Valuation - Basic Flashcards
What are the 3 main valuation methodologies?
- Comparable companies
- Precedent Transactions
- Discounted Cash Flow Analysis
Rank the 3 valuation methodologies from highest to lowest expected value
Trick q - there is no ranking that always holds. In general, precedents will be higher than comps as they have a takeover premium built into the value.
DCFs are generally more variable than other methodologies, but they could go either way.
When would you not use a DCF?
If the company has unstable or unpredictable cash flows (i.e. a startup), or when debt and NWC serve a different role (i.e. banks / AMs do not reinvest debt)
What other methodologies are there?
Liquidation value - used when a company is being liquidated. FV assets - FV liabilities.
Replacement value - used to value the company based on the cost of replacing its assets.
LBO analysis - determining how much a PE firm could pay for a company to hit a target IRR (usually 20-25%)
Sum of the parts - valuing each division of a company separately and adding them together
M&A Premiums analysis - analyzing M&A deals and figuring out the premium each buyer paid, and using this to establish what your company is worth
Future share price analysis - projecting a company’s share price based on the P/E multiples of public company comparables, discounting back to PV
When would you use liquidation valuation?
Commonly used in bankruptcy - used to see whether equity shareholders will receive any capital after the company’s debts have been paid off.
Often used in struggling businesses to advise on whether it is better to sell of assets separately or sell the entire company.
When would you use Sum of the Parts?
Usually when the company has significant, unrelated divisions e.g. a conglomerate like General Electric.
If you have different divisions that are in different industries/sectors, you should not use the same sets of precedents/comparables for all divisions.
Use appropriate precedents/comps for each division, then add together to get the Combined Value.
When would you use LBO analysis?
Often used to set a floor on a valuation for the company you’re looking at. Always used in leverage buyouts when advising PE.
What are the 5 most common multiples used in valuation?
- EV/Revenue
- EV/EBITDA
- EV/EBIT
- P/E
- P/BV
What are some examples of industry-specific multiples?
Tech: EV / Unique visitors; EV / Page views
- visitors/page views are unique value drivers
Retail/Airlines: EV / EBITDAR (R = rent expense).
- Some companies own their own buildings, some rent. EBITDAR normalizes for this.
Energy: EV / EBITDAX (X = Exploration); EV / Daily Production; EV / Proved Reserve Quantities
- energy reserves / production are the unique value drivers
- Some companies capitalize exploration costs, some expense. EBITDAX normalizes for this.
REITs: Price / Funds From Operations per Share
- FFO adds back depreciation and subtracts gains on sale of property (non-recurring)
When you’re looking at industry-specific multiples (e.g. EV / Scientists, EV / Subscribers), why do you use EV rather than Equity Value?
You use EV because those scientists / subscribers are available to all investors.
This doesn’t apply for all multiples - think through the metric and assess whether it is available to all investors.
Would an LBO or a DCF give a lower valuation?
Generally would be LBO:
- LBO only considers a company’s terminal value
- DCF considers both yearly cash flows and terminal value
How would you present the valuations to a company or its investors?
Use a football field chart with the valuation range implied by each methodology.
How would you value an apple tree?
By using comparable / precedent valuations, and you could do a DCF for the after-tax cash generated by selling the apples.
Why can’t you use Equity Value / EBITDA rather than EV / EBITDA?
EBITDA is available to all investors in the company, not just equity holders. This means it makes sense to compare to EV (also available to all investors)
When would a liquidation value provide the highest valuation?
This is unlikely, but could happen when the company has significant tangible assets that the market has undervalued in comp/precedent transaction.
How would you value Facebook in 2004 when it had no profit and no revenue?
You would look at comps / precedents with more industry-specific multiples, such as EV / Unique Visitors, or EV / Page views.
You would not use a DCF as you can’t reasonably predict cash flows for a company that is not yet generating revenue.
When you can’t predict cash flows, use other metrics.
What would you use in conjunction with Free Cash Flow multiples - Equity Value or Enterprise Value?
Unlevered FCF: Enterprise value (excludes interest therefore CF available to all investors)
Levered FCF: Equity value (after interest therefore CF available to only equity holders)
How do you apple the 3 valuation methodologies to get a value for the company you’re looking at?
You take the median multiple of a set of comparable companies (or precedent transactions), then multiply it by the relevant metric of the company you’re valuing.
Use the football field for each methodology by showing:
1. Minimum
2. Maximum
3. 25th percentile
4. 75th percentile
Are there cases where you would use Equity Value / Revenue?
It is rare to see this, but sometimes you see large financial institutions with big cash balances and negative Enterprise Values.
How do you select Comparable Companies / Precedent Transactions?
- Industry Classification
- Financial criteria (similar revenue, EBITDA etc.)
- Geography
For precedent transactions, you normally limit the set based on date and look at txns in the last 1-2 years.
The most important factor is industry, the rest are optional to make the search more specific.
What do you actually use a valuation for?
Usually you would use it in pitch books and client presentations to tell clients what they should roughly expect for their own valuations.
It is also used in a Fairness Opinion right before a deal closes. This shows the bank’s opinion that the purchase price is fair relative to the company’s intrinsic value.
Can also be used as a floor/ceiling in negotiations.
Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium?
This could happen for a number of reasons:
- The company’s expected earnings were lower than comps (i.e. earnings are similar, but this company has beaten expectations)
- The company has a competitive advantage not shown in financials
- It is the market leader and has a greater market share than competitors
- It has won a favourable ruling in a major lawsuit
What are the flaws with public company comps?
- No company is 100% comparable to another company
- The stock market is emotional and subject to various forces other than financial performance
- Share prices for small companies with thinly-traded stocks may not reflect the full value
How do you take a company’s competitive advantage into account in a valuation?
- Look at the higher range of valuations (i.e. 75th percentile rather than median)
- Add in a premium to a multiple
- Use more aggressive projections for the company (i.e. revenue growth rate)
