The base case scenario will be used for the final
valuation price, while the other scenarios are intended to give insights regarding other
possible developments and their consequences for the share price. The forecast is
made under the assumption that Danisco will continue to follow its current strategy
and keep its current structure. The scenario analyses are made in such a way that only
the most important variables are changed, such as revenue and cost of goods sold.
Other variables like WACC and Tax rates are expected to remain stable.
6.1 Base Case Scenario
The base case of Danisco is intended to be the most probable outcome for the future,
and thus the valuation is based on it. Although Danisco has in the past shown rather
unstable performances, the last couple of years have shown a signal of improvements.
The estimation for 2010/11 is high and is based on good performances in the first
three quarters. The revenue growth is highly influenced by positive currency impacts
as around half of the growth can be traced to currency effects. In the following years
the revenue growth is expected to drop and to follow, what can be called as, a normal
market growth.
In the explicit forecast, 2010/11 – 2015/16, Cultures and Genencor divisions are
expected to be the main growth drivers with 7% revenue growth each, Enablers is
estimated to have 4% revenue growth and Sweeteners 5% revenue growth. In the key
driver forecast period revenue growth is expected to be 5.5%. Cost of goods sold is
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expected to be equal to 3Q YTD 2010/11 rather than being as low as it was 2009/10.
The reason being that in 2009/10 price of raw materials was very favorable.
The valuation for this scenario estimates a value of DKK 732 per share.
Table 11 - Base Case Scenario
6.2 Best Case Scenario
In the best case scenario a revenue growth of around 7% annually is expected for the
explicit forecast and 6.7% in the key driver forecast. The main growth driver will be
the Cultures division, which is expected to outperform market growth and have a 9%
annual growth. The high growth in the Cultures divisions will be driven by high
growth in emerging markets such as India and Eastern Europe. The Genencor
division is also estimated to be a growth driver with around 8% revenue growth
annually. The Enablers division is expected to have around 6% growth annually,
highest the next couple of years (14% and 7%) and then fade off a little bit in the
following years to 5%. The same is expected for the Sweeteners division, high
growth for the next few years while regaining their lost market share but then to fade
off to a growth of 5%.
On top of impressive revenue growth, an increased efficiency is projected with
COGS being 51.5% of revenue in 2015/16. At the end of the forecasting period a
terminal growth of 2.5% is applied. With 2.5% terminal growth, the continuing value
represent 77% of operating value.
The best case scenario represents what is estimated to be the utmost best
performances of the company for the period and is expected to be a little bit extreme.
A steady ROIC of 12% and a profit margin of 17% is a great improvement compared
to Danisco´s historical performances. However, the first three quarters of 2010/11
have been very impressive, giving signs that the outlook for coming quarters and
years is a positive one. The share price in the best case scenario is estimated as DKK
1.013 per share.
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Table 12 - Best Case Scenario
6.3 Worst Case Scenario
In the worst case scenario the raw material price is expected to be rise because of
growing demand. Revenue growth is also expected to be decrease through the
explicit forecast period and going from impressive 14.7% in 2010/11 to a less
impressive 2.6% growth in 2015/16 and keeping that growth percentage through the
rest of the forecast period.
In the period the Sweeteners division is not expected to regain it´s former strength
back and will only have a modest 1% growth after an impressive 2010/11. The
revenue growth in the Enablers division is estimated to fade off and decrease to 2%
growth in 2013/14 and keep that growth until the end of the forecast period. The
Cultures division is expected to perform best out of the current divisions and perform
well in until 2012/13 when the revenue growth will drop to 4% and then 3% the year
after and keep that until the end of the forecasting period. Genencor will have a
slower growth rate than the market (which is expected to grow at a rate of 6-8%),
with Novozymes keeping their great market position and increasing their market
share even more.
The continuing value is expected to have a terminal growth of 1.5%, which is 0.5%
less than the continuing value in the base case had. The continuing value represents
59% of operating value. The valuation of the worst case give the fair value of DKK
396 per share.
Table 13 - Worst Case Scenario
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7 Calculating and Interpreting Results
7.1 Value in the Base Case Scenario
Now that in depth analysis on Danisco´s business, which was followed by a scenario
forecast, has been done it´s time to calculate Danisco´s operating, enterprise and
equity value. In order to do that a non-operating assets and non-equity liabilities have
to be added and withdrawn from the operating value.
