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See also: Valuation for Beginners - Check Mate! > Part 1

Author: Eva Hukshorn, EFactor

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- 1. Valuation for Beginners – checkmate againAuthors: Eva Hukshorn, Hein Verloop, ABN AMRO / RBS
- 2. AgendaSession 1:• Introduction• Introduction to value• Basic accounting• Discounted Cash Flow valuationSession 2:• Multiples valuation• Leveraged Buy Out valuation• Capita Selecta• Conclusion
- 3. We aim to understand a range of valuationtechniques – Company X Indicative, preliminary valuation range EV EV/EBITDA 2006 CTA 1.8b - 2.2b 9.5x - 11.5x LBO 1.9b - 2.1b 10.0x - 11.0x DCF 1.8b - 2.3n 9.4x - 12.2x CCA 1.5b - 1.7b 7.9x - 9.0x 1,400 1,600 1,800 2,000 2,200 2,400 In EUR millionIndicative and preliminary valuation range of EUR 1.9 billion to EUR 2.1 billion at this earlystage of due diligence
- 4. We focused on Discounted Cash Flow… In order to derive to a Discounted Cash Flow, we need to develop an understanding about discounting (WACC) and about Free Cash Flows To understand Free Cash Flows, we need to understand cash flows To understand cash flows, we also need to understand the profit & loss statement and the balance sheet i.e. we need some basic understanding of accountingWe applied a ‘bottom-up’ approach is assessing DCF
- 5. ...and by now understand the DCF overview Excess cash P&L & marketable Equity value securities Free Cash MV preferred Cash Flow Flow equity MV of Value of Corporate B/S WACC minority Operations value interests MV of Terminal interest- value bearing debtAccounting MV of MV of other financial financial = input = output fixed assets1 liabilities2 Notes: 1) including non-operating investments 2) including underfunded pension plans Enterprise value is the equivalent of Value of Operations
- 6. Background on net debt andother adjustments
- 7. Net interest bearing debt Net interest bearing debt = Interest bearing debt - Cash Generally: Generally: short- and long-term interest cash and cash equivalents: bearing debt: • Marketable securities • Loans • current assets held for • Bonds sale Short-term deposits • Notes • Commercial paper • Commercial paper • Treasury bills • Overdrafts • Redeemable preference shares • Finance leases • Convertibles • Interest rate swaps Net interest bearing debt is also known as Financial net debt
- 8. Adjustments to Net interest bearing debt (NIBD)Adjusted NIBD to cater for limitations of Financial net debt• Financial NIBD : IBD - Cash• Adjusted NIBD : IBD + other debt like items – CashAdjustments - when do we use them?• Mostly used during high-level execution analysesAdjustments serve to identify potential claims other than straight debt• Other debt like items are usually not easy to recognise and have to be derived through additional calculations (check “Notes to financial statements” in Annual Reports)
- 9. Some examples of other debt like items• Pension adjustments for under- (or over-)funded pension liabilities – Underfunded pension plans in some case represent very significant liabilities – Only applicable for Defined Benefit plans, not for Defined Contribution plans• Operating (and rental) lease obligations – Future lease payments could be considered as debt. NPV of future obligation should be added to IBD• Industry specific Long-term liabilities – E.g. nuclear decommissioning liabilities for energy companies All items above have an impact on a company’s total debt. Be aware interest is paid to compensate debt providers. Equally, implied interest shall be payable for above items. Implied interest should be added to EBITDA and EBIT!
- 10. Other debt-like items• Other debt-like items could be: – Bank overdrafts – Tax accruals – Assets due to financial liabilities – Employee stock options – Preferred equity – Golden parachutes – Other debt / semi - equity instruments – Potential claims – Contingent liabilities – Litigation – Provisions – Other liabilities All debt-like items can be included in net debt under certain circumstances. Including or excluding items should be consistent throughout the peer group in comparable analyses
- 11. 2 Multiples valuation
- 12. Setting the scene: why multiples valuation?Generally, we run valuation analyses to determine:• Value - how much certain assets are worth (to a particular owner)• Price - how much you can get for the assetsPlease remember there is a difference between value and price!• DCF analysis and other more fundamental valuation tools assess value• Multiples analysis tries to estimate the value of an asset, but primarily uses the market price by assuming that the peer companies or transactions are indeed comparable and have been correctly valued by the marketMultiples analysis is a commonly used and relatively easy to understand methodology• However, it is very easy to get it wrong! Multiples are too frequently miscalculated and misused• On the other hand, DCF analysis requires a very thorough understanding of the business, the industry and a good sense of the future
- 13. Advantages and issues of multiples valuationcompared to a DCF valuationAdvantages• Fewer explicit assumptions required• Sensitive to market movements: allows comparison to recent market and transaction evidence• Easy to understand• Analysis can be carried out relatively quickly (although this is not always the case)Issues• Assumes comparables are correctly valued: no value gaps exist for any peer, nor the company being valued• Can be misinterpreted easily, easy to think you have understood• Subjective – easy to influence the outcome through composition of peer group and selective interpretation of outputs – wide range of multiples can “support” nearly any presumed value Theoretically: DCF is the preferred methodology
- 14. Comparable Company Analysis
- 15. Comparable company analysis - introduction• Main purposes of the Comparable Companies Analysis ( CCA ) are: 1. to estimate the value of a non-listed company 2. to compare listed companies in one industry (relative valuation)• Often used alongside the stand-alone DCF as sanity check• Other purpose CCA: Sum-of-the-Parts (SOTP) analysis – Business units with different characteristics should not be valued through an overall comparable analysis• It s a comparison of peers AT THIS MOMENT IN TIME!
