WEBVTT 1 00:00:01.900 --> 00:00:05.760 The aim of the introductory module was to give you some information 2 00:00:05.820 --> 00:00:09.200 about the company itself and the structure of the case. 3 00:00:09.240 --> 00:00:12.480 Now, we are ready for the first step of this LBO 4 00:00:12.540 --> 00:00:15.580 analysis, which is a financial analysis of the 5 00:00:15.620 --> 00:00:16.900 target. 6 00:00:18.820 --> 00:00:20.520 I propose you the following agenda. 7 00:00:20.920 --> 00:00:24.060 First, we are going to read the income statement. 8 00:00:24.100 --> 00:00:27.300 Before calculating any ratio, we have to read the income 9 00:00:27.400 --> 00:00:31.360 statement and understand the relative strengths of each and every 10 00:00:31.500 --> 00:00:35.480 item. Same story for the cash flow statement, and same 11 00:00:35.560 --> 00:00:38.140 story also for the financial balance sheet. 12 00:00:38.600 --> 00:00:42.390 We are going to read the balance sheet, assets and equity and 13 00:00:42.460 --> 00:00:46.340 liabilities. We are going to transform the accounting balance sheet into a 14 00:00:46.400 --> 00:00:49.520 financial balance sheet, and we are going to interpret the 15 00:00:49.560 --> 00:00:53.200 figures. Last but not least, we are going to calculate the return on 16 00:00:53.320 --> 00:00:57.310 sales, the return on capital, estimating the commercial and economic 17 00:00:57.400 --> 00:00:59.480 profitability of the company. 18 00:01:01.880 --> 00:01:05.410 Let's first read the P&L, and as a first step, from the 19 00:01:05.481 --> 00:01:08.940 turnover to the operating profit, from operating 20 00:01:09.040 --> 00:01:12.800 revenues to operating income. The figures which are available 21 00:01:12.920 --> 00:01:16.390 are full years, with details from eighty-five to 22 00:01:16.500 --> 00:01:20.100 eighty-eight. Then, as far as eighty-nine is concerned, it's 23 00:01:20.160 --> 00:01:23.970 about estimated figures because it's the year the transaction is 24 00:01:23.980 --> 00:01:26.960 taking place, and we just have estimates. 25 00:01:26.980 --> 00:01:29.190 We start with the operating revenues. 26 00:01:29.200 --> 00:01:32.280 The operating revenues are split into two parts: 27 00:01:33.180 --> 00:01:37.020 revenues, sales, production, which is sold to the customers, 28 00:01:37.080 --> 00:01:40.900 and capitalized production. Capitalized means that the company is 29 00:01:40.960 --> 00:01:44.820 spending some money to produce machines, which are going to be offered to 30 00:01:44.840 --> 00:01:48.780 the customers. We don't have the split for eighty-five, eighty-six. 31 00:01:48.820 --> 00:01:52.460 We have the split for eighty-seven and eighty-eight. 32 00:01:52.560 --> 00:01:56.220 What do we observe? We observe that the company is growing. 33 00:01:56.640 --> 00:02:00.460 The business looks a little bit mature at first sight, but the growth rates 34 00:02:00.480 --> 00:02:04.060 are ten percent and ten percent and eighteen percent and ten 35 00:02:04.140 --> 00:02:07.980 percent. So the first observation we can make is that the 36 00:02:08.060 --> 00:02:11.300 company is growing in terms of sales. 37 00:02:11.320 --> 00:02:14.630 It's a commercial success. Once we have the operating 38 00:02:14.680 --> 00:02:18.630 revenues, we deduct the operating expenses, and then we make 39 00:02:18.680 --> 00:02:22.180 the split between cash operating expenses and non-cash 40 00:02:22.340 --> 00:02:25.370 items. Non-cash items is depreciation and 41 00:02:25.400 --> 00:02:29.300 amortization. Cost of sales. In the cost of sales, you don't have 42 00:02:29.320 --> 00:02:32.950 any depreciation and amortization, so it's about, 43 00:02:33.040 --> 00:02:36.200 uh, equipment, supplies, and so on and so forth. 44 00:02:36.360 --> 00:02:40.210 Wages and salaries, labor-related expenses, operating 45 00:02:40.300 --> 00:02:43.760 taxes, different from the income tax, of course, some 46 00:02:43.800 --> 00:02:47.660 provisions, some other operating expenses, and cash operating 47 00:02:47.740 --> 00:02:51.600 revenues minus cash operating expenses is a cash operating profit, 48 00:02:51.640 --> 00:02:55.120 well-known EBITDA. EBITDA is extremely 49 00:02:55.200 --> 00:02:59.109 important in the valuation of the company because it's a pillar of the 50 00:02:59.180 --> 00:03:02.400 calculation of the free cash flow to the firm. 51 00:03:02.440 --> 00:03:06.140 Now, EBITDA is before interest and taxes and depreciation and 52 00:03:06.160 --> 00:03:10.020 amortization. Then you depreciate in order to 53 00:03:10.120 --> 00:03:14.040 get the operating income, the EBIT, which is going to be very 54 00:03:14.100 --> 00:03:18.000 important in the calculation of the return on sales and on the return 55 00:03:18.040 --> 00:03:20.800 on capital. 56 00:03:21.780 --> 00:03:24.820 Let's make a first wrap-up about the observation and the reading of the 57 00:03:24.860 --> 00:03:28.700 P&L. The revenues are up. The CAGR is 58 00:03:28.980 --> 00:03:32.880 the average twelve percent per annum, which is quite significant, 59 00:03:32.920 --> 00:03:36.820 but this is in nominal terms. It's not in real terms. 60 00:03:36.880 --> 00:03:40.840 In order to understand really the evolution of the company in 61 00:03:40.860 --> 00:03:43.240 real terms, we have to deduct inflation. 62 00:03:43.280 --> 00:03:46.720 And what's very interesting to observe is that the average inflation of the period 63 00:03:46.780 --> 00:03:50.700 is three percent. So when revenues on the average are 64 00:03:50.840 --> 00:03:54.320 up by twelve and inflation is three, it means that the 65 00:03:54.460 --> 00:03:58.250 real increase in the revenues is nine percent per annum, which 66 00:03:58.280 --> 00:04:01.540 is really a tremendous commercial success. 67 00:04:01.600 --> 00:04:05.340 Now, in nominal terms, the revenues are up by fifty-seven 68 00:04:05.440 --> 00:04:08.820 percent, the EBITDA is up by eighty-eight 69 00:04:08.920 --> 00:04:12.380 percent, and the EBIT by one hundred and twenty-six 70 00:04:12.460 --> 00:04:16.079 percent. So as a consequence of growth, probably the 71 00:04:16.120 --> 00:04:19.370 company is generating extremely interesting economies of 72 00:04:19.399 --> 00:04:23.100 scale, and the growth in the revenue is 73 00:04:23.140 --> 00:04:26.300 boosting the growth in the profit. 74 00:04:26.340 --> 00:04:30.240 So it's a commercial success, and it's very profitable as 75 00:04:30.280 --> 00:04:33.280 far as the commercial profitability is concerned. 76 00:04:35.320 --> 00:04:38.600 Let's now have a look at the second part of the P&L. 77 00:04:38.660 --> 00:04:42.360 From operating profit, from EBITDA to net income to the bottom 78 00:04:42.400 --> 00:04:42.700 line. 79 00:04:43.580 --> 00:04:47.440 You remember that the EBITDA is positive and is growing 80 00:04:47.500 --> 00:04:50.140 from sixty-nine to one hundred and thirty. 