Spring 2021

Corporate Insights

Capital allocation:
paths to value
How much is one dollar
worth?

It isn’t a trick question. But it is a question that corporate

managers must answer to try to generate the most
shareholder value through the deployment of excess capital.
Great capital allocators generate excess returns for their
investors because they can identify opportunities to deploy
cash from their existing businesses into investments and
strategies that are ultimately worth more than the cash used.
They understand that the market environment demands
flexible and opportunistic approaches to investment
opportunities. They have the discipline to retain or return
excess capital when the market requires prudence, and they
avoid expenditures on unproductive or risky projects that
may destroy value. In essence, they can evaluate the value
of a dollar spent on a variety of capital allocation
alternatives.
As Warren Buffett once famously put it, “The In practice, company valuation tends to revolve
first law of capital allocation—whether the around an assessment of existing earnings and
money is slated for acquisitions or share cash flows, how risky they are, and how they
repurchases—is that what is smart at one price are expected to evolve in the short term,
is dumb at another.”1 We must consider because these are the most observable
constantly fluctuating performance and market components of most forecasts. But the most
variables to try to maximize the value of observable value drivers are, by their very
companies’ scarce capital. In this paper, we nature, already baked into market valuations. A
seek to arm our clients with insights to help simple combination of returns on capital,
them navigate these capital deployment expected steady state revenue growth, and
challenges. cost of capital alone can explain current
enterprise value / invested capital2 ratios with
Over time, the ways in which a company 77% explanatory power across U.S. and
deploys capital has an enormous impact on European firms3 (Figure 1).
firm value because it is the most difficult
aspect of company performance to project.

Credit Suisse Corporate Insights 1

How much is one dollar worth?

Figure 1: “Predicting” market multiples with only return on capital, near-term growth, and cost of capital

100.0x

R2 77%
2
Actual enterprise value / invested capital

10.0x

1.0x

0.1x
0.1x 1.0x 10.0x 100.0x
Warranted enterprise value / invested capital2
(given CFROI, cost of capital and sales growth)

It is uncommon for companies to trade wildly out of with the remainder being associated with future
sync with their observable performance. So, past capital allocation decisions and outcomes. That
results and foreseeable changes are less likely to leaves almost two-thirds of valuation dependent on
be sources of incremental market performance and the market’s view of the efficacy of capital
excess total shareholder return (“TSR”). The next deployment.
three years of consensus earnings currently account
for just 34% of aggregate enterprise valuations,

2
Figure 2: Generalized capital allocation decision-making

No Do you have excess capital?

Yes

Are positive-NPV investment opportunities available?

(return on investment greater than cost of capital)

Yes No

Invest in growth Do you need to reduce leverage, enhance liquidity,

Yes
opportunities or maintain / improve credit profile?

No

Either or
Reduce leverage Is excess capital generation expected to be sustained?
both

No Yes
Either or
both
One-time distribution Ongoing shareholder
(recapitalization) distribution

Either or both Either or both

Organic
Focus on Growth Retire Retain excess Tender Share Regular
growth Special
operational through existing capital on offer / repurchase dividend
(capex / dividend
performance acquisitions debt balance sheet ASR program program
R&D)

Capital reinvestment Capital structure Capital return

Capital allocation success requires maximizing the In this issue of Credit Suisse Corporate Insights,
impact of each dollar of capital generated from the we develop a set of distinct frameworks for
business, whether it be invested for growth, evaluating the NPV of $1 of capital deployed to the
retained to strengthen the balance sheet, or, in the primary capital allocation alternatives.4 This paper
absence of value-additive uses, returned to explores the conceptual value drivers for each
shareholders. We often generalize our intuition option in detail. But we also apply these
about capital allocation with a flow chart like Figure methodologies to every firm in a broad market
2, which provides a conceptual hierarchy for capital sample of about 1,400 public, large cap companies
allocation priorities. However, such a crude across the U.S. and Europe. This approach allows
hierarchy ignores the reality that any one of the us to quantify and compare the values of $1 across
options might produce the highest incremental net the options and validate the intuitive hierarchy for
present value (“NPV”) at a given time. value creation (Figure 3).

So we need analytical approaches to facilitate

finding the right answer.

Credit Suisse Corporate Insights 3

How much is one dollar worth?

Figure 3: Value of $1 deployed across primary capital allocation alternatives

Value-neutral Average value of $1 invested in

organic growth: $1.93

% positive NPV (value

$1.00 of $1 deployed >$1) % optimal of $1
$1.93

Organic growth 72%

Reinvestment
Reinvestment

64%
$1.39

M&A 67%

$1.07

Debt reduction 52%

Balance sheet
strengthening
Balance sheet
strengthening

18%
$0.96

Excess cash build 35%

$0.91

Capital return
Share buyback 33%
Capital return

18%
$1.00

Dividend increase 0%

$0.00 $1.00 $2.00 $3.00 $4.00

Average

10th 25th Median 75th 90th

Percentile Percentile

Our results, on average, line up with the generic only 33% of individual companies in our sample
priorities for capital allocation that we introduced in conformed perfectly to the default rankings. For the
Figure 2. But, with this type of analysis, we can bulk of the market, more careful consideration to
now reveal so much more because we have a full capital allocation alternatives and tradeoffs is
set of rankings and priorities for each company. For required to maximize their “bang for the buck”.
example, one of the first things we noticed was that

4
1. Investments in organic
growth

Investments in organic growth include capital And it’s not difficult to understand why investments
expenditures on fixed operating assets, but also in organic growth sit at the top of the capital
other expenses that are meant to build and promote allocation hierarchy when you examine the returns
long-term value, like R&D and advertising expenses. companies have achieved on investments in
Investment in existing operations is the only capital operating assets. Over the last 20 years, large,
allocation option where we can expect to turn a public companies have earned an average cash
dollar not just into a positive NPV, but into a multiple return on operating assets of 11% per year5,
of the original $1. Consider that the aggregate beating out the average returns of investments in
enterprise value / invested capital ratio across the other attractive asset classes over the same time
U.S. and Europe today is 2.7×, meaning, that each horizon (Figure 4).
dollar already invested is now worth about $2.70 on
average. Now, those multiples also embed
expectations for future asset growth and return, so
they are not perfect proxies for the marginal value
of a dollar invested, but they do serve to level-set
the potential value creation offered by organic
investments.

