Valuation Questions - Advanced Flashcards
How do you value banks and financial institutions differently from other companies?
You mostly use the same methodologies except with a few key differences:
1. Look at P / E and P / BV (Book Value) multiples rather than EV / Revenue, EV / EBITDA, and other common multiples, since banks have different capital structures.
2. Pay more attention to bank-specific metrics like NAV and possibly screen companies and precedent transactions based on those instead.
3. Rather than a DCF, use a Dividend Discount Model (DDM) which is similar but is based on the present value of the company’s dividends rather than its free cash flows.
4. It’s important to use these methodologies and multiples because interest is a critical component of a bank’s revenue and because debt is part of its business model rather than just a way to finance acquisitions or expand the business.
Walk me through an IPO valuation for a company that’s about to go public.
Only look at public company comparables. Then decide on the most relevant multiple to use and estimate the company’s Enterprise Value based on that. Once you have the Enterprise Value, work backward to calculate the Equity Value and also subtract the IPO proceeds as “new” cash. Lastly, divide by the total number of shares (old and new), to get its per-share price. If using P / E or any other Equity Value-based multiple, you would get to Equity Value instead and then subtract the IPO proceeds from there.
I’m looking at financial data for a public company comparable, and it’s April (Q2) right now. Walk me through how you would “calendarize” this company’s financial statements to show the Trailing Twelve Months as opposed to just the last Fiscal Year.
The formula to calendarize financial statements is TTM = Most Recent Fiscal Year + New Partial Period - Old Partial Period. So in the example above, we would take the company’s Q1 numbers, add the most recent fiscal year’s numbers, and then subtract the Q1 numbers from that most recent fiscal year.
Walk me through an M&A premiums analysis.
- First, select the right precedent transactions; based on industry, date (past 2-3 years for example), and size (example: over $1 billion market cap).
- For each transaction, get the seller’s share price 1 day, 20 days, and 60 days before the transaction was announced (you can also look at even longer intervals, or 30 days, 45 days, etc.).
- Then, calculate the 1-day premium, 20-day premium, and so on, by dividing the per-share purchase price by the appropriate share prices on each day.
- Get the medians for each set, and then apply them to your company’s current share price. For example, say the median 20-day premium was 40% across all transactions. You would apply this to your company’s current share price to estimate how much a buyer might pay.
Walk me through a future share price analysis.
- First, get the median historical (usually TTM) P / E of your public company comparables.
- Then, apply this P / E multiple to your company’s 1-year forward or 2-year forward projected EPS to get its implied future share price.
- Lastly, discount this back to its present value by using a discount rate in-line with the company’s Cost of Equity figures.
- Note: You normally look at a range of P / E multiples as well as a range of discount rates for this type of analysis, and make a sensitivity table with these as inputs.
Both M&A premiums analysis and precedent transactions involve looking at previous M&A transactions. What’s the difference in how we select them?
For M&A premiums analysis, the companies you look at must be public. You’ll usually use a broader set of transactions; for example, while precedent transactions might use fewer than 10 cases, M&A premiums analysis might involve dozens. The industry and financial screens are usually less stringent. Aside from that, the screening criteria are similar.
Walk me through a Sum-of-the-Parts analysis.
In a Sum-of-the-Parts analysis, you value each division of a company using separate comparables and transactions, get to separate multiples, and then add up each division’s value to get the total for the company. For example, let’s say we have a company with a manufacturing division with $100 million EBITDA, an entertainment division with $50 million EBITDA and a consumer goods division with $75 million EBITDA. We’ve selected comparable companies and transactions for each division, and the median multiples come out to 5x EBITDA for manufacturing, 8x EBITDA for entertainment, and 4x EBITDA for consumer goods. Our calculation would be $100 * 5x + $50 * 8x + $75 * 4x = $1.2 billion for the company’s total value.
How do you value Net Operating Losses and take them into account in a valuation?
You value NOLs based on how much money they’ll save the company on taxes in the future. Then you take that number and find its present value. Two ways to assess these tax savings are:
1. Assume that a company can use its NOLs to completely offset its taxable income until the NOLs run out.
2. In an acquisition scenario, use Section 382 and multiply the adjusted long-term interest rate by the equity purchase price of the seller to determine the maximum allowed NOL usage in each year, and then use that to figure out the offset to taxable income.
I have a set of public company comparables and need to get the projections from equity research. How do I select which report to use?
The two most common methods are:
1. You pick the report with the most detailed information.
2. You pick the report with numbers in the middle of the range.
I have a set of precedent transactions but I’m missing information like EBITDA for a lot of the companies – how can I find it if it’s not available via public sources?
- Try searching online first, and see if you can find press releases or articles in the financial press with these numbers.
- If unsuccessful, look in equity research for the buyer around the time of the transaction and see if any of the analysts estimate the seller’s numbers.
- Also, look at online sources like Capital IQ and Factset and see if any of them disclose numbers or give estimates.
How far back and forward do we usually go for public company comparable and precedent transaction multiples?
For public company comparables and precedent transaction multiples, you typically examine the Trailing Twelve Months (TTM) for both sets and project forward about 1-2 years. It’s more common to look backward beyond 1 year and forward beyond 2 years for public company comparables. However, for precedent transactions, it’s unusual to project more than 1 year forward, as the available information is often more limited.
I have one company with a 40% EBITDA margin trading at 8x EBITDA, and another company with a 10% EBITDA margin trading at 16x EBITDA. What’s the problem with comparing these two valuations directly?
It can be misleading to compare companies with dramatically different EBITDA margins. Due to basic arithmetic, companies with higher margins, like the one with a 40% EBITDA margin, will typically have a lower EBITDA multiple, even if their actual value is not lower. In this situation, it’s more effective to screen companies based on margins and remove outliers rather than attempt to “normalize” EBITDA multiples based on margins, which could obscure important differences and lead to misleading conclusions.
Walk me through how we might value an oil & gas company and how it’s different from a “standard” company.
You use the same methodologies except with a few key differences:
1. Look at industry-specific multiples like P / MCFE and P / NAV in addition to the more standard ones.
2. Oil & gas companies’ are unique in that their revenue is tied directly to the prices of fluctuating commodities like crude oil and natural gas. You need to project the prices of these commodities and also the company’s reserves to determine its revenue and cash flows in future years.
3. Rather than using a DCF model, you rely on the Net Asset Value (NAV) model, where future cash flows are based on reserves, costs, and commodity prices, rather than simple revenue growth or EBITDA margin projections.
Walk me through how we would value a REIT (Real Estate Investment Trust) and how it differs from a “normal” company.
Similar to energy, real estate is asset-intensive and a company’s value depends on how much cash flow specific properties generate.
1. You look at Price / FFO (Funds From Operations) and Price / AFFO (Adjusted Funds From Operations), which add back Depreciation and subtract gains on property sales; NAV (Net Asset Value) is also important to look at.
2. You value properties by dividing Net Operating Income (NOI) (Property’s Gross Income – Operating Expenses) by the capitalization rate (based on market data).
3. Replacement Valuation is more common because you can actually estimate the cost of buying new land and building new properties.
4. While a DCF can still be used, its usefulness may vary depending on the specific type of REIT or the nature of the properties involved.
A. REITs are asset-intensive, meaning their value often depends more on the value of the properties they own rather than traditional revenue and EBITDA growth.
B. Many REITs have relatively stable, predictable cash flows, making a detailed DCF model less insightful than it would be for your standard company.
