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Transcript of Finance Recruiting Interview Preparation Session #1 · Finance Recruiting Interview Preparation...
This presentation is for informational purposes only, and is not an offer to buy or sell or a solicitation to buy or sell any securities, investment
products or other financial product or service, or an official confirmation of any transaction.
Finance Recruiting Interview Preparation
Accounting, Enterprise Value and Comps
Session #1
Introduction & Limestone Capital Offering
“Preparing for finance recruiting isn’t just skimming
The Vault anymore. Students should study for
recruiting like a course and do their homework,
because the final exam is the interview.”
– VP, Recruiter for Queen’s
Like a course, there should be:
“Homework:” regular readings are necessary
Practice (mock interviews)
Comprehensive, accessible resources for all
interested students
The most important “exam” of a finance student’s life
2
Finance Interview Preparation Workshops
4 Sessions: Customized curriculum to prepare you to answer any technical finance question that your recruiters may throw at you
1. Accounting, EV and Comps
2. Precedents & DCF
3. M&A Accretion/Dilution
4. Leveraged Buyouts
Limestone Capital Offering
Candidates differentiate themselves by knowing hard M&A and LBO questions
Queen’s needs to offer comprehensive resources to continue being competitive
You will not learn the required knowledge from class
It is insufficient to memorize an interview guide from WSO, WSP, M&I, Vault, walk into an interview, and hope you get the same questions
Start early!
Rationale
Financial Services Opportunities
3
Undergraduate Roles In…
Industry Groups:
Metals & Mining (BMO)
Financials
TMT (CIBC)
Real Estate (TD, Brookfield)
Healthcare
Consumer
Infrastructure
Diversified
Oil & Gas (Calgary)
Product Groups
M&A
Equity Capital Markets
Debt Capital Markets
Syndication
Restructuring
Equity ResearchSales & TradingInvestment Banking
Groups:
Equity
Fixed Income
Economic
Quantitative
Sovereign
Groups:
Equity
Fixed Income
Derivatives
Currencies
Automated Trading
Asset-Backed Securities
“Buy-Side”
Private Equity / Venture Capital
Pension Funds
Asset Management
Wealth Management
Limestone Capital’s Interview Preparation Workshops are catered towards students interviewing for Investment
Banking, and the “Buy Side”, but also contains crucial knowledge required for other career streams.
Summer Opportunities in Finance
Business Development & Strategy
Commercial Banking, Retail Banking
Unpaid/paid internships for portfolio managers, asset managers, investment advisors (CIBC Wood Gundy, RBC Dominion Securities, etc. See below.)
Oil & Gas Companies
4
First Years
DBRS – Credit Analysis
Granite Tower – Investment Banking (Mississauga)
Greentech – Investment Banking (New York)
National Bank Financial – Investment Banking (Toronto)
Paradigm Capital – Investment Banking (Toronto)
Resolute Funds – Asset Management (Toronto)
Armentum Capital Partners – Investment Banking (San Francisco)
***Sales & Trading***
Second Years
Wealth Management
Summer Opportunities in Finance
5
The “Big 6” Canadian Banks “Bulge Bracket” or “Global” Banks
Firms That Do Not Recruit on Campus“Boutiques” and Other
Summer Opportunities in Finance
6
The “Buy Side”: Private Equity, Pension Funds, Venture Capital, Asset Managers
• Firms listed above recruit undergraduate students, but do not necessarily come to Queen’s
• Only CPPIB, Birch Hill Equity Partners, ARC, OMERS, and ONCAP post positions and/or come to campus
• All “Big 6” Canadian Banks also recruit for their asset management divisions
• Advisory wings of “Big 4” accounting firms (Deloitte Financial Advisory, KPMG Corporate Finance, PwC Deals, E&Y
M&A Advisory) will have you do the exact same work as investment banks, but for smaller clients or transactions
Process, Interviewing, Offers
7
TIMELINE & DETAILS
Process
(Fall) Typically held during October / November
Process
(Winter) Typically held during January
Types of Questions
& Preparation
Fit / Behaviourial
Market
Technical Questions
Prep: Mock Interviews, Limestone Sessions, BIWS, Rosenbaum & Pearl
Interviews First Rounds: 30 minutes to 60 minutes, on-campus or phone
Second Rounds or “Superday”: 4 – 5 hours at the firms’ office
Offers
Non-expiring
Exploding
Firms may accelerate the process for you if you have an exploding offer
Game theory is necessary; know who you’re up against
This presentation is for informational purposes only, and is not an offer to buy or sell or a solicitation to buy or sell any securities, investment
products or other financial product or service, or an official confirmation of any transaction.
Finance Recruiting Interview Preparation
Accounting
Session #1
Agenda
9
1
2
Accounting
Enterprise Value & Multiples
10
Income Statement
Income Statement
Depreciation (10)
Pre-Tax Income (10)
Tax rate 40%
Foregone tax 4
Net Income (6)
AccountingHow will $10 of additional depreciation affect the 3 financial statements?
