Verðmat banka- Afkomuspár o.fl.

Haraldur Yngvi Pétursson

Framkvæmdastjóri L.S.B.Í.

Sérfræðingur í eignastýringu Arion banka

Introduction

Haraldur's Personal Introduction

Academic:

University of Iceland – Cand. Oecon

Professional

Deloitte – Accounting – 3 years

Preparations of financial accounts

Auditing of financial accounts

Kaupthing Bank – Equity Research – 4 years

Focus on the Icelandic market

Part of Kaupthing Scandinavian equity research from 2006

IFS Research – Equity Research – 1 year

Focus on Icelandic equities

Selected Scandinavian companies

S&P 500 selected sectors

Arion banki – Asset Management – Since September 2009

MD of L.S.B.Í. Pension Fund

Goal of Presentation

Discuss company valuation generally and main obstacles (focus on banks)

Review in some detail the main currently employed valuation methods

Don't worry if you don't fully understand everything said

To most ordinary humans this is entirely foreign material

Valuation and Equity Research is very much "on site training"

Hopefully you'll enjoy picking up some of the terminology

and the next valuation presentation you sit through should be slightly more bearable

Reasons for Valuing Companies

Key to successful trading in (and managing) corporations

Ability to estimate their value

Understanding the sources of their value

Investors do not buy corporations for aesthetic or emotional reasons – but for their expected future cashflows

Inherent value of a company based on forward-looking estimates and judgements

Valuation is fundamental for any decision & negotiations relating to e.g.

Company investments

Mergers

IPO / rights issues

Management project evaluation

Portfolio valuation

Valuation – Basics

Valuation a science or an art? A bit of both

Science:

Certain methods are based on solid mathematical pillars. Has (and is) being researched by

entire university departments, thousand's of professors/PhD's/market practitioners

Foundation of the world's financial system

Art:

Modelling and forecasting of the future (?!?)

• management/key employees, tastes/fashion/sentiment, disruptive technologies…

Material role of fickle (and difficult to model) behavioural issues and biases

overconfidence, overreaction, loss aversion, herding, regret, misestimating of

probabilities..

Fact remains – companies need to be valued and the following

methods are the best tools currently available

Valuation - Reservations

Assumptions and inputs into the models are of paramount importance

Garbage in -> Garbage out

Several "difficult-to-model" factors hugely important

Is it for sale? Is there a buyer? Sale under distressed circumstances? is funding available?

Output from valuation models ≠ current price

Additionally some types of companies are tremendously difficult to value analytically

Start-ups

Biotech/pharmaceutical research

Highly cyclical companies

Companies with large "real options"

Rights to unexplored oil-fields / mining

Online companies (social networking, search engine..)

Valuation Methodologies

Discounted Cash-flow (DCF)

Free Cash Flow to Firm (FCFF), FCF to Equity, Adjusted Present Value (APV)

Multiples / Comparables

P/E, EV/EBITDA, EV/Sales etc.

Other methods

Invested capital, VC Capital Method, Option Pricing, Last round of financing, Break-up value and Dividend Models

..and then the more "sketchy" methods

e.g. Technical Analysis

Balance between model relevance, complexity and number of assumptions

Usually at least two methods used in any valuation exercise

Valuation Method:

Multiples / Comparables

Multiples / Comparables (comps) - Introduction

The idea is to approximate a company's value by comparing it to companies with known

value

Source of figures

Comparable public company multiples

Recent private company transactions

Important to only compare relative value of similar companies (apples with apples)

Similar Industry Scope

Similar Growth

Similar Risk

Similar Results (ROE)

Multiples / Comparables (comps) - Introduction

Many benchmarks can be used (usually industry specific)

Enterprise Value / EBITDA

Enterprise Value / Sales

Price / Earnings (I: V/H) – (Often used for banks)

Price / Book (I: Q-hlutfall) – (Often used for banks)

Price / Net Asset Value (NAV) – (Often used for banks)

Monthly Rent Multiple

Funds under management – (... for e.g. asset management)

# subscribers, # patents, # employees, #website hits / Enterprise Value

etc.

Multiples / Comparables (comps) – Introduction cont.

Positives

Quicker and easier than analytical methods (DCF)

Reflects current market conditions (investor sentiment, bargaining power..)

Helpful in "reality-checking" DCF valuations

Disadvantages

Are the comparable companies similar enough?

E.g. public vs. private, future prospects, sector, management quality, market position, capital structure, tax-scheme…

Doesn't capture value of different scenarios/"what-ifs"

E.g. post acquisition cost-cutting is successful, synergies are achieved, pending lawsuit goes one way or the other..

Disconnect between a multiple and inherent firm value. Hence does not capture systemic under-/overvaluation of companies by the market

Price / Earnings (PER or P/E)

Price Earnings (I: V/H) ratio shows how much accounting profit its owners are entitled to

Example: Stock price = 20, EPS= 2 => PER= 20/2 = 10

Compared to companies similar in risk and prospects PER is an indicator of whether a particular stock is under or overpriced

Several variants

Trailing PER or forward PER (using forecasted earnings)

Primary shares outstanding or diluted number of shares

Average price over period

Generally:

High PER (>16) indicates that the market believes significant growth is on horizon

Low PER (<8) indicates that the market believes current profit levels are unsustainable

IncomeNet

ValueEquity

Shareper Earnings

Price ShareEarnings Price

Price/Book (P/B) and Net Asset Value (NAV)

Price / Book = Value of Equity / Book Value of Equity (I: Q-hlutfall)

Purpose of ratio is to show the market premium to the accounting equity

P/B is used for valuing investments whose value is derived primarily from the underlying value of their tangible assets

Holding companies

Real estate companies

Banks

Companies up for liquidation (solvency value)

Net Asset Value (NAV) is a significantly better measure than book equity

Calculated by correcting the value of assets & liabilities in the accounts

Book value of associates

Book value of fishing quota

Goodwill justified?

Deferred tax liability going to be paid in the near future (Real Estate)? etc.

Some examples from the “real world”

DnB NOR report - Feb 2010

Some examples from the “real world”

Historical development (short term though)

Some examples from the “real world”

Interesting to take a closer look at the DnB NOR report

For further view on the DDM

To see different methods of valuation, in use on the market

To better get the “feel” for professional valuation

... and many other things

Questions and Answers

Q & A