Valuation Flashcards
How do you value a company?
Depends on Company and its cash flows:
Look at
1) Operating Statistics
2) Financial Statistics
3) and the market itself (Business Risk)
What is an acquisition comparables analysis?
Method that looks at where similar companies have traded in the M&A market on a multiples basis, and then applies the appropriate multiple to the company in question.
+’s: Includes a premium (control, synergies)
-‘s:
L2:
- Normalize for non-recurring items
- Calculate the LTM for historical data and show forward multiples (projected EBITDA, sales, and etc.)
- Industry specific multiples
What is a public comparable analysis?
Keywords: Similar companies, trading multiples, operating metrics… for similar companies
L1:
Comparison of similar public companies, on multiple bases, allows you to impute an appropriate multiple to apply to the company in question
(Understand why one would trade at a premium/discount relative to its peers)
+’s : Usually LTM / current valuations
-‘s : Sensitive to market fluctuations, Can be difficult to find a similar company
L2:
Normalize none-recurring items
-Calculate LTM for historicals such as EBITDA
-show forward-looking multiples, projected EPS, sales, etc
What are different types of analysis? / Discuss Valuation Methods
DCF Comps Precedent Transactions LBO Merger model Sum of Parts LIquidation analysis
what is a DCF analysis?
Method is used to estimate the intrinsic valuation, independent of the market. It essentially finds the PV of the firm using future UFCF’s over a specific period, plus the terminal value beyond the projections.
The derivations is essentially the enterprise value
Keywords: Annual unlevered free cash flows, terminal value, WACC, to derive the enterprise value of the firm
- estimates the intrinsic value of a business (independent of market)
Level 1 discussion point:
- UFCF projections
- terminal value options
- discount rate methodology
L2:
- calculations for UFCF
- Two TV options
- WACC
- Cost of E using CAPM and role of Beta
What is the best valuation method?
DEPENDS
DCF: Stable, Steady cash flows
Relative: Healthcare, Biotech, Tech
Why use one valuation method over another?
Industry/ stage or life cycle of company / business operations
What is a Leveraged Buyout? And what is an LBO analysis?
1) A financing technique used to acquire a company using a large amount of debt & very little equity.
The analysis is essentially an ‘optimization model’ that evaluates financial sponsors ability to pay while still keeping their IRR in a range of ~20%-25%
+’s: Used as a ‘floor’ valuation to essentially optimize how much the buyer can bid
2) The analysis is an ‘affordability’ analysis that focuses on cash flows generated by the target during the investment period
- this cash pays of debt and interest and provides the financial buyers with ‘leveraged’ returns
IRR goal ~20% + or ~25-30% for growth equity
What is a merger consequences analysis?
Walk me from Equity to Enterprise Value
What happens if the company has net cash in Enterprise value?
How do you calc implied share price given Ent. Value
What is a valuation multiple?
Trading multiples compare a value metric (Ent or Eq) to an operating metrics
(Equity stats)
Only applicable to equity holders after interest expense, dividends, etc,
e.g. P/E, PEG ratio
(Enterprise stats)
Applicable to all capital holders. Debt & others
e.g EV/Sales, EV/ EBITDA
What are the implied multiples?
The trading multiples calculated, hence ‘implied’, based on the valuation methods such as public comps or acquisition comp analyses
How do you get to Unlevered FCF and why use it?
1) Start with Net Income \+ D&A - Change in WC - CapEx =Unlevered free cash flow
How do you calc implied share price given enterprise value?
Can enterprise value be less than equity value?
Yes, more cash than debt
What does Cost of Capital measure (WACC)?
1) Business Risk
- Country risk
- Industry Risk
- Competitive position
- Profitability / peer group comparison
2) Financial Risk
- Accounting
- financial governance
- cash flow adequacy
- Capstructure
- liquidity/short-term factors
How would you find your peer set for public comps?
Based on
1)Operations customer, products/services, maturity/life cycle, geoghraphy, business model)
2) Financial factors( growth, margins > CF generation > returns, Cap structure, size.