AccountingHow will $10 of additional depreciation affect the 3 financial statements?
Start with the income statement
Depreciation expense goes up by $10
Pre-tax income goes down by $10
Ask for the tax rate, or state your tax rate assumption
Usually assume a tax rate of 40% for simplicity
If your company loses $10, then they won’t have to pay the 40% of tax
$4 less tax After tax, net income is only down by $10 - $4 = $6
You can also think of the depreciation expense as a tax shield Net income is down by $10 * (1-tax rate) = $10 * (100% – 40%) = $6
11
Income Statement
Income Statement
Depreciation (10)
Pre-Tax Income (10)
Tax rate 40%
Foregone tax 4
Net Income (6)
AccountingHow will $10 of additional depreciation affect the 3 financial statements?
12
Step 2: Cash Flow Statement
Step 3: Balance Sheet
Go to balance sheet
Cash position has increased by $4, as mentioned previously
Accumulated depreciation (contra-asset) has gone up by $10
- Net assets gone down by $10
- Overall, assets have gone down by $6
Net income is linked to retained earnings on balance sheet
Therefore, retained earnings has gone down by $6
The Assets and the Liabilities and Shareholder’s Equity side
both go down by $6, so they balance
Go to cash flow statement
First line item is net income
Net income is down by $6, as established from before
Add back non-cash operating expenses
Depreciation of $10
Cash increase = NI increase (decrease) + depreciation
= ($6) + $10 = $4
Net income (6)
Add back:
Non-cash operating expenses
Depreciation 10
Increase (decrease) in cash position 4
Assets
Cash 4
Accumulated depreciation (10)
Total assets (6)
Shareholder's Equity and Liabilities
Retained earnings (6)
AccountingHow will $10 of additional depreciation affect the 3 financial statements?
13
Income Statement Cash Flow Statement Balance Sheet
Net income flows to cash flow statement and retained earnings
Cash flow statement flows to cash position in balance sheet
Always go from income statement to cash flow statement to balance sheet
- Methodology of addressing income statement, then cash flow statement, then balance sheet should be applied to any accounting questions in your interviews.
- What happens to all three statements when inventory goes up by $10, assuming you pay for it with cash?
All 3 Statements Connected
Net income (6)
Add back:
Non-cash operating expenses
Depreciation 10
Increase (decrease) in cash position 4
Assets
Cash 4
Accumulated depreciation (10)
Total assets (6)
Shareholder's Equity and Liabilities
Retained earnings (6)
Depreciation (10)
Pre-Tax Income (10)
Tax rate 40%
Foregone tax 4
Net Income (6)
AccountingHow will $10 of additional depreciation affect the 3 financial statements?
14
$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
Start by asking questions:
What is the interest rate?
- Assume 10%
What is the tax rate?
- Assume 40%
What is the depreciation rate?
- Assume 10%
Income Statement Cash Flow Statement Balance Sheet
Depreciation -
Interest expense -
Pre-tax income -
Tax rate 40%
Foregone tax -
Net Income -
Operating cash flows
Net income -
Add back:
Non-cash operating expenses
Depreciation -
Investing cash flows
Investment in factory (100)
Financing cash flows
Debt financing 50
Increase (decrease) in cash position (50)
Assets
Cash (50)
PP&E 100
Accumulated depreciation -
Total assets 50
Shareholder's Equity and Liabilities
Debt 50
Retained earnings -
No Change Cash down $50 Debt up $50, PP&E up $100
AccountingHow will $10 of additional depreciation affect the 3 financial statements?
15
$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
Start by asking questions:
What is the interest rate?
- Assume 10%
What is the tax rate?
- Assume 40%
What is the depreciation rate?
- Assume 10%
Income Statement Cash Flow Statement Balance Sheet
Depreciation -
Interest expense -
Pre-tax income -
Tax rate 40%
Foregone tax -
Net Income -
Operating cash flows
Net income -
Add back:
Non-cash operating expenses
Depreciation -
Investing cash flows
Investment in factory (100)
Financing cash flows
Debt financing 50
Increase (decrease) in cash position (50)
Assets
Cash (50)
PP&E 100
Accumulated depreciation -
Total assets 50
Shareholder's Equity and Liabilities
Debt 50
Retained earnings -
No Change Cash down $50 Debt up $50, PP&E up $100
AccountingHow will $10 of additional depreciation affect the 3 financial statements?
16
$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
Start by asking questions:
What is the interest rate?
- Assume 10%
What is the tax rate?
- Assume 40%
What is the depreciation rate?