7.1.1 Operating Value
The operating value is the present value sum of the forecasted FCF and the
continuing value. The terminal growth in the
base case was estimated to be 2%, which
reflects approximately inflation rate.
Danisco´s operating value was calculated to
be DKK 39.297 million, 74% of which came
from continuing value and the rest from the
cash flow from the forecast period. A midyear
adjustment has to be made because FCF is
discounted as it was all realized at the end of
the period, which it isn´t. The adjustment factor is calculated as:
1+ !!+!"## = 1.0341
These calculations give the adjusted operating value of DKK. 40.650.
7.1.2 Enterprise Value
To find the enterprise value the non-operating assets have to be identified and added
to the adjusted operating value. The most common non-operating assets are the likes
of excess cash, other financial assets and pension assets. In the case of Danisco the
highest non-operating assets are excess cash (DKK 424 million) and other financial
assets (DKK 564 million). The other financial assets are mostly receivables from
Nordic Sugar A/S (DKK 530 million). The enterprise value is DKK 41.906 as can be
seen in table 15.
Table 14 - Operating Value
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7.1.3 Equity Value
In order to find the equity value the
non-equity claims are identified
and derived from the enterprise
value. The most common non-
equity claims are for example debt,
operating leases, pension assets and
employee stock options. The list of
Daniso´s non-equity claims can be
seen in table 15.
To calculate the value of
outstanding stock options a Black
and Scholes sheet gathered from
Aswath Damodaran´s web site was used (Damodaran, 2011). By combining
information given in Danisco´s financial statement and Damodaran´s sheet the value
of stock options was calculated to be DKK 178 million. The equity price was
calculated to be DKK 34.862 million. Number of shares outstanding is 47.655.218 so
the value per share is DKK 732.
7.2 Additional Scenarios
To give insight and room for error scenarios were developed. The main aim with the
scenarios was to show how development could turn out to be in the worst and best
cases. The chance of either the worst case or the best case scenarios to become a
reality are thought to be minimal. A probability of 10% is estimated as a fair
assumption that each of this scenarios turn out to be true. The estimation is based on
the fact that both scenarios have rather extreme development that is highly unlikely to
become reality.
Table 15 - Equity Value
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Table 16 - Scenario Analysis
7.3 Sensitivity Analysis
Now that the value has been calculated and scenarios been developed it is good to do
a sensitivity analysis. Sensitivity analyses are made in order to see how changes in
important variables affect the value of the company. Sensitivity analysis can also help
when there is some uncertainty in the variable inputs and show how much impact
changes would have on stock price. In the first sensitivity analysis made for Danisco
the impact of changes in terminal growth and WACC are calculated, the results can
be seen in table 17. It´s clear that 0.5% change in WACC has more impact on value
per share than 0.5% changes in terminal growth, but non the less both inputs have a
high impact on share price.
Table 17 - WACC and Terminal Growth Sensitivity
In the second sensitivity analysis two estimated inputs in WACC are shown. Risk
premium on debt was calculated using interest coverage and was estimated as 1.1%
given an A- rating in the base case. According to the sensitivity analysis changes in
risk premium do not have a crucial impact on share value of Danisco although if the
debt rating will be BB+ it has some impact.
The changes in market premium can however have a big impact on value per share.
In Danisco´s valuation the market premium was estimated as 5%, the appropriate
market premium is thought to be between 4.5%-5.5% (Koller, Goedhart, & Wessels,
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2010). A 0.5% change in market premium estimation affects the price drastically. If
the market premium would be calculated as 5.5%, keeping the risk premium constant,
the value per share would be DKK 663 and with 4.5% market premium the value will
be DKK 811.
Table 18 - Risk and Market Premium Sensitivity
7.4 Multiples Analysis
In order to make the DCF valuation more robust and tests it´s plausibility a
comparison of Danisco´s forward EV/EBITDA ratio along with its peers is
recommended by Koller et al (2010).5
As Danisco has no peer group the comparison has to consist of comparing the ratios
to food ingredients average´s (Tate & Lyle,
Kerry Group, DSM and Chr. Hansen) and
Novozymes, who represents industrial
enzymes companies. Danisco´s forward
EV/EBITDA ratio is around 12 for both
years, which is higher than for the average
food ingredients company but lower than
Novozymes ratio. The results from this comparison are as expected as the food
ingredients and the industrial enzyme market are different and can´t be compared,
and it was expected that Danisco´s ratio would lie somewhere in between the two.
