Valuation - Basic

Question 1

What are the 3 main valuation methodologies?

Answer 1

1. Comparable companies
2. Precedent Transactions
3. Discounted Cash Flow Analysis

Question 2

Rank the 3 valuation methodologies from highest to lowest expected value

Answer 2

Trick q - there is no ranking that always holds. In general, precedents will be higher than comps as they have a takeover premium built into the value.

DCFs are generally more variable than other methodologies, but they could go either way.

Question 3

When would you not use a DCF?

Answer 3

If the company has unstable or unpredictable cash flows (i.e. a startup), or when debt and NWC serve a different role (i.e. banks / AMs do not reinvest debt)

Question 4

What other methodologies are there?

Answer 4

Liquidation value - used when a company is being liquidated. FV assets - FV liabilities.

Replacement value - used to value the company based on the cost of replacing its assets.

LBO analysis - determining how much a PE firm could pay for a company to hit a target IRR (usually 20-25%)

Sum of the parts - valuing each division of a company separately and adding them together

M&A Premiums analysis - analyzing M&A deals and figuring out the premium each buyer paid, and using this to establish what your company is worth

Future share price analysis - projecting a company’s share price based on the P/E multiples of public company comparables, discounting back to PV

Question 5

When would you use liquidation valuation?

Answer 5

Commonly used in bankruptcy - used to see whether equity shareholders will receive any capital after the company’s debts have been paid off.

Often used in struggling businesses to advise on whether it is better to sell of assets separately or sell the entire company.

Question 6

When would you use Sum of the Parts?

Answer 6

Usually when the company has significant, unrelated divisions e.g. a conglomerate like General Electric.

If you have different divisions that are in different industries/sectors, you should not use the same sets of precedents/comparables for all divisions.

Use appropriate precedents/comps for each division, then add together to get the Combined Value.

Question 7

When would you use LBO analysis?

Answer 7

Often used to set a floor on a valuation for the company you’re looking at. Always used in leverage buyouts when advising PE.

Question 8

What are the 5 most common multiples used in valuation?

Answer 8

1. EV/Revenue
2. EV/EBITDA
3. EV/EBIT
4. P/E
5. P/BV

Question 9

What are some examples of industry-specific multiples?

Answer 9

Tech: EV / Unique visitors; EV / Page views
- visitors/page views are unique value drivers

Retail/Airlines: EV / EBITDAR (R = rent expense).
- Some companies own their own buildings, some rent. EBITDAR normalizes for this.

Energy: EV / EBITDAX (X = Exploration); EV / Daily Production; EV / Proved Reserve Quantities
- energy reserves / production are the unique value drivers
- Some companies capitalize exploration costs, some expense. EBITDAX normalizes for this.

REITs: Price / Funds From Operations per Share
- FFO adds back depreciation and subtracts gains on sale of property (non-recurring)

Question 10

When you’re looking at industry-specific multiples (e.g. EV / Scientists, EV / Subscribers), why do you use EV rather than Equity Value?

Answer 10

You use EV because those scientists / subscribers are available to all investors.

This doesn’t apply for all multiples - think through the metric and assess whether it is available to all investors.

Question 11

Would an LBO or a DCF give a lower valuation?

Answer 11

Generally would be LBO:
- LBO only considers a company’s terminal value
- DCF considers both yearly cash flows and terminal value

Question 12

How would you present the valuations to a company or its investors?

Answer 12

Use a football field chart with the valuation range implied by each methodology.

Question 13

How would you value an apple tree?

Answer 13

By using comparable / precedent valuations, and you could do a DCF for the after-tax cash generated by selling the apples.

Question 14

Why can’t you use Equity Value / EBITDA rather than EV / EBITDA?

Answer 14

EBITDA is available to all investors in the company, not just equity holders. This means it makes sense to compare to EV (also available to all investors)

Question 15

When would a liquidation value provide the highest valuation?

Answer 15

This is unlikely, but could happen when the company has significant tangible assets that the market has undervalued in comp/precedent transaction.

Question 16

How would you value Facebook in 2004 when it had no profit and no revenue?

Answer 16

You would look at comps / precedents with more industry-specific multiples, such as EV / Unique Visitors, or EV / Page views.

You would not use a DCF as you can’t reasonably predict cash flows for a company that is not yet generating revenue.

When you can’t predict cash flows, use other metrics.

Question 17

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

Answer 17

Unlevered FCF: Enterprise value (excludes interest therefore CF available to all investors)

Levered FCF: Equity value (after interest therefore CF available to only equity holders)

Question 18

How do you apple the 3 valuation methodologies to get a value for the company you’re looking at?

Answer 18

You take the median multiple of a set of comparable companies (or precedent transactions), then multiply it by the relevant metric of the company you’re valuing.

