Valuation

Question 1

1. What are the 3 major valuation methodologies?

Answer 1

1. DCF
2. Comparable Companies
3. Precedent Transactions

Question 2

2. Rank the 3 valuation methodologies from highest to lowest expected value.

Answer 2

No rankings that’s always accurate. Generally
1. Precedent Transactions is greater than Comparable Companies due to Control Premium built into acquisitions
2. DCF is the most variable, it can sometimes be the highest and sometimes be the lowest

Question 3

3. When would you not use a DCF in a Valuation?

Answer 3

1. When the company has unpredictable cash flow
2. When the debt and working capitals serve different roles

Question 4

4. What other Valuation methodologies are there?

Answer 4

1. Liquidation Valuation: Calculates the net value of a company if it were to be liquidated by selling off all its assets and paying off liabilities.
2. Replacement Value: Estimates how much it would cost to replace a company’s assets at current market rates.
3. LBO Analysis: Determines the maximum price a private equity firm could pay for a company while achieving a target return (Internal Rate of Return, IRR). It assumes the firm finances the acquisition with a significant amount of debt.
4. Sum of the Parts: calculate the value of each department separately and then adds them up to calculate the value of the company
5. M&A Premiums Analysis
6. Future Share Price Analysis

Question 5

5. When would you use a Liquidation Valuation?

Answer 5

• Bankruptcy scenarios
• Used to see if the investors would receive any capital after the company’s debt is paid off
• often used to advise the struggle company on whether to sell off assets separately or sell the entire company

Question 6

6. When do you use sum of parts

Answer 6

• when a company has a completely different and unrelated departments

Question 7

7. When do you use an LBO Analysis as part of your Valuation?

Answer 7

• whenever looking at a leveraged buyout
• also used to see how much a private equity firm could pay, which is lower than strategic acquirers or companies would pay

Question 8

8. What are the most common multiples used in Valuation?

Answer 8

• EV/Revenue
• EV/EBITDA
• EV/EBIT
• P/E
• P/BV

Question 9

9. What are some examples of industry-specific multiples?

Answer 9

1. Tech
   - EV/Unique Visitors
   - EV/Pageview
2. Retail/Airlines
   - EV/EBITDAR (Earnings before interest, tax, depreciation, amortization, and RENT)
3. Energy:
   - EV/MCFE
4. Real-estate:
   - Price/FFO (funds from operation)
   - Price/AFFO (Adjusted funds from operations)

Question 10

10. When you’re looking at an industry-specific multiple like EV / Scientists or EV / Subscribers, why do you use Enterprise Value rather than Equity Value?

Answer 10

Because scientists and subscribers are “available” and impact all stakeholders.

Question 11

11. Would an LBO or DCF give a higher valuation?

Answer 11

Could go either way, but most cases LBO give a lower valuation.
- LBO: don’t get any value from the cash flow between year 1 and the final year; only valuing based on terminal value
- DCF considers both the company’s cash flows in between and its terminal value, so values tend to be higher.

Question 12

12. How would you present these Valuation methodologies to a company or its investors?

Answer 12

football field graph

Question 13

13. How would you value an apple tree?

Answer 13

The same way you would value a company:
- look at comparable apple trees are worth
- value of the apple tree’s cash flow

Question 14

14. Why can’t you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA?

Answer 14

Because EBITDA is available to all stakeholders. Enterprise value is also available to all stakeholders.

Question 15

15. When would a Liquidation Valuation produce the highest value?

Answer 15

• highly unlikely
• possible when the company has hard assets but the market is severely undervaluing it for a specific reason (such as an earning miss or cyclicality)

Question 16

16. Let’s go back to 2004 and look at Facebook back when it had no profit and no revenue. How would you value it?

Answer 16

• use comparable analysis and precedent transactions
• also look at creative multiples such as EV/ Pageviews or EV/Unique Visitors
• Can’t use DCF because cannot reasonably predict cash flow for a company that’s not even making money yet

Question 17

17. What would you use in conjunction with Free Cash Flow multiples – Equity Value or Enterprise Value?

Answer 17

• For unlevered cash flow ==> exclude debt & interest ==> represent money available to all stakeholders ==> Enterprise Value
• For levered cash flow ==> after interests payment ==> represent money available to shareholders only ==> equity value

Question 18

18. You never use Equity Value / EBITDA, but are there any cases where you might use Equity Value / Revenue?

Answer 18

• For large financial institutions when the Enterprise Value is negative ==> do use Equity Value

Question 19

19. How do you select Comparable Companies / Precedent Transactions?

Answer 19

1. Industry Classification
2. Financial Criteria (Revenue, EBITDA, etc.)
3. Geography
   For precedent transactions, mostly look at transactions within the past 1-2 years.

