Investment Banking: Valuation, Equity Value, and Enterprise Value

Should you use the Book Value or Market Value of each item when calculating Enterprise Value?

Technically, you should use market value for everything. In practice, however, you usually use market value only for the Equity Value portion because it's difficult to determine market values for the rest of the items in the formula - so you take the numbers from the company's Balance Sheet.

How do you select Comparable Companies or Precedent Transactions?

The 3 main criteria for selecting companies and transactions: 1. Industry classification 2. Financial criteria (Revenue, EBITDA, etc.) 3. Geography For Precedent Transactions, you also limit the set based on date and often focus on transactions within the past 1-2 years. The most important factor is industry - that is always used to screen for companies/transactions, and the rest may or may not be used depending on how specific you want to be.

Walk me through a future share price analysis

The purpose of this analysis is to project what a company's share price might be 1 or 2 years from now and then discount it back to its present value. 1. Get the median historical (usually Trailing Twelve Months, or TTM) P / E multiple of the public company comparables. 2. Apply this P / E multiple to your company's 1-year forward or 2-year forward projected EPS to get its implied future share price. 3. Then, discount this share price back to its present value by using a discount rate in-line with the company's Cost of Equity.

Let's say we're valuing a private company. Why might we discount the public company comparable multiples but not the precedent transaction multiples?

There's no discount because with precedent transactions, you're acquiring the entire company - and once it's acquired, the shares immediately become illiquid. But shares - the ability to buy individual "pieces" of a company rather than the whole thing - can be either liquid (if it's public) or illiquid (if it's private). Since shares of public companies are always more liquid, you would discount public company comparable multiples to account for this.

What percentage dilution in Equity Value is "too high?"

There's no strict "rule" here, but most bankers would say that anything over 10% is odd. If the basic Equity Value is $100 million and the diluted Equity Value is $115 million, you might want to check your calculations - it's not necessarily wrong, but over 10% dilution is unusual for most companies. And something like 50% dilution would be highly unusual.

Why do you use Enterprise Value for Unlevered Free Cash Flow multiples, but Equity Value for Levered Free Cash Flow multiples? Don't they both just measure cash flow?

They both measure cash flow, but Unlevered Free Cash Flow (Free Cash Flow to Firm) excludes interest income and interest expense (and mandatory debt repayments), whereas Levered Free Cash Flow includes interest income and interest expense (and mandatory debt repayments), meaning that only Equity Investors are entitled to that cash flow (see the funnel diagram above). Therefore, you use Equity Value for Levered Free Cash Flow and Enterprise Value for Unlevered Free Cash Flow.

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?

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.

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?

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

CALCULATION: A company has 1 million shares outstanding at a value of $100 per share. It also has $10 million of convertible bonds, with par value of $1,000 and a conversion price of $50. How do I calculate diluted shares outstanding?

This gets confusing because of the different units involved. First, note that these convertible bonds are in-the-money because the company's share price is $100, but the conversion price is $50. So we count them as additional shares rather than debt. Next, we need to divide the value of the convertible bonds - $10 million - by the par value - $1,000 - to figure out how many individual bonds there are: $10 million / $1,000 = 10,000 convertible bonds. Next, we need to figure out how many shares this number represents. The number of shares per bond is the par value divided by the conversion price: $1,000 / $50 = 20 shares per bond. So we have 200,000 new shares (20 * 10,000) created by the convertibles, giving us 1.2 million diluted shares outstanding. We do not use the Treasury Stock Method with convertibles because we do not pay the company anything to "convert" the convertibles - it just becomes an option automatically once the share price exceeds the conversion price.

You're analyzing the financial statements of a Public Comp, and you see Income Statement line items for Restructuring Expenses and an Asset Disposal. Should you add these back when calculating EBITDA?

This is a trick question on multiple levels: 1. First, you should always take these charges from the Cash Flow Statement if possible - sometimes the charges are partially embedded within other line items on the Income Statement. If they don't appear on the Cash Flow Statement, look up them in the Notes to the Financial Statements. 2. Second, you only add them back if they're truly non-recurring charges. If a company claims it has been "restructuring" for the past 5 years, well, that's not exactly a non-recurring expense. There's a lot of subtlety when adjusting for these types of charges and there is not necessarily a "correct" way to do it in all cases

When would you use a Sum of the Parts valuation? How would you calculate the total value for a company using this?

This is used when a company has completely different, unrelated divisions - a conglomerate like General Electric, for example. If you have a plastics division, a TV and entertainment division, an energy division, a consumer financing division, and a technology division, you should not use the same set of Comparable Companies and Precedent Transactions for the entire company. Instead, you should use different sets for each division, value each one separately, and then add them together to calculate the Total Value.

Why do you need to add Noncontrolling Interests (AKA minority interest) to Enterprise Value?

