Valuation Flashcards
Why are similar companies a reference point for valuing a given target?
They share:
- key business and financial characteristics
- performance drivers
- organisational and operational risks
So determine relative position compared to peer firms and then trading multiples are selected
What are disadvantages of comparable analysis?
- no 2 companies are the same
- may fail to accurately capture true value
- based on prevailing market condition and sentiment (not intrisic value)
- market trading activities: irrational investors skew valuation
What are the 5 steps of comparable analysis
1) Select universe of comparable companies (UCC):
-internal list or broader net
2) Locate necessary financial infor:
-regulatory filings, equity research reports, press releases
3) Spread key statistics, ratios and trading multiples:
-Enterprise value, EV etc & trading multiples
4) Benchmark the comparable companies:
- target’s relative ranking and closest comparables (remove outliers)
5) Determine valuation
What is equity value
share price*fully diluted shares outstanding
What are fully diluted shares outstanding?
-Basic shares
- outstanding In-the-money options and warrants
- ITM convertibles
What is enterprise value?
equity value+ total debt+preferred stock + non-controlling interest - cash &cash equivalents
Why not (just) use P/E ratio as comparable?
- typically based on forward EPS (=how much investors are willing to pay for unit of company’s earnings)
- Particulary relevant for mature companies (demonstrated ability to consistently grow earnings)
-irrelevant for companies with little or no earnings - dependent on cap structure: net income is after interest expense
- dependent on tax regimes and certain accounting policies: but EV!
What are commonly used comparables?
1) EV/FCF (CCM)(operating cash, cash flows from investing, cf from financing)
2) Enterprise Value/EBITDA (expectations, interest of debt&equity holders)
3) EV/EBITDA (independent of cap structures, addresses financial reporting diff from D&A policy differences)
4) EV/EBIT (where D&A unaivable, eg divisions of public companies)
5) EV/Sales (high growth start-up)
Why can EBITDA be used as a proxy for company’s current operating profit?
it measures the earnings before deducting interest, taxes, depreciation, and amortization, which are considered non-operating expenses
What are sector specific multiples? (EV/..)
- Telecommunication: fiber miles
- Media: broadcast cf, subscriber #
- metals & mining, natural resources, oil&gas: p,pp,ppp
- real estate, retail: sqr meters space
What are the advantages of comparable companies analysis?
1) Market-based: public info, reflects market-growth, risk expectations and overall sentiment
2) Relative: easy to measure and compare
3) Quick and convenient: few simple inputs
4) Current: prevailing market data, updated regularly for up-to-date metrics
What are the disadvantages of comparable companies analysis
1) Market-based: skewed during periods of extreme behaviour
2) Absence of relevant comparables:
difficult to identify
3) Potential disconnect from CF: Market valuations may differ significantly from these implied by a company’s future CFs
4) Company-specific issues
besides comparable companies, what is another valuation approach?
Precedent transaction analysis:
similar to CC but based on multiples paid for comparable companies in M&A transactions
general rule: most recent transactions (<3yrs) most relevant
What are the 5 steps of precedent transaction analysis?
1) Select UCC
2) Locate necessary deal-related & financial info:
-competitive: limit info to legal requirements
3) Spread key statistics, ratios and transaction multiples:
-transaction multiplies reflect a premiumn for control and synergies
4) Benchmark comparable acquisitions:
relative ranking, further tiering
5) Determine valuation: mean/median, high/low.
what does LTM stand for?
Last 12 months
What are PTA multiples?
1) Offerprice/LTM EPS
2) EV/LTM EBITDA
3) EV/LTM EBIT
4) EV/LTM Sales
What are the advantages of precedent analyis?
1) Market based
2) Current activities
3) Relative
4) Simplicity
5) Objectivity
What are the disadvantages of precedent analysis?
1) Market based (skewed econ environment)
2) Time Lag (past: not reflect of current market conditions)
3) Existence Comparable companies &acquisitions (difficult to find robust universe)
4) Available info (not enough)
5) Acquirer’s basis for valuation (multiple paid maybe based on expectation governing target’s future fin performance)
What is discounted CF analysis?
Used to value a company, division, business or collection of assets (target), derived from PV of projected FCFs.
Sensibility check on market-value metrics.
What is the implied DCF valuation?
“intrinsic value”, not distorted by market aberrations.
Can be used in absence of comparables.
What are the 5 steps of DCF analysis?
1) Study target and determine key performance drivers
2) Project FCFs: typically 5yr period or until “steady state” (unlevered: w/o interest)
3) Calculate weighted average cost of capital (WACC) (reflects Kd & Ke and serves as discount rate)
4) Determine terminal value
5) Calculate PV & determine valuation
(Enterprise value = PV(FCFs) + PV(TV)
What are the steps in calculating FCF?
Step 1) Workout EBIT
Step 2) Unlevered net income
Step 3) FCF = unlevered net income + D&A - Cap Ex - ch(NWC)
What is the terminal value?
the value of an asset, business, or project beyond the forecasted period when FCF can be estimated
What are two different methods of calculating terminal value?
1) Perpetuity growth method
- assumes terminal year FCF will continue growth at constant rate (g<=wacc)
2) Exit multiple method:
- use a multiple of terminal year EBIT(DA). TV = exit multiple *EBIT(DA)n
What are the advantages of DCF analysis?
1) Cash-flow based (reflects value of projected FCFs, more fundamental approach to valuation than multiple-based methods)
2) Market independent (insulated from market anomalies)
3) Self-sufficient (doesn’t rely on truly comparable companies)
4) Flexibility (undertake multiple fin performance scenarios)
What are the disadvantages of DCF analysis?
1) Dependence on financial projections (challenging accurate forecasting)
2) Sensitivity assumptions (small chgs in key assumptions: g, margins, WACC,exit mulitples, very diff ranges)
3) Terminal value (very large component DCF value; lower relevance of projection period’s annual FCF)
4) Assumes constant cap structure (doesn’t provide full flexibility to chgs companies cap structure over projection period)
What are sunk costs
irrecoverable costs for which the firm is already liable
What is the sunk cost fallacy?
Continue to invest in a failing project as mngt believe investment wasted otherwise
What is working capital?
The capital of a business which is used in its day-to-day trading operations.
What are equations for NWC
=current assets - current liabilities
= cash + inventory + trade credit
= cash + inventory + (receivables - payables)
What are further adjustments to FCFs
1) Accelerated depreciation (use most accelerated allowable for tax advantages)
2) Liquidation/salvage value (resale price of asset no longer needed, could be neg)
3) Tax carryforwards/carrybacks (tax losses can be offset against gains in nearby years)
