Valuation Concept

8/2/2019 Valuation Concept

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Basics of valuation

Presented By :Prakash kumar Barnwal


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What we will cover

Purpose of valuation Basic valuation concepts

Methods of valuation critical

appreciation of the methods withsome examples


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Why valuation ?

Do you think the price of stock isreasonable? (equity research-investor)

How much can you sell a

companys shares for? (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 payfor a business? (IB)


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Valuation concepts

Valuation of Business Vs. Valueof Equity

Value of theoperationalbusiness i.eEnterpriseValue

-

Value ofdebt (less

cash)

bondholder value Value of

Equity

shareholder value

=


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Valuation concepts ..contd.....

The accounting balance sheetCash Operational

Liabilities

Value ofEquity

Operationalassets

Debt

=


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Valuation concepts .. contd

Market value Vs. book ValueCash Operational

Liabilities

Value ofEquity

Operationalassets

Debt

=

Off balance

sheet value

Value ofIntangibles

Many

Industrieshave Marketvalue > bookvalue


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Valuation concepts .. contd

Market value of assets = Marketvalue of liabilities

EquityNetOperationalassets

Net Debt

=

Enterprise value (Markets opinion)

Capital


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Calculation of enterprisevalue

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


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

EV = Rs. 1700 Ie Market value of equity +

value of net debt


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Given 1200 shares are outstanding at

the valuation date with a share

price of Rs. 15. Market value ofDebt is Rs. 6000, Cash isRs.200. What is EV?


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Given 1200 shares are outstanding at

the valuation date with a share

price of Rs. 15. Market value ofDebt is Rs. 6000, Cash isRs.200. What is EV?

1200*15 + 6000 200

Rs.23800


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EV of unlisted company

??

Use methods like DCF, multiplesto arrive at EV. Then calculatethe implied share price.


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An Example

EV = 10000, Investments =2000, Cash = 500, Debt = 5000,Number of shares = 200.

What is the share price?


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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


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EV Summing it all up

Enterprise value is the marketvalue of net operational assetswhich must equal the marketvalue of net funding THUS :

EV = Equity + Debt - Cash

EV h i


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EV a comprehensive

picture Cash +

Cashequivalents +

Non controlledInvestments +

Non-coreassets +

Enterprisevalue (netoperatingassets)

Debt

PreferenceShares

Minorityinterest

-

Ordinary

Equity value

=


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Concept of trading value Vstransaction value

Trading value is the equity valueof an enterprise without controlie when a small quantity of

shares is bought, IPO, Rightsissue.

Can also be used to value thetotal minority stake in anenterprise


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Concept of trading value Vstransaction value

Transaction value is theenterprise value with control. Egis when there is a buying of

more than 50% of the equity ofthe company.. Takeover etc.

There is a premium involvedwhen there is such a transactionknown as Control premium


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What is control premium?

It is the excess price paid overthe pre-acquisition stock price.

Reasons : synergies perceived,

strategy for future etc.


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Methods for valuation

Multiples based method Discounted Cash flow method


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Multiple based method

Based on linking VALUE with its VALUEDRIVERS ie earnings with value

Cash

Enterprisevalue

Debt

Equity

Interest

income Interestexpense

Net

income

EBIT

EBITDA

Valuation

Value drivers

M lti l G ll


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Multiples : Generally

used Sales : (EV/Sales) Fast

growing, loss makingcompanies

EBITDA : EV/EBITDA where

leverage differs, acqns aregenerating amortizations

EBIT : EV/EBIT where leveragediffers

PE : MPS/EPS for stablecompanies in mature inds. Lev.Is the same


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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.


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Discounted cash flow valuation

Valuation method based on theforecast of future cash flows

Advantages are incorporates

the time value of money, cansubject to sensitivity analysis

Useful in valuation of Earlystages companies, projects withfinite lives, valuing divisions ofcompanies, valuing synergies.


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Discounted cash flow valuation

Has helped in identifyingoverheated market or anundervalued market

Independent of accountingassumptions and estimates


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DCF - Disadvantages

Requires a lot of assumptions :Long term growth, discount rate.

Complex and time consuming


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DCF Calculation Steps involved

Forecast the companys free cash flow

Calculate the WACC

Calculate terminal value andDCF

Using the above calculate EV

Convert EV into implied shareprice


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What is Free cash flow ?

Different for different purposes FCF : The cash flow from

operations of the business

available to pay out debt andequity holders after investing forfuture growth. ( ieincrease/decrease in capital

expenditure and working capital)


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Period for forecasting

Period for forecasting must betill the business reaches aSteady state

Steady state is characterized bylow growth rate, ROIC justabove or approximates WACC,and capital investment is low,

company is a cash cow andpays out most of its earnings.


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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


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Calculation of Terminalvalue

Terminal value is given by : (Steady state FCF) * (1+ g)

(WACC g)

Where g is the long term growthrate into perpetuity.REMEMBER g should not belarger than the nominal GDPgrowth rate.


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To conclude :

Generally using the impliedvalues of shares a value isarrived at which may be medianvalue or wt. avg. etc.


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Documents

Valuation Concept