- Assume 10%
Income Statement Cash Flow Statement Balance Sheet
Depreciation -
Interest expense -
Pre-tax income -
Tax rate 40%
Foregone tax -
Net Income -
Operating cash flows
Net income -
Add back:
Non-cash operating expenses
Depreciation -
Investing cash flows
Investment in factory (100)
Financing cash flows
Debt financing 50
Increase (decrease) in cash position (50)
Assets
Cash (50)
PP&E 100
Accumulated depreciation -
Total assets 50
Shareholder's Equity and Liabilities
Debt 50
Retained earnings -
No Change Cash down $50 Debt up $50, PP&E up $100
AccountingHow will $10 of additional depreciation affect the 3 financial statements?
17
$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
Start by asking questions:
What is the interest rate?
- Assume 10%
What is the tax rate?
- Assume 40%
What is the depreciation rate?
- Assume 10%
Income Statement Cash Flow Statement Balance Sheet
Depreciation -
Interest expense -
Pre-tax income -
Tax rate 40%
Foregone tax -
Net Income -
Operating cash flows
Net income -
Add back:
Non-cash operating expenses
Depreciation -
Investing cash flows
Investment in factory (100)
Financing cash flows
Debt financing 50
Increase (decrease) in cash position (50)
Assets
Cash (50)
PP&E 100
Accumulated depreciation -
Total assets 50
Shareholder's Equity and Liabilities
Debt 50
Retained earnings -
No Change Cash down $50 Debt up $50, PP&E up $100
AccountingHow will $10 of additional depreciation affect the 3 financial statements?
18
$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
Start by asking questions:
What is the interest rate?
- Assume 10%
What is the tax rate?
- Assume 40%
What is the depreciation rate?
- Assume 10%
Income Statement Cash Flow Statement Balance Sheet
Depreciation -
Interest expense -
Pre-tax income -
Tax rate 40%
Foregone tax -
Net Income -
Operating cash flows
Net income -
Add back:
Non-cash operating expenses
Depreciation -
Investing cash flows
Investment in factory (100)
Financing cash flows
Debt financing 50
Increase (decrease) in cash position (50)
Assets
Cash (50)
PP&E 100
Accumulated depreciation -
Total assets 50
Shareholder's Equity and Liabilities
Debt 50
Retained earnings -
No Change Cash down $50 Debt up $50, PP&E up $100
AccountingHow will $10 of additional depreciation affect the 3 financial statements?
19
$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
Depreciation -
Interest expense -
Pre-tax income -
Tax rate 40%
Foregone tax -
Net Income -
Operating cash flows
Net income -
Add back:
Non-cash operating expenses
Depreciation -
Investing cash flows
Investment in factory (100)
Financing cash flows
Debt financing 50
Increase (decrease) in cash position (50)
Assets
Cash (50)
PP&E 100
Accumulated depreciation -
Total assets 50
Shareholder's Equity and Liabilities
Debt 50
Retained earnings -
No Change Cash down $50 Debt up $50, PP&E up $100
Start by asking questions:
What is the interest rate?
- Assume 10%
What is the tax rate?
- Assume 40%
What is the depreciation rate?
- Assume 10%
One year has passed
Start with income statement
$50 of debt x 10% interest rate = $5 interest expense
$100 of P&E * 10% depreciation = $10
Accounting Factory Acquisition Question, Part 2
Pre-tax income goes down by $10 + $5 = $15
40% tax rate
Foregone tax = $15 x 40% = $6
Net income goes down by $15 - $6 = $9
Can also be calculated as: $15 * (100% - 40%) = $9
20
Income Statement
Depreciation (10)
Interest expense (5)
Pre-tax income (15)
Tax rate 40%
Foregone tax 6
Net Income (9)
211
Income Statement
Depreciation (10)
Interest expense (5)
Pre-tax income (15)
Tax rate 40%
Foregone tax 6
Net Income (9)
Pre-tax income goes down by
$10 + $5 = $15
40% tax rate
Foregone tax = $15 x 40% =
$6
Net income goes down by $15
- $6 = $9
• Can also be calculated
as: $15 * (100% - 40%)
= $9
Cash Flow Statement
Operating cash flows
Net income (9)
Add back:
Non-cash operating expenses
Depreciation 10
Investing cash flows
Investment in factory -
Financing cash flows
Debt financing -
Increase (decrease) in cash position 1
Go to cash flow statement
Start with net income decreasing
by $9
Add back depreciation of $10
Cash goes up by $1
Accounting Factory Acquisition Question, Part 2
22
Income Statement Cash Flow Statement Balance Sheet
Depreciation (10)
Interest expense (5)
Pre-tax income (15)
Tax rate 40%
Foregone tax 6
Net Income (9)
Pre-tax income goes down by
$10 + $5 = $15
40% tax rate
Foregone tax = $15 x 40% =
$6
Net income goes down by $15
- $6 = $9
• Can also be calculated
as: $15 * (100% - 40%)
= $9
Operating cash flows
Net income (9)
Add back:
Non-cash operating expenses
Depreciation 10
Investing cash flows
Investment in factory -
Financing cash flows
Debt financing -
Increase (decrease) in cash position 1
Go to cash flow statement
Start with net income decreasing
by $9
Add back depreciation of $10
Cash goes up by $1
Assets
Cash 1
PP&E -
Accumulated depreciation (10)
Total assets (9)
Shareholder's Equity and Liabilities
Debt -
Retained earnings (9)
Cash flow statement is
linked to balance sheet
Cash is up by $1 (as per
previous slide) in year 1
$10 of depreciation
decreases net assets by
$10
Net income down by $9
Retained Earnings down by
$9
Assets down by $9, S / E
down by $9
Accounting Factory Acquisition Question, Part 2
Income Statement
23
What if the factory blows up in a year and we default on the debt?
