Valuation of WEC
1. General Background of the Firm
White Energy Company (WEC) is an innovative coal technology business listed on the Australian Stock Exchange (ASX). It now belongs to the energy and utilities sector according to the 2011 sector profile. WEC was listed on 23 July of 1999 with the initial name Spike networks limited (SPK) which focused on network and media industry. On the 19 January of 2005, the SPK announced of changing the firm’s emphasis from network and media industry to the resources industry. Moreover, WEC stated that they would purchase all of the issued capital of Amerod Resources Limited (ARZ). Following the completion of the acquisition, the name of the company had been change d to “Amerod Resources Limited” on 15 March of 2005. However, on 28 June of 2006, the company released an announcement that demonstrated the acquisition of White Energy Technology Limited, hence, on 3 July of 2006, the company name changed from Amerod Resources Limited to White Energy company which is used until now.
WEC is the exclusively of the Binderless Coal Briquetting (BEB) technology which owns a typical low cost operational process which could upgrade coals. Thus they could achieve products in the form of dense, physical and chemical stable briquette with higher energy content and value which could ultimately performed as normal coal. The commercial goal of the WEC is to obtain low cost/ low rank coals and upgrade the coal to more valuable briquettes. Furthermore, the upgraded coal through the sound process generates lower emissions and facilitated transportation efficiencies compared with lower rank feedstock coal. WEC is traded on the ASX and on the OTCQX in the United States as well. The share price range in ASX is $2.36- $4.27 between 5 May 2010 and 5 may 2011. And the equity market capitalisation is $1198.5M on fully diluted basis in 2010. Furthermore, the Beta of the company is 0.93 while it of industry is 1.08.
WEC belongs to the Energy and Utilities Sector in Australia according to the sector profile in 2011. Moreover, Australia is rich in natural resources and it is the largest
coal exporter to world markets, particularly in Asia. Therefore, the development of the industry is appreciable. Meanwhile, as the popularization of new energy and environment protection, what WEC doing is tally with the trends. Future demand of lower emissions coal is guaranteed by the continually increasingly trends of the lack of energy and environment protection idea. With the global demand for cleaner and more efficient fuels increasing in importance, new technologies will be required to identify more efficient ways of generating energy. WEC, with its advanced and upgraded processing technology, indicates a crucial step to show human beings of a cleaner and more efficient coal solution.
2. Capital Structure of the Firm
2.1 The listing date and an ordinary share offer issue of WEC
White Energy Company limited was listed on July 23 of 1999 on the ASX. As to the capital structure of the White energy company on the listing date, it is the initial capital structure of Spike Company. Spike Company offered 22,500,000 shares at the price of $ 1.45 aiming to raise capital of 32,625,000. An amount of 2,100,000 additional shares would be issued as over subscription to gather fund of $3,045,000. The existing shareholders of the company nearly hold 73.6% of the overall company shares and the company raised the total market capital of nearly $ 123,000,000.
White Energy Company raised capital several times for various reasons and they would raise capital through different approached, such as offering straight debt, hybrid stock, or ordinary share. In the year of 2009, WEC raised a large proportion of fund on the market. The initial announcement of this issue is in 27th November of 2009. As is shown in the WEC company announcement, the company would issue $ 250,000 ordinary shares at the price of $ 1.20 per share and would expire on 30 November 2011.The purpose of fund raising for white energy company is to gather larger amount of working capital. Working capital is crucial to company’s liquidity. WEC expects that they would have a promising future so that they want to expand their business to increase the profitability. In terms of issuing such an amount of ordinary shares, it could ensure that the company would have sufficient cash flow to afford purchasing more machinery to conduct more projects so that it could generate benefits for WEC.
2.2 Share return prior and after the announcement
The announcement date was 27 November of 2009. As we can see from the table above, the share price on 30 October (twenty days before the announcement date) is 2.57 while it on 29 December (twenty days after the announcement date) is 2.38.
