strategic analysis and corporate valuation of ic...

Master thesis

Authors:

MSc. Finance and International Business

Tural Ismayilov

MSc. Finance

Vladlens Proskurovs

Academic supervisor:

Baran Siyahhan

Strategic Analysis and Corporate Valuation

of IC Companys A/S

1st November 2012

Aarhus School of Business and Social Sciences

Aarhus University

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Executive summary

In order to make comprehensive corporate valuation of targeted IC Companys A/S in

the first part of the thesis is performed thorough strategic analysis. Then the second part

mainly deals with various corporate valuation theories and models.

IC Companys has been formed in the merger of Carly Gry International A/S and

InWear Group A/S in 2001. Since that the company has been concentrating on being the

best developer of sports and fashion brands in the apparel industry in different markets

worldwide. Through the last 10 years IC Companys has grown mainly relying on

Merger & Acquisitions and the geographical expansion achieved by operating own

shops and franchising. Currently IC Companys has 11various upper-mid and middle

class brands in the apparel market and a successful implementation of the multi-brand

strategy permits the Group to create more value.

The strategic analysis conducted in this paper mainly divided into two groups - external

and internal analyses. External analysis includes PESTEL and Porter’s five forces where

the first defines macro factors that influence the company’s business, and then Porter’s

five forces determines industry criteria and intensity. While external analysis identifies a

company’s threats and opportunities, internal analysis defines the company’s strengths

and weaknesses through the implementation of Porter’s value chain and Core

competences. The sum-up of strengths, weaknesses, opportunities and threats is done in

SWOT analysis.

The second part of the thesis consists of main and supportive valuation tools. The main

valuation model in this paper is considered to be discounted cash flow which is

accompanied with the sensitivity and scenario analyses. As a part of weighted average

cost of capital, cost of equity is calculated according to the CAPM model.

Then in order to verify results that are derived from DCF model, economic profit model

has been applied. Following these models, real option valuation is implemented to

reveal additional value to the company’s underlying assets. In real option valuation

expansion option is used in the Brazilian.

Finally, multiples analysis is applied with the aim to evaluate whether the results

obtained from the DCF and real option valuation are reasonable.

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Table of Contents Executive summary ..................................................................................................................... 2

1. Introduction ............................................................................................................................ 6

2. Problem statement ................................................................................................................. 7

3. Delimitations ........................................................................................................................... 8

4. Description of IC Companys ................................................................................................. 8

4.1 Introduction ................................................................................................................... 8

4.2 History ........................................................................................................................... 8

4.3 Merger ........................................................................................................................... 9

4.4 IC Companys A/S .......................................................................................................... 9

4.5 Products ...................................................................................................................... 11

4.6 Distribution channels .................................................................................................. 11

4.7 Markets ........................................................................................................................ 12

5. Strategic analysis .................................................................................................................. 14

5.1 PESTEL Analysis ...................................................................................................... 15

5.1.1 Political and Legal Factors ................................................................................. 15

5.1.2 Economic Factors ............................................................................................... 16

5.1.3 Socio-cultural Factors ......................................................................................... 19

5.1.4 Technological and Environmental Factors ......................................................... 20

5.2 Porter's five forces ..................................................................................................... 22

5.2.1 The threat of the new entrants ............................................................................. 23

5.2.2 Bargaining power of the suppliers ...................................................................... 24

5.2.3 Bargaining power of buyers ................................................................................ 25

5.2.4 Threat of Substitute products and services .......................................................... 26

5.2.5 Competition among the existing rivals ................................................................ 26

5.3 Internal analysis ........................................................................................................ 28

5.3.1 Primary activities ................................................................................................ 30

5.3.2 Supportive activities ............................................................................................ 33

5.4 Core Competencies .................................................................................................... 36

5.5 Growth Strategy ........................................................................................................ 37

5.5.1 Cost leadership .................................................................................................... 38

5.5.2 Differentiation ..................................................................................................... 38

5.5.3 Focus ................................................................................................................... 39

5.6 SWOT analysis .......................................................................................................... 41

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5.7 Expansion Strategy ................................................................................................... 43

6. Evaluation of the corporate valuation theories ................................................................. 45

6.1 The Discounted Cash Flow (DCF) Method ............................................................. 46

6.1.1 Variables in the DCF Model ............................................................................... 47

6.1.2 The Weighted Average Cost of Capital ............................................................... 48

6.2 Economic profit model .............................................................................................. 56

6.3 Multiples ..................................................................................................................... 58

6.4 Real Option Valuation (ROV) .................................................................................. 61

6.4.1 The Binomial lattice model ................................................................................. 63

7. IC Companys valuation using DCF model ........................................................................ 67

7.1 The reformulated balance sheet ............................................................................... 67

7.2 The reformulated income statement ........................................................................ 69

7.3 Trend analysis ............................................................................................................ 69

7.4 Operating Leases, Taxes, NOPLAT and Invested Capital .................................... 71

7.4.1 Operating Leases ................................................................................................. 71

7.4.2 Taxes ................................................................................................................... 72

7.4.3 NOPLAT .............................................................................................................. 73

7.4.4 Invested Capital ................................................................................................... 74

7.5 Free Cash Flow .......................................................................................................... 75

7.6 The Weighted Average Cost of Capital of IC Companys ...................................... 76

7.7 Forecasting of the IC Companys’ free cash flow .................................................... 81

7.8 Calculation of the IC Companys’ continuing value ............................................... 84

7.9 Calculation of the IC Companys’ share price ......................................................... 85

7.10 Scenario analysis ....................................................................................................... 86

7.11 Sensitivity analysis..................................................................................................... 88

8. IC Companys valuation using Economic Profit Model .................................................... 90

9. Real Options Valuation of IC Companys ........................................................................... 92

9.1 Expansion option ....................................................................................................... 92

9.2 Binomial lattice approach for IC Companys .......................................................... 94

9.2.1 Step 1: Evaluation of IC Companys’ underlying asset without flexibility .......... 94

9.2.2 Step 2: Event tree ................................................................................................ 94

9.2.3 Step 3: Decision tree ........................................................................................... 97

9.2.4 Step 4: Expansion option for IC Companys’ decision tree with flexibility ......... 98

10. Valuation by multiples ....................................................................................................... 100

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11. Discussion of the results ..................................................................................................... 102

11.1 DCF analysis ............................................................................................................. 102

11.2 EVA analysis ............................................................................................................. 103

11.3 Real Options valuation .............................................................................................. 103

11.4 Multiples .................................................................................................................... 104

12. Conclusion........................................................................................................................... 104

References ................................................................................................................................ 108

Appendices ............................................................................................................................... 115

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1. Introduction

The aim of this paper is to focus on different theories and methods in order to make a

thorough corporate valuation concerning chosen multi-brand apparel enterprise IC

Companys A/S. The theoretical knowledge acquired during Corporate Valuation course

is applied to real life case by using publicly available data such as company’s annual

reports and published articles.

It could be assumed that after the harsh economic crisis in the past 2007/08 that hit

almost all markets and businesses, corporate valuation of different companies becomes

more interesting and challenging due to the recession period.

The main reason of the selection of IC Companys is its multi-brand strategy, where each

brand has separate design and management team. The company’s strong position creates

intensive competition environment for the rivals in the fashion industry. IC Companys

A/S is a Danish fashion and clothing company with relatively short history, but very

colorful and turbulent one. The group was formed on 30 April 2001 by the merger of

two Danish clothing and fashion companies InWear Group A/S and Carly Gry

International A/S. Indeed, newly formed fashion group has experienced some

challenges and difficulties especially within the top management team. As in fact in

2004 it has been realized that in the year 2003/04 company was in turmoil and large

deficit resulted in deposing of CEO and chairman. After some internal changes in the

management team, in the upcoming year of 2004/05 company achieved a surplus and IC

Companys stock price increased from 50 DKK to 400 DKK in spring 2006. This

increase in stock price was indication of positive turnover and IC Companys’ business

in overall. However, it was a temporary rise of stock price, in fact, economic crisis of

2007/08 resulted in turmoil and downturn in almost all kinds of businesses. IC

Company was not an exemption.

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Figure 1. IC Companys’ share price in DKK (January 2003 – April 2012)

Source: finance. yahoo.com

2. Problem statement

The purpose of the master thesis is to analyze and answer the following 2 sub-analyze

questions:

1. What are the competitive advantages of IC Company A/S and how the

company exploits them for development?

2. Does a valuation of real options reveal additional value to the company?

Sub-analyze questions lead to the answer of the main question of the master thesis:

Does IC Company A/S stock price reflect a fair market value as of 30th June 2011?

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3. Delimitations

The dissertation must be considered to be written for a potential investor of IC

Companys and thus it is based on the publically available information such as

company’s annual reports, websites, newspapers, articles, etc. Due to a selected target

group, interviews of company’s employees are not conducted as it is assumed that, first

of all, they are unable to disclose internal information and, secondly, it is always prevail

the fact that employees’ statements contain bias and therefore are subjective.

The thesis is founded on the application of definite theories and models relevant to the

case company. Strategic analysis models are discussed shortly as the main purpose of

the dissertation is a financial valuation of IC Companys. Financial theories are analyzed

in more details, however, only those which are applied in the thesis.

4. Description of IC Companys

4.1 Introduction

IC Company A/S is a Danish fashion group listed on the OMX Copenhagen Stock

Exchange. IC Companys is one of the major players in the fashion industry operating

across much of the world. IC Companys designs and sells apparel in a Scandinavian

style for conscious and self-confident men and women. The enterprise’s eleven brands

are distributed via two main channels: wholesale and retail. In details, wholesale

segment is compounded of wholesale customers and franchise partners, while retail

distribution channel consists of few types: group’s retail stores, concessions, franchises

and outlet stores and e-commerce (IC Companys’ annual report 2010/2011).

4.2 History

IC Companys was founded by the merger of Carli Gry International A/S and Inwear

Group A/S in 2001 (IC Companys, the history of IC Companys).

Carli Gry International A/S

Carli Gry International A/S was one part of the merger that created the IC Companys

A/S. The company was founded in 1940 and introduced Jackpot for women and

Cottonfield for men. Both brands still operate in the IC Companys brand portfolio and

Jackpot itself enters into the composition of five key brands which generate the major

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part of the company’s earnings. Carli Gry was listed in 1996 on the Copenhagen Stock

Exchange. In 1998, the company acquired the Swedish fashion and sports company

Peak Performance, while Carli Gry was also listed on the Stockholm Stock Exchange.

Towards the late 90s the actual results were promising and in 1997 Carli Gry obtained

the largest ever profit before tax of DKK 136 million. The following year the company

experienced growth in revenues, while decreasing profit margins. The development has

been explained by short-sighted focus on margin over long-term focus on IT and

marketing. In order to reverse negative trends, Carli Gry dislocated its sales from

unprofitable stores and increased focus on marketing, branding, logistics and factory

outlets.

Inwear Group A/S

InWear Group A/S was established by Niels Martinsen in 1969, who nowadays is the

major shareholder and chairman of IC Companys. InWear’s primary brands were

InWear focused on young women as the target group, the male counterpart Matinique

and Part Two. InWear and Carli Gry faced some financial troubles before the merger

with deteriorating profit margins in a stressed market. Such difficulties made InWear to

liquidate unprofitable stores and led to further adjustments.

4.3 Merger

Clothing sector experienced the worst times in the late 90s due to a fierce competition.

After evaluation of the strategic and economic considerations of economies of scale, the

merger of Carli Gry and InWear was an obvious decision in order to capture strong

market position, distribution channels, product portfolio and operational synergies. On

12th

March 2001, the companies made the joint announcement where the directors

recommended the merger of Carli Gry and InWear. The merger was approved on 30th

April 2001 with Carli Gry as the continuing corporation under the name of IC

Companys A/S (IC Companys, Fusionsprospekt, 2001).

4.4 IC Companys A/S

After the merger, IC Companys had product portfolio of 13 brands, and in the following

years some additional brands were added to the portfolio. In 2002 IC Companys bought

the Danish company Saint Tropez that was founded in 1993 and specialized in

designing and selling clothes for younger women. At the same year new brand

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Designers Remix Collection was introduced. IC Companys has also established the

cooperation with the Danish haute couture designer Isabell Kristensen who has

launched collection "O", but later her designs were launched under the brand name of

Soaked in Luxury.

In 2003 IC Companys also signed a collaboration agreement with the Danish designer

Malene Birger under the brand By Malene Birger. Later that year IC Companys bought

the dominant brand of clothes for young people in Sweden - Sir Tiger Modebolag.

In October 2003 the CEO and the entire board was replaced, with the exception of Niels

Martinsen, due to disappointing results.

In 2006 IC Companys started to expand business in the emerging markets and

Cottonfield that provides clothing for males has been launched in Chinese market. It

must be mentioned that IC Company has already been introduced in China by InWear

brand for few years.

In 2008 IC Companys has experienced the third major change in management in the

company's short history. Due to depressing growth in bottom line, Niels Mikkelsen was

appointed as a new CEO, and Donald Cleemann and Chris Bigler got promoted to fire

director and CFO (RB-Børsen, 2008), respectively. Therefore IC Companys appears as

the company with a relatively short and turbulent history with several changes in

management, but also as a group with a portfolio of brands covering fashion market

today.

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4.5 Products

IC Companys follows a multi-brand strategy, thus having the product portfolio of

eleven brands.

Table 4.1 IC Companys’ brands revenues (in mil. DKK)

2010/2011 2009/2010 Growth

Peak Performance 977 915 7%

Tiger of Sweden 563 476 18%

Jackpot 426 398 7%

InWear 404 359 13%

Saint Tropez 320 244 31%

Matinique 289 260 11%

Part Two 272 254 7%

By Malene Birger 264 196 35%

Cottonfield 203 197 3%

Designers Remix 91 74 23%

Soaked in Luxury 74 87 -15%

Total 3,883 3,460 12%

Source: IC Companys Annual Reports 2009/2010 and 2010/2011

The five key brands constitutes for approximately 70% of total company’s revenues,

while Peak Performance is the largest contributor with the share of almost 25%. In

general, it marks the interdependence between how long the brand is presented on the

market and how much revenues it produces. For instance, such brands as By Malene

Birger, Designers Remix and Soaked in Luxury were established in the years of 2003,

2002 and 2005, respectively. In the last financial year, Saint Tropez and By Malene

Birger have experienced a rapid surge largely contributing to the group’s growth, while

only the youngest brand Soaked in Luxury has seen declining sales.

4.6 Distribution channels

The group has two main distribution channels: wholesale and retail.

Wholesale is IC Companys’ initial distribution channel contributing to more than 60%

of total revenues in the financial year of 2010/2011 with the growth of 13%. No

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customer accounts for more than 3% of the group’s wholesale revenues, meanwhile the

largest single supplier constitutes for 7% of the total production value (IC Companys’

annual report 2010/2011). Therefore, there is no significant dependence on customers

and supplier.

Retailing is the group’s second major distribution channel which accounts for 1,530.6

mil. DKK in the financial year of 2010/2011 that is equivalent to 40% of total turnover.

As of 30th

June 2011, IC Companys runs 289 retail stores, therefore being presented in

20 countries, primarily in Denmark, Sweden, Benelux countries and Eastern Europe.

Retail revenues experienced an increase of 11% in comparison with the previous

financial year.

The network of outlets is an integral part of the company’s distribution channel as they

allow for more flexibility – any product that cannot be sold through own outlets are sold

to brokers for resale outside the company’s established markets (IC Companys’ annual

report 2009/2010). As of 30th

June 2011, the group runs 28 outlets giving 184 mil. DKK

in total earnings with an increase of 11%.

4.7 Markets

IC Companys’ sales made through its own sales subsidiaries and exports to more than

40 different countries through agents and distributors. Responsibility for the sale is

embedded locally in the respective countries, while in Denmark fire management has an

overall global responsibility. By referring to figure 4.1 it could be calculated that the

group's total turnover is 80% outside Denmark and 45% outside Scandinavia.

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Figure 4.1 Geographic segments measured by revenues in 2010/2011 (in mil. DKK)

Source: Annual report 2010/2011

Geographically it could be stated that IC Companys' main markets are concentrated

mostly in the countries of Northern Europe, primarily Scandinavia, Benelux countries,

the UK and Germany. IC Company has achieved significant growth in the financial year

of 2010/2011. Overall the group has achieved essential growth almost in all markets,

exceptions are China, Russia and Benelux countries. Some problems still concern

business in the Chinese market. By referring to the CEO of IC Companys Niels

Mikkelsen, it is hard to determine particular issue, but Group decided to learn more

from the existing Danish fashion companies that successfully operate in the Chinese

market (RB-Børsen, 2008).

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5. Strategic analysis

In order to identify state of the company in relation to external and internal drivers it is

decided to conduct main models in strategic analysis. As an external analysis it is

referred to PESTEL model with the aim to identify the macro-environmental factors that

influence IC Companys’ business in all aspects. Additionally, Porter’s five forces model

is applied to conduct an industry analysis.

PESTEL analysis is mainly used to examine 6 different aspects of the macro-

environment which are Political, Economic, Socio-cultural, Technological,

Environmental and Legal.

Main target of Porter's five forces is to identify the overall industry attractiveness and its

aspects of profitability. There are five general points to examine industry conditions and

they are: the competitive rivalry among existing competitors, the bargaining power of

the suppliers, the bargaining power of the customers, the threat of the substitute

products and services, and the threat of new entrants.

Beside the external analysis it has been planned to go through internal analysis with the

aim to examine the chosen company's strengths and weaknesses. That is why Value

Chain analysis, which has been developed by Michael Porter in 1985, is conducted.

Value chain analysis mainly discusses issues concerning generic value-adding activities

of an organization. The primary activities include: inbound logistics,

operations/production, outbound, marketing & sales and service; while supportive

activities consist of infrastructure, human resource management, technology

development and procurement.

In the conclusion results from both external and internal analysis are summarized,

where the output of external analysis allows identifying threats and opportunities, and

internal analysis results determine a company’s strengths and weaknesses.

Both results are combined in the SWOT analysis in order to perform the clear and

objective image of the target company.

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5.1 PESTEL Analysis

The purpose of the following analysis is to investigate IC Companys’ macro-economic

aspects that could have an impact on the group’s opportunities and threats as well as its

capability of adjusting to particular environmental factors. PEST analysis reviews the

macro-environment that has the supreme influence on the apparel industry and therefore

on the Group’s strategic position since the clothing industry is considered to be highly

cyclical sector. Specifically, the factors reviewed in this model are Political, Economic,

Socio-cultural, Technological, Environmental and Legal (Kotler & Keller, 2006).

Despite the fact that originally the model reviews each part individually, it is widely

assumed to combine Political and Legal parts of the model in one as well as Technology

and Environment since there have many similarities.

5.1.1 Political and Legal factors

Stability and predictability of a political system any company operates in are vital

requirements for an enterprise to succeed. As IC Companys is an international

company, the Group is highly exposed to political and legal changes in various

countries and thus production, distribution and sales could be extremely influenced by

these factors.

The major part of the company’s sales are conducted in Northern and Western Europe

(IC Companys’ annual report 2010/2011), which are characterized by a steadfast

political environment and relatively similar legal factors. Furthermore, Denmark’s

membership in the EU leads to the uniformity in the legislation. Therefore, it is unlikely

that the Group could face any political and/or legal issues negatively affecting sales.

On the other hand, the major portion of the company’s production is located in China

(including Hong Kong), which accounts for 69%, whereas rest of Asia and Europe

provide 18% and 13%, respectively (IC Companys’ annual report 2010/2011). Thus, the

Group is exposed to risks of political and cultural aspects; meanwhile the main reason

for outsourcing to the Asian region is favorable wage levels and a specialization in

production of clothing. In favor of China says the fact that both Denmark and China are

the members of the World Trade Organization, which actively tries to eliminate trade

barriers among member countries, thereby the EU did not extend the quota system for

goods manufactured in China, which had been introduced in the summer of 2005,

replacing it by a continuous supervision in 2008 (IC Companys’ annual report

2007/2008). Therefore, there are no artificial bureaucratic barriers to Chinese import.

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The outsourcing might be exposed to certain commercial risks. One of them is a steadily

increasing wage level in Asian region. Though, it is still lower than in Europe, but it is

just the question of time and the outsourcing to Asian companies might become

deterrent in the foreseeable future.

To sum up, there are not any serious political or legal issues that might affect the Group

negatively.

5.1.2 Economic factors

As it was mentioned before, the garment industry is highly cyclical and primarily

depends on the level of consumer disposable income that in turn follows economic

conditions. In the following part, economic conditions in the company’s main markets

are examined: Scandinavia (Denmark, Sweden and Norway) and two major and growth

potential markets (Russia and China).

Denmark

According to Nordea’s Economic and Market Outlook for May 2012, the Danish

economy is heading to prosper times. Unemployment is decreasing and consumers are

sensing the rise of better things. The Danish economy is expected to expand gradually

throughout 2012, principally driven by higher consumer spending and firm public

investments. In 2013, the growth must accelerate more broadly grounded on a growing

demand from other countries and higher domestic investment activity. Thus, the

economic outlook for GDP is positive: 1.25% and 1.75% in 2012 and 2013,

respectively.

Housing market trends will be crucial for the Danish economy going forward.

Unfortunately, the price declines in the Danish housing market have accelerated again

in recent months. However, there is a strong belief that house prices will stabilize

towards the end of this year converging to the long-term equilibrium level. Thus,

housing market activity looks to make a positive net contribution to growth of the

Danish economy in the coming years.

Macroeconomic situation is kept in proper perspective by the Danish government which

has managed to sustain robust balances in the form of a record-high current account

surplus, low gross public debt and historically large currency reserves. Having the status

of safe haven, Denmark has been taking advantage of this by luring historically cheap

funding of the government debt (Nordea Markets, 2012).

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Sweden

Sweden is the major market for IC Company, thus economic conditions there are very

significant. Data in the first couple of months of 2012 give a mixed picture. Export has

increased by 6.8% in 2011 and the unemployment rate declined to 7.5% in 2011

compared to 8.4% in 2010; however, it is still essentially higher than what the Swedish

Central Bank considers normal of about 6.5% (Nordea Markets, 2012).

As export-oriented country, Sweden is highly vulnerable to external economic

conditions and uncertainty concerning international developments negatively affects

further recovery following the financial crisis in 2008-2009. Thereby, the GDP growth

for 2012 is expected at 0.5%, while the forecast for the next year is more optimistic and

GDP is predicted to rise 2.2%.

Due to the weak external environment, the main growth engine might be domestic

demand, in particular, private consumption. Real household disposable income is

forecast to grow 2.0% and 2.1% in 2012 and 2013, respectively, what is a reassuring

factor for consumption sectors and particularly for the Group (Swedbank, 2012).

Norway

In the near future, the Norwegian economy undergoes a modest increase of GDP at

2.7% in 2012 and 2013, respectively. The major contribution comes from private

consumption and petroleum investments.

In recent years, high real wage growth has been supported by strong expansion in terms

of trade and partly also by growing productivity, but going forward these drivers have

been depleting. However, it is projected that annual real wage growth will stay at 4.0%

through 2013 what is below the average level over the last 12 years.

Oil and energy related sectors are booming again mainly driven by high oil prices. It is

expected that in coming years a barrel price stays much higher than 100.0 USD, thus

improving prospects for the Norwegian economy.

The unemployment rate will stay low with moderate rise in coming years, but below

4.0% what is the lowest level in Scandinavia (DnB Nor, 2012).

Russia

The Russian economy is performing satisfactory, but it encounters some difficulties

going forward. In 2011, the economy expanded by 4.3% while the unemployment rate

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lowered reaching 6.5% and inflation stayed at surprisingly high level of 8.4% (IMF,

2012).

Amid the global economic slowdown, growth is likely to be somewhat slower in

coming years, but seems to be sustained at reasonable levels backed by still-high oil

prices (OECD, 2012). Slower growth in Europe fighting debt contagion and China

trying to switch to domestic consumption will have a negative impact on the volume of

exports, where about two-thirds of exports consists of energy related goods.

Wage growth has been higher than inflation that also contributed to rising consumer

spending. In addition, a rising value of the currency has played a disinflationary role

boosting consumption. Moreover, fiscal policy has recently been expansionary before

the presidential election. On the one hand, it will contribute to economic growth; on the

other hand, budget deficit will become obvious if oil prices suffer from sharp decline

(Deloitte, 2012).

To sum up, prospects for economic growth remain positive with GDP expansion of

4.0% in 2012 and 3.9% in 2013 and decreasing jobless rate to 6.0% in both 2012 and

2013.

China

In the years following the financial crunch of 2008-2009, China has become the engine

of the world economy contributing the major share to the global growth. Therefore, the

scenario of a sharp tumble in Chinese economic activity is a significant risk, especially

with Europe already in downturn (Royal Bank of Canada, 2012). However, these

prospects are highly unfeasible unless the world economy experiences new turmoil

compared to what happened in 2008-2009.

Growth has continued to ease in emerging Asia largely attributable to weak foreign

demand particularly from advanced countries. China’s first-quarter GDP numbers

(+8.1%) were gently weaker than anticipated due to deteriorating foreign demand, but it

is expected that the Chinese economy has experienced temporary issues and should pick

up in the coming years expanding by 8.2% and 8.8% in 2012 and 2013, respectively

(IMF, 2012).

Meantime, inflation has receded as the result of monetary and lending steps, thus it is

projected to trend down to 3.3% in 2012 and 3.0% in 2013 what is significantly lower

than 5.4% in 2011 (IMF, 2012). Unfortunately, consumer prices have little room to ease

further due to high oil prices (Banco Bilbao Vizcaya Argentaria, 2012).

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Summary

The Northern Europe accounts for the major part in IC Companys sales and economic

conditions in this region are of great significance for the company. According to various

prospects, 2012 and 2013 are the years of continuing recovery and the same issues

coming from the Southern Europe. Scandinavian countries which are highly vulnerable

to external sentiment in terms of export volume have been staying a safe haven in times

of extreme turbulence and it seems that necessary adjustments have been made in order

to get back on the growth rails.

Russia and China are two enormous markets with unrealized potential and the Group’s

management has to develop appropriate strategies to succeed there. Meanwhile the

steady growth in China is also a challenge for the company since production expenses

might jump as a result of general wage level increase.

Foreign Currency Exposure and Interest rate risks

IC Companys is exposed to essential exchange rate risks which arise through purchase

of supplies and sale of goods in foreign currencies. The major part of the company’s

purchase of supplies comes from the Far East and denominated in USD and USD-

related currencies while the main share of the sales and capacity expenses are expressed

in DKK, SEK, NOK and EUR. Given currency model causes concerns especially in the

times of financial crises since USD often appreciates and revenue currencies (SEK,

NOK and PLN) depreciate (IC Companys’ annual report 2010/2011).

Therefore, the Group hedges all material transaction risks on a trailing 15-month

horizon, primarily using foreign exchange forwards and/or options (IC Companys’

annual report 2010/2011).

The company’s interest rate risks are related to the Group’s interest-bearing assets and

liabilities. Those risks are managed by acquiring loans with a floating or fixed rate

and/or financial instruments such as forward rate agreement and/or interest rate swaps

with typical neutral maturity of 2 months (IC Companys’ annual report 2010/2011).

5.1.3 Socio-cultural factors

Nowadays, consumer behavior has been changing swiftly; however, it is quite often

occurs that fashion trends recur with some new features. Moreover, boundaries between

male and female fashions have been blurring. Low customer loyalty and allegiance to

brands are common (McKinsey & Company, 2011).

