Capstone: Valuation 28C00500

Transcription

1 Capstone: Valuation 28C00500 Course introduction Dr Elias Rantapuska Aalto BIZ / Finance

2 MyCourses MyCourses is your source of course material and information Elias Rantapuska / Aalto BIZ Finance 2

3 Lecturer Employment history Business Advisor (domestic and international corporate finance consulting work) 08/2010 Aalto BIZ, Assistant Professor of Finance 07/2010 McKinsey & Company, Sr. Associate 08/ /2010 HSE, researcher 01/ /2006 J.P. Morgan (UK), Intern analyst 07/ /2002 Nordea, financial institutions, intern analyst 05/ /2001 Education: Dr.Sc., HSE, 2006 M.Sc., HSE, 2003 Current research interests: Investor behavior Household finance Current courses: International Financial Management (M.Sc.) Capstone: Valuation (B.Sc.) Corporate Financial Policy (MBA) Office hour: Before / after class or by appointment Elias Rantapuska / Aalto BIZ Finance 3

4 Lecture outline What is value? Corporate strategy and operations as a source of value Valuation techniques Capstone: Valuation Exam and group project Synthesis Interpreting and using financial statements for valuation Forecasting income statement and balance sheet Empirical issues and special cases Elias Rantapuska / Aalto BIZ Finance 4

5 Course content Class topic Valuation basics Corporate strategy and operations as source of value Interpreting and using financial statements for valuation I Interpreting and using financial statements for valuation II Forecasting I: income statement and balance sheet Forecasting II: cash-flow statement Valuation techniques I: DDM and DCF Valuation techniques II: RI and ROE-growth Valuation techniques III: multiples and connection between techniques Question to answer Where does value come from? How to measure value correctly? How to value in theory? Empirical issues Visiting lecture by Nordea Corporate Finance Special issues: high growth, distress, private companies, emerging market companies, and banks How to value in practice? Elias Rantapuska / Aalto BIZ Finance 5

6 This course is applied Hard-core theory Advanced Investment Theory Derivatives and Risk Management Corporate Finance Investments International Financial Management Applied Capstone: Financial Valuation Institutions Venture capital Our approach will be as much hands on as possible The aim is to introduce valuation "as you would do it in practice" Some theory is necessary to bring rationale for doing things as they are done Valuation is more "art" than "science": it is a trade that can be learned and mastered Elias Rantapuska / Aalto BIZ Finance 6

7 Where do we start from Pre-requisites: Introduction to Finance Investment Management Financial Markets and Institutions Corporate Finance Intermediate spreadsheet skills Review necessary material well in advance Our explicit goal is to ensure as much value-added as possible for a final year bachelor's level student without too much overlapping content with other courses Elias Rantapuska / Aalto BIZ Finance 7

8 Course books Lectures Palepu, Healy and Peek: Business Analysis and Valuation IFRS edition Pinto, Henry, Robinson, Stowe: Equity Asset Valuation Exercises Rees: Financial Modeling in Practice Written by Americans for European audience Security analyst (CFA) perspective "How to do in Excel" Elias Rantapuska / Aalto BIZ Finance 8

9 Group valuation project Group formation through MyCourses, max 4 students per group Group valuation project company is Elias Rantapuska / Aalto BIZ Finance 9

10 Case assignments and exercise sessions Group formation through MyCourses, max 4 students per group, separate formation for each case Three case assignments to be returned Sign up to ONE case presentation per group Prepare to discuss your solutions in class Visual aids are allowed, but most important that your group will be able to answer when cold-called Elias Rantapuska / Aalto BIZ Finance 10

11 Class participation As the class size is limited, we have a great opportunity to discuss and share knowledge in the classroom in an interactive way. Class activity constitutes additional 5% of the final grade, outstanding class participation (judged by quality and quantity) may yield extra points above 5% You can score class activity points in lectures or exercises Elias Rantapuska / Aalto BIZ Finance 11

12 Class material Textbooks: Lecture notes: Cases: Exercise and case results: Bookstore or library MyCourses MyCourses MyCourses Elias Rantapuska / Aalto BIZ Finance 12

