# Techniques In Finance & Valuation FINAL

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Techniques in Finance & Valuation1

What is Valuation?Valuation: Methods of quantifying how much money somethingshould be exchanged for today, considering future benefits.We will teach 4 valuation methods Trading Comparables Transaction Comparables Sum-of-the-Parts Valuation Discounted Cash Flow Analysis (DCF) 2

Why is Valuation important?Acquisitions:How much should wepay for the company?Divestitures:How much should wesell our company for?Sell-side Research:Should our clients buy,sell or hold a givenstock (fixed incomesecurity, option etc.,)?ValuationInitial Public Offering(IPO):Hostile defense:How much is thecompany worth?(price per share )Is our companyundervalued/vulnerableto a hostile bidder?Debt offerings:What is the value of thecompany against whichdebt is being issued?(collateral)3

Agenda Multiples: Comparables Trading (transaction comparables will be covered by Mike) Theory: Similar companies (all else equal) should have similar valuations Defining a Peer Group (“similar companies”) Picking the right multiples Calculating CLX’s multiples Spreading Peer Group multiples Calculating CLX’s implied value

First day on the job (potential interview question) Your boss thinks shares of Clorox Co. (“CLX”) might be a good investment: She asks you: “How much do you think they are worth?” One common approach is Multiples Based Valuation Technique6

What are multiples?“CLX” 67 a shareExamples:Price / Earnings (P/E)Firm Value / RevenuesFirm Value / EBITDA?“ENR” 67 a shareEarnings per share 4.24 67 / 4.20 15.8xEarnings per share 2.90 67 / 3.00 23.1x7

Trading Comparables: The Theory Basic Assumption: Similar companies should have similar valuations Employing multiples is a relative valuation technique17xPrice / Earnings ( “Price to 11.0x11.0x10.0x10.9x10.0x8.6x8.5x7.8x7x 1x11.0x10.0x10.5x11.0x10.1x10.0x10.0x 2008Q32008Q42009Q12009Q22009Q32009Q42010Q12010Q28

Trading Comparables – Selecting the right peer group It is important to select the best peer group possible (“similar companies”) How?Operational Filters Financial FiltersIndustry / Sub-Sectors Size (e.g. Market Capitalization, Revenue etc.,)Product Profit MarginsMarkets Leverage (e.g. Debt / Capital)Customers Shareholder base (influence of a large shareholder)SeasonalityCyclicalityClorox Peer Group Kraft – “KFT” Church & Dwight - "CHD" Procter & Gamble – “PG” Energizer Holdings – “ENR” Colgate – “CL” Kimberly-Clark – “KMB” Clorox Corporation – “CLX”9

Next Step: Choosing the right multiples It is important to chose the RIGHT multiplesExamples: MultiplesPrice/earningsFirm value/EBITDAP/E to growthPrice/cash flow Generally, it is appropriate to use the multiples which are being used in the market. Check sell-side research reports It is also important to understand WHY the market is using certain multiplesMultipleProsConsFirm value/subscribers Important telecom ratioGood for more mature situations Assumes same profitability for all compsDifficult to use in high growth situationsPrice/book value Distorted by accounting differencesNeed profitability cross-checkFirm value/sales Useful for capital intensive industries andfinancial institutionsReflects long-term profitability outlookMost often used with high growthcompanies that do not have earnings Need profitability cross-checkPrice / click rate (?) Is not a good predictor of long-term returnto shareholdersUseful for companies without revenues orearnings (?)10

Our multiplesPrice/ Earnings PerShare (EPS) Companies have earnings (relatively stable vs - e.g. tech.) Widely Used (illustration power) Illustrates need for earnings forecastsFirm Value/ EBIT Impact of Leverage (debt interest expense) Debt can be good and bad (efficiently used?) Important Distinction: Firm Value vs. Equity ValueFirm Value /Revenue High fixed costs economies of scale Small change in sales Large Change in Earnings Illustrates need for revenue forecasts1) Calculate CLX’s Price to Earnings Per Share2) Calculate CLX’s Firm Value to EBIT3) Calculate CLX’s Firm Value to RevenueTrading Comparables11

Our multiplesPrice/ Earnings PerShare (EPS) The companies have earnings (stable but cyclical) Widely Used Illustrates need for earnings forecasts1) Calculate CLX’s Price to Earnings (aggregates)Price - Market Capitalization (price x shares)Yahoo Finance: 9.5 billion USDEarnings - Consensus (average) sell-side estimates – Bloomberg Machine –Year-End 2010E: 600mPrice to Earnings: 9500m/ 600m 15.8xWhich is the same as earlier example: 67 / 4.24 15.8XTrading Comparables12