5 The data was received from the web site infinancials.com.
Table 19 - Forward EV/EBITDA
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8 Real Option Approach
In this chapter a real option analysis will be conducted based on the commercial plant
that DuPont Danisco Cellulosic Ethanol (DDCE)6 is planning to do. The goal of this
real option analysis is to value the flexibility, that static NPV models cannot
determine, which is so important in risky projects.
The real option approach will be made on the forthcoming commercial plant DDCE
plans to begin operate in 2014. The estimation will be based on this single
commercial plant, as it is impossible to estimate the amount of plants that DDCE
possible can build in the next few years if the 2G technology will be successful.
DDCE for example estimates that there will be around 600 plants at this size, 94
million liters per year, in 2020 (Bevill, 2011). The real option on this plant will show
how much value the project creates for DDCE and therefore Danisco. The option that
management will have at each node is to continue, expand or abandon the project.
In the real option estimation a framework of five steps will be used. The first step is
identifying a real option, in this step the DDCE operations and 2G industry will be
introduce. Other steps will be further introduced as they come along.
8.1 Identifying a Real Option
8.1.1 Cellulosic Ethanol
Danisco is one of the leaders in the production of first generation (1G) of biofuel and
has that market been growing at a double-digit rate for several years (Danisco, 2010).
6 Danisco´s 50/50 joint venture with DuPont
Source: Based on Mun, (2006)
Identifying a real option
Static Yinancial model
developed Volatility estimation
Framing the Real option
Options analytics,
simulation and optimization
Figure 20 - Real Option Steps
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There were high hopes for the prospect of 1G biofuel when it was first introduced7
but recently 1G biofuel has been widely criticized. The main reason for the criticism
is their use of food crops such as grains, sugar cane and vegetable oils. By using food
crops the biofuel production is competing with the food industry about raw materials,
which leads to increased food price.
Technological advances have been made and non-food-related crops, such as corn
residues and switchgrass, can now be used in the production of cellulosic ethanol.
cellulosic ethanol is the most advanced biofuel amongst second generation (2G)
biofuels and is what DDCE is producing and developing. DDCE has taken a leading
role with Novozymes in the development of 2G of biofuel.
The 2G of biofuel is still not ready to compete with fossil fuel and 1G biofuel due to
high production price, however with increased research and development along with
large degree production it´s believe that it can be competitive on the free market.
Until then, companies have to depend on government subsidies and mandates. There
are several technologies that are promising in the race for a replacement of fossil fuel,
there are however few advantages that 2G biofuel has:
Advantages:
Easy adoption: As 2G is blended with existing refined products such as
gasoline, diesel and jet fuel the hurdles for the 2G will be lower than for
alternatives as electric vehicles and hydrogen.
Technology advances: Even though 2G is still in its development stages,
there are several 2G pilot plants gaining momentum. The commercialization
is just behind the corner, as is evident by DDCE who are planning to have
commercial plant operating in 2014.
7 1G biofuel refers to fuel derived from sources like starch, sugar, animal fats and
vegetable oil and used in the production of bioethanol. The bioethanol is used as a
gasoline additive to decrease greenhouse gas emission by vehicles.
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In the long term, beyond 2020, there are more technologies that are showing
promises, such as algal fuel oil that has potential to supply significant amount
of biomass without the constrains of requiring arable land (UBS, 2010).
Political attractions: The political benefits of 2G are too great to ignore.
Energy dependence is something that China and the United States are keen
on. Energy dependence would save foreign currency reserves, improve rural
economies and provide a great deal of new job opportunities. With that in
mind it is likely that governments will keep on investing in 2G while it shows
potentials.
Environmental attractions: 1G biofuel offers a reduction of greenhouse gases
of 50% compared to traditional petrol (Danisco, 2010, p. 34). The 2G is
expected to reduce greenhouse gases even more as it is expected to be around
60% reduction compared to traditional petrol (UBS, 2010).
