FMVA™ Certification · 2020. 8. 23. · Company Analysis 04. Precedent Transactions 05....

FMVA™ Certification

corporatefinanceinstitute.com

Business Valuation Modeling


Table of Contents


01.

Introduction to Valuation

02.

Equity Value vs Enterprise Value

03.

Comparable Company Analysis

04.

Precedent Transactions

05.

Discounted Cash Flow (DCF)

06.

Factors that Impact Valuation

07.

Interpretation & Presentations of Results

08.

Conclusion

Learning Objectives


Learning objectives


Understand the difference between equity and enterprise value and when to use each of them

Understand why comparable company analysis is performed, the pros & cons of it, and how to calculate the various ratios

Understand why precedent transaction analysis is performed, the pros & cons of it, and how to calculate the various ratios

Understand what discounted cash flow analysis is, how to calculate free cash flow, WACC and NPV

Understand various factors impacting valuation that cannot be discretely modeled

Understand how to effectively present the results of valuation analysis

CFI’s approach


We design all our courses with the following objectives:

01.Teach you how finance professionals actually perform valuation

02.Give you a solid understanding of key concepts, methods, approaches

03.Guide you to perform world class financial analysis

04. Advance your career

Introduction to Business Valuation Concepts


01.


Sell a business Raise money IPO Impairment testing

Estate planning Bankruptcy

Acquire a business

Make investment recommendations

(buy/sell/hold)

Internal business decisions making

Valuing Employee

Options and Compensation

Litigation

Why perform valuation?


Valuation is based on expected future performance not past performance and involves:

Valuation is an art and a science

An analysis of the financial history and prospects of the business, project or asset

Forecast the future operations of the business, project or asset

Analysis of the industry

Analysis of the economic environment

Applying acceptable valuation methods

There are various valuation methodologies which may arrive at differing values for a business, project or asset.


Valuation is an art and a science

Science

01. Historical financials02. Ratios03. Assets04. Track record05. Statistical analysis

Art

01. Management team02. Culture and Strategy03. Forecasting04. “Moat”05. Competition06. Macroeconomic factors07. Cost of capital08. Game theory


Overview of financial valuation techniques

Valuing a business or asset

Cost approach

Cost to build

Replacement cost

Market approach(relative value)

Public company comparables

Precedent transactions

Discounted cash flow (intrinsic value)

approach

Forecast future cash flows



$22.40

$24.81

$28.00

$36.00

$22.00

$49.21

$38.08$36.00

$44.00

$30.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

50.00

55.00

Comps Precedents DCF - base case DCF - blue sky 52 wk hi/lo

Valuation Summary - Equity Value per Share ($)Valuation Summary – Equity Value per Share ($)

Relative value techniques Intrinsic value techniques

Equity Value vs Enterprise Value


02.


Enterprise value vs. equity value

Assets

Market value of net debt

Market value of equity

Enterprise value

Debt investors

Shareholders


House example

House

Debt $100k

Equity$400k

1

House

Debt $400k

Equity$100k

2

House

Debt $250k

Equity$250k

3

Question:

In each case what is the house worth?

Answer:

$500,000. The funding mix for the house is independent of the value of the house - this is what enterprise value reflects for companies.


Terminology

Other names for Enterprise Value include…

Firm Value

Total Enterprise Value (TEV)

EV


Terminology

Other names for Equity Value include…

Market Capitalization

Market Cap


Net debt defined

Net debt defined ($M)

Short-term interest-bearing debt

Long-term interest-bearing debt

Gross debt

5,000

35,000

40,000

Less: cash and cash equivalents

Net debt

10,000

30,000

It’s assumed the cash can be netted against any debt owed.

Cash is not an operating asset that generates cash flow.


Negative net debt (net cash)

Net debt defined ($M)

Short-term interest-bearing debt

Long-term interest-bearing debt

Gross debt

5,000

0

5,000

Less: cash and cash equivalents

Net debt

20,000

(15,000)

Net cash 15,000

Equity Value & Enterprise Value Multiples


03.


