“I Will Return!!” (not GEN MacArthur)
A Charter Class member returns to speak on PE Valuation
Bruce B. Bingham, FASA, FRICS
23 September 2013
Getting Started – Definitions
•
Value – A useless word by itself.
•
Fair Market Value (“FMV”) – Amount at which property would change hands between a willing buyer and a
willing seller where neither is acting under compulsion and when both have reasonable knowledge of the
relevant facts.
•
Fair Value – Statutory standard of value used in courts usually involving dissenting shareholders’ litigation.
•
Going Concern Value – Assumes the business continues as a viable operating enterprise, including
intangibles such as trained workforce, licenses and operating procedures.
•
Investor Value – Value to a particular buyer/investor considering his or her specific personal circumstances,
knowledge of the transaction and potential synergy.
•
Total Capital Value – Value of Fair Market Value of 100% of the equity plus the market value of long term
debt. Usually used in calculating performance ratios.
•
Liquidation Value – Value from piecemeal sale of assets. (Opposite of Going Concern Value). Can be orderly
or forced. Typically low end of value spectrum.
•
Book Value – An accounting term for the value of total net assets minus total liabilities on the balance sheet.
Intangibles usually excluded.
•
Minority Value – Value reflecting an ownership position of less than 50%. Frequently expressed as a discount.
•
Control Value – Additional value inherent in a legally controlling interest, reflecting the power of control.
Frequently expressed as a premium.
•
Marketable Value – Value of an equity assuming a pre-established market in which that equity can be
exchanged.
•
Non-marketable Value: – Decreased value due to the limitation in the marketability of an equity. Opposite of
Freely Traded Value. Usually expressed as a discount.
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Getting Started – Key Questions
• What definition of value?
• What is being valued?
• Premise of Value?
• Valuation Date v. Report Date
• Type of Report?
• Distribution?
2
Approaches – Cost Approach
• Premise
– Value equals FMV of Assets Minus FMV of Liabilities
• Mechanics
– Value Each Tangible and Intangible Asset
– Subtract Market Value of Liabilities
Advantages
Drawbacks
- Useful for asset intensive businesses
profit
- No consideration of "going-concern" or
- Preferred by lenders
- Intangibles defensible, but difficult
- Facilitates purchase price allocation
- Cumbersome valuation process
- Excluding intangibles, can represent
"liquidation" value
- Lack of information
3
Approaches – Market Approach
• Premise
– The value of the target can be estimated by looking at prices paid for minority or controlling
interests in the public marketplace
– Ex-Ante approach
• Mechanics
– Identify "comparable" companies
– Calculate multiples and adjust for target company
– Apply multiples to adjusted subject company financial statements
– Produces minority, marketable value
– Apply premiums or discounts as appropriate
Advantages
Drawbacks
- Value based on actual prices paid
for comparable companies
- Does not take into account synergies
- Use of hard numbers
- Focuses on historical results
- Multiple multiples
- Multiple multiples can lead to a divergence of
indicated values
- Requires estimation and application of premiums
and discounts
4
Market Approach - Nuances
• Guideline Company or Representative Transactions
• Multiples Relevant to Industry Being Valued.
• TIC or Equity Multiples?
• Comparable Company Medians or Averages?
• Haircuts to multiples.
• Adjustment from Minority, Freely Traded Basis.
• For Transaction Comps, Lookbacks before 15 September
2008
• Forward Multiples? An IB tact that mixes approaches
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Income Approach – Premise and Mechanics Overview
• Premise
– The Value of the target can be estimated by forecasting the future financial
performance of the business and identifying the cash flow that the business generates
– Forward-looking approach
• Mechanics Overview
– Forecast the target company's financial performance (income statement, statement of
changes, and balance sheet)
– Identity the cash flow-negative or positive-in each forecasted fiscal year
– Estimate the value of the target at the end of the forecast period (terminal value)
– Estimate the target's risk-adjusted cost of capital
– Discount the forecasted cash flows and the terminal value amounts by the cost of
capital
– Subtract actual borrowings at valuation date (long-term and short-term) to estimate
the value of the business to its owners
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Income Approach – Advantages & Drawbacks
• Advantages
– The DCF method forces you to translate future benefits from a business into hard
dollars.
– The DCF method forces you to understand the target's business
– The DCF method allows one to identify the expected cash flow that may be used to
service debt
– You can reflect the impact of the business cycle in the DCF analysis
• Drawbacks
– It is difficult to forecast with any degree of accuracy. You can compensate by
developing different operating scenarios and measure their impact on value.
– Certain key assumptions can wildly alter DCF values
– It is difficult to value the target at the end of the forecast period
– DCF value, including synergies, may result in the buyer overpaying for the target
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Income Approach - Nuances
• Hockey stick projections
• “Reasonably Objective Basis”
• Perpetual Growth Rate
• Projection Period
• WACC
– Beta
– Company Specific Risk Premium
– Baa as a Proxy for Cost of Debt
– Tax Adjusted Cost of Debt
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Conclusion of Value
• Risk in Market Approach v. Risk in Income Approach
• BBB’s Cherry-Picking Postulate: If information exists with
which to apply an approach to value, then you better use it
(or explain why not).
• Use experience and professional judgment in reconciling
your indications of value from the various approaches.
• No formulas or averages. Explain basis for weighting.
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