Sei sulla pagina 1di 210

Copal Partners

Copal Partners Investment Banking Module

Investment Banking Module

Index Table of Content Introduction to Investment Banking 3 Valuation Methodologies 14 A. Valuation

Index

Table of Content

Introduction to Investment Banking

3

Valuation Methodologies

14

A. Valuation Techniques

18

B. Comparable Company Analysis

21

C. Comparable Transaction Analysis

95

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!

What is Investment Banking?

Is it investing? Is it banking? In reality, it is neither! Investment banking, or I-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
Sales and Trading
Sales and Trading
Equity Research
Equity Research
Corporate Finance / Advisory
Corporate Finance /
Advisory
Buy & Sell securities for their clients and provide stock advice Facilitate buying and selling
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
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
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

3

Dynamics/ Relationship between various institutions Financing M & A Corporate Finance Corporate Finance

Dynamics/ Relationship between various institutions

Financing M & A Corporate Finance Corporate Finance Prospectus, Placement memorandums, Valuation, Underwriting
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
Coverage report
Initiation reports
Coverage Report
Event Report
Coverage report
Deal notes
Road shows
Corporates
Sales & Trading
Sales & Trading
Market making
Proprietary Trading
Market making
Proprietary Trading
Chinese Wall

4

Typical Corporate Finance Deal Team Title Experience Education Role       Managing Directors primarily

Typical Corporate Finance Deal Team

Title Experience Education Role
Title
Experience
Education
Role
     

Managing Directors primarily pitch ideas to clients to source deals.

Managing Director

8+ Years

Top Undergraduate Universities,

Managing Directors spend most of their time in bringing business to the banks, executing transactions for clients and maintaining existing client relationships.

Usually Top-Tier MBA

Vice President

3- 8 Years

Top Undergraduate Universities,

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

Usually Top-Tier MBA

Associate

0-3 Years

Top Undergraduate Universities,

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)

Usually Top-Tier MBA

Analyst

0-1 Years

Top Undergraduate University

Analysts perform all research and analysis, build financial models and put together the pitch book (deal coordination, commercial and financial due diligence)

5

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

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? A brief history: The Chinese wall concept in

What are Chinese Walls in Investment Banking?

What are Chinese Walls in Investment Banking? A brief history: The Chinese wall concept in investing

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.

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.

7

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.

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.

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

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

Role of Corporate Finance

To make it convenient, from now onwards by Investment Banking we would mean Corporate Finance
To make it convenient, from now onwards by Investment Banking we would mean Corporate Finance
Corporate Finance Financings Client Advisory Includes: Includes: Initial Public Offerings (IPO) Secondary Offerings
Corporate Finance
Financings
Client Advisory
Includes:
Includes:
Initial Public Offerings (IPO)
Secondary Offerings
Debt Syndication
Equity Private Placements
Acquisitions
Private Company Sale
Public Company Sale
Corporate Restructuring
Corporate Divestitures
Joint-Ventures

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

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

group. For example, a Healthcare group may be segregated into biotechnology, medical devices, pharmaceuticals,

etc.

Often subgroups exist within the broader

9

Bulge Bracket Banks and Corporate Finance Boutiques Bulge Bracket Banks: The term “bulge bracket” generally

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 Deal Value (in

Top Global Investment Banks (M&A)

Worldwide Announced deals - 2010
Worldwide Announced deals - 2010

Financial Advisor

Deal Value (in $mn)

Freeman Fees (in $mn)

Number of Deals

Goldman Sachs & Co

425,164

1,952.8

325

Morgan Stanley

346,039

1,421.7

331

JP Morgan

330,835

1,400.3

280

Credit Suisse

327,179

1,046.4

249

Citi

299,167

729.4

185

Barclays Capital

265,094

715.6

133

Deutsche Bank AG

242,883

831.5

224

Bank of America Merrill Lynch

236,383

906.6

204

UBS

231 960

850 9

230

 

,

.

