Basics of valuation

Presented By :Prakash kumar Barnwal

What we will cover

Purpose of valuation Basic valuation concepts Methods of valuation critical appreciation of the methods with some examples

Why valuation ? Do you think the price of stock is reasonable? (equity researchinvestor) How much can you sell a companyssharesfor?(Capital Markets IPO) How much should you pay for a business in an M&A deal? (Assets, shares - IB) How much can a PE house pay for a business? (IB)

Valuation concepts

Valuation of Business Vs. Value of Equity

Value of debt (less cash) bondholde r value Value of Equity shareholde r value

Value of the operational business i.e Enterprise Value

Valuation concepts .. contd.....

The accounting balance sheet

Cash Operational Liabilities Debt Operational assets

=
Value of Equity

Valuation concepts .. contd

Market value Vs. book Value

Cash Operational Liabilities Debt Operational assets

= Value of
Equity

Off balance sheet value

Value of Intangibles

Many Industries have Market value > book value

Valuation concepts .. contd

Market value of assets = Market value of liabilities

Net Debt

Net Operational assets

= Equity

Capital

Enterprise value (Markets opinion)

Calculation of enterprise value

Given Cash = Rs.100, Debt = Rs.600, Equity = Rs.1200 find the EV?

Calculation of enterprise value

Given Cash = Rs.100, Debt = Rs.600, Equity = Rs.1200 find the EV? EV = Rs. 1700 Ie Market value of equity + value of net debt

Calculation of enterprise value

Given 1200 shares are outstanding at the valuation date with a share price of Rs. 15. Market value of Debt is Rs. 6000, Cash is Rs.200. What is EV?

Calculation of enterprise value

Given 1200 shares are outstanding at the valuation date with a share price of Rs. 15. Market value of Debt is Rs. 6000, Cash is Rs.200. What is EV? 1200*15 + 6000 200 Rs.23800

EV of unlisted company ??

Use methods like DCF, multiples to arrive at EV. Then calculate the implied share price.

An Example
EV = 10000, Investments = 2000, Cash = 500, Debt = 5000, Number of shares = 200. What is the share price?

An Example
Given :EV = 10000, Investments = 2000, Cash = 500, Debt = 5000, Number of shares = 200. What is the share price? (10000 + 2000 + 500 5000)/200 Rs. 37.5

EV Summing it all up
Enterprise value is the market value of net operational assets which must equal the market value of net funding THUS : EV = Equity + Debt - Cash

EV a comprehensive picture
Cash + Cash equivalents + Non controlled Investments + Non-core assets + Enterprise value (net operating assets)

Debt Preference Shares Minority interest

Ordinary Equity value

Concept of trading value Vs transaction value Trading value is the equity value of an enterprise without control ie when a small quantity of shares is bought, IPO, Rights issue. Can also be used to value the total minority stake in an enterprise

Concept of trading value Vs transaction value Transaction value is the enterprise value with control. Eg is when there is a buying of more than 50% of the equity of the company.. Takeover etc. There is a premium involved when there is such a transaction known as Control premium

What is control premium?

It is the excess price paid over the pre-acquisition stock price. Reasons : synergies perceived, strategy for future etc.

Methods for valuation

Multiples based method Discounted Cash flow method

Multiple based method

Based on linking VALUE with its VALUE DRIVERS ie earnings with value Value drivers

Interest income Cash

Debt

Interest expense Net income

EBIT EBITDA

Enterprise value

Equity

Valuation

Multiples : Generally used : (EV/Sales) Fast Sales

growing, loss making companies EBITDA : EV/EBITDA where leverage differs, acqns are generating amortizations EBIT : EV/EBIT where leverage differs PE : MPS/EPS for stable companies in mature inds. Lev. Is the same

Multiples : industry wise

Energy : EV/reserves of oil,gas Mining : EV/reserves or production ton Media: EV / Subscribers Banks : Price / Book value Hotels : EV / no. of rooms Telecom EV/ Subscribers no.

Discounted cash flow valuation

Valuation method based on the forecast of future cash flows Advantages are incorporates the time value of money, can subject to sensitivity analysis Useful in valuation of Early stages companies, projects with finite lives, valuing divisions of companies, valuing synergies.

Discounted cash flow valuation

Has helped in identifying overheated market or an undervalued market Independent of accounting assumptions and estimates

DCF - Disadvantages
Requires a lot of assumptions : Long term growth, discount rate. Complex and time consuming

DCF Calculation Steps involved

Forecastthecompanysfree cash flow Calculate the WACC Calculate terminal value and DCF Using the above calculate EV Convert EV into implied share price

What is Free cash flow ?

Different for different purposes FCF : The cash flow from operations of the business available to pay out debt and equity holders after investing for future growth. ( ie increase/decrease in capital expenditure and working capital)

Period for forecasting

Period for forecasting must be till the business reaches a Steady state Steady state is characterized by low growth rate, ROIC just above or approximates WACC, and capital investment is low, company is a cash cow and pays out most of its earnings.

WACC - Calculation
WACC = Wt. Cost of equity + Wt. cost of debt Cost of equity is ascertained by using the CAPM model. Cost of Debt is the post tax cost of debt Capital = market value of equity + market value of debt.

Calculation of Terminal value

Terminal value is given by : (Steady state FCF) * (1+ g) (WACC g) Where g is the long term growth rate into perpetuity. REMEMBER g should not be larger than the nominal GDP growth rate.

To conclude :

Generally using the implied values of shares a value is arrived at which may be median value or wt. avg. etc.