Transcript Slide 1

Notes on Valuation
Approaches
Summer 2009
Dr. Keith M. Howe
Scholl Professor of Finance
DePaul University
Valuation Approaches
Methodologies
Comparable Companies
Analysis
Methodology
 Value based on current
trading multiples of
publicly traded
comparables
 Implied value in public
market
Issues
Discounted Cash Flow
Analysis
 Present value of projected
free cash flows
 Best captures value of
management’s plan
 Limited number of true
 Discount rate affected by
comparables given
consolidation and size
considerations
 Comparables’ multiples
based on research
estimates from different
sources
several factors
– Equity risk premium
including size, country
and overall business risk
– Debt cost of capital
 Terminal value range of
based comparable
companies’ current
multiples
Discounted Cash Flows (DCF)
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
Discounted Cash Flows (DCF)
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.
How to Display a DCF- Based Model Assumptions
Example:
Actuals
2000A
2001A
Research Estimates
2002A
CSFB Estimates
2003E
2004E
2005E
2006E
2007E
$8,413.0
12.0%
$9,254.3
10.0%
$10,179.7
10.0%
$8,872.8
32.1%
$7,090.6
(20.1%)
$5,438.4
(23.3%)
$6,345.9
16.7%
`
$7,511.5
18.4%
2,689.1
30.3%
568.9
8.0%
122.7
2.3%
1,179.4
18.6%
1,656.9
22.1%
2,271.6
27.0%
2,591.2
28.0%
2,952.1
29.0%
2,256.9
25.4%
20.7
0.3%
(402.7)
(7.4%)
417.9
6.6%
755.5
10.1%
1,262.0
15.0%
1,480.7
16.0%
1,730.6
17.0%
% of Sales
1,782.1
20.1%
(507.7)
(7.2%)
(118.7)
(2.2%)
419.8
6.6%
615.3
8.2%
1,010.6
12.0%
1,159.7
12.5%
1,318.4
13.0%
FCF
2,768.50
620.30
120.60
1,212.50
1,755.40
2,268.50
2,444.30
2,860.30
Real Asset Growth %
33.8%
7.1%
(1.5%)
8.7%
12.8%
12.2%
11.2%
10.8%
CFROI %
19.6%
3.9%
1.1%
5.2%
6.2%
7.1%
6.9%
6.9%
Revenue
% Growth
EBITDA
% of Sales
EBIT
% of Sales
Net Income
Here we develop a base case model from Wall Street Research and CSFB projections
Discounted Cash Flow Valuation
($ in millions)
2004E(1)
$35.0
(7.9)
$27.1
2005E
$50.0
(7.8)
$42.2
2006E
$52.1
(7.8)
$44.3
2007E
$53.1
(7.8)
$45.3
2008E
$54.1
(8.0)
$46.1
2009E
$55.2
(8.1)
$47.0
Less: Cash Taxes
Unlevered Net Income
Plus: D&A
Less: Capital Expenditures
Less: Change in Working Capital
(8.6)
$18.5
7.9
(11.6)
(1.8)
(9.9)
$32.3
7.8
(23.4)
0.0
(10.5)
$33.7
7.8
(8.0)
(0.8)
(11.4)
$33.9
7.8
(8.0)
(0.3)
(12.3)
$33.8
8.0
(8.0)
(0.3)
(13.1)
$33.9
8.1
(8.0)
(0.3)
Unlevered Free Cash Flow
$13.0
$16.7
$32.7
$33.3
$33.5
$33.8
EBITDA
Less: D&A
EBIT
(1) 2004E not included in calculating NPV of cash flows.
($ in millions)
EBITDA TERMINAL VALUE
6.0x
6.5x
DISCOUNT RATE
5.5x
11.25%
$107
178
$285
8.2x
5.7x
0.1%
$107
194
$302
8.6x
6.0x
0.9%
$107
210
$318
9.1x
6.4x
1.7%
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
11.75%
$106
174
$280
8.0x
5.6x
0.6%
$106
190
$296
8.4x
5.9x
1.4%
$106
206
$312
8.9x
6.2x
2.1%
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
12.25%
$104
170
$275
7.8x
5.5x
1.0%
$104
186
$290
8.3x
5.8x
1.9%
$104
201
$306
8.7x
6.1x
2.6%
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
6
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 less
assumptions)
Price/Sales
Pros