- 16. Step 1: Peer selectionPeer selection criteria• Similarity of product mix• Geographical spread of business• Comparable financial ratios such as sales growth – companies that seem very similar in terms of the business they conduct, can still show deviations in their multiples• Financial ratio analysis can help filter out the right peers – Be mindful that peers may be similar in their operations, but under or outperform other peers representative of the specific industry – Analyse where the target ranks• Clear outliers can be excluded, e.g. companies in financial distress Position your target within the peer group you selected!
- 17. Step 2: Collecting financialsMarket data• Current share price• Number of shares outstanding (including dilution)• Net debt (and all its components)Accounting data for last available reporting years• P&L and Balance SheetForecast data for at least two to three forecast years• Forecast of Income Statement; available in analyst reports ( Research )
- 18. Step 2: Collecting financials - ExampleADIDAS – year 2007Price per shoe EUR 60Production costs per shoe EUR 51Amount of shoes sold 900xMarketing & salary EUR 6,000Interest % 5%Tax 30%Share price EUR 20Outstanding shares 650xInterest bearing debt EUR 1,000Unfunded pensions EUR 700Cash EUR 100Fixed assets EUR 5,000Inventory EUR 6,000Receivables EUR 3,500Payables EUR 600
- 19. Step 2: Collecting financials – Example (cont d)X EUR Adidas Sales xx COGS xxGross margn xx SG&A xxEBIT xx Interest xxPBT xx Tax xxNet profit xx
- 20. Step 2: Collecting financials – Example (cont d)X EUR Adidas Sales 54,000 COGS 45,900Bruto Winst 8,100 SG&A 6,000EBIT 2,100 Interest 50EBT 2,050 Tax 615Net profit 1,435
- 21. Step 2: Collecting financials – Example (cont d)ACTIVA (= DEBET) PASSIVA (= CREDIT)Fixed assets: XXX Equity XXXCurrent Assets: XXX Liabilities XXXTotal Activa XXX Total Equity + Liabilities XXX
- 22. Step 2: Collecting financials – Example (cont d)ACTIVA (= DEBET)` PASSIVA (= CREDIT)Fixed assets: 5,000 Equity 13,000 Share price 20 Outstanding shares 650Current Assets: 9,600 Liabilities 1,600 Cash 100 Debt 1,000 Receivables 3,500 Payables 600 Inventory 6,000Total Assets 14,600 Total Equity + Liabilities 14,600
- 23. Step 3: Calculating multiples – Enterprise value Excess cash & Equity value marketable securities + –MV preferred equity Enterprise value + MV of minority – interests + MV of interest- bearing debt MV of financial fixed + assets 1 MV of otherfinancial liabilities 2 Notes: 1) including non-operating investments 2) including underfunded pension plans
- 24. Step 3: Calculating multiplesYear 2007 AdidasEnterprise Value xxSales xxEBIT xxSales multiple xxEBIT multiple xx
- 25. Step 3: Calculating multiples (cont d)Year 2007 AdidasEnterprise Value 14,600Sales 54,000EBIT 2,100Sales multiple 0.27xEBIT multiple 6.9x
- 26. For Company X the CCA was less relevantdue to absence of directly comparable peers EBITDA EV / EBITDA OpFCF EV / OpFCF Share MarketCompany Adj. EV CAGR CAGR price cap. 05 - 08 2005 2006 2007 2008 05 - 08 2005 2006 2007 2008Fastweb 40 3,184 3,670 43.2% 12.0x 8.2x 5.2x 4.1x nm nm nm 17.6x 5.8xIliad 79 4,297 4,335 nm 19.3x 14.0x 11.9x nm nm nm 35.8x 19.2x naAverage 15.7x 11.1x 8.5x 4.1x na 35.8x 18.4x 5.8xNTL - Telewest 15.14 4,315 9,688 9.9% 8.2x 7.5x 6.8x 6.2x 17.7% 14.6x 13.1x 10.9x 8.9xLiberty Global 20.60 9,510 18,648 20.9% 10.9x 8.0x 6.9x 6.2x 36.3% 36.1x 24.7x 16.8x 14.3xTelenet 17.70 1,735 2,970 7.1% 8.8x 8.2x 7.6x 7.2x 13.5% 19.3x 18.9x 15.3x 13.2xAverage 9.3x 7.9x 7.1x 6.5x 23.3x 18.9x 14.3x 12.1xComcast 28.72 56,993 70,210 15.6% 