mergers and acquisitions finc3013 – valuation in an m&a context angelo aspris
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Mergers and AcquisitionsFINC3013 – Valuation in an M&A context
Angelo Aspris
Valuation Analysis
› Valuation is a critical part of the merger/acquisition process.
- A deal that may be sound from a business standpoint may be unsound from a financial standpoint.
› The purpose of a valuation analysis is to provide a disciplined approach for arriving at a price.
- This approach combines procedural valuation procedures with a fair degree of scepticism and sound business judgement.
› In other words, for a merger/acquisition process to be successful NV > 0
- Where NV = net value, VBT = value of the combined firm, VB = value of the bidder and VT = value of the target.
)( TBBT VVVNV
Valuation Analysis
› Valuation in M&A is used to answer key questions related to shareholder value creation.
Valuation Methodologies
Valuationmethodologies
Publicly tradedcomparable
companies analysis
“Public Market Valuation”
Value based on market trading multiples of comparable companies
Applied using historical and prospective multiples
Does not include a control premium
Comparable transactions
analysis
“Private Market Valuation”
Value based on multiples paid for comparable companies in sale transactions
Includes control premium
Discountedcash flowanalysis
“Intrinsic” value of business
Present value of projected free cash flows
Incorporates both short-term and long-term expected performance
Risk in cash flows and capital structure captured in discount rate
Leveragedbuyout/recap
analysis
Value to a financial/LBO buyer
Value based on debt repayment and return on equity investment
Other
Liquidation analysis
Break-up analysis
Historical trading performance
Expected IPO valuation
Discounted future share price
EPS impact
Dividend discount model
Most Common Valuation Tools
Trading Multiples Live observations of how companies are being valued by investors.
Intuitive link with fundamental value: e.g. high growth will normally be associated with a higher multiple and higher risk with a lower multiple.
Non-control transactions
Transaction
Multiples
Historical observation of how much investors have paid for companies.
Change of control situations – includes mix of control premium and synergies paid.
Discounted Cash Flow (DCF)
Theoretical value (often used to establish “base valuation)
Useful for period of non-constant growth for finite life
Requires significant number of assumptions for future periods.
Leverage Buy-Out (LBO)
What can financial sponsors pay for assets?
Based on our knowledge of their required returns, access to leverage, ability to extract operational synergies.
1. Trading Multiples
Trading Multiples
› A method that allows us to calculate the value of an asset by comparing it
to values assessed by the market for similar or comparable assets.
The process:
1) Identify the comparable assets and obtain market values for the assets.
2) Convert these market values into standardised values.
3) Compare the standardised values (multiples) for the asset analysed with
the comparable asset controlling for any differences between the firm that
affect the multiple
Trading Multiles
Multiple Comment
Firm value / sales (LTM, FY1, FY2) Generally not very accurate although essential for high-tech companies
Firm value / EBITDA (LTM, FY1, FY2) Generally most accurate multiple to use (watch out for interest income)
Good ratio in cyclical industries
Good for cross-country comparisons
Independent of leverage
Firm value / EBIT (LTM, FY1, FY2) Most useful when assessing a capital intensive business
Market cap. / Net income (also known as P/ E)
Historical P/ E ratio – affected by one-off charges
Forward looking P/ E – actively used by Wall Street analysts; forward looking – avoids problems with different fiscal years
Market cap. / book value Most appropriate for financial institutions – Australian trading bank
multiples in particular
Firm value / total assets Useful when assessing utilities and other fixed-asset based companies
Industry specific Price per subscriber / barrel / production, etc.
