investment banking module

Copal Partners

Investment Banking Module

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

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)Sales and Trading

What is Investment 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

Clients include Institutional Investors like pension funds, mutual funds, private clients/ HNI’s and individual investors, investment arms of non-finance companies

Equity Research

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

Corporate Finance / Advisory

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 & ACorporate Finance Corporate Finance

Prospectus, Placement

memorandums, Valuation,

Underwriting

M&A valuation, Deal structuring,

Restructuring, Asset sales and

purchase, Synergy analyses

Equity Research

Initiation reports Coverage report

Road shows

Analyst Presentation

Coverage Report

Corporates

Equity Research

Coverage report Event Report

Deal notes

Sales & Trading Sales & Trading

Market makingProprietary Trading

Market makingProprietary Trading

Chinese Wall

4

Typical Corporate Finance Deal Team

Title Experience Education Role

Managing Director 8+ Years

Top UndergraduateUniversities,

Usually Top-Tier MBA

Managing Directors primarily pitch ideas to clients to source deals.

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

Vice President 3- 8 Years



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

Associate 0-3 Years



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)

Analyst 0-1 Years Top UndergraduateUniversity

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

5

are legally bound to observe.

Includes:Initial Public Offerings (IPO)

Includes: AcquisitionsPrivate Company Sale

Role of Corporate Finance

To make it convenient, from now onwards by Investment Banking we would mean Corporate Finance

Corporate Finance

Financings Client Advisory

Secondary OfferingsDebt SyndicationEquity Private Placements

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

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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 aGroup 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&Atransactions, 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.. Often subgroups exist within the broader group. For example, a Healthcare group may be segregated into biotechnology, medical devices, pharmaceuticals, etc.

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Top Global Investment Banks (M&A)Worldwide Announced deals - 2010

Financial Advisor Deal Value (in $mn) Freeman Fees (in $mn) Number of DealsGoldman Sachs & Co 425,164 1,952.8 325Morgan Stanley 346,039 1,421.7 331JP Morgan 330,835 1,400.3 280Credit Suisse 327,179 1,046.4 249Citi 299,167 729.4 185Barclays Capital 265,094 715.6 133Deutsche Bank AG 242,883 831.5 224Bank of America Merrill Lynch 236,383 906.6 204UBS 231,960 850.9 230Lazard 188,637 845.0 259Rothschild 127,830 746.5 245HSBC Holdings PLC 98,194 212.0 79Nomura 87,404 320.6 171Evercore Partners 79,257 209.4 35BNP Paribas SA 78,350 300.1 110Jefferies & Co Inc 72,904 354.3 114Greenhill & Co, LLC 70,551 202.3 47Houlihan Lokey 61,464 349.6 167Blackstone Group LP 54,777 169.6 41Santander 51,225 – 47Centerview Partners LLC 50,161 – 13RBC Capital Markets 48,909 344.0 133KPMG 44,578 – 327Mizuho Financial Group 43,279 – 121RBS 41,921 153.2 59

Source: Thomson Financial11

Transaction Volumes

Completed Deals Worldwide: Annual Transaction Volume

Date Effective/Unconditional Deal Value (in $mn) Number of Deals2008 1,924,659 24,8902009 1,848,453 30,4312010 1,893,852 32,1142011 824,484 8,762

Industry Total 6,491,448 96,197

Excludes Equity Carveout, Exchange offers and Open Market Purchases

Source: Thomson Financial12

Role of KPOs in the Investment banking industry

CLIENT MARKETING

RESEARCH& ANALYSIS

Investment Banks

DEAL EXECUTION

KPO’s

13

Copal Partners

Valuation Methodologies

14

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?”

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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”?

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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?

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Copal Partners

Valuation Techniques

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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.

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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.

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Copal Partners

Comparable Company Analysis(Trading Comps)

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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

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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

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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 $ 50Shares outstanding 400 mn Options/ warrants outstanding 10 mn Exercise price $ 25Proceeds 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

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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

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Enterprise Value

Formula to calculate Enterprise Value 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)

Market Capitalization

+ Total

Debt

+ Minority

Interest

+

Preferred Stock

+

Capital Leases

-

Cash & Cash Equivalents

= Enterprise Value or

“EV”

En t e r p r ise v a l u e is a m ea s u r e o f t h e a ct ua l e c ono m ic v a l u e o f a c o m pa n y a t a g i v e n po i n t o f ti m e . 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. T h is is a c o mm o n m isc on c ep ti o n be c au se t h e a ss e ts in t h e ba l an ce s hee t a r e r e c o r de d u si n g t h e h ist o r ic a l v a l u e an d t hu s it is no t t h e v a l u e t h e c o m pan y ha s t oda y

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

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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

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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$) 5.00Debt 175 Shares outstanding (in '000) 5,000Minority Interest 50Current exchange rate for HK$ to CNY is 1.1

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 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

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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.

