ARCADIAN

MICROARRAY
TECHNOLOGIES, INC.

BLEMBA 28
SYNDICATE 1
AGENDA
1. Background and history
2. Sierra Capital Partners and RODNEY CHU’S COMPARISON ACTIVITY
3. The doubt of Rodney chu, lead on identification in financial report
4. RODNEY CHU’S COMPARISON ACTIVITY
5. The Idea of Terminal Value
6. taxes in terminal values
7. Liquidation vs. Going Concern Values
Question 1
Question 2
Question 3
Question 4
Question 5
 1. BACKGROUND AND HISTORY ARCADIAN

Arcadian Microarray Technologies, Inc.,3 headquartered in Arcadia,

California, was founded in 2003 by seven research scientists. Arcadian’s
business consisted of two segments: DNA microarrays and Human
therapeutics.
Arcadian’s management believed that applications for its DNA
microarray technology would pay off dramatically and quickly: by the year
2013 they believed the firm’s revenues (namely, sales of proprietary products,
underwritten research, and royalties) would top $1 billion.
In August 2005, The owners of Arcadian, who were also its senior
managers, proposed to sell a 60% equity interest to Sierra Capital for $40
million, would be used to finance the firm’s growth.
 2. SIERRA CAPITAL RODNEY CHU’S ANALYSIS AND
PARTNERS FOCUS
1. Sierra Capital, located in Albuquerque, New
Mexico, had been organized in 1974 as a hedge Estimate a
terminal
fund value
2. The firm had 2 billion under management, ad
financial
64 billion under portofolio Terminal
forecasting
3. Focused almost entirely on the life sciences value to the
of equity
present
sector. cash flows
4. Sierra Capital’s mantra now when evaluating
investments was, “NRDO: no research, Chu’s Analysis
development only.
5. Sierra Capital assigned Rodney Chu, to Negotiation
Forecast strategy of
negotiate the specific price and terms of assumptions Economic
investment. Value

Discount the
cash flows
Rodney Chu’s analysis so far had some of focus,
like in the diagram
3. THE DOUBT OF RODNEY CHU, LEAD ON IDENTIFICATION IN
FINANCIAL REPORT
Arcadian Optimist: DNA microarray
technology would pay off dramatically
and quickly: in 2013, revenues and
royalties would top $1 billion Identification Method to Analyse:
1.assessment of forecast assumptions
2.forecasted free cash flows
Sierra Pessimist: FDA approval would 3.looked toward other publicly held
slow down the commercialization of companies in the general same field
Arcadian’s new products, assumed the
firm would not finance itself with debt
Assign Man power from Sierra in
Assessment Process
requested help from Paige Simon, a new
associate with Sierra Capital.
 4. RODNEY CHU’S COMPARISON ACTIVITY

Rodney Chu was less optimistic toward investment in Arcadian, believing that the FDA approval process would slow down
the commercialization of Arcadian’s new products. In assessing Investment in Arcadian, Chu looked toward two publicly
held companies in the general field of molecular diagnostics :
5. THE IDEA OF TERMINAL VALUE

Terminal values are worth

Terminal value is the lump-
sum of cash flow at the end of
a stream of cash flows.
represents either:
(a) the proceeds to us from
exiting the investment
(b) the present value (at that
future date) of all cash flows
worrying about for two
reasons:
1. TV Present in the
valuation of just about every
asset, PV is The return of
principal at the maturity of the
bond.
2. TV is that in the
valuation of stocks and whole
companies, TV is usually a
very big value driver.
For traders, TV equals the
proceeds from selling the
bonds when you exit
from each position. You can
say the same thing about
stocks, currencies, and all
sorts of
hard assets.

