The Optimal Capital Structure & Valuation of Natus Medical Inc

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Table of Contents

Company Profile Overview
Natus Incorporated Industry and Sub-Industry
Company Background
Calculation of Weighted Average cost of Capital (WACC)
Valuation of Natus Medical Inc.
Optimal Capital Structure and Adjusted Optimal Capital Structure

Company Profile Overview

Natus Medical Incorporated was founded in 1987. It is located in San Carlos, California. It is a company that develops as well as manufactures neuron diagnostic medical products. Such products are used for screening, detecting and tracking common medical-related ailments for treating newborn babies and in-vitros. The firm’s products are utilized in hospitals, laboratories and clinics around the world. Natus Inc. went through an uncertain economy, especially in the year 2010 due to the global economic fall down. There were unfavorable economic changes in the U.S which was also manifested in the global front. They affected normal business and financial results. Basically, such economic conditions affected the company’s markets. For example, the global financial markets were volatile and declining. Therefore, the products could not be sold and make the usual expected sales returns. However, since then, the incorporation has been undergoing a gradual recovery from the recessions experienced in previous years of 2008 and 2009. It is imperative to note that the company itself did not face much of internal fall downs except for this global change. There have been no material changes in the company businesses in relation to economic changes.

The growth in the U.S for Natus Inc. depended much on acquisitions. The completed acquisitions made most of the growth for this company. The company operatives were able to convincing target companies to sell to them. Mutually agreeable terms are negotiated and the acquisition is made. Besides, product lines of the acquired businesses are also taken. Natus Inc. has the financial potential and hence has been able to make these acquisitions so as to generate financial returns or more revenue.

Natus Incorporated Industry and Sub-Industry

Natus Inc. operates in the Medical Appliances and Equipment industry. Its sub-industry is healthcare. This industry is a very competitive one and involves new technologies making companies battle so hard to be remain relevant. Such an industry depends on key skilled personnel and qualified employees are hired more than the unqualified. Hiring the qualified employees translated to the profitability of the companies. Besides, this is done as the industry operates, sells complex products and technologies and hence people with the know-how are the only ones needed. In many cases, qualified people in the medical industry are limited. This makes it difficult for companies in this industry (Natus Inc. included) to attract, recruit and retain qualified personnel necessary for company development.

In this industry, substantial litigations and related administrative regulations, especially with patents and intellectual property rights, are the norm. In fact, ligations could result in huge financial loses for organizations. Therefore, the medical screening or diagnostic products may face third-party infringements and unnecessary scrutiny. This normally happens as it is possible for rival competitors to have functionalities of products overlapping. Claims normally have negative consequences for the company, whether they are true or false. Consequences include costly damage awards and litigations, delayed shipments or suspensions, diverted management attention and resources among others. If the organization can avoid these consequences, then it will strategically position itself in the market for improved growth.

Natus Inc. has taken the necessary compliance approaches to the medical industry and health care sub-industry practices. It has done this so as it keeps its confidentiality intact as well as secrets by signing into the Intellectual Property/Licensing Intellectual Property. This will help the company to retain its innovations and use them to benefit financially.

Company Background

The business establishment has been a leading provider of healthcare products since its inception in 1989. The company has been looking for business stability. Consequently, it has made a notable number of acquisitions since 2003. This has been either through purchasing of a company or product lines. Significant acquisitions have been Neomtrics (2003), Fischer-Zoth (2004), Bio-logic, Olympic, and Deltamed (both in 2006), Schwharzer Neurology (2008), Hawaii Medical (2009), Alpine Biomed (2009), and Medix in 2010. Such have enabled Natus continue operating relatively easy and competitively.

The main challenge Natus Inc. that has faced up to date is the 2009-2009 global financial crises. This global occurrence affected the company in that it was not able to have markets to sell its products as the markets were very volatile and unpredictable. Consequently, the company’s customers somehow delayed or reduced their capital expenditures. Sales were reduced too and collection of accounts receivable was slowed.