Figure 4: Average annualized 20-year returns by asset class

10.8%
Cash return on operating assets
8.6%
Small cap stocks
8.3%
Emerging market stocks
7.6%
High grade bonds
7.5%
Large cap stocks
6.0%
International developed stocks
4.8%
REITs
0.5%
Cash

(25%) (20%) (15%) (10%) (5%) 0% 5% 10% 15% 20% 25% 30% 35% 40%

Average
-1 +1
Standard deviation Standard deviation

Credit Suisse Corporate Insights 5

1. Investments in organic growth

So, companies have access to a productive and asset values raising questions about the potential
relatively stable asset class that is not available to for future market returns, companies with the ability
most institutional and individual investors. However, to invest their operating profit back into profitable
investors are usually precluded from extracting the growth opportunities should continue to attract
same economic advantage that the underlying significant demand and command premium
companies are earning…except to the extent that valuations.
these same companies retain and invest their cash
profits. Organic investment spend thus permits With the proven ability to generate lofty returns by
investors to “buy”, at book value, portions of these investing capital, it stands to reason that companies
businesses that current market multiples indicate would be plowing back as much cash flow as
are worth significantly more than book value. With possible into additional operating assets.
interest rates remaining near all-time lows and lofty

Figure 5: Aggregate capital deployment for U.S. & Europe (last 20 years)

Allocation of Allocation of growth capital

total capital (excluding maintenance spend)

Organic Net organic

Dividend Capital allocated
spend Dividend spend
13% toward expansionary
38% 17% 16%
organic growth is
Share much smaller once
repurchase maintenance spend
11% is subtracted
Share
repurchase
15%

Cash build
10%

De- M&A
leverage 30%
Cash build
7%
13%
M&A De-
22% leverage
9%

Indeed, organic growth expenditures do stand out If we net our aggregation of prior capital spending
as the largest use of capital by large, public to account for maintenance investments6, the
companies over the last 20 years, representing perspective on capital allocation decision-making
38% of all dollars deployed. But this data does not changes a bit.
tell the full story because a large portion of the
organic investment comprises required maintenance Expansionary organic investment only comprised
investments that companies must make in order to 16% of aggregate spending, potentially indicating a
sustain their existing assets. Required maintenance shortage of organic investment opportunities.
expenditures are more like operating expenses in
that they are an ongoing cost of running a business
as a going concern – rather than growth – and we
believe they should be excluded from our discussion
of organic growth investment.

6
 Estimating from arm’s length how individual But we do have the ability to observe market
companies might drive value through organic valuations, which can tell us a lot about what
investments is complicated by a lack of clarity on investors are pricing in for companies’ marginal
what their specific opportunity sets look like. Most returns. In our prior work, we introduced a
companies have options for expansionary framework for isolating the market’s valuation of
investment that range from relatively low-risk growth opportunities – specifically, the additional
expansions of existing capacity to more speculative market enterprise value above and beyond that
investments in new products or expansions into new justified by a steady-state intrinsic valuation of
segments or regions. The relative attractiveness of existing operations without expansionary
these opportunities will depend on their expected investments or real growth. If we connect the
economic returns relative to the cost of the capital. market-implied value of growth opportunities with
In practice, estimating marginal returns on their expected cash flows, we can derive the
investment projects should involve consideration and market-implied marginal investment return (“MIMIR”)
projection of the expected future cash flows for each company.7
associated with the investment. We don’t have
this…neither will your investors.

Figure 6: Isolating the value of growth opportunities

Steady-state equilibrium value assuming

Existing operations current returns on invested capital are
value sustained and only maintenance
investments are made

Market-implied value of Primarily reflects the expected quantity

growth opportunities and quality of growth investments

Embeds information about investors’

Market valuation average expectations and sentiment
about future growth opportunities

With this credible, market-derived assumption for To do this across the market, we assessed the NPV
incremental investment returns, we can estimate of an annuity representing a cash flow outlay of $1
what $1 invested organically is expected to earn in and incremental cash inflows equal to the marginal
economic profit, i.e. returns on capital (or return less the cost of capital for years equal to the
investment) in excess of the cost of capital. life of operating assets.

Credit Suisse Corporate Insights 7

1. Investments in organic growth

Figure 7: Value of $1 deployed towards investments in organic growth

Average value of $1 invested in

organic growth: $1.93
$1.00

Broad Market $1.93 In the U.S., $1 invested in organic growth

is expected to be worth $2.04 vs $1.58 for
10
Europe
U.S. $2.04

Europe $1.58
$1 of organic growth investment in the
8Consumer Staples sector is expected to
Consumer Staples $2.59 recoup nearly $3 of value; current high
expectations for the value of future growth
potentially stem from post-COVID
Health Care $2.45 optimism permeating the sector
6
Industrials $2.20
$1 of organic growth investment in the
Information Technology $2.03 Energy sector is expected to recoup less
than a $1 of value: the sector trades at a
4discount to the value of existing assets and
Consumer Discretionary $1.87 sell-side revenue growth estimates are
much higher than growth implied by current
share prices (average: 6.8% vs 1.2%)
Communication Services $1.40
2
Materials $0.99
Proportion of universe for which
$1 of organic growth investment
Energy $0.53 is worth less than $1 in value

0
($2.00) ($1.00) $0.00 $1.00 $2.00 $3.00 $4.00 $5.00
Average 27.7%

10th 25th Median 75th 90th

Percentile Percentile

After performing this exercise, we found three in the U.S. and Europe, while investors in the
things: Energy sector, mostly made up of fossil fuel
companies, want these companies to avoid plowing
1. Generally, the market’s expectations of value more capital back into additional operating capacity.
creation by companies investing in themselves is
enormous. On average, we estimate the value of $1 3. A substantial number of companies are actually
of organic investment to be worth nearly twice not expected to recoup their initial investments ($1
that…$1.93. of organic growth spend returning less than $1 of
value), and this proportion is higher for Europe
2. There is tremendous dispersion across sectors. (39%) than for the US (24%).
The Health Care and Energy sectors sit at opposite
ends of the spectrum. Health Care is a sector with
high and growing importance to an aging population

8
 Using our framework to profile different sectors taken appropriate advantage of these high expected
highlights some interesting differences in how returns on organic growth spend?
various classes of operating assets contribute value
to their respective enterprises. For example, Digging deeper reveals that organic investment
companies in the Tech space are generally expected rates have slightly declined across the U.S. and
to earn higher marginal returns on each $1 of Europe since the Global Financial Crisis, while the
organic investment than, say, Industrials. However, market’s expectations for future growth have risen.
the core operating assets utilized by Industrial Organic reinvestment rates in the U.S. have
companies tend to have economic useful lives of declined from 66% in 2009 to 50% in 2020;
10-15 years, whereas Tech companies must spend Europe has seen a more drastic decline of 56% to
aggressively on research and development, the 33% over the same period. Conversely, market
benefits of which tend to subside after 5-8 years. expectations for the value of future growth have
That difference narrows the gap between the risen: future growth accounted for 13% of U.S.
respective values of each $1 invested. If a enterprise values in 2009, and that number stands
hypothetical Tech company were fortunate enough at 31% today (the European story is similar: 12%
to seize an R&D opportunity that offered steady and 24%, over the same period). Our MIMIR
cash flows for 13 years rather than 7, the effective framework corroborates that current marginal
value of each $1 invested in the project would returns are indeed priced at their highest levels in a
increase by $1.08, giving $3.23 in value in return decade for our sample, in aggregate.
for the original $1 invested. But have companies

Figure 8: Market-implied marginal return on investment vs. existing asset returns (CFROI)

10%
Tax Cuts &
Jobs Act
9%
Returns on capital generally “fade”
over time, so marginal returns are
8% lower than existing returns on average.
2020 marks a turning point as
expected marginal returns surpass
7% Global historical observed returns on capital.
Financial COVID-19
Crisis Pandemic
6%