8.3x 7.2x 6.6x 6.2x 14.2% 14.4x 5.1x 10.7x 9.7xCharter 1.07 469 20,024 8.9% 10.4x 10.0x 9.3x 8.7x 19.8% 25.1x 20.5x 16.5x 14.6xCablevision 27.93 8,327 17,057 17.2% 10.6x 9.4x 8.4x 7.7x 21.6% 20.2x 15.3x 12.7x 11.3xMediaCom 6.63 751 3,793 11.5% 9.4x 8.8x 8.2x 7.5x 20.4% 21.4x 16.3x 14.5x 12.3xCogeco 29.50 1,161 1,887 nm 8.1x 7.7x nm nm nm 18.3x 17.6x nm nmShaw 31.25 6,437 9,682 14.3% 9.6x 8.9x 8.0x nm nm 18.1x 17.4x 14.3x nmAverage 9.4x 8.6x 8.1x 7.5x 19.6x 15.4x 13.7x 11.9xCasema 18.3% 54.4% Differing growth levels, market positions and country dynamics result in a less relevant peer analysis
- 27. Comparable Transaction Analysis
- 28. Comparable Transaction Analysis - introduction• The Comparable Transactions Analysis ( CTA ) model follows logic of CCA (difference: historic vs. forward looking inputs)• Often used alongside the stand-alone DCF• It s a comparison of transactions THROUGH OUT HISTORY!
- 29. What are comparable transactions?• In accordance with the comparable companies model, the criteria are: – Transactions with similar geographical spread of business – Transactions with similar product mix – Transactions with similar deal size (10 mln. vs. 1 bln.) – Comparable financial ratios (exclude companies in financial distress) – Time frame (I.e. Internet 1 year & steel company 5 years back)• Advantage CTA: it puts a market value on non-listed companies, and is indicative of exit premiums paid in take-overs• Disadvantage CTA: lack of comparable transactions or data• Little data equates to little meaning
- 30. CTA - Example Adidas NikeCompany sold in year 2004 2006Selling price: EUR 15,000 EUR 1,4000Sales 2007 EUR 54,000 EUR 65,000Sales 2006 EUR 50,000 EUR 63,000Sales 2005 EUR 48,000 EUR 61,000Sales 2004 EUR 45,000 EUR 58,000EBIT 2007 EUR 2,100 EUR 1,500EBIT 2006 EUR 2,000 EUR 1,700EBIT 2005 EUR 1,900 EUR 1,200EBIT 2004 EUR 1,800 EUR 1,100
- 31. CTA - Example Adidas NikeEnterprise value company xx xxSales used xx xxEBIT used xx xxSales multiple xx xxEBIT multiple xx xx
- 32. CTA – Output Adidas NikeEnterprise value company 15,000 14,000Sales used 45,000 63,000EBIT used 1,800 1,700Sales multiple 0.33x 0.22xEBIT multiple 8.33x 8.24x
- 33. Company X CTA indicates 9.5 – 11.5x 2006 EBITDADate Acquirer Target Currency Enterprise Value EV/Revenue EV/EBITDA EBITDA CAGR million Historic Forward Historic Forward 05-07Date Acquirer Target Currency Enterprise Value EV/Revenue EV/EBITDA EBITDA CAGR2006Date transactions Acquirer Target Currency million Enterprise Value Historic Forward EV/Revenue Historic Forward EV/EBITDA 05-07 EBITDA CAGR million Historic Forward Historic Forward 05-072006 transactions05-Apr-06 Carlyle/Providence UPC Sverige EUR 349 4.7x na 9.3x na 21.7%2006 transactions23-Mar-06 Altice/Cinven UPC France EUR 1,250 na na 11.4x na n/a05-Apr-06 Carlyle/Providence UPC Sverige EUR 349 4.7x na 9.3x na 21.7%07-Feb-06 Sonaecom-SGPS, SA PT Multimedia EUR 2,896 4.6x 4.3x 14.8x 13.3x n/a23-Mar-0605-Apr-06 Altice/Cinven Carlyle/Providence UPC France UPC Sverige EUR EUR 1,250 349 na 4.7x na na 11.4x 9.3x na na n/a 21.7%07-Feb-0623-Mar-06 Sonaecom-SGPS, SA Altice/Cinven PT Multimedia UPC France EUR EUR 2,896 1,250 Average 4.6x na 4.6x 4.3x na 4.3x 14.8x 11.4x 11.8x 13.3x na 13.3x n/a n/a 21.7%07-Feb-06 Sonaecom-SGPS, SA PT Multimedia EUR 2,896 Median 4.6x 4.3x 14.8x 11.4x 13.3x n/a 21.7% Average 4.6x 4.3x 11.8x 13.3x 21.7% Median Average 4.6x 4.6x 4.3x 4.3x 11.4x 11.8x 13.3x 13.3x 21.7% 21.7%2005 transactions Median 4.6x 4.3x 11.4x 13.3x 21.7%2005 transactions19-Dec-05 Candover UPC Norway EUR 445 4.7x 4.0x 12.2x 10.2x 19.5%2005 