deck_4629084-M&A Flashcards
What are the 3 major valuation methodologies?
- Public Company comparables (public comps) - relative valuation2. Precedent Transactions (trading comps) - relative valuation3. Discounted Cash Flow analysis - intrinsic valuation
Can you walk me through how you use Public Comps and Precedent Transactions?
- Select the universe of comparable companies based on key criteria (e.g. industry‚ financial metrics‚ geography)2. Locate the necessary financial information3. Spread key statistics‚ ratios‚ and trading multiples (e.g. revenue‚ revenue growth‚ EBITDA‚ EBITDA margins‚ revenue and EBITDA multiples)4. Benchmark the comparable companies (min.‚ 25%ile‚ median‚ 75%ile‚ max)5. Apply multiples & determine valuation
How do you select Comparable Companies or Precedent Transactions?
- Business Profile (sector‚ products and services‚ customers and end markets‚ distribution channels‚ geography)2. Financial Profile (size‚ profitability‚ growth profile‚ return on investment‚ credit profile)
For Public Comps‚ you calculate Equity Value and Enterprise Value for use in multiples based on companies’ share prices and share counts… but what about for Precedent Transactions? how do you calculate multiples there?
• multiples should be based on the purchase price of the company at the time of the deal announcement (the affected share price)• you only care about what the offer price was at the initial deal announcement. You never look at the company’s value prior to the deal being announced.
How would you value an apple tree?
• same way you would value a company: what are comparable apple trees worth? (relative valuation)• present value of FCF for the apple (intrinsic valuation)
When is a DCF useful? When is it not useful?
• DCF is best when the company is large‚ mature‚ and has stable and predictable cash flows (the far-in-the-future assumptions will be more accurate)• DCF is not as useful if the company has unstable or unpredictable cash flows (start-up) or when Debt and Operating Assets & Liabilities serve fundamentally different roles (financial institutions)
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• 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 comparables and then discounting it back to its present value
When is a Liquidation Valuation useful?
• Most common in bankruptcy scenarios and is used to see whether or not shareholders will receive anything after the company’s Liabilities have been paid off with the proceeds from selling all its Assets• Often used to advise struggling businesses whether it’s better to sell off Assets or sell 100% of company
When would you use a Sum of the Parts Valuation?
For conglomerates that have completely unrelated divisions (e.g. GE)• Should use different comparable sets for each division‚ value each division separately‚ and then add them back together to calculate Total Value
When do you use an LBO Analysis as part of your valuation?
• obviously for LBOs• used to “set a floor/lower bound” on company valuation‚ min. amount that PE firm would be willing to pay to achieve targeted returns• often see it used when both strategics (normal companies) and financial sponsors are competing to buy the same company and you want to determine the potential price if a PE firm were to acquire the company.
How do you apply the valuation methodologies to value a company?
• Present range of valuations from different methodologies on a “football field”• to do this‚ calculate min.‚ 25%ile‚ median‚ 75%ile‚ max values for each set (2-3 years of comps and the transactions‚ for each different multiple used) and then multiply by the relevant metrics for the company you’re analyzing)• For public companies‚ you will also work backwards to calculate Equity Value and implied per Share Price based on this.
Can you walk me through how to calculate EBIT and EBITDA? How are they different?
• EBIT is just a company’s operating income on its I/S‚ it includes not only COGS and operating expenses‚ but also non-cash expenses such as D&A and therefore reflects‚ at least indirectly‚ the company’s CapEx• EBITDA is defined as EBIT plus D&A. You may sometimes add back other expenses• The idea of EBITDA is to move closer to a company’s “cash flow‚” since D&A are non-cash expenses‚ but the problem is that you exclude CapEx altogether
Can you walk me through how to calculate Unlevered FCF (FCF to Firm) and Levered FCF (FCF to Equity)?
• Unlevered FCF = EBIT*(1 - Tax Rate) + Non-cash expenses - Change in Operating Assets & Liabilities - CapEx• Levered FCF = Net Income + Non-Cash expenses - Change in Operating Assets & Liabilities - CapEx - Mandatory Debt Repayments
What are the most common valuation multiples? And what do they mean?
