Valuation of NIKE inc PDF

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Valuation of NIKE, Inc. Submitted to: Muhammad Nasiruddin Lecturer, Department of Accounting & Finance School of Business & Economics North South University Course: FIN440 Section: 4

Submitted by: Adrita Habib ID# 1330357030

Submitted on: 3rd May, 2018 1

LETTER OF TRANSMITTAL May 03, 2018 Muhammad Nasiruddin Lecturer, Department of Accounting & Finance, School of Business and Economics, North South University Subject: Submission of Final Report. Dear Sir, In response to your assigned work, I would like to inform you that, I have worked on the project regarding the valuation of NIKE, Inc. according to your instruction. In this report, I have given a detailed overview of my findings. Throughout the report, I critically analyzed Nike’s Investment, Financing and dividend decision to finally come up with a valuation analysis. Working on this project has broadened my knowledge about Corporate Finance as well by implementing the theories in a real world scenario. May I, therefore, pray and hope that you will grant my submission of this report on the project regarding the Valuation of NIKE, Inc. and oblige thereby. Sincerely, Adrita Habib ID# 1330357030 FIN440 Section: 04

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EXECUTIVE SUMMARY The main purpose of Corporate Finance is to maximize a company’s value by correctly taking the right investment decisions, financing decisions and dividend decisions. I have chosen NIKE, Inc. to assess its valuation because it is one of the biggest names in the industry of athletic Apparel, Footwear and Equipment industries. In this report, Nike’s activities that might influence their finances are critically analyzed. NIKE, Inc. was incorporated in 1967 under the laws of the State of Oregon. The current CEO of Nike is Mark Parker. The Board of Directors of NIKE, Inc. contains eight members. It is a diversified firm with institutional shareholders as marginal investors. Nike is mostly owned by these institutional investors. The current cost of capital of Nike is 11.25%. Their investments are apparent to have greater returns than their cost of capital assuring their good decisions of selecting projects to invest. Their current debt ratio is 6.96% and the optimal debt ratio is estimated to be 10%. The Operating Income Approach, Cost of Capital Approach and Adjusted Present Value Approach have been used to estimate this optimal ratio. Also, they have been observed to keep their Free Cash Flow to Equity higher than the dividends paid out to have flexibility in investing good projects in future. Finally, it is calculated that they have been 73.44% overvalued by their investors due to their continuous good return on capital invested.

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TABLE OF CONTENTS

COMPANY OVERVIEW .............................................................. 5 CORPORATE GOVERNANCE ANALYSIS ..................................... 6 UNLEVERED BETA ................................................................... 8 COST OF CAPITAL .................................................................... 9 INVESTMENT QUALITY ANALYSIS ............................................ 14 CAPITAL STRUCTURE CHOICES ................................................ 15 OPTIMAL CAPITAL STRUCTURE................................................ 16 DIVIDEND POLICY .................................................................... 22 VALUATION ............................................................................. 23 APPENDIX ................................................................................ 26

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COMPANY OVERVIEW Nike is an American multinational corporation that is engaged in the design, development, manufacturing, and worldwide marketing and sales of footwear, apparel, equipment and accessories. Nike’s headquarter is at Beaverton, Oregon, in the Portland metropolitan area. It is the world's largest supplier of athletic shoes and apparel and a major manufacturer of equipment. The company was founded on January 25, 1964, as Blue Ribbon Sports, by Bill Bowerman and Phil Knight, and officially became Nike, Inc. on May 30, 1971. The company takes its name from Nike, the Greek goddess of victory. Nike markets its products under its own brand, as well as Nike Golf, Nike Pro, Nike+, Air Jordan, Nike Blazers, Air Force 1, Nike Dunk, Air Max, Foamposite, Nike Skateboarding, and subsidiaries including Brand Jordan, Hurley International and Converse. Nike also owned Bauer Hockey (later renamed Nike Bauer) from 1995 and 2008, and previously owned Cole Haan and Umbro. In addition to manufacturing sportswear and equipment, the company operates retail stores under the Niketown name. Nike sponsors many high-profile athletes and sports teams around the world, with the highly recognized trademarks of "Just Do It" and the Swoosh logo.