Suppose Y represents the share price on 20 days after announcement data;
X represents the share price on 20 days before announcement date
Hence, the share return earned by WEC from 20 days before the announcement date to 20 days after the announcement date is:
Share return= = (2.38-2.57)/2.57= - 7.393%.
From the table 2 above, the share price of 26 November 2010 which is $3.58 is shown. It can be found out that during this year, the share price increased from $2.74 to $3.58, and there was no dividends paid during this year. Therefore, the annual share return rate was: (3.58-2.74)/2.74=30.657% which means if an investor bought $100 on 27 November 2009, he or she would get: (100/2.74)*(3.58-2.74)+100=130.6569 on 26 November 2010. And the annual share return was 30.6568/100= 30.657%
2.3 Market and Industry Return During the Announcement
To calculate the market return and industry return, we gathered historical data from the S&P/ASX 200 (XJO) Index and S&P/ASX 200 Materials (XMJ) Index:
Thus, the market return and industry return during this period are:
= (-1)100%=4.35%
= (-1)100%=12.95%
2.4 Annual Market and Industry Return after the Announcement
To calculate the annual market return and industry return for analysis, we still need to acquire historical data from the S&P/ASX 200 (XJO) Index and S&P/ASX 200 Materials (XMJ) Index:
Therefore, the market return and industry return during this period are:
= (-1)100%=0.57%
= (-1)100%=11.98%
2.5 Differences between Returns
From the above calculation, it indicates that the WEC’s rate of return is lower than that of the market return and industry return. From the short-term perspective, the investors show indifference and even negative attitudes toward the performance of WEC which results in the decrease of the enterprise’s share prices. However, in the long run, the annual growth rate of WEC exceeds that of the market and industry which could contribute to the rising of WEC’s share prices. The chart below may provide evidence for this comparison between WEC, market return and industry return.
3. Valuations
3.1 Theoretical Models and Relating Parameters
First of all, by analysing the annual reports of Spike Network Ltd. for the first 5 financial years, there is no dividend was paid. However, the future dividend and growth rate can still be estimated by referring to similar company’s situation. Here we use the Melbourne IT Limited (MLB) as the peer company since they are both in the Information Technology industry that time and were both listed in 1999. MLB has continuously paid dividends since 2003 to 2010 with growth. Therefore, here decide to use the Constant-Growth Dividend Discount Model to value the share (P0) for Spike Network Ltd.:
P0 = D (1 + g) / r-g
Here, D is the dividend ratio per share in certain period, which can be found in MLB’s annual reports. However, since we want to estimate SPK’s dividends from 1999 to 2003 by referring to MLB’s dividend from 2003 to 2007, the D here needs to be discounted considering the time value of money. To simplify, we assume that discount rate equals to the required rate of return r. And g is the expected growth rate in dividend per share. In order to estimate r, we also need the capital asset pricing model (CAPM):
E(R i) = R f+β [ E(R m) - R f ]
Therefore, there are five parameters to be estimated,
1.Growth rate (g),
2.Risk free rate (R f),
3.Market return (R m),
https://www.sodocs.net/doc/fd6550982.html,pany beta (β) and
5.Expected return/ discount rate (r).
