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Valuation Training

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Table of Contents
1. What are we Valuing?

A. Valuing a Public Company

B. Valuing a Private Company

2. Valuation Methodologies

A. Comparable Companies

B. Precedent Transactions

C. Discounted Cash Flow

12

D. Leveraged Buy-out

19

1. What are we Valuing?

What is a Firm and What are we Trying to Value?


A business can have many components to its capital structure, all of which have some form of claim on the overall
business. Firm value represents the aggregate value of all interests in a business.
Creditors
Minority Interests
Pref. Shareholders
Common Shareholders
Firm Value

A firm is a group of assets (and associated liabilities) that is


used to produce output through the transformation of inputs
(e.g. labour, materials, property etc.) and in doing so generate
profit for its owners
Equity, put simply, is
the money that is
injected into the
company by the
owners of the company
in return for shares

Debt is money which is borrowed


from investors and financial
institutions and has an agreed
rate of return (e.g. interest) and
repayment terms between the
company and the lender

When we value a firm we are essentially attempting to put a value on the equity and the debt injected into the company
Both debt and equity holders have a claim on the assets and the profits generated by those assets
As mentioned above, the claim that debt holders have on the profits generated is usually already agreed (e.g. interest)
Equity holders are then entitled to the remaining profit of the company (net profit)
Given that equity and debt holders are entitled to a proportion of profits, several of the methods that we use to value firms are based on the
profit streams of companies and this is what we will focus on today
However depending on the industry you work in, different valuation methodologies exist some of which may not be based on profits
Note that for publicly listed companies, market values already exist and enterprise value can be calculated from market data
However the methodologies discussed today are also used by analysts to determine whether a publicly listed company is over/
under-valued and what is a fair value for a company
Firm Value is the collective value of all stake holdings (equity, debt, etc.) with claims on a valued asset
(e.g. operating assets) or economic streams (e.g. revenue, EBITDA) generated by such assets.

What are we Valuing?

A. Valuing a Public Company

The Composition of Enterprise Value


For a public company, we are able to calculate firm value based on publicly available information.

Market Capitalisation =
Share Price x Number of Shares

Value of shares in the market


Equity
Value
Value of shares potentially issued from
options, net of cash received

Net Impact of Options =


No. of Options x (Share Price Avg. Exercise Price)

+
Value of shares potentially issued from
convertible securities (see later)

In-the-Money Convertible Securities


Potential Shares from In-the-Money Convertibles x Share Price

+
Total Debt =
Debt (LT, ST, Out-of-the-money Convertible) + Finance Leases

Liquid Resources
Cash + Marketable Securities

Market Value of JVs and Associates

+
Market Value of Minority Interests

2Valuing a Public Company

Net
Debt

Bank loans, overdrafts, bonds,


convertible debt as well as
finance leases
Not only cash in the bank, but also
securities held by the company
readily saleable
Interests in companies partially owned
but which the company does not have
control (owns <50%)
Interests of third parties in
subsidiaries under the companys
control (owns >50%)

B. Valuing a Private Company

Valuation Methodologies
The most commonly used methodologies in our advice to clients are outlined below.

Multiples Based Valuation

Comps Based Valuation


(Inc. Sum-of-the-Parts)

Precedent Transactions

Cash Flow Based Valuation

Discounted Cash Flow

Multiples-based technique with


reference to relevant publicly-traded
market prices

Multiples-based technique with


reference to relevant completed
M&A transactions

Most common methodology to


estimate the fundamental of
intrinsic value

Based on relative valuations of


public companies that are most
comparable to our target

Similar to comps based valuation

Valuation is based on cash flows


attributable to the firm, irrespective
of capital structure

Valuation multiples of such


companies are applied to earnings
metrics of our target company
(e.g. sales, EBITDA) to
derive valuation

3Valuing a Private Company

Multiples are applied to earnings


metrics sales, EBITDA

Value equal to the sum of


the present values of such
cash flows
Discounted Cash Flow valuations
are founded on the premise that
company value is equal to the value
of future cash flows generated by
the company and available to be
paid out to investors, discounted at
the required rate of return
demanded by investors

Leveraged Buy Out

Valuation based on the maximum


amount a potential private equity
investor can afford to pay for the
business to achieve a target return

2. Valuation Methodologies

Summary Financial Data Company A

Company A

Our analysis will be based on the following dummy company, Company A.