There are also few risk factors that could prevent the development to be enough to
make 2G ready to compete on the free market:
Risks:
Political apathy: Free market drivers are not sufficient to drive the
technology forward so further development of 2G biofuel is highly dependent
upon government grants and legislations. If the support will subside, it will
prevent further development of 2G.
Raw price inflation: Even though 2G is using material that are low cost now,
there is no guarantee that it will continue forever. It´s likely, when demand
grows for the materials used, that prices will increase and be volatile as is
common with raw materials.
Development: Even though 2G biofuel is showing great potentials there is
still some work do be done in the development stages to make the product
profitable on the free-market without the need for subsidies. The 2G industry
has not developed as quick as was hoped and for instance is the DDCE joint
venture about two years behind schedule.
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8.1.2 Political Support
There are several reasons for governments to invest in 2G biofuel, as been mentioned
earlier the political and environmental attractions are significant, but further
development is needed. In order to get companies to invest in the development of the
technology, governments have to make both current and future market prospects
favorable for profit making. Subsidies and legislations are a good example of ways
for governments to do that.
In the wake of the US renewable fuel
standard since 2007, which states a
60 billion-liters (16 billion gallon)
mandate for cellulosic biofuels by
2022 from virtually zero today, the
US market is the most feasible one in
the short term. The mandate that
started in 2010 was supposed to
increase rapidly from 379 million
liters (100 million gallons) in 2010 to
11.356 million liters (3.000 million
gallon) in 2015 and 60 billion liters in 2022. However, because development has
been slower than originally planned, the production capacity in the US is much less
than the 757 million liters (200 million gallons) expected in 2011. Because of that the
RFS has had to be adjusted and was lowered to only 19 million liters (5 million
gallons). That is a strong indicator that the RFS will also have to be further adjusted
in the next few years.
DDCE main focus is on the US market. In China Novozymes, COFCO and Sinopec
created a joint venture and believe that there is a potential to replace more than 30
billion liters of Chinese gasoline consumption by 2020. China has not as much state
support for 2G biofuel as the US but have been increasing its subsidies rapidly, the
European Union support however has not been significant and has been more in the
form of regulatory enablement instead of financial support (UBS, 2010).
Figure 21 - Renewable Fuel Standard (In million liters)
Source: UBS, (2010)
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8.1.3 DuPont Danisco Cellulosic Ethanol
DDCE is currently working in it second phase of three. A 950.000 liters per year pilot
plant was opened in Tennessee in the beginning of 2010. Now DDCE is working on
going to phase III where a demonstration commercialization plant will be opened.
DDCE has expressed its plans to build a 95 million liter per year commercial
biorefinery in Iowa. According to DDCE communications director Jennifer Hutchins
the primary purpose for the commercial plant is to prove out commercial scale
technology for 2G ethanol and serve as a center of excellence for comprehensive
solutions in cellulosic ethanol (Bevill, 2010).
The capital costs are expected to be approximately USD 200 million (Iowa Dept. of
Economic Development, 2011) and DDCE plans to have the plant operational by
March 2014 (Bevill, 2011).
DDCE main plan is to license the technology. According to DuPont applied
BioSciences president Craig Binetti the commercialization model includes a
comprehensive licensing program that will include licensed technology, plant design,
start-up, training and ongoing technical support (Bevill, 2011).
The projected commercial plant meets all five requirements in order to be appropriate
for real option analysis8. The project has a high degree of uncertainties surrounding
the development of production price and ethanol price. The uncertainties can make or
break the market, as abandonment might be the best option if future development will
be unfavorable. On the other hand an expansion might be needed if the development
8 Requirements listed on pages 4-5
Source: DuPont Danisco Cellulosic Ethanol LLC, (2008)
Figure 22 - DDCE´s Phases
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will be favorable. It is expected that management is smart enough to make the right
decisions at the right time and will be looking to maximize the options value.
8.2 Static Financial Model Development
Real option analysis requires a DCF model of the underlying project and serves as a
base case for the real option analysis. As DDCE no financial statements from DDCE
are available the financial model will be based on reports about the projected
commercial plant. If information will be lacking a best of knowledge assumptions
will be made.
