BSc 6th Semester

Bachelor Thesis
Department of Economics and Business

Writers:
Sofia Jonsson
BScB
Study no: EC87693
Exam no: 402906
Erik Christian Montes Schtte
BScB
Study no: EM86756
Exam no: 300852
Supervisor:
Baran Siyahhan

A Valuation of ABB: A Comparison of Organic and M&A

Growth Strategies.

Aarhus University
Business and Social Sciences
1st May 2012

Executive Summary
The main purpose of this thesis is to determine the fair value of ABB and how it has been affected by
their current strategy of growth through mergers and acquisitions (M&A). To determine this we
decided to value ABB according to a hypothetical scenario where the firm only growths organically
and then we compare this value with the value that includes their M&A growth strategy.
ABB is a Swiss multinational corporation and one of the biggest players in the power and automation
technology industry. They operate in more than 100 countries and obtained revenues equal to 37.990
USD in 2011. The industry in which the firm operates has in recent years been characterized by
consolidation and a merger-wave is anticipated to develop as other competitors begin to follow the
same steps.
The thesis begins with a discussion of different valuation techniques. Based on the intrinsic
characteristics of ABB and the attributes of the valuation models we conclude that that the discounted
cash flow (DCF) model is best suited to use in order to estimate the fair value of ABB. These results
are validated through the use of the Economic profit and multiples valuation.
In addition we examine theoretical frameworks for value creation through M&A and empirical
evidence on that matter. The general purpose of this last point is to accurately address the
implications that growth through M&A will have on the firm's value. In order to assess ABBs future
performance we conduct a strategic analysis of external and internal environmental dynamics. This is
followed by an analysis of the historical financial performance of the firm.
The discount rate for the DCF and EP model is the Weighted Average Cost of Capital (WACC). The
implications and caveats when estimating this rate are discussed. This is followed by the actual
estimation of a forward-looking WACC through the Capital Asset Pricing Model (CAPM).
The intrinsic value of the ABB share is estimated to be 20,02 USD compared to 24,09 USD in case of
a strategy based purely on organic growth. The estimated price of 20,02 USD is very close to the
average price during the last 3 months of 2011, which was 18,24 USD. This implies that the market is
fundamentally valuing ABBs share's correctly. The result highlights the difficulties in creating value
for the acquirers shareholder when engaging into aggressive M&A activities. However, it might be a
necessity for the firm to pursue this strategy in order to maintain their competitive position based on
the current consolidation trends within the industry.

TABLE OF CONTENT
1. INTRODUCTION ........................................................................................... 1
1.1 PROBLEM STATEMENT..................................................................................... 2
1.2 DELIMITATION ............................................................................................ 4
1.3 SOURCE CRITICISM ........................................................................................ 4
2. METHODOLOGY ........................................................................................... 5
2.1 INTRODUCTION TO VALUATION MODELS ................................................................... 5
2.2 CAPITAL BASED MODELS .................................................................................. 6
2.2 REAL OPTIONS ............................................................................................ 9
2.5 CONCLUDING REMARKS ................................................................................... 9
3. MERGERS & ACQUISITIONS ............................................................................ 10
3.1 HISTORICAL OVERVIEW .................................................................................. 10
3.2 ALTERNATIVE THEORETICAL PERSPECTIVES ON M&A ..................................................... 11
3.3 SOURCES OF VALUE CREATION ........................................................................... 12
3.4 EMPIRICAL RESULTS ON RETURNS ........................................................................ 14
4. STRATEGIC ANALYSIS OF THE FIRM ................................................................. 17
4.1 EXTERNAL ENVIRONMENT ................................................................................ 18
4.2 INDUSTRY ANALYSIS PORTERS 5 FORCES .............................................................. 23
4.3 CONSOLIDATION TRENDS IN THE INDUSTRY ............................................................... 27
4.4 INTERNAL ANALYSIS RESOURCES AND CAPABILITIES ..................................................... 28
4.5 SUMMARY OF STRATEGIC ANALYSIS ...................................................................... 34
5. ANALYSIS OF FINANCIAL STATEMENTS ............................................................. 35
5.1 REORGANIZATION OF FINANCIAL STATEMENTS ........................................................... 36
5.2 ANALYSIS OF HISTORICAL PERFORMANCE ................................................................. 37
6. ESTIMATING THE COST OF CAPITAL ................................................................ 42
6.1 CAPITAL STRUCTURE .................................................................................... 43
6.2 ESTIMATING THE COST OF EQUITY ....................................................................... 45
6.3 COST OF DEBT ........................................................................................... 53
6.4 THE WACC ............................................................................................. 54
7. FORECASTING & VALUATION ......................................................................... 55
7.1 FORECASTING STRATEGY 1: ORGANIC GROWTH ......................................................... 56
7.2 FORECASTING STRATEGY 2: GROWTH THROUGH M&A ................................................... 61
7.3 FINAL VALUATION ....................................................................................... 67
7.4 SENSITIVITY ANALYSIS ................................................................................... 68
7.5 MULTIPLES VALUATION .................................................................................. 72
8. DISCUSSION .............................................................................................. 73

9. CONCLUSION ............................................................................................ 74
10. BIBLIOGRAPHY ........................................................................................ 76
11. APPENDICES............................................................................................ 85
APPENDIX 1: SUMMARY RESULTS KPMG REPORT ............................................................. 86
APPENDIX 2: SUMMARY OF PESTEL .......................................................................... 87
APPENDIX 3: METAL PRICES .................................................................................. 88
APPENDIX 4: SUMMARY OF STRATEGIC ANALYSIS ............................................................. 89
APPENDIX 5: REORGANIZATION OF FINANCIAL STATEMENTS .................................................. 90
APPENDIX 6: 10Y TREASURY FORECAST ...................................................................... 92
APPENDIX 7: COMPARISON OF BETA ESTIMATES .............................................................. 93
APPENDIX 8: HISTORICAL RATIOS ............................................................................ 97
APPENDIX 9: FORECAST DRIVERS STRATEGY 1- ORGANIC GROWTH ........................................... 98
APPENDIX 10: FORECAST DRIVERS STRATEGY 2 - M&A ...................................................... 99
APPENDIX 11: RESULTS STRATEGY 1 - ORGANIC GROWTH (BASE CASE) .................................... 100
APPENDIX 12: RESULTS STRATEGY 2 - M&A (BASE CASE) ................................................. 101
APPENDIX 13: SENSITIVITY ANALYSIS ....................................................................... 102
APPENDIX: 14-35 (EXCEL-FILES) ........................................................................... 104

DETAILED TABLE OF CONTENT

1. INTRODUCTION ........................................................................................... 1
1.1 PROBLEM STATEMENT..................................................................................... 2
1.2 DELIMITATION ............................................................................................ 4
1.3 SOURCE CRITICISM ........................................................................................ 4
2. METHODOLOGY ........................................................................................... 5
2.1 INTRODUCTION TO VALUATION MODELS ................................................................... 5
2.2 CAPITAL BASED MODELS .................................................................................. 6
2.2.1 Dividend Discount Model ....................................................................... 6
2.2.2 Residual Income (RI) Model .................................................................... 7
2.2.3 The Enterprise Discounted Cash Flow Model ............................................... 7
2.2.4 The Enterprise Economic Profit Model....................................................... 8
2.2 REAL OPTIONS ............................................................................................ 9
2.5 CONCLUDING REMARKS ................................................................................... 9
3. MERGERS & ACQUISITIONS ............................................................................ 10
3.1 HISTORICAL OVERVIEW .................................................................................. 10
3.2 ALTERNATIVE THEORETICAL PERSPECTIVES ON M&A ..................................................... 11
3.2.1 The Neoclassical Hypothesis .................................................................. 11
3.2.2 Managerial Theories ........................................................................... 12
3.2.2.1 The Managerial Hypothesis ................................................................. 12
3.2.2.2 The Hubris Hypothesis ...................................................................... 12
3.3 SOURCES OF VALUE CREATION ........................................................................... 12
3.3.1 Basic Principles of Value Creation ........................................................... 13
3.3.2 Value Creation through Mergers and Acquisitions ........................................ 13
3.3.2.1 Revenue Enhancement ........................................................................................... 13
3.3.2.2 Cost Savings and Operational Synergies ....................................................................... 13
3.3.2.3 Financial Synergy ................................................................................................. 14
3.3.2.4 New Growth Opportunities ...................................................................................... 14

3.4 EMPIRICAL RESULTS ON RETURNS ........................................................................ 14

3.4.1 Empirical Results on Value Creation ........................................................ 14
3.4.2 Returns to Acquirer Shareholders ........................................................... 15
3.4.3 Returns to Target Shareholders .............................................................. 15
3.4.4 Returns to Bondholders ....................................................................... 16
3.4.5 Situational Factors Affecting Returns ...................................................... 16
3.4.5.1 Acquirer Size and Target Size ................................................................................... 16
3.4.5.2 Friendly versus Hostile ........................................................................................... 16
3.4.5.3 Payment Method .................................................................................................. 16
3.4.5.4 Long-Term Studies ................................................................................................ 17

4. STRATEGIC ANALYSIS OF THE FIRM ................................................................. 17

4.1 EXTERNAL ENVIRONMENT ................................................................................ 18
4.1.1 Political and Legislative Factors ............................................................. 18
4.1.2 Economic Factors ............................................................................... 19
4.1.3 Socio-cultural and Environmental Factors ................................................. 21
4.1.4 Technological Factors.......................................................................... 21
4.2 INDUSTRY ANALYSIS PORTERS 5 FORCES .............................................................. 23
4.2.1. Bargaining Power of Suppliers .............................................................. 24
4.2.2. Bargaining Power of Buyers.................................................................. 24
4.2.3. Competitive Rivalry ........................................................................... 25
4.2.4. Threat of New Entrants ...................................................................... 26
4.2.5. Threat of Substitutes ......................................................................... 26
4.3 CONSOLIDATION TRENDS IN THE INDUSTRY ............................................................... 27
4.4 INTERNAL ANALYSIS RESOURCES AND CAPABILITIES ..................................................... 28
4.4.1 VRIO Framework ................................................................................ 29
4.4.1.1 Tangible Resources ............................................................................................... 29
4.4.1.2 Intangible Resources ............................................................................................. 30
4.4.1.3 Organizational and Human Factors............................................................................. 32
4.4.1.4 Summary of VRIO Analysis ....................................................................................... 33

4.4.2 Internal Weaknesses ........................................................................... 33

4.5 SUMMARY OF STRATEGIC ANALYSIS ...................................................................... 34
5. ANALYSIS OF FINANCIAL STATEMENTS ............................................................. 35
5.1 REORGANIZATION OF FINANCIAL STATEMENTS ........................................................... 36
5.1.1. Major Adjustments to the Reorganized Financial Statements ......................... 37
5.2 ANALYSIS OF HISTORICAL PERFORMANCE ................................................................. 37
5.2.1 Revenue Growth ................................................................................ 37
5.2.2 ROIC .............................................................................................. 40
6. ESTIMATING THE COST OF CAPITAL ................................................................ 42
6.1 CAPITAL STRUCTURE .................................................................................... 43
6.2 ESTIMATING THE COST OF EQUITY ....................................................................... 45
6.2.1 Estimating the Risk Free Rate ................................................................ 47
6.2.2 Estimating the Market Risk Premium ....................................................... 48
6.2.3 Estimating Beta ................................................................................. 50
6.3 COST OF DEBT ........................................................................................... 53
6.4 THE WACC ............................................................................................. 54
7. FORECASTING & VALUATION ......................................................................... 55
7.1 FORECASTING STRATEGY 1: ORGANIC GROWTH ......................................................... 56
7.1.1 Base Case Scenario ............................................................................. 57

7.1.2 Bullish Scenario ................................................................................. 59

7.1.3 Bearish Scenario ................................................................................ 60
7.2 FORECASTING STRATEGY 2: GROWTH THROUGH M&A ................................................... 61
7.2.1 Base Case ........................................................................................ 63
7.2.2 Bullish Scenario ................................................................................. 65
7.2.3 Bearish Scenario ................................................................................ 66
7.3 FINAL VALUATION ....................................................................................... 67
7.4 SENSITIVITY ANALYSIS ................................................................................... 68
7.5 MULTIPLES VALUATION .................................................................................. 72
8. DISCUSSION .............................................................................................. 73
9. CONCLUSION ............................................................................................ 74
10. BIBLIOGRAPHY ........................................................................................ 76
11. APPENDICES............................................................................................ 85
APPENDIX 1: SUMMARY RESULTS KPMG REPORT ............................................................. 86
APPENDIX 2: SUMMARY OF PESTEL .......................................................................... 87
APPENDIX 3: METAL PRICES .................................................................................. 88
APPENDIX 4: SUMMARY OF STRATEGIC ANALYSIS ............................................................. 89
APPENDIX 5: REORGANIZATION OF FINANCIAL STATEMENTS .................................................. 90
APPENDIX 6: 10Y TREASURY FORECAST ...................................................................... 92
APPENDIX 7: COMPARISON OF BETA ESTIMATES .............................................................. 93
APPENDIX 8: HISTORICAL RATIOS ............................................................................ 97
APPENDIX 9: FORECAST DRIVERS STRATEGY 1- ORGANIC GROWTH ........................................... 98
APPENDIX 10: FORECAST DRIVERS STRATEGY 2 - M&A ...................................................... 99
APPENDIX 11: RESULTS STRATEGY 1 - ORGANIC GROWTH (BASE CASE) .................................... 100
APPENDIX 12: RESULTS STRATEGY 2 - M&A (BASE CASE) ................................................. 101
APPENDIX 13: SENSITIVITY ANALYSIS ....................................................................... 102
APPENDIX: 14-35 (EXCEL-FILES) ........................................................................... 104

TABLE OF EXHIBIT
EXHIBIT 1: THESIS OVERVIEW ................................................................................................ 3
EXHIBIT 2: PORTERS FIVE FORCES ......................................................................................... 27
EXHIBIT 3: SUMMARY OF VRIO.............................................................................................. 33
EXHIBIT 4: SUMMARY OF REORGANIZED FINANCIAL STATEMENTS ............................................................. 36
EXHIBIT 5: TOTAL REVENUES ............................................................................................... 38
EXHIBIT 6: REVENUES PER REGION .......................................................................................... 39
EXHIBIT 7: GROWTH IN REVENUES PER REGION.............................................................................. 39
EXHIBIT 8: REVENUES PER DIVISION ......................................................................................... 39
EXHIBIT 9: GROWTH IN REVENUES PER DIVISION............................................................................. 40
EXHIBIT 10: ROIC TREE .................................................................................................... 41
EXHIBIT 11: HISTORICAL LEVELS OF DEBT ................................................................................... 43
EXHIBIT 12: CAPITAL STRUCTURE ........................................................................................... 44
EXHIBIT 13: TEN-YEAR GOVERNMENT BOND YIELDS (AVERAGE) ............................................................. 48
EXHIBIT 14: THE MARKET RISK PREMIUM.................................................................................... 49
EXHIBIT 15: MONTHLY ROLLING BETA ...................................................................................... 51
EXHIBIT 16: WEEKLY ROLLING BETA ........................................................................................ 51
EXHIBIT 17: EVIEWS OUTPUT MONTHLY AND WEEKLY BETA (DEC 2011) .................................................. 52
EXHIBIT 18: BETA ESTIMATES ............................................................................................... 53
EXHIBIT 19: HISTORICAL LONG-TERM CORPORATE CREDIT RATINGS - ABB .................................................. 53
EXHIBIT 20: WACC ........................................................................................................ 54
EXHIBIT 21: FORECAST DRIVERS ............................................................................................ 56
EXHIBIT 22: BASE CASE SCENARIO (ORGANIC GROWTH)..................................................................... 59
EXHIBIT 23: BULLISH SCENARIO (ORGANIC GROWTH) ....................................................................... 60
EXHIBIT 24: BEARISH SCENARIO (ORGANIC GROWTH) ....................................................................... 61
EXHIBIT 25: SOURCES OF VALUE M&A .................................................................................... 62
EXHIBIT 26: CHANGES IS FORECAST DRIVERS FOR STRATEGY 2: M&A ....................................................... 63
EXHIBIT 27: BASE CASE SCENARIO M&A .................................................................................. 65
EXHIBIT 28: BULLISH SCENARIO M&A ..................................................................................... 66
EXHIBIT 29: BEARISH SCENARIO M&A ..................................................................................... 67
EXHIBIT 30: SUMMARY OF VALUATION STRATEGIES AND SCENARIOS ........................................................ 68
EXHIBIT 31: PERCENTAGE CHANGE IN SHARE PRICE RISK PREMIUM & BETA ................................................ 69
EXHIBIT 32: PERCENTAGE CHANGE IN SHARE PRICE RISK FREE RATE & AVERAGE COST OF DEBT ........................... 70
EXHIBIT 33: PERCENTAGE CHANGE IN SHARE PRICE STEADY STATE GROWTH & RONIC .................................... 70
EXHIBIT 34: PERCENTAGE CHANGE IN SHARE PRICE REVENUE GROWTH AND EBITA MARGIN ............................... 71
EXHIBIT 35: PERCENTAGE CHANGE IN SHARE PRICE ACQUIRED GOODWILL / ACQUIRED REVENUES ......................... 71
EXHIBIT 36: HISTORICAL AND FORWARD LOOKING MULTIPLES ............................................................... 72
EXHIBIT 37: MULTIPLES BASED VALUE (M&A STRATEGY) ................................................................... 72
EXHIBIT 38: ABB SHARE PRICE COMPARISON TO OUR RESULTS ............................................................ 74

1. Introduction
I conceive that the great part of the miseries of mankind are brought upon them by false estimates
that have made of the value of things.
Benjamin Franklin, 1779
The question of how to create value is a widely debated subject within the business world. Firms
create a vision, a mission and a strategy that defines how they will go about to reach their goals. The
ultimate goal for a corporation should be to create value for their shareholders, the people that have
invested in their business.
In relation to value creation, one of the most deliberated issues is the concept of mergers and
acquisitions (M&A). It is generally accepted that M&A does create value; however, most this value
ends up in the hands of the target firm's shareholders with little or no benefit for the acquirer's
shareholders. The majority of the empirical literature on M&A takes an industrial perspective and
looks unto the average effect of M&A activity on value creation. We believe that looking into a single
case study might allow us to gain a different insight into the different factors that drive value.
The most appropriate way to look at value creation from an case study perspective is to do perform an
actual valuation; thus, the focus shifts from overall value creation to how a M&A activity has affected
the value of particular firm. Therefore, one of the preconditions of the case study was that the firm in
question had to be part of an industry that was displaying signs of intense M&A activity. The power
and automation technology industry has certainly displayed an intensifying consolidation trend that
started as the world economy began to emerge from the financial crisis. One of the leading forces
behind this consolidation trend has been the ABB group,1 which in 2010 announce that it planned to
achieve an additional compound annual growth rate of 3% by actively engaging into a "growth
through acquisitions strategy".
ABB is a Swiss multinational corporation and the global leader in power and automation
technologies. As one of largest engineering companies in the world, its operations span to more than
100 different countries. Its core business is divided into five segments: power products, power
systems, discrete automation and motion, low voltage products and process automation.
In order to estimate the value which the firm created (or destroyed) by engaging into this "growth
through acquisitions" strategy we estimate the value of the firm under their current strategy and

Simply referred as ABB from now on.

compare this value to the hypothetical value which the firm will have if it only pursued organic
growth.

1.1 Problem Statement

The motivation behind this thesis is our general interest in finance and the wish to put theory into
practice. An estimation of intrinsic value allows us to put out theoretical knowledge of corporate
finance into practice. The secondary focus on value creation through M&A allows expand the scope
of the thesis. This approach has the additional advantage of covering two different, though
interrelated fields within finance.
Additionally, the industry in which ABB operates was of huge interest to e both of us and ABBs
current M&A strategy opened our eyes to an interesting and alternative perspective on valuation. The
main problem this thesis will examine is:
What is the fair value of ABB and how has it been affected by its current M&A growth strategy?
In order to be able to assess the impact of the M&A strategy we need to find the value of the
hypothetical strategy of pure organic growth. Therefore, the sub question in this thesis is:
What is the difference in fair value of ABB in case of an M&A growth strategy and an organic growth
strategy?
Before introducing the reader to how we will go about to solve the abovementioned problems initial
definitions are needed. By the notion of M&A growth strategy we mean organic growth plus
additional growth through M&A2. Thus, organic growth refers to the growth rate obtained without
expansions through acquisitions.

The notion of M&A growth strategy and M&A strategy will be used interchangeably throughout this thesis.

Exhibit 1: Thesis Overview

Theoretical
Foundation

Strategic Analysis

Analysis of
Financial
Statements

Valuation

Finale

Methodology
M&A

External environment
Industry environment
Internal environment

Reorganization of financial statements

Analysis of historical performance

Estimating cost of capital

Forecasting and valuation
Sensitivity analysis
Triangulation with multiples

Discussion
Conclusion

An overview of the thesis can be seen in exhibit 1. First we dwell into the methodology of valuation
models setting the foundation for the techniques we will use to value ABB. This is followed by an
introduction to the theory of M&A and how it can influence the value of a firm. This part is of
particular importance for the forecasting assumptions later in the process.
After the theoretical grounds have been laid out we present the strategic analysis of ABB. This
analysis is roughly divided into three parts: External environment, industry environment and internal
environment (resources and capabilities). Similar to the theoretical section on M&A, the strategic
analysis is essential to the forecasting part.
Next we describe the reorganization of ABBs financial statements and analyze the historical
performance of ABB key variables. This analysis has two primary foci: revenue and its historical
growth rate and return on invested capital (ROIC).
The final step before the actual valuation process can begin is the estimation of the cost of capital
(WACC) and the determination of the forecast drivers determining future performance. We proceed
with the determination of the intrinsic value under each scenario and arrive at two different values per
share, one for each strategy.
Following, we conduct a sensitivity analysis and relative valuation through multiples to appraise the
soundness of the model.
3

Finally, we discuss the results from the valuation and compare it to the market price of the ABB, this
section is called discussion. The thesis ends with a conclusion that summarizes the most important
findings.

1.2 Delimitation
The valuation is made from an investor perspective; hence, the thesis is based on publicly available
information. We have had no access to internal information. The focus of the valuation is on ABB as
a whole; consequently, it has been based on the consolidated annual reports no subsidiary have been
valued separately. Since the latest available annual report is for 2011 (released in the beginning of
2012) the cutoff date for the historical analysis is December 31th 2011. The comparison of fair value
will also be based on this specific date.
We have chosen not to analyze any competitors of ABB because of limited space and have instead
put emphasis on other factors considered more relevant to the question at hand. Since the firm has a
different set of competitors for each industry in which it operates, a sound competitor analysis would
require an industry specific competitor examination. This is beyond the scope of this paper.
Our wish to examine the difference in firm value in case of an organic growth strategy and growth
through mergers and acquisitions directly leads us to discuss the theoretical foundations and empirical
results surrounding M&A. The primary focus of the paper is still on the estimation of intrinsic value.
The secondary focus is on M&A and its effects on the value of the firm.
In addition, since finance is our main area of analysis we have chosen not to go into details related to
ABBs accounting standards, neither do we give an in-depth overview of ABB. It is assumed that the
reader holds basic knowledge about ABBs main operations. If supplementary information is needed
we direct the reader to their web-page: www.abb.com. Additional restrictions will be addressed in the
appropriate section.

1.3 Source Criticism

ABB prepares their consolidated annual report according to the U.S GAAP. Preparation of annual
reports requires them to make subjective estimates and judgments. This estimates can have tendency
to be biased in their favor as companies often engage in "earnings smoothing" (Trueman, Titman, &
Newman, 1988).
Forecasting is among else based on ABBs own key target financials and reports and these kinds of
documents may also present a positively biased picture of the firm. We sought to address this issue by
critically evaluating the plausibility of such forecasts and comparing them to independent analysis
made by newspapers and market research agencies.

The valuation process is primarily based on the books: "Valuation: measuring and managing the
value of companies" by Koller, Goedhart and Wessels (2009) and "Financial statement analysis and
security valuation" by Penman (2007). The M&A section is primarily based on academic journal
articles. These sources are considered to be reliable since they are written by scholars and
practitioners specializing in the field.
The other sources which, among others, include: newspaper articles, magazine articles, blogs and
independent market research reports are assumed to be reliable; however, we do not exclude the
possibility of conflicts of interest, especially regarding those reports sponsored by firms in the energy
sector.

2. Methodology
This section will review the theoretical foundations and classifications of valuation technologies
before choosing the most appropriate model given the characteristics of the firm we are valuing.
Considering that the focus of this thesis is not only on valuation, but the analysis of value in two
different strategies, the most befitting model will need to allow for forecasting flexibility.

2.1 Introduction to Valuation Models

Security analysis can be divided in three main branches: technical analysis, relative valuation and
fundamental analysis. Technical analysis attempts to forecast the direction and trend of prices by
analyzing past data, supply and demand and trend principles like momentum and reversal
(Clatworthy, 2005). While widely used by traders looking for short-term profits, this technique
provides little value for long-term investors who are more interested in the returns that can be earned
by buying and holding the security. Furthermore, if the market is truly efficient and prices already
contain all available information; price movements should follow a random walk and be inherently
unpredictable by using data from the past (Mayo, 2011). Most academics do not consider technical
analysis to be a true valuation technique (Bessembinder, 1998). However, due to the widespread use
of it by traders we believed it deserved to be mentioned. This thesis will disregard technical analysis
and focus solely on relative and fundamental valuation techniques.
Relative valuation techniques, which are also known as multiples, rely on market to book multiples
and compare these estimates to industry averages or close competitors to arrive at an enterprise value
(Penman, 2007). Multiples valuations are commonly used today to support and triangulate results
from capital based models (also known as accounting based models3), the main advantage of relative
models is that they are fairly easy to estimate and do not require forecasting. The biggest weakness of

We will use the terms interchangeably.

these models is that they rest on the belief of an efficient market that has priced future information
correctly. This can be a dubious assumption under market bubbles or extremely pessimistic bear
markets (Ackert & Deaves, 2010; Fama, 1970). Another issue with the approach lies in identifying
relevant value drivers and comparable peer group estimates, since the value will be dependent on how
similar the peer companies are in terms of growth and profitability.
Fundamental analysis relies on financial information in combination with the strategic and
competitive analysis of the firm's performance to establish a valuation based on intrinsic value.
Fundamental valuation models can be divided into at least two main categories: capital based
models4 and substantive value models (Plenborg, Hansen, Lejre, 2003). Substantive value models
are normally used to value firms in financial distress or in risk of going bankrupt and since this is not
the case for ABB the model will not be discussed further. Having excluded substantive value models
from the discussion we will now review capital based models and real options and lastly justify our
final choice of model.

