1. September - November 2011 Session 2 – Valuation September-November 2011 MarkOkes-Voysey

2. September - November 2011 Slide 2 Course outline2 nd week 1. Strategic overview – why deals? 2. Pricing and negotiating a deal – valuation methods and other key terms 3. Dealing with risk and the role of due diligence + integration planning 4. Tax – risks and planning aspects 5. Legal documents (+ presentation of team game) 6. Team game; your presentations 7. Test

3. September - November 2011 Slide 3 Valuation methods 1 Based on market comparables Guideline Public Companies Comparable transactions 2 The “pure” method Discounted Cash Flow Method 3 Used occasionally Net Assets (?) Key factors: Type of deal/investor Available information Purpose of the analysis

4. September - November 2011 Reminder what is value? We said last week it was the net present value of future cash flows: For non-financial people remember the example. How much would you get in a years time if you invest 10 rubles at an interest rate of 10%. The answer is 11. In this simple example 10 is the NPV of 11. Cash flow year 1+ Cash flow year 2 …….Cash flow year n NPV = (1+ i ) (1+ i ) 2 (1+ i ) n Slide 4

5. September - November 2011 Slide 5 Cash Flow Methods Key parameters: Length of the forecast period Terminal value: Gordon’s growth model vs exit multiples Cash flow on equity/invested capital Discount rate Final adjustments (control, marketability, liquidity)

6. September - November 2011 Illustrative example A-Mart is a successful business company with financial results as shown opposite. Historically it has grown with the market. The market is expected to grow by 5% a year into the foreseeable future. The new general director at the target however believes the target will outperform market growth by 20 %. Salaries comprise 20% of the total costs but the company has historically paid at the lower end of the market (10%) below competitors. Management believes this is sustainable even though there is tension with the trade unions over the issue. The company sold last year its last plot of land that it did not need for the business for a profit of £50. The company has not paid taxes on its profits because of brought forward losses. There are £100 of losses still to be used in the future. Management is seeking advice as to how to legally reduce its future tax charge. The company has borrowed heavily and has bank debt at a reasonable interest rate of £500. In a recent deal another retailer in a similar market was sold for 5 times EBITDA which represented 2x sales. Similar quoted companies are trading at EBITDA multiples of 4 to 6 times. 200820092010 Sales100010801200 Cost of materials(500)(540)(600) Depreciation(100) (110) Salary costs(150)(160)(180) Other expenses(30)(35)(40) Profit on sale of land--50 Operating profit220245320 Interest on loan(50) Profit before taxation 170195270 Tax at 24%--- Profit after tax170195270 EBITDA320345430 Cash flow270295540 Slide 6

7. September - November 2011 So we need to build a cash flow model. We agree with the sellers that 5 years is a reasonable period. We both agree that beyond the 5 th year the business will be very stable. Slide 7 20112012201320142015Comments Sales12601323138914581531Market Cost of materials(630)(662)(695)(729)(766)Constant % Depreciation-----Not cash Salary costs(189)(203)(219)(235)(253)Increasing gradually (15% of sales to 16.5%) Other expenses(45)(50)(55)(60)(65)Increasing gradually Profit on sale of land-----Not sustainable Interest on loan(50) Simple assumption EBITDA*346358370384397 Taxation (remember the losses & depreciation!) (33)(59)(62)(66)(69) Cash flow313299308318328 * In reality there would normally be adjustments between EBITDA and cash flow for items such as working capital movements.

8. September - November 2011 Do you think the seller would have the same view of cash flows and value? Slide 8 What arguments would you use if you were the buyer or seller? Can you think how differences may be resolved? 20112012201320142015Comments Sales12721348142915151606Better than Market Cost of materials(636)(674)(715)(758)(803)Constant % Depreciation-----Not cash Salary costs(184)(198)(209)(219)(229)No increase as % of sales Other expenses(45)(50)(55)(60)(65)Increasing gradually Profit on sale of land-----Not sustainable Interest on loan(50) Simple assumption Cash flow before taxes357376400428459 Taxation (remember the losses & depreciation!) (33)(64)(70)(76)(84) Cash flow324312330352375

9. September - November 2011 Calculating value (assuming a 15% discount rate) Buyer NPV = 313+299+308+318+328+ 328/0∙ 15 1∙151∙15 2 1∙15 3 1∙15 4 1∙15 5 Share Value = 2139 – 500 = 1639 Seller NPV = 324+312+330+352+375+ 375/0∙ 15 1∙151∙15 2 1∙15 3 1∙15 4 1∙15 5 NPV = 2374 Share Value = 2374 – 500 = 1874 Slide 9

10. September - November 2011 Using multiples based on comparables Sales1200 x 2 = 2400 EBITDA4 to 6 x 430 = 1720 to 2580 or 4 to 6 x 380 (exclude land!) = 1520 to 2280 What would you argue if you were selling / buying? Slide 10

11. September - November 2011 Slide 11 Final conclusion and adjustments to the result Scenario analysis Sensitivity test Discounts and premiums for control/marketability

12. September - November 2011 Slide 12 Typical final conclusions and adjustments to the result Level of Value Valuation Approach Controlling Non-marketable Interest Minority Non-marketable Interest Market Approach Minority Marketable (where comparable companies are listed) Plus: Control Premium Less: Lack of Marketability Discount Income Approach (Discounted Cash Flow Approach) Controlling MarketableLess: Lack of Marketability Discount Less: Minority Interest Discount Less: Lack of Marketability Discount Minority Marketable Plus: Control Premium Less: Lack of Marketability Discount Underlying Assets Approach Controlling MarketableLess: Lack of Marketability Discount Less: Minority Interest Discount Less: Lack of Marketability Discount

13. September - November 2011 Thank you! Slide 13