Unit 6 company valuation
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There are three main methods for valuing a company: asset valuation, market multiples, and discounted cash flow. Asset valuation values the company based on its assets as shown on the balance sheet, either at book value or adjusted market value. Market multiples compare ratios such as price-to-book or enterprise value to EBITDA to similar public companies. Discounted cash flow estimates future dividends or cash flows from the company and discounts them to calculate a net present value.
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Okay, let's break this down step-by-step:
* Offer price per share is $48
* Mix is 20% cash, 80% stock
* To calculate the exchange ratio, we take the stock portion as a percentage of the total consideration
* Stock portion is 80% of $48, which is 0.8 * $48 = $38.40
* Cash portion is 20% of $48, which is 0.2 * $48 = $9.60
* Total consideration is $38.40 stock + $9.60 cash = $48
* To get the exchange ratio, we take the stock portion ($38.40) and divide it by the acquirer's stock price.
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Unit 6 company valuation
- 1. Unit 6 Company Valuation
- 2. Methods There are three types of valuation Asset valuation Market multiples Discounted cash flow
- 3. Asset valuation With this method we base our valuation of the company on the assets as shown on the balance sheet We can use: Book value, or Adjusted book value
- 4. Asset valuation Book value As the title suggests we value the company based on the net assets as shown on the balance sheet Strengths: Easy Weaknesses: Only useful where accounting book value = market value Omits missing assets and liabilities from valuation eg goodwill, contingent liabilities
- 5. Asset valuation Adjusted book value Books values are adjusted to market value Strength: Removes weakness where book assets do not equal market value Can be easy for assets with ready market values (eg securities) Weakness: Not all assets easily valued (egsecondhand factory equipment, goodwill)
- 6. Asset valuation Adjusted book value Note that when adjusting book values, sometimes one has to “revalue” debt In unit 7 you will learn how to price a bond – ie value debt. For now consider the following: Fixed assets 140 Current assets 25 Current liabilities (10) Debt (50) Net assets 105
- 7. Asset valuation Adjusted book value Note that when adjusting book values, sometimes one has to “revalue” debt In unit 7 you will learn how to price a bond – ie value debt. For now consider the following: Fixed assets 140 160 Current assets 25 35 Current liabilities (10) (10) Debt (50)(50) Net assets 105 135 So we revalue each of the assets. But what about debt?
- 8. Asset valuation Adjusted book value Consider two scenarios – which company will have the higher valuation? A B Fixed assets 160 Fixed assets 160 Current assets 35 Current assets 35 Current liabilities (10) Current liabilities (10) Debt (@7%) (50) Debt (@12%) (50) Net assets 135 Net assets 135
- 9. Asset valuation Adjusted book value Consider two scenarios – which company will have the higher valuation? A B Fixed assets 160 Fixed assets 160 Current assets 35 Current assets 35 Current liabilities (10) Current liabilities (10) Debt (@7%) (50) Debt (@12%) (50) Net assets 135 Net assets 135 This more expensive debt has to make B less valuable than A
- 10. Market multiples There are many listed in unit 6. We shall just consider a few. Market value Price to book Price earnings EV to EBITDA
- 11. Market multiples Market value The price quoted on the market gives us an idea of what others believe is the valuation. Market capitalisation = number of shares x share price = value of the company on the stock exchange So can we buy a company off the stock exchange at its market capitalisation?
- 12. Market multiples Market value No. Market takeovers are ALWAYS at a premium (up to 25% of the previously quoted price). Consider British Airways. Its price as I write this is 198p giving a market cap of £2.3 bn. If my bonus came through and I decided to invest £10m in BA that would get me 0.4%. In other words my significant investment does not get me ANY control – all I am buying is a right to a dividend (as set by the Board). I do not get any: management rights right to be a director right to see classified documents set strategy etc
- 13. Market multiples Market value But if I acquire 100% (indeed anything over 50%) I get control. Now I have the right to: Set strategy Get free flights Put myself on the Board at whatever salary I decide Set dividend policy See all of the companies records and documents, etc But – these extra rights have to be paid for. This extra amount (over the normal share price) is called the “control premium”
- 14. Market multiples Price to book This is a multiple that takes for a similar quoted company the ratio of: Price per share / book value per share Book value and share price differ because of a number of reasons This multiple assumes that the difference is broadly in the same proportion for all similar companies.
- 15. Discounted Cash Flow Number of ways One popular is to try and estimate the dividends from the company and treat them like any other ‘project appraisal’ ie do a DCF, using the cost of equity as the discount rate
- 16. Discounted Cash Flow A very simple approximation Gordon’s Growth Model Price = D1 / (R – G)
- 17. End