Trading Multiples – Boral Example
Company Name Market Capitalisation
($US)
Total Enterprise
Value ($US)
Basic EPS PEG Ratio EV/EBITDA Return on Equity %
EBITDA, 1 Yr Growth %
Adelaide Brighton Ltd. (ASX:ABC)
1,786.14
1,959.53
0.2 2.8x 9.96x
15.5
(7.1)
CSR Limited (ASX:CSR)
2,320.11
3,128.4
(0.1) 2.0x 7.12x
(7.2)
13.8
James Hardie Industries SE (ASX:JHX)
2,172.22
2,303.99
(0.2) 1.2x 9.22x NM
474.2
Boral Ltd. (ASX:BLD)
2,629.58
3,746.23
0.2 0.9x 9.02x
4.8
(21.7)
Summary Statistics
Market Capitalisation
($US)
Total Enterprise
Value ($US)
Basic EPS PEG Ratio EV/EBITDA Return on Equity %
EBITDA, 1 Yr Growth %
High 2,320.11
3,128.4
0.2
2.8x 9.96x 15.5
474.2
Low 1,786.14
1,959.53
(0.2)
1.2x 7.12x (7.2)
(7.1)
Mean 2,092.82
2,463.97
(0.0)
2.0x 8.77x 4.2
160.3
Median 2,172.22
2,303.99
(0.1)
2.0x 9.22x 4.2
13.8
Trading Multiples – Calculation Issues
› Choice of Multiple:
- Which should we chose?
- Common choices include P/E, EV/EBITDA, EV/EBIT, PEG
› “Hairballs” – minority interests, investments, non-comparable divisions
› Post balance sheet events
- Acquisitions, divestitures, buy-backs, equity/debt placements
› Outliers
- Data providers often use different procedures to calculate the same ratio.
› Fiscal v Calendar year
Trading Multiples
› Advantages:
- Based on public information (therefore reflect market perceptions/moods)
- Market Efficiency – valuation should in theory reflect all available information
- Assets are always relatively undervalued/overvalued
- Not as computationally intensive as other approaches
- Does not include control premium
› Disadvantages:
- Difficult to find large sample of truly comparable companies
- Trading valuation may be affected by thin trading, small capitalisation, or poor research
coverage
- The market can be “wrong”
- Undervalued may still equal overvalued.
2. Precedent (Comparable) Transaction Analysis
Precedent (Comparable) Transaction Analysis
› Conceptually similar to the trading multiples approach.
› The multiples used to estimate the value of the target are based on purchase prices of comparable companies that were recently acquired.
› Uses of Comparative Transaction Analysis include:
- Valuing a business in a change of control situation (i.e. inclusive of a control premium)
- Provide statistics on particular transactions as a basis for discussion.
- Display historic acquisition appetite of industry of industry participants and determine willingness to “pay full price”.
- Determine the market demand for different types of assets
- i.e. frequency of transactions and premiums paid
Australian Acquisition Premia - (Deal Size > $100m)
0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
45.0
50.0
Pre
miu
m (
%)
2005 2006 2007 2008 2009 2010
Date
Mean (1 day premium) Median (1 day premium)
Presentation of Transaction Multiples
EBIT multiple
Target Acquirer Ann. date EV (A$mm) Historical Forecast EV/ NTOA multiple
Coates National Hire 10/ 02/ 2007 1,645 12.4x 11.2x NA
PCH Group Ltd Cape Australia Pty Ltd 16/ 10/ 2007 $268.1 18.2 13.2 2.4x
Concept Hire Ltd Cape Australia Pty Ltd 11/ 09/ 2007 128.7 12.6 9.8 2.4
Prime Industrial Rentals Coates 29/ 08/ 2007 39.7 5.0 4.5 1.1
United Rentals Inc Cerberus Capital Management 23/ 07/ 2007 US$6,600.0 9.6 9.0 1.5
Allplant Coates 30/ 11/ 2006 72.4 NA 7.6 1.3
Hirequip NZ Ltd Nikko 28/ 11/ 2006 189.1 12.6 10.2 2.1
Hirepool Ltd Next Capital 1/ 07/ 2006 172.0 10.4 NA NA
Allied Equipment Coates 1/ 07/ 2005 135.7 NA 5.9 1.4
AH Plant Hire National Hire 21/ 10/ 2005 106.5 8.4 8.2 1.9
Sherrin Hire Pty Ltd Boom Logistics Ltd 27/ 06/ 2005 130.0 7.2 NA 1.3
Allight Holdings Pty Ltd National Hire 1/ 11/ 2004 82.5 12.5 7.2 1.6
The Cat Rental Store WA National Hire 1/ 11/ 2004 46.9 12.7 6.2 1.0
Australian Oil and Gas Ensign Ltd 12/ 04/ 2002 149.9 13.2 12.0 1.1
Median 12.5x 8.6x 1.5x
Mean 11.2x 8.8x 1.6x
Transaction Multiples – Advantages and Disadvantages
› Advantages
- Based on public information
- Captures control premium
- May show trends
- i.e. consolidation, foreign/financial acquirers
- Provides guidance to likely interlopers and their willingness and ability to pay.
