IB VINE - Valuation Methodologies

Questions and Answers

What is the key difference between M&A premiums analysis and precedent transactions?

M&A premiums analysis uses a wider transaction set. (correct)

Precedent transactions usually have fewer than 10 examples.

Both focus solely on industry-specific metrics.

All sellers in M&A premiums must be public. (correct)

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?

Selecting reports that are consistent across banks. Signup and view all the answers

Which two sources can help find missing EBITDA information for precedent transactions?

Public Relations articles Signup and view all the answers

How far do we typically look back and forward for public company comparable multiples?

Look at the TTM period and then forward 1 or 2 years. Signup and view all the answers

What needs to be considered when comparing valuations of companies with different EBITDA margins?

Comparing companies with drastically different margins can be misleading. Signup and view all the answers

What methodology differs when valuing an oil & gas company compared to a standard company?

Using a NAV model instead of a DCF. Signup and view all the answers

What is a key aspect in valuing a REIT?

Focus on cash flow generation from properties. Signup and view all the answers

What are the 3 major valuation methodologies?

Precedent Transaction Signup and view all the answers

Rank the 3 valuation methodologies from highest to lowest expected value.

Trick Question: There is no ranking that always holds. Generally, Precedent Transactions will be higher than Comps due to the control premium. Signup and view all the answers

When would you not use a DCF in a valuation?

When a company has unstable or unpredictable cash flows, or when debt and working capital serve a fundamentally different role. Signup and view all the answers

What other valuation methodologies are there?

All of the above Signup and view all the answers

When would you use a Liquidation Valuation?

In bankruptcy scenarios to determine if equity shareholders will receive any capital after the company's debts. Signup and view all the answers

When would you use Sum of the Parts?

When a company has completely different, unrelated divisions like a conglomerate. Signup and view all the answers

When do you use an LBO Analysis?

To establish how much a private equity firm would pay for its target and set a floor on a possible valuation. Signup and view all the answers

What are the most common multiples used in valuation?

All of the above Signup and view all the answers

What are some examples of industry-specific multiples?

For Tech: EV/Unique Visitors; For Retail/Airlines: EV/EBITDAR; For Energy: P/MCFE. Signup and view all the answers

When looking at an industry-specific multiple like EV/Scientists, why do you use Enterprise Value rather than Equity Value?

Because those subscribers/scientists are available to all investors in the company, both debt and equity. Signup and view all the answers

Would an LBO or DCF give a higher valuation?

Typically, the LBO will give a lower valuation compared to DCF. Signup and view all the answers

How would you present these valuation methodologies to a company or its investors?

Using a football field chart showing the valuation range implied by each methodology. Signup and view all the answers

How would you value an apple tree?

By looking at what comparable apple trees are worth and by the apple tree's cash flows. Signup and view all the answers

Why can't you use Equity Value/EBITDA as a multiple rather than Enterprise Value/EBITDA?

Because Equity Value does not reflect the company's entire capital structure, only the part available to equity investors. Signup and view all the answers

When would a Liquidation Valuation produce the highest value?

If a company had substantial hard assets but was severely undervalued for a specific reason. Signup and view all the answers

How would you value Facebook in 2004 when it had no profit and no revenue?

You would use Comps & Precedent Transaction and look at creative multiples like EV/Unique Visitors. Signup and view all the answers

What would you use in conjunction with Free Cash Flow multiples?

You would use EV for FCFF and Equity Value for FCFE. Signup and view all the answers

Is there any case where you might use Equity Value/Revenue?

In rare cases, large financial institutions with big cash balances may have negative Enterprise Values. Signup and view all the answers

How do you select Comparable Companies/Precedent Transactions?

By considering industry classification, financial criteria, and geography. Signup and view all the answers

How do you apply the 3 valuation methodologies to get a value for a company?

Take the median multiple of a set of comps or past transactions and multiply it by the relevant metric of the target. Signup and view all the answers

What do you actually use a valuation for?

For pitch books, client presentations, fairness opinions, merger models, LBOs, and DCFs. Signup and view all the answers

Why would a company with similar growth and profitability be valued at a premium?

Due to competitive advantages not reflected in financials or favorable market conditions. Signup and view all the answers

What are the flaws with public company comparables?

No company is 100% comparable, stock market emotions affect multiples, and share prices may not reflect true value. Signup and view all the answers

How do you account for a company's competitive advantage in a valuation?

Look at higher percentiles for multiples, add premiums, or use more aggressive projections. Signup and view all the answers

Do you always use the median multiple of a set of comparables?

Not always; in distress situations, lower percentiles may be used. Signup and view all the answers

Can you think of a situation where Precedent Transactions do not produce a higher value than Comparable Companies?

When there's a mismatch between the M&A market and the public market. Signup and view all the answers

What are some flaws with precedent transactions?

Past transactions are rarely 100% comparable, and data on them is harder to find. Signup and view all the answers

Why might two companies with the same financial profile have different EBITDA multiples?

Competing bids, different industries, or recent bad news affecting valuations. Signup and view all the answers

Why does Warren Buffett prefer EBIT multiples to EBITDA multiples?

He dislikes EBITDA as it excludes Capex and may misrepresent cash usage. Signup and view all the answers

What is the difference between intrinsic value and relative value?

Intrinsic value is based on cash flows, while relative value assesses similar assets. Signup and view all the answers

How do you value banks differently from other companies?

Focus on P/E and P/BV instead of EV metrics, and consider bank-specific metrics. Signup and view all the answers

Walk me through an IPO valuation.

Use public company comparables, estimate implied EV, discount to get equity value, and determine the price per share. Signup and view all the answers

How would you 'calendarize' a company's financial statements?

TTM equals the most recent fiscal year plus new partial period minus old partial period. Signup and view all the answers

Walk me through an M&A premiums analysis.

Select transactions, gather share prices before the deal, calculate premiums, and estimate the current company's premium. Signup and view all the answers

Walk me through a future share price analysis.

Project future share price using historical P/E, apply to estimated EPS, and discount to present value. Signup and view all the answers

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.

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.