Valuation

Question 1

What are the two main approaches to valuation

Answer 1

Use these to get a potential range for a company’s value. Not exact.

1) Intrinsic:
- Look at biz ability to generate CFs
- DCF -> based on value = PV of its future free cash flows.

2) Relative:
- Look at comparable companies and apply the average/median of peers (EV/EBITDA, P/E)
- Look at trading and transaction comps

Question 2

What are most common valuations used in finance

Answer 2

1) Trading Comps = base on how similar publicly-traded companies are valued.

2) Transaction Comps = Based on amount buyers paid to acquire a similar company

3) DCF: Value is a function of projected CFs, discounted at appropriate rates that reflect risk of those cash flows.

4) LBO: Look at potential acquisition target under highly leveraged scenario to determine max purchase price firm willing to pay.

5) Liquidation Analysis: Used for distressed companies. Value assets of company under worst-case, liqudiation scenario,

Question 3

Public companies already have market caps and share prices. Why do you need to “value them” at all.

Answer 3

Market cap and share reflect current valuation per the market as a whole.

Market may be wrong

You value a company to see if the markets views are right and if the value might change based on your views

Question 4

What are advantages & disadvantages of public comps valuation

Answer 4

Adv:
- Based on real market data
- Quick to find data and calcualte
- Do not depend on far in the future assumptions

Dis:
- No 2 companies are the same
- less accurate for volatile or thinly trade companies (stock is very violitile, small trades can change value)

Question 5

What are advantages & disadvantages of transaction comps valuation

Answer 5

Adv:
- Based on real prices that companies have paid for other companies for.
- May better reflect industry trends than public comps.

Dis:
- Data can be spotty and misleading (especially private companies)
- May not be truly comparable transaction
- Specific deal terms/market conditions might distort multiples

Question 6

What are advantages & disadvantages of DCF

Answer 6

Adv:
- Most “correct” per finance theory.
- Less subject to mkt fluctuations
- Better reflects company-specific factors and LT trends.

Dis:
- Sensitive to assumptions, less useful for fast-growing, unpredictable companies
- Very dependent on far-in-the-future assumptions.

Question 7

When would it not make sense to use a DCF

Answer 7

DCF doesnt make sense when:

1) FCF not a meaningful metric (don’t have stable CFs)
- DCF assumes you can reasonable project revenue, maragins, CapEx etc.. if you cannot then valuation is not accurate.

2) Industry is asset-centric so you are better valuing A/L. Because their value doesn’t come from recurring FCF, and FCF is volatile.
Ex) Commercial banks, insurance firms, REIT

Almost always use public and transaction comps because universally applicable, but change metrics and multiples.

Question 8

When to use a DCF

Answer 8

1) Stable and mature companies
2) Predictable growth rates

Question 9

Which of the 3 main methodologies will produce highest implied values.

Answer 9

• Any could produce depending on industry, time period, and assumptions. BUT

Transaction higher than public because of control premium (can be 25-50%) above market price.

• DCF most variable since dependent on your assumptions.

Question 10

What is control premium

Answer 10

Extra amount that buyers must pay to acquire sellers. Pay it cuz lets them make strategic changes, and capture synergies that minority stakeholders cannot.

Question 11

Which should be worth more a $500MM EBITDA healthcare or industrials company. Assume same growth rates and margins

Answer 11

1) Healthcare since less asset-intensive
2) CapEx / Working Cap will be lower, CFs will be higher.
3) Healthcare tends to be more of a “growth industry”
4) DistRate might be higher for health, but lower asset insensitiy and higher expect growth could offset.

But would need more info.

Question 12

How do you use a public/transaction comp in valuation

Answer 12

1) Select companies/transactions based on industry,size, geo, and time for transactions.

2) Determine and calculate appropriate metrics and multiples for each (rev, rev growth, EBITDA, EBITDA margins, etc)

3) Calc min, 25th, median, 75th, and max for each valuation multiple in set.

4) Apply these to company you analyst to estimate implied value.

Question 13

When screening for similar public comps and transactions give an exp of what that might look like

Answer 13

Comparable: “U.S. based steel manufacturing companies over $500MM in rev)

Precedent: Aussie M&A transaction over past 2 years involving infra sellings with over $200MM in AUD in rev.

Question 14

How do you choose which metrics and multis to use in valuation methods. Why do we do this.

Answer 14

Industry dependent, and what stage of growth the company is in. In general:

1) Revenue multiple (EV/Rev) -> how valuable a firm is relative to net sales
2) 1-2 Profitability multiples (P/E, EV/EBITDA, EV/EBIT, EV/Unlev FCF) -> how valuable relative to profits.

Question 15

Why do you look at both historical and projected metrics in these methods.

