Download Introduction to Valuation Frameworks

Introduction to
Valuation Frameworks
Lecture #2
 Income-Based: Value equals the discounted present
value of future cash flows
Approaches to
Valuation
 Market-Based: Value equals the price on which buyers
and sellers agree. Assumes law of one price and
existence of “comparable” businesses
 Asset-Based: Value equals the sum of the value
individual assets
 These approaches are most often used to value a
business enterprise but conceptually applied to value
almost all assets
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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 Primarily discounted cash flow (DCF). Occasionally, capitalization
of earnings. This course will only use DCF.
 Choices of which cash flow stream to use:
 Free Cash Flow (a.k.a. Unlevered Cash Flow)
 Cash Flow to Equity
Income
Approaches
 Both measures of cash flow are after operating expenses and
taxes (or “tax affected”)
 Free Cash Flow is available to all investors in the firm, both equity
and debt holders
 Cash Flow to Equity is after debt-service payments or is “residual”
cash flow
 Key inputs: Projections (most often, from management), WACC,
long-term growth rate,
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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DISCOUNTED CASH FLOW
Projected FYE Ended January 00,
Year 1
EBITDA
Less: D&A
EBIT
Less: taxes @ 40%
Tax-effected EBIT (NOPAT)
Typical DCF
Model
(simplified)
Year 2
Year 3
Year 4
Year 5
Terminal
Year
100.0
(7.0)
93.0
(37.2)
55.8
105.0
(7.4)
97.7
(39.1)
58.6
110.3
(7.7)
102.5
(41.0)
61.5
114.7
(8.0)
106.6
(42.7)
64.0
118.1
(7.1)
111.0
(44.4)
66.6
120.5
(6.0)
114.4
(45.8)
68.7
Add back: D&A
Less: capital expenditures
+ / - Changes in working capital
Unlevered Free Cash Flow
7.0
(3.5)
(0.5)
58.8
7.4
(5.3)
(1.1)
59.6
7.7
(3.9)
(1.1)
64.3
8.0
(6.9)
2.3
67.4
7.1
(5.3)
0.6
69.0
6.0
(4.8)
(0.6)
69.3
Projection Period
Mid-Year Convention
Present Value Factor
1.0
0.5
0.96
2.0
1.5
0.87
3.0
2.5
0.80
4.0
3.5
0.73
5.0
4.5
0.66
Present Value of Unlevered Free Cash Flows
Sum of PV of Unlevered FCF
Enterprise Value
56.2
254.4
912.1
52.0
51.2
49.1
45.8
Terminal Value: Perpetuity Growth Method
Residual Cash Flow
69.3
Weighted Average Cost of Capital
Long-Term Growth Rate
Capitalization Rate
9.5%
2.5%
7.0% (WACC - LTG)
Future Value of Residual Cash Flow
Present Value Factor
PV Residual Cash Flow
990
0.66
657.7
72%
Terminal Value: Exit Multiple Method
Residual EBITDA
Implied EBITDA Exit Multiple
120.5
8.2x
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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 Reliability of management projections. How can you assess?
Considerations
for Income
Approach
 When and how to calculate terminal value. What % of value is
captured by TV?
 Estimating working capital and capital expenditures (capex)
 Tax rate (for NOPAT)
 Will postpone a detailed discussion of WACC until a future lecture
 Underlying assumptions for ROC = WACC
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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 Two market approaches
 Guideline Public Companies (a.k.a “Comparables”)
 Precedent Transactions
Market
Approaches
 Guideline Public Companies: Estimate of value derived from
stock price/market capitalization of publicly traded companies
 Precedent Transactions: Estimate of value derived from
consideration paid for equity in change-of-control transaction
 Both approaches:
 Derive estimates of value based on valuation multiples. Most
common is EV/EBITDA.
