1. Schedule of free cash flows
1.1. Business plan Horizon
1.1.1. The length of the explicit forecast period will depend on the company’s “visibility”
1.1.2. The period of time over which is it reasonable to establish projections.
1.2. Terminal Value
1.2.1. The terminal value can be based either on the capital employed or on the free cash flow in the last year of the explicit forecast period.
1.2.2. Value formula: is the Gordon–Shapiro formula.
1.2.3. The normalised free cash flow
1.2.3.1. Must be consistent with the assumptions of the business plan. It depends on long-term growth, the company’s invest- ment strategy and the growth in the company’s working capital
2. The value of the net debt
2.1. Once you obtain the enterprise value, you must remove the value of net debt to derive equity value.
2.2. Net debt is composed of financial debt net of cash, i.e of all bank borrowings, bonds, debentures and other financial instruments net of cash, cash equivalents and marketable securities.
2.3. The value of net debt is equal to the value of the future cash outflows it represents, discounted at the market cost of similar borrowings.
2.4. When all or part of the debt is listed or traded over the counter, you can use the market value of the debt. You then subtract the market value of cash, cash equivalents and marketable securities.
2.5. The book value of net debt is often used as a first approximation of its present value.
2.5.1. In some cases:
2.5.1.1. When the firm has borrowed at fixed rates and rates have evolved since then
2.5.1.2. When the company’s solvency situation has significantly changed since it has contracted debt and there has been no spread adjustment to recognise this change
2.5.1.3. When the interest rate has been artificially reduced thanks to the issue of debt with warrants, or other products
3. Other valuation elements
3.1. Provisions
3.1.1. Normally, pension liabilities should be treated as debt. The present value of future out- flows for pensions, net of pension assets, should be subtracted from the enterprise value.
3.2. Unconsolidated or equity-accounted investments
3.2.1. If are not reflected in the projected cash flows (via dividends received), you should add their value to the value of discounted cash flows.
3.2.2. Use the market value of these assets including, if relevant, tax on capital gains and losses.
3.3. Tax-loss carryforwards
3.3.1. If are not yet included in the business plan,8 you will have to value any tax-loss carryforward separately, discounting tax savings until deficits are exhausted.
3.4. Minority interest
3.4.1. If are significant you will have to deduct them from the enterprise value
3.5. Dilution
3.5.1. The number of shares to use in determining the value per share will then be the number of shares cur- rently in circulation.
3.5.2. Alternatively, you could adjust the number of shares used to calculate value per share. This is the treasury stock method
4. PROS AND CONS OF THE CASH FLOW APPROACH
4.1. PROS
4.1.1. Quantifies the often implicit assumptions and projections of buyers and sellers
4.1.2. Makes it easier to keep your feet closer to the ground during periods of market euphoria, excessively high valuations and astronomical multiples.
4.1.3. Forces the valuation to be based on the company’s real economic performance.
4.2. CONS
4.2.1. It is very sensitive to assumptions and, consequently, the results it generates are very volatile. It is a rational method, but the difficulty in predicting the future brings significant uncertainty.
4.2.2. It sometimes depends too much on the terminal value, in which case the problem is only shifted to a later period. Often the terminal value accounts for more than 50% of the value of the company, compromising the method’s validity. However, it is sometimes the only applicable method, such as in the case of a loss-making company for which multiples are inapplicablE.
4.2.3. It is not always easy to produce a business plan over a sufficiently long period of time. External analysts often find they lack critical information.
5. DISCOUNTING CASH FLOW AND DISCOUNTING DIVIDENDS
5.1. The dividend discount method
5.1.1. The value of a share is equal to the present value of all the cash flows that its owner is entitled to receive, namely the dividends, discounted at the cost of equity
5.1.2. Is rarely used today because it is extremely complicated.
5.1.3. Is still used in very specific cases – for example, for companies in mature sectors with very good visibility and high payout ratios, such as utilities, concessions and real estate companies.