2.2 Capital Based Models

The following section introduces the main capital based models. First the dividend discount model is
introduced, followed by the residual income model and finally the enterprise value models are
presented.
2.2.1 Dividend Discount Model
The first capital based model to be developed was the dividend discount model5 (DDM). This model
is based on discounting all future dividends to present value using the cost of equity as a discount
rate. The biggest problem with the approach is that it focuses entirely on dividends and ignores other
aspects such as value creation in the firm or the tax shield. It is not a widely used model anymore
since it is only applicable to firms with steady earnings and a fixed dividend policy. The model can be
considered the most simple of the capital based models and it is the basis for more complex and
robust models. Given its limitations and the fact that it provides no advantages over the DCF model,
we will not address it further in this paper. (Penman, 2007)

Srensen (2009) divides the capital based models further into direct and indirect models. Whereas the first ones
calculate total equity value directly by discounting at the cost of equity, indirect models arrive to total firm value by
discounting at WACC and then subtract the value of debt to arrive at equity value.
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5
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2.2.2 Residual Income (RI) Model

The residual income (RI) 6 valuation model can be considered the equity equivalent of the economic
profit (EP) model7. The RI model, which was developed by Edwards (Edwards & Bell, 1961) in
1961, establishes that a company will only be able to create value if the company's rate of return on
equity exceeds its required return on equity (re). If this is not fulfilled, the company will not have any
residual income (also known as abnormal earnings) and the value of the company will be equal to its
equity value. The biggest disadvantage of the model is that it assumes there is clean surplus
accounting (CSA), which means that all changes in shareholder equity that do not result from
transactions with shareholders are present in the income statement. This practice is often broken in
reality

(Heinrichs, Hess, Homburg, Lorenz, & Sievers, 2008). 8 Precisely because of this some

authors have argued that the DCF is superior to the RI model. In any case, all the relative advantages
that the RI model may have over the DCF model are also present in the EP model.
2.2.3 The Enterprise Discounted Cash Flow Model
The enterprise discounted cash flow model (DCF) is still the preferred model used by academics and
practitioners (Koller, 2009). The model builds on the idea that a firm's value is equal to the present
value of all future cash flows that the firm will generate. Value is derived by discounting the free cash
flow, that is the cash flow available to all investors (debt and equity holders alike), at the weighted
average cost of capital WACC. The basic principle of the model can be synthesized by the following
formula:
!"#$% !" !"#$%&'!() =

!"!!
!
!!! (!!!"##)!

!"!!!!
!"##!! (!!!"!!)!

where:
FCFt = free cash flow in year t = NOPLAT + Noncash Operating expenses - Investments in Invested
Capital
NOPLAT = Net operating profit - adjusted taxes.
!"## = Weighted Average Cost of capital =

!
!
!!! !

1 !" +

!
!
!!! !

Source: (Koller, 2009)

The model requires an infinite budget period of FCF estimation. In practice this is done by dividing
the forecast into two periods; the first period is an explicit forecast period where the analyst makes a
detailed forecast of all the relevant accounts, this normally last between 5 to 20 years or until the
6

!"#$% !" !"#$%& = !"! +

!"#$%& !" !"#$%&! ! !! !"!!!

!!!
(!!!! )!

Based on (Plenborg, 2002) and (Srensen, 2009)

7
8

The Economic Profit model is discussed in section 2.4.

This issue can normally be addressed by the reorganization of financial statements.

company has reached a stable growth rate (Srensen, 2009). The rest of the value is called the
continuing value and it is estimated by a simple perpetuity formula reflecting the firms growth
prospects and return on capital for the remaining time.
Like the dividend discount model, this model is intuitively attractive as it works with cash flows and
the concept of net present value. Both principles are simple to understand and known to anybody
familiar with basic financial theory. In addition, the model incorporates the value of the tax-shield by
using WACC as a discount rate. Nevertheless, the model does have some drawbacks in terms of
assumptions which might not be fulfilled in real life. The most substantial weakness in terms of these
assumptions is the fundamental premise that all excess cash and liquidity is either paid back to
investors or invested in projects with expected returns equal to the cost of capital. In reality firms with
excess cash tend to be more prone to engage in investments that destroy shareholder value (Jensen &
Meckling, 1976). This particular assumption has interesting repercussions when evaluating an M&A
growth strategy because a firm with excess cash might engage into more acquisitions than one with a
tight financing budget. Other weaknesses of the model are stressed by Penman (Penman, 2007) who
argues that the model can be unsuitable for firms that are investing "more in operations than they get
from operations for a long period of time". For this type of companies the detailed forecast period has
to be expanded until the firm reaches a point of steady positive cash flows. This might lead to
speculation and biased results because analysts might "force" unreliable figures into an exceedingly
long forecasting period. He also argues that the model treats necessary investments as a loss of value
and that it works best with firms with a positive and relatively constant free cash flow which growing
at a constant rate. Lundholm (2001) disagrees with this critique. He contends that the model is still
one of the best models available and that the biased results that people obtain in practice come from
the incorrect application of the model and not from the model itself.
2.2.4 The Enterprise Economic Profit Model
The economic profit model (EP) is the enterprise value equivalent of the RI model. It builds on the
same basic premise: a firm will only create value if its return on invested capital is bigger than the
WACC - meaning that the firm is able to produce abnormal returns. For anybody familiar with
microeconomic theory it can be easy to see why the model is appealing; it presents a financial
equivalent on the microeconomic principle of economic surplus. Additionally, the model explicitly
shows how ROIC is a primary driver of value creation. There exist several variants of the model the
one developed by McKinsey, a management consulting firm, can be summarized by the following
formula:
!

!"#$% = !"#$%&$' !"#$%"& +

!!!

!"#$%&$' !"#$%"&!!! (!"#$! !"##)

(1 + !"##)!

where:
ROIC = return on invested capital
Source: (Koller, 2009)

According to Koller (2009) this model provides different and complementary insights to the ones
provided by the DCF model by showing where value is created by laying weight into ROIC9.

2.2 Real Options

Finally, there is real options valuation which has recently gained popularity as it allows business to
value the flexibility of choosing to undertake a project or not. The term was introduced by Myers
(1977) and it alluded to the "application of option pricing theory to the valuation of non-financial or
real investments with learning and flexibility" (Borison, 2005). As a valuation tool it is mostly
applicable and used for investments where flexibility and uncertainty have a substantial impact; e.g.,
in biotechnology or pharmaceutical firms. Utilizing the method for a firm in a mature industry with
relatively stable cash flows would not provide any valuable information beyond what the capital
based models already supply (Amram & Kulatilaka, 1999-2000). Hence, we will not apply it for the
valuation of ABB.

2.5 Concluding Remarks

Most theoretical discussions center on the comparison between the EP and the DCF model.
According to Plenborg (2002) each model has its advantages and disadvantages, in some cases the EP
model yields more accurate results and in others the DCF model prevails. In practice the DCF model
appears to be most commonly used model by practitioners, but the EP model is gaining ground
(Lundholm & O'Keefe, 2001). The greatest problem with arguing for a superior model rests on the
fact that both models are theoretical equivalents and if they are implemented correctly they should
yield the same results (Francis, Olsson, & Oswald, 2000; Plenborg, 2002). In practice, problems
often arise from "simplifying assumptions" which compound on each other and end up giving a
biased result. On these grounds scholars have argued that the EP model appears to "yields more
accurate firm value estimates than the DCF approach" (Lundholm & O'Keefe, 2001). In our case we
will use the same data for both models; therefore, any assumptions we have for the DCF model made
will be carried over the EP model and, given their mathematical equivalence, they will yield the same
results.
Based on the characteristics of ABB we will base our core analysis and forecast drivers on the DCF
model proposed by Koller (2009). The results obtained through the DCF model will be verified with
the EP model. This approach will provide a sanity check for the estimated share price that the DCF
9

As we will discuss in section 5, ROIC is one of the primary drivers of value creation.

model yields and allow us to gain insights into where value is created. Finally, we will triangulate
final share price results with multiples.

3. Mergers & Acquisitions

In order for us to be able to accurately forecast the M&A growth strategy it is necessary to review the
most important theoretical and empirical findings on M&A. This section briefly reviews those
findings.

3.1 Historical Overview

Mergers and acquisitions is a general term that refers to the situation in which two companies are
combined to achieve strategic and business objectives. The difference between a merger and an
acquisition is often blurred because the economic outcome tends to be the same. A merger usually
refers to the mutual agreement by which two equals merge to create a single legal entity.10 An
acquisition on the other hand, normally refers to the takeover of a smaller firm by a much larger one.
When two firms within the same industry11 merge it is called a horizontal merger. Sometimes the
wider notion of related merger is used which is when firms that produce or sells products that share
certain commonalities merge. Horizontal mergers are common within industries where the overall
market is mature and growth rate is low. Total capacity is larger than demand, and since the market
players are competing for a limited demand, rivalry is intense. Companies are thereby pressured to
attain lower costs (DePamphilis, 2011). Mergers between firms that are active at different stages in
the same value chain12 often are categorized as vertical mergers. A conglomerate merger is when
firms who are active in unrelated industries join.
From a historical perspective the most perplexing aspect of mergers and acquisitions is that they tend
to cluster in periods of high activity followed by relative inactivity. These so called merger waves do
not limit themselves to certain periods but also show a clustering pattern at an industry level
(Sudarsanam, 2006-2007). This suggests that firms tend to react to industry specific developments
such as: economic, technological or regulatory shocks (Harford, 2005). However there is also
evidence that point towards potential herding behavior from managers side. This last point is
consistent with the lower returns earned by acquiring firms at the end of the merger wave (Shonlau,
2009).

10

For simplicity reasons in this paper we will use the terms interchangeably.
Defined as an industry that produces or sells similar products or services
12
The value chain represents all stages from raw material (input) to when the product is in the hands of a customer
(Porter, 1980-2004)
11

10

The United States has experienced the longest history of take-over activity; having experienced six
merger waves during the last 120 years (Salter & Weinhold, 1979). The first two waves were
horizontal consolidation waves that had an enormous effect on market power and resulted in stricter
antitrust enforcement. The next wave is normally classified as the growth wave because it had no
substantial effect on industry concentration and the objective was to achieve growth through
diversification. The fourth and fifth waves were a mixture of acquisitions and divestures in which the
big corporations made numerous acquisitions but also sold off some of their underperforming units to
concentrate the focus of their portfolio (Maksimovic & Phillips, 2001). Finally the last wave was
characterized by a re-birth of leverage buy-out and private equity investments accompanied by
complex securitization procedures and securities like CDOs.
In contrast to the US, the merger activity in Europe has been marked by only two merger waves
which occurred during the late 1980s and the 1990s. The main drivers appear to be the political and
economic integration of the continent that were accompanied by deregulation and privatization
among the countries of continental Europe. The UK stands out among the other countries because of
the high proportion of M&A activity which at some point accounted for more 26% of international
mergers involving EU companies (European Commission, 2000).13
During the last three decades the most noticeable trend has been the increasing intensity and
frequency of the merger waves. This has led to speculation about a coming merger wave as the world
emerges from the recession of the late 2000s (Kengelbach & Roos, 2011).

3.2 Alternative Theoretical Perspectives on M&A

There are two competing theories that attempt to explain the ubiquity of mergers and acquisitions and
the increasing intensity of merger waves. One of the most interesting aspects of these competing
theories is that, besides giving a different explanation for mergers, they also predict different
outcomes in terms of returns to shareholders of acquiring and target firms (Wrell, 2007).
3.2.1 The Neoclassical Hypothesis
The first theory is usually referred as the neoclassical hypothesis; this theory argues that mergers lead
to increased profits as a result of stronger market power or increased efficiency. Therefore, rational
managers will only pursue deals that maximize value creation. Accordingly, this hypothesis would
also argue that merger announcements would be received as good news and increase stock prices
(Wrell, 2007). From an economic welfare perspective; efficiency gains would result in gains to
acquiring and target companies, consumers would benefit from lower prices and the overall effects

13

This contrasts with 16% for Germany, 13% for France and 9% for the Netherlands.

11

would be positive.14 These gains to consumer welfare assume that market power gains do not allow
the firm to raise the price of the products on the industry.
3.2.2 Managerial Theories
Unfortunately mergers do not always result in increased profits or value creation. The relative
abundance of value destroying mergers is difficult to justify using the neoclassical hypothesis and
economists have attempted to explain these results using modern microeconomic developments such
as transaction cost economics and principal-agent theories (Rller, Stennek, & Verboven, 2001).
These theories have been called managerial or behavioral theories. The common trait of these
theories is that they argue that managers pursue goals that are non-wealth maximizing and can have a
negative economic result.
3.2.2.1 The Managerial Hypothesis
This theory builds upon the principal-agent theory introduced by Jensen and Meckling (1976).
According to this hypothesis, the shareholders are the principals who hire the managers (agent) to run
the company. The shareholders may not have the ability to control the managers performance.
Moreover the managers and shareholders incentives may not be perfectly aligned because managers
rewards have a positive correlation with company size (Shinn, 1999); thus, they have the motivation
to engage in risky or value destroying acquisitions.
3.2.2.2 The Hubris Hypothesis
The hubris hypothesis (Roll, Aktas, & de Bodt, 2009) assumes that managers overestimate the
possible synergy gains from the acquisition. This miscalculation results in an overpayment and the
market will react negatively to the announcement. The main difference between the hubris and the
managerial hypothesis is that the latter does not assume that managers act against the shareholders
interest but that they are merely overconfident (Wrell, 2007). Hence, this theory would predict
higher overall returns than the managerial hypothesis, which assumes the managers might not even
expect synergetic effects before engaging in an acquisition; however most of these returns would go
to the target firms shareholders.

3.3 Sources of Value Creation

Since our thesis focuses on valuation and we wish to determine the value of the ABB in case of an
M&A strategy we have to investigate how M&A can create value for a firm. This analysis will later
serve as ground for the DCF model and be incorporated into the forecasting of future performance.

14

It is also worth noting that a large merger resulting in increased market power can also increase rivals stock prices
as it results in higher profit margin for all players in the industry.

12

3.3.1 Basic Principles of Value Creation

The primary principle of value creation, also referred to as the conservation-of-value principle, is that
value can only increase by improvements in cash flows. Hence, any investment or corporate
restructuring that does not change the available cash flows will not create value. The core-of-value
principle tells us that the driver of value is the combination of growth and return on invested capital
(ROIC) (Koller, 2009). To create value through mergers and acquisitions cash flows of the combined
firm should be greater then what the sum of the cash flows would have been if the firms operated
separately; this concept is called synergy.
3.3.2 Value Creation through Mergers and Acquisitions
There are numerous ways in which a merger can create value, for simplicity we have chosen to divide
reasons in four broad categories: revenue enhancement, cost savings and operational synergies,
financial synergies, and growth opportunities.
3.3.2.1 Revenue Enhancement
As mentioned earlier, mergers can increase market power. With an increased market share the
combined firm may be able to affect prices or quantities within the market and thus increase revenues.
In addition, vertical integration can result in higher market power by increasing entry barriers and
lowering input costs for the firm.15 Increased revenues can also be obtained by leveraging the
combined firms market resources and capabilities; e.g., the acquiring firm can exploit the distribution
channels of the target firm to market their own product. The use of brand management on newly
acquired segments or products can also be a powerful tool. Furthermore, by exploiting other resources
and capabilities revenue can be enhanced by for example building a more attractive bundle of
products or services (Sudarsanam, 2006-2007).
3.3.2.2 Cost Savings and Operational Synergies
Cost savings and economical efficiency is a common motivation as means for value creation through
mergers and acquisitions. By reducing costs the combined firm can improve its margins and thereby
boost profits given that the price and sales volumes are unchanged. By joining functional activities
one can reduce costs by avoiding duplication in e.g. marketing and R&D expenditures as well as
rationalize costs associated with sales, overhead and workforce. Operational synergies in terms of
economies of scale can be achieved by e.g. spreading the fixed costs over increasing production
volumes and hence lowering the average unit cost. Operational synergy can also be a result of scope
and learning economies. Additionally, a merger can allow for reduction in excess capacity and firms
can thereby adjust supply levels to match demands. This tactic is particularly important in mature
15

Lower input costs can create an absolute value advantage over competitors, forcing them out of the market
(Lipczynski, Wilson, & Goddard, 2009).

13

industries. Last but not least increased market power through collusion and stronger buyer power can
lower input prices (DePamphilis, 2011).
3.3.2.3 Financial Synergy
The guiding principle of value creation is that companies create value by investing capital they raise
from investors to generate future cash flows at rates of return exceeding the cost of capital (Koller,
2009). Financial synergy through mergers and acquisitions can theoretically lower the cost of capital
and thus increase company value. Lower security and transaction costs as well as matching internal
financing with investment opportunities can be factors resulting in a reduction of cost of capital. By
diversification a firm can acquire another company with un-correlated cash flows and thereby obtain
a higher level of debt16 (Schall & Higgins, 1975). Where the value of tax-savings is higher than that
of the cost of leverage value can be created.
3.3.2.4 New Growth Opportunities
The product market matrix can be used to explain different types of growth opportunities (Ansoff,
1958). By leveraging the acquirers and targets capabilities the merged firm can attempt to create new
products or services that can appeal to their existing customer base. In addition there might be
possibilities to access new markets in which one can sell already existing products; e.g., a
geographical expansion. Growth can also rise from diversification by shifting from core products and
markets to new products and markets where there is more growth. Furthermore, new growth
opportunities can come from the invention of completely new products, markets and technologies - so
called discontinuous changes.

3.4 Empirical Results on Returns

This section summarized the most important empirical results of M&A. It will allow us to assess how
realistic the firm's growth and synergetic prospects are when considering ABBs growth through
acquisitions strategy.
3.4.1 Empirical Results on Value Creation
Empirical studies indicate that conglomerate mergers and diversification in unrelated businesses
reduces or has no effect on firm value. Berger and Ofek (1995) investigated the stand-alone value of
segments within diversified firms and found that diversification results in a loss of 13% to 15 % of
total value. In addition, a reduction in business focus can have a similar effect on shareholder value
(Megginson, Morgan, & Nail, 2004). However, there have been studies showing that unrelated
mergers can result in increased firm value through increased debt utilization (Seth, 1990).

16

This notion is usually called coinsurance.

14

In terms of market power, studies show that it is not the driving factor behind value creation; rather it
is increased cost efficiency and operating productivity (Fee, 2004; Shahrur, 2005). KPMG performed
a survey where they investigated the factors leading to successful M&A deals. They found that only
17% of the deals had actually added value whereas 53% of them destroyed value17. The study also
showed that the largest revenue synergies came from new customers and new markets and operational
cost reduction came from head count reduction and buying and merchandising. It also revealed that
operational improvements and cost synergies are easier to achieve than growth synergies (KPMG,
1999). 18
3.4.2 Returns to Acquirer Shareholders
The majority of event studies demonstrate that abnormal returns to acquirer shareholders range from
negative to small but positive; depending on the method and timeframe used by the researchers 19
(Zollo & Meier, 2008). One of the most interesting trends has been a steady decline in returns as a
result of higher premiums. Martynova and Renneboog (2008) use a metadata analysis and come to
the conclusion that in the short-term returns to bidding firms are statistically insignificant and
indistinguishable from zero. However, if one looks at a longer window period, average returns tend to
be small and positive, but vary depending on the merger wave being analyzed.20 Notably, the last two
merger waves have had negative (-1% to -1.4%) and zero average abnormal returns respectively.21
3.4.3 Returns to Target Shareholders
In contrast to the last point, there appears to be consensus among researchers that mergers create
value for the target firms shareholders. The results deviate from 14 to 44% for the two-week period
around the announcement date (DePamphilis, 2011). The most striking trend over time has been the
increasing average returns that each merger wave has brought about for the target shareholders,
toping at 32 to 45% for the fifth merger wave. This trend reflects the propensity of bidding managers
to use a preemptive strategy in which they offer a generous premium to put-off possible adversaries
and the upward revision of the initial bid because of competitors bids. Another interesting fact is that
the share price of the target firm tends to increase already 42 days before the announcement of the
initial offer (Schwert, 1996). This suggests that the market can anticipate the bid, or that there is
information leakage or insider trading.

17

30% showed no difference in value.

See appendix 1 for full results.
19
Researchers can focus on premerger returns or use long-term accounting measures to asses post-merger returns.
20
In this case they look at cumulative average abnormal returns (CAAR) on a period of one to two months
surrounding the announcement.
21
According to Moeller (2004) acquisitions during the early 1990s resulted in small but positive returns; however the
losses in the transactions of the early 2000s erased all the gains made during the previous decade.
18

15

3.4.4 Returns to Bondholders

While shareholders of both firms have high stakes in a takeover, bondholders on either side of the
transaction appear to be relatively unaffected by such an event (DePamphilis, 2011). This is because
the increased risk of default brought about by an increase in leverage is usually offset by the restraint
it imposes on management to improve operating performance. There are special circumstances in
which target bondholders might benefit substantially. For example if the target firm is in distress and
the acquirer has a higher credit rating.
3.4.5 Situational Factors Affecting Returns
This section summarizes the main situational factors that affect returns for shareholders. Evidence on
most of these factors is strong and might explain the great amount of variability in returns
(DePamphilis, 2011).
3.4.5.1 Acquirer Size and Target Size
The empirical evidence has shown that there is a negative relation between acquirers size and
returns. This means that relatively small bidders tend to realize larger returns

(Moeller,

Schlingemann, & Stulz, 2004). This relationship could be explained by the managerial theories
because larger firms usually have greater cash reserves and access to cheap capital. This allows
overconfident and empire-building managers to engage in value destroying takeovers. The same
negative relation is found between returns and target size (Hackbarth & Morellec, 2008). This might
be because larger deals tend to be more risky and it is more difficult to integrate operation or simply
because smaller firms have higher post-acquisition growth prospects.
3.4.5.2 Friendly versus Hostile
Acquisitions are normally divided by the terms on which the agreement is reached. Friendly takeovers
are generally characterized by the fact that the management and the board of the target firm agree to
the bidders proposal and make an approval recommendation to the shareholders. On the other hand a
hostile takeover occurs when the management or the board of the target firm react negatively to the
bidders offer; this usually results in attempts by the bidder to bypass the management by making a
direct offer to the targets shareholders. Hostile takeovers tend to realize lower returns to the acquirer
as a result of higher premiums and less access to information which can result in difficulties to do a
profound due diligence. Servaes (1991) concludes that hostile takeovers result in loses that are 4%
larger for the acquirer and 10% larger gains for the target shareholders.
3.4.5.3 Payment Method
When it comes to payment methods there is strong evidence that cash deals outperform equityfinanced deals. This is normally explained by the fact that it implies an overvalued stock and
16

investors react accordingly. The reason for this is that managers tend to issue shares in order to raise
capital when a stock is overvalued managers. Therefore the market anticipates that stock-financed
deals will underperform and prices decline. However, in the European Union, equity financed deals
tend to outperform their cash equivalent as a result of the active monitoring of large block
shareholders which results in improved performance for the target firm (DePamphilis, 2011). 22
3.4.5.4 Long-Term Studies
Most studies focus on returns in the short-term because these are easy to measure and independent
from market conditions affecting the merged firm during the window period. Consequently, it is
difficult to measure whether or not M&As creates value in the long-term (three to five years) and the
evidence tends to be conflicting. According to the efficient market hypothesis (Fama, 1970) market
should assimilate all public and private information about the transaction. Hence, if markets are
efficient there should be no difference between the short-term and the long-term returns of mergers.23
However, some authors (Harrison, Oler & Allen, 2005) argue that much information provided to the
market is confidential and unavailable to the public, because of this long-term performance might be
better than what short window event studies show.24 Agrawal and Jaffe (2000) combine the results of
22 different papers on long-term performance of M&As and conclude that it is negative following
mergers and non-negative (perhaps even positive) following tender offers.

4. Strategic Analysis of the Firm

The strategic analysis has the primary goal of identifying the main non-financial value drivers that
affect future growth and profit potentials (Schack, 2009). The accounting information from yearly
reports allows us to develop a sound historical analysis of the factors that have influenced past growth
rates and profits. In a static world, one would be able to extrapolate past performance into the future
and develop the valuation model without much more consideration. However, to develop a proper
dynamic model one must supplement the historical performance with an analysis of the non-financial
drivers that determine plausible future scenarios. Accordingly, the aforementioned factors are a
determinant component to include in our forecast considerations.
The focus of our analysis is not just ABB, but on a comparison of strategies; one focusing on organic
growth and another focusing on additional growth through M&A. Most acquisitions are justified on
the basis of synergies, and these synergies can only be realized if a sound long-term strategy is in

22

This kind of shareholders is not as common in the US as they are in the European Union.
An efficient view on the markets would argue that any valuation changes that happen outside the event window,
which should be short, are unconnected to the acquisition and therefore random.
24
There is also evidence for price stickiness, which suggest the market takes time to digest the information. This
would argue for a longer window period. (Sudarsanam, 2006-2007)
23

17

place. Hence the importance of a comprehensive approach that takes into account all relevant factors
when considering both strategies.

4.1 External Environment

The most logical way to structure the strategic analysis is to take a top-down approach. This begins
by looking at the macro-environmental factors, then proceeds to a industry analysis and finishes with
an internal examination of the firm's resources and capabilities.
We have divided the macro-environmental factors into five different segments: political-legislative,
economic, socio-cultural, environmental and technological factors. The organization of these factors
is similar to that of the PESTEL checklist (Lynch, 2009). However some segments have been
merged due to overlapping factors that are not always mutually exclusive.
4.1.1 Political and Legislative Factors
Regulation on energy efficiency will have a direct impact on ABBs growth prospects. Both the
European Union and the United States, which are ABBs two biggest markets, have experienced a
substantial increase in political will towards legislation ensuring higher energy efficiency and
requiring alternative energy sources. As these trends gather momentum ABB will be in an
advantageous position to take part in this growing market since stricter standards on efficiency force
potential consumers to continuously upgrade their technology to meet the new requirements
(European Commission, 2011; European Union, 2009).
Not everything on the political and legislative arena is positive; the firm has been involved in several
legal issues with various authorities over the years, including the Securities Exchange Commission
and other regulatory agencies. Such events damage the reputation of the company and cast a shadow
over its efficient operational activities (ABB ltd, 2010b).
In the longer term a source of potential growth comes from legislation requiring that bigger share of
energy generation should come from renewable sources. The EU has already defined a strategy that
aims to set energy efficiency targets for the coming decade. It has also developed a plan to fully unify
the energy markets and develop a pan-European transmission network (European Commission, 2011).
These initiatives can translate into direct opportunities for the European power industry to outperform
GDP growth for a considerable span of time despite stagnant energy demand (Giglioli & Marci,
2008). There are similar political initiatives on the American market; notably the Pickens plan,25
which aims to make the US energy independent and to establish a nationwide unified national smart
grid. This plan would require an infrastructure investment of around 400 billion USD (Gore, 2008).

