From value investing to modern value · The Value Investing Process Search •Cheap •Ugly...

From value investing to modern value

Tano Santos

David L. and Elsie M. Dodd Professor of Finance

Columbia Business School

Heilbrunn Center for Graham & Dodd Investment

May 2020

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VALUE INVESTING … FOR PEOPLE IN A HURRY

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Risk Management•Margin of safety

•Some diversification•Patience – Default strategy

The Value Investing Process

Search•Cheap•Ugly

•Obscure and otherwise ignored

Valuation•Assets

•Earning Power•Franchise

Review•Key issues

•Collateral evidence•Personal biases

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Value and growth

Asset ValuesAV

Earnings Power ValuesEPV

Franchise ValuesFV>0

Barriers to entry?

yes

no

Franchise ValuesFV≤0

Growth creates value

Growth destroys value

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Risk Management

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Value and growth

Asset ValuesAV

Earnings Power ValuesEPV

Franchise ValuesFV>0

Barriers to entry?

yes

no

Franchise ValuesFV≤0

Growth creates value

Growth destroys value

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Risk Management A bit about this today

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OF SHOCKS AND TRENDS …

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Managing the stock: The many taxonomies of risk

Temporary Permanent

IdiosyncraticManagement

Operational

Industry

Input prices

Technology

Regulation

Import penetration

Aggregate

Recession

Depression

Inflation/deflation

Political

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Nature of risks

On shocks: classification

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Managing the stock: The many taxonomies of risk

Temporary Permanent

IdiosyncraticManagement

Operational

Industry

Input prices

Technology

Regulation

Import penetration

Aggregate

Recession

Depression

Inflation/deflation

Political

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Nature of risks

On shocks: classification

How to think about technology and value? • Disruption and value creation• Example: The payments industry and Adyen

What triggers regulation? • Regulation and value creation• Example: Should we regulate AMZN, FB, …?

What are the effects of import penetration on local industries?

• Import substitution and value creation• Example: The bankruptcy of FBI

What are the effects of a drop in oil prices?• Example: Energy and value traps

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Managing the stock: The many taxonomies of risk

Temporary Permanent

IdiosyncraticManagement

Operational

Industry

Input prices

Technology

Regulation

Import penetration

Aggregate

Recession

Depression

Inflation/deflation

Political

COVID-19

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Nature of risks

On shocks: classification

�

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Adverse shocks: Is the shock permanent?

Yes No

Short term impairment• Cycles in demand• Temp. disruptions

in the supply chain• Temp. disruptions

in operations• Management turnover• Lawsuits …

Do they eliminate barriers to entry?

Yes No

Permanent impairments • Patent expiration • Technological / process innovations• International trade openness• Expropriation …

Limits to profitability• Regulation• Bounds on practices

• Bundling, pricing …

MARGIN OF SAFETY

HORIZONREINVESTMENT

Are there barriers to entry?

Yes

No

Are the shocks industry-wide?

Yes

Survival

No

Exit

Is the firm highly levered?

No Yes

Exit

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On shocks: risk management

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On shocks: What do disruptions (permanent shocks) do?

1. They kill a particular economic activity

Example: Technology – Horse carriage and the car

Example: Regulation – The jitney craze of of 1914 – 1918

2. They transform how a particular economic activity either supplied or consumed

Example: e-retailing,

Example: The payments industry

3. They unbundle how particular economic activities are either supplied or consumed

Example: advertising and news

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On trends: What do trends do?

● Trends refer to the widespread adoption of practices, behaviors and institutions that are already operational in another:

– Country

– Sector

– Demographic groups

● It is the process of diffusion rather than of disruption

– It is predictable and dominated by the trend rather than by the fluctuations around the trend

● It is irreversible, though it can be overtaken by another trend

● Companies benefit from that trend if, and only if, their business operations are protected by barriers to entry.

