APT TECHNICAL CPD - MAF (Valuations) 1 Valuations Nicholas Riemer - - PowerPoint PPT Presentation

APT TECHNICAL CPD - MAF

(Valuations)

1

Valuations

Nicholas Riemer

Agenda

• Workflow to understanding Valuations
• What are Valuations? Generic Problem
• How are valuations performed in specific industries?
• What is the specific problem?
• How to incorporate into your file

Valuation Workflow Approach

What are valuations? Generic problem

• Why we do valuations? Need to know the purpose of your

valuation at hand, not just the theory.

• Myths: Precise?, Objective?(Valuations are all about the

inputs, assumptions being made) who is valuating this business.

• Quantitatively correct? Is a valuation perfect in its final

answer?

Thought process from a practical view

• Step 1: Purpose of the valuation

– For whom? (buyer/seller) – What for? Pe company buying a minority? Individual buying a majority to run? Selling a portion to fund future growth? – Limitations (information available, assumptions, industry)

• Step 2: Date of valuation
• Step 3: Parties involved

– Companies/ individuals/banks/PE – Reason for sale (WHY?)

• Step 4: What is being valued?

– Preference shares/debentures (COC module – value instrument). Link Pref share funding to purchase of businesses. – Equity = enterprise as a whole – Components of the enterprise – Size of the interest (pay more for controlling interest)

Thought process continued.

• Step 5: Choice of valuation method

– MOTIVATE THE USE OF THE METHOD

• Going concern?
• Yes
• No (most likely asset value) or use of assessed loss
• Investment versus income generating
• Minority versus majority shareholding
• Fluctuating growth
• Earnings versus cash

Thought process continued.

• Step 6: Calculate maintainable income for ?
• Given past income statements
• Make certain adjustments to reflect future maintainable income
• Growth trends

– General principles – Dividend yield – Earnings PE and EBITDA – Net asset value – Free cash flow

Thought process continued

• Step 6 cont.: Calculating maintainable income

– Past income statements – Make adjustments to reflect future – GIVE REASONS FOR ADJUSTMENTS

• General principles:

– Emphasis on the word MAINTAINABLE – Impact of buyer/seller – Adjust for:

• Non-recurring items
• Extraordinary items
• Changes in business policy
• Changes in accounting policy
• Changes in tax rate
• Abnormal profit or losses on investments/assets
• Abnormal levies to directors/management
• Changes in salary expense
• Private expenditure
• Changes in inflation

Thought process continued

• Step 6 cont. : Calculating maintainable income
• General principles (continued):

– Adjust for:

• Finance costs unreasonable
• Lease/rent expense – replaced with property purchased
• Etc

– Growth in maintainable earnings

• Growth trend
• Buyer/Seller
• Accounting average
• Weighted average
• Abnormal years (excluded)

Thought process continued

• Step 6 cont.: Calculating maintainable income
• Dividend yield method – calculating the maintainable dividend

– Starting point:

• Identify the future dividend policy: (Link to dividend policy)
• Fixed payout in Rand terms  maintainable income calc not necessary
• Fixed payout ratio  payout dependent on the maintainable income, therefore calculate maintainable

income first

• Earnings yield method/EBITDA – calculating the maintainable earnings

– Starting point

• Calculate maintainable income or EBITDA
• Net asset value

– Calculation of maintainable income not necessary – Emphasis on balance sheet – Future benefits come from sale of assets @ MV or liquidation value – NAV = Assets – Liabilities

• Free cash flow method Starting point
• Calculate free cash flow, applying the general principles

Thought process continued

• Step 7: Discount the maintainable income

– Choosing the appropriate discount rate – Starting point similar listed companies NB for PE and EBITDA – Factors that increase/decrease risk – impact on discount rate – If there is a difference, make adjustments such as:

• Asset structure – age of assets
• Industry changes
• Capital structure
• Economic cycle
• Management experience
• Years of existence
• Unlisted status
• Loss of key staff
• Changes in legislation
• Political risks
• Etc

Thought process continued

Step 7 cont.: Discount rate

• Dividend yield method

– Cost of equity

• Earnings yield method

– Earnings yield %/ PE Multiple which is PPS/EPS

• Net asset value

– No discount rate – MV and liquidation value are values today

• Free cash flow

– Cost of capital – Why??? Permanent sources of finance. Blended approach.

Thought process continued.

• Step 8: Perform the valuation

– Discount the maintainable income – Apply the size of the shareholding – NB Subjective, explain what you are doing. If reasoning is sound C or HC

• Step 9: Reasonableness test NB for real world.

– Perform alternative valuations, based on info available – Listed price (if available)

• Step 10: Recommendations and negotiation factors NB

– For APT and APC this can be an important step. You could simply be asked by the CFO or FD to look at the valuation already performed and give your views as a young CA without reperforming? – NB never too critical. Language, soft skills. Maye re look at the growth rate as WACC should be used to give us a clearer answer as the company does have permanent sources of finance which it utilizes to grow the business, thus leverage must be taken into account etc. not jut, the growth rate is wrong because of…

Methods NB

• Dividend
• Earnings (PE) NB
• EBIT/DA NB

– Calculate EBITDA multiple of a similar company Market capitalization + MV of debt EBITDA – Adjust EBIT/DA multiple to reflect company risk – Calculate maintainable EBITDA – MV of assets (Enterprise value) = EBITDA multiple x maintainable EBITDA – Deduct market value of debt = Equity value.