Question 20

20. How do you apply the 3 valuation methodologies to actually get a value for the
    company you’re looking at?

Answer 20

• take the median multiple of a set of companies or transactions, and then multiply by the relevant metric from the company you’re using

If the EBITDA multiple median is 8x, and you’re company’s EBITDA is $500 million, the implied value is 4 billion

Question 21

21. What do you actually use a valuation for?

Answer 21

• pitch books and client presentations when you’re providing updatees and telling them they should expect from the valuation
• also used in “fairness opinion”

Question 22

22. Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium?

Answer 22

1. The company has reported earnings well-above expectation and stock price rises recently
2. has some types of comparative advantage not reflected in its financials
3. Has won a favorable ruling in a law suit recently
4. Is the market leader in the industry and has greater market share than its competitors

Question 23

23. What are the flaws with public company comparables?

Answer 23

1. No company is 100% comparable
2. The stock market is “emotional” as the multiples might be drastically different depending on the market’s movements
3. share prices for small companies may not reflect their true value

Question 24

24. How do you take into account a company’s competitive advantage in a valuation?

Answer 24

1. Look at the 75th percentile or higher for the multiples rather than the median
2. Add in a premium to multiples
3. Use more aggressive projection

Question 25

25. Do you ALWAYS use the median multiple of a set of public company comparables or precedent transactions?

Answer 25

in most cases you do because you want to use values from the middle range of the set. But if the company you’re valuing is distressed, is not performing well, or is at a competitive disadvantage, you might use the 25th percentile or something in the lower range instead – and vice versa if it’s doing well.

Question 26

26. You mentioned that Precedent Transactions usually produce a higher value than Comparable Companies – can you think of a situation where this is not the case?

Answer 26

sometimes this happens due to a significant mismatch between the M&A market and the public market. For example, there haven’t been large public companies being acquired but a lot of small private companies being acquired at extremely low costs.

Question 27

27. What are some flaws with precedent transactions?

Answer 27

1. Past transactions are rarely 100% comparable
2. Data is harder to find than for public company comoparables

Question 28

28. Two companies have the exact same financial profile and are bought by the same acquirer, but the EBITDA multiple for one transaction is twice the multiple of the other transaction – how could this happen

Answer 28

1. One process was more competitive and had a lot more companies bidding on the target
2. One company had recent bad news or depressed stock price and had been acquired at discount
3. They’re in industries with different median multiples

Question 29

29. Why does Warren Buffett prefer EBIT multiples to EBITDA multiples?

Answer 29

He dislike EBITDA because it excludes CAPEX. In some capital-intense industries, the disparity between EBIT and EBITDA is huge.
EBITDA hides how much cash the company is actually using to finance their operations

Question 30

The EV / EBIT, EV / EBITDA, and P / E multiples all measure a company’s profitability. What’s the difference between them, and when do you use each one?

Answer 30

1. P/E depends on the company’s capital structure
2. EV / EBIT and EV / EBITDA are capital structure-neutral.
3. Therefore, use P/E for banks and financial institutions where interest payment/expense are critical.
4. EV/EBIT includes Depreciation and Amortization, whereas EV/EBITDA doesn’t. Use EV/EBIT for companies that are capitals and fixed assets are essential, and use EV/EBITDA for companies where D&A is smaller.

Question 31

31. If you were buying a vending machine business, would you pay a higher multiple for a business where you owned the machines and they depreciated normally, or one in which you leased the machines? The cost of depreciation and lease are the same dollar amounts and everything else is held constant.

Answer 31

Pay for the one that leased the machines.
Enterprise Value would be the same for both companies, but with the depreciated situation the charge is not reflected in EBITDA – so EBITDA is higher, and the EV / EBITDA multiple is lower as a result. For the leased situation, the lease would show up in SG&A so it would be reflected in EBITDA, making EBITDA lower and the EV / EBITDA multiple higher.

Question 32

32. How do you value a private company?

Answer 32

Use the same methodologies: precedent transactions, comps, DCF. Differences:
1. apply a 10-15% (or more) discount
2. can’t use a premiums analysis or future share price analysis
3. Valueation shows Enterprise Value for the company as opposed to the implied per-share price as with public companies.
4. you would probably just estimate WACC based on the public comps’ WACC rather than trying to calculate it.

Question 33

33. Let’s say we’re valuing a private company. Why might we discount the public company comparable multiples but not the precedent transaction multiples?

Answer 33

There’s no discount because with precedent transactions, you’re acquiring the entire company – and once it’s acquired, the shares immediately become illiquid.

But shares – the ability to buy individual “pieces” of a company rather than the whole thing – can be either liquid (if it’s public) or illiquid (if it’s private).

Since shares of public companies are always more liquid, you would discount public company comparable multiples to account for this.

Question 34

34. Can you use private companies as part of your valuation?

Answer 34

Only in the context of precedent transactions.