Investment Banking Department
Analysis Handbook
Table of Contents
Introduction 11
Comparable Companies Analysis 15
1. Overview 15
1.1. Definition of Compco Analysis 15
1.2. Where Does Compco Analysis Fit into Overall Valuation Analysis? 15
1.3. Key Concepts for Compco Analysis 17
1.3.1. Consistency 17
1.3.2. Full Range of Multiples 17
1.3.3. Forward Looking Nature of Compco 18
1.3.4. Uniformity 19
1.3.5. Correlation 19
1.3.6. Relevance of Multiple 20
1.4. Selection of Comparable Companies 20
1.5. Specific Sector Multiples 20
1.6. Frequency of Updates 22
1.7. Formatting 23
1.7.1. Overall Formatting of Output 23
1.7.2. Pages and Tables 23
1.7.3. Names 23
1.7.4. Notes and Sources 23
2. How to Complete a Compco Analysis 25
2.1. Sourcing Data – Market Cap 25
2.1.1. Share Price 25
2.1.2. Number of Shares 25
2.1.3. Foreign Exchange Translation (P&L versus Balance Sheet Translation) 26 2.2. Sourcing Data - Financial Statements and Financial Projections 26
2.2.1. P&L and Cash Flow Statement 26
2.2.2. Consensus Forecasts 27
2.2.3. Balance Sheet 27
2.2.4. Accounting Standards and Related Issues 27
2.2.5. Calendarisation of Statements 29
2.2.6. LTM Financials 29
2.2.7. Adjustments to Financial Projections 30
2.2.8. Credit Ratings Reports 37
2.3. Mechanics of Compco Analysis 37
2.3.1. Market Cap and Fully Diluted Equity Value 37
2.3.2. Calculation of Enterprise Value 39
2.3.3. Special Dividends 40
2.3.4. Other Adjustments 42
2.4. Core Multiples – Approach to Calculating Multiples of Core Business 43
3. Common Pitfalls 44
4. How to Interpret Comparable Analysis Results 45
5. Case Studies 45
5.1. Basic Comparable Calculation – BSkyB 45
5.1.1. Valuation and Leverage Multiples 48
5.1.2. Business Statistics 48
5.2. Advanced Comparable Calculation – Vodafone 49
5.2.1. Calculation of Vodafone Core Mobile Multiples 50
Comparable Acquisitions Analysis 55
1. Overview 55
1.1. What is a Compacq and What is it Used For? 55
1.1.1. Applications 55
1.1.2. Advantages 55
1.1.3. Disadvantages 55
1.1.4. Overall Comments 55
1.2. Identification of Relevant Precedent Transactions 56
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1.3.1. Sources of Deal Specific Information 57
1.3.2. US Filing Codes 57
1.4. Sample Output Sheet 58
1.4.1. Example: Logistics Sector 58
2. How to Complete a Compacq Analysis 59
2.1. Filling in the Qualitative Columns 59
2.2. Target Financial Performance 59
2.2.1. Selecting which Target Financial Statements to Use 59
2.2.2. Calculating LTM Income Statement 59
2.2.3. Extraordinary / Non-recurring Items 59
2.2.4. Acquisitions / Divestitures 60
2.2.5. Announced Synergies 60
2.2.6. Cyclicality 60
2.3. Consideration Paid and Assumed Liabilities 61
2.3.1. Transaction Structure 61
2.3.2. Consideration Levered or Unlevered? 61
2.3.3. Shares Outstanding 61
2.3.4. Preferred Stock and Convertible Debt 61
2.3.5. Options and Warrants 62
2.3.6. Assumption of Debt 63
2.3.7. Minority Interests 63
2.3.8. Investments in Associated Companies 63
2.3.9. Marketable Securities 64
2.3.10. Capital / Financial Leases 64
2.3.11. Operating Leases 64
2.3.12. Pension Liabilities 65
2.3.13. Financial Fixed Assets 65
2.3.14. Contingent Liabilities 66