(Present and explain data in exhibit 3)

6. TAXES IN TERMINAL VALUES

Big investors do
not pay taxes

The usual
Taxes in Many investors
assumption is not
to tax terminal
Termina really do not have
much tax
exposure
values
l values

in mergers and
acquisitions analysis, the
most reasonable
assumption is to buy and
hold, not too consent in tax
7. LIQUIDATION VS. GOING CONCERN VALUES

We have to do what’s Companies and

economically sensible, businesses are potentially
The real Liquidation very long-lived and
value of Company is in should be valued on a
a stream of future cash going concern basis
flows Need to look at
“continuing value” The assets in corporate
Liquidation Terminal capital budgeting cases liquidation value because,
derived from the going might find some
value is just a summary have definite lives. You
concern of the interesting situations
(or present value) of don’t see those situations
business, indeed many very often, but still where liquidation value is
the cash flows beyond
assets live well beyond higher than going concern
the horizon it’s worth a look. value
the forecast horizon

when
would We
Liquidatio
use
n Values
Liquidatio
n Value?
1.    PLEAS EXPLAIN THE IMPLICATIONS OF CASE EXHIBIT 1 (PAIGE SIMON’S FIRST TASK). BASED ON THAT EXHIBIT, IS
TERMINAL VALUE A MATERIAL COMPONENT OF FIRM VALUES?
SIMON’S FIRST TASK: PRESENT AND EXPLAIN THE DATA IN EXHIBIT 3
 MARKET MULTIPLES AND CONSTANT GROWTH TERMINAL VALUATION

Usage of Multiples as Terminal

Value Estimators For valuing
equity instead
of assets, use
the constant-
growth
valuation
Frequently use, but it has some formula, but
disadvantage with equity-
(Exhibit 4) oriented inputs:

To get really close to the

assumptions about value, use
They’re easy to use, but too
this version of the constant
abstract for analytical work
growth valuation model to value
a firm’s assets

Sellers of companies always want to persuade you of their great growth prospects. If
you buy the optimistic growth assumptions, you’ll have to pay a higher price for the
company.
GROWTH RATE ASSUMPTION
The firm can only grow as fast as it
The Constant adds to its equity capital base (through
“ROE,” less any dividends paid out,
growth formula indicated through the dividend payout
ratio, or “DPO”)
2 Classic approaches
for estimating the
The nominal rate of growth (increase
growth rate The Sum of real in units shipped, increase price,
growth and monopoly, etc) is the product/firm of
the rate of inflation and the “real” rate
inflation of growth

These 2 Formulas, focus on: the real growth rate in the

business, and the ability of the business to pass along the
effects of inflation. The real growth rate is bound to vary by
industry. the increasing maturity of a company will tend to
drive its growth rate downward
CALCULATION OF TERMINAL VALUE
VARIETIES OF TERMINAL VALUES

We can’t really foresee Terminal Value, we can only estimate it. The Remember that they are imperfect estimates in
estimators include: Variety of TV, using many different points of
(a) Accounting Book Value observation from the ground. It takes a lot of careful
(b) Liquidation Value, judgment because some of the varieties of terminal
(c) Multiples of Income value are inherently more trustworthy than others.
(d) Constant Growth Perpetuity value. Varieties of
Terminal Values
(Table of exhibit 4 in next slide)
We can probably figure it out. the various estimators From one situation to the next the different estimators
would be appropriate or inappropriate. But have varying degrees of appropriateness. In fact, even
remember that no single estimator will give us a “true” though some one usually disregard book value, there are
value. Wherever possible, we want to use a variety of a few situations in which it might be a fair estimate of
approaches. terminal value
2.    DRAWING ON CASE EXHIBIT 4 AND YOUR OWN GENERAL KNOWLEDGE, WHERE WOULD THE VARIOUS ESTIMATORS
BE APPROPRIATE? WHERE WOULD THEY BE INAPPROPRIATE? (SIMON’S SECOND TASK)
SIMON’S SECOND TASK: CONSIDER THE APPROACHES DESCRIBED IN EXHIBIT 4.
3.    REGARDING THE CASH FLOW FORECASTS IN CASE EXHIBIT 5, AT WHAT POINT IN THE FUTURE WOULD
YOU SET THE FORECAST HORIZON FOR THE THREE INVESTMENTS? WHY? MORE GENERALLY, WHAT
SHOULD DETERMINE WHEN YOU STOP FORECASTING ANNUAL CASH FLOWS AND ESTIMATE A TERMINAL
VALUE?
USING HISTORICAL GROWTH RATES; SETTING FORECAST HORIZONS

Extrapolating the past

rate of growth of the Each Company
company is one of good A key point of judgment in
parameter because valuation analysis is to set
can’t use same past rates has special
of growth of cash flows in
Companies typically go the forecast horizon at
each projects because the
constant growth
through life cycles. A that point in the future formula, figure it
explosive growth of the past
period of explosive growth where stability or stable
is usually followed by a growth begins
will not be repeated based on actual
period of maturity and/or type of Company
decline.
Forecast Horizons with
Differing Rates of
Company Development
“PETER PAN” GROWTH: WACC < G

The Growth rate Negative Terminal

greater than WACC Value

WACC less than g can’t

happen; a company cannot grow
to infinity at a rate greater
than its cost of capital.