Accounting Factory Acquisition Question, Part 2
Start with income statement
Pre-tax income is down by $80
from PP&E writedown
• 2 years of depreciation
already in effect
Pre-tax income goes up by $50
from debt writedown (no
accrued interest)
Pre-tax income is down $30
overall
Net income is down by: $30 x
(1 – tax rate) = $18
24
What if the factory blows up in a year and we default on the debt?
Income Statement
PP&E writedown (80)
Debt writedown 50
Pre-tax income (30)
Tax rate 40%
Foregone tax 12
Net Income (18)
Accounting Factory Acquisition Question, Part 2
Start with income statement
Pre-tax income is down by $80
from PP&E writedown
• 2 years of depreciation
already in effect
Pre-tax income goes up by
$50 from debt writedown (no
accrued interest)
Pre-tax income is down $30
overall
Net income is down by: $30 x
(1 – tax rate) = $18
25
What if the factory blows up in a year and we default on the debt?
PP&E writedown (80)
Debt writedown 50
Pre-tax income (30)
Tax rate 40%
Foregone tax 12
Net Income (18)
Income Statement Cash Flow Statement
Net income (18)
Add back:
Writedown of PP&E 80
Less:
Writedown of Debt (50)
Increase (decrease) in cash position 12
Go to cash flow statement
Start with net income down by $18
Add back (subtract) non-cash
expenses (revenues)
Add back $80 writedown of PP&E
Subtract $50 writedown of debt
Cash position increase = -$18 +
$80 - $50 = $12
Accounting Factory Acquisition Question, Part 3
Start with income statement
Pre-tax income is down by $80
from PP&E writedown
• 2 years of depreciation
already in effect
Pre-tax income goes up by $50
from debt writedown (no
accrued interest)
Pre-tax income is down $30
overall
Net income is down by: $30 x
(1 – tax rate) = $18
26
What if the factory blows up in a year and we default on the debt?
PP&E writedown (80)
Debt writedown 50
Pre-tax income (30)
Tax rate 40%
Foregone tax 12
Net Income (18)
Income Statement Cash Flow Statement
Net income (18)
Add back:
Writedown of PP&E 80
Less:
Writedown of Debt (50)
Increase (decrease) in cash position 12
Go to cash flow statement
Start with net income down by $18
Add back (subtract) non-cash
expenses (revenues)
Add back $80 writedown of PP&E
Subtract $50 writedown of debt
Cash position increase = -$18 + $80
- $50 = $12
Balance Sheet
Assets
Cash 12
Net PP&E (80)
Total assets (68)
Shareholder's Equity and Liabilities
Debt (50)
Retained earnings (18)
S / E and Liabilities (68)
Go to balance sheet
Cash goes up by $12
Net PP&E goes down by $80
Assets go down by $68
Debt goes down by $50
Retained earnings goes down by
$18
S / E + Liabilities go down by $68
Assets and S / E + Liabilities
balance
Accounting Factory Acquisition Question, Part 3
Other Accounting Questions
If you were stranded on a desert island, and you could only pick one financial statement to assess the health of a company, which statement would you choose and why?
Most people say income statement
But income is not cash flow
Can you really evaluate the health of a company just by looking at an accounting number?
Remember the issues with earnings
Ignores factors like CAPEX, changes in working capital
27
Q:
Correct answer is cash flow statement
When valuing a company, we care about its cash flows,
independent of its non-cash expenses
We can already get net income from the cash flow statement
anyways
Net income is typically stated at the beginning of a cash flow
statement
We can see important items like changes in working capital
and CAPEX
Growing CAPEX suggests expansion
Negative CAPEX suggests rationalization or restructuring
A:
If yes: choose income statement and balance sheet
Can find changes in non-cash operating expenses from Current Assets / Liabilities
Increase in accounts receivable, prepaids, accounts payable
Can derive investing cash flows (CAPEX) from Balance Sheet
Current year fixed assets - prior year fixed assets +
depreciation
Can find financing cash flows from Balance Sheet
Compare current year long term liabilities with prior year’s
Deriving equity financing is harder
B / S sometimes contains number of common shares
Assuming no secondary equity issuance…
Dividends paid = Net Income – R / E (current year) + R / E
(prior year)
A:
If you could only pick two statements…
Ask: do we assume that we have the balance sheet date for the current year and the prior year?
