I am at the moment trying to value Activision Blizzard. I did some research with regards to which method I should use to value the company, either WACC (DCF) or APV. In my studies, I found that WACC should be used if the firm keeps a relatively constant capital structure or if the firm targets a specific capital structure in the future. I have some questions:
1 - How much is “relatively constant”? Activision has been changing its D/E ratio lately (Q4 2015-0,5; Q1 2016-0,7; Q2 2016-0,59; Q3 2016-0,72; Q4 2016-0,54) but I am not sure if that change is enough for the use of APV. Also note that the values I provide represents Book Values and from what I have read the “constant capital structure” should be in market values.
2 - How do I know which capital structure a company wants to achieve in the future? Is it stated in the SEC Fillings?I have read some books and sometimes it is assumed that the target capital structure will be the same as the capital structure of the closest peers even though that might not be true.
Have you gotten the cash flows right first? If not, I would spend a good amount of time doing this first. Too often analysts spend too much time trying to get to a discount rate when it is even more important to dig deep into making sure things like capitalizing vs expensing items are adjusted for, as well as treating operating leases as debt just for an example.
The video below is great and I truly think Damodaran is one of the greatest firm valuation experts of our time:
To answer about discount rates though, perhaps you could take an average of those WACCs and use that as your rate? I would be careful to use any “suggested future target capital structure” figures if they are provided by management, even if you are able to find them in filings because there may be bias in statements about the future and obviously they could change materially over time. I think really all you can do is take an average, use an industry average, or a comparable firm’s WACC. Depends on what you personally feel will best drive your thesis.
There is no time like the present and I think current market values of debt and equity are probably best. In addition to the link I shared, you will see he has other videos in a whole series where he is wearing that red sweater. There is one on discount rates as well. If you haven’t watched that series, I highly suggest it.
From what I could figure from the latest reports, management does not provide figures for future capital structure. So, I guess my best bet is to check peers and check the current capital structure. From historical analysis in the latest years, I could figure out that Activision’s debt is always around $4m. However, the company has so much cash that the value of debt is almost offset, thus making net debt as a % of total capitalization around 5%.
Thanks for suggesting Damondaran. It was actually the first professor I checked when I started valuing the company.