25

An energy policy proposed by T. Boon Pickens

18

However, the political will for strong energy legislation remains weaker in the US than in the EU and
political deadlock lowers the chances of legislative implementation (Nocera, 2011).
On the negative side fiscal sustainability problems in the EU and the US can result in higher corporate
taxes in the near future as politicians in indebted countries take measures to balance their budgets.
According to IMF estimates, by 2015 gross debt as percentage of GDP will reach 115% in the US and
90% in the European Union as a whole (International Monetary Fund, 2012a).26 Fortunately for the
firm it pays most of its taxes in Switzerland and the prospect of higher taxes in this country is
unlikely.
Finally, there is inherent political risk coming from unstable and volatile countries in the Middle East
and Africa. The year 2010 saw the emergence of a revolutionary wave of demonstrations, also known
as the Arab spring, which resulted in a change of regime in three countries and civil uprisings in many
more. While these two markets are still relatively small in terms of revenues the potential for growth
will force the firm to make a clear assessment between the opportunities in the market and the
inherent political risk that results from popular upheaval (The Economist, 2012d). Political risk is not
an issue that is limited to the Middle East and Africa. However, outside this area risk is mostly related
to weak property rights and its consequences (Jackson, 2011).
4.1.2 Economic Factors
In the medium-term the main obstacle that ABB faces is the economic uncertainty that has resulted
from the latest recession. At the time of this writing (Feb 2012) Americas economy is finally
beginning to gain momentum. The gap between potential and real GDP has begun to close and the
unemployment rate has decreased to 8.3% from a peak of 10% in 200927 (Federal Reserve Bank of St.
Louis, 2012a). This is clearly a positive development for ABB since the firm has stated that future
acquisitions will focus on the North American market (ABB ltd, 2012b).
Alas, the economic scenario is much less positive in the EU where GDP is expected to grow by a
mere 0,6%. In addition, the unemployment rate in the union stands at 9,9%, and it is expected to
increase (European Commission, 2012). Since the firm has a relatively high exposure to the economic
conditions in Europe this analysis also needs to weigh the possibility of a sovereign default from
Greece, Spain or Italy. In a worst-case scenario, the EU could enter a new recession and drag the
United States and other advanced economies with it; this could result in a double dip recession in
ABBs two biggest markets (The Economist, 2012b). Nonetheless, ABB has a portfolio of services
26

It is possible to argue that a gross government debt between 90% and 115% of GDP should not represent a clear
and present danger (Japan, has a government debt of 220%). However, to make things fall into perspective we can
look at Ireland which saw its gross government debt increase from 25% to 115% in 5 years. This has led some
European leaders to suggest that Ireland should raise its corporate tax rate, which is among the lowest in the Union.
The same argument has been used for other OECD countries after the latest recession. (Bruton, 2012)
27
The latest economic data from the Bureau of labor and Statistics is from January 2012.

19

and products that are needed in different stages of the economic cycle. Hence, if a new recession
became a reality the firm would be less affected than other industrials.
Rising prices of oil and other energy commodities will continue to be a decisive factor influencing the
firm's growth prospects. During the last ten years oil has seen its price increase sevenfold from 19
USD per barrel in 2002 to a high of 133 USD in 2008 at the peak of the economic boom that preceded
the recession28. Although the price fell immediately after the recession it has regained its prior trend
and is expected to continue its rise by many analysts. This has resulted in strong demand for industrial
efficiency and infrastructure investments in the energy sector (Kremer, 2008). The higher demand for
efficiency is expected to add 2% to 3% to growth for the firm in the coming years (ABB ltd, 2011b).
Whereas the appreciation of oil will only have a positive effect, the rapid appreciation of the Swiss
franc during the last three years can be a double-edged sword for the firm (ECB, 2012). On the one
side it will give the firm an upper hand in terms of growing through M&A since will allow the
company to exploit the currency's buoyancy in pursuit of Euro and Dollar denominated targets. On
the other side, a stronger franc can also affect the firms competitiveness because its headquarters and
main operations are located in Switzerland. As of 2012 the first effect appears to be dominating and
most analysts concur on the fact that a strong franc will be generally positive the firm (Dow Jones &
Company, 2011; Geneva Lunch, 2011).
On the long-term, the economic perspective for ABB looks more attractive. During the next three
decades OECD economies will see an average annual growth of 2% while non-OECD economies will
have a growth rate of 4.5%; economic growth will foster better living standards and investments in
infrastructure and industry (The World Bank, 2011). Furthermore, it will result in higher energy
dependence and demand. A report by BP (2011) states that world primary energy consumption will
grow by 39% from 2010 to 2030; non-OECD countries will be the primary contributors of this
increment. It is anticipated that in 2040 more than forty percent of global energy consumption will be
used to generate electricity, this compares with less than 30% today. In OECD countries the increase
in energy demand will be offset by gains in efficiency; however, stagnant energy demand in the
industrialized world will not hurt ABBs growth potential because part of the firms portfolio deals
with solutions to increase efficiency.
Growth opportunities in long term can be classified into two main categories: in emerging markets
growth will be mainly driven by infrastructure investments and a general expansion in energy
demand. In more mature economies there will be a continuous drive towards energy efficiency and
automation that will keep the industry from slowing down (ExxonMobil, 2012; International Energy
Agency, 2010).
28

West Texas Intermediate price in USD (Federal Reserve Bank of St. Louis, 2012c)

20

4.1.3 Socio-cultural and Environmental Factors

Population growth and environmental awareness are the two main socio-cultural and environmental
factors contributing to possible growth opportunities for ABB. Overall, demographic dynamics
appear to be positive because even though the population growth rate is expected to decline, the total
population is projected to rise to almost 9 billion in 2040. The main forces behind this expansion are
India and Africa where increments in working age population will result in vigorous GDP growth that
will inevitability lead to higher energy demand and increased electricity consumption (ExxonMobil,
2012).
Even though the population drift in OECD countries and China indicates that working population will
decrease in these areas, demand is going to be driven by a different set of factors. For example due to
increased emissions, global warming and radical changes in the global climate, people are becoming
more environmentally conscious and they are increasingly putting a higher value in environmentally
friendly solutions. A Huge amount of energy is lost in the process of producing and transmitting
electricity from one geographical area to the other. Increased efficiency in power generation and
transmission can lower both energy demand and CO2 emissions.
Another consequence of increased environmental awareness is the rising demand for renewable
energy sources such as wind and solar power; Europe alone is expected to increase the amount of
total energy from wind power from 5% to 20% (ExxonMobil, 2012). In addition, from 2010 to 2035
cumulative investments in renewables is expected to be valued at $5,7 trillion (Global Data, 2012).
As a leader within power technology, a provider of numerous products and solutions for electricity
distribution and a strong portfolio of products and services related to the renewables sector, it is easy
to see how environmental consciousness can benefit ABB in the future.
4.1.4 Technological Factors
The rising energy demand and need for improved productivity will require stronger R&D spending in
technologies which can increase efficiency or provide green energy. Several countries are in the phase
of developing efficiency programs with the two most interesting areas for ABB being the US and the
European Union.
The most profound change within technology and operating practices in the energy and electricity
industry are the so-called smart grid initiatives. A smart grid aims at optimizing electricity power
infrastructure by; reduction of losses in transmission and distribution of electricity, lower costs of
electricity delivery, increased reliability and the reduction of total resources used (ABB Inc, 2009).
Technological advancements29 have been a factor contributing to the possibility of developing a smart

29

Such as the power transmission systems HVDC and HVDC light developed by ABB.

21

grid but a smart grid also makes new technological improvements a necessity. A network that allows
for a bi-directional flow of energy and information requires superior hardware management and
advanced power electronics. ABB, as a provider of both power technologies and control systems, has
a strong position for additional growth opportunities in this market. They also have strong R&D focus
on increasing energy efficiency, which enables further innovation within related areas. The current
development in smart grids enables short-term growth in terms of the contracts already established.
Additionally, many of these contracts are long-term investments with sovereign clients looking for
national implementation. Once a smart grid is implemented it requires maintenance service and this
creates sustainable long-term opportunities for the firms involved.
In 2005 the European Technology Platform (ETP) Smart Grid was established with the vision to
create a joint European electricity network from 2020 and forward (European Commission, 2006). In
2008 the EU adopted the SET plan which aims at establishing European Industrial Initiatives (EIIs)
that will eventually become binding (European Commission SETIS, 2012). This resulted in several
initiatives to implement smart grids all over Europe with the plan of interconnecting them in the
future. ABB has been an active player on the market, bidding for contracts and lobbying for further
legislation that ensures the creation of a pan European Super-smart grid. For example in 2011 ABB
started a project to develop a smart grid in the city of Genoa in Italy; they are also cooperating with
Fortum, T-systems and Helsingin Energia, to develop a smart grid system in Stockholm,
Friedrichshafen and Helsinki respectively (ABB ltd, 2011c). Forecasts indicate that by 2020 the
cumulative European investments in smart grid technologies will be above $80 billion (Pike
Research, 2011).
Further in the horizon there are plans to integrate the European electricity market with its neighboring
regions such as North Africa. The main idea behind the Desertec Industry Initiative is to create an
interconnected electricity grid between Europe, Middle East and North Africa (EUMENA). The grid
allows for transmission of electricity generated from solar panels mainly found in the Sahara desert to
key areas of demand (Desertec foundation, 2009). The need for technological expertise as well as
solutions to make this possible creates great business opportunities for ABB who has been involved in
the Desertec Industry Initiative for many years (ABB ltd, 2009).
The US is also taking actions toward creating an interconnected smart grid30; such investment in
renewable energy sources such as the Pickens Plan also creates opportunities for ABB. The Pickens
Plan aims at reducing USA dependence on foreign oil and part of this plan is to use domestic wind
and solar power to generate electricity using an updated smart-grid system (Pickens Plan, 2012).

30

Sometimes this also referred to as: the Unified Smart Grid.

22

Furthermore, there has been a general trend towards higher reliance on automation technologies
because, even though they are initially capital intensive, they can reduce costs in the long run. The
global robots market has shown positive trends within recent years. The compound annual growth
rate for the period 2006 to 2010 was 6,2% (Datamonitor, 2011). However, CAGR between 2010 and
2015 is expected to decline to 3,7% which can imply less growth opportunities within that particular
market. Appendix 2 summarizes the most important factors from the macro-environmental analysis
and their effect on the firm.

4.2 Industry Analysis Porters 5 Forces

In 1981 Harvard University professor Michael C. Porter developed the famous Five Forces model
(Porter, 1980-2004). This model attempts to examine the "forces driving industry competition" and
how those same forces shape the profitability and attractiveness of the industry. The principal
advantage of this model is that it provides a structured approach to decompose the most important
factors driving industry competition. However, the model has been criticized for providing only a
static framework of the current situation (Lynch, 2009). We will try to reduce the impact of this
weakness by making an analysis that includes forward-looking observations. 31 In the case of ABB,
the most difficult part of the analysis was to define the industry in which the firm operates and its
limits. This is because the company has a broad portfolio of products and services that spans over
several interrelated, though still separate, industries.32 It is a major player in the following industries:

Electrical components and equipment - Low voltage products, automation systems and others
Energy equipment and services industry - Power products and power systems
Robotics Automation
Industrial motion (Discrete automation and) motion

Consequently, a comprehensive analysis would have to isolate each industry and explore them
separately. This kind of industry breakdown is beyond the scope of this thesis; therefore, we have
decided to take the most important factors and focus on those factors that, due to their
interrelatedness, affect all industries in which the firm operates; for simplicity, we will call this
amalgamated industry: power and automation technologies.33

31

Some authors have argued that when the theory was developed (1980) was a period characterized by strong
competition, cyclical developments and relatively stable market structures, and that the model is outdated.
Nevertheless it is still a powerful analytical tool that has proven its value with time.
32
The difficulty of defining an industry is not an unknown problem for economists, and there is no single agreed
definition. According to Stigler a industry should embrace "the maximum geographical area and the maximum
variety of productive activities in which there is strong long-run substitution " (Lipczynski, Wilson, & Goddard
2009).
33
However whenever the analysis requires, because of substantial differences between industries, we will separate
them accordingly.

23

4.2.1. Bargaining Power of Suppliers

The main suppliers to this market are the manufacturers of raw materials and principally metals. Steel
and aluminum manufacturers are large and concentrated; this reinforces their relative power over
buyers. The rising prices of metals such as steel, aluminum and copper, which represent the firms
main inputs, could affect future profitability because the company might be unable to pass these cost
increments onto its customers without affecting sales volume; additionally, metals cannot be
substituted as they are required precisely for their physical and chemical properties.
According to the Bureau of Labor Statistics, the producer price index for industrial commodities has
increased by more than 60% during the last decade (Federal Reserve Bank of St. Louis, 2012b). If
one looks at metals alone the price increments have been considerably greater and steeper; for
example, copper saw its price increase by 200% during the 24month period that followed January
2009. These price increments have also been accompanied by a much higher level of volatility;34
firms in the industry have tried to avoid volatility risk by using hedging strategies and writing longterm contracts; however, this approach has the drawback of increased switching costs35 (Global Data,
2012). Supplier power is assessed to be moderate-to-high, with the biggest risk coming from higher
and more volatile metal prices.
4.2.2. Bargaining Power of Buyers
The size and amount of buyers, the uniqueness of industry products, availability of substitutes and
switching costs are the general factors that determine buyers bargaining power. There are many
heterogeneous buyers in the industry; however, key customers are mostly large-scale industrial and
utility companies that possess negotiation power and have significant influence on the volume of
orders within the industry. Some of the industries in which ABB operates, for example switchgear
and AC drives, are characterized by products which are not easily differentiated; this means that
buyers normally search for the lowest price as their first priority. Other industries, such as
automation, are characterized by tailored solutions and have a different set of value drivers related to
quality and implementation time.
Some of the products that the industry already supplies can be classified as essentials for the customer
and as legislation on energy efficiency tightens, products that can improve efficiency and
environmental impact will develop into indispensible requirements. Additionally, the deregulation
trend in the electricity market has fragmented the industry, which used to be dominated by large state
owned utility companies. All of this decreases the overall bargaining power of the buyers.

34

Appendix 3 shows the development of metal prices during the last decade.
The complexity of forecasting commodity prices is beyond the scope of this thesis, however it is a risk worth
looking at from a cost perspective.
35

24

The automation and power services industries are characterized by firms that sell not only single
products but also integrated solutions, this raises the switching cost for customers significantly
because once an integrated solution is installed, the selling firm is usually responsible for
maintenance and upgrading; furthermore, the contracts are generally long-term and products from
different firms might be incompatible. Based on an overall assessment we can conclude that buyers
bargain power is moderate.
4.2.3. Competitive Rivalry
The industries in which ABB operates is characterized by intense competition based on the
development of tailored integrated systems, product performance, pricing and innovation. This kind
of environment is also known as a red queen environment,36 because it forces the firm to perpetually
engage in improvements in order to survive. In addition, high fixed costs for incumbents and lowswitching costs for buyers intensify rivalry between players; therefore, in order to remain competitive,
the company has to invest a substantial amount of capital in R&D and find more effective ways to
reduce operating costs, increase productivity and acquire sustainable sources of skill.
Last but not least, the relaxation of trade barriers during the last 20 years resulted in the
modernization of production structures and technologies, this allowed firms to participate globally
and substantially increased competition.
Some of the competitive pressures in the industry have been eased by the relatively healthy growth
rates in the industry. The company had a compound annual growth rate (CAGR) of 10,29% in the
period 2006 to 2001. This is higher than the industry average but below the 23.24% of the four best
performers in the power and automation technologies sector. This may indicate that the firm lost
market share over the last years due to a weaker competitive position than its rivals (Global Data,
2012).
A high CAGR does not extend to all the sectors in which ABB operates, for example in 2010 the
Global Electric Components & Equipment industry showed positive growth of 4,7% and the expected
CAGR for the 5 year period of 2010 to 2015 is approximately 4%. The Global Robots Market expects
to achieve a CAGR of 3,7% for the same time period, a decrease of almost 15% compared to growth
in 2010 (Datamonitor, 2011).
The relatively high growth rates and positive projections mean that barriers to exit are only
moderately relevant for our analysis since currently there are no incentives for firms to leave the
industry. We conclude that competitive rivalry is strong; however, the relatively high CAGR37 of

36

The term is taken from the Red Queen's race in Lewis Carroll's Through the Looking-Glass. The Red Queen said,
"It takes all the running you can do, to keep in the same place."
37
Particularly the energy services and equipment sector.

25

some segments and the expansion opportunities in mature and emerging markets ameliorate the need
to take market share from rivals in order to grow. This relatively strong rivalry will probably result in
lower margins in the longer term as the different markets begin to saturate.
4.2.4. Threat of New Entrants
The attractiveness to enter a new industry is determined by its profitability and the magnitude of
barriers to entry and exit. Based on our analysis we conclude that the threat of new entrants is
moderate.
The moderate-to-high growth rates in the industry and the relatively high EBITA margins indicate
that the industry is profitable and will probably continue to be so for the next decade. The biggest
threat of entry comes from the Asia-Pacific area where growth in population and the economy is
higher than the global average. Moreover, a positive economic outlook in the medium-term increases
the threat of entry because it encourages firms to take the risks and make the necessary investments
that entry requires (International Monetary Fund, 2012b).
The industries in which the firm operates are relatively concentrated; the CR4 ratio, which measures
the market share of the four largest firms, is above 0,60 for the electrical equipment industry
(Datamonitor, 2011; Lipczynski, Wilson, & Goddard, 2009). These dominant market players enjoy
strong brands and their size makes them able to benefit from economies of scale and other cost
advantages. This results in high barriers to entry and makes it less attractive for new companies to
invest in that industry. In addition, the very high initial capital investments and the specificity of
resources and hardware needed also increase barriers to exit. There is the possibility for companies to
compete with a niche strategy and the growing concern for environmental awareness offers further
growth opportunities; however, this strategy requires high proprietary technology and knowhow to
compete against the big players in the market. Nonetheless, the development of disruptive
technological changes in the industry will always represent a threat for the incumbents.
4.2.5. Threat of Substitutes
Even though substitutes for equipment and components within the electricity industry are difficult to
find; in principle, the use of electricity is possible to substitute. Gas can for example be used instead
of electricity for heating.
In terms of automation technologies, they can be substituted with manual work, e.g. a human can
substitute a robot. The question remains whether this is economically feasible or not since the trend
has been to go the other way around and substitute humans with robots. Overall the threat of
substitutes is assessed to be low. Exhibit 2 summarizes the relative strength of each force.

26

Exhibit 2: Porters Five Forces

Summary of Porter's Five Forces

Threat of Substitutes

Bargain Power of Suppliers

5
3,5
4
3
2
3
1
2
0

Bargain Power of Buyers

2,5
Threat of New Entrants

Competitive Rivalry
4,5

Source: Own estimates

4.3 Consolidation Trends in the Industry

In 2010 ABB attempted to acquire Chloride Group Plc; however, this offer was outbidded by
Emerson Electric, one of its biggest competitors. During 2011 ABB also engaged in bidding war with
Schneider Electric to purchase Leader & Harvest Technologies Holdings Ltd from a private equity
firm. ABB "lost" this bidding war when its competitor acquired the company for 650 million USD.
Other competitors such as Schneider Electric, Emerson Electric, Siemens and Honeywell
International have also entered the bidding war.
The biggest players in the industry are engaging in acquisitions that aims to fill key portfolio gaps
along geographic, product and end-market lines while achieving economies of scale in segments in
which their portfolio is relatively small. Some advisories have even predicted the start of a mega
merger-wave in the industry as soon as the economic conditions stabilize (KPMG, 1999; The street,
2012). This is not surprising since horizontal consolidation is common in mature industries where
rivalry is intense.
As mentioned in the M&A section, early deals in a merger wave tend to be value creating for the
bidder's shareholders; however, late acquisitions tend to be overpaid by the acquirer and thus value
destroying; therefore, acquirers believe that it is a good idea to have a first mover advantage before
prices begin to rise as acquirers try to outbid each other. However, an early start can also be
dangerous due to the current uncertain economical conditions (especially in Europe). Companies with
its base in Europe can hedge this risk by acquiring companies operating in better performing markets.
The competitive implications of a merger wave in the industry are also interesting. As mentioned
before, ABB operates in a red queen environment; therefore, it needs to consider whether a strategy
of expansions through acquisitions makes sense in terms of the competitive environment. This
27

requires a careful analysis of the target firm; e.g., how a particular target fits the overall strategic
goals of ABB and how it might alter the way the competitors behave.
ABBs pace of acquisitions has accelerated from two acquisition announcements in 2009 and 2010, to
eight in 2011 (ABB ltd, 2012b). These acquisitions span over the whole spectrum of markets in which
the company operates. They range from its acquisition of Powercorp Pty Ltd, a power automation
company, to Ventyx a software supplier that provides energy management solutions (smart grid
software). This diversity also extends to the geographical dimension; the company has completed
deals in India, the United States and Europe. As we have mentioned in section 3.1.2 the appreciation
of the Swiss Franc against the Euro and the Dollar has given ABB an advantage when buying targets
denominated in foreign currency.
On late November 2010, ABB announced that it had arranged to acquire Baldor Electric Co., the
North American leader in industrial motors, for 4.2 billion USD (including 1.1 billion of debt). This
all-cash acquisition had the approval of both board of directors and was eventually closed on the 27th
of January 2011. Baldor is headquartered in Fort Smith Arkansas and had, as of January 2010, 7250
employees. Its revenue stream originates from four main business segments: motors, mechanical,
drives and generators (ABB ltd, 2010a). The company was hit hard by the recession of 2008, but it
recovered rapidly and by 2011 sales were projected to be back at pre-crisis levels. Even if the
company had not been acquired by ABB, revenues were projected to grow by 10% annually during
the next 3 years. New efficiency standards on industrial motors were introduced in late 2010,38 and
they will force industrial producers to upgrade their current hardware during the coming years.
Furthermore, according to a forecast by ABB, energy efficiency solutions in the United States will
grow at least twice as fast as GDP growth during the next decade. Baldor was one of the few
companies in the industry that fully implemented the efficiency standards long before the regulations
took place; this provided the company with a head advantage over competitors (ABB ltd, 2010a).
The acquisition could also be a stepping-stone towards an expansion into Canada and Mexico which
have also discussed introducing similar regulations in 2012. At the time of this writing Baldor is the
latest big acquisition undertaken by ABB; therefore, we will base forecast ratios mainly on this
acquisition.

4.4 Internal Analysis Resources and Capabilities

The previous analysis identified opportunities and threats in the external environment; however,
sustainable profitability is never the result of an attractive industrial environment; the basic principles
of microeconomic theory state that abnormal earnings in a given industry will attract new entrants and
this will push profits down until every firm in the industry only earns enough to cover its cost of

38

NEMA standards. (National Electrical Manufacturers Association, 2011)

28

capital. Consequently, the internal examination of strengths and weaknesses unique to the company
has equal or superior importance for the valuation.
For this analysis we have chosen to use the resource-based view. The resource-based view is
grounded on two basic assumptions: resource heterogeneity and resource immobility. Resource
heterogeneity refers to the fact that firms within an industry hold different collections of resources.
Resource immobility suggests that some of these resources are very costly or difficult to imitate. A
competitive advantage can be obtained by possessing resources that are difficult to copy and that are
only possessed by one or a few other firms in the industry (Barney, 2007).
4.4.1 VRIO Framework
According to Barney's Value, Rarity, Imitability and Organization (VRIO) framework; the resources
and capabilities are divided into 3 categories: tangible, intangible and organizational and human. 39
The framework includes a sequence of four specific questions and their answers determine the
prominence of a resource. The first question is whether a resource is valuable or not; it is only
valuable if it allows the firm to exploit external opportunities and threats and have a positive effect on
economic performance. Secondly, the framework asks whether a given resource is rare. The number
of other firms in the industry that possess the same resource or capability defines the answer to this
question. A resource that is valuable and rare can result in a competitive advantage, but if it is easy to
imitate the advantage will not be sustainable. This raises the third question; namely, weather the
resource is costly or difficult to imitate. Last but not least, the question of organization is examined. It
deals with the issue of whether a firm is organized to exploit its resources and capabilities.
4.4.1.1 Tangible Resources
According to our assessment the most valuable tangible resource that ABB holds is its broad product
portfolio that spans over different stages of the economic cycle. This diversification helps the firm to
offset the risk from volatility in individual market segments and results in smoother cash flows. For
example, in the early stages of the business cycle the firm has the low voltage products, which are
highly dependent on consumer demand and respond rapidly to changes in economic activity. Process
automation and power products come later in the cycle because they require large capital
expenditures (ABB ltd, 2012a). Additionally, their portfolio is geographically dispersed. The firm has
a sizable customer base in more than 100 countries and even though the world economy has become
more interlinked, there are still benefits to be gained from this kind diversification, especially during
economic downturns.

39

The VRIO framework cannot be used in an industry characterized by unpredictable changes in the surrounding
environment because these kind of environments do not have stable value drivers.

29

This combination of product and geographical diversification allowed the firm to outperform the S&P
500 during the last recession (ABB ltd, 2012c). In comparison to other competitors the firm is less
affected by the business cycle and earnings appear to be relatively stable. We have assessed product
and geographical diversification to be a sustainable competitive advantage. It is only shared by the
biggest players in the industry and a newcomer would find it difficult and time consuming to achieve
the same degree of diversification.
The company is aware of the extremely competitive environment in which it operates; hence, it has
devoted $1.082 million to R&D expenses in 2010, this accounted for 3,42% of its total revenue for
the year, up from $1.037 million40 the year before. Most of the R&D investments went to the firm's
two global research laboratories. One of them specializes in power technologies and the other in
automation technologies (ABB ltd, 2012a). The seeds of investment in research and development can
take many years to bear fruits; however, the technological superiority that results from this capitalintensive venture is without a doubt a sustainable competitive advantage for the company. It allows
the firm to provide its customers with state of the art solutions and it is a scarce resource because only
sizeable contestants can truly engage in it.
In 2009 ABB introduced an ambitious cost-cutting strategy with the aim of increasing efficiency,
streamlining procurement and centralizing administration. This strategy has resulted in more than 3
billion USD in saving during 2009 to 2011. The program was structured to include benchmarking of
activities against best industry practices and the centralization and streamlining of top managerial
functions. This resulted in the lowest percentage of administrative cost to revenue in the sector (ABB
ltd, 2011a). Although the program has been highly successful and resulted in increased profits, this
capability can at best be considered a temporary competitive advantage because the industry is
characterized by price intense competition; hence, reducing cost is more a necessity than an
advantage in the long run.
Finally, the firm also possesses a relatively strong balance sheet with ample cash reserves; however,
these resources represent a competitive parity at best. It will provide ABB with ample room to
continue in its expansionary acquisitions strategy, but other competitors can easily catch up.
4.4.1.2 Intangible Resources
ABB is the founding father of many technologies, such as the high voltage direct current (HVDC) and
the FACTS technology, which have had a revolutionary impact on the world (ABB Ltd, 2010). Their
long history of technological innovation and their ability to maintain leadership in technology
solutions are proofs of ABBs advanced technological expertise. Today they have almost 20,000
active patent applications and possess approximately 4.780 active patents (ABB Ltd, 2012a). This
40

Equivalent to 3,3% of its revenues for the year.