Valuation using Equity and EV multiples

Calculate and analyze valuation multiples

Appreciate the drivers of equity and enterprise value multiples

Value a company using

•Equity multiples•Enterprise value multiples

Enable you to:


Relative valuation - multiples

The value of an asset is

derived from the pricing of

comparable assets



Assets



100% of cash flow

25% of cash flow (paid first)

75% of cash flow (paid second)



Assets



XYZ Inc. income statement

Sales

Operating expenses

EBITDA

Depreciation

EBIT

Interest

Earnings before tax

Tax

Net earnings

No of shares

Share price

1,000

(350)

650

(400)

250

(100)

150

(50)

100

100 million

20.00

Income Statement millions

Venders & Employees

Non-cash

Debt holders

Government

Shareholders



If the denominator is before

interest expense,

it’s an enterprise value ratio

EV/Revenue, EV/EBITDA, EV/EBIT

If the denominator is after

interest expense,

it’s an equity value ratio

P/E, P/B, P/CF


XYZ Inc. financial statement extracts

XYZ Inc. balance sheet

Liabilities

Cash

Other current assets

PP&E

Total

0

250

800

1,050

Assets millions

Short-term debt

Other current liabilities

Long-term debt

Common stock

Retained earnings

Total equity

Total

50

100

250

250

400

650

1,050


Sales

Operating expenses

EBITDA

Depreciation

EBIT

Interest

Earnings before tax

Tax

Earnings after tax

Number of shares

Share price

1,000

(350)

650

(400)

250

(100)

150

(50)

100

100 million

20.00



Calculating EV multiples

Question:

What is the enterprise value of XYZ Inc.?

Answer:

100m shares x 20.00 per share = 2,000m plus 300m in net debt = 2,300m

Question:

What are the implied EV to sales, EV to EBITDA, EV to EBIT, EV to capital employed and EV to free cash flow multiples?


EV to sales multiple

Enterprise value to sales multiple

EVSales

Enterprise valueSales

2,300m1000m

2.3 times

EVSales

EVEBIT or EBITDA

EBIT or EBITDASales

2,300m650m

65% 2.3 times


EV to EBITDA and EBIT multiples

EVEBIT

Enterprise valueEBIT

2,300m250m

9.2 times

Enterprise value to EBITDA & EBIT multiples

EVEBITDA

Enterprise valueEBITDA

2,300m650m

3.5 times

They are used more often than other EV multiples such as EV to sales or EV to Free Cash Flow

EV to EBIT and EV to EBITDA are prolifically used in valuation


EV to capital employed multiple

Enterprise value to capital employed multiple

EV to capital employed is driven by return on capital employed

EVCE

Enterprise valueBV of debt + equity

2,300m950m

2.4 times

EVCE

EVEBIT or EBITDA

EBIT or EBITDACE


Free cash flows to the firm

XYZ Inc. free cash flows to the firm

FCFF

EBIT (1 - t) + D&A - Change in WC - Capex

167 + 400 – 300 - 150

117


EV to free cash flow multiple

Enterprise value to free cash flow multiple

EV/FCFFEnterprise value

Free cash flow to firm2,300m117m

19.7 times

Reconciling free cash flow to equity and to the firm:

Free cash flow to equity 50m

Add back interest 100m

Deduct tax shield on interest (33m)

Free cash flow to the firm 117m


XYZ Inc. financial statement extracts

XYZ Inc. balance sheet

Liabilities

Cash

Other current assets

PP&E

Total

0

250

800

1,050

Assets millions

Short-term debt

Other current liabilities

Long-term debt

Common stock

Retained earnings

Total equity

Total

50

100

250

250

400

650

1,050


Sales

Operating expenses

EBITDA

Depreciation

EBIT

Interest

Earnings before tax

Tax

Earnings after tax

Number of shares

Share price

1,000

(350)

650

(400)

250

(100)

150

(50)

100

100 million

20.00



Calculating equity multiples

Question:

What is the market capitalization of XYZ Inc.?

Answer:

100m shares x 20.00 per share = 2,000m

Question:

What are the implied price to earnings, price to book and price to cash flow multiples?


Price to earnings multiple

Price to earnings multiples are driven by:

P/Emultiple

Market capitalizationNet earnings

2,000m100m

20 times

Growth prospects Shareholder risk Cash flow generation



Normalized earnings multiples should reflect the on-going performance of the company.

