M&I 400 Technical Prep - Valuation
A company's current stock price is $20.00 per share, and its P / E multiple is 20x,
so its EPS is $1.00. It has 10 million shares outstanding.
Now it does a 2-for-1 stock split - how do its P / E multiple and valuation change?
- ANS - They don't. Think about what happens: the company now has 20 million
shares outstanding... but its Equity Value has stayed the same, so its share price
falls to $10.00.
Its EPS falls to $0.50, but its share price has also fallen to $10.00, so the P / E
multiple remains 20x.
Splitting stock into fewer units or additional units doesn't, by itself, make a
company worth more or less.
However, in practice, often a stock split is viewed as a positive sign by the
market... so in many cases a company's value will go up and its share price won't
necessarily be cut in half, so P / E could increase.
\Both M&A premiums and precedent transactions involve analyzing previous
M&A transactions. What's the difference in how we select them? - ANS - All the
sellers in the M&A premiums analysis must be public.
Usually we use a broader set of transactions for M&A premiums - we
might use fewer than 10 precedent transactions but we might have dozens of
M&A premiums. The industry and financial screens are usually less stringent.
Aside from those, the screening criteria are similar - financial metrics, industry,
geography, and date.
\Can you use private companies as part of your valuation? - ANS - Only in the
context of precedent transactions - it would make no sense to include them for
public company comparables or as part of the Cost of Equity or WACC
calculation in a DCF because they are not public and therefore have no values for
market cap or Beta.
\Can you walk me through how to calculate EBIT and EBITDA? How are they
different? - ANS - EBIT is just a company's Operating Income on its Income
Statement; it includes not only COGS and Operating Expenses, but also non-cash
charges such as Depreciation & Amortization
and therefore reflects, at least indirectly, the company's Capital Expenditures.
EBITDA is defined as EBIT plus Depreciation plus Amortization. You may
sometimes add back other expenses as well (see the Advanced section).
,The idea of EBITDA is to move closer to a company's "cash flow," since D&A are
both non-cash expenses... but there's a problem with that since you're also
excluding CapEx altogether.
\Can you walk me through how you use Public Comps and Precedent
Transactions? - ANS - First, you select the companies and transactions based on
criteria such as industry, financial metrics, and geography (see the next
question).
Then, you determine the appropriate metrics and multiples for each set - for
example, revenue, revenue growth, EBITDA, EBITDA margins, and revenue and
EBITDA multiples - and you calculate them for all the companies and
transactions.
Next, you calculate the minimum, 25th percentile, median, 75th percentile, and
maximum for each valuation multiple in the set.
Finally, you apply those numbers to the financial metrics for the company you're
analyzing to estimate the potential range for its valuation.
For example, if the company you're valuing has $100 million in EBITDA and the
median EBITDA multiple of the set is 7x, its implied Enterprise Value is $700
million based on that. You would then calculate its value at other multiples in this
range.
\Could EV / EBITDA ever be higher than EV / EBIT for the same company? - ANS -
No. By definition, EBITDA must be greater than or equal to EBIT because to
calculate it, you take EBIT and then add Depreciation & Amortization, neither of
which can be negative (they could, however, be $0, at least theoretically).
Since EBITDA is always greater than or equal to EBIT, EV / EBITDA must always
be less than or equal to EV / EBIT for a single company.`
\Do you ALWAYS use the median multiple of a set of public company
comparables or precedent transactions? - ANS - Nope. In fact, you almost always
show a range. And you may make the median the center of that range, but you
don't have to - you could focus on the 75th percentile, 25th percentile, or anything
else if the company is outperforming or underperforming for some reason.
\Does calendarization apply to both Public Comps and Precedent Transactions? -
ANS - It applies mostly to Public Comps because there's a high chance that fiscal
years will end on different dates with a big enough set of companies.
However, in effect you do calendarize for Precedent Transactions as well because
you normally look at the Trailing Twelve Months (TTM) period for each deal.
So if an acquisition was announced on April 30 and the company's fiscal year
ends on December 31, you will calendarize the revenue, EBITDA, and so on by
adding the January 1 - March 31 period of the current year and subtracting the
January 1 - March 31 period of the previous year.