30

expertise is one of ABBs most valuable intangible assets. Technological expertise and patents are
resources likely to give ABB a sustainable competitive advantage.
Their strong customer relations are another source of sustainable competitive advantage. ABB has
shown high backlog orders and in 2010 the numbers were higher than ever before. This is a sign of
customers strong confidence in the business. High backlog suggests that there is robust demand for
their products and it assures future earnings and cash generation. Orders increased from $30.969
million in 2009 to $32.681 in 2010. Backlog orders also increased from $24.771 to $26.193
respectively (ABB ltd, 2011a). This has in its turn resulted in greater investor assurance. For example
Investor AB, the biggest shareholder in ABB41 increased its capital share from 7,3% to 7,8% in 2011
(Investor AB, 2012). The fact that ABB is able to sustain and increase orders and backlog orders in
an environment characterized by high competitive rivalry is a sign of high costumers satisfaction.
This intangible resource is costly for competitors to imitate since it takes a long time to establish a
good reputation and customer relations. Furthermore ABB is constantly working to improve customer
satisfaction, e.g. a new customer satisfaction metric was implemented in 2011 (ABB ltd, 2011a),
which shows that they are exploiting this resource.
ABBs environmental focus is twofold; they offer products that improve environmental impacts and
the firm itself operates in a sustainable fashion. ABB set up an environmental advisory board as early
as 1992 and ever since then they have put a lot of emphasis on being a sustainable company. In 2011
they won 19 awards for environmental and social performance (ABB Ltd, 2012b). In addition they
have topped the Dow Jones Sustainability Index (DJSI) for three consecutive years. An
environmental focus is valuable because of trends in the external environment (ABB Ltd, 2011a).42
However, it can no longer be regarded as a rarity since it has become a necessity to incorporate
sustainability in the business operations.
Last but not least, ABBs strong brand can contribute to a competitive advantage. They have been a
strong innovator within technology and have a large geographical coverage. In 2011 Brandirectory
ranked their brand as number 261 out of 500 global brands. Even though this was a decrease to the
previous year ranking, the brand value according to Brandirectory increased from $3,690 million in
2010 to $3,950 million in 2010 (Brandirectory, 2011).43 The ABB brand is unique in terms of what it
represents to the firms clients.

41

In December 31th 2011 Investor AB, possessed 7,8% of total Ltd share capital (ABB ltd, 2012a).
See section 3.1
43
Another report from 2011 ranked ABB as the 15th most valuable Swiss brand (MPP Consulting, 2011).
42

31

4.4.1.3 Organizational and Human Factors

During the recent decade ABB has reformed a large part of their internal operations. They introduced
a cost cutting program that decreased their administrative costs tremendously. This program included
changes in the organizational structure. Since 2002 the company has moved from being a highly decentralized organization with local autonomy to a highly centralized organization (ABB Ltd, 2011b).
According to Beer and Nohria (2000) there are two different approaches to change: Theory E, where
the main purpose of change is economical value, and theory O, where the goal is to improve corporate
culture. The restructuring at ABB has been a mixture of the two theories and since it has introduced
the organization to new practices it can be regarded as an innovative change. These changes require
the people within the organization to change as well. It involves learning new ways of looking at
things and new ways of doing thing, this is not an easy task since people in general are reluctant to
change. The fact that the restructuring has resulted in such a success is an indication that people
within the organization are willing to change and that suggests a corporate culture of innovation. The
additional cost cutting also shows that the imposed organizational structure is working. An
organizational culture of change and innovation is today a necessity; therefore, we have assessed it to
be a comparative parity.
The low administration cost is one of the lowest in the industry and can be considered rare. Whether it
is costly or problematic for others to implement is difficult to assess; however, based on the fact that
there is generally high resistance to change we conclude that it is challenging but not impossible. The
organizational and human resource of administrative efficiency is therefore considered to be a
competitive advantage.
ABB is a global company that has operations in different parts of the world and is culturally diverse.
Even though it has a centralized organizational structure, its top levels of management are also
culturally heterogeneous (ABB ltd, 2011a). The effects of cultural diversity are both negative and
positive. Different values, language barriers and increased complexity are examples of problems that
can arise due to cultural diversity and may impose organizational costs. On the other hand cultural
diversity can also be beneficial due to access to multiple perspectives, interpretations and local
knowledge, which can foster a more creative and innovative environment (Adler & Gundersen,
2008). In this global environment, a certain amount of cultural knowledge and the means to be able
to exploit it are a necessity. While the firm appears to have the capacity to exploit its cultural
diversity, other competitors have the same capabilities and this cannot be considered a competitive
advantage. However, from an M&A perspective cultural diversity is extremely valuable because it
can result in an easier integration of target firms.
ABB collaborates with 70 universities across the world (ABB Ltd, 2012a). Collaboration with
universities allows the company to have access to the next generation talents. In addition they can
32

establish their brand in the minds of the students and make them develop skills that are of importance
to the firm. It can also strengthen relations with local communities as well as provide them with local
knowledge.
4.4.1.4 Summary of VRIO Analysis
In the previous sections we have described an analyzed the valuable internal resources of ABB in
respect to the VIRO framework. ABB possess tangible, intangible and organizational and human
resources, which if exploited by the organization, can create competitive sustainable advantage.
Exhibit 3 summarize the aforementioned analysis:
Exhibit 3: Summary of VRIO
Summary of VRIO

Tangible Resources
Property Plant and Equipment
Ample Cash Reserves and Strong
Balance Sheet
Cost Efficiency
Georgraphical Dispertion
R&D Facilities and Investments
Broad Product Portfolio
Intangible Resources
Environmental Focus/Reputation
Technological Expertize and Patents
Strong Brand
Strong Customer Relations
Organizational and Human Resources
Collaboration with Universities
Cultural Diversity
Corporate Culture of Continuous
Improvement
Administrative Efficiency
Source: Own estimates

Can it be
Costly to Exploited by the
Valuable? Rare? Imitate? Organization?
Competitive Implications

Comparative Economic
Performance to be Expected
From the Resource

Yes

No

Competitive Parity

Normal

Yes
Yes
Yes
Yes
Yes

No
Yes/No
Yes/No
Yes
Yes

Yes
Yes
Yes

Competitive Parity
Temporary Competitive Advantage
Competitve Advantage
Sustainable Competitive Advantage
Sustainable Competitive Advantage

Normal
Normal
Above Normal
Above Normal
Above Normal

Yes
Yes
Yes
Yes

No
Yes/No Yes
Yes
Yes
Yes
Yes

Yes
Yes
Yes

Competitive Parity
Sustainable Competitive Advantage
Sustainable Competitive Advantage
Sustainable Competitive Advantage

Normal
Above Normal
Above Normal
Above Normal

Yes
Yes

No
No

Competitive Parity
Competitive Parity

Normal
Normal

Yes
Yes

No
Yes

Competitive Parity
Competitive Advantage

Normal
Above Normal

No
Yes/No
Yes
Yes

Yes/No

Yes/No

4.4.2 Internal Weaknesses

Paradoxically one of the firms strengths can also become a weakness. The firm intends to fill key
gaps in their portfolio through strategic acquisitions; this strategy will result in further diversification.
However, if taken too far, these acquisitions can over-stretch the firm and lead to overinvestments in
unsuccessful lines of the business that can end up being subsidized by more successful segments
(Berger & Ofek, 1995). The conglomerate acquisitions of the late 60's and early 70's provide us with
the best historical advice against this practice. This period showed how all the benefits of
diversification can easily be outweighed by its costs if the acquirer goes "overstretches" by bidding
for target firms that come from totally unrelated industries. Furthermore, overconfident managers in
the firm might be unwilling to divest acquisitions that have turned out to be value destroying for fear
of admitting to a mistake.
As mentioned in section 3.3 there appears to be a strong trend towards consolidation in the industry
and this will probably bring about an industry merger wave. So far the firms that ABB has acquired

33

do not diverge from its core businesses;44 nevertheless, it is difficult to draw the line between a
strategically sound acquisition based on the strengthening of the firm's core competencies and
conglomerate acquisitions that go beyond the firm's field of expertise (especially given ABB's
already broad portfolio). Most of ABB's acquisitions during the last two years appeared to fit a wellconstructed scheme that follows their goal of filling gaps in their portfolio without diverting from
core businesses. But the main implication is that even well managed companies can fall victims of
overconfidence of managers (hubris hypothesis). Furthermore, the same managers can engage into
herding behavior as they see competitors acquire targets that operate in unrelated businesses.
As already mentioned,45 ABB has been involved in several legal issues. Most allegations have been in
regards to anti-competitive behavior. In 2005 the firm was charged for making unlawful payments to
the Iraqi government.

46

In 2009 the company was accused of illegal payments related to

anticompetitive practices which resulted in a 33.75 million fine from the European Commission
(EC) (Global Data, 2012). In 2011 they received a statement of objection from the EC as part of an
ongoing investigation of alleged anti-competitive behavior in the cable industry (ABB ltd, 2010b).
Besides the direct effect of costly fines, such behavior damages the firm's reputation and can
eventually lead to overregulation (red tape) in the industry.

4.5 Summary of Strategic Analysis

The strategic analysis has covered the external and internal environment as well as discussed the
consolidation trends in the industry. The main aim was to identify non-financial value drivers that
will affect future growth prospects of ABB. Below follows a summary of what we assessed to be the
most important factors.
Amongst the external factors that are helpful to the firm, we have concluded that the rising demand
for energy efficient solutions will provide the largest growth opportunities in the short- to medium
term. Energy prices are high and highly volatile; therefore, companies are looking for cost-effective
solutions that will allow them to lower costs. Additionally, political actions in terms of legislations
that demand higher environmental standards as well as smart grid initiatives in the EU and North
America will provide for a positive medium and long-term outlook. Increasing energy demand, as
well as the huge investments in energy and electricity infrastructure in emerging markets will also
provide with prevalent growth opportunities in the medium- to long term.
ABBs technological expertise and their strong brand are also considered to be strong resources that
can give sustainable competitive advantage. This is based on the fact that these resources allow the
44

Power products, Power systems, Discrete Automation and Motion, Low Voltage Products and Process
Automation.
45
See section 3.1.1
46
The case concerned contracts for humanitarian goods.

34

firm to react effectively to the environmental changes and threats from competitors. In addition, their
broad geographical presence (which has been further enhanced in the North American market through
the acquisition of Baldor) and their broad product portfolio will allow the firm to better withstand
demand volatility and economic downturns.
ABB has the ability to carry out their "growth through M&A" strategy. Literature tends to be
dismissive of M&A as value destroying, but this view fails to take into account that in merger wave
M&A might become more of a necessity than an option. This refers to the fact that consolidation is
sometimes a requirement for survival in mature industries; however, as mentioned in section 3,
growth through mergers and acquisitions is a double-edged sword that can have both positive and
negative effects.
There are also external factors threatening ABBs future performance. The economical uncertainty
from the previous crisis is still present and its future implications are still difficult to assess, especially
regarding the ongoing European fiscal crisis. At an industry level the firm faces a highly competitive
environment that forces it to constantly improve its core competencies just to retain market share. See
appendix 4 for a summary of the strategic analysis according to the SWOT framework.

5. Analysis of Financial Statements

The value of a company is driven by its capability to generate cash flows from the invested capital,
and the ability to grow. Value is created when the rate of return on invested capital is higher than the
cost of capital (Koller, 2009). In the previous section we have evaluated the non-financial drivers that
can affect the future performance of ABB, in this section we will analyze the historical performance
of the firm. The analysis will be based mainly on information from financial reports; however,
supplementary material is added when deemed necessary. Together with the strategic analysis, this
section will lay the bases upon which the fundamental valuation of ABB will be developed. The
section begins with a description of the reorganized financial statements. This is needed because the
main drivers of value (ROIC and invested capital) cannot be determined directly from the companys
reported financial statements. In addition, we will make an analysis of the historical performance of
ABB that looks into revenue and return on invested capital since those items are of most significance
to the forecasting process.
Even though Koller (2009) recommends using the longest period possible, we decided to go back
only to 2006 because that was the year in which the firm ended its strategy of divestures of nonperforming business units. Most divestures occurred during 2000-2001 but the strategy continued
throughout the first half of the 2000's. When considering strategies, the year 2011 is of particular
interest as it was during this year that the company purchased Baldor. Examining the financial
35

statements during that year will allow us to form a relatively accurate picture of how it affects the
firm from a financial point of view.

5.1 Reorganization of Financial Statements

ROIC and FCF are supposed to measure only operating performance; however, financial statements
mix operating, non-operating and sources of financing items. In order to base ROIC and FCF purely
on operating items it is necessary to reorganize the existing statements into new statements reflecting
only operating performance (Koller, 2009). From the reorganized statements it is possible to derive
invested capital and net operating profit less adjusted taxes (NOPLAT). These elements are then used
to calculate the FCF and ROIC. Using NOPLAT as the base for FCF makes this figure independent of
non-operating items and the firms capital structure. The total capital invested in the operations is
represented by invested capital, independent of the type of financing.
Invested capital is derived from the rearranged balance sheets. The operating assets are separated
from the non-operating assets and the same procedure is true for liabilities. In addition sources of
financing are identified and separated into debt, equity and debt and equity equivalents.47.
NOPLAT should represent the profit available to all investors; hence, the income statement needs to
be adjusted for any expenses (gains) from sources of financing such as interest48 and for any gains
(expenses) from non-operating assets. The adjustments made in NOPLAT have to be consistent with
the classification of invested capital. NOPLAT is the base for calculating the FCF, which is the aftertax cash flow available to all investors. In other words FCF is the cash a firm can generate after
accounting for the capital required to maintain or expand its operations. It is calculated by adding
non-cash operating expenses such as depreciation to NOPLAT and subtracting investments in
invested capital. Exhibit 4 summarizes the results from the reorganization of ABBs financial
statements, detailed calculations can be found in appendix 14 3549 (excel file).
Exhibit 4: Summary of Reorganized Financial Statements
(In million USD)
Invested capital without goodwill
Invested capital with goodwill
NOPLAT
FCF
Source: Own estimates

Summary of Reorganized Financial Statements

2006
2007
2008
2009
$
10.008 $
11.317 $
13.513 $
14.537
$
13.686 $
15.192 $
17.526 $
18.912
$
2.348 $
3.391 $
4.278 $
3.618
$
1.877 $
2.019 $
1.595 $
2.276

$
$
$
$

2010
15.306
20.998
3.682
1.585

$
$
$
$

2011
19.280
29.928
4.770
-3.955

47

Total invested capital can be calculated using two methods the "uses" method and the "financing" method. When
using the first method to calculate invested capital one subtracts operating liabilities from operating assets. The
second method is calculated by taking debt and debt equivalents plus equity and equity equivalents.
48
Since NOPLAT includes the profit available to all investors expenses related to providers of debt (and other
stakeholders) interest expense should not be deducted from operating profit.
49
More specifically appendix 17 20 and 31 35

36

Invested capital and NOPLAT is subsequently used to calculate ROIC, which is derived from
dividing NOPLAT with invested capital. A further description and analysis of ROIC can be found in
section 5.2.2.
5.1.1. Major Adjustments to the Reorganized Financial Statements
Operating leases are not recorded as assets and liabilities in the companys balance sheet; instead they
are recorded as rental expenses in the income statement. In other words, invested capital and
operating profits are artificially low. The net effect is an overestimation of ROIC. To correct for this
Koller (2009) suggests that operating leases should be capitalized and that invested capital, NOPLAT,
and FCF should be adjusted accordingly.
The principle behind R&D capitalization is roughly the same as with operating leases. Without
capitalization of R&D, ROIC can be overstated since this would be equal to assuming that the firm
can enjoy the same competitive advantages without past expenditures on R&D. Historical R&D
expenditures are one of the firm's value adding resources because most of the technology which the
firm has today is the result of these expenditures; moreover, they represent part of the firm's
competitive advantage as they prevent competitors from the opportunity to use the patented
technology. See appendix 5 for details on calculations for capitalization of operating leases and R&D.
In addition to capitalization of R&D expenses and operating leases, we have corrected the existing
financial statements for pension assets and unfunded pension liabilities. Pension assets are treated as
non-operating and pension liabilities as debt equivalents; furthermore, pension expenses have been
separated into operating and non-operating. Since the non-operating assets are not related to the firms
operations they should not be deducted from revenues. (Koller, 2009)

5.2 Analysis of Historical Performance

This section will cover the analysis of ABBs historical performance. This analysis is a vital part in
estimating ABBs future performance and hence the final valuation of the firm. The section will have
two primary foci: growth and ROIC, which are the two main sources of value creation.
5.2.1 Revenue Growth
Assuming that profits and reinvestments stabilize, revenue is the main driver of long-term growth in
the FCF (Koller, 2009). Before the actual analysis, we comment on possible distortion effects on
revenue.
Currency effects can distort growth in revenues because a company that operates globally converts
revenues from different parts of the world to a single currency when preparing their company reports
(Koller, 2009). In its 2011 annual report the company announced that approximately 85% of
consolidated revenues were reported in currencies other than USD. The biggest portion of these
37

consisted of revenues reported in Euro, which compromised 25% of that amount. Since the firm
operates in more than 100 countries an adjustment of currency effects would be overly complex and
beyond the scope of this paper. In addition to currency effects, financial statements have been
adjusted for acquired revenues that resulted from the acquisition of Baldor in 2011.
Exhibit 5: Total Revenues

Total Revenues
$40.000

$37.990
$34.912

$35.000
$30.000

$29.183

$25.000
$20.000

$31.589
$31.795

$23.281
$22.012

$15.000
$10.000
$5.000
$2005

2006

2007

2008

2009

2010

2011

Source: ABB annual reports (own making)

Exhibit 5 shows the historical levels of total revenues. ABB experienced a large increase in revenues
between 2006 and 2008. The year 2007 stands out as a particularly strong year. The increase in
revenues during the period 2006 to 2008 was mainly due to high order backlog and strong growth in
total orders within all divisions. In 2009 total orders decreased significantly due to the financial crisis
and price erosion in utilities and industrial markets.
The spike in revenues in 2011 was mainly due to the acquisition of Baldor. As mentioned previously,
we have adjusted the revenue growth for that year to take this acquisition into account and isolate
organic growth. According to ABBs 2011 annual report the growth in revenue excluding the
acquisition of Baldor was 14%. This is of course taken into consideration when estimating ABBs
future growth possibilities.

38

Exhibit 6: Revenues per Region

Revenues per Region
$40.000
$35.000
$30.000
$25.000

Middle East and Africa

$20.000

Asia

$15.000

Americas

$10.000

Europe

$5.000
$2006 2007 2008 2009 2010 2011
Source: ABB annual reports (own making)

Exhibit 7: Growth in Revenues per Region

2006
Europe
2%
Americas
4%
Asia
14%
Middle East and Africa
6%
Source: ABB annual reports (own making)

2007
21%
19%
28%
53%

Growth in Revenues per Region

2008
2009
2010
19%
-17%
-5%
23%
-6%
3%
20%
-3%
2%
18%
7%
4%

2011 Average
18%
6%
46%
15%
14%
13%
1%
15%

Exhibit 6 and 7 show the development in revenues according to geographical regions. Europe has
consistently been the largest contributor to total revenues; however, as a result of the economic crisis
the European segment has experienced a downturn and is expected to decline in importance.
With the exception of 2009 revenues from the Americas has shown consistent growth that was mainly
driven by increased demand in the U.S and Brazilian markets. In 2011 the acquisition of Baldor
represented 32% of the 46% in revenue growth. From 2006 to 2009 revenue growth in Asia was
mainly driven by investments in infrastructure. This trend has changed during the last two years
where most orders are related to industrial clients from the private sector (ABB ltd, 2012a).
Exhibit 8: Revenues per Division
Revenues per Division
$14.000,00
$12.000,00
$10.000,00
$8.000,00

Power products

$6.000,00

Power systems

$4.000,00

Process automation

$2.000,00

Other*

$2006

2007

2008

2009

2010

2011

Source: ABB annual reports (own making)

* Includes robotics, discrete automation and motion (automation products) and low voltage
products

39

Exhibit 9: Growth in Revenues per Division

Growth in Revenues per Division
2006
2007
2008
2009
2010
Power products
10,43%
33,34%
21,20%
-5,56%
-8,50%
Power systems
6%
27%
18%
-5%
4%
Process automation
4%
17%
21%
0%
-4%
Other*
2%
23%
18%
-20%
8%
Source: ABB annual reports (own making)
* Includes robotics, discrete automation and motion (automation products) and low voltage products

2011% Average
7,13%
9,67%
20%
11,85%
12%
8,45%
39%
11,72%

Exhibit 8 and 9 show historical revenues per division. Power products, power systems and automation
products have shown particularly good results in the period 2006 to 2008. These results were driven
by demand for new power infrastructure to improve energy efficiency in the public sector and the
need for energy efficient solutions in the industrial sector. Additionally, the sales price for power
products and automation products increased as a result of higher cost of raw materials. In 2009
revenues dropped in all divisions as a result of the financial crisis; the drop was mainly due to
reduced demand within industrial and construction related industries, and from customers postponing
their investment plans because of market uncertainties; notwithstanding, due to high backlog orders in
many of the divisions, the total decrease in revenue amounted to only 9%.
The group that we have chosen to label other includes: discrete automation and motion, other
automation products, robotics and the low voltage division.50 In 2011, revenues in the discrete
automation and motion division increased dramatically because of the acquisition of Baldor.
Revenues for low voltage products also increased due to a rise in orders and strong opening backlog
in LV systems. Robotics showed positive trends during the initial historical period but has presented
declining results during the last years (annual reports).
5.2.2 ROIC
This section examines the historical development of ROIC. It is critical to examine ROIC since it is
one of the core drivers of value; it measures how good a firm is at generating returns from the capital
invested. In other words it gives a picture of how efficiently a firm allocates its resources. A firms
ability to create and sustain a rate of ROIC that is higher than the cost of capital is what drives value
creation. ROIC is derived from the following formula:
!"#$ =

!"#$%&
!"#$%&$' !!"#$!%

Source: (Koller, 2009)

Koller (2009) relies on the structure of conduct performance (SCP) framework when explaining the
drivers of ROIC. According to the SCP theory, ROIC is driven by industry structure as well as the

50

ABB has reorganized the divisions included in other during the period 2006-2011.

40

individual firms competitive advantage. Since ABB operates in different industries ROIC per
business division might differ depending on the competitive forces driving that industry. A detailed
analysis of these factors is out of the scope of this paper; additionally, even though the underlying
economics might differ, they do not appear to be large enough to create significant differences in
ROIC.
ROIC can be measured with and without goodwill51. When comparing a companys performance to
competitors ROIC without goodwill is the optimal figure to look at because it measures solely the
operating performance of the company;52 however, when measuring value creation for the companys
shareholders it is more appropriate to analyze ROIC with goodwill since the company has spent
money (or shares) to acquire the target company and has to compensate its investors for it. Our
analysis focuses on the latter. The different components of ROIC are disaggregated an analyzed
independently by means of a ROIC tree:
Exhibit 10: ROIC Tree

51

In this paper the term goodwill includes both goodwill and other intangible assets.
ROIC with goodwill is distorted by premiums paid in acquisitions since goodwill includes the difference between
the purchase price and the fair value of assets and liabilities acquired.
52

41

ROIC including goodwill reached its peak in 2008. 53 This can be explained by the slightly higher
operating margin as a result of a stronger gross margin in that particular year. In addition, the capital
efficiency was somewhat higher in 2008 than previous years because of stronger fixed asset
efficiency. During 2009 ROIC fell as a result of lower capital efficiency that was itself a consequence
of lower revenues and slightly higher fixed assets.
From 2009 to 2011 ROIC including goodwill decreased. This is primarily the result of investments in
M&A. Baldor's acquisition in 2011 increased the total value of goodwill and resulted in a lower
ROIC; however, ROIC excluding goodwill increased slightly due to higher operational efficiency.
Since the acquisition of Baldor is recent and still is in the implementation period, one can assume
further synergies to be realized within the next 2-3 years54. According to ABBs own estimates they
expected to have synergies through increased EBIDTA that amount to 200 million USD (ABB ltd,
2010a). During the last two years ABB has executed a cost cutting programs but these improvements
have been mostly offset by higher commodity prices.
ROIC including goodwill has decreased due to recent acquisitions. The future development in ROIC
depends on ABBs ability to exploit synergies from these investments. Overall there have not been
any major changes to the individual components behind ROIC. If synergies are realized these ratios
will improve and ROIC including goodwill will increase.55 It should also be noted that the figures
during the specified historical period might not be fully representative because of the financial crisis.

6. Estimating the Cost of Capital

Before we move on to the actual valuation we need to estimate the discount rate. The discount rate for
the DCF and EP model is weighted average cost of capital (WACC) and the purpose of this section is
to determine that figure. As with a lot of issues in valuation the estimation requires careful
consideration. Finding the correct WACC is extremely important as even small mistakes in its
estimation can have significant consequences on the final value of the firm.

53

Through algebraic manipulation of the following formula (Koller, 2009):

!"#$ = 1 !"#$!"#$% !"# !"# !"#$

!"#$%
!"#"$%"&

!"#"$%"&
!"#$%&$' !"#$%"&

It is possible to isolate each of the components of the ROIC tree.

54

Improvements in ROIC excluding goodwill will mean improvements in ROIC including goodwill.
Post-acquisition implementation takes around 2 to 3 years to be completed; therefore, improvements will take time
to be reflected in ROIC.
55

42

The weighted average cost of capital (WACC) is the rate of return required by shareholders and
creditors to finance the company's investments. Since it combines the expected return to all investors
into a single figure the formula should also incorporate capital structure by including the debt-tovalue and equity-to-value ratios (Brealey, Myers, & Marcus, 2007). Additionally, the formula takes
into account the value of the tax shield, which is the reduction on income taxes that results from
taking on debt (which is tax deductible). While the overall concept is easy to grasp, estimating the
correct rate is a relatively complicated issue because some of the figures used to estimate it are not
directly observable. The WACC formula is displayed below:
!"## = !"#$!"# !"#$%&# !"#$ !" !"#$%"& =

!
!
!! 1 !" +
!
!+!
!+! !

where:
D = Market value of Debt.
E = Market value of Equity.
D + E = Enterprise value
rd = Required return to debt holders.
re = Required return to equity holders.
Tm = Marginal tax rate
Source: (Koller, 2009)

6.1 Capital Structure

To assess the WACC we need to find reliable estimates of the five elements stated above. In this
section we discuss the capital structure of the firm. The cost of capital should be based on a capital
structure that is forward looking and reflects the expected equity/debt market-based ratio over the
firms lifetime. If the current capital structure is expected to change one must estimate different
WACCs reflecting the particular capital structure of the respective point in time; however, if one
believes that a companys current market-value-based capital structure is close to target weights, it
can be used as a proxy (Koller, 2009).
Exhibit 11: Historical Levels of Debt
2006
Short-term debt
$
122 $
Long-term debt
$
3.160 $
Total debt
$
3.282 $
Source: ABB annual reports (own making)

Historical Levels of Debt

2007
2008
2009
536 $
354 $
161 $
2.138 $
2.009 $
2.172 $
2.674 $
2.363 $
2.333 $

2010
1.043 $
1.139 $
2.182 $

2011
765
3.231
3.996

Average
$
497
$
2.308
$
2.805

From exhibit 11 one can see how debt has changed over the past 5 years. In 2006 long-term debt was
just above 3.000 million USD. This was followed by a decrease during the next 4 years, only to
increase again in 201156. The differences between short-term and long-term debt can primarily be

56

The decrease in debt 2010 was primarily due to exchange rate movements.

