LIBOR

1. LIBOR Introduction to Valuation

2. Why Valuation? • Most important concept in Investment Banking • Determining how much a company is worth • Why do we need this? • M&A (how much should I pay for target?) • Equity (pricing shares) • Debt (maximum debt capacity)

3. Valuation • This is not an exact science • There is no ‘black box’ approach to valuation • Depends greatly on banker’s judgments • All valuations will be biased • Cannot rely on just one method, each has its flaws

4. Multiples • Numerator= Measure of value • Denominator= Operating Statistic • Examples: • P/E (What is this multiple really?) • Market Cap/Net Income • More commonly used on Wall Street are EV multiples (EV/EBITDA) • Aside: Why is EV/NI not used? • EV flows to both debt and equity holders, NI flows only to equity holders

5. EV/EBITDA

6. Break Down EV/EBITDA • EV= Enterprise Value, commonly called Firm Value • Market Cap + Total Debt – Cash & Cash Equiv • Think: How much money would be needed to buy the whole company? • EBITDA= Earnings Before Interest, Taxes, Depreciation and Amortization

7. What is Firm Value? Example • Company Acquirer wants to buy Company Target • Company Target sells at $10 per share • They have 100,000 shares outstanding • What is the Market Cap? • $1,000,000

8. Example Cont. • But that’s not it, if A buys T they also take on their debt • This is going to increase the total price of the purchase

9. Example Cont. • But what about Cash? • If T has Cash, A can use it to pay down some of that Debt • This is going to decrease the total price of the purchase

10. Example Cont. • Market Cap= $1,000,000 • Add $1,000,000 in debt • Subtract $500,000 in cash • FV= $1,500,000

11. What is EBITDA? • Metric to evaluate profitability • Not GAAP, so there’s no legal requirements • Strips out many expenses that may cloud actual performance

12. EBITDA: What am I taking out and Why? • Interest: It’s a function of management’s financing choices • Taxes: Can vary widely depending on prior losses or acquisitions • D&A: Subjective judgments like useful lives, different methods • Now it’s easier to compare companies

13. Comparable Companies Analysis

14. Comps • Reflects current valuation • Can be affected by market conditions and sentiment • Also called Public Market Comps • You can only perform this with Public Companies due to the amount of information needed

15. Step 1: Select Your Universe • I am trying to value Company A • As the name suggests, I need Comparable Companies • These are similar public companies, peers, competitors • Look for similar sectors/sub-sectors, products, geography, size • Realistically you also ask your Associate/VP, they have immense sector and industry knowledge

16. Step 2: Get the Financial Information • Once I have my Comparable Companies, • Locate financial information • What drives value?  both past and future performance • Past Information- SEC filings, press releases • Future Information- Research reports, consensus

17. Step 3: Spread the Comps • ‘Spreading’ • Entering/Updating financial data and calculating statistics/ ratios/ trading multiples • Calculate valuation measures: Mkt Cap, Equity Value, Firm Value • And earnings measures: EBITDA, Net Income • This is getting us to MULTIPLES

18. Why Can’t we just use Yahoo Finance or Something? • Things like Mkt Cap and FV may be available there, but • You need to calculate earnings measures and valuation measures from scratch (this means inputting #’s like revenue, interest, shares outstanding, etc.) • Allows for greater control and the ability to adjust just one piece • People are going to want to know how you got to that number and why it’s so low/high • You can’t trust it, they are often wrong or don’t take into account options/converts/one-time items • What if it’s in between reporting periods? Did I not sell anything in that time period? • If it were that easy, you wouldn’t have a job

19. Step 4: Benchmarking • I calculated the financial stats, used some Excel formulas to show my ratios and trading multiples • Now, which are the closest, most relevant comparables • Elimination of outliers, Creation of ranges for stats and multiples

20. Determine Valuation • Trading multiples of the Comparable Companies allow us to derive a value for the target • Apply the range of multiples to Company A

21. Some Simple Algebra • I found that the average EV/EBITDA for my comps is 10x • I know my financial statistics, EBITDA = $500,000 • What is my EV? • EV/EBITDA=10x • EV/$500,000=10x • EV=$5,000,000 • Note that I will often be using estimated forward financial stats and multiples