5%

4%
2009 2010 2011 2012 2013 2013 2014 2015 2016 2017 2018 2018 2019 2020

Market-implied marginal return Historical CFROI

Assuming the consensus reinvestment rates are expected to earn and the levels of growth they are
accurate, Figure 8 suggests the market currently expected to achieve…and to ensure sufficient,
expects outsized returns on growth opportunities. productive investment in the business to meet and
The market will ultimately reward or punish those exceed those market expectations
companies that surprise, so we think it is vital that
companies understand the marginal returns they are

Credit Suisse Corporate Insights 9

2. Inorganic growth investments
via M&A

We have addressed M&A a number of times in this series8 and

made the point that the market is more receptive of M&A than
many companies seem to believe. Our new work on capital
deployment – and the value of an M&A dollar – underscores this
idea. Some companies have high growth expectations but do not
have an indefinite pipeline of organic projects in which to invest.
For them, M&A provides a bridge between the growth that is
expected by the market and what their actual organic growth
opportunity set may be. For other companies, M&A may present
paths of growth into new areas, more rapid and more certain than
greenfield spend. These companies often need to embrace
strategic shifts to offset the natural lifecycle of companies’ return
pressures as they mature9, and M&A offers a much more
expedient and often lower-risk route than can be accomplished
organically.

So, how much is $1 of capital deployed to M&A The intrinsic value generated via M&A transactions
investments worth? Likely less than the value of is a function of the present value of expected
organic growth spend, since assets acquired synergies, the intrinsic value transferred between
through M&A are purchased at a market, rather buyer and seller…and nothing else. Potential
than at a book, value. It’s like organic investors get acquirers are often very focused on the “optics” of
to purchase wholesale from the manufacturer, while M&A, such as EPS accretion or changes to returns
acquirers must pay retail prices. Additionally, on capital. But this focus fails to account for the
negotiated M&A transactions typically involve a fact that these considerations do not have a
premium paid to the seller above the market value material impact on the shareholder value created by
of its shares, which can further dilute economic M&A.10 We don’t suggest that these factors are not
returns to the acquirer. However, in M&A value-drivers generally – of course, the level and
transactions, acquirers usually offset premiums growth of EPS and expected profitability do impact
through capturing synergies which translate into valuations – but in the context of M&A, these
additional cash flows, as new markets are able to expectations should already be baked in to the
be tapped or operating redundancies are reduced. market price the acquirer needs to pay to purchase
the seller.

10
An “accretive” target that has higher returns, Our analysis accounts for the impact of deal
earnings yield, or growth prospects will likely financing (cash, equity, or a mix), and the
command a commensurately higher valuation and consequent acquirer’s intrinsic downside offloading
takeover price. / upside leakage for those deals with an equity
component. Of the acquirers that were valued at a
M&A deals create value for acquirers if they get premium to their market share prices, 62% of them
more in the form of realized synergies than they pay used equity as a component of their financing,
for in terms of premium. We can better understand which is an NPV-positive decision. However, for the
the expected value of $1 deployed to M&A by acquirers that were trading at a discount to their
analyzing some 5,000 M&A transactions in the U.S. equity values, 56% used equity as a component of
and Europe since 2000 where a public acquirer their financing…an NPV-negative decision. We
purchased another public target.11 If we assume found that – overall – the value of a dollar of M&A
that the expected synergies disclosed by companies including financing mix effects is $1.39 (Figure 9).
when announcing M&A transactions are generally
accurate, then their present values can be
estimated in a fairly straightforward manner given
assumptions around tax and discount rates.12

Conventional analysis of M&A compares synergies

to the price paid as a premium to the seller’s market
price. This is appropriate if the seller’s market price
accurately reflects the present value of its future
cash flows. To consider the true value of completed
M&A deals, we estimated premiums relative to the
then-current intrinsic values of sellers, rather than
using their market prices.13 Through our approach,
acquirers that purchased “undervalued” assets
would see their traditional premium estimates fall,
while those that acquired “overvalued” targets would
be charged a higher premium. We found that most
M&A transactions involved target assets that
seemed to have intrinsic upside as of deal
announcement, suggesting that acquirers were,
on average, investing in “cheap” targets.

Credit Suisse Corporate Insights 11

2. Inorganic growth investments via M&A

Figure 9: Average value of $1 invested in M&A across U.S. & Europe (last 20 years)

$0.13 ($0.03)
$1.39
$0.30 Summarizes the
average intrinsic
value created per
dollar of M&A across
public deals
$1.00 consummated by
U.S. and European
firms since 2000.

$1 invested Present value of Discount / (premium) Intrinsic value transfer Average value
in M&A expected synergies to warranted value from equity financing of $1

Our work shows that capital allocated toward M&A Let’s compare our intrinsic value estimates to the
in the U.S. and Europe has been extremely value- market’s reaction to announced M&A deals, as
enhancing overall. Moreover, our calculations captured by total deal value added16, which is the
indicate that 67% of all historical deals were total combined change in market value of the
value-additive for the acquirer. Ignoring the acquirer and its target upon announcement of the
negative-NPV deals, the average estimated value deal.
per dollar for “good” M&A averaged about $1.71
just shy of the $1.93 we currently see as the
average value of incremental organic growth
investment.14

Is there evidence that this is how the market

actually does evaluate M&A decisions and that
these estimates are aligned with the market’s
pricing of M&A? In our prior work15, we showed that
more acquisitive companies tend to outperform over
time. But is that driven by their M&A activity or other
factors?

12
 Figure 10: Empirical assessment of M&A in the market

Simplistic market valuation approach Holistic warranted valuation approach

(US$ in millions) (US$ in millions)

$25,000 $25,000
Market derived expected value created/destroyed by the

Market derived expected value created/destroyed by the

Market value based approach
R2 0.3% shows no correlation to
R2 21%
observed values
$20,000 $20,000

$15,000 $15,000
deal announcement

deal announcement
$10,000 $10,000

$5,000 $5,000

$0 $0

Integrating warranted
($5,000) ($5,000) values and financing mix
increases the correlation

($10,000) ($10,000)
($10,000) $0 $10,000 $20,000 ($10,000) $0 $10,000 $20,000
Synergies less premium over Synergies less premium over warranted
pre-announcement market price including financing mix effect

Figure 10 demonstrates the relationship between But we think M&A is most beneficial to those
our fundamental valuations of M&A and the companies for whom the market is pricing in
market’s pricing of those same deals. Conventional significant future growth value that may be difficult
estimates of deal value are not correlated with to achieve organically. We’ve identified about 11%
market reactions. However, after incorporating the of the market with an obvious gap between market-
intrinsic valuation of the target, and the intrinsic implied and sell-side forecasted growth rates that
valuation of the acquirer, we see a huge may reveal a strategic need for M&A. In other
improvement in explanatory power. These results words, these companies, with market-implied
reinforce the notion that a disciplined, growth rates which eclipse sell-side growth
fundamentals-based approach to M&A can lead to forecasts, have a valuation imperative to find ways
significant value creation. to generate that incrementally higher growth or risk
missing market expectations and seeing their
While we estimated the value of $1 deployed to valuations fall as a result.
organic growth for individual companies, we
assessed the value of $1 invested in M&A over a
sample of historical deals rather than companies.
Given the substantial value we see associated with
past M&A deals, we believe that M&A can be a
productive component of almost any company’s
capital budget.