Fiscal Year Ending 31 December


Million, Unless Otherwise Stated

2013A

2014E

2015E

2016E

2017E

2018E

2019E

2020E

2021E

2022E

2023E

2024E

1,000.0

1,082.0

1,157.7

1,221.4

1,270.3

1,317.3

1,356.8

1,390.7

1,418.5

1,446.9

1,475.8

1,505.3

P&L
Sales
Growth
EBITDA

8.2%
130.0

Growth
Margin
Depreciation
% Sales
EBIT

13.0%
(50.0)
5.0%
80.0

Growth
Margin

8.0%

162.3

7.0%
196.8

5.5%
224.7

4.0%
241.4

3.7%
256.9

3.0%
271.4

2.5%
278.1

2.0%
283.7

2.0%
289.4

2.0%
295.2

2.0%
301.1

24.8%

21.3%

14.2%

7.4%

6.4%

5.6%

2.5%

2.0%

2.0%

2.0%

2.0%

15.0%

17.0%

18.4%

19.0%

19.5%

20.0%

20.0%

20.0%

20.0%

20.0%

20.0%

(54.1)
5.0%
108.2

(60.2)
5.2%
136.6

(64.7)
5.3%
160.0

(68.6)
5.4%
172.8

(72.4)
5.5%
184.4

(74.6)
5.5%
196.7

(76.5)
5.5%
201.7

(78.0)
5.5%
205.7

(79.6)
5.5%
209.8

(81.2)
5.5%
214.0

(82.8)
5.5%
218.3

35.3%

26.3%

17.1%

8.0%

6.7%

6.7%

2.5%

2.0%

2.0%

2.0%

2.0%

10.0%

11.8%

13.1%

13.6%

14.0%

14.5%

14.5%

14.5%

14.5%

14.5%

14.5%

Cash Flow
CapEx
% Sales
CapEx/Depreciation
Net Working Capital
% Sales
4Change
Valuation
Methodologies
in Working
Capital

(67.5)

(68.7)

(69.8)

(71.2)

(73.4)

(76.1)

(76.1)

(76.5)

(78.0)

(79.6)

(81.2)

(82.8)

6.8%

6.4%

6.0%

5.8%

5.8%

5.8%

5.6%

5.5%

5.5%

5.5%

5.5%

5.5%

135.0%

127.0%

116.0%

110.0%

107.0%

105.0%

102.0%

100.0%

100.0%

100.0%

100.0%

100.0%

(50.0)

(54.1)

(57.9)

(61.1)

(63.5)

(65.9)

(67.8)

(69.5)

(70.9)

(72.3)

(73.8)

(75.3)

(5.0)%

(5.0)%
4.1

(5.0)%
3.8

(5.0)%
3.2

(5.0)%
2.4

(5.0)%
2.4

(5.0)%
2.0

(5.0)%
1.7

(5.0)%
1.4

(5.0)%
1.4

(5.0)%
1.4

(5.0)%
1.5

Valuation Summary

Company A

Based on various valuation methodologies, we have arrived at the following range of values for Company A.

5 Valuation Methodologies

A. Comparable Companies

The Concept of Multiples


The principal of comps based valuation is based on comparing our target company to publicly listed companies to derive
a fair valuation.
Comps Based Valuation (Inc. Sum-of-the-Parts)
Based on relative valuations of public companies that are most comparable to our target
Valuation multiples of such companies are applied to earnings metrics of our target company, e.g. sales, EBITDA to
derive valuation
Compare and benchmark company on both qualitative and quantitative metrics. Examples of such metrics include
Sales and EBITDA growth
EBITDA margin and future margin uplift
Geographic Diversification
Quality of Brand and international potential
Stage in company lifecycle, etc.
Decide whether company should be placed on a valuation multiple at a discount or a premium to the different comps
given the metrics analysed above and value it at a suitable multiple
Using this analysis we can also look at whether current publicly listed companies are undervalued or overvalued
compared to its peer group

6 Comparable Companies

Calculating Comp-based Valuations

Company A

Based on our comparable companies analysis, Target Company A is valued between 1,160m and 1,781m on a trading
basis and between 1,392m and 2,138m on a take-out basis.
Comparable Companies Analysis