3.1.1 Growth Rate (g)
Growth rate is an important figure which needs to be estimated. Based on the formula:
g = ROE × Plowback ratio
=
=
Here we use the MLB’s financial ratios to estimated SPK’s data,
●2003: g = = 17.97%
●2004: g = = 27.62%
●2005: g = = 35.01%
●2006: g = = 16.14%
●2007: g = = 22.26%
3.1.2 Risk Free Rate ()
In Australia, risk free rate mainly refer to the Reserve Bank of Australia (RBA) 90-day Treasury bond. According to the data we acquired at the end of each financial year from RBA, the estimate the risk-free rate each year were shown as followed:
●2000: = 6.23%
●2001: = 4.97%
●2002: = 5.07%
●2003: = 4.67%
●2004: = 5.49%
3.1.3 Market Return ()
The market return rates can be calculated as follows:
(i) = [1]100%
As the S&P/ASX 200 (XJO) index has not start until 31th March 2000, we use the All Ordinaries Index (XAO) instead to represent the market return, according to the historical data from market index in ASX (1999-2004),
Market return rate can be explored as:
●(2000) = 1)100%= 9.72%
●(2001) = 1)100%= 5.14%
●(2002) = 1)100%= -7.65%
●(2003) = 1)100%= -5.19%
●(2004) = 1)100%= 17.72%
3.1.4 Company Beta (β)
In order to estimate β, we use the historical data of XAO index and company share price for the last 8 years (2000-2007) to calculate this coefficient through excel. Also, as the SPK has changed its company structure and main business in the whole period, it is not appropriate to simply use historical price to estimate the β. Henc e, we acquired the adjusted price (*) for further calculation.
As shown, β is approximately equal to 5.5086.
3.1.5 Expected Return Rate(r)
The required rate of return (r) is achieved from the capital asset pricing model (CAPM):
E(R i) = R f+β [ E(R m) - R f ]
●E() = 6.23% + 5.5086( 9.72% - 6.23%) = 25.46%
●E() = 4.97% + 5.5086( 5.14% - 4.97%) = 5.91%
●E() = 5.07% + 5.5086( -7.65% - 5.07%) = -65%
●E() = 4.67% + 5.5086( -5.19% - 4.67%) = -49.64%
●E() = 5.49% + 5.5086( 17.72% - 5.49%) = 72.86%
However, the expected market returns of 2002 and 2003 are negative, which is inappropriate since if the market cannot provide reasonable return, then investor may rather invest in risk free securities. Therefore, we should use risk free rate to replace the required rate of return in 2002 and 2003, which indicates that E(R_2002)=5.07% and E(R_2003)=4.67%
3.2 Valuation of P0
With the results of r, g, and D the share price can be calculated through the Dividend Discount Model. According to the formula: P0 = D (1 + g) / r-g
Dividends yield in 5 financial years (unit: dollars per share)
In order to make it simple, we ignore the time value of the semi-year dividend. Also, since there is a time gap between the real dividends paid time and our research period; those dividends need to be discounted to reflect the true value. Therefore,
●= 0.026(1+17.97%)/(25.46%-17.97%) = 0.41
●= 0.045(1+27.62%)/(5.91%-27.62%) = -0.265
●= 0.058(1+35.01%)/(-65%-35.01%) = -0.078
●= 0.059(1+16.14%)/(-49.64%-16.14%) = -0.104
●= 0.091(1+22.26%)/(72.86%-22.26%) = 0.22
3.2 Differences between theoretical results and actual market value
Comparing the estimated share price to the actual share price for each year, we can find that most of the results are lower than the market share price, no matter the Pspk or the adjusted price (P2000 and P2004) except the negative three years (P2001-P2003). In other words, the company is overpriced. WEC focus on the network and media industry. The main reason for the overpriced is that the internet bubble during the 2000 to 2004. During that time, the information technology is
considered as the new technology, so millions of investors gripped by the chance and created a mass speculative mania.
From the statistic shown above, investors fancy the prospect of the information technology field at the year 2000, and put millions of money to that field even though the company share price is high. The information technology field develops rapidly, but the increasingly rapid speed is not sustainable. The expected return rate was stable during 2001-2003 but the growth rate was increasing, thus r Another problem is the unrealistic assumption and limitation of the CAPM. This model is the reflection of the reality. The potential assumptions for the real world create these mathematical models. The CAPM Model is based on the unrealistic assumptions and limitations, investors are rational and risk averse, and the CAPM only takes into account of the systematic risk and does not focus on the unsystematic risk. Therefore, the company share price is higher than the estimated value. Share price is overpriced during that time.