If yes: choose income statement and balance sheet
You can build the cash flow statement from these two
If no: choose cash flow statement and balance sheet
You can see net income on cash flow statement
Cash flow is more relevant for assessing value
Balance sheet is useful for assessing credit risk, ROA, etc.
Q:
This presentation is for informational purposes only, and is not an offer to buy or sell or a solicitation to buy or sell any securities, investment
products or other financial product or service, or an official confirmation of any transaction.
Finance Recruiting Interview Preparation
Enterprise Value
Session #1
Agenda
29
1
2
Accounting
Enterprise Value & Multiples
Equity Net Debt
Preferred Shares Minority Interest
Enterprise Value
Two ways to think about Enterprise Value (EV)
Value of the firm entire capital structure / “value of the firm’s assets”: both debt and equity
Theoretical takeover price (no control premium)
Enterprise Value = Market cap. + Preferred Equity + Minority Interest + Debt - Cash
29
How is Enterprise Value Calculated?
Market cap. only measures the equity value
Ignores the rest of the capital structure
Enterprise value represents the value of the firm to both debt and equity holders
The market value of all capital invested in the business
Multiples using EV are more “comparable”
Why do we use Enterprise Value?Enterprise Value as “Slices of the Pie”
Enterprise Value
31
Why do we subtract cash from the capital structure in the EV calculation?
Enterprise Value
32
Why do we subtract cash from the capital structure in the EV calculation?
If a company only has $10 of debt and $10 of cash on its balance sheet, it has an Enterprise Value of zero
You can pay off the $10 of debt with $10 of cash; this company is worthless
Debt - Cash = Net Debt
Paying Off Debt with Cash
Imagine buying a company that consisted of the following:
Piggy bank with $99 inside
The “piggy” is worth $1
EV represents the theoretical takeover price
Let the owner keep the $99, pay $1 for the piggy
Buying cash with cash is redundant, so we net it out
Theoretical Takeover Price
Multiples
When we buy stock, we are paying to “own” a piece of a company’s cash flows
Although we don’t receive the cash, market price should adjust to reflect changes in expectations of these projected cash flows
Multiples: how much the market is valuing a company relative to the value stakeholders are receiving, e.g. how much cash that company is generating
33
What are multiples?
Assume price to earnings ratio of 5
Paying $5 for $1 of earnings
5 years before those earnings add up to original price paid
How long before I get my money back?
Enterprise Value (EV) / EBITDA: how much are stakeholders (both bondholders and shareholders) paying for $1 of EBITDA generation?
EV / EBIT
EV / Revenue
Enterprise Multiples
Price / Earnings: how much are shareholders paying for $1 of earnings?
Price / Book: how much are shareholders paying for $1 of equity book value?
Book represents book value of equity per share
Price / Tangible Book Value
Tangible Book Value does not include intangible assets like patents and Goodwill
Price / Cash Flow
Operating cash flow per share
Equity Multiples
Forward Multiples
Historical last twelve months (LTM) vs. projected next twelve months (NTM)
Historical multiples include EV / LTM EBITDA, EV / LTM Revenue, and Price / LTM EPS
Forward multiples include EV / NTM EBITDA, EV / NTM Revenue and Price / NTM EPS
Price / Earnings-to-Growth (PEG):
P/E Ratio / Annual EPS Growth
Most people prefer forward multiples because it accounts for projected growth
LTM results may be a poor proxy for projected growth because of:
One-time charges
Tax (NOLs)
Past ≠ Future circumstances have changed
Where do I get information to calculate multiples?
Enterprise Value
Calculate yourself using balance sheet figures from 10-K’s, 10-Q’s, Annual / Quarterly Reports
LTM EBITDA
Calculate yourself
Forward looking denominator figures (2014E EPS or EBITDA)
Bloomberg EEA / EEO screen
34
Valuing Future Growth vs. Historical Growth What do these mean?
0
2
4
6
8
10
12
14
16
EV / EBITDA Multiples – Technology Space
LTM 2013E 2014E
Intel: Comps make sense for a large-cap, stable, market-leader, as
analysts are projecting healthy growth in EBITDA
Qualcomm: Analysts are either predicting a decrease in EBITDA
between LTM and 2013E, or you messed up a calculation
Google: Not comparable to the rest of the universe, explaining its
high multiples
AMD: “nmf” represents negative LTM EBITDA
Apples-to-Apples
Numerator / Denominator must be “measuring value in the same way”
Dividing kilometers by miles is not meaningful
Apples-to-Apples vs. Apples-to-Oranges
Equity value metrics and enterprise value metrics are different
Value to shareholders vs. value to ALL stakeholders (shareholders, bondholders, preferred shareholders)
Price / Revenue is not meaningful
Price represents the market value of equityholder’sholdings
Revenue goes to ALL stakeholders
EV / Earnings is not meaningful
Enterprise value represents the value of the entire firm
Earnings represents value to shareholders since interest has been deducted
35
Multiples must be consistent
P / E is an equity metric, while EV / EBITDA is an enterprise metric
P / E only looks at equity portion, ignores debt / preferred shareholders
P / E is not capital structure neutral
P / E is highly dependent on leverage
More debt more risk to shareholders shareholders demand lower P / E
Even if debt is cheaper than equity, the P / E metric will penalize companies who choose to finance through debt
Using P / E to value companies violates M&M theory
EV / EBITDA is capital structure neutral
The mix of equity and debt does not change EV assuming similar cost of capital
Doesn’t matter how you “slice the pie”, total EV is the same
Why is EV / EBITDA generally better than P/E?
