Copal Partners Module

Copal Partners

Investment Banking Module

Index Table of Content


Introduction to Investment Banking




Valuation Methodologies

14

A. Valuation Techniques

18

B. Comparable Company Analysis

21

C. Comparable Transaction Analysis

95




3

D. DCF Valuation

112

Pitch book Building

150

A. Profiles

154

B. Case Studies

175

C. Industry overview

187

D. Research Techniques

205

2

What is Investment Banking? Is it investing? Is it banking? In reality, it is neither! Investment banking, or I-Banking, as it is often called, is the term used to describe the business of advising corporates around their financial needs and raising capital for companies



Buy & Sell securities for their clients and provide stock advice



Facilitate buying and selling of stocks, bonds, options, currencies, derivatives and other financial products (Flow & Exotic)



Clients include Institutional Investors like pension funds, mutual funds, private clients/ HNI’s and individual investors, investment arms of non-finance companies



Follow stocks and make recommendations on whether to buy, sell or hold securities



Prepare Initiation Reports, Sector Reports and also Market Reports



Provide investment ideas for the Sales & Trading Group



Analyze and forecast economic trends, interest rate movements and other industry level parameters and perform valuations on companies within industry sectors they follow



Work with clients in determining financing needs and structuring specific financial strategies



Provide underwriting services on issue of equity or debt securities



Provide advice on Mergers and Acquisitions, foreign exchange, economic and market trends, and specific financial strategies such as corporate restructurings

Sales and Trading

Equity Research

Corporate Finance / Advisory

3

Dynamics/ Relationship between various institutions

Financing

M&A

Corporate Finance

Corporate Finance

Prospectus, Placement memorandums, Valuation, Underwriting

M&A valuation, Deal structuring, Restructuring, Asset sales and purchase, Synergy analyses

Equity Research

Analyst Presentation

Equity Research

Initiation reports Coverage report Road shows

Coverage Report

Coverage report Event Report Deal notes

Corporates Sales & Trading

Sales & Trading

Market making Proprietary Trading

Market making Proprietary Trading Chinese Wall

4

Typical Corporate Finance Deal Team Title

Experience

Education

 Managing Director

Vice President

Associate

Analyst

8+ Years 

Usually Top-Tier MBA



Top Undergraduate Universities,



Usually Top-Tier MBA



Top Undergraduate Universities,



Usually Top-Tier MBA

3- 8 Years

0-3 Years

0-1 Years

Top Undergraduate Universities,



Top Undergraduate University

5

Role Managing Directors primarily pitch ideas to clients to source deals. Managing Directors spend most of their time in bringing business to the banks, executing transactions for clients and maintaining existing client relationships. Vice Presidents are also responsible for finding new clients and servicing existing clients. VPs however spend more time managing Analysts and Associates and in the pitch book creation process Associates manage analysts’ work and are primarily responsible for financial models and pitch book creation. In addition, they may be involved in dealing with the MDs and going over details of potential deals or discussing numbers (commercial and financial DD) Analysts perform all research and analysis, build financial models and put together the pitch book (deal coordination, commercial and financial due diligence)

What do they do and how do they make money? Investment banks perform the following major functions: 





Corporate Finance & Advisory services, for which they receive fees –

Underwrite securities and provide advisory services

–

Provide M&A advisory

–

Provide financial advisory services to companies, governments and other agencies

Sales & Trading activities, for which they earn spreads –

Trade securities and commodities

–

Manage individual and institutional investor’s funds

–

Provide brokerage services, invest own resources, make loans

Equity Research, they make money from two sources, primarily from investors / readers of the reports and secondly, from firms they are covering for which they are paid a set annual fee in cash; they do not accept any form of equity, which may cause conflicts of interest –

Provide information on market

–

Conduct financial statement analysis and build financial models to derive a company's proper valuation

Investment banking activities tend to be more profitable than commercial banking activities; based on the fees rather than interest rate differentials

6

What are Chinese Walls in Investment Banking? Legal and physical separation between investment banking and trading activities is termed as Chinese Walls. Chinese walls are necessary to separate different departments within large financial institutions such as investment banks that serve clients in different capacities simultaneously, leading to conflict of interest. All investors in the market should play on a level field, where no one has access to privileged information leading to an undue advantage, due to their favorable position.

A brief history: The Chinese wall concept in investing originated from the Glass-Steagall Act, when the separation of investment banking from brokerage operations was embraced by the securities industry regulators.

For example, the corporate finance department of an investment bank may know of takeover bids that are being considered, but for the bank's trading or fund management operations to act on this information would constitute insider trading. This makes it necessary that such information is restricted to the departments actually involved, so that other departments can function normally.

Glass-Steagall Act: This Act was enacted during the Great Depression in 1933, after the1929 stock market crash, to restrict the securities activities and affiliations of banks. The act was intended to protect banks, prevent conflicts of interest and other abuses and safeguard the financial system. This act set up a regulatory firewall between the commercial and investment banking activities.

This wall is not a physical boundary, but rather an ethical and legal one that financial institutions are legally bound to observe. 7

Role of Corporate Finance To make it convenient, from now onwards by Investment Banking we would mean Corporate Finance

Corporate Finance

Financings

Client Advisory Includes: Acquisitions Private Company Sale Public Company Sale Corporate Restructuring Corporate Divestitures Joint-Ventures

Includes: Initial Public Offerings (IPO) Secondary Offerings Debt Syndication Equity Private Placements

Bankers generally generate business through pitching transaction ideas to clients. “Pitch Books” - presentations the bankers use for their clients, contain general information and include a wide variety of selling points they make to potential clients. Pitch books almost always include valuation and research analysis on a number of companies and/or industries Pitch books again can be categorized as follows: 

General : Usually, general pitch books include an overview of the I-bank and detail its specific capabilities in research, corporate finance, sales and trading, primarily used to showcase credentials.



Deal-specific. Deal-specific pitch books are highly customized and are prepared specifically for the transactions that bankers are proposing to their clients

8

What are the various types of groups within an Investment Bank? There are broadly two types of groups within a typical investment bank (or investment banking division): 

Product groups: The three most well known product groups are mergers and acquisitions (M&A), leveraged finance and restructuring.



The products of an Investment Bank, are basically advisory for M&A, Financing, Restructuring, etc., hence a Group covering any of the above activities would be a Product group



Bankers in Product groups have product knowledge and tend to execute transactions (respectively M&A transactions, leveraged buyouts (LBO’s) and restructuring transactions/bankruptcies).



For e.g. an M&A banker would be a specialist in deal structuring (equity or cash etc.), types of deal structures, takeover codes (legalities, regulation) in a particular country etc .



Industry groups (also called sector groups or domains): Bankers in industry groups cover specific industries and develop expertise in a particular sector. They tend to do more marketing activity (pitching).

Examples of common industry groups include FIG (Financial Institutions Group), Healthcare, Consumer/Retail, Industrials, Natural Resources, TMT (Telecom, Media and Technology.. Often subgroups exist within the broader group. For example, a Healthcare group may be segregated into biotechnology, medical devices, pharmaceuticals, etc.

9

Bulge Bracket Banks and Corporate Finance Boutiques Bulge Bracket Banks: The term “bulge bracket” generally refers to the large investment banks that cover most or all industries and offer most or all of the various types of investment banking services. While there is no official list of bulge bracket banks, some examples are BAML, JP Morgan, Credit Suisse, Deutsche Bank etc. Corporate Finance Boutiques: These are small in size, ranging from a few professionals to hundreds or even thousands of professionals; can generally be categorized into three types: –

specializing in one or more products

–

specializing in one or more industries and

–

specializing in small or mid-sized deals & clients (generally less than $500 million)



Boutiques known for M&A, often compete with the bulge bracket banks for M&A transactions. A few examples include Lazard, Greenhill, Evercore



Other boutiques offer many different products but specialize in one or more industries. Such boutiques often compete with the bulge bracket banks on the basis of their industry knowledge and expertise. A few examples include Cowen & Co. (healthcare), Allen & Co. (media) and Thomas Weisel Partners (technology), Avendus (technology in India)



The third type of boutique, those that offer many products and cover many industries but compete only for “middle market” or smaller deals include Jefferies & Co., Piper Jaffray, Raymond James. Many of these middle market boutiques are regionally focused.

Some of the Indian boutiques are Equirus, O3, Edelweiss, Mape Advisory, Pears Capital , Numinous Consulting, Viedea Capital

10

Top Global Investment Banks (M&A) Worldwide Announced deals - 2010 Financial Advisor Goldman Sachs & Co Morgan Stanley JP Morgan Credit Suisse Citi Barclays Capital Deutsche Bank AG Bank of America Merrill Lynch UBS Lazard Rothschild HSBC Holdings PLC Nomura Evercore Partners BNP Paribas SA Jefferies & Co Inc Greenhill & Co, LLC Houlihan Lokey Blackstone Group LP Santander Centerview Partners LLC RBC Capital Markets KPMG Mizuho Financial Group RBS

Deal Value (in $mn)

Freeman Fees (in $mn)

425,164 346,039 330,835 327,179 299,167 265,094 242,883 236,383 231,960 188,637 127,830 98,194 87,404 79,257 78,350 72,904 70,551 61,464 54,777 51,225 50,161 48,909 44,578 43,279 41,921

1,952.8 1,421.7 1,400.3 1,046.4 729.4 715.6 831.5 906.6 850.9 845.0 746.5 212.0 320.6 209.4 300.1 354.3 202.3 349.6 169.6 – – 344.0 – – 153.2

Source: Thomson Financial 11

Number of Deals 325 331 280 249 185 133 224 204 230 259 245 79 171 35 110 114 47 167 41 47 13 133 327 121 59

Transaction Volumes Completed Deals Worldwide: Annual Transaction Volume Date Effective/Unconditional

Deal Value (in $mn)

Number of Deals

2008 2009 2010 2011

1,924,659 1,848,453 1,893,852 824,484

24,890 30,431 32,114 8,762

Industry Total

6,491,448

96,197

Excludes Equity Carveout, Exchange offers and Open Market Purchases

Source: Thomson Financial 12

Role of KPOs in the Investment banking industry

CLIENT MARKETING

RESEARCH & ANALYSIS

Investment Banks DEAL EXECUTION

KPO’s

13

Copal Partners

Valuation Methodologies

14

Valuation Methodologies 

Valuation Methodologies can be categorized as under: A. Fundamental valuation: A stand-alone valuation methodology to compute the intrinsic value of an asset B. Relative valuation: Valuing an asset relative to its peers

A. Fundamental Valuation:


The DCF (WACC, FTE, APV) model of valuation is a fundamental method.




Value of firm (equity) is the PV of future cash flows.




Ignores the current level of the stock market (industry).




Appropriate for comparing investments across different asset classes (stocks vs. bond vs. real estate, etc).

B. Relative Valuation:


Comparable company analysis and comparable transaction analysis are relative valuation methods




Relative valuation is based on P/E ratios and a host of other “multiples”.




Can not compare value across different asset classes (stocks vs. bond vs. real estate, etc).




Can not answer the question “is the stock market over valued?”




Can answer the question, “I want to buy a tech stock, which one should I buy?”




Can answer the question, “Which one of these overpriced IPO’s is the best buy?”

15

Fundamental Valuation Concepts 

Fundamental analysis is a technique that attempts to determine a security’s value by focusing on underlying factors that affect a company's actual business and its future prospects.



On a broader scope, one can perform fundamental analysis on industries or the economy as a whole. The term simply refers to the analysis of the economic well-being of a financial entity as opposed to only its price movements.



The various fundamental factors can be grouped into two categories: quantitative and qualitative.



–

Quantitative – capable of being measured or expressed in numerical terms.

–

Qualitative – related to or based on the quality or character of something, often as opposed to its size or quantity.

Fundamental analysis serves to answer questions, such as: –

Is the company’s revenue growing?

–

Is it actually making a profit?

–

Is it in a strong-enough position to beat out its competitors in the future?

–

Is it able to repay its debts?

–

Is management trying to “cook the books”?

16

Relative Valuation Concepts 

Relative valuation answers the question “How does the value of an asset compare with the values assessed by the market for similar or comparable assets”



Absolute values of comparable assets are standardized for the purpose of comparison. Friendly – The Board recommends the offer – How would you compare a pencil priced at Rs.10 with another pencil priced at Rs. 20?



Standardized values – values with a common numerator – are called price multiples



Comparing the price multiples of comparable assets can give an indication of whether an asset is under or over valued. – If Rs.10 pencil lasts 10 days and Rs. 20 pencil lasts 16 days, is Rs. 10 pencil over or under valued compared to the Rs. 20 pencil? – Everything else being equal, which one would you buy?

17

Copal Partners

Valuation Techniques

18

Valuation Overview 

Valuation is the process of determining the current worth of an asset. Valuation answers the question “How much will it cost to acquire the asset?”



Further Valuation analysis is done to answer questions like:





–

“How much should Acquirer pay to buy the target?”

–

“Is the price offered for the company fair to shareholders?”

–

“Is company undervalued / overvalued in the industry?”

–

“What is the underlying value of the business against which debt is being issued?”

–

“Should we buy/sell/hold positions in a given security?”

Thus, Investment banks perform valuation on firms, or parts of firms for several reasons: –

Contribution into a Join Venture or Mergers & Acquisitions (Buy side or sell side engagements)

–

Recommended bid for an acquiring firm

–

Assess Public equity offerings IPO etc

–

Floatation of debt or equity or credit

Valuations are not scientific. It is highly dependent on a strong set of assumptions and inputs. A valuation is only as good as the quality of inputs. Analyst look at a variety of valuation methods to quantify value.

19

Valuation Techniques There are three primary methods of valuing a company: 

Comparable Company Analysis (Trading Comps) – Trading Comps analyze key valuation ratios of comparable companies that are trading in the market to give an indication of what fair value is and compares firm’s financial performance to its market value.



Comparable Transactions Analysis (Transaction Comps) – Transaction Comps analyze value based on historical takeout multiples of comparable targets to give an indication of what one would have to pay to acquire the company. It also includes control premium.



Discounted Cash Flow (DCF) – Discounted cash flow analysis is based on cash flow generation potential of business. It uses projected cash flows in the future to determine the value of company at the present time. It involves discounting levered / unlevered cash flows by equity cost of capital or weighted average cost of capital.

20

Copal Partners

Comparable Company Analysis (Trading Comps)

21

Index Table of Content


Overview

23




Key Definitions

24




Source of Information

29




Selection of Comparable Companies

31




Equity and equity linked information

32




Market Capitalization

41




Balance Sheet

47




Enterprise Value

58




Income Statement

61




LTM & Calendarization

74




Understanding Multiples

78 22

Overview 

Comparable Company Analysis (‘comps’) is the most basic and effective valuation tool used by investment bankers for the analysis of publicly listed companies across various industries.



This technique is used in private market valuation, IPO valuation, comparative analyses, identifying potential targets for M&A etc



Comps establishes value of a company and measures its performance vis-à-vis the operating and trading statistics of the company’s peer group (“comparable companies”)



Valuation metrics and financial ratios used/ analyzed vary from project to project, depending on the industry and information available



Trading Comps define the concept – “comparison of apples-to-apples”



A standard comp contains operational statistics containing: –

Financial performance parameters such as Revenue, EBIT, EBITDA and EPS

–

Share price performance parameters such as current & 52 week high/low share price, margin and long term growth rate



These inputs define the output Multiple sheet (the comps) containing various Enterprise Value (EV) multiples. Common valuation multiples used are EV/Sales, EV/EBITDA, EV/EBIT, P/E, P/B



Since the comps provide multiples prevailing at a given point of time, they provide a static view of comparable companies and can change over a period of time depending on the company’s financial performance and market performance (stock performance)

23

Key Definitions 

Represents the market value of all outstanding shares



Calculated as Total number of shares outstanding x current share price



A privilege, in which the underlier is the common stock of a corporation, that gives the buyer the right, but not the obligation, to buy or sell a stock at an agreed-upon price during a certain period of time or on a specific date



A right granted to employees of a company to buy a certain amount of shares in the company at a predetermined price. Employees typically must wait a specified vesting period before being allowed to exercise the option

Warrants



A derivative security or certificate that gives the holder/ bearer the right to purchase securities (usually equity) from the issuer at a specific price within a certain time frame

Convertibles



Securities, usually bonds or preferred shares, that can be converted into common stock at a specified conversion price

Market capitalization

Stock Options

24

Key Definitions (cont’d) Fully Diluted shares

Treasury stock method



Represents the number of shares that would result if all stock options, warrants and convertible debts were traded in for stock.