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Another trend in the fashion world that proves low customer devotion is mix of

products from different price segments. For instance, depending on consumers’

preferences in the fashion the mix of cheap no-name clothes with high-priced high-end

garment is more frequent.

Therefore, it is vital that the Group persists to concentrate on innovation, diversity and

brand development. The company’s collections change at a minimum of four times a

year. For example, Saint Tropez develops 10 collections a year with ongoing deliveries

and just 3 months from sketch to store rack allowing the design team to respond to the

latest trends (IC Companys’ annual report 2010/2011).

Another positive aspect which plays in favor of IC Companys is its multi-brand

strategy. The following model allows determining various target groups’ needs.

Though, in the fashion industry it could be problematic to focus on a specific target

group as the behavior of specific target groups is not always predictable. Furthermore,

various groups sometimes overlap.

Thus, these aspects have been taken into account by IC Companys while creating its

multi-brand strategy which leads to a brand portfolio correction and managing in regard

to price, consumer taste and behavior.

5.1.4 Technological and Environmental Factors

Technology

In the apparel production, the technological level and thus quality is an essential aspect.

Since the Group’s production primarily occurs in developing countries of Asia and

Eastern Europe, it mainly relies on manual tailoring. In the foreseeable future,

production of high volume will be realized by usage of machinery when workflow

could be facilitated and quality ameliorated.

Moreover, in regard to retail business adapting of next-generation technologies is

almost unlimited and might give a competitive advantage. Such innovations as

electronic shelf labeling, digital promotional displays, self-checkout and sales kiosks

could change how fashion companies relate to their customers (McKinsey & Company,

2011).

IC Companys is technologically dependent on reliable IT systems for the day-to-day

business operations as well as to ensure control of product sourcing and to enhance

efficiency throughout the company’s supply chain. IT support in all aspects of sourcing,

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distribution, logistics, administration and sales makes it possible for the individual

brands to focus on the creative and commercial development aspects (IC Companys’


The other aspect of technological factor is e-commerce. The idea that the Group’s

websites are used for both sale and demonstration is essential for enhancing company’s

performance. Currently, all company’s eleven brands have their websites where any

customer may get necessary information, compare prices and conduct purchase.

In general, online trade in Denmark has been experiencing two-digit growth in last

couple of years reaching 46 bil. DKK in 2011 (Ekstrabladet.dk, 2012) from 20 bil. DKK

in 2007 (Computerworld.dk, 2008). Thus, e-commerce becomes an essential

distribution channel with massive potential and direct customer contact. Therefore, IC

Companys has been investing substantial amounts of funds in developing IT systems to

enhance its online sales.

Environment

Since August 2011, IC Companys has participated in the United Nation’s Global

Compact working on Corporate Social Responsibility (CSR). It is a voluntary initiative

for private businesses that are committed to dealing with some of the major social and

environmental challenges. Therefore, the Group has been focusing on five areas: human

rights, labor, anti-corruption, animal welfare and environment. The environmental part

implies the company’s policy regarding environment exploiting and supporting of the

prevention of pollution and use of harmful chemicals in products undertaking initiatives

for promoting greater environmental responsibility and encouraging the development

and diffusion of environmentally friendly technologies (IC Companys’ annual report

2010/2011).

Furthermore, IC Companys has decided to undertake a number of comprehensive

measures to ensure that consumers feel safe when wearing company’s garments.

Therefore, the Group performs a set of strict procedures (IC Companys, 2011):

1) Increase of tests number to test whether company’s products have a risk of

increased permitted values of chemical residues. Furthermore, performance of

spot checks on remaining products will be implemented;

2) Transfer of tests to the production countries implying that the products will

never reach the consumers if findings indicate chemical residues above the

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permitted values. Until the new procedures have been undertaken in, for

instance, India and China, the test products will be transported to Denmark by

plane to have the tests performed before the product lines leave the production

countries;

3) Enforcement of new stringent requirements on suppliers. The number of

suppliers will be reduced in the nearby future leading to working with only the

most responsible ones enhancing even better quality.

5.2 Porter's five forces

After defining the industry’s boundaries for the target company, above mentioned

Porter’s five forces analysis allows managers to identify competitive advantages in

order to operate more efficiently. By referring to Michael Porter (1980), it could be

stated that if each force intensifies and gets stronger that limits an ability of established

companies to raise prices and increase its earnings. It indicates the fact that if

competitive forces intensify that increases a threat factor for existing companies in an

industry. The power of these forces changes over time by creating new opportunities

and threats which is challenging for managers to formulate relevant strategic planning

with attempt to minimize the threats and to take advantage of the opportunities (Hill &

Jones, 2010). Each of the five forces in relation to the chosen IC Companys and the

industry it operates in are elaborated below.

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5.2.1 The threat of the new entrants

There are several requirements for the new entrants to establish their business in the

particular industry. It is assumed to introduce more relevant requirements for the

apparel industry such as investment, brand name, production and distributions

channels. Apparel industry might be assumed as fragmented industry where

standardized fashion is produced in large volume, exclusive collection and high-end

fashion products are produced in low volumes. A barrier overcoming for the new

entrant mainly depends on which end of scale to launch the apparel business from. By

capturing correct trends at the right time, might be possible to enter the market without

having high capital or preferred brand. The ones who want to enter the standardized end

of the apparel market targets a price sensitive customer group that prefers the cheapest

product than expensive high-quality and well-known brand. The existing competitors in

such a segment are those leading in cost leadership, which have expertise in that field

and well-established cheap production facilities. Apparel companies that target price

sensitive customers mostly focus on cost-cutting management and strive to produce

with very low expenses in order to fit into cheap and affordable less expensive products

price interval.

Threat of the new entrants at the low end of apparel industry assumed not to be so

strong in sense of creating high competition since the low end apparel producers

compete not with quality, but with quantity and have already established stable

distribution channels and the cheapest supplies by gaining discounts what might be

complicated for new entrants at the beginning.

On the other end of the apparel industry where prices are too high or mid-upper

segment, existing competitors strive to differentiate their products as differentiation

counts as one of the main barriers for new entrants. By altering its products

manufacturing a company might achieve a premium price and additional cost might

occur if a company has higher quality, better brand or design than its rivals. Indeed,

these factors require significant capital as brand loyalty builds up on customers’

perceptions by investing and using its experience that is earned throughout the years of

satisfaction of customers’ needs and desires. There are already some customer groups

who have defined their preferable brand. It might be assumed that capital is not very

important factor in the high-end price segment since the differentiation and brand image

are more essential.

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Concerning the Group, IC Companys mostly operates in the high premium and upper-

mid class segment. Referring to annual reports, IC Companys’ management sets up a

target to be the best developer of sports and fashion brands what means the Group has

decided to focus mostly on building strong brands for high-end customers (IC

Companys’ annual report 2011/2012). It is assumed that the threat of the new entrants

carries less risk for IC Companys since new entrants usually are small businesses or

companies that probably will not be able to compete directly and might capture only a

small market share. However, on the other side, it has to be supposed that the threat

might come from the other bigger competitors who have significant capital and

expertise in the apparel industry. For example, American apparel company, GAP Inc., is

the one of the world's largest apparel retailers that operates four other brands: Banana

Republic, Old Navy, Piperlime and Athleta. Despite the fact that GAP operates

internationally, they have not entered Scandinavian apparel market yet. It might be

assumed that these kinds of potential new entrants are the threat for the IC Companys. It

has to be mentioned that there are few large companies that might be able to capture

significant share in the Scandinavian apparel market.

5.2.2 Bargaining power of the suppliers

In apparel market the bargaining power of the suppliers has been declining due to the

fact that main textile manufactures and producers have been dislocating their businesses

to the emerging markets where production costs are low. China is one of those countries

that lures with lower cost supplier channels. Mentioning IC Companys’ supplier

channels, it could be stated that the major part of supplies comes from IC Companys’

own shared sourcing offices in China, Bangladesh, Vietnam, India and Romania. 69%

of the production belongs to Chinese supply, with 18% to the rest of Asia and just 13%

to European market. By using its own shared sourcing offices IC Companys has made it

possible to handle geographic sourcing options safely and quickly. Indeed, the Group

could easily move its production wherever the combination of price, quality and supply

stability is the best (IC Companys’ annual report 2010/2011). There are usually some

risks of switching suppliers in relation to quality and credibility. In fact, IC Companys’

management stands for credibility of the production in its own shared sourcing offices.

It has to be mentioned that IC Companys has recently implemented a new sourcing

structure of which the object is to reduce the number of suppliers and improve

efficiency and flexibility. The key element of this new structure is the systematization of

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the Group's sourcing while at the same time adapting it to the efficiency and flexibility

required by the organization’s new set up (fibre2fashion.com, 2011). But independence

of suppliers has been reducing IC Companys’ power and influence on the suppliers in

terms of volume discounts, improved credit term, etc. Still suppliers’ bargaining power

is very limited. That is why it has been concluded that in the apparel industry, suppliers

have very insignificant influence on the price regulation and thereby has relatively weak

bargaining power.

5.2.3 Bargaining power of buyers

In order to analyze the bargaining power of the buyers it is decided to define customer

segment that IC Companys deals with. That is why, first of all, IC Companys’

distribution channels must be reviewed. There are two distribution channels, wholesale

and retail (franchise, e-commerce, outlets). Wholesale accounts for 61% of revenues in

2011, while retail captures the rest of sales. Both have showed significant growth of

13% and 11%, respectively (IC Companys’ annual report 2010/2011). IC Companys’

customers do not account more than 3% of the wholesale revenue which means total

sales are independent of particular customer as a result of diversity in the strategic

management. As it has already been stated IC Companys belongs to the upper-mid

segment and high premium brands. That is why its target customers also represent

higher or upper-mid class, which is not usually price sensitive comparing with preferred

high-quality and defined brands. It could be assumed that IC Companys’ apparel

belongs to luxury category where buyers usually do not have significant bargaining

power. Buyer might have bargaining power if other rivals in the wholesale market

intensify competition producing similar apparel, but with lower price. By implementing

the multi-brand strategy IC Companys focuses on each brand and educates its

employees to perform high service and expertise relating to each brand. But still there

are some buyers that might switch from preferred brands to other apparel products in

case of personal image changes and design preferences. As it is supposed even though

IC Companys strives to build strong and valuable brands, their buyers are not counted to

be "brand loyal" customers which means that brands from various producers might also

satisfy IC Companys buyers. In that case such buyers will have some degree of the

bargaining power.

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5.2.4 Threat of Substitute products and services

As competition intensifies and buyer becomes more price sensitive, the threat of

substitute products and services increases in major markets. By taking into

consideration the existence of such rivals as Inditex, Bestseller, BTX Group, which

produce upper-mid and middle class garments that might substitute products of IC

Companys' respective brands. Indeed, four out of eleven brands (Tiger of Sweden, Peak

Performance, Designers Remix Collection and By Malene Birger) stand for affordable

luxury, where the rest seven brands (Part Two, InWear, Cottonfield, Jackpot, Matinique,

Saint Tropez and Soaked in Luxury) present less expensive modern clothing. On the

high-end the threat of substitute assumed to be less significant as this group of buyers is

not price sensitive, therefore it is unlikely that they could switch to another seller due to

price difference. Indeed, consumers’ needed design and taste might change over time,

thereby influencing a switching from one brand to another. In order to reduce the

switching threat IC Companys educates its labor to focus on premium service that

creates strong brand image among the other competitors’ brands. It might be assumed

that if to consider both middle class and affordable luxury segments, to some extent the

threat of substitutes significantly exists.

5.2.5 Competition among the existing rivals

There are some vital factors that influence behavior of the players in the apparel market.

Industry concentration and growth have direct impact on competition intensity.

Industry concentration

Apparel market is one of the markets characterized by many suppliers with various

market sizes. The global apparel market consists of numerous smaller enterprises

operating internationally and several major companies that operate globally. Owing to

many entities in the apparel industry even the major market participants such as US

GAP, Swedish H&M and Spanish Inditex have relatively low global market shares that

indicates the high industry concentration. High industry concentration intensifies

competition and increases the market attractiveness.

Industry growth

Market growth for the apparel industry could be examined from different aspects.

Through the historical data it could be seen that the global apparel industry had total

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revenues of $1,175.4 billion in 2011, representing a compound annual growth rate

(CAGR) of 2.7% between 2007 and 2011. According to forecasts, the global apparel

retail industry is forecasted to earn a value of $1,348.1 billion in 2016 with an

anticipated CAGR of 2.8% for the five-year period (Companiesandmarkets.com, 2012).

The female wear segment was the industry´s most lucrative in 2011, with total revenues

of $600.5 billion, equivalent to 51.1% of the industry´s overall value.

Beside the hard data calculations and historical financial numbers there are many other

external factors that have an impact on the future growth prospects of the whole apparel

industry. Some external influencing drivers which increase uncertainty about positive

outcomes might be political, economic, technological and environmental issues that

have been already described in the PESTEL model. Report, published in Stitch Times in

2011, states that "The apparel industry and market really are at a tipping-point" meaning

that apparel industry has reached a level where the scenarios of stagnation, growth and

recession are quite real.

In order to identify the level of competition among the main rivals of IC Companys it

has to be determined the main target customer groups and respective geographic areas.

As it is stated in the company’s report, IC Companys focuses on the development of

fashion brands and sport apparel, meanwhile 65% of the annual turnover is created from

sales in Scandinavian and Benelux countries. Main competitors in the defined market

sector are Bestseller, Zara from Inditex group, Hennes & Mauritz AB.

Even though each rival strives to add value to its brand portfolio by increasing quality

and concentrating on modern fashion, the target customer groups still are not considered

as loyal customers what means a brand switching and mixing is a normal tendency for

the middle class and affordable luxury class consumers. That is why in order to gain

share in the apparel market through rough competition, the company might use an

expansion strategy and try to operate more new stores in the emerging markets.

There are some issues concerning the Chinese market where IC Companys’ sales have

been decreasing and the company experiences a relatively negative pace of business

development.

It could be concluded that there is harsh competition in the apparel industry and IC

Companys strives to capture market share by using growth strategy in the potential

emerging markets.

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5.3 Internal analysis

With the aim to create a clear picture and to better understand the activities through

which IC Companys develops a competitive advantage and creates value to its

shareholders, it is decided to proceed with value chain analysis, which defines a

company's strengths and weaknesses.

In his book "Competitive Advantage" published in 1985, Michael Porter presents

generic value chain model which consists of primary and supportive activities

(Netmba.com)

The figure 5.1 introduces the chain value model.

Figure 5.1 Porter’s chain value model

Source: www.netmba.com

As it is shown in figure 5.1 there are five main activities, namely, Inbound logistic,

Operations, Outbound logistics, Marketing & Sales and Service and four support

activities such as Infrastructure, Human Resource Management, Technology

Development and Procurement. Each activity has been structured to end up with

positive margin that creates value for a company.

In accordance with Michael Porter’s concept of the value chain, primary activities are

described as (learnmarketing.net & netmba.com):

Inbound Logistics: refers to raw materials being obtained from suppliers ready to

be used for producing the end product;

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Operations: include processes of transforming raw materials into finished

products and services;

Outbound Logistics: once the products have been manufactured they are ready to

be warehoused and distributed to customers;

Marketing and Sales: identification of needs targeted towards the correct

customer group. Marketing is used to establish an efficient strategy, thus

enhancing the generation of sales;

Service: after the product has been sold, the organization has to offer support

services. They might include such activities as after sales training, warranties

and guarantees.

The supportive activities assist the primary activities in aiding the organization to

achieve its competitive advantage. Aforementioned activities are supported by:

Firm Infrastructure: it is the set of various activities such as organizational

structure, control systems, company culture, etc., to ensure that the entity’s

finances, legal structure and management structure works efficiently enhancing

value creation;

Human Resource Management: in order to succeed in its objectives, the

organization needs to hire, train and develop its employees. Staff has to be

motivated and compensated properly if they are to stay with an organization and

add to it;

Technology Development: technologies are exploited to support value-creating

activities. It is used to reduce cost thus adding value; in research and

development to evolve new products and via the use of the Internet so customers

have access to online facilities;

Procurement: purchasing inputs such as raw materials and equipment obtaining

the best combination of price and quality.

To summarize, the value chain covers the whole entity and focuses on how primary and

supportive activities could cooperate together effectively in helping the organization to

gain an exceptional competitive advantage.

According to the Group’s operational model, it has been decided to adjust its primary

activities with the aim to comply with the steps of the value chain model.

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The first modification is the examination of the additional activity taking place before

Inbound Logistics such as Design. The main reason to start with this phase is related to

specific features of the fashion industry. Before placing orders in manufactures, garment

companies have to develop design of new collection.

5.3.1 Primary activities

5.3.1.1 Design

The design process includes designers’ creativity and inspiration coming alongside with

analysis of sales in stores. By examining data from individual stores, designers might

track customers’ preferences observing sales in each individual store. Following this

procedure, designers analyze fashion trends and gather inspiration for implementing

acquired ideas in new collection, therefore, to satisfy consumers’ desires.

5.3.1.2 Inbound Logistics and Operations

Inbound Logistics and Operations combine Outsourcing and Quality Control stages due

to the fact that IC Companys does not have its own production facilities. Instead of it,

the Group employs suppliers through its own shared sourcing offices which conduct

preliminary research with the aim to develop a unique flexibility. It implies the handling

of geographic sourcing alternatives safely and quickly, thereby moving production to

the most beneficial facilities in Eastern Europe and Asian countries.

As the final step just before manufactured apparel leaves production lines, some

examples of apparel have to pass quality tests conducted in Denmark. If apparel meets

quality requirements, it is ready to be delivered.

5.3.1.3 Outbound Logistics

Fashion industry is heavily dependent on delivery of products at the appropriate time

with convenient circumstances. There are two main distribution channels in IC

Companys, wholesale and retail, where the Group is liable by contract to deliver

finished goods from the sourcing countries directly to the wholesale customers within

the determined time range. In a case when demanded products do not reach the store

shelves at the right time, issues arise concerning the returned and surplus products that

create negative impact on sales thereby resulting in write-downs.

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Products to be realized through the Group’s retail channels are transported on container

lines to Europe where IC Companys has three large warehouses. Modern warehouse in

Brøndby that deals with the flat packages, a warehouse at Raffinaderivej, which handles

the Group’s hanging products, both located in Denmark, and a warehouse in Lódz,

Poland, responsible for surplus products and marketing material.

In general, the company’s products are handled in two ways: either distributed in flat

packages or hanging. The majority, approximately 90% of goods sourced in Asia, is

transported on container liners to Europe while the rest is sent by air freight. All the

merchandise sourced in Europe is transported by truckage (IC Companys’ annual report

2010/2011).

5.3.1.4 Marketing and Sales

Marketing

As stated before, IC Companys follows the multi-brand strategy when each brand has a

market-oriented management that handles market positioning, product development and

marketing – the activities that are essential to the development of each brand identity

and constitute the decisive factors for the customer’s decision to buy (IC Companys’


Needless to say that the multi-brand strategy provides great opportunities, when brand

managers could concentrate on respective brand positioning and development acting in

line with a thoroughly planned brand strategy with a clearly defined fashion position

and market approach in accordance with the company’s business principles which

reduces the total business exposure. Moreover, each brand adds value by being a part of

IC Companys’ portfolio thus delivering financial results to the Group (IC Companys’


Brands position themselves differently with respect to consumer groups, price horizon

and quality. In return, the Group covers various parts of the fashion market since brands

supplement each other. Therefore, brands could market themselves into various

segments and price levels thus boosting sales.

With the aim to gain more awareness, IC Companys has created showrooms for all its

eleven brands for displaying new collections to current and potential customers.

Over several years, the Group has been headquartered on Amager, in an area that is now

transforming into a regular fashion district in Copenhagen, where more than 30 different

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Danish and international brands are presented in 16 individually designed showrooms

(modebranchen.nu, 2012).

Sales

The key focus for all brands is to achieve sales growth and build equity while

prioritizing investments with respect to return on investment and enforcing tight cost

control (IC Companys’ annual report 2010/2011). The strategy of multi-branding

implies the supplement so that customers associate the individual product with IC

Companys. That gives the company a better position in the fashion market where single

brands do possess a tiny fraction of the total market, but a multi-brand company holds a

substantial market share.

As mentioned above, IC Companys uses two channels of distribution, namely,

wholesale and retail. Wholesale dealers sell other brands apart from the Group’s ones.

As a part of wholesale activities, they include franchise stores which pay to IC

Companys to be under the company’s umbrella. The second type of distribution channel

is retail. It involves own stores, outlet stores and e-commerce.

There are shops that only sell individual brands as well as multi-brand stores selling all

the Group’s brands under shops named “IC Companys”. The network of outlets stores

surplus products and sell them during the year as the main purpose of such stores is to

realize out-of-date apparel from previous collections. Furthermore, any products that

cannot be sold through own outlets are sold to brokers for resale outside the Group’s

established markets (IC Companys’annual report 2010/2011). More hard data regarding

distribution channels are given in the Introduction under Products, Distribution

channels and Markets parts.

5.3.1.5 Service

According to authors’ experience and a short interview with IC Companys’ shop seller

who operates in Fisketorv shopping mall in Copenhagen, it could be stated that products

bought in IC Companys' shops have different service options. For example, in the shop

that operates in Fisketorv, it is possible to return product within 3 days if a receipt is

shown; however, this service does not cover products bought with discount. It also has

to be mentioned that according to the seller, other IC Companys shops have different

obligations and periods for refunding, which might vary from 3 days to 2 weeks. All in

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all, it could be concluded that service concerning warranties is different from shop to

shop.

5.3.2 Supportive activities

5.3.2.1 Firm Infrastructure

Despite quite short history, IC Companys has undergone through turbulent periods.

Since the origin of the Group, there were various changes such as the implementation of

the multi-brand strategy, the adjustment of organizational structure and the appointment

of new management team.

After the merger of Inwear Group A/S and Carli Gry International A/S, the newly

created IC Companys has followed centralized form of organization. It implies that the

common company’s management was in charge of all operations both external and

internal ones.

In 2004 the Group has adopted a new multi-brand strategy, with the objective to

maximize the return on a portfolio of independent fashion brands. A market-oriented

management of each brand became responsible for market positioning, product

development and sales. At the same time, there was launched a shared platform for the

brand portfolio which handles and supports all the supply activities that are not relevant

for each particular brand, which included such activities as sourcing, sales, production,

logistics, administration, IT, finance and HR (IC Companys’ annual report 2004/2005).

The starting financial crisis in 2007 had a negative influence on the Group’s

performance as on the whole economy. In such a challenging environment, IC

Companys has failed in cost reduction policy with respect to revenues development.

Therefore, it might be assumed that it was the main reason for the IC Companys to

change its management team.

The new management team has continued the decentralization path what resulted in

giving all 11 brands a full responsibility and power of decision making. It involves full

amenability of entire value chain, including distribution (just-style.com, 2010).

Currently, IC Companys has a two-layer organizational structure: shared service

platform and multi-brand strategy. Figure 5.2 shows separate brand organizations with

full responsibility of own value chain (IC Companys, Corporate presentation, 2012):

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Figure 5.2 IC Companys’ organizational structure

Source: IC Companys’ press release

5.3.2.2 Human Resource Management

In the contemporary global markets almost all products follow with services. High

quality service existence creates additional value and supports companies' preferable

brand building.

Therefore, IC Companys has developed a professional HR strategy. The HR department

is in charge of the development and updating of methods and tools assisting in

prioritizing and continuously evaluating the employees’ performance (IC Companys’


Beside value benefits, highly managed customer service also helps companies to

differentiate themselves from their rivals. With the aim to provide better services IC

Companys is highly focused on HR management and supports employee training by

providing Retail, Leaders, Sales and Brands Academies. HR chief Morten Linnet states

that Retail Academy has been created with a target to support the company’s business

by developing fantastic service, more sales and better carrier possibilities

(fashionforum.dk, 2010). Moreover, in cooperation with consulting agency Franklin

Covey, IC Companys has created a professional leadership program for the Group’s

many leaders to learn new skills in order to enhance the execution of the multi-brand

strategy (Franklincovey.dk, 2012).

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5.3.2.3 Technology Development

Besides the factors mentioned in the PESTEL analysis, such as online sales of apparel

and descriptive websites which refer to each brand, a well-developed IT system ensures

more synchronization in the company’s operations. In fact, IC Companys has been

investing substantial funds in IT systems, specifically in SAP Enterprise Resource

Planning (ERP). The Group’s previous IT architecture consisted of several independent

systems, which were not supportive of business activity and needs for quick and

accurate financial reporting (sap.com, 2011). Thus, the two-phase implementation of

SAP ERP in the years of 2007 and 2008, has allowed IC Companys to gain control of

all economic processes in the Group such as financial management, reporting and

accounting.

As a part of SAP ERP system, IC Companys has implemented SAP Business

Communications Management to improve its customer relationships with business

communications. It implies providing efficient sales service to retail and franchise

partners (ecenta.com, 2009).

5.3.2.4 Procurement

The implementation of the multi-brand strategy led to the shifting of purchasing

function to individual brand managers. As the next step, brand managers make

purchases through the Group’s own shared sourcing offices in China (including Hong

Kong), Bangladesh, Vietnam, India and Romania and to a limited extent by the use of

agents. Therefore, it is no longer a supportive activity, but part of the primary activities

under Inbound and Operations.

More specifically, procurement activities might involve purchasing of commercial

premises, tangible goods and transport services that are related to the shared platform,

however, are not clearly related to the individual brands.

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Summary

All activities directly relating to the each brand are under the responsibilities of

respective brand managers, whereas the activities which have no relevance to brand

identity are handled through the shared service platform. Therefore, the multi-brand

strategy allows brand managers to focus on the development of the individual brand.

All in all, authors find IC Companys’ value chain optimal. There cannot be determined

any activities which do not create value and thus should be outsourced. It is reasonable

that the Group has outsourced the manufacturing function and in result could free

additional funds for creating a greater value in the value chain.

However, there is always a room for improvement in already working principles. In

order to succeed in its multi-brand strategy, each brand should overhaul all its value

chain activities. For instance, an individual brand management has to keep track of sales

to determine which products are less attractive to consumers and thus to change next

collection design ideas.

5.4 Core Competencies

According to Prahalad and Hamel, core competencies are defined as (Prahalad &

Hamel, 2009):

“…the company’s collective knowledge about how to coordinate diverse production

skills and technologies… creating unique, integrated systems that reinforce fit among

your firm’s diverse production and technology skills – a systemic advantage your

competitors can’t copy…”

After the examination of the Group’s value chain, authors have found out three core

competencies of the company: sourcing activities, the multi-brand strategy and human

resource management. These three distinguishing features are the pillars of the Group’s

business which create value and help to compete in an intensive apparel market.

Now, authors will briefly introduce each core competence. First of all, there comes the

multi-brand strategy idea to delegate brand-building activities to the individual brand

management. These individual units enjoyed autonomy in design, sales and marketing,

thus forming dedicated brand teams for the respective functions. This was combined

with a shared service platform to gain efficiencies through the joint operations of

sourcing, distribution, sales logistics, HR, IT, PR, finance, legal and administration.

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Furthermore, the multi-brand strategy allowed IC Companys to diversify risks.

Accurately predicting consumer tastes and preferences is essential to success. To reduce

risk, each brand implements the commercial and fact-based development of its

collections (Foss, Pedersen, Pyndt & Schultz, 2012).

The second core competence is sourcing activities which increase efficiency and

flexibility in the way that the brands produce in the right countries and collaborate with

the best suppliers. As a key element of the interaction with suppliers is the company’s

own shared sourcing offices which are located in the manufacturing countries

(npinvestor.dk, 2011).