Answer 15

Historical:
- Based on what happened in real life.
-They can be deceptive if non-recurring items or company made acquisition or divestitures

Projected:
- Assume company will operate in a study state w/o acquisitions, divestitures, non-recc.
- But less reliable cuz based on predictions rather than historicals

Question 16

When calculating forward multis for comparable companies, should you use current EQV or current EV, or project them to get Y1 and Y2 values.

Answer 16

ALWAYS use current EQV and EV, never project either.

A companys share price, and therefore both EQV and EV reflect past performance and future expectations.

Question 17

Why do we use multiples instead of absolute values

Answer 17

We use multiples because you need to standardize various factors like size differences.

Question 18

How do you interpret the public comps? What does it mean if the medians are above or below the ones of the company you are valuing.

Answer 18

Depends on growth rates and margins.

1) Most meaningful when growth rates and margins are similar
2) But multiples are different. But why? Could mean the company you are valuing is mispriced.

Ex:
- All companies growing at 10-15%, ebitda margins 10-15%. Your company has growth rates and margins in these ranges.
- But your company trades TEV/EBITDA multis of 6x to 8x, while comparable all trades at 10-12x
- could indicate company is undervalued since multi-lower, but growth rates, margins, industry, and size are comparable.

Question 19

What is a liquidation valuation, how do you solve for it.

Answer 19

value of a company by estimating the market values of all assets.

1) add them up
2) sub Liab
3) gives you implied equity value (valuing net assets not net operating assets)

Question 20

What is a liquidation valuation useful and no

Answer 20

useful:
- Distressed companies.
- Tells you have much they might be worth if they liquidate
- How much lender groups might recieve if liquidate

Not:
- Healthy, growing companies = undervalues them.
- Assets like Net PP&E are always worth more to distressed companies

Question 21

Equity Value Multiples

Answer 21

P/E, Price/Book Value

Numerator: Market Cap or Price Per Share.

Denom: Metrics that already include interest exp (NI, BV of equity)

Question 22

Enterprise Value Multiples

Answer 22

EV/EBITDA, EV/Revenue

Numerator: EV
Demom: Metrics that exclude interest expense (EBITDA, EBIT)

Question 23

What is sum of the parts

Answer 23

value each division or business segment seperately using appropriate comps or DCF, then add all up.

• each segment will have different riscount rates.

Question 24

When should you use sum of the parts

Answer 24

• Large conglomorates with distinct, unrelated divisions.

Question 25

Why use a range of values instead of a single number

Answer 25

1) assumption sensi: tiny change in discount rate or growth assumption can shift valuation significantly 2) no perfect comps: no 2 of the same companies 3) negotiation: valuation is part art, part science, each side has reasons to argue for higher or lower.

Question 26

What is liquidation valuation

Answer 26

1) Value a company's assets 2) Assume they are sold to repay Liab 3) Remainder goes to equity, and is the company's equity value

Question 27

When to use liquidation valuation. When to use when to not

Answer 27

In backruptcy or distress to see if assets > liab Good: - Avoids noise in market Bad: - Healthy companies cuz it produces very low values

Question 28

When would liqudiation valuation produce a higher result

Answer 28

Rare case: market is severely undervaluaing a company's share price, while it has substantial tangible assets

Question 29

Free cash flow multiples - enterprise or equity value

Answer 29

Unlevered FCF (before int) -> use with enterprise value Levered FCF (after int) -> equity value

Question 30

When would you use each of the three valuation metrics

Answer 30

Public: - Liquid sector, peer exits, current market sentiment matters Transaction: - Strategic value / control premium is relevant (M&A is the context) DCF: - Stable, forecastable cash flows - LT view matters/

Question 31

Why would you use EV/Revenue

Answer 31

Early-stage companies or businesses with negative earnings but meaningful revenue. Useful cuz: - Revenue is a positive metric unlike EBITDA - less effected by accounting practices like D/A which can impact comparability

Question 32

Why would you use EV/EBITDA. Downsides?

Answer 32

Most common - Considered a proxy for core, unlevered operating cash flow. - Ignores capital structure, so lots of CapEx wouldnt show up

Question 33

Why would you use EV/EBIT

Answer 33

Similar to EV/EBITDA but includes D&A which is helpful for capEx heavy companies

Question 34

Why would you use P/E (price/earnings) = EQT/NI. Downsides

Answer 34

- Asses if stock is over or undervalued, compare to peers and histrocials. - High PE -> growth / Low PE -> undervalued - Bad when company has negative NI, ignores large one time expenses

Question 35

Why would you use P/BV

Answer 35

Helpful to identify undervalued comapnies. - Useful in sectors where earnings can be volatile - Useful with companies that have significant tangible assets. - Can show more stable measure of valuation than P/E

Question 36

Advanced: Valuing Private Companies: Differences vs. Public Valuation

Answer 36

- No publicly traded share price -> no direct equity market cap. - Harder to get data (EBTIDA, revenue) - Beta for CAPM or WACC might be estimated from public comparables

Question 37

What is a Dividend Discount Model (DDM). How does a DDM differ from a DCF

Answer 37

- Rather than projecting FCF project dividends. - Dividends based on per-share figure or % of NI. - Discount dividends to PV using Cost of Equity and add them up.

