Compta 4 - Multiples

Question 1

What IS a valuation multiple? and why?

Answer 1

C’est un raccourci pour rapidement estimer la valeur d’une entreprise en fonction d’un autre parametre, comme les cash flows, la dette.
C’est utile principalement pour faire des comparaisons rapide entre differente compagnies, ou transactions.
2. Calculer les multiples pour plusieurs companies similaire pour faire des comparaisons. C’est la base de quelques technique de valorisation (precendentes transaction et comparables)

Question 2

A company trades at a valuation multiple of 13x EV/EBITDA (based on its Current Enterprise Value). What does that mean?

Answer 2

Ca ne veut pas dire grand chose en soi. C’est surtout important de comparer avec une autre compagnie, ou une moyenne de secteur pour voir si c’est coherent ou non.

Un multiple different c’est generalement un indice, qu’il faille effectuer des recherches plus profondes.

Question 3

Suppose that you graph the EV / EBITDA multiples for a set of similar companies along with the revenue growth rates, EBITDA margins, and EBITDA growth rates.
Which operational metric will MOST LIKELY have the strongest correlation with the EV / EBITDA multiples

Answer 3

Valeur d’une compagnie depend principalement de ses cash flows. Si les cash flow sont attendu a la hausse, la valeur de l’entreprise va monter. Donc je pense que si le growth rate est eleve, la EV va monter, neanmoins, le EBITDA ne va pas changer avant l’annee, ou trimestre prochain.

EBITDA closer to cash flow than revenue
Margins do not tell us much by themselves

Question 4

Why do valuation multiples and EBITDA growth rates often NOT display as much correlation as you might expect?

Answer 4

1. EBITDA are not the same as FCF (WC, Capex, Tax, interest). So much could happen to prevent CF growth.
2. not every company has the same discount rate, some are much risker than others.
3. des raisons non-financieres, un scandale, changement de management…

Question 5

You’re valuing a mid-sized manufacturing company, and you’re comparing it to peer companies in the same industry.
This company’s EV / EBITDA multiple is 15x, and the median EV / EBITDA for the comparable companies is 10x. What’s the MOST likely explanation?

Answer 5

1. Le marche pense que la compagnie va croitre plus rapidement que ses pairs.
2. Discoun rate ne devrait pas etre different puisque peers = structure, taille, systemic risk, similaire.
3. Facteurs non financiers (annonces de business, nouveau management, IP)

Question 6

Would you rather buy a company trading at a 15x EV / EBITDA multiple, or one trading at a 10x multiple?

Answer 6

Impossible a dire comme ca. Ca depend des multiples de compagnies similaires. Ensuite il faut toujours comprendre ce qui justifie tel ou tel multiple.
un faibe multiple pourrait etre une opportunite d’investissement, mais il se pourrait aussi qu’il ne soit pas assez faible.

Question 7

Could a valuation multiple such as P / E or EV / EBITDA ever be negative? What would it mean?

Answer 7

Oui, Ce n’est pas necessairement une mauvaise chose. ca veut surtout dire qu’on devrait utiliser d’autres multiples. AMazon et Tesla avait des cash flow negatifs pendant tres longtemps.

Question 8

If a company’s cash flow matters most, why do you use metrics like EBIT and EBITDA in valuation multiples rather than CFO or FCF?

Answer 8

Principalement par soucis de rapidite d’execution. le CFO et FCF sont plus precis, mais prennent plus de temps a obtenir. (c’est aussi devenu une habitude je pense).
Aussi il peut y avoir beaucoup d’ajustement a faire dans les CF pour arriver a faire des comparaisons utiles (defered taxes, stock based compensations, working cap)

Question 9

If a company has both Debt and Preferred Stock, why is it NOT valid to use Net Income rather than Net Income to Common when calculating its P / E multiple?

Answer 9

Items in numerator and denominator should match to make any sense. For that reason, if we do not include an expense (ie. interest) we usually include the balance sheet item associated to that item (debt holder).
So if we are using Net income, we must use all equity holders.
Because the Price, corresponds to common holders, we must make the change to reflect the protion of net income that belongs to common equity holders.

Question 10

What are the advantages and disadvantages of EV / EBITDA vs. EV / EBIT vs. P / E?

Answer 10

1. Il n’y a pas de meilleur ratio ou multiple, ces indicateurs doivent etre analyses tous ensemble pour developper une vision large de toute les dimensions d’une compagnie, de ses operations, de sa structure de capital.
2. EBITDA will be used when we want to excluse the effect of capital structure, tax, depreciation
   EBIT when we want to exclude only the effect of capital sutrcture but factor in depreciation and capex (usefull in industries where they are big drivers )
3. P/E pas tres utile en soi, parce que c’est altere par different traitements de taxes, structures de capital, etc. Donc pas vraiment les operations en soi
4. Ca depend vraiment de l’industrie et de l’objectif

Question 11

What are the advantages and disadvantages of Unlevered FCF vs. Levered FCF?

