JP morgan valuation training materials

OCTOBER 2004 INTRODUCTION TO VALUATION METHODS USED IN INVESTMENT BANKING STRICTLY PRIVATE AND CONFIDENTIAL MICHIGAN BUSINESS SCHOOL This presentation was prepared exclusively for the benefit and internal use of the JPMorgan client to whom it is directly addressed and delivered (including such client’s subsidiaries, the “Company”) in order to assist the Company in evaluating, on a preliminary basis, the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure, in whole or in part, to any other party. This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be used for any other purpose without the prior written consent of JPMorgan. The information in this presentation may be based upon any management forecasts provided to us and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or any other entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or accounting effects of consummating a transaction. Notwithstanding the foregoing (but subject to any applicable federal or state securities laws), JPMorgan and the Company may disclose to any and all persons, without limitation, the tax treatment and tax structure of any transaction contemplated hereby and all materials (including opinions or other tax analyses) relating thereto, so long as such disclosure is not made prior to the earlier of (x) public announcement of discussions relating to the transaction or of the transaction itself and (y) the execution of an agreement to enter into the transaction. JPMorgan’s policies prohibit employees from offering, directly or indirectly, a favorable research rating or specific price target, or offering to change a rating or price target, to a subject company as consideration or inducement for the receipt of business or for compensation. JPMorgan also prohibits its research analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investors. JPMorgan is a marketing name for investment banking businesses of J.P. Morgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan arranging, financial advisory and other investment banking activities are performed by J.P. Morgan Securities Inc. and its banking affiliates. JPMorgan deal team members may be employees of any of the foregoing entities. CONFIDENTIAL, FOR TRAINING PURPOSES ONLY INTRODUCTION TO VALUATION METHODS USED IN INVESTMENT BANKING Agenda MICHIGAN BUSINESS SCHOOL Additional valuation materials LBO analysis Comparable transactions analysis Publicly traded comparable company analysis Discounted cash flow Valuation overview 1 1 8 17 23 28 36 INTRODUCTION TO VALUATION METHODS USED IN INVESTMENT BANKING MICHIGAN BUSINESS SCHOOL Research Should our clients buy, sell or hold positions in a given security? Research Should our clients buy, sell or hold positions in a given security? Acquisitions How much should we pay to buy the company? Acquisitions How much should we pay to buy the company? New business presentations Various applications New business presentations Various applications Fairness opinions Is the price offered for company/division fair (from a financial point of view)? Fairness opinions Is the price offered for company/division fair (from a financial point of view)? Divestitures How much should we sell our company/division for? Divestitures How much should we sell our company/division for? Hostile defense Is our company undervalued/ vulnerable to a raider? Hostile defense Is our company undervalued/ vulnerable to a raider? Public equity offerings For how much should we sell our company/division in the public market? Public equity offerings For how much should we sell our company/division in the public market? Debt offerings What is the underlying value of the business/ assets against which debt is being issued? Debt offerings What is the underlying value of the business/ assets against which debt is being issued? Valuation Applications 2 VALUATION OVERVIEW MICHIGAN BUSINESS SCHOOL Valuation methodologies  “Intrinsic” value of business  Present value of projected free cash flows to all providers of capital  “Public market valuation”  Value based on multiples for comparable companies in sale transactions  Includes control premium  “Public market valuation”  Value based on market trading multiples of comparable companies  How does a firm’s financial performance match to market value?  Value based on debt repayment and return on investment  Value to a financial/LBO buyer  Liquidation analysis  Break-up analysis  Historical trading performance  Private company valuation  Expected IPO valuation  Premiums paid analysis Valuation methodologies Discounted cash flow analysis Publicly traded comparable companies analysis Comparable acquisitions analysis Leveraged buyout/recap analysis Other 3 VALUATION OVERVIEW MICHIGAN BUSINESS SCHOOL Approach to valuation In arriving at a preliminary valuation for its clients, JPMorgan utilizes several methodologies that are consistent with industry practices In arriving at a preliminary valuation for its clients, JPMorgan utilizes several methodologies that are consistent with industry practices (3) Comparable acquisition transactions Utilizes data from M&A transactions involving similar companies (1) Discounted cash flow Analyzes the present value of a company’s free cash flow (2) Publicly traded comparable companies Utilizes market trading multiples from publicly traded companies to derive value (4) Leveraged buy out Used to determine range of potential value for a company based on maximum leverage capacity 4 VALUATION OVERVIEW MICHIGAN BUSINESS SCHOOL Equity value versus enterprise value Enterprise value = Market value of all capital invested in a business 1 (often referred to as “transaction value”) The value of the total enterprise: market value of equity + net debt Equity value = Market value of the shareholders’ equity (often referred to as “offer value”) The market value of a company’s equity (shares