Our multiplesFirm Value/ EBIT Impact of Leverage (debt interest expense) Debt can be good and bad Important Distinction: Firm Value vs. Equity Value1) Calculate CLX’s Firm ValueLiabilities and Shareholders’ EquityAssetsEquity ValueFirmvalueFirmValue(Common Stock)Debt(Net Debt)Trading Comparables13

Net Debt . . .Debt Long Term Debt - 2,151m Current Portion of Long Term Debt - 577m Short Term Debt - 421m(-) Cash & Cash Equivalents - 206mCash Net Debt - 2,943Trading Comparables14

Our multiplesFirm Value/ EBIT Impact of Leverage (debt interest expense) Debt can be good or bad Important Distinction: Firm Value vs. Equity Value1) Calculate CLX’s Firm ValueLiabilities and Shareholders’ EquityAssetsEquity ValueFirmvalue 12,443FirmValue 9,500mDebt (net debt) 2,943m1) Calculate CLX’s Firm Value to EBITEBIT YE2010E - Consensus sell-side 1,305FV / EBIT 9.5xTrading Comparables15

Our multiplesFirm Value /Revenue High fixed costs economies of scales Small change in sales Large Change in Earnings Illustrates need for revenue forecasts1) Calculate CLX’s Firm Value to RevenuesWhy is a revenue multiple a Firm Value Multiple?Firm Value - 12,443Revenues - Consensus sell-sideYear-End 2010E: 5,579Firm Value to Revenue: 12,443m/ 5,579m 2.2xTrading Comparables16

Trading Comparables: Remember This is a Relative Valuation Method Now we know where CLX is trading TODAY - but our boss / interviewer asked what the VALUE .0x10.0x10.9x10.0x8.6x8.5x7.8x7x 1x11.0x10.0x10.5x11.0x10.1x10.0x10.0x 2008Q32008Q42009Q12009Q22009Q32009Q42010Q12010Q217

Spreading the Trading ComparablesCompany Comp SetEquityValueMultiplesFirm Value MultiplesPrice /Earnings PerShare (EPS)Firm Value /RevenuesFirm Value /EBITChurch & Dwight - "CHD"17.55x2.10x11.36xColgate-Palmolive - "CL"18.23x2.56x10.77xKimberly-Clark - "KMB"21.00x3.30x9.74xEnergizer Holdings - "ENR"17.20x3.80x10.80xKraft Foods - "KFT"17.43x1.80x12.82xProcter & Gamble - xCompany NameClorox Corp - "CLX"Mean18

Trading Comparables – Current Price 67 / share “CLX”( in millions, USD)Peer Group Mean18.1xPrice / Earnings2.7xFV / Revenue11.3xFV / EBIT“CLX “ 600m 5,579 1,305Valuation 10,860 15,063 14,746Equity ValueFirm ValueFirm Value 2,943 2,943Net DebtEquity Value 10,860 12,120 11,803SharesOutstanding140m140M140MImplied Value 77.60 86.57 84.31?Buy? Sell? Hold?Trading Comparables - Valuation Range: 77 - 87 per share19

The SCIENCE is performing the valuation, the ART is interpreting the results in order toarrive at the “right” price. TECHNOLOGY can help you do this more efficiently.Implied Price Per Share 20.00 26.75 15.00 15.00 9.75 10.00 10.25 5.00 5.00 5.00Impliedoffer 8.50 5.50 6.00 4.00 4.94 4.00 3.75 3.50 3.00 0.0052-weekhigh/lowPrice / EarningsPrice / Earning GrowthPrice / SalesPrice / LTM revenueManagement ForecastIncome15% Discount RatePublic trading comparablesStreet ForecastIncome15% Discount RateTransactioncomparablesDCF analysis20

Transaction Comparables

Step 1: Locate Comparable Transactions Equity research reports Merger proxies for similar transactions Fairness opinions of financial advisors disclose the comparabletransactions used in their valuations of the target Company press releases, shareholder presentations, conference calltranscripts and SEC filings Bloomberg transaction description (TICKER EQUITY CACS) – Click on dealTransaction Comparables

Step 2: Select Comparable Transactions Remember that some transactions are more relevant than others whenselecting a range of multiples for a valuation The situation surrounding the acquisition is crucial: Bankruptcy-related acquisitionTelevisa to Take Stake in Univision “Servicing the company’s 10 billion debt loadleft Univsion reeling ” Televisa is buying into the company at avaluation about 40% below its original takeoverprice ”Source: Wall Street Journal (10/4/2010) Hostile transaction Recent deals are typically a more accurate reflection of valueTransaction Comparables