EV / Sales

EV / EBITDA

Share
Price (p)

Market
Cap (m)

Enterprise
Value (m)

2014

2015

2016

2014

2015

2016

Company B

375

5,025

6,556

2.1x

1.9x

1.8x

10.5x

8.6x

8.2x

8.0%

13.3%

22.0%

Company C

1,052

768

968

1.3x

1.2x

1.2x

9.3x

7.3x

7.3x

5.4%

12.7%

17.0%

Company D

786

3,276

3,576

1.6x

1.5x

1.5x

8.9x

7.7x

7.6x

5.0%

7.9%

19.4%

Company E

105

1,074

1,199

1.1x

1.1x

1.0x

9.2x

8.9x

8.3x

4.9%

4.9%

11.8%

Company F

832

202

252

1.5x

1.3x

1.2x

14.5x

9.3x

9.2x

9.9%

25.3%

14.0%

5,025

6,556

2.1x

1.9x

1.8x

14.5x

9.3x

9.2x

9.9%

25.3%

22.0%

Indicative
Valuation Company
A
Mean
2,069
2,510

1.5x

1.4x

1.3x

10.5x

8.4x

8.1x

6.7%

12.8%

16.8%

1.5x

1.3x

1.2x

9.3x

8.6x

8.2x

5.4%

12.7%

17.0%

Company

High

in Millions
Median

1,074

1,199

Multiple
Low

202

1
2015E Sales
2015E EBITDA

Implied EV

Implied 2014E EBITDA Multiple

7Take-out
Comparable
Companies
Premium

252

Value

1.1x

1.1x

1.0x

8.9x

Low

High

Low

High

1,082

1.1x

1.9x

1,136

2,056

162

7.3x

9.3x

1,184

1,507

1,160

1,781

7.1x

11.0x

20%

20142016
Sales CAGR

20142016
EBITDA CAGR

2014 EBITDA
Margin

Takeout Multiples and Control Premia


7.3x
7.3x
4.9%
4.9%
11.8%
However, when public companies are acquired, a premium is
usually paid to the current share price to persuade shareholders to
cede control of the company to the acquiror
This is known as the control premium and varies from market
to market
Valuations including a premium are known as takeout valuations

Sum-of-the-Parts

Company A

If a company is comprised of several separate distinct parts, we may value it based on fair valuations for each part of
the business.
Comps Based Valuation (Inc. Sum-of-the-Parts)
Several companies can be split into separate and distinct operating assets
Companies can be split into parts by operation or by geography for example
Each part can therefore be valued individually to come up with a sum-of-the-parts valuation
Whilst each part can be valued in various ways, we commonly use a range of valuation multiples for each part to derive a fair value for
the company
With public companies, this sum-of-the-parts valuation can then be used to see whether the company is currently over or undervalued at
the current share price and whether there is value to be released from breaking up the company

EBITDA Multiple
Company A

2015E EBITDA

Valuation

Low

High

Low

High

9.5x

10.5x

596.7

659.5

Beer

62.8

Juice

11.0

8.0

9.2

88.3

101.5

Soft Drinks

44.0

12.0

13.5

527.8

593.8

Wine

23.7

9.0

10.2

213.3

241.7

20.8

13.0

14.1

270.1

292.9

10.5x

11.6x

Spirits

Group Total
Take-out Premium
Take-out SOTP Value
8 Comparable Companies

162.3

1,696

20%

Implied Multiple
12.5x

14.0x

1,889

2,035

2,267

B. Precedent Transactions

Principles of Precedent Transactions


The principles of precedent transaction analysis are very similar to comparable companies analysis, although there
are some key differences.
Precedent Transaction
Similar to comps based valuation, multiples are applied to earnings metrics based on analysis of historical transactions
Principles of precedent transactions are very similar to comparable companies analysis, although there are a few key
differences which need to be highlighted
Transaction multiples are generally historic (last twelve months or LTM) to the extent possible and not forward-looking
like comps
Transaction multiples will generally include a control premium and so the value derived is a take-out multiple rather
than a trading multiple
Comps use current market data and as such are based on current investor sentiment on a particular sector. However,
since transactions are historic, the market may have evolved significantly since then and the multiple may not be
relevant any more
There may be factors that are particular to a relevant transaction e.g. structure that may have had an impact
on valuation