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SHOCKS

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Customer

Merchant

Product

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The evolution of the payments system

Product

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Customer

Merchant

“Cash”gold

Product

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The evolution of the payments system

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Customer

Merchant

Cashcoin

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The evolution of the payments system

Royal Mint

The KingProduct

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Customer

Merchant

Product

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The evolution of the payments system

Royal Mint

CoinProduct

CoinGold

The KingCapital

Revenue?

Coin (taxes)

Services

Services

Coin (taxes)

Cashcoin

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Customer

Merchant

Product

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The evolution of the payments system

Royal Mint

CoinProduct

+seignorage

Coin

Gold –

inflation tax

The KingCapital

Revenue!

Coin (taxes)

Services

Services

Coin (taxes)

Cashcoin

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Customer

Merchant

ProductCheck

Customerbank

Check

Cash – t/2

Check

Cash + t/2

Merchantbank

Clearing

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Check

Cash

Cash

Check

The evolution of the payments system

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Customer

Merchant

Presents Card

Customer/issuing bank

Authorizationrequest

Merchantbank

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The evolution of the payments system

Credit card

Authorizationrequest

Authorizationrequest

Product

Credit card: An open systemStep 1: Authorization

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Customer

Merchant

Presents Card

Customer/issuing bank

Authorizationrequest

Merchantbank

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The evolution of the payments system

Credit card

Authorizationrequest

Authorizationrequest

yes

yes

yes

Product

Credit card: An open systemStep 2: Authentication

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Customer

Merchant

Presents Card

Customer/issuing bank

Merchantbank

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The evolution of the payments system

Credit card

Payment – Interchange fee

Product

Credit card: An open systemStep 3.a: Clearing & settlement: 24 – 48 hrs

Payment – Interchange fee –– Assessment & processing fee

Debit

Payment – Interchange fee –– Assessment & processing fee –

– Merchant Discount Rate

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Customer

Merchant

Customer/issuing bank

Merchantbank

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The evolution of the payments system

Credit card

Payment (+ interest)

Credit card: An open systemStep 3.b: Clearing & settlement: end of the month

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Customer

Merchant

Customer/issuing bank

Merchantbank

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The evolution of the payments system

Credit card

Credit risk

Credit card: An open systemWhere is the risk?

Fraud, CNP risk

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Customer

Merchant

Presents Card

Customer/issuing bank

Merchantbank

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The evolution of the payments system

Credit cardProduct

Credit card: An open systemIndustrial Organization – 1

MastercardVisa

CitiChase

Bank of America …

Citi Merchant Serv.Chase Paymentech

BofA Merchant Serv.Wells Fargo Merchant Serv.

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Customer

Merchant

Presents Card

Customer/issuing bank

Merchantbank

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The evolution of the payments system

Credit cardProduct

Credit card: An open systemIndustrial Organization – 2

Non-merchant bank acquirersIndependent Sales Org. (ISOs)

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Customer

Merchant

Presents Card

Customer/issuing bank

Merchantbank

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The evolution of the payments system

Credit cardProduct

Credit card: An open systemIndustrial Organization – 3

Citi Merchant Serv.Chase Paymentech

BofA Merchant Serv.Wells Fargo Merchant Serv.

MastercardVisa

CitiChase

Bank of America …

Fiserv (First Data)FIS (Worldpay)

Global Payments (TSYS, Heartland)

Non-merchant bank acquirersIndependent Sales Org. (ISOs)

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Customers

M1

Customer/issuing bank

Merchantbank

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The evolution of the payments system

Credit card

Credit card: An open systemIndustrial Organization – 4

Non-merchant bank acquirersIndependent Sales Org. (ISOs)

M2 Mn…

POS Infrstr.Payment

Aggregators

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Customers

M1

Customer/issuing bank

Merchantbank

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The evolution of the payments system

Credit card

Credit card: An open systemIndustrial Organization – 5

Non-merchant bank acquirersIndependent Sales Org. (ISOs)

M2 Mn…

SquareStripePaypalAdyen

MastercardVisa

Citi Merchant Serv.Chase Paymentech

BofA Merchant Serv.Wells Fargo Merchant Serv.