transactions08-Dec-05 Providence KDG EUR 3,200 3.2x na 8.6x 8.0x n/a19-Dec-05 Candover UPC Norway EUR 445 4.7x 4.0x 12.2x 10.2x 19.5%08-Dec-05 Mid Europa Partners Aster City EUR 410 6.6x na 13.2x 11.1x n/a08-Dec-0519-Dec-05 Providence Candover KDG UPC Norway EUR EUR 3,200 445 3.2x 4.7x na 4.0x 8.6x 12.2x 8.0x 10.2x n/a 19.5%05-Dec-05 Carlyle/Providence ComHem EUR 1,105 6.6x 5.4x 18.1x 14.2x 36.1%08-Dec-0508-Dec-05 Mid Europa Partners Providence Capital Aster City KDG EUR EUR 410 3,200 6.6x 3.2x na na 13.2x 8.6x 11.1x 8.0x n/a n/a05-Dec-05 Alethia/AA EWT EUR 675 na na na 7.5x n/a05-Dec-0508-Dec-05 Carlyle/Providence Mid Europa Partners ComHem Aster City EUR EUR 1,105 410 6.6x 6.6x 5.4x na 18.1x 13.2x 14.2x 11.1x 36.1% n/a17-Nov-05 Cinven (consortium) AlticeOne EUR 525 7.0x 6.0x 12.7x 10.1x 21.2%05-Dec-0505-Dec-05 Alethia/AA Capital Carlyle/Providence EWT ComHem EUR EUR 675 1,105 na 6.6x na 5.4x na 18.1x 7.5x 14.2x n/a 36.1%06-Oct-05 Warburg Pincus Multikabel EUR 515 6.0x na 10.2x 8.7x n/a17-Nov-0505-Dec-0503-Oct-05 Cinven (consortium) Alethia/AA Capital NTL (merger) AlticeOne EWT Telewest EUR EUR GBP 525 675 3,446 7.0x na 2.8x 6.0x na 2.1x 12.7x na 6.7x 10.1x 7.5x 6.5x 21.2% n/a 6.0%06-Oct-0517-Nov-0530-Sep-05 Warburg Pincus Cinven (consortium) Liberty Global Inc Multikabel AlticeOne Cablecom EUR EUR CHF 515 525 4,536 6.0x 7.0x 6.2x na 6.0x 5.3x 10.2x 12.7x 14.3x 8.7x 10.1x 12.8x n/a 21.2% 16.0%03-Oct-0506-Oct-05 NTL (merger) Warburg Pincus Telewest Multikabel GBP 3,446 515 2.8x 6.0x 2.1x na 6.7x 10.2x 6.5x 8.7x 6.0%29-Jul-05 Ono Auna EUR 2,250 1.9x 1.7x 14.0x 8.1x n/a30-Sep-0503-Oct-05 Liberty Global NTL (merger) Inc Cablecom Telewest CHF GBP 4,536 3,446 6.2x 2.8x 5.3x 2.1x 14.3x 6.7x 12.8x 6.5x 16.0% 6.0%22-Jul-05 Liberty Global Inc Astral USD 405 na na na 7.8x n/a29-Jul-0530-Sep-05 Ono Global Inc Liberty Auna Cablecom EUR CHF 2,250 4,536 1.9x 6.2x 1.7x 5.3x 14.0x 14.3x 8.1x 12.8x n/a 16.0%09-May-05 UnitedGlobalCom NTL Group (Ireland) EUR 325 3.0x na na 8.6x n/a22-Jul-0529-Jul-05 Liberty Ono Global Inc Astral Auna USD EUR 405 2,250 na 1.9x na 1.7x na 14.0x 7.8x 8.1x n/a n/a14-Mar-05 Iesy/Apollo Ish NRW EUR 1,550 na 3.8x na 8.4x n/a09-May-0522-Jul-05 UnitedGlobalCom Liberty Global Inc NTL Group (Ireland) Astral EUR USD 325 405 3.0x na na na na na 8.6x 7.8x n/a n/a14-Mar-0509-May-05 Iesy/Apollo UnitedGlobalCom Ish NRW NTL Group (Ireland) EUR EUR 1,550 Average 325 na 4.8x 3.0x 3.8x 4.0x na na 12.2x na 8.4x 9.4x 8.6x n/a 19.8% n/a14-Mar-05 Iesy/Apollo Ish NRW EUR 1,550 Median na 5.3x 3.8x 4.0x na 12.7x 8.4x 8.6x n/a 19.5% Average 4.8x 4.0x 12.2x 9.4x 19.8% Median Average 5.3x 4.8x 4.0x 12.7x 12.2x 8.6x 9.4x 19.5% 19.8%Highlighted most comparable transactions Median Average 5.3x 5.9x 4.0x 5.2x 12.7x 12.8x 8.6x 11.2x 19.5% 22.9% Median 6.1x 5.4x 12.4x 10.2x 21.2%Highlighted most comparable transactions Average 5.9x 5.2x 12.8x 11.2x 22.9% Implied EBITDA (2006) multiples: Casema EUR Median 9.5x 6.1x 10.3x 5.4x 10.4x 12.4x 11.2x 10.2x 19.9% 21.2%Highlighted most comparable transactions Average 5.9x 5.2x 12.8x 11.2x 22.9% Implied EBITDA (2006) multiples: Casema EUR Median 6.1x 9.5x 5.4x 10.3x 12.4x 10.4x 10.2x 11.2x 21.2% 19.9% Implied EBITDA (2006) multiples: Casema EUR 9.5x 10.3x 10.4x 11.2x 19.9% Comparable transactions imply a valuation range of EUR 1.8bn to EUR 2.2bn
- 34. 4 Leveraged Buy Out valuation
- 35. 4a Introduction