Adjust for:

Non-recurring or exceptional items

Over- or under-depreciation

Profits/loss on sale of property

Significant provisions or asset write downs



Cannot cope with negative earnings

Earnings can be manipulated

Problems with cyclical firms

• Trough of cycle - high P/E• Peak of cycle - low P/E

Problems with price to earnings:

Earnings can be volatile


Price to book multiple

The book value of equity is the total common shareholders’ equity excluding preference shares and minority interest.

Price to book multiples are driven by:

Return on equity (earnings / book value of equity)

PE drivers:• Growth prospects• Shareholder risk• Cash flow generation

P/Bmultiple

Market capitalizationBook value of equity

2,000m650m

3.1 times


Free cash flow to equity

Free cash flows are used to determine how much cash a company has left after satisfying its sustainable obligations.

FCFECash flows from operations –

capital expenditures


XYZ Inc. example – free cash flow to equity

EBIT

Depreciation

EBITDA

Working capital

Operating cash flow

250

400

650

(150)

500

XYZ Inc. free cash flow to equity (millions)

Interest

Taxes

Cash flow pre-investment

(100)

(50)

350

Capital expenditure

Free cash flow to equity

(300)

50

• Accounts Receivable• Inventory• Accounts Payable


Price to free cash flow multiple

Price to free cash flow multiples are driven by:

Cash conversion (earnings / free cash flows)

PE drivers:• Growth prospects• Shareholder risk• Cash flow generation

P/FCFmultiple

Market capitalizationFree cash flow

2,000m50m

40 times


The firm life cycle and choosing multiples

Inception

Sales

Cash flow

Profit

Early signgrowth

Rapidgrowth

Slowinggrowth

Earlymaturity

Latematurity

Decline


When is a multiple appropriate?

Multiple Characteristics Life cycle stage

EV to sales

• No cash or profit

• Pattern of sales clear

• Ignores operating economics

• Ignores capital structure

• Early sign growth

• Rapid growth

EV to EBITDA

• Operating cash flow positive

• Incorporates profitability


• Ignores tax differences

• Rapid growth

• Slowing growth

EV to EBIT• Operating profit


• Ignores tax differences

• Slowing growth

• Maturity

Price to earnings• Stable operating economics

• Stable capital structure

• Profit and cash flow similar

• Early maturity

• Late maturity


Summary

The most commonly used equity values multiples are Price to Earnings, Price to Book and Price to Cash Flow

The most commonly used enterprise value multiples are EV to EBIT, EV to EBITDA, EV to sales, EV to capital employed and EV to free cash flow

The relevance of different valuation multiples changes over time as business models evolve

The key messages from this session are:

Free cash flows to the firm are cash flows generated by the business and exclude financing costs such as interest

Comparable Company Analysis


04.




Cost approach

Cost to build

Replacement cost





approach



Why comparable analysis

Pros:

01. If investors are willing to pay X for our competitors… they must be willing to pay Y for us

02. Observable value for a company (what investors are actually paying for the business right now!)

03. Readily available

04. Current

05. Large number of potential companies to compare to

Cons:

01. No perfect comparable

02. Hard to adjust for growth, management team, or other factors

03. Easy to fall into “value trap” or “overvalued fallacy” (due to above)


What metrics are used?

Industry specific

General examples:

01. EV/Sales

02. EV/EBITDA

03. EV/EBIT

Lifecycle specific

04. P/E

05. P/B

06. P/CF


Example

Market Data Financial Data (FY+1) Valuation (FY+1)

Price Shares Market Cap Net Debt EV Sales EBITDA Earnings EV/Sales EV/EBITDA P/E

Company name ($/share) (M) ($M) ($M) ($M) ($M) ($M) X X X

Micro Partners $9.45 100 $945 $125 $1,070 $268 $76 $47 4.0x 14.1x 20.1x

Junior Enterprises $5.68 1,250 $7,100 $2,00 $9,100 $4,136 $778 $412 2.2x 11.7x 17.2x

