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Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
Mand a toolkit   building a valuation model
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Mand a toolkit building a valuation model

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  • 1. M&A TOOLKIT Valuation: Building a Valuation Model© 2007-2013 IESIES Development Ltd. All Ltd. Reserved © 2007-2013 Development Rights All Rights Reserved
  • 2. FROMFCF FORECAST TO “AS IS”DCF VALUATION © 2007-2013 IES Development Ltd. All Rights Reserved
  • 3. The FCF forecast is the hard work; the valuation model is the payoff8 STEPS TO TURN A FCF FORECAST INTO A DCF VALUATION MODEL 1) Start with an Operating FCF1 projection 2) Calculate a WACC2 3) Calculate an NPV3 for the forecast period 4) Calculate a Terminal Value4 5) Add to get an Enterprise Value5 6) Deduct non-operating assets and liabilities to get an Equity Value6 7) Divide by shares outstanding to get a 1 2 FCF: Free Cash Flow WACC: Weighted Average Cost of Capital share price; compare to actual 3 NPV: Net Present Value 4 Terminal Value: Business Valuation at the 8) Run Sensitivities end of the explicit forecast period 5 Enterprise Value: Valuation of the business before financing 6 Equity Value: Value of the equity of the business © 2007-2013 IES Development Ltd. All Rights Reserved
  • 4. A DCF Valuation starts from an Operating Free Cash Flow projection FREE CASH FLOW PROJECTION RMBm 669 485 300 106 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 -64 -184 -213 -174 -233 -284 -393 -587Source: China Paradise Valuation Model © 2007-2013 IES Development Ltd. All Rights Reserved
  • 5. The FCF forecast is the hard work; the valuation model is the payoff8 STEPS TO TURN A FCF FORECAST INTO A DCF VALUATION MODEL 1) Start with an Operating FCF projection 2) Calculate a WACC 3) Calculate an NPV for the forecast period 4) Calculate a Terminal Value 5) Add to get an Enterprise Value 6) Deduct non-operating assets and liabilities to get an Equity Value 7) Divide by shares outstanding to get a share price; compare to actual 8) Run Sensitivities © 2007-2013 IES Development Ltd. All Rights Reserved
  • 6. Use the formula to calculate Weighted Average Cost of Capital WACC = kd (1-Tc) (D/EV) + ke (E/EV) ke = Cost of equity1 kd = Pretax cost of long term debt Tc = Marginal Tax rate D = Market value of debt E = Market value of equity EV = D+E 1Per CAPM: ke = rf + (MRP) (β)For “As Is” Valuation, use the TARGET’s Beta and rf = Risk free rate gearing ratio; if there are financial engineering MRP = Market Risk Premium opportunities, include them in synergies β = Beta © 2007-2013 IES Development Ltd. All Rights Reserved
  • 7. In practice, low WACCs are regarded with suspicionEXAMPLE WACC CALCULATION • Inflation is 3% • Long dated government bonds yield 5% • The companies debt is trading at a yield to maturity 50 basis points above this • The Market Risk Premium is estimated at 6% • Beta for this company is 1.2 • Marginal tax rate is 30% • The market value of the companies debt is $100m • The market capitalisation of its equity is $400m • There are no preference shares • What is the Real WACC for this company? A: 7.5% In practice, only Investment Bankers and fresh MBAs debate WACC – for corporates it is usually set by CFO © 2007-2013 IES Development Ltd. All Rights Reserved
  • 8. The FCF forecast is the hard work; the valuation model is the payoff8 STEPS TO TURN A FCF FORECAST INTO A DCF VALUATION MODEL 1) Start with an Operating FCF projection 2) Calculate a WACC 3) Calculate an NPV for the forecast period 4) Calculate a Terminal Value 5) Add to get an Enterprise Value 6) Deduct non-operating assets and liabilities to get an Equity Value 7) Divide by shares outstanding to get a share price; compare to actual 8) Run Sensitivities © 2007-2013 IES Development Ltd. All Rights Reserved
  • 9. Free Cash Flow is discounted by the WACC to get Present Value FREE CASH FLOW PROJECTION Free RMBm 669 Cash Flow 485 300 Present 258 206 Value 106 140 54 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 -36 -64 -168 -176 -131 -184 -213 -174 -194 -144 -233 -284 -393 -587Source: China Paradise Valuation Model © 2007-2013 IES Development Ltd. All Rights Reserved
