Valuation Basic Flashcards
What are the three major valuation methodologies?
Comparable companies, precedent transactions and discounted cash flow analysis
Comps value of a company by comparing it to similar companies
Precedent prices paid for similar companies in the past
DCF value of investment based on future cash flow then discounted to present value using appropriate discount rate
Rank the three valuation methodologies from highest to lowest expected value?
Trick question no set ranking or one that holds
Precedent transactions will be higher than comparable companies due to the control, premium built into acquisitions
The acquirer usually wants to own more than 50% of the shares they want to control the business not own a part of its equity
A DCF could go either way and it’s best to say that it’s more variable than other methodologies
It often produces the highest value, but it can produce the lowest value as well, depending on your assumptions.
Precedent transactions often produces highest valuation because it includes control premium that a buyer must pay. This is the amount that a buyer is willing to pay an excess of the fair market value of shares to gain any controlling ownership interest. It’s influenced by potential value increasing competition from other buyers.
The DCF depends on assumptions
And the comparable companies analysis is a market based valuation that usually produces the lowest value as it is based on what the market is currently willing to pay.
When would you not use a DCF in a valuation?
If a company has unstable or unpredictable, cash flows tech or biotech startups or when debt and working capital serve a fundamentally different role
Unpredictable revenue delayed payments, unexpected expenses, inefficient cash management
Banks and financial institutions do not reinvest debt and working capital is a huge part of their balance sheet
Over complexity, large number of assumptions, sensitive to change in assumptions also company isolation.
What other valuation methodologies are there?
Liquidation valuation valuing a companies assets, assuming they are sold off and then subtracting liabilities to determine how much if any equity investors receive
If business is terminated and assets are sold off cash that would be received from selling off assets subtracting any liabilities
Replacement valuation valuing a company based on the cost of replacing assets. How much does it cost to replace a TV with a similar one?
LBO analysis determining how much a private equity firm could pay for a company to hit a target internal rate of return IRR usually in the 20 to 25% range, maximum value a financial buyer could pay for the target company.
Sum of the parts valuing each division of a company separately, and adding them together at the end, think of conglomerates and holding companies example Amazon
M & A premium analysis most acquisitions are competitive analyzing mergers and acquisitions deals and figuring out the premium that each buyer paid and using this to establish what your company is worth
To access on acquirer pays over the market value of the shares, being acquired often used in negotiations for a fair purchase price and a fairness opinions
Future share price analysis projecting a company share price based on the price to earnings multiples of the public company comparables, then discounting it back to its present value think of compound annual growth rate predicting future prices by looking at things like price, movements, charts, trends, trading values and other factors
Overall, all these valuation methodologies are to the industry kind of what what valuation do you use for? What type of company?
When would you use a liquidation valuation bringing a business to an end?
Chapter 7 bankruptcy most common in bankruptcy scenarios and is used to see whether equity shareholders will receive any capital after the companies debt has been paid off
It is often used to advise struggling businesses on whether it’s better to sell off assets separately or to try and sell the entire company
Bankruptcy how much can be recovered
M and A worst-case scenario value of the company
Selling the company to set a minimum price for sale restructuring, and recapitalization
When would you use sum of the parts?
Most often used when a company has completely different unrelated divisions
A conglomerate like general electric, one business consisting of several different companies
If you have a plastic division, a TV and entertainment division and division, a consumer financing division and a technology division, etc.
You should not use the same set of comparable companies and precedent transactions for the entire company
Instead, you should use different sets for each division value each one separately and then add them together to get the combined value distinct assets restructuring value of each business unit
When do you use an LBO analysis as part of your valuation?
Obviously, when you’re looking at a leveraged buyout using debt to buy a company
How much could be paid for the business while still achieving a desired IRR?
Also used to establish how much a private equity firm could pay, which is usually lower than what companies will pay
Often used to set a floor on a possible valuation for the company you’re looking at
In investment banking LBO analysis to get LBO market value as a limit minimum value for company valuation minimum amount of equity
In private equity determining highest possible risk
What are the most common multiples used in valuation?
EV/revenue early stage or high-growth businesses that don’t have earnings yet
EV/EBITDA value of a company EV representing total value EBITDA representing operating performance
EBIT/EV this is the earnings yield ROI based on operating profit and cost by entire company
P/E price to earnings this is the share price divided by your earnings per share stock over or undervalued
P/BV share price divided by book value per share that shows how much investors are prepared to pay per unit of net assets
Why can’t you use enterprise value divided by net income? Net income is included in stockholders equity, which is in enterprise value.
