Class 1 Comparables and Precedents1

8/9/2019 Class 1 Comparables and Precedents1

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Comparables Analysis and

Precedents Transactions

November 3, 2012

Joshua Jia | Instructor / CEOJules Koifman | InstructorAlexander Banh | CSO

In partnership with the


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Preparing for finance recruiting isnt just skimming The Vault anymore. Studentsshould study for recruiting like a course anddo their homework, because the finalexam is the interview. VP, recruiter for Queens

Like a course, there should be: Homework: regular readings are necessary Practice (mock interviews) Comprehensive, accessible resources for all interested students

The most important exam of any Commerce students life

Introduction Enterprise Comparables Precedents

Recruiting1

Finance Interview Preparation Workshops


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Candidates differentiate themselves by knowing hard M&A and LBO questions

Queens needs to offer comprehensive resources to continue being competitive

Further Queens Commerces reputation as a career-minded institution

6 Sessions: Saturdays at 4 p.m., Thursdays at 7 p.m.: November 3November 22

1. Comparables Analysis and Precedent Transactions2. Discounted Cash Flows and Accounting3. Mergers & Acquisitions (M&A)4. Leveraged Buyouts (LBO)

5. Market Questions6. Fit / Deals / Networking

Finance Interview Preparation Workshops

Limestone Capital Offering2

Rationale



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3

Information Sessions

The Process

Second week of November Look professional Meet people, get business cards or remember names, follow up Dont ask fluffy, general questions just for the sake of asking them

If you ask generic questions, you will get generic answers Ask about the business, deals, what they like about working at X firm

Interviews

First rounds: third or fourth week of November 80% technical

Final rounds: fourth week of November or first week of December

Mostly fit The dinner Be ready for exploding offers



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4

Capital Markets

Jobs in Capital Markets

Industry Groups:

Metals & Mining (BMO) Financials TMT (CIBC) Real Estate (TD,

Brookfield) Healthcare Consumer Infrastructure Diversified Oil & Gas (Calgary)

Product Groups

M&A Equity Capital Markets Debt Capital Markets Syndication Restructuring

Investment Banking Equity Research Sales & Trading

Groups:

Equity Fixed Income Economic Quantitative

Sovereign

Groups:

Equity Fixed Income Derivatives Currencies

Automated Trading Asset-Backed

Securities



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5

How is Enterprise Value calculated?

Enterprise Value

Two ways to think about Enterprise Value (EV)

Value of the firm: both debt and equity

Theoretical takeover price (no control premium)

Enterprise Value = Market Cap. + Preferred Equity + Minority Interest + Debt - Cash

Why do we use Enterprise Value?

Market cap. only measures the equity value

Ignores debt and preferred shares

Enterprise value represents the value of the firm to both debt and equity holders

The market value of all capitalinvested in the business

Multiples using EV are more comparable



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6

Why do we subtract cash?

Enterprise Value

Imagine buying a company that consisted of the following: Piggy bank with $99 inside

The piggy is worth $1

EV represents the theoretical takeover price

Let the owner keep the $99, pay $1 for the piggy

Buying cash with cash is redundant, so we net it out

Paying off debt with cash

If a company only has $10 of debt and $10 of cash on its balance sheet, it has an

Enterprise Value of zero You can pay off the $10 of debt with $10 of cash; this company is worthless

Debt - Cash = Net Debt



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7 Enterprise Value

Why do we add preferred equity?

In accounting, equity refers to both common and preferred equity

In finance, equity value (market cap.) only consists of common shares

Preferred equity is treated more like debt

Price doesnt move much, dividends are like interest



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8

What are multiples?

Multiples

When we buy stock, we are paying to own a piece of a companys cash flows Although we dont receive the cash, market price should adjust to reflect changes

in expectations of these projected cash flows

Multiples: how much the market is valuing a company relative to the value

stakeholders are receiving, e.g. how much cash that company is generating

How long before I get my money back?

Assume price to earnings ratio of 5

Paying $5 for $1 of earnings

5 years before those earnings add up to original price paid



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9 Common Multiples

Equity Multiples

Price / Earnings: how much are

shareholders paying for $1 of earnings?

Price / Book: how much are

shareholders paying for $1 of equity

book value?