9 Precedent Transactions

Calculating Precedent Transactions


When calculating enterprise value in precedent transactions, you need to make sure you are calculating a value for
100% of the company.
Calculating Precedents
When calculating precedent transactions, we need to calculate the implied EV as
well as the most recent LTM metric (e.g. Sales, EBITDA, EBIT)
Note however that on several occasions, not enough data will be in the public
domain to calculate a multiple
The calculation of EV is as presented previously, however, there are some key
points to take into consideration when analysing precedent transactions:
Is the transaction value stated the amount paid for equity or the total
company?
In several cases, the acquiror does not purchase 100% of the company and as
a result the equity value stated needs to be grossed up to 100% to calculate
the correct value
Does the value stated include the net value of options?
When calculating LTM metrics, we will use the last reported numbers, taking into
account the last interim results the company has released
LTM EBITDA = Last Reported Full Year EBITDA + Last Reported Interim
EBITDA Prior Year Interim EBITDA
Note that if the last reported numbers are the full year results, we do not need
to make any adjustment for interims

10 Precedent Transactions

Example Calculation
Company B acquires 75% of Target 1 for an equity value of 750m
Company B has net debt outstanding of 250m
Target 1 reported 2013 Sales and EBITDA of 900m and 120m and recently
reported 3Q14 Sales and EBITDA of 750m and 105m for the first nine months
ended 31 September 2011. In 3Q10 it reported Sales and EBITDA of 650m and
100m respectively for first nine months ended 31 September 2013
Price Paid (m)

750

Percent Acquired

75.00%

Implied Equity Value

1,000

Net Debt
Implied EV

250
1,250

FY13 Sales

900

Plus: 3Q14 Sales (L9M)

750

Less: 3Q13 Sales (L9M)

(650)

LTM Sales

1,000

Implied EV / LTM Sales

1.3x

FY13 EBITDA

120

Plus: 3Q14 EBITDA (L9M)

105

Less: 3Q13 EBITDA (L9M)

(100)

LTM EBITDA

125

Implied EV / LTM EBITDA

10.0x

Calculating Precedent-Based Valuations

Company A

When choosing valuing companies based on precedent transactions, whilst qualitative and quantitative comparisons
should be made, you will also need to look at details around the transaction to determine the correct multiple.
Precedent Transactions

EV / LTM
Date Announced

Target

Acquiror

Transaction Value (m)

Sales

EBITDA

EBIT

5 June 2014

Target 1

Company C

1,250

1.3x

10.0x

16.3x

2 January 2014

Target 2

Company C

230

3.0x

12.3x

25.4x

26 May 2013

Target 3

Company A

500

1.1x

12.6x

14.4x

1 April 2013

Target 4

Company B

150

3.1x

13.4x

19.1x

21 February 2013

Target 5

Company D

2,000

2.0x

13.0x

NA

2,000

3.1x

13.4x

25.4x

826

2.1x

12.2x

18.8x

High

Mean

Precedent Transactions

Choosing Multiples
500

Median
EV / EBITDA

Low

Low

Value

High

Low

High

LTM Sales 5

1,000

1.1x

3.1x

1,100

3,100

LTM EBITDA

130

10.0x

13.4x

1,300

1,737

1,200

2,419

Implied EV

Implied LTM EBITDA Multiple

11 Precedent Transactions

9.2x

18.6x

2.0xmultiple to apply to an
12.6x
17.7x may be
When choosing what
LTM earnings figure, there
some precedent transactions which are more relevant than others
Here for example,
only transactions 1510.0x
are relevant from all available
150
1.1x
14.4x
precedent transactions
As with comps, quantitative and qualitative comparisons between companies is
forms the basis of your judgement
However, there are other factors that may need to be accounted for which are
transaction specific such as
Was the acquisition, an acquisition of a minority stake?
Did the acquiror already own a stake in the target?
What was the strategic rationale behind the transaction?

C. Discounted Cash Flow

Discounted Cash Flow Key Building Blocks


With a DCF valuation, we are attempting to put a value on the future operating cash flows of the company that are
available to be paid out to both equity and debt investors.