Question 38

How do you calculate Dividend Discount Model

Answer 38

1) Project Dividends on a per-share figure or % of NI. 2) Discount Dividends to PV using cost of equity and add up. 3) Terminal Value = use equity value based multi like P/E 4) discount to PV using cost of equity. 5) Add PV of terminal to PV of dividends to get implied Equity Value. 6) Divided by diluted share count to get company's implied share price.

Question 39

When to use a DDM

Answer 39

- Banks - Industries that pay regular dividends such as utilities

Question 40

Why use M&A Premium to value a company

Answer 40

- Only for public companies. -Measure the premium paid vs. the stock price prior to deal announcement.

Question 41

When do we use M&A Premium

Answer 41

- Supplement to precedent transaction - Another way to value company besides standard multiples. - Limited: - Cannot indicate a company that is currently undervalued

Question 42

what does a high valuation mean

Answer 42

- High returns on its invested capital by investing in positive NPV projects - Low risk associated with CFs

Question 43

Would you agree that relative valuation relies less on discretionary assumptions of individuals

Answer 43

No: - For peer multiples, still making assumptions about FCF, Cost of Capital, and returns based on assumptions used by others in the market, same way you would in a DCF

Question 44

Importance of including non-operating income/expense for valuation

Answer 44

- in valuation, you must set apart core operation to normalize figures. DCF: - Recurring - CF projected only from sale of goods and services provided. NOT investements, dividends, or asset a sale. Comps: - Core operations of target and comps are benchmarked. - this to get as close to apples-to-apples

Question 45

FCF Yield compared to dividends yield and P/E ratios

Answer 45

FCF Yield = FCF Per Share / Current Share Price - Cash return a company generates relative to EQV. Div Yield: - FCF Yield better since based on cash biz actual gen. - Not just what mgmt chooses to distribute. P/E: - FCF is a cash-based valuation. - P/E uses accounting earnings - Can be distorted by non-cash its, accruals, one-offs. - Inverting it gives you Price/FCF

Question 46

Pros and Cons of Debt and Equity

Answer 46

Equity: Pros: - No required payments = flexibility. - Dividends issues but timing and amt up to board and mgmt. - Access to vast investor base and network Cons: - Dilutes ownership - Public equity comes with more regulatory requirements, scrutiny from shareholders, and equity analyst. - Mgmt can be voted out by shareholders Debt: Pros: - Int Exp is tax deductible - No ownership dilution - Lower cost of capital - Increased leverage forces discipline on mgmt. Cons: - I + P payments that can cause risk of default - Can lose flexability from covenants - Less room for error from mgmt.

Question 47

What are share buybacks, when to use

Answer 47

- Company uses cash on hand to buy back some of its shares. - Can do through shareholders or open market. - Shown as cash outflow on CFS, reflected in treasury stock line items on BS. - Done when company believes company is undervaluing its shares. - Leads to higher EPS and potentially higher P/E ratio.

Question 48

What is the impact of share repurchases. Will it change share price?

Answer 48

- Should not lead to change in share price. - Because while share count is reduced, EV is also reduced by lower cash balance. - Can move it if market sees as positive signals.

Question 49

Why repurchase over issue dividends

Answer 49

1) Dividends are double taxed, buybacks not. (taxed at corporate and shareholder level) 2) Reduce share count can boost EPS 3) Can be seen as a positive signal to market 4) Buybacks are 1 time, dividends are ongoing

Question 50

A company with $100MM in NI and a P/E Multiple of 15x is considering raising 200MM in debt to pay out a one-time cash divided. How do you decide if this is a good idea?

Answer 50

Come back (red book pg 52)

Question 51

when should company distribute dividends

Answer 51

- Low growth with fewer profitable projects in pipeline. - Signal mgmt is confident in companies LT profitability

Question 52

What is CAGR how do you calculate it

Answer 52

Compound Annual Growth Rate. - Return required for an investment to grow from beg balance to end. = (Ending Value / Beg Value) ^ 1/t - 1

Question 53

CAGR vs IRR

Answer 53

IRR is more specific, can deal with more complex such as timing of Cash in/outflows. CAGR used for historical data whereas IRR for investment decision-making

Question 54

Illiquidity discount

Answer 54

Private shares can’t be sold quickly or at will. Investors pay a premium for liquid assets. So private companies require a discount when using public comps. Typical range: 10–30%.

