1、Valuation Valuation as a ToolWe encounter valuation in many situations:Mergers&AcquisitionsLeveraged Buy-outs(LBOs&MBOs)Sell-offs,spin-offs,divestituresInvestors buying a minority interest in companyInitial public offerings How do we establish value of assets?Objective today:To preview valuation met
2、hods used most commonly in practiceBusiness Valuation TechniquesDiscounted cash flow(DCF)approachesDividend discount modelFree cash flows to equity model(direct approach)Free cash flows to the firm model(indirect approach)Relative valuation approachesP/E(capitalization of earnings)Enterprise Value/E
3、BITDA Other:P/CF,P/B,P/S Control transaction based models(e.g.value based on acquisition premia of“similar”transactions)Discounted Cash Flow ValuationWhat cash flow to discount?Investors in stock receive dividends,or periodic cash distributions from the firm,and capital gains on re-sale of stock in
4、futureIf investor buys and holds stock forever,all they receive are dividendsIn dividend discount model(DDM),analysts forecast future dividends for a company and discount at the required equity return Problem with dividends:they are“managed”Dividends:The Stability FactorFactors that influence divide
5、nds:Desire for stabilityFuture investment needsTax factorsSignaling prerogativesDividend changes:Publicly traded U.S.FirmsSource:A.Damodaran,Investment Valuation,Wiley,1997Valuation:Back to First PrinciplesValue of the firm=value of fixed claims(debt)+value of equity How do managers add to equity va
6、lue?By taking on projects with positive net present value(NPV)Equity value=equity capital provided+NPV of future projectsNote:Market to book ratio(or“Tobins Q”ratio)1 if market expects firm to take on positive NPV projects(i.e.firm has significant“growth opportunities”)Valuation:First PrinciplesTota
7、l value of the firm=debt capital provided+equity capital provided+NPV of all future projects project for the firm=uninvested capital+present value of cash flows from all future projects for the firmNote:This recognizes that not all capital may be currently used to invest in projectsThe Valuation Pro
8、cessIdentify cash flows available to all stakeholders Compute present value of cash flowsDiscount the cash flows at the firms weighted average cost of capital(WACC)The present value of future cash flows is referred to as:Value of the firms invested capital,orValue of“operating assets”or“Total Enterp
9、rise Value”(TEV)The Valuation Process,continuedValue of all the firms assets(or value of“the firm”)=Vfirm=TEV+the value of uninvested capitalUninvested capital includes:assets not required(“redundant assets”)“excess”cash(not needed for day-to-day operations)Value of the firms equity=Vequity=Vfirm-Vd
10、ebtwhere Vdebt is value of fixed obligations(primarily debt)Total Enterprise Value(TEV)For most firms,the most significant item of uninvested capital is cashVfirm=Vequity+Vdebt=TEV+cashTEV=Vequity+Vdebt -cashTEV=Vequity+Net debtwhere Net debt is debt-cash(note:this assumes all cash is“excess”)Measur
11、ing Cash FlowsFree Cash Flow to the Firm(FCFF)represents cash flows to which all stakeholders make claim FCFF=EBIT (1-tax rate)+Depreciation and amortization(non cash items)-Capital Expenditures-Increase in Working CapitalWhat is working capital?Non-cash current assets-non-interest bearing current l
12、iabilities(e.g.A/P&accrued liab.)Working Capital vs.Permanent FinancingShort-termassetsShort-termliabilitiesPermanentCapitalLong-termassetsPermanentCapitalOperatingassetsWorking capitalPermanent capital may include“current”items such as bank loans if debt is likely to remain on the booksKey:Treat it