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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.

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Income Statement (cont’d)Income Statement Information

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

If you look at the Consolidated Statement ofOperations you would say that the company’srevenue 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.

There you might find any exceptional item which shall not be included as a part of core revenueof company.

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!!

Net Revenue = USD 811.871 mn

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Example: Normalized EBIT 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 process research & development, gain on saleof property, plant and equipment, gain on sale of subsidiaries.

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.

EBIT = 84.437 + 2.774 = $ 87.211 mn64


Example: Normalized EBITDA

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 asNormalized EBIT + Depreciation andAmortization

Always remember to take Depreciation & Amortization from the cash flow statement

EBITDA = 87.211 + 30.298 = USD 117.509 mn

65


Example: Normalized Net Income

In the Consolidated Statement of Operations, the Company reports a net income of USD377.366 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 I m pa i r m en t / w r ite do w n o f I n v e st m en ts

Now is net Income equal to:

= 377.366 -7.413+2.774= $ 372.727 mn.Wrong!

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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 mn

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Income Statement (cont’d)Income Statement InformationExample: 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

Basic EPS = Normalized Net income

Weighted average basic shares outstanding

Basic EPS = $ 374.582 / 349.741

= $ 1.071

Diluted EPS = Normalized Net income

Weighted averagediluted shares outstanding

Diluted EPS = $ 374.582 / 353.447

= $ 1.059

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Income Statement Information – Indicative exceptional listS. No. Line item Add Back Tax adjustment Comment

1 Joint Venture Y Y Different treatment for different purposes2 Discontinued operations Y Y No tax adjustment if net of tax3 Restructuring cost / expenses Y Y4 Expenses related to merger and acquisition transactions Y Y

5Write down / Impairment of assets (both tangibles and intangiblesincluding goodwill)

Y Y No tax adjustment on Goodwill

6 Impairment of leasehold expenses Y Y7 Loss / Gain on sale of tangible & intangible assets Y Y8 Loss / Gain on sale of investments, other than marketable Y/N Y Loss/ Gain on strategic investment is exceptional9 Amortization of deferred compensation Y Y

10 Equity based compensation expense- stock options or warrants Y Y11 Writing back of any provisions or reserves Y/N Y Provision is exceptional or not12 Gain/Loss on sale of marketable securities N13 Income from associates / affiliates Y Y14 Litigation settlement Y Y15 Loss / Gain on sale or termination of an operation Y Y No tax adjustment if net of tax16 Foreign currency exchange gain / loss Y Y17 Accounting changes Y/N Cumulative effect relating to exceptions is exceptional18 Tax benefit from exercise of options Y N19 Provision for doubtful accounts N N20 Amortization of debt issuance costs Y Y21 Expenses associated with the Sarbanes Oxley Act Y Y22 Rental income N N To be excluded from EBIT calculations23 Government grants or subsidies Y Y24 Severance costs Y Y25 Facilities consolidation Y Y Restructuring expense26 Gain / Loss on early extinguishment of debt Y Y27 Early retirement costs Y28 Redundancy costs Y Y29 Donations Y Y30 Amortization of Negative goodwill Y N

Item can be treated as exceptional or normal depending upon the industry and analysis73

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

Multiples – Example 1EV/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

79

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 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), EPSexpected 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 & adjusted Diluted P/E multiple with the following information:

(all figures in US$ mn except share data)Share price $10.00Shares outstanding 1,000Wtd. Avg. shares outstanding (Basic) 950Wtd. Avg. shares outstanding (Diluted) 990Revenue 5,000Restructuring charges 1,000One-time Insurance recoveries 500Non-recurring charges 300EBIT 1,500Interest Expenses 500Reported 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

mailto:@30%25

Multiples – Example 2 (cont’d)

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

Reported net income = US$ 500 mn

Adjusted net income = Net income + Restructuring charges* - One-time Insurance recoveries* + Non-recurring charges*

* Adjusted for tax @ 30%

Adjusted net income = 500 + (1,000 – 500 + 300)*(1-0.3) = US$ 1,060 mn

Reported Basic EPS = 500/950 = US$ 0.53 Reported Diluted EPS = 500/990 = US$ 0.51

Adjusted Basic EPS = 1,060/950 = US$ 1.12 Adjusted Diluted EPS = 1,060/990 = US$ 1.07