Following the introduction of the multi-brand strategy, IC Companys emphasized HR as

a key focus area that could drive retail sales, enhance leadership development and

strengthen talent management efforts. The idea was realized by establishing four

academies: leaders, sales, retail and brands; meanwhile working more actively with

employee development, internal recruitment and succession planning. Such initiatives

improved internal planning, created awareness about internal career paths and as a result

strengthened the Group’s ability to retain talented employees (Foss, Pedersen, Pyndt &

Schultz, 2012).

5.5 Growth Strategy

In order to grow and generate profit a company might follow internal and/or external

growth strategies. That is why the growth strategy has been divided into two parts

where the external growth is achieved by implementing horizontal, vertical and

diversification strategies and is discussed in section 5.7.

Then the internal growth strategy, which mainly depends on companies’ strengths, is

described according to Porter’s generic framework.

Porter’s Generic Framework

One of the main and traditional growth models, Porter’s generic framework, is applied

to introduce IC Companys’ chosen growth strategy and ability of the company to

perform in the best way by using its core competencies. It is reasonable how Porter

called the model since it is not industry dependent, but mostly reflects a company’s

strengths and weaknesses. Prior to analyzing IC Company's growth strategies, it is

decided to introduce three main strategies from the model that help to define IC

Companys’ market prospects.

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By referring to Porter’s generic framework wide range of companies use one or some

combinations of the three strategies: Cost leadership, Differentiation and Focus. He

states that a company must implement one of these strategies or it might get stuck in the

middle (Porter, 1980).

5.5.1 Cost leadership

Firms that have a cost leadership strategy strive to become the low cost producer in the

industry. The sources of cost advantage vary and depend on the structure of a firm's

industry. It could range from the pursuit of economies of scale in the manufacturing

industries to the lowest overhead costs in human recourse intensive industries, e.g.

security guard services (Porter, 1980).

IC Companys’ market it operates in is highly attractive and thereby an intensive

competition force companies such as IC Companys, Inditex, Bestseller and H&M to

implement more than one strategy. IC Companys operates in the middle and upper-mid

class and its seven brands that operate in the middle class usually are targeted to price

sensitive customer groups. In order to produce with low cost IC Companys successfully

uses its own shared sourcing offices that particularly are in the charge of finding low

cost, but still corresponding to companies required quality level, manufacturing

facilities. IC Companys new strategy that has been implemented in 2010 gave more

responsibility to each brand and now sourcing is also under control of brand

management teams. It has to be noticed that besides middle price segment brands,

Group also holds high-end brands. That is why the company has to be careful with its

cost reduction strategy in order not to deteriorate product quality of IC Companys’

affordable luxury brands.

5.5.2 Differentiation

According to Porter (1980) differentiation strategy creates unique image for a company

within its industry along dimensions that consumers are less price sensitive and willing

to pay price premium. By focusing on superior product quality, product design and

other services such as delivery and marketing approach company might establish brand

loyalty, thus enhancing higher sales margin (Porter, 1980).

Going through IC Companys’ brands, it becomes clear that the Group has been applying

more than one strategy due to its different brands’ market positions. On the high-end,

brands like Peak Performance, Tiger of Sweden, By Malene Birger and Designers

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Remix Collection introduce high quality, preferable product design combined with high

service with the aim to develop unique brand identity for consumers. It could be stated

that the Group gives outmost importance to the differentiation strategy by proceeding

activities such as eliminating or reducing the risk of consumers wearing products which

might contain too many chemicals or dye substances (CEO Niels Mikkelsen, 2011).

Implementation of the multi-brand strategy allows the Group's different brands to use

the shared business platform and increase focus on brand differentiation, customer

loyalty and economies of scale. Recently, each brand took the responsibility of the value

chain with the aim to improve its core competencies and operate more efficiently.

As a part of the differentiation strategy the Group has also been enhancing HR

management to create intelligent employee base that could support high-level service

and customer relations. It has already been mentioned about IC Companys’ academies

for employee training in section 5.4.

5.5.3 Focus

Companies adopting a narrow competitive scope and targeting particular customer base

use the third focus strategy. This niche could be either "a certain kind of customers, a

limited geographic market, or a narrow range of products" (Miller & Friesen, 1986).

The narrow focus in itself though not sufficient for competitive advantage. The firm

needs to optimize the strategy on two variants: cost focus and differentiation focus.

Then by exploiting differences in cost behavior and using differentiation strategy

companies might take advantage of the customer's specific needs.

IC Companys’ relation to the focus strategy might be discussed in different aspects. It

could sound wrong if one would argue that IC Companys does not apply focus strategy

as its products cover broader range than a niche market. However, on the other hand, IC

Companys operates various brands and some of the brands such as Peak Performance

which targets active people who demand extremely functional products with a unique

design and uncompromising quality (IC Companys’ annual report 2010/2011). In that

case, it might be assumed that particularly Peak Performance brand uses the focus

strategy where its mission is to continue developing functionally designed active/casual

wear and holding its leading positions. It could be argued to some degree whether Peak

Performance is just affordable luxury that builds a strong brand name by using the

differentiation strategy or it satisfies customers of the niche market who are extremely

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involved in skiing, training, golf, etc. It is assumed the Group probably uses the focus

strategy for Peak Performance and looks like they succeed in this business.

Evaluation of the Porter’s growth strategy

It is vital for IC Companys to implement hybrid growth strategies to compete

successfully in an intensive fashion industry. However, according to Porter who claims

that firms which have implemented one of his generic strategies benefit from higher

returns, than firms with hybrid strategies (Eldring, 2009). In our case, as IC Companys

has adopted the multi-brand strategy which covers both middle and upper-mid class

clothing. Thus, it might mix various growth strategies from Porter’s generic framework.

As a proof of a successful growth strategy implementation, table 5.1 is presented to

show annual percentage change and compound annual growth rate (CAGR) of each

brand sales and overall of the Group.

Table 5.1 The Group brands measured by revenues (2003/04 – 2010/11)

2005 2006 2007 2008 2009 2010 2011 Brand

CAGR

ICC

CAGR

By Malene

Birger 292.3% 76.5% 40.0% 36.5% 14.5% -0.5% 34.7% 53.7%

Designers

Remix 31.3% 38.1% 65.5% 35.4% 16.9% -2.6% 23.0% 28.2%

Tiger of

Sweden 31.8% 20.1% 9.9% 25.8% -10.9% 9.4% 18.3% 14.1%

Saint

Tropez 12.3% 14.4% -6.0% -2.5% 17.0% 36.3% 31.1% 13.7%

Peak

Performanc

e

20.8% 13.5% 24.1% 11.3% 5.4% -2.8% 6.8% 11.0%

Matinique -13.8% -0.5% 23.1% 20.4% -6.1% -6.1% 11.2% 3.2%

Part Two -5.4% -6.2% -4.1% 18.5% 8.5% 4.5% 7.1% 2.9%

InWear 10.5% 9.7% 13.7% 0.4% -23.8% -13.1% 12.5% 0.4%

Cottonfield 11.6% 6.3% 18.3% 10.4% -13.0% -26.2% 3.0% 0.4%

Soaked in

Luxury 19.2% 0.0% 19.5% 1.0% 11.4% -25.6% -14.9% 0.2%

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Jackpot 2.2% -3.1% -10.8% 2.0% -9.0% -3.6% 7.0% -2.4%

IC

Companys 8.0% 7.1% 11.0% 11.4% -3.1% -3.5% 12.3% 6.0%

Source: IC Companys’ annual reports

5.6 SWOT analysis

SWOT analysis is a tool that helps to evaluate the strengths, weaknesses, opportunities

and threats involved in any business enterprise (Kime & McGee, 2008). The factors

depicted in SWOT analysis are extracted from both external and internal analyses.

Specifically, the company’s strengths and weaknesses are found out and evaluated from

Porter’s value chain which stands for the internal analysis. On the other hand, a firm’s

opportunities and threats are examined through the external analysis by exploiting

PESTEL and Porter’s five forces.

Table 5.2 SWOT analysis of IC Companys

Strengths Weaknesses

1. Independent and strong multi-brand

strategy

2. Shared platform for all brands

3. Synchronized operations through

well-developed IT system

4. Flexible and cost-saving outsourcing

through own sourcing offices

5. Well-developed HR strategy incl.

employee academies

6. Strong quality control

7. Various distribution channels

8. Regular renewal of collections

9. Cover of many customer segments

through broad brand portfolio

10. One of top apparel companies in

Northern Europe in terms of size

1. Lack of expertise in emerging

markets

2. IT dependence

3. Low growth in several brands

4. Shipping to limited numbers of

countries (14 countries)

5. Reliance only on one sport brand

(Peak Performance)

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Opportunities Threats

1. Business development in emerging

markets

2. Demographic development (kids,

baby boomers, etc.)

3. Discount offers in online shopping

4. Building stronger brand loyalty

5. Development and/or acquisition of

new brands

1. Fierce competition in fashion

industry

2. Policy of trading partners

(suppliers)

3. Rising wages in Asia and Eastern

Europe

4. Changing weather conditions

5. Ongoing economic recession in

Europe

6. Fashion risk

The results of the strategic analysis are summarized above in the SWOT table and some

of the factors are discussed in more details.

IC Companys has developed an independent and resilient multi-brand strategy. The

Group has moved purposely to vest each brand with power relating to design, marketing

and sales. Furthermore, IC Companys has acquired and introduced new brands to meet

varying customer preferences. Therefore, the multi-brand strategy supported by various

factors such as shared platform and IT system is considered to be the Group’s main

strength.

One of the major weaknesses of IC Companys is the lack of expertise in Chinese

market. Chinese market is one of the fast growing with great potential for businesses.

On the one hand, the Group has achieved essential results in production sourcing in

Chinese facilities. However, the firm has been struggling to succeed in meeting Chinese

end-users’ needs. IC Companys has experienced unsuccessful attempt in that market

with lower sales due to less knowledge than such competitor as Bestseller.

IC Companys has various opportunities regarding its further development. One of them

is penetration into new markets and age segments. For instance, the Group might create

separate brands for kids (like Zara Kids) and aged people.

Threats are supposed to be of great awareness for IC Companys since these factors are

not in the scope of the firm’s influence. Intense competition in fashion industry leads to

cost reduction to be more efficient and profitable. In fact, rising wages in manufacturing

countries negatively affect cost cutting strategy. Even more, the ongoing financial crisis

creates a threatening business environment. In addition, the Group has experienced a

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sales slowdown in the first half of its fiscal year of 2011 due to unusually warm weather

during the autumn and winter and partly the worsened financial crisis (IC Companys,

Press release, 2012).

5.7 Expansion Strategy

Expansion strategy is mainly subdivided into three categories (Dringoli, 2011):

1. Horizontal expansion: expansion in domestic markets or entering in different

geographical markets, producing the same or new products. A company

continues to operate in the same industry or business with the same product.

The extension to different market segments through new types and models of

the same basic product is also considered as a horizontal expansion;

2. Vertical integration: expansion along the value chain. It refers to direct

operations or phases of activity or services which before were acquired from

other firms;

3. Product diversification: expansion entering different industries producing

substantially different products related or unrelated to the existing ones.

According to IC Companys’ strategy and operations, it has been adopting principally

the horizontal expansion so far, where vertical integration and product diversification

are not in the scope of the Group’s interests.

Among many modes of horizontal expansion, the Group has executed geographic and

Mergers & Acquisitions (M&A) expansions. Geographic expansion is one of the key

factors for the Group to expand since more than 80% of total revenues come from

outside of Danish market. Therefore, if IC Companys is eager to boost its sales, it needs

to open stores in the form of franchising, concessions and own shops.

As of June 2011, IC Companys had 214 retail stores including an opening of 22 new

stores and closing of 14 old ones. 8 stores were opened in Central Europe while 2 shops

were closed. Furthermore, 7 and 5 stores were opened in Denmark and Sweden,

respectively. In the form of retail concessions, IC Companys had 75 stores with 5 new

shops opened and 58 stores closed. Such huge number of concessions was closed due to

the fact that 51 shops were unprofitable in Canada. Moreover, the Group opened 3

concessions in Denmark; while 6 shops were closed in Sweden with only 1 store

opened.

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IC Companys was more active in opening of franchise stores with 33 new shops and

closing of 17 ones. It includes 6 new stores in both Sweden and Eastern Europe and

Russia, 5 new franchises in Rest of Europe and 4 new stores in both Denmark and

Benelux countries.

The other essential distribution channel element is e-commerce where IC Companys has

been investing substantial funds resulting in opening of online shops for each brand.

Currently, the company offers delivery only to 14 countries located in Western Europe

and Scandinavia, namely, Germany, Austria, Netherlands, Italy, France, Belgium,

United Kingdom, Spain, Ireland, Switzerland, Sweden, Denmark, Finland and Norway.

It might be beneficial for the Group to offer delivery to countries where the company is

already presented and new markets.

The second mode of horizontal expansion is M&A. IC Companys has been quite

aggressive in acquisition of fashion brands to cover more consumer segments and

increase the market share. In fact, IC Companys has been created in the result of the

merger of InWear Group A/S and Carli Gry International A/S in 2001.

In 2002, IC Companys has acquired Saint Tropez aimed at girls and women. Key values

such as sound business practice and a customer-centric mindset have served as the

foundation of the brand’s success and became the reason to take it under the wing of the

Group (IC Companys, history of Saint Tropez, 2012). In 2003, IC Companys created

the joint venture with Malene Birger with the vision of being recognised as a highly

respected and prominent player on the global fashion arena (IC Companys, history of

By Malene Birger, 2012). The same year, IC Companys acquired Tiger of Sweden

positioned as a high attitude brand in the mid-price segment (IC Companys, history of

Tiger of Sweden, 2012). In 2006, the Group acquired Adventure Sport & Leisure AS,

the Peak Performance distributor in Norway. The acquisition has given Peak

Performance full control of sales and a strong and smoothly functioning platform for

continued growth in the Norwegian market (IC Companys’ annual report 2005/2006).

In 2010, IC Companys gained a full control of By Malene Birger purchasing a minority

interest of 49%. Malene Birger stated that she had decided to leave the business side of

the company to concentrate on all the existing creative challenges (IC Companys, Press

release, 2010).

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6. Evaluation of the corporate valuation theories

Many different models and methods exist for valuing a company. Some are used only in

specific situations, some are always more or less part of a valuation, and others are used

mostly in conjunction with other models (Frykman & Tolleryd, 2003). These models

often make very different assumptions about the fundamentals that define value, but

they do share some common features and could be classified in broader terms

(Damodaran, 2006).

According to Damodaran (2006) and Ryan (2007), there are four approaches to

valuation, namely, discounted cash flow valuation, asset valuation, relative valuation

and contingent claim valuation. Discounted cash flow valuation relates the value of an

asset to the present value of expected future cash flows on that asset. Asset valuation

implies a method where a summary of the assets less the liabilities of the firm are

valued on some agreed basis. Relative valuation evaluates the value of an asset by

considering the pricing of “comparable” assets relative to a common variable like

earnings, cash flows, book value or sales. Finally, contingent claim valuation exploits

option pricing models to determine the value of assets. These approaches could lead to

various results contingent on assumptions employed in each model.

Benninga and Sarig (1997) recommend to conduct the double-check of estimates the

one has made since there are too many guesstimates involved in calculations. It might

be done by using several methods of calculating the values and if different techniques

give similar outcomes it implies that the one might be sure of the estimated value.

Therefore, several methods are examined and used for the IC Companys valuation.

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6.1 The Discounted Cash Flow (DCF) Method

In the following method, the firm value is calculated as all future free cash flows (FCF)

discounted back to today using the proper cost of capital (Frykman & Tolleryd, 2003)

that reflects the riskiness of these cash flows (Damodaran, 2006).

According to Damodaran (2006), there are two ways how discounted cash flow

valuation could be conducted. The first is to estimate the entire business taking into

consideration both assets-in-place and growth assets. This way is termed as enterprise

valuation model. The enterprise DCF model discounts FCF which are available to all

investors – equity holders, debt holders and any other non-equity investors – at the

weighted average cost of capital (WACC), implying the blended cost for all investor

capital. The second way is the equity valuation model. The claims on cash flow of debt

holders and other non-equity investors are subtracted from enterprise value to find

equity holders’ value (Koller et al., 2010). The derived value is discounted by the rate

which reflects only the cost of raising equity capital (Damodaran, 2006).

Although both methods give identical results when applied appropriately, the equity

method is difficult to apply since matching equity cash flows with the correct cost of

equity is extremely challenging (Koller et al., 2010). Since the focus of this thesis is on

company valuation, the enterprise valuation model is used for further calculations.

The formula for the DCF model looks as follows:

The first part in enterprise valuation is FCF and WACC determination, when they need

to be estimated explicitly for every given year and the cash streams discounted back to

today. The second component is where the cost of capital and the growth rate are

assumed to be constant and the continuing value of all cash streams from the first year

after the explicit period to infinity is calculated (Frykman & Tolleryd, 2003).

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6.1.1 Variables in the DCF Model

Free Cash Flow calculation

There are several key drivers in a company’s valuation such as the return on invested

capital (ROIC), the growth rate and free cash flow (Koller et. al., 2010).

According to Penman (2003), free cash flow (FCF) is the part of the cash from

company’s operations left over after the firm conducted new investments. A firm

reduces its FCF by investing and increases it by cutting its investments. However, a

company is worth more if it invests successfully.

To conduct a robust valuation, a reorganizing of financial statements is needed. ROIC

and FCF are essential to the valuation process, however, it is impossible to calculate

them directly from a firm’s financial reports. Therefore, it is necessary to reorganize the

financial statements into the new ones that separate operating items, non-operating

items and financial structure.

When the firm’s financial reports are completed, the company’s historical financial

performance must be analyzed. Analyzing the past, the one could find out if the firm has

created value, whether it has expanded and how it collates with its competitors. Getting

the sense how key drivers performed in the past assists in making more robust forecast

of future cash flows.

Once the reorganization is completed, two new terms pop out, namely, invested capital

and net operating profit less adjusted taxes (NOPLAT). Return on invested capital

(ROIC) shows the return on the total investments a company has made (Follett, 2012).

ROIC is a better tool for forecasting comparing to return on asset (ROA) and return on

equity (ROE) as it puts equity and debt financing on an identical basis when, for

example, highly leveraged companies may look very profitable valued only by ROE

(Dorsey, 2004). In turn, NOPLAT means the total after-tax operating income generated

by the firm’s invested capital available to all capital investors.

The next step is the calculation of FCF which is derived directly from NOPLAT and the

change in invested funds (Koller et al., 2010).

Forecasting the Growth rate, ROIC and Free Cash Flow

When the company’s historical financial performance has been examined and FCF

derived, the next stage in the DCF valuation is to estimate revenues growth, ROIC and

FCF for an explicit period into the future. In order to forecast FCF, the one should start

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with NOPLAT and invested capital. Over the short period (for instance, the first five

years), it must be estimated such financial statement line items as gross margin, selling

expenses, accounts receivable and inventory. Projecting further into the future becomes

a difficult task. Consequently, considering the medium horizon (five to ten years), the

more emphasis must be put on the firm’s key value drivers such as operating margin

and tax rate as well as capital efficiency. Finally, forecasting beyond the medium

horizon leads to the valuing of a continuing value (Koller et al., 2010).

Forecasting Continuing Value

According to Koller et al. (2010), estimating key drivers on a year-by-year basis

becomes meaningless if the projecting extends far into the future. Therefore, it is

reasonable to apply a perpetuity-based continuing valuation which links cash flow

directly to growth rate and ROIC:

Where

6.1.2 The Weighted Average Cost of Capital

The WACC represents the average cost of each dollar of financing that the company

uses to purchase assets. Therefore, WACC might be considered as the minimum return

the company must earn on its investments to maintain its current well-being (Besley &

Brigham, 2011).

As it has been mentioned earlier, WACC is used to discount FCF. Consequently, slight

changes in WACC might result in significant swings in the company’s value (Bragg,

2009). WACC could be calculated by estimating its three components: the cost of debt

(incl. operating leases), the cost of equity and the target capital structure (Frykman &

Tolleryd, 2003). Thus, the formula for WACC looks as follows (Koller et al., 2010):

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Where

V – enterprise value

D – debt value

L – operating leases value

E – equity value

kd – rate of return required by debt holders

kl – rate of return required by operating leases holders

ke – rate of return required by equity holders

Tm – marginal tax rate

From the formula appears that in order to calculate WACC, the one should follow a

step-by-step process which is divided into four steps (Rosenbaum & Pearl, 2009 &

Koller et al., 2010):

1. Identify Target Capital Structure;

2. Evaluate The Cost of Debt (kd) including The Cost of Operating Lease (kl);

3. Evaluate The Cost of Equity (ke);

4. Calculate WACC.

Identification of the Target Capital Structure

Target Capital Structure consists of the debt-to-total capitalization (D/V), operating-

lease-to-total capitalization (L/V) and equity-to-total capitalization (E/V) ratios

(Rosenbaum & Pearl, 2009 & Koller et al., 2010). Debt, operating lease and equity must

be calculated based on market value. In more details, the market value of all outstanding

debt must be taken into account, involving fixed- and floating-rate debt. However, if

needed information is unavailable, the book value of debt is a sensible proxy when the

likelihood of default is low or interest rates have not changed significantly since the

issue of the debt (Koller et al., 2010). The value of a company’s leased assets must be

estimated using market interest rates, if a company does not disclose it (Koller et al.,

2010). Next step is to derive market value of equity. For this purpose, the price per

share given by the stock market might be considered. The market value of equity is

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usually called “market capitalization” and is calculated by multiplying price per share

with number of shares outstanding (Rosenbaum & Pearl, 2009).

Determination of the Cost of Debt

The cost of debt shows the current cost to the company of borrowing money to finance

its investments in assets. The cost of debt is a function of three components: the risk

free rate, the default spread and the marginal tax rate (Damodaran, 2006).

The risk free rate will be elaborated in the section The Cost of Equity in relation to the

CAPM.

The second component, the default spread, is directly related to lenders and their

perception of the default risk embedded in the firm. In turn, the default risk is a function

of two factors: the firm’s capability to generate cash flows and current financial

obligations. Companies that generate significant cash flows exceeding its financial

obligations must have lower default risk and vice versa. The default spread could be

determined in several ways, among others: 1) for publicly traded debt it could be

determined by the current yield on all outstanding issues (Rosenbaum & Pearl, 2009),

2) bond rating assigned by independent rating agencies and corresponding to associated

default spreads, 3) if the company’s debt is private, the one might examine recent

borrowings made by a firm to get a sense of default spreads or assign its own rating

based on financial ratios (Damodaran, 2006).

The third component is the marginal tax rate. Interest paid on debt is tax deductible

resulting in reduction of the cost of borrowing. Usually, most companies report an

effective tax rate on taxable income which is calculated by dividing the taxes paid by

the net taxable income. Effective tax rate might be different from marginal tax rate.

Therefore, the marginal tax rate might be found in the tax code of the country where the

company earns its operating income. For companies paying taxes in multiple tax

locations, the marginal tax rate should be calculated as the average of the various

marginal tax rates weighted by operating income earned from respective location

(Damodaran, 2006).

All in all, the formula for the cost of debt looks as follows (Damodaran, 2006):

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Furthermore, Koller et al. (2010) state that from an economic perspective, operating

lease is no different from traditional debt; investors, lenders and rating agencies treat it

the same as loan or bond. Thus, operating leases must be included in the enterprise

value and the WACC calculation. Since operating leases are secured by the underlying

asset and are less risky than the company’s unsecured debt, the cost of operating leases

could be estimated by AA-rated yields. Finally, as operating leases is the form of debt,

it implies the effect of tax shield.

Determination of the Cost of Equity

The cost of equity is based on the three components: the risk-free rate, the market risk

premium and a company-specific risk adjustment. The most widely used model to

project the cost of equity is the capital asset pricing model (CAPM) (Koller et al.,

2010).

CAPM is built on the condition that equity investors must be compensated for taking

systematic risk in the form of a risk premium or, in other words, the return in excess of

a risk-free rate. Systematic risk is the one that relates to the overall market and is not

diversifiable. In contrast, unsystematic risk is company-specific and could be avoided

through diversification. Therefore, equity investors are not rewarded for it (Rosenbaum

& Pearl, 2009). Despite the critics, the CAPM model remains the general method for

estimating an expected rate of return of a security. Although the model relies on strong

assumptions, it is based on solid theory about risk and return (Koller et al., 2010).

According to Damodaran (2006), the major advantage of the CAPM is that it captures

an asset’s exposure to all market in one number – the security’s beta – while the rest of

models might need a determining of other factors such as illiquidity, default risk,

macroeconomic indices, etc. Thus, the identification of specific factors directly

affecting a company’s cost of equity might cause a bias in the valuation.

The formula for CAPM calculation looks as follows (Koller et al., 2010):

Where

E(Ri) – expected return of security i

rf – risk-free rate

βi – stock’s sensitivity to the market (the stock’s beta)

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E(Rm) – expected return of the market

In the CAPM, the risk-free rate and market risk premium, defined by [E(Rm) – rf], are

similar for every company being traded in the respective market, whereas stock’s beta is

purely individual.

Further sections delve into factors affecting the application of CAPM and calculation of

the cost of equity.

Risk-free rate

The risk-free rate usually refers to the expected rate of return received by investing in a

riskless asset (Rosenbaum & Pearl, 2009). In turn, a government bond or a treasury bill

in the home country of the firm being valued is considered to be a risk-free security.

Furthermore, a risk-free asset being used for valuation must have a duration that

matches the investor’s investment horizon (Frykman & Tolleryd, 2003). For example, a

cash flow generated 10 years from today must be discounted by WACC derived from a

10-year zero-coupon government bond. For U.S. companies, the most general proxy is

10-year STRIPS (long-term zero-coupon bond). When considering European

companies, the 10-year German Eurobond is embedded in valuation as the most liquid

and least risky than any other European country’s bond (Koller et al., 2010).

Market Risk Premium

The market risk premium is the spread between the expected market return and the risk-

free rate. The history shows that investors have to be rewarded in terms of a risk

premium for holding risky assets instead of riskless government bonds (Brealey et al.,

2001). According to Koller et al. (2010), there are several methods to estimate the

market risk premium; however, none of them is precise model.

In the following paper, historical market risk premium is used as a tool for determining

market risk premium. This method implies that if the level of risk aversion has not

changed over the past century, then historical excess returns must be an appropriate

proxy for future premiums. Koller et al. (2010) suggest the following guidelines in

historical market risk premium calculation:

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1) Compute premiums in relation to long-term government bonds. For the

calculation of premiums, historical market returns must be compared with the

return on 10-year government bonds;

2) Consider the longest period possible. In order to reduce estimation error, a

longer history should be considered to estimate market risk premium;

Furthermore, market risk premium could be computed using either an arithmetic

average or a geometric average. An arithmetic average sums each year’s premium and

divides by the number of observations:

∑

A geometric average compounds each year’s premiums and takes the root of the

resulting product:

(∏

)

Koller et al. (2010) state that the arithmetic average is the best unbiased estimator to

determine a security’s one-period expected return, but a company with many years of

cash flows cannot be valued by this tool. Instead, long-term cash flows must be

discounted by a compounded rate of return. In turn, compounded historical arithmetic

average leads to a biased discount factor. In order to amend the bias caused by

estimation error and negative autocorrelation in returns, the one might use an estimator

proposed by Marshall Blume:

(

) (

)

Where

T – number of observations in the sample

N – forecast period being discounted

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RA – arithmetic average of the historical sample

RG – geometric average of the historical sample

Beta

Beta is a measure of the company-specific risk that is associated with a firm. If beta

exceeds 1, it implies that the company bears a higher risk, thus expected return

supposed to be greater than that of the market. For beta lower than 1 works an inverse

relationship (Frykman & Tolleryd, 2003). From the mathematical point of view, beta is

a measure of the covariance between the rate of return on a firm’s stock and the overall

market return (Rosenbaum & Pearl, 2009).

