TIP Valuation

What are the 3 main valuation methodologies?

Public Comps, Precedent Transactions, and DCF Analysis; Public Comps and Precedent Transactions are examples of relative valuation (based on market values), while the DCF is an intrinsic valuation (based on cash flows)

Can you walk me through how you use Public Comps and Precedent Transactions?

Step 1: Select the peer group/transactions; Step 2: Determine relevant metrics and multiples; Step 3: Calculate median, 25th, 75th percentile across peer set; Step 4: Apply to the target company to find a value range

How do you choose between Comparable companies or Precedent Transactions?

Use Precedent Transactions when valuing a company for a potential M&A sale or change of control. Use Comparable Companies when you need a real-time valuation (IPO) and when you want to avoid the risk of outdated M&A multiples.

For Public Comps, you calculate Equity Value and Enterprise Value for use in multiples based on companies’ share prices and share counts… but what about for Precedent Transactions? How do you calculate multiples there?

You only look at purchase price of the company at the time of the deal announcement

How would you value an apple tree?

Looking at what comparable apple trees are worth (relative valuation) and present value of the apple tree’s cash flows (intrinsic valuation)

When is a DCF useful? When is it not?

DCFs are best when the company is large, mature, and has predictable cash flows. Not useful when company has unpredictable cash flows or when debt, operating assets, and liabilities serve different roles (banks and insurance firms)

When is a liquidation valuation useful?

Bankruptcy scenarios to see whether or not shareholders will receive anything after company’s liabilities have been off from selling all its assets

When would you use a Sum of the Parts valuation?

When a company has completely different and unrelated divisions. You value each division separately and then add them together to calculate the Total Value

When do you use an LBO analysis as part of your valuation?

When analyzing a Leveraged Buyout but also to “set a floor” on the company’s value and determine the minimum amount a PE firm could pay to achieve its targeted returns

How do you calculate Unlevered FCF?

Unlevered FCF = EBIT x (1 - Tax Rate) + Non cash charges - Change in Operating Assets and Liabilities - CapEx

How do you calculate Levered FCF?

Levered FCF = Net Income + Non Cash Charges - Change in Operating Assets and Liabilities - CapEx - Mandatory Repayments

What does Enterprise Value / Revenue tell you?

How valuable a company is in relation to its overall sales

What does Enterprise Value / EBITDA tell you?

How valuable a company is in relation to its approximate cash flow

What does Enterprise Value / EBIT tell you?

How valuable a company is in relation to its pre-tax profit it earns from its core business operations

What does Price per share / Earnings per share tell you?

Tells you how much investors are willing to pay for each dollar of a company’s earnings

Why can’t you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA?

EBITDA is a metric available to all investors in the company while Equity Value belongs exclusively to common shareholders after debt is paid. It’d be comparing apples to oranges.

What would you use with Free Cash Flow multiples – Equity Value or Enterprise Value?

For Unlevered FCF you’d use Enterprise Value and for Levered FCF you’d use Equity Value

What are some problems with EBITDA and EBITDA multiple? And if there are so many problems, why do we still use it?

It hides debt, interest, and CapEx spending. It also ignores A/R, Inventory, and A/P. While EBITDA isn’t the best at measuring cash flow it’s better for comparing the cash generated from core operations.

Could EV / EBITDA ever be higher than EV / EBIT for the same company?

No, because to calculate EV/EBITDA you add back D&A, neither of which can be negative. Since EBITDA is always greater than or equal to EBIT, EV/EBITDA is always going to be less than EV/EBIT for the same company.

Rank the 3 main valuation methodologies from highest to lowest expected value

No ranking always holds up. In general though, Precedent Transactions will be higher than Public Comps because of the control premium. A DCF can go either way and is much more variable. It often produces the highest value but can also produce the lowest depending on assumptions.

Why are Public Comps and Precedent Transactions sometimes viewed as being “more reliable” than a DCF

They’re based on actual market data instead of assumptions far into the future

What are flaws with Public Comps?

No company is 100% comparable, the stock market is emotional, and share prices for small companies with thinly traded stocks may not reflect their full value

You mentioned that Precedent Transactions usually produce a higher value than Comparable Companies – can you think of a situation where this is not the case?

There could be a big mismatch between M&A market and public markets. For example, no public companies have been acquired recently but lots of small private companies have been acquired at low valuations.

What are some flaws with Precedent Transactions?

Past transactions are not 100% comparable and the data is more difficult to find than Public Comps especially with small private companies

How do you take into account a company’s competitive advantage in a valuation?

Highlight the 75th percentile or higher for the multiples, add in a premium to some of the multiples, use more aggressive projections for the company