Cannot use the constant

growth model where WACC is
less than g
4.    ESTIMATE OTHER TERMINAL VALUES BASED ON ALTERNATE ESTIMATION APPROACHES. FROM THESE
VARIOUS ESTIMATES, PLEASE TRIANGULATE TOWARD A SINGLE COMPOSITE ESTIMATE OF TERMINAL
VALUE FOR EACH OF SIERRA CAPITAL AND ARCADIAN’S FORECASTS.
 Price Earning
Ratio
Provide
Price Book
recommendations
about Value Ratio Maximum and
Minimum Value
Constant
Growth Rate

Summary of
All above

Data Collection and Calculation to

Create Decision and Negotiation
Estimate Terminal Values based on Alternate Estimation Approaches
In Million USD In Million USD
Price/Earnings (P/E) In Million USD Price/Sales (P/S)
Arcadian P/E=15 P/E=20 Price/Book Value (P/B) Arcadian Arcadian P/E=15
P/E Ratio 15 20 P/B Ratio 8.5 P/E Ratio 7.49
Net Income 203 203 Current Book Value of Equity 3.5 Net Income 1,065
Terminal Value 2014 3,045 4,060 Forecast Income 2005-2014 669 Terminal Value 2014 7,977
PV Terminal Value 492 656 Total Book Value 673 PV Terminal Value 1,288
PV Free Cash Flow 2005-2014 (151) (151) Terminal Value 2014 5,716 PV Free Cash Flow 2005-2014 (151)
Total Present Value 341 505 PV Terminal Value 923 Total Present Value 1,137
PV Free Cash Flow 2005-2014 (151)
Sierra P/E=15 P/E=20 Total Present Value 772 Sierra P/E=15
P/E Ratio 15 20 P/E Ratio 7.49
Net Income 162 162 Price/Book Value (P/B) Sierra Net Income 558
Terminal Value 2015 2,430 3,240 P/B Ratio 8.5 Terminal Value 2015 4,179
PV Terminal Value 327 436 Current Book Value of Equity 3.5 PV Terminal Value 562
PV Free Cash Flow 2005-2015 (118) (118) Forecast Income 2005-2015 195 PV Free Cash Flow 2005-2015 (118)
Total Present Value 209 318 Total Book Value 199 Total Present Value 444
Terminal Value 2015 1,687
PV Terminal Value 227
PV Free Cash Flow 2005-2015 (118) Calculate present value using Multiple
Total Present Value 109 approach by using P/E and P/B for both
using Arcadian and Sierra forecast.
 5.    WHAT IS THE RESULTING PRESENT VALUE
Total Present Value Arcadian Sierra Range
Price/Earnings (P/E) - 15 341 209 132
(PV) OF CASH FLOWS UNDER SIERRA CAPITAL
Price/Earnings (P/E) - 20 505 318 187 AND ARCADIAN’S OUTLOOK?
Price/Book Value (P/B) 772 109 663
Price/Sales (P/S) 1,137 444 693
Discounted Cash Flow 52 35 17 Calculate total present value using multiple approach give the
wide range of the result, while using constant growth method
60% of Ownership Arcadian Sierra Range
is more close range
Price/Earnings (P/E) - 15 204 125 79
Price/Earnings (P/E) - 20 303 191 112
Price/Book Value (P/B) 463 65 398 Arcadian asking of the 40 mio of 60% of ownership is higher
Price/Sales (P/S) 682 267 416
than the present value using discounted cash flow. The exit
Discounted Cash Flow 31 21 10
value if the deal happen is 31 mio.

Growth using 5% = 2% inflation + 3% economic growth

Present value of Sierra is lower than the Arcadian since it is
more conservatives projection.