QUIZ3:REVIEWSESSION

AswathDamodaran

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Thisquizwillcover…

¨  RelaEveValuaEon¤ DefiniEonalconsistencychecks¤ DistribuEonalcharacterisEcs¤ DriversofmulEples¤  ApplicaEontweaks

¨  PrivatecompanyvaluaEon¤ Discountrateadjustments¤  Cashflowadjustments¤  Post-valuaEonadjustments

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MulEples:ThevariaEons

Numerator = What you are paying for the asset

Denominator = What you are getting in return

Market value of equity Market value for the firmFirm value = Market value of equity

+ Market value of debt

Market value of operating assets of firmEnterprise value (EV) = Market value of equity

+ Market value of debt- Cash

Revenuesa. Accounting revenuesb. Drivers- # Customers- # Subscribers= # units

Earningsa. To Equity investors - Net Income - Earnings per shareb. To Firm - Operating income (EBIT)

Book Valuea. Equity= BV of equityb. Firm= BV of debt + BV of equityc. Invested Capital= BV of equity + BV of debt - Cash

Multiple =

Cash flowa. To Equity- Net Income + Depreciation- Free CF to Equityb. To Firm- EBIT + DA (EBITDA)- Free CF to Firm

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Example:Spring2009(Problem1)

YouhavebeenaskedtoassesstherelaEvevaluaEonsoffourcompanies,withsignificantcrossholdings.YouhavebeenprovidedwiththefollowinginformaEononthecompanies:TheaccounEngnumbers(includingdebt)comefromthefirm’sconsolidatedfinancialstatements,andyoucanassumethatbothminorityholdingsandminorityinterestsareinmarketvalueterms.BasedontheEV/EBITDAraEo,whichofthesefirmsisthecheapestonaconsolidatedbasis,assumingthattheyareequivalentonriskandgrowthcharacterisEcs?

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SoluEon

Company B is the cheapest company.

Since EBITDA does not reflect income from minority holdings, subtract minority holdings.Since EBITDA reflects 100% of consolidated subsidiary’s income, add minority interests.

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DistribuEonalproperEes

¨  AsymmetricdistribuEons:ThedistribuEonforamulEpleacrosscompanieswillnotbesymmetric,sincemulEplescannotbenegaEve.

¨  SummarystaEsEcscanbemisleading:SincealltheoutlierslieononesideofthedistribuEon,theaveragewillbeskewedwellabovetheaverage.

¨  Absoluterulesofthumbbreakdown:TheshiasinthevaluesofmulEplesacrossEmewillmeanthatwhatisalowvalueinoneperiodmaynotbealowoneinthenextperiod.

¨  MulEpleshavenocurrencyabachedtothem:YoucancomparevaluesformulEplesacrossmarkets,thoughyoumayhavetocontrolfordifferencesacrossfirms.

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Example:Spring2011,Problem2

¨  TeleMediaInc.isatelecomcompanythatreportedEBITDAof-$15millioninthelastfiscalyearandisexpectedtohaveacostofcapitalof12%forthenext5years.YouesEmatethatthefirmwillbeahealthytelecomfirmandgenerate$25millioninEBITDAinyear5.a.  Ifhealthytelecomstradeat6EmescurrentEBITDAandhavea

costofcapitalof9%,esEmatetheenterprisevalueforTeleMediatoday,assumingthatthefirmmakesittohealth.

b.  NowassumethatTeleMediahasissueda5-yearzerocouponbond,currentlytradingat60%offacevalue.Iftheriskfreerateis3%,esEmatetheprobabilitythatthefirmwillsurviveunElyear5andthesurvival-adjustedenterprisevalueforTeleMediatoday.

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SoluEon

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Analysis:DeterminantsofmulEples

Equity Multiple or Firm Multiple

Equity Multiple Firm Multiple

1. Start with an equity DCF model (a dividend or FCFE model)

2. Isolate the denominator of the multiple in the model3. Do the algebra to arrive at the equation for the multiple

1. Start with a firm DCF model (a FCFF model)

2. Isolate the denominator of the multiple in the model3. Do the algebra to arrive at the equation for the multiple

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TheDeterminantsofMulEples…

Value of Stock = DPS 1/(ke - g)

PE=Payout Ratio (1+g)/(r-g)

PEG=Payout ratio (1+g)/g(r-g)

PBV=ROE (Payout ratio) (1+g)/(r-g)

PS= Net Margin (Payout ratio)(1+g)/(r-g)

Value of Firm = FCFF 1/(WACC -g)

Value/FCFF=(1+g)/(WACC-g)

Value/EBIT(1-t) = (1+g) (1- RIR)/(WACC-g)

Value/EBIT=(1+g)(1-RiR)/(1-t)(WACC-g)

VS= Oper Margin (1-RIR) (1+g)/(WACC-g)

Equity Multiples

Firm Multiples

PE=f(g, payout, risk) PEG=f(g, payout, risk) PBV=f(ROE,payout, g, risk) PS=f(Net Mgn, payout, g, risk)

V/FCFF=f(g, WACC) V/EBIT(1-t)=f(g, RIR, WACC) V/EBIT=f(g, RIR, WACC, t) VS=f(Oper Mgn, RIR, g, WACC)

Aswath Damodaran10

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Example:Spring2011,Problem1

DylanInc.isaall-equityfunded,publiclytradedfirmthattradesatapricetobookraEoof1.40.Thefirmisinstablegrowth,growing3%ayearandhasacostofequityof8%.a.  EsEmatethereturnonequityforDylanInc.,assuming

thatthefirmiscorrectlypricedatthemoment. b.  Thefirmislookingtorestructureitself,bysellingoffits

worstperformingdivisionforhalfofbookvalueandbuyingbackstockwiththeproceeds;thedivisionaccountedfor25%ofthebookvalueofthecompanybutonly10%ofthenetincome.Ifthecostofequityandgrowthrateremainunchanged,esEmatethepricetobookraEoaaerthetransacEon.

