BIWS Valuation Guide Questions and Answers

BIWS Valuation Guide Questions and Answers Why is P/E is the worst multiple (3)? -it includes non cash charges, is impacted by tax rates, and is not capital structure neutral Why don't we use FCF multiples even though they're more accurate than EBITDA or EBIT multiples (2)? -takes more time to calculate (convenience) -may not be standardized because companies include different items in the CFO in the SCF (comparability) Book Value is another word for shareholders' equity Why is P/BV less relevant now? companies are more service and IP oriented than before (not reflected in the BS) Multiple in retail, restaurant, and airlines EV / ebitdar You add back rental expense for comparability since some companies own buildings and others rent them Multiple in oil and gas -ev / ebidax used for comparability purposes because some companies capitalize explorational expense whereas others expense it on their IS -EV / proved reserves -EV / daily production Multiple in real estate (2) -P / FFO (funds from operations) -P / AFFO (adj funds from operations) More accurate than P/E for reits since they add back depreciation (massive non cash charge) and gains / losses Multiple in internet companies (2) -ev / unique users -ev / pageviews What does valuation mean? gives a RANGE of possible values; doesn't tell you how much a company is worth Public comps pros Based on real data, not future assumptions Public comps cons (3) -there may not be true comparables -less accurate for thinly traded stocks or volatile companies -market is emotional precedent transactions pros Based on what companies have ACTUALLY paid for other companies precedent transactions cons (2) -there may not be true comparable transactions -data can be limited, esp. for private co. acquisitions DCF pros (2) -not as subject to market fluctuations -theoretically sound since it's based on ability to generate cash DCF cons (2) -subject to far in the future assumptions -less useful for fast-growing, unpredictable companies liquidation valuation pros and cons Ignores noise in the market but not useful for most healthy companies m&a premiums analysis pros and cons Based on what companies have actually paid but you can't use acquisitions of private companies (no stock prices) future share price analysis pros and cons Tells you what the company might be worth 1-2 years in the future, but bad because of it's dependence on assumptions sum of the parts pros and cons Good because more accurately values diversified companies, but bad because you often lack specific info on each division LBO analysis pros and cons Good because it sets a floor valuation by determine the max amount a PE firm would pay, but bad because it gives a low number rather than a wide range of values Impact on EBITDA of leasing vs owning buildings Leasing buildings has rental expense which lowers EBITDA (higher multiple). Owning buildings has D&A which doesn't affect ebitda (lower multiple) How to value a company with no profit? Revenue multiples or cash flow based multiples, but DCF may be relatively useless unless you can project far into the future How to value a company with no revenue? 1) alternate metrics and multiples like EV / unique visitors EV / pageviews 2) for biotech companies, you will create a far in the future, multi stage DCF (since potential profits from a drug with a known market size are easier to estimate) 3 major valuation metholodogies -relative valuation: precedent transactions and public comparables -intrinsic valuation: dcf How to use public comps and precedent transactions (4 steps) 1) Select companies / transactions based on industry, financials, geography 2) Determine appropriate metrics and multiples 3) Calculate the min, max, median, 25th, and 75th percentile for each valuation multiple 4) Apply for numbers to the financial metrics for the company you're analyzing to estimate the possible valuation range How to calculate multiples for precedent transactions? Based on purchase price of the company at the time of the deal announcement How to value an apple tree? -What other apple trees are selling for or have sold for on the market -Measure the apple tree's cash flows (the revenue generated from apples less the expenses) and calculate the terminal value of the tree (maybe at the end of 10 years, you sell the apple tree for the value of the wood) When is a dcf useful and not useful? Best for companies with stable, mature, and predictable cash flows (boring F500 companies). Worst for companies with unpredictable cash flows (tech startup) or when debt and operating assets and liabilities serve different roles (banks, insurance) Other valuation methdologies other than prec, public comps, and dcf (5) (1) Liquidation valuation (2) LBO analysis (3) Sum of the parts (4) M&A premiums analysis (5) Future share price analysis When is a liquidation valuation useful (3)? -in a bankruptcy, you have to pass the best interests test to prove that creditors receive more than a reorganization than a liquidation -in a bankruptcy, to see whether shareholders receive anything after assets sold and liabilities paid off -with struggling businesses, to see whether it's better to sell off assets separate or sell 100% When would you use a sum of the parts valuation? When a company has different, unrelated divisions. A company like LG. When do you use an LBO as part of your valuation? Obviously for LBO. Also to set a floor on the value and determine the max amount a PE firm could pay to achieve its targeted returns. How do you apply the valuation methodologies to value a company? Present everything in a Football Field graph How to calculate EBIT and EBITDA EBIT = Operating Income. Revenue - COGS - Operating Expenses such as D&A. EBITDA is EBIT + D&A. EBITDA is closer to cash flow since you exclude non cash expenses like D&A. UFCF formula 4 items from EBIT (TINC). ebit (1-tr) - increases in net working capital + non cash charges like