Questions and Answers
What is the key difference between M&A premiums analysis and precedent transactions?
What is the first step in conducting a Sum-of-the-Parts analysis?
Value each division using separate comparables and transactions.
How do you value Net Operating Losses (NOLs)?
Based on the sum of tax savings in future years.
What method is NOT commonly used when selecting equity research reports?
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Which two sources can help find missing EBITDA information for precedent transactions?
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How far do we typically look back and forward for public company comparable multiples?
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What needs to be considered when comparing valuations of companies with different EBITDA margins?
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What methodology differs when valuing an oil & gas company compared to a standard company?
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What is a key aspect in valuing a REIT?
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What are the 3 major valuation methodologies?
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Rank the 3 valuation methodologies from highest to lowest expected value.
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When would you not use a DCF in a valuation?
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What other valuation methodologies are there?
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When would you use a Liquidation Valuation?
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When would you use Sum of the Parts?
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When do you use an LBO Analysis?
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What are the most common multiples used in valuation?
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What are some examples of industry-specific multiples?
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When looking at an industry-specific multiple like EV/Scientists, why do you use Enterprise Value rather than Equity Value?
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Would an LBO or DCF give a higher valuation?
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How would you present these valuation methodologies to a company or its investors?
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How would you value an apple tree?
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Why can't you use Equity Value/EBITDA as a multiple rather than Enterprise Value/EBITDA?
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When would a Liquidation Valuation produce the highest value?
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How would you value Facebook in 2004 when it had no profit and no revenue?
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What would you use in conjunction with Free Cash Flow multiples?
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Is there any case where you might use Equity Value/Revenue?
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How do you select Comparable Companies/Precedent Transactions?
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How do you apply the 3 valuation methodologies to get a value for a company?
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What do you actually use a valuation for?
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Why would a company with similar growth and profitability be valued at a premium?
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What are the flaws with public company comparables?
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How do you account for a company's competitive advantage in a valuation?
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Do you always use the median multiple of a set of comparables?
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Can you think of a situation where Precedent Transactions do not produce a higher value than Comparable Companies?
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What are some flaws with precedent transactions?
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Why might two companies with the same financial profile have different EBITDA multiples?
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Why does Warren Buffett prefer EBIT multiples to EBITDA multiples?
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What is the difference between intrinsic value and relative value?
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How do you value banks differently from other companies?
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Walk me through an IPO valuation.
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How would you 'calendarize' a company's financial statements?
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Walk me through an M&A premiums analysis.
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Walk me through a future share price analysis.
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Study Notes
Valuation Methodologies
- Three primary valuation methodologies: Comparable Companies, Precedent Transactions, and Discounted Cash Flow (DCF).
- No definitive ranking exists for these methodologies; however, Precedent Transactions typically yield higher valuations due to control premiums in acquisitions.
DCF Exclusions
- Avoid DCF for companies with volatile cash flows (e.g., tech or biotech startups).
- Not suitable for banks where debt and working capital have different roles in their balance sheets.
Alternative Valuation Approaches
- Additional methodologies include Liquidation Valuation, Sum of Parts, LBO Analysis, M&A Premiums Analysis, and Future Share Price Analysis.
Liquidation Valuation Applications
- Typically used in bankruptcy situations to determine available equity after debts are settled; assesses the benefits of selling assets individually versus the whole company.
Sum of Parts Usage
- Applied when a conglomerate comprises unrelated divisions, evaluating each division separately to derive a combined company value.
LBO Analysis Purpose
- Used to gauge what a private equity firm would pay for a target company while ensuring a satisfactory return; helps set a valuation floor.
Common Valuation Multiples
- Frequently used multiples include Price-to-Earnings (P/E), EV/EBITDA, EV/EBIT, and EV/Revenue.
Industry-Specific Multiples
- Tech sector can utilize: EV per unique visitors and EV per page views.
- Retail/Airline sectors focus on EV/EBITDAR.
- Energy sector often considers Price per MCFE.
Enterprise Value vs. Equity Value
- In industry-specific multiples like EV per scientists or subscribers, Enterprise Value is preferred as it represents the value available to all stakeholders—debt and equity.
LBO vs. DCF Valuations
- LBOs usually produce lower valuations compared to DCFs, as LBOs focus on terminal value rather than cash flows during the investment period.
Presentation Techniques
- Valuation results are commonly displayed on a football field chart, which illustrates a range of values derived from various methodologies.
Valuing Alternatives
- An apple tree can be valued using comparable market valuations and its cash flows for intrinsic valuation.
Importance of Enterprise Value
- Equity Value/EBITDA is inadvisable because it doesn’t represent the entire capital structure; Enterprise Value accounts for all equity and debt.
Exceptional Liquidation Valuation
- A liquidation valuation may yield the highest value for a company with substantial hard assets if the market undervalues them due to specific reasons.