6. MULTIPLE APPROACH OR PEER-GROUP COMPARISONS
6.1. High expected growth, low risk in the company’s sector and low interest rates will all push multiples higher.
6.2. BUILDING A SAMPLE OF COMPARABLE COMPANIES
6.3. THE MENU OF MULTIPLES
6.3.1. Based on the enterprise value
6.3.2. Based on the value of equity
6.3.3. Multiples based on enterprise value
6.3.3.1. This value is the sum of the company’s market capitalization and the value of its net debt at the valuation date and other adjustments presented.
6.3.3.2. EBIT multiple
6.3.3.2.1. A company’s genuine profit-generating capacity is the normalised operating profitability it can generate year after year, excluding exceptional gains and losses and other non- recurring items.
6.3.4. Multiples based on equity value
6.3.4.1. Choose multiples based on operating balances after interest expense.
6.3.4.2. These multiples include the P/E ratio, the cash flow multiple and the price-to- book ratio.
6.3.4.3. All these multiples use market capitalisation at the valuation date as their numerator.
6.3.4.4. The denominators are net profit, cash flow and book equity, respectively
7. MEDIANS, MEANS AND REGRESSIONS
7.1. Look at the multiples of the companies in the sample as a function of their expected growth. Sometimes this can be a very useful tool in positioning the company to be valued in the context of the sample.
8. Pragmatic approach
8.1. Instruct value method
8.2. Peer comparison method
9. Fundamental approach
9.1. Dividend discount model
9.2. Discounted cash flow method
10. Direct method
10.1. Value equity directly
11. Indirect method
11.1. Value the firm as a hole
12. The-sum-of-the parts method
12.1. Valuing the company as the sum of its assets less its net debt.
12.2. Combination of direct and indirect
13. Discounted cash flow method
14. Fundamental valuation method
14.1. Focus on the present value
14.1.1. Its aim is to value the company as a whole
14.1.2. After deducting the value of net debt, the remainder is the value of the company’s shareholders’ equity.
14.1.3. Explicit forecast period
14.1.4. Terminal value
14.2. The value of the firm is the sum of the present value of after-tax cash flows over the explicit forecast period and the terminal value at the end of the explicit forecast period
15. Choosing a discount rate
15.1. Weighted average cost of capital (WACC)
15.1.1. Calculating an accurate cost of capital is one of the key drivers of any valuation exercise based on the discounted cash flow approach.
16. THE SUM-OF-THE-PARTS METHOD (SOTP) OR NET ASSET VALUE (NAV)
16.1. The sum-of-the-parts method consists in valuing and summing up the company’s differ- ent assets, divisions or subsidiaries and deducting liabilities. It is a method well suited for diversified groups or conglomerates for which consolidated accounts projections give too global a view.
16.2. TANGIBLE ASSETS
16.2.1. Themain point is that in the sum-of-the- parts method it is important to determine an overall value for productive and commercial assets.
16.3. INVENTORY
16.3.1. Decreasing future profits
16.4. INTANGIBLE ASSETS
16.4.1. The sum-of-the-parts approach makes no sense unless it takes into account the company’s intangible assets.
16.4.1.1. Examples: Brands & lease rights
16.5. TAX IMPLICATIONS
16.5.1. If the objective is to liquidate or break up the target company into component parts, the taxes generated will then decrease (increase) the ultimate value of the asset.
16.5.2. If the objective is to acquire some assets (and liabilities), and to run them as a going concern, then the assets will be revalued through the transaction.
16.5.3. If the objective is to acquire a company and maintain it as a going concern and as a separate entity, the acquiring company buys the shares of the target company rather than the underlying assets.
17. COMPARISON OF VALUATION METHODS
17.1. RECONCILING THE DIFFERENT METHODS OF VALUATION
17.1.1. Analysing the difference between sum-of-the-parts value and discounted cash flow value
17.1.2. Comparison values versus DCF values
17.1.3. Is there one valuation method for selling a company and another for buying it?
17.2. THE LIFECYCLE THEORY OF COMPANY VALUE
18. PREMIUMS AND DISCOUNT
18.1. STRATEGIC VALUE AND CONTROL PREMIUM
18.1.1. When control of a listed company changes hands, minority shareholders receive the same premium as that paid to the majority shareholder.
18.2. MINORITY DISCOUNTS AND PREMIUMS
18.2.1. Whereas a control premium can (and must) be justified by subsequent synergies, there is no basis for a minority discount.