43

explained by the movement of current maturities of long-term debt to short-term debt in annual
statements of ABB (ABB ltd, 2011a).
Exhibit 12: Capital Structure
Capital Structure
2006
2007
Total market value of debt and debt equivalents
$ 9.890 $ 7.985
Excess cash
$ -3.732 $ -4.066
Market value of net debt
$ 6.158 $ 3.918
Total market value of equity and equity equivalents $ 45.407 $ 77.131
Total Value of Capital
$ 51.565 $ 81.050
D/V
11,94%
4,83%
E/V
88,06%
95,17%
Source: ABB annual reports (own estimates)

2008
$ 9.850
$ -5.701
$ 4.149
$ 46.978
$ 51.127
8,12%
91,88%

2009
$ 9.582
$ -6.483
$ 3.099
$ 60.056
$ 63.155
4,91%
95,09%

2010
$ 9.163
$ -5.265
$ 3.897
$ 71.557
$ 75.455
5,17%
94,83%

2011
$ 12.482
$ -4.059
$ 8.423
$ 65.247
$ 73.669 Average
11,43%
7,73%
88,57%
92,27%

Exhibit 12 shows ABBs historical capital structure. Non-operating liabilities such as provisions
related to litigations and environmental provisions have been regarded as debt equivalents; even
though it is uncertain to what extent ABB is obliged to perform, the reported values have been based
on the probability of occurrence and a reasonable amounted loss. Operating liabilities, such as
accounts payable, have not been regarded as debt. Some authors argue that not including nonfinancial liabilities can distort capital structure if non-financial liabilities are of significant weight
57

(Wech, 2006). Nonetheless, in order to be consistent with the method described by Koller (2009) we

choose only to include debt and debt equivalents. This is also critical because the components of
WACC must be consistent with the components of free cash flow. Debt and debt equivalents are
calculated by the sum of short-term debt, long-term debt, capitalized operating leases, pension
liabilities and non-operating liabilities. Subtracting the excess cash held by ABB from total debt
results in net debt.
As mentioned before, debt and equity should be based on market values and not book values. To find
the market value of equity we multiply the number of outstanding58 shares with the market share
price. On the 31st of December ABBs stock was valued at $18,83 and the number of outstanding
shares was 2.290.411.120, this gives a market value of common stock at $44,128. For non-operating
liabilities, capitalized operating leases and pension liabilities the book values are used. The same
stands for short-term debt, where we believe book value to be a good estimate for the current market
value. In terms of long-term debt we have used 2011 as a base year to estimate market value in the
years 2006 to 2010. 59 In 2011 long-term debt consisted of 5 different outstanding bonds that
constituted $3.059 million out of $3.231 million of total long-term debt. The market value of these

57

When non-financial liabilities-to-asset ratio is relatively insignificant financial debt-to-asset ratio is a good
estimate of capital structure.
58
It is important to use outstanding shares and not issued shares since the company might have repurchased shares.
59
We used the % difference between market value and book value in 2011 as a driver to estimate market value of
long-term debt the previous year. This is done for simplicity since parts of long-term debt have been reported as
short-term debt.

44

bonds has been calculated by multiplying the book value of each bond with its market price on the
31st of December (see appendix 22 for details) (Thompson Reuters Datastream, 2012).
As we can see from exhibit 12, ABB has had a quite conservative policy regarding capital structure.
Debt-to-value ratio has never been higher than 12% and the average for the 6 years is only 7,78%.
The relatively low debt-to-value ratio in 2007 can be explained by the large increase in the market
value of equity. In the same way the increase in 2008 is a result of a fall in share price due to the
financial crisis. Since ABB has stated that it values a strong balance sheet and wishes to maintain its
current credit rating (ABB ltd, 2011b) we believe that the debt level in 2011 is a good proxy for
target market-based weights. We base this assumption on the fact that the company has not
announced any particular changes to current capital structure. Predicting future changes in capital
structure without any information regarding their key target financials would result in pure
speculation.60 Furthermore, ABB has had a relatively stable credit rating since 2008 (Moody's and
S&P). 61 Thus, the debt-to-value ratio we will base our forward-looking WACC on is 11,43%.
ABBs capital structure is assumed to be the same in the scenario of business as usual and in the
scenario of growth by M&A strategy. ABB has specifically announced that acquisition financing
should always be in line with balance sheet targets and that the financing of acquisitions will not
affect their credit ratings (ABB ltd, 2011b).

6.2 Estimating the Cost of Equity

The cost of equity is the required return that stockholders demand to compensate them for the risk
they undertake by investing in the firm. The biggest problem with this factor is that it is unobservable
and difficult to estimate with reliability. The most common way to estimate it is to make use of asset
pricing model (Penman, 2007). The most popular of these models is the influential capital asset
pricing model (CAPM) (Lintner, 1965a; Lintner, 1965b; Sharpe, 1964). According to this model the
required return for an investment is determined by the following formula:
! !! = !! + !! ! !! !!
where:
! !! Expected return for of security !
!! : The risk free rate
!! : The stock ! s sensitivity to the market

60

It is worth noting that Rolling beta has been relatively stable throughout the last 3 years. Beta reflects both
operational an financing risk (Penman, 2007). If the figure is stable the market must believe that neither risk is
expected to change substantially.
61
See section 6.1.4.

45

! !! : Expected return of the market

Source: (Koller, 2009)

In simple terms, it means that the expected return of a stock is equal to the return of the risk free rate
plus the stock's returns sensitivity to the market's returns times the market's risk premium. The CAPM
is based on the premise that an investor can diversify away a substantial amount of risk by holding a
market portfolio of all investment assets; therefore, the only risk that matters is the risk that cannot be
diversified away, that is, the risk of the market as a whole (Penman, 2007). The model has been
criticized on the grounds that it relies on strong assumptions that are not always fulfilled in reality.62
Alternatively, and as a response to the limitations of CAPM to explain anomalies in market returns,
academia has developed the so-called multifactor models. The main difference between these models
and the CAPM is that they add additional risk factors (that cannot be avoided by diversification). The
two most popular multifactor models are the arbitrage pricing theory (APT) (Ross, 1976) and the
Fama-French three factor model (Fama & French, 1992). The APT expands the risks factors of the
CAPM model and asserts that there are other economy wide influences that cannot be diversified
away; however, it has been criticized on theoretical grounds for not specifying precise number or
origin of these factors.63 Koller (2009) contends that the APT has little use outside academia as there
is no agreement unto which and how many factors to use in the regression; hence, estimating risk
using the APT model is considered too complex and beyond the scope of this thesis.
The Fama-French three-factor model is similar to CAPM but it asserts that there are two other sources
of risk besides the market risk. The model can be synthesized by the following formula:
!! = ! + !! (!! !! ) + !! (!! !! ) + !! (!! !! )
where:
!! : Return of small stocks
!! : Return of big stocks
!! : Return of stocks with high book-to-market values
!! : Return of stocks with low book-to-market values
Source: (Koller, 2009)

62

For a thorough review of CAPM assumptions see (Brigham & Gapenski, 1990)
Commonly used factors are: the inflation rate, the spread between short and long-term interest rates, industrial
activity indicators and high-risk corporate bonds. (Penman, 2007)
63

46

The basic premise behind the two extra risk factors is that historically 64 small cap stocks had
outperformed big stocks. The same holds true for the so-called value stocks that have a high marketto-book value ratio. The biggest problem with the model is that it builds entirely on empirical studies
and it is difficult to argue that firm size and book-to-market are "real" risk factors. Whereas the
CAPM model builds on theoretically sound arguments, the Fama-French model has added two risk
factors that many people claim to be investor error. Fama and French replied to this criticism by
stating that the two added factors captured distress risk and were valid risk factors. This hypothesis
has also been criticized on the grounds that these stocks do not actually perform worse than others
during times of economic distress (Lakonishok, Shleifer, & Vishny, 1994). Furthermore, empirical
studies have demonstrated that when momentum is added to the regression it can be statistically
significant (depending on the period of measurement). It would be difficult to argue that momentum
is a risk factor65 (Ackert & Deaves, 2010).
In this thesis we will solely rely on the CAPM model to estimate the cost of equity. The main reason
for our choice is that we agree with Koller (2009) in their argument that this model is the most
theoretically sound and simple asset-pricing model to date.66
6.2.1 Estimating the Risk Free Rate
The risk free rate is the theoretical rate of return of an investment with no risk of default or financial
loss. For its estimation Koller (2009) suggests using the long-term 67rate for government bonds
denominated in same currency as cash flows; however, if we were to use the Swiss government bond
yields we would artificially depress our risk free rate estimation68. This is because Swiss government
bonds are treated as safe heavens by investors in times of economic distress and this pushes bond
prices up (and yields down) (The Economist, 2011). Therefore, using this rate as a proxy would result
in a downwardly biased WACC and an overestimation of the value of the discounted cash flows.
Alternative, we could use U.S. or German government long-term bond yields but these are also at
historical lows as a result of the tremendous effects of the expansionary monetary policy that central
banks in the western world have undertaken during and after the financial crisis. In general, these
artificially low rates push asset prices up and affect our valuation results.69 Some of these rates are so
low that after accounting for inflation (the real rate) returns are negative (Financial Times, 2012). A

64

At least at the time at which the article was published, because as Koller promptly notes, the small stock effect
reversed during the period 1984-2000( Koller, 2009)
65
This is a fact that even Fama and French agree to.
66
To put it in simple terms: we agree with the school of thought that argues that the extra factors in the regression,
though they might be statistically significant, are only capturing investor irrationality and do not represent real risk
factors.
67
Long-term here is defined as 10 year government bonds.
68
Cash flows for the company are reported in Swiss Francs. We use the financial statements that have already been
converted to USD.
69
This monetary expansion has lowered rates even in the father end of the yield curve (The Economist, 2011).

47

forward looking WACC needs to include a risk free rate that takes into account the possibility of
higher rates in the future. Most economists believe that the rates have reached a turning point and
that, in the absence negative economic shocks, rates will rise as the world economy picks up and lax
monetary policy begins to tighten (Financial Forecast Center, 2012; The Economist, 2012a) 70. With
this in mind, we have decided to take the German 10 year bond-rate and adjust it upwards by 175
basis points to 3,77%. This estimate reflects future rises and is also consistent with the figure from
JyskeMarkets, which at the end of 2011 estimated the risk free rate at 3,8% (JyskeMarkets, 2011).
Exhibit 13 shows the 10 year Euro area, German, Swiss and US Government bond yields.
Exhibit 13: Ten-Year Government Bond Yields (Average)
Ten Year Goverment Bond Yields (Average)
dec/06
dec/07
dec/08
dec/09
Euro Average
3,70%
4,32%
2,94%
3,20%
Germany
3,70%
4,31%
2,96%
3,19%
United States
4,57%
4,12%
2,19%
3,59%
Switzerland
2,48%
2,99%
2,06%
1,85%
Source: Economist Intelligence Unit and Blooomberg (own making)

dec/10
2,97%
3,02%
3,52%
1,83%

dec/11
2,02%
2,02%
2,01%
0,70%

6.2.2 Estimating the Market Risk Premium

The market risk premium is the extra return of the market in excess of the risk free rate. In other
words, it is the minimum required return that investors require from holding equities (which bear
more risk and are more volatile) against a risk free asset like government bonds (Ackert & Deaves,
2010). Financial theory argues that holding equities is more risky than holding bonds because equity
investors are subject to two main kinds of risk: the first one is that shareholders only get paid after
other claimants such as creditors and workers have received their share of the cash flow, the second
kind comes from share price volatility, which is considerably higher than the one from bonds or other
fixed-income securities (The Economist, 2012c). When considering the market risk premium it is
important to differentiate the ex-post rate, which is the extra return equity investors have actually
received, from the ex-ante rate, which is the extra return investors expected to receive when they
originally purchased the stock. The ex-ante figure is not observable; hence, to estimate the expected
risk premium on forward-looking basis we need to rely on historical data. Koller suggest using the
following formula:
1
!"#$!"#$% !"#$%&# =
!

!!!
!

!"#$"%&'( !"#$%&! = (
!!!

70

1 + !! (!)
1
1 + !! (!)
!/!

1 + !! (!)
)
1 + !! (!)

See appendix 6 for Ten Year U.S. Treasury Securities Forecast.

48

where:
!: !"#$%& !" !"#$%&'()!*#
!! : !! !"#$!% !" !! !"#$%&
!! : !! !"#$ !"## !"#$
Source: (Koller, 2009)

We used total returns data from the MSCI world index71 to estimate the return of the market. The
returns from the index can be used a proxy for market returns because it includes a collection of
stocks from all the developed markets in the world (MSCI Inc., 2012). DataStream adjusts the index
to include total returns (dividends reinvested); therefore, the index delivers a fairly reliable proxy for
the total returns of the market as a whole.
The risk free rate in the calculation is approximated by taking the average yearly yield for 10-year
U.S. government bonds. Exhibit 14 below displays our own estimates together with estimates from
Dimson (2011) Shiller (2000) and Siegel (1998). Estimating the real number requires a longer period
of estimation. To reduce this bias we have decided to take the average of the four estimates and use
this number to derive WACC. It must be noted that our own estimate is much lower than the figures
estimated by the experts because our historical estimation period only goes back to 1970. Equities
have performed particularly badly during the last 15 years and this causes the projection of the
historical risk premium to be lower than other estimates that use a longer time frame. DataStreams
data on total returns (RI) only goes back to 1969; this made it impossible to use a longer time frame.
If we were to estimate returns based on price indexes (PI), which do not correct for dividend yields,
the figures will be downwardly biased and unreliable.72
We rely on the arithmetic average instead of taking the geometric average because this is a more
reliable estimate of the true market risk premium. According to exhibit 14 the average figure of the
five estimates is 5,20%. This figure is assumed to be fairly close the real risk premium.
Exhibit 14: The Market Risk Premium
The Market Risk Premium
Dimson (2011) Dimson (2011)
Own estimates Historical
Expected
Shiller (2000) Siegel (1998) Average
Arithmetic Average
3,89%
5%
4,50%
6%
6,60%
5,20%
Geometric average
2,51%
3,80%
3,50%
4,30%
5,20%
3,86%
Source: Own estimates from DataStream, Dimson (2011), Shiller (2000), Siegel (1998)

71

The MSCI world index is a stock market index of 1600 stocks from all the developed world markets.
"A return index (RI) for a sector or market expresses the theoretical growth in value of a share holding over a
specified period, assuming dividends are reinvested to purchase additional units of the stock. The calculation used is
determined by the source index agency." Source: (Thomson Reuters Datastream, 2012)
72

49

6.2.3 Estimating Beta

Beta is a measurement of the company's stock sensitivity (correlation) to the market. It measures the
asset's statistical variance that cannot be diversified away because of the correlation of the asset's
returns with the returns of the market as a whole. In simple terms, a beta above 1 indicates the stock is
more risky than the market while a beta below 1 indicates the opposite. In practice raw beta is
estimated by regression analysis of the firm's stock returns against a stock market index (such as the
S&P500 or the MSCI world index) returns. In our case we decided to use the MSCI world index as it
includes more stocks than the SP&50073. There are several methods to estimate beta but most of them
rely on historical data. The biggest problem with this approach is that past estimates do not
necessarily reflect the forward-looking figure that we need to obtain (Srensen, 2009). Penmann
(2007) is critical of "beta technologies" and instead relies on the fundamental characteristics of the
firm for its estimation. We do not posses enough insider knowledge to truly estimate the riskiness of
the assets; therefore, we will rely on the market model which is the method suggested by Koller
(2009). This model can be expressed by the following formula:
!! = ! + !!! + !
where:
!! = !"#$! ! ! !"#$!%&
!! = !"#$%&! !"#$%&
! =

!"#(!! !! )
!"#(!! )

! = !""#" !"#$ (!"!#$%&'()*!' !"#$)

Source: (Koller, 2009)

The most substantial hurdle when it comes to the estimation of beta through (ordinary least squares)
OLS regression is deciding the right frequency of observations and length of the measurement period.
Koller maintains that a five year measurement period with monthly returns provides the most
unbiased estimate of the true raw beta; however, suggestions from academics range from a period of
two to ten years (Roenfeldt, Griepentrog, & Pflaum, 1978; Shanken, 1992; Theobald, 1981). We
decided to empirically test the stability of beta through time by estimating rolling betas of monthly
and weekly returns using data from a five-year period in the regressions. The results are shown in
exhibit 15 and 16.74

73

The choice of index does not alter results in any significant manner as both indexes are highly correlated.
Rolling betas estimated from daily returns are not presented since they have proven to be too unreliable in terms of
stability and explained variance (R2) (Hawawini, 1983).
74

50

Exhibit 15: Monthly Rolling Beta

Monthly Rolling Beta

01

/0
1
01 /08
/0
3
01 /08
/0
5
01 /08
/0
7
01 /08
/0
9/
01 08
/1
1
01 /08
/0
1
01 /09
/0
3
01 /09
/0
5
01 /09
/0
7
01 /09
/0
9/
01 09
/1
1
01 /09
/0
1
01 /10
/0
3
01 /10
/0
5
01 /10
/0
7
01 /10
/0
9/
01 10
/1
1/
01 10
/0
1
01 /11
/0
3
01 /11
/0
5
01 /11
/0
7
01 /11
/0
9/
01 11
/1
1/
11

2
1,8
1,6
1,4
1,2
1
0,8
0,6
0,4
0,2
0

Source: DataStream (own making)

Log Returns

Arithmetic Returns

Exhibit 16: Weekly Rolling Beta

Weekly Rolling Beta
1,4
1,2
1
0,8
0,6
0,4
0,2

02

/0
1
02 /08
/0
3/
02 08
/0
5/
02 08
/0
7/
02 08
/0
9/
02 08
/1
1/
02 08
/0
1
02 /09
/0
3/
02 09
/0
5/
02 09
/0
7/
02 09
/0
9/
02 09
/1
1/
02 09
/0
1
02 /10
/0
3/
02 10
/0
5/
02 10
/0
7/
02 10
/0
9/
02 10
/1
1/
02 10
/0
1
02 /11
/0
3/
02 11
/0
5/
02 11
/0
7/
02 11
/0
9/
02 11
/1
1/
11

Arithmetic returns Beta

Log Returns Beta

Source: DataStream (own making)

Even though the weekly-rolling-beta-estimate includes approximately four times as many

observations per estimate75 the monthly rolling beta appears to be more stable and reliable. This is
confirmed by the figures in exhibit 17 which displays the E-views estimation output for both betas in
the last period (Dec 2011). The monthly returns figure has a much higher coefficient of determination
(0,66 vs. 0,33) than the beta from weekly returns. Betas estimated from logarithmic returns were
chosen due to a higher degree of explained variance when compared to the same estimates using
arithmetic returns.76 Furthermore, robust standard errors and covariance are used in the regression due
to a marginally significant Breush-Pagan heteroscedasticity test (Wooldridge, 2009).77

75

Including more observations in the sample should in principle make the rolling beta smoother. Since both
estimations use five years of data the weekly sample includes approximately four times as many observations per
beta.
76
Defined as:
Log returns rt = log(Pt / Pt-1) = log(Pt) log(Pt-1)
Arithmetic returns: Rt = (Pt Pt-1) / Pt-1 = Pt / Pt-1 1 (Wooldridge, 2009)
77
For a more detailed comparison between models see appendix 7.

51

Exhibit 17: Eviews Output Monthly and Weekly Beta (Dec 2011)

As it can be appreciated in exhibit 15, the rolling (monthly) beta has been relatively stable throughout
the last five years. The most interesting pattern is the slow (and steady) downward drift which the
estimates show; especially after mid 2009. This is consistent with studies that report that raw beta
estimates tend to increase during times of economic distress and fall as the economy recovers
(Annema & Goedhart, 2003). The declining values of raw beta could also reflect the perception of
lower operational risk by investors. This is a plausible argument since the company has kept a
relatively stable capital structure with low levels of debt during the past five years. Beta is a measure
of both operational and financial risk. Since financial risk has not changed in a considerable manner
the fall can be attributed to lower operational risk.78 Regardless of the reason, it is clear that the raw
beta estimated from monthly data represents a relatively sound estimate of the true beta (Blume,
1975; Carleton & Lakonishok, 1985). We base this conclusion on the stability of beta through time
and the relatively high R2 of the regression that suggest that 66% of the stock's total risk is market
related. This is safely above the minimum requirement of between 0,10 and 0,20 suggested by
PricewaterhouseCoopers (PricewaterhouseCoopers, 2010).
Koller (2009) suggests improving the precision of our beta by calculating an industry beta. He argues
that companies within the same industry face similar operational risks and, after adjusting for
financial risk, this beta would be a good estimate for the true forward looking beta. But as mentioned
in the delimitation, there is no single real competitor that operates in the same industries and with the
same revenue weighs per industry as ABB. Thus, it would be difficult to estimate an industry beta
that truly reflects ABB's operational risk.
The authors of the book also suggest improving the beta estimate by applying the simple smoothing
technique used by Bloomberg (Koller, 2009):

78

See section 5.2.2 for details on capital structure.

52

!"#$%&'" !"#$ = 0,33 + 0,67(!"# !"#$)

They justify their assumption by referring to Blume's (1975) observation that all betas demonstrate
some kind of regression towards the mean. While we do not dispute Blume's affirmation of reversion
towards the mean, we believe the measure is arbitrary and that it will only result in downward bias of
the relatively good estimate which we obtained through the market model. Accordingly, we will
retain the last period's estimate as the best measure there is for the forward-looking beta (see exhibit
18).
Exhibit 18: Beta Estimates
2008*
Average* Raw Beta
1,75
Source: DataStream (own making)

2009*

Beta estimates
2010*
2011*
1,46
1,39

1,32

December/11 Forward looking

1,30
1,30

6.3 Cost of Debt

The cost of debt is the required return to debt holders. The yield to maturity of a firms long-term debt
should be used to estimate the cost of debt (Koller, 2009). This figure can be found in two different
ways: the direct method and the indirect method. Through the direct method one uses the actual yield
to maturity of the firms long-term debt. The indirect method uses the firms credit rating to
determine yield to maturity. This is done by observing the average yield to maturity on a portfolio of
long-term bonds with the same credit rating.79 In this paper the latter method has been used.
Standard and Poors (S&P) and Moodys are two credit rating services that have evaluated ABBs
ability to meet financial commitments. It should be noted that these credit ratings are the result of
internal analysis made by these companies and we cannot attest to the fidelity of this analysis. 80 In
addition the agencies use different rating hierarchies and even though they are supposed to be
comparable their methodology might be different.
Exhibit 19: Historical Long-Term Corporate Credit Ratings - ABB
Historical long-term corporate credit ratings - ABB
2006
2007
2008
2009
2010
Moody's
Baa1
Baa1
A3
A3
A3
S&P
BBB+
AAAASource: Historical Credit Rating ABB (own making)

2011
A2
A

S&Ps and Moody's credit ratings of ABB have followed each other consistently through the last 6
years. According to Moodys, ABBs long-term corporate credit rating has been upgraded from Baa1

79

In order for any of these two methods can be used a company has to have investment grade debt, which is debt
rated at BBB or higher (Koller, 2009). ABB has had a credit rating higher than that hence the methods are applicable.
80
Despite their expertise, credit ratings agencies have lost credibility after the subprime mortgage crisis (CNN,
2008).

53

to A2 during the period 2006 to 2011. As of December 2011 ABB was rated A281 according to
Moody's and A82 on S&Ps scale.
The firm has stated that it aims at maintaining its credit rating; therefore, we consider that the yields
from 2011 are a reliable proxy for the future rate. On December 30st 2011 the average 10-year
corporate bond yield with an A rating was 4,62% (Thomson Reuters Datastream, 2012). Since interest
rate is tax deductible we need to calculate the after tax cost of debt. This is determined by multiplying
cost of debt by 1 minus the marginal tax rate. The after tax83 cost of debt for ABB is equal to:
!"#$ !" !"#$ = 4,62 1 27,19% = 3,23%.

6.4 The WACC

Exhibit 20 displays historical WACC rates as well as our best estimate of the forward-looking
WACC. The biggest weakness with our estimate is the lack of information about the target capital
structure of the firm. Notwithstanding, it is possible to infer from the firm's announcements that they
intend to keep a relatively stable equity/debt ratio over the coming years and this will remain close to
the current level. Lundholm (2007) suggests that the average WACC from the past years could be
used to estimate the forward looking WACC, but we have decided against this method because low
interest rates stemming from post-crisis expansionary monetary policy are unlike to continue in place
for the coming years; therefore, taking this approach will only bias our estimate. In conclusion, the
estimated forward-looking figure of 9,48% is regarded as a robust figure and it will be used for all
valuation scenarios.
Exhibit 20: WACC

Marginal income tax rate (T)

E/V
Cost of equity
Risk-free rate
Market risk premium
Company beta
Cost of equity
D/V
After tax cost of debt
YTM
Cost of debt
After tax cost of debt
WACC
Source: Own making

2007
29,75%
95%

WACC
2008
2009
28,18%
23,54%
92%
95%

2010
24,71%
95%

4,32%
5,21%
1,75
13,44%
12%

2,94%
5,21%
1,75
12,06%
5%

3,20%
5,21%
1,46
10,82%
8%

2,97%
5,21%
1,39
10,22%
5%

2,02%
5,21%
1,32
8,92%
5%

3,77%
5,21%
1,30
10,54%
11%

4,43%
6,50%
4,57%

4,43%
6,56%
4,71%

4,43%
6,00%
4,59%

4,43%
5,02%
3,78%

4,43%
4,62%
3,36%

4,43%
4,62%
3,36%

13,33%

11,31%

10,66%

9,88%

8,07%

9,72%

2011 Forward Looking

27,19%
27,19%
89%
89%

81

A credit rating of A according to Moodys standards is defined as Considered upper-medium grade and are
subject to low credit risks (Moody's Investor Service, 2009)
82
A credit rating of A according to S&Ps standards is defined as Strong capacity to meet financial commitments,
but more subject to adverse economic conditions and changes in circumstances (Standard & Poor's, 2012)
83
A detailed analysis of marginal tax-rate can be found in appendix 34.