Reported Basic P/E = 10.00/0.53 = 19.00x Reported Diluted P/E = 10.00/0.51 = 19.80x

Adjusted Basic P/E = 10.00/1.12 = 8.96 x Adjusted Diluted P/E = 10.00/1.07 = 9.34x

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PE Fundamentals

To understand the fundamentals, start with a basic equity discounted cash flow model

– Dividend discount model for equity price

PDPS1

0 r g

– Where, DPS1 is dividends per share next year, r is equity risk, and g is perpetual growth rate

The above relationship implies that, other things held equal:

– Higher growth firms will have higher PE ratios than lower growth firms

– Higher risk firms will have lower PE ratios than lower risk firms

– Firms with lower reinvestment needs will have higher PE ratios than firms with higher reinvestment rates

84

Enterprise Value (EV) Ratios

While Price earnings ratios look at the market value of equity relative to earnings to equity investors, EnterpriseValue ratios look at total value of the firm relative to total operating earnings or free cash flows

The form of value to cash flow ratios that has the closest parallels in DCF valuation is the value to Free CashFlow to the Firm, which is defined as:

– EV/FCFF

– EV = Market Value of Equity + Market Value of Debt - Cash

– FCFF = EBIT (1-t) - (Cap Ex - Depreciation) - Chg in Working Cap

85

Multiples – Example 3

Example 3. What is the EV/EBITDA, EV/EBIT and EV/FCFF for the company:

(all figures in US$ mn)

S h a r e D a t a In c ome S t a t e m e nt Share Price $5.00 Revenue 1,000

Shares outstanding 1,000 COGS 270

B a l a n c e S h e e t SG&A 200

Cash 200 R&D 50

Debt 175 Restructuring expenses 30

Minority Interest 50 EBIT 450

Tax rate 30.0%

C as h Flow S t a t e m e nt Depreciation 50

Amortization of intangibles 50

Capex 100

Change in Working Capital (75)

a) EV/EBITDA = 9.14x, EV/EBIT = 11.17 & EV/FCFF =

12.88x b) EV/EBITDA = 8.66x, EV/EBIT = 10.47 & EV/FCFF

= 12.88x c) EV/EBITDA = 8.66x, EV/EBIT = 10.47 & EV/FCFF

= 12.23x d) EV/EBITDA = 9.14x, EV/EBIT = 11.17 &

EV/FCFF = 12.23x

86

Multiples – Example 3 (cont’d)

Correct answer is (c) !!!!!…

EV = (5*1,000) + 175 + 50 – 200 = $ 5,025 mn

Adjusted EBIT = Reported EBIT + Restructuring expenses

Adjusted EBIT = 450 + 30 = $ 480 mn

Adjusted EBITDA = Adj. EBIT + Depreciation + Amortization of intangibles

Adjusted EBITDA = 480 + 50 + 50 = $ 580 mn

FCFF = Adj. EBIT * (1 - tax rate) – (Capex – D&A) – Change in working capital

FCFF = 480 * (1-0.3) – (100 – 50 – 50) – (-75) = US$ 411 mn

EV/EBITDA= 5,025 / 580 = 8.6x

EV/EBIT = 5,025 / 480 = 10.4x

EV/FCFF = 5,025 / 411 = 12.2x

87

EV Ratio Alternatives

Most analysts find FCFF to complex or messy to use in multiples (partly because capital expenditures and working capital have to be estimated) They use modified versions of the multiple with the following alternative denominators such as EBIT or EBITDA

– EBIT: pre-tax operating income

– EBITDA: earning before interest, taxes, depreciation, and amortization

Assume that you have computed the value of a firm, using discounted cash flow models. Rank the following multiples in the order of magnitude from lowest to highest?

– EV/EBIT

– EV/EBITDA

– EV/FCFF

88

Why use EV/EBITDA?

It can be computed even for firms that are reporting net losses, since earnings before interest, taxes and depreciation are usually positive

For firms in certain industries, such as cellular, which require a substantial investment in infrastructure and long gestation periods, this multiple seems to be more appropriate than the price/earnings ratio

In leveraged buyouts, where the key factor is cash generated by the firm prior to all discretionary expenditures, the EBITDA is the measure of cash flows from operations that can be used to support debt payment at least in the short term

By looking at cash flows prior to capital expenditures, it may provide a better estimate of “optimal value”, especially if the capital expenditures are unwise or earn substandard returns.

By looking at the value of the firm and cash flows to the firm it allows for comparisons across firms with different financial leverage.

