Corporate Valuation By Edward Bodmer Finance Energy Institute www.financeenergyinstitutue.com pg. 1
INTERMEDIATE CORPORATE VALUATION MODELLING WITH EXCEL Target Audience The target audience is anyone who is interested in understanding the details and theory of how valuation really works and at the same time getting highly practical hands on experience. Examples of professionals who may be interested in the course as well as the associated sample models, excel tools, valuation articles, case studies and databases include: Investment bankers Fund managers Equity analysts Equity traders Equity sales professionals Corporate Finance Lawyers Credit analysts at banks and other financial institutions Business strategists at corporations Treasurers Compliance officers Training Objectives Using a number of intensive hands-on exercises and case studies, participants work through the theory and application of a wide range of valuation techniques. The course will move from fundamental ideas involving economic drivers and financial statement analysis to advanced valuation issues. Participants consider advantages and advantages of major unresolved debates in finance including equity versus free cash flow valuation, use of multiples versus DCF versus IRR, and mathematical analysis versus judgement. In describing valuation analysis particitpants will understand how to implement different valuation concepts with practical excel exercises. Some of the specific objectives of the course include: What are the fundamental economic factors that underlie valuation and how can this theory be used in a practical way How can structured financial models be created that clearly delineate risks and value without being overly complex and what can be done to effectively present risk analysis in valuation analysis 2
How can you get around major problems with the DCF model which include wide range in valuation results and estimation of residual value How do long-term versus short term growth rates, risk premiums and costs of capital drive multiples such as the P/E ratio and the EV/EBITDA ratio and how can these multiples be used in valuation Can models used to evaluate LBO s, project finance and M&A provide ways to value investments without necessitating estimation of terminal growth rates, betas or WACC Methodology/Teaching Methods The teaching methodology used on this course combines formal theoretical instruction with frequent reference to market data, use of practical exercises and case studies. Case studies and databases are based on real situations and are designed to help delegates implement new valuation techniques and to learn from empirical experience. A vast library of case studies, financial models, excel tools for financial analysis and other information is provided to participants. The course is intended to be practical and inter-active, with delegates encouraged to ask questions. The techniques taught to delegates are intended to be of immediate practical use in the workplace. Day 1 Introduction, Valuation Fundamentals, Multiples and Return on Invested Capital Session 1: Introduction to Materials and Valuation Lessons from Valuation Mistakes The course will begin with and overview of the subjects covered along with the large database of practical materials that are provided on a pin drive. To introduce valuation lessons on valuation, risk assessment and forecasting are reviewed. A lecture and discussion reviews mistakes made in valuing sub-prime loans compared to other famous valuation errors. This introduction demonstrates that real valuation errors were not made by wrongly estimating items like Beta, the weighted average cost of capital or wrongly measuring surplus cash. Instead, mistakes in evaluating value drivers, effects of surplus capacity and lack of independent analysis has driven most valuation mistakes. Review of valuation lessons at the beginning of the course provides context for other subjects in the course. 1. Introduction to Resources a. Reading Financial Statements from PDF b. Acquiring Market Data from the Internet c. Overview of Case Studies on Valuation d. Review of Corporate and M&A Financial Models and Exercises e. Articles and Books on Vauation and ModellingImportance of Growth in Valuation 3
