Valuation

Trading Comps

  1. Select Universe of Comps
  1. Get Financial Info
  1. Calculate Statistics, Ratios, Multiples
  1. Benchmark comps
  1. Determine Valuation

Sources

Consensus research estimates

equity research reports

Press releases

Lay out ratios of comps vs. target

Determine targets relative ranking

Eliminate outliers

Potentially cluster comps

Means / median of comps

High / low comp multiples provide ceiling / Floor

Use closest comps for tighter range

  1. Study Target

Sources

Investor relations

Earnings calls slides

filings

External research reports

Trade Journals

Outcome

Business Profile

Financial Profile

Sector

Products and Service

Customers and Markets (also referring to "housing market", "automobile market", etc.)

Distribution Channels

Geography (base and customers)

Size

Profitability

Growth Profile

ROI

Credit Profile

Mature companies should measure EPS growth, early stage should measure EBITDA growth

Debt levels (leverage)

Coverage (ability to make interest payments)

  1. Screen for Comps

Look for similar Business Profile

Often lists of comps are cultivated and kept up to date for certain sectors

Start with competitors

SEC filings

10-K (Annual report)

10-Q (Quaterly report)

8-K (Current report -> material corporate event)

Proxy Statement

Hardly relevant, since it only discusses what shareholders are expected to vote on. May have a more recent share count

Size

Growth profile

ROI

Credit Profile

Market Valuation

Equity Value (IMG 1 )

image

Current stock price as % of 52w high
-> If one percentage is out of line, it can indicate company (as opposed to sector/market) specific issues

Fully diluted shares = in the money options + warrants + convertible securities + basic shares

Treasury Stock Method for options: Take weighted avg of all itm-options and assume all are exercised. Proceeds are used to repurchase shares, so that:
((Current price - avg opt exerc. price)* Number of options)/Current share price) = Number of new shares
(See Exhibit 1.7)

If-Converted Method for convertible bonds: Assume all convertible debt with conversion price lower than share price is converted. Net income needs to be adjusted due to forgone interest expense

Net share settlement for convertible bonds: Only the difference between conversion price

Enterprise Value (IMG 2)

image

EV = Equity Value + Debt + Preferred Stock + Non-controlling interest - Cash and Cash equivalents

Key Financial Data

Sales

Higher sales leads to scale, market share, purchasing power, lowe

Gross profit

= Sales - COGS

expressed as % of Sales (gross profit margin)

EBITDA

Often used as proxy for operating cash flow

EBIT

Often the same as operating profit / income from operations

Net income

All profits available to shareholders

Profitability

Gross profit margin

Improved through better purchasing / procurement of raw materials and more efficiencies in the production process

EBIT / EBITDA margin

Net income margin

Shows overall (as opposed to operating) profitability

Is affected by capital structure and tax regimes

Historical EPS growth must be adjusted for non-recurring items

EPS growth estimates are usually taken from consesus

ROIC (return on invested capital)

= NOPAT / (Average net debt + equity)

Comparing ROIC with WACC shows whether capital is being used efficiently

ROE (return on equity)

ROA (Return on Assets)

= Net Income / Avg. Shareholders Equity

= Net Income / Avg Total Assets

Dividend yield

Leverage

Debt-to-EBITDA

Can be viewed as "How many years of cash flow are needed to repay debt

Debt-to-total capitalization

Coverage

Can be with EBIT, EBITA or EBITDA-CapEx divided by interest expense

Credit ratings

Misc.

Calculate LTM data (Prior year + current stub - prior stub)

Calendarization of financial data (When fiscal year =/= calendar year, data must be calendarized)

Adjust for non-recurring items

"scrubbing" / "sanitizing"

Sample items

restructuring cost

Losses/gains on asset sales

Changes in accounting principles

Inventory write-offs

Goodwill impairment

Extinguishment of debt

litigation settlements

Tax adjustments

Research reports often explain more reasoning behind certain non-recurring charges/gains

Which items are non-recurring depends on business (pharma may consider litigation settlements as regular business)

Items will need to be tax-effected if looking at net income numbers

Adjust for recent events

M&A transactions

Financing activities

share repurchases

stock splits

conversion of convertibles

Calculations

P/E and Equity-Value/Net Income

Mostly for mature companies

Is affected by leverage

EV/EBITDA (more common) and EV/EBIT

Very standard

EV/Sales

Mostly just sanity check

May be used for early stage tech without profits

Process

  1. Benchmark multiples with peer group
  1. Benchmark financials with comp universe

Precedent Transaction Analysis ("Transaction comps")

Info

Acquirers look closely at Transaction comps, so banker needs to know

Tend to provide higher valuations due to:

  1. Premium paid for control of company
  2. Premium paid for potential synergies

Process

  1. Select Universe of Comps
  1. Locate Deal- and Financial Info
  1. Spread Ratios, Statistics, Transaction multiples
  1. Benchmark Comps
  1. Valuation

Sources of comps

Databases like SDC Platinum, Capital IQ, FactSet Mergerstat

Target's M&A History for multiples paid/received

Merger proxies for comps mentioned in FOs

Equity research reports for target and sector

Look at internal M&A databases

Information to gather

Conditions and circumstances of transactions

Market Conditions

Deal Dynamics

Strategic vs. fin. sponsor

motivation for transaction

friendly v. hostile
auction v. negotiation

Stock v. cash consideration

Strategic can generally pay more due to synergies

Target critical to future of acquirer?

Fits great with portfolio company?

Seller in hurry to get rid of non-core business for cash?

Stock usually leads to lower valuation

Proxy Statements

Must be sent to shareholders prior to acquisition and contains all relevant transaction info, including FO

Stock

Fixed exchange ratio

Floating exchange ratio

ratio of stocks per stock is fixed (e.g. 3 shares of acquirer per 1 share of target

ratio of value per stock is fixed (e.g. 20$ worth of acquirer stock for each target stock)

Key multiples

Enterprise Value to LTM EBITDA

P/E

DCF

  1. Study Target and determine Perfomance driver
  1. Project FCF
  1. Calculate WACC
  1. Determine Terminal Value
  1. Calculate Present Value and determine Valuation

Exit multiple

Perpetuity growth

Changes in NWC

DIH

DSO

DPO

  1. Determine Target Capital Structure
  1. Estimate Cost of Debt
  1. Estimate Cost of Equity

Current capital structure may not be target

Needs to be benchmarked with public comps

If the current capital structure is not ideal (as determined by comps), the mean or median of comps may be a better measure

Easy if at target capital structure

CAPM

Market risk premium is often decided upon by the firm to ensure consistency. Some take returns from pre 1926 to today, others focus on more recent periods

Market risk premium is between 4-8% on Wall Street

Beta is often looked on on a forward basis. External resources offer this

For private companies, peers need to be assessed for their beta

To assure capital structure doesn't affect the beta, it needs to be "unlevered"

FCF is discounted on a mid-year basis

Sensitivity analysis

Most common are WACC, Exit Multiple and Perpetuity growth rate

DCF valuation may differ from multiples due to company specific factors

Key parameters of WACC calculation are sensitizes to give a WACC range