Transcript Slide 1
Corporate Valuation
Keith M. Howe Scholl Professor of Finance DePaul University Summer 2009
Valuation Approaches
I.
Discounted cash flow (DCF) analysis
II.
Relative valuation analysis
comparable companies analysis equity valuation using P/E multiples enterprise valuation using EBITDA multiples
Discounted cash flow (DCF) analysis
Basic idea : find the present value of the expected future cash flows over the asset’s life and discount at cost of capital (required rate).
Value N CF t Where: CF t =Cash flow in period t r = discount rate Notes: 1.
2.
Discount rate is an opportunity cost.
CF = Rev - Costs - Taxes - Investment = (Rev - Costs) (1 - T c ) + (T c * Dep) - Investment
Discounted cash flow (DCF) analysis
A DCF model has three parts:
Explicit forecast period
Cash flows are after-tax incremental cash flows
Continuing value or terminal period
Perpetuity
FCF, NOPLAT, NOPAT
Constant growth
Multiples
Discount rate
Discount rates can be determined a number of different ways (e.g., CAPM, Gordon growth model, APT, etc), but the expected free cash flows are discounted at the rate that reflects the risk of the cash flows.
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Discounted cash flow (DCF) analysis Continuing Value
V
O
t N
1 ( 1
CF
t
r
)
t
PV
(
CFs beyond t
N
)
PV of forecasted CFs Continuing Value (CV)
Discounted cash flow (DCF) analysis Two general approaches are taken:
For the continuing value (or terminal value) component, simplifying assumptions are made about future CFs (e.g., g=3% in perpetuity) or future valuation alignment based on market multiples.
Two general approaches: 1) Constant growth rate of CFs.
2) Market-based multiples
Discounted cash flow (DCF) analysis
Forecasting Continuing Value CFs
Forecasted Cash Flows g = ?
0 1 2 Explicit forecast 3 4 Time 5 Assumed growth path
Discounted cash flow (DCF) analysis
1) Constant growth approach:
CV t = FCF t+1 WACC - g • Over what period will the firm earn abnormal returns?
• What is the relation between the period of competitive advantage and the continuing value formula?
Discounted cash flow (DCF) analysis
2) Multiples Approach:
CV t = EV t * EBITDA Peers EBITDA Where: EV = enterprise value EBITDA = earning before interest, tax, depreciation and amortization • Aligns DCF value with market pricing for the industry
Discounted cash flow (DCF) analysis
Example: Discounted Free Cash flow
Year Free Cash flow 2008 2009 2010 2011 250 260 280 300 Terminal Value 3,000 Value of Operations Less: Value of Debt Equity Value Price per share Discount Present Factor (10%) Value 0.9091
0.8264
0.7513
0.6830
0.6830
227.28
214.86
210.36
204.90
2,049.00
2,906.40
(600.00)
$2,306.40
$4.16
Discounted cash flow (DCF) analysis
Required Rates for DCF Method
r =D
1
/P
0
+ g r = r
f
+ β (r
m
Gordon’s Model - r
f
) CAPM r = r
f
+ β
1
(r
1
- r
f
) + β
2
(r
2
- r
f
) +… Arbitrage Pricing Theory Fama-French model (size, BV/MV)
Discounted cash flow (DCF) analysis
Weighted average cost of capital (WACC) WACC = R D (1-T) * D/V + R E * E/V
Where: R D (1-T) = after-tax cost of debt (current) R E = cost of equity (CAPM) D/V, E/V = debt and equity proportions (market-value based)
Discounted cash flow (DCF) analysis
Market Forces Value Drivers Competitive Nature Required Investment Market Demand Profitability Investment Corporate Value Competitive Position Cost Advantage Product Differentiation Growth Risk
Discounted cash flow (DCF) analysis
Forecasting CF Performance 1. Develop the forecast period
•
How long will it take to reach an mature, equilibrium stage?
(often 10 years is used)
2. Define strategic perspective
•
Tell the story - give the context
(For example, demand will peak in 4-5 years and then decline as competitors enter the market. Margins will decline following the period.)