89

Other Common Ratios

EV/Sales: ratio of the market value of the firm to the sales

Price/Book Value: ratio of market value of equity to the book value of equity, i.e., the measure of shareholders’equity in the balance sheet

– If the market value of equity refers to the market value of equity of common stock outstanding, the book value of common equity should be used in the denominator

– If there is more than one class of common stock outstanding, the market values of all classes (even the non- traded classes) needs to be factored in.

EV/Book Value: ratio of sum of market value of equity and market value of debt to sum of book value of equity and book value of debt

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Choosing Between Multiples

There are dozens of multiples that can be potentially used to value an individual firm. In addition, relative valuation can be relative to a sector (or comparable firms) or to the entire market (using the regressions, for instance). However, since there can be only one final estimate of value, there are three options:

– Use a simple average of the valuations obtained using a number of different multiples

– Use a weighted average of the valuations obtained using a number of different multiples

– Choose one of the multiples and base your valuation on that multiple

The best approach is to choose a set of relevant multiples that make most sense for that industry or sector, given how value is measured and created

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Sector Multiples

Sector Multiple Used Rationale

Cyclical ManufacturingPE, Relative PE (Firm PE Relative to Market PE); Often with normalized earnings

Stable industry with established fundamentals

High Tech, High Growth PEG (PE/Growth Rate) Big differences in growth across firms

High Growth, No Earnings EV/Sales, Price/Sales Zero or negative earnings

Heavy infrastructure EV/EBITDA Capital intensive, with high depreciation expense

Financial Services Price/Book Value, PEOperations for these companies is borrowing and lending debt, we only consider equity related ratios

Retailing Price/Sales, EV/Sales Low margins across board, Value is predominantly measured with sales

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Copal Partners

DCF Valuation

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Index

Table of Content

Time value of money 114

Cost of capital 127

Free Cash Flows (FCF) 137

Sensitivity Analysis 138

DCF-based valuation 139

Terminal Value 145

Equity Value from Firm Value 148

Advantages and Disadvantages of DCF 149

113

Time Value of Money

Let’s review the three main concepts used in DCF-based valuation

Time value of money

– Cash flows

– Present value (PV)

– Net present value (NPV)

– Perpetuities

– Discount rate

Cost of Capital

– Cost of Equity

– CAPM

– Cost of Debt

– WACC

Free Cash Flow (FCF)

– Free cash flow to firm (FCFF)

– Free cash flow to equity (FCFE)

114

Cost of Capital

Corporate capital budgeting decisions are based on expected return on investment

– Investment examples include building a new plant, launching a new product, or acquiring another company

Cost of Capital is the required return necessary to make a capital investment worthwhile

Capital is provided as either debt or equity, hence Cost of capital includes Cost of Debt and Cost of Equity

– Cost of Capital = Weighted average of Cost of Debt and Cost of Equity

The Cost of Capital determines the optimal way for the company to raise money (through a stock issue, borrowing, or a mix of the two)

127

Cost of Equity

The cost of equity is the rate of return that investors require to make an equity investment in a firm

There are two approaches to estimate the cost of equity

– Dividend-growth model

– Risk and return model

Dividend growth model specifies the cost of equity to be the sum of the dividend yield and the expected growth in earnings

– Useful for mature companies that distribute most of the earnings to shareholders as dividends

Risk and return model, on the other hand, tries to answer two questions:

– How do you measure risk?

– How do you translate this risk measure into a risk premium?

We will use Risk and return model to compute Cost of Equity

128

CAPM

CAPM or Capital Asset Pricing Model is a risk and return based model for computing expected return on equity(Cost of Equity to the firm)

According to CAPM, expected return of a security or a portfolio equals the return on a risk-free security plus a risk premium

– Re = Rf + b (Rm- Rf)

Rf: Rate of return for a risk-free security

Beta b: measure of equity risk relative to market portfolio

Rm: Expected return on market portfolio (average risk investment)

Rm-Rf: Market risk premium

Example: Compute the expected return on IBM stock, given that risk-free rate is 4%, IBM beta is 1.4, and market risk premium is 5.5%

– Re [IBM] = 4% + 1.4*5.5% = 11.70%

– Implies that in the long-term, investors expect to earn 11.70% return on IBM stock

129

CAPM Inputs

Rf: Riskfree rate

– Usually the short-term US Govt. T-bill rate or the long-term US Govt. Security rate, since they have no default risk

– The choice between short-term rate and long-term rate depends on the investment horizon

– Firm valuations are over a long-term horizon, so use long-term US Govt. Bond rate for firm valuation

Beta b: measure of equity risk relative to market portfolio

– = 1 ... Average risk investment (same as Market Portfolio)

– > 1 ... Above Average risk investment

– < 1 ... Below Average risk investment

– = 0 ... Riskless investment

130

CAPM Inputs (cont’d)

Computing Beta:

Approach 1: Regress the historical return on equity (Re) with historical market portfolio return

(Rm) Regression output:: Re = a + b Rm

– Where a is the intercept and b, the slope of regression, is the beta of stock and measures the riskiness of

the stock.