Beta cannot be determined directly, therefore, it should be estimated. The estimation of

beta might be done by using regression. The most general regression used to evaluate a

company’s beta is the market model (Koller et al., 2010):

Where

Ri - stock’s return regressed with respect to the market’s return

Furthermore, the estimation of a company’s beta might be implemented using average

beta of similar companies’ corresponding measures. This method is called “Bottom up

betas”. Damodaran (2006) suggests the following procedure:

1. Comparable firms. Find similar businesses in a respective industry;

2. Beta estimation. When a list of comparable firms is set, each company’s beta

must be estimated against a common index;

3. Levered betas. Each company’s levered beta is calculated through the regression

mentioned earlier;

4. Unlevered betas. Unlevered beta for each company is computed using the debt

to equity ratio and tax rate:

(

)

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5. Averaging approach. The average beta across the comparable firms is the

estimator of the target company’s beta, which must be adjusted in the same way

to derive a levered beta.

In detail, concerning the estimation of beta, Koller et al. (2010) suggest several

guidelines:

1) The minimum estimation period should be 60 data points. The following number

of observations originated as a rule of thumb during early tests of CAPM;

2) Regression should be built on monthly returns. In that case, the one might avoid

a systematic biases;

3) Company’s stock returns should be regressed against a well-diversified market

portfolio. The most common proxy is the S&P 500, a value-weighted index of

large U.S. companies. In some cases, it is reasonable to use MSCI World Index

which captures more than 1,600 stocks across 24 developed markets (MSCI Inc.,

2012). However, two indices had a 95.8% correlation between 2000 and 2009.

Liquidity premium (LP)

Liquidity has always been a significant factor in corporate valuation, however, investors

usually pay less attention to that. One of the reasons is that liquidity premium is hard to

measure and it does not pose troubles in the most active markets. In opposite, liquidity

factor may lead to essential valuation imprecisions if a company is traded in less liquid

market. Moreover, liquidity premium is distinguished between large and small market

capitalization companies, where premiums for small market capitalization companies

may be much higher than those for large market capitalization companies (Xue &

Zheng, 2010).

Damodaran (2006) states few determinants of illiquid stock among others:

1. Bid-Ask spread;

2. Price Impact: the effect that an investor could create by trading an asset in

significant volume.

IC Companys belongs to middle capitalization (mid-cap) companies traded on

Copenhagen Stock Exchange (CSE). The Bid-Ask spread for IC Companys varies

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around 0.5%, while the same measure for large-cap companies equals to 0.2%. In terms

of trading volume, IC Companys significantly underperforms comparing to other mid-

cap companies having been traded averagely 8,000 shares a day from 30 June 2010 to

30 June 2011. Moreover, an absence of liquidity provider or market maker in IC

Companys stock leads to greater volatility when a large trade may create an inadequate

price change. As a result, it has been decided to add a liquidity premium of 2%

(Petersen et al., 2006) to the computation of IC Companys’ cost of equity. Thus, the

cost of equity formula for IC Companys looks as follows:

[ ]

6.2 Economic profit model

Besides the DCF model, it is intended to apply also Economic Profit Model in order to

confirm the results from the DCF model. In fact, when both models applied accurately

they perform different, but complementary benefits, thus results from both valuation

models have to be equal. The economic profit valuation model has become popular due

to its close link to economic theory and competitive advantage (Koller et al., 2010).

Economic Profit Model is also called Economic Value Added (EVA) which has been

commercially developed in 1982 by the corporate advisory team of Joel Stern and G.

Bennet Stewart III. One of the main reasons of EVA to become more favorable as a

valuation tool is the fact that unlike traditional measures of profit such as EBIT,

EBITDA, and net operating income, EVA looks at the firm's residual profitability, net

of both the directs cost of debt and the indirect cost of equity capital. Generally, three

famous economists Irving Fisher during the 1930s and Franco Modigliani and Merton

Miller in the late 1950s focused and elaborated on meaning of economic profit in

corporate valuation context (Grant, 2003). By referring to the economists’ aspects, the

theory of EVA relies on two principle assertions which are stated below:

1. A company is not truly profitable if its opportunity cost of capital is higher than

company's return on invested capital;

2. In order to create wealth for the shareholders, firm's managers have to make

positive NPV investment decision.

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According to Grant (2003), EVA might be defined by two operational ways, accounting

and financial. From the accounting perspective EVA could be calculated as difference

between the firm's net operating profit less adjusted taxes (NOPLAT) and its weighted

average cost of capital (WACC). Accounting based approach relies on conventional

accounting income and balance sheets, footnotes to financial statements and additional

external data concerning beta that is used in CAPM also has to be included.

From the finance perspective, EVA is defined in terms of its relation to firm’s market

value added (MVA) or net present value (NPV) which equals to the present value of the

firm's expected future EVA. On the other hand, while dealing with EVA from the

finance perspective, it is necessary to note that key drivers for the financial approach are

primarily discounting or present value process with the aim of determining market value

added, enterprise value and stock price.

Main distinction between EVA and MVA is that when interpreting MVA, market data

is primarily used in the calculation while using EVA it is referred to firm's financial data

and adjustments to firms accounting profit (Fabozzi & Peterson Drake, 2009).

The economic profit model examines how and when the company gains value and

introduces identical valuation process as enterprise DCF (Koller et al., 2010). Single

period value creation by the company is measured by economic profit formula below:

Where ROIC stands for return on invested capital and WACC is the weighted average

cost of capital, thereby their difference might be defined as economic spread. Instead of

using economic spread multiplied by invested capital, ROIC might be replaced by

NOPLAT divided by invested capital (Koller et al., 2010).

In order to deliver the full meaning of the economic profit and its role in a company’s

value, it is intended to demonstrate the formula that encompasses comprehensive

valuation tool. The formula below is economic-profit-based key value driver model

which has been transformed from cash flow perpetuity formula.

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∑

The formula above states that operating value of a company is the sum of its book value

of invested capital and present value of all future value created. It also confirms that if

company's sum of future economic profit equals to zero, the value of company

operations equals to invested capital. But there are two main aspects in the above

mentioned formula that economists have to draw attention to. These factors are WACC

and ROIC. The main issue might occur while discounting company’s projects at

constant cost of capital and forecasting economic profit for the future years in order to

calculate a continuing value with the same ROIC. The inconsistency of using constant

WACC is that a company might change its financial structure. Thereby, WACC has also

to be changed, for example, deleverage has direct impact on company's cost of capital.

That is why, companies that plan to change its capital structure and debt-to-value ratios,

have to adjust their WACC on annual basis in order to handle fluctuations in the capital

structure. Then, calculating continuing value by using economic-profit-based key value

driver, it is necessary to examine whether return on new invested capital (RONIC)

equals to historical ROIC in the continuing value formula. In the case when RONIC

differs from the last year ROIC, the equation has to be transformed by separating into

current and future economic profits (Koller et al., 2010).

6.3 Multiples

There are some other ways of valuing firms beside DCF which could be referred to two

additional valuation techniques such as multiples and real options (Koller et al., 2010).

In this section it is decided to describe the role of multiples analysis for a company

valuation. Before starting to elaborate on particular multiples it has to be stated that

market multiples have two primary classifications, analytical tools and valuation tools.

Multiples for analytical tools introduce the relative valuation per dollar of book value or

per dollar of earnings. Such multiples measure share price relative to a key accounting

numbers that enable analytics to draw illation concerning firm's comparative market

capitalization, to observe fluctuations in firm's valuation over time and compare value

across the firms. Advantage of market multiples over analytical is the ability to conduct

time-series and cross-sectional analyses in order to compare how capital markets value

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stocks (Wahlen et al., 2010). For example, according to Jerald et al. (2010), it could be

stated that by multiplying benchmark value of the price-to-earnings (P/E) ratio with the

estimate of a particular company's earnings per share (EPS) presents quick estimate of

the chosen company's stock that makes it able to compare with the stock's market price.

Multiples could also be used efficiently as a valuation tool, but it must be applied and

interpreted carefully concerning relevant peer group, industry definition, firm's expected

return, profitability growth and risk (Wahlen et al., 2010). Multiples in valuation

process might play very supportive role in two aspects, as the method of comparable

and the method based on forecasted fundamentals (Pinto et al., 2010).

The method of comparable could be easily applied to enterprise value multiples with

purpose to evaluate the market value of the whole company with the specific value

measures that provide relevant results concerning both equity and debt holders. If the

appropriate multiple has been assessed then finance manager might use it to check their

results from the DCF method. Koller et al. (2010) highly suggest starting with

enterprise value to earnings before interest tax and amortization (EBITA) multiples as it

determines more accurate company's value than any other multiples. In the equation

below is introduced commonly used multiple EV/ EBITA:

The formula above is quite similar to the P/E ratio, but the main difference is to

calculate enterprise value, not the share price.

According to Koller et al. (2010), there are three main requirements that have to be

fulfilled in order to achieve more plausible and efficient multiple comparable:

1. Collecting the right multiples. More relevant multiples for the valuation analysis

are assumed to be the EV/EBITDA, EV/EBITA. Despite the fact that price-to-

earnings (P/E) is commonly used, it is distorted by capital structure and non-

operating gains and losses;

2. Apply compatible calculation manner. The most correct mode is defining the

numerator with value and the denominator with earnings taken from the

particular underlying assets. It has also to be mentioned that if an analytic

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excludes surplus cash from value, then interest income on such cash has also to

be subtracted from the earnings;

3. The best chosen peer group. It is one of the main aspects in the multiple

analysis to choose the right peer group that corresponds to the target company's

long-term growth and return on invested capital (ROIC).

Application of method based on forecasting or use of forward-looking multiples is

another efficient method that has been broadly applied in forecasting of a company's

long-term cash flows by avoiding one-time past charges.

Even though the DCF analysis is assumed to present the most accurate and flexible

method for valuing project, the credibility and accuracy of the DCF valuation model

highly depends on reliable forecast numbers that have significant impact on final

company’s value. The main difference between forward-looking multiples and

backward-looking multiples is the fact that in constructing forward-looking multiples

denominator should use a forecast of profits rather than historical profits. Indeed,

empirical evidence informs that forward-looking multiples are more robust predictors of

value than historical multiples. In order to construct forward-looking multiples it has to

be chosen forecast year for EBITA which introduces the most relevant long-term

prospects. In periods of stable growth and profitability future years estimates are more

plausible.

Evaluation of multiples

Multiples method is quite easy and simple to use in a company’s valuation, but in fact

multiples are usually misinterpreted and mislead. Main confusion might arise while

building multiples for particular target. Majority of books concerning multiples analysis

suggest to use commonly accepted price-to-earnings multiples where the numerator

presents market price which is easy to determine and interpret, but the denominator is

related to earnings-per-share ratio which is based on the complex rules of accrual

accounting and presents significant interpretation issues (Pinto et al., 2010). Koller et al.

(2010) also argue between the choice of EV/EBITA and P/E by stating that P/E

multiples have two major flaws. P/E might mislead as it is affected by a company's

capital structure, but not only by its operating performance. Then, the second flaw

occurs in calculating net income by subtracting or adding non-operating loss or gain

what affects the final result of earnings and has direct effect on P/E fluctuations.

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Other issues might arise in selecting a sample of comparable firms. According to

Benninga and Sarig (1997), the selection of the comparable firms has to be based on

tight restrictions such as gathering firms whose market price are averaged in order to be

less different from the firm being valued, however, peculiarity of each firm is not

considered in the valuation prospects. With aim to reduce uncertainty concerning

idiosyncrasy within each firm, sample size has to be large enough to average out such

phenomenon. In a conclusion it could be stated that due to its simplicity and

convenience multiples might provide rapid valuable "sanity check", but being simple

refers to sweeping many factors that create problems associated with less certainty. All

in all, as the main valuation tool DCF is considered to be the preferable technique while

multiples analysis is secondary or supportive method in valuation of companies.

6.4 Real Option Valuation (ROV)

Real option valuation is another appropriate method for valuation of companies'

underlying non-financial assets and capital investment projects. An option itself is the

right, but not the obligation, to take an action in the future and options are valuable

when the market is highly uncertain or volatile (Amram & Kulatilaka, 1999). According

to the authors, the real option approach is the extension of financial option theory to

options on real assets. Financial options might be divided into two classes where

American option is allowed to be executed before and at the expiration date, while

European option might be executed only at the expiration date or never. There are some

similarities between financial and real options such as both options are more valuable

while uncertainty increases and also both types of options provide companies with a

tool that limits their downside risk while also gaining from advantage to upside

opportunities in the future. But the main difference between these two approaches is

that, unlike financial options, real options are applied in such opportunities which were

created by company's strategic investments (Boyer et al., 2003).

It is decided to use the extension of financial options – real options, which are broadly

used in the academic world. However, implementation of the real options in the

contemporary corporate world has been proceeding slower than expected (Amram &

Kulatilaka, 1999).

By having in mind that contemporary business market involves high degree of

uncertainty and risks due to recent economic fluctuations, development of real options

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theory might be used as an important tool that describes and evolves relationship

between risk and value (Boer, 2002).

According to Mun (2002), the main difference of real option valuation method from the

traditional valuation approaches lies in the fact that the DCF model underestimates the

value of a project by excluding its value of flexibility. Traditional way of project

appraisal within the capital budgeting where the DCF method is used, assumes that a

company follows rigid and inflexible path forward by ignoring and failing to respond

and adjust to any fluctuations in the market place. Thereby, traditional methods ignore

the risk pattern for the specific project that might change over time (Brach, 2003). The

main value-added component in applying real options is the fact that it considers

management's ability to create, execute and abandon strategic and flexible options

(Mun, 2002).

By referring to Mun (2002), it could be stated that real option approach is applied by

considering multiple decision abilities according to issues arising due to high

uncertainty complied with management’s flexibility in selecting the optimal strategies

or execution of an option might change due to new observed information.

It has to be mentioned that real option analysis does not necessarily preclude or replace

traditional DCF and NPV analyses. According to Brach (2003), the DCF model

considers cash flows which are based on past data while the further implication of the

real options might create value in constructing and adjusting cash flows for the future

investment projects.

Real options, according to Mun (2002), might be calculated in various ways, by taking

into consideration the use of path-dependent simulation, closed-form models, partial-

differential equations, and multinomial and binomial approaches. In practice of real

option valuation, analytics mainly use mainstream methods which consist of closed-

form solutions, partial-differential equations and the binomial lattice tree. As an

example for closed-form solutions it could be referred to Black-Scholes model where

equation is solved by forming set of input assumptions. Even though the

implementation of the model might be quick and exact by using some programming

knowledge, difficulties occur while explaining the results as they tend to involve highly

technical stochastic calculus mathematics. The disadvantage of Black-Scholes model

concerning the flexibility is limited due to its nature. Another model of closed-form

equations as it has already been mentioned above is binomial lattice model which is

very simple and explicit in aspects of implementation and explanation. Unlike Black-

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Scholes model, Binomial lattice is highly flexible, but demands significant computing

ability and might consist of plural time steps in order to obtain relevant approximation.

Due to appropriateness of the latter model, it is decided to implement it in connection to

IC Companys’ possible option valuation.

6.4.1 The Binomial lattice model

First time in 1979 Cox Ross and Rubinstein have created the binomial option pricing

model which is a discrete model for valuing European and American options. Indeed,

there are various possible ways of solutions for real options including other lattice

approaches, but the binomial lattice is considered to be the most robust, simple and

mature in its implementation. According to Mun (2002), the binomial lattice model

results might be achieved by using two different ways of calculations. The first way of

such calculation is based on market-replicating portfolio and the second approach might

be achieved by using risk-neutral probabilities. In fact, use of replicating portfolio

approach is assumed to be more complicated considering both understanding and

implementation. Despite the difference in calculations the results obtained from both

replicating portfolio and risk-neutral probabilities approaches are identical.

Furthermore, elaboration on the binomial lattice model considers risk-neutral

probabilities which are mainly based on four-step process according to Koller et al.

(2010). It is assumed that due to its simplicity in implementation and explanation of the

process, binomial tree with risk-neutral probabilities might be relevant tool kit for

valuation of IC Companys’ possible future activities. The main purpose of

implementation of four-step process in ROV approach with straight forward binomial

lattice is to assess flexibility tendency which is consistently driven by non-diversifiable

risk.

Figure 6.1 introduces Koller et al. (2010) four-step binomial lattice approach in real

option valuation:

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Figure 6.1 Binomial lattice approach in ROV

Source: Koller et al. (2005)

Step 1: Evaluation of the companies underlying asset without flexibility

In order to proceed to the first step it is necessary to value companies’ investment

projects without any flexibility. In our case, it is assumed to value the whole IC

Companys where evaluation of the company’s assets is done by using the DCF model

which determines the company’s underlying assets value without flexibility. The value

of the company’s assets or stock price which is defined by the DCF method is used in

the first lattice while the second lattice has two outcomes with up and down

probabilities.

Step 2: Modeling event tree without any decision impact

At the second step of the binomial lattice the focus is on two possible outcomes of the

company’s project or underlying asset value. By calculating risk-neutral probabilities it

is conditional to define whether the target company is profitable or unprofitable in the

next periods of the lattice. According to Mun (2002), it could be mentioned that using

the binomial lattice with higher number of time-steps results in higher level of

granularity and accuracy.

In order to find up and down movements it is referred to equations below:

√

In the equations above T stands for estimated number of years per upward movement

and σ is an annualized volatility of the underlying company’s asset. By analyzing up

and down movements it becomes obvious that when the annual volatility, σ, equals to

zero, uncertainty concerning cash flows equals to zero. When volatility is eliminated the

Estimate NPV

without

flexibility

Model

uncertainty

in event tree

Model

flexibility in

decision tree

Estimate

contingent

NPV

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result of the binomial lattice is equal to results from discounted cash flow model since

the volatility elimination excludes any gains of flexibility. It could be briefly stated that

referring to up movement formula, when σ=0, the binomial lattice model becomes

useless as up and down movements are equal to one.

After determination of up and down movements, risk-neutral probabilities have to be

calculated by the following formula below:

Where

down probability is

In the formula above r is the cost of capital of a company's underling asset.

According to Koller et al. (2010), when using PV formula it is possible to verify that the

present value concerning a company’s assets in the event tree has to be equal to

expected payout at a company's cost of capital. The formula below introduces PV

calculation for a chosen node in the event tree:

Step 3: Using flexibility in decision tree

Unlike the step 2, underlying asset’s value in the future periods of binomial lattice

includes flexibility where event tree transforms to decision tree. Decisions concerning

company’s future aspects might be various by referring to management options such as

expansion, abandonment, delay, etc. After adding decision points to the event tree, it is

necessary to estimate percentage increase in a company’s value and expenses, for

example, due to expansion or growth strategy. After implementation of chosen strategy,

management might define new estimated cash flow due to new circumstances by

discounting payouts backward through the time. If an observed value with added

flexibility due to accepted decision points is higher than the value without flexibility,

the company tends to exercise its option and gain from the value increase of a

company’s assets.

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Step 4: Final value of the real option with flexibility

In the last step of ROV it is intended to use risk-neutral probabilities in order to value

company’s assets with flexibility. According to Koller et al. (2005), risk-neutral

valuation includes risk adjustment as a part of scenario analysis rather than the discount

rate. In the process of option valuation instead of implementing actual scenario

probabilities, it is considered to weight the future cash flows by risk-adjusted

probabilities. After determination of probability-weighted average cash flow, it is

assumed to discount the cash flows by risk-free rate to define the current value of the

company’s assets. The formula below demonstrates how to find the probabilities of

upside and downside movements:

Then by applying probabilities determined from the formula above it is possible to

define option values in each node, then, to discount them with risk-free rate doing

backward calculations or just simply discounting them from right to the left.

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7. IC Companys valuation using DCF model

As mentioned before, the key drivers of a company’s value are the return on invested

capital (ROIC), the growth rate and free cash flow (FCF), which cannot be directly

derived from financial statements.

The balance sheet blends operating assets, non-operating assets and financing sources,

while the income statement consolidates operating profits with financing costs.

Therefore, financial statements need to be reorganized for unbiased assessments of a

company’s value (Koller et al., 2010).

To compute ROIC and FCF, the balance sheet has to be reformulated to create invested

capital as well as reorganize the income statement to establish net operating profit less

adjusted taxes (NOPLAT) (Koller et al., 2010).

7.1 The reformulated balance sheet

The reformulation of the balance sheet leads to the definition of invested capital which

represents the total investor capital needed to fund operations without reference to

sources of capital. In detail, a company’s operating assets need to be separated from its

non-operating assets, while the same has to be done for items related to liabilities

(Koller et al., 2010).

Principally, operating assets (OA) consist of items such as receivables, inventory and

property, plant and equipment. Operating liabilities (OL) are mainly compounded of

accounts payable, accrued salaries and interest-bearing debt. When a balance sheet is

properly reorganized, it leads to net operating assets (NOA) and other long-term assets

(OLTA), and, finally, to invested capital (Koller et al., 2010):

Where

It has been decided to examine five IC Companys’ financial statements starting from the

year of 2006/2007 and ending with the year 2010/2011. Throughout the observing

period, IC Companys had net financial obligations rather than net financial assets.

According to Penman (2010), if a company has financial obligations exceeding financial

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assets, then it finances its operations by attracting loans rather than issuing new equity.

As it is seen from table 7.1, before the credit crunch in 2008 and 2009, IC Companys

was heavily relying on loans. However, in the last two years net operating assets were

largely financed through equity.

Table 7.1 IC Companys: Reformulated balance sheet activities calculations (in mil.

DKK).

2007 2008 2009 2010 2011

NOA 820.3 826.4 702.5 686.6 790.4

FA 24.4 25.6 35.4 36.0 33.8

FO 702.5 771 615.3 315.3 364.7

NFO 678.1 745.4 579.9 279.3 330.9

NFO/NOA 82.66% 90.20% 82.55% 40.68% 41.86%

Source: Authors’ own calculations

The major item of the company’s assets is inventories, which account for 556.5 million

DKK (29%) out of the total 1926.4 million DKK in the financial year of 2010/2011.

The third largest item is trade receivables accounting for 358 million DKK (19%) in the

same year. These two items, which account for almost half of assets, are directly tied to

the company’s core operations – distribution and selling of clothes. Property, plant and

equipment make up 375.5 million DKK (19%). The following item mostly consists of

the company’s inventory facilities and leasing rights. It might have been larger, but

almost the half of shops under IC Companys’ brands is franchises.

Operating liabilities list is much shorter, where only two items make up the most of it.

Trade payables account for 348.9 million DKK (29%) that is low relative to trade

receivables. It implies that IC Companys does not purchase more on credit than it sells.

Otherwise, more purchases need to be financed through either debt or equity, what

reduces cash flows to the company. The second largest item is financial obligations

(364.7 million DKK or 31%), which consist of mortgage loan and credit facilities for

operations.

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7.2 The reformulated income statement

According to Koller et al. (2010), the core element in the valuation of a company is

Earnings Before Interest, Taxes and Amortization of Acquired Intangibles (EBITA),

which equals revenue less operating expenses (e. g., cost of sales, staff costs,

depreciation). The following measure is a base for calculating NOPLAT.

EBITA is used instead of EBITDA and EBIT in the valuation due to several reasons.

When a company buys a tangible asset, it gets capitalized on the balance sheet and

depreciates over its lifetime. Since the asset loses economic value, depreciation has to

be included as an operating expense when determining NOPLAT. The same argument

refers to the amortization: they have fixed lives and losing value, too. However,

investments in intangibles are expensed and not capitalized, what makes difference from

accounting of physical asset. Thus, when an intangible loses value and must be

replaced, a company gets penalized twice: through amortization and reinvestment.

Therefore, EBITA avoids double-counting amortization expense (Koller et al., 2010).

The reformulated income statement is presented in appendix 1. As it is seen, EBITA

was in quite short range between 300 and 360 million DKK with the year of 2008/2009

as the exception. The same is attributable to the final results of the years, which showed

fairly stable dynamic in the range of 220 and 250 million DKK, and with extraordinary

low profit in 2008/2009.

7.3 Trend analysis

Trend analysis shows how financial statements items have changed over specific period

of time. The analysis expresses items as an index relative to a base year. Thus, the trend

analysis is made for the all of IC Companys’ financial years with 2006/2007 as the base

year. Derived results are presented in table 7.2.

Table 7.2 IC Companies: Trend analysis for the reformulated income statement

2007 (in

mil. DKK)

2007 2008 2009 2010 2011

Revenue 3353.8 100.00 111.43 107.97 104.22 117.04

Cost of sales 1370.9 100.00 107.84 106.84 100.00 116.99

Gross profit 1982.9 100.00 113.91 108.75 107.14 117.08

Staff costs 807.2 100.00 115.36 117.52 114.84 125.92

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EBITA 344.2 100.00 104.91 50.78 88.15 95.35

Profit for the

year

240.6 100.00 93.14 45.39 98.00 102.37


Throughout the observed period, revenues have grown 17.0% suffering moderate

decrease in 2009 and 2010. Unfortunately, dynamics of cost of sales has developed in

the same way. They have grown 16.9%, what is comparable with the overall growth in

revenues. Accordingly, gross profit has showed the similar results and ended up by

growing 17.1% over five years. Staff costs have experienced the highest growth rate of

25.9%, what is a negative fact since the staff costs growth rate has surpassed the growth

in gross profit. EBITA has struggled to recover to the levels of 2008 underperforming

the last two years. In opposite, profit for the year of 2011 has grown slightly with

respect to the results in 2007.

Table 7.3 IC Companys: Trend analysis for the reformulated balance sheet

2007 (in

mil.

DKK)

2007 2008 2009 2010 2011

Intangible

assets

245.8 100.00 102.69 89.59 101.30 106.75

PPE 408.8 100.00 103.69 102.52 99.90 91.85

Inventories 466.4 100.00 114.15 94.25 91.92 119.32

Trade

receivables

266.6 100.00 111.29 96.62 98.31 134.28

Trade payables 296.8 100.00 105.73 98.28 119.54 117.55

Cash 144.9 100.00 91.10 56.73 49.62 37.13

Financial assets 24.4 100.00 104.92 145.08 147.54 138.52

Financial

obligations

702.5 100.00 109.75 87.59 44.88 51.91

Total equity 566.6 100.00 83.57 89.85 131.87 131.08


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In table 7.3 is presented the dynamics of selected items in the reformulated balance

sheet. Both intangible assets and PPE have fluctuated moderately over the analyzed

period. Trade receivables have showed a significant increase of 34.3% implying that IC

Companys allowed its customers to purchase more products on credit, what postpones

inflows into the company. Trade payables have increased by 17.6%, but due to higher

base in 2007 compared to trade receivables, they both have almost matched in actual

terms. Cash and cash equivalents have declined by 62.9%. Financial assets have showed

the highest increase of 38.5%, however, due to low actual size of this item, it does play

a moderate role. More important is that financial obligations almost halved over the

analyzed period what is considered positively since the financial burden has been

reduced. Total equity rose by 31.1% mostly due to retained earnings, thus, creating a

financial cushion for the future.