› Disadvantages
- Public data can be limited and misleading
- Precent transactions are rarely directly comparable (stock market, business, financing, bidders may have all changed)
- Values obtained often vary over a wide range
- Not all aspects of a transaction can be captured in multiple valuation.
- Market conditions at time of transaction may have significant influence on valuation.
3. Discounted Cash Flow Analysis (DCF)
DCF Analysis
› DCF value is simply the present value of the projected cash flows of a business.
- Cash flows are discounted to reflect the time value of money and riskiness of the asset.
› In practice DCF analysis is used for:
- A base case scenario (to satisfy market convention)
- An asset with a finite life
- A start up business or early stages of development
- A turnaround situation (i.e. when earnings will be very different in a few years)
› Key Steps:
- Determine forecast horizon cash flows
- Determine Terminal Value cash flows (i.e. perpetual growth rate, asset/equity multiple)
- Calculate the WACC to discount cash flows.
› Various cases can be evaluated
- upside (favourable) versus downside (unfavourable) cases
- base / low cases to manage expectations, establish floor
- key sensitivities on price, cost, growth etc.
DCF Components
› Forecasted free cash flows:
- cash flows before debt service or distributions to shareholders
› Terminal value:
- estimate of future value at “steady state”
- a number of methodologies can be used
› Cost of capital
- represents current return requirements on capital invested (debt and equity) and the
appropriate risk of the underlying cash flows
- reflects target capital structure on a market weighted basis
Free Cash Flow
› Free cash flow is the cash that remains after all necessary reinvestments (e.g. capital expenditure and working capital) have been made.
- Free cash flow is measured prior to any debt service (interest and debt repayment), but after cash taxes
- Free cash flow therefore is the amount of cash that can be distributed to shareholders and debt holders (also known as the ‘unlevered cash flow’)
- Cash flows discounted at the weighted-average cost of capital to calculate firm value
- Occasionally and primarily for financial institutions, we calculate cash flows after interest expense and interest income (‘levered’ cash flow)
- Levered cash flows discounted at the cost of equity
- Present value represents equity value
Calculating Unlevered Free Cash Flow (UFCF)
› Unlevered cash flow is the cash generated without regard to capital structure and financing (hence “un-levered”).
› One way of arriving at UFCF:
Net Income
Depreciation Amortisation Change in Deferred Taxes Other Non-Cash Charges After-tax
interest expense
Capital Expenditures
Investment in Working
Capital
Unlevered Free Cash
Flow (UFCF)
-+ =
Free Cash Flow – Terminal Value
› Terminal value is the portion of a company’s total value that can be attributed to
cash flows expected in the period beyond the specific forecast period
- the terminal value period is the time from the end of the specific forecast period to infinity
- Can be measured via perpetual growth method, or multiples approach
› Terminal value should be estimated when the forecast reaches “steady state”
- long-term assumptions have been stabilised
- little added value by forecasting more years
- for practical purposes around ten years
› The terminal value is equivalent to making infinite year-by-year forecasts
Weighted Average Cost of Capital
› The Weighted Average Cost of Capital is defined by:
› Where E is the value of equity, D the value of debt and V the value of the firm.