Whenever a company owns over 50% of another company, it is required to report 100% of the financial performance of the other company as part of its own performance. So even though it doesn't own 100%, it reports 100% of the majority-owned subsidiary's financial performance. You must add the Non-controlling Interest to get to Enterprise Value so that your numerator and denominator both reflect 100% of the majority-owned subsidiary. If you did not do that, the numerator would reflect less than 100% of the company, but the denominator would reflect 100%

What's the purpose of "calendarization"? How do you use it in a valuation?

You "calendarize" because different companies have different fiscal years. For example, some companies' fiscal years may run from January 1 to December 31 - but others may have fiscals year that run from April 1 to March 31, or from July 1 to June 30. This creates a problem because you can't directly compare all these periods - you always need to look at the same calendar period when you create a set of Public Comps. So you adjust all the fiscal years by adding and subtracting "partial" periods. You almost always adjust other companies' fiscal years to match the company you're valuing.

How do you value Net Operating Losses (NOLs) and take them into account in a valuation?

You determine how much the NOLs will save the company in taxes in future years, and then calculate the net present value of the total future tax savings. There are two ways to estimate the tax savings in future years: 1. Assume that a company can use its NOLs to completely offset its taxable income until the NOLs run out. 2. In an acquisition scenario, use Section 382 and multiply the highest adjusted long-term rate (http://pmstax.com/afr/exemptAFR.shtml) of the past 3 months by the Equity Purchase Price of the seller to determine the maximum allowed NOL usage in each year - and then use that to determine how much the company can save in taxes.

Let's say that you're looking at a set of Public Comps with fiscal years ending on March 31, June 30, and December 31. The company you're analyzing has a fiscal year that ends on June 30. How would you calendarize the financials for these companies?

You generally calendarize based on the fiscal year of the company you're valuing. So in this case you would adjust and make the other companies' fiscal years end on June 30. For the one with the March 31 year, you would take that year and then add the March 31 - June 30 period, and subtract the March 31 - June 30 period from the previous year. For the one with the December 31 year, you would take that year and add the January 1 - June 30 period, and subtract the January 1 - June 30 period from the previous year.

Are there any exceptions to the rules about subtracting Equity Interests and adding Noncontrolling Interests when calculating Enterprise Value?

You pretty much always add Noncontrolling Interests because the financial statements are always consolidated when you own over 50% of another company. But with Equity Interests, you only subtract them if the metric you're looking at does not include Net Income from Equity Interests (which only appears toward the bottom of the Income Statement).

This same company also has Cash of $10,000, Debt of $30,000, and Noncontrolling Interests of $15,000. What is its Enterprise Value?

You subtract the Cash, add the Debt, and then add Noncontrolling Interests: Enterprise Value = $222,000 - $10,000 + $30,000 + $15,000 So Enterprise Value = $257,000

When you're looking at an industry-specific multiple like EV / Proved Reserves or EV / Subscribers (for telecom companies, for example), why do you use Enterprise Value rather than Equity Value?

You use Enterprise Value because those Proved Reserves or Subscribers are "available" to all the investors (both debt and equity) in a company. This is almost always the case unless the metric already includes interest income and expense (FFO and AFFO above).

How do you value a private company?

You use the same methodologies as with public companies: public company comparables, precedent transactions, and DCF. But there are some differences: • You might apply a 10-15% (or more) discount to the public company comparable multiples because the private company you're valuing is not "liquid" like the public comps are. • You can't use a premiums analysis or future share price analysis because a private company doesn't have a share price. • Your valuation shows the Enterprise Value for the company as opposed to the implied per-share price as with public companies. You can still calculate Equity Value, but a "per-share price" is meaningless for a private company. • A DCF gets tricky because a private company doesn't have a market capitalization or Beta - you would probably estimate WACC based on the public comps' WACC rather than trying to calculate it yourself.

If you were buying a vending machine business, would you pay a higher EBITDA multiple for a business that owned the machines and where they depreciated normally, or one in which the machines were leased? The Depreciation expense and the lease expense are the same dollar amounts and everything else is held constant.

You would pay a higher multiple for the one with leased machines if all else is equal. The Purchase Enterprise Value would be the same for both acquisitions, but Depreciation is excluded from EBITDA - so EBITDA is higher, and the EV / EBITDA multiple is lower for the one that owns its own machines. For the company with leased machines, the lease expense would show up in Operating Expenses, making EBITDA lower and the EV / EBITDA multiple higher.

How do you apply the valuation methodologies to display the valuation range of a company?

You would present everything in a "Football Field" graph. 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.

EV / Revenue and P / E multiples, while easy to calculate, are taken the least/most seriously because?

least seriously because 1) A company should be valued based on its earning revenue is easy, keeping it is hard; and 2) P / E is subject to non-cash and non-recurring charges, significantly different tax rates, the company's capital structure, and a host of other problems.