1. FCF for 10 Years

Free Cash Flow

=
EBITDA

2. WACC

WACC
=
E/(E+D)*Cost of Equity
+
D/(E+D)*Cost of Debt

3. Terminal Value
Using DCF Method

FCFTx(1+g)
Kg

CapEx

Change in WC
(Rec Pay + Inv)

Tax on Operating Profit

12 Discounted Cash Flow

Cost of Equity
=
Rf + beta*(EMRP)
Cost of debt =
(Rf + Credit differential)
*(1-t)

Proportion
of Debt and Equity

Using Multiple Method


Apply a multiple
to the Terminal EBITDA

4. NPV

Net Present Value

=
FC1*(1+WACC)-1
+
FC2*(1+WACC)-2
+
FC2*(1+WACC)-3
+ ....
+
(FC10+TV)*(1+WACC)-10

Calculating the FCF


A Basic Definition of Free Cash Flow is
The amount of cash that a company has left over after it has paid all of its expenses, but before any payments or
receipts of interest or dividends, before any payments to or from providers of capital and adjusting tax paid to
what it would have been if the company had no cash or debt
Sales
Operating Costs

X
(X)

EBIT

Depreciation

Amortisation

EBITDA

Changes in Working Capital


Operating Cash Flow

X/(X)
X

Tax Paid

(X)

CapEx

(X)

FCF before Interest


Interest Paid
Free Cash Flow

13 Discounted Cash Flow

X/(X)
(X)
X/(X)

Calculating the WACC


The WACC for a company is calculated from a specific formula. Citi have issued guidelines for estimating the correct
parameters for this calculation.
After calculating the required rates of return for both debt and equity investors, we then weight these required returns according to a target capital structure for the
company, to come to an overall cost of capital for the company
Weighted Average Cost of Capital (WACC) =
Cost of Equity x (Equity/(Debt + Equity)) + Cost of Debt x (Debt/(Debt + Equity)) x (1 Tax Rate)

WACC Calculation Company A


The Cost of Equity is based on the CAPM and the following formula

WACC Analysis

KE = Rf + (Rm Rf)
Low

High

Cost of Equity

3.8%

3.8%

Risk Free Rate (30 Year)

3.8%

3.8%

Equity Market Risk Premium

5.0%

7.0%

Equity Beta

1.07

1.07

Adjusted Equity Market Risk Premium

5.4%

7.5%

Sovereign Risk Premium

0.0%

0.0%

Inflation Differential

0.0%

0.0%

Small Cap Premium

0.0%

0.0%

Cost of Equity

9.1%

11.3%

Cost of Debt
Risk Free Rate (10 Year)

3.8%

3.8%

Credit Spread

1.0%

2.0%

Inflation Differential

0.0%

0.0%

Cost of Debt (Pretax)


Effective Marginal Tax Rate
Cost of Debt (Aftertax)
Debt/Capitalisation (Market)
WACC

14 Discounted Cash Flow

4.8%

5.8%

30.0%

30.0%

3.4%

4.1%

30.0%

30.0%

7.4%

9.1%

where KE is the cost of equity Rf is the risk free rate and


(Rm Rf) is known as the equity market risk premium
The EMRP is estimated by Citi to be between 57%
Relevant government bonds are used for the risk free rate
The Beta is calculated by taking an average of asset betas of comparable
public companies
Tax rate is usually the company specific tax rate
Industry average is usually used for debt/capitalisation unless a specific target is
known for the company

The Concept of Present Value


When deriving a value for a companys cash flows, we need to take into account the future timing of the cash flows in the
forecast period.
Once we have derived an overall required rate of return for the company, the cost of capital, we are able to value the
value of the cash flows generated by the company in terms of how much it is worth today, the Present Value
The value of 1 tomorrow is worth less than the value of 1 today
Say an investor has 100 to invest today and his required rate of return is 10%
In 1 year, he will want to receive 10% of 100 = 10 in addition to the 100. Therefore, to the investor, receiving 110
in one year is equivalent to receiving 100 today, i.e. 110/1.1 = 100
In 2 years, he will want to receive 10% of 100 and 10% of 110 in addition to the original
100 = 100 x 1.1 x 1.1 = 121
In 3 years etc.
We use this concept therefore to derive the following formula for the present value of future cash flows which fall at the
end of the year in every year from now