depreciation and amortization - capex excludes interest income and expenses, and mandatory debt repayments LFCF formula UFCF - interest expense + interest income - mandatory debt repayments 4 items from Ni (MINC) NI - mandatory debt repayments - increases in net working capital + non cash charges - capex Most common 4 multiples EV / rev EV/ ebitda EV / ebit P/E Correlation between ____ and valuation multiples growth Why can't you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA? Not apples to apples because they don't correspond to the same capital structure. Equity value corresponds to the equity investors whereas EBITDA is available to all investors. Equity value or enterprise value with FCF multiples? Equity value for LFCF Enterprise value for UFCF When to prefer EBIT to EBITDA multiples? in assets that are capital intensive and asset heavy, where capex makes a larger difference Problems with EBITDA and its multiple? Why we still use it? Hides debt principal and interest, capex, working capital requirements Not true to cash flow but used because of convenience and comparability Differences between and uses of EV/EBIT, EV/EBITDA, and PE PE depends on capital structure; used for banks, insurance firms, and other companies where interest is critical and capital structures are similar. EV / ebit includes d&a, so you'd use it in capital intensive and asset heavy, like manufacturing. EV / ebitda excludes d&a, so you'd use it in industries where fixed assets are less important, like internet companies. Could EV / EBITDA ever be higher than EV / EBIT for the same company? No, ebitda is always greater or equal to EBIT, so EV / EBITDA must be less less than or equal to ev / ebit. Rank the 3 main valuation methodologies from highest to lowest expected value. Precedent transactions higher than public comps because of the control premium. DCF is more variable because it's assumption dependent. LBO or DCF higher valuation It depends. LBO generally gives a lower valuation because you don't get value from cash flows of a company between Year 1 and the final year, only get value out of its final year. Also no synergies. When would a Liquidation Valuation produce the highest value? When the market is severely undervaluing it (cyclicality or earnings miss), but the company has substantial hard assets. Why are public comps and precedent transactions sometimes viewed as being more reliable than a DCF? Based on actual market data, not assumptions far into the future. You still make future assumptions though with forward year 1 and 2 multiples though. When would precedent transactions produce a lower value than public comparables? When there's a substantial disconnect between the M&A market and the public markets. Perhaps no public companies have been acquired recently but many private ones have. What might you use a valuation for (3)? 1) Pitch books and client presentations. 2) Parts of other models. 3) Fairness opinions. Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium (6)? 1) surpassed earnings expectations 2) competitive advantages like patents or IP 3) won a lawsuit 4) market leader 5) it's public 6) Warren buffet invested How to account for a company's competitive advantage (3)? 1) 75th percentile multiples 2) add premium to multiples 3) aggressive projections 2 companies have the exact same financial profiles (rev, growth, profits) and are purchased by the same acquirer, why is the EBITDA multiple for one transaction 2x the other (4)? 1) one process had more companies bidding on the target 2) one company had recent bad news like a unfavorable lawsuit 3) different industries 4) different accounting standards Higher ebitda multiple for a company that leased or owned buildings? leased how does a 2 for 1 stock split affect a company's P/E multiple and valuation? No change theoretically, but it might be viewed as a positive sign by the market Walk me through an M&A premiums analysis (4 steps) 1) Select precedent transactions 2) For each transaction, get seller's share price 1, 20, and 60 days before transaction was announced 3) Calculate 1, 20, 60 day premium 4) Get medians for each set and apply to company's current, 20, and 60 days ago price Only for valuing public companies. Walk me through a future share price analysis (3 steps) 1) Get median historical P/E multiple of the public company comps 2) Apply this multiple to your company's 1 and 2 year forward projected EPS to get the implied future share price 3) Discount the share price back to the PV using the cost of equity Walk me through a sum of the parts analysis Value each division using separate comps and transactions and add each division's value together. Always use a range of multiples. How do you value Net Operating Losses and account for them in a valuation? Calculate the NPV of the total future tax savings from the NOLs. For instance, you can assume the company will use its NOLs to completely offset its taxable income until the NOLs run out. You rarely factor them in - if you did, they would be treated like Cash and subtracted from Equity Value to Enterprise Value. What's the purpose of calendarization and how do you use it in a valuation? To standardize other companies' fiscal years to match the company you're valuing. For example, to calendarize a company whose fiscal year ends on June 30 to Dec 31, you add the financials from June 30 to Dec 31 for this year, and subtract the financials from June 30 to Dec 31 from last year. Does calendarization apply to both Public Comps and Precedent Transactions? Mostly to public comps (high chance that fiscal years will end on different dates), but you do effectively calendarize for precedent transactions by looking at the TTM period for each deal. Formula to calendarize financial statements TTM = most recent fiscal year + new partial period - old partial period Calendarize a company in April (Q2) Add Q1 of this year to the most recent fiscal year, subtract Q1 of last year Calendarize a set of public comps with fiscal years ending on March 31 and Dec 31 to June 30 For the March 31 company, add the financials from March 31 to June 30 from this year to the most recent fiscal year, and subtract the financials from March 31 to June from last year. For the Dec 31 company, add the financials from Dec 31 to June 30 to the most recent fiscal year, and subtract the financials from Dec 31 to June 30 for last year. When analyzing income statements of a public comp, should you add back restructuring expenses and an asset disposal back when calculating EBITDA if you see those items on the income statement (2)? 