What does NASDAQ stand for? What's the largest stock exchange in the world?

originally stood for the: National Association of Securities Dealer Automated Quotation system. Largest Exchanges NYSE: 19.2 trillion NASDAQ: 6.8 trillion London Stock Exchage: 6.2 trillion

Both M&A premiums and precedent transactions involve analyzing previous M&A transactions. What's the difference in how we select them?

• 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.

What are the most common Valuation multiples? And what do they mean?

• Enterprise Value / Revenue: How valuable is a company in relation to its overall sales. • Enterprise Value / EBITDA: How valuable is a company in relation to its approximate cash flow. • Enterprise Value / EBIT: How valuable is a company in relation to the pre-tax profit it earns from its core business operations. • Price Per Share / Earnings Per Share (P / E): How valuable is a company in relation to its after-tax profits, inclusive of interest income and expense and other non-core business activities.

What are 3 flaws with Public Company Comparables?

• No company is 100% comparable to another company. • The stock market is "emotional" - your multiples might be dramatically higher or lower on certain dates depending on the market's movements. • Share prices for small companies with thinly-traded stocks may not reflect their full value.

Two companies have the exact same financial profiles (revenue, growth, and profits) and are purchased by the same acquirer, but the EBITDA multiple for one transaction is twice the multiple of the other transaction - how could this happen?

• One process was more competitive and had a lot more companies bidding on the target. • One company had recent bad news or a depressed stock price so it was acquired at a discount. • They were in industries with different median multiples. • The two companies have different accounting standards and have added back different items when calculating EBITDA, so the multiples are not truly comparable.

What are 2 flaws with Precedent Transactions?

• Past transactions are rarely 100% comparable - the transaction structure, size of the company, and market sentiment all make a huge impact. • Data on precedent transactions is generally more difficult to find than it is for public company comparables, especially for acquisitions of small, private companies.

Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium?

• The company has just reported earnings well-above expectations and its stock price has risen in response. • It has some type of competitive advantage not reflected in its financials, such as a key patent or other intellectual property. • It has just won a favorable ruling in a major lawsuit. • It is the market leader in an industry and has greater market share than its competitors.

How do you take into account a company's competitive advantage in a valuation?

1. Highlight the 75th percentile or higher for the multiples rather than median. 2. Add in a premium to some of the multiples. 3. Use more aggressive projections for the company. In practice you rarely do all of the above - these are just possibilities.

I have a set of precedent transactions but I'm missing information like EBITDA for a lot of the companies, since they were private. How can I find it if it's not available via public sources?

1. Search online and see if you can find press releases or articles in the financial press with these numbers. 2. Failing that, look in equity research for the buyer around the time of the transaction and see if any of the analysts estimate the seller's numbers. 3. Also look at online sources like Capital IQ and Factset and see if any of them disclose numbers or give estimates for the deals.

Walk me through an IPO valuation for a company that's about to go public.

1. Unlike normal valuations, in an IPO valuation we only care about public company comparables - we select them as we normally would. 2. After picking the public company comparables, we decide on the most relevant multiple(s) to use and then estimate our company's Enterprise Value based on that (or Equity Value depending on the multiple). 3. Once we have the Enterprise Value, we work backwards to calculate Equity Value. We also have to account for the IPO proceeds in here, i.e. by adding them since we're working backwards (these proceeds are what the company receives in cash from the IPO). 4. Then we divide by the total number of shares (old and newly created) to get its per-share price. When people say "An IPO priced at..." this is what they're referring to. If you were using P / E or any other "Equity Value-based multiple" in step #2 here, then you could skip step #3 and just take into account the cash proceeds.

How would you value a company that has no profit and no revenue?

1. You could use Comparable Companies and Precedent Transactions and look at more "creative" multiples such as EV / Unique Visitors and EV /Pageviews (for Internet start-ups, for example) rather than EV / Revenue or EV / EBITDA. 2. You could use a "far-in-the-future DCF" and project a company's financials out until it actually earns revenue and profit.

What 4 factors do you use to pick comparable public companies? Example of a comps set title?

Acronym: GIFT! - Geography (US? China? Europe? South America?). - Industry (Diversified Consumer? Food and Beverages specifically?). - Financials (Revenue or EBITDA above, below, or between certain numbers). - Time (Transactions Since... or Transactions Between Year X and Year Y). Example title: Food & beverage M&A Transactions with US Based sellers and Enterprise Value between $1B and $900M since January 2016

What are 4 industries where DCFs are not relevant?

Commercial Banks Insurance Firms (Some) Oil & Gas Companies Real Estate Investment Trusts (REITs).

What's the formula for Enterprise Value?