 

Lazard

188,637

845.0

259

Rothschild

127,830

746.5

245

HSBC Holdings PLC

98,194

212.0

79

Nomura

87,404

320.6

171

Evercore Partners

79,257

209.4

35

BNP Paribas SA

78,350

300.1

110

Jefferies & Co Inc

72,904

354.3

114

Greenhill & Co, LLC

70,551

202.3

47

Houlihan Lokey

61,464

349.6

167

Blackstone Group LP

54,777

169.6

41

Santander

51,225

47

Centerview Partners LLC

50,161

13

RBC Capital Markets

48,909

344.0

133

KPMG

44,578

327

Mizuho Financial Group

43,279

121

RBS

41,921

153.2

59

Source: Thomson Financial

11

Transaction Volumes Completed Deals Worldwide: Annual Transaction Volume Date Effective/Unconditional Deal Value (in

Transaction Volumes

Completed Deals Worldwide: Annual Transaction Volume
Completed Deals Worldwide: Annual Transaction Volume

Date Effective/Unconditional

Deal Value (in $mn)

Number of Deals

2008

1,924,659

24,890

2009

1,848,453

30,431

2010

1,893,852

32,114

2011

824,484

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

Role of KPOs in the Investment banking industry

CLIENT MARKETING RESEARCH & ANALYSIS Investment Banks DEAL EXECUTION KPO’s
CLIENT
MARKETING
RESEARCH
& ANALYSIS
Investment Banks
DEAL
EXECUTION
KPO’s

13

Copal Partners

Copal Partners Valuation Methodologies 14

Valuation Methodologies

14

Valuation Methodologies Valuation Methodologies can be categorized as under: A. Fundamental valuation: A stand-alone

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

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

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

Copal Partners Valuation Techniques 18

Valuation Techniques

18

Valuation Overview Valuation is the process of determining the current worth of an asset. Valuation

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

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

Copal Partners Comparable Company Analysis (Trading Comps) 21

Comparable Company Analysis

(Trading Comps)

21

Index Table of Content Overview 23 Key Definitions 24 Source of Information 29 Selection of

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

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 Market capitalization Represents the market value of all outstanding shares Calculated as Total

Key Definitions

Market capitalization

Represents the market value of all outstanding shares

Calculated as Total number of shares outstanding x current share price

Stock Options

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

24

Key Definitions (cont’d) Fully Diluted shares Represents the number of shares that would result if

Key Definitions (cont’d)

Fully Diluted shares

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

Treasury stock method

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

400 mn

Options/ warrants outstanding

10 mn

Exercise price

$ 25

Proceeds from conversion of in the money options

10 x $ 25 = $ 250mn

Stock buyback (at premium)

$ 250 / $ 50 = 5 mn

Diluted Shares

400 + 10 – 5 = 405 mn

25

Key Definitions (cont’d) Total debt Includes all interest bearing obligations both long-term and short-term such

Key Definitions (cont’d)

Total debt

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

26

Key Definitions – Some Examples Example 2. Which of the following statement is correct: a)

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
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

Warrants o/s 5 mn

Exercise price

$40.00

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

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

Dilution effect of Options

Total number of diluted shares

= 200 / 30 = 6.67 mn shares

= Number of Options - Shares bought back at current market price

= 10 – 6.67 = 3.3 mn 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

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

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.

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

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,

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

This is obtained from the cover page of 10Q Jan 2011 filing Annotation 10Q Jan 11,

Annotation

10Q Jan 11, cover page,

Shares outstanding as of 28 Feb 2011

from the cover page of 10Q Jan 2011 filing Annotation 10Q Jan 11, cover page, Shares
from the cover page of 10Q Jan 2011 filing Annotation 10Q Jan 11, cover page, Shares

33

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

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
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

Equity and equity linked information – Shares (cont’d)

Example 5. Calculate the latest shares outstanding with below mentioned data:

Particulars

Date Details

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

15-Mar-11 10 mn Stock dividend 20-Feb-11 2:1 b) 1,360 mn c) 690 mn d) 1,380 mn

b) 1,360 mn

c) 690 mn

d) 1,380 mn

35

The correct answer is (a)!!!!!!!! Since the stock split has been effected on June 30,
The correct answer is (a)!!!!!!!!
Since the stock split has been effected on June 30,
2010, we will not adjust the Shares outstanding
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
350 + 700 – 10 = 1,040 mn
Equity and equity linked information – Options and warrants Input information on Options (and Warrants)

