Rsyncosx multipe streams9/3/2023 Doing so shrinks the multiple, but it also creates more absolute shareholder value. It looks like a win-win-win.Ī junior colleague, however, proposes strategy 2: deploy all the excess cash into a lower-multiple business. That’s awfully tempting: strategy 1 generates value, produces a higher multiple, and enables buybacks. Executing on strategy 1 would expand your company’s EV/NOPAT multiple of core operations (that is, the multiple, adjusted for cash holdings, observed today by investors) to 16.4. Therefore, the stock buyback has no impact on the value of the core business, and the fair value of the growth businesses reflects all future growth opportunities. 1 We assume, for purposes of this example, that all assets and companies are fairly valued. Your team is excited about strategy 1, which involves an investment of $100 million to grow a new, high-multiple business, which requires less capital, leaving $200 million to buy back shares. ![]() You are faced with the choices in Exhibit 1. You understand that the company should invest for growth a board member suggests more share repurchases in order to “stabilize the price.” For purposes of this example, the company also has $300 million of excess cash, and $9 million of posttax earnings, which leads to an observed market multiple of 16.5. The current core business generates net operating profit after taxes (NOPAT) of $100 million the EV-to-NOPAT multiple is therefore 15. Imagine you are the CEO of a company with an enterprise value (EV), excluding excess cash, of $1.5 billion. The ‘higher multiple’ trapĪ higher multiple is a head turner. In particular, there are three instances when an overreliance on multiples can contribute to poor strategic decisions in capital allocation: (1) prioritizing multiples when investments at a lower multiple could generate more value (2) ignoring the interplay between multiples, returns on capital, and cost of capital when allocating capital to a noncore business and (3) extrapolating from a start-up’s results when determining a conglomerate’s potential for value creation. Sometimes companies miss this essential point. Multiples are the result of good outcomes, but they are not the primary objective.
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