Book represents book value of

equity per share

Price / Tangible Book Value

Tangible Book Value does not

include intangible assets like

patents and Goodwill

Price / Cash Flow

Operating cash flow per share

Enterprise Multiples

Enterprise Value (EV) / EBITDA: how

much are stakeholders (both

bondholders and shareholders) paying

for $1 of EBITDA generation?

EV / EBIT

EV / Revenue



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10 Forward Multiples

Valuing future growth vs. historical growth

Historical last twelve months (LTM) vs. projected next twelve months (NTM)

Historical multiples include EV / LTM EBITDA, EV / LTM Revenue, and Price / LTM EPS

Forward multiples include EV / NTM EBITDA, EV / NTM Revenue and Price / NTM EPS

Price / Earnings-to-Growth

Known as PEG

Price / Earnings Ratio

Annual EPS Growth

Most people prefer forward multiples because it accounts for projected growth

LTM results may be a poor proxy for projected growth because of:

One-time charges

Tax (NOLs)

Past Futurecircumstances have changed



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Multiples must be consistent

Apples-to-Apples

Numerator / Denominator must be the same unit

Dividing kilometers by miles is not meaningful

Apples-to-Apples vs. Apples-to-Oranges

Equity value metrics and enterprise value metrics are different

Value to shareholders vs. value to ALL stakeholders (shareholders, bondholders,preferred shareholders)



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Multiples must be consistent

Apples-to-Apples

Price / Revenue is not meaningful

Price represents the market value of equityholdersholdings

Revenue goes to ALL stakeholders

EV / Earnings is not meaningful

Enterprise value represents the value of the entire firm

Earnings represents value to shareholderssince interest has been deducted



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13

Why is EV / EBITDA generally better than P / E?

EV / EBITDA vs. P / E

P / E is an equity metric, while EV / EBITDA is an enterprise metric

P / E only looks at equity portion, ignores debt / preferred shareholders

P / E is not capital structure neutral

P / E is highly dependent on leverage

More debt

more risk to shareholders

shareholders demand lower P / E

Even if debt is cheaper than equity, the P / E metric will penalize companies who

choose to finance through debt

Using P / E to value companies violates M&M theory

EV / EBITDA is capital structure neutral

The mix of equity and debt does not change EV assuming similar cost of capital

Doesnt matter how you slice the pie, total EV is the same



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What are some issues with using earnings?

Earnings vs. EBITDA

Earnings are subject to manipulation, one-time charges, differing accounting policies,

non-cash expenses, and ambiguity

e.g. Enron

Why do we like EBITDA?

EBITDA is more similar to cash flow and is capital structure neutral

Less room for manipulation

Ignores D&A, a non-cash expense

Ignores interest expense; EBITDA is available to shareholders, bondholders, and

preferred shareholders

EBITDA is a proxy for cash flow available to all stakeholders



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When is P / E better than EV / EBITDA?

Advantages of P / E

If interest is a part of a companys cost of doing business

Banks, financial institutions

Financial

If companies in the industry have negligible amounts of debt

Tech companies

Junior mining companies

Volatile businesses (e.g. startups)

If you are valuing a minority investment

Equity investments with


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16

What is minority interest?

Minority Interest

Also known as non-controlling interest If we own more than 50% of a subsidiary, we consolidate our financial statements with

the subsidiarys

Even if we own only 51% of Company S, 100% of Company Ss income statement line

items are added to our income statement line items

However, only 51% of Company Ss balance sheet line items are added to our

balance sheet items

49% of Company Ss net assets (assetsliabilities) go into minority interest

Minority interest is the part of a subsidiary that we dont own

Found in equity section of balance sheet (IFRS)



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How do we consolidate the parent and subsidiary?

Minority Interest

Parent Corp.

-Income Statement

-Balance Sheet

Subsidiary Corp.

-Income Statement

-Balance Sheet

Consolidated Entity

(Reported by Parent Corporation) Combined Balance Sheet, line-by-line Combined Income Statement, line-by-line Eliminate things like

inter-company gains and losses inter-company balances (Assets/Liabilities) Parents investment in the subsidiary company

Minority interest reported (the percent of the subsidiary not owned by theparent) on both statements



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Why do we add minority interest to get Enterprise Value?