Treasury stock method is used in determining the number of shares outstanding



Results in an increased number of shares outstanding and decreased earnings per share



The purpose of the Treasury method is to account for the cash generated by the exercise of options and/or warrants



Treasury stock method assumes that the options and/or warrants are exercised at the beginning of the year (or issue date if later) and such proceeds are used to repurchase outstanding shares of common stock



Example Current share price

$ 50

Shares outstanding Options/ warrants outstanding Exercise price Proceeds from conversion of in the money options

400 mn 10 mn $ 25 10 x $ 25 = $ 250mn

Stock buyback (at premium) Diluted Shares

$ 250 / $ 50 = 5 mn 400 + 10 – 5 = 405 mn

25

Key Definitions (cont’d) 

Includes all interest bearing obligations both long-term and short-term such as loans, credit facilities etc



Excludes in-the-money convertible debt

Minority Interest



Represents portion of equity not owned by the majority shareholder - a significant but non-controlling interest of less than 50%

Preferred equity



Represents class of stock carrying preference over equity stake holders to receive dividend and repayments in the event of liquidation

Capital lease



A lease that transfers substantially all risks and rewards of ownership to the lessee

Cash and cash equivalents



Represents cash, marketable securities and short-term investments that can easily be converted to cash

Total debt

26

Key Definitions – Some Examples Example 2. Which of the following statement is correct: a) Restricted cash is always excluded from cash for calculation of net debt b) Restricted cash, if related to debt, include in cash for calculation of net debt c) Restricted cash, if related to Letter of credit and Bank Guarantees, include in cash for calculation of net debt d) Restricted cash is always included in cash for calculation of net debt Example 3. Calculate the fully diluted shares outstanding: Shares o/s

470 mn

Current price

$30.00

Options o/s

10 mn

Exercise price

$20.00

Exercise price

$40.00

Warrants o/s 5 mn a) 470 mn b) 485 mn c) 473.3 mn d) 471.6 mn

27

Key Definitions – Some Examples (cont’d) The correct answer is (c)!!!!!!!! Current stock price

$30.00

Exercise price of options

$20.00

Since, the exercise price of options is less than the current stock price, the options are “In the money” However, the exercise price of warrants is more than the current stock price, the warrants are “Out of the money” Dilution effect of Options can be calculated as: Amount raised from exercise of options

= Number of Options X Exercise price of options = 10 X 20 = $ 200 mn

Shares bought back at current market price = Amount raised from exercise of options / Current stock price = 200 / 30 = 6.67 mn shares Dilution effect of Options

= Number of Options - Shares bought back at current market price = 10 – 6.67 = 3.3 mn shares

Total number of diluted shares

= 470 + 3.33 = 473.3 mn shares

28

Filings and Sources Source all data from the Company’s official latest financial filings Check Company Website, Investor Relation Section, look out for latest:  Annual Report (AR)  Quarterly / Interim / Half Yearly Report ( Q1, Q2, Q3, Q4 or IR )  Press Releases and Announcements For US companies  Annual report - SEC filing - 10K (From 10kwizard.com or www.sec.gov)  Quarterly report (SEC – 10Q)  Press releases, pro forma filings, M&A announcements (SEC filing – 8K)  Prospectus (SEC filing – 424B series) For Non-US companies listed in US stock exchange  Annual report (SEC filing – 20F, 40F )  Quarterly/ Half-yearly report (SEC – 6K )  Press releases and Announcements (SEC – 6K )  Research Reports (For Forward Estimates) Note:

(i) Always use most recent filings for EV calculation as we are looking for the current and most recent financial position of the company (ii) Always use the pro-forma financials in case the company has completed a major acquisition or divestiture (iii) Where the company has made restatements and filed restated financials, always use such restated financials.

29

Filings and Sources (cont’d) 

Stock Exchange where Company is listed



Stock exchange is a very important source and provides lot of useful information such as latest shares outstanding, latest financials filed by the Companies, recent press releases or announcements.



Apart from Company Website and Stock Exchange, bankers also use various databases for their cross references such as: –

Bloomberg

–

FactSet

–

Thomson Reuters

–

Thomson One Banker

–

Capital IQ

–

Merger Market

–

Factiva

–

Hoovers

–

One Source

–

DataStream

Note:

There are many more databases apart from the names mentioned above used by companies for their analysis. Since these are all paid data sources, companies subscribe them according to their work requirement.

30

Peer Group Identification 

Peer Group Analysis means identifying a list of comparable companies for valuation.



The following criteria should be borne while doing the preliminary search for selecting the companies to form a peer set: –

Similar Industry, featuring into the same sub-sector, having product categories which are related

–

Same size of companies, can be identified with similar operating margins, growth rate, cash flow, number of employees etc

–

Having similar customer segmentation

–

Ideally should belong to same region/country/geography

–

Should not be undergoing any unusual or major strategic changes, such as an M&A, divestiture

There are various sources available for Peer Analysis such as Thomson One Banker, Bloomberg, Reuters, OneSource, Research Report, Google Finance, Company Websites (for Description), broker reports etc.

31

Equity and equity linked information – Shares 

Source Shares Outstanding from the most recent financials



Number of shares should exclude the treasury shares or own shares. Treasury shares are shares repurchased by the company and do not have the right to dividends, have no voting rights, and should not be included in shares outstanding calculations.



In case of companies filing with SEC, outstanding shares can generally be found on the cover page of the 10K, 10Q, 20F report. In case of Non US companies search out for filings on various sources including Company Website, Latest Filings and Stock Exchanges of the respective country.



Where a Company has more than one class of share, with all classes being listed, input the total of all classes of shares in shares outstanding and calculate weighted average share price



In case, one class of share is listed and the other class of shares are unlisted, input the total of listed and unlisted shares in shares outstanding and assume the share price of unlisted shares to be equal to that of listed shares

32

Equity and equity linked information – Shares (cont’d) In the given example of Novell Inc, the number of shares outstanding is 353.053202 mn. This is obtained from the cover page of 10Q Jan 2011 filing Annotation 10Q Jan 11, cover page, Shares outstanding as of 28 Feb 2011

33

Equity and equity linked information – Shares (cont’d) Example 4. Calculate the Market cap of ABC Co. with the available information Particulars

Details

Par Value

Market price

Class A Shares o/s

200 mn

$10.00

$500.00

Class B Shares o/s

10 mn

$100.00

Unlisted

a. $ 100,000 mn b. $ 100,500 mn c. $ 105,000 mn d. $ 150,000 mn The market cap in this case is $150,000 mn Market Cap for Class A shares = 200 X 500 = $100, 000 mn Since Class B shares are unlisted, we will calculate the price of class B shares as follows: Price of Class A shares / Par value of Class A shares X Par value of Class B shares $500.00 / $10 X $100 = $5,000.00 Market Cap for Class B Shares = 10 X 5,000 = $50,000 mn Market Cap for the Company = $100,000 + $50,000 = $150,000 mn

34

Equity and equity linked information – Shares (cont’d) Example 5. Calculate the latest shares outstanding with below mentioned data:

The correct answer is (a)!!!!!!!!

Particulars

Date Details

Since the stock split has been effected on June 30, 2010, we will not adjust the Shares outstanding

Shares O/S

31-Dec-10

350 mn

Stock split

30-Jun-10

2:1

Share buyback

15-Mar-11

10 mn

Stock dividend

20-Feb-11

2:1

Shares Outstanding as on Dec 31 = 350 mn Stock dividend

= 350 X 2/1 = 700 mn

Share buyback (March 15) = 10 mn Latest Shares Outstanding as on March 15, 2011= Shares Outstanding as on Dec 31 + Stock dividend - Share buyback

a) 1,040 mn b) 1,360 mn c) 690 mn

350 + 700 – 10 = 1,040 mn

d) 1,380 mn

35

Equity and equity linked information – Options and warrants 

Input information on Options (and Warrants) from latest financials. 10K or annual filings are usually the best source



Notes to the financials should provide detailed information on total number of Options & warrants outstanding, traunche-wise details and the weighted average strike price on them. Ensure that the equivalent number of shares and not “number of options or warrants” are entered



Input the ‘Options Outstanding’ and weighted average exercise price of such outstanding options and NOT the ‘Options Exercisable’



Depending on the space available in the template, input options/ warrants outstanding and weighted average exercise price tranche-wise or in aggregate.



In case options/warrants have a range of exercise price, take the average or lower of the range for maximum dilution effect.



Read Management Discussion & Analysis and Notes to Financial statements closely and ensure all option plans/ warrants are incorporated

36

Equity and equity linked information – Options and warrants (cont’d) In the given example of Novell Inc, the total options (equivalent shares) outstanding are 30.933 mn, with a weighted average exercise price of USD 3.96

37

Equity and equity linked information – Convertible debt 

Input information on Convertible debt (value) from latest financials. Latest financials should provide price of Conversion or at least the conversion ratio from where the conversion price can be deduced. If not, revert to the previous annual report for conversion price



If convertible price of the convertible debt is not given, read the relevant notes and MD&A to figure out the conversion ratio i.e. the number of shares into which the debt will be converted. Only “in the money” debt are considered for weighted average exercise price of the convertible debt



While convertible debt is in the money, it will be treated as equity, once it falls out of the money it will be added back to debt



Depending on the space available in the template, input convertible debt and conversion price tranche-wise or in aggregate.



Input a comprehensive note for the convertible debt

38

Equity and equity linked information – Convertible debt (cont’d) Equity and equity linked information – Convertible debt Example 6 Current share price Book value of Convertible debt

$ 50 $ 200 mn

Conversion price per share Equivalent shares on conversion of in-the-money convertible debt

$ 40 200/ 40 = 50 shares

Current share price Book value of convertible debt (par value $1000 each) $ 100 mn Conversion ratio Conversion price per share of convertible debt

$ 50

Example 7

(out of money and hence added to debt)

39

16 $ 1000/ 16 = $ 62.5

Equity and equity linked information – Convertible debt (cont’d) Example 8. If a company has convertible debt of US$100 mn with a conversion price of US$ 50.00, the company's current price is US$ 51.00, which of the following treatment is correct: a) Include US$ 100 mn in net debt b) Include US$ 100 mn in Market Cap c) Include equivalent number of shares in shares outstanding d) Include equivalent number of shares in shares outstanding and do not include US$100 mn in net debt

The correct answer is (d)!!!!!!!

When the convertible debt is converted into equity shares, the liability for the debt is eliminated and the number of common equity shares is increased

40

Market Capitalization Dual Listing When a security is registered for trading on more than one exchange. The treatment of dual listed companies depends upon the specifications of the end user . However, the two common treatments of dual listed companies are as follows: Treatment 1 : In certain cases, weighted average market capitalization is calculated by adding the product of share prices prevailing on both the exchanges & shares outstanding for respective classes of shares Treatment 2 : Output for both the classes of securities is shown separately. Market Capitalization is calculated using the share price on each exchange. For example, in case of Chinese companies which are also listed on Hong Kong stock exchange, will have inflated prices on Chinese stock exchange, so it is better to analyze them using both the classes of shares separately. Market Cap, EV and multiples for different class of shares are calculated as: Market Capitalization: Market Capitalization to be calculated for both class of shares using share outstanding for each class and their respective share price Net Debt : Bifurcate total net debt into two classes of shares based on proportion of market cap Enterprise Value: Calculate EV (Market cap + Net debt for respective class) and EV per share for each class Multiples: Calculate per share value of relevant financial metrics (Revenue, EBIT, EBITDA, EPS) Calculate multiples for each class separately using EV per share for each class and per share financials as calculated

41

Market Capitalization (cont’d) Example 11 A Company XYZ Inc. has two Class of shares A & H. As at 30 Apr 11 Share Price (April 30, 2011) Shares outstanding HKD - CNY Exchange rate

Class A CNY 50.00 16,500 mn 0.8955

As at 31 Mar 11 Net Debt Minority Interest LTM Revenue LTM EBIT LTM EBITDA LTM EPS

CNY 4,250 mn CNY 20,500 mn CNY 82,000 mn CNY 33,000 mn CNY 41,500 mn CNY 1.04

Calculate the relevant multiples

42

Class H HKD 35.00 3,400 mn

Market Capitalization (cont’d) Step 1. Calculation of Market Cap, EV and Multiples for both the class of shares Class A Share Price CNY 50.00 Shares outstanding 16,500 mn Market Cap CNY825,000 mn Market Cap (CNY) CNY825,000 mn Proportion of Market Cap 88.56% Net Debt (In proportion of Market Cap) CNY 3,763.8 mn Minority Interest CNY 18,154.9 mn Enterprise Value CNY 846,919 mn (approx.) EV / Share CNY 51.33

Step 2. Calculation of financials per share

Class H HKD 35.00 3,400 mn HKD 11,9000 mn CNY 106,565 mn (approx.) 11.44% CNY 486.1 mn CNY 2,345.1 mn CNY 109,396 mn (approx.) CNY 32.18

Multiples

Class A

Class H

Revenue / share

CNY 82,000 / 19,900 (16,500+3,400)

CNY 4.12

Revenue

12.46x

7.81x

LTM EBIT / share

CNY 33,000 mn / 19,900

CNY 1.66

EBIT

30.95x

19.40x

LTM EBITDA CNY 41,500 mn / 19,900

CNY 2.09

EBITDA

24.61x

15.43x

LTM EPS

CNY 1.04

P/E

48.08x

30.14x

43

Market Capitalization (cont’d) Shares / Depositary Receipts A negotiable financial instrument issued by a bank to represent a foreign company's publicly traded securities. The depositary receipt trades on a local stock exchange. When the depositary bank is in the U.S., the instruments are known as American Depositary Receipts (ADRs). European banks issue European depositary receipts, and other banks issue global depositary receipts (GDRs).

Treatment of shares / DR’s Generally, the companies which have depository receipts, are analyzed on the basis of the stock price of the company. In that case, all the shares related information is calculated on the basis of stock price. However, in certain cases, two individual tabs are created for the same company – in one tab, all the shares and price related information is calculated on the basis of DR’s using the Shares-DR ratio with the price of DR’s and in the other, on the basis of stock price. Also, in this case, the company is presented twice, once on the basis of stock price and second, on the basis of DR.

44

Market Capitalization (cont’d) Example 12. XYZ Inc. has 250 mn shares outstanding as at 31 Dec 2010. The company’s also has its ADRs listed at NYSE Following information is available from company’s AR Dec 10 Shares outstanding

250 mn

Price per ADR as on 25 Apr 2011

$20.00

Company made following fresh issues during the month of March: On 10 Mar 2011

25 mn shares

On 25 Mar 2011

10 mn ADR

On 30 Mar 2011, company announced bonus issue of 1 share for every 4 shares held. 1 ADR represents 4 ordinary shares of the company Calculate the Market cap of company as on 25 Apr 2011 a)

$ 1,968.8 mn

b)

$ 5,700 mn

c)

$ 6,300 mn

d)

$7,875 mn 45

Market Capitalization (cont’d) The correct answer is (a) !!!!! Shares outstanding as on 31 Dec 10 Add Shares issued on 10 Mar 11 Add ADR issued on 25 Mar 11 Equivalent number of shares*

= 250 mn = 25 mn = 10 mn = 10 X 4 = 40 mn

Shares outstanding as on 25 Mar 11

= 315 mn

Adjusted for Bonus issue (1:4)

= 315*1.25 = 393.8 mn

ADR Price per share Market Capitalization

= $20.00 = 393.8 X 20 / 4 = $ 1,968.8 mn

* Each ADR represents 4 ordinary shares

46

Balance Sheet Balance Sheet Information - Source data in this section from the latest financials Cash and Cash Equivalents

Consolidated Balance sheet as at 31 Jan 2011 Novell Inc (amounts in thousands)

In the above case of Novell, cash and cash equivalents shall be: $ 981.426 + $ 150.009 = $ 1,042.915 mn

47



Includes cash and bank balances



Includes cash equivalents & marketable securities



Includes short-term investments



Cash equivalents are highly liquid short-term investments that can be easily converted to cash



Short term investments aren't as liquid as money in a bank account, but provide added cushion if some immediate need arises



Cash and cash equivalents should generally exclude restricted cash. Restricted cash represents that portion of cash or equivalents that are earmarked for specific purposes or restricted for the purpose of intended use. However, if cash is earmarked for a particular debt fund, that has been included in total debt, then such restricted cash is included in the calculation of EV



Strategic investments are not taken into consideration



Check end user requirements for changes in assumptions

Balance Sheet (cont’d) Balance Sheet Information - Source data in this section from the latest financials Total Debt 

Debt includes all interest bearing liabilities (long term and short term) of the Company i.e. obligations that have a financing cost to the company (such as Bank overdrafts / Current portion of long term borrowings / short term and long term loans / Convertible debts)



Include preferred equity, minority interest and capital leases in debt.