Fiserv (First Data)FIS (Worldpay)

Global Payments (TSYS, Heartland)

CitiChase

Bank of America …

POS Infrstr.Payment

Aggregators

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Customers

M1

Customer/issuing bank

Merchantbank

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The evolution of the payments system

Credit card

Credit card: An open systemIndustrial Organization – 5

Non-merchant bank acquirersIndependent Sales Org. (ISOs)

M2 Mn…

SquareStripePaypalAdyen

MastercardVisa

Citi Merchant Serv.Chase Paymentech

BofA Merchant Serv.Wells Fargo Merchant Serv.

Fiserv (First Data)FIS (Worldpay)

Global Payments (TSYS, Heartland)

CitiChase

Bank of America …

POS Infrstr.Payment

Aggregators

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Customers

M1

Customer/issuing bank

Merchantbank

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The evolution of the payments system

Credit card

Credit card: An open systemIndustrial Organization – 6

Non-merchant bank acquirersIndependent Sales Org. (ISOs)

M2 Mn…

MastercardVisa

Chase PaymentechSquarePOS Infrstr.Payment

Aggregators

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Merchant Gateway Risk management Processing

Acquiring bankCredit cardIssuing bankAuthorization

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Where is Adyen in the payment process

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TRENDS

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Trends: Taxonomy

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Trends

The consumer The firm Governance & Institutions• Wealth accumulation• Demographic changes• Behavioral changes• Technology adoption

• Business process adoption• Automatization• Direct to consumer• Standardization• HR practices• Compliance

• Regulation• Market adoption• Political trends

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Trends: The death of the movie theater

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$10.00

$10.50

$11.00

$11.50

$12.00

$12.50

$13.00

$13.50

$14.00

$14.50

$15.00

1,000

1,100

1,200

1,300

1,400

1,500

1,600

1,700

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Tickets Sold (in millions; left) Box Office (adjusted for inflation; in billions; right)

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US: Tickets sold (in millions) and Box office receipts (in billions). 1995 – 2019 Source: The Numbers

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Trends: The death of the movie theater

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0

5

10

15

20

25

30

35

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Walt Disney 20th Century Fox Paramount Pictures Sony Pictures Universal

US: Major releases by big studios. 1995 – 2019 Source: The numbers

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Travel agencies: Stock Prices: This year

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0

2

4

6

8

10

12

1/2/20 2/2/20 3/2/20 4/2/20

TUI AG: Stock price (€)

1000

1200

1400

1600

1800

2000

2200

1/2/20 2/2/20 3/2/20 4/2/20

Bookings: Stock price ($)

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TUI AG: Stock price (£): 03/17/2006 – 04/21/2020

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0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

03/17/06 03/17/07 03/17/08 03/17/09 03/17/10 03/17/11 03/17/12 03/17/13 03/17/14 03/17/15 03/17/16 03/17/17 03/17/18 03/17/19 03/17/20

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TUI AG

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-800

-600

-400

-200

0

200

400

600

800

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20002001200220032004200520062007200820092010201120122013201420152016201720182019

Revenues (left) EBIT (Operating Income; right)

TUI AGRevenues and operating income (mns. of £)

2000 – 2019

0.0

5.0

10.0

15.0

20.0

25.0

200620072008200920102011201220132014201520162017201820192020 (A

pril)

EBIT: Guidance (€

622) divided by 5EBIT:FY

2019 EBIT

TUI EV/EBIT2006 – 2019

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Is it growing?

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-6

-4

-2

0

2

4

6

8

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Rate of growth of international arrivals. Source: UNWTO

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1.5bn visitors

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The “Travel” business: A bird’s eye view

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The “Travel” Business

Tourism

Mass AdventureWildlife

Cultural Religious

Corporate travel

Households Firms

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The “Travel” business: Exposure to Coronavirus

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The “Travel” Business

Tourism

Mass AdventureWildlife

Cultural Religious

Corporate travel

Households Firms

Short

Long

High High High High High

HighLow Low Low Low

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The “Travel” business: Main economic determinant

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The “Travel” Business

Tourism

Mass AdventureWildlife Cultural Religious

Corporate travel

Economies of scale

Limited supply

Safari Venice Middle EastSpain

Industry Retreats Conferences

World Mobile Congress

AEA/AFA

Firms’ balance sheet

You know …

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Tourism: Is this a good country for tourism?