What a good indicator a company is in steady-state and heading into its terminal value stage?
1) constant growth rate
2) Capex = Depreciation
e.g if capex is greater than depreciation … Tesla
What accounts for the discount rate in WACC?
It is the riskiness of the cash flows in the projections
- we are discounting unlevered flows, so we need a discount rate appropriate enough for these
Components on WACC
WACC = (Ke * wE) + (Kd * wD)(1-T)
Ke = CAPM rf+B*MRP ——> MRP (Rm-Rf)
Kd =
What determines the cost of debt (Kd) in WACC?
kd = (Cost of Debt x %D) (1-T)
Todays current MARKET rate, or for FORWARD rate. i.e. YTM on the treasury rate 10 yr
As opposed to historical yield
What does the Beta represent in Ke > WACC
Volatility of the stock compared to the market
B less than 1 = less volatile/sensitive or UNCORRELATED to markets
B of 1 = in-line / moves with the with market
B greater than 1 = more volatile/sensitive
What makes up the Cost of Equity?
CAPM = Rf + Beta * (MRP)
MRP = the spread, i.e the avg return on the market less the risk free rate of a 10 yr treasury bond
What happens to cost of equity when the Rf rate increases? Decreases?
Rf vvv = Ke vvv
and vice versa
What happens to cost of equity (Ke) when the Beta increases? Decreases?
Beta increases, Ke ^^ and vice versa
What happens to cost of equity (Ke) when the return on the market increases? Decreases?
Rm ^^^ = Ke ^^^^
What the difference between Levered and Unlevered Beta?
1) Unlevered: Business risk or ASSET BETA
- looks at the industry and competitive dynamics
whereas, Levered takes into account both types of risk
2) Levered: BOTH business & financial risk or EQUITY BETA
When you run your regression in excel you are running an EQUITY or LEVERED BETA
What type of beta is used in CAPM?
An equity beta, because you find the product of the MRP & Beta
What is an industry Beta?
Average of Unlevered (ASSET) Beta in a particular industry
Describe Unlevering/relevering Beta
1) you want to find each peer companies LEVERED beta
2) unlever each company at their D/E ratio
3) Find the Average or median of entire peer set
4) relever the average at appropriate cap structure
- Rationale: Why go through the brain damage of doing this? : Using the financial risk of other companies to find the risk of your own is irrelevant. Industry risk is more important
In a DCF, walk me down to the unlevered free cash-flows
should take 30 seconds
1) Start with EBITDA less D&A to get EBIT
2) Less the affect of taxes to get After Tax Profit Figure (Tax Affected EBIT)
3) Add back in D&A
4) Remove any changes in CapEx and Changes in Working Capital
This will get you to your Unlevered free cash flow with Interest expense (No Financing activity Included) removed to show an unlevered free cash flow amount
What is a terminal value?
Value of the business beyond its annual projections
1) Perpetuity Growth Method
FCF of final year * (1+growth rate)/ (discount rate - growth rate)
* growth rate sits in between inflation and GDP growth
2) Exit Multiple Method
Final year EBITDA * Multiple which is… (TEV/EBITDA )
Whats the difference between an IRR and WACC?
Both discount rates
WACC: used in DCF to calculate the cost of equity and debt. Calculates unlevered FCF’s
IRR: used in LBO’s to calculate a specific return given an offer price. Uses levered FCF’s.
What makes a great LBO candidate?
- Stable cash flows with room for growth (via margins)
- Undervalued
- Mature / stable
- Good management (this will ensure debt is being paid down)
- ability to exit via strategic or sponsor sale, dividend recap
How do LBO’s create value?
1) Delevering (using available FCF’s to repay debt)
2) Operational improvements
- increased margins via optimization
3) Increasing multiples upon exit
Why is EBITDA often used in finance?
(Quick, Easy, Agnostic of capital structure)
(Comparability)
(Links to cash flows which allows you to come up with valuation and lending metrics)