Minature Company $18.11 50 $906 $25 $931 $443 $96 $56 2.1x 9.7x 16.3x

Average Limited $12.27 630 $7,730 $350 $8,080 $1,949 $528 $294 4.1x 15.3x 26.3x

Bohemeth Industries $9.03 1,500 $13,545 $0 $13,545 $6,622 $795 $423 2.0x 17.0x 32.0x

Average 2.9x 13.6x 22.4x

Median 2.2x 14.1x 20.1x

How to perform comparable company analysis


Use Bloomberg / Capital IQ / Equity Research Reports / Google Finance / Yahoo finance / Hoovers to find comps

01.Go to EDGAR / SEDAR / Company website

02.Download 3-5 years of historical data

• Revenue, Gross profit, EBITDA, EBIT, net income

• Shares outstanding, share prices, cash, debt, minority interest

03.

Obtain forecast metrics from Equity Research / Bloomberg / Company Guidance / Google Finance

• Revenue, Gross profit, EBTIDA, EBIT, net income

04.Build a table and calculate Market Cap, EV, all ratios, growth rates, margins, etc.

05.Compare the adjusted average to the company you are trying to value

06.


Multiples valuation requires an in-depth understanding of the company being valued and its peers. The relative valuation is only useful if the companies are a comparable peer group. We need to consider companies that have similar:

How - Selecting a comparable universe

Business activities Geographical location Size and growth profiles

Profitability profiles Accounting policies Similar capital structures

Precedent Transaction Analysis


05.




Cost approach

Cost to build

Replacement cost





approach



Why M&A precedent transactions?

Pros:

01. Shows the value investors paid for the entire company (not just one share)

02. Includes takeover premium / control premium

03. Includes synergy value

Cons:

01. Hard to find (few transactions)

02. Need access to a database like Bloomberg, Capital IQ

03. Become stale dated quickly (valuations from years ago are not relevant today)


What metrics are used?

Industry specific

General examples:

01. EV/Sales

02. EV/EBITDA

03. EV/EBIT

Lifecycle specific

04. P/E

05. P/B

06. P/CF


Example

Valuation

Date Target Transaction Value ($M) Buyers Ev/Sales EV/EBITDA EV/EBIT

01/24/2017 Current Ltd 2,350 Average Limited 1.9x 9.4x 11.2x

04/19/2016 Recent lnc 6,500 Bohemeth Group 1.4x 8.0x 12.6x

04/19/2014 Past Co 2,150 Other Group 1.3x 8.7x 12.1x

11/07/2014 Historical LLP 450 Junior Enterprises 2.3x 11.1x 13.6x

11/01/2012 Old Group 325 Minature Company 5.1x 18.8x 21.5x

11/07/2011 Dated Enterprises 150 Micro Partners 2.1x 9.3x 13.2x

Average 2.3x 10.9x 14.0x

Median 2.0x 9.4x 12.9x

How to perform precedent M&A transaction analysis


Use Bloomberg / Capital IQ / Equity Research Reports / Google Finance to find past transactions

01.Find press release for each transaction

02.Obtain relevant data from press release (may be very limited)

• Price paid• Form of consideration (cash /

shares)• Takeover premium (implied or

explicit)• Synergies announced (if available)• Another other terms/conditions

interesting to note

03.

Build a table and calculate ratios paid at the time, where possible

04.Compare the adjusted averageto the company you are trying to value

05.


We need to consider companies that have similar:

How - Selecting relevant transactions

Business activities Geographical location Type of transaction/buyer

Size and growth profiles Recent time period

Intrinsic Valuation –Discounted Cash Flow (DCF)


06.




Cost approach

Cost to build

Replacement cost





approach



DCF valuation techniques

Value a business using a two-stage DCF valuation model

Calculate free cash flows to the firm and to equity

Outline the main drivers of free cash flows

Identify what discount rate to use

A four-step approach


01.Gather critical information about the company

02.Undertake a comprehensive company analysis

03.Determine the key assumptions that will drive your valuation

04. Build your valuation model from scratch

Step 1


01.Gather critical information about the company

At a minimum you should:

Review the latest annual report in detail

01.Listen to the most recent quarterly earnings webcast / conference call

02.Review available sell side research

03.Review research on the industry

04.