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Tourism: Is this a good country for tourism?

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Tourism: Is this a good country for tourism?

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Tourism: The value chain

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Tourist

Travel Agencies

Transportation

Hotels & Accommodations

Transportation

Amenities & services

Expedia (Travelocity, Worldwide Travel, Orbitz, …)Bookings (priceline, agoda, …), BCD , Amex, CWTTUI Group, Trip.com, Google Travel, …

American, Delta, United, Air France/KLM, Ryanair,Tui Airlines, IAG, China Eastern, China Southern, ...

Wyndham, Marriott, Hilton, Best Western, Accor, JinJiang, Hyatt, InterContinental, Airbnb, …

Local arilines (Vueling,Wow, Ryanair, Norwegian, …)Car rental (Hertz, Avis, …)Trains, public transportation, …

Insu

ranc

e, a

dver

tisin

g, …

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Tourism: The value chain

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Tourist

Travel Agencies

Transportation

Hotels & Accommodations

Transportation

Amenities & services

Insu

ranc

e, a

dver

tisin

g, …

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Barriers to entry: Sources of customer captivity

High: Network externalities

Low: Rewards programs

Traditional: Low: Rewards programsAirbnb: High: Network externalities

Low: Rewards programs

High: inelastic supply

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Tourism: OTAs

● How do you book a hotel in Rome?

1. OTA

• Bookings, Expedia

2. Metasearch/aggregator

• Trivago, TripAdvisor

3. Alternative

• Airbnb

4. Direct booking

• Le Meridien Visconti

5. Search engine

• Google

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Tourism: OTAs

● OTAs: Business models

1) Merchant model

• OTA buys blocks of rooms at a discount and resells them for a profit

• Customers pay the OTA in time of booking and the OTA pays the hotel at checkout.

• 20-30% fee

• Example: Expedia

2) Agency model

• Middleman and no payment upfront

• 10-15% fee at checkout from hotel

• Small versus large hotels (think Europe)

• Example: Bookings

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Tourism: OTA

● OTAs match customers with hotels

– The logic of platform economics

– Example: Mastercard or Visa

● Problem

– Most travelers start their trip by searching locations, amenities and hotels in … Google.

– Would Google steal the business away?

• How much does the travel industry pay Google in marketing expenses? $14bn

• Value of travel industry payments to Google (annuity) at 10% with 5% growth: $280bn

– Cost of reproducing the network?

• Operating margins of a network at work next

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OTAs: Bookings: Operating margins

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-10

-5

0

5

10

15

20

25

30

35

40

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Bookings: Operating margins. 2000 – 2019 Source: Annual Reports

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OTAs: Bookings: Revenue and operating income growth

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0

10

20

30

40

50

60

70

80

90

100

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Sales Operating income

Bookings: Revenue and Op. Income growth (MA4) . 2008 – 2019 Source: Annual Reports

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OTAs: Bookings: EPV

item FY2019

Revenues 15,066.0Operating Margin 35.5

Op. Income 5,345.0Adjustments

Performance marketing 4,419.0

Brand Marketing 548.0Adj. Op. Income 5,893.0

Tax Rate (%) 22.8NOPAT 4547.1

Discount rate (%) 10.0EPV Op. Buss. 45,470.8

Cash 7,330.0Debt 9,251.0

EPV Equity 43,549.8Market cap

(05-11-2020)56,730.0

Market cap(03-23-2020)

47,303.2

54

0.0

10.0

20.0

30.0

40.0

50.0

60.0

200220032004200520062007200820092010201120122013201420152016201720182019

Bookings: EV/ebit

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