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Comparable Valuation Analysis Course Presentation.pdf

This document provides an introduction to comparable valuation analysis. It discusses the key aspects of relative valuation using comparable companies and precedent transactions. The document outlines the learning objectives, defines relative valuation, and discusses the advantages and disadvantages of the approach. It provides examples of how to select comparable companies and transactions based on business and financial characteristics. The document also shows how to perform the actual valuation by locating relevant data, calculating valuation multiples, and applying those multiples to the target company.

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Comparable Valuation Analysis
Corporate Finance Institute® Jeff Schmidt VP, Financial Modeling About Jeff... Course Instructor Prior to joining CFI, for over a decade Jeff taught financial modeling and valuation to thousands of students all over the world. Before his career in financial education, Jeff covered approximately 50 companies with a combined market cap of $500 billion during his career in equity research. He also worked in corporate development leading M&A modeling and due diligence, and FP&A, as well as working in investment banking and restructuring. Jeff has a B.S. from Texas A&M University and obtained his MBA from the University of Houston. He is a CFA charterholder.
Corporate Finance Institute® Learning Objectives Understand relative valuation versus other valuation methodologies. Recognize the advantages and disadvantages of relative valuation. Determine how to pick comparable companies and precedent transactions. Match enterprise value and equity value with appropriate metrics. Identify debt and debt equivalents as well as cash and other non-operating assets. Find and enter the applicable data using real-world examples.
Introduction to Comparable Valuation Analysis
Corporate Finance Institute® “Price is what you pay, value is what you get.” – Warren Buffet (2008 Berkshire Hathaway shareholder letter) Examples of investments: Company stock, assets, prospective projects, real estate. Valuation is the art and science of attributing a value to an investment. Valuation does not equal price. A public company’s stock price may not be properly valued by the market, hence why we go through the valuation process. Valuation
Corporate Finance Institute® Valuation is probably the most crucial aspect of finance and is used in the processes below: Why Value Companies or Assets Investment Purposes Buy, Sell or Hold a stock; Invest in a company project Certain Accounting Policies Acquisition Accounting; Mark-to- Market Accounting Corporate Actions Purchase a company; Sell a division
Corporate Finance Institute® Valuation Techniques Valuing a Business or Asset • Cost to build • Replacement Cost Income Approach (Intrinsic Value) • Discount Free Cash Flows (DCF) • Residual Income (Economic Value Added) • Public Company Comparables • Precedent Transactions Asset Approach (FMV of Net Assets) Market Approach (Relative Value)
Corporate Finance Institute® Why is the market approach also called relative valuation? Market Approach The ultimate valuation is based relative to other, similar assets.
Corporate Finance Institute® Types of Relative Valuation Public Company Comparables Valuation based on the idea that similar public companies share similar risk and reward characteristics, and therefore should trade similarly. Precedent Transactions Valuation based on the acquisition of companies similar to the target company. Key difference is that precedent transactions usually result in higher multiples due to the presence of the 'control premium' in an acquisition. Due to size differences, we scale similar companies by using a ratio or multiple. The multiple is usually based on a financial metric (e.g. Revenue, EBITDA, Earnings Per Share (EPS)). Sometimes the multiple is based on a capacity factor (e.g. Oil or Mining Reserves).
Corporate Finance Institute® Advantages and Disadvantages of Relative Valuation Let’s discuss some advantages and disadvantages of relative valuation. Calculating and applying multiples is a relatively simple and user-friendly way of valuing a company, as well as communicating that value. Avoids the potentially misleading precision of other, more ‘precise’ valuation methodologies like DCF, so it’s harder to manipulate. Market data is directly observable. We can directly observe a public company’s market capitalization. Advantages While simplicity is an advantage, relative valuation can also be too simplistic. No two companies, or transactions, are exactly alike making the valuation more difficult. Even if you find good peer companies or transactions, sometimes information can be hard to find or out-of-date. Disadvantages
Corporate Finance Institute® One of the best and most intuitive ways to conceptualize relative valuation is by looking at the value of house sales. Valuation Example We need to look for a common denominator that neutralizes size discrepancies… Price Sq / ft We scale for differences in size.
Corporate Finance Institute® Price Per Square Foot Comparable House 1 Sales price: 352,000 Square Feet: 2,500 Comparable House 2 Sales price: 494,000 Square feet: 3,000 Comparable House 3 Sales price: 346,000 Square feet: 2,250 346,000 2,250 = = 153.78 / Sq Ft 494,000 3,000 = = 164.67 / Sq Ft Homeowner’s House Sales price: ?? Square feet: 3,500 = = 140.80 / Sq Ft 352,000 2,500 Price Sq / ft
Corporate Finance Institute® 1. Find the average price / sq ft from the comparable houses. Valuation Example Continued 2. Multiply the average price / sq ft by the house’s sq ft. 153.08 * 3,500 = 535,785 Homeowner’s House Square ft: 3,500 Sales Price (USD) Sq Feet Price / Sq Ft Comparable House 1 352,000 2,500 140.80 Comparable House 2 494,000 3,000 164.67 Comparable House 3 346,000 2,250 153.78 AVERAGE 153.08 While this is technically an example of a precedent transaction valuation, this basic methodology also works for publicly traded companies.
Corporate Finance Institute® Putting It All Together The same methodology applies to companies. In this example, we scale different companies’ enterprise value by EBITDA. From there, we calculate the average, median, maximum and minimum enterprise value to EBITDA multiples. We then apply these multiples to the target company’s EBITDA to calculate the target’s enterprise value. Comparable Trading Analysis All figures in USD millions unless stated Enterprise EBITDA EV / EBITDA Peer Companies Value LTM 1 LTM 1 Company 1 10,142 586 17.3x Company 2 10,846 569 19.1x Company 3 11,584 530 21.9x Company 4 12,787 542 23.6x Company 5 12,328 525 23.5x Company 6 10,500 516 20.3x Target Company Valuation 2 Average 10,178 486 20.9x Median 10,256 486 21.1x Maximum 11,466 486 23.6x Minimum 8,411 486 17.3x LTM means Last Twelve Months. ⁽¹⁾ Target Company Valuation based on LTM Multiple. ⁽²⁾
Screening for Comps
Corporate Finance Institute® In order to learn about the target company, read as much about it as possible, including sector-specific material. Screening for Comparables Annual & Quarterly Reports Equity & Credit Research Investor Presentations Earnings Conference Transcripts Pay special attention to the conference call Q&A as that gives you a better idea of what concerns or opportunities research analysts focus on.
