Post on 09-Apr-2018
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Alexander Groh 2
Structure
Introduction
Fundamentals of Valuation
Tax Shields and Cost of Capital
Multiples and Hurdle Rates
Free Cash Flow Valuation and the LBO Model
Modelling a Companys Free Cash Flows
Summary
Recommended Literature:
Koller/Goedhart/Wessels: Valuation, New Jersey, Wiley, 2005
Arzac: Valuation for Mergers, Buyouts, and Restructuring, New Jersey, Wiley,
2005
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Alexander Groh 3
Meaning of Valuation for
Financial Investors
Finding a Bidding-Range in transaction processes It is not the point to find the fair value
If the bid is too low you are out!
If the bid is too high youll have problems with built expectations and
with your own companys governance
Finding a price for expected Exit
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Alexander Groh 4
Meaning of Valuation for
Financial Investors
Deal
Valuation
Negotiation
Reputation Deal Structure
Tax-Modell
Atmosphere
Luck
Essentials of Deal-Making:
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Alexander Groh 5
Valuation Methods
Value
Comparing Market Values
of quoted companies
Comparing similar
recent M&A-Transactions
Liquidation Value
Net Asset Value
Discounting expected
Cash Flows
Real Options-Approach
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Alexander Groh 6
Fundamental Valuation Principle
for a Financial Investor
Calculate Present Value of future Cash Flows !!!
V 10=
Example:
( )rV += 111( ) ( ) ( ) ( ) 2
12111111 rrrrVV +=++=+=
( ) ( ) ( ) ( )nnn rrrrVV +=++=+= 1111111
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Alexander Groh 7
( )505
1100 rVmnV +==
Example
What is the Present Value of 100 mn to be received
by redemption of a Zero-Bond in five years?
r = 5%
V0 = 78,35 mn
r = 10%
V0 = 62,09 mn
r = 15%
V0 = 49,72 mn
( )50
1
100
r
mnV
+
=
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Alexander Groh 8
Valuing Perpetuities
A Perpetuity is a Cash Flow that is payed (annually) inequal amounts until infinity
( ) ( ) ( ) ( )
+
++
+
+
+
+
+
=
r
CF
r
CF
r
CF
r
CFV
1111
3
3
2
21
0
r
CFV =
0
results in
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Alexander Groh 9
Perpetuities and Multiples
The valuation of a Perpetuity can be transferred into aMultiple-Valuation
rCF
r
CFV
1
0==
Multipler=
1
MultipleCFV =0
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Alexander Groh 10
Example
Calculate the Net Present Value of a 10 mn Perpetuity !!!
Multiplemnr
mn
r
CFV === 10
10
0
Multiple = 20
r = 5%
V0 = 200 mn
Multiple = 10
r = 10%
V0 = 100 mn
Multiple = 6,7
r = 15%
V0 = 67 mn
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Alexander Groh 11
Growing Perpetuities
Imagine a Perpetuity that grows every year at a constantgrowth rate g
( ) ( ) ( ) ( )
+
++
+
+
+
+
+
=
r1
CF
r1
CF
r1
CF
r1
CFV
3
3
2
210
( )( )
( )
( )
( )
( )
( )
( )
+
+++
+
++
+
++
+
+=
r1
g1CF
r1
g1CF
r1
g1CF
r1
g1CFV 0
3
3
0
2
2
000
( )
( ) ( )
2g1CFg1CFCF
g1CFCF
012
01
+=+=
+=
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Alexander Groh 12
Growing Perpetuities
( )( )
( )( )
( )( )
( )( )
+
+++
+
++
+
++
+
+=
r1
g1CF
r1
g1CF
r1
g1CF
r1
g1CFV 0
3
30
2
200
0
gr
g1
CFV0
+=
Multiple of a
Growing Perpetuity
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Alexander Groh 13
Growing Perpetuity Multiples
grg1PerpetuityGrowingaofMultiple
+=
g = 5% g = 7% g = 10%
r = 15%
Be realistic: What can grow forever at a rate of 5% ???
Multiple = 10,5 Multiple = 13,8 Multiple = 22
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Alexander Groh 14
The Principle Valuation Tasks
1. Estimating future Cash Flows (Modelling)
2. Determining Discount Rates (Comparables
and Structuring)
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Alexander Groh 15
Discount Rates
Discount Rates are also referred to as the Cost ofCapital and have to reflect the uncertainty of the
Cash Flow Stream.