7.4 Operating Leases, Taxes, NOPLAT and Invested Capital

7.4.1 Operating Leases

Despite many companies, IC Companys reveals the value of its leased assets (note 25 in

the annual report 2010/2011), which need to be included as an operating asset in

invested capital. Thus, the valuation of capitalized operating leases might be skipped.

Asset life is computed by the weighted average method and equals to 4 years for the

whole valuation period. Furthermore, when the cost of debt is derived, the next step is

to calculate implied interest, which is embedded in operating leases expenses. Implied

interest equals the cost of debt times the prior year’s value of operating leases and a

derived value is added back to EBITA resulting in adjusted EBITA (Koller et al., 2010).

The operating leases calculations overview is presented in table 7.4, the more detailed

information might be found in appendix 9.

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Table 7.4 IC Companys: Operating leases activities calculations (in mil. DKK)

2007 2008 2009 2010 2011

Operating leases

expenses

233.6 246.7 286.9 314.0 329.7

Cost of debt 16.1% 19.6% 18.8% 20.8% 19.3%

Asset life 4 4 4 4 4

Value of operating leases 553.5 655.4 686.3 744.7 842.2

Implied interest 88.9 128.3 128.9 154.5 162.3


7.4.2 Taxes

Reported taxes get affected by non-operating items, therefore they need to be adjusted

to an operating level. Deferred tax assets (DTA) and deferred tax liabilities (DTL) flow

through NOPLAT via cash taxes, but there are some non-operating items in them,

which must be adjusted. Koller et al. suggest applying the following approach for

calculating net operating deferred tax liabilities (NODTL) to be subtracted from

operating taxes:

( )

The calculations of NODTL are presented in appendix 8.

The next important step is marginal tax rate determination. In the last IC Companys’

annual report the marginal tax rate is given at 25% which equals to the corporate tax

rate in Denmark. Thus, the same marginal tax rate is applied in the company’s

valuation.

After determining the marginal tax rate, the last step is to calculate operating cash taxes.

According to Koller et al. (2010), adjusted EBITA gets multiplied by marginal tax rate

resulting in marginal taxes on EBITA. Afterwards, NODTL is subtracted from marginal

taxes on EBITA to determine operating cash taxes.

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7.4.3 NOPLAT

NOPLAT is the after-tax profit generated from core operations, excluding any gains

from financing expenses, such as interest, and non-operating assets. While net income is

available only to equity holders, NOPLAT is accessible to all financial investors. Thus,

NOPLAT is a better indicator of operating efficiency comparing to net income.

As stated before, NOPLAT starts with EBITA, which, in the case of IC Companys, was

derived according to the following procedure suggested by Koller et al. (2010):

The derived EBITA is still incomplete since IC Companys has got operating leases and

pays for leased assets usage, thus, getting exposed to cash outflows. Since operating

leases are not capitalized on the balance sheet, implied interest calculated in section

7.4.1 must be added back to EBITA resulting in adjusted EBITA.

The next step is calculations of operating cash taxes which combine operating taxes and

NODTL. In section 7.4.2 is described the calculations of operating cash taxes. Finally,

when operating cash taxes are computed, they must be subtracted from adjusted EBITA

resulting in NOPLAT. Calculations of NOPLAT are presented in table 7.5. As it is seen

from the table, NOPLAT has undergone a significant drop due to declined sales

combined with upward trend in operating expenses.

Table 7.5 IC Companys: NOPLAT calculations (in mil. DKK)

2007 2008 2009 2010 2011

EBITA 344.2 361.1 174.8 303.4 328.2

Implied interest 88.9 128.3 128.9 154.5 162.3

Adjusted EBITA 433.1 489.4 303.7 457.9 490.5

Operating taxes 108.3 122.3 75.9 114.5 122.6

NODTL 19.3 29.3 7.0 -8.8 76.3

NOPLAT 344.2 396.3 234.7 334.7 444.2


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7.4.4 Invested Capital

Invested Capital represents the total amount the company has invested in its core

operations by summing operating working capital, fixed assets and net other long-term

operating assets. In detail, operating working capital calculated by subtracting operating

current liabilities (cash and cash equivalents, inventory and net receivables) from

operating current assets (trade payable, accrued salaries, provisions and income taxes).

Fixed assets are presented by the book value of net property, plant and equipment. The

third element of invested capital is net other long-term operating assets, which equals to

other long-term assets (deferred tax assets, financial assets) minus the corresponding

liabilities (provisions, deferred tax liabilities). Finally, investments in capitalized

operating leases must be included in invested capital calculations (Koller et al., 2010).

The overview of IC Companys’ invested capital calculations are presented in table 7.6,

more detailed information might be found in appendix 14. Invested capital has shown

quite stable fluctuations in the narrow range with a moderate slump in 2009.

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Table 7.6 IC Companys: Invested Capital calculations (in mil. DKK)

2007 2008 2009 2010 2011

Total current

operating assets

935.3 997.7 888.9 905.8 1048.9

Total current

operating liabilities

523.8 594.9 605.5 627.6 634.0

Operating working

capital

411.5 402.8 283.4 278.2 414.9

Total non-current

operating assets

196.3 184.1 181.3 198.9 129.2

Total non-current

operating liabilities

29 44.9 50.2 49.7 100.3

Net other long-term

operating assets

167.3 139.2 131.1 149.2 28.9

Net PPE 408.8 423.9 419.1 408.4 375.5

Capitalized leases 553.5 655.4 686.3 744.7 842.2

Invested Capital 1541.1 1621.3 1519.9 1580.5 1661.5


7.5 Free Cash Flow

Free cash flow is defined as (Koller et al., 2010):

Noncash Operating Expenses are presented by depreciation and noncash employee

compensation, while Investments in Invested Capital is the result of various elements:

Change in operating working capital, Net capital expenditures, Change in capitalized

operating leases, Investment in goodwill and acquired intangibles and Change in other

long-term operating leases. Therefore, free cash flow is calculated as gross cash flow

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minus gross investment. The overview of IC Companys’ free cash flow is presented in

table 7.7 and appendix 16.

Table 7.7 IC Companys: Free Cash Flow calculations (in mil. DKK)

2008 2009 2010 2011

NOPLAT 396.3 234.7 334.7 444.2

Depreciation 95.5 123.5 108.8 109.6

Gross Cash Flow 491.8 358.2 443.5 553.8

Gross Investment 174.8 -0.1 184.7 196.6

Free Cash Flow 317.0 358.3 258.8 357.2


Free cash flow clearly shows the drop in sales affecting NOPLAT earned in 2009-2010.

Furthermore, operating working capital has decreased substantially during the financial

turmoil through cash and inventory, while operating liabilities slightly increased.

7.6 The Weighted Average Cost of Capital of IC Companys

As mentioned in section 6.1.2, WACC could be calculated by estimating its three

elements: the cost of debt, the cost of equity and the target capital structure of the

company (Frykman & Tolleryd, 2003). Thus, the formula for WACC looks as follows

(Koller et al., 2010):

Determination of the risk free rate

As stated in section 6.1.2, it is general technique to use the yield-to-maturity (YTM) of

the German Government Bonds as the risk free rate for companies based in Europe

taking into account that those securities are assumed to be the most liquid and of higher

credit quality than bonds of other European countries. However, since IC Companys’

sales mostly come from Scandinavian countries including almost 20% of Danish share,

it has been decided to take the YTM of the 10-year Danish Government Bonds, which is

2.98% as of 30 June 2011 (Bloomberg.com). Therefore, this YTM is used as the riskless

rate in the WACC calculation.

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Determination of the IC Companys’ cost of debt

As stated in section 6.1.2, the cost of debt could be determined by three components:

the risk free rate, the default spread and the tax rate. IC Companys has not issued any

debt obligations, but relies solely on loans from credit institutions. Thus, the company’s

debt is not traded on open market and the interest rate on those obligations is directly

derived from the company’s annual report. In the last financial statement (Note 29), IC

Companys states that it holds two loans from credit institutions: 224.7 mil. DKK in

current liabilities and 140.0 mil. DKK in non-current liabilities with the effective

interest rates of 2.99% and 2.02%, respectively. Thus, it has been decided to calculate

the weighted average cost of debt (WAECD). The calculation looks as follows:

Thus, the WACD already combines the risk free rate and the default spread. The derived

cost of debt is lower than the risk free rate. First of all, the difference could arise due to

timing reasons – the risk free rate was determined after the loans had been taken.

Secondly, the loan accounted in non-current liabilities is the mortgage loan, thus it is

pledged by the security in the form of the company’s headquarters. The loans accounted

in current liabilities are operating and short-term ones. Thirdly, both interest rates are

floating taking into account that in recent years interest rates have been on their

historically low levels.

By using IC Companys’ marginal tax rate of 25%, the after tax cost of debt is calculated

as follows:

Determination of the IC Companys’ cost of operating leases

IC Companys’ does not provide any information in its annual reports concerning the

level of the cost of operating lease. Thus, Koller et al. (2010) suggest estimating the cost

of operating leases using AA-rated corporate bond yields. The next step is to determine

the maturity of corporate bonds in order to match it with operating asset life. For the

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base is taken U.S. corporate bond yields with 5 years to maturity, since the IC

Companys’ operating asset life is 4 years. As of 30 June 2011, the AA-rated 5-year

U.S. corporate bond yield is 2.70% (Bondsonline.com, 2012), which is used in the

WACC calculation.

Determination of the IC Companys’ cost of equity

The calculation of the cost of equity is based on the CAPM discussed in section 6.1.2.

The inputs to the CAPM: the risk free rate, beta and the market risk premium (MRP).

The risk free rate is already determined to be 2.98%, when the other inputs are

determined below.

Estimation of the IC Companys’ beta

It has been decided to estimate the IC Companys’ beta using the corresponding

measures of other similar public firms. Thus, to determine beta, four competitors were

selected for the regression, while the market returns are derived from MSCI World

Index. The regression results are presented in table 7.8, where both the levered and

unlevered betas and debt to equity ratio for each comparable firm are calculated as well

as the averages. More detailed information concerning the calculations is presented in

electronic appendix.

Table 7.8 IC Companys’ levered beta calculations

Companies Levered Beta R-squared Debt/Equity Unlevered

Beta

Marimekko 0.65 5% 0.15 0.56

H &M 0.77 17% 0.00 0.77

Inditex 0.55 12% 0.0004 0.55

Esprit

Holdings

0.87 12% 0.13 0.77

Average 0.71 12% 0.07 0.66

Source: Datastream, authors’ own calculations

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Furthermore, to calculate IC Companys’ levered beta, Damodaran (2006) suggests the

following formula for adjusting the average peer group unlevered beta to derive the IC

Companys’ levered beta:

(

)

IC Companys’ beta is less than one implying that the company is exposed moderately to

the market fluctuations and shows low returns opposed to market ones.

In addition, the regression shows that the average R2 is dramatically low, when only

12% in the comparable firms’ returns is explained by the market, while the major part

relates to company’s individual factors. Thus, the results must be treated with caution.

Estimation of the Market Risk Premium (MRP)

To derive the MRP, the historical market index and risk free rate returns were extracted,

namely, the MSCI World Index (in U.S. dollar) and 10-year U.S. Treasury Notes

(Forecasts.org, 2012). Both measures are retrieved for the period from 1970 to 2011.

The MRP was calculated implementing the Blume’s estimator described in section

6.1.2. According to the Blume’s estimator, the calculated MRP is 0.9%. Detailed

calculations are presented in electronic appendix. The given result is quite questionable,

since according to PriceWaterHouseCoopers’ published report in 2010 concerning the

pricing on the stock market, the MRP used by companies in corporate valuation lies

within the interval of 4.0% to 7.2% with the average of 4.9%.

Therefore, the derived MRP of 0.9% turns out to be extremely low, what could cause

bias in further valuation. Such difference might have arisen due to the time series

shortage, when only 42 observations were used. MSCI World Index was launched only

in 1970, thus there is not enough history to conduct an unbiased valuation of the MRP.

Thus, it has been decided to use the MRP of 4.9% for the WACC calculation.

Calculation of the IC Companys’ cost of equity

To calculate the cost of equity, the formula mentioned in section 6.1.2 is used:

[ ]

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The determined IC Companys’ cost of equity is used in the WACC calculation.

Estimation of the IC Companys’ capital structure

IC Companys’ target capital structure consists of the equity-to-total capitalization, debt-

to-total capitalization and operating-lease-to-total-capitalization. First of all, to estimate

equity value based on market indicators, the IC Companys’ share price is derived as of

30 June 2011, which equals to 221 DKK. The number of outstanding shares is

16.942.807. Thus, the equity value equals to:

The second component is the debt value, which the same needs to be evaluated using

market parameters. However, IC Companys’ has not issued any debt obligations

recently, totally relying on loans from credit institutions. As mentioned in section 6.1.2,

IC Companys’ has liabilities in the amount of 364.7 mil. DKK, which is used in further

calculations.

The last component is operating leases value. Fortunately, IC Companys’ discloses this

amount in its financial reports. As of 2011, IC Companys has got operating leases

commitments in the amount of 842.2 mil. DKK.

Finally, enterprise value used for determining weighted target capital levels might be

defined as (Koller et al., 2010):

Calculation of the IC Companys’ WACC

Since all the inputs necessary for the WACC calculation are determined, WACC could

be found by using the following formula mentioned in section 6.1.2:

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More comprehensive information concerning the WACC calculation might be found in

appendix 18 and electronic appendix.

As mentioned in section 6.1.2, slight changes in WACC could lead to significant swings

in the company’s value. Therefore, the sensitivity analysis is conducted in section 7.11

to examine how changes in WACC affect the company’s value parameters.

7.7 Forecasting of the IC Companys’ free cash flow

The enterprise DCF valuation model solely relies on forecasted free cash flow.

However, free cash flow should be created implicitly by first forecasting the income

statement and balance sheet (Koller et al., 2010).

To forecast the income statement, Koller et al. (2010) suggest a three-step process in

relation to each line item:

1. Decide what economic relationships drive the line item;

2. Estimate the forecast ratio;

3. Multiply the forecast ratio by an estimate of its driver.

Furthermore, Koller et al. (2010) advise typical forecast driver for few line items. For

example, revenues are a common driver of cost of goods sold and staff. Prior-year net

property, plant, and equipment and prior-year intangible assets are typical drivers of

depreciation and amortization, respectively.

To forecast the balance sheet, Koller et al., (2010) favor the relationship between the

balance sheet accounts and revenues being the most stable. Thus, the most of the IC

Companys’ operating items are forecasted based on revenues, while non-operating

accounts are fixed throughout the forecasting period. For example, revenues are typical

driver of accounts receivable and PP&E. The complete information concerning

forecasting of the income statement and balance sheet might be found in appendixes 4

and 6, respectively.

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Therefore, Koller et al. (2010) determine revenues as the main driver in the forecasting

process. To build the revenues forecast, there are two methods, namely, top-down

forecast and bottom-up approach. In the first method, revenues must be estimated by

sizing the total market, determining market share and forecasting prices; the second

technique suggest using the company’s own forecasts of demand from existing

customers, customer turnover and the potential for new customers. In both methods, the

needed information is quite specific and confidential. Thus, to forecast revenues,

Penman (2010) considers the other three areas: the firm’s strategy, the market

conditions and the firm’s marketing plan.

As discussed in the strategic analysis, IC Companys’ follows the differentiation strategy

by proceeding activities such as reducing the risk of consumer wearing products, which

might contain too many unhealthy chemicals, in order to build strong brands for high-

end customers. Furthermore, IC Companys implements the growth strategy through

acquisitions (Saint Tropez, Tiger of Sweden, Peak Performance and By Malene Birger)

and capturing market share in the potential emerging markets (e.g. China).

In relation to the market conditions for the fashion industry, it is forecasted that the

global apparel industry will accelerate in coming years as mentioned in section 5.2.5. In

the years 2007-2011, the global apparel industry has showed a compound annual growth

rate of 2.7% and it is anticipated that it could accelerate to the annual rate of 2.8% in

2016. The past results were showed in times of lack of confidence and financial

confusion, however, when the situation begins improving and consumer confidence

recovers the global apparel market might experience even higher growth rates. In

relation to IC Companys, which earns the major part of revenues in Europe, could reach

higher growth, if the company realizes its declared intentions concerning the presence in

China.

The IC Companys’ marketing plan consists of various actions such as multi-brand

strategy and showrooms, among others (section 5.3.1.4).

To forecast IC Companys’ revenues for the valuation period, historical growth rates in

revenues are examined first. The analysis is made for the years 2004-2011 as shown in

table 7.9.

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Table 7.9 IC Companys’ revenues annual growth calculations

2004 2005 2006 2007 2008 2009 2010 2011

Revenues

(in mil.

DKK)

2,612 2,821 3,022 3,354 3,737 3,621 3,495 3,925

Growth 8.0% 7.1% 11.0% 11.4% -3.1% -3.5% 12.3%


As seen from the table, IC Companys showed high growth rates partly due to

acquisitions. However, the financial turmoil caused two-year decrease in sales. All in

all, IC Companys has showed a compound annual growth rate of 6.0% throughout the

observed period. Taking into consideration that there are positive prospects in relation

to the global apparel industry, the projected revenues growth rates for the valuation

period look as follows:

Table 7.10 IC Companys’ revenues forecast for 2012-2021

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Revenues

(in mil.

DKK)

3,847 4,000 4,240 4,580 5,038 5,390 5,660 5,830 6,004 6,185

Growth -2.0% 4.0% 6.0% 8.0% 10.0% 7.0% 5.0% 3.0% 3.0% 3.0%


In 2012 IC Companys is expected to show a slight decline in its sales partly due to

threatening business environment caused by the confusion in Europe. Furthermore,

unusually warm weather during the last autumn and winter brought down the demand

for warm clothes (IC Companys, 2012). In 2013-2016, it is expected a gradual growth

in the company’s revenues as forecasts for the world economy and the European Union

are positive (IMF, 2012).

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Table 7.11 GDP growth rates in the world economy and EU

2012 2013 2014 2015 2016 2017 Average

World

economy

3.28% 3.62% 4.15% 4.42% 4.51% 4.56% 4.09%

EU -0.21% 0.49% 1.53% 1.91% 2.02% 2.06% 1.30%

Source: IMF, October 2012

Moreover, the low base effect due to lost opportunities might play a complimentary

role. Following the upward trend in revenues, the growth is expected to decline slowly

in the period 2017-2018 until they reach a constant level of 3.0% in 2019-2021.

Furthermore, the growth rate of 3.0% is used in a perpetuity-based continuing value

estimation (see electronic appendix).

Based on the forecasts of the income statement, balance sheet and revenues, the IC

Companys’ future free cash flow is presented in table 7.12.

Table 7.12 Forecast of IC Companys’ free cash flow (in mil. DKK)

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

FCF 235.9 266.8 258.4 252.0 246.6 280.1 304.0 325.9 326.2 326.2


Despite growing revenues, free cash flow shows a gradual decrease due to the fact that

few non-operating components in forecasting are fixed throughout the valuation period,

thus they do not have any positive effect on value. For example, deferred tax liabilities

are constant resulting in no value, however, this item is a key element in NOPLAT

calculation (appendixes 12 and 13).

7.8 Calculation of the IC Companys’ continuing value

To calculate the continuing value for 2021, the perpetuity-based formula discussed in

section 6.1.1is used:

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To estimate the present value, the calculated continuing value must be discounted back

to the end of 2011 by 10 years:

7.9 Calculation of the IC Companys’ share price

According to Koller et al. (2010), the first step in the company’s valuation is the

determination of value of operations, where the standard formula of DCF model

described in section 6.1 is used:

When the value of operations is determined, the enterprise value might be calculated by

adding non-operating assets. In the case of IC Companys, tax loss carry-forwards are

summed to the value of operations resulting in the enterprise value:

When enterprise value is derived, other non-equity claims must be identified and

subtracted from the enterprise value in order to find equity value. IC Companys has

several non-equity claims to deduct from the enterprise value: debt, capitalized

operating leases, stock options, retirement-related liabilities and minority interest. The

calculation of the IC Companys’ equity value is presented below:

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Finally, to estimate price per share, the equity value needs to be divided by the number

of shares outstanding:

Since the forecasting of the company’s revenues involves relying on the assumptions

concerning the growth in the world economy, regional economies and global apparel

industry, it is obvious that these forecasts contain some degree of uncertainty. Thus, to

address that uncertainty, the scenario and sensitivity analyses are performed in sections

7.10 and 7.11, respectively.

7.10 Scenario analysis

According to Koller et al. (2010), valuation requires a forecast, however, the future

might take many paths. Therefore, since the future is never actually knowable, it is

reasonable to consider financial projections under different scenarios.

The valuation of IC Companys is based on projecting the company’s revenues growth,

thus, it has been decided to examine how changes in the revenues growth affect the

company’s value and share price. The scenario analysis implies considering three paths

– best case, base case and worst case. The comprehensive information concerning the

scenario analysis is presented in appendix 26. The results obtained in the DCF valuation

are considered as the base scenario, therefore, are not elaborated further. The best and

worst case scenarios are described below.

Best case scenario

The best case scenario assumes that IC Companys could avoid negative effects of the

European financial contagion and repeat the last year results. With the anticipation that

the world economy will find the way to recovery, the growth might accelerate reaching

more than 4.0% annually until 2017 (IMF, 2012). In addition, IC Companys will

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succeed in overhauling its multi-brand strategy and penetration into the Chinese market.

All in all, 2.0% of growth has been added to each year comparing with the base case

scenario.

Table 7.13 The IC Companys’ best case scenario

Forecast

Year 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Revenue

s (in mil.

DKK)

3,925.0 4,160.5 4,493.3 4,942.7 5,535.8 6,034.0 6,456.4 6,779.2 7,118.2 7,474.1

Growth 0.0% 6.0% 8.0% 10.0% 12.0% 9.0% 7.0% 5.0% 5.0% 5.0%


Furthermore, the constant growth rate after the explicit period to infinity is assumed to

be 4.0%, which is slightly below the world economy average growth of 4.1% and higher

than the anticipated growth of 2.8% in the global apparel industry as discussed in

section 6.1.1.

In the best case scenario, the enterprise value grows to 6,847.7 mil. DKK corresponding

to the increase of 22.8% compared with the results obtained from the DCF valuation.

Hence, the IC Companys’ share price shows the growth of 30.1% reaching the level of

324.1 DKK per share.

Worst case scenario

Under the worst case scenario it is assumed that IC Companys could not realize its plans

in building the independent brand platform as well as fails in capturing a market share

in the Chinese market. The recovery after the European debt crisis resolving might

delay or be quite moderate. Thus, the expected growth is assumed to be lower than that

in the base scenario. Furthermore, IC Companys will reach the long-term growth rate of

2.0% in 2019 under negative circumstances. The worst case scenario results are

presented in table 7.14.

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Table 7.14 The IC Companys’ worst case scenario

Forecast

Year 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Revenu

es (in

mil.

DKK)

3,768.0 3,843.4 3,997.1 4,236.9 4,575.9 4,804.7 4,948.8 5,047.8 5,148.7 5,251.7

Growt

h

-4.0% 2.0% 4.0% 6.0% 8.0% 5.0% 3.0% 2.0% 2.0% 2.0%


Therefore, the enterprise value grows only to 4,857.6 mil. DKK resulting in the decline

of 13.1% relative to the base case scenario and the share price corresponds to 205.9

DKK with the drop of 17.4%.

The scenario analysis has showed the IC Companys’ share price sensitivity to

fluctuations in growth rates. In the best case scenario realization investors who hold the

company’s shares might earn a significant profit opposed to losses investors could

suffer if the worst case scenario confirms.

7.11 Sensitivity analysis

According to Koller et al. (2010) sensitivity analysis is an important tool for both

management in sense of optimal control over value and investors in respect of future

investigations and monitoring of sensible drivers that substantially affect a company’s

value. Concerning the DCF valuation, some of the drivers which have major impact on

the enterprise value and stock price for the IC Companys are assumed to be the cost of

capital (WACC) and the long-term growth in continuing value. Change in the sales

growth after the explicit period is discussed in the current section. In the first place, the

one-by-one analysis is conducted to show the impact of 0.5% change in WACC on the

enterprise value and IC Companys’ share price. Graph 7.1 shows how the enterprise and

stock values are sensible to fluctuations in WACC.

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Graph 7.1 Sensitivity analysis


After defining the sensitivity by changing only one input it is decided to perform the

dependence test of the IC Companys stock price on two drivers, namely, the growth and

WACC. Simultaneous changes of both inputs are shown in table 7.1.

Table 7.1 IC Companys’ stock price sensitivity


Summarizing observations from table 7.1, it is determined that the IC Companys stock

price is more sensitive to fluctuations in WACC than in the growth. The detailed

calculations are presented in electronic appendix.

Therefore, the attention has to be drawn to the cost of capital since slight increases in

WACC creates a huge impact on the company’s value lowering the stock price. The

-80,0%

-60,0%

-40,0%

-20,0%

0,0%

20,0%

40,0%

Sensitivity Analysis

Wacc(change by 0,5%) Change in stock price Change in Enterprise value

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decline in the company’s value might have a negative effect when the company would

like to issue new shares to attract additional capital.

On the other side, investors have to monitor key factors such as debt and equity that

define the cost of capital. In order to avoid negative effects of high cost of capital in the

future cheap investment options have to be monitored and discovered. In appendix 27,

the 3-D surface graph is presented that illustrates the sensitivity of stock price in relation

to WACC and the growth rate.

8. IC Companys valuation using Economic Profit Model

The main purpose of using economic profit model is to demonstrate and confirm

whether the result from DCF is correct. That is why this model is not going to reveal

additional value for the company, but instead has to end up with the corresponding

company value. The major difference of the EVA model is its alternative approach to

the DCF model, where a company's value is made of future cash flows. First of all, in

order to define whether a company's business strategy is profitable from the value

creation aspects, the economic spread (ROIC-WACC) has to be determined.

Fortunately, the IC Companys’ economic spread is positive and average economic

spread is 8.8% for the period of 2012-2022. There are two different methods of

calculations of economic profit, which are shown in table 8.1. Detailed information is

presented in appendix 22.

In the first method, the economic profit could be calculated by multiplying economic

spread with invested capital. In the second method, firstly the capital charge has to be

defined by multiplying invested capital with WACC, then subtracting the result from

NOPLAT what equals to the economic profit. The results from both methods have to

coincide as in table 8.1.

Table 8.1 IC Companys: Economic profit calculations


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Then the next step is to make an economic profit valuation which is to calculate the

present value of the economic profit for the period of 2012-2022, summing up with the

present value of the continuing value and invested capital from the initial year. In order

to find the value of IC Companys’ operations the total value of economic profit has to

be adjusted by the mid-year factor.

As the last step for the verification of the results acquired from the DCF model it is

reasonable to calculate IC Companys’ enterprise value through the results of the

economic profit model with the aim to determine the stock price. In table 8.2 is shown

the details of the calculation which ends with corresponding stock price.

Table 8.2 IC Companys: share price calculation by EVA


From table 8.2 it could be seen that the stock price of 249.17 DDK per share

corresponds exactly to the same stock price derived in the DCF valuation, proving the

plausibility of computed results from both methods.

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9. Real Options Valuation of IC Companys

In the theoretical part related to real options valuation it has already been discussed that

by using traditional DCF model, valuation does not include a management flexibility

concerning a company’s opportunities in the future investment prospects. Valuation

based on the DCF model usually results with lower company value which excludes any

possible alternatives regarding future growth investments. Proceeding from

aforementioned it is decided to include real options valuation of IC Companys in order

to reveal comprehensive company value.