› For the calculation of WACC one should always:
- Use market weights
- Use market based opportunities
- Use forward looking weights and opportunities
V
Dtr
V
ELrWACC cde 1)(
Summary of DCF results
Year end 30 J une 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Total sales 277.0 290.9 305.4 320.7 336.7 350.2 364.2 375.1 386.3 397.9 409.9
% growth -- 5.0% 5.0% 5.0% 5.0% 4.0% 4.0% 3.0% 3.0% 3.0% 3.0%
EBIT 24.8 30.5 42.9 46.2 50.2 52.1 53.4 54.7 56.1 57.5 59.2
% margin 8.9% 10.5% 14.0% 14.4% 14.9% 14.9% 14.7% 14.6% 14.5% 14.4% 14.4%
Taxes 9.2 9.1 12.9 13.8 15.1 15.6 16.0 16.4 16.8 17.2 17.8
% rate 36.9% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0%
Deprec’n & Amortisation 17.8 16.1 7.5 8.4 8.7 8.5 8.9 8.7 8.4 8.2 8.5
Less: Capex (9.8) (9.8) (9.8) (10.5) (10.5) (11.0) (11.0) (11.0) (11.5) (11.5) (10.4)
Less: NWI change 2.2 0.4 0.4 0.5 0.5 0.4 0.4 0.3 0.3 0.3 0.4
Free cashflow2 25.6 28.1 28.2 30.6 33.8 34.4 35.7 36.3 36.5 37.3 39.8
Free cashflow summaryFree cashflow summary
Key valuation outputsKey valuation outputs
Firm value (A$mm)
Terminal growth (%)
2.5% 3.0% 3.5%
9.3% 472.1 492.8 517.1
9.8% 440.0 457.1 477.0
10.3% 412.0 426.3 442.7
10.8% 387.3 399.4 413.1
WACC
11.3% 265.5 375.8 387.4
Equity value (A$mm)
Terminal growth (%)
2.5% 3.0% 3.5%
9.3% 462.7 483.4 507.7
9.8% 430.6 447.7 467.5
10.3% 402.6 416.9 433.3
10.8% 377.9 390.0 403.7
WACC
11.3% 356.1 366.4 378.0
Equity value per share (A$)
Terminal growth (%)
2.5% 3.0% 3.5%
9.3% $4.63 $3.83 $5.08
9.8% $4.30 $4.48 $4.68
10.3% $4.03 $4.17 $4.33
10.8% $3.78 $3.90 $4.04
WACC
11.3% $3.56 $3.66 $3.78
Summary of DCF results
› Summary of sensitivity analysis:
› Key sensitivities for DCF valuations include- WACC / discount rates
- Terminal growth rates / multiples
- Earnings growth / margins
510
489
505
466
493
499
450 470 490 510 530 550 570 590
Plus/minus 0.25% WACC
Plus/minus 0.5% terminal growth rate
Plus/minus 0.5% division 2 gross margin
Plus/minus 0.5% division 1 gross margin
Plus/minus 0.1% division 2 revenue growth
Plus/minus 0.1% division 1 revenue growth
Enterprise value (A$m)
528
549
533
572
545
539
DCF – Advantages and Disadvantages
› Advantages:
- Theoretically, the most sound valuation method
- Forward looking analysis, based on cash flow (rather than net income).
- Incorporates expecting operating strategy into the model
- Less influenced by volatile market conditions
- Allows a valuation of the separate components of a business or synergies separately from the business.
› Disadvantages
- Valuation is highly sensitive to underlying assumptions, terminal value calculation and discount rate.
- Terminal value often represents a significant portion of total value
- Impervious to market dynamics and control premia
4. Leveraged Buy-out Analysis (LBO)
LBO Analysis
› How does the LBO analysis fit into the range of valuation methodologies?