- 36. Immediate causes for a Leveraged Buyout• Business is considered to be non core by the mother company• Underperformance of the business under current ownership• Retirement of owner / manager leading to succession issue• Investment cycle of current owner is ending (secondary / tertiary buyouts)• Shareholder Pressure in the case of listed companies LBO – VALUATION: • Debt is cheaper than equity • Calculate the maximum affordable consideration by financial sponsor given a certain return e.g Internal Rate of Retunr (IRR)
- 37. First calculate target’s debt capacity whichresults from forecasted financials (bankers case) Historic financials + Bankers case + Covenants Forecasted cash flows + Debt financing Maximum debt capacity
- 38. Second, the return for equity providers can becalculated depending on equity structure & consideration Forecasted + Equity structure + Consideration + Exit multiple financials Internal Rate of Return
- 39. 4b What really happens
- 40. General structure of LBO: shareholder structureShareholder structure Remarks • Equity providers (sponsor and management) Private Equity Management together form an acquisition vehicle NewCo (ordinaries: (ordinaries: which makes the offer for the target 85-95%) 5-15%) • Management might hold 5-15% of ordinary shares and will be expected to invest 1-2x annual salary / bonus depending on “pain level” 100% • NewCo is a clean vehicle and often set up in a Newco tax-friendly jurisdiction 100% TARGET
- 41. The Leverage Effect: Funding with debt or equity Un-leveraged LeveragedEquity 100.0 30.0Third party Debt 0.0 70.0 Debt free company,EBIT 20.0 20.0 no interest payments,Interest @ 7% 0.0 -4.9 taxes of 30%EBT 20.0 15.1Tax -6.0 -4.5 Leveraged company, interest payments, taxNet income 14.0 10.6 benefitROE 1 14.0% 35.2%• The return on equity can be increased through the inclusion of debt in the capital structure• Two features provide for the increase in ROE; – Debt is cheaper – Tax shield Note: 1) ROE = Return on Equity
- 42. Introduction to LBO debt financing:overview of instrumentsA risk reward trade-off Quasi- Vendor/shareholder loan2 equity3 (25-30%) PIK / PIYC Notes Mezzanine Subordinated debt High yield bonds/notes (20-25%) Return Second lien Senior Stretch / Institutional Senior (Term loan B and C) debt (50-55%) Senior Bank Debt (Term loan A / Facilities1) Risk Notes: For example revolver, capex- and/or acquisition facility 1) Pricing of vendor and shareholder loan typically not in line with the risk-profile 2) Shareholder loan will be discussed under LBO equity funding
- 43. Introduction to LBO debt financing:debt structuringTypical debt structuring Debt funding: • NewCo and target is funded with debt (65-75%) and equity Private Equity Management (25-35%) (85-95%) (5-15%) • Subordinated debt primarily 100% used for goodwill financing of Subordinated NewCo Debt NewCo • Senior debt will be pushed down to OpCo’s as much as 100% possible because collateral / Senior Senior A/B/C security is in OpCo’s Debt Facilities • Maximum debt levels at OPCO’s NewCo to be guaranteed by OpCo’s is subject to legal restrictions (free distributable reserves of OpCo’s)
- 44. 4c basic calculations
- 45. Internal Rate of Return (IRR)• IRR is that rate of return at which the NPV of an investment equals zero• Compounded average growth rate at which your cash flows grow every year• In LBO s, IRR is the most important return measure for equity investorsYear 0 1 2 3 4Cash flow (400) 110 121 133 146Discounted at (1+IRR)^0 (1+IRR)^1 (1+IRR)^2 (1+IRR)^3 (1+IRR)^4 1.00 1.10 1.21 1.33 1.46PV (Cash flow) (400) 100 100 100 100NPV 0IRR 10% So if IRR represents the discount rate at which investment = return e.g no profit is made, 2 questions are raised: 1. On what are you making a profit then? 2. Why calculate an IRR?
