1. Mergers and Acquisitions
FINC3013 – Valuation in an M&A context
Angelo Aspris

2. Valuation Analysis
Valuation is a critical part of the merger/acquisition process.
A deal that may be sound from a business standpoint may be unsound from a financial standpoint.
The purpose of a valuation analysis is to provide a disciplined approach for arriving at a price.
This approach combines procedural valuation procedures with a fair degree of scepticism and sound business judgement.
In other words, for a merger/acquisition process to be successful NV > 0
Where NV = net value, VBT = value of the combined firm, VB = value of the bidder and VT = value of the target.

3. Valuation Analysis
Valuation in M&A is used to answer key questions related to shareholder value creation.

4. Valuation Methodologies
Publicly traded comparable companies analysis
“Public Market Valuation”
Value based on market trading multiples of comparable companies
Applied using historical and prospective multiples
Does not include a control premium
Comparable transactions analysis
“Private Market Valuation”
Value based on multiples paid for comparable companies in sale transactions
Includes control premium
Discounted cash flow
analysis
“Intrinsic” value of business
Present value of projected free cash flows
Incorporates both short-term and long- term expected performance
Risk in cash flows and capital structure captured in discount rate
Leveraged buyout/recap analysis
Value to a financial/LBO buyer
Value based on debt repayment and return on equity investment
Other
Liquidation analysis
Break-up analysis
Historical trading performance
Expected IPO valuation
Discounted future share price
EPS impact
Dividend discount model 4

5. Most Common Valuation Tools
Trading Multiples
Live observations of how companies are being valued by investors.
Intuitive link with fundamental value: e.g. high growth will normally be associated with a higher multiple and higher risk with a lower multiple.
Non-control transactions
Transaction
Multiples
Historical observation of how much investors have paid for companies.
Change of control situations – includes mix of control premium and synergies paid.
Discounted Cash Flow (DCF)
Theoretical value (often used to establish “base valuation)
Useful for period of non-constant growth for finite life
Requires significant number of assumptions for future periods.
Leverage Buy-Out (LBO)
What can financial sponsors pay for assets?
Based on our knowledge of their required returns, access to leverage, ability to extract operational synergies.

6. 1. Trading Multiples

7. Trading Multiples
A method that allows us to calculate the value of an asset by comparing it to values assessed by the market for similar or comparable assets.
The process:
1) Identify the comparable assets and obtain market values for the assets.
2) Convert these market values into standardised values.
3) Compare the standardised values (multiples) for the asset analysed with the comparable asset controlling for any differences between the firm that affect the multiple

8. Trading Multiles

9. Trading Multiples – Boral Example
Company Name
Market Capitalisation ($US)
Total Enterprise Value ($US)
Basic EPS
PEG Ratio
EV/EBITDA
Return on Equity %
EBITDA, 1 Yr Growth %
Adelaide Brighton Ltd. (ASX:ABC)
1,786.14
1,959.53
0.2
2.8x
9.96x
15.5
(7.1)
CSR Limited (ASX:CSR)
2,320.11
3,128.4
(0.1)
2.0x
7.12x
(7.2)
13.8
James Hardie Industries SE (ASX:JHX)
2,172.22
2,303.99
(0.2)
1.2x
9.22x NM
474.2
Boral Ltd. (ASX:BLD)
2,629.58
3,746.23
0.9x
9.02x
4.8
(21.7)
Summary Statistics
High
Low
Mean
2,092.82
2,463.97
(0.0)
8.77x
4.2
160.3
Median

10. Trading Multiples – Calculation Issues
Choice of Multiple:
Which should we chose?
Common choices include P/E, EV/EBITDA, EV/EBIT, PEG
“Hairballs” – minority interests, investments, non-comparable divisions
Post balance sheet events
Acquisitions, divestitures, buy-backs, equity/debt placements
Outliers
Data providers often use different procedures to calculate the same ratio.
Fiscal v Calendar year

11. Trading Multiples Advantages: Disadvantages:
Based on public information (therefore reflect market perceptions/moods)
Market Efficiency – valuation should in theory reflect all available information
Assets are always relatively undervalued/overvalued
Not as computationally intensive as other approaches
Does not include control premium
Disadvantages:
Difficult to find large sample of truly comparable companies
Trading valuation may be affected by thin trading, small capitalisation, or poor research coverage
The market can be “wrong”
Undervalued may still equal overvalued.