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

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

the total options (equivalent shares) outstanding are 30.933 mn, with a weighted average exercise price of

37

Equity and equity linked information – Convertible debt Input information on Convertible debt (value) from

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 –

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

$ 50 $ 200 mn $ 40 200/ 40 = 50 shares

Example 7

 

Current share price

$ 50

Book value of convertible debt (par value $1000 each)$ 100 mn Conversion ratio

16

Conversion price per share of convertible debt (out of money and hence added to debt)

$ 1000/ 16 = $ 62.5

39

Equity and equity linked information – Convertible debt (cont’d) Example 8. If a company has

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)!!!!!!!
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

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

Market Capitalization (cont’d)

Example 11

A Company XYZ Inc. has two Class of shares A & H.

As at 30 Apr 11

Class A

Class H

Share Price (April 30, 2011)

CNY 50.00

HKD 35.00

Shares outstanding

16,500 mn

3,400 mn

HKD - CNY Exchange rate

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

Market Capitalization (cont’d) Step 1. Calculation of Market Cap, EV and Multiples for both the

Market Capitalization (cont’d)

Step 1. Calculation of Market Cap, EV and Multiples for both the class of shares Class A

Share Price Shares outstanding Market Cap Market Cap (CNY) Proportion of Market Cap Net Debt (In proportion of Market Cap) Minority Interest Enterprise Value EV / Share

CNY 50.00 16,500 mn CNY825,000 mn CNY825,000 mn

88.56%

CNY 3,763.8 mn CNY 18 154.9 mn

, CNY 846,919 mn (approx.) CNY 51.33

Step 2. Calculation of financials per share

Revenue / share

LTM EBIT / share

LTM EBITDA CNY 41,500 mn / 19,900

LTM EPS

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

CNY 33,000 mn / 19,900

CNY 4.12

CNY 1.66

CNY 2.09

CNY 1.04

43

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 12.46x 7.81x EBIT 30.95x 19.40x EBITDA 24.61x 15.43x P/E
Multiples
Class A
Class H
Revenue
12.46x
7.81x
EBIT
30.95x
19.40x
EBITDA
24.61x
15.43x
P/E
48.08x
30.14x
Market Capitalization (cont’d) Shares / Depositary Receipts A negotiable financial instrument issued by a bank

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

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 On 25 Mar 2011

25 mn shares 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

Market Capitalization (cont’d)

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

Shares outstanding as on 31 Dec 10 Add Shares issued on 10 Mar 11

= 250 mn = 25 mn

Add ADR issued on 25 Mar 11 Equivalent number of shares*

= 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

ADR Price per share Market Capitalization

= 393.8 mn

= $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

Balance Sheet

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

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

sheet as at 31 Jan 2011 Novell Inc (amounts in thousands) In the above case of

In the above case of Novell, cash and cash equivalents shall be:

$ 981.426 + $ 150.009 = $ 1,042.915 mn

47

Cash and Cash Equivalents

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

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

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)

sheet as on 31 Jan 2011 Novell Inc (amounts in thousands) Shareholders’ equity In the given

Shareholders’ equity

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

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

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

Balance Sheet (cont’d)

Balance Sheet (cont’d) Check the note for Non Current Investment – Long Term and consider only

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

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

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

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

C

ompany

b

oug

ht b

ac

k

s

h

f

k

t

ares rom open mar e as

f

ll

o ows:

$12.00

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

Balance Sheet (cont’d)

The correct answer is (c) !!!!!

Shares outstanding as on 31 Mar 11 Less Shares bought back on 15 Apr 2011 Shares outstanding as on 15 Apr 2011

= 465.52 mn = 25.00 mn = 440.52 mn

Adjustment for Stock Split:

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

= 440.52*2

Shares o/s adjusted for Stock dividend of 25% Shares o/s as on 10 May 2011 Less: Shares bought back on 12 May 2011 Latest shares outstanding

= 881.04 mn = 881.04*1.25 = 1,101.30 mn = 55 mn = 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

Balance Sheet (cont’d)

Example 10. Following information is available from company’s AR Dec 10

Short-term debt

$ 50mn

Long-term debt

$ 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 On 15 Mar 2011 On 18 Mar 2011