Consider Capital lease obligation ONLY if it is stated in the Balance Sheet. Do not confuse capital lease obligations with the operating lease obligations. The latter is an expense item in the income statement



Read the MD&A and Notes to financial statements closely as sometimes ‘Minority Interest’ is not represented in the Balance Sheet as a separate item but is given in the ‘Other Liabilities’



Include pension liabilities (deficit) in debt, only if specific guidelines have been given to that effect. Pension deficit is the value of all pension obligations minus the market value of any pension assets



–

In case of a US Company: US GAAP has the requirement for the company to give a separate note for Pension assets and pension liabilities. Pension deficit is = Pension Liabilities Less Pension Assets

–

For a company in UK: FRS 17 gives the accounting policy for a separate disclosure of pension deficit

–

For other companies: Read the MD&A and Notes to financial statements and determine accordingly

–

Always consider Net Pension Liability recognized in the balance sheet or Unfunded or Deficit in Pension Fund. In case company reports surplus ie Pension Assets are more than Liabilities, ignore it.

Remember to exclude in-the-money convertible debt and include out of money convertible debt in total debt 48

Balance Sheet (cont’d) Balance Sheet Information - Source data in this section from the latest financials Consolidated Balance sheet as on 31 Jan 2011 Novell Inc (amounts in thousands)

In the given example, the total debt for EV calculation shall be: Senior Convertible Debenture (Add minority interest if reported separately)

Shareholders’ equity 

Input from the latest financials the book value of shareholders’ equity or stockholders’ equity.



Remember shareholders’ equity is always excluding minority interest. 49

Balance Sheet (cont’d) Balance Sheet Information - Source data in this section from the latest financials Long Term Investments 

Read the note for Long term investment and check whether company has invested in private unquoted company or in Quoted/ Listed/ Traded company or in mutual funds or government stocks.



Consider the long term investment in public company, mutual funds and government stocks as their market value can be assessed easily. Ignore any invest done in private or unquoted company.



Remember for the ultimate effect, long term investment is treated as a part of cash and cash equivalents and gets excluded from EV.

Equity Investments 

Includes Investment in Affiliates / Subsidiaries / Joint Ventures / Associated Company / Equity Affiliates



Mostly Company reports equity investments as a separate line item in their balance sheet.



Consider all equity investments irrespective of short term or long term or quoted or unquoted.



Remember for the ultimate effect, long term investment is treated as a part of cash and cash equivalents and gets excluded from EV.

50

Balance Sheet (cont’d)



Check the note for Non Current Investment – Long Term and consider only the portion invested in Quoted/ Listed/ Traded company or in mutual funds or government stocks.



Add Current Investment in Marketable Securities in Cash and Cash Equivalents



Also consider Investments in Associates Undertaking for valuation.

51

Balance Sheet (cont’d) Balance Sheet Information – Adjustments The latest financial publication is used to determine Enterprise value. However, there are certain corporate actions, which if they occur subsequent to the date of the latest filing, have to be given effect as these have an impact on the Enterprise value. A few of these adjustments include: Stock Split : A stock split is a corporate action involving the dividing of company’s existing stock into multiple shares. This is effected by reducing the par value of shares and increasing the number of shares. The Shareholders’ equity remains the same. Adjustments to be effected include:. 

Increase the number of outstanding shares



Check that the stock price is split-adjusted



Increase the number of equivalent shares on conversion of options and reduce (in the same ratio) the exercise price



Similar effect on warrants and convertible debt (exercise price)

Equity issue : In case a company makes a fresh additional equity issue, the following adjustments have to be made: 

Increase the number of shares outstanding by the fresh number of shares issued



Increase shareholders’ equity by issue value



Increase cash by the “net proceeds” of the issue



Check for pro forma filings

Stock Buyback : When a company repurchases the shares it had previously issued, it is called a ‘Stock buyback’. This reduces the number of shares outstanding in the market. Adjustments to be effected include: 

Decrease the number of shares outstanding by the number of shares repurchased



Decrease cash by the amount used to repurchase shares



Reduce shareholders’ equity by value of treasury stock repurchased 52

Balance Sheet (cont’d) Balance Sheet Information – Adjustments Debt Issue : A Company when in need of funds, can raise Debt as a source of funds. It may be preferable than issue of shares as debt issue leads to no dilution of control of company. Adjustments include: 

Add the ‘Net proceeds’ to Cash. Net Proceeds means proceeds received, net of any discount and expenses of issue.



Add the face value of the debt to the Total debt

Debt Redemption or repayment of a Debt outstanding in the books. 

Deduct the ‘Net outflow’ from Cash. Net Outflow means net outflow of cash including discount or premium on redemption



Deduct the face/ book value of the debt from the Total debt outstanding before such redemption

Rights Issue: If the company decides to issue additional shares (equity) as a source of raising additional capital, it may be obliged to first offer such shares (or rights) to the existing shareholders. In effect , the number of shares outstanding increases. Adjustments similar to equity issue. Bonus Issue: In the case of a bonus issue, equity shares are issued to existing shareholders for no additional consideration. It is also called a capitalization issue. There is no effect on shareholders’ equity. Adjustments are to be made to outstanding shares, options/ warrants and corresponding exercise prices with respect to bonus factor. Stock Dividend: A dividend is the distribution of profits to a company's shareholders. Such distribution can be in the form of cash or issue of stock ( i.e. Stock Dividend). In the case of stock dividend additional shares are issued to existing shareholders without any receipt of cash from them. There is no effect on shareholders’ equity. Adjustments are to be made to outstanding shares, options/ warrants and corresponding exercise prices

53

Balance Sheet (cont’d) Example 9.

A company announced a two for one stock split and a stock dividend of 25% on 10 May 2011 ( i.e. after the release of results for Q1 Mar 2011):

Following information is available from company’s IR Mar 11 Shares outstanding

465.52 mn

Share price as on 15 May 2011

$12.00

Company bought back shares from open market as follows: On 15 April 2011

25 mn shares

On 12 May 2011

55 mn shares

What is the share outstanding and market cap as on 15 May 2011? a) 963.8 mn shares and Market cap $11,565.6 mn b) 1,083.8 mn shares and Market cap $13,005.6 mn c) 1,046.3 mn shares and Market cap $12,555.6 mn d) 1,163.8 mn shares and Market cap $13,965.6 mn

54

Balance Sheet (cont’d) The correct answer is (c) !!!!! Shares outstanding as on 31 Mar 11

= 465.52 mn

Less Shares bought back on 15 Apr 2011

= 25.00 mn

Shares outstanding as on 15 Apr 2011

= 440.52 mn

Adjustment for Stock Split: Shares o/s adjusted for Stock split of 2:1

= 440.52*2 = 881.04 mn

Shares o/s adjusted for Stock dividend of 25%

= 881.04*1.25

Shares o/s as on 10 May 2011

= 1,101.30 mn

Less: Shares bought back on 12 May 2011

= 55 mn

Latest shares outstanding

= 1,046.30 mn

Share price as on 15 May 2011

$ 12.00

Market Cap

$12,555.6 mn

55

Balance Sheet (cont’d) Example 10. Following information is available from company’s AR Dec 10 Short-term debt Long-term debt

$ 50mn $ 200mn

Cash and cash equivalents$ 150mn (Convertible notes included in Long term debt $ 50mn, conversion price $20 per share) Company did following transactions during the March 2011: On 5 Mar 2011 Issued debentures worth $100mn (debt issue expenses $ 9mn) On 15 Mar 2011 Redeemed senior notes of face value of $20mn On 18 Mar 2011 Holders of convertible debt worth $ 25mn exercised their option of conversion Calculate adjusted total debt and cash and cash equivalents a) Cash $230mn, Debt $305mn b) Cash $221mn, Debt $305mn c) Cash $205mn, Debt $305mn d) Cash $230mn, Debt $330mn

56

Balance Sheet (cont’d) The correct answer is (b) (in USD mn)

Particulars

Balance as on 31 Dec 10

Cash

Short term debt

Long Term Debt

Total Debt

150

50

200

250

5 Mar 11

Issue of debentures

91

-

100

100

15 Mar 11

Redemption of senior notes

(20)

(20)

-

(20)

18 Mar 11

Conversion of convertible debt

-

-

(25)

(25)

221

30

275

305

Adjusted balance

57

Enterprise Value Formula to calculate Enterprise Value

Total Enterprise Value (TEV or EV) is the term bankers use when they refer to the total value of a company (also referred to as Aggregate Value)

Market Capitalization + Total Debt

Enterprise value is a measure of the actual economic value of a company at a given point of time. It reflects what it would actually cost to purchase the entire company

+ Minority Interest + Preferred Stock +

One could believe that a possible way to calculate the value of a company would be to look at the value of the assets in the company’s balance sheet. This is a common misconception because the assets in the balance sheet are recorded using the historical value and thus it is not the value the company has today

Capital Leases

Cash & Cash Equivalents

Generally for public companies TEV = market value of the equity + total debt (short and long term) + minority interest + preferred stock + capital leases – cash and cash equivalents

= Enterprise Value or “EV”

The method and assumptions for calculation of enterprise value varies with every financial institution, banker and industry

-

58

Enterprise Value vis-à-vis Market cap Enterprise value 

is a measure of the actual economic value of a company at a given point of time



reflects the actual purchase price anyone acquiring the company would have to pay



indicator of how the market attributes value to a firm as a whole



many investors use the current value of all of a company's outstanding shares or market capitalization, as a proxy for its economic value

Why doesn't market capitalization properly represent a firm's value? Although market capitalization is the key component of the actual economic value of a company, it is not the only one. In order to calculate a more ‘Accurate value’ we need to consider the other things which come as a baggage along with the company when it is acquired. We have to take into account all the obligations which are now to be discharged by the acquirer Role of Debt and Cash In the event of a buyout, the buyer has to pay the equity value and would have to assume/ repay the company’s debt. Of course, the buyer gets to keep the cash available with the firm, which is why cash needs to be deducted from the firm's price

59

Enterprise Value Example 1. What is the Market Cap & EV for the company: B/S as on 31 Dec 2010 (in CNY mn): Cash Debt Minority Interest Current exchange rate for HK$ to CNY is 1.1

200 175 50

Share Price (in HK$) Shares outstanding (in '000)

a) Market Cap is CNY 25 mn & EV is CNY 50 mn. b) Market Cap is HK$ 25,000 mn & EV is CNY 25,025 mn. c) Market Cap is HK$ 27.5 mn & EV is CNY 52.5 mn. d) Market Cap is CNY 27.5 mn & EV is CNY 52.5 mn. The correct answer is (d)!!!!!!!! Share Price (HK$)

5.00

Share Price (CNY) = SP(HK$) X HKD – CNY Exchange Rate Share Price (CNY) = 5.00 X 1.10 = CNY 5.50 Market Cap (CNY mn) = 5.50 X 5,000 / 1,000 = CNY 27.5 mn Enterprise Value (CNY mn) = Market Cap + Debt + Minority Interest – Cash Enterprise Value (CNY mn) = 27.5 + 175 + 50 – 200 = CNY 52.5 mn

60

5.00 5,000

Income Statement Income Statement Information 

Revenue/ Net Sales: Income from sales of goods and services, minus the cost associated with elements such as returned or undeliverable merchandise, discounts, and allowances. Also called ‘sales revenue’, ‘net sales’, ‘net revenue’, and ‘sales’



Other revenues: The total revenues which the company has earned may include other revenues incidental to business. These are revenues derived from activities not directly related to the operations of the Company and therefore should not be included in turnover. For instance, Rental income should not be included in turnover. However, revenues of real estate companies will primarily consist of rental income. Therefore, identify the Company’s business and decide the composition of revenues accordingly



EBITDA: EBITDA means earnings before interest, taxes, depreciation and amortization. It is an indicator of the cash earnings that a company generates from its on going and recurrent operations regardless of its capital structure. EBITDA can be used to analyze the profitability between companies and industries, because it eliminates the effects of financing and accounting decisions. (EBITDA is often used as an indicator of unlevered cash flow in case of scarce information).



EBIT: EBIT means earnings before interest and taxes. It measures the income that a company generates from its on going and recurrent operations. Also called Operating Income or Income from Operations



Net Income: Net Income represents total earnings available to common shareholders. Net Income is derived by subtracting all costs of doing business, depreciation, interest and taxes from revenues. Share of minorities for the period and preferred stock dividends, must also be deducted to arrive at Net Income. 61

Income Statement (cont’d) Income Statement Information - Normalization 

Normalization refers to the process of adjusting/ removing the effect of extraordinary and one-time items from components of Income Statement (revenues, EBITDA, EBITA, EBIT & Net Income)



For the purpose of Comps, companies have to be evaluated and compared on basis of trading / valuation metrics and thereby it is imperative that any exceptional and non-recurring items impacting the operating results of a company be removed and cleaned, so as to make its results comparable within its peer group



Some examples of exceptional / non-recurring items include restructuring charges, impairment, gain on sale of fixed assets, income from divested business etc



Always read through the Notes to Financial Statements and MD&A closely to identify extraordinary items. Details of exceptional items are generally found in the Notes to financial statements and MD&A



Rule for making adjustments

–

ADD Exceptional charge, non-recurring expense or loss

–

REDUCE Exceptional or non-recurring gain, one-time gains

–

For adjusted net income, make appropriate tax adjustments for the tax impact of such extraordinary items. Read the MD&A closely for actual tax impact of exceptionals, if available. If not, use the marginal tax rate for making tax adjustments. Marginal Tax rate should be effective or statutory tax rate.

62

Income Statement (cont’d) Income Statement Information Let us consider the case of Novell Inc. Example: Normalized Revenue

If you look at the Consolidated Statement of Operations you would say that the company’s revenue for FY 2010 would be USD 811.871 mn. But it is equally important to check the Management Discussions & Analysis (MD&A) section of the Annual 10K, where you will find the breakup of the total net revenue figure. There you might find any exceptional item which shall not be included as a part of core revenue of company. This is the reason why it is very important to carefully review the notes to the financial statements and the MD&A section. Also, always consider Net revenue after deducting sales tax and not the Gross Revenue!!

Net Revenue = USD 811.871 mn

63

Income Statement (cont’d) Income Statement Information Example: Normalized EBIT

The Company states that its operating income was USD 84.437 mn Is this equal to EBIT? No! Look carefully at the line items above the operating income. These include the following expenses which are non-recurring and not directly related to the operation of the business : Restructuring expenses, impairment of goodwill, impairment of intangible assets, purchased in process research & development, gain on sale of property, plant and equipment, gain on sale of subsidiaries. These items should not be included in the EBIT calculation. We need to adjust for these “one time” expenses or gains to get the correct EBIT

Company has not reported any amount except restructuring expenses, hence we will adjust EBIT for the latter.

EBIT = 84.437 + 2.774 = $ 87.211 mn

64

Income Statement (cont’d) Income Statement Information Example: Normalized EBITDA EBITDA is one of the most commonly used terms by investment banker because it is an efficient way to understand the efficiency and profitability of a company EBITDA is calculated as Normalized EBIT + Depreciation and Amortization Always remember to take Depreciation & Amortization from the cash flow statement

EBITDA = 87.211 + 30.298 = USD 117.509 mn

65

Income Statement (cont’d) Income Statement Information Example: Normalized Net Income

In the Consolidated Statement of Operations, the Company reports a net income of USD 377.366 mn We need to adjust the reported Net income figure to get the normalized net income like we did for the previous EBIT calculation. The company has a couple of non-recurrent and extraordinary items which also have to be adjusted to get the accurate net income. One of such items is the Impairment / write down of Investments Now is net Income equal to: = 377.366 -7.413+2.774= $ 372.727 mn. Wrong!