13 House rules for the course Please do not arrive late or leave class early Active participation is expected We love discussing anything that contributes to your learning, both in class and outside of class We cannot comment exercises or cases (other than clarifying questions in exceptional cases) before deadline We are obsessed with sticking to deadlines. 100% adherence to honor code is expected. Do not copy exercise or case answers from the web, even if they would be available Elias Rantapuska / Aalto BIZ Finance 13

14 Feedback use the opportunities to develop this course Elias Rantapuska / Aalto BIZ Finance 14

15 Scholastic honesty and academic integrity We expect adherence to highest standards of scholastic honesty Examples of scholastic dishonesty are: - Exercise answer sharing between groups - Presenting answers as own work without proper citation to the sources (plagiarism) - Sharing answers during the final exam. All class work (exercises and final project) is to be done by the students that return the work, co-operation in preparing answers to the exercises between groups (or individuals not belonging to the same group) is strictly prohibited. However, you are allowed to discuss the exercise problems with fellow students on a principal level: the definition of terms and concepts in the questions, and what issues are central to a particular question. Every group should proceed on their own from there: copying answer from another group is a clear case of scholastic dishonesty Failure to adhere to these guidelines is subject to disciplinary action, such as cancellation of class work credit, extra assignments, or removal from the course. Turning in class assignments is considered acknowledgement of these guidelines. Please read more in Into about the Academic Integrity and Handling Violations Thereof Elias Rantapuska / Aalto BIZ Finance 15

16 Lecture 1 Introduction to course Valuation basics

17 Structure of discussion today Basic concepts of value Valuation process Valuation models Uses and abuses of valuation Elias Rantapuska / Aalto BIZ Finance 17

18 Basic concepts of value Private value Intrinsic value Market price Value to a specific buyer "Objective" value based on cash flows and risk Latest known transaction price or price between bid/ask Elias Rantapuska / Aalto BIZ Finance 18

19 Why is market price different than "value"? Private value Intrinsic value Market price Italian scarf sold at Century 21 in New York City Our price USD 6.97, value USD 20 Which number is relevant? Input your answer through presemo.aalto.fi/valuation0 Elias Rantapuska / Aalto BIZ Finance 19

20 Market price is the value at which an asset can be bought or sold Private value Intrinsic value Market price The current price at which an asset can be bought or sold Market price converges when supply and demand meet Shocks to either the supply side and/or demand side can cause the market price for an asset to be reevaluated In practice, operationally often defined as: Latest transaction price Some point between bid/ask price If buy-side offer is unknown, offer to sell or vice versa Elias Rantapuska / Aalto BIZ Finance 20

21 Intrinsic value is same for all Private value Intrinsic value Market price Intrinsic value depends on objective properties only For cash flow generating assets, only expected cash flows and riskiness of cash flows matters Discounted cash-flow (DCF) analysis is a way for figuring out intrinsic value. Or is it? Market price = intrinsic value + mispricing + (private value above or below intrinsic value) Elias Rantapuska / Aalto BIZ Finance 21

22 What if intrinsic value is different from market price? Private value Intrinsic value Market price Efficient market hypothesis Perceived mispricing Intrinsic value = market price V I P = (V P) + (V I V) Market mispricing Analyst error where V I = intrinsic value calculated by the analyst P = market price V = "true" intrinsic value Elias Rantapuska / Aalto BIZ Finance 22

23 Going concern vs. liquidation value Private value Intrinsic value Market price Going concern value: Firm will continue in its business activities Firm will continue to sell its goods and services Firm will use its assets for value maximization Firm will access its optimal sources of financing Liquidation value: Firm will be dissolved Firm assets will be sold separately If going concern value > Liquidation value Value added from asset synergy Value added by managerial skills If going concern value < Liquidation value Negative synergy or managerial skill Elias Rantapuska / Aalto BIZ Finance 23

24 Private value reflects subjective differences in intrinsic value Private value Intrinsic value Market price Assume two tickets to see Star Wars: The Last Jedi" this Friday How much would you be willing to pay? Submit your answer through Elias Rantapuska / Aalto BIZ Finance 24

