Valuation Advanced Questions and Answers

Valuation Advanced Questions and Answers 1. Which of the following steps might you go through when valuing Net Operating Losses (NOLs) and counting them as a cash-like item in a valuation? a. Calculate the Net Present Value of future tax savings from these NOLs b. Adjust the Deferred Tax Asset on the company's Balance Sheet up or down by 10-20% and use that to approximate the value of the NOLs c. Assume that the NOLs can be used to completely offset taxable income until they run out d. Use Section 382 and multiply the adjustable long-term tax rate by the equity purchase price to determine the maximum allowable NOL usage per year Explanation: You might use A, C, or D as part of the process when valuing NOLs. You should always assume that only a portion of the NOLs can be used each year, so D is correct; C is also correct because you generally keep using NOLs to offset taxable income until they are completely used up. A is also correct because you want to capture the NPV of these future tax savings - that's what NOLs would really be worth to an acquirer, which is what we care about when calculating Enterprise Value. 2. A conglomerate has 3 divisions: 1) A traditional manufacturing unit with EBITDA of $100M; 2) An entertainment division with EBITDA of $200M; and 3) A consumer goods division with EBITDA of $50M. You have gathered public comps for each division, and the median values are an EBITDA multiple of 2.0x for manufacturing, an EBITDA multiple of 5.0x for entertainment, and an EBITDA multiple of 4.0x for consumer goods. Assume that the conglomerate (ACME Co.) has a total of $150M in long-term debt, $250M of cash, and a total diluted share count of 100 million. Using a Sum-of- the-Parts analysis, what is the implied per share value for ACME Co.? a. $13.50 per share b. $16.00 per share c. $13.00 per share d. $15.00 per share Explanation: For a Sum-of-the-Parts analysis, we simply take the financial metric (in this case EBITDA) for each of its 3 separate divisions, and multiply by the appropriate median EV/EBITDA multiple to get us to Enterprise Value for each of its 3 divisions. So in this case, $100M 2x + $200M 5x + $50M * 4x = $1.4B. Then, we take that value and subtract the long-term debt of $150M and add the cash of $250M to calculate Equity Value since we're working backwards. $1.4B - $150M + $250M = $1.5B. $1.5B / 100 million shares = $15.00 per share. 3. Which of the following steps do you go through when completing a Future Share Price Analysis for a company? a. Find the median P / E (or other) multiple for the Public Comps over the Trailing Twelve Months (TTM). b. Find the median P / E (or other) multiple for the Public Comps over the next year or the year after the next year. c. Apply the multiple you're using to the company's relevant TTM metric. d. Apply the multiple you're using to the company's relevant 1-year forward or 2-year forward metric. e. Discount the implied share price back to its present value using the appropriate discount rate. Explanation: This is a tricky question designed to test whether or not you really understand the analysis. The idea here is to say, "Let's see what the comps have been trading at, and then apply those multiples to the company's expected future performance... and discount back the implied share price." That is why we take the TTM numbers for the comps, but we still apply them to the company's 1-year forward or 2-year forward metrics. B and C are incorrect because they flip the order of the analysis. 4. Which of the following represent DIFFERENCES in an M&A Premiums Analysis compared to a Precedent Transactions analysis? a. All the sellers in the M&A Premiums Analysis must be public companies. b. You often apply a liquidity discount to the implied premiums in an M&A Premiums Analysis, but you do not do this in a Precedent Transactions Analysis. c. Usually you use broader screening criteria for M&A Premiums, and include a greater number of transactions, if possible. d. The screening criteria are different and you almost always use a shorter timeframe for the M&A Premiums. e. The data in an M&A Premiums Analysis is less reliable because there's often a run-up in companies' share prices just prior to acquisition. Explanation: The only differences are that all sellers in an M&A Premiums Analysis must be public because you're looking at share prices, and that the screening criteria tend to be broader because you often use more companies. Other than that, the selection criteria (industry, geography, financial metrics, and time period) tend to be similar. B is false because liquidity / illiquidity discounts are only relevant for private companies or lack-of-control situations. D is false because, if anything, you will use a longer timeframe for the M&A Premiums. While E can be true, it's not really a "difference" because the same thing happens with Precedent Transactions - and if it really is a problem, you can use longer-term numbers such as the premium to the 180-day or 90-day price rather than 1-day and 20-day premiums. 1. Which of the following do you need when calculating the "Trailing Twelve Months" for metrics such as revenue and EBITDA in a Public Comps Analysis? a. Most Recent Fiscal Year b. Old Partial Period c. New Partial Period d. None of the above - the TTM number is always listed in companies' filings. Explanation: A, B, and C are correct. The official formula is TTM = Most Recent Fiscal Yr. + New Partial Period - Old Partial Period. So if the most recent fiscal year was January 1 - December 31 and we're valuing the company on June 30, the partial period would be January 1 - June 30 of this year, the old partial period would be January 1 - June 30 of LAST year, and the most recent fiscal year would be January 1 - December 31 of LAST year. So TTM here would be June 30 of last year through June 30 of this year. D is incorrect because TTM numbers are never listed in filings - that's why you have to go through the work of calculating them in the first place! 