Discount Rates are the Cost of Capital for foregone
Investments of equal Risk!!!
Economic risk Subject to changes
Leverage risk Definitely changes through debt redemption in Buyout
Transactions
Cost of Capital change !!!
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Alexander Groh 16
Common
Pref.
C-Class
B-Class
Cost of Capital
Equity
Entity
Value,Paid to
Seller
Debt
Senior
Cost
of
Debt
Cost
ofEquity
Weighted
AverageCost
of
Capital
(WACC)
Remind the InterestTax Shield
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Alexander Groh 17
Cost of Debt
r
Maturity T
inverse Yield-Structure
flat Yield-Structure
normal Yield-Structure
The base is the Zero Cupon Yield Curve of riskfree debt:
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Credit Spread-Term Structure
1 35 7
9 11 1315 17
190,01%
0,10%
1,00%
10,00%
B
A
AAA
Rating
Maturity
Added
Spreads
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Alexander Groh 19
Tax Shield of Debt
PAT
EBIT
Tax(on PBT)
PBT
Companyall Equity
financed
=
Equity
Newco
Assets
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Alexander Groh 20
Debt
Tax Shield of Debt
PAT
EBITTax(on PBT)
PBT
Interest
Debt finance included
Newco
Assets
Equity
Tax Savings =
Interest X Corporate Tax Rate
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Leverage and Tax Shield
Equity
Newco
Assets
Debt
Newco
Assets
Equity
PAT Equity PAT Equity
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Alexander Groh 22
Cost of Equity
Academics estimate Cost of Equity with Capital Market Models
CAPM (Capital Asset Pricing Model)
APT (Arbitrage Pricing Theory)
Models can surely help to find benchmarks !
To use the models correctly you will need many information, calculations and
experience !
Betas Return of Market Portfolio
Models are sensitive to time horizon and basis-effects !
We are valuing non quoted companies generally !
It is questionable to find Equity Costs for Private Equity Investments by
models that assume fully diversified portfolios and perfect markets !
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Alexander Groh 23
Multiples and Hurdle Rates
We often use Multiples and Hurdle Rates
PAT
EBIT
Depre-
ciations
SalesCore
ActivitiesTax
Interest
EBITDA
Operating
Costs
Banks
State
PE Investor
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Multiples and Hurdle Rates
P/E Ratio
PAT
Tax
Interest Banks
State
PE Investor X P/E Multiple = 1/Hurdle Rate
results in Equity Value !!!
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Alexander Groh 25
Multiples and Hurdle Rates
EBIT
PAT
Tax
Interest Banks
State
PE Investor
EBIT Multiple
X EBIT Multiple
Results in
Entity Value
But what about Taxes ???
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Alexander Groh 26
Multiples and Hurdle Rates
EBITDA Multiple
Results in
Entity Value
This Entity Value is hard to justify !!!
X EBITDA Multiple
Depre-
ciations
EBITDA
PAT
EBIT Tax
Interest Banks
State
PE Investor
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Alexander Groh 27
A Correct Multiple
PAT
EBIT Interest Banks
PE Investor
Tax State
X PBIAT Multiple
Cash Flow Definition and
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Cash Flow Definition and
Investments for Growth
EBIT
Depre-
ciations
SalesCore
ActivitiesEBITDA
OperatingCosts
Cash
Flow(generated by
the Company)
NetInvestments
+
Corrections
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Alexander Groh 29
Free Cash Flow Definition
Cash
Flow(generated by
the Company) Free
Cash
Flow
Tax(as if the
company
had no
debt)
Could flow to the Investors
if the company had no debt!!!
Sets all companies equal disregarding
different Degrees of Leverage!!!