Issued debentures worth $100mn (debt issue expenses $ 9mn) Redeemed senior notes of face value of $20mn 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 Cash Short term

Balance Sheet (cont’d)

The correct answer is (b)

(in USD mn)

Particulars

Cash

Short term

Long Term

Total Debt

debt

Debt

Balance as on 31 Dec 10

 

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)

Adjusted

 

221

30

275

305

balance

57

Enterprise Value Formula to calculate Enterprise Value Market Capitalization + Total Debt + Minority Interest

Enterprise Value

Formula to calculate Enterprise Value

Market Capitalization
Market Capitalization
+ Total Debt
+
Total Debt

+

Minority Interest
Minority Interest

+

Preferred Stock
Preferred Stock
+ Capital Leases
+
Capital Leases

-

Cash & Cash Equivalents
Cash & Cash Equivalents

=

Enterprise Value or “EV”
Enterprise Value or
“EV”

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)

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

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

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

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

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

Enterprise Value

Example 1. What is the Market Cap & EV for the company:

B/S as on 31 Dec 2010 (in CNY mn):

Cash

200

Share Price (in HK$)

5.00

Debt

175

Shares outstanding (in '000)

5,000

Minority Interest Current exchange rate for HK$ to CNY is 1.1

50

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
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
Income Statement Income Statement Information Revenue/ Net Sales: Income from sales of goods and services,

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

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:

Income Statement (cont’d)

Income Statement Information

Let us consider the case of Novell Inc. Example: Normalized Revenue

the case of Novell Inc. Example: Normalized Revenue Net Revenue = USD 811.871 mn 63 If

Net Revenue = USD 811.871 mn

63

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.

Th

shall not be included as a part of core revenue of company.

i

ere you m g

ht fi

n

d

ti

any excep ona

l it

em w

hi

c

h

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!!

Income Statement (cont’d) Income Statement Information E x a m p l e : N

Income Statement (cont’d)

Income Statement Information

Example: Normalized EBIT

m p l e : N o r m a l i z e d E
m p l e : N o r m a l i z e d E
m p l e : N o r m a l i z e d E

EBIT = 84.437 + 2.774 = $ 87.211 mn

64

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 l

process researc

of property, plant and equipment, gain on sale of subsidiaries.

h & d

l

eve opmen , ga n on sa e

t

i

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.

Income Statement (cont’d) Income Statement Information Example: Normalized EBITDA EBITDA = 87.211 + 30.298 =

Income Statement (cont’d)

Income Statement Information

Example: Normalized EBITDA

Income Statement Information Example: Normalized EBITDA EBITDA = 87.211 + 30.298 = USD 117.509 mn 65
EBITDA = 87.211 + 30.298 = USD 117.509 mn
EBITDA = 87.211 + 30.298 = USD 117.509 mn

65

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

Income Statement (cont’d) Income Statement Information Example: Normalized Net Income 66 In the Consolidated Statement

Income Statement (cont’d)

Income Statement Information

Example: Normalized Net Income

Income Statement Information Example: Normalized Net Income 66 In the Consolidated Statement of Operations, the Company

66

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!

Income Statement (cont’d) Income Statement Information Example: Normalized Net Income Adjust for Tax : Always

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) = $ 374.582
Therefore, the adjusted Net Income
= 377.366 + ( -7.413+2.774)* (1- 0.40)
= $ 374.582 mn

67

Income Statement (cont’d) Income Statement Information Example: Normalized EPS Earnings per share (EPS) represents

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

allocated to each share of the company’s common stock 68 Basic EPS = Normalized Net income
allocated to each share of the company’s common stock 68 Basic EPS = Normalized Net income
allocated to each share of the company’s common stock 68 Basic EPS = Normalized Net income

68

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

Pro-forma Financials Companies may acquire or divest businesses during the year Pro-forma financials means restated

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

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)

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)

Table 1

FY10A

FY11E

FY12E

Revenues

1400

3000

3500

EBITDA

750

2300

2450

EBIT

600

2050

2180

Table 2

 

FY10A

FY11E

FY12E

Revenues

1400

550

610

EBITDA

750

350

390

EBIT

600

310

380

70

Pro-forma Financials (cont’d) 1. In case the pro forma financials are reported by the company