Corporate Finance Institute® Once we understand the target’s business, we can go through a comparable company analysis, which consists of 3 steps. Steps in Performing a Comparable Trading Analysis Select Select appropriate peer companies. Locate Locate and enter the relevant information into a comps model. Value Value the ‘target’ company using the selected multiples. This is the most important part of comps modeling. We will cover this in later lessons!
Corporate Finance Institute® Closest Comps The valuation should be determined based on the closest comps. Realistically, this is the most important part of comps modeling and where you should spend the bulk of your time. Selecting Appropriate Peer Companies Similar Risks Factors You want to identify firms with similar risk factors as the ‘target’ firm. No Peers? If there are no peers, you can look outside of the target firm’s sector.
Corporate Finance Institute® There are two categories of key characteristics. Business and Finance Characteristics Business Characteristics Industry/Sector (Sub-sector) Geography Products/Services Customers Distribution network Finance Characteristics Size Growth Margins Seasonality/Cyclicality Leverage/Credit rating
Corporate Finance Institute® Why Perform a Precedent Transaction Analysis To determine a hypothetical sales price for a company. To compare against other valuation methodologies (e.g. Trading Comps, Discounted Cash Flow (DCF)) Let’s talk about the other relative valuation technique: precedent transactions. Why perform a precedent transactions analysis?
Corporate Finance Institute® Select Just like trading comps analysis, there are three main steps in performing a precedent transactions analysis: Selecting Appropriate Transactions Locate Select appropriate transactions. Locate and enter the relevant information into a comps model. Value Value the ’target’ company using the selected multiples. Financial or Strategic, Offer/Transaction Value, Consensus estimates, Control Premium, Synergies, etc Some financial details are typically only provided when material. Most important part of Comps modeling and time consuming.
Corporate Finance Institute® The process is essentially the same as trading comparables as we focus on the same business and financial characteristics. Recent Deals and Fairness Opinions Recent Deals Try not to use older transactions as industries and market conditions change. However, older deals may be necessary in order to create a more robust valuation. Fairness Opinions A good source for recent transactions is by looking at fairness opinions. These are documents put together by investment bankers highlighting recent transactions to advise shareholders.
Corporate Finance Institute® In a transaction, the terminology changes. Business and Finance Characteristics Offer Value When we refer to offer value, we are referring to the purchase of the target company’s equity. Transaction Value When we refer to transaction value, we are referring to the offer value plus net debt (so roughly analogous to enterprise value).
Corporate Finance Institute® 8,411 11,673 6,850 11,466 14,569 12,848 6,000 7,000 8,000 9,000 10,000 11,000 12,000 13,000 14,000 15,000 Comparable Trading Analysis Precedent Transaction Analysis DCF Valuation Analysis Comparable Trading Analysis Precedent Transaction Analysis DCF Valuation Analysis Comparable Trading Analysis Value cannot be directly observed. That’s why we use multiple different valuation approaches to ‘triangulate’ what we think the value of a company should be. Football Field Chart Comparable Trading and Precedent Transaction Analysis both use LTM EBITDA. Precedent Transaction Analysis DCF Valuation Analysis Typically returns the highest valuation because of the control premium.
Enterprise Value vs. Equity Value
Corporate Finance Institute® Operating Liabilities (e.g. Accounts Payable, Deferred Revenue) Financial Liabilities Balance Sheet Equation Operating Assets (e.g. Inventory, PP&E) Non-Operating Assets (e.g. Cash, Securities) Equity (e.g. Common Shareholder Equity) (e.g. Interest-Bearing Liabilities, Debt) Equity Assets Liabilities Let’s look at the balance sheet equation: Assets equals Liabilities plus Equity.
Corporate Finance Institute® Operating Assets Operating Assets Enterprise value is the total value of a company’s operations. What is Enterprise Value? Shareholder Equity Financial Liabilities Operating Liabilities Non-Operating Assets Market Cap/Equity Enterprise Value Debt Cash We generally do not use balance sheet numbers when calculating enterprise value; however, we can use the balance sheet equation to show that Enterprise Value is the value of a company’s operations. Shareholder Equity Financial Liabilities Operating Liabilities Non-Operating Assets
Corporate Finance Institute® Next, the other measure of a company’s size is its equity value or market cap. While enterprise value is the value of a company’s operations, equity value is the residual value of the business, after all claims on that business have been paid. We can directly calculate market cap by taking the public company’s share price times the number of shares outstanding. Enterprise Value and Equity Value If there is a significant difference between the equity value and market cap, then that could result in a profitable trading strategy. Market Cap Net Debt Equity Value Net Debt Equity Debt Cash Enterprise Value Enterprise Value
Enterprise Value: Debt and Debt Equivalents
Corporate Finance Institute® List of Debt and Debt Equivalents Current Portion of Long-term Debt Long-term Debt Revolving Line of Credit Commercial Paper Leases Noncontrolling Interest Preferred Stock Debt Debt Equivalents
Corporate Finance Institute® Debt is interest-bearing and generally has a higher ‘claim’ on a company’s business than any other source of funding. This is important because debt gets paid first before other funding sources. Debt may have different names and come in different structures: Traditional Debt Long-term Debt (including Current Portion of Long-term Debt) Commercial Paper (Unsecured money-market instrument sold at a discount to face value; usually repaid within a year) Notes, Bonds, Loans, Borrowings Revolving Line of Credit (Revolver) Convertible debt may even be convertible into common equity.
