Principles of Finance: Unit 8, Way More Valuable Investment: Who Gets What?

After a company has been successfully bought, taken private, and then brought public again... how are the profits distributed? Who gets what? BANK!

CoursesFinance Concepts
Principles of Finance
FinanceFinancial Responsibility
Personal Finance
Finance and EconomicsPrinciples of Finance
LanguageEnglish Language
Life SkillsPersonal Finance
SubjectsFinance and Economics

Transcript

00:26

drone a small but scrappy competitor powerful in Latin America then growth

00:31

slowed Wall Street fell out of love with the company the company stock got cheap [People working in Wall Street and broken love heart appears]

00:37

and it was bought by the private equity firm of the agony and the equity for one

00:41

point four billion dollars with a hundred fifty million of the firm's own

00:45

equity in it 50 million bucks from management 500 million of the company's

00:50

own cash and then seven hundred million of debt to complete the MV oh well the

00:55

company has been flat for three years in revenues profits and other metrics while [Company stock growth chart]

00:59

it upgraded and updated its Factory and came out with a new underwater drone

01:04

huge excitement now from the investment community about how big this underwater

01:08

droning can be so the company goes public for a second time after having

01:12

been taken private and the stock Rockets the numbers are kind of simple Wall [stock rockets in the sky]

01:17

Street is telling you that the company is worth in the form of the 200 ish

01:22

dollars a share that they're paying for its stock a lot yeah they're telling you

01:26

what it's worth two hundred bucks what they're paying so be rnd came public at

01:29

60 bucks with over 50 times oversubscribed demand and was a rocket

01:34

ship given the trigger of the green shoe the right of the underwriting Investment

01:38

Bank to sell more shares in the IPO than originally planned is the base case well

01:42

there are now 35 million total shares outstanding and at 200 bucks a share

01:46

that's a market cap of seven billion dollars the company has 700 million of

01:51

debt and 300 million of cash to give it a net enterprise value of 7.4 billion [net value of company formula appears]

01:56

note that the enterprise value reflects the cost to replace the entire

02:00

enterprise not just the equity that is the enterprise value of a house is

02:05

whatever you paid for it I eat the down payment of 100 grand plus the dead IE

02:10

mortgage of 400 K that house has an inner

02:13

prized value kind of of 500 grand its equity value to you however is a hundred

02:19

grand get it got it good all right well there are also a bunch of stock options [man discussing stock options]

02:22

that employees were granted in this latest IPO of the company they will vest

02:26

into them and dilute ownership about ten percent over time but will generate cash

02:31

and tax losses for the company as those options are exercised and then sold into

02:36

the market so while there are thirty five million shares outstanding at this [stock working out at the gym]

02:39

moment there are another and three million or so options with an average

02:43

strike price of fifty bucks out there so if all were exercised well

02:47

there would be on a fully diluted basis thirty eight million shares outstanding

02:51

but also another three million times the fifty dollar each strike price or a

02:56

hundred fifty million dollars more in cash generated from the conversion of

03:00

those options to being shares for the company and there would also be a tax

03:04

loss generated in the form of the spread from the trading price of the stock at

03:08

fifty sixty dollars to where the strike price is converted options into shares

03:13

so if the stock were forever flat at two hundred bucks a share well that'd be a [company stock value appears]

03:17

hundred fifty dollars a share times three million shares or a whopping four

03:23

hundred fifty million dollars in tax losses generated by the conversion of

03:27

those options as the IRS essentially counts those options as being

03:31

compensation just a normal cost that gets deducted against profits yeah go

03:36

figure so if B rnd was in fact profitably paying taxes there would be a

03:41

value of say a thirty percent tax rate against that four hundred fifty million

03:45

in tax losses or a value of about a hundred fifty million dollars in tax

03:49

sheltered profits against which the company would pay no taxes courtesy of [company stamped no taxes]

03:54

their generous option grants to key employees well as the television flashes

03:58

Cramer yelling about some haircare product on CNBC and a funky monkey

04:02

dances over the BR nd stock ticker as it flirts back and forth with a two hundred [monkey hanging from stock ticker]

04:06

dollar line the senior partner who told you the naive young analysts to not sell

04:11

to Apple for the 1.6 billion dollars they wanted to pay in the middle of the

04:15

IPO yeah he walks by your desk well I'll just say it don't you feel stupid now [man approaches woman desk]

04:20

and you hang your head thinking for a moment that your career might in fact

04:25

don't despite this great phone until victory here at the firm be pretty

04:29

much over in dead well the now expected five ish there so

04:33

billion dollars of game would trigger the 25 percent carry figure instead of

04:39

the 90 million you overly conservatively wanted your firm to make on a sure thing

04:44

with Apple well now they're gonna make more like a billion in a quarter bucks

04:48

that is have you taken the offer the firm would have collected ninety million

04:52

dollars in profit participations spread among the five partners and other key

04:56

players you in theory would have gotten about 10 percent of that figure or nine

05:00

million bucks or about six million after tax not great wealth by Silicon Valley [Silicon Valley street appears]

05:05

standards maybe at Google but decent money enough to buy a small home and

05:08

have a few bucks left over as a cushion so that was you in your overly

05:12

conservative child of a schoolteacher mindset but now with the stock at $200 a

05:18

share your firm stands to make 1.25 billion dollars in profit participations

05:24

or carry same five people and change-- split it just massively bigger pie to

05:29

split and you wonder openly if you'll still be getting anything close to that

05:33

10 percent or carry you've gulp almost unable to even think about it that you [woman gulps as man walks away]