IC Companys’ growth strategy might be divided into two entities. On the one hand, for

the last ten years company has been growing by mergers and acquisitions as an example

it could be mentioned the acquisition of By Malene Birger, Saint Tropez, etc. On the

other hand, according to IC Companys’ annual reports, growth of the company for the

recent years was based on operating new shops and franchising mainly in Europe and

slightly in the emerging markets. By making some observations it could be stated that

there are great opportunities within the apparel sector for the growth option in the

emerging markets which is not actively adopted in the IC Companys. Even though IC

Companys has experienced negative progress in the Chinese market, it is decided to

implement expansion option in the potentially relevant emerging markets other than

China.

9.1 Expansion option

In order to implement option to expand in the first place it has to be identified business

environment in the emerging markets as in fact there are many countries in the different

continents that need specific approach. The most popular emerging markets are

considered to be the BRIC (Brazil, Russia, India and China) countries. The intention is

to determine country where business environment for apparel market is more

convenient and economically beneficial. In order to observe those characteristics in the

determined country it is very important to have access to the publicly traded companies'

hard data with the aim to calculate markets volatility. Then the next step is to exclude

those countries where IC Companys is already operating. Based on above mentioned

assumptions, it was decided to focus on the Brazilian apparel market. According to the

market potential index that is developed by Global Edge (globaledge.msu.edu, 2011) for

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the 26 emerging markets where Brazil is ranked 11th

with market growth rate of 57%. In

table 8.3 it is introduced top 11 countries according to their market size.

Table 8.3 Market potential index, 2011

Source: globaledge.msu.edu, 2011

IC Companys has already been operating in some of those countries from the table

except for Singapore, South Korea, India, Israel and Brazil. One of the main reasons of

focusing on Brazil instead of others is the fact that the Brazilian market size is bigger

than the rest of the emerging markets except for India. The preference is still on Brazil

due to the fast growing apparel market, especially prospering forecasts for the high

quality and expensive brands. According to the latest issue of Textile Outlook

International (just-style.com, 2012), textile and clothing production in Brazil rose by

25.2 % in the period from 2005 to 2010 and this positive trend is expected to continue.

It could be argued that the Indian market is one of the fast growing markets as in fact

India has emerged as the fourth largest economy in the world with a high growth rate

and has improved its global ranking in terms of per capita income. The issue is even

though Indian GDP per capita income has been increasing, it still remains very low

compared to the other emerging markets. In order to compare per capita income it is

referred to the hard data developed by The World Bank (2012) that shows GDP per

capita in Brazil is 12,594 US dollars, when it is only 1,489 US dollars in India. That is

why it is decided to avoid implementation of option to expand in India as demand for

the expensive high-quality brands might not be satisfactory. According to another report

prepared by Research and Markets (2012), the compound annual growth rate of the

Brazilian apparel retail industry is expected to be 8% for the five-year period between

2011 and 2016, what makes this market very attractive for IC Companys.

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It has been decided if IC Companys intends gaining from expansion option by focusing

on the Brazilian apparel market then real option has to be realized in the period of 2011-

2016, when market is estimated to demonstrate high growth. IC Companys might

successfully implement expansion option by operating its own stores and using

franchising. The other alternative to penetrate into the Brazilian market is to acquire a

local brand. In this case, IC Companys gets the expertise in the Brazilian market that

might support the promotion of the IC Companys’ own brands.

According to IC Companys’ annual report 2011 it could be stated that the company is

able to invest 3% of the annual revenues which is around 120.0 mil. DKK in order to

support growing business.

It is estimated initially to invest 100.0 mil. DKK into the Brazilian market within the

next five years and it is assumed that the company's operating revenues will increase by

0.8 % until 2016, then it will slow down in 2017 to 0.6%, then in 2018 estimated growth

might be 0.4% and in the period of 2018-2021 the growth increase is around 0.3% and

finally the long-term growth rate is 0.1%. By using expansion option the increase in

operating revenues will boost the company’s enterprise value by 5.49%. Calculations

regarding increase in the operating revenues are shown in appendixes 28 and 29.

9.2 Binomial lattice approach for IC Companys

9.2.1 Step 1: Evaluation of IC Companys’ underlying asset without flexibility

In the first step according to real option theories a company value has to be calculated

without any flexibility. Required company's underlying asset value has been calculated

by using the DCF valuation method in section 7.9. The value which is considered to use

in ROV is 5,578.20 mil. DKK.

9.2.2 Step 2: Event tree

As it has already been stated in the theoretical part of ROV, in the second step in order

to fulfil requirements of expansion option, up-down movements of binomial lattice has

to be determined by using annual volatility of the emerging market. Before calculating

volatility, beta and variance must be estimated by implementing the CAPM model:

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Indeed there is a lack of data concerning the Brazilian apparel market variation and beta

as, in fact, this is a new market for IC Companys. In order to calculate needed numbers

it is decided to determine companies which already operate in the Brazilian apparel

market. It has been collected four companies which are Le Lis Blanc, Marisa Lojas,

Lojas Renner and CIA Hering. Thus, the stock returns for the Le Lis Blanc, Marisa

Lojas, Lojas Renner and CIA Hering are regressed on the MCSI world index in Eviews.

The regression outputs for the market model are stated in table 9.1. The data for the

regression is retrieved from Datastream and could be seen in the electronic appendix.

Table 9.1 shows the resulting annual volatility. The monthly variance is determined as

(Grinblatt & Titman, 1998):

Table 9.1 Volatility

Le Lis

Blanc

Marisa

Lojas

Lojas

Renner

CIA Hering Average

β 1,8361 2,3197 2,1862 1,7036 2,0114

Standard Error 0,3820 0,4584 0,3807 0,3844 0,4014

Variance (ei) 0,0125 0,0180 0,0124 0,0126 0,0139

Variance (Rm) 0,0023

Monthly variance

(σ2i)

0,0232

Monthly volatility 0,1523

Annual volatility 0,5277


Since annual volatility is calculated, now up and down movements of the event tree will

be performed.

√ √

Hence,

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In the equation above, estimated number of years per upward movement equals to one.

By having calculated numbers for upward and downward movements and value of the

company’s underlying asset, the company's enterprise value which was extracted from

the DCF analysis could be used for the purpose of constructing estimated value of IC

Companys for the next five years in the event tree.

Figure 9.1 Event tree for IC Companys’ expansion option in Brazil (in mil. DKK)

T 0 1 2 3 4 5

78067,14

46054,65

27169,31

27169,31

16028,16

16028,16

9455,60

9455,60

9455,60

5578,20

5578,20

5578,20

3290,78

3290,78

3290,78

1941,35

1941,35

1145,27

1145,27

675,64

398,58


Since event tree was constructed, now the point is to calculate risk-neutral probabilities

in the binomial lattice. According to the formula in the section of ROV, calculation is

performed below:

And,

In the formula above r stands for WACC which has been calculated in section 7.6. In

order to verify whether the present value of IC Companys’ assets in the event tree is

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equal to expected payout at the company's cost of capital, the calculation below is

performed.

To check calculations it is decided to proceed present value calculation, for example, in

the upper branch in year T=3.

By proceeding calculation above, it could be stated that the event tree is constructed

correctly as the numbers in the event tree correspond to the present value of each node.

9.2.3 Step 3: Decision tree

In the third step according to theories behind the binomial lattice approach, real option

is included into the event tree getting transformed to the decision tree where it is

assumed to apply expansion option. Assumed initial investment costs of IC Companys

in Brazilian market to be 100.0 mil. DKK and, in fact, this investment into expansion

will increase the company’s enterprise value by 5.49%. Figure 9.2 illustrates the

decision tree for IC Companys:

Figure 9.2 Decision tree for IC Companys (in mil. DKK)

T 0 1 2 3 4 5

82255,70

48487,52

28567,54

28561,84

16817,09

16811,55

9886,12

9880,74

9875,03

5811,99

5793,07

5787,53

3391,76

3377,26

3371,56

1972,03

1950,89

1140,58

1145,27

661,31

398,58


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In order to show the difference between the event tree and decision tree in year 5 it is

decided to perform following calculation where the value of the upper node in year 5 in

the event tree has to be increased by 5.49% as a result of exercising of expansion option.

Since the values with option are calculated, now the main point is to verify that the

values in the fifth year are higher with expansion option than without it. By checking

out the values it shows up that in the last two years in the two lowest nodes the value is

less with option than without it.

And,

These kinds of calculations for the all nodes in the fifth year have been applied. Besides

the lowest node in the last year all other outcomes of the decision tree with exercising

expansion option estimated to be profitable for IC Companys.

9.2.4 Step 4: Expansion option for IC Companys’ decision tree with flexibility

In the last step of the real options valuation it is important to apply risk-neutral

probabilities with the aim to value the company's underlying assets with flexibility. The

risk-neutral probabilities allow weighting company's future cash flows with risk-

adjusted probabilities which extracts more feasible numbers than the random scenario

probabilities. After proceeding calculation of probability-weighted average cash flows,

the final calculation is to discount those cash flows from right to the left or just

backwards what results in the current value of the company including real option. The

calculations below introduce the risk-neutral probabilities:

And,

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After determining the risk-neutral probabilities, now cash flows could be weighted by

the following formula:

Cash flows discounting with risk free rate goes backwards starting from the year 5.

By discounting cash flows until year 0, the company's underlying asset value is

5,803.62 mil. DKK. The rest of the calculation is performed in the electronic appendix.

In order to understand whether to exercise expansion option in the Brazilian apparel

market, it is important to compare the numbers that were extracted from the DCF

method without ROV and including ROV. IC Companys’ enterprise value with ROV is

5,811.99 mil. DKK and the value without ROV is 5,578.20 mil. DKK. It could be

concluded that if IC Companys exercises its expansion option within the next five years,

the company's enterprise value will increase by 233,79 mil. DKK (5,811.99 - 5,578.20).

In table 9.2 presented obtained numbers from the company valuation:

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Table 9.2 Summary of DCF valuation and ROV

Enterprise

Value (in mil.

DKK)

Equity

Value (in

mil. DKK)

Share Price

(DKK)

Without Expansion Option 5,578.20 4,221.70 249.17

With Expansion Option 5,811.99 4,447.12 262.97

Less: Value of Debt 364.7

Less: Value of cap. oper. leases 842.2

Less: Stock Options 139.7

Less: Retirement-related liabilities 5.8

Less: Minority interest 4.1

Number of shares outstanding 16.942807


The main purpose of implementing option valuation for the IC Companys business line

is to value the company's underlying assets with comprehensive and flexible decision

making abilities of strategic and finance management. By obtaining valuation results the

assumption concerning ROV confirms that the effective implementation of the

expansion option in the IC Companys business strategy might increase the company's

share price by 5.53%.

10. Valuation by multiples

In the description of multiples it has already been discussed the different classifications

of multiples and their interpretation. In order to implement multiples for the IC

Companys valuation, it is decided to use valuation multiples, not analytical. When using

valuation multiples one of the important aspects is the determination of the right peer

group, industry sector and relevant company size that might affect average multiple

ratios. The peer group includes 6 apparel companies and all calculations are enclosed in

appendix 25. In table 9.3 EV/EBITDA multiples of comparable companies are

presented.

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Table 9.3 Peer group analysis

Peer group EV/EBITDA

2009 2010 2011

ESPRIT 8.6 13.0 16.7

GIORDANO INT. LMT. 2.0 3.7 8.2

INDITEX 8.0 8.7 11.0

THE JONES GROUP 2.9 5.4 4.3

BILLABONG INT.

LMT.

9.3 11.8 16.1

H & M 20.2 14.2 13.0

Average 8.5 9.5 11.5


It has to be stated that in table 9.3 the ratios have been calculated by implementing

forward looking multiples. As it has already been stated in the theoretical part in order

to apply forward looking multiples, a denominator equals to the next year forecasted

EBITDA, while a numerator is the current year's EV.

Since average ratios for EV/EBITDA are calculated, the IC Companys enterprise value

and stock price could be also estimated with respect to the corresponding ratios. Table

9.4 shows the IC Companys stock prices and other respective values.

Table 9.4 Multiples analysis of IC Companys (in mil. DKK)

2009 2010 2011 2012

EBITDA 456.0 412.0 446.0 289.0

Enterprise Value 3,503.9 4,230.4 3,334.9

Debt 533.1 243.4 310.9

Cash and cash equivalent 82.2 719.0 53.8

Equity Value 3,954.8 4,401.9 3,592.0

Shares Outstanding 16.942807 16.942807 16.942807

Share Price (in DKK) 233.4 259.8 212.0


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From the numbers presented above it could be seen that enterprise value in 2011 is

3,334.9 mil. DKK which is lower than either in DCF valuation (5,578.5 mil. DKK) or

ROV (5,811.99 mil. DKK) for the same year. The same holds for the share price, what

according to multiples analysis equals to 212.00 DKK compared to 249.17 DKK from

DCF valuation and 262.97 DKK from ROV. It could be made some assumptions for

such lower results. One of the explanations might be the peer group average itself is

low. Actually, it is very complicated to define a peer group that might match all criteria.

There are always some mismatches related to company size, turnover, etc. Another

explanation might be the fact that investors tend to pay lower price based on a

company's current market performance without considering future growth possibilities.

11. Discussion of the results

The summing-up of the results derived by DCF/EVA, ROV and multiples analyses is

made in order to highlight the main points of the valuation methods.

11.1 DCF analysis

The main and traditional valuation model has been applied successfully defining the IC

Companys’ value. According to results the enterprise value equals to 5,578.2 mil. DKK,

where the equity value is 4,221.7 mil. DDK and the stock price is 249.17 DDK. There

are some aspects that have to be underlined and treated with caution. One of the main

entries that takes the major part of value is the continuing value that equals to 3,511.7

mil. DKK and presents 58.8% of the IC Companys’ enterprise value. In order to extract

more accurate results from the DCF valuation, the key factors such as WACC and the

continuing value have enormous impact on final results. By making several assumptions

both in the scenario and sensitivity analyses it is estimated that factors as WACC and

the growth in continuing value might change overall picture of the IC Companys' value.

In fact, 1% decrease in the growth might cause the drop of continuing value by 10%.

From the sensitivity analysis it is observed that WACC is the most pivotal entity that

influences the company’s value.

It has to be stated that forecasting of sales and growth rate is mainly based on authors’

assumptions in compliance with some estimates of GDP and industry growth rates. That

is why it has to be mentioned that results from the DCF model might be considered

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subjectively and highly dependent on authors’ future expectations from both the world

economy and apparel industry especially.

11.2 EVA analysis

The main purpose of implementing the EVA analysis is to ensure the plausibility of the

results that are extracted from the DCF analysis. The difference of EVA from other two

methods (real options and multiples) is that EVA does not reveal additional value;

instead of using free cash flows, the alternative computation method estimates the

present value of economic profit to derive the final stock price. The main difference

between the EVA and DCF valuation methods is their approach to the valuation. DCF is

more applicable for practitioners and academics as it defines in-out cash flow streams of

company. On the other hand, EVA is related to economic theory and competitive

strategy, highlighting whether company's earnings cover its cost of capital and how

company's financial performance behaves over time.

In fact, WACC, NOPLAT and ROIC used in the EVA calculations are solely excerpted

from the DCF valuation. Resulted stock price of 249.17 DKK from the EVA valuation

corresponds to the same stock price that is found via the DCF valuation. According to

Koller et al. (2010) both methods yield the same result if applied correctly.

11.3 Real Options valuation

The main purpose of implementing ROV is to unveil an additional value for IC

Companys by including management's flexibility, which has been abandoned in the

DCF valuation. The IC Companys' enterprise value with the 5-year expansion option in

Brazil equals to 5,811.9 mil. DKK, while the equity value and share price are 4,455.4

mil. DKK (+4.2%) and 262.9 DKK (+5.5%), respectively. The calculated results imply

that the expansion option creates an additional value for IC Companys.

The robustness of results obtained in ROV solely depends on correct estimates of the

underlying asset value and variance. Underlying asset value has been taken from the

DCF valuation and, hence, is exposed to subjectivity. Since IC Companys plans to

operate in an unfamiliar market, the estimate of variance is based on the corresponding

values of the potential competitors in the Brazilian apparel market. Therefore, the value

of expansion option might be approximate, rather than precise.

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11.4 Multiples

As elaborated in section 6.3, the multiples analysis is performed to estimate the

company value based on peer group fundamentals and market perception of target

industry. Hence, results obtained from the analysis must be interpreted with caution

since it is quite challenging to select perfectly matching competitors.

The multiples analysis shows that the IC Companys’ enterprise value and stock price

are highly overpriced in both the DCF valuation and ROV. For example, stock price

derived by the multiples analysis is 17.5% lower than in the DCF valuation and 24.0%

lower than in ROV.

12. Conclusion

The main purpose of the thesis is to estimate the value of IC Companys. It has been

done by conducting two comprehensive analyses – strategic and corporate valuation.

Strategic analysis identifies the state and future perspectives of the company in relation

to external and internal factors. To determine IC Companys’ opportunities and threats,

PESTEL and Porter’s five forces analyses are implemented. Value chain and Core

competencies analyses allow identifying the company’s strengths and weaknesses. The

obtained results are summarized in SWOT analysis to build the overall company’s

conditions.

The implementation of the strategic analysis gave an answer to the question mentioned

in Problem statement section concerning the competitive advantages of IC Companys

and how the company exploits them for development.

PESTEL analysis investigates macro-economic aspects that influence market

environment from various angles. Since IC Companys is closely tied to the

Scandinavian market, such factors as economics, legislation and socio-culture are more

familiar and predictable compared to emerging markets.

To move from macro-economic environment to the industry, Porter’s five forces

analysis is conducted. It has been concluded that there is a slight risk coming from the

new competitors, due to their relatively small size and portfolio of unknown brands, as

well as the bargaining power of the suppliers and buyers, which is limited to moderate

levels through diversification. Modern apparel market is assumed to be highly saturated,

thus the risk of substitute products and intense competition is significant.

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Turning to the internal aspects, the value chain analysis examines the IC Companys’

capabilities to develop a competitive advantage and improve the efficiency. IC

Companys has vested its brand managers with wide responsibilities in market

positioning, product development and sales in relation to every individual brand. In

addition, the activities with no relevance to brand identity are handled through the

shared service platform what fastens the information interchange within the company.

Core competencies analysis underlines the aforementioned strengths and mentions the

emphasis IC Companys puts on HR as a key focus area to drive retail sales and enhance

leadership.

The results derived from external and internal analyses are summarized in SWOT

analysis. The main IC Companys’ strength lies in the independent and resilient multi-

brand strategy. The quality control of clothes has become another important focus area

to improve the brand image. Furthermore, the company has achieved significant results

in production sourcing in China; however, this expertise has not given any boost in

meeting Chinese end-users’ needs.

In the corporate valuation, four various methods are applied, namely, Discounted cash

flow model, Economic profit model, Real option valuation and multiples.

The DCF valuation of IC Companys is based on the corporate valuation book by Koller

et al. (2010). According to the DCF method, IC Companys’ financial statements for the

period 2007-2011 are reformulated to derive historical free cash flows. The company’s

free cash flows forecast for the period 2012-2021 relies on Porter’s five forces analysis

and historical results from reformulated financial statements. As the result, IC

Companys’ enterprise value equals to 5,578.2 mil. DKK, which combines the present

value of free cash flow of 1,875.6 mil. DKK and the continuing value of 3,511.7 mil.

DKK. Thus, the share price derived by the DCF valuation is 249.17 DKK. Since

forecasting of free cash flows are highly dependent on market conditions, possible

fluctuations are analysed by conducting the scenario analysis. In the best case scenario

IC Companys share price increases by 30.1% to 324.1 DKK due to anticipation in

improving European economic conditions and success in emerging markets. Then in the

worst case scenario, recovery from debt crisis in Europe might extend for longer period

that estimated and IC Companys might not succeed in emerging markets. Respective

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share price for the worst case scenario is calculated to be 205.9 DKK which shows

17.4% decrease from the base case scenario.

IC Companys enterprise value and stock price are highly vulnerable to slight

fluctuations in the company’s cost of capital. In order to create a clear picture the

sensitivity analysis demonstrates that 1% increase in WACC leads to drop in stock price

by 23% while decline of 1% in WACC boosts company stock price by 20% resulting in

312.8 DKK.

Economic profit model that is used in this thesis is mainly implemented to verify results

extracted from DCF. By applying different method of measuring company’s enterprise

value and stock price via economic profit model, analysis ended with the same

corresponding enterprise and stock values from DCF. It proves the robustness of

proceeded valuation models.

The main purpose of implementing real option valuation in the thesis is to reveal

additional value to the underlying asset value that is captured in the DCF valuation.

According to the authors research it is assumed that the Brazilian apparel market is one

of the most attractive in the world. Therefore, IC Companys might get advantage of the

fast growing fashion sector by exercising option to expand within the next five years.

The initial investment is estimated to be 100.0 mil. DKK in order to operate new shops

in the prestigious shopping malls and downtowns. This embedded expansion option

results in increase of enterprise value by 5.49%. Management of IC Companys might

reveal additional value to the company’s underlying assets of 233.79 mil. DKK by

implementing ROV. The final results of ROV for enterprise value and share price are

5,811.99 mil. DKK and 262.97 DKK, respectively. This increase in both values

confirms that real option valuation might create an additional value to the company.

As the last valuation method, multiples analysis is considered to value IC Companys

with respect to market based ratios. Share price that is found from multiples analysis is

lower than both DCF and ROV and equals to 212.0 DKK.

Finally, with the aim to answer the main question in the problem statement whether IC

Companys A/S stock price reflects a fair market value as of 30th

June 2011, share

market price at that date needs to be compared with the obtained results from DCF and

ROV. As of 30th

June 2011 share market price was 221.0 DKK which lower than both

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DCF and ROV stock prices of 249.17 DKK and 262.97 DKK, respectively. It could be

concluded that IC Companys share price is undervalued by the market. The explanation

of that might be the recent turbulence in financial markets that still has negative effect

on stock prices. In fact IC Companys had demonstrated higher price levels before 2008

when the share value was over 300 DKK.

The conclusion is that the combined value from DCF and ROV is considered to be the

fair value and is estimated at 262.97 DKK.

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of 157

Appendices

Appendix 1: Income statement (in mil. DKK)

Realized

2007 2008 2009 2010 2011

Revenue 3353,8 3737,2 3621,1 3495,3 3925,4

Cost of sales 1370,9 1478,4 1464,7 1370,9 1603,8

Gross Profit 1982,9 2258,8 2156,4 2124,4 2321,6

Depreciation 76,0 95,5 123,5 108,8 109,6

Amortization 20,3 17,2 23,2 20,8 15,4

Staff costs 807,2 931,2 948,6 927 1016,4

Other operating expenses 755,5 871 909,5 785,2 867,4

Other operating income 16,2 5,5 10,5 0 8,5

Financial Income 16,9 13,2 31,5 13,7 7,4

Financial Expenses 36,6 45,1 42,3 18,9 20,8

Net Financial Items -19,7 -31,9 -10,8 -5,2 -13,4

EBIT 340,1 349,4 162,1 282,6 321,3

EBIT margin 10,1% 9,3% 4,5% 8,1% 8,2%

EBITA 344,2 361,1 174,8 303,4 328,2

EBITA margin 10,3% 9,7% 4,8% 8,7% 8,4%

EBITDA 420,2 456,6 298,3 412,2 437,8

EBITDA margin 12,5% 12,2% 8,2% 11,8% 11,2%

EBT 320,4 317,5 151,3 277,4 307,9

EBT margin 9,6% 8,5% 4,2% 7,9% 7,8%

Income Taxes 79,8 93,4 42,1 41,6 61,6

Profit for the year 240,6 224,1 109,2 235,8 246,3

of 157

Appendix 2: Balance sheet (in mil. DKK)

Assets

Realized

2006 2007 2008 2009 2010 2011

NON-CURRENT ASSETS

Goodwill 176,6 201 198,2 178,8 194,3 199,4

Software and IT systems 22,4 24 30,5 21,5 21,4 28,6

Trademark rights 0,2 0,2 0,2 0,1 0,1 0,1

Leasehold rights 22,3 20,6 22,5 19,8 19,6 20,5

IT systems under construction 0 0 1 0 13,6 13,8

Intangible assets 221,5 245,8 252,4 220,2 249 262,4

Land and buildings 159,7 177,6 174,6 167,3 161,5 155

Leasehold improvements 87,1 100,2 108 124,5 132,5 118

Equipment and furniture 83,7 122,8 129,8 119,6 106,9 96,6

PPE under construction 31,2 8,2 11,5 7,7 7,5 5,9

PPE 361,7 408,8 423,9 419,1 408,4 375,5

Financial assets 21,8 24,4 25,6 35,4 36 33,8

Deferred tax assets 182,5 137,1 123,9 129 99,9 99

Other non-current assets 204,3 161,5 149,5 164,4 135,9 132,8

TOTAL NON-CURRENT ASSETS 787,5 816,1 825,8 803,7 793,3 770,7

CURRENT ASSETS

Inventories 391,1 466,4 532,4 439,6 428,7 556,5

Trade receivables 207,7 266,6 296,7 257,6 262,1 358

Income tax receivables 9,7 3,1 1,6 48,3 30,2 35,2

Other receivables 76,3 54,3 35 61,2 112,9 45,4

Prepayments 93,1 97,9 108,8 92,1 104,7 106,8

Cash and other equivalents 99,6 144,9 132 82,2 71,9 53,8

Excess cash 0,0 0,0 0,0 0,0 0,0 0,0

TOTAL CURRENT ASSETS 877,5 1033,2 1106,5 981 1010,5 1155,7

TOTAL ASSETS 1665 1849,3 1932,3 1784,7 1803,8 1926,4

of 157

Liabilities

Realized

2006 2007 2008 2009 2010 2011

Share capital 188,5 183,9 179,2 169,4 169,4 169,4 Reserve for hedging transactions -17,2 -4,7 -22,1 21,2 2,4 -47,7

Translation reserve -8,6 -10,7 -23,9 -62,5 -30,4 -40,6

Retained earnings 415,3 391 331,8 367,5 591,9 657,5

Equity att. to eq. holders of the parent 578,0 559,5 465,0 495,6 733,3 738,6

Minority interest 1,5 7,1 8,5 13,5 13,9 4,1

TOTAL EQUITY 579,5 566,6 473,5 509,1 747,2 742,7

LIABILITIES

Deferred tax liabilities 19,9 29 44,9 39,3 47,5 56,3

Retirement benefit obligations 8,3 5,1 5,7 4,6 6,9 5,8

Financial institutions 117,5 168 168 168 140 140

Capitalised lease liability 8,8 0 0 0 0 0

Other accrued liabilities 0 0 0 10,9 0 0

Provisions 0 0 0 0 2,2 0

Other liabilities 0 0 0 0 0 44

TOTAL NON-CURRENT LIABILITIES 154,5 202,1 218,6 222,8 196,6 246,1

Financial institutions 333 534,5 603 447,3 175,3 224,7

Capitalised lease liability 42,2 0 0 0 0 0

Trade payables 287,4 296,8 313,8 291,7 354,8 348,9

Income tax 47,5 38,9 45,4 63,7 12,3 10,2

Provisions 1,5 0 0 0 0 0

Other liabilities 219,4 210,4 278 250,1 317,6 353,8

TOTAL CURRENT LIABILITIES 931 1080,6 1240,2 1052,8 860 937,6

TOTAL LIABILITIES 1085,5 1282,7 1458,8 1275,6 1056,6 1183,7

TOTAL EQUITY AND LIABILITIES 1665 1849,3 1932,3 1784,7 1803,8 1926,4

of 157

Appendix 3: Revenues forecast (in mil. DKK)