Corporate Finance Institute® Debt Equivalents = Leases Nearly all leases, whether classified as a finance or operating lease, are recognized on the balance sheet. Finance and Operating Leases Assets Liabilities Equity Balance Sheet Lease liability Right-of-use asset One way to think of a lease is a company purchasing a piece of property or equipment by issuing debt. Leases have an implicit interest rate embedded in the lease terms so we should consider leasing a form of collateralized borrowing.
Corporate Finance Institute® US GAAP There is a key difference between how US GAAP accounts for operating leases versus IFRS: Finance and Operating Leases IFRS Depreciation Expense Interest Expense Any lease cost A lease is essentially a collateralized borrowing so this treatment should make sense.
Corporate Finance Institute® Finance and Operating Leases Finance Leases Operating Leases Depreciation Expense Interest Expense US GAAP IFRS There is a key difference between how US GAAP accounts for operating leases versus IFRS: Expressed as rent EBITDA This presents some comparability issues between IFRS and GAAP.
Corporate Finance Institute® If we want to compare an IFRS company with an US GAAP company, we need to add back the US GAAP company’s rent expense. Finance and Operating Leases IFRS US GAAP EBITDA + R Operating Leases Expensed as Rent Results in numerator and denominator consistency since leases will be a debt equivalent in the numerator of enterprise value.
Corporate Finance Institute® Preferred stock is essentially a hybrid debt and equity security. Preferred Stock It has a higher claim than common shareholders on the company, and preference on dividends. Common Stock Preferred Stock Retained Earnings Valuation Purposes Preferred stock should still be considered a debt equivalent for valuation purposes and included in net debt. (Net debt = Debt – Cash) Assets Liabilities Equity IFRF & US GAAP Balance Sheet Equity
Corporate Finance Institute® Although noncontrolling interest (NCI) typically shows up in shareholder’s equity on a balance sheet, it is not considered common equity and should be included in net debt as a debt equivalent. Noncontrolling Interest (NCI) Parent 80% Subsidiary A Consolidate 30% Subsidiary B Equity Method EV EBITDA 80% of Subsidiary A reflected 100% of Subsidiary A reflected = We need to think of how much of the subsidiary is reflected in the numerator and denominator of the parent.
Corporate Finance Institute® We want to use market values for all debt and debt equivalents, but that is not always the case. Nuances of Debt and Debt Equivalents Sometimes, we favor the book value since that is the actual contractual amount the company must pay to settle the debt. Usually, we do not have enough information to estimate the market value of something like noncontrolling interest (NCI), so we use book value instead. An alternative would be to apply a price-to-book multiple to NCI to proxy the market value, but this would require doing a separate comps analysis with less information. Market Values Book Values
Enterprise Value: Cash and Non-operating Assets
Corporate Finance Institute® List of Cash and Non-Operating Assets Marketable or Liquid Assets Cash & Cash Equivalents Assets Held for Sale Investments in Unconsolidated Affiliates
Corporate Finance Institute® An investment in an unconsolidated affiliate occurs when a company has significant influence over another company (affiliate) but does not control it (between 20%-50% ownership). Investments in Unconsolidated Affiliates Parent 80% Subsidiary A Consolidate 30% Subsidiary B Equity Method EV EBITDA 30% of Subsidiary A reflected 0% of Subsidiary A reflected = The company is entitled to a proportionate share of the affiliate’s income, usually below EBIT or operating income.
Income Statement and Last Twelve Months (LTM)
Corporate Finance Institute® Now that we have determined the company’s size (enterprise value and equity value), we need to work out the appropriate financial metrics to calculate multiples. Income Statement Data We will focus on Enterprise Value to EBITDA and Share Price to Earnings per Share (PE ratio). We can easily calculate the enterprise value today, as well as obtain the current share price. However, we will need to calculate profitability metrics on a historic or forward basis (using analyst estimates). We will start by calculating historical profitability for the last twelve months (LTM).
Corporate Finance Institute® There are a couple of different ways we can calculate an LTM. Last Twelve Months (LTM) Q4 Oct - Dec Q3 Jul - Sep Q2 Apr - Jun Q1 Jan - Mar Q2 Apr - Jun Q1 Jan - Mar YTD 2023 YTD 2022 Latest Fiscal Year EBITDA: $18,283 FYE Dec 31, 2022 Latest Fiscal Year EBITDA: $8,471 Current Year-to-date (YTD) EBITDA: $8,591 LTM EBITDA: 18,283 + 8,591 – 8,471 = $18,403 Let’s adjust reported data to the last twelve months assuming the date is July 12, 2023.
Normalization and Analyst Estimates
Corporate Finance Institute® After entering the income statement data and calculating LTM metrics, we need to normalize these numbers. What do we mean by normalizing? Normalization Remove any non-recurring or unusual gains or losses the company reports. In effect, we want to determine what we think the core, ongoing profitability of the company should be, excluding these one-off items.
Corporate Finance Institute® Typical Non-Recurring/Normalization Adjustments Asset/Goodwill Impairments Impairment Reversal (IFRS only) Amortization of Intangible Assets Litigation Gains/Expense Gain/Loss on Sale of Assets Restructuring Stock-based Compensation Acquisition Integration Expenses Foreign Exchange Adjustments
Corporate Finance Institute® Forward Estimates When research analysts make projections (whether it’s EBITDA or earnings per share or another metric), they use normalized numbers. So, we build the comps template to have research estimates in the same area as the normalized numbers. That way we are comparing like-for-like.
Corporate Finance Institute® Before we move on, we need to define the appropriate financial metrics to be used for multiples. We can categorize an income statement into 2 different types of metrics. Unlevered vs. Levered Metrics Unlevered Any financial metric before interest expense. For example, earnings before interest and taxes, or EBIT. Levered Any financial metric after interest expense. For example, net income.
