01 Valuation Models

24/02/2013

1

Valuation models

Company Valuation (JEM 132)

Radovan Chalupka

25 February 2013, Prague

Institute of Economic Studies School of Social Sciences

Charles University in Prague (founded 1348) ies.fsv.cuni.cz

Learning objectives

All theory is grey,

and green the golden tree of life The objectives of this seminar are as following:

• Get a hand-on experience of the valuation through a quick overview of different valuation approaches and methods;

• Understand the difference between enterprise value and equity value;

• Have a big picture for the details to be provided in the following lectures and seminars.

2 Valuation models – Company Valuation (JEM 132), 25 Jan 2013, [email protected]

Case study

The choice of a valuation method

depends on available data and time • You are about to value a Czech company as at 31 December 2012 having this information:

– Book value of common equity of CZK 63,813m as at 3Q 2012;

– EBITDA of CZK 19,653m for last twelve months ending 4Q 2012;

– Dividends paid in 2011 in the total amount of CZK 12,878m;

– Total debt of CZK 2,966m, cash and cash equivalents of CZK 12,469m, zero preferred equity and minority interest as at 3Q 2012;

– LT Czech government bonds having yield of 3.0% and equity risk premium estimated to 6.0% as at 4Q 2012.

• What is your estimated value of equity of this company?

• Hints from the lecture and theory:

• Gordon formula:

• Capital asset pricing model (basic):

• What is the enterprise value?


gr

dV

e

10

ERPrr fe

Cost approach

Cost approach is based on the principle

of substitution Cost based approach

• Based on the principal of substitution, a prudent buyer would not pay more than the cost to replace an asset.

• Normally not used to value companies other than holdings, used to value individual assets.

• Not very useful if significant non-tangibles (brand name, customer relationships, valuable contracts, goodwill) are involved.

Valuation methods

• Reproduction cost – The costs involved with identically reproducing an asset or property with the same materials and specifications as the valued asset based on current prices.

• Replacement cost new (RCN) – The cost to replace an asset of the same or equal utility.

• Depreciated RCN – Taking into account all forms of obsolescence (physical, functional, economic).

• Net asset value (book value of equity) can be viewed as a method of the cost approach.

Case study application

• Use the cost approach to get an indication of the value of the company.


Simple approach

Everything should be made as simple

as possible, but not simpler Simple approach

• “Rough and dirty” ways to obtain approximate idea about company value for quick orientation.

• Usually industry-specific multiples based on financial or non-financial factors (e.g. number of customers).

Valuation methods

• The rule of Čihák’ hand – The equity value of a company = 5 × EBITDA – debt.

• The method was devised by a Czech valuation expert Petr Čihák Ph.D. combining his thorough understanding of valuation principles and rather basic understanding of anatomy.


• Use the rule of Čihák’ hand to get an indication of the value of the company.


Revenue approach

Those who look only to the past or

present are certain to miss the future Revenue approach

• The present value of future benefits an asset is expected to generate.

Valuation methods

• Dividend growth model (DG) – Assumes time-series consistency in dividend payout.

• Discounted dividend model (DDM) – Forecast dividends discounted at cost of equity.

• Discounted cash flow (DCF) to the firm – Forecast free cash flow discounted at weighted average cost of capital.

• Residual income model (RIM) – Book value of equity + residual income (EVA) discounted at cost of equity.


• Use the DG model to get an indication of the value of the company.


24/02/2013

2

Case study

More complexity brings more precise

results but also more possible errors • Revise your value estimates using the following information:

– Two peer companies have a median EV/EBITDA multiple of 4.2x, M/B multiple of 1.8x and P/E multiple of 13.4x, net income of the company for last twelve months ending 4Q 2012 was CZK 5,028, all multiples are calculated as at 31 December 2012 vis-à-vis 2012 financials;

– Based on consensus analyst estimates EBITDA of CZK 19,653m in 2012 is expected to decrease to CZK 19,197m, CZK 18,925m and CZK 18,517m in 2013, 2014 and 2015, respectively;

– Corresponding EBIT estimates for 2013–2015 are CZK 8,395m, 8,568m and 9,132m;

– Unlevered beta was estimated to 0.8 and a sum of country and size premiums to 1.5%;

– LT EUR corporate bonds with the same rating having the yield of 3.0% as at 4Q 2012 can be translated to CZK using -0.2% adjustment;

– Median capital structure (% of common equity) of the peers was 55%.

• How would you revise your estimated value of this company?


Comparable approach

People (and companies) are different,

especially some of them Comparable approach

• The price of comparable assets in liquid markets.

• Quick orientation about the approximate range within which the value is likely to lie.

• Verifying plausibility of value estimate produced by more sophisticated methods.

Valuation methods

• Guideline public companies – Various multiples (M/B, P/E, EV/EBITDA) of comparable publicly traded companies (peer companies).

• Comparable transactions – Various multiples achieved in recent comparable transactions of both publicly traded and private companies.


• Use median multiples of peer companies to get an indication of the value of the company.


Discounted cash flow model

DCF method is reliant on proper

projections and discount rate Discounted cash flow to the firm model

• Forecast free cash flow to all capital providers (owners and debtors) discounted at weighted average cost of capital (WACC).

• Subtract claims of other investors (net debt, share options, preferred shares, minority interest) to get value of the common equity.

• WACC as the discount factor should represent the risk of all capital providers.


• Use the DCF to the firm model to get an indication of the value of the company.

• Hints from the theory:

• Discounting FCFF:

• Capital asset pricing model (extended):

• WACC:


1

0)1(t

t

t

WACC

FCFFV

sizecountryfe rrERPrr

ED

Dtr

ED

ErWACC de )1(

Case study

More sophisticated methods

should lead to more precise results Reconciliation of results

• All applied valuation methods are benchmarked against the market capitalization (market value of all shares) and enterprise value based on the stock exchange data.

• Market value of a liquid share indicates opinions of thousands investors with their valuation models and assumptions.


Approach Method Equity value EV Δ% Δ%

Cost Historical cost 63,813m 54,310m -39% -43%

Revenue Dividend growth model 143,089m 133,586m 37% 41%

DCF to the firm 103,666m 94,163m -1% -1%

Comparable Trading multiples: M/B EV/EBITDA P/E

111,673m 92,046m 67,241m

111,673m 82,643m 57,738m

7%

-12% -35%

8%

-13% -39%

Market price 104,228m 94,725m

Simple The rule of Čihák’s hand 95,299m 98,265m -9% 4%

[email protected]

Thank you for attention

01 Valuation Models

Documents

Transcript of 01 Valuation Models