25 Private valuations are common in both financial and real assets Private value Intrinsic value Market price Value of same asset may be different depending on the owner Dividend paying stock for investors with different tax rates Industrial company for a financial or industrial buyer Your grandmother's clock A movie ticket to a theatre next to your flat vs. a theatre in Tampere Final comic book in the almost perfect collection of Donald Duck comics from 1960's Elias Rantapuska / Aalto BIZ Finance 25

26 Private value can also be influenced by management Number of games and goals by Zlatan 122 Private value Intrinsic value Market price Games Goals (71%) (55%) (69%) 113 (93%) Zlatan Ibrahimovic sold at EUR 70 mn Inter Barca Milan PSG Zlatan Ibrahimovic sold at EUR 24 mn Source: I, Zlatan Ibrahimovic (David Lagercrantz); Wikipedia Elias Rantapuska / Aalto BIZ Finance 26

27 Structure of discussion today Basic concepts of value Valuation process Valuation models Uses and abuses of valuation Elias Rantapuska / Aalto BIZ Finance 27

28 Valuation is a structured, often iterative process Understand Select valuation model Forecast Perform valuation Communicate results What is the business model? What is the competitive strategy? What drives revenues, costs, and investment? Who are the competitors? How is the firm positioned vis-àvis competitors? Select appropriate valuation model based on availability of data, maturity of business, business model, and intended depth of the analysis Structure revenue, cost and balance sheet drivers Identify most important value drivers Forecast most important value drivers by using industry (analyst) estimates, macro-estimates, interviews, and judgment Estimate discount rate Perform valuation Sanity check and re-iterate forecasts Create summary valuation with most important valuation inputs Ensure all results can be traced back to inputs with ease Apply results to investment decisions and corporate strategy Elias Rantapuska / Aalto BIZ Finance 28

29 Often it is pragmatic to add level of detail in steps Step 5: Also model entire income statement and balance sheet by line item Step 4: Detailed DCF with entire tree for revenues, costs and balance sheet buildup Step 3: Simple DCF with one top-line for revenues Step 2: Gordon's DDM Step 1: Quick and dirty multiples valuation High Level of detail Low Elias Rantapuska / Aalto BIZ Finance 29

30 Structure of discussion today Basic concepts of value Valuation process Valuation models Uses and abuses of valuation Elias Rantapuska / Aalto BIZ Finance 30

31 Four generic approaches to valuation Present value models Present value models Dividend discount models Free cash flow to equity Free cash flow to the firm Residual income Asset-based models Liquidation value (shortcut: book value of assets minus liabilities) Replacement cost Relative valuation models Enterprise value multiples, e.g., - EV/Sales - EV/EBITDA Equity value multiples, e.g., - P/E - P/B - P/CF Contingent claim valuation Equity as a call option Real asset as an option Elias Rantapuska / Aalto BIZ Finance 31

32 Each approach has its right application Present value (DCF) models Cash flows currently positive and can be estimated with some reliability for future periods Proxy for risk that can be used to obtain discount rate Most appropriate for established, cash-generating companies Relative valuation models Peer firms are comparable to the firm being valued and market values the peers correctly When only top-line data is available When there is no time or need to get a detailed answer Asset-based models When the company is about to be liquidated A competing enterprise would be easy to set up Contingent claim valuation Firms in distress Firms with underutilized assets IPR, such as patents Natural resource reserves Elias Rantapuska / Aalto BIZ Finance 32

33 Golden rules of DCF valuation 1 Adjust cash flows or discount factor for risk, not both 2 Select which cash flows to whom are you modeling and discounting Elias Rantapuska / Aalto BIZ Finance 33

34 DCF valuation can be done in two different ways 1 The value of a risky asset can be estimated by discounting the expected cash flows on the asset over its life at a riskadjusted discount rate (99.9% of analysts do this): Or, replace the expected cash flows with certainty equivalent cash flows (CE) and discount these at the riskfree rate: Elias Rantapuska / Aalto BIZ Finance 34