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CORPORATE GOVERNANCE ANALYSIS

Management and Ownership There are eight members in Nike’s Board of Directors. A list of them is given below. Name

Position

Mark G. Parker

Chairman, President and CEO

Chris L. Abston

Vice President and Corporate Controller

David J. Ayre

Executive Vice President, Global HR

Andrew Campion

Executive Vice President and CFO

Trevor A. Edwards Hilary K. Krane

President, NIKE brand Executive Vice President, Chief Administrative Officer and General Counsel

John F. Slusher

Executive Vice President, Global Sports Marketing

Eric D. Sprunk

Chief Operating Officer

Table 1 Board of Directors of NIKE, Inc.

These are the individuals behind Nike’s tremendous success. They have 74,400 retail and part time employees worldwide but most of them are not involved with any union. In United States, they have employee representatives to abide by the local law. There is no history of interruption in operation due to conflicts between upper and lower management. Top individual shareholders of Nike are listed below. Name

Number of Shares Owned

Knight Philip H

19,010,687

Parker Mark G

1,502,736

Edwards Trevor A

543,592

Graf Alan B Jr

195,715

Krane Hilary K

182,859

Slusher John F

168,169

Sprunk Eric D

141,709

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Campion Andrew

130,777

Spillane Michael

107,709

Ayre David J

86,344

Table 2 Top Individual Shareholders

Among these shareholders, Mark Parker is the Chairman of Board of Directors and CEO of Nike since 2006. He owns 1,502,736 shares which is .05% of Nike’s total outstanding shares. Individually, the most number of shares is owned by Philip Knight who is one of the co-founders of Nike and he owns 19,010,678 shares which is .57% of Nike’s total share. In total, these individuals own 22,070,897 shares which is .66% of Nike’s total shares outstanding. Overall, including stock options, 1.07% of Nike’s total share is owned by insiders (Yahoo Finance). The biggest portion of Nike’s share is owned by institutions. A list of top institution holders is given below. Name

Number of Shares

% Out

Owned Vanguard Group, Inc. (The)

101,511,950

7.82%

Blackrock Inc.

79,221,723

6.10%

Capital World Investors

64,646,705

4.89%

State Street Corporation

59,685,279

4.60%

Wellington Management Company, LLP

48,222,328

3.72%

Capital Research Global Investors

45,569,320

3.51%

Bank Of New York Mellon Corporation

27,058,353

2.08%

Morgan Stanley

24,969,718

1.92%

Northern Trust Corporation

21,121,095

1.63%

FMR, LLC

20,101,835

1.55%

Table 3 Top Institutional Shareholders

In total, all these institutions hold about 492 millions of Nike’s share which is 14.8% of its total shares outstanding. All the institutional shareholders of Nike hold 85.26% of its total share. Among these, Vanguard Group Inc. holds the most numbers of shares and they own 3.05% of Nike. It is an investment management company, and assumed to be diversified. Blackrock Inc. is another investment firm owing 2.38% of Nike’s shares and also assumed to be diversified. 7

Capital World Investors is a privately owned investment manager owning 1.94% of Nike’s Equity and assumed as diversified. Similarly, FMR LLC is a privately owned investment manager that invested in Nike, Amazon, Facebook, Microsoft and others. Hence, FMR, LLC is also diversified. Since, percentage of stock held by institutions is higher than the percent of stock held by insiders. This indicates, marginal investors of Nike might be the Institutional Investors. And since these institutions are diversified, Nike is also supposed to a diversified company as well.

