1. Introduction to Valuation
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Introduction to Valuation

2. Why Valuation? Most important concept in Investment Banking
Determining how much a company is worth
Why do we need this?
M&A (how much should I pay for target?)
Equity (pricing shares)
Debt (maximum debt capacity)

3. Valuation This is not an exact science
There is no ‘black box’ approach to valuation
Depends greatly on banker’s judgments
All valuations will be biased
Cannot rely on just one method, each has its flaws

4. Multiples Numerator= Measure of value Denominator= Operating Statistic
Examples:
P/E (What is this multiple really?)
Market Cap/Net Income
More commonly used on Wall Street are EV multiples (EV/EBITDA)
Aside: Why is EV/NI not used?
EV flows to both debt and equity holders, NI flows only to equity holders

5. EV/EBITDA

6. Break Down EV/EBITDA EV= Enterprise Value, commonly called Firm Value
Market Cap + Total Debt – Cash & Cash Equiv
Think: How much money would be needed to buy the whole company?
EBITDA= Earnings Before Interest, Taxes, Depreciation and Amortization

7. What is Firm Value? Example
Company Acquirer wants to buy Company Target
Company Target sells at $10 per share
They have 100,000 shares outstanding
What is the Market Cap?
$1,000,000

8. Example Cont.
But that’s not it, if A buys T they also take on their debt
This is going to increase the total price of the purchase

9. Example Cont. But what about Cash?
If T has Cash, A can use it to pay down some of that Debt
This is going to decrease the total price of the purchase

10. Example Cont. Market Cap= $1,000,000 Add $1,000,000 in debt
Subtract $500,000 in cash
FV= $1,500,000

11. What is EBITDA? Metric to evaluate profitability
Not GAAP, so there’s no legal requirements
Strips out many expenses that may cloud actual performance

12. EBITDA: What am I taking out and Why?
Interest: It’s a function of management’s financing choices
Taxes: Can vary widely depending on prior losses or acquisitions
D&A: Subjective judgments like useful lives, different methods
Now it’s easier to compare companies

13. Comparable Companies Analysis

14. Comps Reflects current valuation
Can be affected by market conditions and sentiment
Also called Public Market Comps
You can only perform this with Public Companies due to the amount of information needed

15. Step 1: Select Your Universe
I am trying to value Company A
As the name suggests, I need Comparable Companies
These are similar public companies, peers, competitors
Look for similar sectors/sub-sectors, products, geography, size
Realistically you also ask your Associate/VP, they have immense sector and industry knowledge

16. Step 2: Get the Financial Information
Once I have my Comparable Companies,
Locate financial information
What drives value?  both past and future performance
Past Information- SEC filings, press releases
Future Information- Research reports, consensus

17. Step 3: Spread the Comps ‘Spreading’
Entering/Updating financial data and calculating statistics/ ratios/ trading multiples
Calculate valuation measures: Mkt Cap, Equity Value, Firm Value
And earnings measures: EBITDA, Net Income
This is getting us to MULTIPLES

18. Why Can’t we just use Yahoo Finance or Something?
Things like Mkt Cap and FV may be available there, but
You need to calculate earnings measures and valuation measures from scratch (this means inputting #’s like revenue, interest, shares outstanding, etc.)
Allows for greater control and the ability to adjust just one piece
People are going to want to know how you got to that number and why it’s so low/high
You can’t trust it, they are often wrong or don’t take into account options/converts/one-time items
What if it’s in between reporting periods? Did I not sell anything in that time period?
If it were that easy, you wouldn’t have a job

19. Step 4: Benchmarking
I calculated the financial stats, used some Excel formulas to show my ratios and trading multiples
Now, which are the closest, most relevant comparables
Elimination of outliers, Creation of ranges for stats and multiples

20. Determine Valuation
Trading multiples of the Comparable Companies allow us to derive a value for the target
Apply the range of multiples to Company A

21. Some Simple Algebra
I found that the average EV/EBITDA for my comps is 10x
I know my financial statistics, EBITDA = $500,000
What is my EV?
EV/EBITDA=10x
EV/$500,000=10x
EV=$5,000,000
Note that I will often be using estimated forward financial stats and multiples