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Entity vs. Equity Valuation
Entity-
Value =
Equity-Value
Value
of
Net Debt
Intellectual foundation: 1963 by Franco Modigliani and Merton Miller
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Cash Flow Definitions
Cash
Flow(generated bythe Company) Free
Cash
Flow
Tax(as if thecompany
had no
debt) Cash
Flow(generated bythe Company)
Tax(real
payment)
CashFlow for
Debt
Service
Cash
Flow(generated bythe Company)
Tax(realpayment)
Cash
Flow for
Redemption
Interest
Alexander Groh
Typical Buyout Model Cash Flows
Linking FCF and
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Alexander Groh 32
Linking FCF and
PE Cost of Capital
FreeCash
Flow
Flows to banks but the cost are less
than the nominal interest rate
due to the tax savings!!!
Interest
Cash
Flow
to
Equity
The residual can flow to
the equity investors at their
Cost of Equity
resp. Hurdle Rate
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Alexander Groh 33
PE Cost of Capital
Debt
Newco
Assets
EquityHurdle
Rate
(constant)
Debt/
Equity Tax Rate
Cost
of
Debt WACC
30% 1 40% 8% 17%
30% 2 40% 8% 13%
30% 3 40% 9% 12%
30% 4 40% 10% 11%
30% 5 40% 11% 11%
30% 6 40% 12% 10%
30% 7 40% 13% 11%30% 8 40% 14% 11%
( )VEr
VDrWACC ED += 1
Return Determinants of Private
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Equity
Return Determinants of Private
Equity Investments
Entity
Value,
Paid to
Seller
Year 0
Debt
Equity
Debt
Equity
Debt
Equity
Debt
Equity
Debt
Transaction
Structure
1 2 3 4
Market Value Added
Dele
ve
rage
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Alexander Groh 35
Changing Cost of Capital
Equity
Entity
Value,Paid to
Seller
Year 0
Debt
Equity
Debt
Equity
Debt
TransactionStructure
1 2
WACC0 WACC2WACC1
WACC
is notConstant!!!
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Alexander Groh 36
Changing Cost of Capital
Should we use different Discount Rates then in ourtransaction model ???
Pros and cons
To be precise we should!
It is not necessary because bandwidth of expected Cash Flows isvery broad anyway!
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Debt Capacity
Alexander Groh 37
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Equivalent Multiples
Alexander Groh 38
Modelling a Corporations
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Alexander Groh 39
10
12
15 15 15 15
0
2
4
6
8
10
1214
16
2009 2010 2011 2012 2013 2014
Year
mn
Modelling a Corporation s
Free Cash Flows
...
Variable Cash Flows Perpetuity
Growth rates could be considered !!!
Duplicating a Corporations
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Duplicating a Corporation s
Free Cash Flows
Present Value = Present Value of Variable Cash Flows +Present Value of Perpetuity
( ) ( ) ( ) rmn15
r1
1
r1
mn12
r1
mn10V
220
+
+
+
+
+
=
r = 5%
NPV(Perp.) = 272 mn
V0 = 293 mn
r = 10%
NPV(Perp.) = 124 mn
V0 = 143 mn
r = 15%
NPV(Perp.) = 76 mn
V0 = 93 mn
Using an Average of
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Alexander Groh 41
Using an Average of
Free Cash Flows ???
No satisfying results !!!
r
mnmnmn
VAverage 3151210
0
++
=
%86143
3,123
V
V
0
Average0
==
mn,,
mn,3123
10
3312==
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Alexander Groh 42
Modelling Free Cash Flows
Modelling the Free Cash Flows is the only way to come to a
fair bid: Analyze historical performance first !!!
Calculate Key Value Drivers
Understand strategic position
Develop performance scenarios Forecast individual line items
Check overall forecast for reasonableness
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Alexander Groh 43
Calculate Key Value Drivers
Use (part of the) ROIC-tree for example:
Operating Margin
= (EBIT/Revenues)
Cost of Goods Sold/
Revenues
Depreciation
Expenses/
Revenues
Selling, General and
Administrative
Expenses/Revenues
= 1- (...)
+ +
Key Value Drivers can be further broken down to operational
levels !!!
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Alexander Groh 44
Develop Performance Scenarios
Get as many research reports as possible !
Read the businessplan critically !
Get information from consultants, market researchers,
competitors and professionals !
Perform best-, worst- and most likely scenarios !
Perform sensitivity analysis !
Interpret the result of different scenarios and sensitivity analysis
carefully !
Discuss possible scenarios in your management team !