Discounted cash flow (DCF) analysis
Forecasting CF Performance 3. Period of competitive advantage
(ROIC > WACC) •
Providing superior value to consumers thru better service, a
• •
differentiated product.
Low cost provider Barriers to entry - patents, government policy 4. Develop financial forecast based on the strategic perspective
• • •
Begin with revenue forecast.
Develop the income and balance sheet forecasts.
Then calculate CFs and key value drivers.
Discounted cash flow (DCF) analysis
Forecasting CF Performance 5. Develop performance scenarios
(best and worst cases) •
Sets of plausible assumptions.
6. Check consistency and alignment with industry structure
•
Entry barriers, technology, strategic issues
How to Display a DCF- Based Model Assumptions Example:
Revenue % Growth EBITDA % of Sales EBIT % of Sales Net Income % of Sales FCF Real Asset Growth % CFROI %
2000A
$8,872.8
32.1% 2,689.1
30.3% 2,256.9
25.4% 1,782.1
20.1% 2,768.50
33.8% 19.6% Actuals 2001A 2002A
$7,090.6
(20.1%) $5,438.4
(23.3%) 568.9
8.0% 122.7
2.3% 20.7
0.3% (507.7) (7.2%) 620.30
7.1% 3.9%
(402.7) (7.4%) (118.7) (2.2%) 120.60
(1.5%) 1.1% Research Estimates CSFB Estimates 2003E
$6,345.9
16.7% 1,179.4
18.6%
2004E `
$7,511.5
18.4% 1,656.9
22.1% 417.9
6.6% 755.5
10.1%
2005E 2006E
$8,413.0
12.0% 2,271.6
27.0% 1,262.0
15.0% $9,254.3
10.0% 2,591.2
28.0% 1,480.7
16.0% 419.8
6.6% 1,212.50
8.7% 5.2%
615.3
8.2% 1,755.40
12.8% 6.2%
1,010.6
12.0% 2,268.50
12.2% 7.1%
1,159.7
12.5% 2,444.30
11.2% 6.9% 2007E
$10,179.7
10.0% 2,952.1
29.0% 1,730.6
17.0% 1,318.4
13.0% 2,860.30
10.8% 6.9% Here we develop a base case model from Wall Street Research and CSFB projections
Discounted Cash Flow Valuation
($ in millions)
EBITDA
Less: D&A EBIT Less: Cash Taxes Unlevered Net Income Plus: D&A Less: Capital Expenditures Less: Change in Working Capital
Unlevered Free Cash Flow
(1) 2004E not included in calculating NPV of cash flows.
($ in millions)
DISCOUNT RATE
11.25%
2004E (1) $35.0
(7.9) $27.1
(8.6) $18.5
7.9
(11.6) (1.8)
$13.0
2005E $50.0
(7.8) $42.2
(9.9) $32.3
7.8
(23.4) 0.0
$16.7
2006E $52.1
(7.8) $44.3
(10.5) $33.7
7.8
(8.0) (0.8)
$32.7
11.75% 12.25%
5.5x
$107 178 $285 8.2x
5.7x
0.1% $106 174 $280 8.0x
5.6x
0.6% $104 170 $275 7.8x
5.5x
1.0%
EBITDA TERMINAL VALUE 6.0x
6.5x
$107 194 $302 8.6x
6.0x
0.9% $106 190 $296 8.4x
5.9x
1.4% $104 186 $290 8.3x
5.8x
1.9% $107 210 $318 9.1x
6.4x
1.7% $106 206 $312 8.9x
6.2x
2.1% $104 201 $306 8.7x
6.1x
2.6%
2007E $53.1
(7.8) $45.3
(11.4) $33.9
7.8
(8.0) (0.3)
$33.3
2008E $54.1
(8.0) $46.1
(12.3) $33.8
8.0
(8.0) (0.3)
$33.5
2009E $55.2
(8.1) $47.0
(13.1) $33.9
8.1
(8.0) (0.3)
$33.8
Present Value of Free Cash Flow Present Value of Terminal Value
Enterprise Value
Implied EV / 2004E EBITDA Implied EV / 2005E EBITDA Implied Perpetuity Growth Rate Present Value of Free Cash Flow Present Value of Terminal Value
Enterprise Value
Implied EV / 2004E EBITDA Implied EV / 2005E EBITDA Implied Perpetuity Growth Rate Present Value of Free Cash Flow Present Value of Terminal Value
Enterprise Value
Implied EV / 2004E EBITDA Implied EV / 2005E EBITDA Implied Perpetuity Growth Rate 18
Scenario analysis
critically review your assumptions on the following variables
Broad economic conditions:
economic conditions?