54

7. Forecasting & Valuation

This paper examines the value of ABB in case of an organic growth strategy and growth through
mergers and acquisitions. This requires two different valuation models; one for each strategy. We
have modeled three different scenarios for each strategy: base, bullish and best. These scenarios are
then given a probability weight that represents the different possible paths that the future might take.
Firstly we discuss the forecast drivers and since these will differ in case of an organic growth strategy
and growth through M&A the discussion will be divided accordingly. Next, we will compare the
outcome in each scenario and analyze how the value of ABB differs across the two strategies
Following, we will perform a sensitivity analysis to measure how sensitive the model is to changes in
key variables. Finally, we will triangulate our results with multiples and discuss the results.
The valuation of ABB is conducted with a 2-stage model: the 1st stage is the forecasted explicit period
(which we have determined to be 15 years84) and the 2nd stage is the continuing value. In terms of
forecast drivers, the explicit forecast period is itself divided into two periods: a detailed and an
undetailed period. During the first five years it is easier to make predictions and the model is more
flexible. During the last 10 years of the explicit period it is difficult to estimate without falling into
the category of pure speculations.
Revenues are forecasted using the top-down approach. This approach bases future estimates on
historical performance and the strategic position of the firm in relation to the external factors and
industry structure (Koller, 2009). In other words, we combine the analysis of non-financial value
drivers with the analysis of financial performance.85
The main difference between the detailed period and the non-detailed period is the forecasting of
revenues. In the detail period (2012 to 2016) we have chosen to forecast revenues based on each
division. This approach is taken because industry forecasts are better estimates of growth perspectives
for ABB than the geographical growth rate. In the undetailed period (2017-2016) total revenues are
estimated directly. During this period we also refrain from forecasting expenses and chose only to
forecast EBITA margin.
For the balance sheet, as with the income statement, only items necessary to determine NOPLAT
have been forecasted. Following Koller's (2009) suggestion they have been forecasted in stocks rather
than flows. All items are estimated as a % of revenue since this is considered to be the best driver. To
avoid making the model overly complex only key items (instead of each line item) have been
84

Koller (2009) recommends one to use an explicit forecasting period of 10 to 15 years. After that the company is
assumed to move into steady-state.
85
In relation to the remaining items on the income statement we have chosen only to forecast the items necessary to
determining NOPLAT. For simplicity and since the firm has relatively stable ratios, all of these items are tied to
revenues.

55

forecasted. Generally historical ratios are used to forecast these variables. If the ratios have been
relatively stable we have taken the last years estimate as a constant; however, if the ratios are volatile
during the historical period we have used the average ratio. This is done to avoid volatility effects
from affecting the forecast. Growth rate and RONIC are the two drivers of the terminal value for the
continuing period.
Exhibit 21 describes the different forecast drivers for the detailed and undetailed period.
Exhibit 21: Forecast Drivers

Power products
Power systems
Automation processes
Other

Forecast Drivers
2012-2016
!
!
!
!

2016-2026

Steady-State

Total revenues
Total cost of sales

Non-operating pension expenses

SG&A
R&D amortization
Implicit lease interest expense
Operating cash taxes

!
!
!
!
!

Adjusted EBITA margin

Growth rate
RONIC
Source: Own making

!
!

The WACC remains at the same level during both the organic growth and M&A growth strategies.
This is because ABB has stated that they want to maintain their strong balance sheet and credit rating,
even if they engage into intense M&A activity(ABB ltd, 2012b). The WACC will also remain the
same in the different scenarios since it is difficult to speculate on how the market will react to
changes in the macroeconomic environment.86
See appendix 8-10 for detailed information on forecasting.

7.1 Forecasting Strategy 1: Organic Growth

The primary purpose of this section is to outline the forecast of the first hypothetical scenario. This
scenario assumes that the firm decides to pursue pure organic growth instead of investing part of the

86

There is a caveat to this assumption because the cost of equity normally increases in times of economic distress.
This rise in the cost of equity might be counterbalanced by the fall in the risk free rate (Annema & Goedhart, 2003).

56

cash flow in acquisitions. This strategy is further divided into three different scenarios: base case,
bullish and bearish.
7.1.1 Base Case Scenario
This scenario builds on the most probable future situation for the firm and the world economy. From
a macroeconomic perspective this scenario builds upon the strategic analysis. To avoid falling into
speculation we have based the firm's revenue projections on the industry growth rates, ABB's internal
growth estimates and our own strategic analysis. In general terms the scenario assumes relatively high
growth rates during the first two years of the explicit forecast period, followed by slower growth
during the later years.
2012-2016
Power products: ABB is still in the leading supplier of power products in both the EU and the US.
The company has stated that they project an annual growth rate between 5% and 7% for this division.
Independent analysts expect the industry's growth rate to slow down from double-digit rate to around
4% in the next five years. This is primarily the result of a mature and cyclical market where a
generational upgrade period in switchgear and transformers is coming to an end. Nevertheless, the
need for energy efficient solutions and green power integration will allow the industry to outgrow
GDP for at least the next 5 years. We have estimated a CAGR of approximately 6 %. This is figure,
which is above industry averages, is a result of a strong competitive position in the market.
(Datamonitor, 2011)
Power systems: This is division accounted for 20% of total revenues in 2011 and the firm estimates
that organic revenue growth will average 10% to 14%. This rather positive projection is based on
strong demand coming from investments in smart grid systems from the Euro-zone governments.
Furthermore, similar infrastructure investments are projected to begin in the U.S. within the next 3 to
5 years. These two factors, combined with green energy initiatives in the public and private sectors,
have led us to estimate a CAGR of approximately 10 % for the period 2012-2016.87
Process automation: Industry growth is expected to decelerate to a CAGR of 5,5% during the next
five years (Global Data, 2011; ABB ltd, 2011b). Due to a relatively strong position and high
switching costs for its customers ABB has stipulated that they expect to outgrow the industry by 1%
to 3%. The firm intends to steal market share from competitors by pushing for "price excellence" and
focusing on oil and gas related solutions (ABB ltd, 2011b). Taking into consideration the firm's

87

This figure is slightly below ABB's own estimates but we believe the firm's figure overstate growth rates due to

the highly competitive environment in the industry.

57

strategic position in the market88 and the increased reliance on automation in emerging markets, we
have estimated that this division will have a CAGR of approximately 6,5% during the next five years.
Other divisions: The firm's other divisions are primarily composed of discrete automation and low
voltage products. According to the firm's own projections the discrete automation business unit will
grow at a CAGR of 12% to 15% while the low voltage products unit will grow at a CAGR of 9% to
11%.89 Both estimates are more than 4% above the industrys forecasted growth rates (Datamonitor,
2011; Global Data, 2011; Global Data, 2012). Given the intense competitive environment and the
divisions' susceptibility to higher input prices we have deemed the firm's projections to be
overoptimistic. Nevertheless, the firm does enjoy a relatively strong competitive advantage which
stems from its reputation as a world leader in the markets and "know-how". We have estimated that
the combined revenues for other divisions will grow an annualized compounded growth rate of 10%
in the next five years.
2017-2026
During this time period we expect EBITA margin to decrease slowly due to higher input prices and
the intense competitive environment. Revenue growth is projected to average 3,5% a year. This
growth will be primarily driven by smart grid investments in the US and green energy infrastructure
investments in emerging markets. The Euro zone will provide a smaller, but sustainable, source of
revenue stemming from grid maintenance and locked-in automation customers. Finally, we assume
the firm will be able to retain its ROIC at about 18% during this period because of their ample
technological expertise, an advantage that is difficult for competitors to imitate.
Continuing Value
The highly competitive environment of the market will eventually erode the firms competitive
advantages. Therefore, in our continuing value assumptions we have set RONIC equal to WACC. The
firm has a rather ample portfolio of products closely tied to the energy sector. While the market is
expected to grow at least as fast as the overall economy for a considerable span of time, no company
can outgrow the global economy forever (BP, 2012). The OECD has estimated that world's GDP will
increase by 3,5% annually from 2010 to 2050. After this period economic convergence will probably
result in slower growth of around 2 to 3% (OECD, 2010). Our basic assumption is that revenue
growth will be equal to global GDP growth. Value per share in this scenario is 25,40 USD.

88

ABB is the world market leader in this industry.

According to ABB these favorable growth prospects are based on the firm's robust strategic position within the
discrete automation industry where it has enjoyed growing market share and double-digit growth as firms make the
transition to holistic industrial motion solutions.89
89

58

Exhibit 22: Base Case Scenario (Organic Growth)

Base Case Scenario
$90.000

30,00%

$80.000

25,00%

$70.000
$60.000

20,00%

$50.000

15,00%

$40.000
$30.000

10,00%

$20.000

5,00%

Source: Own making

Revenue

EBITA margin

2026

2025

2024

2023

2022

2021

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

$-

2006

$10.000

0,00%

ROIC

Exhibit 22 displays the development of ROIC, revenue and EBITA margin. ROIC increases in the
early years as a result of revenue enhancements and the lack of investments in goodwill. While
EBITA margin begin to decrease already after 2013, the firm will be able to maintain a high ROIC for
a considerable amount of time.
7.1.2 Bullish Scenario
On the macroeconomic front this scenario assumes that the economic situation in Europe will
stabilize and improve; thus, growth in GDP will be above the anticipated 0.6%90. The American
economy will regain part of its strength and grow at around 3% to 3,5% for the next 5 years.
As a result of improved economical conditions across the world, industrial companies will feel
confident to resume investments in projects that were previously put on hold. All of ABB's product
segments are expected to benefit from this increase in demand. Heightened demand for renewable
energy and energy efficiency in Asia and the North America will have a particularly strong impact on
ABB's power systems and power products segments. These conditions will have their biggest impact
on the first five years of the forecasting period. Revenue growth is expected to slow down after
2017.91 In addition, economic growth and population growth is expected to reach a stable rate in the
long run. This stabilization pattern will project directly unto demand.
On the cost side raw material prices will stabilize and the cost cutting program initiated in 2009 will
result in additional increments to EBITA margin. However, in the final years of the explicit
forecasting period input prices are expected to rise slightly due to overall economic growth.

90
91

See section 4.1.2

It is much more difficult for large companies to sustain a high growth rate for log period of time (Koller, 2009).

59

In contrast to the base case scenario, the firm is expect to retain some of its competitive advantage; in
particular their technological expertise and strong brand. This will result in a RONIC that is slightly
above the cost of capital.
Exhibit 23: Bullish Scenario (Organic Growth)
Bullish Scenario
$100.000

30,00%

$90.000
25,00%

$80.000
$70.000

20,00%

$60.000
$50.000

15,00%

$40.000
10,00%

$30.000
$20.000

5,00%

Source: Own making

Revenue

EBITA margin

2026

2025

2024

2023

2022

2021

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

$-

2006

$10.000
0,00%

ROIC

From exhibit 23 one can see the development in revenues, EBITA margin and ROIC during the
explicit forecasting period. The value per share under this scenario is equal to 33,43 USD compared
to 25,40 USD in the base scenario.
7.1.3 Bearish Scenario
On a macroeconomic level the main assumption behind this scenario is an economic contraction that
will affect the economy at a global level. 92 Recession will lower consumer confidence and this will
result in an extensive contraction in demand. Even though an economic shock will probably be
accompanied by expansionary monetary policy around the world we have decided to avoid
speculating on its effect on the risk free rate (and WACC).93 In other words, we will use the same cost
of capital as in the other scenarios.
Our projections assume that this hypothetical economic shock will affect revenues in a manner
similar to what happened during last recession; however, we expect this new shock to have a slightly
smaller impact due to lower levels of leverage in the industry and higher reliance on emerging
economies. Emerging market economies have proven to be rather resilient to negative shocks in the
developed world and the firm still obtains almost half of its revenues from emerging market; thus,

92

Such an event could for example be triggered by sovereign default from Greece, Spain or Italy. We will abstain
from providing details into the hypothetical reason for this recession. It is however expected to be similar to the last
recession but on a smaller scale.
93
The effect of a lower risk free rate might be offset by a higher cost of capital (or debt).

60

even if a new recession in the developed world materialized the firm will be less severely affected
than during last economic downturn.
At the industry level lower revenues will translate into increased competition for a smaller market.
This will erode profitability and decrease ROIC to around 14%. Furthermore, this scenario assumes
bad operational and strategic decisions that will not allow the firm to recover the ROIC and EBITA
margins it enjoyed before the recession. ABB is also expected to repeat the same mistake as they did
in the 90s where they overinvested in R&D. Continuing value assumptions are not significantly
different from the base case scenario. Value per share is equal to 15,35 USD. This is roughly 40%
lower than under the base case scenario.
Exhibit 24: Bearish Scenario (Organic Growth)
Bearish Scenario

Revenue

EBITA margin

2026

2025

2024

2023

2022

2021

2020

2019

0,00%

2018

$-

2017

5,00%

2016

$10.000

2015

10,00%

2014

$20.000

2013

15,00%

2012

$30.000

2011

20,00%

2010

$40.000

2009

25,00%

2008

$50.000

2007

30,00%

2006

$60.000

ROIC

Source: Own making

7.2 Forecasting Strategy 2: Growth through M&A

This section describes the forecast for ABB in case of the second hypothetical strategy: growth
through mergers and acquisitions. To avoid complicating the analysis beyond what is necessary we
have made some assumptions:

The first one is that, in average, target companies will have the operational ratios as ABB.
This will allow us to model post-acquisition synergies directly by changing ratios in the postacquisition scenario.

The second simplifying assumption is that the cost of capital will remain unchanged even
though the firm pursues an aggresive M&A strategy. We base this assumption on the fact that

61

the firm has stated that they want to keep their debt-to-equity levels stable and relatively
unchanged.94

The third and last assumption is that the growth through M&A strategy will only span over
detailed explicit forecasting period. This is done because ABBs "Key Target Financials"
only stretch 5 years ahead and we do not want to speculate unto the development of the firms
M&A strategy beyond that point (ABB ltd, 2011b).

As discussed in section 3 there are several sources of value creation through mergers and acquisitions.
Based on the fact that ABB pursues an M&A strategy mainly to fill portfolio gaps along geographical
product and end market lines (ABB ltd, 2012a) we have chosen only to model revenue and
operational cost reduction synergies (hard keys). Exhibit 25 shows a simplified model of how
sources of value through M&A are incorporated in the DCF (and EP) model.
Exhibit 25: Sources of Value M&A

Cost synergies can also originate from enhanced utilization of assets in place and increased capital
efficiency. This reduction of operating working capital and capital expenditure will result on a higher
FCF. For simplicity we have chosen not to model this kind of synergies because, according to KPMG
(1999), the largest source of value creation in M&A deals comes from headcount reductions and
reductions of SG&A expenses. It is also much more difficult to assess the pact that acquisitions will
have on working capital.
In relation to M&A, two of the most important items to forecast are the amount of acquired revenues
and the premium paid for the target firms. The first element is forecasted in the acquired revenues

62

line item.95 The second element, which is the premium paid, is forecasted in the acquired goodwill to
acquired revenues item. We assume that the premium that the firm paid when it acquired Baldor
(1,42) represents a good proxy for the base rate. According to data compiled by Bloomberg, the
median multiple for transactions in the industry is 1,19 (Business week, 2012). This might indicate
that the firm overpaid for its acquisition of Baldor, but this depends on the amount of synergies they
expect to achieve.
Exhibit 26 shows the drivers that are different in the model when valuating ABB in case of a growth
strategy through M&A.
Exhibit 26: Changes is Forecast Drivers for Strategy 2: M&A
Changes in Forecast Drivers for Strategy 2: M&A
2012-2016
2016-2026
Acquired revenues
!
Power products
!
Power systems
!
Automation processes
!
Other
!
Total revenues
!
Acquired goodwill/aquired revenues

Total cost of sales

Selling general and administrative expenses

!
!

Adjusted EBITA margin

Source: Own making

As in the organic growth strategy we have forecasted three different scenarios and given them a
probability weight.
7.2.1 Base Case
The overall macroeconomic conditions are assumed to be the same as in the base case scenario for
organic growth. This will isolate the effects of M&A and allow for a better comparison of value
creation (or destruction). The base case scenario under an M&A strategy follows the firm's key
performance targets of achieving a CAGR of 3,1% from mergers and acquisitions. The company has
stated that they will pursue acquisitions for a market value of at least 18 billion USD during the next
five years (Business week, 2012). 96 As mentioned in the strategic analysis, the consolidation trend
that started to develop after the financial crisis is already evolving into a full-blown industry wide
merger wave.

95
96

The amount of acquired revenues is based on the firm's goal of achieving a 3% CAGR through M&A.
This is obviously only the minimum amount they want to spend.

63

ABB's acquisitions strategy is mainly driven by the necessity to become more vertically integrated,
expand product and services portfolio and to hedge the against a Euro zone slowdown by expanding
in North America and emerging markets.
2012-2016
In the base case scenario we expect the acquired revenue to acquired goodwill ratio to average 1,42
during the first two years. This ratio is expected to increase to 1,7 as the merger wave pushes prices
up (Business week, 2012). This phenomenon is consistent with empirical studies which show that
M&A deals in the last stages of a merger wave tend to be value destroying because acquirer firms
overpay for their acquisitions when competitors try to outbid each other.
It will be easier for the firm to reduce cost than to increase revenues; hence, we expect that the
greatest share of realized synergies will originate from post-acquisition operational improvements.
Most of these cost reductions will come in the form of lower SG&A expenses through head reduction,
the centralization of administration expenses and overhead pooling. Other significant operational
improvements are modeled in the total cost of sales. These are achieved through purchasing
economies, the integration of supply chain and the streamlining of sourcing. The average
implementation time for these operational improvements is expected to be 2 years. After this period
the firm will have reached its target improvements and the ratios will remain constant.
Most target firms are expected to be based in the U.S. This is consistent with the firm's aim of
diversifying its geographical base and decreasing its exposure to a possible European slowdown. 97
Additionally this strategy will expand its exposure to smart grid investments in the U.S.
From an industry perspective it is expected that the better part of transactions will come from the
power systems, low-voltage and discrete automation markets. The average size of the deal is
projected to decrease after the first two years.98 As we mentioned in section 3.4 the size of deal is
negatively correlated with returns. This would imply better synergetic opportunities in those
acquisitions. However, the benefits from increased synergies can be outweighed by the higher
premium paid for firms in the last stages of a merger wave.99 In our forecast assumptions synergies
improve only slightly for acquisitions in the last two years and this effect is eclipsed by the higher
ratio of acquired goodwill to acquired revenues.
2017-2026

97

The base case scenario assumes no negative economic shocks in the euro-zone. Thus, this hedging effects is not
captured in this scenario.
98
While the size of the deal is assumed to decrease after 2012, the amount of acquired revenues is expected to
increase as the merger wave intensifies.
99
This results from managers that try to outbid or preempt counter offers from competitors.

64

The period of growth through acquisitions is expected to end in 2017. This means that all postacquisitions operational improvements will have been implemented by 2019; therefore, EBITA
margins are expected to peak around this time and fall during the following years as a result of the
intense competitive environment. Total revenues are forecasted to have a slightly higher CAGR than
under the organic growth strategy. This additional growth stems from the fact that the firm is
expected to acquire firms with growth prospects that are equal or higher than its own.

Terminal Value
Continuing value is not expected to differ from the base case scenario. This assumption originates
from the implicit difficulty of forecasting the effects that the M&A strategy can have on RONIC and
growth so far ahead in the future. To avoid speculation, the forecasted parameters are the same.
Exhibit 27: Base Case Scenario M&A
Base Case Scenario - M&A
$100.000

30,00%

$90.000
25,00%

$80.000
$70.000

20,00%

$60.000
$50.000

15,00%

$40.000
10,00%

$30.000
$20.000

5,00%

Source: Own
making

Revenue

EBITA margin

2026

2025

2024

2023

2022

2021

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

$-

2006

$10.000
0,00%

ROIC

From Exhibit 27 it is possible to see that ROIC drops during the first 5 years of the explicit forecast
period due to the investments in acquisitions. EBITA margin increases due to the operational
improvements. However, the rate of return on invested capital is never really regained. Value per
share in this scenario is 22,00 USD.
7.2.2 Bullish Scenario
From a macroeconomic perspective this scenario follows the same forecasting assumptions as its
counterpart in organic growth. It also assumes the same amount of acquired revenues as the base case
scenario (M&A).
The main difference between this scenario and the base case lies in the way ABB's managers perform
the pre-deal evaluation process and how effective they are at implementing post-acquisition
65

improvements. The company's managers are careful to perform a sound pre-deal due diligence
process that carefully selects firms where operational improvements are easier to achieve. In contrast
to the other two scenarios, management will focus their sights on smaller firms since these can
normally be bought for lower price. Additionally, economies of scale and purchasing economies are
easier to carry out in smaller firms.
Operational improvements will allow the firm to come close to their key target EBITA margin of
19% by 2017 (ABB ltd, 2011b). After this period is over, we expect that competition and higher input
prices will slowly wear profitability down. Revenue enhancement synergies are expected to be
significantly larger than under the base case due to the substantial amount of exposure to smart grid
infrastructure investments and emerging markets growth.
While we expect growth to eventually fall down to 3%, the company will be able to maintain most of
their competitive advantages. This reflects in a higher ROIC throughout the explicit forecasting
period. The share price in this scenario is 29.83 USD.
Exhibit 28: Bullish Scenario M&A
Bullish Scenario - M&A
$100.000

30,00%

$90.000
25,00%

$80.000
$70.000

20,00%

$60.000
$50.000

15,00%

$40.000
10,00%

$30.000
$20.000

5,00%

Source: Own making

Revenue

EBITA margin

2026

2025

2024

2023

2022

2021

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

$-

2006

$10.000
0,00%

ROIC

7.2.3 Bearish Scenario

The economical conditions are assumed to be the same as in the bearish scenario for an organic
growth strategy; however, acquisitions in North America and emerging markets reduce exposure to a
weak European economy. This implies that revenue growth will not decrease as much as in the
bearish scenario with organic growth. Investments in the North American market are mainly related
to discrete automation and low voltage products (Business week, 2012). Acquired revenues are the
same as in the base case scenario because it is assumed that ABB will not deviate from this key
performance target.

66

Besides the negative macroeconomic conditions we assume that the firm's managers will experience
managerial hubris and overestimate the possible synergies from acquisitions. This means that the
company will pay premium that exceeds the realized synergies. Acquired goodwill to acquired
revenue is expected to be 5% higher than in the base case scenario. Managerial hubris will also lead
to poor synergy evaluation and integration project planning. This will result in higher costs associated
with integration and implementation that will erase the cost reductions in SG&A expenses and
headcount reduction. 100 Bad operational decisions that resulted in low EBITA margins in case of an
organic growth strategy are offset by some operational synergies coming from M&A activities.
Total revenue growth is expected to be slightly higher in the last 10 years when compared to the
organic growth strategy.101 Drivers for terminal value are expected to be the same as in the organic
growth equivalent.
Exhibit 29: Bearish Scenario M&A
Bearish Scenario

Revenue

EBITA margin

2026

2025

2024

2023

2022

2021

2020

2019

0,00%

2018

$-

2017

5,00%

2016

$10.000

2015

10,00%

2014

$20.000

2013

15,00%

2012

$30.000

2011

20,00%

2010

$40.000

2009

25,00%

2008

$50.000

2007

30,00%

2006

$60.000

ROIC

Source: Own making

Exhibit 29 displays the development of ROIC and EBITA margin. It is interesting to note that
pursuing an M&A strategy under bad economic conditions lead the firm to have a ROIC that is
almost at the same level as the WACC during most of the forcasting period. This means that the firm
is barely creating any value for its shareholders. The share price under this scenario is estimated to be
9.39 USD.

7.3 Final Valuation

100

The study on M&A by KPMG (1999) showed that there was a bigger chance of success in case of synergy
evaluation and integration project planning.
101
This is done for the same reasons as in the other M&A scenarios. The firm will mostly acquire firms with a higher
growth rate than their own.

67

We can now summarize the results for each strategy and determine the final share price. Each
scenario has been assigned a weight based on the probability of occurrence. The base case scenario is
considered to be the most plausible outcome.
In their latest economic outlook the IMF has stressed the intensified risks of Euro area recession
stemming from the higher sovereign yields, bank deleveraging and fiscal consolidation. We have
decided to reflect this higher downside risk by assigning a higher probability weight to the bearish
scenarios, which assume that an economic recession materializes.
Exhibit 30 summarizes the results from the previous sections and the derived final share-price based
on the assigned weights.
Exhibit 30: Summary of Valuation Strategies and Scenarios
Summary of Valuation - Strategies and Scenarios
Share-Price Share-Price (In USD)
Weights
Organic Growth
M&A
Bullish
15% $
33,43 $
29,83
Base
60% $
25,40 $
22,00
Bearish
25% $
15,35 $
9,39
Final Share Price
$
24,09 $
20,02

The final share price in case the firm pursues organic growth only is 24,09 USD. This price is roughly
20% higher than the estimated intrinsic value of 20,02 USD which the firm will have if it continues
with its growth through M&A strategy. In broad terms it can be said that the results in exhibit 30
show how difficult it is to create value through M&A. Not only is the final value higher but each
scenario has a higher price per share under the organic growth strategy. This is consistent with the
empirical results that show that returns to acquirer shareholder are generally small or negative.
It is important to notice that when comparing our results to the market price we have to use the share
price in case of an M&A strategy. This is because investors have already incorporated this in their
valuation of ABB since it is their stated future strategy. The market price as of December 31st 2011
was 18,83 USD. For a detailed analysis between the different values see section 8.

7.4 Sensitivity Analysis

The sensitivity analysis aims to appraise the underlying uncertainty associated with the subjective
assumptions required for the forecasting process. We have decided to focus on two kinds of
parameters; those that have the biggest risk of being misestimated due to inherent uncertainty in the
estimation process and those factors to which the model is very sensitive. A more detailed analysis
presented in appendix 13. Finally, the analysis will also compare the sensitivity of the organic and
M&A strategy models to changes in the designated parameters.
The Cost of Equity
68

The model relies on the same discount rate to bring all future values to present value; thus, even small
changes in the WACC can result in significant changes in total value. Beta and the market risk
premium are fundamental constituents of the CAPM. Both components are inherently difficult to
estimate in a forward looking basis since we do not know how investor risk aversion and firm specific
risk might develop in the future. Additionally, misestimating both factors at the same time can have a
compounding effect; e.g., underestimating beta by 0,15 and the risk premium by 1 percentage point
will result on a value that is 32% higher than the base value. As stated in section 6.2.3 ABB's beta has
been relatively stable over time. Furthermore, the standard error of our beta estimate is relatively low;
this suggest a narrow confidence interval indicating that the extreme values in the table below can be
discarded as improbable. In relation to the market risk premium we have tried to minimize bias by
taking the average between our own estimations and what other scholars have estimated but the
possibility of error cannot be fully avoided.
Exhibit 31: Percentage Change in Share Price Risk Premium & Beta

Risk premium
3,21%
4,21%
5,21%
6,21%
7,21%

Risk premium
3,21%
4,21%
5,21%
6,21%
7,21%

% Change in Share Price - Organic Growth

Beta
1,00
1,15
1,30
72%
58%
46%
45%
32%
20%
24%
11%
0%
8%
-5%
-15%
-6%
-17%
-27%
% Change in Share Price - M&A
Beta
1,00
1,15
1,30
96%
77%
61%
60%
42%
26%
32%
15%
0%
10%
-6%
-20%
-7%
-23%
-35%

1,45
35%
9%
-10%
-24%
-36%

1,60
26%
-3%
-18%
-32%
-43%

1,45
47%
12%
-13%
-31%
-46%

1,60
34%
-5%
-23%
-41%
-55%

Cost of Debt
The firm has a relatively low debt-to-enterprise value ratio. This means that total enterprise value is
hardly sensitive to changes in the cost of debt. The share price is substantially more sensitive to
changes in estimations of the risk free rate. In relation the latter point, the biggest problem lies in the
fact that the risk free is very dependent on monetary policy and it is difficult to predict how the
central banks around the world will react to the different economic conditions.