 Depend critically on choice of comparable companies
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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Range of Indicated Multiples
Typical GPC
Model
Sample Multiples
Minimum
[1]
Mean
[2]
Median
[3]
Subject
Company
Financials
[5]
Maximum
[4]
EV using
Median
Multiple
[7]
EV using Mean
Multiple
[6]
EV / LTM Total Revenues
0.5x
1.5x
1.0x
2.5x
$
100.00
$
150.00
$
100.00
EV / LTM EBITDA
4.0x
5.8x
6.2x
7.5x
$
25.00
$
143.75
$
155.00
EV / NFY EBITDA
3.5x
5.3x
5.7x
7.0x
$
30.00
$
157.50
$
171.00
EV / NFY EBIT
3.5x
5.8x
5.9x
8.0x
$
27.90
$
146.48
$
159.03
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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 How to identify comparables?
Considerations
for Market
Approach
 How to assess comparables?
 Estimating working capital and capital expenditures (capex)
 Tax rate (for NOPAT)
 Select valuation multiple
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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 Value of the business enterprise is equal to the sum of the values
of the company’s identifiable assets
 Most often used for asset holding companies
Asset
Approach
 e.g., parent company with operating subs; investment portfolio
 May depend on other valuation approaches to value the individual
assets
 Also used in situations where a company’s assets are or have
become “non operating”. Examples:
 A mothballed plant
 A distressed company holding excess inventory
 A company being liquidated
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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 Premise of value:
 Going-concern
 Liquidation, may be orderly or forced (e.g., “fire sale”)
 Standard of value:
Standard and
Premise of
Value
 Fair market value
 Investment value
 Fair value (most often define by legal statute or accounting
guidelines)
 Idiosyncratic, where typically defined by contact (e.g., buy-sell
agreements)
 Replacement value
 Although not technically a standard or premise, LBO modeling is
another approach to valuation
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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Deriving an
Estimate of
Value
 Do you need a point estimate of value or is a range more
appropriate?
 How do you reconcile if different methods provide different
estimates of value?
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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Case Study #1:
The Record
Company
 The company owns a library of “rights” connected to recorded
music, sheet music, lyrics and photo likenesses of artists. The
company leases these rights to third-parties allowing the use of
these assets in live performance, recorded performance, movies,
advertising, etc.
 The company also manages a portfolio of artists (musician and
vocal). The company advances monies to the artists to fund
various development efforts such as live shows, public
appearances, music recording, marketing memorabilia, etc. As
the artist become profitable, the company “recoups” the advances
and then earns a % of revenue. The percentages vary by the
revenue stream (e.g., concert versus CD sales)
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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 A large U.S. based company operates in the metals and mining
sector. It mines, sources and develops materials that are used in
large infrastructure development.
Case Study #2:
Metals and
Mining
 The large U.S. company is purchasing a smaller Canadian company
that operates in the same sector. The smaller company produces
an excess of certain material (it is a by-produce of other materials
it mines and produces). The excess material will be used in a
current manufacturing process of the U.S. company. The U.S.
company is currently sourcing this same material from third-party
suppliers.
 The Canadian company recently emerged from bankruptcy.
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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 The bookseller operates a national chain of general purpose
bookstores
Case Study #3
The Bookseller
 The bookseller also operates an online bookstore that competes
most directly with Amazon.com (as it pertains to books and
related publications). The online business provides book in
written, audio and electronic form.
 The company recently acquired a college book business that
operates dozens of college bookstores. These bookstores are
“branded” as college or university but are managed and operated
by the company. The college book business also leases text books
directly to students, including students at universities where the
company does not operate the college bookstore.
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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 The bank is a registered broker-dealer. It derives revenue in three
ways:
Case Study #4
The Bank
 Mergers & acquisitions and capital markets advisory services.
 It manages a portfolio of proprietary investments. Some of the
investments are in companies that are advisory clients of the bank.
At times, the bank will accept an equity interest in a client in lieu (in
whole or in part) of advisory fees.
 Regional retail bank that provides customer checking and savings
accounts, home mortgages, consumer loans and small business
loans.
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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 Financial statements
 Public disclosures (SEC filings, press releases, etc.)
Primary
Sources of
Information
 Stock price (publicly-traded companies)
 Earnings calls/Investor presentations
 Equity (and credit ) analyst reports
 Publicly-announced M&A transactions
 Third-party industry research
 Information brokers
Harvard University Extension School, Business Analysis and Valuation, Instructor: Yvette Austin Smith
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