Question 55

What is an M&A Premium Analysis

Answer 55

1) Still look at prescedent transactions 2) Instead of calculating multiples, calculate premium buy paid.

Question 56

What is a Future Share Price Analysis

Answer 56

1) Project future share price based on P/E 2) Or other multiple of comparable companies 3) Discount back to the present value

Question 57

If a company does not have revenue yet, how do you value it

Answer 57

1) Use alternative metrics and multiples. (EV/users, or other creative ones) 2) Create far in the future, multi-stage DCF (biotech, pharama since known market size)

Question 58

For Public Comps, you calculate Equity Value and Enterprise Value for use in multiples based on companies’ share prices and share counts... but what about for Precedent Transactions? How do you calculate multiples there?

Answer 58

1) Based on the purchase price of the company at the time of deal announcement EX) - Sellers current share price = $40 and has 10MM shares outstanding. - Buy says it will pay $50 per share 1) EQV = 10MM * 50 =500MM 2) EV = 500MM + debt + preStock + minInt - cash

Question 59

How are key operating metrics and valuation multiples correlated? In other words, what might explain a higher or lower EV/EBITDA multiple

Answer 59

1) Usually, correlation between growth and valuation multiples. - So if company is growing rev or EBITDA more quickly, multiples for both may be higher. 2) Math can play a role. If you have very high EBITDA marigns, may have lower EBITDA cuz EBITDA much higher and is in deno. 3) Non-financial factors can play a role.

Question 60

What are some problems with EBITDA and EBITDA multiples. If there are so many problems why would we still use it?

Answer 60

Problems: - Hides Capex -> depreciation effects - Doesn't accounting for non-cash expenses - Doesnt account for working capital - Doesn't account for interest and principal exp Use: - Most convenient (easy to calculate), and has become a standard over time. - Useful for comparing cash generated by company's core biz opperatins. So more about comparability rather than cash flow approx.

Question 61

Would an LBO or DCF produce a higher valuation

Answer 61

Most cases LBO will give lower LBO: - dont get any value from CF of company between year 1 and final year, only value out of final year. DCF: - You are taking into account both company cash flows in period and terminal value so tends to be higher.

Question 62

Precedent Transactions usually produce a higher value than comparable companies. Where would this not be the case?

Answer 62

- when substantial mismatch between M&A market and public markets. - Ex: no public companies have been acquired recently but small private companies have been acquired at low valuations.

Question 63

Why would a company with similar growth and profitability to its comparable companies be valued at a premium

Answer 63

1) Earnings well above expectation so stock price increased 2) A competitive advantage not reflected in financials (IP or pattent) 3) Won a favorable ruling in major lawsuit 4) Market leader and has greater market share

Question 64

How do you take into account a company's competitive advantage in valuation

Answer 64

1) Highlight 75th% or higher for multiples rather than median 2) Add in a premium to some of the multis 3) Use more aggresive projections Typically dont do all but these are possibilities

Question 65

Do you always use the median multiple of a set of a public company comparables

Answer 65

No. You usually show a range and you can see if under/over perform look at 25th/75th percentiles

Question 66

Two companies have the exact same financial profiles (revenue, growth, and profits) and are purchased by the same acquirer, but the EBITDA multiple for one transaction is twice the multiple of the other transaction – how could this happen?

Answer 66

1) One process more competitive and had more bids 2) One had recent bad nes or depressed stock price 3) in industries with different median multis 4) Different accounting standards

Question 67

6. If you were buying a vending machine business, would you pay a higher EBITDA multiple for a business that owned the machines and where they depreciated normally, or one in which the machines were leased? The Depreciation expense and the lease expense are the same dollar amounts and everything else is held constant.

Answer 67

You would pay a higher multiple for the one with leased machines if all else is equal. The Purchase Enterprise Value would be the same for both acquisitions, but Depreciation is excluded from EBITDA – so EBITDA is higher, and the EV / EBITDA multiple is lower for the one that owns its own machines. For the company with leased machines, the lease expense would show up in Operating Expenses, making EBITDA lower and the EV / EBITDA multiple higher. This goes back to one of the points we’ve made throughout this guide: in isolation, specific valuation multiples don’t mean much. You need to see what goes into the numbers and what standards are used. In this case, it would be more meaningful to use an EBIT or EBITDAR multiple to compare the two potential acquisitions.

Question 68

Let’s say that you’re comparing a company with a strong brand name, such as Coca-Cola, to a generic manufacturing or transportation company. Both companies have similar growth profiles and margins. Which one will have the higher EV / EBITDA multiple?

Answer 68

In all likelihood, Coca-Cola will have the higher multiple due to its strong brand name. Remember that valuation is not a science – it’s an art, and the market often behaves in irrational ways. Values are not based strictly on financial criteria, and other factors such as brand name, perceived “trendiness,” and so on all make a huge impact.