outstanding x current stock price) Equity value = Enterprise value - net debt 2 Liabilities and shareholders’ equity Assets Enterprise value Net debt Equity value Enterprise value 1 Assume book value of debt approximates market value of debt 2 Net debt equals total debt + minority interest + capitalized leases + short-term debt - cash and cash equivalents 5 VALUATION OVERVIEW MICHIGAN BUSINESS SCHOOL Equity value versus enterprise value (cont’d)  Value for owners of business  Multiples of  Net income  After tax cash flow  Book value Equity value or offer value Equity value or offer value  Value available to all providers of capital  Multiples of  Sales  EBITDA  EBIT Enterprise value or transaction value Enterprise value or transaction value 6 VALUATION OVERVIEW MICHIGAN BUSINESS SCHOOL Application example: Valuation summary $60.00 $45.00 $64.60 $50.50 $34.75 $55.50$54.70 $55.00 $47.10 $37.60 $37.30 $38.00 $50.40 $19.25 10.00 20.00 30.00 40.00 50.00 $60.00 7.0x—9.0x 2004E EBITDA 7.0x—9.0x 2008E EBITDA 8.0%—11.0% discount rate 1.6x LTM sales 9.8x LTM EBITDA 13.3x LTM EBIT Public market comparables 2 Precedent comparable transactions 52-week trading range 1 Share prices are based on 157.6 million diluted shares outstanding 2 Forecasts are based on JPMorgan research 3 Synergies assumed to be 6.0% of sales, capitalized at 8.0x DCF analysis Analyst price target With synergies of $1,500mm 3 Current stock price = $34.20 7.0x—9.0x 25% IRR LTM EBITDA LBO Implied share price Implied share price 7 VALUATION OVERVIEW Agenda MICHIGAN BUSINESS SCHOOL Additional valuation materials LBO analysis Comparable transactions analysis Publicly traded comparable company analysis Discounted cash flow Valuation overview 8 1 8 17 23 28 36 INTRODUCTION TO VALUATION METHODS USED IN INVESTMENT BANKING [...]... Plus: Depreciation D I S C O UN T E D C A S H F L OW Plus: Deferred taxes Discounted value of unlevered FCF Discounted value of FCF 2004P—2008P Key assumptions: Deal /valuation date = 12/31/04 Marginal tax rate = 40% Discount rate = 10% $189.6 JPMorgan convention is to use the “mid-year” convention—which assumes cash flows happen midway during the year MICHIGAN BUSINESS SCHOOL 12 Weighted average cost of... warrants, etc Check it with a calculator! MICHIGAN BUSINESS SCHOOL 16 B A N KI N G I N V E S T M E N T I N U S E D M E TH OD S Valuation overview 1 Discounted cash flow 8 Publicly traded comparable company analysis 17 Comparable transactions analysis 23 LBO analysis 28 Additional valuation materials 36 I N T R O D U C TI O N T O VAL U ATI O N Agenda MICHIGAN BUSINESS SCHOOL 17 Overview P U BLIC LY T RAD E D... value versus Equity value issue) MICHIGAN BUSINESS SCHOOL 22 B A N KI N G I N V E S T M E N T I N U S E D M E TH OD S Valuation overview 1 Discounted cash flow 8 Publicly traded comparable company analysis 17 Comparable transactions analysis 23 LBO analysis 28 Additional valuation materials 36 I N T R O D U C TI O N T O VAL U ATI O N Agenda MICHIGAN BUSINESS SCHOOL 23 Overview of comparable transactions... calculating LTM results, not three months MICHIGAN BUSINESS SCHOOL 27 B A N KI N G I N V E S T M E N T I N U S E D M E TH OD S Valuation overview 1 Discounted cash flow 8 Publicly traded comparable company analysis 17 Comparable transactions analysis 23 LBO analysis 28 Additional valuation materials 36 I N T R O D U C TI O N T O VAL U ATI O N Agenda MICHIGAN BUSINESS SCHOOL 28 LBO analysis provides another... 5 years forward must then be discounted back to the valuation date Note: DCF value as of 12/31/04 based on mid-year convention 1 Based on 40.0 million basic shares outstanding and 2.0 million options with a weighted exercise price of $8.13 calculated using the treasury method MICHIGAN BUSINESS SCHOOL 15 Concluding DCF remarks DCF analysis is a key valuation methodology Three key variables Projections/relevant... companies Trading comps are an important valuation metric for a number of reasons Benchmark of how the equity market is valuing the company stand alone and relative to its peers Every CEO knows his own multiples and those of his peers P U BLIC LY T RAD E D C O M P ARA B L E C OM P ANY ANALY SI S Key steps for comps Choose the right comparable companies and valuation metrics to focus on Spread the comps... free cash flows dictate whether a company is an attractive or viable LBO target Cash flows are not discounted Terminal value drives valuation, and is calculated on the basis of multiples L B O AN A L Y S I S Multiple of exit-year EBITDA is generally used to bound the valuation of the enterprise in any possible exit scenario MICHIGAN BUSINESS SCHOOL 31 Pro forma capitalization and transaction structure... analysis values a company by reference to other publiclytraded companies with similar operating and financial characteristics It compares the public company value with operating statistics to calculate the valuation multiple Comparable companies values do not incorporate the “control” premiums reflected in comparable acquisitions Depending on market conditions, the comparable companies' multiples may or... similar to that of public comparables analysis except that by looking at prior acquisitions, insight can be gained as to the premium paid to gain control (i.e., control premium) of the target company, valuation multiples, social issues, and technical transaction elements In addition, “private market” values sometimes differ from public market values Measure private market value, including control value,... UN T E D C A S H F L OW Present value Determine a range of values for the enterprise by discounting the projected free cash flows and terminal value to the present Adjustments Step 5 Step 5 Adjust your valuation for all assets and liabilities not accounted for in cash flow projections MICHIGAN BUSINESS SCHOOL 9 The first step in DCF analysis is projection of unlevered free cash flows Calculation of unlevered