Answer 11

Levered FCF (FCF to equity) c’est les cash flow libre de la compagnie une fois que les obligations ont ete versees. DOnc on prend en compte la structure de capital (interets+ paiement de dette obligatoire).ca donne le residu disponibe aux investisseurs fonds propres. (use cost of equity)

Unlevered FCF on ignore la structure de capital, c’est mieux pour comparer les operations des compagnies, aussi pour semmetre des hypotheses de changement de structure de capital. (use WACC). Generalement on s’interesse a ce genre de cash flow.

1. a company could have positive unlevered, positive levered, alors attention.

Question 12

Why do we subtract the change in net working capital in FCF?

Answer 12

Car ce sont des mouvements de tresorerie qui ne sont pas pris en compte pas le net income.

Question 13

Could Levered FCF ever be higher than Unlevered FCF?

Answer 13

Yes, if the company has net positive interest income.

Question 14

If EBITDA decreases, how do Unlevered and Levered FCF change?

Answer 14

it means that either revenue has decreased or operational expense have increased. either way, CFO goes down. to FCF goes down. Assuming all else equal.

Question 15

What are some different ways you can calculate Unlevered FCF?

Answer 15

1. EBIT * tax
changes WC
non cash
- Capex
2. CFO 
add back after tax interest expense
- Capex

Question 16

When you calculate Unlevered FCF starting with EBIT * (1 – Tax Rate), or NOPAT, you’re not counting the tax shield from the interest expense. Isn’t that incorrect?

Answer 16

No correct, if you ignore interest expense you can not assume that you still have the interest tax shield

Question 17

Could a company’s EV / EBITDA multiple ever equal its P / E multiple?

Answer 17

Yes easy.Two companies have the same P / E multiples but different EV / EBITDA multiples. How can you tell which one has more Debt?

1. no debt
   2.only operating assets
   so EQV = EV
2. no TAx, no interest, no D&A so E = EBITDA

Also.
EV = 100 EQV = 50
EBITDA = 10 NI = 5

Question 18

Two companies have the same P / E multiples but different EV / EBITDA multiples. How can you tell which one has more Debt?

Answer 18

you can’t tell, because the company could be different sizes.
Company B could have higher EV/EBITDA, but lower absolute debt.
If you assume they have same NI then, you can kind of assume that the highest EV/EBITDA is more leveraged, but that is not sure. (because it might just have worse margins)

Question 19

How do you decide whether to use Equity Value or Enterprise Value when you create valuation multiples?

Answer 19

You should look at which type of investors the numerator refers to. If it excludes interest expense, then you should include debt holders in the denominator, Hence EV.

Question 20

Should you use Equity Value or Enterprise Value with Free Cash Flow

Answer 20

depends if it is levered or unlevered.

Question 21

Two companies have the same amount of Debt, but one company has Convertible Debt, and the other has traditional Debt.
Both companies have the same Operating Income, Tax Rate, and Equity Value. Which company will have a higher P / E multiple?

Answer 21

Since the interest rates on Convertible Debt are lower than the rates on traditional Debt, the company with Convertible Debt will have a lower interest expense and therefore a higher Net Income.
As a result, its P / E multiple will be lower. So, the company with Convertible Debt will have a lower P / E multiple, and the company with traditional Debt will have a higher P / E multiple

Question 22

A company is currently trading at 10x EV / EBITDA. It wants to sell an Asset for 2x the Asset’s EBITDA. Will that sale increase or decrease the company’s Enterprise Value? and EV/EBITDA?

Answer 22

Si l’actif est considere comme essentiel aux operations aors ca va faire baisser le EV.
Sinon ca ne changera rien.

Even though the company’s Enterprise Value decreases in the first case, its EV / EBITDA multiple increases because the Asset’s multiple was lower than the multiple for the entire company. (the average will go up)

Question 23

Is it accurate to subtract 100% of the Cash balance when moving from Equity Value to Enterprise Value?

Answer 23

No, but everyone does it anyway. The reasoning is that a portion of any company’s Cash balance is a “core-business Asset” because the company needs a certain minimum amount of Cash to continue running its business.
So technically, you should subtract only the Excess Cash, i.e. the portion of the Cash balance above this number. For example, if the company has $1,000 in Cash but needs only $200 to run its business, you should subtract $800 rather than $1,000 when calculating Enterprise Value.
However, companies rarely disclose this number, and it is almost impossible to determine on your own, so in practice, everyone just subtracts the entire Cash balance.
`

Question 24

Why do you NOT subtract Goodwill when moving from Equity Value to Enterprise Value? The company doesn’t need it to continue operating its business

Answer 24

Goodwill is a core-business Asset, so you should NOT subtract it when moving to Enterprise Value.
Remember that Goodwill reflects the premiums paid for companies that the company previously acquired – if you subtracted it, you’d be saying, “Those previous acquisitions are not a part of this company’s core business anymore.”
And that’s true only if the company has shut down or sold those companies, in which case it removes all Assets and Liabilities associated with them.

