Mand a toolkit generating a fcf forecast

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  • 1. M&A TOOLKIT Valuation: Generating an “As Is” FCF Forecast© 2007-2013 IESIES Development Ltd. All Ltd. Reserved © 2007-2013 Development Rights All Rights Reserved
  • 2. Building a DCF Valuation model is a valuable career skill JOBS VALUING DCF VALUATION SKILLS• Management Consulting• Corporate Development• Investment Banking• Equity Analysis• Financial analysis © 2007-2013 IES Development Ltd. All Rights Reserved
  • 3. Build your valuation model in logical steps, debugging at every stageSTEPS IN BUILDING A VALUATION MODELBuild FCF Model 1) Enter 3 years of historical cashflow, P&L and balance sheet 2) Calculate key drivers/ratios of historical results 3) Project flat “vanilla” assumptions for key ratios 4) Calculate projected cashflow, P&L and balance sheet 5) Debug your model – check you get sensible numberGenerate FCF forecast 6) Develop a “story’ on the future of the industry/business 7) Turn your story into different financial assumptions on the key drivers 8) Sense check your FCFBuild Valuation Model 9) Calculate terminal values, enterprise value, equity value 10) Compare equity value to current market capitalisation 11) Run sensitivities © 2007-2013 IES Development Ltd. All Rights Reserved
  • 4. Operating free cash flow is the cash generated by a business The amount of cash, after all taxes, that the business generates for its shareholders and debtholders © 2007-2013 IES Development Ltd. All Rights Reserved
  • 5. Operating free cash flow equals gross cash flow less gross investmentOPERATING FREE CASH FLOW Earnings before interest and taxes (EBIT) - -Cash Taxes = Net Operating Profit Less Adjusted Taxes (NOPLAT) + Depreciation =Gross cash flow Remember: Gross Investment + Increase in Working Capital + Capital Expenditures Leave out all + Investment in goodwill financing cash + Increase in other assets flows! = Gross investment Gross cash flow - -Gross investment = Free cash flow from operations © 2007-2013 IES Development Ltd. All Rights Reserved
  • 6. Operating Free Cash Flow is equals Financing Cash FlowUSES OF FREE CASH FLOW PAID TO PAID TO DEBTHOLDERS SHAREHOLDERS THE COMPANY Interest payments Dividends Kept as cash [Invested in Share repurchases Repayment of debt buying new businesses] © 2007-2013 IES Development Ltd. All Rights Reserved
  • 7. Every aspect of a company needs to be either incorporated into FCF forecast or treated as a non-operating asset/liabilityMake a decision on every cashflow and balance sheet item: Include in the valuation by……Is this part of thecompanies normal Put it in the freeoperations? cashflow forecastIs this part of Put it as a non-operatingfinancing or non- asset/liability to determineoperating? the equity value © 2007-2013 IES Development Ltd. All Rights Reserved
  • 8. Build a FCF forecast in a logical sequenceSTEPS 1-4: BUILDING A “VANILLA” VALUATION MODELCASHFLOW Historical Historical Estimate Forecast 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Revenue 8,267 12,246 14,789 17,085 19,427 21,815 24,251 26,736 29,271 31,857 Cost of Goods -7,684 -11,332 -13,760 -15,804 -17,970 -20,179 -22,433 -24,731 -27,076 -29,467 Gross Profit 583 914 1,029 1,281 1,457 1,636 1,819 2,005 2,195 2,389 Other income 300 760 1,169 1,281 1,457 1,636 1,819 2,005 2,195 2,389 Distribution expense 1) -508 -1,097 -1,563 HISTORICAL -1,794 4) PROJECTED FIGURES -2,040 -2,291 -2,546 -2,807 -3,073 -3,345 Other operating expenses FIGURES -146 -273 -325 -427 (Calculated output) -585 -466 -502 -534 -561 -605 Operating profit (EBIT) 229 304 310 342 408 480 558 642 732 828 Cash taxes -39 -64 -37 -68 -82 -96 -112 -128 -146 -166 NOPLAT 190 240 273 273 326 384 446 513 585 663 Depreciation 25 59 106 157 209 271 335 422 510 586 Gross Cash Flow 215 299 379 430 535 655 781 935 1,095 1,248ASSUMPTIONSASSUMPTIONSNew stores 67 101 100 100 100 100 100 100 100 100 Cost (RMBm)/new store Revenue per new store 2) HISTORICAL 29 3 49 3 39 4 4.2 20 3) 4.4 4.6 PROJECTED 20 20 4.9 20 5.1 20 5.4 20 5.6 20Other capex spend DRIVERS/ 78 121 57 RATIOS 140 DRIVERS/RATIOS (Input422 157 209 271 335 data)510Like for like sales growth, % 2% 0% -3% 2% 2% 2% 2% 2% 2% 2% © 2007-2013 IES Development Ltd. All Rights Reserved
  • 9. Pick your forecast period to achieve stability by the end year RIGHT FORECAST PERIOD Explicit Forecast Examples Period 5 years Businesses with stable cashflows in developed markets PRINCIPLE: •Utilities In order to value in •FMCG perpetuity, businesses must be stable by the 10 years Typical businesses outer year of the forecast: 15 years Businesses with unstable yet predictable •Stable market share cashflows: •Sustainable growth •Cyclical businesses (chemicals, shipping) rate •Low term investment (airports, oil) •No net investment •Fast growth emerging markets (China)YYDDMM Syndicate Case_name © 2007-2013 IES Development Ltd. All Rights Reserved 8