22. Pros and Cons • Pros • Based on actual public market data, reflects market’s expectations • Can be updated based on day-to-day market data (What impact would a change in the price of a comp’s stock have?) • Cons • Market based- What happens if there’s excessive bearishness/a bubble? • Relevant Comps may not exist • Not an intrinsic valuation, not based on cash flow

23. Precedent Transactions Analysis

24. Precedents • Similar to Comps • Looks at multiples paid for comparable companies in past M&A deals • Will always give you the highest valuation, why? • If I am looking at what A paid for T 6 months ago, A likely paid a premium for T. This is because A saw the opportunity for synergies and needed to pay more than the market price for T

25. Step 1: Universe • This time I need a universe of similar companies that have been bought recently • I’m looking at targets, why wouldn’t I care about buyers?

26. Step 2: Get the Info • I now need financial information for the M&A activity • Proxy statements, 8K, 10K/Q

27. Step 3: Spreading • Enter key financial data such as purchase price, the target’s financial stats • Use Excel to calculate multiples • You’re going to end up with EV/EBITDA (or comparable multiple) and use that to find your firm’s EV

28. Pros and Cons • Pros • Objective, I’m not making assumptions • Market-based, based on what companies actually paid for similar companies • Cons • These deals, by definition occurred in the past • Hard to find comps, harder to find precedents • Hard to find info on some transactions

29. Discounted Cash Flow Analysis

30. DCF • The value of a company is derived from the present value of its future cash flows • What cash flows?  Free Cash Flow • How do I discount it to PV?  WACC • This is establishing an intrinsic value (as opposed to market value)

31. Step 1: Project Free Cash Flow • Projected for 5 years • This is actually unlevered FCF • Unlevered FCF= Cash that a company is able to generate after laying out money to maintain/expand its asset base • This is the cash that could be paid out to lenders and investors • How do I grow FCF? use growth assumptions developed by historical performance and expected sales growth rates, margins, capex, etc.

32. Step 1 Cont. • Why 5 years?  by this time the company is deemed to have reached a ‘steady state’ • Formula: • EBIT * (1-Tax Rate) • + D&A • -Δ Net Working Capital • -Capex • = Unlevered Free Cash Flow

33. Step 2: WACC • We know that Present Value= Future Value/(1+i)n • So we have FV (the FCF), now what do we discount this by? • WACC= Weighted Average Cost of Capital

34. Step 2 Cont. • Every company has a capital structure made up of Debt and Equity • Any investor in our company needs to be compensated, how much depends on whether they are taking on the risk of owning equity or owning debt • What is the Cost of Equity?  CAPM • Cost of Debt?  usually the current yield on outstanding issues (it’s complex and it’s DCM’s job)

35. Step 2 Cont. • So say rd =5% and re =10% • My company’s cap structure is 70% debt and 30% equity • Now we weight these • WACC= (rd * (1-T) * % debt) + (re * % equity) • What’s that tax rate doing? • Interest paid is often tax deductible

36. What happens after year 5, does the company cease to exist? • No, use Terminal Value

37. Step 3: Terminal Value (Perp Method) • This will give us the value of all future FCF for the company beyond those 5 years • How many years is this projecting out? • 10, we use the final years FCF as a starting point • We know WACC too, but what is g? • Perpetuity growth rate= long-term growth rate usually b/t 2 % and 4%

38. Step 4 • Set up your formula, input your numbers • Discount each cash flow for the 5 years, sum this, and add it to you TV calculation • This number is equal to your company’s Firm Value

39. Pros and Cons • Pros • Insulated from the market • Based on cash flows, a very fundamental and intrinsic valuation • Allows for flexibility (I can change factors affecting FCF in future periods) • Cons • Are your forecasts accurate? • How much of my valuation is consumed by TV? (it’s often ¾’s or more) • Small changes lead to big differences

40. So What do you do Now? • Combine Valuation Methods • Think about which Method you feel is most accurate • You can combine and weight them to come out with a number

41. How to Pretend that you’re a Banker • Turn it Gray • Blue=Input, Black=Calculation, Green=Link to other sheet • Center Across Selection • Go back to the old Office • Turn off your Excel Gridlines • Unplug your Mouse • Use Shortcuts • Customize your Keyboard • How quick are you?

42. Sources • Investopedia.com • Investment Banking by Josh Rosenbaum and Josh Pearl