The current Natus Inc.market in the U.S. is not growing. It stagnated many years ago. This means that the company may not be having further improvements in the U.S and, therefore, has to seek markets outside the U.S. in the U.S, Natus Inc. derives most of its revenues from sales proceeds of disposable supplies used for screening devices. Existing customers are expected to continue contributing to the revenue of the company. The company, through its acquisitions, has expanded its markets abroad as it looks to increase sales of its products in foreign countries.

Natus Inc. faces stiff competition from other companies who are in similar product lines. Competitors range from private companies as well as multinational companies. Such competitors offer products which vary in scope as well as breadth. Notable competitors are Johnson & Johnson (JNJ), Astro-Med Inc. (ALOT) and Welch Allyn Holdings Inc.

Calculation of Weighted Average cost of Capital (WACC)

WACC represents the simple weighted average of the cost and equity. Cost is the value of money that a company spends in the production of products. Equity is used to refer to the balance between assets and liabilities. High equity of a firm implies that the firm is financially stable because it could finance most of its projects. On the other hand, business establishments that are marked by low equities have very little money to finance their projects, which lead to financial growth. A company’s liabilities refer to the value of money that it owes to investors and/or financiers.

WACC is the least amount of money that an organization should earn from its investments within a specified period of time. Good WACC values imply that a firm could satisfy the requirements of its investors and other stakeholders. In fact, companies work on improving their WACC values so that they could have good relationships with their creditors and other financiers. The weightings are normally appropriated proportionately to the market values of equity and debt. Changing the debt and equity proportions achieves this. Debt is better than equity in some scenarios where risk is less. By using the Capital Asset Pricing Model and beta, it is possible to calculate both the cost of debt and stock. The calculation enhances the probability of obtaining accurate financial attributes of a business organization. Beta can also be used by third party, though using a straight line regression analysis. This uses data having different price changes of a broad market index, which are compared to the price changes of a risky asset. However, beta can be different following the time frames the data are obtained. For example, data for 12 years are much different from data used in the previous 12 months.

This could be explained by several market factors, which the firm does not have the ability to control. For example, political events could result in losses because of uncertain financial and property markets. From the above, it can be noted that there are two important considerations, market return and risk-free return. The CAPM model indicates that the cost of equity of an investor is determined by its beta. The Security Market Line (SML) is used in relation to the expected return and beta (systematic risk). This SML helps in calculating the reward associated with each risk for any investment on the overall market. It means that beta co-efficient affects the rate of return whenever it is deflated or altered. The reward to risk for individual portfolio or investment is equal to the market reward for a reward to risk, making the ratio one. From the calculation in the excel file, it can be seen that the firm’s rate of return is about 8.25% lower than what was projected. This could imply that the company is underpriced. Underpriced companies do not get good value from potential investors because they feel that the management has not been proactively and strategically participating in business activities that could improve the bottom line. One way the company could avoid this is through investing in stocks. In fact, stocks have been shown to earn good returns and they represent correct values of firms in a market that is characterized by an efficient flow of information. See attached spreadsheet (CAPM working for Natus Medical Inc).

Valuation of Natus Medical Inc.

Valuation of a company is an important process because it provides its financial status and its overall value. It is the value of a company that potential buyers use to estimate the amount of money they could use to attain such a company. The use of a higher rate value will lead to a lower estimated fair value, and the reverse is true. Natus Medical Inc. was involved in many acquisitions over the last 10 years, which have greatly contributed to the value of this company. The company is required to use the acquisition values at the date with which it made the acquisitions. These will include the valuation allowances offered. Besides, the assets and liabilities need to be recorded at their fair values represented during the acquisition date. Established valuation techniques help in arriving at the fair value of assets. For example, Natus Medical Inc. hires experienced firms such as Deloitte to evaluate its intangible assets, real estate, goodwill, and other additional purchase considerations.

The valuation of some components of acquisition such as accounts receivables, identifiable intangible assets, real estate, inventories, and accounts payable, accrued warranty, other accrued expenses and contingent earn outs meant that the some estimates for the future would be provided. And the final estimates are adjusted to the preliminary allocation of prices, and Goodwill is also offset.

