valuation

Question 1

Company valuation Rule 1: Think like an investor
describe:
- key question
- most important elements

Answer 1

Key question: will I be wealthier as a result of the M&A?

Most important elements:

• Focus on the future, not the past
• Focus on economic reality: cash flow, not earnings
• Get paid for the risks you take
• Time is money
• Remember ‘opportunity cost’: alternative deals or actions
• Private information is the main source of advantage
• Take into account diversification: Evaluate deals in terms of the risk they add to your portfolio, rather than their total risk on a stand-alone basis.

Question 2

Company valuation Rule 2: Intrinsic value is unobservable.
elaborate

Answer 2

• The aim of valuation is to assess the true or intrinsic value of an asset.
• Unfortunately, this value is unobservable
• The results of valuation analysis are estimates, measured with error.
• The process of valuation analysis should be structured as a triangulation from several vantage points.
• Do not work with point estimates of value, but with ranges. Do not expect precision

Question 3

Company valuation Rule 3: If price < >intrinsic Value → Opportunity
explain the buyers and the sellers view

Answer 3

• Rules for creating value (and avoiding value destruction):

Buyer’s view: Accept if: Intrinsic value of target to buyer > Price

Seller’s view: Accept if: Price > Intrinsic value of target to seller

Question 4

Company valuation what estimators are there

Answer 4

Accounting book value
Liquidation value
Replacement value
Market value
Trading multiples of peer firms
Transaction multiples of peer firms
Discounted cash flow (DCF) values
Venture capital/private equity approach – focus on short run and early exit
Option valuation approach

Question 5

describe the accounting book value

Answer 5

= The book value of the company stated on the balance sheet

+: Simple Based on audited information

–: Ignores intangibles eg know-how, brands
Backward-looking (breaks Rule 1)
Subject to accounting manipulation

Question 6

describe Liquidation value:

Answer 6

= Sum of the values that might be realized if firm is liquidated today

+: Conservative

–: Ignores ‘going concern’ value

Difficult to determine
Probably not useful in M&A setting, except for ‘buy and bust’ transactions eg failing firms

Question 7

describe Replacement value:

Answer 7

= Cost to replace the assets of the firm today

+: Gives valuable insights in high-inflation setting
Reflects current conditions rather than past

–: Often unclear what needs to be replaced
Highly subjective
Difficult to use for intangible assets

Question 8

describe Market value

Answer 8

= Sum of market values of equity and debt

+: Presents reasonable floor for valuation
Reflects what is publicly known about a firm

–: Only useful if
Target firm’s securities are actively traded
Markets are efficient

Question 9

describe, Trading multiples of peer firms

Answer 9

= Estimate of a target’s value by applying multiples (e.g., P/E, EV/EBITDA) of peer firms to the target

+: Simple
Widely used by practitioners
Can be used to value private company

–: Good peers are hard to find
Depends on accounting practices
Not always comparable
Not cash-flow oriented (loss making start-ups?)

Question 10

describe, Transaction multiples of peer firms:

Answer 10

example
Same as trading multiples for peer firm, except that we use transaction values (TV) instead of market values ie M&A deal values (use Thomson One)

Question 11

describe, Discounted cash flow (DCF) values

Answer 11

Firm value = Present value of future cash flows, using an estimated cost of capital.

• Acquisition is fundamentally a capital budgeting problem.

Engage in M&A if: NPV > 0 i.e. if DCF value – price > 0

+: Captures three important notions:
Investors want cash and no accounting stuff
£ now is worth more than £ tomorrow
Risk-free £ is worth more than risky £

–: Time consuming
Risk of ‘analysis paralysis’

Question 12

describe: Venture capital/private equity approach – focus on short run and early exit

Answer 12

= Stripped-down version of DCF methods:
No interim cash flows (before exit date) because of nature of business. Simply discount exit multiple at given discount rate (30-75%)

\+:  Simpler than standard DCF valuation. Focus on exit value and timing                                         

–:   Discount rates may appear arbitrary            
and too high           
Interim cash flows may be material           
Ignores debt financing – firm financed by equity 
e.g valuation of “Unicorn” (privately held start-up company valued at over $1 billion) firms

Question 13

describe: Option valuation approach

Answer 13

= Takes into account the real options
embedded in firm value – the (small) probability of a large payoff in future

   		\+:  Augments DCF for hidden option value           
	Permits explicit modelling of hidden rights                                       

	–:   Difficult to estimate parameters           
	Complex modelling may be required

Question 14

Company valuation Rule 5: Exercise estimators
explain…

Answer 14

*Analysts should ‘exercise’ the estimators to define
- a reasonable range of value
- identify key value drivers or assumptions

*Some techniques:
- Scenario analysis (‘What if…’)
- Breakeven analysis (examine the sensitivity of estimate to changes in main value drivers)

Question 15

Company valuation Rule 6: Think critically, triangulate carefully
explain…

Answer 15

*If done right, valuation yields a large number of value estimates
*These need to be boiled down to a range of value that forms the basis of a negotiation strategy, by means of triangulation

*Different steps in triangulation:
- Scrutinize data and estimators
- Scrutinize spreadsheet model
- Eliminate estimates in which you have little confidence
- Compare the final value estimates
- Choose!
*Eventually you should end up with a negotiation range,
varying between an opening bid and a walk-away bid.