13、ems as either working capital permanent capital but not bothUninvestedcapitalFCFF vs.Accounting Cash FlowsIncome Statement,Hudsons Bay($millions,FYE Jan 1999)Sales$7,075Cost of Goods Sold$6,719EBITDA$356Depreciation$169EBIT$187Interest Expense$97Income Taxes$50Net Income$40Dividends$53Cash Flow Stat
14、ement,Hudsons Bay,($millions,FYE Jan 1999)Cash flow from operations Net Income$40 Non-cash expenses$169 Changes in WC ($116)Cash provided(used)by investments Additions to P,P&E ($719)Cash provided(used)by financing Additions(reductions)to debt$259 Additions(reductions)to equity$356 Dividends ($53)Ov
15、erall Net Cash Flows ($64)Hudsons Bay FCFF =187*(1-0.44)+169-719-116=($561)Cash Flow Definition IssuesHow is FCFF different than accounting cash flows?Operating cash flows includes interest paid We want to identify cash flows before they are allocated to claimholdersFCFF also appears to miss tax sav
16、ings due to debtKey:these tax savings are accounted for in WACCAn Example$1 million capital required to start firmCapital structure:20%debt(10%pre-tax required return)10%preferred debt(7%required return)70%equity(15%required return)tax rate is 50%firm expects to generate 244,000 EBIT in perpetuityfu
17、ture capital expenditures just offset depreciationno future additional working capital investments are requiredWhat should be the value of this firm?An Example,continuedAfter tax WACC is 12.2%so pre-tax WACC is 24.4%EBIT/capital is also 24.4%,so NPV of future projects for this firm is zeroValue of f
18、irm should equal$1 million(invested capital)FCFF=EBIT*(1-t)=$122,000Value=122,000/0.122=$1,000,000Two Stage FCFF ValuationImpossible to forecast cash flow indefinitely into the future with accuracyTypical solution:break future into“stages”Stage 1:firm experiences high growthSources of extraordinary
19、growth:product segmentationlow cost producerPeriod of extraordinary growth:based on competitive analysis/industry analysisStage 2:firm experiences stable growthStage 1 ValuationForecast annual FCFF as far as firm expects to experience extraordinary growthgenerally sales driven forecasts based on his
20、torical growth rates or analyst forecastsEBIT,capital expenditures,working capital given as a percentage of salesDiscount FCFF at the firms WACC(kc)FCFF1 +FCFF2 +.+FCFFt1+kc (1+kc)2 (1+kc)tVALUE1 =Stage 2 ValuationStart with last FCFF in Stage 1Assume that cash flow will grow at constant rate in per
21、petuityInitial FCFF of Stage 2 may need adjustment if last cash flow of Stage 1 is“unusual”spike in sales or other itemscapital expenditures should be close to depreciationValue 1 year before Stage 2 begins=FCFFt*(1+g)Kc-gStage 2 ValuationPresent value of Stage 2 cash flows(Terminal Value or TV):Key
22、 issue in implementation:Terminal growth(g)rate of“stable”growth in the economy(real rate of return 1-2%plus inflation)TEV=VALUEt+TV1(1+kc)txTV =FCFFt*(1+g)Kc-gDiscounted FCFF ExampleAssumptionsYearEBIT Dep Cap ExW/C Change1 40 4 6 22 50 5 7 33 60 6 8 4Tax rate=40%kc =10%Vdebt=value of debt=$100 Gro
23、wth(g)of FCFFs beyond year 3 =3%Discounted FCFF Example(contd)FCFF=EBIT*(1-t)+Dep-CapEx-Increase in WC Year 1 FCFF=40*(1-0.4)+4-6-2=20Year 2 FCFF=50*(1-0.4)+5-7-3=25Year 3 FCFF=60*(1-0.4)+6-8-4=30Discounted FCFF Example(contd)20 25 30 30*(1+g)30*(1+g)2|t=0 1 2 3 4 5P=Vfirm 30*(1+g)/(kc-g)TEV=20/(1+k
24、c)+25/(1+kc)2+30/(1+kc)3+30*(1+g)/(kc-g)/(1+kc)3Discounted FCFF Example(contd)TEV=20/(1.10)+25/(1.10)2+30/(1.10)3+30*(1.03)/(0.10-0.03)/(1.10)3 =18.2+20.7+22.5+331.7=393.0TEV+Cash=Vfirm=Vfirm=TEV=393.0Vfirm=Vdebt+Vequity=Vequity=Vfirm-Vdebt Vequity=393.0-100.0=293.0Relative Valuation ApproachesCapit
