Pharma Lab Bhd (PLB) Valuation of Tawakal Medical (TMed)

PLBs market value had plunged more than 6% in a single day following the announcement of the firms acquisition of TMed on 16 January 2020, as investors expressed their disapproval. Their concern was that PLB was overpaying and would not earn the financial returns demanded by investors. The deal included a premium of 37% above TMeds closing price on 15 January 2020. TMeds shares soared by more than 20% the prior day.

PLBs primary motive for the takeover was to expand its heart device business. PLB is the industry leader in manufacturing coronary stents and heart valves, wanted to combine with TMed, a pacemaker maker, and other devices for failing hearts. The aging population makes the failing heart market likely to show considerable growth in the coming years. PLB said its deal would help it compete more effectively against larger rivals such as Medtronic, Scientific Corp., and Life Sciences.

Table 1 provides data enabling an analyst to value TMed on a stand-alone basis using the comparable company method. Note that the table contains valuation multiples for TMeds three primary competitors as well as earnings, revenue, book value, and enterprise value per share.

Table 1: Valuing TMed Using the Comparable Company Method Target Valuation Based on Following Multiples (MVC/VIC)
Comparable Company	Forward P/E	Price / Revenue	Price /Book	Enterprise Value to EBITDA	Enterprise Value to Revenue
Medtronic (ratio)	16.1	4.2	2.3	15.2	4.7
Scientific Corp (ratio)	18.1	4.1	4.8	18.4	4.7
Life Sciences (ratio)	29.3	4.9	9.1	26.8	5.0
Tawakal Medical (RM Per Share)	Earnings per share, RM1.06	Annual revenue / share, RM5.54	Book value / share, RM4.04	Enterprise value / share, RM1.12	Annual revenue / share RM5.54

The choice of valuation multiples is subjective in that it is unclear which best mirror the standalone value of TMeds. Abnormally low-interest rates at the time of the merger announcement could have resulted in artificially high valuation multiples. Also, the competitors selected are larger and more diversified than TMeds, and their growth rates and profitability tend to be more outstanding. In contrast, the riskiness of their cash flows tends to be less.

Required:

1. Based on the information provided in Table 1, calculate a reasonable standalone value for TMed. (Hint: Use the comparable company valuation method to derive a single point estimate of standalone value.)

[18 marks]

2. Explain why the purchase price premium needs to be included in the calculation and state the implication of not having the purchase price premium.

• (c) Discuss the key limitations of the comparable companies' valuation methodology that you used in your calculation.

• (d) Assume that TMeds Tangible Book Value (TBV) is RM198.5 million and profit after-tax is RM20 million. A comparable company, Bio-O Medical was recently acquired for RM325.5 million, a 22% more than its tangible book value (TBV).

1. (i) Calculate the TBV for Bio-O Medical during the acquisition.
2. (ii) How much should PLB expect to pay for TMed based on this recent transaction?

5. The two methods that you used, the comparable companies in (a) and recent transactions method in (d), discuss the appropriateness of those methods.

6. It is expected that TMed is to grow at 5% annually into the foreseeable future. The firm has a debt, capital spending equals the firm's depreciation rate, and the annual change in working capital is expected to be minimal. TMed's beta is estimated to be 2.0, the 10-year Treasury bond is 5%, and the historical risk premium of stocks over the risk-free rate is 5.5%.

1. Calculate the value of TMed using the DCF method.
2. Discuss the circumstances that might be more appropriate to use DCF methods rather than the relative-valuation approach and the limitations of using DCF methods.