66

Income Statement (cont’d) Income Statement Information Example: Normalized Net Income Adjust for Tax : Always remember that when you are dealing with net income you have to account for the tax implications of an increase or decrease in profits. Net income is always calculated after taxes, and in a way expenses act as a tax shield, as the higher expenses you have the less taxes you pay. Thus, One time and extraordinary charges have to be adjusted for tax. Here, we shall use the statutory tax rate of the country of incorporation of the Company (which is 40% in case of Novell Inc. as it is a US company ) There are certain cases we need to remember when we charge Net Income for tax such as – 1. Always charge Exceptional or one off items for tax whenever company is reporting net profit in its books. 2. In case company is reporting net loss, tax adjustment is done only if loss turns into profit after adjusting for exceptional items and than tax is charged on the whole figure including net loss. 3. If the resulting figure for net loss remains negative even after adjusting exceptional items, there will be no tax adjustment at all. 4. Remember to tax-effect all adjustments to net income, if items relate to an after-tax financial statistic and are tax-deductible. Do not tax adjust a net loss or non-tax deductible items such as goodwill Therefore, the adjusted Net Income

= 377.366 + ( -7.413+2.774)* (1- 0.40)

67

= $ 374.582 mn

Income Statement (cont’d) Income Statement Information Example: Normalized EPS Earnings per share (EPS) represents the portion of a company's earnings, net of taxes and preferred stock dividends, but before equity dividends allocated to each share of the company’s common stock Basic EPS = Normalized Net income Weighted average basic shares outstanding

Basic EPS = $ 374.582 / 349.741 = $ 1.071

Diluted EPS = Normalized Net income Weighted average diluted shares outstanding

Diluted EPS = $ 374.582 / 353.447 = $ 1.059

68

Pro-forma Financials 

Companies may acquire or divest businesses during the year



Pro-forma financials means restated financials of the company adjusted to give effect to any corporate actions so as to reflect the continuing financials position of the company going forward



Reasons for calculating Pro-forma financials: –

Acquisitions

–

Mergers

–

Divestitures

–

Spin offs

–

Capital Restructuring

69

Pro-forma Financials (cont’d) How to identify whether Pro-forma financials to be done 

Checking corporate actions (Source: Company Press Releases, Announcements, Stock Exchange press releases)

Table 1



Comparing historical financials vis-à-vis forward estimates –

–

Exceptionally high increasing trend in forward financials as compared to reported financials reflect the possibility of a major acquisition (Table 1)

Similarly very steep decline in forward financials as compared to reported financials reflect the possibility of a divestiture/ hive off/ spin-off, etc (Table 2)

FY10A

FY11E

FY12E

Revenues

1400

3000

3500

EBITDA

750

2300

2450

EBIT

600

2050

2180

FY10A

FY11E

FY12E

Revenues

1400

550

610

EBITDA

750

350

390

EBIT

600

310

380

Table 2

70

Pro-forma Financials (cont’d) 1. In case the pro forma financials are reported by the company – use them for your analysis to know the current position of the company

71

Pro-forma Financials (cont’d) 2. If pro-forma financials are not reported by the company, calculate it by adding financials of the acquired company in case of acquisition and exclude the financials of the divested business in case of a divestiture

Question. On 15 Dec 10, ABC Ltd announced the acquisition of XYZ plc. The acquisition was completed on 12 February 2011. Now, in case ABC does not release proforma financials adjusted for the acquisition of XYZ for its Fiscal year ended 31 Dec 10, then we may calculate the proforma financials of the combined entity by adding the financials of ABC and XYZ for the fiscal year ended 31 Dec 10

72

Income Statement Information – Indicative exceptional list S. No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Line item Joint Venture Discontinued operations Restructuring cost / expenses Expenses related to merger and acquisition transactions Write down / Impairment of assets (both tangibles and intangibles including goodwill) Impairment of leasehold expenses Loss / Gain on sale of tangible & intangible assets Loss / Gain on sale of investments, other than marketable Amortization of deferred compensation Equity based compensation expense- stock options or warrants Writing back of any provisions or reserves Gain/Loss on sale of marketable securities Income from associates / affiliates Litigation settlement Loss / Gain on sale or termination of an operation Foreign currency exchange gain / loss Accounting changes Tax benefit from exercise of options Provision for doubtful accounts Amortization of debt issuance costs Expenses associated with the Sarbanes Oxley Act Rental income Government grants or subsidies Severance costs Facilities consolidation Gain / Loss on early extinguishment of debt Early retirement costs Redundancy costs Donations Amortization of Negative goodwill

Add Back Y Y Y Y

Tax adjustment Comment Y Different treatment for different purposes Y No tax adjustment if net of tax Y Y

Y

Y

Y Y Y/N Y Y Y/N N Y Y Y Y Y/N Y N Y Y N Y Y Y Y Y Y Y Y

Y Y Y Y Y Y Y Y Y Y

No tax adjustment on Goodwill

Loss/ Gain on strategic investment is exceptional

Provision is exceptional or not

No tax adjustment if net of tax Cumulative effect relating to exceptions is exceptional

N N Y Y N Y Y Y Y

To be excluded from EBIT calculations

Restructuring expense

Y Y N

Item can be treated as exceptional or normal depending upon the industry and analysis 73

LTM & Calendarization Trailing Twelve Months (TTM / LTM) A Graphical Representation

There will be times when the most recent company financial statement is a quarterly report or a half-year report. In such cases the results for the last twelve months/ trailing twelve months are derived.

LTM Results

LTM is calculated as under:

Reported Fiscal Year- annual report

Q1

Q2

Reported previous year accumulated 6 month results LTM =

Q3

Q4

Q1

Q2

Reported accumulated current year 6 month results

Fiscal year results + Results of current stub period Results of corresponding prior stub period



Input financial results of the latest complete fiscal year



Add financial results for the accumulated current partial year result (stub period)



Deduct financial results for the corresponding stub period (partial year) of the previous year (i.e. for the same period but for the previous year



Remember to follow all the guidelines previously discussed for income statement when inputting the figures

74

LTM & Calendarization (cont’d) Example 13: If LTM Sales need to be calculated (for a company with Dec FYE) as in March‘11, calculate the LTM sales from the below mentioned data: Dec 09

1,200

Dec 10

1,300

Mar 11

850

Mar 10

900

b)1,300

c) 1,250

a) 1,200

Dec 11E

1,400

d) 1,350

The correct answer is (c) !!!!! LTM Sales as on Mar’11 as: Sales for Fiscal Year

= 1300 mn

Add: Current Stub ending Mar 11

= 850 mn

Less: Prior Stub ending Mar 10

= 900 mn

LTM Sales for Mar 11

= 1300 + 850-900 = 1250 mn

75

LTM & Calendarization (cont’d) Forward Information – Estimates 

Valuation multiple can be calculated on both a latest twelve months (“LTM”) and a forecasted basis. Companies trade most typically off expected future performance (analysts’ estimates)



Earnings estimates are obtained from various broker research reports or databases such as Bloomberg, Capital IQ, Factset estimates. Adjust the earnings estimates for any exceptionals



For the purpose of deriving trading multiples, estimates are determined on a calendar year basis. This is done to ensure consistency and enhance comparability within comps



In case of companies with fiscal year end other than December, the forecasted estimates are “calendarized”. Calendarization is the process of prorating estimates that are available on fiscal year basis, to derive estimates on a calendar year basis.



Consider the following example Fiscal year end of company XYZ Forecasted revenues for FY 2011 Forecasted revenues for FY 2012

30 September $ 1,200 mn $ 1,440 mn

Revenues for calendar year 2011 shall be determined as under: Forecasted revenues for FY 2011 pro rated for 9 months Add Forecasted revenues for FY 2012 pro rated for 3 months Forecasted revenues for calendar year 2011 (Jan – Dec 11) 76

$ 1200 x 9/12 = $ 900 mn $ 1440 x 3/12 = $ 360 mn $ 900 + $ 360 = $ 1,260 mn

LTM & Calendarization (cont’d) Output currency Find out the output currency in which the figures are to be reported. The output flows in the desired currency when we input the relevant exchange rates ( i.e. Local currency to the desired currency). This is done to ensure consistency and enhance comparability within comps The following exchange rates are used for conversion: 

Average exchange rate for income statement figures for the relevant fiscal years Example: If the fiscal year of a company ends in September 2010 (Local currency being USD and Desired currency being EUR) the exchange rate to be used will be USD - EUR average conversion rate from 1st October 2009 to 30th September 2010



Period end exchange rate for balance sheet figures In case the latest filling period ends on 30th Sep 2010, use USD-EUR conversion rate as on 30th Sep 2010



Current spot rate for forward estimates and market capitalization USD-EUR spot rate as on the date of share price Ques: Which of the following exchange rates will be used for converting Net debt outstanding as on 31 Dec 10 (FYE) for the comparable company analysis being done on 31 Mar 11 (a) Average exchange rate for FYE 31 Dec 10 (b) Spot exchange rate as on 31 Dec 10 (c) Spot exchange rate as on 31 Mar 11 (d) Average exchange rate for the quarter ended 31 Dec 10

77

Understanding Multiples 

Multiples are ratios with equity value (Price) or enterprise value (EV) in the numerator and a standardizing factor (Earnings, Sales, Book Value, etc.) in the denominator. – Price/Earnings (PE) and variants (PEG and Relative PE) – EV/EBIT – EV/EBITDA – EV/Cash Flow – EV/ Book Value of Assets – EV/Sales – P / Book value



Both the value (the numerator) and the standardizing factor ( the denominator) in multiples represent the same claimholders in the firm – For instance, value of equity is standardized with equity earnings, and enterprise value (value of entire firm) is standardized with EBITDA or book value of assets



For multiples to make sense, the standardizing factor (earnings, EBITDA, etc) must be computed using same accounting rules across all firms being compared

78

Multiples – Example 1 Example 1. Please calculate Sales, EBITDA, EBIT and P/E multiple: (all figures in US$ mn except share price) Share Price20.00

Correct answer is (b)!!!!!!…

Market Cap10,000 Debt

250

Cash

400

Minority Interest

100



Enterprise Value = Market Cap + Debt + Minority Interest – Cash



EV = 10,000 + 250 + 100 – 400 = 9,950



Multiples:

Cash in Escrow account 50

– Revenue = 9,950/2,500 = 3.98x

Sales

2,500

– EBITDA = 9,950/(800+200) = 9.95x

EBIT

800

– EBIT = 9,950/800 = 12.44x

D&A

200

– P/E = 20.00/0.75 = 26.67x

EPS

0.75

EV/Sales=4.00x, EV/EBITDA=10.00x, EV/EBIT=12.50x, P/E=26.67x EV/Sales=3.98x, EV/EBITDA=9.95x, EV/EBIT=12.44x, P/E=26.67x EV/Sales=3.96x, EV/EBITDA=9.90x, EV/EBIT=12.38x, P/E=26.67x EV/Sales=3.94x, EV/EBITDA=9.85x, EV/EBIT=12.31x, P/E=26.67x 79

Using Multiples In order to use a multiple effectively to pass judgment on valuation of a firm: 

Know how the multiple was computed – Same multiples can be computed differently. For instance, P/E can be computed as Price/LTM Earnings, Price/Fiscal Year Earnings, or Price/Forward Earnings Estimate



Define the comparable asset universe of the multiple – It can be all firms in a sector, industry, entire market, or any subset thereof



Understand the fundamentals (growth, risk, profit margin, etc. ) that drive the multiple, and the nature of the relationship between the multiple and each fundamental variable – These relationships explain the variations in multiple across firms – The relationship between a fundamental (like growth) and a multiple (such as PE) is seldom linear. For example, if firm A has twice the growth rate of firm B, it will generally not trade at twice its PE ratio – It is impossible to properly compare firms on a multiple, if we do not know the nature of the relationship between fundamentals and the multiple



Know the cross sectional distribution of the multiple across comparables – Multiples have no value when looked at in isolation

80

Price/Earnings (PE Ratio) 

PE = Market Price per Share / Earnings per Share



There are a number of variants on the basic PE ratio, based upon how the price and the earnings are defined



Price is usually the current price – Though some like to use average price over last 6 months or year



EPS can have following variations – Time variants: EPS in most recent financial year (current), EPS in most recent four quarters (trailing), EPS expected in next fiscal year or next four quarters (both called forward) or EPS in some future year – Primary, diluted or partially diluted EPS – EPS before or after extraordinary items – EPS measured using different accounting rules for outstanding shares (options expensed or not, pension fund income counted or not, etc)

81

Multiples – Example 2 Example 2. Calculate the Basic P/E, Diluted P/E, adjusted Basic P/E & adjusted Diluted P/E multiple with the following information: (all figures in US$ mn except share data) Share price $10.00 Shares outstanding

1,000

Wtd. Avg. shares outstanding (Basic) 950 Wtd. Avg. shares outstanding (Diluted) 990 Revenue

5,000

Restructuring charges

1,000

One-time Insurance recoveries Non-recurring charges EBIT

500

300

1,500

Interest Expenses

500

Reported Net Income

500

(after adjusting tax @30%) a) P/E 19.00x, Diluted P/E 19.80x, Adj. P/E 19.00x, Adj. Diluted P/E 19.80x b) P/E 19.00x, Diluted P/E 19.80x, Adj. P/E 8.96x, Adj. Diluted P/E 9.34x c) P/E 19.00x, Diluted P/E 19.80x, Adj. P/E 7.31x, Adj. Diluted P/E 7.62x d) P/E 19.00x, Diluted P/E 19.80x, Adj. P/E 4.13x, Adj. Diluted P/E 4.30x 82

Multiples – Example 2 (cont’d) Correct answer is (b)!!!!!!!!!... Reported net income = US$ 500 mn Adjusted net income = Net income + Restructuring charges* - One-time Insurance recoveries* + Non-recurring charges* * Adjusted for tax @ 30% Adjusted net income = 500 + (1,000 – 500 + 300)*(1-0.3) = US$ 1,060 mn Reported Basic EPS = 500/950 = US$ 0.53

Reported Diluted EPS = 500/990 = US$ 0.51

Adjusted Basic EPS = 1,060/950 = US$ 1.12

Adjusted Diluted EPS = 1,060/990 = US$ 1.07

Reported Basic P/E = 10.00/0.53 = 19.00x

Reported Diluted P/E = 10.00/0.51 = 19.80x

Adjusted Basic P/E = 10.00/1.12 = 8.96 x

Adjusted Diluted P/E = 10.00/1.07 = 9.34x

83

PE Fundamentals 

To understand the fundamentals, start with a basic equity discounted cash flow model – Dividend discount model for equity price

P0 =

DPS1 r−g

– Where, DPS1 is dividends per share next year, r is equity risk, and g is perpetual growth rate 

The above relationship implies that, other things held equal: – Higher growth firms will have higher PE ratios than lower growth firms – Higher risk firms will have lower PE ratios than lower risk firms – Firms with lower reinvestment needs will have higher PE ratios than firms with higher reinvestment rates

84

Enterprise Value (EV) Ratios 

While Price earnings ratios look at the market value of equity relative to earnings to equity investors, Enterprise Value ratios look at total value of the firm relative to total operating earnings or free cash flows



The form of value to cash flow ratios that has the closest parallels in DCF valuation is the value to Free Cash Flow to the Firm, which is defined as: – EV/FCFF – EV = Market Value of Equity + Market Value of Debt - Cash – FCFF = EBIT (1-t) - (Cap Ex - Depreciation) - Chg in Working Cap

85

Multiples – Example 3 Example 3. What is the EV/EBITDA, EV/EBIT and EV/FCFF for the company: (all figures in US$ mn) Share Data

Income Statement

Share Price

$5.00

Revenue

Shares outstanding

1,000

COGS

270

SG&A

200

Balance Sheet

1,000

Cash

200

R&D

50

Debt

175

Restructuring expenses

30

Minority Interest

50

EBIT Tax rate

450 30.0%

Cash Flow Statement Depreciation

50

Amortization of intangibles

50

Capex

100

Change in Working Capital

(75)

a) EV/EBITDA = 9.14x, EV/EBIT = 11.17 & EV/FCFF = 12.88x b) EV/EBITDA = 8.66x, EV/EBIT = 10.47 & EV/FCFF = 12.88x c) EV/EBITDA = 8.66x, EV/EBIT = 10.47 & EV/FCFF = 12.23x d) EV/EBITDA = 9.14x, EV/EBIT = 11.17 & EV/FCFF = 12.23x 86

Multiples – Example 3 (cont’d) Correct answer is (c) !!!!!… EV

= (5*1,000) + 175 + 50 – 200 = $ 5,025 mn

Adjusted EBIT

= Reported EBIT + Restructuring expenses

Adjusted EBIT

= 450 + 30 = $ 480 mn

Adjusted EBITDA

= Adj. EBIT + Depreciation + Amortization of intangibles

Adjusted EBITDA

= 480 + 50 + 50 = $ 580 mn

FCFF

= Adj. EBIT * (1 - tax rate) – (Capex – D&A) – Change in working capital

FCFF

= 480 * (1-0.3) – (100 – 50 – 50) – (-75) = US$ 411 mn

EV/EBITDA= 5,025 / 580 = 8.6x EV/EBIT

= 5,025 / 480 = 10.4x

EV/FCFF

= 5,025 / 411 = 12.2x 87

EV Ratio Alternatives 

Most analysts find FCFF to complex or messy to use in multiples (partly because capital expenditures and working capital have to be estimated) They use modified versions of the multiple with the following alternative denominators such as EBIT or EBITDA – EBIT: pre-tax operating income – EBITDA: earning before interest, taxes, depreciation, and amortization



Assume that you have computed the value of a firm, using discounted cash flow models. Rank the following multiples in the order of magnitude from lowest to highest? – EV/EBIT – EV/EBITDA – EV/FCFF

88

Why use EV/EBITDA? 