69

Exhibit 32: Percentage Change in Share Price Risk Free Rate & Average Cost of Debt

Risk free rate

1,77%
2,77%
3,77%
4,77%
5,77%

Risk free rate

1,77%
2,77%
3,77%
4,77%
5,77%

% Change in Share Price - Organic Growth

Average Cost of Debt
2,62%
3,62%
4,62%
37%
35%
33%
18%
16%
15%
2%
1%
0%
-10%
-11%
-12%
-20%
-21%
-22%
% Change in Share Price - M&A
Average Cost of Debt
2,62%
3,62%
4,62%
49%
46%
44%
23%
21%
19%
3%
2%
0%
-13%
-14%
-16%
-27%
-28%
-29%

5,62%
31%
13%
-1%
-13%
-23%

6,62%
29%
12%
-2%
-14%
-24%

5,62%
41%
17%
-2%
-17%
-30%

6,62%
38%
15%
-3%
-18%
-31%

Terminal Value: RONIC and Growth

When estimating terminal value, one of our main assumptions was that RONIC would be equal to
WACC. Our ability to forecast decreases with time, but so does the importance of the forecast. That is
not to say that estimating RONIC and growth in the steady state is unimportant, but that the model is
relatively insensitive to changes in the parameters at this point in time. The only situation in which
value changes considerably is when RONIC is below WACC and the firm grows at a faster rate than
that of what is expected of the world economy; in this quadrant of the table the firm engages in value
destroying investments at the expense of rapid growth. This is obviously a very implausible scenario.
Contrary to this, if we have underestimated RONIC and the firm is able to keep some of their
competitive advantages in the far future, the firm will be constrained to in the growth parameter as no
single company can outgrow global GDP growth for a long span of time.
Exhibit 33: Percentage Change in Share Price Steady State Growth & RONIC

Steady State Growth

5,00%
4,00%
3,00%
2,00%
1,00%

Steady State Growth

5,00%
4,00%
3,00%
2,00%
1,00%

% Change in Share Price - Organic Growth

ROINC
4,72%
7,22%
9,72%
-46,42%
-14,65%
0,79%
-30,47%
-9,69%
0,39%
-19,53%
-6,38%
0,00%
-11,61%
-4,06%
-0,39%
-5,71%
-2,40%
-0,79%
% Change in Share Price - M&A
ROINC
4,72%
7,22%
9,72%
-63,27%
-20,05%
1,09%
-41,68%
-13,27%
0,55%
-26,68%
-8,73%
0,00%
-15,91%
-5,59%
-0,55%
-7,82%
-3,32%
-1,09%

12,22%
9,92%
6,38%
3,78%
1,77%
0,16%

14,72%
15,94%
10,31%
6,26%
3,19%
0,79%

12,22%
13,55%
8,68%
5,14%
2,41%
0,18%

14,72%
21,77%
14,09%
8,55%
4,36%
1,05%

70

Revenue growth and EBITA Margin

Exhibit 34: Percentage Change in Share Price Revenue Growth and EBITA Margin
% Change
Revenue
EBITA Margin
Revenue
EBITA Margin

$
$

-2
17,67
15,81
-20%
-28%

Change in Share Price

-1
0
$
19,72 $
22,00 $
$
18,90 $
22,00 $
% Change is Share Price - M&A
-10%
0%
-14%
0%

1
24,53 $
25,09 $
12%
14%

2
27,34
28,19
24%
28%

Exhibit 34 shows percentage changes in share price if total revenues or EBITA margin changes. From
a value creation perspective it is interesting to notice that, keeping all other factors equal, if ABB was
able to achieve improvements to EBITA margin of 1% throughout the explicit forecasting period the
share price would be 25,09 USD. This price is actually higher the price estimated in the organic
growth strategy.
Acquired Goodwill to Acquired Revenues
Exhibit 34 displays the percentage change in value from an increase/decrease in the acquired
goodwill to acquired revenue ratio. While the model does exhibit some sensitivity to changes in the
ratio, these changes are not extreme. If ABB paid 30% more for its acquisitions and still achieved the
same amount of synergies, value would drop by around 11,1%. On the other hand if they ratio would
decrease with 30%, all else being equal, the firm can obtain approximately the same share price as in
the case of purely organic growth.
Exhibit 35: Percentage Change in Share Price Acquired Goodwill / Acquired Revenues
% Change
Acquired goodwill / Acq. Revenues
Share price
$
% change in share price

-30
24,44 $
11,09%

-15
23,22 $
5,55%

0
22,00 $
0,00%

15
20,78 $
-5,55%

30
19,55
-11,14%

In general the M&A strategy model is more sensitive to changes parameters; this is because investors
are giving up cash flows during the next five years to receiver a bigger cash flow after the
acquisitions strategy is completed. In broad terms this means that cash flows further in future have a
bigger weigh in total value. The sensitivity analysis has accurately displayed by how much our fair
value estimations vary when some of the parameters change. This is especially true for the cost of
capital which is arguably another big weakness of the capital based models (Penman, 2007).

71

7.5 Multiples Valuation

As mentioned in the methodology section, we will triangulate our DCF and EP model results with
multiples. According to Koller (2009) this provides a sanity check for the results obtained through
fundamental analysis. Several scholars have argued against the use of relative valuation techniques,
since they break away from the intrinsic value principle (Nissim & Penman, 2001; Penman, 2007).
Koller (2009) argues that EV/EBITA102 is the best multiple available; it is superior to P/E because it
is not distorted by capital structure. The authors also recommend using forward looking multiples
since empirical evidence suggest that they are a more robust predictor of future prices. The peer group
is based on those firms that ABB considers to be their biggest competitors and from what we
conceive to be the best comparables in relation to the strategic analysis.
The exhibit below displays the historical and forward-looking P/E and EV/EBIDTA. The figures do
not diverge considerably from each other. In fact, while ABBs multiples happen to be the highest
they are only slightly above the average from the peer group. Our own estimates at the end of the
table reflect the relatively positive outlook for the firm in the coming years.
Exhibit 36: Historical and Forward Looking Multiples
Historical and Forward Looking Mutiples
P/E
Company

EV/EBIDTA

EV/EBIDTA Own estimates

2011 2012 (F) 2013 (F) 2011 2012 (F) 2013 (F)

ABB

14,98

12,41

11,00

8,52

7,52

6,83

Emerson Electric

14,58

12,10

10,12

8,24

8,17

7,46

Honeywell Int.

13,17

13,24

11,85

13,57

7,79

7,17

Schneider Electric

13,98

11,58

10,56

8,35

7,80

7,30

Siemens AG.

9,68

10,86

9,59

7,67

7,17

6,52

Eaton Corp

11,92

10,73

9,31

8,52

7,40

6,60

Average

13,05

11,82

10,41

9,15

7,64

6,98

2012 (F)

2013 (F)

8,45

7,60

Source: Bloomberg & DataStream

The value of the firm using the average forward looking P/E and EV/EBITDA is 24,19 USD and
19,27 USD respectively. Both values are fairly close to our own DCF estimate. Since these values are
based upon the average peer group multiples and ABB is expected (by us and the market) to have a
better strategic and financial position than its competitors in the near future, it is not surprising that
the value which we found is slightly above the multiples based figure.
Exhibit 37: Multiples Based Value (M&A Strategy)
Multiples Based Value (M&A Strategy)
P/E
$ 24,19
EV/EBITA
$ 19,27

102

The authors recommend using EV/EBITA instead of the more commonly used EV/EBITDA. We have opted for
the first one since we depreciation expense is not likely to affect results in any significant manner.

72

8. Discussion
The main purpose of this paper was to examine the amount of value that was created or destroyed by
ABBs attempt to grow through acquisitions. As Penman (2007) points out, one of the weaknesses of
the DCF model is that it can be difficult to assess whether or not sound and necessary investments
will end up creating or destroying value. From a DCF models perspective this statement is related to
the effects that an M&A growth strategy would have on final value. In the final valuation we
concluded that the share price in case of pure organic growth would be 24,09 USD whereas with
additional growth through M&A (as is the case) share price is 20,02 USD.
The fundamental premise behind growth through M&A is that the investments in acquisitions today
(and in the near future) will decrease and even make the FCF become negative; however, lower
earnings today (and in the near future) will be offset by higher FCF in the longer term (as a
consequence of cost and revenue synergies). The greatest problem with this proposition is that when
companies engage in acquisitions they have to pay a premium for the firms they acquire; thus, the
difficulty lies in achieving synergies big enough to offset the premium paid. In our assumptions we
have based the "standard" acquired goodwill to acquired revenues ratio on the premium that ABB
paid when it acquired Baldor in 2011. If the actual ratio between acquired goodwill and acquired
revenue turns out to different, the final value of the share price will change.
The M&A growth strategy was announced in early 2010. Hence, it is clear that the present market
value of the firm has taken the effects of this strategy into consideration. Therefore, a fair
examination of results would compare our fundamental DCF estimation of price for the "M&A
growth strategy" with the market price.
The estimated price, 20,02 USD, is almost equal to the average price during the last 6 months of 2011
which was 20,74 USD. During the last 3 months of the year, the price fell to an average of 18,24
USD. This small discrepancy is relatively insignificant and probably the result of a pessimistic market
that is slightly overweighing the possibilities of recession in the EU. In general terms it appears that
the market is fundamentally valuing ABB's shares correctly.

73

Exhibit 38: ABB Share Price Comparison to our results (Source: (ABB ltd, 2012c))

The organic growth strategy can be viewed as a "what if" scenario that permits us to assess whether or
not the acquisitions strategy was truly in best interest of the shareholders. Managers may be over
optimistic (as explained by the hubris hypothesis) or simply pursuing an "empire building" desire (as
in the managerial hypothesis). The implications of this managerial bias are that the firm might end up
paying a premium that exceeds the achieved synergies. In fact the managerial hypothesis would
predict that even if managers know that no value would be created (premium is roughly equal to
synergies) they would still pursue an acquisitions strategy because managerial compensation is
positively correlated to firm size. This would help explain why on average M&A activity fails to
create value.
What the DCF model often fails to take into account are the strategic implications of an M&A
strategy. It is a common mistake to assume that the firm will be able to maintain its competitive
position even if it does not engage into M&A when all the competitors in the industry are
consolidating. Some authors have argued that if the firm fails to grow at the same pace as competitors
(whether it is through M&A or pure organic growth) it might lose some its advantages that stem from
size and brand recognition (Sudarsanam, 2006-2007). Therefore, from a DCF perspective the
acquisitions might appear to be value destroying, but this view ignores the possibility of lower growth
or return on capital in case the firm decides to stay out of the merger wave.

9. Conclusion
The aim of this thesis was to identify the fair value of ABB and how it has been affected by its current
M&A growth strategy. To do this we decided to value ABB according to the hypothetical case of an
74

organic growth strategy and then compare that value to the fair value of ABB with growth through
M&A.
Based on the intrinsic characteristics of ABB and the analysis of different valuation techniques, we
determined that the discounted cash flow model was most appropriate to apply in this case study. To
validate our results we also used the economic profit model and triangulation with multiples.
In order to be able to estimate ABBs future performance properly we performed a strategic analysis.
Through the strategic analysis we identified opportunities and threats from the external and industry
environment as well as internal strengths and weaknesses unique to the firm. We determined that the
rising demand for energy efficient solutions and political actions demanding higher environmental
standards were the factors providing the biggest growth opportunities for the firm. In addition, the
firm's technological expertise and strong brand will give them a powerful competitive position.
However, economical uncertainties (particularly in Europe) are casting a shadow over the otherwise
generally bright future. We also examined the implications that the merger wave developing in the
industry might have for the firm's strategy.
After analyzing the industrial conditions and the non-financial drivers of future performance we
investigated ABBs historical performance. This analysis is primarily based on information from
annual reports. Firstly we reorganized the financial statements to be able to examine historical levels
of revenue and ROIC. The company showed generally stable rates of ROIC and operating
performance throughout the period 2006 to 2011. However, the recent investments in M&A clearly
had an impact that could be seen in high levels of acquired goodwill. Even though the firm was hit by
the financial crisis they managed quite well in terms of revenues. Slow growth in Europe affecting
revenues negatively was counter balanced with good results in US, Brazil and Asia.
Finally, we derived the cost of capital and determined the forecast drivers based on the strategic
analysis and the historical performance of the firm. From the discounted cash flow model we
estimated the fair value of ABBs share to be 20,02 USD compared to 24,09 USD in case of a
strategy based purely on organic growth. A sensitivity analysis of the most relevant input factors in
the model was performed. As expected the most critical factor is the estimation of the cost of capital.
The estimated intrinsic value of ABB's share, 20,02 USD, is close to the market average during the
last months of 2011, 18,24; this implies that the market is fundamentally valuing the firm correctly.
Interestingly, 20,02 USD is lower than the share price they could obtain in case of pure organic
growth. This means that their M&A strategy is currently destroying value for the shareholders.
However, when considering that the industry is going through a consolidation phase, engaging in
mergers & acquisitions might be necessary for ABB to maintain its competitive position.

75

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84

11. Appendices
Appendix 1: Summary Results KPMG Report
Appendix 2: Summary of PESTEL
Appendix 3: Metal Prices
Appendix 4: Summary of Strategic Analysis
Appendix 5: Reorganization of Financial Statements
Appendix 6: 10Y Treasury Forecast
Appendix 7: Comparison of Beta Estimates
Appendix 8: Historical Ratios
Appendix 9: Forecast Drivers Strategy 1 Organic Growth
Appendix 10: Forecast Drivers Strategy 2 M&A
Appendix 11: Results Strategy 1 Organic Growth (Base Case)
Appendix 12: Results Strategy 2 M&A (Base Case)
Appendix 13: Sensitivity Analysis
Appendix 14: Excel-Files

85

Appendix 1: Summary Results KPMG Report

Objective measure of success in unlocking value

17%

Deals added value

Deals produced no
discernible difference

53%
30%

Deals destroyed value

The three pre-deal hard keys to success

Synergies

Integration Project Planning

Due diligence
Revenue benefits delivered (% of total investigated deals)
New customers

45%

New markets

42%

Marketing

34%

New product development

34%

Customer service and back-up

32%

Access to new distribution channels

32%

New products

29%

Sales force efficiency

26%

Cross selling

25%
0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Direct operational cost reductions delivered (% of total investigated deals)

Head count reductions
Buying and merchendising
Supply chain
Procurement
Manufacturing
Warehousing/distribution
New product development
Outsourcing
R&D
Other

66%
60%
60%
48%
35%
32%
32%
25%
24%
8%
0%

10%

20%

30%

40%

50%

60%

70%

Source: (KPMG, 1999)

86

Appendix 2: Summary of PESTEL

Summary of PESTEL
Segment

Factor

Effect/Magnitude

Stricter Energy Efficiency Standards

EU Legislation on power transmision and distribution
Political/Legislative
Picken's Plan
Law Suits
Political instability in the Middle East/Africa
Risk of Higher Coporate Taxes
Rising Oil Prices
Infrastructure Investments in Emerging markets
Higher energy Dependance
Economic
Currency Exposures (Overvalued Swiss Franc)
Commodity Prices (Raw materials and metals)
Financial Crisis
EU Super Grid
DESERTEC
Technological
Unified Smart grid (US)
Increased Dependence on Automation
Rapid Technological Changes in End Markets
Growing Population in Emerging Markets
Demographic/Socio-cultural
Higher Public Enviromental Awareness
Higher Demand for Renewable Energy
Environmental
Increased Efficiency in Power Generation
Source: Own estimates

87

Appendix 3: Metal Prices

Metal Prices Monthly Index

350,00

Jan 2005=100

300,00
250,00
200,00
150,00

Aluminium

100,00

Copper

50,00

Steel
01/01/12

01/04/11

01/07/10

01/10/09

01/01/09

01/04/08

01/07/07

01/10/06

01/01/06

01/04/05

01/07/04

01/10/03

01/01/03

01/04/02

01/07/01

01/10/00

01/01/00

0,00

Source: World Bank (own making)

88

Appendix 4: Summary of Strategic Analysis

89

Appendix 5: Reorganization of Financial Statements

Following are descriptions of major items adjusted for in order to calculate NOPLAT, invested capital
and FCF.
Adjusting for Operating Leases
In order to estimate the value of ABBs operating leases we have used rental expense, the cost of
secured debt, and an estimated asset life.
!"#$%& !"#!$%!! = !""#$ !"#$%!!! (!! +

!""#$ !"#$%!!! =

!""#$ !"#$ =

1
)
!""#$ !"#$

!"#$%& !"!"#$"!

1
!! +
!""#$ !"#$

!!&!
!""#$% !"#$%&%'(%)*

Source: (Koller, 2009)

Cost of secured debt has been proxied by the average yield to maturity on AAA and ABB- rated 10yead corporate bonds. The following formula has been used to calculate implicit lease interest
expense and depreciation:
!"#$%&%' !"#$%$&# !"#!$%! = !"#$% !" !"#$%&'() !"#$"$ !"#$ !" !!"#$!% !"#$
Source: (Koller, 2009)

We assume that asset lifetime in 2010 is a good estimate for the average lifetime. Nothing out of the
ordinary happened regarding PP&E and it is also within the interval of ABBs own estimates on
assets lifetime(ABB ltd, 2012a). The estimated value of the leased assets has been added to book
assets and debt. Implicit lease interest expense has been added to operating profit (since the expense
should be removed). Since depreciation is not related to capital structure it remains an operating
expense. The cost of capital has also been adjusted for capitalized operating leases as well as FCF
where depreciation is added back.
Adjusting for Research and Development expenses
We chose 1999 as the earliest feasible year to start the analysis from because in 1998 approximately a
third of the company was divested in addition research and development (R&D) expenses relative to
revenues also decrease significantly. We have assumed a 10-year asset life and straight-line
amortization. The amortization rate for 10-year asset life is 10%. The following formula has been
used to calculate asset value of R&D expenditures and amortization:
90

!""#$ !"#$%! = !""#$ !"#$%! + !&! !"#$%&'()*$! !"#$%&'(%&#)!

!"#$%&'(%&#)! = !"#$%&'(%&#) !"#$ !""#$ !"#$%!
Source: (Koller, 2009)

The estimated value of R&D has been added to book assets and equity. The ROIC will be
significantly lower when R&D capitalization is included in invested capital. R&D expenses in the
income statement have been replaced with amortization. Note however it has not had an effect on
FCF since the amortization is deducted from NOPLAT but added back to gross cash flow.

91

Appendix 6: 10Y treasury forecast

Source: (Financial Forecast Center, 2012)

92

Appendix 7: Comparison of Beta Estimates

Estimation output: Beta from Monthly (Log Returns)
Dependent Variable: ABB_LOG
Method: Least Squares
Date: 03/30/12 Time: 13:18
Sample: 2007M01 2011M12
Included observations: 60
White Heteroskedasticity-Consistent Standard Errors & Covariance
Variable

Coefficient

Std. Error

t-Statistic

Prob.

MSCI_LOG
C

1.307792
0.005207

0.133156
0.008170

9.821489
0.637270

0.0000
0.5265

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.663418
0.657615
0.063578
0.234443
81.21030
114.3208
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.003685
0.108654
-2.640343
-2.570532
-2.613036
2.140267

Heterosckedasticity Test

Heteroskedasticity Test: Breusch-Pagan-Godfrey

F-statistic
Obs*R-squared
Scaled explained SS

4.008227
3.878414
2.119061

Prob. F(1,58)
Prob. Chi-Square(1)
Prob. Chi-Square(1)

0.0500
0.0489
0.1455

Test Equation:
Dependent Variable: RESID^2
Method: Least Squares
Date: 04/26/12 Time: 13:58
Sample: 2007M01 2011M12
Included observations: 60
White Heteroskedasticity-Consistent Standard Errors & Covariance
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
MSCI_LOG

0.003889
-0.016009

0.000535
0.006913

7.262411
-2.315686

0.0000
0.0241

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.064640
0.048513
0.004156
0.001002
244.8667
4.008227
0.049963

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.003907
0.004261
-8.095558
-8.025746
-8.068251
2.508860

93

Residuals from Beta Monthly Log Returns

RESIDLOG
9
8
7

Frequency

6
5
4
3
2
1
0
-.15

-.10

-.05

.00

.05

.10

.15

_______________________________________________________________________________
Estimation Output: Beta Monthly (Arithmetic Returns)
Dependent Variable: ABB_ARTH
Method: Least Squares
Date: 03/30/12 Time: 13:25
Sample: 2007M01 2011M12
Included observations: 60
White Heteroskedasticity-Consistent Standard Errors & Covariance
Variable

Coefficient

Std. Error

t-Statistic

Prob.

MSCI_ARTH
C

1.288604
0.008011

0.116850
0.008046

11.02783
0.995647

0.0000
0.3236

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.658751
0.652868
0.062214
0.224496
82.51088
111.9640
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.009376
0.105595
-2.683696
-2.613885
-2.656389
2.163633

94

Heteroscedasticity Test Beta Arithmetic Returns

Heteroskedasticity Test: Breusch-Pagan-Godfrey
F-statistic
Obs*R-squared
Scaled explained SS

4.553399
0.567071
0.298978

Prob. F(1,58)
Prob. Chi-Square(1)
Prob. Chi-Square(1)

0.0499
0.4514
0.5845

Test Equation:
Dependent Variable: RESID^2
Method: Least Squares
Date: 04/26/12 Time: 14:09
Sample: 2007M01 2011M12
Included observations: 60
White Heteroskedasticity-Consistent Standard Errors & Covariance
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
MSCI_ARTH

0.003748
-0.005859

0.000519
0.006216

7.220264
-0.942528

0.0000
0.3498

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.009451
-0.007627
0.004023
0.000939
246.8179
0.553399
0.459936

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.003742
0.004008
-8.160597
-8.090785
-8.133290
2.489755

Residuals from Beta (Arithmetic Returns)

Series: RESIDART
Sample 2007M01 2011M12
Observations 60

6
5
4
3
2
1

Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis

3.18e-18
0.006996
0.117441
-0.120284
0.061685
-0.223120
2.128439

Jarque-Bera
Probability

2.396871
0.301666

0
-0.10

-0.05

-0.00

0.05

0.10

______________________________________________________________________________________________

95

Beta from Weekly Log Returns

Dependent Variable: LOG_RET_ABB
Method: Least Squares
Date: 04/26/12 Time: 14:21
Sample: 1/03/2007 12/28/2011
Included observations: 261
Variable

Coefficient

Std. Error

t-Statistic

Prob.