– This approach has several issues:

High standard error

Beta is based on historical business and leverage of the firm, either or both of which may be different in the present

Approach 2: Bottom-up approach

– Find out the businesses that a firm operates in

– Find the unlevered betas of other firms in these businesses

– Take a weighted (by sales or operating income) average of these unlevered betas

– Lever up using the firm’s debt/equity ratio

131

Estimating Cost of Equity

Let’s estimate Intel’s Cost of Equity

– Intel equity beta: 1.36

– Current risk-free rate: 4.5% (long-term US Government Bond Rate)

– Risk premium = 5.5% (Historical value)

– Expected return on equity using CAPM:

Re = 4.5% + 1.36*5.5% = 11.98%

– Hence, Intel needs to make at least 11.98% as return for their equity investors. This is the hurdle rate for projects, when investments are analyzed from an equity standpoint. In other words, Intel’s Cost of Equity is11.98%

132

Cost of Debt and its Estimation

Cost of Debt is

– the market rate of interest at which the company can borrow today

– corrected for the tax benefit it gets for interest payments

Cost of debt = Rd = Interest rate on debt (1 - tax rate)

Caution: Cost of debt is not the interest rate at which the company obtained the old debt that it has on its books

Use one of the following to estimate cost of debt

– If the firm has long-term bonds that are traded, use the current yield to maturity on firm’s bonds as the interest rate in cost of debt calculation

– If the firm is rated, use the rating and a typical default spread on bonds with that rating to estimate the interest rate

– If the firm has recently borrowed long-term from a bank, use the interest rate on the borrowing

– If the firm is not rated and no other information about recent bank loans is available, use interest coverage ratio (EBIT/Interest expense) of the firm to estimate a rating and use the default spread on bonds with that rating to estimate interest rate

– Quick (and dirty) computation of cost of debt: current interest expense/book value of total debt

NOTE: The cost of debt has to be estimated in the same currency as the cost of equity and the cash flows

133

Cost of Capital (WACC)

Market Value of Equity (E) should include the following

– Market Value of Shares outstanding

– Market Value of Warrants outstanding

– Market Value of Conversion Option in Convertible Bonds

Market Value of Debt is more difficult to estimate because few firms have only publicly traded debt. There are two solutions:

– Assume book value of debt is equal to market value

– Estimate the market value of debt from the book value?

134

Cost of Capital (WACC) (cont’d)

A firm’s Cost of Capital is calculated by taking a weighted average of the firm’s cost of equity and cost of debt.

WACC represents the investor’s opportunity cost for investing in a particular business instead of others with a similar risk.

Cost of capital so computed is called Weighted Average Cost of Capital or WACC

WACC EV

* ReDV

* Rd (1 Tc )

Re = cost of equityRd = cost of debtE = market value of the firm's equityD = market value of the firm's debtV = E + DE/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate

WACC is used as the discount rate for all cash flows with risk that is similar to that of the overall firm

135

Cost of Capital (WACC) (cont’d)

Example: Compute IBM’s WACC, given:

Re = cost of equity = 11.7%Rd = cost of debt = 8%

E = market value of the firm's equity = $150 billion D = market value of the firm's debt = $50 billion Assume Tc = 35%

V = E+D = $200 billion

WACC EV

* ReDV

* Rd (1 Tc )

WACC[IBM ]150

*11.70%20010.08%

50200

*8%(1 35%)

IBM’s Cost of Capital: 10.08%

136

Free Cash Flow – FCF

Free Cash Flow to Firm (FCFF) is the cash flow that is generated by company’s operations and available to all the company’s capital providers (investors), including both debt and equity

Computed as operating income less expenses, taxes, and changes in net working capital and investments

Measures company's profitability after all expenses and reinvestments

FCFF is also equal to the sum of CFs paid to or received from all the capital providers (interest, dividends, new borrowing, debt repayments and so on)

FCFF = CF available to all investors = EBIT – taxes – increases in working capital +/- deferred taxes + D&A - Capex

Free Cash Flow to Equity (FCFE) is the portion of FCFF that is available to company’s equity investors.