Question 25

Why might you subtract only part of a company’s Deferred Tax Assets (DTAs) when calculating Enterprise Value?

Answer 25

Deferred Tax Assets can contain many different items, some of which are related to simple timing differences or tax credits for operational items.
But you should subtract ONLY the Net Operating Losses (NOLs) that are in the DTA because those are non-operational in nature.

Question 26

How do you factor in Working Capital when moving from Equity Value to Enterprise Value?

Answer 26

You don’t. Remember that Equity Value represents the value of ALL the company’s Assets but only to equity investors.
So, you subtract items only if they’re non-core-business Assets, and you add Liability and Equity line items only if they represent different investor groups
The Assets that comprise Working Capital all count as core-business Assets (e.g., Inventory, Accounts Receivable, Prepaid Expenses, etc.), and the Liabilities in Working Capital are all operational items that do not represent other investor groups (e.g., Accrued Expenses, Deferred Revenue, etc.).
So, there’s no reason to add or subtract Working Capital, as both Equity Value and Enterprise Value reflect it implicitly.

Question 27

Why do you subtract Equity Investments, AKA Associate Companies, when moving from Equity Value to Enterprise Value?

Answer 27

Two reasons. First, they’re non-core-business Assets since the company could operate fine without them. You should, therefore, exclude them from Enterprise Value.
Second, you need to do this for comparability purposes. Metrics like EBITDA, EBIT, and Revenue include 0% of these Equity Investments’ financial contributions, but Equity Value implicitly includes the value of the stake.
So, if a Parent Company owns 30% of an Associate Company, the Parent Company’s Equity Value will include the value of that 30% stake. However, its Revenue, EBIT, and EBITDA include nothing from it.
Therefore, you have to subtract this 30% stake when moving from Equity Value to Enterprise Value to ensure that all Enterprise Value-based valuation multiples exclude Equity Investments in both the numerator and the denominator.

Question 28

Why do you add Noncontrolling Interests when moving from Equity Value to Enterprise Value?

Answer 28

First, these Noncontrolling Interests represent another investor group: Another company that the Parent Company owns a majority stake in. Enterprise Value reflects all the investor groups in a company, so you must add Noncontrolling Interests.
Second, you need to do this for comparability purposes. Since the financial statements are consolidated 100% when the Parent Company owns a majority stake in the Other Company, metrics like Revenue, EBIT, and EBITDA include 100% of the Other Company’s financials.
Equity Value, however, includes only the value of the actual percentage the Parent owns.So, if a Parent Company owns 70% of the Other Company, the Parent Company’s Equity Value will include the value of that 70% stake. But its Revenue, EBIT, and EBITDA reflect 100% of the Other Company’s Revenue, EBIT, and EBITDA.
Therefore, you have to add the 30% the Parent Company does not own – the Noncontrolling Interest – when you move from Equity Value to Enterprise Value, so that Enterprise Value reflects 100% of that Other Company’s value.
Doing so ensures that metrics such as EV / Revenue and EV / EBITDA include 100% of the Other Company’s value and financial contributions so that the multiples are consistent. `

Question 29

A company has 100 shares outstanding, and its current share price is $10.00. It also has 10 options outstanding at an exercise price of $5.00 each. What is its Diluted Equity Value?

Answer 29

Its Basic Equity Value is $1,000, or 100 * $10.00. To calculate the diluted shares, note that the options are all “in-the-money” – their exercise price is less than the current share price.
When these options are exercised, 10 new shares get created – so the share count is now 110 rather than 100.
The investors paid the company $5.00 to exercise the options, so the company gets $50 in cash. It uses that cash to buy back 5 of the new shares, so the diluted share count is 105, and the Diluted Equity Value is $1,050.

Question 30

A company has 100 shares outstanding, and its current share price is $10.00. It also has 10 options outstanding at an exercise price of $15.00. What is its Diluted Equity Value?

Answer 30

$1,000. The options’ exercise price is above the current share price, so they have no dilutive effect.

Question 31

A company has 1 million shares outstanding, and its current share price is $100.00. It also has $10 million of convertible bonds, with a par value of $1,000 and a conversion price of $50.00.
What are its diluted shares outstanding?

Answer 31

First, note that these convertible bonds are convertible because the company’s share price is above the conversion price. So, you count them as additional shares rather than Debt.
Next, you divide the value of the convertible bonds – $10 million – by the par value – $1,000 – to figure out how many individual bonds there are:
$10 million / $1,000 = 10,000 convertible bonds.
Next, the number of shares per bond is the par value divided by the conversion price:
$1,000 / $50.00 = 20 shares per bond.
So, the convertibles create 20 * 10,000, or 200,000 new shares, and the diluted share count is 1.2 million.
You don’t use the Treasury Stock Method with convertibles because the investors don’t pay the company anything to convert the bonds into shares.