M&I 400 Valuation Basic Questions and Answers

M&I 400 Valuation Basic Questions and Answers Rank the 3 valuation methodologies from highest to lowest expected value. Precedent Transaction will usually produce a higher valuation than Comps because of the Control Premium associated with acquisitions. DCF has most variable value(usually the highest, but dependent on assumptions) When would you not use a DCF in a Valuation? A DCF should not be used for companies with unsteady/unstable cash flow(like tech or bio-tech firms) or when debt and working capital have different roles than normal firms. What is an example of firms that should be not use a DCF in Valuation? Tech/bio-tech firms (because of cash position) or banks because they do not reinvest debt and working capital is much more important for them(much have high liquidity) Liquidation Valuation Valuing a company's assets, assuming they are sold off and then subtracting liabilities to determine how much capital equity investors receive Replacement Value Valuing a company based on the cost of replacing its assets LBO Analysis Determining how much a PE firm could pay to hit a "target" IRR(20-25%) Sum of the Parts Analysis Valuing each division of a company separately and adding them together at the end M&A Premiums Analysis Using M&A premiums to value a company Future Share Price Analysis Projecting share price growth using P/E comps and discounting to present When would you use a Liquidation Valuation? Bankruptcy scenarios(used to see whether equity shareholders will receive capital after debt payoff). Helps companies decide whether you should sell assets separately or sell company When would you use Sum of the Parts? Used when a company have unrelated divisions(ex. GE). Cannot do comps for companies that have a diversified product stream. When do you use an LBO Analysis as part of your Valuation? A Leveraged Buyout or how to establish a value for PE to buy the company What are the most common multiples used in Valuation? EV/Revenue, EV/EBIT(DA), P/E, P/BV Tech Specific Multiples EV/page views or EV/Unique Visitors Retail/Airlines Specific Multiples EV/EBITDAR Energy Specific Multiples Energy: P/MCFE or P/MCFE/D (MCFE = 1 Million Cubic Foot Equivalent, MCFE/D = MCFE per Day) Real Estate Investment Trust Specific Multiples Price/FFO, Price/AFFO(Funds From Operations, Adjusted Funds From Operations since FFO adds back depreciation and subtracts gains from sale of property to normalize cash flow) Why do you use Enterprise Value for industry-specific multiples Industry-specific calculations must be connected to who has "access" to the asset(Unique visitors aren't just for equity holders) Would an LBO or DCF give a higher valuation? Usually an LBO will give you a lower valuation because you do not get any value from cash flows of a company between Year 1 and the final year(you're only valuing it based on terminal value) while DCF values all cash flows How would you present these Valuation methodologies to a company or its investors? You show a football field showing the valuation range implied by each method How would you value an apple tree? By looking at what comparable apple trees are worth(relative valuation) or looking at the apple flows from the trees(intrinsic valuation) Why can't you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA? EBITDA is available to all investors in the business. Enterprise Value/Net Income would not work because Net Income is only available to equity holders(since we have paid interest expense so debt-holders are not counted) When would a Liquidation Valuation produce the highest value? If a company has substantial hard assets and the market is undervaluing them for a specific reason(like missed earnings). In this case, Comps and Precedent Transaction will produce depressed values. Let's go back to 2004 and look at Facebook back when it had no profit and no revenue. How would you value it? You could use Comps/Precedent Analysis with unique multiples like EV/Unique Users and EV/Viewers rather than EV/Revenue What would you use in conjunction with Free Cash Flow multiples - Equity Value or Enterprise Value? For Unlevered Free Cash Flow, you would use EV(since this excludes Interest payments, so all investors have claim to those). Levered Free Cash Flow multiples would use Equity Value(since Interest payments were made so equity investors only have claim) You never use Equity Value / EBITDA, but are there any cases where you might use Equity Value / Revenue? A large financial institution with big cash balances could have a negative EV, so you would use Equity Value for multiples. You could also use this to compare financial and non-financial institutions How do you select Comparable Companies? 3 Ways: 1. Industry classification 2. Financial profile(revenues, 3. Geography How do you select Precedent Transactions? Only look at data from the past two years How do you apply the 3 valuation methodologies to actually get a value for the company you're looking at? Find a median multiple of a set of companies/transactions, and apply the relevant financial statistic to find implied value(ex: median EBITDA multiple * company's EBITDA) What do you actually use a valuation for? Used in pitch books/client presentations when explaining a company's valuation. Also used during a Fairness Opinion (a document used by a bank to prove the value of a purchase/sale is fair) Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium? Earnings beat, competitive advantage(intellectual property), lawsuit win, market share leader What are the flaws with public company comparables? No companies are identical, share prices for small companies may not reflect full value, market volatility might skew results How do you take into account a company's competitive advantage in a valuation? Rather than use the median of a comparables universe, you could use the top quartile multiples, add a premium, or use more aggressive projections Do you ALWAYS use the median multiple of a set of public company comparables or precedent transactions? Usually, but depending on a company's position within a market You mentioned that Precedent Transactions usually produce a higher value than Comparable Companies - can you think of a situation where this is not the case? If a comparable transactions have occurred at very low valuations and there is been sparse activity in the market What are some flaws with precedent transactions? No transactions are 100% identical(market factors, size of the company) and data is hard to find on smaller companies Two companies have the exact same financial profile and are bought by the same acquirer, but the EBITDA multiple for one transaction is twice the multiple of the other transaction - how could this happen 3 possibilities: 1. Heightened competition for acquisition 2. Bad news depressing stock price 3. Different industries with different median multiples Why does Warren Buffett prefer EBIT multiples to EBITDA multiples? Warren Buffet prefers EBIT multiples because capital expenditures are a core part of a business and should be included in valuation The EV / EBIT, EV / EBITDA, and P / E multiples all measure a company's profitability. What's the difference between them, and when do you use each one? P/E is dependent capital structure(debt vs equity financing) and is used for financial institutions and businesses where interest payments / expenses are crucial. EV/EBITDA excludes Depreciation and Amortization so it is used for companies with small D&A (like real estate or retail) EV/EBIT includes D&A and uses companies with large D&A If you were buying a vending machine business, would you pay a higher multiple for a business where you owned the machines and they depreciated normally, or one in which you leased the machines? The cost of depreciation and lease are the same dollar amounts and everything else is held constant. Higher multiple for the company with the leases. The company who owned the factories would have a higher EBITDA, meaning EV/EBITDA would be lower(lease expenses are in SG&A) How do you value a private company? Same methodology(DCF, precedent, comps) with a few differences: 1. You might apply a 10-15% (or more) discount to the public company comparable multiples because the private company you're valuing is not as "liquid" as the public comps. 2. You can't use a premiums analysis or future share price analysis because a private company doesn't have a share price. 3. Your valuation shows the Enterprise Value for the company as opposed to the implied per-share price as with public companies. 4. A DCF gets tricky because a private company doesn't have a market capitalization or Beta - you would probably just estimate WACC based on the public comps' WACC rather than trying to calculate it. Let's say we're valuing a private company. Why might we discount the public company comparable multiples but not the precedent transaction multiples? With precedent transaction, an entire company is acquired, meaning all shares become illiquid. However, shares are either liquid or illiquid; liquidity creates a market premium, meaning you should discount comps.