Minority Interest

EV = Market Cap + Preferred Equity + DebtCash + Minority Interest In enterprise multiples, EV is the numerator, and an income statement line item is

often the denominator

Denominator: Income statement line items are consolidated and include 100% of the

subsidiarys (Company S) income statement line items

Numerator:Market Cap + Preferred Equity + Debt accounts for 51% of Company S

The 49% we dont own is not factored into the prices of the parents stock,

bonds, or preferred shares

To make the numerator consistent with the denominator, we add in the 49% of

Company S we dont own (minority interest)

To make multiples like EV / EBITDA, EV / EBIT and EV / Revenue an apples-to-

apples comparison, we add minority interest



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EV / EBITDA Apples-to-Apples

Minority Interest

Market Capitalization + Minority Interest + Preferred Equity + DebtCash

Add the portion of the subsidiary we dont ownso numerator and denominator are consistent

Enterprise Value

EBITDA

subsidiary consolidated byadding minority interest

subsidiary consolidated

from accounting rules



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20

What if we only own 20 to 50% of a company?

Equity Method

Use the Equity Method If we bought 20% of Company E, we get 20% of Company Es net income

Ignore Company Es stock price

Company E is worth $100, we pay $20

Balance sheet itemInvestment in Company E: $20

If Company E reports $10 of net income, we get 20% of that $2

Investment in Company goes up by $2 (Debit)

Investment income goes up by $2 (Credit)



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Short Term Investments

Investments

Short-term investments with less than 20% control Also known as investments held for trading

Mark-to-market

Unrealized gains or losses flow straight to Net Income

Long Term Investments

Long-term investments with less than 20% control

Also known as investments available for sale

Unrealized gains or losses flow through Other Comprehensive Income (OCI)

Only flows through net income after investment is sold



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22

What is comparable companies analysis?

Comparable Companies Analysis

Looking at similar companies and seeing how they are valued on a multiples basis

Common multiples include EV / EBITDA, EV / Revenue, P / B

Taking the average (median) multiple

e.g. 6.0x EV / EBITDA

Apply to target companys metric to get implied valuation

Target companys EBITDA is $5 mm

6.0 x $5 mm = $30 mm implied enterprise value

Valuing a house

Similar to valuing a house

Look at how much surrounding houses are worth relative to square feet (or other metric)

Find median price-to-square feet multiple

Apply this multiple to number of square feet in target house to get implied valuation



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Issues?


Are mansions comparable to normal houses?

Size must be comparable

What other features might affect how much houses are worth?

Number of garage doors?

Number of bedrooms? Bathrooms?

Furnished?

Should price-to-square-feet be the only multiple?



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Pros


Market-based valuation

DCFs often do not reflect short-term market conditions

Reflects market trends: poor marketlower multipleslower implied value

Useful when a DCF is impossible or hard to do

IPO

Private companies with limited information

Minority investments

Shortcut to a DCF

Assume comparables are valued efficiently by the market in a DCF fashion

If every house around you has been appraised, do you really need an appraisal?

Less room for manipulation compared to DCF

Provides a benchmark value based on similar companies



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Cons


Does not account for synergies or control premiums in M&A analysis

Doesnt explain market inefficiencies

If market is irrational, then valuation may be irrational

Difficult to find comparable companies

e.g. Facebook

May not accurately reflect intrinsic value in small-cap, thinly traded stocks

Disconnect from companys projected cash flows

Ignores company specific issues



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Using the Quick Comps Capital IQ feature


Background Situation Solution Implementation

1. Select company in Capital IQ search bar

2. Select Quick Comps



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Using the Quick Comps Capital IQ feature


1. Scrutinize automatically generated list of comparables

2. Add and delete companies

Delete

Add

Export toExcel



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Using Bloomberg to build comps


1. Select company

2. Type in: RV (stands for relative valuation)

3. Add and delete companies to the list

4. Go to Edit Comparables if you want to add different columns (e.g. P / NAV)

5. Export to Excel

6. If file is saved on the same computer, file will automatically update



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Complete Process


1. Select the universe of comparable companies

Competitors, look at research reports

Pull research reports from Bloomberg / Capital IQ

2. Locate the necessary financial information

Canada: Pull annual / quarterly reports from SEDAR, pull investor presentations

United States: Pull 10Ks / 8Ks from EDGAR

Research reports / Factset / Bloomberg for forward estimates

3. Spread key statistics, ratios, and trading multiples

Measure profitability, growth, returns and credit strength

4. Benchmark the comparable companies

Scrutinize list of companies, delete ones that are not comparable

5. Determine valuation



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Selecting your universe of comparables