12. 2. Precedent (Comparable) Transaction Analysis

13. Precedent (Comparable) Transaction Analysis
Conceptually similar to the trading multiples approach.
The multiples used to estimate the value of the target are based on purchase prices of comparable companies that were recently acquired.
Uses of Comparative Transaction Analysis include:
Valuing a business in a change of control situation (i.e. inclusive of a control premium)
Provide statistics on particular transactions as a basis for discussion.
Display historic acquisition appetite of industry of industry participants and determine willingness to “pay full price”.
Determine the market demand for different types of assets
i.e. frequency of transactions and premiums paid

14. Australian Acquisition Premia - (Deal Size > $100m)

15. Presentation of Transaction Multiples

16. Transaction Multiples – Advantages and Disadvantages
Based on public information
Captures control premium
May show trends
i.e. consolidation, foreign/financial acquirers
Provides guidance to likely interlopers and their willingness and ability to pay.
Disadvantages
Public data can be limited and misleading
Precent transactions are rarely directly comparable (stock market, business, financing, bidders may have all changed)
Values obtained often vary over a wide range
Not all aspects of a transaction can be captured in multiple valuation.
Market conditions at time of transaction may have significant influence on valuation.

17. 3. Discounted Cash Flow Analysis (DCF)

18. DCF Analysis
DCF value is simply the present value of the projected cash flows of a business.
Cash flows are discounted to reflect the time value of money and riskiness of the asset.
In practice DCF analysis is used for:
A base case scenario (to satisfy market convention)
An asset with a finite life
A start up business or early stages of development
A turnaround situation (i.e. when earnings will be very different in a few years)
Key Steps:
Determine forecast horizon cash flows
Determine Terminal Value cash flows (i.e. perpetual growth rate, asset/equity multiple)
Calculate the WACC to discount cash flows.
Various cases can be evaluated
upside (favourable) versus downside (unfavourable) cases
base / low cases to manage expectations, establish floor
key sensitivities on price, cost, growth etc.

19. DCF Components Forecasted free cash flows: Terminal value:
cash flows before debt service or distributions to shareholders
Terminal value:
estimate of future value at “steady state”
a number of methodologies can be used
Cost of capital
represents current return requirements on capital invested (debt and equity) and the appropriate risk of the underlying cash flows
reflects target capital structure on a market weighted basis

20. Free Cash Flow
Free cash flow is the cash that remains after all necessary reinvestments (e.g. capital expenditure and working capital) have been made.
Free cash flow is measured prior to any debt service (interest and debt repayment), but after cash taxes
Free cash flow therefore is the amount of cash that can be distributed to shareholders and debt holders (also known as the ‘unlevered cash flow’)
Cash flows discounted at the weighted-average cost of capital to calculate firm value
Occasionally and primarily for financial institutions, we calculate cash flows after interest expense and interest income (‘levered’ cash flow)
Levered cash flows discounted at the cost of equity
Present value represents equity value

21. Calculating Unlevered Free Cash Flow (UFCF)
Unlevered cash flow is the cash generated without regard to capital structure and financing (hence “un-levered”).
One way of arriving at UFCF:
Net Income
Depreciation
Amortisation
Change in Deferred Taxes
Other Non-Cash Charges
After-tax interest expense
Capital Expenditures
Investment in Working Capital
Unlevered Free Cash Flow (UFCF) - + =

22. Free Cash Flow – Terminal Value
Terminal value is the portion of a company’s total value that can be attributed to cash flows expected in the period beyond the specific forecast period
the terminal value period is the time from the end of the specific forecast period to infinity
Can be measured via perpetual growth method, or multiples approach
Terminal value should be estimated when the forecast reaches “steady state”
long-term assumptions have been stabilised
little added value by forecasting more years
for practical purposes around ten years
The terminal value is equivalent to making infinite year-by-year forecasts

23. Weighted Average Cost of Capital
The Weighted Average Cost of Capital is defined by:
Where E is the value of equity, D the value of debt and V the value of the firm.
For the calculation of WACC one should always:
Use market weights
Use market based opportunities
Use forward looking weights and opportunities

