Dallas CPA Society Convergence 2013

Transcription

1 Dallas CPA Society Convergence 2013 Cash Flow Projections May 8, 2013 Shishir R. Khetan, CFA Stout Risius Ross Carla G. Glass, CFA, FASA Hill Schwartz Spilker Keller

2 Preview Forecasts in business valuation Examples Good, Bad, Ugly More Bad & Ugly Regulatory 2

3 Forecasts in Business Valuation 3

4 Forecasts in Business Valuation Assets Liabilities and Equity Valuing Equity vs. Current Assets Cash Accounts Receivable Inventory Current Liabilities Accounts Payable Accrued Expenses Income Taxes Payable Valuing Invested Other Current Assets Other Current Liabilities Net Working Capital Fixed Assets Interest-Bearing Debt Land (includes current portion Capital Buildings Equipment and short-term notes payable) Other Assets Invested Investments Stockholders' Equity Capital Life Insurance Preferred Stock Intangible Assets Identifiable Common Stock Nonidentifiable 4 All assets, liabilities, and equity are at fair market value.

5 Forecasts in Business Valuation INVESTED CAPITAL NCF Sales COGS (excl. depr. & amort.) Gross Profit Operating Expense (excl. depr. & amort.) EBITDA Depreciation Amortization EBIT (Operating Income) Taxes on Operating Income NOPAT Plus: Depreciation Amortization Less: Capital Expenditure Plus/Less: Change in Net Working Capital Equals Invested Capital Net Cash Flow EQUITY NCF Sales COGS (excl. depr. & amort.) Gross Profit Operating Expense (excl. depr. & amort.) EBITDA Depreciation Amortization EBIT (Operating Income) Interest Expense Pretax Income Taxes on Pretax Income NOPAT Plus: Depreciation Amortization Less: Capital Expenditure Plus/Less: Change in Net Working Capital Change in Debt Principal Equals Equity Net Cash Flow 5

6 Forecasts in Business Valuation Time period of forecast Business cycle Until growth mature and/or stabilized Five years Single period capitalization Effective only if growth mature and/or stabilized 6

7 Forecasts in Business Valuation Single Period Capitalization usually not a good alternative if unstable because Net working capital use higher during high growth Capital expenditure higher and uneven Profitability varies during high growth 7

8 Forecasts in Business Valuation Beginning place for forecasts Focus on Growth of revenue Profit margins Things needed to achieve growth Capital expenditures (facilities) Net working capital Capital People 8

9 Forecasts in Business Valuation Beginning place for forecasts Historical performance (what time period) Economic outlook (versus company) Industry outlook (versus company) Outlook for any key factor that affects the subject entity (such as petrochemical costs for plastic company) 9

10 Some Examples Good, Bad, Ugly 10

11 Common Errors Growth too high or too low Forecast stopped before growth stabilized Unrealistic and continuing margin gains Net working capital assumption Capital expenditure consistent with all else Terminal value assumptions reasonable and consistent 11

12 Start with base case, low growth scenario What about amortization? 12

13 EXHIBIT A Fairly Mature Trailing Year 1 Year 2 Year 3 Year 4 Year 5 Residual Revenue $6,000 $950 $6,450 $6,869 $7,247 $7,609 $7,914 $8,230 Revenue Growth 7.5% 6.5% 5.5% 5.0% 4.0% 4.0% Gross Profit 3, % 3,870 4,122 4,348 4,566 4,748 4,938 Total Operating Expenses 2, % 2,774 2,954 3,116 3,272 3,403 3,539 EBITDA 1, % 1,097 1,168 1,232 1,294 1,345 1,399 Depreciation % Amortization EBIT ,040 1,081 1,125 Taxes % Debt Free Net Income Incremental Working Capital 30.0% Depreciation Amortization Capital Expenditures Debt Free Cash Flow Residual Value 9,660 Discounting Periods PV Factor 10.0% PV DFCF ,719 Total Invested Capital Value 7,809 Residual Value Calculation Interest-Bearing Debt 1,716 Residual Debt Free Cash Flow 580 Equity Value $6,093 Cost of Capital 10.0% Estimated Residual Growth Rate 4.0% Residual Capitalization Rate 6.0% Residual Value 9,660 13

14 Higher Growth at Beginning Timing of decline to residual growth? No effect on margins? Reasonable capital expenditures and use of working capital with this high growth? Exceed capacity of facility? More risky? V.P. of Marketing forecast? 14