Easy to calculate
Maybe the only available multiple
Cons




Ignores profitability
 Does not account for margins (Fed Ex vs. UPS) or taxes
(PFE vs. BMY)
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
While simple Price/Sales has numerous pitfalls users must be aware of.
Price/Earnings (P/E)
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 (AutoZone example, see next page)
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.
Are Autozone’s Investors Only
Concerned With Earnings?
$2.50
160
140
$2.00
120
100
$1.50
80
$1.00
60
40
$0.50
20
$0.00
0
1991
1992
1993
1994
1995
EPS
1996
1997
1998
1999
2000
Relative TSR
Through the 90’s – Autozone’s EPS grew at a 25% CAGR.
2001
Enterprise Value/EBITDA
(EV/EBITDA)
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.
Value/Book or EV/Book
Important here is that Value/Book defines how much the market is paying
for past investments.
Pros



Used by Wall Street to gauge capital intensity and investment
return
Easy to calculate
Takes into account capital structure
 Includes debt in the value of the firm
 Includes Interest as part of cash flow
Cons


Ignores both accounting and economic profitability
Any additional problems with these metrics? (Matching/timing of
values)
Value/Book accounts for the investments made into a business and its future value
creation potential. Profitability however is now ignored.
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

One more thing…..
Choosing a Peer Group for
Relative Valuation Methods
Why are you trying to determine value?
Defining why you are performing a valuation has a direct effect on choosing a firm’s
peers.
Display Example: A Valuation Perspective
P/E 2004E
20.0x
18.3x
16.0x
16.0x
15.8x
14.0x
13.3x
Median 15.8x
15.0x
10.0x
6.9x
5.0x
0.0x
JEC
TANGO
TTEK
FLR
CBI
GVA
2.0x
1.9x
URS
Market/Book-Current
6.0x
4.9x
4.0x
3.3x
2.3x
2.3x
2.0x
Median 2.3x
1.0x
0.0x
CBI
JEC
TTEK
TANGO
URS
FLR
From our analysis what can you tell me about our company?
GVA
Display Example: Relative Valuation- Utility Holding
Companies mismatched time periods
P/E – 2003(1)
20.0x
15.0x
10.0x
5.0x
–
15.9x
NU
15.3x
SO
14.9x
AEE
14.9x
HE
14.1x
ED
13.5x
13.2x
KSE
NS
T
Median 13.2x
12.3x
11.8x
13.0x
12.5x
12.5x
SCG
DQE
EAS
PNM
FE
10.5x
POM
EV/EBITDA – 2004(2)
15.0x
12.5x
10.0x
7.5x
5.0x
2.5x
–
Median 7.7x
12.0x
9.4x
EAS
SO
8.6x
PNM
8.6x
HE
8.3x
7.9x
7.7x
7.6x
POM
AEE
NS
T
ED
7.5x
SCG
7.1x
FE
7.1x
KSE
6.9x
6.2x
DQ
E
NU
Market/Book
2.00x
1.50x
1.00x
0.50x
–
1.4x
KSE
Median 1.1x
1.2x
NST
1.2x
FE
1.2x
ED
1.1x
1.1x
1.1x
0.9x
0.9x
0.9x
0.9x
0.8x
SO
HE
SCG
EAS
DQE
POM
PNM
AEE
0.8x
(1) Source: First Call
(2) Source: Wall Street Research
Errors to note here PE is 2003, EV/EBITDA is 2004 and Market to book is not label.
Remember you MUST match time periods.
NU
Display Example:
Relative Valuation - Correct Time Periods
P/E - 2004E
20.0X
18.1x 18.0x 17.8x 17.5x
17.1x
14.9x
15.0X
16.4x 15.6x
EV / 2004E EBITDA
10.0x
15.3x 15.1x
14.0x 13.2x
8.7x
8.2x
8.0x
7.7x
7.3x
6.0x
6.0x
4.8x
10.0X
4.0x
5.0X
2.0x
0.0X
APD AIRL ARG PX LNDE BOC
AIRL ARG PX APD LNDE BOC
2003EP/E
P/E
2003
2004E P/E
0.0x
PX
ARG
APD
AIRL
BOC
LNDE
Source: I/B/E/S Estimate.
Market/Book – Current
V/C for S&P 500
2.0x
1.6x
1.5x
S&P Median 1.85x
1.5x
1.4x
1.3x
1.1x
1.0x
0.9x
0.5x
0.0x
PX
Note:
ARG
AIRL
APD
BOC
LNDE
Value-to-Cost defined as a “real” market-to-book ratio. A Value-to-Cost ratio >1.0x implies that the market is expecting future profitable growth from the Company. Current value-to-cost
ratio for the S&P 500 = 1.85x.
PX’s trading multiples are consistent with the market’s expectations for future
performance.