81 00:04:50.180 --> 00:04:53.840 Depreciation and amortization is consuming a significant part of the 82 00:04:53.880 --> 00:04:57.690 EBITDA. EBITDA is before 83 00:04:57.690 --> 00:05:01.460 depreciation, so before investment, because at the end of the day, depreciation and 84 00:05:01.480 --> 00:05:05.180 amortization is a consequence of capital expenditures on 85 00:05:05.240 --> 00:05:08.630 industrial investment. And the figure, DA, is 86 00:05:08.640 --> 00:05:11.880 consuming about half of the EBITDA, which is quite 87 00:05:11.940 --> 00:05:15.640 significant. Now, the operating income from thirty-one to 88 00:05:15.700 --> 00:05:19.520 seventy, more than doubling, and the EBIT 89 00:05:19.740 --> 00:05:23.720 is before interest and taxes. Then we have to deduct the interest, and we 90 00:05:23.760 --> 00:05:27.660 have to deduct the taxes. The financial result is almost 91 00:05:27.740 --> 00:05:31.640 zero during three years and then positive, which means that the 92 00:05:31.700 --> 00:05:35.180 company has more cash than financial debt and is 93 00:05:35.240 --> 00:05:38.790 receiving more financial income than it pays 94 00:05:38.860 --> 00:05:42.480 financial expenses, which is very important in the 95 00:05:42.540 --> 00:05:44.700 financing structure of the company. 96 00:05:44.740 --> 00:05:47.640 Exceptional items is really exceptional. 97 00:05:47.680 --> 00:05:51.660 Sometimes it's negative, sometimes it's positive, but it's a very 98 00:05:51.680 --> 00:05:55.520 negligible figure. Profit before income tax, and then 99 00:05:55.560 --> 00:05:59.120 we pay the taxes, which is a percentage of the profit 100 00:05:59.140 --> 00:06:02.520 before income tax. The net income is a bottom 101 00:06:02.560 --> 00:06:06.240 line, and the bottom line is also nicely growing 102 00:06:06.300 --> 00:06:08.160 from fourteen to 103 00:06:08.300 --> 00:06:12.230 forty-two.... 104 00:06:12.239 --> 00:06:16.010 So on wrap up about the P&L. It's really a commercial 105 00:06:16.090 --> 00:06:18.710 success, but it's really a financial success. 106 00:06:19.250 --> 00:06:22.660 We have slightly positive financial results, which is the 107 00:06:22.710 --> 00:06:25.550 consequence of cash, which is exceeding the financial 108 00:06:25.670 --> 00:06:29.650 debt. The exceptional items on the average is very close 109 00:06:29.690 --> 00:06:32.770 to zero, and the net income is multiplied by 110 00:06:32.810 --> 00:06:36.600 three. So we have an increase in, uh, 111 00:06:36.630 --> 00:06:40.550 revenues, and this increase is boosted if you transform that 112 00:06:40.610 --> 00:06:43.790 into increase in EBITDA, then EBIT, then net 113 00:06:43.870 --> 00:06:47.670 income. So definitely, the P&L looks absolutely great for 114 00:06:47.730 --> 00:06:49.350 this company. 115 00:06:51.230 --> 00:06:54.370 We have observed that the net income is positive and the net income is 116 00:06:54.410 --> 00:06:58.370 growing, but net income is not cash for a number of 117 00:06:58.410 --> 00:07:01.990 reasons. The first reason is, in the calculation of the net 118 00:07:02.010 --> 00:07:05.950 income, we deduct a cost, which is a non-cash item, depreciation 119 00:07:05.970 --> 00:07:09.870 and amortization. So if we want to understand how you transform the net 120 00:07:09.930 --> 00:07:13.890 income into change in a cash position, you first have to 121 00:07:13.990 --> 00:07:16.790 add depreciation and amortization. 122 00:07:16.810 --> 00:07:19.990 So net income plus depreciation and amortization 123 00:07:20.290 --> 00:07:23.410 is minus depreciation, plus depreciation, you 124 00:07:23.630 --> 00:07:27.350 offset. And at the end of the day, you get something which is gross cash flow, but 125 00:07:27.430 --> 00:07:30.970 which is more or less EBITDA, minus interest, 126 00:07:31.170 --> 00:07:34.610 minus taxes. That's quite interesting, but that's not yet 127 00:07:34.750 --> 00:07:38.090 cash, because you have to take into account the transformation from the 128 00:07:38.130 --> 00:07:41.890 potential cash into actual cash. And this is done 129 00:07:41.950 --> 00:07:45.130 by deducting the change in a working capital 130 00:07:45.350 --> 00:07:49.210 requirement, which is going to be a very important item in 131 00:07:49.290 --> 00:07:53.150 this case. Then you get real cash from business operations, which 132 00:07:53.190 --> 00:07:56.770 is namely operating cash flow. Then you can finance your 133 00:07:56.830 --> 00:08:00.190 capital expenditures. Net of divestment, you get the free cash 134 00:08:00.210 --> 00:08:04.090 flow, and then you have to take into account the financial strategy in order 135 00:08:04.150 --> 00:08:07.410 to get to the bottom line of the cash flow statement, the change in cash 136 00:08:07.510 --> 00:08:11.030 position. Let's observe what happens in this 137 00:08:11.040 --> 00:08:14.610 company. First, net income is up, no change. 138 00:08:14.650 --> 00:08:18.590 Then we add depreciation and amortization, which is growing because the company is 139 00:08:18.609 --> 00:08:22.490 growing and investing more. The gross cash flow moves from 140 00:08:22.830 --> 00:08:25.650 sixty-three to one hundred and two. 141 00:08:25.670 --> 00:08:29.510 But what is very interesting to observe is that the minus change in working 142 00:08:29.610 --> 00:08:33.350 capital requirement is, except in eighty-seven, 143 00:08:33.410 --> 00:08:37.170 positive. So the change in the working capital requirement is a 144 00:08:37.211 --> 00:08:40.530 resource, and then the working capital requirement in 145 00:08:40.610 --> 00:08:44.071 absolute terms, is growing as a consequence of growth in the 146 00:08:44.110 --> 00:08:46.959 revenues, but it is a negative figure. 147 00:08:47.030 --> 00:08:50.790 This is why the absolute increase is transforming to a 148 00:08:50.850 --> 00:08:53.850 resource and not into a use of funds. 149 00:08:53.870 --> 00:08:57.470 Then the operating cash flow is more than the gross cash 150 00:08:57.510 --> 00:09:01.050 flow. It's by far paying the capital expenditures. 151 00:09:01.090 --> 00:09:04.990 CapEx is more than depreciation, because depreciation is the CapEx of 152 00:09:05.030 --> 00:09:08.490 yesterday, and CapEx is more today because the company is 153 00:09:08.530 --> 00:09:11.630 growing, and then the free cash flow of the company is 154 00:09:11.930 --> 00:09:15.590 nice, beautiful, positive, and growing. 155 00:09:15.610 --> 00:09:18.990 Then you have a negligible change in long-term debt, 156 00:09:19.170 --> 00:09:22.130 negligible other items. And what do you observe? 