Realized

2004 2005 2006 2007 2008 2009 2010 2011

2,612.0 2,821.0 3,022.0 3,354.0 3,737.0 3,621.0 3,495.0 3,925.0

8.0% 7.1% 11.0% 11.4% -3.1% -3.5% 12.3%

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

3,846.5 4,000.4 4,240.4 4,579.6 5,037.6 5,390.2 5,659.7 5,829.5 6,004.4 6,184.5

-2.0% 4.0% 6.0% 8.0% 10.0% 7.0% 5.0% 3.0% 3.0% 3.0%

of 157

Appendix 3: Income statement forecast assumptions

Realized performance of IC Companys

Forecast Assumptio

ns

Realized

2007 2008 2009 2010 2011

Revenues

Ratio Cost of sales 40,9% 39,6% 40,4% 39,2% 40,9%

Gross Profit

Ratio Depreciation 21,0% 23,4% 29,1% 26,0% 26,8%

Ratio Amortization 9,2% 7,0% 9,2% 9,4% 6,2%

Ratio Staff costs 24,1% 24,9% 26,2% 26,5% 25,9%

Ratio Other operating expenses 22,5% 23,3% 25,1% 22,5% 22,1%

Ratio Other operating income 0,5% 0,1% 0,3% 0,0% 0,2%

Financial Income

Ratio Interest on bank deposits 0 0 0 0 0

As of 2011 Realized gain on forward contracts 9,0 5,2 27,4 0,0 0,9

As of 2011 Net gain on foreign currency translation 0 0 0 0,1 0

As of 2011 Other financial income 3,4 4,1 1,8 13,1 6,5

Financial Expenses

Ratio Interest on debt to fin. institutions 4,5% 5,6% 6,4% 4,8% 4,0%

As of 2011 Realized loss on forward contracts 0 0 0 0 4,5

As of 2011 Net currency loss 0,3 0,8 1,9 3,7 0,5

As of 2011 Other financial expenses 4,5 1,1 1,2 0 1,3

EBIT margin 10,1% 9,3% 4,5% 8,1% 8,2%

EBITA margin 10,3% 9,7% 4,8% 8,7% 8,4%

EBITDA margin 12,5% 12,2% 8,2% 11,8% 11,2%

EBT margin 9,6% 8,5% 4,2% 7,9% 7,8%

Effective Income Taxes/Marginal Taxes 24,9% 29,4% 27,8% 15,0% 20,0%

of 157

Forecasted performance of IC Companys

Forecast Assumptio

ns

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Revenues Ratio Cost of sales 41,1% 41,4% 41,6% 41,9% 42,1% 42,4% 42,6% 42,9% 43,1% 43,4%

Gross Profit

Ratio Depreciation 27,0% 27,0% 27,0% 27,0% 27,0% 27,0% 27,0% 27,0% 27,0% 27,0%

Ratio Amortization 8,0% 8,0% 8,0% 8,0% 8,0% 8,0% 8,0% 8,0% 8,0% 8,0%

Ratio Staff costs 26,0% 26,0% 26,0% 26,0% 26,0% 26,0% 26,0% 26,0% 26,0% 26,0%

Ratio Other operating expenses 22,1% 22,1% 22,1% 22,1% 22,1% 22,1% 22,1% 22,1% 22,1% 22,1%

Ratio Other operating income 0,2% 0,2% 0,2% 0,2% 0,2% 0,2% 0,2% 0,2% 0,2% 0,2%

Financial Income

Ratio Interest on bank deposits 1,4% 1,4% 1,4% 1,4% 1,4% 1,4% 1,4% 1,4% 1,4% 1,4%

As of 2011 Realized gain on forward contracts 0,9 0,9 0,9 0,9 0,9 0,9 0,9 0,9 0,9 0,9

As of 2011 Net gain on foreign currency translation 0 0 0 0 0 0 0 0 0 0

As of 2011 Other financial income 6,5 6,5 6,5 6,5 6,5 6,5 6,5 6,5 6,5 6,5

Financial Expenses

Ratio Interest on debt to fin. institutions 3,0% 3,0% 3,0% 3,0% 3,0% 3,0% 3,0% 3,0% 3,0% 3,0%

As of 2011 Realized loss on forward contracts 4,5 4,5 4,5 4,5 4,5 4,5 4,5 4,5 4,5 4,5

As of 2011 Net currency loss 0,5 0,5 0,5 0,5 0,5 0,5 0,5 0,5 0,5 0,5

As of 2011 Other financial expenses 1,3 1,3 1,3 1,3 1,3 1,3 1,3 1,3 1,3 1,3

Effective Income Taxes/Marginal Taxes 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0%

of 157

Appendix 4: Income statement forecast (in mil. DKK)

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Revenue 3846,5 4000,4 4240,4 4579,6 5037,6 5390,2 5659,7 5829,5 6004,4 6184,5

Cost of sales 1581,2 1654,4 1764,3 1916,9 2121,2 2283,1 2411,4 2498,3 2588,3 2681,4

Gross Profit 2265,3 2345,9 2476,1 2662,7 2916,4 3107,1 3248,3 3331,2 3416,1 3503,1

Depreciation 101,4 109,0 113,4 120,2 129,8 142,8 152,8 160,5 165,3 170,2

Amortization 21,0 20,9 21,1 21,3 21,6 22,0 22,3 22,5 22,6 22,8

Staff costs 1000,1 1040,1 1102,5 1190,7 1309,8 1401,5 1471,5 1515,7 1561,1 1608,0 Other operating expenses 850,0 884,0 937,0 1012,0 1113,2 1191,1 1250,6 1288,2 1326,8 1366,6 Other operating income 8,3 8,7 9,2 9,9 10,9 11,7 12,3 12,6 13,0 13,4

Financial Income 7,4 7,4 7,4 7,4 7,4 7,4 7,4 7,4 7,4 7,4

Financial Expenses 17,2 17,2 17,2 17,2 16,6 16,0 15,4 14,8 14,2 13,6

Net Financial Items -9,8 -9,8 -9,8 -9,8 -9,2 -8,6 -8,0 -7,4 -6,8 -6,2

EBIT 301,2 300,6 311,3 328,5 353,0 361,4 363,3 357,0 353,2 348,9

EBIT margin 7,8% 7,5% 7,3% 7,2% 7,0% 6,7% 6,4% 6,1% 5,9% 5,6%

EBITA 313,9 312,8 323,2 339,8 363,6 371,7 373,3 366,9 362,9 358,3

EBITA margin 8,2% 7,8% 7,6% 7,4% 7,2% 6,9% 6,6% 6,3% 6,0% 5,8%

EBITDA 415,3 421,9 436,6 460,1 493,5 514,5 526,1 527,3 528,1 528,5

EBITDA margin 10,8% 10,5% 10,3% 10,0% 9,8% 9,5% 9,3% 9,0% 8,8% 8,5%

EBT 291,4 290,8 301,5 318,7 343,8 352,8 355,3 349,6 346,4 342,7

EBT margin 7,6% 7,3% 7,1% 7,0% 6,8% 6,5% 6,3% 6,0% 5,8% 5,5%

Income Taxes 72,9 72,7 75,4 79,7 85,9 88,2 88,8 87,4 86,6 85,7

Profit for the year 218,6 218,1 226,1 239,0 257,8 264,6 266,5 262,2 259,8 257,0

of 157

Appendix 5: Balance sheet forecast assumptions

Assets

Forecast Assumptio

ns Asset Realized

Item 2007 2008 2009 2010 2011

NON-CURRENT ASSETS

As of 2011 Goodwill 201 198,2 178,8 194,3 199,4

Ratio Software and IT systems 0,7% 0,8% 0,6% 0,6% 0,7%

As of 2011 Trademark rights 0,2 0,2 0,1 0,1 0,1

As of 2011 Leasehold rights 20,6 22,5 19,8 19,6 20,5

Ratio IT systems under construction 0,0% 0,0% 0,0% 0,4% 0,4%

Ratio PPE 12,2% 11,3% 11,6% 11,7% 9,6%

As of 2011 Financial assets 24,4 25,6 35,4 36 33,8

As of 2011 Deferred tax assets 137,1 123,9 129 99,9 99

CURRENT ASSETS

Ratio Inventories 34,0% 36,0% 30,0% 31,3% 34,7%

Ratio Trade receivables 7,9% 7,9% 7,1% 7,5% 9,1%

As of 2011 Income tax receivables 3,1 1,6 48,3 30,2 35,2

Ratio Other receivables 1,6% 0,9% 1,7% 3,2% 1,2%

Ratio Prepayments 2,9% 2,9% 2,5% 3,0% 2,7%

Ratio Cash and other equivalents 4,3% 3,5% 2,3% 2,1% 1,4%

of 157

Liabilities

Forecast Assumptio

ns Asset Realized

Item 2007 2008 2009 2010 2011

EQUITY

As of 2011 Share capital 183,9 179,2 169,4 169,4 169,4

As of 2011 Reserve for hedging transactions -4,7 -22,1 21,2 2,4 -47,7

As of 2011 Translation reserve -10,7 -23,9 -62,5 -30,4 -40,6

As of 2011 Minority interest 2,2% 2,7% 8,9% 5,0% 1,3%

LIABILITIES

As of 2011 Deferred tax liabilities 29 44,9 39,3 47,5 56,3

Ratio Retirement benefit obligations 0,2% 0,2% 0,1% 0,2% 0,1%

Change Financial institutions 168 168 168 140 140

As of 2011 Capitalized lease liability 0 0 0 0 0

As of 2011 Other accrued liabilities 0 0 10,9 0 0

As of 2011 Provisions 0 0 0 2,2 0

Change Other liabilities 0 0 0 0 44

As of 2011 Financial institutions 534,5 603 447,3 175,3 224,7

As of 2011 Capitalized lease liability 0 0 0 0 0

Ratio Trade payables 21,7% 21,2% 19,9% 25,9% 21,8%

As of 2011 Income tax 38,9 45,4 63,7 12,3 10,2

As of 2011 Provisions 0 0 0 0 0

Ratio Other liabilities 6,3% 7,4% 6,9% 9,1% 9,0%

of 157

Assets

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

NON-CURRENT ASSETS

Goodwill 199,4 199,4 199,4 199,4 199,4 199,4 199,4 199,4 199,4 199,4 Software and IT systems 0,7% 0,7% 0,7% 0,7% 0,7% 0,7% 0,7% 0,7% 0,7% 0,7%

Trademark rights 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0,1

Leasehold rights 20,5 20,5 20,5 20,5 20,5 20,5 20,5 20,5 20,5 20,5 IT systems under construction 0,4% 0,4% 0,4% 0,4% 0,4% 0,4% 0,4% 0,4% 0,4% 0,4%

PPE 10,5% 10,5% 10,5% 10,5% 10,5% 10,5% 10,5% 10,5% 10,5% 10,5%

Financial assets 33,8 33,8 33,8 33,8 33,8 33,8 33,8 33,8 33,8 33,8 Deferred tax assets 99 99 99 99 99 99 99 99 99 99

CURRENT ASSETS

Inventories 34,7% 34,7% 34,7% 34,7% 34,7% 34,7% 34,7% 34,7% 34,7% 34,7%

Trade receivables 9,1% 9,1% 9,1% 9,1% 9,1% 9,1% 9,1% 9,1% 9,1% 9,1% Income tax receivables 35,2 35,2 35,2 35,2 35,2 35,2 35,2 35,2 35,2 35,2

Other receivables 1,2% 1,2% 1,2% 1,2% 1,2% 1,2% 1,2% 1,2% 1,2% 1,2%

Prepayments 2,7% 2,7% 2,7% 2,7% 2,7% 2,7% 2,7% 2,7% 2,7% 2,7% Cash and other equivalents 1,4% 1,4% 1,4% 1,4% 1,4% 1,4% 1,4% 1,4% 1,4% 1,4%

of 157

Liabilities

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

EQUITY

Share capital 169,4 169,4 169,4 169,4 169,4 169,4 169,4 169,4 169,4 169,4 Reserve for hedging transactions -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 Translation reserve -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6

Minority interest 1,3% 1,3% 1,3% 1,3% 1,3% 1,3% 1,3% 1,3% 1,3% 1,3%

LIABILITIES

Deferred tax liabilities 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3 Retirement benefit obligations 0,1% 0,1% 0,1% 0,1% 0,1% 0,1% 0,1% 0,1% 0,1% 0,1% Financial institutions 140 140 140 0 0 0 0 0 0 0 Capitalised lease liability 0 0 0 0 0 0 0 0 0 0 Other accrued liabilities 0 0 0 0 0 0 0 0 0 0

Provisions 0 0 0 0 0 0 0 0 0 0 Other liabilities 0 0 0 0 0 0 0 0 0 0

Financial institutions 224,7 224,7 224,7 224,7 224,7 224,7 224,7 224,7 224,7 224,7 Capitalized lease liability 0 0 0 0 0 0 0 0 0 0 Trade payables 21,8% 21,8% 21,8% 21,8% 21,8% 21,8% 21,8% 21,8% 21,8% 21,8%

Income tax 10,2 10,2 10,2 10,2 10,2 10,2 10,2 10,2 10,2 10,2

Provisions 0 0 0 0 0 0 0 0 0 0 Other liabilities 7,5% 7,5% 7,5% 7,5% 7,5% 7,5% 7,5% 7,5% 7,5% 7,5%

of 157

Appendix 6: Balance sheet forecast (in mil. DKK)

Assets

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

NON-CURRENT ASSETS

Goodwill 199,4 199,4 199,4 199,4 199,4 199,4 199,4 199,4 199,4 199,4 Software and IT systems 28,0 29,1 30,9 33,4 36,7 39,3 41,2 42,5 43,7 45,1

Trademark rights 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0,1

Leasehold rights 20,5 20,5 20,5 20,5 20,5 20,5 20,5 20,5 20,5 20,5 IT systems under construction 13,5 14,1 14,9 16,1 17,7 18,9 19,9 20,5 21,1 21,7

Intangible assets 261,5 263,2 265,8 269,5 274,4 278,2 281,1 283,0 284,9 286,8

PPE 403,9 420,0 445,2 480,9 528,9 566,0 594,3 612,1 630,5 649,4

Financial assets 33,8 33,8 33,8 33,8 33,8 33,8 33,8 33,8 33,8 33,8 Deferred tax assets 99 99 99 99 99 99 99 99 99 99

Other non-current assets 132,8 132,8 132,8 132,8 132,8 132,8 132,8 132,8 132,8 132,8

TOTAL NON-CURRENT ASSETS 798,2 816,0 843,8 883,1 936,2 977,0 1008,2 1027,9 1048,1 1069,0

CURRENT ASSETS Inventories 548,7 574,1 612,2 665,1 736,0 792,2 836,7 866,9 898,1 930,4

Trade receivables 350,8 364,8 386,7 417,7 459,4 491,6 516,2 531,7 547,6 564,0 Income tax receivables 35,2 35,2 35,2 35,2 35,2 35,2 35,2 35,2 35,2 35,2

Other receivables 44,5 46,3 49,0 53,0 58,3 62,3 65,5 67,4 69,4 71,5

Prepayments 104,7 108,8 115,4 124,6 137,1 146,7 154,0 158,6 163,4 168,3 Cash and other equivalents 52,7 54,8 58,1 62,8 69,0 73,9 77,6 79,9 82,3 84,8

Excess cash 83,3 180,0 252,5 279,6 278,4 300,1 336,4 389,0 431,4 463,6

TOTAL CURRENT ASSETS 1219,8 1364,0 1509,2 1637,9 1773,4 1902,0 2021,6 2128,7 2227,4 2317,8

TOTAL ASSETS 2018,0 2180,1 2353,0 2521,1 2709,6 2879,0 3029,8 3156,5 3275,5 3386,8

of 157

Liabilities

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Share capital 169,4 169,4 169,4 169,4 169,4 169,4 169,4 169,4 169,4 169,4 Reserve for hedging transactions -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 Translation reserve -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6

Retained earnings 802,4 940,5 1077,0 1214,0 1354,0 1489,7 1618,6 1737,7 1848,1 1949,8

Equity att. to eq. holders of the parent 883,5 1021,6 1158,1 1295,1 1435,1 1570,8 1699,7 1818,8 1929,2 2030,9

Minority interest 3,9 3,9 4,0 4,2 4,6 4,7 4,7 4,7 4,6 4,6

TOTAL EQUITY 887,4 1025,5 1162,1 1299,3 1439,6 1575,5 1704,4 1823,5 1933,8 2035,4

LIABILITIES

Deferred tax liabilities 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3 Retirement benefit obligations 5,7 5,9 6,3 6,8 7,4 8,0 8,4 8,6 8,9 9,1 Financial institutions 140 140 140 120 100 80 60 40 20 0 Capitalized lease liability 0 0 0 0 0 0 0 0 0 0 Other accrued liabilities 0 0 0 0 0 0 0 0 0 0

Provisions 0 0 0 0 0 0 0 0 0 0

Other liabilities 0 0 0 0 0 0 0 0 0 0

TOTAL NON-CURRENT LIABILITIES 202,0 202,2 202,6 183,1 163,7 144,3 124,7 104,9 85,2 65,4

Financial institutions 224,7 224,7 224,7 224,7 224,7 224,7 224,7 224,7 224,7 224,7 Capitalised lease liability 0 0 0 0 0 0 0 0 0 0

Trade payables 344,0 359,9 383,8 417,0 461,5 496,7 524,6 543,5 563,1 583,3

Income tax 10,2 10,2 10,2 10,2 10,2 10,2 10,2 10,2 10,2 10,2

Provisions 0 0 0 0 0 0 0 0 0 0

Other liabilities 349,8 357,6 369,7 386,8 409,8 427,6 441,2 449,7 458,6 467,6

TOTAL CURRENT LIABILITIES 928,7 952,4 988,4 1038,7 1106,2 1159,2 1200,7 1228,2 1256,5 1285,9

TOTAL LIABILITIES 1130,7 1154,6 1191,0 1221,7 1269,9 1303,5 1325,4 1333,1 1341,7 1351,3

TOTAL EQUITY AND LIABILITIES 2018,0 2180,1 2353,0 2521,1 2709,6 2879,0 3029,8 3156,5 3275,5 3386,8

of 157

Appendix 7: Equity capital forecast (in mil. DKK)

Realized performance

Forecast Assumptions Realized

2006 2007 2008 2009 2010 2011

Change Share capital 188,5 183,9 179,2 169,4 169,4 169,4

Reserve for deriv. fin. instruments -17,2 -4,7 -22,1 21,2 2,4 -47,7

Translation reserve -8,6 -10,7 -23,9 -62,5 -30,4 -40,6

Retained earnings 415,3 391 331,8 367,5 591,9 657,5

Prior year's Retained earnings

391 331,8 367,5 591,9

Profit for the year

218,7 101,5 229,7 242,6

As of 2011 Capital reduction

5,8 9,8 0 0

As of 2011 Share buyback

-237,8 -13,1 -10,6 -13

Proposed dividend

-70 -66 0 -69,7

As of 2011 Recognition of share-based payments

6,2 3,5 5,3 7,7

As of 2011 Issue of share-based payment plans

25,3 0 0 0

As of 2011 Tax on equity movements

-7,4 0 0 0

As of 2011 Share options exercised

0 0 0 3

Change Other transactions with shareholders

0 0 0 -105

Equity att. to eq. holders of the parent com. 578 559,5 465 495,6 733,3 738,6

Forecast

Ratio Proposed dividend 32,0% 65,0% 0,0% 28,7%

Ratio Share buyback

108,7% 12,9% 4,6% 5,4%

Ratio Recognition of share-based payments 2,8% 3,4% 2,3% 3,2%

of 157

Forecasted performance

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Share capital 169,4 169,4 169,4 169,4 169,4 169,4 169,4 169,4 169,4 169,4 Reserve for deriv. fin. instruments -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 -47,7 Translation reserve -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 -40,6 Retained earnings 802,4 940,5 1077,0 1214,0 1354,0 1489,7 1618,6 1737,7 1848,1 1949,8 Prior year's Retained earnings 657,5 802,4 940,5 1077,0 1214,0 1354,0 1489,7 1618,6 1737,7 1848,1 Profit for the year 214,7 214,2 222,1 234,8 253,3 259,9 261,7 257,5 255,2 252,5 Capital reduction 0 0 0 0 0 0 0 0 0 0

Share buyback -14,7 -17,9 -21,9 -26,7 -32,6 -37,3 -41,5 -44,7 -48,1 -51,4 Proposed dividend -64,9 -68,0 -73,8 -81,5 -91,8 -98,1 -102,7 -104,9 -107,8 -110,4 Recognition of share-based payments 6,8 6,8 7,0 7,5 8,0 8,3 8,3 8,2 8,1 8,0 Issue of share-based payment plans 0 0 0 0 0 0 0 0 0 0 Tax on equity movements 0 0 0 0 0 0 0 0 0 0 Share options exercised 3 3 3 3 3 3 3 3 3 3 Other transactions with shareholders 0 0 0 0 0 0 0 0 0 0

Equity att. to eq. holders of the parent com. 883,5 1021,6 1158,1 1295,1 1435,1 1570,8 1699,7 1818,8 1929,2 2030,9

Forecast Proposed

dividend 30,2% 31,7% 33,2% 34,7% 36,2% 37,7% 39,2% 40,7% 42,2% 43,7%

Share buyback 6,9% 8,4% 9,9% 11,4% 12,9% 14,4% 15,9% 17,4% 18,9% 20,4% Recognition of share-based payments 3,2% 3,2% 3,2% 3,2% 3,2% 3,2% 3,2% 3,2% 3,2% 3,2%

of 157

Appendix 8: Taxes


Forecast Assumptions

Realized

2007 2008 2009 2010 2011

As of 2011 Marginal Tax Rate 25,0% 25,0% 25,0% 25,0% 25,0%

Deferred Tax Liabilities (in mil. DKK) 19,3 29,3 7 -8,8 76,3


Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Marginal Tax Rate 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0%

Deferred Tax Liabilities (in mil. DKK) 0 0 0 0 0 0 0 0 0 0

of 157

Appendix 9: Operating leases (in mil. DKK)


Realized

2006 2007 2008 2009 2010 2011

Operating lease expenses 229,8 233,6 246,7 286,9 314 329,7

Cost of debt

16,1% 19,6% 18,8% 20,8% 19,3%

Weighted average of asset life 4 4 4 4 4 4

Value of operating leases 568,8 553,5 655,4 686,3 744,7 842,2

Implied interest - 88,9 128,3 128,9 154,5 162,3

Tax shield from Implied interest - 22,2 32,1 32,2 38,6 40,6

Lease depreciation - 211,4 214,6 254,7 275,4 289,1

Marginal Tax rate 25%

Appendix 10: Operating leases forecast assumptions


Realized

2006 2007 2008 2009 2010 2011

Operating lease expenses

1,7% 5,6% 16,3% 9,4% 5,0%

Value of operating leases

-2,7% 18,4% 4,7% 8,5% 13,1%


Forecast Assumptions

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

As of 2011 5,0% 5,0% 5,0% 5,0% 5,0% 5,0% 5,0% 5,0% 5,0% 5,0%

As of 2011 5,0% 5,0% 5,0% 5,0% 5,0% 5,0% 5,0% 5,0% 5,0% 5,0%

of 157

Appendix 11: Operating leases forecast (in mil. DKK)


Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Operating lease expenses 346,2 363,5 381,7 400,8 420,8 441,8 463,9 487,1 511,5 537,0

Cost of debt 16,1% 16,1% 16,1% 16,1% 16,1% 16,1% 16,1% 16,1% 16,1% 16,1% Weighted average of asset life 4 4 4 4 4 4 4 4 4 4 Value of operating leases 884,3 928,5 975,0 1023,7 1074,9 1128,6 1185,1 1244,3 1306,5 1371,9

Implied interest 142,4 149,5 157,0 164,9 173,1 181,8 190,9 200,4 210,4 220,9

Tax shield from Implied interest 35,6 37,4 39,3 41,2 43,3 45,4 47,7 50,1 52,6 55,2

Lease depreciation 310,6 326,1 342,4 359,5 377,5 396,4 416,2 437,0 458,9 481,8

of 157

Appendix 12: NOPLAT (in mil. DKK)

Realized

2007 2008 2009 2010 2011

EBITA 344,2 361,1 174,8 303,4 328,2

Implied interest 88,9 128,3 128,9 154,5 162,3

Adjusted EBITA 433,1 489,4 303,7 457,9 490,5

Operating taxes 108,3 122,3 75,9 114,5 122,6

Net oper. DTL 19,3 29,3 7,0 -8,8 76,3

NOPLAT 344,2 396,3 234,7 334,7 444,2

Appendix 13: NOPLAT forecast (in mil. DKK)

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

EBITA 313,9 312,8 323,2 339,8 363,6 371,7 373,3 366,9 362,9 358,3 Implied interest 142,4 149,5 157,0 164,9 173,1 181,8 190,9 200,4 210,4 220,9 Adjusted EBITA 456,3 462,4 480,2 504,7 536,8 553,5 564,2 567,3 573,3 579,2 Operating taxes 114,1 115,6 120,0 126,2 134,2 138,4 141,0 141,8 143,3 144,8 Net oper. DTL 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 NOPLAT 342,2 346,8 360,1 378,5 402,6 415,1 423,1 425,5 430,0 434,4 438,9

of 157

Appendix 14: Invested capital (in mil. DKK)

Realized

2007 2008 2009 2010 2011

OPERATING ASSETS

Cash and cash equivalents 144,9 132 82,2 71,9 53,8

Inventory 466,4 532,4 439,6 428,7 556,5

Net receivables 324,0 333,3 367,1 405,2 438,6

Total current operating assets 935,3 997,7 888,9 905,8 1048,9

OPERATING LIABILITIES

Trade payables 296,8 313,8 291,7 354,8 348,9

Accrued salaries 106,6 110,3 110,8 123,2 125,6

Provisions 0 0 0 0 0

Income tax 38,9 45,4 63,7 12,3 10,2 Other payables+taxes+severance payments 81,5 125,4 139,3 137,3 149,3