DDCE plans to make a 95 million liter (25 million gallon) per year plant that will
cost around DKK 1059 million (USD 200 million) (Iowa Dept. of Economic
Development, 2011). Its estimated that the plant will start producing in March 2014,
it will be assumed that DDCE financial year is the same as Danisco´s from 01 May to
30 April. In order to simplify calculation production will be estimated to start in the
financial year 2014/15.
The production price is currently DKK 2.79 per liter, the production price is
estimated to go as low as DKK 2.09-2.38 per liter. In our static financial model the
current production price will be used as well as ethanol price of DKK 3.48 per liter,
which was the market price 29.03.2011 (Wikinvest, 2011). The current market price
is considerably higher than the average market price from 2005-2011 that was DKK
2.67 per liter. The high market price might lead to the project having a higher NPV
than regularly expected.
Subsidies will be the tax credit of DKK 1.41 per liter that the US government gives to
cellulosic ethanol producers (Babcock, Marette, & Treguer, 2010). The fixed cost
associated with a plant at this scale was estimated 23.2% of total sales, which is the
percentage used by Leistritz et al (2007). Continuing growth is expected to be 3%,
which reflects possibilities in more efficiency as well as market growth in this
undeveloped market.
8.3 Cost of Capital
Although DDCE is a joint venture between DuPont and Danisco it does not mean that
it has the same WACC as the two companies. DDCE is a limited liability company
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that means that the money it borrows will not fall on DuPont or Danisco in case of
bankruptcy, and for that reason WACC has to be calculated for DDCE. As DDCE is
not on the stock market there is no way to calculate it´s beta. Instead an average beta
of petroleum producers, which is 1.13 will be used (Damodaran, 2011). The market
premium is unchanged and is estimated to be 5%. The marginal tax rate is expected
to be the same in the US as in Denmark and is 25%.
As there are no information available regarding DDCE debt rating or interest on
current debt so it´s difficult to estimate the company´s risk premium on debt. DDCE
is a small company in a risky business but however has strong owners who seem to
be willing back the company up in it´s development. With that in mind the debt rating
is estimated to be BB+ which means a 3% spread on top of risk free rates.
The only available information on DDCE´s capital structure is in book value. Total
assets in the end of 2009/10 were DKK 208 million and liabilities DKK 70 million.
The WACC is estimated to be:
138208 3.39+ 1.13 ∗ 5% +
70208 ∗ 6.39% ∗ 1− 25% = 7.6%
With WACC as 7.6% and continuing growth as 3% the NPV of the project is DKK
623 millions. The NPV is higher than expected because of unusually high ethanol
price. If the ethanol price would be as it averaged through 2005-2011, DKK 2.67 per
liter, the NPV would have negative value of DKK 19 million.
Table 20 - DDCE´s Static Net Present Value
8.4 Volatility Estimation
Volatility is critical for real options as it drives the value of the option and can also be
the most difficult part to calculate. Items that should be involved in the volatility
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estimation should be variables that will change management´s decision about whether
to execute particular project. In case of the commercial plant there are two variables
that are decisive in the development of cash flow, those are production price and
ethanol price.
In order to calculate the volatility of the cash flow a Monte Carlo simulation9 is
used10. Before the Monte Carlo simulation can be used the variables, ethanol price
and production price, have to be further defined as the simulation requires the
variables volatility, mean and probability distribution in order to get reliable results.
The dependent variables are estimated to follow Geometric Brownian Motion
(GBM). The GBM expects uncertainty to increases over time, because of the time
factor, although volatility stays the same, which is one of the key assumptions made
in order to solve binomial lattice. The equitation for GBM is:
Equation 7 - Geometric Brownian Motion
!"! = ! !" + !" !"
Where S is dependent variable. The change in the dependent variable is equal to the
deterministic part (! !" ), where ! is a drift term, and the stochastic part (!" !")
where ! is the volatility and ! is a simulated variable.
The Monte Carlo Simulation was made with variables in USD and gallons instead of
DKK and liters as used in DCF calculation above. This should however not have any
impacts on results as volatility is based on the natural logarithm of the changes in
price that is the same whether it is gallons in USD or liters in DKK.
9 Monte Carlo simulation is an analytical tool used to simulate real life systems. The
simulation randomly generates values of uncertain valuables in order to compute it´s
results.