Make sure companies have similar traits in the following areas

Industry Products Businessis this a pure play? Locationdifferent tax codes Cyclicality Customers

Distribution channels

Operational Financial

Size Leverage Projected growth Risk profile Shareholder base



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Valuation


Current % of Enterprise Value /

Share 52-wk. Equity Enterprise LTM 2013E LTM 2013E LTM 2013E

Company Ticker Price High Value Value Sales Sales EBITDA EBITDA EBIT EBIT

Best Buy Co. Inc BBY:NYSE 18.24$ 64% 6,238$ 6,723$ 0.1x 0.1x 2.6x 2.6x 3.1x 3.9x

Comparables

Radioshack RSH:NYSE 2.79$ 20% 288$ 450$ 0.1x 0.1x 4.6x 3.7x 20.7x 16.5x

Gamestop GME:NYSE 23.15$ 87% 2,673$ 2,535$ 0.3x 0.3x 3.4x 3.3x 4.4x 4.3x

Target TGT:NYSE 64.67$ 74% 42,351$ 58,673$ 0.8x 0.8x 7.9x 7.7x 11.0x 10.9x

Wal-Mart Stores WMT:NYSE 74.50$ 99% 251,537$ 254,048$ 0.6x 0.9x 7.3x 6.7x 9.6x 8.7x

Mean 0.4x 0.5x 5.8x 5.3x 11.4x 10.1x

Median 0.4x 0.5x 6.0x 5.2x 10.3x 9.8x

High 0.8x 0.9x 7.9x 7.7x 20.7x 16.5x

Low 0.1x 0.1x 3.4x 3.3x 4.4x 4.3x

How can we find implied value? Take median multiple (e.g. EV / LTM Sales, EV / 13E EBITDA) Multiply with BestBuys corresponding metric (e.g. LTM Sales, 13E EBITDA) Valuation typically presented in a range



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Issues?


Current % of Enterprise Value /

Share 52-wk. Equity Enterprise LTM 2013E LTM 2013E LTM 2013E

Company Ticker Price High Value Value Sales Sales EBITDA EBITDA EBIT EBIT

Best Buy Co. Inc BBY:NYSE 18.24$ 64% 6,238$ 6,723$ 0.1x 0.1x 2.6x 2.6x 3.1x 3.9x

Comparables

Radioshack RSH:NYSE 2.79$ 20% 288$ 450$ 0.1x 0.1x 4.6x 3.7x 20.7x 16.5x

Gamestop GME:NYSE 23.15$ 87% 2,673$ 2,535$ 0.3x 0.3x 3.4x 3.3x 4.4x 4.3x

Target TGT:NYSE 64.67$ 74% 42,351$ 58,673$ 0.8x 0.8x 7.9x 7.7x 11.0x 10.9x

Wal-Mart Stores WMT:NYSE 74.50$ 99% 251,537$ 254,048$ 0.6x 0.9x 7.3x 6.7x 9.6x 8.7x

Mean 0.4x 0.5x 5.8x 5.3x 11.4x 10.1x

Median 0.4x 0.5x 6.0x 5.2x 10.3x 9.8x

High 0.8x 0.9x 7.9x 7.7x 20.7x 16.5x

Low 0.1x 0.1x 3.4x 3.3x 4.4x 4.3x

Are these companies really comparable with BestBuy? Sometimes it is difficult to find truly comparable companies



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Establishing Multiple Range


HighLow

Note: this example is unrelated to the BestBuy example

4.0x

ClosestComparable A

5.0x

ClosestComparable C

6.0x 7.0x

ClosestComparable A

6.5x

Median Mean

Selected Multiple Range



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EV / EBITDA Valuation

Comparables Valuation

Establish EV / EBITDA range from comparables

Decide range by analyzing closest comparables, median, mean, high and low

Build range for LTM, 2012E, and 2013E

Multiply to companys EBITDA (LTM, 2012E and 2013E)

Arrive at Implied Enterprise Value range

Less: Net Debt (DebtCash)

Assume no minority interest or preferred equity in this case

Arrive at Implied Equity Value

Divide by Fully Diluted Shares Outstanding


Less: FullyFinancial Implied Net Implied Diluted Implied

EBITDA Metric Multiple Range Enterprise Value Debt Equity Value Shares Share Price