Natus Medical Inc ability to determine its liquidity depends on effective management of the cash flow statement. Therefore, the company will have to generate adequate cash flows solely from the operating activities. Such cash flows will be used in meeting the company obligations and commitments. The capital resources available to the company are the funds currently available as well as the potential to increase such funds in the projected future. From the attached excel worksheet; the company’s cash and cash equivalents will be sufficient for the company’s operations in the foreseeable future.

Having completed some significant acquisitions such as Medix and others in recent years, the company capital structure and requirements were altered. Such a point will require evaluation of two options of financing: equity or debt. Companies have to use cash flows to portray their cash status and hence investors can make a choice as whether to invest in such companies or not. That is why Natus Medical prepared the cash flow statement on the ongoing operations. The cash flow statement should include any external investment sources available to the companies as well as the cash outflows used for paying such business activities as the acquisitions should be factored in. The capital structure of the company is quite appealing ($1.3762). This is an attractive feature that could be considered by potential investors before they could commit their monies into the firm. Receivable accounts ($9.104 billion) are less than accounts payable ($ 13.845 billion). This difference shows that, within that financial year, the firm was spending more than it was earning. This is a bad financial trend because investors and potential buyers would not be willing to invest in the company or to acquire it. The medical company should focus on improving its cash flow statements because, currently, it cannot attract investors into the firm. It should be improved by the operations of the organization to in order for the company to earn more money than it spends. See attached spreadsheet on Natus Medical Inc cash flow statement.

Optimal Capital Structure and Adjusted Optimal Capital Structure

The optimal capital structure for Natus Medical Inc. refers to the best debt-to-equity ratio through which the company maximizes its value. Debt negatively characterizes an organization. If a firm has many debts, then it could be difficult to obtain credit facilities from financial organizations and investors. However, a firm that a minimal value of debts has very high chances of benefiting from loans from banks and capital from willing investors. It is the ideal point in which a company operates its ratio of debt and equity so as it minimizes the cost of capital. It is, however, not the ideal optimal capital structure since as it increases, so does the company’s risk. Investment managers should focus on reducing the chances of a company’s incurring losses due to risks. Risks could be wrong choices of investments avenues and uncertain financial trends, among others. Adjusted optimal capital structure is the altered optimal capital structure. This is done by manipulating the figures, for example, of debt and equity, so as to have the right mix that reduces the ratio and increases the company value. It requires analysts to follow the required standards in calculating optimal capital structure and adjusted the optimal structure of a company. If standards are not utilized, then the wrong values would be obtained. Wrong values could result in misperception of a company’s financial attributes. However, correct optimal capital structure figures enhances the reputation of a company with regard to financial reporting to stakeholders.

The capital structure of firms is the debt-to-equity ratio and hence shows the extent of risk a firm is facing. This is useful information for potential investors. Therefore, estimating the optimal and adjusted optimal capital structure is an important component for providing information to investors. There are two methods of determining the optimal and adjusted optimal capital structures:

First, it is using the average or the median structure of capital of companies in the market such as Natus Medical Inc. This is an important approach as it highlights all the companies present in the market and the degree of relationship to the market. The limit is that fluctuations in market prices may lead to an improper representation of debts and equity. This would mean that the actual capital structure will significantly vary from the target capital structure. The second method is applying as much capital as possible due to the fact that there is no risk involved.

The optimal capital structure is achieved through lowering the weighted average cost of capital (WACC). This is because when lowering the WACC, the shareholder’s wealth is maximized. Optimal capital structure varies from one company to another.

It is the duty of the finance managers in companies to determine the right combinations of equity and debt that will yield the maximum wealth. This will help the company and its shareholders in a great deal. Managers will determine which is cheaper between equity and debt so as to minimize the averages of the two. When the optimal capital structure is altered for best values of equity and debt, this is called the adjusted optimal capital structure. The capital structure theory explains this altering as one way of maximizing shareholder’s wealth. The company being analyzed in this paper is in a perfect capital market. See attached excel worksheet for the optimal capital structure.

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