157 00:09:22.140 --> 00:09:25.570 There is no equity issue because you don't need equity, but there is 158 00:09:25.730 --> 00:09:29.470 no dividend payment. This is why this free cash flow 159 00:09:29.570 --> 00:09:33.290 is almost entirely transformed into a change in a cash 160 00:09:33.330 --> 00:09:37.170 position, which is absolutely fundamental to understand the 161 00:09:37.210 --> 00:09:40.750 rationality of this LBO. 162 00:09:41.530 --> 00:09:43.850 A wrap up on the cash flow statement. 163 00:09:43.890 --> 00:09:46.650 From net income to change in cash position. 164 00:09:46.710 --> 00:09:50.250 Net income is up. Depreciation is up 165 00:09:50.490 --> 00:09:53.920 because the company is growing and because it's investing more. 166 00:09:53.930 --> 00:09:57.750 But what is extremely interesting is that the changes in the working capital 167 00:09:57.790 --> 00:10:00.710 requirement are not a consumption of cash, it's a 168 00:10:00.810 --> 00:10:04.470 resource, and that's a consequence of a negative working 169 00:10:04.570 --> 00:10:07.970 capital requirement in a growing environment. 170 00:10:07.990 --> 00:10:10.210 The investments are relatively stable. 171 00:10:10.230 --> 00:10:13.930 You are simply building up the portfolio of the machinery, the 172 00:10:14.010 --> 00:10:16.850 machines you are going to lease to your customers. 173 00:10:16.870 --> 00:10:20.670 But the gross cash flow is transforming to operating cash flow, and 174 00:10:20.710 --> 00:10:23.950 by far it pays for the capital expenditures. 175 00:10:23.970 --> 00:10:27.410 And as the company is paying absolutely no dividend to its 176 00:10:27.490 --> 00:10:31.170 shareholders, there's a significant and stable cash 177 00:10:31.249 --> 00:10:34.910 generation, which is absolutely fundamental when you consider 178 00:10:35.170 --> 00:10:37.670 a leveraged buyout. 179 00:10:39.890 --> 00:10:43.250 Now, let's have a look at the balance sheet, which is absolutely fundamental in the 180 00:10:43.410 --> 00:10:47.230 structuration of the case. First, we are going to do exactly the 181 00:10:47.290 --> 00:10:50.970 same with the balance sheet as what we did with the P&L and the cash flow 182 00:10:51.010 --> 00:10:54.990 statement. We are going to read both sides of the balance sheet, the assets 183 00:10:55.230 --> 00:10:58.910 on one side and the equity and liabilities on the other side. 184 00:10:58.930 --> 00:11:02.470 But then we are going to transform the accounting balance sheet 185 00:11:02.810 --> 00:11:06.470 into a financial balance sheet, and there will be some adjustments 186 00:11:06.970 --> 00:11:10.930 leading to concepts like capital employed and net financial 187 00:11:10.970 --> 00:11:14.910 resources. Capital employed is absolutely fundamental to calculate the 188 00:11:14.970 --> 00:11:18.250 return on capital employed, the economic performance of the 189 00:11:18.290 --> 00:11:21.750 company. There is another set of concepts which are quite 190 00:11:21.770 --> 00:11:25.610 important. The working capital, to which extent your 191 00:11:25.690 --> 00:11:29.050 permanent resources are financing these 192 00:11:29.130 --> 00:11:32.890 long-term assets. Then working capital and working 193 00:11:32.950 --> 00:11:36.740 capital requirement are combined in order to get the net cash 194 00:11:36.850 --> 00:11:40.730 position, and we are going to do some interpretation of these 195 00:11:40.770 --> 00:11:42.510 transformations. 196 00:11:44.390 --> 00:11:46.710 Let's start with the asset side of the balance sheet. 197 00:11:47.130 --> 00:11:50.890 You remember that the balance sheet is split into two categories of assets: the 198 00:11:50.950 --> 00:11:54.630 long-term assets, the non-current assets, and the short-term, the current 199 00:11:54.690 --> 00:11:58.630 assets. As far as non-current assets are concerned, there are 200 00:11:58.670 --> 00:12:02.390 two lines here: property, plant, and equipment, tangible assets, net of 201 00:12:02.430 --> 00:12:06.110 accumulated depreciation, which is definitely the dominant 202 00:12:06.310 --> 00:12:10.300 item in the non-current assets. Non-current financial asset is a little 203 00:12:10.300 --> 00:12:13.160 bit growing, but quite negligible. 204 00:12:13.160 --> 00:12:17.050 The big chunk of money is invested in, in tangible assets, which is basically the 205 00:12:17.130 --> 00:12:20.664 machines which are offered to the customers.... 206 00:12:20.664 --> 00:12:24.503 Then as far as current assets are concerned, the inventories are growing 207 00:12:24.894 --> 00:12:27.054 simply because production is growing. 208 00:12:27.094 --> 00:12:30.814 Trade accounts receivable are growing because the sales are growing. 209 00:12:30.874 --> 00:12:34.574 Other current assets about prepared expenses, and they are also growing with the 210 00:12:34.654 --> 00:12:38.614 activity. But what is extremely interesting to observe in the current 211 00:12:38.694 --> 00:12:41.154 assets is the accumulation of cash. 212 00:12:41.174 --> 00:12:45.014 The company is generating a lot of cash, is transforming this cash, 213 00:12:45.054 --> 00:12:49.014 thanks to the negative working capital requirement, is generating much 214 00:12:49.054 --> 00:12:52.854 more cash than what it needs for capital expenditures, and pays no 215 00:12:52.894 --> 00:12:56.494 dividend. Then, as a consequence, the cash which is 216 00:12:56.534 --> 00:13:00.274 generated by the company is accumulated in the bank account of the 217 00:13:00.334 --> 00:13:04.314 company. If you look at the asset side of the balance sheet, you have two 218 00:13:04.574 --> 00:13:08.104 main items: property, plant, and equipment, and 219 00:13:08.154 --> 00:13:10.114 cash. 220 00:13:11.314 --> 00:13:14.434 Quick wrap-up on the asset side of the balance sheet. 221 00:13:14.454 --> 00:13:18.014 Property, plant, and equipment, tangible fixed assets, net of accumulated 222 00:13:18.074 --> 00:13:21.874 depreciation, is simply the fleet of the leased machines, 223 00:13:21.934 --> 00:13:22.694 machinery. 224 00:13:23.534 --> 00:13:27.234 Then we have the net income, the profit, which is growing, and is 225 00:13:27.294 --> 00:13:30.714 growing with, uh, depreciation, which is increasing as a 226 00:13:30.754 --> 00:13:33.514 consequence of CapEx, which are increasing. 227 00:13:33.554 --> 00:13:37.484 So the cash flow is nicely increasing, and there's 228 00:13:37.534 --> 00:13:41.274 no dividend which is paid. So as a consequence, the company 229 00:13:41.414 --> 00:13:45.134 is generating a lot of earnings. All these 230 00:13:45.234 --> 00:13:48.714 earnings are reinvested. The consequence is accumulation of 231 00:13:48.994 --> 00:13:52.674 cash. Then there is a substantial cash reserve in the 232 00:13:52.694 --> 00:13:56.574 company, and you can question: Why do you keep this cash? 233 00:13:56.614 --> 00:14:00.344 The answer is not given in the case, but what we know is that 234 00:14:00.434 --> 00:14:03.714 this cash will have a huge impact on the 235 00:14:03.794 --> 00:14:07.474 valuation of the company, on the valuation process, and on the 236 00:14:07.534 --> 00:14:10.814 financing of the holding. 