- 46. 1. On what are you making a profit then? – In the DCF you have created you have assumed in what direction the future cash flows will go – Based on that you have calculated an Enterprise value – Now translate this into a multiple• This is called your ENTRY MULTIPLE, e.g the multipe against which you buy the company• Your EXIT MULTIPLE is the multiple against which you expect to sell the business in 2-6 years• If you translate this back again into an Enterprise value than your profit is the difference between the Enterprise value you bought the company for AND the Enterprise value against which you sell the company for
- 47. 2. Why calculate an IRR?The higher the Case 1 2008 2009 2010 2011 2012IRR, the higher EBITDA 100 110 121 133 146your EBITDA will IRR 10.0% 10.0% 10.0% 10.0%be after 2-6 PV cash flow 100 100 100 100years, the higher Enterprise value 2007 400the absolute NPV 0amount you will Calculated entry multiple 4.0x = ( 400 / 100)receive for the Estimated exit multiple 4.0xbusiness 4 Enterprise value 2011 584 = ( 4 * 146) Profit 184 = 584 - 400 Case 2 2008 2009 2010 2011 2012 EBITDA 100 130 169 220 286 IRR 30.0% 30.0% 30.0% 30.0% PV cash flow 100 100 100 100 Enterprise value 2007 400 NPV 0 Calculated entry multiple 4.0x = ( 400 / 100) Estimated exit multiple 4 4.0x Enterprise value 2011 1,144 = ( 4 * 286) Profit 744 = 1,144 - 400
- 48. 4d What about management?
- 49. Management incentive program - Envy ratio• Success of a buy-out depends largely on the quality and commitment of management• Management is therefore offered / required to participate in the Buy-out• As an incentive, management is offered the opportunity to invest at a discount compared to the Financial Sponsor• This sweetener is expressed in a ratio - the Envy ratio (the higher this is, the more beneficial the offer to management)
- 50. Envy between management and financial buyer• Envy (also ratchet mechanism) is the ratio between the effective price paid by management IRR and that paid by the financial holder for their stakes in the NewCo• It refers to the inequality in investment between the financial buyer and management (in favour of management) IRR• High envy between management and financial management buyer means that management can participate Typical envy ratio relatively cheap and therefore is indicative for between IRR difference between management and financial buyer 1 4-8x IRR financial buyer Envy Note: 1) However, high envy does not automatically mean higher IRR as financial buyer can increase return on equity layers management does not participate in hence diluting IRR management
- 51. Envy ratio - exampleExample of envy-calculation Financial Management Investment Percentage Investment Percentage buyer Ordinary Ordinary EUR 3.0 10% EUR 27.0 90% shares shares Preferred Preferred EUR 5.0 5% EUR 95.0 95% shares shares Shareholder EUR 200.0 100% loan Total EUR 8.0 Total EUR 322.0ENVY ordinary shares 1.0x Management is offered the opportunity to invest in theENVY ordinaries plus prefs 1.7x equity at 4.5x more favorableENVY total equity contribution 4.5x terms than the financial buyer In a flat priced deal, the envy on the ordinary shares is 1.0
- 52. 5 Capita Selecta
- 53. 5a Introduction
- 54. Closing date is Effective Date 3. Arrangeme 2. Transaction nts1. Exchange of structure and between 4. New information between terms & signing ownership buyer and seller conditions and completio 31 Dec 1 Aug n 30 Sep 28 Dec Last Price Closing Date Closing Accounts Accounts agreement & = as per Closing Date signing SPA Effective Date date final Conditions precedent Covenants to completion Representations and warranties Indemnities Breach and damages Effective date?