RETURNS_MSCI
C

1.042665
0.000311

0.091927
0.002837

11.34230
0.109659

0.0000
0.9128

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.331868
0.329288
0.045833
0.544071
435.2591
128.6478
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.000393
0.055964
-3.319993
-3.292679
-3.309014
2.346220

_______________________________________________________________________________

0,3

ABB and MSCI Monthly Returns

0,2
0,1
0

/0
1
01 /08
/0
3
01 /08
/0
5
01 /08
/0
7
01 /08
/0
9
01 /08
/1
1
01 /08
/0
1
01 /09
/0
3
01 /09
/0
5
01 /09
/0
7
01 /09
/0
9
01 /09
/1
1
01 /09
/0
1
01 /10
/0
3
01 /10
/0
5
01 /10
/0
7
01 /10
/0
9
01 /10
/1
1
01 /10
/0
1
01 /11
/0
3
01 /11
/0
5
01 /11
/0
7
01 /11
/0
9
01 /11
/1
1/
11

-0,1

01

-0,2
-0,3

-0,4
-0,5
Source: DataStream (own making)

ABB

MSCI

96

Appendix 8: Historical Ratios

Historical Ratios
2007
2008
33,34%
21,20%
27%
18%
17%
21%
23%
18%

Power products
Power systems
Process automation
Other*

2006
10,43%
6%
4%
2%

2009
-5,56%
-5%
0%
-20%

2010
-8,50%
4%
-4%
8%

2011
7,13%
20%
12%
39%

Average
9,67%
11,85%
8,45%
11,72%

Total revenue growth

6%

25%

20%

-9%

-1%

14%

9%

Total cost of sales

Non operating pension expenses
Selling general and administrative expences
R&D
Implied interest and operating lease
Lease depriciation
Operating cash taxes

70,46%
0,18%
15,27%
1,50%
0,80%
0,76%
2,91%

68,84%
0,11%
14,06%
1,34%
0,68%
0,65%
4,28%

68,22%
0,11%
13,73%
1,26%
0,70%
0,61%
4,72%

70,19%
0,42%
14,12%
1,57%
0,84%
0,76%
3,23%

69,34%
0,20%
14,61%
1,75%
0,79%
0,83%
2,82%

68,97%
-0,09%
14,14%
1,59%
0,75%
0,83%
2,56%

69,34%
0,16%
14,32%
1,50%
0,76%
0,74%
3,42%

EBITA

13,00%

15,90%

16,98%

14,61%

14,47%

15,12%

15,01%

Operating working capital

Property, plant and equipment
Capitalized operating leases
Other non current assets (net of liabilities)
Capitalized R&D assets

2,93%
12,00%
13,32%
2,10%
16,83%

5,05%
11,12%
11,28%
3,74%
15,07%

6,91%
10,20%
10,68%
3,37%
14,28%

6,54%
12,81%
13,30%
4,30%
17,37%

5,12%
13,79%
14,38%
4,00%
19,16%

8,16%
12,96%
14,53%
2,84%
17,95%

5,78%
12,15%
12,91%
3,39%
16,78%

Depreciation expense
Net capital expenditure

6,80%
2,23%

7,18%
2,59%

7,31%
3,35%

5,88%
3,04%

6,05%
2,66%

7,13%
2,69%

6,72%
2,76%

Additional Driver Ratio M&A - Historical

Acquired revenues from Baldor
$
Acquicred goodwill from Baldor
$
Acquired goodwill / acquired revenues

1.920
2.728
1,42

97

Appendix 9: Forecast Drivers Strategy 1- Organic growth

Power products
Power systems
Process automation
Other*

2012
7%
14%
8%
13%

Forecast Drivers - Strategy 1: Organic Growth, Scenario: Base Case

Detailed Explicit Forecast Period
Undetailed Explicit Forecast Period
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
6%
5%
5%
5%
12%
11%
8%
6%
8%
6%
6%
6%
12%
11%
7%
6%

Total revenue growth

4,0%

2024

2025

2026

3,9%

3,8%

3,6%

3,5%

3,4%

3,4%

3,4%

3,4%

3,1%

15,76%

15,66%

15,56%

15,46%

15,36%

15,26%

15,16%

15,06%

14,96%

14,86%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

2024

2025

2026

Total cost of sales

Non operating pension expenses
Selling general and administrative expences
R&D
Implied interest and operating lease
Lease depriciation
Operating cash taxes

68,47%
0,16%
14,1%
1,5%
0,76%
0,74%
3,42%

68,47%
0,16%
14,1%
1,5%
0,76%
0,74%
3,42%

68,47%
0,16%
14,1%
1,5%
0,76%
0,74%
3,42%

68,47%
0,16%
14,1%
1,5%
0,76%
0,74%
3,42%

68,47%
0,16%
14,1%
1,5%
0,76%
0,74%
3,42%

0,74%
3,42%

EBITA

16,06%

16,06%

16,06%

16,06%

16,06%

Operating working capital

Property, plant and equipment
Capitalized operating leases
Other non current assets (net of liabilities)
Capitalized R&D assets

8,16%
12,15%
14,53%
2,84%
17,95%

7,16%
12,15%
14,53%
2,84%
17,95%

6,16%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

Depreciation expense
Net capital expenditure

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

Power products
Power systems
Process automation
Other*

Forecast Drivers - Strategy 1: Organic Growth, Scenario: Bullish

Detailed Explicit Forecast Period
Undetailed Explicit Forecast Period
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
8%
7%
6%
7%
7%
14%
13%
12%
12%
11%
9%
9%
7%
7%
6%
14%
13%
12%
8%
6%

Steady-State

Total revenue growth

4,2%

4,1%

4,0%

3,9%

3,8%

3,7%

3,6%

3,5%

3,4%

3,1%

Total cost of sales

Non operating pension expenses
Selling general and administrative expences
R&D
Implied interest and operating lease
Lease depriciation
Operating cash taxes

68,47%
0,16%
14,1%
1,5%
0,76%
0,74%
3,42%

67,97%
0,16%
14,1%
1,5%
0,76%
0,74%
3,42%

67,67%
0,16%
14,1%
1,5%
0,76%
0,74%
3,42%

67,37%
0,16%
14,1%
1,5%
0,76%
0,74%
3,42%

67,07%
0,16%
14,1%
1,5%
0,76%
0,74%
3,42%

0,74%
3,42%

EBITA

16,06%

16,56%

16,86%

17,16%

17,46%

17,46%

17,46%

17,46%

17,46%

17,46%

17,46%

17,46%

17,46%

17,46%

17,46%

Operating working capital

Property, plant and equipment
Capitalized operating leases
Other non current assets (net of liabilities)
Capitalized R&D assets

8,16%
12,15%
14,53%
2,84%
17,95%

7,16%
12,15%
14,53%
2,84%
17,95%

6,16%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

Depreciation expense
Net capital expenditure

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

2024

2025

2026

Power products
Power systems
Process automation
Other*

2012
3%
3%
3%
3%

Growth
RONIC

3%
9,72%

Steady-State

Forecast Drivers - Strategy 1: Organic Growth, Scenario: Bearish

Detailed Explicit Forecast Period
Undetailed Explicit Forecast Period
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
-1%
1%
4%
4%
-2%
2%
3%
3%
-1%
1%
3%
3%
-2%
2%
4%
4%

Total revenue growth

2,5%

2,5%

2,5%

2,5%

2,5%

2,5%

2,5%

2,5%

2,5%

2,5%

Total cost of sales

Non operating pension expenses
Selling general and administrative expences
R&D
Implied interest and operating lease
Lease depriciation
Operating cash taxes

69,34%
0,16%
14,3%
1,5%
0,76%
0,74%
3,42%

69,44%
0,16%
14,5%
1,6%
0,76%
0,74%
3,42%

69,54%
0,16%
14,6%
1,7%
0,76%
0,74%
3,42%

69,64%
0,16%
14,7%
1,8%
0,76%
0,74%
3,42%

69,74%
0,16%
14,8%
1,9%
0,76%
0,74%
3,42%

0,74%
3,42%

EBITA

14,99%

14,59%

14,29%

13,99%

13,69%

13,59%

13,49%

13,39%

13,29%

13,19%

13,19%

13,19%

13,19%

13,09%

12,99%

Operating working capital

Property, plant and equipment
Capitalized operating leases
Other non current assets (net of liabilities)
Capitalized R&D assets

8,16%
12,15%
14,53%
2,84%
17,95%

7,16%
12,15%
14,53%
2,84%
17,95%

6,16%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

5,78%
12,15%
14,53%
2,84%
17,95%

Depreciation expense
Net capital expenditure

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

Growth
RONIC

3%
11,22%

Steady-State
Growth
RONIC

2,50%
9,72%

98

Appendix 10: Forecast Drivers Strategy 2 - M&A

Power products
Power systems
Process automation
Other*

Forecast Drivers - Strategy 2: M&A, Scenario: Base Case

Detailed Explicit Forecast Period
Undetailed Explicit Forecast Period
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
7%
7%
6%
6%
6%
14%
12%
11%
8%
6%
8%
8%
6%
6%
6%
13%
13%
12%
8%
7%

Total revenue growth

4,2%

4,1%

4,0%

3,9%

3,8%

3,7%

3,6%

3,5%

2025

2026

3,4%

3,1%

Total cost of sales

Non operating pension expenses
Selling general and administrative expences
R&D
Implied interest and operating lease
Lease depriciation
Operating cash taxes

68,47% 68,32% 68,17% 68,02% 67,87%

0,16% 0,16% 0,16% 0,16% 0,16%
14,3% 14,2% 14,1% 14,0% 13,8%
1,5%
1,5%
1,5%
1,5%
1,5%
0,76% 0,76% 0,76% 0,76% 0,76%
0,74% 0,74% 0,74% 0,74% 0,74%
3,42% 3,42% 3,42% 3,42% 3,42%

EBITA

15,88% 16,13% 16,38% 16,63% 16,98% 17,18% 17,18% 17,03% 16,88% 16,73% 16,58% 16,43% 16,28% 16,13% 15,98%

Operating working capital

Property, plant and equipment
Capitalized operating leases
Other non current assets (net of liabilities)
Capitalized R&D assets

8,16% 7,16% 6,16% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78%
12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15%
14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53%
2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84%
17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95%

Depreciation expense
Net capital expenditure
Acquired goodwill / acquired revenues

6,72%
2,76%
1,42

Power products
Power systems
Process automation
Other*

Forecast Drivers - Strategy 2: M&A, Scenario: Bullish

Detailed Explicit Forecast Period
Undetailed Explicit Forecast Period
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
8%
8%
7%
8%
8%
14%
13%
12%
12%
11%
9%
9%
7%
7%
6%
14%
14%
13%
9%
7%

6,72%
2,76%
1,42

6,72%
2,76%
1,5

6,72%
2,76%
1,6

6,72%
2,76%
1,7

Total revenue growth

0,74%
3,42%

6,72%
2,76%

4,4%

6,72%
2,76%

4,3%

6,72%
2,76%

4,2%

6,72%
2,76%

4,1%

6,72%
2,76%

4,0%

6,72%
2,76%

3,9%

6,72%
2,76%

3,8%

6,72%
2,76%

3,7%

6,72%
2,76%

6,72%
Steady-State
2,76% Growth
RONIC

2025

2026

3,6%

3,1%

Total cost of sales

Non operating pension expenses
Selling general and administrative expences
R&D
Implied interest and operating lease
Lease depriciation
Operating cash taxes

68,47% 67,97% 67,47% 66,97% 66,97%

0,16% 0,16% 0,16% 0,16% 0,16%
14,0% 13,7% 13,7% 13,4% 13,1%
1,5%
1,5%
1,5%
1,5%
1,5%
0,76% 0,76% 0,76% 0,76% 0,76%
0,74% 0,74% 0,74% 0,74% 0,74%
3,42% 3,42% 3,42% 3,42% 3,42%

EBITA

16,18% 16,98% 17,48% 18,28% 18,58% 18,88% 18,88% 18,78% 18,68% 18,58% 18,43% 18,28% 18,13% 17,98% 17,83%

Operating working capital

Property, plant and equipment
Capitalized operating leases
Other non current assets (net of liabilities)
Capitalized R&D assets

8,16% 7,16% 6,16% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78%
12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15%
14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53%
2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84%
17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95%

Depreciation expense
Net capital expenditure
Acquired goodwill / acquired revenues

6,72%
2,76%
1,42

Power products
Power systems
Process automation
Other*

Forecast Drivers - Strategy 2: M&A, Scenario: Bearish

Detailed Explicit Forecast Period
Undetailed Explicit Forecast Period
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
3%
0%
2%
5%
5%
3%
-2%
2%
3%
3%
3%
-1%
1%
3%
3%
4%
-1%
3%
5%
4%

6,72%
2,76%
1,42

6,72%
2,76%
1,5

6,72%
2,76%
1,6

6,72%
2,76%
1,7

Total revenue growth

0,74%
3,42%

6,72%
2,76%

2,7%

6,72%
2,76%

2,7%

6,72%
2,76%

2,7%

6,72%
2,76%

2,7%

6,72%
2,76%

2,7%

6,72%
2,76%

2,7%

6,72%
2,76%

2,7%

6,72%
2,76%

2,7%

6,72%
2,76%

6,72%
Steady-State
2,76% Growth
3%
RONIC
11,22%

2025

2026

2,7%

2,7%

Total cost of sales

Non operating pension expenses
Selling general and administrative expences
R&D
Implied interest and operating lease
Lease depriciation
Operating cash taxes

69,34% 69,34% 69,34% 69,34% 69,34%

0,16% 0,16% 0,16% 0,16% 0,16%
14,3% 14,3% 14,3% 14,3% 14,3%
1,5%
1,6%
1,7%
1,8%
1,9%
0,76% 0,76% 0,76% 0,76% 0,76%
0,74% 0,74% 0,74% 0,74% 0,74%
3,42% 3,42% 3,42% 3,42% 3,42%

EBITA

15,01% 14,91% 14,81% 14,71% 14,61% 14,51% 14,41% 14,31% 14,21% 14,11% 14,01% 13,91% 13,81% 13,71% 13,61%

Operating working capital

Property, plant and equipment
Capitalized operating leases
Other non current assets (net of liabilities)
Capitalized R&D assets

8,16% 7,16% 6,16% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78% 5,78%
12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15% 12,15%
14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53% 14,53%
2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84% 2,84%
17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95% 17,95%

Depreciation expense
Net capital expenditure
Acquired goodwill / acquired revenues

6,72%
2,76%
1,49

6,72%
2,76%
1,49

6,72%
2,76%
1,575

6,72%
2,76%
1,68

6,72%
2,76%
1,785

3%
9,72%

0,74%
3,42%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
2,76%

6,72%
Steady-State
2,76% Growth
RONIC

99

3%
9,72%

Appendix 11: Results Strategy 1 - Organic Growth (Base Case)

Value of Operations: Discounted Cash Flow
Discount
Factor
Year
FCF
PV of FCF
2012
$
3.605
0,91
$
3.285
2013
$
4.253
0,83
$
3.533
2014
$
4.894
0,76
$
3.705
2015
$
5.404
0,69
$
3.729
2016
$
5.676
0,63
$
3.569
2017
$
6.145
0,57
$
3.522
2018
$
6.351
0,52
$
3.317
2019
$
6.557
0,48
$
3.121
2020
$
6.785
0,43
$
2.944
2021
$
6.985
0,40
$
2.762
2022
$
7.184
0,36
$
2.589
2023
$
7.356
0,33
$
2.416
2024
$
7.531
0,30
$
2.254
2025
$
7.710
0,27
$
2.103
2026
$
7.976
0,25
$
1.983
Continuing Value
$
96.571
0,25
$
24.012
Value of Operations

68.844

Distribution of Value

Explicit Forecast
period FCF in %

35%
65%

Continiung Value in
%

Value of Operations: Economic Profit

Economic
Discount
Profit
Factor
Year
PV of EP
2012
$
2.402
0,91
$
2.189
2013
$
2.751
0,83
$
2.285
2014
$
3.097
0,76
$
2.344
2015
$
3.358
0,69
$
2.317
2016
$
3.610
0,63
$
2.270
2017
$
3.579
0,57
$
2.051
2018
$
3.696
0,52
$
1.930
2019
$
3.810
0,48
$
1.814
2020
$
3.913
0,43
$
1.698
2021
$
4.016
0,40
$
1.588
2022
$
4.115
0,36
$
1.483
2023
$
4.218
0,33
$
1.385
2024
$
4.322
0,30
$
1.294
2025
$
4.426
0,27
$
1.208
2026
$
4.506
0,25
$
1.120
Continuing Value
$
48.018
0,25
$
11.940
Invested Capital 2011
$
29.928
Value of operations
$
68.844

Value of Equity
Value of Operations
Non-operating Assets
Enterprice Value
Debt and Debt Equivalents
Equity Equivalents
Equity Value

$ 68.843,65
$
6.948
$ 75.791,85
$
-12.482
$
-5.130
$ 58.179,65

Outstanding Shares (as of Dec. 31 2011)

Share Price

2290411120
$
25,40

Development in FCF & PV of FCF

$9.000
$8.000
$7.000
$6.000
$5.000
$4.000
$3.000
$2.000
$1.000
$2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
FCF

PV of FCF

Development in EP and PV of EP
$5.000
$4.000
$3.000
$2.000
$1.000
$2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Economic Profit

PV of EP

100

Appendix 12: Results Strategy 2 - M&A (Base Case)

Value of Operations: Discounted Cash Flow
Discount
Factor
Year
FCF
PV of FCF
2012
$
-2.755
0,91
$
-2.511
2013
$
-299
0,83
$
-248
2014
$
-1.627
0,76
$
-1.232
2015
$
2.943
0,69
$
2.031
2016
$
3.280
0,63
$
2.063
2017
$
7.356
0,57
$
4.216
2018
$
7.686
0,52
$
4.015
2019
$
7.922
0,48
$
3.771
2020
$
8.157
0,43
$
3.539
2021
$
8.390
0,40
$
3.318
2022
$
8.621
0,36
$
3.107
2023
$
8.849
0,33
$
2.906
2024
$
9.074
0,30
$
2.716
2025
$
9.294
0,27
$
2.536
2026
$
9.568
0,25
$
2.379
Continuing Value
$ 114.400
0,25
$ 28.445,08
Value of Operations

Value of Operations: Economic Profit

Economic
Discount
Profit
Factor
Year
PV of EP
2012
$
2.762
0,91
$
2.517
2013
$
2.606
0,83
$
2.165
2014
$
2.766
0,76
$
2.094
2015
$
2.259
0,69
$
1.559
2016
$
2.416
0,63
$
1.519
2017
$
2.412
0,57
$
1.383
2018
$
2.647
0,52
$
1.383
2019
$
2.784
0,48
$
1.325
2020
$
2.917
0,43
$
1.265
2021
$
3.044
0,40
$
1.204
2022
$
3.166
0,36
$
1.141
2023
$
3.281
0,33
$
1.078
2024
$
3.390
0,30
$
1.015
2025
$
3.491
0,27
$
952
2026
$
3.564
0,25
$
886
Continuing Value
$
38.758
0,25
$
9.637
Invested Capital 2011
$
29.928
Value of operations
$
61.051

61.051

Distribution of Value

53%
47%

Explicit Forecast
period FCF in %
Continiung Value
in %

Value of Equity
Value of Operations
Non-operating Assets
Enterprice Value
Debt and Debt Equivalents
Equity Equivalents
Equity Value

$ 61.050,63
$
6.948
$ 67.998,83
$
-12.482
$
-5.130
$ 50.386,63

Outstanding Shares (as of Dec. 31 2011)

Share Price

2290411120
$
22,00

Development in FCF & PV of FCF

$12.000
$10.000
$8.000
$6.000
$4.000
$2.000
$$-2.000

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026

$-4.000
FCF

PV of FCF

Development in EP and PV of EP
$4.000
$3.500
$3.000
$2.500
$2.000
$1.500
$1.000
$500
$2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Economic Profit

PV of EP

101

Appendix 13: Sensitivity Analysis

Strategy 1: Organic Growth (Base Case Scenario)
Wacc
Risk premium
3,21%
4,21%
5,21%
6,21%
7,21%
Share Price
Risk premium
3,21%
4,21%
5,21%
6,21%
7,21%
% change in share price
Risk premium
3,21%
4,21%
5,21%
6,21%
7,21%

1,00
6,57%
7,45%
8,34%
9,22%
10,11%

$
$
$
$
$

$
$
$
$
$

1,00
72%
45%
24%
8%
-6%

Wacc
Risk free rate

Share price
Risk free rate
$
$
$
$
$

1,15
40,24
33,43
28,25
24,20
20,96

$
$
$
$
$

1,15
58%
32%
11%
-5%
-17%

2,62%
7,78%
8,67%
9,56%
10,44%
11,33%

1,77%
2,77%
3,77%
4,77%
5,77%

1,77%
2,77%
3,77%
4,77%
5,77%
% change in share price
Risk free rate
1,77%
2,77%
3,77%
4,77%
5,77%

1,00
43,70
36,92
31,60
27,42
23,99

1,15
6,99%
8,01%
9,03%
10,05%
11,07%

2,62%
34,80
29,93
26,03
22,88
20,23

3,62%
7,87%
8,75%
9,64%
10,52%
11,41%

$
$
$
$
$

3,62%
34,25
29,54
25,72
22,62
20,01

2,62%
37%
18%
2%
-10%
-20%

3,62%
35%
16%
1%
-11%
-21%

-2
21,84
19,65

-1
23,53
22,52

Beta
1,30
7,42%
8,57%
9,72%
10,87%
12,02%
Beta
1,30
37,12
30,42
25,40
21,54
18,47
Beta
1,30
46%
20%
0%
-15%
-27%

Cost of debt
4,62%
7,95%
8,84%
9,72%
10,61%
11,49%
Cost of debt
4,62%
$
33,78
$
29,12
$
25,40
$
22,33
$
19,80
Cost of debt
4,62%
33%
15%
0%
-12%
-22%

1,45
7,85%
9,13%
10,41%
11,70%
12,98%

$
$
$
$
$

1,45
34,37
27,81
22,98
19,26
16,37

1,60
8,27%
9,96%
11,11%
12,52%
13,94%

$
$
$
$
$

1,45
35%
9%
-10%
-24%
-36%

1,60
26%
-3%
-18%
-32%
-43%

5,62%
8,03%
8,92%
9,81%
10,69%
11,58%

$
$
$
$
$

1,60
31,98
24,52
20,84
17,33
14,58

5,62%
33,31
28,75
25,07
22,09
19,57

6,62%
8,12%
9,00%
9,89%
10,77%
11,66%

$
$
$
$
$

5,62%
31%
13%
-1%
-13%
-23%

6,62%
32,80
28,39
24,78
21,84
19,36
6,62%
29%
12%
-2%
-14%
-24%

% Change
Share price
Revenue
EBITA Margin

$
$

Share price
Revenue
EBITA Margin

Share Price
Steady growth
5,00%
4,00%
3,00%
2,00%
1,00%
Share Price
Steady growth
5,00%
4,00%
3,00%
2,00%
1,00%

$
$
$
$
$

$
$

-2
-14%
-23%

-1
-7%
-11%

4,72%
13,61
17,66
20,44
22,45
23,95

7,22%
21,68
22,94
23,78
24,37
24,79

4,72%
-46,42%
-30,47%
-19,53%
-11,61%
-5,71%

$
$
$
$
$

7,22%
-14,65%
-9,69%
-6,38%
-4,06%
-2,40%

$
$

$
$
$
$
$

0
25,40 $
25,40 $
% Change
0
0%
0%

ROINC
9,72%
25,60
25,50
25,40
25,30
25,20
ROINC
9,72%
0,79%
0,39%
0,00%
-0,39%
-0,79%

$
$
$
$
$

1
27,49
28,28

$
$

1
8%
11%

12,22%
27,92
27,02
26,36
25,85
25,44
12,22%
9,92%
6,38%
3,78%
1,77%
0,16%

2
29,80
31,16
2
17%
23%

$
$
$
$
$

14,72%
29,45
28,02
26,99
26,21
25,60
14,72%
15,94%
10,31%
6,26%
3,19%
0,79%

102

Strategy 2: M&A (Base Case Scenario)

Wacc
Risk premium

Beta
1,00
6,57%
7,45%
8,34%
9,22%
10,11%

3,21%
4,21%
5,21%
6,21%
7,21%
Share Price
Risk premium
3,21%
4,21%
5,21%
6,21%
7,21%

$
$
$
$
$

% change in share price

Risk premium

1,00
43,05
35,20
29,08
24,30
20,40

1,15
6,99%
8,01%
9,03%
10,05%
11,07%

$
$
$
$
$

1,15
39,04
31,18
25,24
20,64
16,98

3,21%
4,21%
5,21%
6,21%
7,21%

1,00
96%
60%
32%
10%
-7%

1,15
77%
42%
15%
-6%
-23%

1,77%
2,77%
3,77%
4,77%
5,77%

2,62%
7,78%
8,67%
9,56%
10,44%
11,33%

3,62%
7,87%
8,75%
9,64%
10,52%
11,41%

Wacc
Risk free rate

Share price
Risk free rate
1,77%
2,77%
3,77%
4,77%
5,77%

$
$
$
$
$

% change in share price

Risk free rate
1,77%
2,77%
3,77%
4,77%
5,77%

2,62%
32,75
27,16
22,71
19,14
16,17

$
$
$
$
$

3,62%
32,12
26,72
22,36
18,85
15,93

$
$
$
$
$

1,30
7,42%
8,57%
9,72%
10,87%
12,02%
Beta
1,30
35,44
27,72
22,00
17,64
14,21
Beta
1,30
61%
26%
0%
-20%
-35%

Cost of debt
4,62%
7,95%
8,84%
9,72%
10,61%
11,49%
Cost of debt
4,62%
$
31,58
$
26,23
$
22,00
$
18,53
$
15,69
Cost of debt
4,62%
44%
19%
0%
-16%
-29%

2,62%
49%
23%
3%
-13%
-27%

3,62%
46%
21%
2%
-14%
-28%

-2
17,67 $
15,81 $

-1
19,72 $
18,90 $

1,45
7,85%
9,13%
10,41%
11,70%
12,98%

$
$
$
$
$

$
$
$
$
$

1,45
32,26
24,74
19,25
15,09
11,88

1,60
8,27%
9,96%
11,11%
12,52%
13,94%

$
$
$
$
$

1,60
29,51
21,00
16,85
12,95
9,93

1,45
47%
12%
-13%
-31%
-46%

1,60
34%
-5%
-23%
-41%
-55%

5,62%
8,03%
8,92%
9,81%
10,69%
11,58%

6,62%
8,12%
9,00%
9,89%
10,77%
11,66%

5,62%
31,04
25,81
21,62
18,25
15,43

$
$
$
$
$

6,62%
30,46
25,40
21,29
17,98
15,20

5,62%
41%
17%
-2%
-17%
-30%

6,62%
38%
15%
-3%
-18%
-31%

1
24,53 $
25,09 $

2
27,34
28,19

% Change
Share price
Revenue
EBITA Margin

$
$

Share price
Revenue
EBITA Margin

Share Price
Steady growth
5,00%
4,00%
3,00%
2,00%
1,00%

$
$
$
$
$

Share Price
Steady growth

-2
-20%
-28%

-1
-10%
-14%

4,72%
8,08
12,83
16,13
18,50
20,28

7,22%
17,59
19,08
20,08
20,77
21,27

$
$
$
$
$

4,72%
-63,27%
-41,68%
-26,68%
-15,91%
-7,82%

5,00%
4,00%
3,00%
2,00%
1,00%

$
$
$
$
$

7,22%
-20,05%
-13,27%
-8,73%
-5,59%
-3,32%

0
22,00 $
22,00 $
% Change
0
0%
0%

ROINC
9,72%
22,24
22,12
22,00
21,88
21,76
ROINC
9,72%
1,09%
0,55%
0,00%
-0,55%
-1,09%

$
$
$
$
$

1
12%
14%

12,22%
24,98
23,91
23,13
22,53
22,04

2
24%
28%

$
$
$
$
$

14,72%
26,79
25,10
23,88
22,96
22,23

12,22%
13,55%
8,68%
5,14%
2,41%
0,18%

14,72%
21,77%
14,09%
8,55%
4,36%
1,05%

15
20,78 $
-5,55%

30
19,55
-11,14%

% Change
Aquired goodwill / Acq. Revenues
Share price
% change in share price

-30
24,44 $
11,09%

-15
23,22 $
5,55%

0
22,00 $
0,00%

103

Appendix: 14-35 (excel-files)

Strategy 1:
Organic growth

Strategy 2:
Growth through
M&A

Base Case

14a 35a

14d 35d

Bullish

14b 35b

14e 35e

Bearish

14c 14c

14f 35f

Appendix 14a 35a: Strategy 1 (organic growth) Base Case Scenario

14a: Overview
15a: Balance Sheet (BS)
16a: Income Statement (IS)
17a: Reorganization of Balance sheet (detailed item list)
18a: Invested Capital
19a: NOPLAT
20a: Analyzing Performance
21a: Driver Ratios
22a: Capital Structure
23a: Rolling Beta Monthly
24a: Rolling Beta Weekly
25a: WACC
26a: Free Cash Flow
27a: Discounted Cash Flow Model
28a: Overview DCF
29a: Economic Profit Model
30a: Sensitivity Analysis
31a: 35:a Items adjusted for reorganization of financial statements

104

Appendix 14b 35b: Strategy 1 (organic growth)- Bullish Scenario

The file is divided in exactly the same way as appendix 14a-35a; however, there are changes in
certain items according to the bullish scenario.
Appendix 14c 35c: Strategy 1 (organic growth) - Bearish Scenario
The file is divided in exactly the same way as appendix 14a-35a; however, there are changes in
certain items according to the bearish scenario.
Appendix 14d 35d: Strategy 2 (M&A) Base Case Scenario
The file is divided in exactly the same way as appendix 14a-35a; however, there are changes in
certain items according to strategy 2, namely growth through M&A.
Appendix 14e 35e: Strategy 2 (M&A) Bullish Scenario
The file is divided in exactly the same way as appendix 14a-35a; however, there are changes in
certain items according to strategy 2, namely growth through M&A, and according to the bullish
scenario.
Appendix 14f 35f: Strategy 2 (M&A) Bearish Scenario
The file is divided in exactly the same way as appendix 14a-35a; however, there are changes in
certain items according to strategy 2, namely growth through M&A, and according to the bearish
scenario.

105