2. The company you are valuing has a Fiscal Year End (FYE) of June 30th and the Public Comp you're analyzing has a FYE of March 31st. Which of the following would you need to do in order to 'calendarize' the financials? a. Leave the Public Comp's FYE set to March 31th b. Change the Public Comp's FYE to June 30th c. Calculate March 31st Previous Year to March 31st Current Year + March 31st to June 30th Current Year - March 31st to June 30th Previous Year for the Public Comp. d. Since March 31st and June 30th are fairly close, only 3 months apart, you don't need to do anything here - it's a trick question. e. Change the FYE of the company you're analyzing to March 31st instead to make it match up. Explanation: A and D are both false because March 31st and June 30th are not "close" - if the FYEs ended within a month of each other, we might leave them as is, but 3 months is too much time to leave as is. E is also incorrect because you almost always adjust the public comps to match the FYE of the company you're analyzing. B and C are correct and describe the process of adjusting the fiscal years for the public comps - take the most recent fiscal year, add the March 31st - June 30th period from this year, and subtract that same period from the previous year. 3. You are calculating EBITDA over the most recent TTM period for a Public Comp by starting with Operating Income (EBIT) and adding back various items on the financial statements. Which of the following charges SHOULD you add back when calculating EBITDA in this analysis? a. The Depreciation number that appears on the Income Statement b. The Depreciation number that appears on the Cash Flow Statement c. The Amortization number (it's the same on both the IS and CFS) d. A Restructuring Charge that appears as an Operating Expense and which has been on the Income Statement for the previous 4 years e. A Goodwill Impairment charge that appears as an Operating Expense and has not shown up in any prior years f. Net Interest Expense Explanation: A is incorrect because you always want to use the versions of these items on the Cash Flow Statements since they're "all-inclusive." The portion shown on the Income Statement may only reflect part of the true expense. B and C are therefore correct, while A is incorrect. D is incorrect because something that has recurred for years and years is not a true "non-recurring expense," especially if it's a real cash expense. E is correct because Goodwill Impairment is non-cash and is clearly a one-time item here. F is incorrect because we're starting with EBIT, which excludes Interest Income and Interest Expense to begin with. Adding it back here would effectively be double-counting it and artificially boosting EBITDA. 4. Which of the following criteria should an expense meet before you add it back when calculating EBITDA? a. It should impact Operating Income (EBIT), as opposed to appearing "below the line." b. It must always be a cash expense. c. It must always be a non-cash expense. d. It must be a non-recurring item that only shows up once and doesn't recur from year to year. e. It must be a recurring item that impacts the company's financials on an ongoing basis. Explanation: This is a trick question, because the only real "requirement" here is that the expense must impact EBIT in some way (answer choice A). There are no hard-and-fast rules other than that and there is a lot of subjectivity with adding back charges when calculating EBITDA. Non-cash charges such as D&A are common to add back, but you sometimes see non-recurring cash expenses (e.g. legal fees) added back as well. An expense doesn't have to necessarily be recurring or non-recurring, or cash or non-cash, to be added back. Of course, you should not be adding back common items like COGS, SG&A, and so on - if something is a normal part of the company's business operations and is a true cash expense that occurs from year to year, you leave it in. Otherwise EBITDA would be artificially inflated and not even meaningful. 5. When valuing a 30% Investment in Equity Interest (aka Associate Company), it's common to apply a "Lack of Control Discount" to represent the fact that the parent company doesn't control the other company and may therefore have to sell its stake at a discount. a. True b. False Explanation: The correct answer choice is A. With Equity Interests, the company making the investment does not have full control over the investee company. As a result, when trying to determine the market value (as opposed to book value) of such Equity Interests, after one has determined the fair value one needs to reduce that value by what is called a "Lack of Control Discount" which simply represents the fact that the investor company is a passive investor. When the Equity Interest is a public company, you take the price per share multiplied by the number of shares owned to get to market value, and then apply the "Lack of Control Discount" to this value. If you assume that these Equity Interest investments are sold off, you need to use the parent company's tax rate to calculate the after-tax proceeds, after all discounts have been applied. You are gathering data for Precedent Transactions, but most acquired companies in the set were small, private companies with limited data. What are possible sources to find data such as EBITDA, Revenues, and Enterprise Value for these deals? a. Search press releases at deal announcement for financial figures b. Search equity research for the buyer at the time of transaction to find estimates c. Search trade journals or reputable news sources online for financial figures d. All of the above Explanation: The correct answer choice is D. When completing a Precedent Transaction Analysis, sometimes the target companies that have been acquired are privately held. This means that financial data is not publicly filed or available. In these instances, you need to use alternative sources for information. Press releases on the deal will often include basic information regarding revenues, EBIT, and deal assumptions. If no press release can be found, another reputable source is sell-side research reports on the buyer prior to deal announcement. It is very possible that some Research Analyst provided estimates for the target company that can be used. If that fails, you can search industry trade journals or other online news sources (e.g. TechCrunch for the tech industry) and find estimates there. 