This is a measure of how much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment

FCFE = CF available to equity investors only = Earnings after interest and taxes – increases in working capital +/- deferred taxes + D&A - Capex

137

Sen

sitiv

ity T

able

Sensitivity Analysis

Sensitivity Analysis aim at showing the value impact if changing individual key assumptions or the main value drivers. Following is an example of valuation sensitivity to assumptions regarding cost of capital and terminal growth.

Few factors that are subject to sensitivities are:

– Revenue growth, price , Volume

– EBIT, EBITDA, PE Margins

– Capex, Cost of Capital

There are many lot many other potential sensitivity variables. However, the focus on those factors which have the greatest uncertainty or the greatest value impact.

138

DCF – based Valuation

DCF-based valuation analysis discounts projected (expected) “cash flows” of a firm with an appropriate “discount rate” to determine firm’s value in present time

The fundamental choices for DCF-based valuation

– Cash flows to Discount

Free Cash Flows to Equity (FCFE)

Free Cash Flows to Firm (FCFF)

– Discount Rate

Cost of Equity

Cost of Capital (WACC)

– Base Year Numbers

Current Earnings / Cash Flows

Normalized Earnings / Cash Flows

139

DCF – based Valuation (cont’d)

Firm / Equity Valuation Overview

There are two approaches to valuation: A firm can be valued from two different perspectives –

Firm valuation (Enterprise Value or Transaction Value) – represents the value of all capital invested in business

EV = Equity Value + Net Debt

Equity valuation (Market Value or Offer Value) – Value attributable to owners of the company after paying debt.

Firm valuation vs. equity valuation

Firm valuation values the entire business including both debtand equity claims thereby giving value of the company to debtholders and shareholders.

Assets(A)

Firm

Debt (D)

Equity (E)Claim holders

A = D+E

140

Equity valuation values just the equity claim in business i.e. value of a company to shareholders


Equity vs. Firm Valuation

Equity Valuation: value just the equity stake in the businesst n FCFE

– Obtained by discounting expected cash-flows to equity (FCFE), ValueEquity ∑ (1

t

R )ti.e., the residual cash-flows after meeting all operatingexpenses, tax obligations, interest and principal payments, and reinvestment needed for future growth

– Discount rate used is the Cost of Equity

t 1 e

t n FCFF Firm valuation: value the entire business, including, besides ValueFirm ∑

(1t

WACC )tequity, the other claimholders in the firm t 1

– Obtained by discounting expected cash-flows to the firm (FCFF), i.e., the residual cash-flows after meeting all operatingexpenses, taxes, and reinvestments needed for future growth, but prior to debt payments

– Discount rate used is the weighted average cost of capital(WACC)

n = life of the company

141


DCF-based Firm Valuation

Common steps:

Compute firm’s WACC

– WACC can be in nominal terms or real terms, depending upon whether the cash flows are nominal or real

– WACC can vary from year to year depending on changes in cost of equity or cost of debt

Obtain latest financial statements for the firm

– You may want to normalize the earnings and cash flows

Project future earnings and cash flows (FCFF) for 5-7 years by estimating an expected growth rate in sales and earnings during this period

Growth rate may also vary from year to year

For fast growth companies, estimate when the firm will reach “stable growth” and what characteristics (risk & cash flow) it will have when it does

For mature companies, estimate a nominal growth rate for cash flows beyond the projection period. This is usually equal to the growth rate of the economy

142


DCF-based Firm Valuation

Value of Firm

=

Present value of operating FCFF during explicit forecast period (5-7 years)

+

Present value of cash flow after explicit forecast period (Terminal Value)

143

t


Computing FCFF

Start with EBIT

Less: Taxes on EBIT

Plus or minus: change in deferred taxes

= NOPLAT (Net Operating Profits less adjusted

taxes) Add: Depreciation and Amortization

Plus or minus: Change in Working Capital

Less: Capital Expenditure

=Operating Free Cash Flow

Plus or minus: Cash flow from Non Operating Investments

=Cash Flow available to investors (FCFF)

NOTE : FCFF does not include any of the financing related cash flows such as interest expense or dividends

PVFCFF

n

∑ (1

FCFFt

WACC )t1

144

EBITDA

Terminal Value

Two ways for estimating terminal value:

Assume that the firm will generate the last forecast year cash flows in perpetuity

– Can also assume a modest growth rate (usually equal to the GDP growth rate)

Terminal Value =

Cn (1 g )WACC g

Cn = FCFF in the last year of forecast g = cash flow growth rate in perpetuity

Compute terminal value as a multiple of EBITDA in the last year of forecast

– Use current EV/EBITDA multiple to estimate terminal value

Terminal Value = EBITDA *

EVcurrent n = last year of forecastn

current

145

DCF Worksheet Example

146

Cash Flow Considerations

Capital Expenditures:

– Treatment of R&D expenses

– Treatment of operating leases

– Acquisitions

– Other capitalizable expenses

Normalization of earnings and cash flows

– Treatment of one-time/unusual/restructuring expenses

Tax rate:

– Marginal tax rate vs. Effective tax rate?