2. Discussion of Valuation Errors and Industry Forecasting a. Demand Volatility b. Surplus Capacity and Marginal Cost c. Asset Life and Competitive Advantage d. Product Obsolescence and Cost Structure Changes 3. General Discussion of EBITDA and Financial Ratios a. Why Financial Analysts use EBITDA and Free Cash Flow b. Introduction to ROE, ROIC and IRR c. Difference between P/E and EV/EBITDA Day 1, Session 2: Cash Flow Forecast and Risk 1. Two Problems in Valuation: Forecasting Cash Flow and Measuring Risk of the Cash Flow a. Forecasting Cash Flow b. Why Valuation Comes from Earning a Return above Cost of Capital c. Definition of Cost of Capital and Risk Premium d. Discounting Future Cash Flow e. Importance of Growth in Valuation 2. Valuation of Risky Bonds a. Basic problem of cash flow forecast and risks b. Introduction to Excel Short-cuts c. Use of Excel tools 3. Theory of Valuation and Practical Problems a. Difficulty in measuring Risk and Cost of Capital b. Problems in Measuring Length and Magnitude of Growth Rates c. Projecting Long-term Returns Day 1, Session 3: Valuation Using Multiples; Value Drivers of Return, Risk and Growth 1. Examples of Multiples in Valuation a. Process of Deriving Valuation from Comparative Multiples b. Alternative Multiples c. Problem and Biases in Comparative Valuation d. Reconciliation of P/E ratio and EV/EBITDA Ratio 2. Practical Exercise on Derivation of P/E Ratios from Value Drivers a. Model of Valuation from Equity Cash Flow b. Dividend Pay-out Ratio and Growth Rate c. Computation of P/E Ratio and Market to Book Ratio with Growth and Returns d. Evaluation of the Cost of Equity Capital from the P/E Ratio and Use of Goal Seek together with MACRO in Excel 3. Transition Period, Terminal Value and Underlying Value Drivers a. Changes in Growth Rates and Transition Periods b. Convergence of Cost of Capital and Rate of Return c. Incorporation of Transition Periods in P/E Analysis with Terminal Value d. Analysis of P/E and EV/EBITDA ratio with alternative value drivers and alternative transition periods 4. Analysis of Actual P/E, EV/EBITDA and M/B Ratio 4
a. Theory of Establishing Comparable Samples b. M/B ratio and ROE c. Use of M/B Ratio in Deriving Cost of Equity 5. Derivation of EV/EBITDA Ratio from Value Drivers a. Importance of Stable Ratio of Capital Expenditure to Depreciation and Ratio of Depreciation to Net Plant b. Calculation of NOPLAT and Free Cash Flow c. Analysis of Enterprise Value and Free Cash Flow Day 1, Session 4: Return on Invested Capital and Disceting the Balance Sheet 1. Importance of Computing Return on Investment in Valuation a. Why you want to know about Core Operations b. Difference between ROE and ROIC c. Exposure to Threats of Competition d. Use of ROIC in Assessing the Reasonableness of Financial Forecasts e. Debates Concerning Gradual Movement of Return on Investment to Cost of Capital 2. Real World Issues in Computing Return on Invested Capital and Return on Equity a. Reconciliation of Invested Capital from Assets and Liabilities side of Balance Sheet b. Problem of write-offs and re-struturing c. Associated Investments, Discontinued Operations d. Accumulated Other Comprehensive Income and Derivatives 3. Reconciliation of IRR and ROI a. Understanding of IRR as Growth Rate b. Financial Analysis that Uses IRR and ROI c. Exel Exercise on Reconciliation of ROI and IRR 4. Case Studies of ROIC and Risks a. Understanding ROIC versus ROE with Apple Corporation b. ROIC for Solar Industry and Danger of Competition from China c. ROI in Long-term and Country Risk Day 2 Discounted Cash Flow Model, Terminal Value, Enterprise Value and Bridge to Equity Value Day 2, Session 1: Discounted Cash Flow Model Exercise 1. Review of Analysis in M&A with DCF Model a. Calculation and Theoretical Basis of Free Cash Flow b. Mechanics and Presentation of DCF c. Alternative Computations of WACC and Cost of Equity d. Difference Calculations of Terminal Value 2. Development of DCF Model Through Construction of Fundamental Model a. Value Drivers and Changes in EBITDA b. Use of Switches for Flexible Timing c. Computation of Free Cash Flow 5
3. Analysis of DCF Model a. Efficient Use of Data Tables and Major Problem of Value Ranges with Growth Method b. Reduction of Value Range with EV/EBITDA 1. Theory and Calculation of Terminal Value Using Three Approaches a. Growth Model b. Value Driver -- ROIC, Growth and Cost of Capital c. Application of Multiples 2. 3. Use of EV/EBITDA Ratio and Alternative Transition Factors in Terminal Value a. Problems with Alternative Terminal Value Calculations b. Computation of EV/EBITDA after Growth Transition c. Sensitivity Analysis with Alternative Value Drivers 4. Establishment of Stable Period in DCF Calculation a. Problems without Stable Period Example of Working Capital b. Mechanics of Computing Stable Period c. Adjustments in Stable Period 5. Relationship between growth and cost of capital a. Cost of Capital Model b. Convergence between Cost of Capital and Return on Capital c. Consistency with Inflation d. Declines with Stable Cash Flows 6. Inclusion and Exclusion of Items in Bridge between Equity and Enterprise Value a. Market Value versus