Enterprise Value = Equity Value + Debt + Preferred Stock + Noncontrolling Interests - Cash This is a "simplified" formula that you can usually get away with in interviews - for a more complete version see the More Advanced questions below

Why do we look at both Enterprise Value and Equity Value?

Enterprise Value represents the value of the company that is attributable to all investors; Equity Value only represents the portion available to shareholders (equity investors). You look at both because Equity Value is the number the public-at-large sees ("the sticker price"), while Enterprise Value represents its true value, i.e. what it would really cost to acquire.

How do you use Equity Value and Enterprise Value differently?

Equity Value gives you a general idea of how much a company is worth; Enterprise Value tells you, more specifically, how much it would cost to acquire. Also, you use them differently depending on the valuation multiple you're calculating. If the denominator of the multiple includes interest income and expense (e.g. Net Income), you use Equity Value; otherwise, if it does not (e.g. EBITDA), you use Enterprise Value.

What's the difference between Equity Value and Shareholders' Equity?

Equity Value is the market value and Shareholders' Equity is the book value. Equity Value could never be negative because shares outstanding and share prices can never be negative, whereas Shareholders' Equity could be positive, negative, or 0. For healthy companies, Equity Value usually far exceeds Shareholders' Equity because the market value of a company's stock is worth far more than its paper value. In some industries (e.g. commercial banks and insurance firms), Equity Value and Shareholders' Equity tend to be very close.

CALCULATION: do it in your head bitchboy Let's say that a company has 10,000 shares outstanding and a current share price of $20.00. It also has 100 options outstanding at an exercise price of $10.00. It also has 50 Restricted Stock Units (RSUs) outstanding. Finally, it also has 100 convertible bonds outstanding, at a conversion price of $10.00 and par value of $100. What is its Diluted Equity Value?

First, tackle the options outstanding: since they are in-the-money (exercise price is lower than share price), assume they get exercised and that 100 new shares get created. Company receives 100 * $10.00, or $1,000, in proceeds. Its share price is $20.00 so it can repurchase 50 shares with these proceeds. Overall, there are 50 additional shares outstanding now (100 new shares - 50 repurchased). The 50 RSUs get added as if they were common shares, so now there's a total of 100 additional shares outstanding. For the convertible bonds, the conversion price of $10.00 is below the company's current share price of $20.00, so conversion is allowed. Divide the par value by the conversion price to see how many new shares per bond get created: $100 / $10.00 = 10 new shares per bond Since there are 100 convertible bonds outstanding, we therefore get 1,000 new shares (100 convertible bonds * 10 new shares per bond). In total, there are 1,100 additional shares outstanding. The diluted share count is therefore 11,100. The Diluted Equity Value is 11,100 * $20.00, or $222,000.

How do you value banks and financial institutions differently from other companies?

For relative valuation, the methodologies (public comps and precedent transactions) are the same but the metrics and multiples are different: • The financial criteria consist of Assets, Loans, or Deposits rather than revenue or EBITDA. • You look at metrics like ROE (Return on Equity = Net Income / Shareholders' Equity), ROA (Return on Assets = Net Income / Total Assets), and Book Value and Tangible Book Value rather than Revenue, EBITDA, and so on. • You use multiples such as P / E, P / BV, and P / TBV rather than EV / EBITDA.

How do you factor in Convertible Bonds into the Enterprise Value calculation?

If the convertible bonds are in-the-money, meaning that the conversion price of the bonds is below the current share price, then you count them as additional dilution to the Equity Value (no Treasury Stock Method required - just add all the shares that would be created as a result of the bonds). If the Convertible Bonds are out-of-the-money, then you count the face value of the convertibles as part of the company's Debt. See the "Calculations" section for an example of how to do the math and swag up.

Walk me through a Sum-of-the-Parts analysis

In a Sum-of-the-Parts analysis, you value each division of a company using separate comparables and transactions, get to separate multiples, and then add up each division's value to get the total for the company.

Let's say that you're comparing a company with a strong brand name, such as Coca-Cola, to a generic manufacturing or transportation company. Both companies have similar growth profiles and margins. Which one will have the higher EV / EBITDA multiple?

In all likelihood, Coca-Cola will have the higher multiple due to its strong brand name. Remember that valuation is not a science - it's an art, and the market often behaves in irrational ways. Values are not based strictly on financial criteria, and other factors such as brand name, perceived "trendiness," and so on all make a huge impact. So pull up on the gang with your fidget spinners and Matt Ox for the #team

Why do you subtract Cash in the formula for Enterprise Value? Is that always accurate?

In an acquisition, the buyer would "get" the cash of the seller, so it effectively pays less for the company based on how large its cash balance is. Remember, Enterprise Value tells us how much you'd effectively have to "pay" to acquire another company. It's not always accurate because technically you should subtract only excess cash - the amount of cash a company has above the minimum cash it requires to operate. But in practice, the minimum cash required by a company is difficult to determine; also, you want the Enterprise Value calculation to be relatively standardized among different companies, so you normally just subtract the entire cash balance.