The public information book


Question:

What is in a public information book (PIB)?

News releases – last 6-12 months

01.SEC Filings – 10Q, 10K, non-financial (ownership changes, key events) last 3-5 years

• Familiarize yourself with the various SEC Filings (e.g. proxy, 8k, 13D)

02.Research – industry, comps and your client (especially your own bank’s research)

03.

Corporate / investor presentations – industry conferences, investor calls (e.g. quarterly conference calls)

04.Credit ratings – 2 to 3 rating agency reports

05.Conference call transcripts – pay particular attention to the Q&A by analysts

06.

Step 2


02.Undertake a comprehensive company analysis

At a minimum you should undertake:

A thorough assessment and critique of a company’s stated strategy supported by evidence

01.An assessment of the management team and its ability to deliver against its stated strategy

02.A robust review of a company’s financial statements

03.

A detailed and quantified assessment of a company’s competitive advantages / disadvantages

04.An assessment of industry dynamics within the industry as well as general economic and demographic trends

05.


Assessing future sustainable cash flows requires an analysis of the company, industry, and external environment.

Valuation starts with…

Company

ExternalEnvironment

Industry


PEST analysis is a useful framework for analyzing the external environment.

Tools for analyzing the external environment

Political forecasting

Economic forecasting

Technological forecasting

Social forecasting

Identifyopportunities and

threatsAnticipate React


Porter’s 5 forces is a powerful tool for assessing industry attractiveness. Michael Porter identified FIVE forces driving industry competition:

Tools for analyzing industry dynamics

Potential new entrants and barriers

to entry

Rivalry amongstfirms in industry

Suppliers and their bargaining power

Threat of substitutes

Buyers and their bargaining power


Michael Porter identified the following strategies for gaining competitive advantage in an industry.

Tools for assessing competitive advantage

2. Differentiation

1. Cost

Leadership

3b. Differentiation

Focus

3a. Cost Focus

Co

mp

eti

tiv

e s

cop

e

Bro

ad

ta

rget

Na

rro

w t

arg

et

Competitive advantage

Lower cost Differentiation


Tools for assessing the business lifecycle

Time (years)

Cash

Life cycleextension

Sales

$

Profit

Launch Growth Shake-Out

Maturity Decline

Problem child Rising star Cash cow Dog

Tools for assessing management


Question:

When assessing a management team’s character, which particular aspects / traits should you consider?

Past performance – What does their track record look like?

01.Reputation – What do the press, customers, suppliers, and the competition say about management?

02.Planning – Is there a clear and consistent business strategy? What is management’s approach to growth?

03.

Experience/stability –Qualifications, business and financial acumen, time in business, etc.

04.Attitude towards risk –Have risks been identified? Are there mitigation strategies in place?

05.

Putting it all together - SWOT


Strengths Weaknesses

Internal factors which already exist and have contributed to the current position and maycontinue to exist.

Opportunities Threats

External factors which are contingent events. Assess their importance based on the likelihood of them happening and their impact on the company. Also consider whether management

have the intention and ability to take advantage of the opportunity/avoid the threat.

Step 3


03.Determine the key assumptions that will drive your valuation

From your analysis to date, determine the key assumptions that will drive your valuation. In particular, you must determine what will drive the following:

Revenues

01.Gross margins

02.EBIT(DA) margins

03.

Working capital

04.Capital expenditure

05.Capital structure (debt versus equity)

06.

Step 4


04.Build your valuation model from scratch

Company value

Value of the future cash flows generated by the company discounted at the required rate of return demanded by the investors

Two stage DCF valuation model


Value of the firm

Cash flows for forecastable period

Terminal value

1 2

The two-stage approach to DCF valuations is a common solution to the problem of how we forecast the cash flow of a company because of issues of uncertainty:

We do not know how long the company will exist and hence how many years to include in our cash flow forecast

Forecasting is estimation. The further we predict into the future, the more prone to error our estimates become.

Free cash flows to the firm


Free cash flows to the firm are the cash flows available to all funding providers (debt holders, preferred stock holders, common stock holders, convertible holders, etc.)