UNLEVERED BETA The calculation of Nike’s Unlevered Beta is shown below. Businesses

Revenues

EV/Sales

Value of

Proportion of

Unlevered

business

Nike

beta

Apparel

9654

2.04

19694.16

30.14962937

0.77

Equipment

1425

1.84

2622

4.013998475

1.03

Footwear

21081

2.04

43005.24

65.83637215

1.01

Nike operations

32160

65321.4

100

0.938841418

Unlevered Beta of Nike as A

0.88712524

Company (adjusted for cash) Table 4 Calculation of Unlevered Beta

Nike operates their businesses mainly in three sectors, Apparel, Equipment and Footwear. As of May 31, 2017, Nike had $21,081 million of revenues from their Footwear business worldwide. At the same time, they had $9,654 million of revenues from Apparel business and $1,425 million revenues from Equipment business. They also had revenues of $73 million in Global Brand Divisions which are revenues primarily attributable to NIKE Brand licensing businesses that are not part of a geographic operating segment. So this revenue was not calculated.

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The ratio between Enterprise value and sales for each business and unlevered beta was collected from secondary sources. The weighted average of these betas were calculated and adjusted for cash. This unlevered beta of .89 was included in the cost of capital worksheet and was levered up to .94. Since the beta in less than 1, it is apparent that instead of having a moderately high debt to equity ratio, Nike’s stocks move less than the market. It happens because Nike is a Strong contender in the share market with 26.01% market share in footwear industry. Being a dominating company in the market, Nike does not have lots of competitors because the market of athletic apparel and equipment does not contain much strong companies. The main competitors of Nike are Addidas, Puma and Reebok. Since there is not much competitor and Nike is dominating the market, the any change in market affects Nike less than it should have. The bottom up beta will be used in calculating Nike’s current cost of equity and therefore, the cost of capital.

COST OF CAPITAL Nike’s current cost of capital is consisted of their cost equity and cost of debt. Since Nike is originated in United States, the calculations are done in US dollar currency. The 10 year Government bond rate in US is currently 2.96%. Also, according to Nike’s Interest Coverage Ratio and synthetic rating, Nike is a Aaa/AAA rated company and US is a mature market which is also AAA rated. Nike conducts its operations globally; their territories are in North America, Western Europe, Central and Eastern Europe, China, Japan and some emerging markets. In 2017, the biggest portion of their revenue came from North America which was $15,216 million. The calculation of cost equity is done by taking the risk- free rate of US, the bottom up beta calculated before and the Country Equity Risk Premiums of Nike’s Geographic dispersion. The detailed overview of the calculation is illustrated below.

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Equity Number of Shares outstanding =

3325.00

Current Market Price per share =

$

52.99

Approach for estimating beta

MultiBusiness(Global)

If direct input, enter levered beta (or regression beta) Unlevered beta =

0.89

Riskfree Rate =

2.96%

What approach do you want to use to input ERP?

Operating countries

Direct input for ERP (if you choose "will input" Equity Risk Premium used in cost of equity =

9.45%

Debt Book Value of Straight Debt =

$

12,770.00

Interest Expense on Debt =

$

60.00

Average Maturity =

6

Approach for estimating pre-tax cost of debt

Synthetic rating

If direct input, input the pre-tax cost of debt If actual rating, input the rating