- 55. How to get to a target price…• The buyer makes assumptions on the assets and the cash flows of the company both historically as well as in the future• Based on this it will create a fundamental model (DCF)• In addition, it will do a sanity check using multiple analysis• The above will lead to the so-called target priceHOWEVER:• The only information available at signing are the last audited accounts, management estimates and budgets
- 56. Purchase Price Adjustments: Why?To assure that the Purchase Price represents the value of the company:• Lock-in items crucial to sustain operational business AND are able to change on short term notice• Lock-in the exact liabilities the buyer will face after closingAdjust the Purchase Price to reflect the actual position at closing:• Reflect seasonal fluctuations in net debt as a result of seasonal working capital fluctuations (protection of Buyer and Seller)• Reflect over- or under performance up to closing compared to budget (protection Buyer and Seller)• Secure that net profits up to closing are for the account of the Seller, should the closing be delayed (protection of Seller)• As additional security for some unwanted Sellers actions before closing (protection of Buyer)
- 57. How does this work?Equity Value offer• In case of an Equity Value offer, the purchase price to be paid is not influenced by changes in the net debt or working capital, but only by changes in the book value of the equity as per effective dateEnterprise Value offerEnterprise Value aNet Debt b–Other adjustments c +/-Equity Value X• The purchase prices for the shares is in theory calculated as: – The Enterprise Value is an amount which is agreed upon as a fixed price based on certain working capital assumptions – The net debt can change over time and is influenced by a changing level of working capital as per effective date
- 58. Leading to terms and conditions in the SPA• Although the offer price will be negotiated, it is generally subject to the following financing conditions: – working capital mechanism, normal working capital level – working capital definitions (what is included, what is the basis and how to avoid disputes) – Performance relative to budget – net debt definitions (what is included) – other• Terms and conditions will be negotiated in the SPA
- 59. 5b Working capital
- 60. Seasonality or other changes in working capital 500 Negative adjustment 250 on purchase price Positive adjustment on purchase price 0 time (1 yr) (250) (500) Working Capital Average Working Capital Net Debt• As working capital changes continuously, the level of working capital at the effective date is probably not equal to the level as agreed upon• The movement in net debt is opposite to the movement in working capital, which causes changes in the purchase price for the shares
- 61. The impact of working capital…Signing at a working capital level of 200 Closing at a working capital level of 300Fixed Assets 100 Equity 100 Fixed Assets 100 Equity 100Debtors 300 Debt 250 Debtors 500 Debt 350Cash 50 Creditors 100 Cash 50 Creditors 200Total 450 Total 450 Total 650 Total 650No reference made to working capitalEnterprise value for the company 2,000 Enterprise value for the company 2,000Net debt (200) Net debt (300)Purchase price for the shares 1,800 Purchase price for the shares 1,700• Is the difference of 100 in value correct?• Based on the same assumptions for the calculation of the Enterprise Value, the Equity Value should not change – Let’s discuss
- 62. …demonstrates the importance to makeagreements on the working capital level• Enterprise Value and (base) working capital are interrelated and therefore should be agreed upon simultaneously during negotiations• The base working capital assumption used in calculating the Enterprise Value should be agreed upon together with the Enterprise Value as part of the deal 500 400 Adjustments 300 should be made 200 for any deviations from the 100 assumptions 0 year 0 year 1 year 2 year 3 year 4 Working Capital level year end Base Working Capital Working Capital movement
- 63. Movement of working capitalDate of acquisition Date of acquisition 350 350 300 300 250 250 200 200 Date of acquisition 150 150 100 100 50 50 0 0 year 0 year 1 year 0 year 1 Working Capital level year end Working Capital level year end Working Capital movement Working Capital movement Base Working Capital Base Working Capital• Although working capital can be stable throughout the year, it is more likely that the working capital level will fluctuate within a year• Secondly, a seller can pro-actively influence the working capital level just to increase the purchase price for the shares (for example ask clients to pay their bills earlier, reduce the inventory or postpone payments to suppliers)
- 64. Pre-agreement on WC level solves the issuesSigning at a working capital level of 200 Closing at a working capital level of 300Fixed Assets 100 Equity 100 Fixed Assets 100 Equity 100Debtors 300 Debt 250 Debtors 500 Debt 350Cash 50 Creditors 100 Cash 50 Creditors 200Total 450 Total 450 Total 650 Total 650No reference made to working capitalEnterprise value for the company 2,000 Enterprise value for the company 2,000Net debt (200) Net debt (300)Actual WC -/- reference WC (50) Actual WC -/- reference WC 50Purchase price for the shares 1,750 Purchase price for the shares 1,750• To have a reference to the working capital level prevents the buyer from any (unwanted) actions by the seller to adjust the net debt level and consequently the purchase price• Normal business related fluctuations in working capital level will also be adjusted for• Disputes can arise in case definitions of working capital are not clear: provide (and negotiate) clear definitions
- 65. 5c Net debt
- 66. Example – Net DebtBudget at signing Actual at closingFixed Assets 100 Equity 100 Fixed Assets 150 Equity 100Debtors 300 Debt 250 Debtors 300 Debt 300Cash 50 Creditors 100 Cash 50 Creditors 100Total 450 Total 450 Total 500 Total 500No reference made to working capitalEnterprise value for the company 2,000 Enterprise value for the company 2,000Net debt (200) Net debt (250)Actual WC -/- reference WC (50) Actual WC -/- reference WC (50)Purchase price for the shares 1,750 Purchase price for the shares 1,700
- 67. 5d Performance relative to budget
- 68. Performance relative to budget• The Buyer will want cash net profits earned over and above the budget before Closing to be for his account• The Seller will want the shortfall of cash net profits earned to be for the account of the Buyer• This is covered on a Euro-for-Euro basis if actual (net) debt at closing is deducted from a fixed enterprise valueBudget at signing Actual at closingFixed Assets 100 Equity 100 Fixed Assets 100 Equity 130Debtors 300 Debt 250 Debtors 300 Debt 220Cash 50 Creditors 100 Cash 50 Creditors 100Total 450 Total 450 Total 450 Total 450Reference made to working capital of 250 Enterprise value for the company 2,000 Enterprise value for the company 2,000 Net debt (200) Net debt (170) Actual WC -/- reference WC (50) Actual WC -/- reference WC (50) Purchase price for the shares 1,750 Purchase price for the shares 1,780
- 69. Performance relative to budget• A more aggressive way of dealing with over- or under performance up to closing would be to adjust the Enterprise Value using multiples, based on the actual profitability realized up to closing (e.g EBITDA or EBIT)• Note that this is a far more aggressive way of adjusting the purchase price, especially if the period on which one bases itself is short – If a period of less than a year is at hand, make sure to use multiples proportionally – For example: if the EBITDA multiple is 8 and the period over which the performance is measured is 3 months the EBITDA multiple would be 32 (!)
