Lithium Battery Producer
NuCell is a German company producing lithium battery power units for use in electric cars made by domestic auto manufacturers.
The company has been profitable for the past few years. However, the owner of NuCell has become aware of an innovative new technology which will be entering the market within the next 18 months. This new technology promises to make equivalent power units, but storing energy as capacitors rather than lithium batteries. Such capacitor power units will offer similar or better performance for a lower production cost, due to using much cheaper raw materials.
NuCell’s owner wants to know how to respond to the advent of this new technology. He is considering investing to refit NuCell’s factory to produce the new capacitor units, but is also concerned that the best course of action might simply be to sell NuCell.
This case is in a McKinsey-style interviewer-led format. As such, the interviewer should actively lead the candidate through the case, sharing new information and providing guidance as appropriate.
Which options are available to NuCell’s owner?
The candidate should consider which options are open to NuCell’s owner
- Do nothing – simply continue the business as-is
- Keep operating and invest to re-fit the factory for capacitor technology
- Sell the company
- Close the company and sell its assets
The candidate should then set out a structured plan to decide upon which course of action to pursue. A key first step will be understanding NuCell's current position in the market.
Analysing the market and calculating the current value of NuCell
The candidate should begin by seeking information on NuCell’s competitors and the state of the market in general.
Having grown rapidly in recent years, we now expect the market for electric car batteries to be stable in the near-term.
NuCell has a 10% share of the market.
NuCell’s production is highly automated, so that labour costs are relatively low. Material costs are very high, as lithium is an expensive raw material.
The market is highly commodified, such that NuCell's cost structure and gross margin is closely representative of the market as a whole.
We can calculate the total size of the market (and thus the size of NuCell’s share) in several different ways.
Using the data from Exhibits 1 and 2, the candidate can calculate the size of the German electric car battery market in terms of number of battery units sold per year.
Number of electric cars = 1/6 of national car sales = 1/6 of 6m
Number of electric cars = 1m electric cars per year
Number of batteries = 4 per electric car = 4 million
NuCell supplies 10% of these batteries.
Number of units sold by NuCell = number sold in market/market share = 4m/10
Number of units sold by NuCell = 400,000 battery units
Contribution margin = (battery price – battery cost) x number of batteries sold = (210 – 200) x 400,000
Contribution margin = €4m
Profit = contribution margin – fixed costs = 4m – 2m
Profit = 2m
Net Present Value
On the assumption of a stable market for the foreseeable future, we can calculate the Net Present Value (NPV) of NuCell as follows:
They should also make a reasonable assumption as the discount rate. Here, we assume 10%.
NPV = Cashflow/Discount Rate = 2m/0.1
NPV = €20m
NuCell, as a functioning business, is worth €20m if the owner decides to sell.
What is the value of NuCell’s assets?
The candidate should note that the value of the company’s assets might be different and possibly higher than its value as a going concern.
The candidate should ask structured questions to gather relevant information.
The company’s assets are predominantly made up of its equipment, factory premises and the land this sits on. That, is machinery and real estate. NuCell does not own any intellectual property relating to the batteries it manufactures.
NuCell’s machinery should raise €10m if sold.
NuCell bought and set up in its current factory a decade ago. Since then, property prices in the region have changed significantly.
There are multiple ways to calculate the value of NuCell’s real estate.
Ways which we might calculate the value of NuCell’s land and premises are as follows:
- Find the sale price of comparable real estate
- Find the rental rates for comparable real estate and calculate the present value via discounting this cash flow.
- Find the appreciation rate of similar real estate in the same area and use this to calculate the property’s current value from its initial purchase value and value of any improvements.
Based on this data, the candidate can calculate the value of NuCell’s real estate as follows:
Initial purchase value of NuCell real estate = €2m
Value of improvements made upon purchase = €1m
Appreciation rate = 5% per annum
Therefore, current value of real estate = 3 x 1.0510 = €4.89
The value of NuCell’s machinery should then be added to establish the total value of NuCell’s assets.
Value of NuCell's assets = 10m + 4.89m = €14.89m
If NuCell were wound up and its assets sold off, this would raise €14.89m
Key Takeaway from Valuing NuCell Generally
The value of the cashflow generated by NuCell is lower than the value of the company’s assets. This suggests that the owner should attempt to keep NuCell running. If he does decide to sell up, he should aim to sell the company as a going concern rather than winding it up and then selling the assets.
What would NuCell be worth if it invested to transition to capacitor technology?
The candidate should ask structured questions to gather salient information.
The rights to manufacture the new capacitor power units and the specialist equipment required to do so are sold exclusively by the British technology firm CapTech which developed and patented the idea.
The total amount invested for rights and equipment from CapTech to transition the factory to producing capacitor power units is estimated at €5m.
All of NuCell’s costs will stay around the same values after this transition, except for material costs, which will be reduced by 85%.
CapTech will not sell exclusively to any one battery producer and will be happy to deal with any and all of NuCell’s competitors across the German electric car battery market.
NuCell will not gain any additional brand recognition or similar from adopting the new technology, as it is assumed that multiple players in the market will also make the transition to capacitor technology around the same time.
Since all players in the current electric car battery market can access the new capacitor technology, we can assume that the overall cost structure of the industry will be diminished.
We can thus expect prices to fall as firms seek to maintain or gain market share.
The gross margin will be maintained at its current level, since the overall structure of the industry has not changed.
The existing gross margin, given cost of €200 and sale price of €210 is 5%
Existing material cost per battery unit:
200 x 0.9 = €180
Labour cost per unit = 200 – 180 = €20
Labour cost per unit = €20
New material cost per capacitor unit = old cost – 85%
New material cost per capacitor unit = 15% of old cost = 180 x 0.15
New material cost per capacitor unit = €27
New unit cost = labour + materials = 20 + 27
New unit cost = €47
New sale price = new unit cost + margin
New sale price = 47 + (5% of 47)
New sale price = €49.35
New contribution margin = (Unit sale price – unit cost) x number sold
New contribution margin = 2.35 x 400,000
New contribution margin = €940,000
New profit = new contribution margin – fixed costs
New profit = 940k – 2m
New profit = -€60,000
Therefore, the company now loses €60,000 per annum
The client should sell NuCell as soon as possible.
The advent of CapTech’s capacitor technology will make NuCell unprofitable, even without considering the costs of re-fitting their factory.
The business should be sold as a going concern, as this will yield a higher value than selling off the assets.
The only alternative would be to increase sales by gaining market share. This could allow for sufficient revenues to cover fixed costs. However, this would be difficult given that the power unit market both before and after the transition will be highly commodified and cutting prices to pursue a cost advantage would only exacerbate NuCell’s problems.