Is it always accurate to add Debt to Equity Value when calculating Enterprise Value?

In most cases, yes, because the terms of a Debt issuance usually state that Debt must be repaid in an acquisition. And a buyer usually pays off a seller's Debt, so it is accurate to say that Debt "adds" to the purchase price. Adding Debt is also partially a matter of standardizing the Enterprise Value calculation among different companies: if you added it for some and didn't add it for others, EV would no longer mean the same thing and valuation multiples would be off.

Does calendarization apply to both Public Comps and Precedent Transactions?

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.

The S&P 500 Index (or equivalent index in other country) has a median P / E multiple of 20x. A manufacturing company you're analyzing has earnings of $1 million. How much is the company worth?

It depends on how it's performing relative to the index, and relative to companies in its own industry. If it has higher growth and/or higher margins, you may assign a higher multiple to it - maybe 25x or even 30x, and therefore assume that its Equity Value equals $25 million or $30 million. If it's on par with everyone else, then maybe its valuation is just $20 million. And if it's underperforming, perhaps it's lower than that. Qualitative factors, such as management team and market position, also come into play and may determine the appropriate multiple to use.

Let's say we create a brand-new operating metric for a company that approximates its cash flow. Should we use Enterprise Value or Equity Value in the numerator when creating a valuation multiple based on this metric?

It depends on whether or not this new metric includes the impact of interest income and interest expense. If it does, you use Equity Value. If it does not, you use Enterprise Value... starting to notice a pattern here? Hey bitch boi?

Why are Public Comps and Precedent Transactions sometimes viewed as being "more reliable" than a DCF?

It's because they're based on actual market data, as opposed to assumptions far into the future. Also note that sometimes you don't have good or truly comparable data for these, in which case a DCF may produce better results.

When is a Liquidation Valuation useful?

It's most common in bankruptcy scenarios and is used to see whether or not shareholders will receive anything after the company's Liabilities have been paid off with the proceeds from selling all its Assets. It is often used to advise struggling businesses on whether it's better to sell off Assets separately or to sell 100% of the company.

CALCULATION: Let's say a company has 100 shares outstanding, at a share price of $10.00 each. It also has 10 options outstanding at an exercise price of $5.00 each - what is its Diluted Equity Value?

Its basic equity value is $1,000 (100 * $10 = $1,000). To calculate the dilutive effect of the options, first you note that the options are all "in-the-money" - their exercise price is less than the current share price. When these options are exercised, 10 new shares get created - so the share count is now 110 rather than 100. However, that doesn't tell the whole story. In order to exercise the options, we had to "pay" the company $5 for each option (the exercise price). As a result, it now has $50 in additional cash, which it uses to buy back 5 of the new shares we created. So the fully diluted share count is 105 and the Diluted Equity Value is $1,050. TREASURY STOCK METHOD BOIIII - lez get it

7. What other Valuation methodologies are there?

Liquidation Valuation - Valuing a company's Assets, assuming they are sold off and then subtracting Liabilities to determine how much capital, if any, equity investors receive. • LBO Analysis - Determining how much a PE firm could pay for a company to hit a "target" IRR, usually in the 20-25% range. • Sum of the Parts - Valuing each division of a company separately and adding them together at the end. • M&A Premiums Analysis - Analyzing M&A deals and figuring out the premium that each buyer paid, and using this to establish what your company is worth. • Future Share Price Analysis - Projecting a company's share price based on the P / E multiples of the public company comparables and then discounting it back to its present value.

What's the distinction between Options Exercisable vs. Options Outstanding? Which one(s) should you use when calculating share dilution?

Options Exercisable vs. Options Outstanding: Normally companies put in place restrictions on when employees can actually exercise options - so even if there are 1 million options outstanding right now, only 500,000 may actually be exercisable even if they're all in-the-money. There's no "correct" answer for which one to use here. Some people argue that you should use Options Outstanding because typically, all non-exercisable Options become exercisable in an acquisition, so that's the more accurate way to view it.

CALCULATION: Let's say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $15 each - what is its Diluted Equity Value?

$1,000. In this case the options' exercise price is above the current share price, so they have no dilutive effect.

1. What are the 3 major valuation methodologies? What type of valuations are these (intrinsic or relative)

- Public Company Comparables (Public Comps) - Precedent Transactions - Discounted Cash Flow Analysis. Public Comps and Precedent Transactions are examples of relative valuation (based on market values), while the DCF is intrinsic valuation (based on cash flows).

What are some problems with EBITDA and EBITDA multiple? And if there are so many problems, why do we still use it?