  • 10. The FCF forecast is the hard work; the valuation model is the payoff8 STEPS TO TURN A FCF FORECAST INTO A DCF VALUATION MODEL 1) Start with an Operating FCF projection 2) Calculate a WACC 3) Calculate an NPV for the forecast period 4) Calculate a Terminal Value 5) Add to get an Enterprise Value 6) Deduct non-operating assets and liabilities to get an Equity Value 7) Divide by shares outstanding to get a share price; compare to actual 8) Run Sensitivities © 2007-2013 IES Development Ltd. All Rights Reserved
  • 11. The Terminal Value is the value of the business at the end of your explicit forecast period FREE CASH FLOW PROJECTION RMBm 669 What about 485 2017, 2018, 20 106 300 140 206 258 19, 2020, 2030 2005 2006 2007 2008 2009 2010 2011 2012 54 2013 2014 2015 2016 , 2050 etc? -36 -64 -168 -176 -131 -184 -213 -174 -194 -144 -233 -284 -393-587 © 2007-2013 IES Development Ltd. All Rights Reserved
  • 12. One way to calculate Terminal Valuer is to project out the cashflow for a long time PRESENT VALUES OF FREE CASH FLOWS $m $327m $192m $90m $42m $20m $9m $4m $2m $1m $0m2009 2014 2019 2024 2029 2034 2039 2044 2049 2054 2059 2064 2069 2074 2079 2084 2089 2094 2099 2104 With Excel copy and paste functionality, this is easy © 2007-2013 IES Development Ltd. All Rights Reserved
  • 13. The most common way to calculate Terminal Value is to use the Perpetuity FormulaPerpetuity formula: Value = K (WACC-g) Alternatives: •Multiple-basedTerminal ValueT = FCFT+1 ending valuation (WACC-g) •Ending book value EXAMPLE • WACC is 10% A: Terminal Value in Year 10 • Perpetuity growth is 2% = $75m x 1/(10%-2%) • FCF in year 11 is $75m = $937.5m • What is the Terminal Value PV of Terminal Value (in present value)? = $937.5m/(1+10%)10 = $361m © 2007-2013 IES Development Ltd. All Rights Reserved
  • 14. Use the Perpetuity Formula with care PITFALLS IN USING THE TERMINAL VALUE FORMULA • FCF must be steadyTerminal ValueT = FCFT+1 state, consistent with the (WACC-g) growth rate forecast (Check capex and working capital ratios for your projected growth rate) g is the expected growth rate of free cash flow in perpetuity • If steady state has not been reached, extend the explicit g is a measure of the expected competitive advantage of the forecast period company at the end of the forecast period • FCFT+1 is the year AFTER your MAX: Companies with a rock solid competitive advantage, the last forecast period economy sustainable long term growth rate (e.g. Coca Cola g=5% at 2% inflation and 3% real GDP growth) TYPICAL: Inflation rate for normal business LOW: 0% for businesses with weak competitive advantages or for cost synergies that are likely to be competed away NEGATIVE: For disappearing businesses (music, newspapers) TIP: Check implied ending multiples to sense check © 2007-2013 IES Development Ltd. All Rights Reserved
  • 15. You can pick any inflation assumption you want as long as you are consistentINFLATION ASSUMPTION Inflation assumption Real Nominal Typical Perpetuity(applied to ALL FCF items WACC WACC g% P/FCFincluding revenues, costs Multiple and investment)Modeling US market in 7% 9% 2% 1/(9%-2%) =US$: 2% 14.3Modeling Chinese market 7% 13% 6% 1/(13%-6%)in RMB:6% = 14.3 If modeling in multiple currencies with different inflation assumptions, flex exchange rate over time to maintain purchasing power © 2007-2013 IES Development Ltd. All Rights Reserved
  • 16. The FCF forecast is the hard work; the valuation model is the payoff8 STEPS TO TURN A FCF FORECAST INTO A DCF VALUATION MODEL 1) Start with an Operating FCF projection 2) Calculate a WACC 3) Calculate an NPV for the forecast period 4) Calculate a Terminal Value 5) Add to get an Enterprise Value 6) Deduct non-operating assets and liabilities to get an Equity Value 7) Divide by shares outstanding to get a share price; compare to actual 8) Run Sensitivities © 2007-2013 IES Development Ltd. All Rights Reserved
  • 17. Add Present Value of the Terminal Value to the NPV of the forecast period to get the Enterprise Value – the value of the business FREE CASH FLOW PROJECTION RMBm $689m 72 75 68 Terminal 60 Value Sense check 55 361 ratio:46 47 48 42 45 44 Terminal 39 Value is 52% 34 32 of Enterprise 30 30 31 31 31 29 FCF 14-18 153 Value FCF 174 09-132009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Enterprise © 2007-2013 IES Development Ltd. All Rights Reserved Value
  • 18. The FCF forecast is the hard work; the valuation model is the payoff8 STEPS TO TURN A FCF FORECAST INTO A DCF VALUATION MODEL 1) Start with an Operating FCF projection 2) Calculate a WACC 3) Calculate an NPV for the forecast period 4) Calculate a Terminal Value 5) Add to get an Enterprise Value 6) Deduct non-operating assets and liabilities to get an Equity Value 7) Divide by shares outstanding to get a share price; compare to actual 8) Run Sensitivities © 2007-2013 IES Development Ltd. All Rights Reserved