It can be computed even for firms that are reporting net losses, since earnings before interest, taxes and depreciation are usually positive



For firms in certain industries, such as cellular, which require a substantial investment in infrastructure and long gestation periods, this multiple seems to be more appropriate than the price/earnings ratio



In leveraged buyouts, where the key factor is cash generated by the firm prior to all discretionary expenditures, the EBITDA is the measure of cash flows from operations that can be used to support debt payment at least in the short term



By looking at cash flows prior to capital expenditures, it may provide a better estimate of “optimal value”, especially if the capital expenditures are unwise or earn substandard returns.



By looking at the value of the firm and cash flows to the firm it allows for comparisons across firms with different financial leverage.

89

Other Common Ratios 

EV/Sales: ratio of the market value of the firm to the sales



Price/Book Value: ratio of market value of equity to the book value of equity, i.e., the measure of shareholders’ equity in the balance sheet – If the market value of equity refers to the market value of equity of common stock outstanding, the book value of common equity should be used in the denominator – If there is more than one class of common stock outstanding, the market values of all classes (even the nontraded classes) needs to be factored in.



EV/Book Value: ratio of sum of market value of equity and market value of debt to sum of book value of equity and book value of debt

90

Choosing Between Multiples 

There are dozens of multiples that can be potentially used to value an individual firm. In addition, relative valuation can be relative to a sector (or comparable firms) or to the entire market (using the regressions, for instance). However, since there can be only one final estimate of value, there are three options: – Use a simple average of the valuations obtained using a number of different multiples – Use a weighted average of the valuations obtained using a number of different multiples – Choose one of the multiples and base your valuation on that multiple



The best approach is to choose a set of relevant multiples that make most sense for that industry or sector, given how value is measured and created

91

Sector Multiples Sector

Multiple Used

Rationale

Cyclical Manufacturing

PE, Relative PE (Firm PE Relative to Market PE); Often with normalized earnings

Stable industry with established fundamentals

High Tech, High Growth

PEG (PE/Growth Rate)

Big differences in growth across firms

High Growth, No Earnings

EV/Sales, Price/Sales

Zero or negative earnings

Heavy infrastructure

EV/EBITDA

Capital intensive, with high depreciation expense

Financial Services

Price/Book Value, PE

Operations for these companies is borrowing and lending debt, we only consider equity related ratios

Retailing

Price/Sales, EV/Sales

Low margins across board, Value is predominantly measured with sales

92

Things to check Numbers across the years are in line, both historicals and forecast 

Double-Check for dips or sharp increases



Figure out the reasons for the differences – Can be because of exceptions item miss – Pro-forma numbers – Mergers / divestitures – Different currency – Different company – Consolidation status – specifically East Asian companies – Restatements – Accounting period changes; short periods



Any change of more than 10% has to be rechecked



Establish the reasons for difference in multiples

93

Obvious errors 

P/E multiple 0.1x or 1000x



EV/Sales multiple of 500x



EBITDA multiple more than EBIT multiple



Options more than outstanding shares



Negative EV with multiples



52 week high lower than current price



Date of 52 week high/low more than a year old



No estimates after filing for company



Sales of dipping exceptionally low



No calendarisation for non-US company



EPS more than a Pound

94

Copal Partners

Comparable Transactions Analysis (Transactions Comps)

95

Index Table of Content


Introduction

97




Transactions Overview

98




M&A Deals Identification

99




Transaction Value

100




Type of Consideration

101




Target Financials – Sources

107




Target Financials – LTMs

109




Premium Analysis

110




Amendment of Deal Terms

111

96

Introduction 

Transaction Comps is a valuation tool to look at the precedent transactions in a specific sector



Precedent transaction comps is the analysis of M&A Deals which have already taken place in past.



It involves valuing the target company based on relative prices (or multiples) paid for similar business in the past



The financial ratios and values analyzed vary from project to project, depending on the industry and information available



A standard transaction comp contains operational statistics containing: –

Transaction overview (Announcement and closing date, Target name, Acquirer name)

–

Financial performance parameters such as revenue, EBIT, EBITDA and EPS



These inputs define the output Multiple sheet containing various Enterprise Value (EV) multiples



Unlike trading comps, precedent transactions multiple contain an element of control premium paid by the acquirer to gain control over target company

97

Transaction overview Announcement Date 

This is the day the transaction is announced by the company. The source should be the official company press release/ stock exchange announcements/ Merger documents etc

Amendment Date / Rank Date 

The date on which company revises its original offer. The source should be the official company press release/ Merger documents etc. In case of any amendment in deal, always new offer is considered for analysis.

Target Name 

Company or the division of any company being acquired

Acquirer 

Company that is purchasing the Target

Date Completed 

Date the company announced that the transaction was successfully closed



Source should be acquirer's/ seller’s/ target’s press release or filings after the date of close of the deal



In case that the transaction has not closed, consider it “Pending”

* Note: Terminated deals are generally excluded from analysis, unless specifically required

98

M&A Deals Identification 

M&A Deal Run means identifying a list of comparable precedent (which have already been done in past) transactions in specific sector or industry for valuation or acquisition purposes. For Deal Run all targets should belong to same industry.



Identifying Industry / Sector / Product for which comparable deals is required .



Specify Region / Country target companies should belong to. For e.g. searching out deals in Beverages Industry on Global level or restricting search to Asia Pacific region or may be Europe only.



Other criterions can be considering a set Deal Value range. Such as deals should have Deal Value ranging from US$100 mn to US$1,500 mn for a particular time period such as last 5 years.



There are various sources available for extracting Deal Run such as Thomson One Banker, Bloomberg.



After doing the preliminary search like understanding industry or the product for which past deals are required, check various sources mentioned above for M&A Deal Run by doing industry specific or company specific search and extract list of comparable past deals for transaction comps valuation.

99

Transaction Value Offer Value is similar to Equity Value - also called “Total Equity Purchase Price”

Offer Value = (Total Shares Outstanding* x Purchase Price per Share)

*Total Shares Outstanding = Basis Shares + In-the-money-options + Shares from in-the-money convertible securities)

Transaction Value = Offer Value + Total Debt* + Pref. Stock + Minority Interest – Cash & Equiv.

*Total Debt excludes convertible securities that are assumed to convert into common shares (do not double count)

100

Types of Consideration Consideration can be paid to the Target as: 

Cash consideration per target share



Acquirer share per target share based on pre-determined exchange ratio



Lump-sum cash consideration



Lump-sum stock issued by the acquirer



Combination of cash and stock consideration (either lump-sum or per share stock and cash)

*There may be other forms of consideration like issue of loan notes or other debt instruments by the acquirer or asset swaps

101

Types of Consideration (cont’d) I. Lump sum cash consideration The acquiror might pay a lump sum cash to acquire the target Example 1. Piramed acquired by Roche Slough, UK, 15 April 2009 – Piramed Limited (Piramed), a privately owned UK biotechnology company, today announces that it has signed a definitive agreement with Roche that will result in Piramed being fully acquired for an upfront cash payment of US$160 million plus a milestone payment of US$15 million, which is due upon the commencement of Phase II clinical trials for the company’s oncology programme. The final transaction value will be adjusted by the net cash balance remaining upon closing. Closing of the transaction is subject to standard conditions including review by anti-trust authorities.

Here equity value would be US$175 mn (160 mn+15mn) … Is it correct!!!!!!

No!!!!!

The Equity Value of the transaction is 160 mn

* Milestone payments are contingent considerations, so they are generally not considered as part of Equity Value

102

Types of Consideration (cont’d) II. Lump sum Stock consideration For Lump sum stock consideration, the Equity Value can be calculated as follows: Number of acquirer shares issued X Acquirer's share price 1 day prior to date of announcement / % stake acquired Example 2. How will we calculate the Equity Value in this case?? Equity Value = Number of share issued as consideration = 24.75 mn X Concord share price as on October 8, 2008 = $34.50 / % stake acquired i.e. 100% Equity Value = USD 854 mn

Concord EFS and Star Systems to Merge MEMPHIS, Tenn.--(BUSINESS WIRE)--Oct. 9, 2008 Concord EFS, Inc. (Nasdaq: CEFT), a leading electronic commerce processor, and Star Systems, Inc., the largest PINsecured payments network in the U.S., today announced that they have entered into a merger agreement pursuant to which Star Systems would become a wholly-owned subsidiary of Concord. Concord currently owns the MAC(R) EFT network, which provides services to over 3,300 financial institutions primarily in the Northeast and Midwest. The STAR (sm) network has 3,500 financial institution members, and operates primarily in 22 states in the West, Southwest, and Southeast, plus the District of Columbia. In connection with the closing of the merger, Concord will issue 24.75 million shares of common stock for all of the outstanding shares of Star Systems' common stock. Other Information Concord share price as on October 8, 2008 = $34.50 103

Types of Consideration (cont’d) III. Cash consideration per target share In case acquirer pays cash consideration per target share, the Equity Value can be calculated as follows: Target share outstanding as on date of announcement X Cash consideration per share

Example 3. Calculate the Equity Value in this case?? Equity Value = Navteq shares outstanding = 98.8 mn + Dilution impact of options = 4.54 mn Total Diluted shares outstanding =103.34 mn Offer price per share = $78.00 Equity value = $ 103.74 * 78 = $8,060 mn

Nokia to Acquire NAVTEQ The combined entity would create a leading global player in the fast growing location based services market NAVTEQ to support existing customers as before CHICAGO, Oct. 1 /PRNewswire-FirstCall/ -- Nokia and NAVTEQ today announced a definitive agreement for Nokia to acquire NAVTEQ. Under the terms of the agreement, Nokia will pay $78 in cash for each share of NAVTEQ including outstanding options for an aggregate purchase price of approximately $8.1 billion (euro 5.7 billion), or approximately $7.7 billion (euro 5.4 billion) net of NAVTEQ existing cash balance. The acquisition has been approved by the board of directors of each company and is subject to customary closing conditions including regulatory approvals and NAVTEQ shareholders' approval.

Other Information “Navteq” shares outstanding as on October 1, 2007= 98.8 mn Dilution impact of options = 4.54 mn shares 104

Types of Consideration (cont’d) IV. Acquirer share issued as consideration per target share The Equity Purchase Price in this case would be: Target share outstanding as on date of announcement X Exchange ratio X Acquirer's share price 1 day prior to date of announcement Example 4. State Street to Acquire Investors Financial Services Corporation 05/02/2007 BOSTON, February 5, 2007 – State Street Corporation (NYSE: STT), the world's leading provider of financial services to institutional investors, announced today that it has signed a definitive agreement to acquire Investors Financial Services Corporation (NASDAQ: IFIN). In the transaction, Investors Financial Services Corporation shareholders will receive 0.906 shares of State Street common stock for each share of Investors Financial Services Corporation common stock, based upon the closing price of State Street common stock on February 2, 2007

Calculate the Equity value when IFS Shares outstanding as on date of announcement = 65.99 mn Dilution impact of options = 2.98 mn State Street share price as on 2 Feb 07 = $71.75 Equity value = IFS Shares outstanding as on date of announcement + Dilution impact of options = 65.99 mn + 2.98 mn = 68.97 mn Equity Value = Total Diluted shares outstanding X Exchange ratio State Street share price as on 2 Feb 07 (last trading day prior to announcement) Equity value = 68.97*0.906*71.75 = $ 4,483.43 mn 105

Types of Consideration (cont’d) V. Cash and stock consideration The equity value would be combination of cash and stock offered Example 5. Thomson and Reuters in Discussions to Form Global Leader in Business-Business Information Services STAMFORD, Conn. and LONDON, May 7, 2007 The boards of The Thomson Corporation (“Thomson”) and Reuters Group PLC (“Reuters”) confirm that they are in discussions for the combination of their two businesses. Both boards believe there is a powerful and compelling logic for the combination which would create a global leader in the business-to-business information markets. Each Reuters share would be entitled to 352.5 pence per share in cash and an equity participation based on an equalization ratio of 0.1600 Thomson shares for each Reuters share.

Other information: Reuters shares o/s as on May 4, 2007

1,256.56 mn

Dilution impact of options Thomson share price as on 3 May 07 GBP-CAD exchange rate as on 3 May 07

16.05 mn shares CAD 48.46 2.19795

Equity value = (Reuters Shares o/s + Dilution Impact of Options) X (Thomson Share price one day prior to announcement X Exchange Ratio + Cash per share) = (1,256.56+16.05)*((48.46/2.19795*0.16)+3.525) Equity value = GBP 8,975 mn

106

Target Financials – Sources Financials in case Target is Public company 

We can divide transaction comps in three sections viz basic transaction data, deal consideration and financial multiples.



Transaction comps look out for the status of target company as on the Date of Announcement i.e. what was the EV and other relevant multiples as on that date.



For Multiple calculations, please cross check the financials or filings to be used.



Multiples vary and depend from industry to industry for which analysis is being conducted.



For calculating financials, use the latest filings available just before the Date of Announcement. For example, if DOA is 25 April 09, consider AR Dec 08 and IR Mar 09 filings. Also, please check whether calculating LFY or LTM multiples. The former filings will be used for calculating LTM multiples. In case of LFY multiples use IR Mar 09 for EV calculations and consider only AR for Income Statement.



In case of Amendment, consider the latest filings available as per the Date of Amendment and not the initial date. For Examples DOA is 17 May 08, later on deal got revised on 21 July 08, consider AR Dec 07 and IR June 08 for financials and not IR Mar 08.



Calculation and adjustments of EV and Income Statement Normalization is similar as it is done for Trading Comps.

107

Target Financials – Sources (cont’d) In case the Target is a Public company 

Offer Document



Annual Reports and Interim Reports prior to date of announcement



Press Releases



Stock Exchanges if target or acquirer is listed entity

In case The Target is a Private company or Unit / Division of a listed company 

Offer Document



Annual Reports and Interim Reports prior to date of announcement



Acquiror’s / Seller / Target’s press releases



Stock exchange announcements



8K / 8KA (in case Target/ Acquiror / Seller is an US Company)



Seller / Acquiror’s filings



Databases (Bloomberg/ FactSet / CapitalIQ / Reuters)



Brokers Reports



General Web search

108

Target Financials – LTMs Refers to the last twelve months financials of the target prior to the announced date. LTM is calculated as under: 

Financial results of the latest complete fiscal year



+ financial results for the accumulated current partial year result (stub period)



- financial results for the corresponding stub period (partial year) of the previous year (i.e. for the same period but for the previous year)



+/- extraordinary / non recurring items LTM Results LTM =

Fiscal year results + Results of current stub period Results of corresponding prior stub period

Reported Fiscal Year- annual report

Q1

Q2

Reported previous year accumulated 6 month results

Q3

Q4

Q1

Q2

Reported accumulated current year 6 month results

109

Premium Analysis Premium (%) = (Offer Price / Target Price) – 1 Generally acquirer would offer to acquire the target a value more than its current trading price. The excess of offer price over current trading price is the control premium for the target 

Premium may depend on the strategic fit or the expected synergies



Use unaffected stock price of target for calculating the premium i.e. prior to announcement of possible acquisition

Example 6. On May 5, 2010, A announced to acquire B for a cash consideration of USD 15 per share. B’s share price as on May 4, 2010 was USD 12. Here premium paid by the acquiror is 25% But in this case had there been some rumor in the market since February 5, 2010, and B’s share price as on February 4, 2010 was USD 10, then premium should be 50% Case 1. Premium = (Offer Price / Target Price on last trading day prior to announcement) – 1 = ($15-$12)/$12 - 1 = 25% Case 2. Premium = (Offer Price / Target Price on last trading day prior to rumor in public) – 1 = ($15-$10)/$10 - 1 = 50%

110

Amendment of Deal Terms 

In case deal terms gets amended after initial announcement, use final deal terms for valuation



Target’s LTM financials will be taken with respect to date of announcement of final deal terms



Example: On May 5, 2010, A announced to acquire B for a cash consideration of 0.5 A shares per B share. On July 6, 2010, the consideration was increased to 0.55 A shares per B share and further increased to 0.60 A shares on October 6, 2010. Share price as on relevant dates are as under: A

B

May 4, 2010

$18

$7.50

July 5, 2010

$20

$8.00

October 5, 2010

$19

$11.00

What should be the offer price per share? $11.40 What is one day premium paid by the acquirer? (a) 42.5%

(b) 52.0%

(c) 3.6%

111

(d) 44.0%

Copal Partners

DCF Valuation

112

Index Table of Content


Time value of money

114




Cost of capital

127




Free Cash Flows (FCF)

137




Sensitivity Analysis

138




DCF-based valuation

139




Terminal Value

145




Equity Value from Firm Value

148




Advantages and Disadvantages of DCF

149

113

Time Value of Money Let’s review the three main concepts used in DCF-based valuation 





Time value of money –

Cash flows

–

Present value (PV)

–

Net present value (NPV)

–

Perpetuities

–

Discount rate

Cost of Capital –

Cost of Equity

–

CAPM

–

Cost of Debt

–

WACC

Free Cash Flow (FCF) –

Free cash flow to firm (FCFF)

–

Free cash flow to equity (FCFE)

114

Time Value of Money (cont’d) 

 

Which would you take? – Rs. 2 Crore today? – Rs. 3 Crore in exactly 5 years? Assume again: – Both payments are riskless i.e. it is 100% certain that you will be paid once you make a choice Assume also that: –

Bank offers 10% interest on 5 year deposits

Value of Rs. 2 Crore in 5 years: 2 * (1 + 10%)5 = 3.22 Crore Conclusion: Rs. 2 Crore today is greater than Rs. 3 Crore in exactly 5 years!