237 00:14:11.954 --> 00:14:15.894 Interestingly, when you read the equity and liability side of the 238 00:14:16.014 --> 00:14:18.004 balance sheet, you get to the same conclusion. 239 00:14:18.034 --> 00:14:21.914 There are two main items. The first one is shareholders' equity. 240 00:14:21.934 --> 00:14:25.914 Shareholders' equity is made of capital plus additional paid-in capital. 241 00:14:25.994 --> 00:14:29.714 Stable, no equity issue. Plus, retained earnings are-- that's 242 00:14:29.754 --> 00:14:33.274 growing because the company is generating profits, more and more 243 00:14:33.354 --> 00:14:36.974 profits, and reinvests one hundred percent of its profit 244 00:14:37.054 --> 00:14:39.634 because it does not pay any dividend. 245 00:14:39.674 --> 00:14:43.574 Non-current provisions about provisions for risks and charges will be linked to 246 00:14:43.614 --> 00:14:47.114 the business operations, so it's a little bit up, but not that 247 00:14:47.154 --> 00:14:51.094 big. Long-term debt is negligible and stable, and 248 00:14:51.234 --> 00:14:54.954 all these make the permanent resources, resources for which the 249 00:14:54.994 --> 00:14:58.334 maturity is more than one year. And you understand that it's 250 00:14:58.354 --> 00:15:02.294 predominantly about shareholders' equity, one hundred and seventy-one 251 00:15:02.374 --> 00:15:05.414 out of two hundred and four. Then you have the current 252 00:15:05.474 --> 00:15:08.814 liabilities, trade accounts payable, consequence of 253 00:15:09.094 --> 00:15:12.754 purchases, supplies, other current liabilities, what is due 254 00:15:12.794 --> 00:15:16.674 to, et cetera. But what is very important is the deferred revenue 255 00:15:16.774 --> 00:15:20.654 figure. Deferred revenue means that the customers are paying before 256 00:15:20.754 --> 00:15:24.154 actually using the service. So you receive the 257 00:15:24.274 --> 00:15:27.974 cash before they start. They pay the rent for the 258 00:15:28.014 --> 00:15:30.334 machine before they use the machine. 259 00:15:30.374 --> 00:15:34.014 Then you are going to progressively transform this deferred revenue, which is 260 00:15:34.094 --> 00:15:37.794 cash, into actual revenue in the P&L. 261 00:15:37.854 --> 00:15:41.174 But first, it's deferred revenue, and definitely it's cash. 262 00:15:41.674 --> 00:15:45.514 And if you remember that there are one hundred and ten million of cash on the asset 263 00:15:45.574 --> 00:15:48.734 side of the balance sheet, you understand that it comes from the deferred 264 00:15:48.794 --> 00:15:52.394 revenue. Then you make the sum of permanent resources and current 265 00:15:52.454 --> 00:15:56.234 liabilities, and you get total equity and liabilities, which 266 00:15:56.294 --> 00:16:00.254 obviously matches with the total asset side of the balance 267 00:16:00.314 --> 00:16:00.834 sheet. 268 00:16:03.634 --> 00:16:07.274 The consequence of this reading of equity and liabilities is you 269 00:16:07.294 --> 00:16:11.054 observe that equity is increasing, but it's increasing with a net 270 00:16:11.114 --> 00:16:15.054 income, which is fully reinvested, because no dividend, again and again, 271 00:16:15.074 --> 00:16:19.034 is paid to the shareholders. Deferred revenue is a rent which is 272 00:16:19.074 --> 00:16:22.684 paid in advance by the customers, and it matches... 273 00:16:22.714 --> 00:16:26.274 It generates a cash, which shows on the asset side of the balance 274 00:16:26.354 --> 00:16:30.054 sheet. This is absolutely great because you receive the cash before 275 00:16:30.114 --> 00:16:33.634 revenue and before profits and revenues are 276 00:16:33.694 --> 00:16:36.434 recognized in the P&L. 277 00:16:38.654 --> 00:16:42.433 Now, we need to make some adjustments in order to transform the accounting 278 00:16:42.514 --> 00:16:46.094 balance sheet into a financial balance sheet and introduce 279 00:16:46.334 --> 00:16:48.754 interesting concepts as a working capital. 280 00:16:49.654 --> 00:16:53.374 So after that, we are going to be able to run the financial analysis of the 281 00:16:53.434 --> 00:16:56.754 company, understand its financial strategy, and try to 282 00:16:56.794 --> 00:17:00.694 identify the level of liquidity risk of the company, which 283 00:17:00.734 --> 00:17:04.434 is definitely the objective of the working capital. 284 00:17:04.474 --> 00:17:07.174 The first concept which we use in finance is capital employed. 285 00:17:07.214 --> 00:17:11.154 Capital employed is also named invested capital, and it's a kind of net 286 00:17:11.295 --> 00:17:14.274 operating assets, operating assets net of operating 287 00:17:14.354 --> 00:17:17.904 liabilities. So basically, you take the uh, asset side of the 288 00:17:18.014 --> 00:17:21.835 balance sheet, you exclude cash, which is not an operating asset, it's a financial 289 00:17:21.874 --> 00:17:25.614 asset, and you deduct from that all the operating liabilities, be 290 00:17:25.674 --> 00:17:29.244 they current or non-current. So it's net operating 291 00:17:29.334 --> 00:17:33.134 assets and capital employed. In front of that, you have the net 292 00:17:33.214 --> 00:17:36.634 financial resources. Operating means business operations. 293 00:17:36.694 --> 00:17:40.074 Financial means capital markets related. 294 00:17:40.114 --> 00:17:43.534 In the net financial resources, obviously, you have the shareholders' equity, but 295 00:17:43.574 --> 00:17:47.094 you also have the financial debt. But the financial debt net of 296 00:17:47.394 --> 00:17:51.274 cash, because you can repay your financial liabilities with the cash 297 00:17:51.314 --> 00:17:54.934 which is in the bank account. And mechanically, technically, the 298 00:17:54.994 --> 00:17:58.914 capital employed, net operating assets, are absolutely matching 299 00:17:58.954 --> 00:18:00.854 with the net financial resources. 300 00:18:01.214 --> 00:18:04.434 You just take the balance sheet, and you move items from one side to the 301 00:18:04.514 --> 00:18:07.954 other. Then capital employed is non-current fixed 302 00:18:08.094 --> 00:18:11.814 assets, plus the working capital requirement, which is made 303 00:18:11.974 --> 00:18:15.814 of operating assets, current operating assets, minus the 304 00:18:15.894 --> 00:18:19.474 current operating liabilities. What about the non-current 305 00:18:19.534 --> 00:18:23.174 operating liabilities?... is not directly related with the 306 00:18:23.234 --> 00:18:26.944 operating cycle working capital requirement, then 307 00:18:26.994 --> 00:18:30.294 the long-term operating liabilities deserve a separate line in the 308 00:18:30.334 --> 00:18:33.014 calculation of the capital employed. 