15 EXHIBIT B Higher Growth Stabilized Trailing Year 1 Year 2 Year 3 Year 4 Year 5 Residual Revenue $6,000 $950 $6,600 $7,920 $9,108 $9,837 $10,230 $10,639 Revenue Growth 10.0% 20.0% 15.0% 8.0% 4.0% 4.0% Gross Profit 3, % 3,960 4,752 5,465 5,902 6,138 6,384 Total Operating Expenses 2, % 2,838 3,406 3,916 4,230 4,399 4,575 EBITDA 1, % 1,122 1,346 1,549 1,672 1,739 1,809 Depreciation % Amortization EBIT ,082 1,245 1,344 1,398 1,454 Taxes % Debt Free Net Income Incremental Working Capital 30.0% Depreciation Amortization Capital Expenditures Debt Free Cash Flow Residual Value 12,490 Discounting Periods PV Factor 10.0% PV DFCF ,394 Total Invested Capital Value 9,381 Residual Value Calculation Interest-Bearing Debt 1,716 Residual Debt Free Cash Flow 749 Equity Value $7,665 Cost of Capital 10.0% Base Case Equity Value $6,093 Estimated Residual Growth Rate 4.0% Effect 25.8% Residual Capitalization Rate 6.0% Residual Value 12,490 15

16 Higher growth not normalized at end Incorrect working capital used in Residual period? Reasonable capital expenditures and use of working capital with this high growth? Making more widgets than market demands? More risky? 16

17 EXHIBIT C Higher Growth not Stabilized Trailing Year 1 Year 2 Year 3 Year 4 Year 5 Residual Revenue $6,000 $950 $6,600 $7,920 $9,108 $10,474 $11,731 $12,670 Revenue Growth 10.0% 20.0% 15.0% 15.0% 12.0% 8.0% Gross Profit 3, % 3,960 4,752 5,465 6,285 7,039 7,602 Total Operating Expenses 2, % 2,838 3,406 3,916 4,504 5,044 5,448 EBITDA 1, % 1,122 1,346 1,549 1,781 1,995 2,154 Depreciation % Amortization EBIT ,082 1,245 1,432 1,604 1,732 Taxes % Debt Free Net Income ,039 Incremental Working Capital 30.0% Depreciation Amortization Capital Expenditures Debt Free Cash Flow Residual Value 37,840 Discounting Periods PV Factor 10.0% PV DFCF ,402 Total Invested Capital Value 24,201 Residual Value Calculation Interest-Bearing Debt 1,716 Residual Debt Free Cash Flow 757 Equity Value $22,485 Cost of Capital 10.0% Base Case Equity Value $6,093 Estimated Residual Growth Rate 8.0% Effect 269.0% Residual Capitalization Rate 2.0% Residual Value 37,840 17

18 Lower growth Not even keeping up with inflation Certain circumstances might make reasonable The CFO forecast? 18

19 EXHIBIT D Low Growth Trailing Year 1 Year 2 Year 3 Year 4 Year 5 Residual Revenue $6,000 $950 $6,180 $6,365 $6,556 $6,753 $6,956 $7,164 Revenue Growth 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% Gross Profit 3, % 3,708 3,819 3,934 4,052 4,173 4,299 Total Operating Expenses 2, % 2,657 2,737 2,819 2,904 2,991 3,081 EBITDA 1, % 1,051 1,082 1,115 1,148 1,182 1,218 Depreciation % Amortization EBIT Taxes % Debt Free Net Income Incremental Working Capital 30.0% Depreciation Amortization Capital Expenditures Debt Free Cash Flow Residual Value 7,490 Discounting Periods PV Factor 10.0% PV DFCF ,434 Total Invested Capital Value 6,559 Residual Value Calculation Interest-Bearing Debt 1,716 Residual Debt Free Cash Flow 525 Equity Value $4,843 Cost of Capital 10.0% Base Case Equity Value $6,093 Estimated Residual Growth Rate 3.0% Effect -20.5% Residual Capitalization Rate 7.0% Residual Value 7,490 19

20 Increasing margins Is margin stabilized by end? Can it really improve this much (peers)? More risky? Huge effect on value. 20

21 EXHIBIT E Increasing Margins Trailing Year 1 Year 2 Year 3 Year 4 Year 5 Residual Revenue $6,000 $950 $6,450 $6,869 $7,247 $7,609 $7,914 $8,230 Revenue Growth 7.5% 6.5% 5.5% 5.0% 4.0% 4.0% Gross Profit 3, % 3,870 4,122 4,348 4,566 4,748 4,938 Operating Exp. As % of Revenue 43% 41% 39% 37% 36% 35% Total Operating Expenses 2,580 2,774 2,816 2,826 2,815 2,849 2,881 EBITDA 1, % 1,097 1,306 1,522 1,751 1,899 2,057 Depreciation % Amortization EBIT ,077 1,280 1,497 1,635 1,783 Taxes % Debt Free Net Income ,070 Profit Margin 8% 8% 9% 11% 12% 12% 13% Incremental Working Capital 30.0% Depreciation Amortization Capital Expenditures Debt Free Cash Flow Residual Value 16,250 Discounting Periods PV Factor 10.0% PV DFCF ,620 Total Invested Capital Value 12,331 Residual Value Calculation Interest-Bearing Debt 1,716 Residual Debt Free Cash Flow 975 Equity Value $10,615 Cost of Capital 10.0% Base Case Equity Value $6,093 Estimated Residual Growth Rate 4.0% Effect 74.2% Residual Capitalization Rate 6.0% Residual Value 16,250 21