How sensitive is the forecast to the
Competitive structure of the industry:
How competitive and concentrated is the industry? What impact will this have?
Internal capabilities of the company :
products on time and manufacture them within the expected range of costs?
Can the company develop its
Financing capabilities of the company:
changes in its plan? How?
Can the company finance the
Discounted cash flow (DCF) analysis
Pros
Widely accepted
Provides a generally reliable and sophisticated approach to valuation by accounting for:
Profitability Growth
Capital investment/intensity Capital structure Risk and opportunity cost Cons
Generally not easy to calculate
Grounded by assumptions
Gives only an absolute valuation, which in isolation is not telling
Loaded with assumptions
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Note on Cash Flow Analysis
We can use free cash flows to find: a) Enterprise Value b) Value of Equity
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Note on Cash Flow Analysis
Matching CFs and discount rates in DCF analysis Project or Firm Valuation (Debt Plus Equity Claim) Equity Valuation Steps Step 1
: Estimate the amount and timing of future cash flows Project (firm) free cash flow (i.e.,
PFCF = FFCF
) Equity free cash flow (
EFCF
)
Step 2
: Estimate a risk appropriate discount rate
Step 3
: Discount the cash flows Combine debt and equity discount rate (weighted average cost of capital -
WACC
) Equity required rate of returm (
cost of equity
) Calculate the PV(FCF) using the WACC to estimate
V (Firm)
Calculate the PV(EFCF) using the equity discount rate to estimate
V(Equity) Note that we have the same value of equity and the value of project (firm) from using project and equity valuation methods
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Less: Less: Less: Add: Less: Less: Definitions: Project (firm) free cash flow Sales Cost EBITDA Depreciation EBIT Tax @ 40% Unlevered Net Income Depreciation CAPEX NWC Increase Free Cash Flows
to the firm
##### ##### ##### ##### ##### ##### ##### ##### ##### #####
Definitions: Equity free cash flow Less: Less: Less: Less: Add: Less: Less: Sales Cost EBITDA Depreciation EBIT Interest expense Levered net income before taxes Tax @ 40% Levered net income or Net Income* Depreciation CAPEX NWC Increase Cash Flows
to equity
*Note that Net Income + Interest (1-t) = EBIT (1-t) ##### ##### ##### ##### ##### ##### ##### ##### ##### ##### ##### #####
Cash Flow Outline Firm Valuation Method Subtract taxes
(tax rate X EBIT) Unlevered Net Income Plus Depreciation, Less Capital Expenditure, Less Working Capital Change
Firm Free Cash Flow
Discount at WACC
EBIT Equity Valuation Method Subtract Interest Expense
Net Income before Taxes
Subtract taxes
(Tax rate X Net income before taxes) Plus Depreciation, Less Capital Expenditure, Less Working Capital Change
Equity Free Cash Flow
Discount at Cost of Equity
Example:
Sample data
Cost of Equity (Rs) = 12% Cost of Debt (Rd) = 8% Tax rate = 40% Earnings before Interest and taxes (EBIT) = $40 million Depreciation = $15 million Capital Expenditures = $15 million The EBIT is perpetual (mature firm) Target debt-to-value ratio (D/V) = 40% Current value of debt is $105.26 million Using free cash flows to find:
Enterprise Value Value of Equity
Firm Valuation Method Firm Free Cash Flow WACC
EBIT(1 T) Depreciati on Capital Expenditur es - Change in NWC $40(1 0.4) $15 $15 0 $24 million R d (1 T)D/V R S * E/V .08
* .4
* (1 .4) .12
* .6
.0912
or 9.12%
Enterprise Value (EV) Value of Equity
Free Cash Flow WACC $24 million .0912
$263.16
million Enterprise Value Debt 263.16
105.26
$157.9
million
Equity Valuation Method Interest Payments Cash Flows to Equity
8% * 105.26
$8.42
million [EBIT Interest]( 1 T) Depreciati CAPEX Change in NWC on [40 8.42](1 .4) 15 15 0 $18.947
million
Equity Value Enterprise Value
Cash Flows to Equity Cost of Equity $18.947
million .12
$157.9
million Equity Value Debt $157.35
$105.26
$263.16
million
Relative valuation analysis
General thoughts on relative valuations
Most valuations on Wall Street use multiples
Multiples reflect current market perceptions
Relative valuations require fewer explicit assumptions and are easier to use
Relative valuations often find a more receptive audience (easier to understand as there are fewer assumptions)
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Relative valuation analysis
Equity valuation using P/E multiples Pros
Most commonly used and accepted multiple with sell side research Easy to calculate (simply need to ensure you match time periods, trailing, current, future) Takes into account profitability
Cons
• • Cannot use if companies do not have accounting earnings Are GAAP earnings a good measure of cash flow?