Total current operating liabilities 523,8 594,9 605,5 627,6 634

NON-CURRENT OPERATING ASSETS

Deferred tax assets 171,9 158,5 145,9 162,9 95,4

Financial assets 24,4 25,6 35,4 36,0 33,8

Total non-current operating assets 196,3 184,1 181,3 198,9 129,2

NON-CURRENT OPERATING LIABILITIES

Provisions 0 0 0 2,2 0

Other non-current liabilities 0 0 0 0 44

Other accrued non-current liabilities 0 0 10,9 0 0

Deferred tax liabilities 29 44,9 39,3 47,5 56,3

Total non-current operating liabilities 29 44,9 50,2 49,7 100,3

Land and buildings 177,6 174,6 167,3 161,5 155

Leasehold improvements 100,2 108 124,5 132,5 118

Equipment and furniture 122,8 129,8 119,6 106,9 96,6

PPE under construction 8,2 11,5 7,7 7,5 5,9

Net PPE 408,8 423,9 419,1 408,4 375,5

Operating working capital 411,5 402,8 283,4 278,2 414,9

Net other long-term operating assets 167,3 139,2 131,1 149,2 28,9

Capitalized operating leases 553,5 655,4 686,3 744,7 842,2

Invested Capital 1541,1 1621,3 1519,9 1580,5 1661,5

of 157

Realized

2007 2008 2009 2010 2011

Goodwill 201 198,2 178,8 194,3 199,4

Trademark rights 0,2 0,2 0,1 0,1 0,1

Leasehold rights 20,6 22,5 19,8 19,6 20,5

Invested Capital incl. Goodwill 1762,9 1842,2 1718,6 1794,5 1881,5

Retirement benefit obligations 5,1 5,7 4,6 6,9 5,8

Treasury shares 8,5 13,2 4,2 5 5,4

Tax loss carry forward -34,8 -41 -3 -69,4 -12,9

Other payables 21,9 42,3 0 57,1 78,9

Provisions 0 0 10,9 2,2 0

Total funds invested 1692,6 1740,0 1695,9 1653,9 1778,5

Total funds invested sources

Equity 566,6 473,5 509,1 747,2 742,7

Treasury shares (own shares) 8,5 13,2 4,2 5 5,4

Excess cash 0 0 0 0 0

Equity 558,1 460,3 504,9 742,2 737,3

Mortgage loans 168 168 168 140 140

Other loans 534,5 603 447,3 175,3 224,7

Cash and Cash equivalents 144,9 132 82,2 71,9 53,8

Debt 557,6 639 533,1 243,4 310,9

Capitalized leases 553,5 655,4 686,3 744,7 842,2

Total funds invested 1669,2 1754,7 1724,3 1730,3 1890,4

of 157

Appendix 15: Invested capital forecast (in mil. DKK)

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

OPERATING ASSETS

Cash and cash equivalents 52,7 54,8 58,1 62,8 69,0 73,9 77,6 79,9 82,3 84,8

Inventory 548,7 574,1 612,2 665,1 736,0 792,2 836,7 866,9 898,1 930,4

Net receivables 430,5 446,3 471,0 505,8 552,9 589,1 616,8 634,3 652,3 670,8

Total current operating assets 1031,9 1075,2 1141,3 1233,7 1358,0 1455,2 1531,1 1581,1 1632,7 1685,9

OPERATING LIABILITIES

Trade payables 344,0 359,9 383,8 417,0 461,5 496,7 524,6 543,5 563,1 583,3

Accrued salaries 123,1 128,0 135,7 146,5 161,2 172,5 181,1 186,5 192,1 197,9

Provisions 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0

Income tax 10,2 10,2 10,2 10,2 10,2 10,2 10,2 10,2 10,2 10,2

Other payables+taxes+severance payments 147,8 150,7 155,1 161,3 169,8 176,2 181,2 184,3 187,5 190,9

Total current operating liabilities 625,1 648,8 684,8 735,1 802,6 855,6 897,1 924,6 952,9 982,3

NON-CURRENT OPERATING ASSETS

Deferred tax assets 95,4 95,4 95,4 95,4 95,4 95,4 95,4 95,4 95,4 95,4

Financial assets 33,8 33,8 33,8 33,8 33,8 33,8 33,8 33,8 33,8 33,8

Total non-current operating assets 129,2 129,2 129,2 129,2 129,2 129,2 129,2 129,2 129,2 129,2

NON-CURRENT OPERATING LIABILITIES

Provisions 0 0 0 0 0 0 0 0 0 0

Other non-current liabilities 0 0 0 0 0 0 0 0 0 0

Other accrued non-current liabilities 0 0 0 0 0 0 0 0 0 0

Deferred tax liabilities 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3

Total non-current operating liabilities 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3 56,3

Net PPE 403,9 420,0 445,2 480,9 528,9 566,0 594,3 612,1 630,5 649,4

Operating working capital 406,8 426,4 456,5 498,7 555,4 599,6 634,0 656,5 679,7 703,7

Net other long-term operating assets 72,9 72,9 72,9 72,9 72,9 72,9 72,9 72,9 72,9 72,9

Capitalized operating leases 884,3 928,5 975,0 1023,7 1074,9 1128,6 1185,1 1244,3 1306,5 1371,9

Invested Capital 1767,9 1847,9 1949,6 2076,1 2232,1 2367,1 2486,3 2585,8 2689,6 2797,8

of 157

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Goodwill 199,4 199,4 199,4 199,4 199,4 199,4 199,4 199,4 199,4 199,4 Trademark rights 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0,1 Leasehold rights 20,5 20,5 20,5 20,5 20,5 20,5 20,5 20,5 20,5 20,5

Invested Capital incl. Goodwill 1987,9 2067,9 2169,6 2296,1 2452,1 2587,1 2706,3 2805,8 2909,6 3017,8

Retirement benefit obligations 5,7 5,9 6,3 6,8 7,4 8,0 8,4 8,6 8,9 9,1 Treasury shares 5,4 5,4 5,4 5,4 5,4 5,4 5,4 5,4 5,4 5,4 Tax loss carry forward -12,9 -12,9 -12,9 -12,9 -12,9 -12,9 -12,9 -12,9 -12,9 -12,9 Other payables 78,9 78,9 78,9 78,9 78,9 78,9 78,9 78,9 78,9 78,9

Provisions 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0

Total funds invested 1885,0 1964,8 2066,1 2192,2 2347,5 2482,0 2600,7 2700,0 2803,5 2911,5

Total funds invested sources

Equity 887,4 1025,5 1162,1 1299,3 1439,6 1575,5 1704,4 1823,5 1933,8 2035,4 Treasury shares (own shares) 5,4 5,4 5,4 5,4 5,4 5,4 5,4 5,4 5,4 5,4

Excess cash 83,3 180,0 252,5 279,6 278,4 300,1 336,4 389,0 431,4 463,6

Equity 965,2 1200,1 1409,2 1573,5 1712,6 1870,3 2035,5 2207,0 2359,8 2493,6

Mortgage loans 140,0 140,0 140,0 120,0 100,0 80,0 60,0 40,0 20,0 0,0

Other loans 224,7 224,7 224,7 224,7 224,7 224,7 224,7 224,7 224,7 224,7 Cash and Cash equivalents 52,7 54,8 58,1 62,8 69,0 73,9 77,6 79,9 82,3 84,8

Debt 312,0 309,9 306,6 281,9 255,7 230,8 207,1 184,8 162,4 139,9

Capitalized leases 884,3 928,5 975,0 1023,7 1074,9 1128,6 1185,1 1244,3 1306,5 1371,9

Total funds invested 2161,5 2438,5 2690,7 2879,1 3043,2 3229,7 3427,7 3636,2 3828,7 4005,4

of 157

Appendix 16: Free cash flow (in mil. DKK)

Realized

2007 2008 2009 2010 2011

NOPLAT 344,2 396,3 234,7 334,7 444,2

Depreciation 76 95,5 123,5 108,8 109,6

Gross cash flow 420,2 491,8 358,2 443,5 553,8

Change in Operating working capital

-8,7 -119,4 -5,2 136,7

Net Capital Expenditures

110,6 118,7 98,1 76,7

Net Capitalized operating leases

101,9 30,9 58,4 97,5 Net Investments in goodwill & acquired rights

-0,9 -22,2 15,3 6

Net other long-term

-28,1 -8,1 18,1 -120,3

Gross investment 174,8 -0,1 184,7 196,6

Free Cash Flow 317,0 358,3 258,8 357,2

After tax interest income 88,9 128,3 128,9 154,5 162,3

After tax nonrecurring charge 0,0 0,0 0,0 0,0 0,0

Non-operating taxes 0,0 0,0 0,0 0,0 0,0

Long-term investments 0,0 0,0 0,0 0,0 0,0

Excess cash 0,0 0,0 0,0 0,0 0,0

Net loss carry forward -34,8 -41 -3 -69,4 -12,9

Non-operating cash flow 54,1 87,3 125,9 85,1 149,4

Cash flow available to investors 54,1 404,3 484,2 343,9 506,6

of 157

Appendix 17: Free cash flow forecast (in mil. DKK)

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

NOPLAT 342,2 346,8 360,1 378,5 402,6 415,1 423,1 425,5 430,0 434,4

Depreciation 101,4 109,0 113,4 120,2 129,8 142,8 152,8 160,5 165,3 170,2

Gross cash flow 443,6 455,8 473,6 498,8 532,4 557,9 575,9 585,9 595,2 604,7

Change in Operating working capital -8,1 19,6 30,1 42,2 56,7 44,3 34,4 22,5 23,2 24,0 Net Capital Expenditures 129,8 125,2 138,6 155,8 177,9 179,8 181,1 178,3 183,6 189,1 Net Capitalized operating leases 42,1 44,2 46,4 48,7 51,2 53,7 56,4 59,3 62,2 65,3 Net Investments in goodwill & acquired rights 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 Net other long-term 44,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0

Gross investment 207,7 189,1 215,1 246,8 285,8 277,9 272,0 260,0 269,0 278,4

Free Cash Flow 235,9 266,8 258,4 252,0 246,6 280,1 304,0 325,9 326,2 326,2

After tax interest income 142,4 149,5 157,0 164,9 173,1 181,8 190,9 200,4 210,4 220,9 After tax nonrecurring charge 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 Non-operating taxes 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 Long-term investments 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0

Excess cash 83,3 180,0 252,5 279,6 278,4 300,1 336,4 389,0 431,4 463,6 Net loss carry forward -12,9 -12,9 -12,9 -12,9 -12,9 -12,9 -12,9 -12,9 -12,9 -12,9

Non-operating cash flow 212,8 316,6 396,6 431,6 438,6 469,0 514,4 576,5 628,9 671,6

Cash flow available to investors 448,7 583,4 655,1 683,6 685,2 749,1 818,4 902,4 955,1 997,8

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Appendix 18: WACC

Realized

2011

Share Price 221

Shares Outstanding 16942807

Equity Value 3744,4

Capitalized operating leases 842,2

Debt Value 364,7

Cash and cash eq. 53,8

Enterprise Value 4897,5

Interest on leases 2,70%

Interest on debt 2,62%

MRP 4,90%

Risk free rate 2,98%

Beta 0,91

Cost of Equity 9,44%

Tax rate 25,00%

Liquidity Premium 2,00%

WACC 7,7085%

Appendix 19: ROIC & RONIC


Realized

2007 2008 2009 2010 2011

NOPLAT 344,2 396,3 234,7 334,7 444,2

Invested Capital excl. goodwill 1541,1 1621,3 1519,9 1580,5 1661,5

Invested Capital incl. goodwill 1762,9 1842,2 1718,6 1794,5 1881,5

ROIC excl. goodwill 22,3% 24,4% 15,4% 21,2% 26,7%

ROIC incl. goodwill 19,5% 21,5% 13,7% 18,6% 23,6%

RONIC 65,8% 130,7% 131,6% 125,9% -95,9%

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Appendix 20: ROIC & RONIC


Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

NOPLAT 342,2 346,8 360,1 378,5 402,6 415,1 423,1 425,5 430,0 434,4

Invested Capital excl. goodwill 1767,9 1847,9 1949,6 2076,1 2232,1 2367,1 2486,3 2585,8 2689,6 2797,8 Invested Capital incl. goodwill 1987,9 2067,9 2169,6 2296,1 2452,1 2587,1 2706,3 2805,8 2909,6 3017,8

ROIC excl. goodwill 19,4% 18,8% 18,5% 18,2% 18,0% 17,5% 17,0% 16,5% 16,0% 15,5% ROIC incl. goodwill 17,2% 16,8% 16,6% 16,5% 16,4% 16,0% 15,6% 15,2% 14,8% 14,4%

RONIC 5,7% 13,1% 14,5% 15,4% 9,3% 6,7% 2,3% 4,3% 4,1% 14,4% 14,4%

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Appendix 21: DCF valuation (in mil. DKK)

Year FCF DF PV(FCF)

2012 235,9 0,93 219,0

2013 266,8 0,86 229,9

2014 258,4 0,80 206,8

2015 252,0 0,74 187,2

2016 246,6 0,69 170,1

2017 280,1 0,64 179,4

2018 304,0 0,59 180,8

2019 325,9 0,55 179,9

2020 326,2 0,51 167,2

2021 326,2 0,48 155,2

Continuing Value

0,48 3511,7

Operations Value

5387,3

Mid-year adjustment factor 1,04 5591,1

Share price estimation

Value of Operations 5591,1

Add: Value of excess cash 0

Add: Tax Loss Carry-forwards -12,9


Less: Value of debt 364,7

Less: Value of capitalized operating leases 842,2

Less: Stock Options 139,7

Less: Retirement-related liabilities 5,8

Less: Minority interest 4,1

Equity Value 4221,7

Number of shares outstanding 16,942807

Share Price 249,1736

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Appendix 22: EVA valuation (in mil. DKK)

2011 2012 2013 2014 2015 2016

Invested Capital incl. Goodwill 1881,5 1987,9 2067,9 2169,6 2296,1 2452,1

NOPLAT 444,2 342,2 346,8 360,1 378,5 402,6

ROIC

18,2% 17,4% 17,4% 17,4% 17,5%

WACC

7,7% 7,7% 7,7% 7,7% 7,7%

2017 2018 2019 2020 2021 2022

Invested Capital incl. Goodwill 2587,1 2706,3 2805,8 2909,6 3017,8

NOPLAT 415,1 423,1 425,5 430,0 434,4 438,9

ROIC 16,9% 16,4% 15,7% 15,3% 14,9% 14,5%

WACC 7,7% 7,7% 7,7% 7,7% 7,7% 7,7%

Method 1

2011 2012 2013 2014 2015 2016

Economic Spread

10,5% 9,7% 9,7% 9,7% 9,8% x Invested Capital, beginning of year

1881,5 1987,9 2067,9 2169,6 2296,1

Economic Profit 197,2 193,5 200,7 211,3 225,6

2017 2018 2019 2020 2021 2022

Economic Spread 9,2% 8,6% 8,0% 7,6% 7,2% 6,8% x Invested Capital, beginning of year 2452,1 2587,1 2706,3 2805,8 2909,6 3017,8

Economic Profit 226,1 223,7 216,8 213,7 210,1 206,3

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Method 2

2011 2012 2013 2014 2015 2016

Invested Capital, beginning of year

1881,5 1987,9 2067,9 2169,6 2296,1

x WACC

7,7% 7,7% 7,7% 7,7% 7,7%

Capital Charge

145,0 153,2 159,4 167,2 177,0

NOPLAT

342,2 346,8 360,1 378,5 402,6

Capital Charge

145,0 153,2 159,4 167,2 177,0

Economic Profit 197,2 193,5 200,7 211,3 225,6

2017 2018 2019 2020 2021 2022

Invested Capital, beginning of year 2452,1 2587,1 2706,3 2805,8 2909,6 3017,8

x WACC 7,7% 7,7% 7,7% 7,7% 7,7% 7,7%

Capital Charge 189,0 199,4 208,6 216,3 224,3 232,6

NOPLAT 415,1 423,1 425,5 430,0 434,4 438,9

Capital Charge 189,0 199,4 208,6 216,3 224,3 232,6

Economic Profit 226,1 223,7 216,8 213,7 210,1 206,3

Economic profit valuation

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 CV (t)

Economic Profit 197,2 193,5 200,7 211,3 225,6 226,1 223,7 216,8 213,7 210,1 4361,6 Discount Factor 0,93 0,86 0,80 0,74 0,69 0,64 0,59 0,55 0,51 0,48 0,48

Present Value of Economic Profit 183,1 166,8 160,7 157,0 155,6 144,8 133,0 119,7 109,5 100,0 2075,6

of 157

Share price estimation

PV Economic profit year 2012-2021 1430,2

PV of Continuing value 2075,6

Total Present Value of economic profit 3505,8

Invested Capital in 2011 1881,5

Invested Capital plus value of Economic profit 5387,3

Midyear adjustment factor 1,04

Value of operations 5591,1

Add: Value of excess cash 0,0








Equity Value 4221,7



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Appendix 23: Trend analysis of the reformulated income statement

2007 2007 2008 2009 2010 2011

Revenue 3353,8 100 111,43 107,97 104,22 117,04

Cost of sales 1370,9 100 107,84 106,84 100,00 116,99

Gross profit 1982,9 100 113,91 108,75 107,14 117,08

Staff costs 807,2 100 115,36 117,52 114,84 125,92

EBIT 340,1 100 102,73 47,66 83,09 94,47

Profit for the year 240,6 100 93,14 45,39 98,00 102,37

Appendix 24: Trend analysis of the reformulated balance sheet

2007 2007 2008 2009 2010 2011

Intangible assets 245,8 100 102,69 89,59 101,30 106,75

PPE 408,8 100 103,69 102,52 99,90 91,85

Inventories 466,4 100 114,15 94,25 91,92 119,32

Trade receivables 266,6 100 111,29 96,62 98,31 134,28

Trade payables 296,8 100 105,73 98,28 119,54 117,55

Cash and cash equiv. 144,9 100 91,10 56,73 49,62 37,13

Financial assets 24,4 100 104,92 145,08 147,54 138,52

Financial obligations 702,5 100 109,75 87,59 44,88 51,91

Total equity 566,6 100 83,57 89,85 131,87 131,08

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Appendix 25: Multiples

Peer group

ESPRIT Realized Forecast

2009 2010 2011 2012

in mil. HDK EBITDA 6500 6337 4010 1744

Share Price 42,236 42,45 24,2 Shares Outstanding 1290976114 1290976114 1290976114 Equity Value 54525,7 54801,9 31241,6 Debt 4840 4148 2714 Cash and cash equivalents 4840 6748 4794 Enterprise Value 54525,7 52201,9 29161,6 EV/forward-EBITDA 8,6 13,0 16,7

GIORDANO INT. LMT. Realized Forecast

2009 2010 2011 2012

in mil. HDK EBITDA 487 866 1123 1086


INDITEX Realized Forecast

2009 2010 2011 2012

in mil. EUR EBITDA 2374 2966 3258 3850


of 157

THE JONES GROUP Realized Forecast

2009 2010 2011 2012

in mil. USD EBITDA 280.0 343.0 293.0 282.0

Share Price 10,26 15,33 10,64 Shares Outstanding 81700000 82600000 81300000 Equity Value 838,2 1266,3 865,0 Debt 499,5 510 580 Cash and cash equivalents 333,4 200,8 238,8 Enterprise Value 1004,3 1575,5 1206,2 EV/forward-EBITDA 2,9 5,4 4,3

BILLABONG INTERNATIONAL

LIMITED Realized Forecast

2009 2010 2011 2012

in mil. AUD EBITDA 285.0 261.0 205.0 124.0

Share Price 8,75 8,74 6,01 Shares Outstanding 252018000 253123000 254038000 Equity Value 2205,2 2212,3 1526,8 Debt 557,9 425,5 613,2 Cash and cash equivalents 332,9 208,7 144,9 Enterprise Value 2430,1 2429,0 1995,1 EV/forward-EBITDA 9,3 11,8 16,1

H & M

Realized Forecast

2009 2010 2011 2012

in mil. SEK EBITDA 24,474.0 27,720.0 23,641.0 27,455.0

Share Price 342,36 206,42 218,3 Shares Outstanding 1655072000 1655072000 1655072000 Equity Value 566630,4 341640,0 361302,2 Debt 0,0 0,0 0,0 Cash and cash equivalents 6629,0 5437,0 5739,0 Enterprise Value 560001,4 336203,0 355563,2 EV/forward-EBITDA 20,2 14,2 13,0

of 157

Peer group average

EBITDA/EV

Companies 2009 2010 2011

ESPRIT 8,6 13,0 16,7

GIORDANO INT. LMT. 2,0 3,7 8,2

INDITEX 8,0 8,7 11,0

THE JONES GROUP 2,9 5,4 4,3

BILLABONG INT. LMT. 9,3 11,8 16,1

H & M 20,2 14,2 13,0

Average 8,5 9,5 11,5

IC Companys evaluation by multiples

IC COMPANYS 2009 2010 2011 2012

in. mil. DKK

EBITDA 456 412 446 289

Enterprise Value 3503,9 4230,4 3334,9

Debt 533,1 243,4 310,9

Cash and cash equivalent 82,2 71,9 53,8

Equity Value 3954,8 4401,9 3592,0

Shares Outstanding 16942807 16942807 16942807

Share Price (in DKK) 233,4 259,8 212,0

of 157

Appendix 26: Scenario analysis

Best case scenario

Realized

2011

Operating Revenues (in mil. DKK) 3925,0

Revenues Growth 12,3%

Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Operating Revenues (in mil. DKK) 3925,0 4160,5 4493,3 4942,7 5535,8 6034,0 6456,4 6779,2 7118,2 7474,1 Revenues Growth 0,0% 6,0% 8,0% 10,0% 12,0% 9,0% 7,0% 5,0% 5,0% 5,0%

Perpetuity

Operating Revenues (in mil. DKK)


of 157

Worst case scenario

Realized

2011

Operating Revenues (in mil. DKK) 3925,0


Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Operating Revenues (in mil. DKK) 3768,0 3843,4 3997,1 4236,9 4575,9 4804,7 4948,8 5047,8 5148,7 5251,7 Revenues Growth -4,0% 2,0% 4,0% 6,0% 8,0% 5,0% 3,0% 2,0% 2,0% 2,0%

Perpetuity

Operating Revenues (in mil. DKK)


of 157

Summary of the scenario analysis

PV of FCF

PV of Continuing

Value Operations

Value Enterprise

Value Equity Value

Stock price

Best Scenario 1881,30 4729,30 6860,60 6847,70 5491,20 324,10 Base Scenario 1875,60 3511,70 5591,10 5578,20 4221,70 249,20 Worst Scenario 1854,20 2826,30 4857,60 4844,70 3488,20 205,90

Appendix 27: Sensitivity analysis

Stock price changes with respect to changes in WACC and the growth rate

WACC changes Stock price

Change in stock price

Enterprise value

Change in Enterprise

value

2% 168,8 -48% 4216,87 -32%

1,5% 185,0 -35% 4490,35 -24%

1% 203,4 -23% 4802,17 -16%

0,5% 224,5 -11% 5160,97 -8%

0% 249,2 0% 5578,20 0%

-0,5% 278,2 10% 6069,36 8%

-1% 312,8 20% 6655,94 16%

-1,5% 354,9 30% 7368,69 24%

-2% 407,1 39% 8253,12 32%

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Stock price changes with respect to fluctuations in WACC and the growth (in DKK)

g +2% g +1.5% g +1% g +0,5% g 0% g -0,5% g -1% g -1,5% g -2%

WACC +2% 199,2 189,2 181,1 174,4 168,8 164,1 159,9 156,4 153,2

WACC +1,5% 224,4 211,2 200,6 192,1 185,0 179,0 173,9 169,5 165,6

WACC +1,0% 255,2 237,3 223,5 212,4 203,4 195,8 189,5 184,0 179,3

WACC +0,5% 293,4 269,0 250,6 236,1 224,5 215,0 207,1 200,3 194,5

WACC 0,0% 342,4 308,2 283,2 264,2 249,2 237,1 227,1 218,7 211,5

WACC -0,5% 407,3 357,9 323,3 297,8 278,2 262,6 250,0 239,5 230,7

WACC -1% 497,7 423,1 373,8 338,9 312,8 292,6 276,4 263,3 252,3

WACC-1,5% 632,0 512,3 439,3 390,2 354,9 328,2 307,4 290,7 277,0

WACC -2% 853,2 642,0 527,8 456,1 407,1 371,3 344,1 322,7 305,5

Stock price changes with respect to fluctuations in WACC and the growth (in %)

g +2% g +1,5% g +1% g +0,5% g 0% g -0,5% g -1% g -1,5% g -2%

WACC +2% -25% -32% -38% -43% -48% -52% -56% -59% -63%

WACC +1,5% -11% -18% -24% -30% -35% -39% -43% -47% -50%

WACC +1,0% 2% -5% -11% -17% -23% -27% -32% -35% -39%

WACC +0,5% 15% 7% 1% -6% -11% -16% -20% -24% -28%

WACC 0,0% 27% 19% 12% 6% 0% -5% -10% -14% -18%

WACC -0,5% 39% 30% 23% 16% 10% 5% 0% -4% -8%

WACC -1% 50% 41% 33% 26% 20% 15% 10% 5% 1%

WACC-1,5% 61% 51% 43% 36% 30% 24% 19% 14% 10%

WACC -2% 71% 61% 53% 45% 39% 33% 28% 23% 18%

of 157

Stock price surface with respect to WACC and the growth rate

Sensitivity analysis for the IC Companys stock price and enterprise value

wacc +2%

wacc +0,5%

wacc -1%

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

g +

2%

g +

1,5

%

g +

1%

g +

0,5

%

g 0

%

g -0

,5%

g -1

%

g -1

,5%

g -2

%

60%-80%

40%-60%

20%-40%

0%-20%

-20%-0%

-40%--20%

-60%--40%

-80%--60%

-40,0%

-30,0%

-20,0%

-10,0%

0,0%

10,0%

20,0%

30,0%

40,0%

50,0%

WACC Change in stock price Change in Enterprise value

of 157

Appendix 28: Revenues forecast for ROV (in %)

Forecast

2012 2013 2014 2015 2016

Base case forecast for IC Companys revenues growth

-2.0% 4.0% 6.0% 8.0% 10.0%

Expected growth rate in Brazilian apparel market

8.0% 8.0% 8.0% 8.0% 8.0%

Fraction of the expected growth rate related to IC Companys

10.0% 10.0% 10.0% 10.0% 10.0%

Additional revenues growth rate

0.8% 0.8% 0.8% 0.8% 0.8%

Forecast

2017 2018 2019 2020 2021 Perpetuity

Base case forecast for IC Companys revenues growth

7.0% 5.0% 3.0% 3.0% 3.0% 3.0%

Expected growth rate in Brazilian apparel market

6.0% 4.0% 3.0% 3.0% 3.0%

Fraction of the expected growth rate related to IC Companys

10.0% 10.0% 10.0% 10.0% 10.0%

Additional revenues growth rate

0.6% 0.4% 0.3% 0.3% 0.3% 0.1%

Appendix 29: Revenues forecast for ROV (in mil. DKK)

Forecast Growth in

perpetuity

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

3,877.9 4,064.0 4,340.4 4,722.3 5,232.4 5,630.0 5,934.0 6,129.9 6,332.2 6,541.1

-1.2% 4.8% 6.8% 8.8% 10.8% 7.6% 5.4% 3.3% 3.3% 3.3% 3.1%

of 157

Appendix 30: Underlying asset estimation for ROV (in mil. DKK)

Estimation of value of operations for ROV

Year FCF DF PV(FCF)

2012 236,6 0,93 219,7

2013 269,1 0,86 232,0

2014 261,9 0,80 209,6

2015 256,3 0,74 190,4

2016 251,5 0,69 173,5

2017 288,4 0,64 184,7

2018 315,7 0,59 187,7

2019 340,1 0,55 187,8

2020 340,8 0,51 174,7

2021 341,2 0,48 162,4

Continuing Value

0,48 3760,1

Operations Value

5682,6

Mid-year adjustment factor 1,04 5897,5

Estimation of enterprise value for ROV

Value of Operations 5897,5

Add: Value of excess cash 0








Equity Value 4528,1



of 157

Appendix 31: Volatility for ROV

Le Lis Blanc

Marisa Lojas

Lojas Renner CIA Hering Average

β 1,8361 2,3197 2,1862 1,7036 2,0114

Standard Error 0,3820 0,4584 0,3807 0,3844 0,4014

Variance (ei) 0,0125 0,0180 0,0124 0,0126 0,0139

Variance (Rm)

0,0023

Monthly variance (σ2i)

0,0232

Monthly volatility 0,1523

Annual volatility

0,5277