Let’s Pull Transaction Comparables for Clorox ( in 912/11/20095/11/20094/1/20081/25/2008Target / AcquirorSilpada / AvonBare Escentuals / ShiseidoChattem / Sanofi AventisSimple skin care / Alberto CulverAmbi Pur (Sara Lee) / P&GEdge (SC Johnson) / EnergizerOrajel / Church & DwightFrederik Fekkai / P&GAVERAGECLX FinancialsImplied ValueTransaction Value EV / LTM Revenue EV / LTM EBITDA EV / LTM EBIT 6502.8x10.9x11.8x 1,8283.4x11.1x12.3x 2,1564.5x13.1x13.5x 3963.7x11.0x12.0x 4702.6x12.5x13.5x 2751.8x9.2x9.8x 3803.8x13.6x15.8x 4403.5x16.0x17.6x 8243.9x 6,000 23,20011.7x 1,500 17,60012.6x 1,300 16,380Transaction Comparables

Sum of the Parts Valuation

Sum of The Parts Valuation Example:Time Warner, Inc. (TWX)SegmentEBITDATargetEV/EBITDAImplied ValueMovies 1,5007.0x 10,500Cable Networks 3,90010.0x 39,000Publishing 450 5,8505.0x 2,250 51,750SegmentTotalImplied EV/EBITDA:8.8x What is the “Conglomerate Discount”? Full value of TWX cannot be realized unless we unlock it Sometimes SOTP does not equal the value whole company 51,750 * (90%) 46,675 (Implied Multiple: 8.0x)Sum of Parts

Time Warner, Inc. (TWX) – Spin-offsCable Spin“Simpler, Leaner, Better & More” “The company will finally, fully separate its cableoperations creating a near-pure contentcompany enabling better investor focus.”Source: Collins Stewart (1/30/2009)AOL Spin“AOL Exit Clarified ” “Cable networks eventually become the focus.Over the long-term, we think investors willappreciate Time Warner’s leading contentcentric assets and streamlined strategicapproach focused on generating high-quality andpopular programming.”Source: Goldman Sachs (5/28/2009)Sum of Parts

Discounted Cash Flows – “DCF”

DCF AnalysisDiscounted cash flow analysis is based upon the theory that the valueof a business is the sum of its expected future free cash flows,discounted at an appropriate rate. Three key drivers: Free cash flow projections Terminal value at the end of the projection period Discount Rate (weighted average cost of capital or “WACC”)Discounted Cash Flow

Free Cash FlowLevered Free Cash FlowEBITDA(-) Interest Expense(-) Capital Expenditures(-) Cash Taxes(-) Changes in Working CapitalLevered Free Cash FlowUnlevered Free Cash FlowEBITDA(-) Capital Expenditures(-) Cash Taxes(-) Changes in Working CapitalUnlevered Free Cash FlowLet’s setup a DCF Model .Discounted Cash Flow

Calculating WACC WACC [(rd * (1 – T)) * (D / (D E))] [re * (E/ (D E))] Let’s look at two capital structures: (1) 100% debt (2) 100% equityD / (D E) 100%vs.E / (D E) 100% There is a cost associated with debt and equity used to fund businessinitiatives There is a rate charged for debt issued There is a rate charged for equity issued [rd * (D / (D E))] [re * (E/ (D E))] The rate used for debt should be reduced to account for the tax shield WACC [(rd * (1 – T)) * (D / (D E))] [re * (E/ (D E))]Discounted Cash Flow

Cost of Equity – “CAPM”“CAPM” Capital Asset Pricing ModelRf β * ( rm – rf) “The 10 Question” As the perceived risk of a company increases, an equity investor will requirea higher rate of return Risk free rate of return (“rf”) – the minimum return an investor shouldexpect to receive Rf (rm – rf)10% (1000% - 10%) 1000% Treasury securities are a good proxy for rf3% (10% - 3%) 10%Discounted Cash Flow

Cost of Equity - BetaQuestion: If the stock market were to fall 50% next year, would you prefer tohave been invested in a mature and stable company or an early stagetechnology software growth company? CAPM says an investor should be rewarded more for investing in a stock thatfluctuates more with stock market performance Beta provides a method to estimate the riskiness of a stock with the overallstock market Beta of 1.0 is “as risky” as the overall stock market Beta of 2.0 should see returns on its equity rise or drop twice as fast as theoverall marketRf β * ( rm – rf) Question: What are the limitations of WACC?Discounted Cash Flow

We will teach 4 valuation methods Trading Comparables Transaction Comparables Sum-of-the-Parts Valuation Discounted Cash Flow Analysis (DCF) 2. Why is Valuation important? . The SCIENCE is performing the valuation, the ART is interpreting the results in order to arrive at the "right"price. TECHNOLOGY can help you do this more efficiently.

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