Palmer WU law school ppt business valuation

An overview of the art of business valuation – determining a range of values for operating businesses Robert D. Palmer Co-founder and Managing Director The Gabriel Management Group, LLC March 17, 2008 Expectations regarding future growth and interest rates are imputed in current market multiples; combining future expectations with unknown business performance create substantial levels of variability/risk. There are no precise valuations. Industry specific knowledge, substantial due diligence, quality management and the use of talismans (lucky charms) can mitigate this risk. Why merge or acquire another firm?  Efficiency - “synergistic gains”  Opportunistic purchases - “undervalued assets”  Value creation - “multiple expansion” [...]... in troubled firm Undeveloped land Firm Valuation Models Patent Free Cashflow to Firm Option to expand Firm Market Replacement Cost Option to delay Undeveloped Reserves Investor Time Horizon and Valuation Approaches Very short time horizon Liquidation value Long Time Horizon Relative valuation Option pricing models Discounted Cashflow value Views on market and Valuation Approaches Markets are correct... Present Value Approach (NPV) – imprecise measure, the reality check - Do we want to buy it? Valuation Models Asset Based Valuation Discounted Cashflow Models Relative Valuation Liquidation Value Equity Stable Current Contingent Claim Models Sector Two-stage Three-stage or n-stage Equity Valuation Models Normalized Earnings Book Revenues Value Sector specific Dividends Aswath Damodaran Young firms Cost...Sources of complexity in valuation Control Issues Complex holding structures Minority shareholder issues Tax Issues Complex tax law begets complex business mixes and holding structures Deceit Different tax rates for different locales and different transactions Tax credits The buyer needs... of growth period Value the firm and then discount value for complexity Common Business Valuation Errors 1 Overpayment – this error can often times end the party before it begins Assuming margins constant even when they are currently high and there is potential future competition Underestimating the cost of changing the way a business is run Underestimating investment in fixed assets e.g assuming that... (depreciation is based on historic costs) Underestimating working capital flows Common Business Valuation Errors 2 Assuming overhead is fixed for long periods and for supporting growth Using historical percentages for such things as marketing costs and administrative costs when the cash flow forecast involves a significant change in the business Valuing a highly leveraged cash flow stream at a discount rate that... better than other methods Weakness: Relies heavily on projections Valuations are only as good as assumptions supporting the projections! Valuing Firms using Discounted Cash Flow Analysis The total value of a firm also equals the sum of value of the claims against its cash flows VF = PV(FCF) + PV(TV) + NOA Where: VF = the value of the business PV(FCF) = the present value of the total free cash flows... distributions of cash flows, which in practice can be difficult to estimate Sample valuation output @RISK Output Graphs Simulation: 1 / Output: NPV @ 30% discount rate Values in 10^ -8 Distribution for NPV @ 30% discout rate/C20 9 8 7 6 5 4 3 2 1 0 -4 Mean=4904881 1.5 7 12.5 18 Values in Millions 5% -1.2536 90% 5% 12.4075 Balance Sheet Valuation Models Book Value: the net worth of a company as shown on the balance... to Company Valuation – in the order TGMG performs them 1 2 3 4 Relative Value (Comparables/Ratio Analysis) – quick and dirty, will they sell? Book Value/Asset Value – less quick and dirty, need financials to perform Option Value/Contingent Claim Analysis – nebulous, inherent in high risk deals Net Present Value Approach (NPV) – imprecise measure, the reality check - Do we want to buy it? Valuation Models... and Valuation Approaches Markets are correct on average but make mistakes on individual assets Relative valuation Asset markets and financial markets may diverge Liquidation value Markets make mistakes but correct them over time Discounted Cashflow value Option pricing models Aswath Damodaran EBITDA Valuation - Example ABC Widget Manufacturing: EBITDA = $5 million Value of debt = $2 million Comparable... Depreciation & Amortization (tax‐deductible portions)  =  Earnings Before Interest and Taxes (EBIT)          OR    Net Operating Profit (NOP)  How to compute comparables: 1 2 3 Start with a sample of securities whose business characteristics are similar to the company being valued Assume that the company has similar financial ratios to the “comparable” companies A number of different ratios are typically used: Price/Earnings, . buy it? Valuation Models Asset Based Valuation Discounted Cashflow Models Relative Valuation Contingent Claim Models Liquidation Value Replacement Cost Equity Valuation Models Firm Valuation Models Cost. Disclosure  Complex types and mixes of businesses  Multiple businesses (Eg. GE)  Multiple countries (Eg. Coca Cola)  Complex technologies  Structuring of businesses  Cross border holdings . An overview of the art of business valuation – determining a range of values for operating businesses Robert D. Palmer Co-founder and Managing Director The