PV =

CF1
(1+K)1

CF2
(1+K)2

CF3
(1+K)3

CF4
(1+K)4

Where CF is the cash flow in its respective year and K is the required rate of return (the WACC)

15 Discounted Cash Flow

Mid-year Cash Flow Convention


A companys cash flows are continuous and we need to account for this in valuing cash flows over the forecast period by
using the mid-year convention.
Cash flows for a company are continuous and do not fall to the investor at the end of the year in every year as the
formula in the previous slide suggests
We generally therefore use a mid-year convention, where we assume for valuation purposes that the cash flows that
are generated in every year fall in the middle of the year and we value them on that basis
In order to do this, we need to divide the formula in the previous slide by (1+K)0.5 to essentially shift cash flows back by
half a year
As a result the formula on the previous slide changes to as follows

PV =

16 Discounted Cash Flow

CF1
(1+K)0.5

CF2
(1+K)1.5

CF3
(1+K)2.5

CF4
(1+K)3.5

Terminal Value
The terminal value of a company is the future value of the cash flows of the company after the forecast period and
into perpetuity.
Whilst we have discussed valuing cash flows over a discrete period of time (e.g. 10 years), we also have to value the cash flows of the
company post the forecast period into perpetuity
The value of the cash flows into perpetuity is known as the Terminal Value and can be calculated in one of two ways
Applying an multiple to a profit metric (e.g. EBITDA) in the final year (Comps Method)
Consider the steady state of the company and value its future cash flows based on an assumption as to the average long term growth
rate of the cash flows into perpetuity (DCF Method)
Both methods can be used as a cross check against each other to see if the result is sensible
However note that the value derived is the value of the cash flows into perpetuity at the end of the forecast period (e.g. in 10 years time if
the forecast period is 10 years long) and therefore needs to be discounted back to present value
However, note that we do not use the mid-year convention for discounting back

Comps Method
The approach used here is the same as in our comps
based valuation focusing on average trading multiples of
comparable companies
You can use any profit metric you see suitable, although EBITDA
most commonly used
Note that the metric used should be excluding any
exceptional items
Assuming a 9.0x EBITDA multiple we derive a terminal value
(future value) of 301m x 9 = 2,710m

DCF Method
For this, there are two steps to be taken
Calculate adjusted terminal year CF accounting for any
exceptional items and equalising CapEx and depreciation
In the long term CapEx = depreciation and so if CapEx is
higher than depreciation we need to add the difference to the
final year FCF and conversely if lower
Assume a perpetuity growth rate (g)
The FV of the terminal value is then derived from the
following formula
FCFT x (1+g)
(K g)

17 Discounted Cash Flow

Discounted Cash Flow Model


in Millions
Sales
EBITDA
Depreciation
EBITA

2014
1,082
162
(54)
108

Company A

Year Ending 31 December


2018
2019
2020
1,317
1,357
1,391
257
271
278
(72)
(75)
(76)
184
197
202

2015
1,158
197
(60)
137

2016
1,221
225
(65)
160

2017
1,270
241
(69)
173

(41)

(48)

(52)

(55)

(59)

96

112

121

129

(70)

(71)

(73)

60

65

(Increase)/Decrease in WC

Other
Terminal
EBITDA
EBITDA Multiple
FV
of Terminal
Unlevered
FCFValue
Discount Factor
PV of Terminal Value
Time Period

Taxes
Taxed EBITA
CapEx
Deprecation

Using Comps Method

90

2022
1,447
289
(80)
210

2023
1,476
295
(81)
214

(60)

(62)

(63)

(64)

(65)

138

141

144

147

150

153

(76)

(76)

(76)

(78)

(80)

(81)

(83)