24. Summary of DCF results
Free cashflow summary
Key valuation outputs 13

25. Summary of DCF results Summary of sensitivity analysis:
Key sensitivities for DCF valuations include
WACC / discount rates
Terminal growth rates / multiples
Earnings growth / margins

26. DCF – Advantages and Disadvantages
Theoretically, the most sound valuation method
Forward looking analysis, based on cash flow (rather than net income).
Incorporates expecting operating strategy into the model
Less influenced by volatile market conditions
Allows a valuation of the separate components of a business or synergies separately from the business.
Disadvantages
Valuation is highly sensitive to underlying assumptions, terminal value calculation and discount rate.
Terminal value often represents a significant portion of total value
Impervious to market dynamics and control premia

27. 4. Leveraged Buy-out Analysis (LBO)

28. LBO Analysis
How does the LBO analysis fit into the range of valuation methodologies?
It is based on cash flow projections like a DCF but takes the Company’s leveraged capital structure into consideration
From a technical perspective, it is therefore similar to a leveraged DCF analysis
LBO analysis should answer the following questions:
Does the LBO work within a sensible range of purchase prices?
Are equity returns high enough (>15%)?
How much debt can be put into the company?
Reimbursed before/within maturity while maintaining credit ratios in acceptable ranges at all times?

29. LBO modelling Step 1 Determine purchase price
Determine how much will be paid for using debt vs. equity
What is the entry multiple (i.e. EV/EBITDA of x)
Step 2
Project company’s cash flows over investment horizon (e.g. over 5 years)
Use any excess cash (after operating expenses and interest has been paid) to pay down debt
Equity holders receive no cash during these years

30. LBO Modelling Step 3 Assume an exit multiple (i.e. EV/EBITDA of x)
Multiply this with EBITDA in exit year (e.g. in year 5)
You now have EV. EV – outstanding debt = Value of Equity at Exit
Using Equity put in from Step 1 and Equity at exit from Step 3, you can calculate IRR of equity investment
Step 4
Assess key sensitivities:
Entry vs. Exit multiple (EBITDA multiples)
Gearing vs. Entry multiple
Exit year vs. Exit multiple

31. LBO Methodology: A summary
INPUTS
Projected Cash Flows
Discount Rate (WACC)
Terminal Value
OUTPUT
Enterprise Value (PV)
DCF Analysis
INPUTS
Projected Cash Flows
Purchase Price (PV)
Sale Price (TV)
OUTPUT
IRR (Equity Discount Rate)
LBO Analysis
IPO
Trading Multiple
Sale to Buyer
Transaction Multiple

32. 5. Conclusion

33. Final Valuation
Determining a final valuation recommendation is a process of triangulation using insight from each of the relevant valuation methodologies
1. Discounted
cash flow
Utilises data from M&A transactions involving similar companies.
Analyses the present value of a company's free cash flow.
Utilises market trading multiples from publicly traded companies to derive value.
Used to determine range of potential value for a company based on maximum leverage capacity.
3. Comparable
Acquisition Transactions
4. Leveraged Buy Out
2. Publicly Traded
Comparable
Companies

34. Summary of Results
Typically results are presented to management using a “football field” type presentation analysis

35. Factors affecting the takeover premium
Must win!
Potential cost to bidder if a competitor gets target
Cost of building from scratch vs. purchase
Potential value of ownership, either due to high return investments or unforeseen events
Defensive /
greenfield /
platform / option
Buyer’s perception of the future is different from the market’s view
Outlook
Net cost savings and
revenue enhancements
Synergies
Buyer’s cost of capital is lower than target’s
(sometimes viewed as a synergy)
Cost of capital
Under-valuation
Target trades at a discount to DCF value (eg. Diversified holdings; industry out of favour, poor communications with investors, etc.)
Highest final offer
Trading price before announcement
Target
company price
Potential control premium 29

36. Transaction Values can differ from Valuation Methodologies
Higher level of synergies
revenue enhancements
cost savings
Cross border
differences in capital costs, tax rules, repatriation levels, etc.
Differences in view of the future
buyer may have a dramatically different view of the future than the market
Other strategic reasons
buy versus build
platform for other investments
defensive acquisition