• EV/Revenue: how valuable a company is relative to its overall sales• EV/EBITDA: how valuable a company is relative to its approximate cash flow• EV/EBIT: how valuable a company is relative to the pre-tax profit it earns from its core business operations• P/E: how valuable a company is in relation to its after-tax profits‚ inclusive of interest income and expense and other non-core business activities• Other multiples include P/BV‚ EV/Unlevered FCF‚ Equity Value/Levered FCF• EV/Unlevered FCF is closer to true cash flow than EV/EBITDA but takes more work to calculate‚ and Equity Value/Levered FCF is even closer‚ but is affected by company’s capital structure and takes even more time to calculate.
How are the key operating metrics and valuation multiples correlated? In other words‚ what might explain a higher or lower EV/EBITDA multiple?
• Usually there is a correlation between growth and valuation multiples• Math also plays a role‚ sometimes companies w/ extremely high EBITDA margins may have lower EBITDA multiples because EBITDA itself is much higher to begin with (and its in the denominator)
Why can’t you use Equity Value / EBITDA as a multiple rather than EV/EBITDA?
Equity Value/EBITDA is comparing apples to oranges because equity value does not reflect the company’s entire capital structure (only what is available to common shareholders).
What would you use with Free Cash Flow multiples - Equity Value or Enterprise Value?
• For Unlevered FCF‚ you use enterprise value (cash flow available to all investors)• For levered FCF‚ you use equity value (cash flow available to equity investors)
Why does Warren Buffet prefer EBIT multiples to EBITDA multiples?
• WB dislikes EBITDA b/c it hides the CapEx companies make and disguises how much cash they require to finance their operations• Any industry that is capital intensive and asset-heavy will have a huge disparity between EBIT and EBITDA• Note: EBIT itself does NOT include CapEx but it includes depreciation (which is directly linked to CapEx). If a company has high depreciation‚ chances are it has high CapEx spending
What are some problems with EBITDA and EBITDA multiple? And if there are so many problems‚ why do we still use it?
• It hides the amount of debt principal and interest that a company is paying each year‚ which can be very large and make company cash flows negative‚ also hides CapEx spending• EBITDA also ignores working capital requirements (e.g. A/R‚ Inv.‚ A/P)‚ which can be large for some companies• in a lot of cases EBITDA may not even be close to true cash flow‚ it’s widely used for convenience and comparability (better for comparing cash generated by a company’s core business operations than other metrics)
The EV/EBIT‚ EV/EBITDA‚ and P/E multiples all measure a company’s profitability. What’s the difference between them‚ and when do you use each one?
• P/E is dependent on company’s capital structure‚ EV/EBIT and EV/EBITDA are capital structure-neutral. So you use P/E for financial institutions where interest is critical and capital structures are similar.• EV/EBIT includes D&A‚ where EV/EBITDA excludes it‚ more likely to use EV/EBIT in industries where D&A is large and where CapEx and fixed assets is important (manufacturing) and EV/EBIT where fixed assets are less important and where D&A is comparatively smaller (e.g. internet companies)
Could EV/EBITDA ever be higher than EV/EBIT for the same company?
• No‚ by definition EBITDA must be greater than or equal to EBIT‚ b/c EBITDA = EBIT + D&A (neither of which can be negative‚ can be $0 theoretically)• Since EBITDA is always greater than or equal to EBIT‚ EV/EBITDA must always be less than or equal to EV/EBIT for a single company
What are some examples of industry-specific multiples?
• Technology/Internet: EV/Unique Visitors‚ EV/Page Views• Retail/Airlines: EV/EBITDAR (EBITDA + Rental Expense)• Oil & Gas: EV/EBITDAX (EBITDA + Exploration Expense)‚ EV/Production‚ EV/Proved Reserves• Real Estate Investment Trusts (REITs): Price/FFO per Share‚ Price/AFFO per Share (Funds from Operations‚ Adj. Funds from Operations)
When you’re looking at an industry specific multiple like EV/Proved Reserves or EV/Subscribers (for telecom companies‚ for example)‚ why do you use Enterprise Value rather than Equity Value?
Enterprise Value is used b/c those proved reserves or subscribers are “available” to all the investors (both debt and equity) in a company. This is almost always the case unless the metric already includes interest income and expense (FFO & AFFO)
Rank the 3 main valuation methodologies from highest to lowest expected value.
Trick question - there is no one ranking that will always hold up.• In general‚ precedent transactions will be higher than comparable public companies due to the control premium built into acquisitions (buyer must pay premium to acquire seller)• DCF could go either way‚ best to say it’s just more variable than other methodologies. Often produces highest value‚ but can produce lowest value as well depending on assumptions.