05:37

not even 30 years old would six months and change after this hugely hot IPO of

05:42

be rnd after the partners sold beginning a check personally for run some 20 30 40

05:49

maybe a hundred million dollars or there abouts and change life-changing

05:53

incredible compensation well you tried desperately to convince yourself that

05:57

you earned the money and note that you did work evenings and weekends regularly [woman sleeping]

06:02

by being just a little greedy impatient you stand to have made a dozen times as

06:06

much as you would have in the Apple scenario fear had won in the wrestling

06:10

match in your brain you vowed and never let that happen again [reason and fear men wrestling]

06:14

but then you look at the stock screener ticking by with $200 flashing green on

06:18

it and you wonder about the awesome things you learned in this shmoop

06:22

finance course one of the most important being that nothing trades at a hundred

06:27

times earnings ever that is a given stock may look like it's trading at a

06:32

hundred times earning a rearview mirror but then the street is [stock earning appear in car rear view mirror]

06:35

expecting massive earnings growth so on next year's numbers now that stocks

06:40

trading it more like 30 times in the following year 15 times because they're

06:44

expecting earnings to grow massively well like a typical hyper growth stock

06:48

might have almost no debt and very little cash and have trailing earnings

06:51

of $1 a share and trade for a hundred bucks a share

06:54

but then that company would be expected to be generating three dollars a share

06:58

in earnings in the current year and maybe something like six bucks a share

07:01

the following year something like that anyway such that the hundred dollars a

07:05

share divided by that $6 share in earnings is a reasonable close to what

07:09

the overall stock market is trading multiple of high teens low 20s you know

07:13

somewhere in there something such that well you can do the math and glean that [math equations appear on board]

07:17

if in a finite decade or two yeah if the company was flat on earnings investors

07:22

would at least get all their money back and probably a bit more right not crazy [money transfers to investors]

07:27

but you know the inside numbers of B rnd and it ain't the above story at all B

07:33

are nd has trailing operating profit before interest costs of 115 million

07:37

dollars and you take away about 30 million bucks in net interest cost to

07:41

you know pay the rent on the bond B rnd still has the 700 million bucks in debt

07:45

but it has 400 million in cash it pays a lot more rent on the debt than it makes

07:50

on interest on its cash so it still has net debt costs add in a few more cash

07:56

expenses for factory service and other quote being public unquote expenses like

08:00

filings and more lawyers and all that crap and roughly you figured that B rnd

08:04

has real pre-tax earnings of give or take 75 million bucks a year in cash

08:09

earnings since losses from employee stock options are likely years away from

08:13

kicking in because the employees first have to vest into the options and then [man discussing BRND company profits]

08:17

decide to sell them well the company has only modest tax shelters at work so they

08:21

do pay real cash taxes and those taxes then eat another and say 20 million

08:25

dollars of cash earnings from the company so after everything B R and D

08:29

has about 55 million dollars in real cash earnings and it has 35 million

08:33

shares outstanding so that's a trailing earnings of 55 divided by 35 there it's

08:38

a buck 57 a share in earnings at $200 a share the stock trades at something like

08:43

a hundred twenty-five times but you remember the schmoopy watchword

08:47

whisper here that nothing trades there right so that means the street must be [important note appears]

08:52

thinking that next year the company must earn like maybe five dollars a share or

08:58

more that would be earnings of five bucks times thirty five million shares

09:02

or earnings of a hundred seventy five million ish and the next year after that

09:07

it must earn something like eight dollars a share or about three hundred [wall street projection appears]

09:11

million well at those levels then yes today B R and D is in fact worth what

09:15

the street is dreaming of at achieving three years later when it's trading for

09:19

two hundred bucks a share but you keep staring at the sales figures you're

09:22

getting as reports from salesforce.com and your gut tells you that the tidal [woman staring at computer screen]

09:27

wave of sales that the street needs to continue to keep paying two hundred

09:30

dollars a share for your stock well those sales they ain't happening for a

09:35

fleeting moment you wonder can we sell a ton more stock at these prices I'd [woman asking if she can sell more stock]

09:40

happily dilute myself a hundred percent at a seven billion dollar cap take the

09:45

money and run and then you see a little old lady being interviewed by Kramer on

09:49

TV she's so happy she bought a hundred shares of B RN D at [woman smiling on TV]

09:54

the sixty dollar IPO price and she just made 14 grand and Kramer asks if she's

10:00

gonna sell and get new dentures and she says no way silver slacks analyst says

10:06

the stocks going to a thousand I may buy some more stock here and you muse and [old woman saying she wants to buy more stock]

10:11

it's the environment of a casino and that would be great if this really were

10:16

a casino but it's not this is a place where people invest for retirement for [old man reading]

10:21

real things of value not for a wild night's entertainment like its Vegas so

10:26

what is going on here you know you can't shouldn't sell more stock at these

10:30

prices but already you can hear the senior PE guys strategizing with your

10:35

bank about doing the secondary offering in six months they'll dump all their

10:38

shares onto the market take their huge gains and run audibly you can hear

10:43

yourself expressing concerns that VR nd will vastly miss its expectations toward

10:48

the end of the year that you realize you have a 144 a restriction on selling your

10:52

own shares until six months and change after the company's been public but you

10:56

feel like you quote just know unquote that the company

10:58

we'll miss numbers badly at some point here in the near future the masses just

11:02

aren't buying the Thunder drone like everyone thought they would and you [Woman giving speech and thunder drone appears behind her]

11:06

wonder if you should purchase one yourself and have it get to work digging

11:10

a grave for your once promising career [drone fades into ocean bottom]