8. FM - Business Valuation Flashcards
How is organic growth achieved?
Through internally generated projects whether funded with RE or new finance
What are the adv of organic growth?
- Spreads Costs
- No disruption to business
What are the disadvantages of organic growth?
- Risk
- Slower
- Barriers
What is an acquisition?
When a bidder company squires a target company either entirely or by buying enough shares to exercise control
What are the advantages of acquisition?
- Synergy
- Risk reduction
- Reduced competition
- Vertical protection
When is an acquisition deemed successful?
When additional cash flows exceed the cost of the acquisition
and/or
Overall risk reduction is achieved
What are the disadvantages of growth by acquisition?
- Synergy is not automatic, it must be pursued
- Restructuring costs following the acquisition may be significant
- Buying company may end up paying more in terms of both price and fees than it gains in synergistic benefits
Give some examples of things that may affect the price paid to acquire a company
- How desperate is the seller to sell (another other potential buyers?)
- How desperate is buyer to buy (anything else to spend money on?)
- If the target company is listed, what is the existing SP
- Is the consideration to be paid in cash or shares?
- Is the purchase of a controlling interest? (in which case a premium might be paid)
- Are key e’ees or key clients likely to leave after the acquisition (thus reducing val of target)
What are the 2 main types of method for valuing a business?
Asset based approach
Income based approach
How does asset based approach work?
Considers that the value of a business is dependent on the assets that it owns
How does income based approach work?
Considers that the value of a business is dependant on income that the business is likely to generate in the future
What are the asset based approaches?
NRV - effectively the cash that could be generated from selling of the assets piecemeal. Min price for seller
Replacement cost - cost of setting an equiv business up from scratch. Max price for buyer
What is the NRV method for business valuation?
Asset based approach
effectively the cash that could be generated from selling of the assets piecemeal. Min price for seller
What is the replacement cost business valuation method?
Asset based approach
- cost of setting an equiv business up from scratch. Max price for buyer
What are the main problem with the asset based approach?
Value of intangibles not included on the balance sheet will be missed (e.g. value of staff, client relationships, brand value)
What are the 3 income based approach techniques for business valuations?
- Dividends
- Earnings
- Cash flows
When is the dividend based approach used?
Normally used for valuing a minority interest, as the inv can’t control dividend policy, so his income depends on the div that the company is likely to pay how
How is the dividend valuation model used to value businesses?
- Value is simply the PV of the future expected dividend payments discounted at ke
- If dividends are expected to grow by a constant rate in a perpetuity then
PV = d1 x 1/(Ke - g)
What are the 2 types of dividend based approaches?
Dividend valuation model
Using dividend yield
What is the formula for using the dividend valuation model?
PV = d1 x 1/(Ke - g)
How is the dividend yield used as a business valuator?
More simplistic valuation can be achieved by using the dividend yield
Yield = Dividend/Price
So can use the yield by looking at similar companies we can estimate the price as
Price = Dividend/yield
What are the problems with dividend based evaluations?
- Estimating future dividends
- Finding similar listed companies
- If Ke is estimated using CAPM, or by looking at other quoted companies, then a pvte company valuation will need to be adj downwards to reflect the lack of marketability
When is the earnings based approach used?
Commonly used to value controlling interests, as the inv can control the div policy and can therefore extract all the earnings from the company as div if they wanted to
What are the 2 key methods for earnings based valuations?
PE multiple valuation
EBITDA multiple
What are the problems with earnings based valuations?
- If earnings have been erratic, then the latest earnings figures may be misleading
- Acc policies can be used to manipulate earnings figures (although EBITDA multiple attempts to reduce this manipulation)
- Finding appropriately similar listed companies
- Pvte company valuation will need to be adj down to reflect lack of marketability
How does the PE multiple valuation work?
Equity value = Earnings x PE ratio
- Earnings are taken as profit after tax and pref div, but before ordinary dividends
- PE ratio is generally found bu looking at PE ratios of a range of similar listed companies- High PE ratio implies a high level of inv confidence that earnings will grow strongly
- Low PE ratio implies the opposite. Therefore, it is important to select a PE ratio from listed companies that have similar growth expectations to the target
What does a high PE ratio imply in PE multiple valuation?
- PE ratio is generally found bu looking at PE ratios of a range of similar listed companies- High PE ratio implies a high level of inv confidence that earnings will grow strongly
What does a low PE ratio imply in PE multiple valuation?
- Low PE ratio implies the opposite. Therefore, it is important to select a PE ratio from listed companies that have similar growth expectations to the target
Describe the EBITDA multiple as a business valuation technique
Enterprise value = EBITDA x EBITDA multiple
Val gives us the enterprise value, rather than just the value of equity
What is Enterprise value made up of?
Enterprise value = EBITDA x EBITDA multiple
Enterprise value = MV of equity + preference shares + minority interest + debt - cash and cash equiv
What adjustment needs to be made when valuing a business using EBITDA multiple?
If you only want the MV of equity only, need to deduct the MV of other types of finance and add back cash and cash equips
What does EBITDA stand for?