LTM 50 10.0x - 13.0x $500 - $650 ($100) $400 - $550 100 $4.00 - $5.50

2012E 55 9.0x - 12.0x 495 - 660 ($100) 395 - 560 100 3.95 - 5.60

2013E 80 8.0x - 11.0x 640 - 880 ($100) 540 - 780 100 5.40 - 7.80


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Similar to comps, but focused on transactions


Comparable transaction analysis

Looks at historical transactions

Similar multiples, but EV is based on EV paid as opposed to market-implied EV

EV Paid / EBITDA, EV Paid / Revenue

Valuation derived from precedents will typically be higher than comparables and DCF

because of control premium

Control premium:

Synergies

Ability to control timing of cash flows

Ability to change management, improve business

Precedents are similar to valuing your house based on how much surrounding houses

were bought for on a price-to-square-feet basis



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Precedents Example


Enterprise Value / LTM Equity Value / Premiums Paid

Date Transaction Purchase Equity Enterprise LTM L TM LTM EBITDA LTM Days Prior to Unaffected

Announce d Acquire r Ta rge t Type Conside ra tion Va lue Va lue Sa le s EBITDA EBIT Ma rgin Ne t Income 1 7 30

03/11/2010 A K Public / Public Cash $1,600 $1,900 1.5x 8.0x 9.1x 18% 13.6x 30% 27% 33%

30/10/2010 B L Public / Public Cash / Stock 900 1,200 1.2x 7.6x 8.7x 16% 13.9x 29% 32% 31%

22/06/2010 C M Public / Private Cash 600 800 1.1x 7.1x 8.1x 15% 12.0x NA NA NA

15/04/2010 D N Public / Public Stock 1,300 1,350 1.6x 8.5x 12.5x 19% 14.4x 29% 36% 34%

01/10/2009 E O Sponsor /

Private

Cash 200 250 1.3x 7.7x 9.2x 17% 13.3x NA NA NA

01/07/2009 F P Public / Public Stock 2,800 3,000 1.4x 8.0x 10.7x 18% 17.7x 33% 31% 36%

06/07/2008 G Q Sponsor /

Public

Cash 1,600 2,000 1.2x 7.5x 9.3x 15% 12.4x 38% 42% 43%

09/11/2008 H R Sponsor /

Public

Cash 900 950 1.2x 7.3x 8.3x 16% 13.1x 34% 35% 36%

21/06/2008 I S Sponsor /

Public

Cash 1,300 1,800 1.0x 7.2x 8.3x 13% 16.0x 35% 37% 39%

20/03/2007 J T Public / Private Cash 370 600 0.9x 6.5x 8.1x 14% 10.6x NA NA NA

Mean 1.2x 7.5x 9.2x 16% 13.7x 33% 34% 36%

Median 1.2x 7.5x 8.9x 16% 13.4x 33% 35% 36%

High 1.6x 8.5x 12.5x 19% 17.7x 38% 42% 43%Low 0.9x 6.5x 8.1x 13% 10.6x 29% 27% 31%



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Pros


Market-based

Based on actual acquisition multiples paid for comparable companies

Recent transactions reflect current market trends, economic conditions, etc.

Simple to use

Recent, key transactions provide a benchmark acquisition multiples

Objective

Based on actual acquisitions, does not make assumptions about the future



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39 More Multiples

Resource

P / NAV: used in mining and energy NAV is a DCF on each of a

companys assets, using a different

discount rate for each project

EV / Production

Measured in BOE / day (barrels of

oil equivalent) or Tonnes / day

(metric tons)

EV / Reserves

EV / Proven Reserves (1P)

EV / Proven + Probable (2P)

1P90%, 2P50%, 3P10%

Finance / Real Estate

P / B and P / E for banks

EV / AUM for asset management firms

AUM = Assets Under Management

EV / FFO for REITs

FFO = Funds from Operations

Net Income + D&A

EV / AFFO

AFFO = Adjusted Funds from Ops

FFO + Rent Increases + Certain

CAPEX Items


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40 More Multiples

Tech

EV / Registered Users EV / Pageviews

EV / Unique Visitors

EV / Subscribers

Retail

EV / Square Feet of Retail EV / EBITDAR

Add back rent to EBITDA

Some retail firms choose to rent,

others choose to buy stores

EBITDAR does not penalize retail

firms for rentingAirlines

EV / Planes

EV / Passengers

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