Use the football field for each methodology by showing:
1. Minimum
2. Maximum
3. 25th percentile
4. 75th percentile

Question 19

Are there cases where you would use Equity Value / Revenue?

Answer 19

It is rare to see this, but sometimes you see large financial institutions with big cash balances and negative Enterprise Values.

Question 20

How do you select Comparable Companies / Precedent Transactions?

Answer 20

1. Industry Classification
2. Financial criteria (similar revenue, EBITDA etc.)
3. Geography

For precedent transactions, you normally limit the set based on date and look at txns in the last 1-2 years.

The most important factor is industry, the rest are optional to make the search more specific.

Question 21

What do you actually use a valuation for?

Answer 21

Usually you would use it in pitch books and client presentations to tell clients what they should roughly expect for their own valuations.

It is also used in a Fairness Opinion right before a deal closes. This shows the bank’s opinion that the purchase price is fair relative to the company’s intrinsic value.

Can also be used as a floor/ceiling in negotiations.

Question 22

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

Answer 22

This could happen for a number of reasons:
- The company’s expected earnings were lower than comps (i.e. earnings are similar, but this company has beaten expectations)
- The company has a competitive advantage not shown in financials
- It is the market leader and has a greater market share than competitors
- It has won a favourable ruling in a major lawsuit

Question 23

What are the flaws with public company comps?

Answer 23

• No company is 100% comparable to another company
• The stock market is emotional and subject to various forces other than financial performance
• Share prices for small companies with thinly-traded stocks may not reflect the full value

Question 24

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

Answer 24

• Look at the higher range of valuations (i.e. 75th percentile rather than median)
• Add in a premium to a multiple
• Use more aggressive projections for the company (i.e. revenue growth rate)

Question 25

Do you always use the median multiple of a set of public company comps / precedents?

Answer 25

Usually you use the median, but you can adjust if there is a competitive advantage (75th percentile) or disadvantage (25th percentile)

Question 26

Precedent transactions usually produce a higher valuation than comps (due to takeover premium). Is there a situation where this might not be the case?

Answer 26

This might happen if there is a mismatch between the M&A market and the public stock market - e.g. no public companies have been acquired recently but lots of smaller companies have been acquired at extremely low valuations.

Question 27

What are some flaws with precedent transactions?

Answer 27

• Past transactions are rarely 100% comparable (structure, size and market sentiment all have an impact)
• Data on precedent transactions is normally harder to find (and substantiate) that for public company comparables

Question 28

Two companies have the same financial profiles and are bought by the same acquirer, but the EBITDA multiple for one transaction is twice the multiple of the other. Why?

Answer 28

• One process could have been more competitive, leading to a higher purchase price
• One company had a temporarily depressed stock price, leading to a discounted purchase price
• They were in two different industries with different median multiples

Question 29

Why does Warren Buffet prefer EBIT multiples to EBITDA multiples?

Answer 29

He believes EBITDA hides the Capital Expenditures and disguises how much cash they are actually using to finance their operations.

In some industries there is also a large gap between EBITDA and EBIT e.g. manufacturing

(EBIT includes depreciation and amortization, which is closely linked to CapEx)

Question 30

What is the difference between the following:
- EV / EBIT
- EV / EBITDA
- P / E

Answer 30

P/E depends on the company’s capital structure, whereas the EV multiples are capital-structure neutral. P/E is used in companies where interest payments are crucial (i.e. banks and financial institutions)

EV / EBIT includes depreciation and amortization, so you are more likely to use it in industries where D&A is large and where CapEx is important (i.e. manufacturing, utilities)

EV / EBITDA is more useful in industries where D&A is lower and CapEx is less important (i.e. tech, professional services)

Question 31

If you are buying a vending machine business, would you pay a higher multiple for a business where you owned the machines or one where you leased them?

Assume depreciation and lease expense are the same and all else is constant.

Answer 31

You would pay more for one where you leased the machines. Enterprise Value would be the same for both companies, but lease expense reduces EBITDA whereas depreciation does not.

If EBITDA is lower in the leased machines case, assuming EV is constant, then you have a higher multiple than the owned machine case.

Question 32

How do you value a private company?

Answer 32

Same options with some changes:
- You would apply a 10-15% discount to the public company comp multiples, as the private companies are not as liquid
- You can’t use a premium analysis or future share price analysis
- Your valuation would show the Enterprise Value for the company, rather than the implied per-share price
- You would estimate WACC based on public comps rather than trying to calculate it

Question 33

If we are valuing a private company, why would we discount the public company comps but not the precedent transaction multiples?

Answer 33

Because once a company is acquired, its shares immediately become illiquid.

Since shares of a public company are more liquid than those of a private company, you discount the public company comps.

Question 34

Can you use private companies as part of your valuation?

Answer 34

Yes - in the context of precedent transactions.

They have no values for market cap or Beta, therefore you cannot use them in comps or in DCFs.