Credit Suisse Corporate Insights 13

3. Proactive debt reduction

As we’ve seen, most firms should try to prioritize growth, either

organically or opportunistically via M&A, because it offers the
potential to earn a substantial NPV on each $1 deployed on the
margin. Other options for deploying that $1 generally are worth
about $1 for the average company. But the averages could
potentially be misleading, especially for the option of debt
reduction, since many companies have little to no debt and would
not consider it a viable capital allocation option. But by our
estimation, the roughly 50% of companies that currently have too
much debt would earn an average NPV of $0.36 for $1 of
proactive debt reduction. In other words, the average value of a
dollar spent to de-lever these companies is $1.36.

Let’s walk through how we think about this. uncertainty related to COVID-19 have limited the
intrinsic value of levered capital structures. But our
We evaluate the value of capital deployed towards observations do not reflect an anti-debt sentiment;
proactive debt reduction from an optimal capital it’s much more of an anti-financial engineering
structure perspective. “Capital structure sentiment. We recognize that optimal target
optimization” is about balancing the long-term costs leverage and optimal actual use of debt are two
and benefits of permanent debt leverage to create distinct things. In fact, one of the primary risks of
additional shareholder value. It quantifies the tax permanent debt that our optimal capital structure
benefit of interest deductions against the perceived framework aims to mitigate is the potential for fixed
risks of financial leverage to identify a point that debt charges to limit financial flexibility, crowd out
maximizes intrinsic value, thereby minimizing the investment spend, and stifle future growth, so there
cost of capital. All else equal, capital structure is a direct and explicit accounting of the need for
optimization provides a long-term target for how and value of tactical debt use for growing firms. This
companies should seek to finance their overall value exists, because choosing the cheapest source
operations given their riskiness. of funds on the margin is the preferred way to fund
capital projects. In practice, this means that growth
In recent years, we’ve told many of our clients that initiatives that can’t be covered by cash flow and
their optimal leverage is at a lower debt balance liquidity tend to be financed with new debt rather
than currently…largely because recent exogenous than new equity, which will pull growing companies’
changes like reduced corporate tax rates in the U.S. leverage above their theoretical targets over time.
and heightened global macroeconomic

14
 This bias is fine – in fact, while rates remain at estimating optimal capital structure fail to take it into
historic lows, it is value-maximizing – as long as account. By valuing the potential loss of financial
managing the balance sheet remains a competency flexibility and its impact on realizing value from
and capital allocation priority. future growth, our approach generally favors
conservative financial targets for permanent
So the value of growth opportunities, capital leverage that ensures market capacity and dry
structure policy, and optimal capital allocation are powder to fund profitable growth when the
intricately linked. As growing companies become opportunities arise. Again, it’s an acknowledgement
more levered in the pursuit of growth, the implied that the use of new debt to fund growth can offer
value of proactive de-leverage also increases as significant potential to drive higher shareholder value
those companies drift further from a theoretically than financial engineering. And we can observe this
optimal debt financing level. Eventually, the need to in practice.
strengthen the balance sheet and de-lever towards
the long-term optimal leverage leads to a situation
where proactive de-leverage spend can outperform
other uses.

This feedback loop between the value of growth

and of target leverage is not well-understood,
because most conventional approaches to

Figure 11: Leverage and the market-implied value of growth opportunities vs. valuation multiples

Value of growth opportunities vs. leverage Deviations from “optimal” leverage vs. valuation

Under-levered Near “optimal” Over-levered

80% 50x
The perceived Companies whose Having leverage
Economic leverage (adjusted debt / economic EV)

value of growth leverage is aligned that is “too high”

clearly matters 45x to the value of is more value-
70%
to companies’ growth destructive than
leverage choices 40x opportunities trade leverage that is
60% at least 2.4x higher, “too low”
on average
35x
EV / NTM EBITDA

50%
30x

40% 25x

20x
30%
15.4x
15x
20% Average multiple: 13.0x
10.9x
10x

10%
5x

0% 0x
(75%) (50%) (25%) 0% 25% 50% 75% 100% (60%) (40%) (20%) 0% 20% 40% 60%

Market-implied value of growth opportunities (% of EV) Under (over) leverage relative to average relationship

Credit Suisse Corporate Insights 15

3. Proactive debt reduction

Figure 11, which uses the same methodology we’ve leverage spend that we’ve estimated for each
discussed for parsing out future growth, company relates to a presumed, permanent change
demonstrates a distinct correlation between to their ongoing financial strategy.
expected future growth value and capital structure.
Companies whose valuations depend most on For many companies, changing target leverage is
expected future growth maintain the lowest leverage not a major needle-mover. Indeed, the median firm
ratios, on average. More importantly, deviations in our sample has an insignificant NPV for reducing
from this relationship are priced by investors. When permanent leverage by $1. And the NPV of $1
we plot valuation multiples vs. under- and over- deployed is similarly immaterial or negative for over
leverage relative to the line of best fit, a clear 60% of the sample, many of which already maintain
pattern emerges: dots closest to zero (companies low or negative net debt. That being said, debt
whose leverage best aligns with their growth reduction appears to be the best capital allocation
opportunities) have higher average multiples than alternative for about 16% of the market. For this
their counterparts that seem to have too much or specific cohort of companies, $1 deployed to debt
too little debt financing. As expected, in a world reduction is worth an average of $1.35! For some
where the value of permanent leverage is reduced of these firms, de-leverage spend is optimal simply
by low taxes and high volatility, the valuation penalty because their current ability to drive growth is
for being over-levered is about 2.5 turns higher than limited. However, for many others, protecting their
that for being similarly under-levered. ongoing ability to funnel capital towards growth is, in
fact, the reason that de-leverage spend is valuable.
So, the market’s perception of growth opportunities To that point, companies in this sample which we
not only drives the value of organic and inorganic estimate to also have positive expected NPV to
growth investment, but, perhaps counterintuitively, growth investment average a market implied value
of de-leverage spend as well. In practice, it is rare of growth opportunities equal to 45% of their
to see companies plowing significant capital back enterprise valuations. As can be seen in Figure 12,
into growth initiatives at the same time they are this is well above the market average and about
deploying capital to debt reduction. High NPV equal to that of those companies for whom growth
opportunities, particularly via M&A, can be lumpy investment looks to be the best use of the marginal
and sporadic, but companies with significant future $1. The data also shows that this interaction
value expectations can usually be confident that between the value of investing in growth and the
growth opportunities will present themselves value of strengthening the balance sheet is unique
eventually. For these companies, balance sheet to de-leverage spend – for the options of returning
fortification is a perfect way to extract value through capital via buybacks or dividends, their value
capital allocation by optimizing the capital structure propositions are more related to the absence of
for additional financial flexibility and dry powder to opportunities for profitable growth investments.
take opportunistic advantage of growth initiatives
when they do arise. Of course, companies can find their balance sheets
overextended for a number of reasons not related to
In order to estimate which companies have an optimal use of debt to fund growth investments and
opportunity to benefit from proactive de-leverage M&A. Even companies that had made optimal
spend and by how much, we applied our proprietary financing decisions in the past could currently find
capital structure intrinsic valuation framework to themselves in an over-levered position due to
each and every company in our broad U.S. and outside influences like the reduction in statutory
European sample and evaluated the marginal corporate tax rates or a cap on interest deductions
theoretical impact of reducing debt by $1. The (like in the U.S.), or operating headwinds introduced
interpretation of these valuations is more than by unforeseen global pandemics that resulted in
merely paying down $1 of existing debt using exogenous credit deterioration. And then there are
operating cash flow, but also making a permanent, those firms that were pushed to the brink of distress
credible commitment to maintain future leverage during 2020 due to imprudent balance sheet
targets at the lower level. So, the impact of de- management during the tail end of the bull market.
While the risks of levered capital distributions are