10 An Excel add-on program called Crystal Ball was used to perform the simulation.
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8.4.1 Ethanol Price
According to monthly data of historical prices
since January 2005 average price of ethanol
has been 1.91$ per gallon (DKK 2,67 per liter)
and the yearly volatility was calculated as
$0.45 per gallon (DKK 0.62 per liter)
(Hofstrand & Johanns, 2011). As for the
probability distribution Ethanol price, based on its historical prices, is estimated to
cluster around its mean and follow Normal distribution.
8.4.2 Production Price
DDCE´s current production price is $2.0 per
gallon (DKK 2.79 per liter), however their
commercial target is $1.5-$1.7 per gallon
(DKK 2.1-2.38 per liter). With that in mind a
triangular distribution was decided to be best
fitted as a probability distribution for the
production price with mean $1.75 per gallon as the most likely value and $1.5 per
gallon as it´s minimum value and $2.0 per gallon as it´s maximum value.
There is some correlation between production price and ethanol price. Due to lack of
informative material there was no correlation estimation available for 2G biofuel.
There is however material available regarding correlation between 1G biofuel and
production price and it is estimated to be 0.77 (O´Brien & Woolverton, 2009). The
high correlation can be traced back to the fact that 1G biofuel is produced from corn
and corn is the main driver for ethanol’s market price11. The 2G biofuel does not rely
on corn price as much as it does not use food crops like 1G. 2G however use corn
residues and other raw materials that should have similar fluctuations, given the
importance of good harvest for both, and therefore some correlation is estimated to
11 For example the correlation between a rolling 1 year Ethanol and Corn futures was
0.757 (CME Group, 2011).
Figure 23 - Normal Distribution
Source: Output from Crystall Ball
Figure 24 - Triangular Distribution
Source: Output from Crystall Ball
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exist. As there is no correlation numbers available, a correlation of 0.5 will be
deemed fit as an appropriate proxy for correlation of 2G production price and ethanol
price.
8.4.3 Monte Carlo Simulation
In most cases it would be appropriate do run Monte Carlo simulation by taking the
natural logarithm12 of the relative value using:
Equation 8 - Natuarl Logarithm of the Cash Flow
! = ln (!"!!!!"!
)
However, in case of the commercial plant option the cash flow can be negative,
which makes it impossible to use this equation, as natural logarithm is not defined for
negative numbers. Instead an approach called “Natural Logarithmic Present Value
Returns” will be used. The equation for that approach is:
Equation 9 - Natural Logarithmic Present Value Returns
! = !"!"#$!!
!!!
!"#$!!!!!
By using this approach the impact of the possible negative cash flow is reduced as
well as the risk of autocorrelated cash flow is reduced. According to Mun (2006) this
approach is the best for estimating volatilities in most real options problems.
A Monte Carlo simulation of 50.000 trials was made and gave a standard deviation of
0.1, in order to annualize the results the standard deviation was multiplied by the
square root of 1213, which gave the volatility of 34.6%.
12 Natural logarithm of the relative returns is used because it is comparable with
exponential Brownian Motion, an important aspect because Brownian Motion is a
fundamental assumption in real option analysis.
13 Number of cash flow periods within the calculations.
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8.5 Framing the Real Option
In the real option approach a binomial lattice approach will be used. The Binomial
lattice method is the most mainstream one and is easy to explain. There are two ways
to solve the binomial lattice, with risk neutral probabilities and with market
replication portfolios. The latter demands the creation of cash equivalent replicating
portfolio from risky and risk free assets. In case of this option risk neutral
probabilities will be used. The risk neutral approach is explained in a good way svo f
in Mun, (2006)
Simply stated, instead of using a risky set of cash flows and discounting
them at a risk-adjusted rate akin to the discounted cash flow models, one
can instead easily risk-adjust the probabilities of specific cash flows
occurring at specific times. Thus, using these risk-adjusted probabilities
on the cash flows allows the analyst to discount these cash flows (whose
risks have now been accounted for) at the risk-free rate. (p.128)
In order to find how much movement is at each node the following equations are
used.
Equation 10 - Real Option Up Movement
! = !! !"
And
Equation 11 - Real Option Down Movement
! = !!! !" =1!
Where u stands for up movement, d stands for down movement, ! is volatility and t
is the time to expiration in years.
Equation 12 - Risk Neutral Probability
! =!(!"!!) − !! − !
