Lecture 2 Flashcards
How do comparable transactions analyse wor?
Comparable transaction analysis:
- Derive implied market valuation for a company in an acquisition context Those control premiums are the reason why transaction multiples are generally higher than trading multiples
- Right peer group Business activity (industry, products and distribution channels), geographical focus, size, growth profile, profitability, accounting policies, public vs. private
- Ideally, the transactions should be of similar proportions (30% vs 100% as premiums paid), and be of similar considerations (cash vs debt vs equity) as 100% cash offer likely lower than 100% equity offer / involve similar bidders (strategic vs financial) , have similar transaction profile (friendly, hostile bid)
- Be prepared to discuss outliers (low = distressed e.g. & high = “bad year”)
How do comparable transaction analyse work?
Comparison of relative valuation metrics (multiples, yields) or operating performance metrics (e.g. growth, profitability) of comparable publicly traded companies
Why use this method?
- Compare relative valuation of listed target vs. peers to determine if it is fairly valued
o Triangulate relative valuation analysis with corresponding operating performance characteristics of the peer group Regression
- Perform valuation of a private target applying val metrics to the operating metrics of the target
o Such valuation is market-based and does not fully take into account any long-term cash flow-generating ability of the company. Therefore, other valuation techniques are needed
- Perform operating benchmarking analysis to determine operating performance of the target vs. peers; such regression analyses help to identify on which metrics companies (or sectors) trade
Growth factors for dcf
LT growth Extrapolated approach – essentially move towards a steady state of growth
Factors include:
- High growth (abnormally high growing industries & forecast period should be long enough for this to return to a steady state)
- Cyclicality (FP should be long enough to allow to play over an up- and down-cycle before reaching mid-cycle)
- Extraordinary influences or fundemenal changes (Long enough to capture extra influences which could not be captured in TV)
- Finite asset life (if asset is significant part of business, projections must capture full life time)
TV normalisation
Terminal value normalisations:
- Sales growth: In line with nominal GDP
- EBITDA Margin: Are margins sustainable in the long-run compared to market, peers?
- CAPEX: Adaquate to support the business
- D&A: Function of capex & usually capex exceeds
- Change in WC: Should not have impact on TV & consistent with assumed growth rate
LBO IDeal candidate
Potential debt structures
- Dependent on current financing markets and driven by investor appetite for specific loan products and comparative pricing
- Input from leverage finance department (origination, syndication, etc.)
- Vendor may help offer vendor loan or stapled financing
MAximum amount of debt
Driven by debt capacity (amortisation and repayment), safety headroom and minimum equity requirements
Debt capacity consideration
- Financiers typically want to see the viability of de-leveraging over time, hence guaranteed repayment. Sustainable sales growth, EBITDA Margin, future capex and working capital needs are all factors in this consideration.
- Key indicators for max debt capacity are: (1) liquidity over forecast period, (2) leverage levels over forecast period (comparing EBITDA to leverage) , and (3) the debt service coverage ratio must remain above 1.3.
Two Uses
Refinancing existing net debt
- Typically targets lever down so the objective is to lever it up to the maximum sustainable level
Pensions
- Typically need to be refinanced in German transactions,
Purchase Price
- Maximum equity purchase price is output of LBO valuation, negoation and assessment of value for buyer
Transaction Fees
- Financing fees = largest part financial, legal, tax and due diligence account for the rest
THree -paydown profile
- Different types of financing: Some are amortising and some are bullets
- If performance is better than planned, the firm will try to de-risk its position
o Buy-out company to commit 50% cash flow after int and amortisation to extraordinarily pay off debt (“cash sweep”)
o The amount of cash subject to cash sweep depends on existing leverage - If ahead of plan and FM are favourable, funds can boost returns by relevergin the buy-out company in order to finance a special dividend (“recap”) replacing equity with more debt
Four Entry Multiples
IRR drivers:
- (End Eq V/ Start Eq V)(1/t)-1 = Rough rule (72/ number of years it takes to double)
- To calculate IRR, the PE fund must determine an assumption at which valuation levels the buy-out firm can be sold for
Exit Multiple:
- Current valuation levels may not representative for valuation levels at sale PE Funds look at historical CCA and CTA multiples to determine valuation levels across business cycles
- Exit multiple equals entry / optimistic = multiple grows/ pessismistic = multiple contracts
Five ratios,debt package
- Financing banks “play“ with the proposed debt package to ensure that the company can sustain the burden - Leverage and coverage ratios help in determining such sustainability
- Covenants set boundaries for the debtor to decrease lender risk
- Major financial covenants: Leverage cover ratio (Net debt to EBITDA), interest cover ratio, fixed charge coverage Financial covenants are determined from ratios in business plan plus safety headroom
- Non-financial covenants (incurrence covenants) (1) Negative pledge & no pledge in favor of other creditors (2) Pari passu – all current and future senior debt is of equal ordination
Six Value creation
Merger analysis
The merger model analyses the financial impact of a business combination on the potential buyer
⎯ Earnings growth and margin profile, financial leverage and coverage, as well as cash flow profile of the combined entity vs.
buyer stand alone
▪ For a publicly listed buyer this analysis is an important instrument in developing a judgment on a potential market reaction to a transaction
▪ Given investors focus on the P/E multiples as a metric of relative market valuation of the company, and its direct mathematic al relationship with EPS, the main focus of
the analysis becomes impact of the transaction on EPS, that is, EPS accretion/dilution
▪ As such, besides the financial profile of the buyer and target stand alone and combined (i.e. including any potential synergi es), the analysis also takes into account such
important EPS impact factors as various prices paid for the target as well as different forms of financing
Vendor Loan
In M&A (mergers and acquisitions), vendor financing or seller’s loan is also one of the solutions to facilitate deal funding. It is often up to 20% of the purchase price and stands at the same level as the buyer’s contribution, bank, and institutional debt.