1) Always take these charges from the CFS or Notes to the financial statements (the charges are sometimes partially embedded in other IS line items). 2) Only add them back to create adjusted ebitda if they're truly non-recurring charges. How do non-recurring charges typically affect valuation multiples? They should increase valuation multiples because non-recurring expenses reduce metrics like EBIT, EBITDA, and EPS. We're valuing a company's 30% interest in another company - in other words, an Investment in Equity Interest or Associate Company. We could just multiply 30% by that company's value, but what other adjustments might we make (2)? Apply a liquidity or lack of control discount and assume the stake is worth 20-30% less than the book value. Or you can assume that the investments are sold off, so you apply the company's tax rate and calculate after-tax proceeds, after discounts have been applied. I have a set of public company comparables and need to get the projections from equity research. How do I select which report to use (2)? 1) Pick the report with most detailed information. 2) Pick the report with numbers in the middle of the range. How do find missing information like ebitda for precedent transactions (3)? 1) Search online for press releases 2) Look in equity research for any analysts' estimates of the seller's numbers 3) Look at sources like CapIQ and Factset You're analyzing a set of transactions where the buyers have acquired everything from 20-100% of the other companies - should you use all of them in your valuation? Ideally, you should limit the set to just 100% acquisitions, or at least 50% acquisitions, because the dynamics are different when you acquire a smaller stake. You're analyzing a transaction where the buyer acquired 80% of the seller for $500 million. The seller's revenue was $300 million and its EBITDA was $100 million. It also had $50 million in cash and $100 million in debt. What were the revenue and EBITDA multiples for this deal? Equity value = 500mm/(4/5) = 500mm*5/4 = 625mm Enterprise value = 625 + 100 - 50 = 675mm Enterprise value / Rev = 675 / 300 = 2.25x Enterprise value / ebitda = 675 / 100 = 6.75x How far back and forward do we usually go for public company comparable and precedent transaction multiples? Look at TTM (trailing 12 months) period for both sets, and look forward either 1 or 2 years. You're more likely to look backward more than 1 year and go forward more than 2 years for public company comparables; for precedent transactions it's odd to go forward more than 1 year because the information is more limited. How do you value a private company (4 adjustments)? Same methodologies as with public companies: public comps, precedent transactions, and DCF. 1) Liquidity discount of 10-15% to the public comp multiples 2) Can't use an M&A premiums or future share price analysis 3) Valuation shows enterprise value, not implied per share price 4) DCF is tougher because you don't have market cap or beta - you would estimate the WACC based on public comps' WACC 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 transactions, you're acquiring the entire company, and once it's acquired the share immediately become illiquid. Can you use private companies as part of your valuation? Only with precedent transactions - can't for public comps or as part of Cost of Equity or WACC calculation in a DCF because they have no market cap or beta. Walk me through an IPO valuation for a company that's about to go public (4 steps) 1) Unlike normal valuations, we only select public company comps. 2) Decide the most relevant multiples to use and estimate the company's enterprise value 3) Once we have the enterprise value, we calculate equity value, accounting for IPO proceeds by adding them to equity value 4) Divide the equity value by total # of shares to get its per-share price How do you value banks and financial institutions differently from other companies? For relative valuations, you still use public comps and precedent transactions but the multiples are different: -financial criteria is assets, loans, or deposits rather than revenue or ebitda -you look at metrics like ROE (NI/SE), ROA (NI/Total Assets), and Book Value and Tangible Book value -use multiples like P/E, P/BV, P/TBV rather than EV/EBITDA Rather than a DCF, you use: -Dividend Discount Model: you sum up the present value of a bank's dividends in future years and then add it to the present value of the bank's terminal value, usually basing that on a P / BV or P / TBV multiple. -a Residual Income Model (also known as an Excess Returns Model), you take the bank's current Book Value and simply add the present value of the excess returns to that Book Value to value it. The "excess return" each year is (ROE Book Value) - (Cost of Equity Book Value) - basically by how much the returns exceed your expectations. You need to use these methodologies and multiples because Interest is a critical component of a bank's revenue and because Debt is a "raw material" rather than just a financing source; also, banks' Book Values are usually very close to their Market Caps. What's in a pitchbook? 1. Bank credentials 2. Summary of a company's strategic options 3. Valuation and models 4. Potential acquisition targets / buyers (not applicable for equity/debt deals) 5. Key recommendations / summary