1. it hides the amount of debt principal and interest that a company is paying each year, which can be very large and may make the company cash flow-negative; as mentioned above, it also hides CapEx spending, which can also be huge. 2. EBITDA also ignores working capital requirements (e.g. Accounts Receivable, Inventory, Accounts Payable), which can be very large for some companies 3. companies like to "add back" many charges and expenses to EBITDA, so you never really know what it represents unless you dig into it in-depth. So in many cases, EBITDA is not even close to true "cash flow" - it is widely used mostly because of convenience (it's easy to calculate) and because it has become a standard over time. 4. although EBITDA is not close to cash flow, it's better for comparing the cash generated by a company's core business operations than other metrics - so you could say that EBITDA is more about comparability than cash flow approximation.

When is a DCF useful? When is it not so useful?

A DCF is best when the company is large, mature, and has stable and predictable cash flows (think: Fortune 500 companies in "boring" industries). Your far-in-the-future assumptions will generally be more accurate there. A DCF is not as useful if the company has unstable or unpredictable cash flows (tech start-up) or when Debt and Operating Assets and Liabilities serve fundamentally different roles (ex: Banks and Insurance Firms - see the industry-specific guides for more).

When do you use an LBO Analysis as part of your Valuation?

Clearly, you use this whenever you're analyzing a Leveraged Buyout - but it is also used to "set a ceiling" on the company's value and determine the maximum amount that a PE firm could pay to achieve its targeted returns. You often see it used when both strategics (normal companies) and financial sponsors (PE firms) are competing to buy the same company, and you want to determine the potential price if a PE firm were to acquire the company

Can you walk me through how you use Public Comps and Precedent Transactions?

First, you select the companies and transactions based on criteria such as industry, financial metrics, and geography. 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.

Why can't you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA?

If the metric includes interest income and expense, you use Equity Value; if it excludes them (or is "before" them), you use Enterprise Value. EBITDA is available to all investors in the company - not just common shareholders. Similarly, Enterprise Value is also available to all investors since it includes Equity and Debt, so you pair them together. Calculating Equity Value / EBITDA, however, is comparing apples to oranges because Equity Value does not reflect the company's entire capital structure - only what's available to common shareholders.

How do non-recurring charges typically affect valuation multiples?

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.

Could EV / EBITDA ever be higher than EV / EBIT for the same company?

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.

Could a company have a negative Equity Value? What would that mean?

No. This is not possible because you cannot have a negative share count and you cannot have a negative share price.

Do you ALWAYS use the median multiple of a set of public company comparables or precedent transactions?

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.

Can you describe a few of the additional items that might be a part of Enterprise Value, beyond Cash, Debt, Preferred Stock, and Noncontrolling Interests, and explain whether you add or subtract each one?

Note that many of these items are discretionary. Everyone agrees that Cash should be subtracted and Debt should be added when calculating Enterprise Value, but when you get to more advanced items, treatment varies greatly between different banks and different groups. Items That May Be Counted as Cash-Like Items and Subtracted: • Net Operating Losses - Because you can use these to reduce future taxes; may or may not be true depending on the company and deal. • Short-Term and Long-Term Investments - Because theoretically you can sell these off and get extra cash. May not be true if they're illiquid. • Equity Investments - Any investments in other companies where you own between 20% and 50%; this one is also partially for comparability purposes since revenue and profit from these investments shows up in the company's Net Income, but not in EBIT, EBITDA, and Revenue (see the Accounting section). Items That May Be Counted as Debt-Like Items and Added: • Capital Leases - Like Debt, these have interest payments and may need to be repaid. 21 / 27 • (Some) Operating Leases - Sometimes you need to convert Operating Leases to Capital Leases and add them as well, if they meet the criteria for qualifying as Capital Leases (see the Accounting section). • Unfunded Pension Obligations - These are usually paid with something other than the company's normal cash flows, and they may be extremely large. • Restructuring / Environmental Liabilities - Similar logic to Unfunded Pension Obligations.

Can you use private companies as part of your valuation?

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. So don't even think about it.. Buddy guy.

The EV / EBIT, EV / EBITDA, and P / E multiples all measure a company's profitability. What's the difference between them, and when do you use each one?

P / E depends on the company's capital structure, whereas EV / EBIT and EV / EBITDA are capital structure-neutral. Therefore, you use P / E for banks, insurance firms, and other companies where interest is critical and where capital structures tend to be similar. EV / EBIT includes Depreciation & Amortization, whereas EV / EBITDA excludes it - you're more likely to use EV / EBIT in industries where D&A is large and where Capital Expenditures and fixed assets are important (e.g. manufacturing), and EV / EBITDA in industries where fixed assets are less important and where D&A is comparatively smaller (e.g. Internet companies). NOTE: Many bankers get this logic reversed and think that EV / EBITDA is better when CapEx and Depreciation are both large... which is not correct, if you take a second to think about it. If they start arguing about it an interview, just give in and agree with what they say.