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SoluEon

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Analysis:Controllingfordifferences

1.  Directcomparisons:Ifthecomparablefirmsare“justlike”yourfirm,youcancomparemulEplesdirectlyacrossthefirmsandconcludethatyourfirmisexpensive(cheap)ifittradesatamulEplehigher(lower)thantheotherfirms.

2.  Storytelling:Ifthereisakeydimensiononwhichthefirmsvary,youcantellastorybaseduponyourunderstandingofhowvaluevariesonthatdimension.Anexample:Thiscompanytradesat12Emesearnings,whereastherestofthesectortradesat10Emesearnings,butIthinkitischeapbecauseithasamuchhighergrowthratethantherestofthesector.

3.  ModifiedmulEple:YoucanmodifythemulEpletoincorporatethedimensiononwhichtherearedifferencesacrossfirms.

4.  StaEsEcaltechniques:Ifyourfirmsvaryonmorethanonedimension,youcantryusingmulEpleregressions(orvariantsthereof)toarriveata“controlled”esEmateforyourfirm.

Aswath Damodaran13

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Example:Spring2012,Problem1

¨  SerengeEHotelsisamulEnaEonalhotelcompanythatgenerated$60millioninaaer-taxoperaEngincome(aaertaxesof40%)andreporteddepreciaEonof$80millioninthemostrecentyear.Thefirmalsoreported$300millioninbookvalueofequity,$300millioninbookvalueofdebtandacashbalanceof$100million.SerengeEhas100millionsharestradingat$7/shareanditsbookvalueofdebtisequaltoitsmarketvalue.a.  EsEmatetheEV/EBITDAmulEpleforSerengeEHotels.(1point)b.  YouhaverunaregressionofEV/EBITDAformulEnaEonalhotelsand

arrivedatthefollowingoutput:EV/EBITDA=1.60–1.50(Taxrate)+36.00(Returnoninvestedcapital)–0.50

(DebttoEquityraEo)(Allindependentvariablesareenteredasdecimals.Thus,a40%taxrateisenteredas0.40)

IfSerengeEisfairlypriced,relaEvetothesector,esEmatethedebttoequityraEoforthefirm.

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SoluEon

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PrivateCompanyValuaEon:DiscountRateAdjustments

¨  Costofequity:ThebiggestissuethatyouwillfaceinvaluingprivatebusinessesisthatthecostofequitywilldependuponhowdiversifiedthepotenEalbuyerofthebusinessis,withlessdiversifiedbusinessesseeingmoreriskanddemandinghighercostsofequity.

¨  DebtraEo:AsecondaryissueisthatprivatebusinesseshavenomarketvaluesandusingamarketD/EraEocanbeproblemaEc.

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TheBetaConEnuum&DebtSoluEon

Market BetaUsually obtained from publicly traded companies in business

Diversified buyerPublic company or IPO

Total Beta = Market Beta/ Correlation of typical firm in the sector versus market

Buyer invested only on this business

Partially diversified investor: VC or PE firm

Total Beta = Market Beta/ Correlation of VC portfolio versus market

Once you have an unlevered beta or total beta, you can either use the industry average debt ratio, a target debt ratio or an iterated debt ratio (based on your values).

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Privatefirms:TheCashflowchecks

1.  Istheownerinvolvedinthebusinessbutnotpayinghimself/herselfasalary?

2.  Arethereany“ghost”or“personal”expensesintermingledwithbusinessexpenses?

3.  DothereporEngbooksmatchthetaxbooks?4.  Isthereakeypersondiscount?5.  Isthereapossibilityofataxrateshiaaaerthe

transacEon?

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Example:Spring2012,Problem3

¨  YouareCEOofapubliclytradedcompany,ProExMedia,andthecompanyiscurrentlyallequity-fundedandhasabetaof1.20;thecorrelaEonofthestockwiththemarketis0.40.ProExMediaisexpectedtogeneratenetincomeof$60millionnextyearonbookequityof$1billion;itisastablegrowthcompanythatexpectstogrow3%ayearinperpetuity.Ifyouinvesttherestofyourpersonalwealthinit,youbelievethatyoucouldtakethecompanybacktobeingaprivatebusinessandcoulddoubleitsnetincome(withoutchangingthebookequityinvestedortheexpectedgrowthrate).Assumingthatyouplantokeepthebusinessasaprivatelyownedbusinessintheaaermath,evaluatewhetherthistransacEonmakessense.(Theriskfreerateis3%andtheequityriskpremiumis6%)

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SoluEon