25、alization of EarningsCompute the ratio of stock price to forecasted earnings for“comparable”firms determine an appropriate“P/E multiple”If EPS1 is the expected earnings for firm we are valuing,then the price of the firm(P)should be such that:P/EPS1 =“P/E multiple”Rearranging,P =“P/E multiple”x EPS1P
26、/E Ratios and the DDMRecall the constant growth DDM model,but apply it to a firm with 100%payout ratio:P/E ratios capture the inherent growth prospects of the firm and the risks embedded in discount rateP =D1 ke-gP =EPS1 ke-g P =1 EPS1 ke-gP/E Ratio Based ValuationFundamentally,the“P/E multiple”rela
27、tes to growth and risk of underlying cash flows for firmKey:identification of“comparable”firmssimilar industry,growth prospects,risk,leverageindustry averageTEV/EBITDA ApproachTEV=MVequity+MVdebt-cashEBITDA:earnings before taxes,interest,depreciation&amortizationCompute the ratio of TEV to forecaste
28、d EBITDA for“comparable”firms determine an appropriate“TEV/EBITDA multiple”If EBITDA1 is the expected earnings for firm we are valuing,then the TEV for the firm should be such that:TEV/EBITDA1=“EV/EBITDA multiple”TEV/EBITDA ApproachRearranging:TEV=“EV/EBITDA multiple”x EBITDA1Next solve for equity v
29、alue using:MVequity=TEV-MVdebt+cashMultiples again determined from“comparable”firms similar issues as in the application of P/E multiplesleverage less important concernOther Multiple Based ApproachesOther multiples:Price to Cash Flow:P =“P/CF multiple”X CF1Price to Revenue:P =“P/Rev multiple”X REV1M
30、ultiple again determined from“comparable”firmsWhy would you consider price to revenue over,for example,price to earnings?Merger MethodsComparable transactions:Identify recent transactions that are“similar”Ratio-based valuationLook at ratios to price paid in transaction to various target financials(e
31、arnings,EBITDA,sales,etc.)Ratio should be similar in this transactionPremium paid analysisLook at premiums in recent merger transactions(price paid to recent stock price)Premium should be similar in this transactionValuation Case ProcessSize-up the firm being valueddo projections seem realistic(look
32、 at past growth rates,past ratios to sales,etc.)?what are the key risks?Valuation analysisseveral approaches+sensitivities(tied to risks)Address case specific issuese.g.for M&A:what is fit(size-up bidder),any synergies,bidding strategy,structuring the transaction,etc.e.g.for capital raising:timing,d
33、eal structure,etc.The Valuation“Myths”Like all analytical disciplines,valuation has developed its own set of myths over time:Myth 1.Valuation models are quantitative,so it is objective and precise.Myth 2.A well-researched,well-done model is timeless.Myth 3.The more quantitative a model,the better th
34、e valuation.Myth 4.The output,not the process,of the valuation is what counts.Myth 5.The market is generally wrong.ApplicationsWe will apply valuation principles in variety of settings:Private sales Graphite Mining,Oxford Learning CentresMergers&Acquisitions Husky Energy,United Grain Growers,Empire
35、CompanyCapital Raising Eatons,Huaneng Power)Valuation ReferencesCopeland,Koller and Murrin,1994,Valuation:Measuring and Managing the Value of Companies(Wiley)Damodaran,1996,Investment Valuation(Wiley);Pratt,Reilly and Schweihs,1996,Valuing a Business:The Analysis and Appraisal of Closely Held Compan
36、ies(Irwin)Benninga and Sarig,1997,Corporate Finance:A Valuation Approach(McGraw Hill)Stewart,1991,The Quest for Value(Harper Collins)Harvard Business School Notes:An Introduction to Cash Flow Valuation Methods(9-295-155)A Note on Valuation in Private Settings(9-297-050)Note on Adjusted Present Value(9-293-092)