Corporate Finance Institute® Normalization Income Statement Revenues Less: Cost of sales = Gross profit Less: Selling, general & administrative = Earnings before interest, taxes, depreciation & amortization (EBITDA) Less: Depreciation & amortization = Earnings before interest, taxes (EBIT) Less: Interest expense = Earnings before taxes (EBT) Less: Income taxes = Net income ÷ Shares outstanding = Earnings per share (EPS) Unlevered Metrics (Enterprise Value Multiples) Levered Metrics (Equity Value Multiples)
Corporate Finance Institute® Finding Normalization Adjustments and Entering Analyst Estimates Before we get back into Excel, we need to find the company’s suggested normalizations. In the case of our comps, we can find the normalization adjustments on the income statement, but this will not always be the case. After normalizing several metrics, we will then enter the analyst estimates we obtained from Capital IQ and calculate enterprise value and equity value multiples. Let’s get started!
Fully Diluted Shares Outstanding
Corporate Finance Institute® We need to properly calculate a company’s true market cap. Therefore, we need to discuss the number of shares a company has or may have. Fully Diluted Shares Outstanding (FDSO) Basic Shares Outstanding Fully Diluted Shares Outstanding Analysts prefer fully diluted shares outstanding as this captures all potential shares. The fully diluted share count is the basic share count plus any potentially dilutive securities. Potentially dilutive shares come from: - Employee stock options - Warrants - Restricted stock or other share awards - Convertible debt or convertible preferred stock.
Corporate Finance Institute® In many companies, employees are given stock options to help incentivize them. Stock Option Basics These stock options have a strike price (exercise price) that the employee pays to receive the number of shares in the options agreement. An employee would only exercise the option if the exercise price is less than the company’s market price. $5.00 < $5.50 In-the-money options (ITM): Exercise Price < Current Market Price Out-of-the-money options (OTM): Exercise Price > Current Market Price $5.00 > $4.50
Corporate Finance Institute® When calculating the number of options to include in the fully diluted share count, we typically use a calculation known as the treasury stock method. The treasury stock method assumes that any proceeds the company receives from the employee will be used to repurchase shares at the current market price. Fully Diluted Shares Outstanding (FDSO) – Options and Warrants Net Impact of Dilution = ITM Options – Shares Repurchased by Company Technically, we should also include any unrecognized compensation cost as proceeds but we don’t typically have enough information to do so.
Corporate Finance Institute® We also use the treasury stock method to calculate the dilution from restricted stock awards and/or restricted stock units. Fully Diluted Shares Outstanding – Restricted Stock Given the lack of information, we typically just add unvested restricted stock or other stock awards directly to the basic share count to derive the diluted share count. Net Dilution from Restricted Stock: Hypothetical Proceeds Unrecognized compensation costs related to RSAs/RSUs =
Trading Comps Summary
Corporate Finance Institute® Final Steps: Comparable Companies After completing our first comp, we link our Summary table to the appropriate metrics. We then repeat the process for all our comparable companies (use Excel’s find and replace to expedite this task). We then add in the target company metrics and calculate the implied valuations. We will use a football field chart for the final output.
Precedent Transaction Nuances
Corporate Finance Institute® While the process behind selecting precedent transactions vs. public company comps is similar, there are several additional data points and calculations we need to consider. Precedent Transactions: Additional Details Needed Deal Announcement Date Deal Status Target Share Price Acquirer Share Price (e.g., Announced, Pending, Closed, Withdrawn) Merger consideration can come in either stock, cash or a combination of cash and stock.
Corporate Finance Institute® Mixed Offer All-Stock Offer Mixed Offer All-Stock Offer Merger Consideration All-Cash Offer • The acquirer makes a cash offer for all the target’s outstanding shares, assuming the target is a public company. Total Consideration = Per-Share Amount * Target's Share Count • If the target is private, the all-cash offer will be a lump-sum amount.
Corporate Finance Institute® All-Stock Offer All-Stock Offer Mixed Offer Mixed Offer Merger Consideration All-Cash Offer • If the acquirer and the target company are both public, the acquirer will usually use an ‘exchange ratio’. Acquirer Shares to be Issued: Number of Target Shares to be Acquired • While there are different ways to structure an exchange ratio (fixed, floating, collared), we will assume it is a fixed exchange rate. Exchange Ratio * Acquirer’s Share Price = Target Share Amount All-Cash Offer
Corporate Finance Institute® Mixed Offer Mixed Offer All-Stock Offer Merger Consideration All-Cash Offer All-Cash Offer All-Stock Offer • The Mixed Offer accounts for both the cash consideration and the stock consideration. • Our analysis will be set up to handle all 3 structures.
Corporate Finance Institute® An acquisition premium is a figure that's the difference between the target’s market price and the actual price paid to acquire it. Premium Paid Analysis • If the target is public, we also want to know what the premium paid might be. • A premium is paid in order to acquire control of the target. • If no premium was offered, selling shareholders would have no incentive to sell. • This premium is expected by both the acquirer and target. • It is a common measure in mergers, acquisitions and precedent transactions.
Corporate Finance Institute® With precedent transactions, we need to be aware of timelines. Transaction Timing: 2021 Acquisition of Morrison’s PLC We are going to use the data available when the auction was held when we calculate the offer value and transaction value. For the premiums paid analysis, we are going to use the dates when the original offer was made and the final, winning offer. The transaction won’t close for some time after the announcement and signing of the merger documents. An analyst must make a judgment call on what information to use based on timing.
Corporate Finance Institute® Transaction Timing: 2021 Acquisition of Morrison’s PLC June 14 First Offer June 21 First Offer Rejected August 19 Original bidder raises bid price October 2 Auction July 3 Another Bid* October 4 Original Bidder Wins Auction * The other bid price was subsequently raised on August 6.
Corporate Finance Institute® Learning Objectives Understand relative valuation versus other valuation methodologies. Recognize the advantages and disadvantages of relative valuation. Determine how to pick comparable companies and precedent transactions. Match enterprise value and equity value with appropriate metrics. Identify debt and debt equivalents as well as cash and other non-operating assets. Find and enter the applicable data using real-world examples.

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Comparable Valuation Analysis Course Presentation.pdf

  • 1.
  • 2.