EBIT

(1 – Tax Rate)

Depreciation and Amortization

Changes in Working Capital(Deduct net increase in working capital)

Capital Expenditure

Free Cash Flows to the Firm

Forecasting free cash flows


Forecast Drivers

• Market size

• Sales mix

• Volume/price

• Materials price

• Staffing levels

• Wage rates

• Tax effective structures

• A/R, Inventory, A/P

• Terms• Plant life

• Maintenance

• Scale

Revenue

Operating margin

Taxes

Workingcapital

Capital expenditures

EBIT x (1 – T)(NOPAT)

Total capital

Free cash flow

Weighted Average Cost of Capital (WACC)


07.


Estimating the cost of capital

Assets

Equity

Debt

What is the cost of equity?

What is the cost of debt?

The discount rate used in DCF valuations is based on the cost of capital.

There are two main sources of capital funding – debt funding and equity funding.


Calculating the WACC

Weighted average cost of capital

Cost of equity

Cost of debt

Equity risk premium

Beta

Risk free rate

Average yield on debt

Tax shield

Cost of debt (after-tax)

Cost of equity

Weighted average cost of

capital


Factors affecting cost of equity

Beta

01. Market risk02. Interest rates03. Business/economic cycle04. Inflation 05. Political/legislation06. Socio-economic

Alpha

01. Firm-specific risk02. Management03. Profits 04. Operations 05. Projects06. Products

Question:

What factors affect share prices?


CAPM risk / reward model

Re

turn

%

Risk (market)

Riskfree rate

Beta of the market = 1

Risk free rate is normally taken as the yield on a long-term government bond in the country where the project/company is based.

Risk premium between 3% and 9%


Beta is the slope of the line of best fit

Beta can be understood as the slope (gradient) of the line of best fit.

x

x

xx

x

x

xx xx

x

x

x

x

x

x

xMarket (% change)

Share (% change)

Beta = slope of the line

-

-

+

+


The weighted average cost of capital (WACC)

WACC Ke

EquityDebt + Equity

Kd

DebtDebt + Equity

Where

Ke = Cost of equity = RFR + (Beta x MRP)

Equity = Market value of equity

Debt = Market value of debt

Kd = After tax cost of debt


CAPM cost of equity example

Internet Co CAPM calculation

You have been provided with the following information for Internet Co:

Risk free rate

5.0%Equity market premium

4.0%Beta

2.38

Calculate the equity return required by Internet Co. shareholders


CAPM example solution

Internet Co. CAPM calculation

Return required by shareholder

Risk free + (β x Equity market premium)

5.0% + (2.38 x 4.0%)

5.0% + 9.52%

14.52%


WACC example

Consider the following information for Brick and Mortar Co:

Cost of debt

10%Cost of equity

15%Tax rate

30%Market value of debt

10mMarket value of equity

40m

Question:

What is the WACC of Brick and Mortar Co?


WACC example solution

WACC(80.0% x 15.0%) + (20.0% x 7.0%)

12.0% + 1.4%

13.4%

15.0% + 10.0% (1 – 30.0%)40

40 + 10

10

40 + 10

Analysis and Presentation


08.




Cost approach

Cost to build

Replacement cost





approach




$22.40

$24.81

$28.00

$36.00

$22.00

$49.21

$38.08$36.00

$44.00

$30.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

50.00

55.00

Comps Precedents DCF - base case DCF - blue sky 52 wk hi/lo

Valuation Summary - Equity Value per Share ($)Valuation Summary – Equity Value per Share ($)

Relative value techniques Intrinsic value techniques

Conclusion


09.

Recap of learning objectives


Understand the difference between equity and enterprise value and when to use each of them

Understand why comparable company analysis is performed, the pros & cons of it, and how to calculate the various ratios

Understand why precedent transaction analysis is performed, the pros & cons of it, and how to calculate the various ratios

Understand what discounted cash flow analysis is, how to calculate free cash flow, WACC and NPV

Understand various factors impacting valuation that cannot be discretely modeled

Understand how to effectively present the results of valuation analysis

FMVA™ Certification · 2020. 8. 23. · Company Analysis 04. Precedent Transactions 05....

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Transcript of FMVA™ Certification · 2020. 8. 23. · Company Analysis 04. Precedent Transactions 05....