Get Help by
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Alexander Groh 45
Get Help by
Mathematical Tools
Monte Carlo Simulation with Crystal Ball
2005 2006 2007 2008 2009
Revenues 100,00 103,01 106,11 109,30 112,59 3% est. Annual Growth Rate
Cost of Goods Sold 54,00 55,15 56,81 58,52 60,28 54% est. COGS/Revenues
SGA Expenses 3,00 3,09 3,18 3,28 3,38 3% SGA/Revenues (constant)
Depreciation Expenses 29,00 29,87 30,77 31,70 32,65 29% Dep./Revenues (constant)
EBIT 14,00 14,89 15,34 15,80 16,28
Get Help by
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Alexander Groh 46
Get Help by
Mathematical Tools
Play with the assumptionsfor sensitivity analysis !!!
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Alexander Groh 47
Simulation of Possible Scenarios
Frequency Chart
Euro
Mean = 112,65,000
,008
,015
,023
,030
0
7,5
15
22,5
30
100,00 106,25 112,50 118,75 125,00
1.000 Trials 4 Outliers
Forecast: Revenues 2004
Frequency Chart
Euro
Mean = 60,31,000
,008
,015
,023
,030
0
7,5
15
22,5
30
52,50 56,25 60,00 63,75 67,50
1.000 Trials 3 Outliers
Forecast: COGS 2004
Si l d EBIT
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Alexander Groh 48
Simulated EBIT
Frequency Chart
Euro
,000
,007
,015
,022
,029
0
7,25
14,5
21,75
29
12,00 13,25 14,50 15,75 17,00
1.000 Trials 0 Outliers
Forecast: Ebit 2001
Frequency Chart
Euro
,000
,006
,013
,019
,025
0
6,25
12,5
18,75
25
12,00 13,50 15,00 16,50 18,00
1.000 Trials 0 Outliers
Forecast: Ebit 2002
Frequency Chart
Euro
,000
,006
,013
,019
,025
0
6,25
12,5
18,75
25
12,00 13,75 15,50 17,25 19,00
1.000 Trials 0 Outliers
Forecast: Ebit 2003
Frequency Chart
Certainty is 80,80% from 15,01 to +Infinity Euro
Mean = 16,29,000
,005
,011
,016
,021
0
5,25
10,5
15,75
21
12,00 14,00 16,00 18,00 20,00
1.000 Trials 0 Outliers
Forecast: EBIT 2004
Calculating FCFs
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Alexander Groh 49
Calculating FCFs
and Entity Values
2005 2006 2007 2008 2009Revenues 100,00 103,01 106,11 109,30 112,59 3% est. Annual Growth Rate
Cost of Goods Sold 54,00 55,15 56,81 58,52 60,28 54% est. COGS/Revenues
SGA Expenses 3,00 3,09 3,18 3,28 3,38 3% SGA/Revenues (constant)
Depreciation Expenses 29,00 29,87 30,77 31,70 32,65 29% Dep./Revenues (constant)
EBIT 14,00 14,89 15,34 15,80 16,28
Taxes on EBIT 5,60 5,96 6,14 6,32 6,51 40% assumed marginal Tax Rate
Operating Cash Flow 8,40 8,93 9,20 9,48 9,77
Net Investments 2,00 2,06 2,12 2,19 2,25 3% est. Growth Rate
Free Cash Flow 6,40 6,87 7,08 7,30 7,51
Net Present Values 5,98 5,35 4,80 32,94 15% Discount Rate
Entity Value 49,1
P ibl Biddi R
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Alexander Groh 50
Possible Bidding Range
Frequency Chart
Certainty is 50,40% from 44,84 to 52,48 Euro
Mean = 49,10,000
,021
,042
,063
,084
0
21
42
63
84
35,00 41,88 48,75 55,63 62,50
1.000 Trials 0 Outliers
Forecast: Entity Value
P tti All T th !!!
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Alexander Groh 51
Putting All Together !!!
Use your Valuation-Spreadsheet
Forecast future Earnings
and Free Cash Flows
Perform Scenario-Planning
and Sensitivity Analysis
Build a transaction
structure
(Taxes!)
Calculate IRRs for
financing layers
(reversed DCF-
Valuation)
Find company market value
Compare IRRs with
Hurdle Rates of each investor
Adjust leverage
Formulate your bid !!!