Accounting Book Value in Bridge b. Market Value of Debt versus Book Value of Debt and Valuation of Derivatives c. Valuation of Other Derivatives on Balance Sheet d. Valuation of Deferred Taxes in Cash Flow or Bridge i. Simple Case with No Growth ii. Deferred Taxes with Growth iii. Net Operating Loss Deferred Tax e. Valuation of Non-Associated Investments and Other Assets f. Valuation of Minority Interest on Balance Sheet g. Valuation of Pension Liabilities h. Valuation of Stock Options Cost of Equity Capital and Cost of Debt After analysing valuation techniques, application of cost of capital is discussed with emphasis on application of discount rates in real world circumstances. The final topic addresses adjusted present value where all-equity cost of capital is applied. 1. General Definition and Components of Cost of Capital a. Consistency of Forecasts and Inflation Rate b. Risk Free Rate and Inclusion of Real Interest Rate c. Real Interest Rate and Real Growth in Economy 6
d. Risk Premium for Debt e. Risk Premium for Equity 2. Measurement of Cost of Equity with CAPM a. Measurement of Risk Free Rate b. General Notion of Beta c. Alternative Measurement of Beta d. Difficult Problem of Equity Market Risk Premium 3. Alternative Measurement of Cost of Equity a. Dividend Discount Model b. Use of P/E Ratio c. Use of M/B Ratio d. Project Finance, LBO and Surveys Day 3 Corporate Modelling for Valuation Corporate Modelling for Valuation The third day of the course moves to central corporate finance issues of measuring value and assessing risk. The models created in the first two days are extended to a comprehensive corporate model. Topics covered include: Comprehensive Model for Computing Value from Free Cash Flow and For Computing Return on Invested Capital Forecasting models are the centrepiece of most valuation analyses. Therefore, the course includes discussion and exercises on development of a solid foundation in modelling. In addressing model structure and programming techniques for valuation modelling, the course covers: 1. Efficient Model Structure a. Flexible, Accurate, Structured, Transparent b. Complex Modelling Issues in Corporate Model i. Time Periods and Incorporation of History ii. Computation of market shares and volumes from industry demand and supply iii. Depreciation and retirements iv. Deferred taxes and implied tax versus book depreciation c. Avoiding Bad Programming Practices i. Long-formulas ii. Mixing inputs with calculations iii. Non-modular structure 7
iv. Inconsistent time lines v. Circular references 2. Setting-up Corporate Model a. Importance of Time Line and Using TRUE/FALSE commands along with AND function i. Use of dates and EDATE function to enter historic period, transaction period, explicit period and stable period and use of DATA VALIDATION to limit time period increments in the model ii. Historic period and flexibility to add new historic financial statements iii. Effective use of CONDITIONAL FORMATTING to highlight alternative periods in model iv. Development of dates from EDATE function, time periods, days per year b. Development of Assumptions Module i. Creation of MACRO with F5 key to find and colour cells ii. Use of historic financial statements and operating reports to establish assumptions iii. Structure of assumptions operating assumptions, tax and depreciation assumptions, financing assumptions, valuation parameters iv. Effective and in-effective use of SPINNER BUTTONS in setting-up assumptions v. Alternative set-up of time series assumptions with INDEX function c. Setting-up Model Integrity Page i. Idea of effective integrity page find and report errors without having to look around model ii. Tests in corporate model historic income statement, historic balance sheet, debt balance, prospective balance sheet iii. Use of TRUE/FALSE variables in making tests iv. Use of AND function in for Aggregate tests v. Putting together the integrity label with IF tests 3. Operating Analysis, Working Capital, Depreciation and Free Cash Flow a. Operating Analysis i. Converting annual growth rate, inflation and other assumptions to periodic assumptions ii. Use of LOOKUP function (rather than VLOOKUP) in converting assumptions iii. Developing transparent formulas iv. Use of F11 and ALT,F1 to effectively display historic analysis together with prospective assumptions 8