22 Higher net working capital Industry norm versus company norm Shortfall existing on Valuation Date would be adjusted for Huge effect on value if Working capital large part of business and Low margins (such as retail or wholesale not here) 22

23 EXHIBIT F Higher Net Working Capital Trailing Year 1 Year 2 Year 3 Year 4 Year 5 Residual Revenue $6,000 $950 $6,450 $6,869 $7,247 $7,609 $7,914 $8,230 Revenue Growth 7.5% 6.5% 5.5% 5.0% 4.0% 4.0% Gross Profit 3, % 3,870 4,122 4,348 4,566 4,748 4,938 Total Operating Expenses 2, % 2,774 2,954 3,116 3,272 3,403 3,539 EBITDA 1, % 1,097 1,168 1,232 1,294 1,345 1,399 Depreciation % Amortization EBIT ,040 1,081 1,125 Taxes % Debt Free Net Income Incremental Working Capital 40.0% Depreciation Amortization Capital Expenditures Debt Free Cash Flow Residual Value 9,130 Discounting Periods PV Factor 10.0% PV DFCF ,405 Total Invested Capital Value 7,340 Residual Value Calculation Interest-Bearing Debt 1,716 Residual Debt Free Cash Flow 548 Equity Value $5,624 Cost of Capital 10.0% Base Case Equity Value $6,093 Estimated Residual Growth Rate 4.0% Effect -7.7% Residual Capitalization Rate 6.0% Residual Value 9,130 23

24 Large capital expenditure one year No resulting increase in revenue or reduction of expenses No related increase in depreciation (just constant percent of revenue) 24

25 EXHIBIT G Capital Expenditure versus Depreciation Trailing Year 1 Year 2 Year 3 Year 4 Year 5 Residual Revenue $6,000 $950 $6,450 $6,869 $7,247 $7,609 $7,914 $8,230 Revenue Growth 7.5% 6.5% 5.5% 5.0% 4.0% 4.0% Gross Profit 3, % 3,870 4,122 4,348 4,566 4,748 4,938 Total Operating Expenses 2, % 2,774 2,954 3,116 3,272 3,403 3,539 EBITDA 1, % 1,097 1,168 1,232 1,294 1,345 1,399 Depreciation % Amortization EBIT ,040 1,081 1,125 Taxes % Debt Free Net Income Incremental Working Capital 30.0% Depreciation Amortization Capital Expenditures Debt Free Cash Flow Residual Value 9,660 Discounting Periods PV Factor 10.0% PV DFCF ,719 Total Invested Capital Value 7,400 Residual Value Calculation Interest-Bearing Debt 1,716 Residual Debt Free Cash Flow 580 Equity Value $5,684 Cost of Capital 10.0% Base Case Equity Value $6,093 Estimated Residual Growth Rate 4.0% Effect -6.7% Residual Capitalization Rate 6.0% Residual Value 9,660 25

26 Revenue forecast only existing contracts but expenses continue Not reasonable Revenue and expenses must be consistent 26

27 EXHIBIT H Contracts Only Trailing Year 1 Year 2 Year 3 Year 4 Year 5 Residual Revenue $6,000 $950 $6,450 $6,869 $5,000 $2,500 $2,000 $0 Revenue Growth 7.5% 6.5% -27.2% -50.0% -20.0% % Gross Profit 3, % 3,870 4,122 3,000 1,500 1,200 - Total Operating Expenses (up 3%/year) 2, % 2,774 2,954 3,042 3,134 3,228 3,325 EBITDA 1, % 1,097 1,168 (42) (1,634) (2,028) (3,325) Depreciation up 3%/year) % Amortization EBIT (278) (1,877) (2,278) (3,582) Taxes % (111) (751) (911) (1,433) Debt Free Net Income (167) (1,126) (1,367) (2,149) Incremental Working Capital 30.0% (561) (750) (150) (600) Depreciation Amortization Capital Expenditures Debt Free Cash Flow (376) (1,217) (1,549) Residual Value (5,160) Discounting Periods PV Factor 10.0% PV DFCF (269) (792) (3,055) Total Invested Capital Value (2,828) Residual Value Calculation Interest-Bearing Debt 1,716 Residual Debt Free Cash Flow (1,549) Equity Value ($4,544) Cost of Capital 10.0% Not Meaningful Estimated Residual Growth Rate -20.0% Residual Capitalization Rate 30.0% Residual Value (5,160) 27