Aaa/AAA

If synethetic rating, input the type of company

1

Pre-tax Cost of Debt =

4.18%

Tax Rate =

24%

Book Value of Convertible Debt =

0

Interest Expense on Convertible =

0

Maturity of Convertible Bond =

0

Market Value of Convertible =

0

Debt value of operating leases =

$

3,226.85

Preferred Stock Number of Preferred Shares =

10

Current Market Price per Share=

$1

Annual Dividend per Share =

0.1

Table 5 Calculation of Current Cost of Capital’s Inputs

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As of 2017, the number of Nike’s shares outstanding was 3,325 million. Here, there are two types of common shares, Class A and Class B. Each share of Class A Common Stock is convertible into one share of Class B Common Stock. Voting rights of Class B Common Stock are limited in certain circumstances with respect to the election of directors. There are no differences in the dividend and liquidation preferences or participation rights of the holders of Class A and Class B Common Stock. The authorized number of shares of Class A Common Stock, no par value, and Class B Common Stock, no par value, are 400 million and 2,400 million, respectively. Under stock incentive plan, Nike provides Class B common stocks to their employees. The Stock Incentive Plan authorizes the grant of non-statutory stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units and performance-based awards. The exercised price of these stocks is not guaranteed to be lower than the fair value for the employees. Board of Directors administers these Stock Incentive Plans. According to their Financial Statement of 2017, the market price per share was $52.99 and Earning per share was $2.56. As for the unlevered beta, I directly input the unlevered beta (adjusted for cash) I calculated manually. The risk- free rate taken is the 10 year US Government Bond rate which is 2.96% and the Equity Risk Premium 9.45% was calculated in excel spreadsheet. The book value of debt until February, 2018 was $12,770 million and interest expense (trailing 12 months) was $60 million. As I used the synthetic rating, Nike was rated Aaa/AAA with an interest coverage ratio of 24.17. Nike is a large manufacturing firm. The estimated company default spread is 0.40% and the estimated country default spread is 0.82%, resulting into a pre- tax cost of debt of 4.18%. Nike does not issue any convertible bond. The NIKE World Campus, their international headquarter and other regional offices are built on leased properties. They also lease properties for their retail businesses. All of these leases will expire on 2033. Rent expense was $731 million, $661 million and $594 million for the years ended on May31, 2017, 2016 and 2015, respectively. Amounts of minimum future annual commitments under non- cancelable operating leases are $537 million in 2018, $509 million in 2019, $438 million in 2020, $399 million in 2021, $350 million in 2022 and $1672 million thereafter. The detailed calculation of the debt value of Nike’s operating leases is given below.

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Operating lease expense in current year =

$

731.00

Operating Lease Commitments (From footnote to financials) Commitmen Year

t

1

$537.00

2

$509.00

3

$438.00

4

$399.00

5

$350.00

6 and beyond

$1,672.00

Output Pre-tax Cost of Debt =

4.18%

Number of years embedded in yr 6 estimate =

4

Converting Operating Leases into debt Commitmen

Present

t

Value

Year

1

2

3

4

5

6 and beyond

$

$

537.00

515.45

$

$

509.00

468.97

$

$

438.00

387.37

$

$

399.00

338.72

$

$

350.00

285.20

$

$

418.00

1,231.14

Debt Value of

$

leases =

3,226.85

Restated Financials Depreciation on Operating Lease Asset =

$

12

358.54

Adjustment to Operating Earnings =

$372.46

Adjustment to Total Debt outstanding =

$

3,226.85

Adjustment to Depreciation =

$358.54

Table 6 Calculation of Debt Value of Operating Lease Commitments

The preferred stocks issued by Nike are restricted to only Sojitz America, A Japanese trading company. Sojitz America provides Nike import- export financial services. Any failure of Sojitz America to provide these services or any failure of Sojitz America’s banks could disrupt Nike’s ability to acquire products from their suppliers and to deliver products to their customers in those markets. Such a disruption could result in canceled orders that would adversely affect sales and profitability. As an important business partner, Sojitz America has been the sole owner of Nike’s preferred stocks at $1 par value since 1972. Sojitz America does not have a voting right. The redeemable preferred stock has been fully issued to Sojitz America and the Company’s articles of incorporation do not permit the issuance of additional preferred stock. With all these inputs, the current cost of capital is calculated in the spreadsheet. The calculation is given below. Output $ Estimating Market Value of Straight Debt =

10,300.84

Estimated Value of Straight Debt in Convertible

$

=

$

Value of Debt in Operating leases =

3,226.85 $ -

Estimated Value of Equity in Convertible = Levered Beta for equity =

0.94

Preferred Equity

Market Value

Debt

Stock

Capital

$

$
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