Lecture 1: Valuation Flashcards
P&L proxy for cash generated by operations of firm during a FY
EBITDA, we consider that tax payment and change in WC are minimal
Different types of NI on consolidated P&L?
“Net Income Group” (NIG): attributable to all shareholders of the consolidated companies i.e. parent SH and SH of subidaries controlled but not 100% owned by parent company. –> total net income of consolidated companies
“Net Income Group Share (NIGS)”: share of net income group only attributable to parent companies
NICS = NIG - NNCI
Which NI for P/E ratio of a listed company?
NIGS (numerator: Market Cap which does not include NCI shares)
Formula Operating WC?
OpWC = A/R + Inventory - AP (+ Prepaid Expenses - Accrued Interest)
Difference operating and total WC?
WC = Op WC + non Op WC (amounts due on Fixed assets, dividends to be paid, Extraordinary items, corporate tax payable)
Capital Employed (qualitative)
BV of 100% of all controlled subsidiaries’ net operating assets (incl. parent company)
CE being BV items and EV MV
Associates vs. Minority Investment
Both are equity investments
Associate: equity ownership (usually 20-49.9%) that provides you a significant influence on the firm
Investment (<20%), only classical role of a minority shareholder
Difference between ROCE and ROIC
should be no general definition but might vary between companies
Use of ROCE (3x)
1) look ex-post at historical performance
2) Measure of business performance to pay top managers
3) Comparing company operating performance vs. its competitors
(Cannot be interpreted over only one year, e.g. company can have negative ROCE during one year because it is investing in the future)
Two levers to increase ROCE
1) Operating profit (after tax)
2) increase capital efficiency (i.e. increase number of € generated in sales for a given € invested in CE)
ROCE depends on capital structure?
No
ROE, dependent on capital structure (i.e. leverage effect is positive only if ROCE after tax > cost of debt x (1-t).
CoD: accounting CoD (i.e. interest expenses/financial debt)
Other name of EBIT(1-T)
NOPAT (Net Operating Profit After Tax) or EBIAT or NOPLAT
Which coherence do you need to ensure between EBIT and CE when computing historical ROCE?
1) “Core business”, businesses having the same risk/return profile
- EBIT only include these expenses/income
- CE only net operating assets of such core business
CB could be asked regarding equity investment (associates). In same “core business”?
2) “Recurring”: i.e. not include income/expense which are not recurring
Which expected return can you compare the ROCE? Interpretation?
To WACC (if consistent with tax rate used)
ROCE > WACC (i.e. return obtained on operations higher than weighted average expected return of your capital providers). –> creating value –> increase EV
How is WACC impacted by capital structure?
1) PV of tax shield lower or higher than PV of bankruptcy costs depending on capital structure, WACC will depend on capital structure (as will be the value of firm) and there will be optimal WACC
2) If WACC corresponds riskiness of operating net assets of a firm (which should be the case), such risk should be independent from the way operating assets are financed
3 drivers of EV
1) Expected growth: direct
2) Expected ROCE: direct
3) Operating risk: indirect
4) Financial risk: more leverage -> higher risk
Return expected by shareholders? By debtholders?
Cost of equity (Ke) and Cost of debt (Kd)
Higher expected growth secondary effect (apart higher EV)
1) Generating growth means investing, i.e. increasing CE, therefore reducing expected Roce
2) could mean increased competition, therefore increased operating risk, leading to lower EV
Criteria for a company to create value? Can this be judged on a single year?`Impact on EV of value creation?
ex-post ROCE (post tax) > WACC. Cannot judge this on a single year basis as a company can destroy value for 1-2 years in order to create value in the future
Create value –> increases EV
Company increasing regularly its ROCE?
Manages to reinvest € at higher rate than WAC, creating value and increasing its ROCE
Factor that can accelerate or not value destruction (or creation)? How dies it relate to M&A operations?
Future Growth.
M&A way to increase very significantly growth vs. organic growth. Carefully assessed as growth factor coming from M&A operation will magnify the value creation/destruction risk
Condition to have a positive leverage effect on ROE?
ROE (after tax) > higher than cost of debt (post tax). –> accounting cost of debt (i.e. net interest expense / net debt).
But higher ROE comes with higher risk.
Def.: Enterprise Value
MV of 100% of all controlled subsidiaries’ net operating assets (including parent company).
EV - Equity bridge (asset-like items)
- Associates
- Asset like items
- Cash
- Investments
- Tax-loss carried forward
- Overfunded pensions (barely done bc. associated cost is usually very highly or sth. forbidden)
EV - Equity bridge (debt-like items)
- NCI
- Debt
- Debt-like items
- Preferred stocks
- Underfunded pension deficit (UPD) = (PBO - PA)*(1-t) (since gap can be filled through contributions that are tax deductible)
- Operating leases that are “artificially” capitalized
- Significant provisions (not related to day to day operations, financing partially its operations through these provisions)
- OPEBs: Other Post Employment Benefits (e.g. healthcare plan)
Which case do we need to compute EV from Eqv / Evq from EV?
Trading/Transaction multiples to EV.
DCF to EqV (to purchase minority stake)
SPA includes EV but also EqV
Preferred shares and how to take them into account in EV - EqV bridge?
No voting rigths but preferential fixed dividends (usually not very liquid), (junior to common shares)
Considered as debt-like items: deduct them from EV)
NCI in EV - Equity bridge?
Debt like items and add them to EqV
Investment EV - Equity bridge?
Asset like. Substract them. These value are outside of EV.