b. Working Capital Analysis i. Use of historic balances and projected balances with historic switch ii. Accumulation of working capital and calculation of changes in working capital c. Depreciation and Deferred Tax Analysis i. Potential distortion created by not accounting for retirements ii. Existing depreciation on net plant and use of stable ratios using OFFSET function for computing retirements iii. Depreciation on new plant using TRANSPOSE function and age calculation iv. Calculation of depreciation using SUMPRODUCT function 4. Calculation of Discounted Cash Flow and Return on Invested Capital a. Computation of EBITDA, EBIT and Operating Taxes b. Presentation of Free Cash Flow and Enterprise Value c. Calculation of Enterprise Value and EV/EBITDA together with Return on Invested Capital Equity Cash Flow and Credit Analysis for Full Corporate Model Analysis The operating part of a corporate model derives the information for computing the free cash flow and the return on invested capital. A full financial model includes financial statements, debt structure and derives earnings per share, return on equity and measures of credit quality. Exercises and discussion of creating a full integrated corporate model include: 1. Structure of Financial Model and Accounting Framework a. Inclusion of debt and liabilities b. Importance of closing balance accounts for every balance sheet account c. Profit and loss statement for taxes and earnings d. Cash flow statement and computation of debt and cash balance e. Balance sheet as audit and verification tool 2. Debt Schedule a. Separation of long-term and short-term debt b. Importance of use of MIN function in modelling with example for long-term debt c. Computation of short-term debt and cash balances to tie cash flow together with balance sheet d. Use of MAX function to compute cash balances and short-term debt with assumptions for minimum cash balance 3. Computation of Financial Statements a. General notion of only computing subtotals in financial statements b. Calculation of taxes in profit and loss statement 9
i. Addition of Net operating loss balance using MAX and MIN functions ii. Adjustment for Tax and Book Depreciation iii. Computation of change in deferred tax and accumulated deferred tax c. Development of cash flow statement from EBITDA d. Computation of equity balance and balance sheet 4. Alternative Financing in Corporate Models a. Use of SOLVER for Target Capital Structure b. Computation of new equity issues and new shares c. Calculation of earnings per share, return on equity and return on invested capital 5. Use of EPS and P/E ratio in valuation a. Calculation of EPS with alternative capital structure b. Inclusion of dividends and equity financing in cash flow c. Use of M/B ratio in terminal value d. Computing value per share from equity cash flow Risk Analysis, Valuation and Modelling The next module of the course covers risk analysis as well as options pricing exchange rate risk, interest rate risk and debt management. Traditional risk analysis tools and mathematical approaches to measure risk are described. Debt management issues include credit analysis, forwards, swaps and financial engineering. The final subject is computation of value at risk for foreign exchange and interest rate risk. Subjects include: Sensitivity Analysis, Scenario Analysis and Tornado Diagrams in Valuation The most time spent valuation analysis is generally spent developing economic assumptions that form a base case. Evaluating valuation risks and developing sensitivity analysis should be an integral part of valuation. A case study is used to develop economic assumptions and to demonstrate use of sensitivity analysis, break-even analysis and tornado diagrams. 1. General Discussion of Risk Analysis a. Break-even Analysis b. Sensitivity Analysis c. Scenario Analysis d. Variance Analysis e. Combination of Scenario and Sensitivity Analysis 2. Sensitivity and Scenario Analysis a. Sensitivity analysis on WACC and terminal growth i. Use of DATA TABLE 10
ii. Setting the calculation to automatic except data table iii. Creation of calculation macro to improve data tables iv. Creation of macro to save without re-computing data tables v. Use of macro to compute sensitivity analysis rather than using data tables b. Implementation of Master Scenario Page i. Idea of control panel to manage key inputs and develop risk analysis ii. Combination of DATA TABLE and INDEX or CHOOSE function iii. Step by step process to add scenario analysis to any analysis to any analysis iv. Incorporation of time series assumptions with changing year by year assumptions using INDEX function v. Creation of sensitivity analysis from scenario analysis to evaluate relative effects of changing different assumptions vi. Addition of sensitivity scenario to incorporate forms (SPINNER BOXES, COMBO BOXES) with losing track of the base case assumptions Alternatives to DCF and Multiples - Leveraged Buyout, Structured Finance and M&A Valuation The final part of the course involves case studies that investigate valuation issues associated with Leveraged Buyouts, structured finance and M&A. Issues include modelling cash flow waterfalls in leveraged buyouts and structured finance as well as accounting and economic issues associated with valuing M&A transactions. Valuation and Modelling for Leveraged Buyouts The debt capacity in valuation provides an alternative way to assess risk and make valuations as it is the fundamental job of bankers to assess risk. This section describes the theory and practice of using structured finance as an alternative to DCF in developing valuation. 