Earnings vs. EBITDA Multiples
Earnings are subject to manipulation, one-time charges, differing accounting policies, non-cash expenses, and ambiguity
e.g. Enron
36
What are some issues with using earnings?
EBITDA is more similar to cash flow and is capital structure neutral
Less room for manipulation
Ignores D&A, a non-cash expense
Ignores interest expense; EBITDA is available to shareholders, bondholders, and preferred shareholders
EBITDA is a proxy for cash flow available to all stakeholders
Why is EBITDA a more suitable metric??
Incomplete proxy for cash flow
Ignores change in working capital
Does not consider the amount of required reinvestment
Says nothing about the quality of earnings
Not suited for the analysis of many industries and ignores their unique attributes (Banks, O&G, RE)
Misleading measure of liquidity
Offers limited protection when used in indenture covenants
What are the drawbacks of using EBITDA?
If interest is a part of a company’s cost of doing business
Banks, financial institutions
Mortgage lenders
If companies in the industry have negligible debt
Tech companies
Junior mining companies
Volatile businesses (e.g. startups)
If you are valuing a minority investment
Equity investments with <50% ownership
No control over enterprise, therefore enterprise multiples are inappropriate
P / E is easier to calculate than EV / EBITDA
When is P/E better than EV / EBITDA?
Minority Interest
Also known as “non-controlling interest”
If we own more than 50% of a subsidiary, we consolidate our financial statements with the subsidiary’s
Even if we own only 51% of Company S, 100% of Company S’s income statement line items are added to our income statement line items
However, only 51% of Company S’s balance sheet line items are added to our balance sheet items
The other 49% of Company S’s assets go into one item: “minority interest”
Minority interest is the part of a subsidiary that we don’t own
Found in equity section of balance sheet (IFRS)
37
What is minority Interest?
Graphical Representation of Consolidation / Minority Interest Accounting
ParentCo.
• Income Statement
• Balance Sheet
SubCo.
• Income Statement
• Balance Sheet
Consolidated Entity
(Reported by Parent Corporation)
• Combined Balance Sheet, line-by-line
• Combined Income Statement, line-by-line
• Eliminate things like
• Inter-company gains and losses
• Inter-company balances (Assets/Liabilities)
• Parent’s investment in the subsidiary company
• Minority interest reported (the percent of the subsidiary not owned by the parent) on both statements
Minority Interest
EV = Market Cap + Preferred Equity + Debt – Cash + Minority Interest
In enterprise multiples, EV is the numerator, and an income statement line item is often the denominator
APPLES TO APPLES
Denominator: Income statement line items are consolidated and include 100% of the subsidiary’s (Company S) income statement line items
Numerator: Market Cap + Preferred Equity + Debt accounts for 51% of Company S
The 49% we don’t own is not factored into the prices of the parent’s stock, bonds, or preferred shares
To make the numerator consistent with the denominator, we add in the 49% of Company S we don’t own (minority interest)
38
Graphical Representation of EV / EBITDA Multiple Mechanics
Add the portion of the subsidiary that ParentCo does not own so numerator and denominator are consistent
EV = Market Capitalization + Minority Interest + Preferred Equity + Debt - Cash
ENTERPRISE VALUE
EBITDASubsidiary consolidated from
accounting rules
Subsidiary consolidated by
adding minority interest
Why do we add minority interest to get EV?
Equity Method & Short / Long-term Investments
Use the Equity Method
Proportionate Consolidation: If we bought 20% of Company E, we get 20% of Company E’s net income on our Income Statement
Ignore Company E’s stock price
Company E is worth $100, we pay $20
Balance sheet item: Asset (Investment in Company E: $20)
If Company E reports $10 of net income, we get 20% of that = $2
Investment in Company goes up by $2 (Debit)
Investment income goes up by $2 (Credit)
39
What if we only own 20 – 50% of a company?
Short-term investments with less than 20% control
Also known as investments held for trading
Mark-to-market
Unrealized gains or losses flow straight to Net Income
Short Term Investments
Long-term investments with less than 20% control
Also known as investments available for sale
Unrealized gains or losses flow through Other Comprehensive Income (OCI)
Only flows through net income after investment is sold
Long Term Investments
This presentation is for informational purposes only, and is not an offer to buy or sell or a solicitation to buy or sell any securities, investment
products or other financial product or service, or an official confirmation of any transaction.