Adjustments for normalized earnings?
• Ignores Economic Profitability A company could be buying earnings Completely ignores capital structure Debt not included in the value of the firm Interest costs and tax shield are ignored Ignores future growth opportunities Ignores capital intensity and investment
Although widely accepted, P/E has serious drawbacks.
Example: P/E multiples
(
P
)
E peers
Multiple of comparable firms EPS subjectfir m
(
P
)
peers E
Price of subject firm
Relative valuation analysis
Equity valuation using P/E multiples Example
Comparable firm example (Automotive): Toyota Motor Corp P/E Ratio 13.2
DaimlerChrysler AG 10.5
General Motors Corp 6.6
Ford Motor Company Average 16.0
11.575
Relative valuation analysis
Equity valuation using P/E multiples Example (con’t) Private Company:
EPS = $2.50
P = 2.50 x 11.575 = $28.94 Estimate
Traded Company:
GM P/E=6.6
What can we say about GM? Price too low?
Need to look at accounting methods, risk, growth rates, and payout to see if comparable.
Display Example: A Valuation Perspective
20.0x
15.0x
10.0x
5.0x
0.0x
18.3x
JEC 16.0x
16.0x
TANGO TTEK
P/E 2004E
15.8x
FLR 14.0x
CBI 13.3x
Median 15.8x
6.9x
GVA URS
From our analysis what can you tell me about our company?
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Display Example: Relative Valuation - Correct Time Periods P/E - 2004E
20.0X
15.0X
18.1x
18.0x
17.8x
17.5x
17.1x
14.9x
16.4x
15.6x
15.3x
15.1x
14.0x
13.2x
10.0X
5.0X
0.0X
APD AIRL ARG PX LNDE BOC AIRL ARG PX APD LNDE BOC Source: I/B/E/S Estimate.
10.0x
8.0x
6.0x
4.0x
2.0x
0.0x
8.7x
PX
EV / 2004E EBITDA
8.2x
7.7x
7.3x
ARG APD AIRL 6.0x
BOC 4.8x
LNDE
PX’s trading multiples are consistent with the market’s expectations for future performance.
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Relative valuation analysis
Enterprise valuation using EBITDA multiples Pros
Second most commonly used and accepted multiple on Wall Street Easy to calculate (but need to ensure you match time periods, trailing, current, future) Takes into account profitability EBITDA generally a good proxy for cash Takes into account capital structure • Includes debt in the value of the firm (should use net debt) • Includes Interest as part of cash flow
Cons
Ignores Economic Profitability Ignores capital intensity and investment
The EBITDA multiple is a “cleaner” multiple, however it still misses the hurdle rate and investment required into the business.
Implementing a Multiples Approach
Define the multiple
There are different definitions for the same multiple (current, trailing, forward).
It is integral to look at the entire distribution of the multiple
Understand the differences between the mean, median and standard deviation Understand why the outlier are outliers (question relevance of the multiple and the companies inclusion in the peer group)
Understand the fundamentals of the multiple
What are the strengths and weaknesses of the multiple?
Choosing a peer group for Relative Valuation Methods
Why are you trying to determine value?