Where rf stands for risk free rates and b stands for the rate of continuous dividend.
In the commercial plant estimation each node will represent a 1-year and the
estimation period will be in total 15 years. A period of 15 years is estimated as the
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time period needed to realize how further development of the 2G industry will be and
if other fossil fuel replacements will be better suited as a competitive force on the
free market. There are other products such as algal fuel in development that could be
commercialized at this 15 year time period that are showing promises.
Now that all the variables needed in order to make the binomial lattice have been
decided, it´s time to calculate u, d and p values:
! = !!.!"# ! = 1.41; ! = !!!.!"# ! = !!.!"
= 0.71; ! = !!.!""#!!.!"!.!"!!.!"
= 0.46
All calculations shown in the binomial lattice in table 21 are based on the up factor,
down factor and the risk neutral probability calculated above.
Table 21 - Binomial Lattice of the Underlying
8.6 Option Analytics, Simulation and Optimization
8.6.1 Option to Abandon
If development of the produced product is not favorable it can be valuable to abandon
the project. In order to calculate the abandonment option for the commercial plant a
salvage value has to be estimated. Little information is available about salvage value
for ethanol plants but Schmit et al (2009) estimates a salvage value of about 25%.
Given that the technology used is rather specialized and perhaps assets can´t be used
for different production, a 25% salvage value is estimated to be a fair assumption. A
25% salvage value gives a DKK 265 million salvage price (25%*DKK 1059
million).
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The abandonment option can be described as an American put option as the option
can be exercised at every node. When valuing the option calculation is done
backwards, that is, calculations begin at the end (2024) using, the put formula:
Equation 13 - Abandonment Option
!"#(!"#$"%& !"#$% ∗ !"#$% !"#$ = 265,!"#$%#&%#' !"#$%)
Where continuing value represents relevant node value as can be seen in table 21. As
shown below the lowest six nodes in 2024 have a continuing value smaller than 265
so the company would decide to abandon at those nodes.
The values in the next node, 2023, are calculated using the neutral probability
calculated above with the formula:
Equation 14 - Risk Neutral Value of Node
!! = (! ∗ !!!! + ( 1− ! ∗ !!!!) ∗ !!!"
Where U represents value of up node and D represents value of down node. If the
value calculated with this formula is lower than DKK 265 million the abandonment
option is used.
The value of the option with the abandonment option can be seen below, it is DKK
658 million and therefore adds DKK 35 million to the NPV.
Table 22 - Abandonment Option Valuation Lattice
8.6.2 Option to Expand
If the development of the 2G biofuel business will turn out to be favorable, then the
option to expand might be valuable. The expansion option, call option, to 473 million
liter (125 gallon) per year plant is given in the table below as well as the
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abandonment option. The option can be exercised at any time and is therefore an
American option. The expansion size of 379 liters per year was decided as plants that
are equal or larger than 473 million liters per year are expected to be the most cost
efficient ones, decreasing production cost of up to DKK 0.3-0.4 per liter (Kocoloski,
Griffin, & Matthews, 2011).
The expansion cost is expected to be DKK 2.118 million, which is according to
estimated capital expenditures at commercial state by DDCE (Althoff, 2010). The
cash flow from the expanded plant will be five times the cash flow before expansion.
As was done when the value of abandonment option was calculated, calculations for
the expansion have to start at the last node, 2024. The decision at the end note can be
described by the formula:
Equation 15 - Expansion Option
!"# !"#$%&'(% ∗ !"#$%#&%#' !"#$% − !"#$%&'(% !"#$,!"#$%#&#%' !"#$%
Where continuing value represents the value at relevant node from table 22. These
calculations give the results that at the eight nodes at the top in 2024 the call option
on expansion would be exercised.
It has however to be calculated whether the expansion option could possible be more
profitable at an earlier node. For explanatory purpose the calculation for the
highlighted node in table 23 will be shown.
Value of expansion in the node:
Expansion*Continuing Value - Expansion Cost = 5*28.160-2.118 = DKK 138.682
million
Keeping option open:
V = (p*U + (1-p)*D)*!!!" = (196.971*0.46 + 97.459*0.54)*0.967 = DKK 138.752
million
As a result the option is rather exercised in 2024 than in 2023, as management will
choose the strategy that maximizes the value of the option. These calculations are
performed for every node and as a result expansions are most profitable at the end of
the period. The value of the expansion option is DKK 1599 million, which is much
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higher than the NPV of the project itself. The high price can be explained by some
part because of the large expansion but also reflects the value of being able to have
the option every year.