35 What do these alternative DCF approaches mean in practice? 1 Anything that has no impact on cash flows or risk has no impact on intrinsic value: Outstanding research scientists who create a drug that fails phase III Patent that is never commercialized Brand value in bankruptcy If something is very risky, promises of future cash flow must be very, very high Eternal cash burner cannot have a positive value Earlier money is better money Elias Rantapuska / Aalto BIZ Finance 35

36 Firm or equity valuation? 2 Assets Liabilities Enterprise (or firm) valuation Assets in place Debt Growth assets Equity valuation Equity Elias Rantapuska / Aalto BIZ Finance 36

37 Never mix and match cash flows and discount rates 2 Make sure you understand what entity you are valuing Discounting cash flows after debt cash flows (equity cash flows) at the weighted average cost of capital will lead to an upwardly biased estimate of the value of equity Discounting pre-debt cash flows (cash flows to the firm) at the cost of equity will yield a downward biased estimate of the value of the firm Cost of equity is equal to cost of capital only when firm is 100% equity financed Elias Rantapuska / Aalto BIZ Finance 37

38 Same inputs are required for different DCF approaches 2 Input Dividend Discount Model FCFE (Potential dividend) discount model Cash flow Dividend Potential dividends = FCFE = Cash flows after taxes, reinvestment needs and debt cash flows Expected growth In equity income and dividends In equity income and FCFE FCFF (firm) valuation model FCFF = Cash flows before debt payments but after reinvestment needs and taxes. In operating income and FCFF Discount rate Cost of equity Cost of equity Cost of capital Steady state When dividends grow at constant rate forever When FCFE grow at constant rate forever When FCFF grow at constant rate forever Elias Rantapuska / Aalto BIZ Finance 38

39 If applied correctly, FCFE and FCFF should yield same results 2 Consider a firm with the following cash flows Year FCFE Interest x (1-tax rate) FCFF Terminal Value (equity) (firm) Assume also that the cost of equity is % and the firm can borrow long term at 10% with tax rate of 50% The current market value of equity is 1,073 and the value of debt outstanding is 800 Elias Rantapuska / Aalto BIZ Finance 39

40 FCFE or FCFF? Method 1: Discount FCFE at Cost of Equity to get value of equity: Cost of Equity = % Value of Equity = 50/ / / / ( )/ = 1073 Method 2: FCFF at WACC to get value of firm: Cost of Debt = Pre-tax rate (1- tax rate) = 10% (1-.5) = 5% WACC = % (1073/1873) + 5% (800/1873) = 9.94% 2 PV of Firm = 90/ / / / ( )/ = 1873 Value of Equity = Value of Firm - Market Value of Debt = = 1073 Elias Rantapuska / Aalto BIZ Finance 40

41 Structure of discussion today Basic concepts of value Valuation process Valuation models Uses and abuses of valuation Elias Rantapuska / Aalto BIZ Finance 41

42 Uses of equity valuation Investment decisions Business strategy decisions Corporate finance decisions Inferring expectations Questions valuation can answer Is stock under- or overvalued? How much should a buyer be willing to pay for a firm in an auction? Is the price paid for an IPO stock or minority share fair? What is the impact of new strategy on firm value if the strategy succeeds or fails? What would be our firm worth if we could increase our margins or sales growth rate? What is the effect of a merger on stock value? What are the executive options worth? How much earnings growth is expected based on current market valuation? Have investors misunderstood the value of our firm? Elias Rantapuska / Aalto BIZ Finance 42

43 Abuses of valuation Corporations: Overstatement of earnings (Enron) Overstatement of assets Understatement of assets (taxation) Individuals: Distribution of an estate Purchasing a car (car retail value vs. shipment costs) Governments: Overstatement of assets (banking sector debt in sovereign debt crisis) Valuation is often political Sell-side has an incentive to overstate value, while buy-side would like to understate value When assessing a valuation report, ask who has written the report and for what purpose In the valuation industry independent opinions are hard to come by because somebody will always pay for the valuation report Elias Rantapuska / Aalto BIZ Finance 43

44 Valuation quiz to recap first lecture presemo.aalto.fi/valuation1b Elias Rantapuska / Aalto BIZ Finance 44