Error Log Valuation IBV Flashcards
Is a company with a 50x P/E overvalued or undervalued? Why?
- A P/E multiple alone does not tell us if it is over or undervalued.
- We would need to look at the industry average, the expectations for the company’s growth and forward performance, and other qualitative and quantitative considerations.
- Maybe the industry average is 40x and this company seems overvalued relative to its performance, or maybe it is lagging behind and this multiple is “cheap”
- You could compare it to the S&P 500 P/E, but still wouldn’t tell you much since its value should be judged relative to its peer companies
What other Valuation methodologies are there?
Other methodologies include:
* 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 comparables, then discounting it back to its present
value
What are some examples of industry-specific multiples?
Technology (Internet): EV / Unique Visitors, EV / Pageviews
Retail / Airlines: EV / EBITDAR (Earnings Before Interest, Taxes, Depreciation, Amortization & Rent)
Energy: P / MCFE, P / MCFE / D (MCFE = 1 Million Cubic Foot Equivalent, MCFE/D = MCFE per Day), P / NAV (Share Price / Net Asset Value)
Real Estate Investment Trusts (REITs): Price / FFO, Price / AFFO (Funds From Operations, Adjusted Funds From Operations)
Technology and Energy should be straightforward - you’re looking at traffic and energy reserves as value drivers rather than revenue or profit.
For Retail / Airlines, you often remove Rent because it is a major expense and one that varies significantly between different types of companies.
For REITs, Funds From Operations is a common metric that adds back Depreciation and subtracts gains on the sale of property. Depreciation is a non-cash yet extremely large expense in real estate, and gains on sales of properties are assumed to be non-recurring, so FFO is viewed as a “normalized” picture of the cash flow the REIT is generating.
What would you use in conjunction with Free Cash Flow multiples - Equity Value
or Enterprise Value?
Trick question. For Unlevered Free Cash Flow, you would use Enterprise Value, but for Levered Free Cash Flow you would use Equity Value.
Remember, Unlevered Free Cash Flow excludes Interest and thus represents money available to all investors, whereas Levered already includes Interest and the money is therefore only available to equity investors.
Debt investors have already “been paid” with the interest payments they received.
Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium?
This could happen for a number of reasons:
* The company has 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, such as a key patent or other intellectual property.
* It has just won a favorable ruling in a major lawsuit.
* It is the market leader in an industry and has greater market share than its competitors.
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?
Possible reasons:
1. One process was more competitive and had a lot more companies bidding on the
target.
2. One company had recent bad news or a depressed stock price so it was acquired at a discount.
3. They were in industries with different median multiples.
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 depends on the company’s capital structure whereas EV / EBIT and EV / EBITDA are capital structure-neutral. Therefore, you use P / E for banks, financial institutions, and other companies where interest payments / expenses are critical.
EV / EBIT includes Depreciation & Amortization whereas EV / EBITDA excludes it - you’re more likely to use EV / EBIT in industries where D&A is large and where capital expenditures and fixed assets are important (e.g. manufacturing), and EV / EBITDA in industries where fixed assets are less important and where D&A is comparatively smaller (e.g. Internet companies).
If you were buying a vending machine business, would you pay a higher multiple
for a business where you owned the machines and they depreciated normally, or one in which you leased the machines? The cost of depreciation and lease are the same dollar amounts and everything else is held constan
You would pay more for the one where you lease the machines. Enterprise Value would
be the same for both companies, but with the depreciated situation the charge is not reflected in EBITDA - so EBITDA is higher, and the EV / EBITDA multiple is lower as a result. For the leased situation, the lease would show up in SG&A so it would be reflected in EBITDA, making EBITDA lower and the EV / EBITDA multiple higher.
Let’s say we’re valuing a private company. Why might we discount the public company comparable multiples but not the precedent transaction multiples?
There’s no discount because with precedent transactions, you’re acquiring the entire company - and once it’s acquired, the shares immediately become illiquid.
But shares - the ability to buy individual “pieces” of a company rather than the whole thing - can be either liquid (if it’s public) or illiquid (if it’s private).
Since shares of public companies are always more liquid, you would discount public company comparable multiples to account for this.
Can you use private companies as part of your valuation?
Only in the context of precedent transactions - it would make no sense to include them for public company comparables or as part of the Cost of Equity / WACC calculation in a DCF because they are not public and therefore have no values for market cap or Beta.
How do you value banks and financial institutions differently from other
companies?
You mostly use the same methodologies, except:
* You look at P / E and P / BV (Book Value) multiples rather than EV / Revenue, EV / EBITDA, and other “normal” multiples, since banks have unique capital structures.
* You pay more attention to bank-specific metrics like NAV (Net Asset Value) and you might screen companies and precedent transactions based on those instead.
* Rather than a DCF, you use a Dividend Discount Model (DDM) which is similar but is based on the present value of the company’s dividends rather than its free cash flows.
You need to use these methodologies and multiples because interest is a critical
component of a bank’s revenue and because debt is part of its business model rather than just a way to finance acquisitions or expand the business.
I’m looking at financial data for a public company comparable, and it’s April (Q2)
right now. Walk me through how you would “calendarize” this company’s financial statements to show the Trailing Twelve Months as opposed to just the last Fiscal Year.
The “formula” to calendarize financial statements is as follows:
TTM = Most Recent Fiscal Year + New Partial Period - Old Partial Period
So in the example above, we would take the company’s Q1 numbers, add the most recent fiscal year’s numbers, and then subtract the Q1 numbers from that most recent fiscal year.
For US companies you can find these quarterly numbers in the 10-Q; for international companies they’re in the “interim” reports.
Walk me through an M&A premiums analysis.
The purpose of this analysis is to look at similar transactions and see the premiums that
buyers have paid to sellers’ share prices when acquiring them. For example, if a company is trading at $10.00/share and the buyer acquires it for $15.00/share, that’s a 50% premium.
- First, select the precedent transactions based on industry, date (past 2-3 years for example), and size (example: over $1 billion market cap).
- For each transaction, get the seller’s share price 1 day, 20 days, and 60 days before the transaction was announced (you can also look at even longer intervals, or 30 days, 45 days, etc.).
- Then, calculate the 1-day premium, 20-day premium, etc. by dividing the per-share purchase price by the appropriate share prices on each day.
- Get the medians for each set, and then apply them to your company’s current share price, share price 20 days ago, etc. to estimate how much of a premium a buyer might pay for it.
Note that you only use this analysis when valuing public companies because private companies don’t have share prices. Sometimes the set of companies here is exactly the
same as your set of precedent transactions but typically it is broader.
Both M&A premiums analysis and precedent transactions involve looking at previous M&A transactions. What’s the difference in how we select them?
- All the sellers in the M&A premiums analysis must be public.
- Usually we use a broader set of transactions for M&A premiums - we might use fewer than 10 precedent transactions but we might have dozens of M&A
premiums. The industry and financial screens are usually less stringent. - Aside from those, the screening criteria is similar - financial, industry, geography, and date.
Walk me through a Sum-of-the-Parts analysis.
In a Sum-of-the-Parts analysis, you value each division of a company using separate comparables and transactions, get to separate multiples, and then add up each division’s
value to get the total for the company. Example:
We have a manufacturing division with $100 million EBITDA, an entertainment division
with $50 million EBITDA and a consumer goods division with $75 million EBITDA. We’ve selected comparable companies and transactions for each division, and the median multiples come out to 5x EBITDA for manufacturing, 8x EBITDA for
entertainment, and 4x EBITDA for consumer goods.
Our calculation would be $100 5x + $50 8x + $75 * 4x = $1.2 billion for the company’s total value.