  • 10. The more you practice, the better you will get at modelingGENERAL TIPS ON VALUATION MODEL BUILDING •Think through key value drivers, ratios and economics of the industry/company you are modeling – include as assumptions •One source principle: Set it up so that changing one cell impacts all related cells, don’t have to remember to enter twice •Don’t “hardwire” numbers; even if you think it won’t change, set it up as a separate assumption •Make it easy to edit – you are certain to want to change your model •Start simple. Get something that works, then incrementally make it more accurate/complicated, don’t build something complicated and never know where the bugs are •Best practice is to Project P&L, Balance sheet as well as Cash flow (can simplify, but MUST project Working Capital and fixed asset register) © 2007-2013 IES Development Ltd. All Rights Reserved
  • 11. Build your valuation model in logical steps, debugging at every stageSTEPS IN BUILDING A VALUATION MODELBuild FCF Model 1) Enter 3 years of historical cashflow, P&L and balance sheet 2) Calculate key drivers/ratios of historical results 3) Project flat “vanilla” assumptions for key ratios 4) Calculate projected cashflow, P&L and balance sheet 5) Debug your model – check you get sensible numberGenerate FCF forecast 6) Develop a “story’ on the future of the industry/business 7) Translate story into different financial assumptions on key drivers 8) Sense check your FCFBuild Valuation Model 9) Calculate terminal values, enterprise value, equity value 10) Compare equity value to current market capitalisation 11) Run sensitivities © 2007-2013 IES Development Ltd. All Rights Reserved
  • 12. Think about your future business “story” as three or four actsSTEP 6: CREATE A BUSINESS “STORY” Act I: Starting Point Act II: Development Business Financial Story Assumptions Act III: Resolution Act IV: Finale © 2007-2013 IES Development Ltd. All Rights Reserved
  • 13. The art of financial modeling is knowing what detail you have to put in, and what you can leave outTHE GOLDEN RULE OF FINANCIAL MODELLING 80/20 • Don’t sweat the small stuff • Focus your time and attention on what matters • The purpose is insight and understanding…. • ….not accounting perfection • Start simple • Layer on complexity as you need it © 2007-2013 IES Development Ltd. All Rights Reserved
  • 14. Don’t flex every assumption, pick the 2-5 that are the key drivers of the economicsSTEP 7: CREATE A BUSINESS “STORY” Act I: Starting Point Act II: Only flex 2-5 Key Development Assumptions Business e.g. Story • Gross margin Act III: • LFL Growth % Resolution • New stores • New store economics Act IV: Finale © 2007-2013 IES Development Ltd. All Rights Reserved
  • 15. Then translate your 4 Acts into consistent financial assumptions on the key driversKEY ASSUMPTIONS ACT I ACT II ACT III ACT IV LAND GRAB BLOODBATH CONSOLIDATION STABILITYYear 2007-2008 2009-2011 2012-2014 2015-2016Gross MarginNumber ofnew storesLfL SalesGrowthNew storeeconomics Assumptions should be best estimate of the midpoint – only overlay “conservative” once, not at every level © 2007-2013 IES Development Ltd. All Rights Reserved
  • 16. Your assumptions should be consistent with the business story for each ActKEY ASSUMPTIONS ACT I ACT II ACT III ACT IV LAND GRAB BLOODBATH CONSOLIDATION STABILITYYear 2007-2008 2009-2011 2012-2014 2015-2016Gross Margin 15% 14.5% 15% 15.5%Number of 100 50 50 20new storesLfL Sales -1% -2% +1% +2%GrowthNew store 6-7 years 8-9 years 7 years 6-7 yearsEconomics(payback) You will not be right. Your objective is to be credible and defensible © 2007-2013 IES Development Ltd. All Rights Reserved
  • 17. You can build a reputation as a “scary numbers person” if you master a few quick checksQUICK CHECKS OF A VALUATION MODELKey numbers 1) Is the base (last historical) year right? 2) Are there any jumps in the first forecast year? Can you explain them? 3) Is the terminal value year realistic? 4) Does Depreciation roughly equal capex in the terminal year?Patterns over time•Can you explain why the key ratios (e.g. store margin %) change over time?•Are there unusual jumps between years? Can you explain them?•Are ratios and patterns stable by the outer years of your forecast?•Predict how changing one number will impact the FCF. Then change it and test your prediction.•What costs have you assumed toIES Development Ltd. All andReserved fixed? © 2007-2013 be variable Rights what