Why do we add Preferred Stock to get to Enterprise Value?

Preferred Stock pays out a fixed dividend, and Preferred Shareholders also have a higher claim to a company's assets than equity investors do. As a result, it is more similar to Debt than common stock. Also, just like Debt, typically Preferred Stock must be repaid in an acquisition scenario.

Walk me through how we might value an oil & gas company and how it's different from a "standard" company?

Public comps and precedent transactions are similar, but: • You might screen based on metrics like Proved Reserves or Daily Production. • You would look at the above metrics as well as R/P (Proved Reserves / Last Year's Production), EBITDAX, and other industry-specific ones, and use matching multiples. You could use a standard Unlevered DCF to value an oil & gas company as well, but it's more common to see a NAV (Net Asset Value) Model where you take the company's Proved Reserves, assume they produce revenue until depletion, assign a cost to the production in each year, and take the present value of those cash flows to value the company. There are also a host of other complications: oil & gas companies are cyclical and have no control over the prices they receive, companies use either "full-cost accounting" or "successful efforts accounting" and treat the exploration expense differently according to that, and so on.

How do you factor in Restricted Stock Units (RSUs) and Performance Shares when calculating Diluted Equity Value?

RSUs should be added to the common share count, because they are just common shares. The only difference is that the employees who own them have to hold onto them for a number of years before selling them. Performance Shares are similar to Convertible Bonds, but if they're not in-the-money (the share price is below the performance share price target), you do not count them as Debt - you just ignore them altogether. If they are in-the-money, you assume that they are normal common shares and add them to the share count.

Walk me through how you would value a REIT (Real Estate Investment Trust) and how it differs from a "normal" company

Similar to energy, real estate is asset-intensive and a company's value depends on how much cash flow specific properties generate. • You look at Price / FFO per Share (Funds from Operations) and Price / AFFO per Share (Adjusted Funds from Operations), which add back Depreciation and subtract Gains (and add Losses) on property sales. • A Net Asset Value (NAV) model is the most common intrinsic valuation methodology; you assign a Cap Rate to the company's projected NOI and multiply to get the value of its real estate, adjust and add its other assets, subtract liabilities and divide by its share count to get NAV per Share, and then compare that to its current share price. • You value properties by dividing Net Operating Income (NOI) (Property's Gross Income - Property-Level Operating Expenses and Property Taxes) by the capitalization rate (based on market data). • Replacement Valuation is more common because you can actually estimate the cost of buying new land and building new properties. • A DCF is still a DCF, but it flows from specific properties instead and it tends to be far less common than the NAV model.

Should you use Enterprise Value or Equity Value with Net Income when calculating valuation multiples?

Since Net Income includes the impact of interest income and interest expense, you always use Equity Value.

You mentioned that Precedent Transactions usually produce a higher value than Comparable Companies - can you think of a situation where this is not the case?

Sometimes this happens when there is a substantial mismatch between the M&A market and the public markets. For example, no public companies have been acquired recently but lots of small private companies have been acquired at low valuations.

How do you calculate diluted shares and Diluted Equity Value?

Take the basic share count and add in the dilutive effect of stock options and any other dilutive securities, such as warrants, convertible debt, and convertible preferred stock. To calculate the dilutive effect of options and warrants, you use the Treasury Stock Method (see the Calculations questions below).

Would an LBO or DCF produce a higher valuation?

Technically it could go either way, but in most cases the LBO will give you a lower valuation. Here's the easiest way to think about it: with an LBO, you do not get any value from the cash flows of a company in between Year 1 and the final year - you only get "value" out of its final year. With a DCF, by contrast, you're taking into account both the company's cash flows in the period itself and its terminal value, so values tend to be higher. Note: Unlike a DCF, an LBO model by itself does not give a specific valuation. Instead, you set a desired IRR and back-solve for how much you could pay for the company (the valuation) based on that.

Wait a second, why might you add back Unfunded Pension Obligations but not something like Accounts Payable? Don't they both need to be repaid?

The distinctions are magnitude and source of funds. Accounts Payable, 99% of the time, is paid back via the company's cash flow from its normal business operations. And it tends to be relatively small. Items like Unfunded Pension Obligations, by contrast, usually require additional funding (e.g. the company raises Debt) to be repaid. These types of Liabilities also tend to be much bigger than Working Capital / Operational Asset and Liability items.

I'm looking at financial data for a public company comparable, and it's April (Q2) right now. Walk me through how you would "calendarize" this company's financial statements to show the Trailing Twelve Months as opposed to just the last Fiscal Year.

The formula to calendarize financial statements is as follows: TTM = Most Recent Fiscal Year + New Partial Period - Old Partial Period So in the example above, we would take the company's Q1 (January 1 - March 31 of this year ) numbers, add the most recent fiscal year's (January 1 - December 31 of last year) numbers, and then subtract the previous year's Q1 numbers (January 1 - March 31 of last year).