Sum of the Parts: Summing up the value of each independent business, what positive value is not taken into account and what two negative value are usually taken into account?
+ No synergies “offensive”
- Holding costs Value (overhead costs at the holding level)
- Holding discount (lack of focus)
Main drivers of multiples
- Interest rate (indirect)
- Expected growth
- Risk level (Operating, Financial)
Relationship between multiple levels and future earnings growth in a given industry?
EBITDA CAGR n to (n+2) vs. EV/EBITDA n
EBIT CAGR n to (n+2) vs. EV/EBIT n
EPS CAGR n to (n+2) vs. P/E n
Small firms usually compare with bigger ones?
Small companies are usually valued at lower multiples than bigger ones (more risky due to lack of diversification, smaller mgmt. team and higher cost of funding)
How to select relevant peers for a trading comparable analysis?
Same risk/return profile
Risk: same business, geographies, size
Return: growth, profitability, same EBITDA growth, P/E similar capital structure
Trading comparable method: minority vs. majority?
Minority stake (based on current share price)
2 main pros and 2 cons of trading multiple method
pro: public data, tells about market thoughts (terms of company strategies in given sector or across sectors)
con: no control premium, accurate choice of set of comps
How to find comparable Transactions?
- change of control
- characteristics of target
- recent (same macro, micro context)
- time with same macro/micro (e.g. GDP growth)
- same context: 1) competitive bid vs. fire sale, 2) strategic vs. financial buyer, 3) level of leverage feasible at time of transaction
Which fiscal year to use when compute Transaction multiples?
LTM since mostly private targets (no forecasts).
Furthermore, only public information useable
Transaction with 80% acquisition of equity
Gross up to 100% the value paid for 80% of equity
2 main pros/cons: Transaction comps
Pro: Control premium, help identify Interpols
Cons: no single transaction is identical (timing, context), accurate data are difficult to get
EV/EBITDA vs EV/EBIT
EV/EBITDA non capital intense companies as you do not get distortion from accounting treatment of D&A by using EBITDA
Capital intense: EV/EBIT since Capex is taken into account (assume D&A = Capex)
Multiple to take into account capital intensity of a firm and avoid accounting distortions? What other as proxy?
EV/(EBIDA-CAPEX), implies volatility since CAPEX might change.
EV/EBIT as proxy as assume Capex = D&A
EV/FCFF relevant?
best EV multiple but most difficult to compute (EBITDA as proxy)
Pros and cons: P/E ratio
Pro: very easy, no computation
Cons: NI polluted by non-recurring item; depends on capital structure
When P/B ratio?
Financial institutions as they don’t have EBIT or EBITDA (also for Real Estate since vast majority of assets reassessed at MV in accounting books regularly)
When EV/Sales?
- Negative earnings
- Industry where sales level is key and small and similar margins
2-3 examples of common non-recurring items? Where to find the info?
Impairment, capital gain asset sale
Need to adjust (and how) when we wish to clean non-recurring items from earnings?
Clean both EBIT and EBITDA using pre-tax amount of non-recurring items
NI post tax (mostly effective tax rate)
Forecasts most of time without non-recurring items
Tax rate to compute FCFF
normative tax rate but take statutory tax rate as proxy.
Non-cash items to add back to compute FCFF. Start EBIT(1-T)
+ D&A
+ Non recurring cash items like Capital Gain on Asset Sale or Impairments
Coherence when computing FCFF
What to include in FCFF and what in Bridge. Not double. E.g. restructuring cost
Normative FCFF
Last year FCFF
- same margin (cycle)
- Level of Capex > D&A
- delta NWC at historical % of delta Sales
- ROCE at industry level
Projection period DCF
Until mature (5-10y) Infrastructure (20-40y) and activity will stop at the end of this period
Maximum perpetuity growth in TV?
Growth rate of global economy (to not become global economy)
Value driver method: TV on case marginal ROCE = WACC
TV = EBIT normative (1-t) / WACC (same as no g for normative FCFF, independent of ROCE)
Which case FCFE? Discount rate? Result of NPV calculation?
For financial institutions. CoE as discount. NPV is EqV
Exit multiple method to assess TV? How do you ensure it is coherent with perpetual growth method?
Assume Multiple in last year of forecasted period is equal to today’s LTM Multiple
Graph of EV/EBITDA LTM vs. EBITDA future growth. Look for multiple that matches a EBITDA growth rate which is equal to the perpetual growth rate “g” used in the perpetual growth rate method
If TV found with exit multiple differs from the one found through perpetual growth method: adjust g to make the 2 values converge.
Back-up g used in perpetual growth method: g found can be interpreted as LT steady-stake growth rate of set of peers as viewed by market today.
Value of Equity Risk Premium (CAPM Modell)?
Between 4-6% depending geography (compare with researches or internal teams at bank)
2 main pros/cons of DCF
Pro: all time even with loss making companies, sensitivities
Cons: easy to manipulate (WACC, g), assume constant capital structure
No potential dilution what number of share to use for market cap.?
number of shares outstanding: NOSH = nb. of shares issued - nb of treasury shares
Formula shares equivalent due to exercise of stock option? Assumption underlying the Treasury Stock Method TSM?
Shares equivalent = N x (1 - K/P) with N: nb of options; K: strike price of option, P: current share price
TSM assumes that all cash received by company from exercise of options will be used to buyback shares at current share price
Rank valuation methods?
Trading < Transactions
DCF depending on assumptions but should be between the two of them