Earnings before interest, tax, depreciation and amortisation
What is the formula for EBITDA multiple ?
Enterprise value / EBITDA
What does the EBITDA multiple indicate?
Indicates how long it would take for an acquisition to earn enough money to pay off its const and so a high valued company will have a high multiple
When using PE ratio or EBITDA multiple, what is it important to do?
Need to use a multiple that is not of the company you are valuing, otherwise it doesn’t give a useful valuation
What is the issue of synergy?
The various business valuation models value a company on a standalone basis
But where a company is acquiring a target in a similar industry, it may be willing to pay more than that due to synergies
When is the cash flow based approach used?
Used to value controlling interests
How are cash flow based approach calculated?
Calculated by estimating the post-tax operating cash flows of the target company to infinity and discounting at the investing companies WACC
Normally a detailed CF forecast is done for the next few years and then a sampling assumption is made about CF from that point to infinity
Value calc’ed will be the value of both equity and debt together, so need to deduct the MV of debt to give equity value
Value =
PV of cash flows to infinity, discounted at WACC X
Less MV of debt (X)
= Value of equity X
If the company holds any investments, then the value of these must be added separately
What are the main problem with the cash flow based approach to business valuations?
Theoretically the best approach but it may be difficult to estimate the future ash flows and the relevant discount rate
Which of the business valuation techniques is theoretically the best?
Cash flow based valuations
What is the SVA valuation technique?
Common way to estimate cash flows to infinity is to use estimates of 7 value drivers of SH value analysis
How can the cash flows to infinity be estimated for the cash flow based approaches to business valuations?
Using Share Value Analysis valuation technique - i.e. to use estimates of 7 value drivers of SH value analysis
But remember the value calculated will be debt + equity so value of debt must be deducted
What are the main methods of payment a bidding company can pay to the target SH for their shares?
Cash
Bid company shares
Loan stock
What are the advantages of using cash to pay target SH for their shares?
Buyer gets full control of the target as well as full entitlement to future profits
- Seller may prefer this method, as they receive a certain, unconditional amount
What are the disadvantages of using cash to pay target SH for their shares?
- Buyer will have to find the cash from somewhere
- Seller’s expertise may be lost from the business as there is no motivation for them to stay to ensure the success of the new venture
- Capital gains tax liabilities arise immediately
What are the advantages of using bid company shares to pay target SH for their shares?
- No need to fund a cash payment
- Seller is motivated to stay to work for the success of the combination
- CGT effects are deferred
What are the disadvantages of using bid company shares to pay target SH for their shares?
Control is diluted and future profits will be shared with the seller
What are the adv and disadvantages of using loan stock to pay target SH for their shares?
Adv = cash payment without the need to find immediate finance
But buyer will of course have to pay interest on the debt until it is redeemed
Give some examples of why subsidiaries may be divested?
Raising cash
Lack of fit
Diseconomies of scale
Cheaper than liquidation
Who may a subsidiary be sold to?
- Existing management (an MBO) this can be difficult to finance and often involves the use of junk bonds or mezzanine debt
- External management team (an MBI)
- Another established business (a trade sale)
What is a spin off?
Where shares in a subsidiary company are ‘given’ to the SH of the parent in proportion to there SH
Thus group of companies are split into 2 separately held entities
No cash changes hands
How are spin offs paid for?
They aren’t - no cash changes hands
Group companies are split into 2 separately held entities
Why might a spin off occur?
- Lack of fit
- Diseconomies of scale
- Forced division due to a competition commission ruling
What are the options for when a company buys back shares from SH?
Either bought back in proportion to their SH
or from a single SH
Give some reasons to repurchase SH in proportion to their holdings
- Reduce level fo equity and therefore increase gearing
- Get unused funds back into the hands of the SH
- To maintain EPS following divestment
Give some reasons for a share repurchase of a single SH
- To provide an exit route for an investor
- To take a listed company off the market and back tint private ownership
What is a debt for equity swap
- Where creditors (usually bank/ bond holder) gives up their debt in return for equity stake in the comp
- Generally happens if comp is in trouble and unable to pay the interest or repayment on debt
- Lenders COULD force into liquidation, but they might get nothing at all
- By taking equity and allowing a company to continue, may get higher return
gIve some examples of divestment and other forms of restructuring
Spin off
Share repurchase
Debt for equity swap
Liquidation
Why might debt holders opt for debt for equity rather than liquidation?
- Lenders COULD force into liquidation, but they might get nothing at all
- By taking equity and allowing a company to continue, may get higher return
- Often SH will lose a significant amount of control as a result
What is usually the result of a debt for equity swap
- Often SH will lose a significant amount of control as a result
What is liquidation?
When a company is wound up and its assets are passed out the SH
Although before this, all CR must be paid in full
Can be forced into liquidation by CR as can’t pay debts, and SH are v unlikely to receive anything
Solvent comp may be put into liquidation by SH if they wish to wind up the company and take their money
Is liquidation always a last resort?
No
Can be forced into liquidation by CR as can’t pay debts, and SH are v unlikely to receive anything
Solvent comp may be put into liquidation by SH if they wish to wind up the company and take their money