28 Forecast already outdated Revenue growth not sufficient first year Affects all else 28

29 EXHIBIT I Outdated Forecast Trailing Year 1 Year 2 Year 3 Year 4 Year 5 Residual Revenue $6,000 $5,800 $6,177 $6,517 $6,843 $7,116 $7,401 Revenue Growth -3.3% 6.5% 5.5% 5.0% 4.0% 4.0% Gross Profit 3, % 3,480 3,706 3,910 4,106 4,270 4,441 Total Operating Expenses 2, % 2,494 2,656 2,802 2,942 3,060 3,182 EBITDA 1, % 986 1,050 1,108 1,164 1,210 1,259 Depreciation % Amortization EBIT ,012 Taxes % Debt Free Net Income Incremental Working Capital 30.0% (60) Depreciation Amortization Capital Expenditures Debt Free Cash Flow Residual Value 8,700 Discounting Periods PV Factor 10.0% PV DFCF ,151 Total Invested Capital Value 7,226 Residual Value Calculation Interest-Bearing Debt 1,716 Residual Debt Free Cash Flow 522 Equity Value $5,510 Cost of Capital 10.0% Base Case Equity Value $6,093 Estimated Residual Growth Rate 4.0% Effect -9.6% Residual Capitalization Rate 6.0% Residual Value 8,700 29

30 Other Bad & Ugly Growth or margins not supported by Economic research Industry research Historical results Some particular issue regarding this entity Demand and competitive environment 30

31 Regulatory Review 31

32 Regulatory PCAOB and SEC comments have focused on the following points related to projected financial information: failure to evaluate the reasonableness of assumptions relating to revenue growth rates, capital expenditures, terminal growth rates and the discount rate failure to assess the reasonableness of improved margins failure to consider industry growth rates 32

33 Questions? 33

34 Shishir R. Khetan, CFA Shishir R. Khetan is a Managing Director in the Valuation & Financial Opinions Group. He has extensive experience in corporate finance, valuations and strategic planning. He has over 16 years of global experience and has advised clients ranging from Fortune 500 companies to medium and small privately held companies, private equity and investment funds, family offices, and accounting, legal and tax advisors. Mr. Khetan serves a wide range of industries including energy, infrastructure, real estate, chemicals, financial services, healthcare, technology, general manufacturing and services. Prior to joining SRR, Mr. Khetan was a Senior Managing Director of HFBE where he performed financial advisory and valuation services for financial reporting, mergers and acquisitions, strategic planning, raising capital and tax. Mr. Khetan s past experience includes serving as the Head of Mergers & Acquisitions at Maytas Infra Limited, a publicly traded infrastructure development and construction company in India, where he led a division focused on inorganic growth through acquisitions and joint ventures, debt, and equity capital for acquisition finance and infrastructure projects. Mr. Khetan was also a Senior Manager at Ernst & Young LLP where he provided financial advisory and valuation services for financial reporting, mergers and acquisitions and strategic planning purposes. Mr. Khetan earned his bachelor's degree in Finance, summa cum laude, from the University of Houston and his MBA from the University of Houston earning the Dean s Award for Academic Excellence. He is a Chartered Financial Analyst and a member of the Houston Society of Financial Analysts and the Association of Corporate Growth. 34

35 Carla G. Glass, CFA, FASA Carla Glass is a Partner of Hill Schwartz Spilker Keller LLC. She has over 25 years of experience in the valuation of businesses, partnerships, employee stock ownership plans (ESOPs), debt, derivative securities, intellectual property and other intangibles in a wide range of industries, including healthcare. Her valuation expertise includes financial reporting, gift and estate tax, corporate and partnership reorganizations, minority shareholder rights, bankruptcy proceedings, merger and acquisition analysis, and litigation, among others. She is nationally recognized as a distinguished thought leader, educator and contributor to the valuation body of knowledge. She has served as Chair of the Business Valuation Committee of the American Society of Appraisers (ASA) and also as Chair of the Standards Committee of The Appraisal Foundation, the organization which promulgates the Uniform Standards of Professional Appraisal Practice (USPAP). Carla earned her bachelor's degree from Vanderbilt University and her MBA from the University of Houston. She is a Fellow in ASA College of Fellows (FASA), which is awarded in recognition of exceptional appraisal proficiency, as well as notable contributions to the valuation profession. She is currently one of only nine valuation professionals serving on the Valuation Resource Group of the Financial Accounting Standards Board. This is not a CPA firm. 35

36 Thank You Shishir R. Khetan,, CFA Managing Director Carla G. Glass, CFA, FASA Partner Esperson Buildings 815 Walker Street Suite 1140 Houston, TX Lincoln Center Tower LBJ Freeway Suite 610 Dallas, TX ext. 103 cglass@hssk.com 36