AB is a telecommunications consultancy based in Europe that trades globally. It was established 15 years ago. The four founding shareholders own 25 per cent of the issued share capital each and are also executive directors of the entity. The shareholders are considering a flotation of AB on a European stock exchange and have started discussing the process and a value for the entity with financial advisers. The four founding shareholders, and many of the entity’s employees, are technical experts in their field, but have little idea how entities such as theirs are valued.

Assume you are one of AB’s financial advisers. You have been asked to estimate a value for the entity and explain your calculations and approach to the directors. You have obtained the following information.

Summary financial data for the past three years and forecast revenue and costs for the next two years is as follows.

Income Statement for the years ended 31 March Actual Forecast 2016

€ million 2017

€ million 2018

€ million 2019

€ million 2020

€ million Revenue Less:

Cash operating costs Depreciation Pre-tax earnings Taxation 125.0 37.5 20.0 67.5 20.3 137.5 41.3 22.0 74.2 22.3 149.9 45.0 48.0 56.9 17.1 172.0 52 48 72 22 198.0 59 48 91 27 Other information/assumptions:

Growth in after-tax cash flows for 2021 and beyond (assume indefinitely) is expected to be 3 per cent per annum. Cash operating costs can be assumed to remain at the same percentage of revenue as in previous years. Depreciation will fluctuate but, for purposes of evaluation, assume the 2020 charge will continue indefinitely. Tax has been payable at 30 per cent per annum for the last three years. This rate is expected to continue for the foreseeable future, and tax will be payable in the year in which the liability arises.

Statement of financial position at 31 March 2016 € million 2017 € million 2018 € million Assets Non-current assets Property, plant and equipment Current assets Equity and liabilities Equity Share capital (shares of €1)
Retained earnings Current liabilities 150 48 198 30 148 178 20 198 175 54 229 30 179 209 20 229 201 62 263 30 203 233 30 263 Note: The book valuations of non-current assets are considered to reflect current realisable values.

The average P:E ratio for telecommunication entities’ shares quoted on European stock exchanges has been 12.5 over the past 12 months. However, there is a wide variation around this average, and AB might be able to command a rating up to 30 per cent higher than this.
An estimated cost of equity capital for the industry is 10 per cent after tax.
The average pre-tax return on total assets for the industry over the past three years has been 15 per cent.
Required

(a) Calculate a range of values for AB, in total and per share, using methods of valuation that you consider appropriate. Where relevant, include an estimate of value for intellectual capital.

(b) Discuss the methods of valuation you have used, explaining the relevance of each method to an entity such as AB. Conclude with a recommendation of an approximate flotation value for AB, in total and per share.