Session 10: Estimating Hurdle Rates - Bottom up Betas

New Section

In this section, the speaker introduces the concept of bottom-up beta estimation as a more robust method compared to regression betas. The discussion focuses on how betas are determined by business choices and fixed cost structures.

Introduction to Bottom-Up Beta Estimation

• The speaker emphasizes the importance of estimating betas in determining a company's hurdle rate and discusses the foundational aspects of risk-free rates, equity risk premiums, and betas.

• Betas are highlighted as weighted averages, with an example illustrating how mutual fund betas are calculated based on individual stock betas and investment proportions.

• The concept of bottom-up beta is introduced as a weighted average of individual business betas within a company, emphasizing the significance of business diversification in determining overall company beta.

• The process of estimating bottom-up beta involves averaging regression betas for publicly traded companies in specific industries to derive pure play or unlevered betas for each business segment.

Exploring Business Segments for Disney

This section delves into applying the bottom-up beta approach to Disney by analyzing its distinct business segments, including broadcasting, theme parks, movies, and consumer products.

Analysis of Disney's Business Segments

• Disney's five primary business segments are outlined: broadcasting (including Disney Cable and ESPN), theme parks (e.g., Disney World), movies (encompassing various entities like Pixar and Marvel), and consumer products (involving licensing revenues).

Disney's Business Analysis

In this section, the speaker delves into Disney's various business segments and the process of deriving a bottom-up beta for the company.

Analyzing Different Business Segments

• The speaker focuses on determining betas for each of Disney's five businesses, starting with the movie business.

• For the movie business, a median regression beta of 1.24 is calculated after considering various publicly traded US movie companies.

• Unlevering the beta involves adjusting for debt and cash percentages to arrive at an unlevered beta specific to the movie business.

Dealing with Sample Size Issues

• To address small sample size concerns in broadcasting, companies related to broadcasting activities are included in the analysis.

• Expanding globally is necessary for theme park businesses due to limited US-based publicly traded companies in this sector.

Finalizing Unlevered Betas

• Consumer products and interactive gaming segments provide relatively straightforward calculations for unlevered betas.

• Understanding how levered and unlevered betas are derived aids in determining accurate values for different businesses within Disney.

Weighting Business Segments

Understanding Disney's Business Valuation

In this section, the speaker explains the process of valuing Disney's different business segments by using comparable company data and various financial metrics.

Valuing Disney's Movie Business

• Utilized enterprise value to revenue ratio from comparable movie companies to estimate the value of Disney's movie business.

• Converted revenues into value using enterprise value to sales ratio from comparable companies.

Calculating Unlevered Beta for Disney

• Determined the unlevered beta for Disney's operating assets by taking a weighted average of unlevered betas across its businesses.

• Compared operating asset beta with unlevered beta for Disney as a whole, factoring in cash holdings.

Computing Levered Beta and Cost of Equity

• Allocated debt across divisions based on identifiable assets to calculate levered beta for each business segment.

• Noted varying levered betas across businesses impact costs of equity, emphasizing importance in multi-business valuation.

Investment Evaluation in Multi-Business Companies

This part delves into the significance of setting distinct hurdle rates for different businesses within a multi-business company when evaluating investments.

Setting Hurdle Rates

• Advocated for establishing different hurdle rates for diverse businesses within a company to avoid subsidizing riskier ventures with safer ones.