What are some examples of industry specific multiples?
EV/unique investors
EV/page viewers
These relate to tech and Internet
You use industry specific multiples when you don’t have good stable, financial data or you have unique assets making revenue so early in and more impactful industry, specific private you know different things publicly available
Retail airlines use EV/EBITDAR R standing for rental expenses
Energy uses things like EV/EBITDAX standing for exploration expense
They also use EV/daily production
And EV/proved reserve quantities
Real estate investment trust REITs
Price/FFO per share funds from operations
Price/AFFO per share adjusted funds from operations
Tech and energy, you are looking at and energy resources as drivers rather than revenue or profit,
Retail airlines, you add back rent because some companies own their own buildings and capitalize the expense where others rent and have rental expenses
Energy, All value is derived from companies reserves of oil and gas, which explains EBITDAX because some companies capitalize their exploration expenses and some expense, then add back exploration expense to normalize the numbers
REITs FFO‘s is a common metric that adds back depreciation and subtracts gains on the sale of property depreciation is a non-cash yet extremely large expense in real estate and gains on sales of properties are assumed to be non-recurring so FFO is viewed as a normalized picture of the cash flow the REIT is generating.
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?
You use enterprise value because the scientists or subscribers are available to all the investors both debt and equity in a company
Same logic does not apply to everything
You need to think through the multiple and see which investors the particular metric is available to
Enterprise value considers the company regardless of capital structure
Would an LBO or DCF give a higher valuation?
It could go either way most cases LBO gives you a lower valuation.
LBOs do not get any value from the cash flows of a company in between year one and the fiscal year
They are only based on terminal value valuing based on terminal value, which is the value today of all profits. This company will make from a certain point in the future and annually.
DCF taken into account both companies cash flows in between and it’s terminal value values tend to be higher, projectable, cash flow, optimistic assumptions
Unlike a DCF and LBO by itself does not give a specific valuation you get a desired IRR and determine how much you could pay for the company
How do you present these valuation methodologies to a company or its investors?
Usually a football field chart where you show the valuation range implied by each methodology always show a range rather than one specific number
Variety of bar charts line graph scatterplots, looking at share price
How would you value an apple tree?
Same way you would value a company look at what comparable Apple trees are worth and the value of the apple trees cash flows
Do you want a relative valuation which is the quick market informed assessment financial multiples, ratios, etc.
And you want an intrinsic valuation, which is projected cash flows companies, financial health and future potential DCF
Why can’t you use equity value/EBITDA as a multiple rather than enterprise value/EBITDA?
EBITDA is available to all investors in the company rather than just equity holders and enterprise value is also available to all shareholders so it makes sense to pair them together
Equity value/EBITDA is comparing apples to oranges because does it does not reflect companies entire capital structure only part available the equity investors
Equity value doesn’t consider debt or cash holdings enterprise value does equity value represents the claims of equity holders
The point of multiple is to represent value of enterprise value/ET gives you the value of a companies operations and its earnings before interest, taxes, depreciation, and amortization
When would a liquidation valuation produce the highest value?
This is highly unusual given it to cyclical industry, but this happens if a company had substantial hard assets, but the market severely undervaluing it like an earnings miss cyclicality
Companies, comparable companies and precedents would likely produce lower values as well
And if assets were valued highly enough
Valuable tangible assets like real estate equipment inventory
Under performing business assets could potentially be worth more separately than the value generated by the same if a company could use the assets more efficiently
Let’s go back to 2004 and look at Facebook back when it had no profit and no revenue. How would you value it?
No valuation methods will really work. You can start by looking at any comparable companies and Preston transactions. You can look at acquisition prices of similar companies similar companies like my space at the time you’ll have to use creative multiples.
These multiples could include things like EV/unique investors, EV/page viewers, EV/new visitors to site
Not use a fair in the future DCF can’t reasonably predict cash flow. Don’t try to predict cash flow.
Long-term DCF technically this is classified as a start up a text startup not many tangible assets mostly intangible find a unique multiple we can compare to other companies is the main goal
What would you use in conjunction with free cash flow multiples equity or enterprise value?