309 00:18:33.094 --> 00:18:36.334 Net financial resources is equity plus net financial 310 00:18:36.414 --> 00:18:39.934 debt. Net financial debt is long-term plus short-term financial 311 00:18:40.054 --> 00:18:43.554 debt, net of cash. And again, capital 312 00:18:43.614 --> 00:18:46.834 employed equals net financial resources. 313 00:18:47.574 --> 00:18:51.474 Working capital is an extremely interesting concept as far as liquidity is 314 00:18:51.494 --> 00:18:55.174 concerned. Uh, the heart of the company is its 315 00:18:55.254 --> 00:18:59.014 non-current assets. It's the ability of the company to transform raw 316 00:18:59.074 --> 00:19:03.034 materials into finished goods and create value for the customers. 317 00:19:03.044 --> 00:19:06.674 So you have to protect the non-current assets because they're absolutely not 318 00:19:06.814 --> 00:19:10.274 liquid assets. So they should not be financed with 319 00:19:10.574 --> 00:19:14.014 short-term financial and operating resources. 320 00:19:14.034 --> 00:19:17.474 Then they should be financed by long-term permanent 321 00:19:17.574 --> 00:19:21.314 capital, which is made of shareholders' equity and 322 00:19:21.454 --> 00:19:24.894 long-term liabilities, operating liabilities, and financial 323 00:19:24.934 --> 00:19:28.394 debt. The net between permanent capital and 324 00:19:28.434 --> 00:19:30.954 non-current asset is named working capital, 325 00:19:31.814 --> 00:19:35.474 and it should be positive. Otherwise, it means that you're financing your 326 00:19:35.514 --> 00:19:38.964 manufacturing footprint with bank overdraft, which is 327 00:19:39.074 --> 00:19:42.834 absolutely dramatic. Now, technically, you calculate the 328 00:19:42.854 --> 00:19:45.734 working capital and you deduct the working capital 329 00:19:45.814 --> 00:19:49.514 requirement. You get cash minus short-term 330 00:19:49.674 --> 00:19:53.434 financial debt, which is named the net cash or the net cash position of the 331 00:19:53.474 --> 00:19:57.364 company. Then we are going to make all these calculations and 332 00:19:57.414 --> 00:20:00.154 observe, interpret what it means for 333 00:20:00.314 --> 00:20:01.954 SECAP. 334 00:20:03.994 --> 00:20:07.914 Here you can see the capital employed, which is matching with the net financial 335 00:20:07.974 --> 00:20:11.914 resources, which is no surprise, just mechanical stuff. 336 00:20:11.934 --> 00:20:15.734 But it's very interesting to observe that non-current assets are up 337 00:20:16.114 --> 00:20:19.874 as a consequence of growth, capitalization, 338 00:20:19.934 --> 00:20:23.354 property, plant, and equipment. But the working capital 339 00:20:23.394 --> 00:20:27.354 requirement is negative. So when you add 340 00:20:27.554 --> 00:20:31.374 the working capital requirement, you add a negative figure. 341 00:20:31.434 --> 00:20:35.134 So the working capital requirement is financing a significant chunk of the 342 00:20:35.194 --> 00:20:39.014 non-current assets. Minus non-current liabilities, 343 00:20:39.154 --> 00:20:42.674 non-current provisions, you get to the capital employed. 344 00:20:43.074 --> 00:20:46.784 And shareholders' equity, you remember, is a very high figure and 345 00:20:46.834 --> 00:20:50.714 it's financing the company. But it's more than financing the 346 00:20:50.734 --> 00:20:54.354 company, it's financing the cash, if I may say, because the net financial debt is 347 00:20:54.434 --> 00:20:58.064 strongly negative. You remember that the long-term debt 348 00:20:58.274 --> 00:21:02.214 is negligible, and you remember that the cash position is absolutely 349 00:21:02.294 --> 00:21:05.714 fantastic. So the net financial debt is negative. 350 00:21:05.734 --> 00:21:09.574 The company is a negative leverage, negative gearing 351 00:21:09.634 --> 00:21:13.574 company. Some 352 00:21:13.614 --> 00:21:16.734 comments about capital employed and net financial resources. 353 00:21:17.314 --> 00:21:20.974 Again, the working capital requirement is negative and is 354 00:21:21.114 --> 00:21:25.054 significantly negative, and the consequence is that financial debt 355 00:21:25.694 --> 00:21:29.154 is significantly negative. But you could 356 00:21:29.294 --> 00:21:33.114 have a positive net financial debt with a negative 357 00:21:33.154 --> 00:21:37.034 working capital requirement. For example, if the company was paying a 358 00:21:37.114 --> 00:21:39.434 dividend or buying back its shares. 359 00:21:39.814 --> 00:21:43.774 Now, the financial strategy of the company is extremely conservative. 360 00:21:43.954 --> 00:21:47.494 The company definitely has the capacity to return to shareholders, 361 00:21:47.534 --> 00:21:50.314 again, through dividends and share buybacks. 362 00:21:50.334 --> 00:21:54.094 But for any reason, the company has decided to retain the 363 00:21:54.214 --> 00:21:58.054 cash in the bank account of the company and 364 00:21:58.134 --> 00:22:01.854 not distribute. This is going to be, of course, a key 365 00:22:01.934 --> 00:22:04.534 part in the financial structure of the leverage 366 00:22:04.614 --> 00:22:06.014 buyout. 367 00:22:08.274 --> 00:22:11.734 You remember what I just said. The working capital should be 368 00:22:11.774 --> 00:22:15.654 positive, because then it means that the permanent resources are entirely 369 00:22:15.794 --> 00:22:19.594 financing the heart of the company, its non-current assets. 370 00:22:19.614 --> 00:22:22.954 Well, it was a little bit negative in eighty-five and 371 00:22:23.034 --> 00:22:26.154 eighty-six, but no big issue. Why? 372 00:22:26.174 --> 00:22:29.174 Because the working capital requirement being so strongly 373 00:22:29.374 --> 00:22:32.794 negative, the net cash position is already quite 374 00:22:32.894 --> 00:22:36.524 positive. Then, if you look at the working capital, it's 375 00:22:36.524 --> 00:22:39.734 turning positive in eighty-seven and it's expanding in 376 00:22:39.814 --> 00:22:43.694 eighty-eight and eighty-nine. The working capital requirement 377 00:22:43.754 --> 00:22:47.574 is growing in absolute term, but it's negative, so it's more and more contributing 378 00:22:47.614 --> 00:22:51.594 to the financing. And at the end of the day, the net cash position of 379 00:22:51.634 --> 00:22:55.544 the company is plus, plus, plus one hundred and 380 00:22:55.574 --> 00:22:59.524 ten. Cash is one hundred and ten. There's no bank overdraft, 381 00:22:59.574 --> 00:23:03.434 no current financial liability. So at the end of the day, the 382 00:23:03.494 --> 00:23:07.054 liquidity of the company is extremely strong. 