115

Time Value of Money (cont’d) 

But how much is Rs. 3 Crore in 5 years worth today? –

Alternatively, how much money deposited at 10% today will equal Rs. 3 Crore in 5 years?

Calculation:

X * (1 + 10%)5 = 3 3 X= (1 + 10%)5 X = 1.86 Crore

Crore

The amount of Rs. 1.86 Crore is known as the Present Value of Rs. 3 Crore in 5 years

116

Present Value 

A “cashflow” is time-dated money –

It consists of an amount (in some currency), a date (or a point in time), and a sign (positive or negative)



In order to compare different cashflows, we convert all future cashflows to their present values



Use:

PVt =0 =

Ct =i (1 + rt =i ) i

PVt=0 = present value (at time zero) Ct=i = cashflow in the future (in ith year) rt=i = interest rate for payments in ith year (annualized) – also called discount rate 

A simplification of PV formula –

Assume r is same for all time intervals (years)

PVt =0 =

Ct = i (1 + r ) i

117

Present Value (cont’d) Example 1: One future cashflow 

What is the present value of US $100,000 received in year 10 if the discount rate (for ten-year horizons) is 12%

$100,000 Cash Flow Diagram:

PV = ??

Present Value Calculation:

PVt =0 =

Year 5

100,000 = 32,197.32 10 (1 + 12%)

118

Year 10

Present Value (cont’d) Example 2: Effect of discount rate 

What would you rather have: –



$10,000 today or $12,000 in exactly 2 years

Scenario 1: Discount rate = 8% –

Present value to have $12,000 in 2 years is:

PV [$12,000; Yr 2; 8%] = –

12,000 = $10288.0 (1 + 8%) 2

Value of $10,0000 in 2 years is:

FV [$10,000; Yr 2; 8%] = 10000 * (1 + 8%) 2 = $11664.0 –

In this case, take $12,000 in 2 year

119

Present Value (cont’d) Example 2: Effect of discount rate 

What would you rather have: –



$10,000 today or $12,000 in exactly 2 years

Scenario 2: Discount rate = 10% –

Present value to have $12,000 in 2 years is:

PV [$12,000; Yr 2; 10%] = –

12,000 = $9917.3 (1 + 10%)2

Value of $10,0000 in 2 years is:

FV [$10,000; Yr 2; 10%] = 10000 * (1 + 10%) 2 = $12100.0 –

In this case, take $10,000 today

120

Present Value (cont’d) Example 3: Multiple future cash flows 

What is the present value of $50,000 received in year 5 and $100,000 received in year 10 if the discount rate is 12%

$100,000 $50,000 Cash Flow Diagram: PV = ??

Year 5

T

Present Value Formula:

PV = PVt =0 (C1...CT ) = ∑ t =1

Present Value Calculation:

PV =

Year 10

Ct (1 + rt ) t

50,000 100,000 + = 60568.67 (1 + 12%)5 (1 + 12%)10

121

Net Present Value 

Net present value combines the initial investment (usually made at time zero) and the PV of expected future cash flows T

NPV = C0 + ∑ t =1

Ct (1 + rt ) t



A positive NPV is a key criteria for a sound investment



What is the NPV for the following set of cash flows (assume r = 8%) –

C0 = -$100, C1 = $10, C2 = $10, C3= $110

–

NPV =

− 100 +

10 10 110 + + = 5.15 (1 + 8%) (1 + 8%) 2 (1 + 8%)3

122

Perpetuity 

A perpetual stream of equal cash flows received at equal time intervals is known as a perpetuity



Present value of a perpetuity

C C C C + + + ..... 1 2 3 (1 + r ) (1 + r ) (1 + r ) (1 + r ) ∞ C = Sum of infinite geometric series r

PV =



Example 1: What is the PV of $10 received in perpetuity, starting in one year? Assume discount rate of 10% –

PV = $10/0.1 = $100

123

Perpetuity (cont’d) 

Example 2: What is the PV of $10 received in perpetuity, starting in 6 years? Assume discount rate of 10%

$10 Cash Flow Diagram:

$10

$10

PV = ??

$10 …..

0

5

6

7

Value of perpetuity at Year 5:

PVt =5 =

10 = 100 0.1

PV today (t=0):

PVt =0 =

PVt =5 100 = = 62.09 5 5 (1 + r ) (1.1)

124

8

∞

Growing Perpetuity 

Example 3: What is the PV of a perpetual cash flow starting at $10 in Year 1 and growing at 5% each year subsequently? Assume discount rate of 10%

C C (1 + g ) C (1 + g ) 2 C (1 + g ) ∞ PV = + + + ... (1 + r )1 (1 + r ) 2 (1 + r )3 (1 + r ) ∞ C = (r - g)

C = first cashflow g = Growth rate of cashflows r = discount rate

–

For our case, PV = 10/(0.1-0.05) = $200

125

Discount Rate 

Discount rate used for NPV calculations is the rate of return on the best alternate investment with comparable risk



It is also called the hurdle rate or the opportunity cost of capital



It often comes from the return on a traded asset such as stocks, bonds, etc. with comparable risk.



Risk-less cash flows are discounted using the current rate for US government bonds or bills as they are considered riskless

126

Cost of Capital 

Corporate capital budgeting decisions are based on expected return on investment –

Investment examples include building a new plant, launching a new product, or acquiring another company



Cost of Capital is the required return necessary to make a capital investment worthwhile



Capital is provided as either debt or equity, hence Cost of capital includes Cost of Debt and Cost of Equity –



Cost of Capital = Weighted average of Cost of Debt and Cost of Equity

The Cost of Capital determines the optimal way for the company to raise money (through a stock issue, borrowing, or a mix of the two)

127

Cost of Equity 

The cost of equity is the rate of return that investors require to make an equity investment in a firm



There are two approaches to estimate the cost of equity



–

Dividend-growth model

–

Risk and return model

Dividend growth model specifies the cost of equity to be the sum of the dividend yield and the expected growth in earnings –



Useful for mature companies that distribute most of the earnings to shareholders as dividends

Risk and return model, on the other hand, tries to answer two questions: –

How do you measure risk?

–

How do you translate this risk measure into a risk premium?

We will use Risk and return model to compute Cost of Equity

128

CAPM 

CAPM or Capital Asset Pricing Model is a risk and return based model for computing expected return on equity (Cost of Equity to the firm)



According to CAPM, expected return of a security or a portfolio equals the return on a risk-free security plus a risk premium –

Re = Rf + b (Rm- Rf)
Rf: Rate of return for a risk-free security
Beta b: measure of equity risk relative to market portfolio
Rm: Expected return on market portfolio (average risk investment)
Rm-Rf: Market risk premium



Example: Compute the expected return on IBM stock, given that risk-free rate is 4%, IBM beta is 1.4, and market risk premium is 5.5% –

Re [IBM] = 4% + 1.4*5.5% = 11.70%

–

Implies that in the long-term, investors expect to earn 11.70% return on IBM stock

129

CAPM Inputs 



Rf: Riskfree rate –

Usually the short-term US Govt. T-bill rate or the long-term US Govt. Security rate, since they have no default risk

–

The choice between short-term rate and long-term rate depends on the investment horizon

–

Firm valuations are over a long-term horizon, so use long-term US Govt. Bond rate for firm valuation

Beta b: measure of equity risk relative to market portfolio –

= 1 ... Average risk investment (same as Market Portfolio)

–

> 1 ... Above Average risk investment

–

< 1 ... Below Average risk investment

–

= 0 ... Riskless investment

130

CAPM Inputs (cont’d) Computing Beta: 

Approach 1: Regress the historical return on equity (Re) with historical market portfolio return (Rm) Regression output:: –

Re = a + b Rm

Where a is the intercept and b, the slope of regression, is the beta of stock and measures the riskiness of the stock.

–

This approach has several issues:
High standard error
Beta is based on historical business and leverage of the firm, either or both of which may be different in the present



Approach 2: Bottom-up approach –

Find out the businesses that a firm operates in

–

Find the unlevered betas of other firms in these businesses

–

Take a weighted (by sales or operating income) average of these unlevered betas

–

Lever up using the firm’s debt/equity ratio

131

Estimating Cost of Equity 

Let’s estimate Intel’s Cost of Equity –

Intel equity beta: 1.36

–

Current risk-free rate: 4.5% (long-term US Government Bond Rate)

–

Risk premium = 5.5% (Historical value)

–

Expected return on equity using CAPM:
Re = 4.5% + 1.36*5.5% = 11.98%

–

Hence, Intel needs to make at least 11.98% as return for their equity investors. This is the hurdle rate for projects, when investments are analyzed from an equity standpoint. In other words, Intel’s Cost of Equity is 11.98%

132

Cost of Debt and its Estimation 

Cost of Debt is –

the market rate of interest at which the company can borrow today

–

corrected for the tax benefit it gets for interest payments Cost of debt = Rd = Interest rate on debt (1 - tax rate)



Caution: Cost of debt is not the interest rate at which the company obtained the old debt that it has on its books



Use one of the following to estimate cost of debt –

If the firm has long-term bonds that are traded, use the current yield to maturity on firm’s bonds as the interest rate in cost of debt calculation

–

If the firm is rated, use the rating and a typical default spread on bonds with that rating to estimate the interest rate

–

If the firm has recently borrowed long-term from a bank, use the interest rate on the borrowing

–

If the firm is not rated and no other information about recent bank loans is available, use interest coverage ratio (EBIT/Interest expense) of the firm to estimate a rating and use the default spread on bonds with that rating to estimate interest rate

–

Quick (and dirty) computation of cost of debt: current interest expense/book value of total debt

NOTE: The cost of debt has to be estimated in the same currency as the cost of equity and the cash flows

133

Cost of Capital (WACC) 



Market Value of Equity (E) should include the following –

Market Value of Shares outstanding

–

Market Value of Warrants outstanding

–

Market Value of Conversion Option in Convertible Bonds

Market Value of Debt is more difficult to estimate because few firms have only publicly traded debt. There are two solutions: –

Assume book value of debt is equal to market value

–

Estimate the market value of debt from the book value?

134

Cost of Capital (WACC) (cont’d) 

A firm’s Cost of Capital is calculated by taking a weighted average of the firm’s cost of equity and cost of debt.



WACC represents the investor’s opportunity cost for investing in a particular business instead of others with a similar risk.



Cost of capital so computed is called Weighted Average Cost of Capital or WACC

WACC =

E D * Re + * Rd (1 − Tc ) V V

Re = cost of equity Rd = cost of debt E = market value of the firm's equity D = market value of the firm's debt V=E+D E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate



WACC is used as the discount rate for all cash flows with risk that is similar to that of the overall firm

135

Cost of Capital (WACC) (cont’d) 

Example: Compute IBM’s WACC, given: Re = cost of equity = 11.7% Rd = cost of debt = 8% E = market value of the firm's equity = $150 billion D = market value of the firm's debt = $50 billion Assume Tc = 35% V = E+D = $200 billion

WACC =

E D * Re + * Rd (1 − Tc ) V V

150 50 *11.70% + * 8%(1 − 35%) 200 200 = 10.08%

WACC[ IBM ] =



IBM’s Cost of Capital: 10.08%

136

Free Cash Flow – FCF 

Free Cash Flow to Firm (FCFF) is the cash flow that is generated by company’s operations and available to all the company’s capital providers (investors), including both debt and equity



Computed as operating income less expenses, taxes, and changes in net working capital and investments



Measures company's profitability after all expenses and reinvestments



FCFF is also equal to the sum of CFs paid to or received from all the capital providers (interest, dividends, new borrowing, debt repayments and so on)

FCFF = CF available to all investors = EBIT – taxes – increases in working capital +/- deferred taxes + D&A - Capex



Free Cash Flow to Equity (FCFE) is the portion of FCFF that is available to company’s equity investors.



This is a measure of how much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment

FCFE = CF available to equity investors only = Earnings after interest and taxes – increases in working capital +/deferred taxes + D&A - Capex

137

Sensitivity Analysis Sensitivity Analysis aim at showing the value impact if changing individual key assumptions or the main value drivers. Following is an example of valuation sensitivity to assumptions regarding cost of capital and terminal growth.



Few factors that are subject to sensitivities are:

Sensitivity Table





–

Revenue growth, price , Volume

–

EBIT, EBITDA, PE Margins

–

Capex, Cost of Capital

There are many lot many other potential sensitivity variables. However, the focus on those factors which have the greatest uncertainty or the greatest value impact.

138

DCF – based Valuation 

DCF-based valuation analysis discounts projected (expected) “cash flows” of a firm with an appropriate “discount rate” to determine firm’s value in present time



The fundamental choices for DCF-based valuation –

Cash flows to Discount
Free Cash Flows to Equity (FCFE)
Free Cash Flows to Firm (FCFF)

–

Discount Rate
Cost of Equity
Cost of Capital (WACC)

–

Base Year Numbers
Current Earnings / Cash Flows
Normalized Earnings / Cash Flows

139

DCF – based Valuation (cont’d) Firm / Equity Valuation Overview 

There are two approaches to valuation: A firm can be valued from two different perspectives –



Firm valuation (Enterprise Value or Transaction Value) – represents the value of all capital invested in business EV = Equity Value + Net Debt



Equity valuation (Market Value or Offer Value) – Value attributable to owners of the company after paying debt.



Firm valuation vs. equity valuation Firm Firm valuation values the entire business including both debt and equity claims thereby giving value of the company to debt holders and shareholders.

Debt (D)

Assets (A)

Claim holders Equity (E)

A = D+E Equity valuation values just the equity claim in business i.e. value of a company to shareholders

140

DCF – based Valuation (cont’d) Equity vs. Firm Valuation 

Equity Valuation: value just the equity stake in the business –

Obtained by discounting expected cash-flows to equity (FCFE), i.e., the residual cash-flows after meeting all operating expenses, tax obligations, interest and principal payments, and reinvestment needed for future growth

–

Discount rate used is the Cost of Equity

t =n

ValueEquity = ∑ t =1

t =n



Firm valuation: value the entire business, including, besides equity, the other claimholders in the firm –

Obtained by discounting expected cash-flows to the firm (FCFF), i.e., the residual cash-flows after meeting all operating expenses, taxes, and reinvestments needed for future growth, but prior to debt payments

–

Discount rate used is the weighted average cost of capital (WACC)

141

ValueFirm = ∑ t =1

FCFEt (1 + Re )t

FCFFt (1 + WACC ) t

n = life of the company

DCF – based Valuation (cont’d) DCF-based Firm Valuation Common steps: 



Compute firm’s WACC –

WACC can be in nominal terms or real terms, depending upon whether the cash flows are nominal or real

–

WACC can vary from year to year depending on changes in cost of equity or cost of debt

Obtain latest financial statements for the firm –

You may want to normalize the earnings and cash flows



Project future earnings and cash flows (FCFF) for 5-7 years by estimating an expected growth rate in sales and earnings during this period



Growth rate may also vary from year to year



For fast growth companies, estimate when the firm will reach “stable growth” and what characteristics (risk & cash flow) it will have when it does



For mature companies, estimate a nominal growth rate for cash flows beyond the projection period. This is usually equal to the growth rate of the economy 142

DCF – based Valuation (cont’d) DCF-based Firm Valuation

Value of Firm = Present value of operating FCFF during explicit forecast period (5-7 years) + Present value of cash flow after explicit forecast period (Terminal Value)

143

DCF – based Valuation (cont’d) Computing FCFF 

Start with EBIT Less: Taxes on EBIT Plus or minus: change in deferred taxes = NOPLAT (Net Operating Profits less adjusted taxes) Add: Depreciation and Amortization Plus or minus: Change in Working Capital Less: Capital Expenditure =Operating Free Cash Flow Plus or minus: Cash flow from Non Operating Investments =Cash Flow available to investors (FCFF)



NOTE : FCFF does not include any of the financing related cash flows such as interest expense or dividends n

PVFCFF = ∑ t =1

FCFFt (1 + WACC ) t 144

Terminal Value 

Two ways for estimating terminal value:



Assume that the firm will generate the last forecast year cash flows in perpetuity –

Can also assume a modest growth rate (usually equal to the GDP growth rate)

Terminal Value =



Cn (1 + g ) WACC − g

Cn = FCFF in the last year of forecast g = cash flow growth rate in perpetuity

Compute terminal value as a multiple of EBITDA in the last year of forecast –

Use current EV/EBITDA multiple to estimate terminal value

Terminal Value =

EBITDAn *

EVcurrent EBITDAcurrent

145

n = last year of forecast

DCF Worksheet Example

146

Cash Flow Considerations 



Capital Expenditures: –

Treatment of R&D expenses

–

Treatment of operating leases

–

Acquisitions

–

Other capitalizable expenses

Normalization of earnings and cash flows –



Treatment of one-time/unusual/restructuring expenses

Tax rate: –

Marginal tax rate vs. Effective tax rate?