• Before interest = different gearing is accounted for
• Before depreciation and amortisation = closer to cash(Older assets)

DCF (Discounted cash flow)

• Free Cash Flow Available for Distribution to all

providers of permanent capital included in the WACC”

• Bucket Principle…. I like Revenue when given the option
• Bucket for all stakeholders vs. Bucket for equity
• Starting point Income Statement

Balance Sheet Cash flow Statement

How do we do Free Cash Flow ?

Base Year “0” Year 1 Year 2 Year 3 Current Year – Historical data i.e. IS Planning Period of extraordinary growth Representative year

• Use of PV techniques in order to value the cash flows in the

FUTURE years only

• Base Year is our starting point but not included in the valuation
• Growth phase – new business or reasonably forecast-able
• Representative year – annuity
• PV of future cash flows, discounted at required rate of return

planning Into calculation

Expect > 1 growth rate Expect stable growth

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STEP 1 – Calculating the cash flows: Base Year

Make adjustments to manipulate from our starting point in order to get “Free Cash Flow available for distribution to all providers of WACC capital”

1.Non-Cash items – we want the cash flows 2.Non-Operating Item – not related to core business, different risk profiles 3.Finance Costs why? Permanent sources of finance key principle for valuations in the APT and APC 4.Cash tax adjustments

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Planning Phase

• Growth

– Real {volume} – Inflation {price} – Nominal – N = [(1 + R)(1 + i) – 1]

• Make adjustments for the following

1.Working capital adjustments 2.Costs to maintain the business 3.Costs to expand the business

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Representative Year

• Make adjustments in order to make the year representative (in

addition to all the other adjustments mentioned) perpetuity, so must be a clear reflection of the business going forward.

• Sustainable – as it will be the PV of an annuity, thus must be

representative of the future

• Formula for an annuity = Po = D1/(Rqd Return-g)
• When is the representative year – growth is stable, normally year

6 or year 11 of a forecast.

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STEP 2 – Discounting to PV

• WACC(Ke=CAPM), market value of debt
• Annuity for representative year – Gordons Growth Model
• Only future cash flows
• Value obtained = Value of business for both equity and debt

providers

– Remember the bucket principle

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STEP 3 – Obtaining the equity value

• Deducting the MV of debt
• Adding the value of non-operating items such as properties and

investments etc.

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Specific Industry?

• What is the industry?
• How are valuations performed in this industry,

Fast food, pharmaceutical, Fuel?

• Research, but what kind of research? What

type of information are you looking for?

• Are you applying the technical detail of the

topic to the industry in your research time?

Models in practice?

• EBITDA and PE: the multiples here are the big talking
• point. Can we find comparable multiples in the

industry research? Why need this for the day’s tasks. Not going to be there.

• DCF: Growth rates in the industry, industry outlook,

discount rate(WACC) but? CAPM requires the Rf rate and b. do you have those?

• Have you calculated the market value of Debt? Can

you?

• Need this information as its not ITC now.

Industry Fast Food:

• In the pre release the Fast food industry is triggered.
• How would I handle this industry?
• 1) Identify the technical concepts and basics of valuations.
• 2) Start with general research, google. What are you seeing
• 3) From simple research you will identify the key issues at hand, that

EBITDA multiples are used in this space. Multiples range from 5-8 in this

• industry. Need to know what food you are selling to compare to other

similar franchisees. Remodel costs, how are these treated?, Macro analysis? Who is buying these right now, can one be bought on its own or is a group required? Exit points for PE companies? This is what you must be looking at and knowing before the Exam.

• This is what you are identifying with regards to the trigger industry
• research. Cannot just rely on overall industry research for valuations.

Fast food example

– Be very careful with valuations, can be triggered from something

• small. Debt for equity swap from tax trigger, what’s the equity value?

Different classes of shares? Director A needs to sell? – From a model point of view EBITDA is used. DCF can also be used thus know the principles but very difficult to project future earnings with changes in store numbers and sales price of food as franchisor controls this. – Thus EBITDA used. – The multiples range per franchise based on the following: How big is the group? Profitability normally running from 4-6% net yield with an EBITDA yield of around 12%. – How is debt used in the business? Senior debt vs rolling facility? – Listed? Marketability discount.

Continued

• Are the properties included? Not in most cases thus rental

expenses has 16 been adopted? Will change your EBITDA

• Minimum and maximum values are created and the mid point

is the starting point of the negotiation.

• The franchisor provides cash flow forecasts so DCF can be

used, however not the preferred method but remains a valid trigger.

• Private equity companies starting to invest heavily in this

space? Why? What’s the strategy? What’s the exit point?

• Operators are key in this business? Are senior staff staying on,

who’s driving this business when acquired?

Specific Case study

• What is the specific problem for the specific case
• Determine what information is available to prepare a
• valuation. What is missing what methods are used?
• Now link Technical, Industry research the case study

at hand. Multiples, how valued, key issues from the industry and then key issues from your information.

• Not predicting the question for the day. Arriving with

a full tool box, meaning methods covered, multiples covered, Rf rate b and debt covered, projections researched, other models for reasonability.

• Coverage Coverage Coverage NB

Specific case study

• Always answer all the questions related to the

valuation.

• Tone when assisting, not critical.
• Remember valuations were asked in 3 of the 7 tasks

in last years APC so really look through that case study when valuations in mind picking up on the triggers.

• Rarely perform the valuation, comment on, assist,

how would you approach in terms of just talking a CFO through it. Need to know basics well.

Building a file for coverage

• My File.
• Everything summarized in sequence NB

1) Industry research for the trigger, 2) Technical principles summarized for each of the applicable models and methods and 3) all my key coverage points from the pre release for coverage. Below this in the file, the rest of your notes.

• You got this.