Chapter 2 - A Primer On Value Flashcards
Valuation is the___ of Investment Banking
Foundation
Valuation is a critical component to the advice that investment bankers provide to their clients and is used in several scenarios:
Acquisitions: How much is the target company worth? What is the value of potential synergies?
Divestitures: How much can a company or division be sold for?
Public Equity Offerings: How much is a company or division worth in the public markets?
Debt Offerings: What is the value of the business or assets against which debt is being issued?
Equity Research: Should the firm’s clients buy, hold or sell positions in a particular security?
Investor Marketing: Is the company undervalued relative to its peers despite better performance?
Corporate Strategy: What are the key value drivers in the sector (ie. growth, margins, ROIC)?
When valuing a business, the two most common measures of value are ____ Value and ___ Value, which
are market-driven values rather than accounting values
Equity Value and Enterprise Value
Under Market Value, Enterprise Value =
Net Debt + Equity Value
Under Accounting Value, Assets=
Liabilities + Shareholders Equity
Enterprise Value (1):
Market value of a company’s operations attributable to all capital
providers (ie. Debtholders and equityholders)
Equity Value (1):
Market value of a company’s operations attributable to equityholders (ie. Shareholders)
Assets:
Assets generate earnings and free cash flow, which we
use to assess equity and enterprise value (ie. market value)
Equity Value (4):
Represents the market value of a company’s operations attributable to equityholders
It is the value remaining after all debt and other obligations have been satisfied
Often referred to as “market capitalization” for public companies
Market Capitalization = Fully Diluted Shares Outstanding * Current Share Price
Enterprise Value (3):
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Represents the market value of a company’s operations attributable to all capital providers
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Enterprise Value = Market Capitalization + Net Debt + Minority Interest
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Minority interest is the portion of a subsidiaries book value of equity that a company does not own; it needs to be included because 100% of the subsidiaries financials are consolidated on the income statement
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Net Debt = Short-Term Debt + Long-Term Debt – Cash & Cash Equivalents
–
Cash & Cash Equivalents includes highly liquid investments such as marketable securities; it is subtracted from enterprise value because it is considered a non-operating asset
Equity Value Multiples:
Financial statement values that are after the cost of debt (interest costs), such as net income, cash flow and book value, are availbale to equity holders only (debtholders have no claim beyond interest payments)
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Any multiples applied to these values determine equity value only
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Some relevant equity value multiples are:
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Price / Earnings (P/E)
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Price / Cash Flow (P/CF)
–
Price / Book Value (P/BV)
Enterprise Value Multiples:
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Income statement values that are before the cost of debt, such as revenue, EBITDA and EBIT, are available to all capital providers (ie. equity and debt providers)
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Multiples applied to these values determine enterprise value only
*
Some relevant Enterprise Value multiples are:
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EV / Sales
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EV / EBITDA <— We will focus on this metric in this course
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EV / EBIT
Main Difference between Equity Value or Enterprise Value
The main difference revolves around the treatment of debt
A multiple with debt included in the numerator (ie. Enterprise value) must contain a value that is before interest in the denominator (ie. EBITDA) – after interest has been paid, debtholders no longer have a claim in the earnings
Market value of a company’s operations attributable to common shareholders:
Multiple type - Has Interest Been Subtracted - Numerator
Net Income -Yes- Equity Value
Cash Flow- Yes- Equity Value
Book Value*- Yes- Equity Value
Market value of a company’s operations attributable to all capital providers
Multiple type - Has Interest Been Subtracted - Nominator (Enterprise Value)
Revenue- No- Enterprise Value
EBITDA- No- Enterprise Value
EBIT- No- Enterprise Value
____________ multiples are the most commonly used valuation metric in investment banking because of a few distinct advantages compared to equity value multiples
Enterprise value
Benefits of Using EV/EBITDA Multiples
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Shortcut to a DCF analysis
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Represents the total value of the company (ie. its core operating assets)
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Not influenced by capital structure differences between companies
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Less influenced by accounting differences (ie. taxes, depreciation)
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EBITDA is often positive even when earnings per share are not
Drawbacks of Using EV/EBITDA Multiples
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EBITDA is not always a great proxy for unlevered free cash flow
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EBITDA can overstate cash flows if a company is aggressively investing in its working capital
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EBITDA can overstate cash flows if the company is in a prolonged period of elevated capital expenditures
Shares Outstanding (Types:)
Basic Shares Outstanding
Fully Diluted Shares Outstanding
Weighted Average Shares Outstanding
Basic Shares Outstanding
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Often reported multiple times throughout a company’s quarterly or annual financials
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The correct number to use is the one with the most recent date (often in the MD&A)
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This number may differ from the shares outstanding as of the latest balance sheet date if the company issues or repurchases shares subsequent to the quarter
Fully Diluted Shares Outstanding
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This number is used to calculate a company’s market capitalization – it is not reported and needs to be calculated using the “Treasury Stock Method”
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Basic shares outstanding + the net impact of in-the-money stock options
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Only vested/exercisable stock options should be included in the calculation
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The treasury stock method is an approach used to calculate the number of new shares (on a net basis) that will be issued based on unexercised in-the-money stock options
Weighted Average Shares Outstanding
The weighted average shares outstanding (or the fully diluted weighted shares outstanding) takes into consideration any changes in the number of outstanding shares over a specific reporting period (ie. quarterly or annually) – DO NOT USE THIS NUMBER IN YOUR EQUITY VALUE CALCULATIONS
Calculating Fully Diluted Shares Outstanding Using the Treasury Stock Method
- The treasury stock method assumes that the proceeds that a company receives from the exercise of in-the-money
stock options is used to repurchase common shares at the current share price in the market
– A stock option can be exercised if it has vested and is in-the-money; a stock option is in-the-money if the
current share price is greater than the exercise price - Companies provide details on their stock option plan in their financial disclosure; the annual filings typically
provide more detailed information than the quarterly filings
F.D. Shares Outstanding =
Basic Shares Outstanding + Net Impact of In-the-money Stock Options
Market Capitalization
Fully Diluted Shares Outstanding * Current Share Price
Net Debt=
Total Debt – Cash & Cash Equivalents
((Note: There are many types of debt instruments that need to be included in your total debt calculation, such as shortterm
debt, long-term debt, notes payable, revolving credit facility, senior notes, etc.)
Enterprise Value =
Market Capitalization + Net Debt + Minority Interest (if any)
It is very challenging to identify if a company is undervalued, overvalued or fairly valued without reviewing the:
company’s strategy, financial performance and valuation relative to its peer group (ie. “trading comps”)
more commonly used valuation methodologies:
- Comparable Company Analysis
- Precedent Transaction Analysis
- Discounted Cash Flow Analysis
- Leveraged Buyout Analysis
- Other Methodologies
Comparable Company Analysis
- Valuation based on trading multiples of comparable public companies
- Often regarded as the market’s shortcut to a DCF
- This methodology does not usually reflect a “control premium”
Precedent Transaction Analysis
- Valuation based on multiples paid for comparable companies in a change of control
- This methodology includes a “control premium”
Discounted Cash Flow Analysis
- Valuation methodology used to determine the intrinsic value of a business
- Requires a detailed financial forecast (typically 5 years but industry and business cycle
dependent) - Usually the most detailed and intensive methodology to prepare
Leveraged Buyout Analysis
- Variation on a DCF with different financial assumptions (ie. significant leverage)
- Represents the value to a financial buyer (ie. private equity or pension funds)
Other Methodologies
- Sum-of-the-parts analysis
- Liquidation analysis
- Greenfield / “cost to build” analysis
