How much is MTN
really worth?
Introduction
The
on-going MTN Initial Public Offer (IPO), which was officially launched on the
29th May 2018 and ends on 31st July 2018 with a possible
listing on 5th September 2018, undoubtedly, has brought some much
needed verve to the capital markets scene and among investors after quite a
long period of very little action. As the prospectus states in page 7, the
offer is in fulfillment of the condition precedent by the government of Ghana
for the purchase of the 4G spectrum license that 35% of MTN be offered to
Ghanaians. The organization of the launch and on-going marketing campaign
complemented by the ease with which investors can acquire the shares are truly
commendable and worthy of emulation in future IPOs. However, beyond the
excitement which has greeted this much anticipated share offer, there is the issue around pricing of the IPO which I would like to explore as a market
observer. In more advanced markets, anytime there is an IPO or similar market
activity, there is always a lot of analysis and commentary on it facilitating
market efficiency and educating investors in the process. It is in this spirit
that I believe my comments should be received.
My "teacher" (if watching his youtube videos counts for that) in Corporate Finance, Aswath Damodaran, Professor of Finance at the
Stern School of Business (New York University), makes a distinction between
Valuation and Pricing when it comes to publicly listed companies. He asserts
that Investment bankers don’t necessarily value a company but determine a price
they believe they can sell the shares for. This is the context in which all
IPOs must be analyzed. Which also means that investors, both retail and
institutional, must do their homework before buying these shares. This brings the
issue of bias in Valuation to the fore. In spite of the quantitative approaches
used in valuing companies, it is also very much an art as it is a science. To
account for bias, he advises investors in shares to answer the question for
themselves of who is doing the valuation since the interests of buyers and
sellers of a share in a company are not necessarily aligned: sellers are most
likely to value the shares aggressively whilst buyers are most likely to value
these shares conservatively. With this background, I would like to use the MTN
IPO as a case study of this phenomenon.
Is MTN fairly valued or aggressively
priced?
According to Damodaran, there are,
broadly, three main valuation approaches: 1) Discounted Cash Flow/Intrinsic
Valuation, 2) Relative Valuation, and 3) Real Option Valuation. These are
deployed depending on the context of the valuation but they tend to be used
together. In solving complex problems or situations, there is a very effective
technique used called Occam’s razor or rule. It asserts that: “… When presented with competing hypotheses
to solve a problem, one should select the solution with the fewest assumptions[1].”
Valuation is one of the most complex undertakings anyone would ever undertake
because it requires one to make a judgement about the future trend of several
variables of a firm to arrive at an estimate of value which is prone to error.
This makes Occam’s razor a very useful framework when doing valuations. In
using it as a tool in my valuation of MTN, I have selected the Dividend
Discount Model (DDM), also referred to as the Gordon Growth model, which is
based on Discounted Cash Flows (DCF) as my valuation model to calculate the
intrinsic value of the MTN share being mindful that there are other ways of
doing so. However, in my view, for DDM’s shear simplicity and intuitive nature,
and also because of MTN’s consistent dividend payout record, I think my choice
is justified. After all, for all the other approaches, they cannot guarantee
that their estimates are any more accurate than mine. In fact, I am convinced
that in this I have an edge over them because, consistent with Occam’s razor, I
am attempting this using the fewest possible assumptions to limit my error
margin. To compensate, I will do this over a range of possible values to get a
sense of the lower and upper bands.
So,
briefly, what is the Dividend Discount Model[2]? It is essentially just a simple mathematical
equation that is supposed to produce a result for the value of a stock.
Basically, one must first select a company that pays a dividend and also choose
how much of a return they would like to see from that investment. So this is how
it works: Price equals forecasted dividends divided by the expected rate of
return minus the dividend growth rate.
Price = Dividends
Expected Return (r) – Dividend Growth Rate
(g)
The
purpose of using this model is to give an accurate value to the stock based on
what it pays out as a dividend. There are some assumptions that one must plug
in to the model to make it work, but once those assumptions are plugged in all
of the guesswork is done. The model will just churn out a number for what the
price of the stock should be and you are on your way. Simple, right? Yep, but this
comes with a tradeoff which is sort of a draw back. The main ones being: 1) not
all companies are dividend-paying and so may not be suitable for growth
companies and 2) it assumes dividends continue to grow at the same rate
forever. Clearly, no company lives forever. It will either be overtaken by
industry dynamics or by another firm. There are other critiques but I consider
these to be the most salient. So in spite of this, why am I still using DDM?
Because it’s a good starting point for valuing a company like MTN. It provides
a good baseline for one to build on.
Dividend
Valuation Model
Fig. 1
Based
on the above, it is quite clear that in analyzing the MTN share offer, an
investor must answer two key questions: 1) What return one expects from MTN as
a Going Concern, and 2) How fast will its dividend grow in the years ahead.
Based on the scenario analysis above, one would have to be extremely bullish on
MTN’s growth prospects to justify the initial share price of GHS 0.75.
[1]
https://en.wikipedia.org/wiki/Occam%27s_razor
[2]
https://www.suredividend.com/pros-cons-dividend-discount-model/