16
Figure 12: Market-implied value of growth opportunities by optimal capital allocation

The value of a dollar spent on de-

leverage is far higher for those
companies whose valuations are
dependent on high expected …whereas low/negative levels of
future growth… implied future growth are
indications that returning capital
via share repurchase/dividends is
48% the optimal strategy
43% 45%

27% 28%

4%

(23%)
"Good" M&A Organic De-leverage De-leverage Dividend Share Average of
candidates growth better than optimal optimal repurchase entire sample
optimal organic optimal
growth

Percent of
sample: 8.6% 63.7% 5.6% 15.9% 5.6% 12.3% 100%

often obscured during speculative, “risk-on” market companies are way more leveraged, on average,
rallies, ultimately, levered companies are left to pay than the typical company in our universe. These
the proverbial piper (even if their short-term companies are also way more risky, with much
investors are able to get out) when market higher equity betas and implied stock volatilities. We
sentiment takes a downturn. also saw that implied operating risk18 and observed
cash flow volatility are trademarks of companies that
We saw this in March 2020, where the COVID-19- can usually benefit from de-leverage. Cash flow
related market selloff had a disproportionate impact uncertainty reduces the expected value of the debt
on companies with weak balance sheets. tax shield because it increases the likelihood of
Companies with stronger balance sheets experiencing insufficient operating profits to take full
outperformed by almost 40% TSR over the first advantage of the interest tax deduction, but it also
three quarters of the year.17 increases sensitivity to perceived financial risk
because of the increased probability of adverse
Other than companies looking to build flexibility and changes to the credit profile. Said differently, for
capacity for growth investment, who should be two companies with the same financial leverage
considering de-leverage as a primary capital profile, the one with higher operating risk is likely to
allocation priority in the near term? We looked more have a lower credit rating and higher cost of capital.
closely into some of the salient characteristics of the
cohort to identify those most likely to benefit from
debt reduction.

Obviously, a pre-requisite to needing to de-lever is

having a considerable debt load, and indeed, these

Credit Suisse Corporate Insights 17

4. Build excess cash on balance
sheet

From an optimal capital structure perspective, adding $1 of

permanent excess cash to the balance sheet looks a lot like
reducing debt by $1. The drivers are conceptually the same –
trading off the increases in the present value of taxes payable on
interest income against the impact that incremental cash liquidity
has on credit profile, financial flexibility, and the perceived risks of
(net) financial leverage. Therefore, the outputs are reasonably
similar as well, including the profile of companies most likely to
benefit.

However, because cash interest income rates are structure lens, we see building cash as the optimal
generally lower than corporate debt all-in costs, the use of the next dollar for less than 1% of the
tax implications are reduced, meaning that adding a market, and even for those companies, the
dollar of cash on the balance sheet is a somewhat expected value of that dollar averages only about
more tax-efficient way to strengthen the balance $1.23.
sheet than reducing debt balance by the same
dollar. At the same time, both the markets and the However, as the COVID-19 market shock showed
credit rating agencies tend to view cash balances as us, optimizing capital structure is not the primary
significantly more ephemeral than debt balances – rationale for which most companies might consider
after all, companies have the discretion to spend all building cash on the balance sheet. Outside of
of their cash on hand on any given day. So cash significant market dislocations and extreme levels of
positions tend to get heavily discounted or even market volatility, most academic research considers
ignored from the valuation of liquidity benefits and excess cash to be a value inhibitor. A bloated cash
the analysis of credit risk. Because of this, position leaks cash taxes, exposes companies to a
optimizing the capital structure through debt cost of carry (vs. higher-returning debt or equity
reduction is a more credible capital allocation choice capital that can be retired using excess cash), and
and therefore generally commands higher NPVs on could invite the unwanted attention of activist
the margin than building excess cash. Our own investors.19
analysis validates that for companies positioned to
generate positive NPV from de-leverage, the
average value of $1 deployed to debt reduction was
$1.36 vs. just $1.06 for the same dollar that gets
stockpiled on balance sheet. Through the capital

18
A wide array of academic research seeking to associated special dividends implies a 30% haircut
quantify the value of $1 of cash held on balance on the valuation of undistributed excess capital. In
sheet reveals limited consensus. These experts other words, a dollar of free cash flow left on
value one dollar on the balance sheet in a range balance sheet may only be worth $0.70, all else
from $0.30 at the low end to $1.63 at the high, equal.
averaging $0.96 and corroborating the position that
holding excess cash is value-negative on average.20 Our assessment of this data dictates that, outside
We decided to come at this from a different angle of major market meltdowns or idiosyncratic liquidity
and attempted to quantify investor sentiment around crises where the value of incremental cash is
corporate cash by looking at market reactions to generally immediately obvious, most companies
company announcements reflecting reductions in should be targeting a lean balance sheet. But there
cash, i.e. the payment of large special dividends. is one cohort where extra cash liquidity is usually
Looking at 852 special dividends (where the cash beneficial: companies with high future growth value.
distribution represented 5% or more of market cap) Once again, the value of growth proves its all-
over the last 20 years, we’ve found that these encompassing importance as cash on hand can
companies’ stock prices increased by an average of provide the “dry powder” to take advantage of
5.8% on the day of announcement.21 Such a result profitable growth opportunities.
defies theoretical rationales, unless investors value
the cash in their pockets at a higher level than if
held by the company. Adjusting these
announcement effects by the actual sizes of the

Credit Suisse Corporate Insights 19

5. Opportunistic share
buybacks

If a company still has excess capital after exhausting its profitable

investment opportunities and optimizing its capital structure, it
should generally be thinking about returning the residual cash flow
to shareholders via some combination of dividends and buybacks.