Finance Recruiting Interview Preparation
Comparable Companies Analysis
Session #1
Overview
Looking at similar companies and seeing how they are valued on a multiples basis
Common multiples include EV / EBITDA, EV / Revenue, P / B
Taking the average (median) multiple
e.g. 6.0x EV / EBITDA
Apply to target company’s metric to get implied valuation
Target company’s EBITDA is $5 mm
6.0 x $5 mm = $30 mm implied enterprise value
Overview A Visual
IssuesValuing a House
41Source: SEC Filings
Are mansions comparable to a shack?
Size must be comparable
What other features might affect how much houses are worth?
Number of garage doors?
Number of bedrooms? Bathrooms?
Furnished?
Should price-to-square-feet be the only multiple?
Similar to valuing a house
Look at how much surrounding houses are worth relative to square feet (or other metric)
Find median price-to-square feet multiple
Apply this multiple to number of square feet in target house to get implied valuation
Comparable Company Analysis
Operational Characteristics
Industry
Products
Business Segments – is this a pure play?
Location – different tax codes
Listing Market – U.S.? Canada? Shanghai?
Cyclicality
Customers
Distribution channels
Financial Characteristics
Size (Market Capitalization / EV)
Leverage (Debt)
Projected growth
Risk profile
Shareholder base
42
Step 1: Selecting the Universe
Process of pulling comparable company data, from sources such as
Bloomberg
Capital IQ
U.S. Companies: 10-K, 10-Q, MD&A
Canadian Companies: Annual / Quarterly Reports, MD&A, AIF
Oil & Gas Companies: NI 43-101
Mining Companies: NI 51-101
Financial Institutions: OSFI website
Issues with quick & dirty sources (Bloomberg & CapIQ)
EV calculation almost always “wrong”
Step 2: “Spread the Comps”
Step 3: Establishing the Multiple Range Step 4: Finding Implied Valuation
See upcoming slides for step 3 and 4
P/E EV/EBITDA EV/Revenue Revenue Growth
Equity Value Enterprise Value LTM 2015E 2016E LTM 2015E 2016E LTM 2015E 2016E 2015E 2016E
Traditional Software Companies
Symantec Corporation $16,636 $14,991 12.7x 12.9x 12.5x 9.0x 6.8x 6.5x 2.2x 2.3x 2.3x (2.3%) (0.9%)
CA Technologies $14,568 $13,145 10.7x 13.3x 13.2x 8.7x 7.9x 8.0x 2.9x 3.1x 3.1x (5.2%) (1.7%)
Citrix Systems $10,195 $10,843 19.3x 17.5x 15.7x 17.1x 10.9x 9.9x 3.5x 3.3x 3.1x 5.6% 6.7%
Red Hat Software $12,747 $12,437 46.6x 44.1x 37.7x 40.6x 25.4x 22.1x 8.1x 7.0x 6.1x 16.2% 13.5%' ' ' ' ' ' ' ' ' ' ' ' '
Traditional Software Adj. Average 22.3x 21.9x 19.8x 18.8x 12.7x 11.6x 4.2x 3.9x 3.7x 3.6% 4.4%
Large Cap Tech Companies
Apple $733,336 $737,276 19.5x 14.6x 13.5x 12.2x 9.6x 9.0x 4.0x 3.3x 3.1x 23.4% 5.4%
Oracle $195,021 $182,744 15.5x 15.4x 14.6x 10.3x 9.2x 9.0x 4.8x 4.7x 4.6x 1.0% 2.2%
Intel $148,284 $147,941 13.6x 14.0x 12.7x 6.2x 6.3x 5.8x 2.6x 2.7x 2.5x (0.2%) 4.7%
Qualcomm $115,535 $97,747 13.3x 13.9x 12.9x 11.2x 10.0x 9.2x 3.7x 3.6x 3.4x 2.7% 4.7%
Hewlett-Packard $60,488 $67,027 8.9x 9.1x 8.7x 5.8x 4.9x 4.9x 0.6x 0.6x 0.6x (5.4%) (0.4%)
EMC Corporation $53,082 $51,885 14.1x 13.4x 12.1x 8.8x 6.8x 6.6x 2.1x 2.0x 1.9x 6.6% 6.2%
Texas Instruments $62,075 $63,176 22.2x 19.6x 17.9x 12.2x 11.3x 10.7x 4.8x 4.6x 4.4x 5.1% 5.2%' ' ' ' ' ' ' ' ' ' ' ' '
Large Cap Tech Adj. Average 15.2x 14.3x 13.2x 9.8x 8.4x 7.9x 3.5x 3.2x 3.1x 3.0% 4.4%
Overall Adjusted Average 18.8x 18.1x 16.5x 14.3x 10.6x 9.8x 3.8x 3.6x 3.4x 3.3% 4.4%
Microsoft Corporation $351,778 $289,837 16.1x 17.1x 14.7x 8.8x 9.3x 8.4x 3.3x 3.1x 2.9x 8.3% 4.8%
43Source: Bloomberg, SEC Filings
Microsoft Universe
Comparable Companies AnalysisSample Output: Microsoft and Peers
(in US$ millions, except per share data)
Why is the company we are trying to analyze not in the comps set average?