    Corporate Finance Institute® JeffSchmidt VP, Financial Modeling About Jeff... Course Instructor Prior to joining CFI, for over a decade Jeff taught financial modeling and valuation to thousands of students all over the world. Before his career in financial education, Jeff covered approximately 50 companies with a combined market cap of $500 billion during his career in equity research. He also worked in corporate development leading M&A modeling and due diligence, and FP&A, as well as working in investment banking and restructuring. Jeff has a B.S. from Texas A&M University and obtained his MBA from the University of Houston. He is a CFA charterholder.
  • 3.
    Corporate Finance Institute® LearningObjectives Understand relative valuation versus other valuation methodologies. Recognize the advantages and disadvantages of relative valuation. Determine how to pick comparable companies and precedent transactions. Match enterprise value and equity value with appropriate metrics. Identify debt and debt equivalents as well as cash and other non-operating assets. Find and enter the applicable data using real-world examples.
  • 4.
    Introduction to ComparableValuation Analysis
  • 5.
    Corporate Finance Institute® “Priceis what you pay, value is what you get.” – Warren Buffet (2008 Berkshire Hathaway shareholder letter) Examples of investments: Company stock, assets, prospective projects, real estate. Valuation is the art and science of attributing a value to an investment. Valuation does not equal price. A public company’s stock price may not be properly valued by the market, hence why we go through the valuation process. Valuation
  • 6.
    Corporate Finance Institute® Valuationis probably the most crucial aspect of finance and is used in the processes below: Why Value Companies or Assets Investment Purposes Buy, Sell or Hold a stock; Invest in a company project Certain Accounting Policies Acquisition Accounting; Mark-to- Market Accounting Corporate Actions Purchase a company; Sell a division
  • 7.
    Corporate Finance Institute® ValuationTechniques Valuing a Business or Asset • Cost to build • Replacement Cost Income Approach (Intrinsic Value) • Discount Free Cash Flows (DCF) • Residual Income (Economic Value Added) • Public Company Comparables • Precedent Transactions Asset Approach (FMV of Net Assets) Market Approach (Relative Value)
  • 8.
    Corporate Finance Institute® Whyis the market approach also called relative valuation? Market Approach The ultimate valuation is based relative to other, similar assets.
  • 9.
    Corporate Finance Institute® Typesof Relative Valuation Public Company Comparables Valuation based on the idea that similar public companies share similar risk and reward characteristics, and therefore should trade similarly. Precedent Transactions Valuation based on the acquisition of companies similar to the target company. Key difference is that precedent transactions usually result in higher multiples due to the presence of the 'control premium' in an acquisition. Due to size differences, we scale similar companies by using a ratio or multiple. The multiple is usually based on a financial metric (e.g. Revenue, EBITDA, Earnings Per Share (EPS)). Sometimes the multiple is based on a capacity factor (e.g. Oil or Mining Reserves).
  • 10.
    Corporate Finance Institute® Advantagesand Disadvantages of Relative Valuation Let’s discuss some advantages and disadvantages of relative valuation. Calculating and applying multiples is a relatively simple and user-friendly way of valuing a company, as well as communicating that value. Avoids the potentially misleading precision of other, more ‘precise’ valuation methodologies like DCF, so it’s harder to manipulate. Market data is directly observable. We can directly observe a public company’s market capitalization. Advantages While simplicity is an advantage, relative valuation can also be too simplistic. No two companies, or transactions, are exactly alike making the valuation more difficult. Even if you find good peer companies or transactions, sometimes information can be hard to find or out-of-date. Disadvantages
  • 11.
    Corporate Finance Institute® Oneof the best and most intuitive ways to conceptualize relative valuation is by looking at the value of house sales. Valuation Example We need to look for a common denominator that neutralizes size discrepancies… Price Sq / ft We scale for differences in size.
  • 12.
    Corporate Finance Institute® PricePer Square Foot Comparable House 1 Sales price: 352,000 Square Feet: 2,500 Comparable House 2 Sales price: 494,000 Square feet: 3,000 Comparable House 3 Sales price: 346,000 Square feet: 2,250 346,000 2,250 = = 153.78 / Sq Ft 494,000 3,000 = = 164.67 / Sq Ft Homeowner’s House Sales price: ?? Square feet: 3,500 = = 140.80 / Sq Ft 352,000 2,500 Price Sq / ft
  • 13.
    Corporate Finance Institute® 1.Find the average price / sq ft from the comparable houses. Valuation Example Continued 2. Multiply the average price / sq ft by the house’s sq ft. 153.08 * 3,500 = 535,785 Homeowner’s House Square ft: 3,500 Sales Price (USD) Sq Feet Price / Sq Ft Comparable House 1 352,000 2,500 140.80 Comparable House 2 494,000 3,000 164.67 Comparable House 3 346,000 2,250 153.78 AVERAGE 153.08 While this is technically an example of a precedent transaction valuation, this basic methodology also works for publicly traded companies.
  • 14.
    Corporate Finance Institute® PuttingIt All Together The same methodology applies to companies. In this example, we scale different companies’ enterprise value by EBITDA. From there, we calculate the average, median, maximum and minimum enterprise value to EBITDA multiples. We then apply these multiples to the target company’s EBITDA to calculate the target’s enterprise value. Comparable Trading Analysis All figures in USD millions unless stated Enterprise EBITDA EV / EBITDA Peer Companies Value LTM 1 LTM 1 Company 1 10,142 586 17.3x Company 2 10,846 569 19.1x Company 3 11,584 530 21.9x Company 4 12,787 542 23.6x Company 5 12,328 525 23.5x Company 6 10,500 516 20.3x Target Company Valuation 2 Average 10,178 486 20.9x Median 10,256 486 21.1x Maximum 11,466 486 23.6x Minimum 8,411 486 17.3x LTM means Last Twelve Months. ⁽¹⁾ Target Company Valuation based on LTM Multiple. ⁽²⁾
  • 15.
  • 16.
    Corporate Finance Institute® Inorder to learn about the target company, read as much about it as possible, including sector-specific material. Screening for Comparables Annual & Quarterly Reports Equity & Credit Research Investor Presentations Earnings Conference Transcripts Pay special attention to the conference call Q&A as that gives you a better idea of what concerns or opportunities research analysts focus on.
  • 17.