Historical Valuation Cases
- In instances like evaluating Facebook in 2004, comps and precedent transactions would utilize non-traditional multiples due to the absence of profit.
Free Cash Flow and Value
- Free Cash Flow to Firm (FCFF) relates to Enterprise Value while Free Cash Flow to Equity (FCFE) relates to Equity Value, due to their different perspectives on debt treatment.
Rarity of Equity Value/Revenue
- Equity Value/Revenue might be utilized for financial institutions with negative Enterprise Values.
Selecting Comparable Companies
- Crucial factors include industry classification, financial metrics, and geographical considerations.
- For Precedent Transactions, only consider deals from the last 1-2 years.
Valuation Applicability
- Valuations support pitch books, client presentations, fairness opinions in transactions, and various financial models including mergers and LBOs.
Premium Factors
- Companies can command premiums if they possess competitive advantages, experienced favorable legal outcomes, or have recently seen a rise in share price.
Pitfalls of Public Comparables
- Issues include uniqueness of companies, market emotionality affecting multiples, and illiquidity of smaller companies impacting valuations.
Adjusting for Competitive Advantages
- To reflect competitive benefits, consider upper percentiles for multiples, include premium adjustments, or employ aggressive financial projections.
Median Multiple Usage
- Using median multiples is preferred but may vary based on company performance; distressed entities may require 25th percentile adjustments.
Precedent Transactions Anomalies
- Instances may occur where Precedent Transactions yield lower valuations than comps due to discrepancies in market conditions.
EBITDA vs. EBIT Preferences
- Warren Buffett's preference for EBIT stems from the exclusion of depreciation costs from EBITDA, which obscures cash usage field dynamics.
Profitability Measurement Differences
- P/E is capital structure-dependent, while EV/EBITDA and EV/EBIT are neutral. Use context-specific multiples based on industry characteristics.
Valuing Business Models
- Higher multiples are deserved for leasing machines rather than owning them due to depreciation differences affecting EBITDA calculation.
Private Company Valuation Nuances
- Apply the same methodologies but adjust for liquidity discounts, lack of market data, and challenges of DCF due to missing metrics.
M&A Premiums Analysis
- Focuses on historical transaction premiums compared to share prices pre-announcement; involves strict selection criteria based on size and timeframe.
Future Share Price Estimation
- Estimate a company's future share price using historical multiples, project forward growth, and discount back to present value for analysis.
Distinction in Transaction Sets
- Both M&A premiums analysis and precedent transactions share criteria but differ in the public status of sellers and the breadth of analyzed transactions.
Sum-of-the-Parts Analysis Process
- Value divisions separately with relevant comparables, combine these values for a total company worth, reflecting distinct operational sectors.
Net Operating Losses Valuation
- Assess NOLs by projecting future tax savings, discounting to present value, and utilizing adjusted long-term rates for acquisitions.### Valuation Techniques and Considerations
- Net Operating Losses (NOLs) might be considered in valuations but are often excluded; if included, they should be treated like cash when transitioning between Equity Value and Enterprise Value.
Equity Research Report Selection
- Choose equity research reports based on detailed information or median numbers, rather than the bank's name to maintain objectivity in valuations.
Finding Missing Financial Information
- To locate missing EBITDA for companies in precedent transactions, search for press releases or articles, check equity research analysts' estimates, and utilize platforms like Capital IQ and Factset for disclosures or estimates.
Time Frame for Multiples Analysis
- For public company comparables and precedent transaction multiples, examine the Trailing Twelve Months (TTM) data and project forward for one to two years.
Comparing Valuations of Companies with Different Margins
- Comparing companies with differing EBITDA margins can be misleading; the company with a lower margin may exhibit a lower multiple due to arithmetic differences, thus identifying outliers based on margin is recommended but normalization of multiples is discouraged.
Valuing Oil & Gas Companies
- Valuation methods for oil and gas companies include industry-specific multiples such as Price to MCFE (Thousand Cubic Feet Equivalent) and Price to NAV (Net Asset Value).
- Future revenue and cash flows depend on projected commodity prices (oil, natural gas) and reserve estimates.
- A Net Asset Value (NAV) model is preferred over a standard Discounted Cash Flow (DCF) model as it concentrates on reserves rather than revenue growth.
Valuing Real Estate Investment Trusts (REITs)
- REIT valuation hinges on cash flow generation from specific properties, using metrics such as Price to FFO (Funds From Operations) and Price to AFFO (Adjusted Funds From Operations).
- Properties are valued by calculating Net Operating Income (NOI) and dividing it by the capitalization rate derived from market data.
- While DCF can apply, its usefulness varies depending on the type of REIT and underlying assets.
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Description
Test your knowledge on the three major valuation methodologies: Comparable Companies, Precedent Transactions, and DCF. This quiz will help you understand their differences and how to rank them in terms of expected value.