1. Which of the following methodologies can you NOT use when valuing a private company? a. Public Company Comparables b. Precedent Transactions c. M&A Premiums Analysis d. Discounted Cash Flow Analysis e. Future Share Price Analysis f. Liquidation Valuation g. Sum of the Parts Analysis Explanation: The only methodologies here that you can't use for a private company are the ones that involve share prices - M&A premiums (e.g. if the median acquisition premium is 30% over the company's 20-day share price, you apply that same premium to this company) and future share price analysis. You can still use everything else, but it will be slightly different; you might apply a discount to Public Comps due to the lack of liquidity for the private company, and in a DCF you have to calculate WACC and/or Cost of Equity differently. A Liquidation Valuation still works but market values may be more difficult to determine. Sum of the Parts also still works, but may be much more difficult for private companies due to limited information. 2. When valuing a private company, you often apply a 'Liquidity Discount' of 10 - 15% (or more) to public comparable company multiples to reflect the fact that the private company's shares are illiquid. a. True b. False Explanation: The correct answer choice is A. This statement is true. When valuing a private company, both relative and intrinsic valuation methods remain the same, but there are slight modifications. For instance, in the case of Public Trading Comps, once the mean (or median) multiple for the peer group is derived, one would need to discount the multiple anywhere from 10 - 15% (or more) to reflect the fact that given multiple is for highly liquid, publicly traded shares, whereas the company being valued is privately held and thus needs a discount to reflect this illiquidity. The logic is that since a private company is much harder to sell, it should not be valued as highly - it would be much easier to buy and sell even a sizable stake in a public company, but doing the same for a private company would be much more time-consuming and expensive. 3. When completing a valuation for an Initial Public Offering (IPO), which of the following valuation methods would be most appropriate? a. M&A premiums analysis b. Liquidation valuation c. LBO analysis d. Comparable companies analysis Explanation: The correct answer choice is D. When working on an IPO issuance, it would not make sense to utilize an LBO methodology, or liquidation analysis. Public trading comps represent what is called a 'non-control minority investment' in a company. This means that in an IPO you are valuing the shares without consideration to control premiums, which are only relevant in M&A transactions. Another consideration is that usually only a minority stake (less than full control) of the new company's IPO shares are floated on the first day of trading, which makes public trading comps most appropriate for valuing an IPO offering. 4. All of the following represent valuation metrics and methodologies that are specific to and highly applicable for commercial banks and insurance firms EXCEPT: a. Dividend Discount Model (DDM) b. Discounted Cash Flow Model (DCF) c. Residual Income (Excess Returns) Model d. Price Per Share / Tangible Book Value Per Share e. Enterprise Value / EBIT Explanation: All of the answer choices, with the exception of answer choices B and E, represent applicable relative valuation metrics or intrinsic valuation measures specifically for commercial banks and insurance companies. Answer choice A is a twist on the traditional DCF analysis in which dividends (instead of Unlevered or Levered FCF) are projected and discounted back to determine intrinsic value. Answer choice B is incorrect, as a traditional DCF analysis does not work for banks and insurance firms since CapEx and "Working Capital" serve different purposes. Answer choice C is the second intrinsic valuation method (aside from DDM) that's specific to banks; the terms 'Residual Income Model' and 'Excess Returns Model' are synonymous. Answer choice D is a correct application of a relative valuation multiple that is meaningful for these firms, but not as meaningful for normal companies. Answer choice E is incorrect as EV/EBIT is not a meaningful metric here - Interest Income is a critical component of revenue for banks and insurance firms, so you cannot exclude it for valuation purposes. Also, Enterprise Value is meaningless for these types of firms and you only calculate Equity Value for valuation purposes. 5. All of the following valuation metrics and methodologies are relevant for exploration & production (E&P)-focused Oil & Gas companies EXCEPT: a. Enterprise Value / Revenue b. Net Asset Value (NAV) Model c. Enterprise Value / EBITDAX d. Enterprise Value / Proven Reserves e. Enterprise Value / EBITDA Explanation: The NAV model is very common for E&P companies and one of the key methodologies, so that is true. EV / EBITDAX (Add back the Exploration expense to adjust for companies that capitalize vs. expense it) is common, as are EV / Proved Reserves multiples. Even EV / EBITDA can be used for oil & gas companies, especially if they all use the same accounting standards. EV / Revenue is NOT relevant and is rarely used because O&G companies' revenue is highly dependent on commodity prices, and it's a less meaningful way to analyze the company compared to looking at reserves, production, or some measure of profitability.