Treatment for Minority holdings, Preferred Equity or Pension Obligations



Options, Warrants, and equity value portion of convertible debt



Revenue and earnings growth rate

147

Equity Value from Firm Value Steps: 

Compute present value of all operating cash flows during projected years

Add: Present value of terminal value Add: Present value of minority interests

–

Total value of firm

Less: Value of outstanding debt Less: Value of outstanding options Less: Value of outstanding warrants Less: Value of equity portion of convertible debt –

Total Equity Value

Divide by: Number of number of outstanding shares –

Value of equity per share

148

Advantages and Disadvantages of DCF Approach 



Advantages –

Theoretically, the most sound method of valuation.

–

Since it provides intrinsic value as opposed to market value, hence less influenced by temperamental market conditions economic or other factors

–

Can value components of business or synergies separately from the business

–

Very helpful to capture businesses in transition

–

It allows a detailed assessment of alternative strategies through formulation of alternative cash flow projections.

Disadvantages: –

Present value obtained are sensitive to assumptions and methodology

–

Terminal value represents a significant portion of value and is highly sensitive to valuation assumptions.

–

Need realistic projected financial statements over at least one business cycle or until cash flows are normalized.

–

Sales growth rate, margins, investment in working capital, capital expenditures and terminal value assumptions along with the discount rate assumptions are key to the valuation.

149

Copal Partners

Pitchbook Building

150

Introduction & Types of Pitch book 

What Does Pitch book Mean? A sales book created by an investment bank/firm that details the main attributes of the firm. The pitch book is used by the firm's sales force to aid it with selling products and issues, and generating new clients.



Usually there can be the following types of book, depending on the purpose : A. Market Overviews / Bank Introductions: Introducing the bank and giving updates to potential clients. B. Deal Pitches: Sell-side M&A, buy-side M&A, IPOs, debt issuances, and so on C. Management Presentations: Used for pitching to the existing client D. Execution Pitch books: Prepared by the bank for a particular client:

151

Pitch book Building A. Market Overviews / Bank Introductions: generally small in size, showcasing the bank’s credentials, having the following elements
Slides showing the bank’s organization, the different departments
Several “tombstone” slides that show recent deals the bank has done in a particular sector.
Along with these, there can be “league table” slides that show how the bank ranks in different areas like tech M&A deals, equity issuances, and so on
“Market overview” slides showing recent trends and deals in the market and data on how similar banks (“comps”) have been performing lately. B. Deal Pitches: These pitch books are long and most complex, and are basically focused on idea generation, they talk about all the aspects of the selected deals/deal. These are in response to invitations from the clients. e.g. RFPs & RFIs (colloquially called beauty parade)
Bank Overview: Update about the bank and the introduction of deal team
Situation / Positioning Overview : Information on what makes the company attractive. It also includes the update about the market
Preliminary Valuation analysis: Valuation of the company using various valuation techniques discussed before
Then you show individual methodologies such as public comps, precedent transactions, and a DCF.
Primarily based on public information
Potential Buyers: an exhaustive list of everyone who could potentially buy this company, strategic acquirers (normal companies) and financial sponsors (PE firms and hedge funds).
It contains a summary slide in the beginning followed by detailed descriptions (“company / asset profiles”) afterward.
Summary / Recommendations: The bank’s advice and recommendation to the company. 152

Pitch book Building C. Management Presentations: These pitch books – created for real clients instead of prospective clients – are less quantitative and are more focused on the client’s strengths. The common elements of this book would be the following:
Executive Summary / Company Highlights
Market Overview
Products & Services
Sales & Marketing
Customers
Expansion Opportunities
Organization Chart
Historical & Projected Financial Performance D. Execution Pitch books: These books are prepared only once the bank has been mandated by a particular client(company):
Highly focused on ongoing deals
Primarily based on the primary information given by the client (company)
Normally include detailed valuation analysis (key assumptions, detailed operating model output, updates on the deal’s progress)

153

Copal Partners

Profiles

154

Index Table of Content


Overview

156




Business Description

157




Key Customers/Partners

158




Key Investors

159




Shareholders’ Structure

160




Key Management

161




Recent News

162




Products and Services

165




Broker’s Rating

166




Share Trading Analysis

167

155

Overview 

A profile is the most basic presentation tool for research used by investment bankers



It gives a brief overview of a company, clearly laying out key details to enable the reader to form a judgment over its operation, financial and strategic health



Company Profile describes a company in concise form focusing on – Business description – Key customers/partners/investors – Shareholders’ structure – Management – Recent news – Products and services – Key financials (Refer to Trading Comps Module) – Brokers rating

156

Business Description 

Company description gives a snapshot of a company providing information such as what a company does, its products & services, geographic presence, number of employees etc.



It is the crux/summary of information provided in other sections of a profile



Since description constitutes a starting point of any profile and is the first thing an investor reads, it needs to be crisp, accurate and concise



A company description normally contains the following: – What a company does – Briefing on its products and services – – – –

Industries, the company caters to Key customers Partners/strategic alliances Location and geographic presence



Sources

– Founded date and listing – Number of employees

 157

Company website – “About us” section of the website is the best source – Company’s fillings, reports and presentations can also be used Other databases such as Capital IQ, Bloomberg, Reuters etc

Key Customers/Partners 

Reflects the Company’s relationships in the industry i.e. strong association with large size companies guarantees future contracts



This section includes a list of the company’s key customers/partners in alphabetical order – Can also include the logos of key customers/partners; Logos should be properly aligned and sized, with no loss of clarity



Always mention a few names (preferably familiar names)



If the number of customers/partners is available, the same should be included



Full name of the customer/partner should be avoided (Microsoft Corporation can be mentioned as Microsoft, ignoring Corporation) 

Sources  

Company website – “About us” section of the website is the best source – Company’s fillings, reports and presentations can also be used – Press releases Other databases such as Capital IQ, Bloomberg, Reuters etc In the absence of any information, do a web search, for example “company+ customer” and “company+partner”

158

Key Investors 





Financing Summary

Provides information about the owners of the Company i.e. who owns the majority stake, what type of investors are they (strategic or financial) Round 1

NA

12 / 93

0.05

NA

Startup / Seed

2

NA

01 / 94

2.0

7.8

Early Stage

3

NA

04 / 96

3.0

17.7

Expansion

4

NA

03 / 00

4.3

32.4

Later Stage

5

NA

06 / 02

21.2

35.2

Expansion

6

NA

05 / 03

4.2

21.2

Expansion

7

NA

02 / 05

2.5

NA

Later Stage

Applicable for a private company, the section provides information on the Company’s various financing rounds Also provides the list of investors who have invested in the Company



Information includes the round number, round type, date, amount raised ($m), post-money valuation ($m) and company stage



If information is not available on financing rounds, include the logos of the investors



Sources

Amount Post-Money Raised Valuation Date ($MM) ($MM)

Round Type

Company Stage

Company Filings – Press releases



Other databases such as Capital IQ, VentureSource, Thomson etc

159

Shareholders’ Structure 

Provides information about the owners of the Company i.e. who owns the majority stake, what type of investors are they (strategic or financial)



This section provides the top shareholders of the Company by number of shares held & % held



Details include name of shareholder, shares held and percentage ownership



The top shareholders are calculated by considering all the shareholders (institutional, insider and float)



In case of Multiple class of shares (MSH), shareholding of the primary listing is considered

Private Companies 

In case of private companies, ownership is included in the form of a pie chart or qualitative text writing

Sources



Company Website or Filings



Other databases such as Capital IQ, Thomson, Bloomberg etc

160

Key Management  

   

Gives an overview about the key decision makers of the Company. Their affiliations provides additional information of the experience they have in the relevant industry Includes the list of the top management team (C-Level) as per the following hierarchy – Founder – Chairman – Vice/Deputy Chairman – President – CEO – CFO – COO – CIO – CTO Always mention all the designations applicable for every individual e.g. if CFO is also SVP, Finance; the designation should be written as CFO & SVP, Finance Abbreviations such as CFO, CTO, CIO, COO, SVP, EVP etc need not be expanded Always cross check the Executive Management with the Company’s news section; sometimes a management change is announced but not updated on the website State the management names in the format, , preferably; Exclude middle names, nick-names, initials and titles (Mr. , Sir, etc.)

Sources

  

Company website (Management/Board/Executives section) Company filings (Proxy filing/AR), presentations Other databases such as Capital IQ, Bloomberg etc 161

Recent News Recent news section reflects the key happenings in the company, and its economic and regulatory environment



Primary objective is to give a quick snapshot about recent developments in the company in the past few months

DO NOT include news such as

Types of news to be included



     

Acquisitions Mergers Divestiture Management changes Stock buyback/split, IPO Follow-on offering

 

Customer contracts Partnerships/strategic alliances

  

Organizational changes Product launches Funds raised



Financial news



Dividend declaration (a normal feature; usually declared every quarter) Award wins Participation in conferences Launch of updated versions of any products, if the updates are too frequent Law suits

   

162

Sources



Company Website



Other databases such as Capital IQ, Factiva etc

Recent News (cont’d) Examples News Headline

News details

Post formatting 

163

Partnered with Novell Inc. to deliver hybrid options for high-performance computing, enabling users to balance server workloads using both SUSE Linux Enterprise Server and Windows HPC Server

Recent News (cont’d) Examples News Headline

News details

Post formatting 

164

Announced the retirement of Robbie Bach from his position of the President, Entertainment and Devices division of the Company

Products and Services 

Helps understand the business of the Company and its reporting structure



This section describes the products, services and solutions of the company



Each product/service should be briefly explained in 1-2 sentences focusing on what that product does/is used for



Provide explanation in a meaningful manner



If the list of products is too long to categorize, look for the same in the annual report/10K, which categorizes the products in a more suitable manner



Services, if ‘not very’ relevant (e.g. 24x7 support, training etc) can be mentioned in a single sentence



On the other hand if the company has 4-5 main product categories and each one of them includes 1-2 sub categories, briefly explain all the products including the sub categories



Also pictures provides better understanding, Use as much as possible

Sources

165



Company Website or Filings



Presentations

Broker’s Rating 

Reflects the market / broker views on fundamentals of the Company i.e. a higher rating reflects strong fundamentals & hence low level of risk and a lower rating reflects weak fundamentals & hence high level of risk



Indicates the analyst consensus



The Broker’s rating chart gives the breakup of the total number of Buy, Hold and Sell recommendations over an last twelve months (LTM) period



The section on Analyst Commentary provides commentary on the company from the analyst’s research reports – The commentary highlights the strengths of the company and how it has been able to benefit from these strengths. It may also include the Company’s recent developments and which may have affected the share price and/or the analyst recommendation of the company

Sources



Databases such as Bloomberg, FactSet, Capital IQ, Thomson etc 166

Share Trading Analysis 

Share trading analysis provides an overview of the share price and the various trends related to capital markets



This section is key to any of the books prepared



The purpose of this section is to understand and analyze the share price and capital market movements with respect to the chosen company



Various types of charts prepared – Relative share price performance – Annotated share price performance – Volume at price and liquidity analysis – Overview of Research analyst ratings – Development of Consensus Estimates – Broker Comment Frequency Analysis – Valuation methods used by research analysts

167

Share Trading Analysis (cont’d) Relative share price performance 

Used to compare the performance of the company’s share with respect to the primary index in the market



Points to remember – Always consider closing price of the stock instead of the last traded price – The closing price to be considered should be of a day prior to the date on which it is created –

The index should always be rebased to the company’s share price in order to have an apples to apples comparison

Sources



Stock exchange websites



Databases such as Bloomberg, FactSet, DataStream, Capital IQ etc

168

Share Trading Analysis (cont’d) Annotated share price performance 

Prepared exactly as a normal share price performance chart with the only difference being the inclusion of news that reflect the changes in the share price movement



Always look for dates where there has been a drastic change in the share price movement vis-à-vis its primary index. Thereafter look for news that have triggered those changes in the share price

Sources



Press releases from company website



Stock exchange websites



Databases such as Bloomberg, FactSet, DataStream, Capital IQ etc

169

Share Trading Analysis (cont’d) Volume at price and liquidity analysis 

Objective is to show in a chart how has traded volume of the share been distributed between different price ranges

Sources



Stock exchange websites



Databases such as Bloomberg, FactSet, DataStream, Capital IQ etc

170

Share Trading Analysis (cont’d) Overview of Research analyst ratings 

Gauges different analysts’ perception of the stock and what kind of recommendation they are making on it



The purpose is to understand the view of the market on the stock

Sources



Research reports



Databases such as Bloomberg, Capital IQ etc

171

Share Trading Analysis (cont’d) Development of Consensus Estimates 

Gauges the consensus estimates on Revenues, EBITDA and EPS for the future years and how they evolve



Consensus estimates represent the market perception on the future operational results of the company



Always calendarize the estimate to have a constant point of reference

Sources



Databases such as Bloomberg, Reuters, Capital IQ etc

172

Share Trading Analysis (cont’d) Broker Comment Frequency Analysis 

Conduct a qualitative analysis of the perception of the stock in the market, identifying key and recurrent themes in the different analyst reports



Categorize these themes as positive and negative to indicate analyst comments



Key themes may include: trends in the industry, technological trends, extraordinary events, risks, challenges etc

Sources



Research reports

173

Share Trading Analysis (cont’d) Valuation methods used by research analysts  To describe the valuation methods used by the research analysts covering the stock  Information to be included: – bank/broker name – main valuation methods used – main comparable companies used for valuation purposes – key comments on the valuation of the company

Sources



Research reports 174

Copal Partners

Case Studies

175

Index Table of Content


Introduction

177




Types of Acquisition

178




Transaction Types

179




Overview

181




Target Business Description

182




Transaction Overview

183




Transaction Highlights

184




Transaction Rationale

185




Market /Broker’s perception

186

176

Introduction 

Mergers and Acquisitions (M&A) are a big part of the corporate finance world. Every day, Wall Street investment bankers arrange M&A transactions, which bring separate companies together to form larger ones.



M&A are a combination of two or more companies, or the acquisition of a part of a corporation for which some payment is given in compensation. This payment can be in stock, cash or a combination of the two.



Investors in a company, that are aiming to take over another one, must determine whether the purchase will be beneficial to them. In order to do so, they must determine how much the company being acquired is really worth.



The success of a merger is measured by whether the value of the buyer is enhanced in medium to long term, by the action.



A transaction case study aim at analyzing the merger and acquisition deal that has taken place.