22. Pros and Cons
Pros
Based on actual public market data, reflects market’s expectations
Can be updated based on day-to-day market data (What impact would a change in the price of a comp’s stock have?)
Cons
Market based- What happens if there’s excessive bearishness/a bubble?
Relevant Comps may not exist
Not an intrinsic valuation, not based on cash flow

23. Precedent Transactions Analysis

24. Precedents Similar to Comps
Looks at multiples paid for comparable companies in past M&A deals
Will always give you the highest valuation, why?
If I am looking at what A paid for T 6 months ago, A likely paid a premium for T. This is because A saw the opportunity for synergies and needed to pay more than the market price for T

25. Step 1: Universe
This time I need a universe of similar companies that have been bought recently
I’m looking at targets, why wouldn’t I care about buyers?

26. Step 2: Get the Info
I now need financial information for the M&A activity
Proxy statements, 8K, 10K/Q

27. Step 3: Spreading
Enter key financial data such as purchase price, the target’s financial stats
Use Excel to calculate multiples
You’re going to end up with EV/EBITDA (or comparable multiple) and use that to find your firm’s EV

28. Pros and Cons Pros Cons Objective, I’m not making assumptions
Market-based, based on what companies actually paid for similar companies
Cons
These deals, by definition occurred in the past
Hard to find comps, harder to find precedents
Hard to find info on some transactions

29. Discounted Cash Flow Analysis

30. DCF
The value of a company is derived from the present value of its future cash flows
What cash flows?  Free Cash Flow
How do I discount it to PV?  WACC
This is establishing an intrinsic value (as opposed to market value)

31. Step 1: Project Free Cash Flow
Projected for 5 years
This is actually unlevered FCF
Unlevered FCF= Cash that a company is able to generate after laying out money to maintain/expand its asset base
This is the cash that could be paid out to lenders and investors
How do I grow FCF? use growth assumptions developed by historical performance and expected sales growth rates, margins, capex, etc.

32. Step 1 Cont.
Why 5 years?  by this time the company is deemed to have reached a ‘steady state’
Formula:
EBIT * (1-Tax Rate)
+ D&A
-Δ Net Working Capital
-Capex
= Unlevered Free Cash Flow

33. Step 2: WACC We know that Present Value= Future Value/(1+i)n
So we have FV (the FCF), now what do we discount this by?
WACC= Weighted Average Cost of Capital

34. Step 2 Cont.
Every company has a capital structure made up of Debt and Equity
Any investor in our company needs to be compensated, how much depends on whether they are taking on the risk of owning equity or owning debt
What is the Cost of Equity?  CAPM
Cost of Debt?  usually the current yield on outstanding issues (it’s complex and it’s DCM’s job)

35. Step 2 Cont. So say rd =5% and re =10%
My company’s cap structure is 70% debt and 30% equity
Now we weight these
WACC= (rd * (1-T) * % debt) + (re * % equity)
What’s that tax rate doing?
Interest paid is often tax deductible

36. What happens after year 5, does the company cease to exist?
No, use Terminal Value

37. Step 3: Terminal Value (Perp Method)
This will give us the value of all future FCF for the company beyond those 5 years
How many years is this projecting out?
10, we use the final years FCF as a starting point
We know WACC too, but what is g?
Perpetuity growth rate= long-term growth rate usually b/t 2 % and 4%

38. Step 4 Set up your formula, input your numbers
Discount each cash flow for the 5 years, sum this, and add it to you TV calculation
This number is equal to your company’s Firm Value

39. Pros and Cons Pros Cons Insulated from the market
Based on cash flows, a very fundamental and intrinsic valuation
Allows for flexibility (I can change factors affecting FCF in future periods)
Cons
Are your forecasts accurate?
How much of my valuation is consumed by TV? (it’s often ¾’s or more)
Small changes lead to big differences

40. So What do you do Now? Combine Valuation Methods
Think about which Method you feel is most accurate
You can combine and weight them to come out with a number

41. How to Pretend that you’re a Banker
Turn it Gray
Blue=Input, Black=Calculation, Green=Link to other sheet
Center Across Selection
Go back to the old Office
Turn off your Excel Gridlines
Unplug your Mouse
Use Shortcuts
Customize your Keyboard
How quick are you?

42. Sources Investopedia.com
Investment Banking by Josh Rosenbaum and Josh Pearl