Arcadian

Arcadian Analysis

Andrey Dyblenko

Andrew Klaasen

Jeremy Hutton

Introduction

In August 2005, the owners of Arcadian proposed to sell a 60% equity interest in their business to a private equity firm called Sierra Capital for $40 million. Arcadian provided a highly promising high risk investment for Sierra and Arcadian would look to use this money to finance the firm’s growth. Rodney Chu was assigned the job of negotiating a specific price and terms for the Arcadian investment for Sierra Capital.

Arcadian Microarray Technologies is headquartered in Arcadia, California and operates in the Gene Diagnostics industry. Arcadians management had optimistic beliefs for its operations and projected firm revenues to top $1billion by 2013. However Rodney Chu, from Sierra Capital was less optimistic. Some analysis from the market supported Mr Chu view. Analysts were now cautious about the gene diagnostic industry as their market was being flooded by entrepreneurial research scientists. Also FDA approval was uncertain at best and this was key for Arcadian getting its products into the market.

Importance of Terminal Value

The final steps in Chu’s analysis were to estimate a terminal value for Arcadian. In order to evaluate the market price of a firm, one of the methods involves discounting future dividends at the cost of equity (dividend discount model). After discounting projected 5 year dividends for 19 randomly picked firms it was established that resulting prices were considerably lower than actual market prices for that time. The average percentage of market price not attributable to dividends of these 19 firms equated to 93%. This discrepancy is largely due to the terminal value, which is the lump-sum of cash flow at the end of a stream of forecasted cash flows. Thus, terminal value proves to be a huge value driver.

The unexplained part of the share price could also be due to option values that are not readily captured in a discounted cash flow valuation. A...