, \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? - ANS - They
should be based on the purchase price of the company at the time of the deal
announcement.
For example, a seller's current share price is $40.00 and it has 10 million shares
outstanding. The buyer announces that it will pay $50.00 per share for the seller.
The seller's Equity Value in this case, in the context of the transaction, would be
$50.00 * 10 million shares, or $500 million. And then you would calculate its
Enterprise Value the normal way: subtract cash, add debt, and so on.
You only care about what the offer price was at the initial deal announcement.
You never look at the company's value prior to the deal being announced.
\How are the key operating metrics and valuation multiples correlated? In other
words, what might explain a higher or lower EV / EBITDA multiple? - ANS -
Usually, there is a correlation between growth and valuation multiples. So if one
company is growing revenue or EBITDA more quickly, its multiples for both of
those may be higher as well.
However, math also plays a role and sometimes companies with extremely high
EBITDA margins (for example) may have lower EBITDA multiples because
EBITDA itself is much higher to begin with... and it's in the denominator.
Finally, keep in mind that plenty of other non-financial factors explain higher or
lower multiples (see the "Real-World" section).
\How do non-recurring charges typically affect valuation multiples? - ANS - Most
of the time, these charges effectively increase valuation multiples because
they reduce metrics such as EBIT, EBITDA, and EPS. You could have
non-recurring income as well (e.g. a one-time asset sale) which would have the
opposite effect.
So be aware that it works both ways, and be ready to adjust for both non-
recurring expenses and non-recurring income sources.
\How do you apply the valuation methodologies to value a company? - ANS - You
would present everything in a "Football Field" graph such as the one shown
below:
To do this, you need to calculate the minimum, 25th percentile, median, 75th
percentile, and maximum for each set (2-3 years of comps and the transactions,
for each different multiple used) and then multiply by the relevant metrics for the
company you're analyzing.
Example: If the median EBITDA multiple from your set of Precedent Transactions
is 8x and your company's EBITDA is $500 million, the implied Enterprise Value
would be $4 billion.
A company's current stock price is $20.00 per share, and its P / E multiple is 20x,
so its EPS is $1.00. It has 10 million shares outstanding.
Now it does a 2-for-1 stock split - how do its P / E multiple and valuation change?
- ANS - They don't. Think about what happens: the company now has 20 million
shares outstanding... but its Equity Value has stayed the same, so its share price
falls to $10.00.
Its EPS falls to $0.50, but its share price has also fallen to $10.00, so the P / E
multiple remains 20x.
Splitting stock into fewer units or additional units doesn't, by itself, make a
company worth more or less.
However, in practice, often a stock split is viewed as a positive sign by the
market... so in many cases a company's value will go up and its share price won't
necessarily be cut in half, so P / E could increase.
\Both M&A premiums and precedent transactions involve analyzing previous
M&A transactions. What's the difference in how we select them? - ANS - All the
sellers in the M&A premiums analysis must be public.
Usually we use a broader set of transactions for M&A premiums - we
might use fewer than 10 precedent transactions but we might have dozens of
M&A premiums. The industry and financial screens are usually less stringent.
Aside from those, the screening criteria are similar - financial metrics, industry,
geography, and date.
\Can you use private companies as part of your valuation? - ANS - Only in the
context of precedent transactions - it would make no sense to include them for
public company comparables or as part of the Cost of Equity or WACC
calculation in a DCF because they are not public and therefore have no values for
market cap or Beta.
\Can you walk me through how to calculate EBIT and EBITDA? How are they
different? - ANS - EBIT is just a company's Operating Income on its Income
Statement; it includes not only COGS and Operating Expenses, but also non-cash
charges such as Depreciation & Amortization
and therefore reflects, at least indirectly, the company's Capital Expenditures.
EBITDA is defined as EBIT plus Depreciation plus Amortization. You may
sometimes add back other expenses as well (see the Advanced section).
,The idea of EBITDA is to move closer to a company's "cash flow," since D&A are
both non-cash expenses... but there's a problem with that since you're also
excluding CapEx altogether.