    Corporate Finance Institute® Oncewe understand the target’s business, we can go through a comparable company analysis, which consists of 3 steps. Steps in Performing a Comparable Trading Analysis Select Select appropriate peer companies. Locate Locate and enter the relevant information into a comps model. Value Value the ‘target’ company using the selected multiples. This is the most important part of comps modeling. We will cover this in later lessons!
  • 18.
    Corporate Finance Institute® ClosestComps The valuation should be determined based on the closest comps. Realistically, this is the most important part of comps modeling and where you should spend the bulk of your time. Selecting Appropriate Peer Companies Similar Risks Factors You want to identify firms with similar risk factors as the ‘target’ firm. No Peers? If there are no peers, you can look outside of the target firm’s sector.
  • 19.
    Corporate Finance Institute® Thereare two categories of key characteristics. Business and Finance Characteristics Business Characteristics Industry/Sector (Sub-sector) Geography Products/Services Customers Distribution network Finance Characteristics Size Growth Margins Seasonality/Cyclicality Leverage/Credit rating
  • 20.
    Corporate Finance Institute® WhyPerform a Precedent Transaction Analysis To determine a hypothetical sales price for a company. To compare against other valuation methodologies (e.g. Trading Comps, Discounted Cash Flow (DCF)) Let’s talk about the other relative valuation technique: precedent transactions. Why perform a precedent transactions analysis?
  • 21.
    Corporate Finance Institute® Select Justlike trading comps analysis, there are three main steps in performing a precedent transactions analysis: Selecting Appropriate Transactions Locate Select appropriate transactions. Locate and enter the relevant information into a comps model. Value Value the ’target’ company using the selected multiples. Financial or Strategic, Offer/Transaction Value, Consensus estimates, Control Premium, Synergies, etc Some financial details are typically only provided when material. Most important part of Comps modeling and time consuming.
  • 22.
    Corporate Finance Institute® Theprocess is essentially the same as trading comparables as we focus on the same business and financial characteristics. Recent Deals and Fairness Opinions Recent Deals Try not to use older transactions as industries and market conditions change. However, older deals may be necessary in order to create a more robust valuation. Fairness Opinions A good source for recent transactions is by looking at fairness opinions. These are documents put together by investment bankers highlighting recent transactions to advise shareholders.
  • 23.
    Corporate Finance Institute® Ina transaction, the terminology changes. Business and Finance Characteristics Offer Value When we refer to offer value, we are referring to the purchase of the target company’s equity. Transaction Value When we refer to transaction value, we are referring to the offer value plus net debt (so roughly analogous to enterprise value).
  • 24.
    Corporate Finance Institute® 8,411 11,673 6,850 11,466 14,569 12,848 6,000 7,000 8,000 9,000 10,000 11,000 12,000 13,000 14,000 15,000 ComparableTrading Analysis Precedent Transaction Analysis DCF Valuation Analysis Comparable Trading Analysis Precedent Transaction Analysis DCF Valuation Analysis Comparable Trading Analysis Value cannot be directly observed. That’s why we use multiple different valuation approaches to ‘triangulate’ what we think the value of a company should be. Football Field Chart Comparable Trading and Precedent Transaction Analysis both use LTM EBITDA. Precedent Transaction Analysis DCF Valuation Analysis Typically returns the highest valuation because of the control premium.
  • 25.
  • 26.
    Corporate Finance Institute® OperatingLiabilities (e.g. Accounts Payable, Deferred Revenue) Financial Liabilities Balance Sheet Equation Operating Assets (e.g. Inventory, PP&E) Non-Operating Assets (e.g. Cash, Securities) Equity (e.g. Common Shareholder Equity) (e.g. Interest-Bearing Liabilities, Debt) Equity Assets Liabilities Let’s look at the balance sheet equation: Assets equals Liabilities plus Equity.
  • 27.
    Corporate Finance Institute® Operating Assets Operating Assets Enterprisevalue is the total value of a company’s operations. What is Enterprise Value? Shareholder Equity Financial Liabilities Operating Liabilities Non-Operating Assets Market Cap/Equity Enterprise Value Debt Cash We generally do not use balance sheet numbers when calculating enterprise value; however, we can use the balance sheet equation to show that Enterprise Value is the value of a company’s operations. Shareholder Equity Financial Liabilities Operating Liabilities Non-Operating Assets
  • 28.
    Corporate Finance Institute® Next,the other measure of a company’s size is its equity value or market cap. While enterprise value is the value of a company’s operations, equity value is the residual value of the business, after all claims on that business have been paid. We can directly calculate market cap by taking the public company’s share price times the number of shares outstanding. Enterprise Value and Equity Value If there is a significant difference between the equity value and market cap, then that could result in a profitable trading strategy. Market Cap Net Debt Equity Value Net Debt Equity Debt Cash Enterprise Value Enterprise Value
  • 29.
    Enterprise Value: Debtand Debt Equivalents
  • 30.
    Corporate Finance Institute® Listof Debt and Debt Equivalents Current Portion of Long-term Debt Long-term Debt Revolving Line of Credit Commercial Paper Leases Noncontrolling Interest Preferred Stock Debt Debt Equivalents
  • 31.
    Corporate Finance Institute® Debtis interest-bearing and generally has a higher ‘claim’ on a company’s business than any other source of funding. This is important because debt gets paid first before other funding sources. Debt may have different names and come in different structures: Traditional Debt Long-term Debt (including Current Portion of Long-term Debt) Commercial Paper (Unsecured money-market instrument sold at a discount to face value; usually repaid within a year) Notes, Bonds, Loans, Borrowings Revolving Line of Credit (Revolver) Convertible debt may even be convertible into common equity.
  • 32.
    Corporate Finance Institute® DebtEquivalents = Leases Nearly all leases, whether classified as a finance or operating lease, are recognized on the balance sheet. Finance and Operating Leases Assets Liabilities Equity Balance Sheet Lease liability Right-of-use asset One way to think of a lease is a company purchasing a piece of property or equipment by issuing debt. Leases have an implicit interest rate embedded in the lease terms so we should consider leasing a form of collateralized borrowing.