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

forma financials are reported by the company – use them for your analysis to know the
forma financials are reported by the company – use them for your analysis to know the

71

Pro-forma Financials (cont’d) 2. If pro-forma financials are not reported by the company, calculate it

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. Line item Add Back Tax adjustment

Income Statement Information – Indicative exceptional list

S. No.

Line item

Add Back

Tax adjustment

Comment

1

Joint Venture

Y

Y

Different treatment for different purposes

2

Discontinued operations

Y

Y

No tax adjustment if net of tax

3

Restructuring cost / expenses

Y

Y

 

4

Expenses related to merger and acquisition transactions

Y

Y

 

5

Write down / Impairment of assets (both tangibles and intangibles including goodwill)

Y

Y

No tax adjustment on Goodwill

6

Impairment of leasehold expenses

Y

Y

 

7

Loss / Gain on sale of tangible & intangible assets

Y

Y

 

8

Loss / Gain on sale of investments, other than marketable

Y/N

Y

Loss/ Gain on strategic investment is exceptional

9

Amortization of deferred compensation

Y

Y

 

10

Equity based compensation expense- stock options or warrants

Y

Y

 

11

Writing back of any provisions or reserves

Y/N

Y

Provision is exceptional or not

12

Gain/Loss on sale of marketable securities

N

   

13

Income from associates / affiliates

Y

Y

 

14

Litigation settlement

Y

Y

 

15

Loss / Gain on sale or termination of an operation

Y

Y

No tax adjustment if net of tax

16

Foreign currency exchange gain / loss

Y

Y

 

17

Accounting changes

Y/N

 

Cumulative effect relating to exceptions is exceptional

18

Tax benefit from exercise of options

Y

N

 

19

Provision for doubtful accounts

N

N

 

20

Amortization of debt issuance costs

Y

Y

 

21

Expenses associated with the Sarbanes Oxley Act

Y

Y

 

22

Rental income

N

N

To be excluded from EBIT calculations

23

Government grants or subsidies

Y

Y

 

24

Severance costs

Y

Y

 

25

Facilities consolidation

Y

Y

Restructuring expense

26

Gain / Loss on early extinguishment of debt

Y

Y

 

27

Early retirement costs

Y

   

28

Redundancy costs

Y

Y

 

29

Donations

Y

Y

 

30

Amortization of Negative goodwill

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 LTM Results Reported

LTM & Calendarization

Trailing Twelve Months (TTM / LTM)

A Graphical Representation

LTM Results

Months (TTM / LTM) A Graphical Representation LTM Results Reported Fiscal Year- annual report Q1 Q2

Reported Fiscal Year- annual report

LTM Results Reported Fiscal Year- annual report Q1 Q2 Q3 Q4 Q1 Q2 Reported previous year
Q1 Q2 Q3 Q4 Q1 Q2
Q1
Q2
Q3
Q4
Q1
Q2

Reported previous year accumulated 6 month results

Reported accumulated current year 6 month results

LTM =

Fiscal year results

+

Results of current stub period

-

Results of corresponding prior stub period

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 is calculated as under:

Input financial results of the latest complete fiscal

y

ear

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

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

Dec 11E

1,400

Mar 11

850

Mar 10

900

a) 1,200

b)1,300

c) 1,250

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

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

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

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

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

Market Cap10,000

Debt 250

Cash 400

Minority Interest

Cash in Escrow account 50

Sales 2,500

EBIT 800

D&A 200

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

Correct answer is (b)!!!!!!… Enterprise Value = Market Cap + Debt + Minority Interest –
Correct answer is (b)!!!!!!…
Enterprise Value = Market Cap + Debt +
Minority Interest – Cash
EV = 10,000 + 250 + 100 – 400 = 9,950
Multiples:
– Revenue = 9,950/2,500 = 3.98x
– EBITDA = 9,950/(800+200) = 9.95x
– EBIT = 9,950/800 = 12.44x
– P/E = 20.00/0.75 = 26.67x

100

79

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

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

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

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 500

Non-recurring charges 300

EBIT 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

Multiples – Example 2 (cont’d)

Correct answer is (b)!!!!!!!!!

Reported net income = US$ 500 mn