Session 2 – Valuation

Session 2 – Valuation September-November 2011 MarkOkes-Voysey

Course outline 2nd week • Strategic overview – why deals? • Pricing and negotiating a deal – valuation methods and other key terms • Dealing with risk and the role of due diligence + integration planning • Tax – risks and planning aspects • Legal documents (+ presentation of team game) • Team game; your presentations • Test

1 Based on market comparables Guideline Public Companies Comparable transactions 2 The “pure” method Discounted Cash Flow Method 3 Used occasionally Net Assets (?) Key factors: Type of deal/investor Available information Purpose of the analysis Valuation methods

Reminder what is value? Cash flow year 1+ Cash flow year 2 …….Cash flow yearn NPV = (1+i) (1+i)2 (1+i)n We said last week it was the net present value of future cash flows: For non-financial people remember the example. How much would you get in a years time if you invest 10 rubles at an interest rate of 10%. The answer is 11. In this simple example 10 is the NPV of 11.

Cash Flow Methods • Key parameters: • Length of the forecast period • Terminal value: Gordon’s growth model vs exit multiples • Cash flow on equity/invested capital • Discount rate • Final adjustments (control, marketability, liquidity)

Illustrative example • A-Mart is a successful business company with financial results as shown opposite. • Historically it has grown with the market. The market is expected to grow by 5% a year into the foreseeable future. The new general director at the target however believes the target will outperform market growth by 20 %. • Salaries comprise 20% of the total costs but the company has historically paid at the lower end of the market (10%) below competitors. Management believes this is sustainable even though there is tension with the trade unions over the issue. • The company sold last year its last plot of land that it did not need for the business for a profit of £50. • The company has not paid taxes on its profits because of brought forward losses. There are £100 of losses still to be used in the future. Management is seeking advice as to how to legally reduce its future tax charge. • The company has borrowed heavily and has bank debt at a reasonable interest rate of £500. • In a recent deal another retailer in a similar market was sold for 5 times EBITDA which represented 2x sales. Similar quoted companies are trading at EBITDA multiples of 4 to 6 times.

So we need to build a cash flow model. We agree with the sellers that 5 years is a reasonable period. We both agree that beyond the 5th year the business will be very stable. * In reality there would normally be adjustments between EBITDA and cash flow for items such as working capital movements.

Do you think the seller would have the same view of cash flows and value? What arguments would you use if you were the buyer or seller? Can you think how differences may be resolved?

Calculating value (assuming a 15% discount rate)

Using multiples based on comparables What would you argue if you were selling / buying?

Final conclusion and adjustments to the result • Scenario analysis • Sensitivity test • Discounts and premiums for control/marketability

Typical final conclusions and adjustments to the result

Thank you!

Session 2 – Valuation