Comparable Companies Analysis

Question 1

How to calculate Enterprise Value?

Answer 1

EV =

Equity Value

+ Total Debt

+ Preferred Stock

+ Non-controlling interest

• Cash & Cash Equivalents

Question 2

How to calcute equity value?

Answer 2

Equity Value =

Share price x Fully Diluted Shares Outstanding

Question 3

Describe the components of fully diluted shares outstanding.

Answer 3

Fully diluted shares outstanding =

Basic shares outstanding +

In-the-money options and warrants +

In-the-money convertibles

Question 4

How to value in-the-money options and warrants in the calculation of fully diluted shares outstanding?

Answer 4

Use the “Treasury Stock Method”.

1) All outstanding options and warrants are exercised at weighted average strike price.
2) Proceeds are used to repurchase shares at current share price/offer price.

Since current price > strike price for in-the-money options, net issuance occurs, which is dilutive

Question 5

Name the methods used for calculating in-the-money convertible and equity-linked securities.

Answer 5

1) If-converted method (in-the-money converts are converted into additional shares by dividing the converts amount outstanding by its conversion price)

Conversion increases the # of shares (EPS dilutive), but also requires upward adjustment of net income due to foregone interest payment of convertible

2) Net share settlement (only difference between current share price and conversion price is settled by additional share issuance, while face value is settled in cash => less dilutive than “if-converted”)

Question 6

Elements of a company’s business profile

Answer 6

• Sector
• Products and Services
• Customers and End Markets
• Distribution Channels
• Geography

Question 7

Elements of a company’s financial profile.

Answer 7

• Size (market value (EV, Equity Value), key financial data (Sales, Gross profit, EBITDA,EBIT, net income)
• Profitability (Gross / EBITDA/ EBIT / Net income margins)
• Growth (historical sales, EPS, EBITDA etc.)
• Return on investment (ROIC, ROE, ROA)
• Credit profile (Leverage, Coverage, Rating)

Question 8

Gross profit

Answer 8

Sales - COGS

COGS: costs directly related to production of company’s products and services such as manufacturing cost, raw materials, direct labor etc.

Gross margin = (Gross profit) / (Sales)

A key indication of operational efficiency.

Question 9

EBITDA

Answer 9

Take EBIT and add D&A sourced from Cash Flow Statement.

Best proxy of operating cash flow, as EBIT includes non-cash D&A expense. Independent of capital structure and taxation, so good comparative measure.

Also, since pre-D&A, differences in recent CapEx, depreciation policy & amotization from recent acquisitions are excluded

Question 10

EBIT

Answer 10

Sales - COGS - SG&A

Operating income, independent of capital structure and taxes, but includes non-cash D&A expense, so less indicative measure of operating cash flow than EBITDA and reflects discrepancies in capital spending, depreciation policy and acquisition histories (amortization)

Question 11

Net income

Answer 11

“Earnings”

Residual profit available to shareholders after all expenses have been netted out.

Question 12

ROIC

Answer 12

Return on invested capital

Return generated by all capital provided to a company.

EBIT/ EBITDA / NOPAT

/

(Average Net Debt + Equity)

Question 13

ROE

Answer 13

Return on equity

Return generated on the equity provided to a company by its shareholders.

Net income / Shareholders Equity

Question 14

ROA

Answer 14

Return on Assets

Measures the return generated by a company’s asset base

ROA = Net income / Total Assets

Question 15

Dividend yield

Answer 15

Measures the return to shareholders from a company’s dividends.

Div. yield = Dividend / Share price

Question 16

Leverage

Answer 16

Leverage refers to a company’s debt level.

Measured as

a) Debt / EBITDA (how many years of a company’s cash flows are needed to repay its debt)
b) Debt / Total Capitalization , where

Total Capitalization = Equity + Debt + Pref. Stock + Non-controlling interest

Question 17

Coverage

Answer 17

Measures company’s ability to meet its interest obligations.

Coverage ratio = EBITDA / Interest Expense

Question 18

Credit ratings

Answer 18

S&P, Fitch

Investment Grade

AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-

Non-investment grade:

BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D

Question 19

Income statement overview

Answer 19

Sales - COGS

= Gross profit

• SG&A

= EBITDA

• D&A

= EBIT

• Taxes, Interest payments

=Net income

Question 20

Equity Value Multiples

Answer 20

Share price / Diluted EPS (“P/E”)

=

Equity value / Net income

For equity value, need profit flowing to equity holders, i.e. net income

Question 21

EV multiples

Answer 21

EV / EBITDA

EV / EBIT

EV / Sales

For EV-multiples, need profit accruing to both equity and debt holders.

Question 22

Limitations of P/E

Answer 22

• mainly for mature companies with stable earnings
• problematic for companies with little or no earnings such as startups or distressed companies
• dependent on capital structure since net income is after interest payments
• dependent on taxation as net income is after taxes

Question 23

Common mistakes in comparable companies analysis.

Answer 23

• inappropriate comparables
• incorrect calculations (fully diluted equity value, EV LTM, Calendarization)
• failure to accurately scrub financial for non-recurring items and recent events

Question 24

Advantages of Comparable Companies Analysis

Answer 24

• Market-based (information used to value a company based on actual market prices, reflecting market information and expectations)
• Relativity (easily measurable and comparable versus other companies)
• Quick and convenient (valuation is based on a few easy-to-calculate inputs)
• Current (based on prevailing market data, i.e. can be updated daily)

Question 25

Disadvantages of comparable companies analysis

Answer 25

• Market-based (valuation can be skewed by market gyrations, e.g. Dot-Com boom or Credit crunch)
• Absence of relevant comparables (often hard to find perfect, “pure-play” comparables)
• Potential disconnect from cash-flow (based on prevailing market condition instead of company’s projected cash flow generation)
• Company specific issues (valuation based on OTHER companies fails to capture target specific strengths and weaknesses)