Trick question for unlevered, free cash flow use enterprise value and for levered free cash flow use equity value
Un levered, free, cash flow, excludes interest, expenses, and debt repayments. It’s only the money available to investors debt and equity abbreviation is FCFF free cash flow to firm.
Leverage free, cash flow or FCFE free cash flow to equity includes affects of interest, expense, and mandatory debt repayment money is therefore only available to equity investors after expenses, rev investments, and debt repayments
Debt investors have already been paid with interest payments and principal repayments
Use Debt levered debt relative to equity called leverage
You never use equity value/EBITDA but are there many cases where you use equity value/revenue?
Very rare to see this but large financial institutions with big cash balances have negative enterprise values so might use equity values/revenue instead companies with a little to no debt
Might use it if you’ve listed a set of financial and non-financial institutions on a slide you’re showing revenue multiples for the non-financial institutions want to show something similar for the financial institutions
Low debt, companies, minority investments, buying portions of equity early stage companies that don’t have positive earnings yet are all scenarios and which equity values/revenue might be used
How do you select, comparable companies and precedent transactions?
Three main ways, industry classification financial criteria like revenue, EBITDA, etc., and geography
For precedence limit the set based on date transactions within the past 1 to 2 years
Utilize NI BC
For comparables, here’s an example oil and gas products with market caps over $5 billion
Precedents airline M&A transactions over the past two years involving sellers with over $1 billion in revenue
How do you apply the three valuation methodologies to actually get a value for the company you’re looking at?
The simple fact gets lost in discussion
Take the median multiple of a set of companies or transactions then multiply it by the relevant metric from the company your valuing
Example, if median EBITDA multiple from your set of precedent transactions is 8X in your companies EBITDA is $500 million. The implied enterprise value would be $4 billion.
To get the football field valuation graph look at min and Max 25th percentile and 75th percentile in each set as well as create a range of values based on each methodology
Median multiple this is the middle value in a set of multiples from comparable companies represents a point at which 50% of businesses sell for a higher multiple and 50% sell for a lower valuation multiple
Say you were looking at price to earnings ratio from a group of similar companies arranged from low to highest medium multiple is the middle one
What do you actually use a valuation for?
Usually use it in a pitch book and or in client presentations when you’re providing updates and telling them what they should expect for their own valuation
Also used right before a deal closes in a fairness opinion a document a bank creates that proves the value their client is paying or receiving is fair from a financial point of view
Also used in defense analysis, merger, models, LBO models, DCF because terminal multiples are based off of comparables and pretty much anything else in finance
Dealmaking M&A LBO IPOs determine price bought or sold
Fairness opinions, financial fairness of a proposed deal
Strategic planning know their worth
Capital Raising know their worth to price new shares or debt
Restructuring, restructure or bankruptcy
Why would a company with similar growth and profitability to its comparables be valued at a premium?
Could happen for a number of reasons the company has just reported earnings well above expectations and it’s stock price has risen recently
It has some type of competitive advantage, not reflected in its financials, such as a key patent or other intellectual property
It has just won a favorable ruling in a major lawsuit
It is the market leader in an industry and has greater market share than its competition
Superior earnings competitive advantage, higher earnings, gross profit margin operating profit margin net profit margin, future growth potential promising opportunity
What are the flaws with public company comparables?
No, two companies are the same or 100% comparable. The stock market is emotional market. Movements multiples might be dramatically higher or lower.
Share prices for small companies with thinly traded stocks may not reflect their full value
Data availability for private companies, incomplete financial information
Small stocks have lower liquidity, fewer buyers and sellers higher volatility, not closely, followed by analysts, lack of available and more risk
How do you take into account a companies competitive advantage in a valuation?
Look at the 75th percentile, or higher for the multiples rather than the medians these usually reflect superior performance
Add in a premium to some of the multiples, investors and buyers will pay a premium for competitive advantage
Use more aggressive projections for the company
Rarely do all of the above possibilities
Intellectual property stands for intangible creations of the human intellect, like pens, copyrights, and trademarks
The whole point of valuation is estimates
Do you always use the medium multiple of a set of public company comparables or precedent transactions?
There is no rule, but most cases yes you do you want to use values from the middle range of the set
Company your valuing is distressed not performing well or it is at a competitive disadvantage. You might use the 25th percentile or something in the lower range instead vice versa if the company is doing well.