Table 23 - Expansion Option Valuation Lattice
It always maximizes American call option to be exercised at the end of the option
period except when there is no dividend paid. So without dividend payments the
value of American and European options stays the same. The reason for this is the
same as for regular options. Firstly if the company waits instead of exercising early
the company has insurance if the development will be unfavorable until the end of the
period and secondly is the time value of money, which is in this case the cost of the
plant.
The commercial plant project has the
value of DKK 2.257 million for DDCE
when value of flexibility has been
calculated using the real option approach.
As DDCE is a 50/50 joint venture between
DuPont and Danisco the value is divided
be the two. The value for Danisco is
therefore DKK 1.128 million, which adds DKK 23 per share to the DCF valuation.
9 Conclusion
The objective of this study was to analyze Danisco in order to find it´s fair value. Just
as the study began, DuPont made a DKK 665 per share offer for Danisco´s, which
was later raised to DKK 700 per share which was then accepted by majority of
Table 24 - Value of the Real Option
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Danisco´s shareholders. The second aim of the study was then to estimate whether
DuPont´s offer was fair or whether Danisco´s shareholder should have rejected it.
The method used to valuate Danisco was the DCF approach, which called for
reformulation of Danisco´s historical financial statements in order to separate the
operating part from the non-operating. Danisco´s last six years were reformulated and
the results from it made it clear that Danisco has been underperforming. The
underperformance can by some part be explained because of high volatility in raw
material prices. Another explanation might also be that Danisco lacks focus, as their
products ranges from sweeteners in chewing gum to alternatives of fossil fuel and
detergents. However, recent annual and quarterly results have been impressive and it
looks as though Danisco is gaining some momentum.
Danisco is working in a very innovative driven market, especially in the industrial
enzymes market. They have a strong market position within it´s field and are ranked
as first or second in every field they operate in. Their main growth drivers are
Genencor and Cultures divisions. There is a great deal of first mover advantage in
Danisco´s markets so in order to keep its impressive market share Danisco has to
keep on improving and above all, not to lose their focus.
Genencor has the second highest market share in industrial enzymes, where Genencor
and Novozymes have a commanding market share. In comparison, Genencor has had
a much lower EBIT-margin than Novozymes. The difference might be partly because
of the economics of scale as Novozymes has almost double the market share of
Genencor. With more efficiency, there is no reason why Genencor shouldn’t be able
to get closer to Novozymes EBIT-margin.
When Danisco´s forecast was estimated, historical performances, market growth and
other analysis were used in order to have the forecast as accurate as possible. In order
to give a better insight, into the uncertainty that can affect the forecast, scenarios of
worst and best cases were developed. The scenarios were made rather extreme, but
realistic, to show how the development could be. The best case and worst case were
given probability of 10% each. With the base case representing 80%, the expected
value from the scenario analysis was DKK 727 per share, which is very close to the
DKK 732 per share calculated from the base case.
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Danisco is currently involved in two biochemical projects, DDCE and BioIsoprene,
who both have high growth potential. BioIsoprene is still early in it´s development
stages but the 2G biofuel project that DDCE operates is on it´s way to be
commercialized. Constructions on the commercial plant are expected to begin this
year and will take about 18 months until the commercial plant will be opened. In
order to give better insight into Danisco´s future and growth prospects a real option
approach was made on the commercial plant. The real option approach is better
suited for projects with high uncertainty than the casual NPV as it values flexibility.
The NPV of the commercial plant project was estimated to have NPV of DKK 623
million, but by using the real option approach with the option to abandon, at 5%
salvage value, and to expand production, to a total of 473 liter (125 gallon) per year,
the value increased to DKK 2.257 million. Given that the value of the commercial
plant project reflects the DDCE´s value, as there are not substantial assets in the
company other than pilot plant and technical knowledge, this option would add value
of DKK 24 per share.
Given the analysis of DCF valuation on Danisco and the real option approach on the
commercial plant a fair value of Danisco´s share is DKK 756, which is well above
DuPont´s successful offer of DKK 700 per share.
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