Originally Posted by
Snoopy
Gregr, I think my comment was slightly screwed up. What I was trying to say in an overly twisted way is that I think there are some issues regarding the appropriate discount rate that should be used to value RBD.
In an extreme situation it would be possible to have a discount rate greater than the earnings growth rate. With the benefit of hindsight, this is what has happened with RBD. I would argue that five years ago RBD was a $12.5m per year profit company given normal business conditions. I would equally argue today that RBD is a $25m per year profit company. That is very roughly a 15% compounding growth rate of 'underlying earnings' over 5 years. As long as the PWC discount rate for RBD was under 15% over those 5 years (and I think it was, let's make it 10%), then when we work out the present value of that underlying earnings growth pattern from a 2006 perspective then an interesting thing happens:
2006: $12.5m
2007: $12.5m x (1.15/1.1)= $13.0m
2008: $12.5m x (1.15/1.1)^2 = $13.6m
2009: $12.5m x (1.15/1.1)^3 = $14.2m
2010: $12.5m x (1.15/1.1)^4 = $14.9m
2011: $12.5m x (1.15/1.1)^5 = $15.6m
What we have here is an increasing earnings number every year, even though these future earnings are being discounted back to 2006 dollars. If this trajectory were to continue you could argue that the PV of Restaurant Brands earnings (from a 2006 perspective) can be as high as you like by just looking out into the future far enough. Obviously this is not possible, so there is some fantasy going on within this calculation somewhere. But the average earnings growth of 15% that I used is not the fantasy, because this is the actual growth rate achieved in this period (we know this with the benefit of hindsight). That means something else must be wrong, and the only thing in that equation not based on fact is the discount rate. The discount rate must be higher than the earnings growth rate to obtain a convergent share valuation.
Of course the other thing that must happen foir this farcical divergent valuation to be true is that earnings must keep growing at above 10% indefinitely. Clearly this also is unlikely, although we may get an average 10%+ growth rate for 10 years, and 10 years is 'indefintely' for some investors. I used the 10% average discount rate for ease of calculation but in reality I think the PWC discount rate for RBD over that period would have been less. That means my example as presented is conservative.
The point I am trying to make ( I think! )is that the PWC discount rate for RBD can never have been as low as they suggested. The whole basis for their calculation cannot be right, even if the actual mathematics they used to calculate that figure contains no computational errors. This is why I take these discount rates very cynically.
SNOOPY