Theoretically, returning capital is a value-neutral clear up some of the most common myths about
pass through of operating profits to their beneficial buybacks.
owners, and in a hypothetical world of rational
investors, no taxes, and perfect information, Fallacy: Share repurchases create value by
dividends and buybacks are economically enhancing EPS
equivalent. In the real world, other practical factors
intrude, like the tax position of investors, free float Reality: While most buybacks are EPS accretive,
%, shareholder ownership stakes, or the intrinsic engineered EPS growth is not a source of
value of the shares. This last factor, the intrinsic fundamental value because the P/E multiple
value of shares being bought back, is key to our contracts by an offsetting amount to keep expected
discussion of opportunistic buybacks, which we’d share price constant. This is easiest to see if one
define as incremental share repurchase spend considers the price / earnings ratio on an
specifically aimed at taking advantage of perceived aggregate, rather than a per share basis as market
undervaluation of the stock and earning an excess cap / net income. The expenditure of capital on a
return for shareholders. The truth is, many cash share repurchase reduces market capitalization by
generative companies must continually buy back the amount of cash deployed, with no
shares in the open market simply to avoid a corresponding impact on net income (ignoring the
ballooning balance sheet – they generate way too negligible interest income foregone).
much cash flow to be reasonably plowed back into
This may be counterintuitive because we see that
business growth every period and deploy capital to
EPS growth is positively correlated to valuation
open market repurchases each and every reporting
multiples across the market. However, net income
period without concern for valuation or any attempt
growth has a stronger correlation, indicating that the
to time the market.
market actually values true earnings growth, and
But many other companies consider buybacks to be the engineered component of EPS growth from
a value-creation tool, and deploy capital towards expected buybacks is actually priced negatively, on
them opportunistically in an effort to meet average (Figure 13). Share buybacks can create
performance goals. While opportunistic share value only to the extent that they help optimize the
repurchases can be an effective tool, they are also capital structure, and that impact is generally
one of the most misunderstood tools in all of limited.
corporate finance.

Therefore, before considering the value of $1

deployed to share repurchases for our analysis, let’s

20
Figure 13: Price / earnings vs. expected growth

50× 50× 50×

Price / NTM earnings

Price / NTM earnings

Price / NTM earnings
40× 40× 40×

30× 30× 30×

20× 20× 20×

10× 10× 10×

R2 10% R2 14%

0× 0× 0×
0% 5% 10% 15% 20% 25% 0% 5% 10% 15% 20% 25% -25% 0% 25% 50% 75%
Expected EPS growth Expected net income growth Engineered EPS growth

Fallacy: Levered buybacks directly boost TSR as repurchases.”22 Although he is right, estimating
intrinsic value is difficult for many management
Reality: Debt-financed shareholder distributions teams who tend to believe their shares are
have no theoretical effect on TSR. TSR is driven by consistently undervalued. For these companies,
business operations earning returns on capital that buying back shares always looks productive, so they
exceed the cost of that capital. Strong profitability tend to deploy most capital towards buybacks when
enables companies to return capital, so payouts are they generate their highest cash flows…which
the vehicle by which operating performance can be tends to coincide with peak valuations.
shared (dollar for dollar) with their beneficial owners.
Issuing new debt to finance capital distributions is
not a form of business return, but a form of capital
structure rebalancing, which is accompanied by the
theoretical valuation sensitivities to increasing
leverage.

Fallacy: Buying back undervalued shares creates

value

Reality: Returning capital “creates” nothing. It is a

financing decision that splits up the metaphorical
capital pie in a different way. Only investing in
business assets grows the pie and has the potential
to truly create shareholder value. Buying back
undervalued shares can transfer intrinsic value from
the sellers in a repurchase program to the
company’s remaining shareholders. In other words,
buying back undervalued shares leaves the
company’s remaining shareholders in the position to
benefit, if and when the intrinsic value gap closes, in
the form of excess TSR. Warren Buffett has said,
“When companies … find their shares selling far
below intrinsic value in the marketplace, no
alternative action can benefit shareholders as surely

Credit Suisse Corporate Insights 21

 5. Opportunistic share buybacks

What’s actually needed to get opportunistic buyback Leveraging intrinsic share price estimates derived
activity “right” is a conservative and robust intrinsic from profitability, growth, and risk forecasts, we
valuation approach, a credible belief or narrative bucketed companies into five equal samples
about why the market mispricing is likely to close, representing misvaluation quintiles in Figure 14. For
and the discipline and processes to stick to a instance, the middle quintile contains companies
valuation rules-based strategy. that were roughly fairly valued, with intrinsic value
estimates within +/- 6% of actual share prices. The
In order to quantify the expected value of $1 most undervalued companies across our universe
deployed to opportunistic buybacks for U.S. and over the last 20 years that we evaluated, by
European companies today, we need to first answer contrast, had indicated upside of 23% or more.
the question “do valuation gaps eventually erode?”

Figure 14: Warranted share prices vs. actual share prices

$10,000 The vertical deviations of the

warranted share prices are mapped to
quintile valuation buckets

R2 87%
$1,000 Most upside
1
> 23% upside
Actual share price

$100 Moderate upside

2
6% – 23% upside

Fairly valued
$10 3
6% upside – 6% downside

HOLT turns operational

drivers into robust Moderate downside
valuation signals 4
$1 6% – 19% downside

Most downside
5
> 19% downside
$0

$0 $1 $10 $100 $1,000 $10,000

Warranted share price
(given profitability, growth and risk expectations)

What we were most interested in was the valuation companies that were valued in each of the buckets
change for companies in these various buckets after at a given point in time were distributed across the
measuring relative intrinsic value. We measured buckets 3 months later.
“persistence” as the frequency with which

22
Figure 15: Valuation state transition matrix

An intuitive approach to testing valuation "persistence"

Valuation state transition matrix
(average quarterly migration since 2001)

Valuation bucket 3 months later

1 2 3 4 5

Upside 1
63% 24% 8% 3% 2%

2 19%
Starting valuation bucket

44% 26% 9% 3%

3 6% 24% 41% 24% 6%

4 2% 8% 26% 46% 18%

2% 3% 6% 25% 64%
Downside 5

For instance, in Figure 15, the higher frequencies undervalued companies are measured to have less
across the diagonal indicate that valuation is and less upside over time, while the opposite was
persistent – companies are more likely to stay in true for the companies that appeared the most
their bucket than transition to another – but also overvalued.
variable, indicating that there is a chance they could
mean revert towards 0%, or fair valuation. And, lo
and behold, that is exactly what the average
valuation gap does over time, regardless of what its
initial value gap was observed to be. The most

Credit Suisse Corporate Insights 23

5. Opportunistic share buybacks

Figure 16: Intrinsic value gaps erode over time on average

50%
Upside Large mispricings do not persist for long
1

25%
Average intrinsic value gap

0% 3

Trading deviations from fundamentally-

4
warranted valuations have fully eroded over
3 to 5 years on average
25%

5
Downside
50%
0 1 2 3 4 5
Years

Figure 16 makes it clear that large valuation gaps whether share prices converge towards fundamental
do not persist for long, falling by over half, on intrinsic values, thereby producing excess returns,
average, over the ensuing one year. And, by three or if share prices are a leading indicator of where
to five years from observing misvaluation, all market expectations were headed. To test this, we
valuation cohorts average about 0% upside/ constructed portfolios of companies in each of the
downside. valuation quintiles and back-tested their relative
TSRs, rebalancing quarterly.
So market price deviations from fundamentally-
warranted valuations erode over time. But that does
not yet prove anything about repurchasing
undervalued shares, because we haven’t tested