Treatment for Minority holdings, Preferred Equity or Pension Obligations

Options, Warrants, and equity value portion of convertible debt

Revenue and earnings growth rate

147

Equity Value from Firm Value

Steps:

Compute present value of all operating cash flows during projected years

Add: Present value of terminal value

Add: Present value of minority interests

– Total value of firm

Less: Value of outstanding debt

Less: Value of outstanding options

Less: Value of outstanding

warrants

Less: Value of equity portion of convertible debt

– Total Equity Value

Divide by: Number of number of outstanding shares

– Value of equity per share

148

Sources Company Website or Filings

Presentations

165

Broker’s Rating

Reflects the market / broker views on fundamentals of the Company i.e. a higher rating reflects strong fundamentals & hence low level of risk and a lower rating reflects weak fundamentals & hence high level of risk

Indicates the analyst consensus

The Broker’s rating chart gives the breakup of the total number of Buy, Hold and Sell recommendations over an last twelve months (LTM) period

The section on Analyst Commentary provides commentary on the company from the analyst’s research reports

– The commentary highlights the strengths of the company and how it has been able to benefit from these strengths. It may also include the Company’s recent developments and which may have affected the share price and/or the analyst recommendation of the company

Sources Databases such as Bloomberg, FactSet, Capital IQ, Thomson etc

166

Share Trading Analysis

Share trading analysis provides an overview of the share price and the various trends related to capital markets

This section is key to any of the books prepared

The purpose of this section is to understand and analyze the share price and capital market movements with respect to the chosen company

Various types of charts prepared

– Relative share price performance

– Annotated share price performance

– Volume at price and liquidity analysis

– Overview of Research analyst ratings

– Development of Consensus Estimates

– Broker Comment Frequency Analysis

– Valuation methods used by research analysts

167

Share Trading Analysis (cont’d)

Relative share price performance Used to compare the performance of the company’s

share with respect to the primary index in the market

Points to remember

– Always consider closing price of the stock instead of the last traded price

– The closing price to be considered should be of a day prior to the date on which it is created

– The index should always be rebased to the company’s share price in order to have an apples to apples comparison

Sources

Stock exchange websites

Databases such as Bloomberg, FactSet, DataStream, Capital IQ etc

168


Annotated share price performance

Prepared exactly as a normal share price performance chart with the only difference being the inclusionof news that reflect the changes in the share price movement

Always look for dates where there has been a drastic change in the share price movement vis-à-vis its primary index. Thereafter look for news that have triggered those changes in the share price

Sources

Press releases from company website

Stock exchange websites


169


Volume at price and liquidity analysis

Objective is to show in a chart how has traded volume of the share been distributed between different price ranges

Sources Stock exchange websites


170


Overview of Research analyst ratings

Gauges different analysts’ perception of the stock and what kind of recommendation they are making on it

The purpose is to understand the view of the market on the stock

Sources Research reports

Databases such as Bloomberg, Capital IQ etc

171


Development of Consensus Estimates

Gauges the consensus estimates on Revenues, EBITDA and EPS for the future years and how they evolve

Consensus estimates represent the market perception on the future operational results of the company

Always calendarize the estimate to have a constant point of reference

Sources Databases such as Bloomberg, Reuters, Capital IQ etc

172


Broker Comment Frequency Analysis

Conduct a qualitative analysis of the perception of the stock in the market, identifying key and recurrent themes in the different analyst reports

Categorize these themes as positive and negative to indicate analyst comments

Key themes may include: trends in the industry, technological trends, extraordinary events, risks, challenges etc


173


Valuation methods used by research analysts To describe the valuation methods used by the research analysts covering the stock Information to be included:

– bank/broker name– main valuation methods used– main comparable companies used for valuation purposes– key comments on the valuation of the company


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Case Studies

175

Data gathering (cont’d)

Develop a Search Strategy– Using the Internet to search for business valuation information

is potentially one of the most efficient ways– Boolean logic is the basic logic system used for online searching;

uses three logical operators: AND, OR and NOT The AND connector means that all search terms connected by the

AND must be present The OR connector requires either term to be present The NOT connector returns records where the designated

term does not appear– Another helpful search logic tool is truncation. Truncation, also

known as wild card searching, allows searching of word variations Wild cards can vary from database to database but usually

are either the “*” or “?” Evaluate Information

The following questions should be asked for evaluation:– Who authored this information? - Is the author’s name and affiliation

disclosed? Is there an e-mail address so that you can inquire further? Is the author the creator or the compiler of the information?