383 00:23:08.934 --> 00:23:12.854 When you observe a company whose working capital is positive, you understand 384 00:23:12.894 --> 00:23:15.814 that there is absolutely no short-term liquidity 385 00:23:15.874 --> 00:23:19.454 risk. When you observe that the company has a negative 386 00:23:19.514 --> 00:23:23.434 working capital requirement, you understand that any evolution in the 387 00:23:23.514 --> 00:23:26.764 working capital requirement is going to be an additional source of 388 00:23:26.874 --> 00:23:30.834 cash. And this is why static point of view, the company has a 389 00:23:30.874 --> 00:23:34.694 substantial net cash position. And then the 390 00:23:34.734 --> 00:23:37.774 question is: How do you return the cash to the 391 00:23:37.834 --> 00:23:41.794 shareholders? Returning the cash to the shareholder will be the 392 00:23:41.934 --> 00:23:45.414 rationality of the financial holding, which is going to buy 393 00:23:45.534 --> 00:23:47.654 SECAP eventually. 394 00:23:49.634 --> 00:23:53.284 Now, we are ready to run the financial analysis of the company and 395 00:23:53.394 --> 00:23:57.094 identify the economic and commercial return generated by 396 00:23:57.134 --> 00:24:00.774 SECAP. I'm going to first introduce you the ratios which I 397 00:24:00.854 --> 00:24:04.414 selected to make the financial analysis, and we are going to have a 398 00:24:04.434 --> 00:24:07.374 discussion on the DuPont Numau formula. 399 00:24:07.414 --> 00:24:10.214 In fact, the DuPont Numau formulas, because there are two 400 00:24:10.654 --> 00:24:14.594 formulas. The one which I prefer is a simpler one, 401 00:24:14.634 --> 00:24:18.606 and I will tell you why.... But you remember that when you calculate the ROCE of a 402 00:24:18.646 --> 00:24:22.626 company, you calculate the return, which is generated by the business operations. 403 00:24:22.646 --> 00:24:26.066 But in order to understand the economic profit of the company, you have to control 404 00:24:26.086 --> 00:24:29.906 the return capital and the cost of capital, the weighted average cost of 405 00:24:29.946 --> 00:24:33.726 capital. This part of the financial analysis is going to be described in the 406 00:24:33.786 --> 00:24:37.426 next module, which is about the financial forecast and the valuation of the 407 00:24:37.486 --> 00:24:41.256 company. Because in the valuation, I will have to calculate the cost of 408 00:24:41.286 --> 00:24:44.626 capital to discount the cash flows. 409 00:24:46.006 --> 00:24:49.986 The first ratios I'm going to use in the financial analysis are the ones which are 410 00:24:50.026 --> 00:24:53.986 related with the commercial profitability, the return on sales. 411 00:24:54.026 --> 00:24:57.956 So the denominator is about revenues, operating revenues, sales, and 412 00:24:57.986 --> 00:25:00.886 the numerator is about how much profit you make. 413 00:25:00.926 --> 00:25:04.716 You can calculate, uh, gross margin, you can calculate EBITDA and 414 00:25:04.806 --> 00:25:08.146 EBIT. This is these last two, which I selected. 415 00:25:08.186 --> 00:25:11.886 You can also do some deep dive, calculating cost per 416 00:25:11.926 --> 00:25:15.646 revenues, for example, labor-related expenses or R&D 417 00:25:15.686 --> 00:25:19.326 expenses for other companies. But here I'm limiting to the 418 00:25:19.386 --> 00:25:23.306 EBITDA, which is absolutely fundamental in this case, because it's 419 00:25:23.346 --> 00:25:27.106 a source of free cash flow for the valuation, and EBIT, because EBIT is a 420 00:25:27.126 --> 00:25:30.986 return on sales, which we use in the DuPont formula. 421 00:25:31.026 --> 00:25:34.046 In order to calculate the return capital, you have to combine the commercial 422 00:25:34.126 --> 00:25:37.146 profitability with the assets productivity, which is namely assets 423 00:25:37.206 --> 00:25:40.866 turnover. Asset turnover is revenues divided 424 00:25:40.926 --> 00:25:44.846 by non-current assets and working capital requirements. 425 00:25:44.856 --> 00:25:48.706 So we are going to have a look at the CapEx, the investment as a percentage 426 00:25:48.726 --> 00:25:52.336 to revenues, and we are going to get back to the working capital and 427 00:25:52.426 --> 00:25:56.326 working capital requirement. As a consequence, we are going to 428 00:25:56.366 --> 00:26:00.226 calculate the ROCE as return on sales times assets turnover, which is the first 429 00:26:00.246 --> 00:26:03.786 and initial version of the DuPont and the Moore formula. 430 00:26:03.906 --> 00:26:07.626 There's a second one, which is more sophisticated and, in my opinion, 431 00:26:07.686 --> 00:26:11.346 less useful. No need to calculate some financial 432 00:26:11.586 --> 00:26:15.546 structure ratios, because as a debt is negative, the gearing is negative, 433 00:26:15.586 --> 00:26:19.406 the leverage is negative, and calculating how many years 434 00:26:19.466 --> 00:26:23.266 of EBITDA you should need in order to repair debt which does 435 00:26:23.286 --> 00:26:26.825 not exist is nonsense. So I'm going to limit to all these 436 00:26:26.926 --> 00:26:29.426 ratios which I just described. 437 00:26:31.426 --> 00:26:35.326 It's very interesting to observe the evolution of the return on sales generated 438 00:26:35.426 --> 00:26:39.186 by SECAP. The green line is about EBIT, and EBIT 439 00:26:39.366 --> 00:26:43.166 is up year after year, with a kind of stabilization in 440 00:26:43.266 --> 00:26:45.726 eighty-nine versus eighty-eight. 441 00:26:45.766 --> 00:26:49.746 EBITDA is roughly the same. The difference between EBITDA and EBIT is 442 00:26:49.826 --> 00:26:53.606 depreciation amortization, which again, is a consequence of capital 443 00:26:53.646 --> 00:26:57.426 expenditures. It was up during the first three years, and then 444 00:26:57.486 --> 00:27:01.446 it's kind of plateauing. The EBITDA is 445 00:27:01.506 --> 00:27:05.186 at its maximum in eighty-eight and slightly declining 446 00:27:05.286 --> 00:27:09.266 in eighty-nine. That's not very big in terms of 447 00:27:09.326 --> 00:27:12.226 decline, but that might be a concern for the future. 448 00:27:12.926 --> 00:27:15.846 But what is interesting is to observe the capital expenditures. 449 00:27:16.026 --> 00:27:19.726 CapEx is not down, but CapEx as a percentage to 450 00:27:19.806 --> 00:27:23.566 revenues is down. Why? Because even though the company 451 00:27:23.686 --> 00:27:27.546 is increasing, is growing its fleet of 452 00:27:27.686 --> 00:27:31.086 machines, it's not growing at the same rate as the 453 00:27:31.166 --> 00:27:34.826 revenues. And so as a consequence, what is happening is 454 00:27:34.886 --> 00:27:38.806 that, uh, the capital expenditures, which were consuming twenty-five percent of 455 00:27:38.866 --> 00:27:41.366 the revenues, are now consuming only twenty percent. 