1. Overview of valuation models that do not require estimation of WACC or terminal growth a. LBO Analysis b. Project Finance Analysis c. M&A Consolidation Analysis 2. Theory of using debt capacity to assess risk and value a. Risk Analysis in Measurement of Debt Capacity b. Computation of Project IRR versus Equity IRR c. Trade-off Between Financial Risk and Operating Risk 3. Review of Multiples and Terms for Leverage Buyout a. EV/EBITDA Entry Multiples b. Holding Periods 11
c. Exit Strategies d. Debt to EBITDA and Financing 4. Structure and Format of a Leveraged Buyout Model a. Holding Period b. Transaction Assumptions c. Sources and Uses Analysis d. Cash Flow Waterfall e. Equity Cash Flow 5. Objectives and Complexities a. Computation of equity IRR from alternative purchase prices and alternative capital structures b. Development of pro-forma balance sheet c. Construction of cash flow waterfall d. Income tax adjustments e. Calculation of default points and IRR on alternative debt instruments 6. Structuring alternative debt instruments a. Pro-forma Balance Sheet i. Alternative structuring of acquisition assumptions ii. Inputs for debt 1. Amortising debt 2. Bullet debt 3. Capitalising debt 4. Revolving debt facility 5. Minimum cash requirements 6. Debt fees b. Accounting inputs and goodwill i. Consideration and existing equity ii. Increase in valuation of assets and liabilities iii. Calculation of deferred taxes iv. Goodwill computation 7. Adjustments to existing model a. Timing and beginning with transaction period b. Calculation of exit proceeds and exit EV/EBITDA multiple c. Adjustments to depreciation module for intangible assets 8. Cash flow Waterfall and Debt Module a. Structure on model and connections between debt schedule and cash flow statement b. Complexities in computing A,B and C debt with use of switches and MIN function c. Structuring of cash flow statement with numerous sub-total accounts 12
d. Key programming concept in LBO model combined use of MIN and MAX functions e. Computation of draws and repayments from revolving credit facility with MIN and MAX functions f. Computation of debt defaults with MIN and MAX functions 9. Risk Analysis with LBO Model a. Computation of IRR on equity, senior and subordinated debt b. Sensitivity analysis with different rates of return c. Calculation of Break-even with DATA TABLE, MATCH and INDEX M&A Case Study Valuation of M&A transactions involves valuing synergies and considering accounting and tax analysis. 1. Overview of M&A Terms and Alternative Techniques for Measuring Costs and Benefits 2. M&A Transaction and Accounting Modelling 3. M&A Consolidation and Earnings Accretion/Dilution 4. Structure of Integrated M&A Model 5. Work with Completed Model 6. Exercise to Construct Integrated Model Resources Received by Participants Other than the instruction in how to build, use and analyze financial models, participants in the course will receive a comprehensive suite of financial modeling software on a compact disk that includes a number of template models and excel add-ins. The software consists of corporate models that accept historic financial data and generate alternative valuation measures; M&A models that consolidate two companies using alternative financing assumptions and produce accretion and dilution estimates; project finance models that measure the effect of alternative elements in a cash flow waterfall including debt service reserves, junior debt, covenants, defaults and pre-payments; LBO models that measure the debt capacity of a transaction; option pricing models that account for alternative structures; and debt valuation spreadsheets, Monte Carlo simulation models, tornado diagram and sensitivity analysis. Optional Added Sessions on Financial Modelling in Excel Corporate Valuation Modelling uses case studies, hands-on analysis and template models as the primary teaching tools. However, in teaching this course in the past, we have found that some participants are interested in practical mechanics of excel (macros, offset and indirect functions 13
etc.). Added optional sessions will be held after 5:00 PM to provide instruction on many practical excel topics. 14