BIWS Technical Flashcards
Why do we look at both Enterprise Value and Equity Value?
Enterprise Value is the value of the company that is attributable to all investors; Equity Value only represents the portion available to shareholders (equity investors). You look at both because Equity Value is the number the public-at-large sees, while Enterprise Value represents its true value.
When looking at an acquisition of a company, do you pay more attention to Enterprise or Equity Value?
Enterprise Value, because that’s how much an acquirer really “pays” and includes the often mandatory debt repayment
What’s the formula for Enterprise Value?
EV = Equity Value + Debt + Preferred Stock + Minority Interest - Cash
Why do you need to add Minority Interest to Enterprise Value?
When a company owns over 50% of another company, they have to report that other company’s financial performance as part of its own performance. So, even though it doesn’t own 100%, it reports 100% of the majority-owned subsidiaries financial performance. In keeping with the “apples-to-apples” theme, you have to add Minority Interest to get to Enterprise value.
What are the 3 major valuation methodologies?
Comparable Companies, Precedent Transactions and Discounted Cash Flow Analysis.
Rank the 3 valuation methodologies from highest to lowest expected value.
Trick Question, there is no ranking that always holds.
When would you NOT use a DCF in Valuation?
You do not use a DCF if the company has unstable or unpredictable cash flows (tech or biotech startup) or when debt and working capital have a fundamentally different role. Ex. banks and financial institutions don’t reinvest debt, and working capital is a huge part of their balance sheet - so you wouldn’t use a DCF on such companies.
What other Valuation methodologies are there?
- Liquidation Valuation - valuing a company’s assets, assuming they are sold off and then subtracting liabilities to determine how much capital, if any, 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 for a company to hit a “target” IRR, usually in the 20-25% range
- Sum of the Parts - Valuing each division of a company separately and adding them together at the end
- M&A Premiums Analysis - Analyzing M&A deals and figuring out the premium that each buyer paid, and using this to establish what your company is worth
- Future Share Price Analysis - Projecting a company’s share price based on the P/E multiples of the public company comps, then discount it back to PV
When would you use Liquidation Value?
This is the most common in bankruptcy scenarios and is used to see whether equity shareholders will receive any capital after the company’s debts have been paid off. Used to advise struggling businesses on whether it’s better to sell off assets separately or to try to sell the entire company
When would you use Sum of the Parts?
This is most often used when a company has completely different, unrelated divisions - a conglomerate like GE for example. You would use different sets of comps for each division, value each separately, and then add them together to get the Combined Value.
When do you use an LBO Analysis as part of your Valuation?
When you’re looking at doing a Leveraged Buyout - but it is also used to establish how much a PE firm could pay, which is usually lower than what companies will pay.
It is often used to set a “floor” on a possible Valuation for the company you’re looking at.
What are the most common multiples used in Valuation?
EV/Revenue
EV/EBITDA
EV/EBIT
P/E (Share Price / Earnings per share)
P/BV (Share Price / Book Value)
Would an LBO or DCF give a higher valuation?
Technically, it could go either way, but in MOST cases the LBO will give you a lower valuation.
With an LBO, you do not get any value from the cash flows of a company in between year 1 and the final year - you’re only valuing it based on its terminal value. With a DCF, you’re taking into account BOTH the company’s cash flows in between and its terminal value, so values tend to be higher.
How would you present these Valuation methodologies to a company or its investors?
Usually you use a “football field” chart where you show the valuation range implied by each methodology. You ALWAYS show a range rather than one specific number.
How would you value an apple tree?
The same way you would value a company: by looking at what comparable apple trees are worth (relative valuation) and the value of the apple tree’s cash flows (intrinsic valuation). Yes, you could do a DCF for anything - even an apple tree.
Why can’t you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA?
Enterprise Value and EBITDA are available to all investors in the company. This gives better apples to apples comparison of the whole company value to the whole company earnings, rather than Equity Value which only tells us a part of the company’s value (the stockholders’ part).
You never use Equity Value / EBITDA, but are there any cases where you might use Equity Value / Revenue?
You might use this for large financial institutions with big cash balances, but you are more likely to use other multiples like P/E or P/BV with banks.
How do you select comparable companies/ precedent transactions?
- Industry classification
- Financial criteria (Revenue, EBITDA, etc)
- Geography
Precedent transactions: transactions that happened recently in the industry, within the past 1-2 years.
How do you apply the 3 valuation methodologies to actually get a values for the company you’re looking at?
You take the median multiple (EV/EBITDA) of a set of companies or transactions, and then multiply it by the relevant metric from the company you’re valuing.
What do you actually use a valuation for?
Usually you use it in pitch books and in client presentations when you’re providing updates and telling them what they should expect for their own valuation. They can also be used right before a deal closes in a Fairness Opinion, which a bank creates to prove the value their client is paying is fair from a financial POV. Can also be used in merger models, LBO models, and more!
Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium?
- The co. just reported earnings well above expectations and its stock price has risen recently.
- It has some type of competitive advantage not reflected in its financials, like a patent
- It has just won a lawsuit
- It is the market leader in an industry and has greater market share than its competitors
What are the flaws with public company comparables?
- No company is 100% comparable to another company
- The stock market is “emotional” - your multiples could be high/low depending on market movements
- Share prices for small companies with thinly-traded stocks may not reflect their full value
How do you take into account a company’s competitive advantage in a valuation?
- Look at the 75th percentile or higher for the multiples rather than the medians
- Add in a premium to some of the multiples
- Use more aggressive projections for the company
Do you ALWAYS use the median multiple of a set of public company comparables for precedent transactions?
You normally should, unless it has a competitive advantage or disadvantage.
Precedent Transactions usually produce a higher value than comparable companies - when is this NOT the case?
When there is a substantial mismatch between the M&A market and the public market (no public cos have been acquired recently but a lot of private cos have been acquired at low valuations)
What are some flaws with precedent transactions?
Past transactions are rarely 100% comparable - the transaction structure, size of the company, and market sentiment all have huge effects. Data on precedent transactions is generally harder to find than it is for public 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?
- One company had more bidders, competition drove up price
- One company had bad news or depressed stock price so it was acquired at a discount
- They were in different industries
Why does Warren Buffett prefer EBIT to EBITDA?
He dislikes EBITDA because it excludes often sizable CAPEX companies make and hides how much cash they are actually using to finance their operations. Capital-intensive companies will have big gap between EBIT and EBITDA.