69

72

75

76

78

80

81

83

0
301
9.0x
2,710
119
0.45
1,226
2.5

0
154

109

0.5

1.5

WACC

8.3%

8.3%

Discount Factor
Implied Enterprise Value

0.96

0.89

86EBITDA Multiple
97

PV of FCF
PV of Forecast Cash Flows
WACC

8.5x

0.82
2,111
97

9.0x

9.5x
2,260

2,043

2,111

2,179

1,971

2,036

2,101

2,117

8.3%
8.8%

18 Discounted Cash Flow

884

8.3%

2,189

7.8%

Terminal
2024
EBITDA
1,505
301
(83)
218

2021
1,419
284
(78)
206

Using DCF Method


0 Cash Flow
Final Year
Perpetuity Growth Rate

128

Terminal
138FCF
WACC

2.0%

143

3.5

FV of Terminal Value
4.5
Discount Factor

8.3%

PV of Terminal Value
8.3%
8.3%
Implied Enterprise Value

0.76
97

0.7
97

145

5.5

0.65
92

148

151

157
154
8.3%

6.5

7.5

8.5

2,518
9.5
0.45

8.3%

8.3%

8.3%

1,139
8.3%
2,024

0.6

0.55

0.51

87

Property Growth
82
77Rate

0.47
73

1.5x

2.0x

2.5x

2,092

2,202

2,332

8.3%

1,934

2,024

2,129

8.8%

1,799

1,873

1,959

7.8%
WACC

Final Year
FCF

D. Leveraged Buy-out

Principles of an LBO
Given the increase in M&A activity by private equity players, working out how much they can potentially pay to generate a
required return has become a key driver of valuation.
In a leveraged buyout the principle is as follows
A company is acquired for a given price through a combination of debt funding (usually between 5070% of total funding) and equity
from the private equity firm
Over the next few years, the company increases its profitability and also uses its cash generated to pay down the debt that the PE firm
has used to acquire the business
In the medium term, usually 35 years, the company is sold, based on a higher EBITDA with the proceeds being used to pay back debt
(which is now lower than when the company was acquired originally) and the difference in the exit price and the level of debt goes to the
private equity player
The private equity player generates returns from selling its equity in the business for a substantially higher price and as such, we can derive
a maximum price payable today for the company by setting a level of target returns for the private equity player

19

Leveraged Buy-out

Example LBO Model

Company A

Generally speaking, a private equity player will look to generate returns in excess of 20%, although this will vary from
sector to sector.
Cash Flow Statement Company A
of Million

2015

2016

2017

2018

EBIT
Depreciation
EBITDA
Change in WC
Net Interest
Tax
Capex
Change in Net Debt
Starting Net Debt
Closing Net Debt

137
(60)
197
4
(61)
(23)
(70)
47
900
853

160
(65)
225
3
(57)
(31)
(71)
69
853
785

173
(69)
241
2
(52)
(36)
(73)
82
785
702

184
(72)
257
2
(46)
(42)
(76)
96
702
607

Exit Valuation Company A


EBITDA
Exit Multiple
Exit Value
Less: Net Debt
Equity Value
Target IRR
Discount Factor
Implied Current Value of Equity
Plus: Net Debt on Acquisition
Implied Acquisition Value

257
9.0x
2,312
(607)
1,705
20.00%
0.48
822
900
1,722

We have acquisition of the target for 1,500m financed through 900m of


funded debt and 600m equity
Every year the company generates cash and by 2018, the net debt of the
company is only at c.600m
We have assumed an exit at 9.0x EBITDA in 2018 valuing the company at c.
2,300m on exit
Given implied net debt of c.600m in 2018, this implies an equity value of c.
1,700m on exit
The internal rate of return (IRR) is the return made on the investment and is the
same in principle to the discount rate
The IRR is the rate of return on the investment where the present value of
the future cash flows to the equity investor at that rate is equal to the initial
value of equity used to buy the business
The IRR in this case is 29.8%, i.e. 1,705m discount back 4 years at a rate of
20.0% gives us a value of 822m
Therefore based on a value on exit, we are able to calculate the maximum price
payable by a firm today to generate a given return
Max Price Calculation Company A
EBITDA

257

Exit Multiple

9.0x

Exit Value
Target IRR

15.0%

17.5%

20.0%

22.5%

8.0x

1,728

1,660

1,598

1,543

1,493

8.5x

1,801

1,727

1,660

1,600

1,546

9.0x

1,875

1,795

1,722

1,657

1,598

9.5x

1,948

1,862

1,784

1,714

1,651

10.0x

2,022

1,929

1,846

1,771

1,704

Exit Multiple

20

Leveraged Buy-out

25.0%

2,312

Less: Net Debt

(607)

Implied Equity Value

1,705

EV on Acquisition

1,500

Less: Net Debt on Acquisition

(900)

Equity Value on Acquisition


Cash on Cash Return
Implied IRR

600
2.8x
29.8%

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