24
Figure 17: Investing in undervalued shares has generated excess returns

2000%
Because market valuations mean revert Annualized return
towards fundamental intrinsic value,
identifying and buying undervalued shares is
a source of alpha 1 17.2%

1500%
Cumulative TSR

1000% 2 13.8% +7.8%

3 12.6%

4 11.3%
500%

5 9.4%

0%
2001 2003 2006 2009 2012 2015 2018 2020

Sure enough, Figure 17 shows that buying shares opportunistic buybacks and their intuition and
of companies identified as being undervalued impact, before examining the value of $1 deployed
produced excess returns vs. the performance of for each company in our universe.
those the framework indicated as having downside.
To put the relative TSRs into context, the annualized Value of the decision: As mentioned, if a stock is
spread of buying the most undervalued shares vs. trading at a price below its intrinsic value, it stands
the most overvalued of +7.8% was 3.5× higher to reason that the per share difference between
than the annualized risk free rate of return over the price and value accrues to the company. This value
same horizon of 2.2%, indicating true value-creating is the actual NPV assuming that the stock price
information. It’s the most significant value gaps that moves immediately to the expected intrinsic value,
maximize the likelihood of realizing the benefit from realizing the excess return.
repurchasing undervalued shares opportunistically.
Time value effects: In practice, it takes time to
Given that buying shares based on credible execute a share repurchase program in the open
valuation signals from a robust intrinsic valuation market, over which time the stock price is expected
framework is empirically value-creating, how should to “drift” upward, increasing the average market
you think about the potential NPV of buying back execution price and limiting the average intrinsic
shares in the face of undervaluation? If your shares value capture. Ultimately, the value of the buyback
are trading $1 below intrinsic value, and you buy is only “monetized” when the intrinsic value gap
one back, is your NPV $1? Seems like a reasonable closes fully in the future, which we’ve seen tends to
logic, but time value effects, idiosyncratic risks, and take 3 to 5 years, on average. This can reduce the
the real option value of discretion are all expected economics marginally, but assuming the
considerations that can further impact the value of company’s cost of equity is used as the discount
an opportunistic buyback. Let’s walk through the rate, opportunistic repurchases of undervalued
components of our framework for valuing shares will always have positive NPV.

Credit Suisse Corporate Insights 25

5. Opportunistic share buybacks

Risk adjustment (for uncertainty around allow companies to increase outlays when market
realizing NPV): Because most companies are left price drops well below expected intrinsic value and
with a binary option to buy, or not to buy, their own get less aggressive when the shares look more fully
equity, the subsequent performance of buyback valued.
“investments” is exposed to much more idiosyncratic
risk. Moreover, the expected horizon for earning the Across our sample of U.S. and European
benefit of value gap mean reversion is at least 3 companies, we currently see an average of 6%
years, but the decision to buy back shares may be share price upside. But because of the time dilution
called into question well before that, especially if and the risks around being able to fully realize the
there is some share price weakness in the interim. upside, the value of $1 used to buy back shares
Therefore, we value expected share price averages less than $1 at $0.91. If we limit our view
appreciation towards intrinsic value at a hurdle rate to only those companies that see upside to their
that includes an enhanced premium for these extra shares (why would companies with downside be
risks by stripping out the implied diversification entertaining opportunistic buybacks?), the average
benefit, and rebuilding a cost of equity from the value increases to $1.07. Still, opportunistic
bottom up using idiosyncratic volatility only, rather buybacks looks like the top capital allocation option
than beta. Across our sample, the risk adjustment is on the margin for about 1/8 of all firms in our
responsible for a $0.15 average reduction in the sample. We believe that the best candidates for
NPV of $1 deployed. opportunistic buybacks have lower volatility, lower
levels of top-line growth, and trade at lower
Real option value of discretion: Opportunistic multiples.
buyback spend is, by definition, discretionary, and
companies can scale up or scale down their
deployment of capital to buybacks based on real
time valuation signals. Implementing a rules-based
execution paradigm for opportunistic buybacks can

26
6. Increase dividends

Distributing excess capital to shareholders via dividend payments

is value-neutral. It’s hard to argue that taking excess cash out of a
company’s bank account and putting it into an investor’s has any
effect whatsoever on the company’s future cash flows. But the
funny thing about dividend payments, at least regular dividends in
the U.S., is that they are “sticky”. Once a company announces a
plan to initiate or increase a regular dividend, the market tends to
view it as a permanent commitment, almost like a fixed coupon
payment. Because of this, the announcement of changes to
dividend policy can be interpreted by the market to contain
information about the company’s future prospects.

Probably most obviously, dividend reductions, If all else fails – all other capital allocation decisions
omissions, and suspensions are usually viewed as produce negative NPV – companies have at their
leading indicators of financial distress and are met disposal a value-neutral way to return capital to
with significant negative stock price reactions in shareholders dollar for dollar. The companies for
general. But declarations of dividends increases can whom this is the only non-value-destructive decision
also have signaling effects, as investors re-calibrate to make generally have significantly lower cash flow
their expectations for profitability and growth in light return on investment, lower market implied value of
of new information they perceive embedded in the growth opportunities, and much lower levels of total
dividend commitments. So, while the payment of shareholder returns.
dividends is not value-relevant, the decision to pay
dividends can have a marginal impact when it is
announced to the market.

Credit Suisse Corporate Insights 27

Conclusions

There are many insights that can be gained from flow indefinitely. Corporate managers need the
examining the value of $1 invested at the macro analytical tools to make smart, value-maximizing
and sector level, but in order to truly benefit decisions on the margin and balance their pursuit of
managers, these analyses should be undertaken on business growth with a diversified and flexible
an individual basis. While the evidence is clear that approach to capital budgeting that also focuses on
profitable growth investment is the primary pathway strengthening the balance sheet and returning cash
to value via capital allocation for most companies, it to owners when appropriate.
is also true that no profitable company can find
opportunities to reinvest all of its operating cash

