Primer on Relative Valuation Methodology

1. Primer on Relative Valuation Methodology

3. Learning Objectives Primary learning objective: To provide students with knowledge of alternatives to discounted cash flow valuation methods, including Market Approach Comparable companies Comparable transactions Same industry or comparable industry Asset oriented approach Tangible book value Liquidation value Break-up value Cost approach Weighted average method

4. Applying Market-Based (Relative Valuation) Methods MVT = (MVC / IC) x IT Where MVC = Market value of the comparable company C IC = Measure of value for comparable company C IT = Measure of value for company T (MVC/IC) = Market value multiple for the comparable company

5. Market-Based Methods:Comparable Companies� Example

6. Market-Based Methods:Comparable Transactions� Method Calculation similar to comparable companies� method, except multiples used to estimate target�s value based on purchase prices of recently acquired comparable companies. Most accurate method whenever the transaction is truly comparable and very recent. Major limitation is that truly comparable transactions are rare.

7. Market-Based Methods:Same or Comparable Industry Method Multiply target�s earnings or revenues by market value to earnings or revenue ratios for the average firm in target�s industry or a comparable industry. Primary advantage is the ease of use and availability of data. Disadvantages include presumption industry multiples are actually comparable and analysts� projections are unbiased.

8. Asset-Based Methods:Tangible Book Value Tangible book value (TBV) = (total assets - total liabilities - goodwill) Target�s estimated value = Target�s TBV x [(industry average or comparable firm market value) / (industry or comparable firm TBV)]. Often used for valuing Financial services firms where tangible book value is primarily cash or liquid assets Distribution firms where current assets constitute a large percentage of total assets

9. Asset-Based Methods: Liquidation Method Value assets as if sold in an �orderly� fashion (e.g., 9-12 months) and deduct value of liabilities and expenses associated with asset disposition. While varies with industry, Receivables often sold for 80-90% of book value Inventories might realize 80-90% of book book value depending on degree of obsolescence and condition Equipment values vary widely depending on age and condition and purpose (e.g., special purpose) Book value of land may understate market value Prepaid assets such as insurance can be liquidated with a portion of the premium recovered.

10. Asset-Based Method: Break-Up Value Target viewed as series of independent operating units, whose income, cash flow, and balance sheet statements reflect intra-company sales, fully-allocated costs, and operating liabilities specific to each unit After-tax cash flows are valued using market-based multiples or discounted cash flows analysis to determine operating unit�s current market value The unit�s equity value is determined by deducting operating liabilities from current market value Aggregate equity value of the business is determined by summing equity value of each operating unit less unallocated liabilities and break-up costs

11. Replacement Cost Method All target operating assets are assigned a value based on what it would cost to replace them. Each asset is treated as if no additional value is created by operating the assets as part of a going concern. Each asset�s value is summed to determine the aggregate value of the business. This approach is limited if the firm is highly profitable (suggesting a high going concern value) or if many of the firm�s assets are intangible.

12. Weighted Average Valuation Method An analyst has estimated the value of a company using multiple valuation methodologies. The discounted cash flow value is $220 million, comparable transactions� value is $234 million, the P/E-based value is $224 million and the liquidation value is $150 million. The analyst has greater confidence in certain methodologies than others. Estimate the weighted average value of the firm using all valuation methodologies and the weights or relative importance the analyst gives to each methodology.

13. Adjusting Firm Value Generally, the value of the firm�s equity is the sum of the value of the firm�s operating assets and liabilities plus terminal value less market value of firm�s long-term debt. However, value may be under or overstated if not adjusted for non-operating assets or liabilities assumed by the acquirer.

14. Adjusting Firm Value Example A target firm has the following characteristics: An estimated enterprise value of $104 million Long-term debt whose market value is $15 million $3 million in excess cash balances Estimated PV of currently unused licenses of $4 million Estimated PV of future litigation costs of $2.5 million 2 million common shares outstanding What is the value of the target firm per common share?

15. Adjusting Firm Value Example Cont�d.

16. Things to Remember Alternatives to discounted cash flow analysis include the following: Market based methods Comparable companies Recent transactions Same or comparable industries Asset based methods Tangible book value Liquidation value Break-up value Replacement cost method Weighted average method Firm value must be adjusted for both non-operating assets and liabilities.