The Business of Value Investing.pdf

Effective Business Valuation 109

Table 6.5 shows a discounted cash fl ow analysis for Ensco over the

next fi ve years. To be conservative, these assumptions will be made:

• 2009 remains a slow year for the economy, so free cash flow
  remains stagnant at $ 450 million.


• Free cash flow picks back up in 2010 as cap ex declines and
  oil industry improves and more ultra-deepwater rigs come
  on board.


• 2010 free cash flow of $ 500 million, or an 11 percent growth rate.


• 15 percent free cash flow growth over the next three years.


• 12 percent discount rate to account for oil industry volatility.

I purposely chose a fi ve - year analysis in this case to keep the

example simple and concise. A lot can happen in 10 years, and

assuming cash fl ow growth for 10 consecutive years can come back

to haunt you. Notice also how the free cash fl ow fi gure in 2013 is

almost equal 2007, a conservative assumption considering the

demand for ultra-deepwater drilling rigs is expected to increase over

time. Unless this business commits a major blunder, it should easily

surpass 2007 levels by then, but let ’ s stick to the listed assumptions.

The fi nal piece is to determine the terminal value of the busi-

ness, or what it would be worth to a buyer. Based on the numbers and

Table 6.5 Ensco Discounted FCF Analysis

Year Free Cash Flow Present Value at 12%

2009 $450 $401

2010 $500 $399

2011 $575 $409

2012 $660 $419

2013 $760 $431

Total $2,059

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