– Who is publishing this information? - Can the producer be identified and contacted? Is it a professional organization? Does the organization have a particular bias? Who is the intended audience?

– What can you determine about the content? - How complete is the information? Is it an abstract of the complete text? Are the references documented, current and relevant?

201

Creating an analysis structure

Providing an overview and describing a situation

– Always start with the subject familiar to the target audience

– Establish facts about the subject

– Prove it is a profitable venture for investment

Highlighting opportunities arising out of the situation

– Identify and state the factors that are creating opportunities

– Establish facts and future prospects of the available opportunities

– Compare available opportunities

Tapping opportunities through M&A

– Show how M&A can help in tapping opportunities

– Prepare a supply/value chain showing benefits of the transaction to both the acquirer and the target

Appendix

– Should contain all necessary definitions of the jargons used in the presentation

– Include profiles of the selected target companies

– Include previous transactions & comps for that industry

202

Project execution

Insights through primary research

– Using insights from industry personnel will help in a deeper understanding of the industry on which you are working

– Create a call list within 1-2 days so that the questions that arise from the hypothesis are sent to these contacts

– Assign 1 or 2 persons to check for information on companies, industry associations and their contact details

– Send the interview requests by email at the beginning of the study. This allows for the process to get started while the team conducts the secondary research

– The same set of questions should not to be sent to all persons in the mailing list.Queries sent to different persons should be pertaining to their respective areas of operations

Do not just write an email for information request and wait for people to respond. Be proactive, keep calling until you get the desired data from external and internal contacts

Follow a reasonable caution while calling up external sources

203

Project execution (cont’d)

Apply “So what” analysis to convert a data dump into a storyline

For all facts and information on each slide, always ask yourself “so what”

Always present in a way that forces reader to prompt “so what” and then answer it in the next section. Keep doing this unless no such question arise

If the implication of a slide comes out clearly, it transforms a ‘data dump’ into a ‘value-added analysis’

Key questions:

“So what does this mean”?

“Will this affect the sector, economy or the region being analyzed”?

“Will the impact be positive or negative”?

“Is the rate of change fast or slow”? (Will the impact be strong and immediate or not?)

“Does this get you closer to proving or disproving your current hypotheses”?

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Research Techniques

205

Introduction

There are a lot of research methodologies used to prepare an Industry piece. The most extensively used techniques are as follows:

A. SWOT Analysis

B. PESTEL Analysis

C. Porter’s Five forces model

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SWOT Analysis

A. SWOT Analysis: An analysis of STRENGTHS,WEAKNESSES, OPPURTUNITIES and THREATS. Extremely useful tool for understanding and decision-making

– Applicable in all businesses and organizations

– Provides a framework for reviewing strategy, position and direction of a company or business proposition, or any other idea

– Can be used for business planning, strategic planning, competitor evaluation, marketing, business and product development and research reports

– Presented as a grid, comprising four sections, one for each of the SWOT headings

– SWOT analysis can be used to assess:

company (its position in the market, commercial viability, etc)

method of sales distribution

product or brand

business idea

strategic option, such as entering a new market or launching a new product

opportunity to make an acquisition

potential partnership

changing a supplier

outsourcing a service, activity or resource

an investment opportunity

207

PESTEL Analysis

B. PESTEL Analysis

– PESTEL is an acronym for Political, Economic, Social, Technological, Environmental and Legal

– PESTEL Analysis helps analyze factors in the macro-environment that affect the decisions of the managers of any organization

Examples include: Tax changes, new laws, trade barriers, demographic change, government policy changes etc

– Helps analyze the many different factors in a firm's macro environment

It is important not to just list PESTEL factors because this does not in itself tell much

Need to find out, which factors are most likely to change and which ones will have the greatest impact on the company i.e. each firm must identify the key factors in their own environment

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Porter’s Five forces model

C. Porter’s Five forces model

– It is designed to explain the relationship between the five dynamic forces that affect an industry’s performance;these are the:

intensity of competitive rivalry;

threat from new entrants;

threat from substitutes;

bargaining power of buyers;

bargaining power of suppliers.

– The Five Forcers Analysis model tries to identify what factors shape the character of competition within an industry.

– Targets the assessment of the structural attractiveness of the analyzed industry.

– Finally the Five Forces Analysis pinpoints strengths and weaknesses in a company and discovers opportunities or threats within the industry

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Competitive forces at work in the industry

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investment banking module

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