- It is based on cash flow projections like a DCF but takes the Company’s leveraged capital structure into consideration
- From a technical perspective, it is therefore similar to a leveraged DCF analysis
› LBO analysis should answer the following questions:
- Does the LBO work within a sensible range of purchase prices?
- Are equity returns high enough (>15%)?
- How much debt can be put into the company?
- Reimbursed before/within maturity while maintaining credit ratios in acceptable ranges at all times?
LBO modelling
Step 1
› Determine purchase price
› Determine how much will be paid for using debt vs. equity
› What is the entry multiple (i.e. EV/EBITDA of x)
Step 2
› Project company’s cash flows over investment horizon (e.g. over 5 years)
› Use any excess cash (after operating expenses and interest has been paid) to pay down debt
› Equity holders receive no cash during these years
LBO Modelling
Step 3
› Assume an exit multiple (i.e. EV/EBITDA of x)
› Multiply this with EBITDA in exit year (e.g. in year 5)
› You now have EV. EV – outstanding debt = Value of Equity at Exit
› Using Equity put in from Step 1 and Equity at exit from Step 3, you can calculate IRR of equity investment
Step 4
› Assess key sensitivities:
- Entry vs. Exit multiple (EBITDA multiples)
- Gearing vs. Entry multiple
- Exit year vs. Exit multiple
LBO Methodology: A summary
INPUTS
Projected Cash Flows
Discount Rate (WACC)
Terminal Value
INPUTS
Projected Cash Flows
Purchase Price (PV)
Sale Price (TV)
DCF Analysis
LBO Analysis
OUTPUT
Enterprise Value (PV)
OUTPUT
IRR (Equity Discount
Rate)
IPO
Trading Multiple
Sale to Buyer
Transaction Multiple
5. Conclusion
Final Valuation
› Determining a final valuation recommendation is a process of triangulation using insight from each of the relevant valuation methodologies
1. Discountedcash flow
Utilises data from M&A transactions involving similar companies.
Utilises data from M&A transactions involving similar companies.
Analyses the present value of a company's free cash flow.
Analyses the present value of a company's free cash flow.
Utilises market trading multiples from publicly traded companies to derive value.
Utilises market trading multiples from publicly traded companies to derive value.
Used to determine range of potential value for a company based on maximum leverage capacity.
Used to determine range of potential value for a company based on maximum leverage capacity.
3. Comparable Acquisition Transactions 4. Leveraged
Buy Out
2. Publicly Traded ComparableCompanies
Summary of Results
› Typically results are presented to management using a “football field” type presentation analysis
750
883
787
704
837
725
732
770
578
598
672
613
562
645
535
542
616
536
400 500 600 700 800 900 1,000
Broker expectations
Comparable transactionmultiples
Comparable tradingmultiples
LBO valuation (20% IRR)
LBO valuation (15% IRR)
Unlevered DCF valuation
Enterprise value ($m)
Factors affecting the takeover premium
Must win!
Potential cost to bidder if a competitor gets target Cost of building from scratch vs. purchase Potential value of ownership, either due to high return investments or unforeseen
events
Defensive /greenfield /
platform / option
Buyer’s perception of the future is different from the market’s viewOutlook
Net cost savings and revenue enhancements
Synergies
Buyer’s cost of capital is lower than target’s
(sometimes viewed as a synergy)Cost of capital
Under-valuation Target trades at a discount to DCF value (eg. Diversified holdings; industry out of
favour, poor communications with investors, etc.)
Highest finaloffer
Highest finaloffer
Trading price before
announcement
Trading price before
announcement
Targetcompany
price
Pote
nti
al con
t rol p
r em
ium
Pote
nt i
al con
t rol p
r em
ium
Transaction Values can differ from Valuation Methodologies
› Higher level of synergies
- revenue enhancements
- cost savings
› Cross border
- differences in capital costs, tax rules, repatriation levels, etc.
› Differences in view of the future
- buyer may have a dramatically different view of the future than the market
› Other strategic reasons
- buy versus build
- platform for other investments
- defensive acquisition