3.13) Other Valuation Methodologies Flashcards
- What is a Liquidation Valuation, and when is it useful and not so useful?
In a Liquidation Valuation, you value a company by determining the market values of all its Assets, adding them up, and subtracting its Liabilities (i.e., full repayment of all Liabilities). It gives you the company’s Implied Equity Value because you’re valuing the company’s Net Assets, not its Net Operating Assets. This methodology is useful for distressed companies because it tells you how much they might be worth if they liquidate and shut down and how much different lender groups might receive. It’s less useful for healthy, growing companies because it tends to undervalue them significantly; assets like Net PP&E are always worth more to “going concern” companies.
- How does a Dividend Discount Model (DDM) differ from a DCF?
In a DDM, rather than projecting Free Cash Flow, you project the company’s Dividends, usually based on a per-share figure or a percentage of Net Income. You then discount the Dividends to their Present Value using the Cost of Equity and add them up. To calculate the Terminal Value, you use an Equity Value-based multiple such as P / E, and you discount it to its Present Value using the Cost of Equity. You add the PV of the Terminal Value to the PV of Dividends o calculate the company’s Implied Equity Value at the end rather than its Implied Enterprise Value – there’s no “bridge” – and you divide it by the diluted share count to get the company’s Implied Share Price. The DDM is essential in some industries, such as commercial banks and insurance, useful for other industries that pay regular dividends, such as REITs, utilities, and some MLPs, and not so useful for most others because it takes more time and effort to set up and tends to undervalue companies that do not distribute high percentages of their cash flows.
- Why might you use an M&A Premiums analysis to value a company?
The M&A Premiums analysis applies only to public companies because you look at acquisitions of similar public companies and calculate the “premium” each buyer paid for each seller. For example, if the seller’s share price was $12.00 before the deal, and the buyer paid $15.00 per share, that represents a 25% premium. You then use these percentages to value your company. If the median premium in a set of deals is 20%, and your company’s share price is $10.00, it’s worth $12.00 per share. This analysis is typically a supplement to Precedent Transactions and gives you another way to value your company besides just the standard multiples. But it’s also a bit limited because M&A Premiums cannot indicate that a company is currently undervalued.
- How do you build a Future Share Price Analysis? When is it useful?
The idea is to project a company’s stock-price appreciation and its Dividends between today and some future date, discount them to Present Value, and add them up (since these are the two “returns sources” if you buy a company’s shares). The Dividend projections are based on Net Income or per-share figures; to project a company’s future stock price, you normally take the company’s current NTM multiple, the median from the comps, or something similar, and apply it to a future figure, such as its EBITDA in Year 3. You then back into the future Implied Equity Value based on this future Implied Enterprise Value and divide by the share count on that date to get the “future share price,” which you discount to PV using the Cost of Equity. You then compare this to the current share price. This analysis adds little over traditional Public Comps, but it can be useful if a company wants to assess the valuation impact of changing its capital structure or Dividend policy.
- What are the advantages and disadvantages of a Sum-of-the-Parts Valuation?
The Sum-of-the-Parts methodology, in which you value each division of a company separately and add them up to determine the company’s Implied Value, works well for conglomerates that have very different divisions (e.g., retail vs. transportation vs. digital media). The divisions operate in such different industries that it would be meaningless to value the company as a whole – no other public company would be comparable. But Sum of the Parts also takes far more time and effort to set up because you have to find comparable companies and transactions for each division, build a separate DCF for each division, and so on. Also, you may not have enough information to use it; companies sometimes don’t disclose EBIT, CapEx, or Working Capital by division, and they may not disclose the corporate overhead expenses that you must factor in at the end of the analysis.
- How do you set up an LBO valuation, and when is it useful?
You set up the LBO valuation by creating a leveraged buyout model in which a private equity firm acquires a company using Debt and Equity, holds it for several years, and then sells it for a certain multiple of EBITDA.
Most private equity firms target an internal rate of return (IRR) in a specific range, so you work backward and determine the maximum price the PE firm could pay to achieve a targeted IRR.
You could use the “Goal Seek” function in Excel to do this, and you solve for the purchase price based on constraints for the IRR, exit multiple, and Debt / Equity split.
This methodology is most useful as a way to screen LBO candidates and see which ones might warrant further attention; it can also be useful for helping a company compare its options and see what different types of acquirers (e.g., PE firms vs. normal companies) might pay.
