Valuation - Basic Flashcards
What are the 3 major valuation methodologies?
Comparable Companies, Precedent Transactions, Discounted Cash Flow Analysis.
Rank the 3 valuation methodologies from highest to lowest expected value.
Trick question - there is no ranking that always holds. In general, Precedent Transactions will be higher than Comparable Companies due to the Control Premium built into acquisitions.
Beyond that, a DCF could go either way and it’s best to say that it’s more variable than other methodologies. Often it produces the highest value, but it can produce the lowest value as well depending on your assumptions.
When would you not use a DCF in a Valuation?
You do not use a DCF if the company has unstable or unpredictable cash flows (tech or bio-tech startup) or when debt and working capital serve a fundamentally different role. For example, banks and financial institutions do not re-invest debt and working capital is a huge part of their Balance Sheets - so you wouldn’t use a DCF for such companies.
What other Valuation methodologies are there?
Other methodologies include:
- Liquidation Valuation - Valuing a company’s assets, assuming they are sold off and then subtracting liabilities to determine how much capital, if any, equity investors receive.
- Replacement Value - Valuing a 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 in the 20-25% range.
- Sum of the Parts - Valuing each division of a company separately and adding them together at the end.
- M&A Premium Analysis - Analyzing M&A deals and figuring out the premium that 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 the public company comparables, then discounting it back to its present value.
When would you use a Liquidation Valuation?
This is most common in bankruptcy scenarios and is used to see whether equity shareholders will receive any capital after the company’s debts have been paid off. It is often used to advise struffling businesses on whether it’s better to sell off assets separately or to try and sell the entire company.
When would you use Sum of the Parts?
This is most often used when a company has completely different, unrelated divisions - a conglomerate like General Electric, for example.
If you have a plastics division, a TV and entertainment division, an energy division, a consumer financing division and a technology division, 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.
When do you use an LBO Analysis as part of your Valuation?
Obviously you use this whenever you’re looking at a Leveraged Buyout - but it is also used to establish how much a private equity firm could pay, which is usually lower than what companies will pay.
It is often used to set a “floor” on a possible Valuation for the company you’re looking at.
What are the most common multiples used in Valuation?
The most common multiples are:
- EV / Revenue
- EV / EBITDA
- EV / EBIT
- P/E (Share Price / Earnings per Share)
- P/BV (Share Price / Book Value)
Whare are some examples of industry-specific multiples: Technology (Internet)?
- EV / Unique Visitors
- EV / Pageviews
Technology should be straight forward you’re looking at traffic as a value driver rather than revenue or profit.
What are some examples of industry-specific multiples: Retail/Airlines?
- EV / EBITDAR (Earnings before Interest, Taxes, Depreciation, Amortization, & Rent)
For Retail/Airlines, you often remove Rent b/c it is a major expense and one that varies significantly between different types of companies.
What are some examples of industry-specific multiples: Enerygy?
- P / MCFE
- P/MCFE/D (MCFE = 1 Million Cubic Foot Equivalent, MCFE/D = MCFE per Day)
- P/NAV (Share Price / Net Asset Value)
Energy should be straight forward, energy reserves as value drivers rather than revenue or profit.
What are some examples of industry-specific multiples: Real Estate Investment Trusts (REITs)?
- Price / FFO (Funds from Operations)
- Price / AFFO (Adjusted Funds from Operations)
For REITs, Funds From Operations is a common metric that adds back Depreciation and subtracts gains on the sale of the company. 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/Scientist or EV/Subscribers, why do you use Enterprise Value rather than Equity Value?
You use Enterprise Value because those scientist or subscribers are “available” to all the investors (both debt and equity) in a company. The same logic doesn’t apply to everything, though - you need to think through the multiple and see which investors the particular metric is “available” to.
Would an LBO or DCF give a higher valuation?
Technically it could go either way, but in most cases the LBO will give you a lower valuation.
With a DCF, by contrast, you’re taking into account both the company’s cash flows in between and its terminal value, so value tends to be higher.
Note: Unlike a DCF, an LBO model by itself does not give a specific valuation. Instead, you set a desired IRR and determine how much you could pay for the company (the valuation) based on that.
How would you present these Valuation methodologies to a company or its investors?
Usually you use a “football field” chart where you show the valuation range implied by each methodology. You always show a range rather than one specific number.