How do you factor in Convertible Preferred Stock in the Enterprise Value calculation?

The same way you factor in normal Convertible Bonds: if it's in-the-money, you assume that new shares get created, and if it's not in the money, you count it as Debt.

How would you value an apple tree?

The same way you would value a company: by looking at what comparable apple trees are worth (relative valuation) and the present value of the apple tree's cash flows (intrinsic valuation). Yes, you could build a DCF for anything - even an apple tree.

When would a Liquidation Valuation produce the highest value?

This is highly unusual, but it could happen if a company had substantial hard assets but the market was severely undervaluing it for a specific reason (such as an earnings miss or cyclicality). As a result, the Comparable Companies and Precedent Transactions would likely produce lower values as well - and if its assets were valued highly enough, Liquidation Valuation might give a higher value than other methodologies

Rank the 3 main valuation methodologies from highest to lowest expected value

Trick question - there is no ranking that always holds up. In general, Precedent Transactions will be higher than Comparable Public Companies due to the Control Premium built into acquisitions (i.e. the buyer must pay a premium over a company's current share price to acquire it). Beyond that, a DCF could go either way and it's best to say that it's more variable than other methodologies. Often it produces the highest value, but it can produce the lowest value as well depending on your assumptions.

What would you use with Free Cash Flow multiples - Equity Value or Enterprise Value?

Trick question. For Unlevered Free Cash Flow (Free Cash Flow to Firm), you would use Enterprise Value, but for Levered Free Cash Flow (Free Cash Flow to Equity) you would use Equity Value. Remember, Unlevered Free Cash Flow excludes Interest (and mandatory debt repayments) and thus represents money available to all investors, whereas Levered FCF already includes the effects of Interest expense (and mandatory debt repayments) and the money is therefore only available to equity investors. Debt investors have already "been paid" with the interest payments and principal repayments they received.

Unlevered and Levered FCF calculations?

Unlevered FCF = EBIT * (1 - Tax Rate) + Non-Cash Charges - Change in Operating Assets and Liabilities - CapEx With Unlevered FCF, you're excluding interest income and expenses, as well as mandatory debt repayments. Levered FCF = Net Income + Non-Cash Charges - Change in Operating Assets and Liabilities - CapEx - Mandatory Repayments With Levered FCF, you're including interest income, interest expense, and required principal repayments on the debt.

How far back and forward do we usually go for public company comparable and precedent transaction multiples?

Usually you look at the TTM (Trailing Twelve Months) period for both sets, and then you look forward either 1 or 2 years. You're more likely to look backward more than 1 year and go forward more than 2 years for public company comparables; for precedent transactions it's odd to go forward more than 1 year because the information is more limited.

How would you present these Valuation methodologies to a company or its investors? And what do you use it for?

Usually you use a "Football Field" chart where you show the valuation range implied by each methodology. You always show a range rather than one specific number. You could use a Valuation for: • Pitch Books and Client Presentations - When you provide updates and tell them what you think they're worth. • Parts of Other Models - Defense analyses, merger models, LBO models, DCFs, and almost everything else in finance will incorporate a Valuation in some way. • Fairness Opinions - Right before a deal with a public seller closes, its financial advisor creates a "Fairness Opinion" that justifies the acquisition price and directly estimates the company's valuation.

Why does Warren Buffett prefer EBIT multiples to EBITDA multiples?

Warren Buffett once famously asked, "Does management think the tooth fairy pays for capital expenditures?" He dislikes EBITDA because it hides the Capital Expenditures companies make and disguises how much cash they require to finance their operations. In some industries there is also a large gap between EBIT and EBITDA - anything that is capital-intensive and asset-heavy, for example, will show a big disparity. Note that EBIT itself does not include Capital Expenditures, but it does include Depreciation and that is directly linked to CapEx - that's the connection. If a company has a high Depreciation expense, chances are it has high CapEx spending as well.

Why do we bother calculating share dilution? Does it even make much of a difference?

We do it for the same reason we calculate Enterprise Value: to more accurately determine the cost of acquiring a company. Normally in an acquisition scenario, in-the-money securities (ones that will cause additional shares to be created) are 1) Cashed out and paid by the buyer (raising the purchase price), or 2) Are converted into equivalent securities for the buyer (also raising the effective price for the buyer). Dilution doesn't always make a big difference, but it can be as high as 5-10% (or more) so you definitely want to capture that.

Could a company have a negative Enterprise Value? What does that mean?

Yes. It means that the company has an extremely large cash balance, or an extremely low market capitalization (or both). You often see it with companies on the brink of bankruptcy, and sometimes also with companies that have enormous cash balances.