456 00:27:42.226 --> 00:27:46.046 Now, if the EBITDA is roughly thirty-four, thirty-five percent and 457 00:27:46.106 --> 00:27:49.406 CapEx is twenty, you understand that the free cash flow, which is 458 00:27:49.426 --> 00:27:52.766 predominantly made of EBITDA minus CapEx, is strongly 459 00:27:52.846 --> 00:27:56.506 positive. And it is even more positive because the working 460 00:27:56.606 --> 00:27:59.886 capital requirement itself is negative. 461 00:27:59.966 --> 00:28:03.506 So there is no problem to generate a high and 462 00:28:03.626 --> 00:28:07.466 absolutely stable and recurrent free cash flow. 463 00:28:09.566 --> 00:28:13.386 It's interesting to observe that this significant EBITDA rate, which is 464 00:28:13.446 --> 00:28:16.726 generated by SECAP, is the one we generally observe in 465 00:28:16.866 --> 00:28:19.866 highly capital-intensive sectors, such as the 466 00:28:20.186 --> 00:28:23.756 telecommunication operators, by the way, thirty, thirty-five, forty 467 00:28:23.866 --> 00:28:27.716 percent EBITDA rate. And this is, uh, 468 00:28:27.826 --> 00:28:31.426 an obligation for these companies, because these companies are capital 469 00:28:31.486 --> 00:28:33.766 intensive, so the assets turnover is low. 470 00:28:33.786 --> 00:28:36.805 When the assets turnover is low, the return sales must be quite 471 00:28:36.865 --> 00:28:40.266 high. The company is quite capital 472 00:28:40.306 --> 00:28:44.086 intensive because of this very substantial investment 473 00:28:44.166 --> 00:28:47.166 rate, which is about twenty percent of revenues. 474 00:28:47.186 --> 00:28:50.786 But remember that the working capital requirement is negative, so it's going to 475 00:28:50.866 --> 00:28:54.026 change a little bit the picture. Now, why do you 476 00:28:54.066 --> 00:28:57.726 invest? Because you need to build your portfolio of rental 477 00:28:57.906 --> 00:29:01.606 property, the machines which are in the offices of your 478 00:29:01.646 --> 00:29:03.786 beloved customers. 479 00:29:05.606 --> 00:29:09.526 The cash conversion cycle is a version of the working capital requirement in 480 00:29:09.586 --> 00:29:13.505 days of something. So the trade receivables are in 481 00:29:13.546 --> 00:29:17.526 days of revenues, the inventories are in days of cost of goods sold or 482 00:29:17.566 --> 00:29:21.226 whatsoever. The working capital requirement is, 483 00:29:21.406 --> 00:29:25.006 generally speaking, for an industrial firm, inventories, plus trade accounts 484 00:29:25.046 --> 00:29:27.406 receivable, minus trade accounts payable. 485 00:29:27.426 --> 00:29:31.266 But here we have a curiosity. We have to add an additional line, which is 486 00:29:31.286 --> 00:29:34.906 deferred revenue, which is definitely a resource in the 487 00:29:34.946 --> 00:29:38.726 operating cycle, so it's absolutely legitimate to introduce it in the 488 00:29:38.786 --> 00:29:42.706 working capital requirement. So the cash conversion cycle is days 489 00:29:42.826 --> 00:29:46.566 of inventories, plus receivables, minus payables, and minus deferred 490 00:29:46.606 --> 00:29:47.186 revenue. 491 00:29:48.006 --> 00:29:51.766 Here, what we observe is something which is very often the case. 492 00:29:51.786 --> 00:29:55.586 In industrial firms, generally speaking, inventories are more or 493 00:29:55.606 --> 00:29:57.755 less financed by the trade accounts payable. 494 00:29:57.806 --> 00:30:01.736 The suppliers are financing the inventories more or less, and 495 00:30:01.766 --> 00:30:04.566 the company has to finance the accounts receivable. 496 00:30:04.586 --> 00:30:08.206 But here, the accounts receivable is by far financed by the deferred 497 00:30:08.266 --> 00:30:11.586 revenue. So at the end of the day, you have 498 00:30:11.646 --> 00:30:15.206 inventories and payables, which are matching, and deferred 499 00:30:15.246 --> 00:30:18.686 revenue, which is significantly more than the trade accounts receivable. 500 00:30:18.726 --> 00:30:22.646 As a consequence, the cash conversion cycle is strongly 501 00:30:22.706 --> 00:30:25.106 negative by twenty days of 502 00:30:25.166 --> 00:30:26.836 revenues.... 503 00:30:29.116 --> 00:30:32.276 Then we have this deferred revenue, which represents three months of 504 00:30:32.356 --> 00:30:35.616 sales. Basically, it's one quarter of rental 505 00:30:35.656 --> 00:30:39.396 income. Consequence, very negative working capital 506 00:30:39.476 --> 00:30:43.176 requirement. Again, when the sales are growing, the 507 00:30:43.236 --> 00:30:47.136 working capital requirement is an additional resource, and it 508 00:30:47.216 --> 00:30:49.676 contributes to the gross financing of the company. 509 00:30:49.736 --> 00:30:53.176 It pays part of the CapEx. We have a kind of 510 00:30:53.376 --> 00:30:56.536 similar situation in distribution, retail 511 00:30:56.556 --> 00:31:00.366 distribution, because you remember that the accounts receivable then is 512 00:31:00.416 --> 00:31:04.316 close to zero, and the suppliers are more than financing the 513 00:31:04.336 --> 00:31:08.256 inventories. But it's not exactly the same situation, because here 514 00:31:08.556 --> 00:31:12.276 there are some trade accounts receivables in the balance sheet, but the 515 00:31:12.316 --> 00:31:15.576 deferred revenue is immense, absolutely 516 00:31:15.636 --> 00:31:19.026 fundamental in the financing of the company. 517 00:31:21.216 --> 00:31:24.956 Then we can combine the return on sales, EBIT divided by revenues, and 518 00:31:24.996 --> 00:31:28.096 the, uh, assets turnover, revenues divided by capital 519 00:31:28.136 --> 00:31:31.596 employed, to calculate the return on capital employed, which is EBIT 520 00:31:31.636 --> 00:31:35.596 divided by capital employed. And then what we observe is 521 00:31:35.656 --> 00:31:39.276 quite interesting. Very often, when a company is 522 00:31:39.316 --> 00:31:43.196 generating a high return on sales, uh, the objective is that 523 00:31:43.256 --> 00:31:46.306 it compensates more or less a low assets turnover. 524 00:31:46.456 --> 00:31:50.376 This is a case of high return on sales, nice P&L, combining 525 00:31:50.476 --> 00:31:54.016 capital-intensive, low assets turnover. 526 00:31:54.036 --> 00:31:57.396 But here, it's not exactly the case, because there are plenty of 527 00:31:57.496 --> 00:32:01.396 non-current assets in the balance sheet of the company, but these non-current 528 00:32:01.456 --> 00:32:04.976 assets are very much financed by the working capital 529 00:32:05.076 --> 00:32:08.556 requirement. So as a consequence, it's a business which is 530 00:32:08.576 --> 00:32:12.536 profitable as far as commercial profitability is concerned, and it is a 531 00:32:12.656 --> 00:32:16.576 high assets turnover. It's not capital intensive 532 00:32:16.696 --> 00:32:20.656 because of the deferred revenues, which is, you understand, absolutely 533 00:32:20.756 --> 00:32:24.656 a key in the financial analysis of this company, not only in 534 00:32:24.696 --> 00:32:28.616 terms of ROCE, which you can observe here, which is absolutely 535 00:32:28.736 --> 00:32:32.556 mind-blowing, but it is also fundamental in the free cash flow 536 00:32:32.616 --> 00:32:36.256 calculation, in the valuation of the company, and in the financing of the 537 00:32:36.376 --> 00:32:37.956 financial holding. 