177

Types of Acquisition An Acquisition can take the form of a purchase of stock and other equity in the target entity or the purchase of all or a substantial portion of its assets 

Share Purchase – In a share/stock purchase, the seller transfers shares in the target entity to the acquirer in exchange for an agreed-upon consideration. The acquirer takes on the target company with all its assets and liabilities



Asset Purchase – In an asset purchase, the acquirer buys all or a substantial portion of the assets of the target company. An advantage for the acquirer in an asset purchase is that it can cherry-pick the assets it wants and leave assets and liabilities that it does not want to purchase

178

Transaction Types Some common types of deals 

Leveraged Buyout – An LBO is essentially a strategy whereby the acquirer gains control over the target’s stock or assets through significant amount of borrowed money, making the acquired company’s new capital structure highly levered; for e.g. - Kohlberg Kravis Roberts & Co. and Texas Pacific Group’s acquisition of TXU Corp



Secondary Buyout – The management team, in conjunction with a private equity fund, acquires the business, allowing the existing private equity supplier to exit from its investment. Thus, it is an exit mechanism whereby one investment firm sells its position in a venture on to another; for e.g. - The sale of textile and cleaning group Elis by French buyout firm PAI Partners to rival Eurazeo



Public to Private Buyout – This involves the management or a private equity provider making an offer for the listed shares of a public quoted company, then taking the company private; for e.g. - Blackstone Group’s acquisition of German chemical maker Celanese



Management Buyout – Existing management of a company buys the Company from its owners; foe e.g. A.T.Kearney’s management buy-out



Tender Offers – A formal offer of determined duration to acquire a public company’s shares made to equity holders. The offer is often conditioned upon certain requirements such as a minimum number of shares being tendered; for e.g. - Sanofi-Aventis’ tender offer to acquire all outstanding shares of Genzyme for $69 per share in cash



Divestiture – A deal which results in the loss of majority control, such as sale of subsidiary; for e.g. - Kodak’s sale of Health Group to Onex



Privatization – Sale of a government-controlled entity to a single or consortium of bidders or by floatation of stock via public offering; for e.g. - Rosneft privatization 179

Transaction Types (cont’d) Deal Attitude 

Represents the recommendation of the target company’s Management or Board of Directors on the transaction – Friendly – The Board recommends the offer – Hostile – The Board officially rejects the offer (but the acquirer persists with the takeover) – Neutral – The Management has nothing to do with the transaction – Not applicable – The attitude of the Board is not applicable, i.e. open market repurchases, spin-offs – Unsolicited – The offer is a surprise to the target’s board, and it has yet not given a recommendation.

Deal Consideration 

There are three common ways to pay for a M&A Transaction – All Cash
The acquirer pays a lump sum cash consideration to purchase shares/assets in the target
The acquirer offers per share cash consideration for every target share – All Stock – The acquirer offers its own shares in consideration for each share of the target – Stock & Cash – The acquirer makes payment for the target partly by issuing its own stock and partly in cash



Additionally, the deal consideration may also include provision for Earnouts. Earnout is a method of compensating a seller based on the future earnings of the acquired entity. It is the contingent portion of the purchase price 180

Overview 

Case studies focus on different M&A transactions and include the following information regarding the deal: – Target/Acquiror Business Description – Transaction Highlights – Transaction Overview – Transaction Rationale – Implied Multiples (Refer to Trading/Transaction Comp Modules) – Market/broker’s Perception

181

Target Business Description 

Give a brief description of the target company – Include main business of the company, major product categories, geographic presence and other details like brands, headquarter, listing, employees



In case only one division or segment of the company is being acquired then focus on that particular segment or division



Also, include data related to the market position of the Target (for example: largest produce of chemicals in China; one of the leading provider of software solutions etc)

Sources



Company Website or Filings



Other databases such as Capital IQ, Thomson, Factiva etc

182

Transaction Overview 

This section captures the various news items that have been released regarding the transaction



Start from the first mention of the deal (rumors date) or management’s wish to get acquired



It might be the first bid by the acquirer or a competitive bid



Move in ascending order to the latest available news on the deal



Try to capture all news regarding the deal including – Market rumors – Other bidders – Revised bids – Change in value of the deal – Search for partners

Sources



Company Website or Filings



Other databases such as Bloomberg, Capital IQ, Thomson, Factiva etc

183

Transaction Highlights 

Covers a summary of all events that took place in the course of the deal, starting from the announcement of the deal includes: – Items such as the %age held, final price, dividends declared, financing details, advisors, etc. and Information regarding the terms and conditions of the deal – Management and shareholding changes, post transaction, if any – Status of the deal, pending or completed – Any other post transactions plans – Compliance requirements with governing agencies

Sources



Company Website: Fillings, presentations and press releases



Other databases such as Bloomberg, Capital IQ, Thomson, Factiva etc

184

Transaction Rationale 

Rationale for Seller/Target: Mention benefits which the seller/target is expecting from the deal or why they want to sell off the Company



Synergy: Overall synergy benefits expected out of the joint entity post merger. The functions of synergy allow for the enhanced cost efficiency of a new entity made from two smaller ones - synergy is the logic behind mergers and acquisitions



Focus on various strategic benefits of the deal such as combining the product portfolio of current target with its existing portfolio companies and entering a new geography with the current acquisition



Include potential synergies, increase in market share, enhancement in product portfolio, geographic expansion, financing further growth and divesting non-core activities

Sources



Company Website: Fillings, presentations and press releases



Other databases such as Bloomberg, Capital IQ, Thomson, Factiva etc

185

Market /Broker’s perception 

The section provides commentary on the company from the analyst’s research reports; try to include comments from the brokers who have made commentary on the deal – Also, in some cases, the commentary includes quotes by Key management of the target and acquirer on the deal



The commentary highlights the attractiveness of the target, deal rationale, comments on valuation or future predictions of the deal



In case of private companies, try to find out analyst’s comments on the deal through web search



Try to incorporate broker comments on target/acquirer and seller for the deal

Sources



Research reports pertaining to the transaction



Other databases such as Bloomberg, Press etc

186

Copal Partners

Industry Overview

187

Introduction 

Industry overview analysis presents a snapshot of the industry and its competitive landscape



This is provided to gauge the current positioning of the particular company and identify certain strategic areas that the company may consider, including M&A options



Broadly, the following sections exist in this overview –

Industry snapshot
this section details the current state of the industry
provides figures relating to market size and growth rates
also details how the industry is structured in terms of various segments
the current and expected trends are then highlighted to understand the future outlook for the industry

–

Evolution
briefly highlight the evolution of the industry, and analyze any specific pattern
competitive landscape
briefly describe the competition in each segment highlighting large players and their positioning

–

Company’s positioning
given the industry trends, future outlook and competition, highlight the company’s competitive positioning and suggest any specific strategic actions (this may include a SWOT analysis)

–

Options
present a case for various strategic options that could be possible given the industry scenario, competitive landscape and the current state of the company 188

Introduction (cont’d) 

An industry analysis should answer the following questions: – What are the industry dominant economic traits? – What competitive forces are at work in the industry and how strong are they? – Which companies are in the strongest/weakest competitive position? – Who’s likely to make what competitive moves next? – What key factors will determine success or failure? – How attractive is the industry in terms of its prospects for above average profitability? – What are the forces of change in the industry and what impact will they have?

189

Industry’s dominant economic traits Covers 

Market size (Small markets don’t attract big fish)



Scope of competitive rivalry



Market/industry growth rate (life cycle) – Fast growth breeds new entry; slowdowns lead to increased competition



Number of rivals and their size



Number of buyers and their size



Level of backward and forward integration



Technological change (rate and scope)



Level of differentiation between firms’ products



Opportunities for economies of scale



Ease of entry and exit



Capital requirements

190

Forces of change in the industry 

The most dominant forces that cause the industry to change are called driving forces – Task 1 - identify the driving forces – Task 2 - assessing their impact on the industry (few are important, generally)



Common Driving Forces – Changes in long term industry growth rate – Changes in who buy the products and for what reason – Product innovation – Technological change – Marketing innovation – Increasing globalization – Regulatory changes – Changing societal concerns, attitudes and lifestyles

191

Companies in the strongest/weakest competitive position 





Identify strongest/weakest competition using strategic group mapping: two dimensional representation according to the competitive characteristics of the competitors in the industry – Identify competitive characteristics – Plot firms on a 2 variable map – Assign firms to strategic groups – Circle groups proportional to size Variables: – Axes should not be correlated – Expose differences in rival strategies – Need not be quantitative or continuous The closer the circles, the stronger the rivalry

Product line/merchandise mix

192

Variables in identifying competitors 

How do other firms define the scope of their market? – The more similar the definitions of firms, the more likely the firms will view each other as competitors



How similar are the benefits the customers derive from the products and services other firms offer? – The more similar the benefits, the higher the level of substitutability between them



How committed are other firms to the industry? – To size up commitment of potential competitors to industry, reliable intelligence data are needed concerning potential resource commitments

193

Common mistakes in identifying competitors 

Overemphasizing current and known competitors while ignoring potential entrants



Overemphasizing large competitors while ignoring small ones



Overlooking potential international competitors



Assuming competitors will continue to behave in same way



Misreading signals indicating a shift in focus of competitors



Overemphasizing competitors’ financial resources, market position, and strategies while ignoring their intangible assets



Assuming all firms in industry are subject to same constraints or are open to same opportunities

194

Who’s likely to make what competitive moves next? In order to outmaneuver your competition you have to evaluate the competitors’ future moves 

Identify competitors strategies



Evaluate who are the current major players – Which are strong and which are weak



Evaluate who will be the major players?



Predict competitors’ move – Strategic changes – Moves into new markets – Acquisition – targets or movers

195

Key factors that determine success or failure Key success factors (KSF) are crucial elements that lead to success 

Technology related KSFs – Scientific research expertise (important in such fields as pharmaceuticals, medicine, space exploration, other "high-tech" industries)



–

Production process innovation capability

–

Production innovation capability

–

Expertise in a given technology

Manufacturing related KSFs –

Low-cost production efficiency (achieve scale economies, capture experience curve effects)

–

Efficiency / Quality of manufacturing (fewer defects, less need for repairs)

–

High utilization of fixed assets (Asset Turnover) (important in capital intensive/high fixed-cost industries)

–

Low-cost plant locations

–

Access to adequate supplies of skilled labor

–

High labor productivity (important for items with high labor content)

–

Low-cost product design and engineering (reduces manufacturing costs)

–

Flexibility to manufacture a range of models and sizes/take care of customer orders 196

Key factors that determine success or failure (cont’d) 



Distribution related KSFs –

A strong network of wholesale distributors/dealers

–

Gaining ample space on retailer shelves

–

Having company-owned retail outlets

–

Low distribution costs

–

Fast delivery

Marketing related KSFs – A well-trained, effective sales force –

Available, dependable service and technical assistance

–

Accurate filling of buyer orders (few back orders or mistakes)

–

Breadth of product line and product selection

–

Merchandising skills

–

Attractive styling/packaging

– Customer guarantees and warranties (important in mail-order retailing, big ticket purchases, new product introductions)

197

Key factors that determine success or failure (cont’d) 



Skills related KSFs –

Superior talent (important in professional services)

–

Quality control know-how

–

Design expertise (important in fashion and apparel industries)

–

Expertise in a particular technology

–

Ability to come up with clever, catchy ads

–

Ability to get newly developed products out of the R&D phase and into the market very quickly

Organizational capability related KSFs – Superior information systems (important in airline travel, car rental, credit card, and lodging industries)



–

Ability to respond quickly to shifting market conditions (streamlined decision-making, short lead times to bring new products to market)

–

More experience and managerial know-how

What they are now? What they will be?

198

Attractiveness of the industry in terms of its prospects for above average profitability Can be judged by the following parameters: 

Growth potential



Impact of prevailing driving forces



Potential entry or exit of major firms



Stability of demand



Trend of competitive forces



Severity of problems confronting industry



Future risk and uncertainty



Competition and its impact on the industry’s future

199

Data gathering Four considerations to be kept in mind: 

Determine what information is needed – Define the topic – Consider the goals to be reached and how much information is needed to achieve them – Identify the key words or central concepts in the research question – Develop a standard research form to use



Determine where you are going to look – Consider who might produce the type of information you have defined in step 1 – Sources to look at:
Trade association
Trade publications
Business broker
Print media i.e. newspapers, magazines, journals etc
Periodical databases
Reports by industry analysts

200

Data gathering (cont’d) 



Develop a Search Strategy – Using the Internet to search for business valuation information is potentially one of the most efficient ways – Boolean logic is the basic logic system used for online searching; uses three logical operators: AND, OR and NOT
The AND connector means that all search terms connected by the AND must be present
The OR connector requires either term to be present
The NOT connector returns records where the designated term does not appear – Another helpful search logic tool is truncation. Truncation, also known as wild card searching, allows searching of word variations
Wild cards can vary from database to database but usually are either the “*” or “?” Evaluate Information The following questions should be asked for evaluation: – Who authored this information? - Is the author’s name and affiliation disclosed? Is there an e-mail address so that you can inquire further? Is the author the creator or the compiler of the information? –

Who is publishing this information? - Can the producer be identified and contacted? Is it a professional organization? Does the organization have a particular bias? Who is the intended audience? – What can you determine about the content? - How complete is the information? Is it an abstract of the complete text? Are the references documented, current and relevant? 201

Creating an analysis structure 

Providing an overview and describing a situation – Always start with the subject familiar to the target audience – Establish facts about the subject – Prove it is a profitable venture for investment



Highlighting opportunities arising out of the situation –

Identify and state the factors that are creating opportunities

–

Establish facts and future prospects of the available opportunities

– Compare available opportunities 

Tapping opportunities through M&A – Show how M&A can help in tapping opportunities – Prepare a supply/value chain showing benefits of the transaction to both the acquirer and the target



Appendix – Should contain all necessary definitions of the jargons used in the presentation – Include profiles of the selected target companies – Include previous transactions & comps for that industry 202

Project execution 

Insights through primary research – Using insights from industry personnel will help in a deeper understanding of the industry on which you are working – Create a call list within 1-2 days so that the questions that arise from the hypothesis are sent to these contacts – Assign 1 or 2 persons to check for information on companies, industry associations and their contact details – Send the interview requests by email at the beginning of the study. This allows for the process to get started while the team conducts the secondary research – The same set of questions should not to be sent to all persons in the mailing list. Queries sent to different persons should be pertaining to their respective areas of operations

 Do not just write an email for information request and wait for people to respond. Be proactive, keep calling until you get the desired data from external and internal contacts  Follow a reasonable caution while calling up external sources

203

Project execution (cont’d) Apply “So what” analysis to convert a data dump into a storyline 

For all facts and information on each slide, always ask yourself “so what”



Always present in a way that forces reader to prompt “so what” and then answer it in the next section. Keep doing this unless no such question arise



If the implication of a slide comes out clearly, it transforms a ‘data dump’ into a ‘value-added analysis’

Key questions: 

“So what does this mean”?



“Will this affect the sector, economy or the region being analyzed”?



“Will the impact be positive or negative”?



“Is the rate of change fast or slow”? (Will the impact be strong and immediate or not?)



“Does this get you closer to proving or disproving your current hypotheses”?

204

Copal Partners

Research Techniques

205

Introduction There are a lot of research methodologies used to prepare an Industry piece. The most extensively used techniques are as follows: A. SWOT Analysis B. PESTEL Analysis C. Porter’s Five forces model

206

SWOT Analysis A. SWOT Analysis: An analysis of STRENGTHS,WEAKNESSES, OPPURTUNITIES and THREATS. Extremely useful tool for understanding and decision-making – Applicable in all businesses and organizations – Provides a framework for reviewing strategy, position and direction of a company or business proposition, or any other idea – Can be used for business planning, strategic planning, competitor evaluation, marketing, business and product development and research reports – Presented as a grid, comprising four sections, one for each of the SWOT headings –

SWOT analysis can be used to assess:
company (its position in the market, commercial viability, etc)
method of sales distribution
product or brand
business idea
strategic option, such as entering a new market or launching a new product
opportunity to make an acquisition
potential partnership
changing a supplier
outsourcing a service, activity or resource
an investment opportunity

207

PESTEL Analysis B. PESTEL Analysis – PESTEL is an acronym for Political, Economic, Social, Technological, Environmental and Legal – PESTEL Analysis helps analyze factors in the macro-environment that affect the decisions of the managers of any organization
Examples include: Tax changes, new laws, trade barriers, demographic change, government policy changes etc – Helps analyze the many different factors in a firm's macro environment
It is important not to just list PESTEL factors because this does not in itself tell much
Need to find out, which factors are most likely to change and which ones will have the greatest impact on the company i.e. each firm must identify the key factors in their own environment

208

Porter’s Five forces model C. Porter’s Five forces model – It is designed to explain the relationship between the five dynamic forces that affect an industry’s performance; these are the:
intensity of competitive rivalry;
threat from new entrants;
threat from substitutes;
bargaining power of buyers;
bargaining power of suppliers. – The Five Forcers Analysis model tries to identify what factors shape the character of competition within an industry. – Targets the assessment of the structural attractiveness of the analyzed industry. – Finally the Five Forces Analysis pinpoints strengths and weaknesses in a company and discovers opportunities or threats within the industry

209

Competitive forces at work in the industry

210