Valuation

Question 1

Why are similar companies a reference point for valuing a given target?

Answer 1

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

Question 2

What are disadvantages of comparable analysis?

Answer 2

• 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

Question 3

What are the 5 steps of comparable analysis

Answer 3

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

Question 4

What is equity value

Answer 4

share price*fully diluted shares outstanding

Question 5

What are fully diluted shares outstanding?

Answer 5

-Basic shares
- outstanding In-the-money options and warrants
- ITM convertibles

Question 6

What is enterprise value?

Answer 6

equity value+ total debt+preferred stock + non-controlling interest - cash &cash equivalents

Question 7

Why not (just) use P/E ratio as comparable?

Answer 7

• 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!

Question 8

What are commonly used comparables?

Answer 8

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)

Question 9

Why can EBITDA be used as a proxy for company’s current operating profit?

Answer 9

it measures the earnings before deducting interest, taxes, depreciation, and amortization, which are considered non-operating expenses

Question 10

What are sector specific multiples? (EV/..)

Answer 10

• Telecommunication: fiber miles
• Media: broadcast cf, subscriber #
• metals & mining, natural resources, oil&gas: p,pp,ppp
• real estate, retail: sqr meters space

Question 11

What are the advantages of comparable companies analysis?

Answer 11

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

Question 12

What are the disadvantages of comparable companies analysis

Answer 12

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

Question 13

besides comparable companies, what is another valuation approach?

Answer 13

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

Question 14

What are the 5 steps of precedent transaction analysis?

Answer 14

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.

Question 15

what does LTM stand for?

Answer 15

Last 12 months

Question 16

What are PTA multiples?

Answer 16

1) Offerprice/LTM EPS
2) EV/LTM EBITDA
3) EV/LTM EBIT
4) EV/LTM Sales

Question 17

What are the advantages of precedent analyis?

Answer 17

1) Market based
2) Current activities
3) Relative
4) Simplicity
5) Objectivity

Question 18

What are the disadvantages of precedent analysis?

Answer 18

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)

Question 19

What is discounted CF analysis?

Answer 19

Used to value a company, division, business or collection of assets (target), derived from PV of projected FCFs.
Sensibility check on market-value metrics.

Question 20

What is the implied DCF valuation?

Answer 20

“intrinsic value”, not distorted by market aberrations.
Can be used in absence of comparables.

Question 21

What are the 5 steps of DCF analysis?

Answer 21

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)

Question 22

What are the steps in calculating FCF?

Answer 22

Step 1) Workout EBIT
Step 2) Unlevered net income
Step 3) FCF = unlevered net income + D&A - Cap Ex - ch(NWC)

Question 23

What is the terminal value?

Answer 23

the value of an asset, business, or project beyond the forecasted period when FCF can be estimated

Question 24

What are two different methods of calculating terminal value?

Answer 24

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

Question 25

What are the advantages of DCF analysis?

Answer 25

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)

Question 26

What are the disadvantages of DCF analysis?

Answer 26

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)

Question 27

What are sunk costs

Answer 27

irrecoverable costs for which the firm is already liable

Question 28

What is the sunk cost fallacy?

Answer 28

Continue to invest in a failing project as mngt believe investment wasted otherwise

Question 29

What is working capital?

Answer 29

The capital of a business which is used in its day-to-day trading operations.

Question 30

What are equations for NWC

Answer 30

=current assets - current liabilities
= cash + inventory + trade credit
= cash + inventory + (receivables - payables)

Question 31

What are further adjustments to FCFs

Answer 31

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)