Presentation on theme: "Discounted Cash Flow (“DCF”)"— Presentation transcript:
1 Discounted Cash Flow (“DCF”)
Section 1 Discounted Cash Flow (“DCF”)
2 PV of projection period
Valuation implied by a DCF model is known as the intrinsic value, as opposed to the market value Important alternative to market-based valuation techniques such as comparable companies and precedent transactions Forward looking, focus on cash generation, recognise time value of money Projected FCF is derived from a variety of assumptions and judgments about its expected financial performance DCF – Overview Overview Free Cash Flow Income Statement Earning before interest and tax (“EBIT”) Less: Taxes (at the Marginal Tax Rate) = EBIAT Balance Sheet Plus: Depreciation and Amortization Less: Capex Less: Increase/(Decrease) in NWC Cash Flow Statement = FCF DCF PV of projection period PV of terminal value
3 DCF – Key drivers Driver Comment Financial Projections
Management forecasts Wall Street consensus estimates Generally helpful when performing DCF based on more than one operating scenario Equity Risk Premium Financial and market trends, recommended US equity risk premium (vs. US treasury bond): 5.00% % Cost of Equity and Weighted Average Cost of Capital (“WACC”) Equity Beta Company’s predicted Beta Historical adjusted Beta, past two or five years, e.g. Bloomberg Cross check with Beta for peer companies Capital Structure Forward looking, or expected Capital Structure Correspond expected interest rate Risk-Free Rate Long-term treasury security as the proxy for risk free rate Shorter-term can be appropriate if warranted by the circ*mstance (finite life and no terminal value) Size Premium Greater risk for smaller companies, e.g. Ibbotson Size premium is normally added to the Cost of Equity 3
4 DCF – FCF Calculation
5 DCF – WACC Cost of Equity (re) Cost of Debt (rd) CAPM:
rf : risk-free rate rm: expected return on the market SP: size premium Beta calculation: Unlevering Beta (peer group): βL: levered or equity Beta βU: unlevered Beta 2) Leveraged Beta (target): rd: long-term cost of debt based on the current yield on its existing term loan Market interest rate that the firm has to pay on its borrowing. It depends upon three components: The general level of interest rates The default premium The firm’s tax rate Alternatively, rd can be extrapolated from that of its peers Beta – measure of the covariance between the rate of return on a company’s stock and the overall market return
6 DCF – WACC Calculation and output
7 Comparable Company Analysis (“Trading Comps”)
Section 2 Comparable Company Analysis (“Trading Comps”)
8 Trading Comps – Identify Key Characteristics
Business Profile Sector – industry or markets in which a company operates Products and services – core business model Customers and end markets – opportunities and risks of underlying markets Distribution channels – key driver of operating strategy and performance Geography – different fundamental business drivers and characteristics for different regions Financial Profile Size – similar size in a given sector are more likely to have similar multiples Profitability – ability to convert sales into profit, “margins” Growth profile – historical and estimated future financial performance Return on investment – ability to provide earnings to its capital providers Credit profile – creditworthiness as a borrower Information can be found on Google Finance (open to all), Bloomberg / Factset / Capital IQ (subscription required) or Competition Sections in company presentations / annual reports Remember to check valuation date, financials refer to the same period (LTM and projected )
9 Trading Comps – Key Matrix
Claim of equity investors Claim of debt investor Basic Shares Outstanding In-the-Money Options and Warrants + + In-the-Money Convertibles
10 Trading Comps – ConAgra / RalcorpTransaction
Note: Key multiples for Public Comps: EV / Revenue EV / EBITDA EV / EBIT P / E …But why not EV / Net Income?...
11 Precedent Transaction Analysis (“M&A Comps”)
Section 3 Precedent Transaction Analysis (“M&A Comps”)
12 M&A Comps – Points to Note
Source of information? Public Targets: proxy statements, company fillings, equity and fixed income research reports, press releases Private targets: depends on type of acquirer and/or acquisition financing WSJ Deal Journal / Bloomberg / Factset / Capital IQ Deal Dynamics! Strategic buyer vs. financial sponsor Motivations Sale process and nature of the deal Purchase consideration Industry + Geography + Size + Time
13 M&A Comps
14 Football Field – Valuation Summary
15 What do investment banks do?
Corporates Corporates are companies that actually make products or provide services Their customers could be other businesses, consumers, or both Professional services Consulting firms City law firms Audit Tax Risk Give clients strategy advice Improve management Technology Legal aspects of the functioning of their businesses Disputes with other parties Corporate finance Examples: Markets M&A: Advise corporates on mergers, sales and purchases of companies and corporate restructuring Equity: Advise corporates on initial public offerings (IPOs) of shares on a public exchange and further offerings of share Debt: Advise on loan packages for corporate clients which may be funded by them or institutional investors Goldman Sachs Morgan Stanley JP Morgan Credit Suisse Deutsche Bank UBS Barclays Research: Gather and interpret market data for trading or sales colleagues, or for clients Sales: Advise clients on potential trades, typically institutional investors or corporates Trading: Trade shares, bonds and other tradable assets with and on behalf of clients, typically institutional investors or corporates Private equity firms Asset management firms Hedge fund managers Invest money in shares in companies, often taking private control of publicly-listed companies They aim to improve the businesses they invest in and then sell their stake later for a profit Invest money entrusted to them by their clients, usually pension funds, insurance companies and retail banks, which hold large pools of individual savings Tend to stay “long”, that is, they hold assets for the long term Invest money entrusted to them by various investors Tend to use a variety of complex investment strategies, including short selling (selling borrowed shares hoping their value will fall before they have to buy them back), using borrowed money, and using derivatives
16 Map of an investment bank
Corporate finance Markets M&A Capital markets (ECM/DCM) Loan finance Trading Sales Research Structured finance Syndication Asset management Specialists in particular products, industries or regions are found across the bank Product specialists Industry specialists Regional specialists Compliance Finance Risk management Operations IT
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