- 70. 5c Unwanted sellers actions
- 71. Unwanted sellers’ actions• In principle, pre-closing covenants deal with unwanted Seller’s actions• Nonetheless, purchase price adjustment mechanisms can provide a backstop to some of these actions• Examples: – Paying out 50 million in dividends – Accelerated collecting of 100 million in debtors – Stop paying creditors for a benefit of 100 million – Stop the budgeted 50 million in investments
- 72. Example I – Paying out 50 mil in dividendBudget at signing Actual at closingFixed Assets 100 Equity 100 Fixed Assets 100 Equity 50Debtors 300 Debt 250 Debtors 300 Debt 300Cash 50 Creditors 100 Cash 50 Creditors 100Total 450 Total 450 Total 450 Total 450Reference made to working capital of 250Enterprise value for the company 2,000 Enterprise value for the company 2,000Net debt (200) Net debt (250)Actual WC -/- reference WC (50) Actual WC -/- reference WC (50)Purchase price for the shares 1,750 Purchase price for the shares 1,700
- 73. Example II – Accelerated collecting ofEUR 100m in debtorsBudget at signing Actual at closingFixed Assets 100 Equity 100 Fixed Assets 100 Equity 100Debtors 300 Debt 250 Debtors 200 Debt 150Cash 50 Creditors 100 Cash 50 Creditors 100Total 450 Total 450 Total 350 Total 350Reference made to working capital of 250Enterprise value for the company 2,000 Enterprise value for the company 2,000Net debt (200) Net debt (100)Actual WC -/- reference WC (50) Actual WC -/- reference WC (150)Purchase price for the shares 1,750 Purchase price for the shares 1,750
- 74. Example III – Stop paying creditors for abenefit of EUR 100mBudget at signing Actual at closingFixed Assets 100 Equity 100 Fixed Assets 50 Equity 100Debtors 300 Debt 250 Debtors 300 Debt 200Cash 50 Creditors 100 Cash 50 Creditors 100Total 450 Total 450 Total 400 Total 400Reference made to working capital of 250Enterprise value for the company 2,000 Enterprise value for the company 2,000Net debt (200) Net debt (150)Actual WC -/- reference WC (50) Actual WC -/- reference WC (50)Purchase price for the shares 1,750 Purchase price for the shares 1,800
- 75. Example IV – Stop the budgetedEUR 50m investmentsBudget at signing Actual at closingFixed Assets 100 Equity 100 Fixed Assets 100 Equity 100Debtors 300 Debt 250 Debtors 300 Debt 150Cash 50 Creditors 100 Cash 50 Creditors 200Total 450 Total 450 Total 450 Total 450Reference made to working capital of 250Enterprise value for the company 2,000 Enterprise value for the company 2,000Net debt (200) Net debt (100)Actual WC -/- reference WC (50) Actual WC -/- reference WC (150)Purchase price for the shares 1,750 Purchase price for the shares 1,750
- 76. Unwanted sellers’ actions (cont’d)Stop the budgeted EUR 5m in investments• Buyer is not protected with a simple (net) debt and reference working capital adjustment• Possible (additional) protection mechanisms: – Keep the period between signing and closing as short as possible – Don’t allow the seller to be able to postpone the closing – Pre-closing covenants (ordinary course of business); – Pre-closing covenants (seller to procure to make investments); – Adjust on reference fixed assets (as well as all reference working capital and (net) debt)
- 77. 5d Other
- 78. Delay or postponing of closing• The Buyer will want cash net profits earned before Closing to be for his account• This is covered on a Euro-for-Euro basis if actual (net) debt at closing is deducted from a fixed enterprise value in the contract
- 79. 5e Adjustments
- 80. How to make adjustments1. Define ‘net debt’ and ‘working capital’2. Determine historic monthly working capital development and net debt development3. Determine budgeted monthly working capital and net debt development4. Normalize these monthly numbers (for one-offs or changes in accounting treatment)5. Based on the normalized monthly numbers, determine a reference working capital (choose tactically)6. Communicate the reference working capital to the potential Buyer(s)7. Check for other specific line items which may require likewise attention (seasonality, one-offs)
- 81. 6 Role financial advisor
- 82. Diagram Client (Company) Assistance & Advice Contact with lawyers, Process management consultants, accountants, etc. Corporate Finance Due Diligence Valuation Negotiation Transaction structuring
- 83. The end

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