What would “nmf” mean?
Comparable Companies AnalysisEstablishing the Multiple Range
44
HighLow
4.0x
Closest
Comparable A
5.0x
Closest
Comparable C
6.0x
Closest
Comparable B
6.5x
Median Mean
Selected Multiple Range
45Source: Bloomberg, BMO Equity Research
Comparable Companies: Farmland Partners
Comparable Companies AnalysisImplied Valuation
P/FFO P/AFFO P/NAV
(US$ millions, except per share data) Price Equity Value Enterprise Value LTM 2015E 2016E LTM 2015E 2016E
Farming REITS
Gladstone Land Corporation $9.29 $84 $194 38.7x 21.3x 17.5x 20.2x 21.1x 18.2x 0.7x
Micro REITS #N/A Invalid Security
Terreno Realty Corporation $19.98 $860 $1,173 23.2x 21.6x 18.3x 30.7x 26.2x 21.9x 0.9x
Cedar Realty Trust $6.27 $533 $1,390 12.3x 11.7x 10.9x 11.6x 14.6x 13.3x 0.8x
Monmouth Real Estate Investor $9.54 $581 $1,108 16.7x 16.6x 14.3x 16.4x 16.9x 14.6x 1.0x' ' ' ' ' ' ' ' ' '
Farming and Micro REIT Weighted Average 33.4x 20.2x 16.8x 20.0x 20.6x 17.8x 0.7x
Farmand Partners $10.18 $119 $226 46.3x 44.3x 23.4x 39.2x 18.6x 16.9x 0.8x
Multiple Implied Share Price Implied Return
Metic Lower Limit Mean Upper Limit Metric Lower Limit Mean Upper Limit Lower Limit Mean Upper Limit
P/FFO LTM 15.6x 33.4x 27.1x $0.22 $3.44 $7.35 $5.96 (66.2%) (27.8%) (41.4%)
P/FFO FY1 15.4x 20.2x 21.4x $0.23 $3.55 $4.63 $4.92 (65.2%) (54.5%) (51.7%)
P/FFO FY2 13.5x 16.8x 17.7x $0.44 $5.86 $7.30 $7.71 (42.4%) (28.3%) (24.2%)
P/AFFO LTM 15.2x 20.0x 22.8x $0.26 $3.96 $5.21 $5.94 (61.1%) (48.8%) (41.7%)
P/AAFO FY1 16.4x 20.6x 22.4x $0.55 $8.96 $11.31 $12.27 (12.0%) 11.1% 20.5%
P/AFFO FY2 14.3x 17.8x 19.1x $0.60 $8.63 $10.76 $11.56 (15.2%) 5.7% 13.5%
P/NAV 0.8x 0.7x 0.9x $12.96 $10.43 $9.71 $12.26 2.5% (4.7%) 20.4%
Average $8.00 $9.25 $10.50 (21.4%) (9.2%) 3.2%
• Finding an implied value• Take median multiple (e.g. EV / LTM
Sales, EV / ‘13E EBITDA)
• Multiply with Farmland’s corresponding metric (e.g. LTM Sales, ’13E EBITDA)
• Valuation typically presented in a range (low & high)
• “Low” does not mean taking
the minimum• How would I find an implied valuation from
an EV multiple?
Comparable Companies AnalysisEstablishing the Multiple Range
Energy
Consumers / Retail
Healthcare / Pharma / Biotech
Financial Institutions
Metals & Mining
Real Estate
Technology, Media, Telecom
EV / EBITDAR
EV / Researchers or Scientists
EV / mboe / d (production) P / NAV
EV / 2P Reserves P / DACF
Price to Book EV / AUM
P / Tangible Book
EV / tonnes / d (production) P / NAV
EV / Reserves
P / FFO P / NAV
P / AFFO
EV / tonnes / d (production) P / NAV
EV / Reserves
Natural Resources
P/NAV: used in in mining and energy
NAV is a DCF on each company’s assets using a different discount rate for each project
EV / Production Measured in BOE / day (barrels of oil
equivalent) or Tons / day (metric tons)
EV / Reserves EV / Proven Reserves (1P) EV / Proven & Probable (2P)
1P 90%, 2P 50%, 3p 10%
FIG & Real Estate
P/B and P/E for banks
EV / AUM for asset management firms
AUM = Assets Under Management
P / FFO for REITS
FFO = Funds from Operations
Net Income + D&A P / AFFO
AFFO = Adjusted Funds
from Ops Net Income + Rent
Increases + Certain CAPEX