538 00:32:40.256 --> 00:32:43.076 A wrap-up on the ROCE. You have a high commercial 539 00:32:43.176 --> 00:32:46.176 profitability, and you have a high assets 540 00:32:46.216 --> 00:32:50.086 productivity. CapEx, of course, but 541 00:32:50.096 --> 00:32:53.896 working capital requirement. And as a working capital requirement 542 00:32:53.936 --> 00:32:57.566 is financing the CapEx, the assets turnover is high. 543 00:32:57.596 --> 00:33:01.496 And as a consequence, if you combine a high return on sales and a high assets 544 00:33:01.536 --> 00:33:05.456 turnover, you have a very high return capital employed, 545 00:33:05.516 --> 00:33:09.396 which is, in this case, very close to one hundred percent. 546 00:33:09.476 --> 00:33:13.076 Very close to one hundred percent means that the operating income is extremely 547 00:33:13.136 --> 00:33:16.336 close to the capital employed. The operating profit 548 00:33:16.536 --> 00:33:20.396 pays, if I may say, the capital employed each and every 549 00:33:20.456 --> 00:33:23.856 year. So the profitability, economic profitability is 550 00:33:23.956 --> 00:33:26.476 absolutely huge. 551 00:33:27.716 --> 00:33:31.556 The Dupont de Nemours formula, which I introduced in the financial analysis, is the 552 00:33:31.616 --> 00:33:35.516 first version. It was initially named Return on Investment, by the 553 00:33:35.576 --> 00:33:39.536 way, and it was return on sales times assets turnover, developed by the 554 00:33:39.576 --> 00:33:42.936 financial controller of this company at the beginning of the twentieth 555 00:33:43.016 --> 00:33:46.716 century. And what was interesting is that the 556 00:33:46.756 --> 00:33:50.416 objective was to demonstrate if you have a low assets turnover, you need a 557 00:33:50.436 --> 00:33:54.216 high return on sales. But it is also interesting to make the 558 00:33:54.276 --> 00:33:57.936 link between the assets turnover and the return on equity, that's 559 00:33:57.996 --> 00:34:01.836 return on shareholders' equity, the return attributable to the shareholders on 560 00:34:01.856 --> 00:34:05.486 net income divided by equity, how much they earn, divided by how much they 561 00:34:05.516 --> 00:34:09.437 invested. And then you can start decomposing the return on 562 00:34:09.476 --> 00:34:12.926 equity. You start with the net income, and you divide by revenues. 563 00:34:12.957 --> 00:34:16.296 It's another version of the return on sales, P&L. 564 00:34:16.316 --> 00:34:18.446 Then you have revenues divided by what? 565 00:34:18.457 --> 00:34:21.857 Certainly not divided by equity, divided by capital 566 00:34:21.897 --> 00:34:25.336 employed, and then you get back to the assets turnover. 567 00:34:25.357 --> 00:34:29.296 But then you are left with the capital employed, which you divide by equity, 568 00:34:29.917 --> 00:34:33.056 and capital employed is equity plus debt. 569 00:34:33.096 --> 00:34:36.877 So equity plus debt, divided by equity is one 570 00:34:36.897 --> 00:34:38.397 plus debt divided by equity, 571 00:34:39.276 --> 00:34:41.256 and debt divided by equity is the gearing. 572 00:34:41.276 --> 00:34:44.877 So at first sight, it looks great, because the return on sales is about 573 00:34:44.917 --> 00:34:48.556 P&L, the assets turnover is about capital intensity, and one plus the 574 00:34:48.636 --> 00:34:51.296 gearing is about the financial structure of the company. 575 00:34:51.336 --> 00:34:55.236 That's quite interesting, but there's a significant drawback. 576 00:34:55.316 --> 00:34:58.396 It's, uh, the gearing has an impact on the net income. 577 00:34:58.456 --> 00:35:01.416 If you increase debt, you have more interest, you have less 578 00:35:01.496 --> 00:35:05.156 earnings, and so you understand that you cannot try to 579 00:35:05.216 --> 00:35:08.456 maximize independently these, all these 580 00:35:08.516 --> 00:35:12.376 ratios. There is a relationship and a negative relationship 581 00:35:12.396 --> 00:35:15.356 between the return on sales, as it's calculated here, and the 582 00:35:15.456 --> 00:35:19.216 gearing. This is why I prefer the first one, which is a 583 00:35:19.456 --> 00:35:23.416 little bit more simple and a little bit more useful in the 584 00:35:23.476 --> 00:35:27.356 evaluation of the financial and economic profitability of the 585 00:35:27.436 --> 00:35:28.376 company. 586 00:35:30.946 --> 00:35:34.516 Now, a few conclusions about the financial analysis of this company. 587 00:35:34.556 --> 00:35:37.836 We have observed a highly profitable company. 588 00:35:37.856 --> 00:35:41.686 The return on sales is high, the assets turnover is high, the return on 589 00:35:41.736 --> 00:35:45.586 capital is high, and the company is financially very 590 00:35:45.696 --> 00:35:48.576 sound, very conservative financial resources. 591 00:35:48.596 --> 00:35:51.616 The company is generating cash and retaining the cash. 592 00:35:51.636 --> 00:35:55.176 Though the gearing is strongly negative, cash is by far 593 00:35:55.316 --> 00:35:58.996 exceeding the debt, and the company is extremely strong. 594 00:35:59.746 --> 00:36:02.716 The good news about the rental business is that there is a kind of 595 00:36:02.836 --> 00:36:05.696 stability. Once you have negotiated the 596 00:36:05.756 --> 00:36:09.396 contract, you have a kind of medium-term visibility of your 597 00:36:09.476 --> 00:36:13.236 cash flows. So the revenues are reasonably predictable and 598 00:36:13.276 --> 00:36:17.196 stable, and the cash flow is quite stable and quite 599 00:36:17.296 --> 00:36:19.916 high because the customers are paying in advance. 600 00:36:19.926 --> 00:36:23.656 Deferred revenue, negative working capital requirement. 601 00:36:24.176 --> 00:36:26.936 Then financing growth is not a challenge. 602 00:36:26.956 --> 00:36:30.936 You make a profit. The working capital requirement is financing a 603 00:36:30.996 --> 00:36:34.616 part of the CapEx. Financing growth is not a problem. 604 00:36:34.676 --> 00:36:38.456 You don't need cash from outside. This is exactly the other way 605 00:36:38.476 --> 00:36:41.996 around. You are a cash machine with a 606 00:36:42.176 --> 00:36:45.586 nice stability and predictability of your cash flow. 607 00:36:45.676 --> 00:36:48.456 This is a perfect target for a leveraged 608 00:36:48.556 --> 00:36:50.796 buyout.