Key to understand distribution of the data
Medium central tendency, often less affected by outliers or extreme values
The data is symmetrical without extreme outliers
You mentioned that precedent transactions usually produce a higher value than comps. Can you think of a situation where this is not the case?
Timing: Precedent transaction data can quickly become outdated, especially in fast-changing industries. If the market conditions have shifted significantly since the precedent transactions occurred, the comps may provide a more current and thus potentially higher valuation
Availability of Information: It can be challenging to find detailed information on precedent transactions, especially for private companies or deals that were not widely reported. If the available precedent transactions are not truly comparable due to lack of information, the comps might result in a higher valuation
Market Conditions: In certain market conditions, such as during a market downturn, buyers may not be willing to pay a premium for control, leading to lower valuations in precedent transactions compared to comps
Quality of Comparables: If the comps are of exceptionally high quality and closely match the company being valued, they might produce a higher valuation than precedent transactions, which could include a broader range of companies and deal circumstances
Red Flags in Valuation: Sometimes, the implied valuation range from precedent transactions is lower than the range computed in comps analysis. This could indicate a need to revisit assumptions and calculations in both valuation methods
What are some of the flaws with precedent transactions?
Past transactions are rarely 100% comparable
transaction structure size of company market sentiment all have huge effects
Data on precedent transactions is generally more difficult to find than it is for public comparables, especially for acquisitions of a small private company
Time sensitive last one to two years not all deals are fully disclosed
Two companies have the exact same financial profiles 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?
One process was more competitive and had a lot more companies bidding on the target
One company had recent bad news or a depressed stock price so it was acquired at a discount
They were industries with different median, multiples, different comps, different valuation
Different risk, profiles, different growth prospects
Synergies refers to the combine value value and performance will be greater than the sum of the separate individual parts revenue cost financial negative synergies are opposite
Why does Warren Buffett prefer EBIT multiples to EBITDA multiples?
“Does management think the tooth fairy pays for capital expenditures?”
He dislikes EBITDA because it hides the capital expenses companies make, and disguises how much cash they’re actually using to finance their operations potential for manipulation more fraud
Some industries there’s also a large gap between EBIT and EBITDA anything very capital intensive will show a big disparity
Significant investment in PP and E, which depreciate one time added back when calculating EBITDA not EBIT your operating income
EBIT does not include capX but depreciation directly linked to cap X high depreciation high cap X
EBITDA subtract DA to get EBIT add back DA to get EBITDA
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?
P/E depends on companies capital structure
EV/EBIT capital structure neutral
Same for EV/EBITDA
P/E for banks, financial institutions and other companies where interest payments expenses are critical
EV/EBIT includes D and A
EV/EBITDA excludes it
More likely to use EV/EBIT in industries where D and A is large and where cap X and fixed assets are important
EV/EBITDA in industries where fixed Assets are less important and where D&A is smaller think of Internet companies.
P/E heavily affected by capital structure financial institutions
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
You would pay more for the one where you lease 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.
Lease situation lease will show up in SG and A so it would be reflected in EBITDA making it lower and EV/EBITDA higher
How do you value a private company?
Same methodologies
Maybe apply a 10 to 15% discount to public company comparable multiples because the private company is not as liquid as the public companies no access to public market harder to sell shares and convert into cash. There are restrictions.
Can’t use premium analysis or future share price analysis no share price
shares like p stock and common stock
Valuation shows EV instead of implied per share price
DCF gets tricky, private company no capitalization or beta just estimate WACC based on public companies WACC rather than trying to calculate it
Beta is a volatility risk measure measures expected, increase or decrease in the stock price a beta, less than one means less volatile than the market more than one more volatile than the market one means with market
Example 1.2 means 20% more volatile used in capital asset pricing model CAPM relation between risk and expected return
Let’s say we’re valuing a private company. Why might we discount the public company comparable multiples but not the precedent transaction multiples?
No discount because with precedent transactions, you’re acquiring the entire company and once it’s acquired, the shares immediately become liquid, but sold quickly without really affecting the share price
Liquid public
illiquid private
Shares from public always more liquid discount comparable multiples to account for this
Can you use private companies as part of your valuation ?
Only in the context of precedent transactions makes no sense to include them for a public company comparables or as part of the cost of equity/WACC calculation in a DCF because they are not public and therefore have no values for market capitalization or beta