  • 33.
    Corporate Finance Institute® US GAAP Thereis a key difference between how US GAAP accounts for operating leases versus IFRS: Finance and Operating Leases IFRS Depreciation Expense Interest Expense Any lease cost A lease is essentially a collateralized borrowing so this treatment should make sense.
  • 34.
    Corporate Finance Institute® Financeand Operating Leases Finance Leases Operating Leases Depreciation Expense Interest Expense US GAAP IFRS There is a key difference between how US GAAP accounts for operating leases versus IFRS: Expressed as rent EBITDA This presents some comparability issues between IFRS and GAAP.
  • 35.
    Corporate Finance Institute® Ifwe want to compare an IFRS company with an US GAAP company, we need to add back the US GAAP company’s rent expense. Finance and Operating Leases IFRS US GAAP EBITDA + R Operating Leases Expensed as Rent Results in numerator and denominator consistency since leases will be a debt equivalent in the numerator of enterprise value.
  • 36.
    Corporate Finance Institute® Preferredstock is essentially a hybrid debt and equity security. Preferred Stock It has a higher claim than common shareholders on the company, and preference on dividends. Common Stock Preferred Stock Retained Earnings Valuation Purposes Preferred stock should still be considered a debt equivalent for valuation purposes and included in net debt. (Net debt = Debt – Cash) Assets Liabilities Equity IFRF & US GAAP Balance Sheet Equity
  • 37.
    Corporate Finance Institute® Althoughnoncontrolling interest (NCI) typically shows up in shareholder’s equity on a balance sheet, it is not considered common equity and should be included in net debt as a debt equivalent. Noncontrolling Interest (NCI) Parent 80% Subsidiary A Consolidate 30% Subsidiary B Equity Method EV EBITDA 80% of Subsidiary A reflected 100% of Subsidiary A reflected = We need to think of how much of the subsidiary is reflected in the numerator and denominator of the parent.
  • 38.
    Corporate Finance Institute® Wewant to use market values for all debt and debt equivalents, but that is not always the case. Nuances of Debt and Debt Equivalents Sometimes, we favor the book value since that is the actual contractual amount the company must pay to settle the debt. Usually, we do not have enough information to estimate the market value of something like noncontrolling interest (NCI), so we use book value instead. An alternative would be to apply a price-to-book multiple to NCI to proxy the market value, but this would require doing a separate comps analysis with less information. Market Values Book Values
  • 39.
    Enterprise Value: Cashand Non-operating Assets
  • 40.
    Corporate Finance Institute® Listof Cash and Non-Operating Assets Marketable or Liquid Assets Cash & Cash Equivalents Assets Held for Sale Investments in Unconsolidated Affiliates
  • 41.
    Corporate Finance Institute® Aninvestment in an unconsolidated affiliate occurs when a company has significant influence over another company (affiliate) but does not control it (between 20%-50% ownership). Investments in Unconsolidated Affiliates Parent 80% Subsidiary A Consolidate 30% Subsidiary B Equity Method EV EBITDA 30% of Subsidiary A reflected 0% of Subsidiary A reflected = The company is entitled to a proportionate share of the affiliate’s income, usually below EBIT or operating income.
  • 42.
    Income Statement andLast Twelve Months (LTM)
  • 43.
    Corporate Finance Institute® Nowthat we have determined the company’s size (enterprise value and equity value), we need to work out the appropriate financial metrics to calculate multiples. Income Statement Data We will focus on Enterprise Value to EBITDA and Share Price to Earnings per Share (PE ratio). We can easily calculate the enterprise value today, as well as obtain the current share price. However, we will need to calculate profitability metrics on a historic or forward basis (using analyst estimates). We will start by calculating historical profitability for the last twelve months (LTM).
  • 44.
    Corporate Finance Institute® Thereare a couple of different ways we can calculate an LTM. Last Twelve Months (LTM) Q4 Oct - Dec Q3 Jul - Sep Q2 Apr - Jun Q1 Jan - Mar Q2 Apr - Jun Q1 Jan - Mar YTD 2023 YTD 2022 Latest Fiscal Year EBITDA: $18,283 FYE Dec 31, 2022 Latest Fiscal Year EBITDA: $8,471 Current Year-to-date (YTD) EBITDA: $8,591 LTM EBITDA: 18,283 + 8,591 – 8,471 = $18,403 Let’s adjust reported data to the last twelve months assuming the date is July 12, 2023.
  • 45.
  • 46.
    Corporate Finance Institute® Afterentering the income statement data and calculating LTM metrics, we need to normalize these numbers. What do we mean by normalizing? Normalization Remove any non-recurring or unusual gains or losses the company reports. In effect, we want to determine what we think the core, ongoing profitability of the company should be, excluding these one-off items.
  • 47.
    Corporate Finance Institute® TypicalNon-Recurring/Normalization Adjustments Asset/Goodwill Impairments Impairment Reversal (IFRS only) Amortization of Intangible Assets Litigation Gains/Expense Gain/Loss on Sale of Assets Restructuring Stock-based Compensation Acquisition Integration Expenses Foreign Exchange Adjustments
  • 48.
    Corporate Finance Institute® ForwardEstimates When research analysts make projections (whether it’s EBITDA or earnings per share or another metric), they use normalized numbers. So, we build the comps template to have research estimates in the same area as the normalized numbers. That way we are comparing like-for-like.
  • 49.
    Corporate Finance Institute® Beforewe move on, we need to define the appropriate financial metrics to be used for multiples. We can categorize an income statement into 2 different types of metrics. Unlevered vs. Levered Metrics Unlevered Any financial metric before interest expense. For example, earnings before interest and taxes, or EBIT. Levered Any financial metric after interest expense. For example, net income.
  • 50.
    Corporate Finance Institute® Normalization IncomeStatement Revenues Less: Cost of sales = Gross profit Less: Selling, general & administrative = Earnings before interest, taxes, depreciation & amortization (EBITDA) Less: Depreciation & amortization = Earnings before interest, taxes (EBIT) Less: Interest expense = Earnings before taxes (EBT) Less: Income taxes = Net income ÷ Shares outstanding = Earnings per share (EPS) Unlevered Metrics (Enterprise Value Multiples) Levered Metrics (Equity Value Multiples)
  • 51.