28
Endnotes
1 Buffett, Warren. Berkshire Hathaway Letter to Shareholders, Berkshire Hathaway, 25 Feb. 2012, https://www.
berkshirehathaway.com/letters/2011ltr.
2 Enterprise value/invested capital defined as (market value of equity + HOLT debt) / inflation adjusted net assets,
including capitalized operating leases and R&D. Return on capital defined as HOLT CFROI. Sales growth defined as
sell-side consensus FY3/FY2 revenue growth. Cost of capital defined as HOLT discount rate.
3 S&P 1500 and EuroStoxx 600 (excluding financials, real estate, and utilities). This universe was used throughout the
paper.
4 For this paper we standardized everything to USD, however, these insights apply to other currency equivalents.
5 Defined as (EBIT × (1- statutory tax rate) + depreciation & amortization expense + rent expense + R&D expense) /
(Total assets + accumulated depreciation + rent expense × 8 + R&D expense × 5 – non-interest bearing current
liabilities – intangible assets & goodwill – equity method investments).
6 Assumes depreciation and trailing 5-year average R&D expense as proxies for maintenance investment spend.
7 See Credit Suisse Corporate Insights - The Roots of Growth: Strategies for Optimal Capital Deployment, “Reverse
engineering the value chain to create a decision framework.” To calculate MIMIR, we first derive a value for existing
assets and subtract that value from observed firm value to arrive at the expected value for future growth opportunities.
MIMIR then represents the internal rate of return of the value of future growth and a cash flow stream composed of
incremental operating cash flows above those associated with current assets (i.e. cash flow growth) and incremental
investment outlays beyond maintenance expenditures (i.e. expansionary spending).
8 See Credit Suisse Corporate Insights - Tying the Knot: M&A as a Path to Value Creation and Behind the Numbers:
Mastering M&A.
9 See Credit Suisse Corporate Insights – Fighting the fade: Strategies for sustaining competitive advantage.
10 See Credit Suisse Corporate Insights – Behind the Numbers: Mastering M&A.
11 The transaction universe of ~5,000 was ultimately distilled into a data set of 741 transactions (those for which both
synergy and premium data was available).
12 Analysis assumes that present value of synergies are estimated as a perpetuity taxed at the acquirer’s statutory rate at
the time of the acquisition, and discounted at the acquirer’s cost of equity.
13 There is a high degree of correlation (87% r-square) when regressing observed share prices to warranted share prices.
Warranted share prices are estimated using a combination of HOLT warranted share prices and sell-side target prices.
14 The “good” M&A cohort is defined as companies within the sample for whom organic growth value is negative and
market-implied growth (growth required to support the current share price) is 5% or higher than sell-side consensus
growth forecasts (127 companies).
15 See Credit Suisse Corporate Insights - Tying the Knot: M&A as a Path to Value Creation.
16 Deal Value Added defined by McKinsey as combined (acquirer and target) change in market capitalization, adjusted for
market movements, from 2 days prior to 2 days after announcement, as a percentage of transaction value. To ensure
that we are isolating only the market’s idiosyncratic sentiment around the deal, we made further adjustments to
market- and risk-adjust these market reactions for the market index’s return over the same horizon and the parties’
respective equity betas as a measure of the riskiness of their returns.
17 “Strong” and “weak” balance sheet indexes were constructed from the S&P 500 based on the 50 companies with the
best and worst Altman’s Z-scores respectively.
18 Derived for each company using the Merton model given assigned ratings and actual financial leverage.
19 See Credit Suisse Corporate Insights – Shareholder Activism: An Evolving Challenge and Credit Suisse Corporate
Insights – The Activism Agenda: What are Activist Investors Looking For?
20 Sampled literature: Bates, Thomas W., Ching-Hung Chang, and Jianxin Daniel Chi, "Why Has the Value of Cash
Increased Over Time?" January 2017.
Dittmar, Amy, and Jan Mahrt-Smith, "Corporate Governance and the Value of Cash Holdings." May 2005.
Faulkender, Michael, and Rong Wang, "Corporate Financial Policy and the Value of Cash." July 2004.
Guimarães, Miguel Fernando Taveira, "What is a Euro Worth? The Market Value of Cash of Eurozone Firms." 2018.
Keefe, Michael O’Connor, and Robert Kieschnick, "Why does the Marginal Value of Cash to Shareholders Vary over
Time?" December 2013.
Opler, Tim, Lee Pinkowitz, René Stulz, and Rohan Williamson, "The Determinants and Implications of Corporate Cash
Holdings." October 1997.
Ozkan, Aydin, and Neslihan Ozkan, "Corporate Cash Holdings: An Empirical Investigation of UK Companies." 2004.
Pinkowitz, Lee, and Rohan Williamson, "What is a Dollar Worth? The Market Value of Cash Holdings?" October 2002.
Tong, Zhenxu, "Firm Diversification and the Value of Corporate Cash Holdings." February 2008.
21 Share price returns are market and risk adjusted.
22 Buffett, Warren. Berkshire Hathaway Letter to Shareholders, Berkshire Hathaway, 25 Feb. 1984, https://www.
berkshirehathaway.com/letters/1984.html.

Credit Suisse Corporate Insights 29

30
Authors from Credit Suisse
Investment Bank

Rick Faery – Managing Director, Global Head of Corporate Insights Group

Eric Rattner – Managing Director, Corporate Insights Group
Austin Rutherford – Vice President, Corporate Insights Group
Rhys McDonald – Associate, Corporate Insights Group
Rahul Ahuja – Analyst, Corporate Insights Group
Irek Akberov – Analyst, Corporate Insights Group

Credit Suisse Corporate Insights 31

About Credit Suisse
Investment Bank

Credit Suisse Investment Bank is a division of Credit

Suisse, one of the world’s leading financial services
providers. We offer a broad range of investment banking
services to corporations, financial institutions, financial
sponsors and ultra-high-net-worth individuals and
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includes advisory services related to mergers and
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engages in debt and equity underwriting of public
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Credit Suisse
Corporate Insights

The Credit Suisse Corporate Insights series provides our

perspective on the key and critical corporate decision
points many of our clients face, regarding corporate
strategy, market valuation, debt and equity financing,
capital deployment and M&A.

32
This material has been prepared by personnel of Credit Suisse Securities (USA) LLC and its affiliates (“CSSU”) and not by the CSSU research department. It is not investment
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Backtested, hypothetical or simulated performance results have inherent limitations. Simulated results are achieved by the retroactive application of a backtested model itself
designed with the benefit of hindsight. The backtesting of performance differs from the actual account performance because the investment strategy may be adjusted at any
time, for any reason and can continue to be changed until desired or better performance results are achieved. Alternative modeling techniques or assumptions might produce
significantly different results and prove to be more appropriate. Past hypothetical backtest results are neither an indicator nor a guarantee of future returns. Actual results will
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The HOLT methodology does not assign ratings or a target price to a security. It is an analytical tool that involves use of a set of proprietary quantitative algorithms and
warranted value calculations, collectively called the HOLT valuation model, that are consistently applied to all the companies included in its database. Third-party data (including
consensus earnings estimates) are systematically translated into a number of default variables and incorporated into the algorithms available in the HOLT valuation model. The
source financial statement, pricing, and earnings data provided by outside data vendors are subject to quality control and may also be adjusted to more closely measure the
underlying economics of firm performance. These adjustments provide consistency when analyzing a single company across time, or analyzing multiple companies across
industries or national borders. The default scenario that is produced by the HOLT valuation model establishes a warranted price for a security, and as the third-party data are
updated, the warranted price may also change. The default variables may also be adjusted to produce alternative warranted prices, any of which could occur. The warranted
price is an algorithmic output applied systematically across all companies based on historical levels and volatility of returns. Additional information about the HOLT methodology
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