\Can you walk me through how you use Public Comps and Precedent
Transactions? - ANS - First, you select the companies and transactions based on
criteria such as industry, financial metrics, and geography (see the next
question).
Then, you determine the appropriate metrics and multiples for each set - for
example, revenue, revenue growth, EBITDA, EBITDA margins, and revenue and
EBITDA multiples - and you calculate them for all the companies and
transactions.
Next, you calculate the minimum, 25th percentile, median, 75th percentile, and
maximum for each valuation multiple in the set.
Finally, you apply those numbers to the financial metrics for the company you're
analyzing to estimate the potential range for its valuation.
For example, if the company you're valuing has $100 million in EBITDA and the
median EBITDA multiple of the set is 7x, its implied Enterprise Value is $700
million based on that. You would then calculate its value at other multiples in this
range.
\Could EV / EBITDA ever be higher than EV / EBIT for the same company? - ANS -
No. By definition, EBITDA must be greater than or equal to EBIT because to
calculate it, you take EBIT and then add Depreciation & Amortization, neither of
which can be negative (they could, however, be $0, at least theoretically).
Since EBITDA is always greater than or equal to EBIT, EV / EBITDA must always
be less than or equal to EV / EBIT for a single company.`
\Do you ALWAYS use the median multiple of a set of public company
comparables or precedent transactions? - ANS - Nope. In fact, you almost always
show a range. And you may make the median the center of that range, but you
don't have to - you could focus on the 75th percentile, 25th percentile, or anything
else if the company is outperforming or underperforming for some reason.
\Does calendarization apply to both Public Comps and Precedent Transactions? -
ANS - It applies mostly to Public Comps because there's a high chance that fiscal
years will end on different dates with a big enough set of companies.
However, in effect you do calendarize for Precedent Transactions as well because
you normally look at the Trailing Twelve Months (TTM) period for each deal.
So if an acquisition was announced on April 30 and the company's fiscal year
ends on December 31, you will calendarize the revenue, EBITDA, and so on by
adding the January 1 - March 31 period of the current year and subtracting the
January 1 - March 31 period of the previous year.
, \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? - ANS - They
should be based on the purchase price of the company at the time of the deal
announcement.
For example, a seller's current share price is $40.00 and it has 10 million shares
outstanding. The buyer announces that it will pay $50.00 per share for the seller.
The seller's Equity Value in this case, in the context of the transaction, would be
$50.00 * 10 million shares, or $500 million. And then you would calculate its
Enterprise Value the normal way: subtract cash, add debt, and so on.
You only care about what the offer price was at the initial deal announcement.
You never look at the company's value prior to the deal being announced.
\How are the key operating metrics and valuation multiples correlated? In other
words, what might explain a higher or lower EV / EBITDA multiple? - ANS -
Usually, there is a correlation between growth and valuation multiples. So if one
company is growing revenue or EBITDA more quickly, its multiples for both of
those may be higher as well.
However, math also plays a role and sometimes companies with extremely high
EBITDA margins (for example) may have lower EBITDA multiples because
EBITDA itself is much higher to begin with... and it's in the denominator.
Finally, keep in mind that plenty of other non-financial factors explain higher or
lower multiples (see the "Real-World" section).
\How do non-recurring charges typically affect valuation multiples? - ANS - Most
of the time, these charges effectively increase valuation multiples because
they reduce metrics such as EBIT, EBITDA, and EPS. You could have
non-recurring income as well (e.g. a one-time asset sale) which would have the
opposite effect.
So be aware that it works both ways, and be ready to adjust for both non-
recurring expenses and non-recurring income sources.
\How do you apply the valuation methodologies to value a company? - ANS - You
would present everything in a "Football Field" graph such as the one shown
below:
To do this, you need to calculate the minimum, 25th percentile, median, 75th
percentile, and maximum for each set (2-3 years of comps and the transactions,
for each different multiple used) and then multiply by the relevant metrics for the
company you're analyzing.
Example: If the median EBITDA multiple from your set of Precedent Transactions
is 8x and your company's EBITDA is $500 million, the implied Enterprise Value
would be $4 billion.