  • 19. Calculate the Equity Value by subtracting the non-operating liabilities and adding the non-operating assets to the Enterprise ValueCALCULATING EQUITY VALUE 5 10 e.g. Surplus e.g. Minority 30 cash or interests, 110 marketable pension deficit securities 85 Enterprise Value Non-operating Non-operating Debt Value Equity Value assets liabilities © 2007-2013 IES Development Ltd. All Rights Reserved
  • 20. The FCF forecast is the hard work; the valuation model is the payoff8 STEPS TO TURN A FCF FORECAST INTO A DCF VALUATION MODEL 1) Start with an Operating FCF projection 2) Calculate a WACC 3) Calculate an NPV for the forecast period 4) Calculate a Terminal Value 5) Add to get an Enterprise Value 6) Deduct non-operating assets and liabilities to get an Equity Value 7) Divide by shares outstanding to get a share price; compare to actual 8) Run Sensitivities © 2007-2013 IES Development Ltd. All Rights Reserved
  • 21. Calculate the Equity Value by subtracting the non-operating liabilities and adding the non-operating assets to the Enterprise ValueCALCULATING COMMON SHARE VALUE 10 5 85 $70m Divided by 3.5m 70 shares issued = $20/share Equity Value Preference shares Outstanding options Ordinary shares Valued at market Valued as if all Divide by number price converted to of shares issued to common stock get equivalent share price © 2007-2013 IES Development Ltd. All Rights Reserved
  • 22. The FCF forecast is the hard work; the valuation model is the payoff8 STEPS TO TURN A FCF FORECAST INTO A DCF VALUATION MODEL 1) Start with an Operating FCF projection 2) Calculate a WACC 3) Calculate an NPV for the forecast period 4) Calculate a Terminal Value 5) Add to get an Enterprise Value 6) Deduct non-operating assets and liabilities to get an Equity Value 7) Divide by shares outstanding to get a share price; compare to actual 8) Run Sensitivities © 2007-2013 IES Development Ltd. All Rights Reserved
  • 23. If you are valuing a multi-business company, build a DCF for each business unit then add them upMULTI-BUSINESS VALUATION 10 20 15 110 30 20 35 80 50 BU 1 BU 2 BU 3 BU 4 Cash Corporate Enterprise Debt Equity Overheads Value Value © 2007-2013 IES Development Ltd. All Rights Reserved
  • 24. You run sensitivities to test your model and your financial intuitionRUNNING SENSITIVITIES AND SCENARIOSSENSITIVITIES Purpose: 1) Record and save your base case 2) Select 5-8 assumptions, mixing different types • Growth • Margins Understand how • Valuation sensitive the 3) Change each assumption one-by-one and note the % valuation is to change to Equity Value different • Select the % to change each assumption based on assumptions reasonable range • Select the % to make all value changes positive (for ease of comparison) • Remember to return to the base case each time! 4) Sense check results 5) Create a chart to display model sensitivitiesSCENARIOS 1) Identify different business scenarios Create a realistic 2) Translate these scenarios into different financial range for the assumptions valuation 3) Change all these assumptions at once 4) Note the new Equity Value under this scenario © 2007-2013 IES Development Ltd. All Rights Reserved
  • 25. The valuation of China Paradise is very sensitive to future gross margin % and store costsCHINA PARADISE SENSITIVITY ANALYSIS% Change in value –1% g 10% –1% WACC 18% –1% cash tax 2%–10% on capex/new store? 5% –10% inventory 8% +10% supplier credit 18% –10% Overheads 12% –10% store costs 51% +1% Gross Margin 49% +1% LFL growth 8% 0% 10% 20% 30% 40% 50% 60% © 2007-2013 IES Development Ltd. All Rights Reserved 24
  • 26. Discounted cashflow valuation is a bankable career skill• Discounted cashflow is the only professional valuation method; but watch for GIGO - it is only as good as its assumptions• Discounted cashflow valuation is a tool for understanding the economics, key assumptions and sensitivities of a business, not coming up with a “magic number”• 80/20 – spend the time on the assumptions that matter; don’t sweat the small details• Keep the valuation model clear and flexible – you will have many changes during the deal © 2007-2013 IES Development Ltd. All Rights Reserved
  • 27. Buy the McKinsey “bible” on valuation to improve your skills Amazon LinkYYDDMM Syndicate Case_name © 2007-2013 IES Development Ltd. All Rights Reserved 26

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