    Corporate Finance Institute® FindingNormalization Adjustments and Entering Analyst Estimates Before we get back into Excel, we need to find the company’s suggested normalizations. In the case of our comps, we can find the normalization adjustments on the income statement, but this will not always be the case. After normalizing several metrics, we will then enter the analyst estimates we obtained from Capital IQ and calculate enterprise value and equity value multiples. Let’s get started!
  • 52.
  • 53.
    Corporate Finance Institute® Weneed to properly calculate a company’s true market cap. Therefore, we need to discuss the number of shares a company has or may have. Fully Diluted Shares Outstanding (FDSO) Basic Shares Outstanding Fully Diluted Shares Outstanding Analysts prefer fully diluted shares outstanding as this captures all potential shares. The fully diluted share count is the basic share count plus any potentially dilutive securities. Potentially dilutive shares come from: - Employee stock options - Warrants - Restricted stock or other share awards - Convertible debt or convertible preferred stock.
  • 54.
    Corporate Finance Institute® Inmany companies, employees are given stock options to help incentivize them. Stock Option Basics These stock options have a strike price (exercise price) that the employee pays to receive the number of shares in the options agreement. An employee would only exercise the option if the exercise price is less than the company’s market price. $5.00 < $5.50 In-the-money options (ITM): Exercise Price < Current Market Price Out-of-the-money options (OTM): Exercise Price > Current Market Price $5.00 > $4.50
  • 55.
    Corporate Finance Institute® Whencalculating the number of options to include in the fully diluted share count, we typically use a calculation known as the treasury stock method. The treasury stock method assumes that any proceeds the company receives from the employee will be used to repurchase shares at the current market price. Fully Diluted Shares Outstanding (FDSO) – Options and Warrants Net Impact of Dilution = ITM Options – Shares Repurchased by Company Technically, we should also include any unrecognized compensation cost as proceeds but we don’t typically have enough information to do so.
  • 56.
    Corporate Finance Institute® Wealso use the treasury stock method to calculate the dilution from restricted stock awards and/or restricted stock units. Fully Diluted Shares Outstanding – Restricted Stock Given the lack of information, we typically just add unvested restricted stock or other stock awards directly to the basic share count to derive the diluted share count. Net Dilution from Restricted Stock: Hypothetical Proceeds Unrecognized compensation costs related to RSAs/RSUs =
  • 57.
  • 58.
    Corporate Finance Institute® FinalSteps: Comparable Companies After completing our first comp, we link our Summary table to the appropriate metrics. We then repeat the process for all our comparable companies (use Excel’s find and replace to expedite this task). We then add in the target company metrics and calculate the implied valuations. We will use a football field chart for the final output.
  • 59.
  • 60.
    Corporate Finance Institute® Whilethe process behind selecting precedent transactions vs. public company comps is similar, there are several additional data points and calculations we need to consider. Precedent Transactions: Additional Details Needed Deal Announcement Date Deal Status Target Share Price Acquirer Share Price (e.g., Announced, Pending, Closed, Withdrawn) Merger consideration can come in either stock, cash or a combination of cash and stock.
  • 61.
    Corporate Finance Institute® MixedOffer All-Stock Offer Mixed Offer All-Stock Offer Merger Consideration All-Cash Offer • The acquirer makes a cash offer for all the target’s outstanding shares, assuming the target is a public company. Total Consideration = Per-Share Amount * Target's Share Count • If the target is private, the all-cash offer will be a lump-sum amount.
  • 62.
    Corporate Finance Institute® All-StockOffer All-Stock Offer Mixed Offer Mixed Offer Merger Consideration All-Cash Offer • If the acquirer and the target company are both public, the acquirer will usually use an ‘exchange ratio’. Acquirer Shares to be Issued: Number of Target Shares to be Acquired • While there are different ways to structure an exchange ratio (fixed, floating, collared), we will assume it is a fixed exchange rate. Exchange Ratio * Acquirer’s Share Price = Target Share Amount All-Cash Offer
  • 63.
    Corporate Finance Institute® MixedOffer Mixed Offer All-Stock Offer Merger Consideration All-Cash Offer All-Cash Offer All-Stock Offer • The Mixed Offer accounts for both the cash consideration and the stock consideration. • Our analysis will be set up to handle all 3 structures.
  • 64.
    Corporate Finance Institute® Anacquisition premium is a figure that's the difference between the target’s market price and the actual price paid to acquire it. Premium Paid Analysis • If the target is public, we also want to know what the premium paid might be. • A premium is paid in order to acquire control of the target. • If no premium was offered, selling shareholders would have no incentive to sell. • This premium is expected by both the acquirer and target. • It is a common measure in mergers, acquisitions and precedent transactions.
  • 65.
    Corporate Finance Institute® Withprecedent transactions, we need to be aware of timelines. Transaction Timing: 2021 Acquisition of Morrison’s PLC We are going to use the data available when the auction was held when we calculate the offer value and transaction value. For the premiums paid analysis, we are going to use the dates when the original offer was made and the final, winning offer. The transaction won’t close for some time after the announcement and signing of the merger documents. An analyst must make a judgment call on what information to use based on timing.
  • 66.
    Corporate Finance Institute® TransactionTiming: 2021 Acquisition of Morrison’s PLC June 14 First Offer June 21 First Offer Rejected August 19 Original bidder raises bid price October 2 Auction July 3 Another Bid* October 4 Original Bidder Wins Auction * The other bid price was subsequently raised on August 6.
  • 67.
    Corporate Finance Institute® LearningObjectives Understand relative valuation versus other valuation methodologies. Recognize the advantages and disadvantages of relative valuation. Determine how to pick comparable companies and precedent transactions. Match enterprise value and equity value with appropriate metrics. Identify debt and debt equivalents as well as cash and other non-operating assets. Find and enter the applicable data using real-world examples.