2.4. Special Situations 66
2.4.1. Dividend Distributions to Selling Shareholders 66
2.4.2. Earn-Outs 66
2.4.3. Tax Basis Step-up 67
3. Compacq Analysis Output 67
3.1. Cross Checking the Results 67
3.2. Standard Output 67
3.3. Sector Specific Multiples 67
4. Common Pitfalls 68
5. Example 68
5.1. Step 1: Information Gathering 68
5.2. Step 2: Filling in the Qualitative Columns 68
5.3. Step 3: Prepare LTM Income Statement 69
5.4. Step 4: Calculate Consideration Paid and Assumed Liabilities 69
5.4.1. Calculation of Equity Consideration 70
5.4.2. Calculation of Enterprise Value 71
5.5. Step 5: Calculate Industry Specific Multiples 71
5.5.1. Calculate Adjusted Enterprise Value 71
5.5.2. Calculate EBITDAR 71
5.5.3. Resulting Multiples 72
Valuation Matrix 75
1. Overview 75
1.1. Objectives 75
1.2. What Is a Valuation Matrix? 75
1.3. What Is a Valuation Matrix Used For? 75
1.4. What Is Needed to Complete a Valuation Matrix? 75
1.5. What Does a Valuation Matrix Look Like? 75
2. How to Complete a Valuation Matrix 78
2.1. Getting Started 78
2.1.1. Select Appropriate Sources of Information 78
2.1.2. Setting Up a Valuation Matrix 78
2.2. Common Inputs and Outputs 78
2.2.1. Range of Offering Prices / Company Values 78
2.2.3. Multiples 78
2.3. General Valuation Matrix Steps 78
3. Common Pitfalls 80
4. Case Studies 82
4.1. Merger Application 82
4.2. IPO Application 85
Merger Consequences Analysis 93
1. Overview 93
1.1. What is the Analysis? 93
1.1.1. Description of the Analysis 93
1.1.2. Why is it Used? 93
1.2. What Information is Needed to Complete the Analysis? 93
1.2.1. Form of Consideration (Cash, Stock, Mix) 94
1.2.2. Stock Prices / Transaction Value 94
1.2.3. Buyer / Target’s P&L / Balance Sheet / Cash Flow Historical and
Projected Statements 95
1.2.4. Buyer’s and Target’s Fully Diluted Number of Shares 95
1.2.5. Post Transaction Capital Structure 95
1.3. What does a Merger Consequences Analysis Look Like? 95
2. How to Complete a Merger Consequences Analysis 96
2.1. Key Aspects of the Analysis 96
2.1.1. Merger vs. Stock vs. Asset Purchase 96
2.1.2. Considerations on Accounting Treatment – IFRS Regime – and Tax
Implications 97
2.1.3. EPS Accretion / Dilution 98
2.1.4. Adjustments in the Merger Plans 98
2.1.5. Advanced Themes 101
2.2. What are the Inputs / Where Do I Find the Information? 105
2.3. Mechanics of the Analysis 105
2.3.1. Steps of Merger Model Mechanics 105
3. Common Pitfalls 106
3.1. Calendarisation 106
3.2. Currency 106
3.3. Goodwill Impairment Treatment / Deductibility 106
3.4. Financing Costs and Expenses 106
3.5. Options and Other Dilutive Securities 107
3.6. Dividend Policy 107
3.7. Synergies 107
3.8. Lack of Footnotes 107
3.9. Sanity Check of the Outputs 107
4. Examples 107
4.1. 100% Cash Transaction 109
4.2. 100% Stock Transaction 110
4.3. 50% Stock / 50% Cash Transaction 111
4.4. Acquisition of Minority Stake in a Consolidated Company 112
5. Case Studies 114
5.1. Pro Forma EPS With Different Forms Of Consideration 114
5.1.1. Assumptions 114
5.1.2. Required Analysis 114
5.1.3. Transaction Prices 114
5.1.4. Scenarios 114
5.2. EPS and Balance Sheet Impact 115
5.2.1. Assumptions 115
5.2.2. Required Analysis 116
Contribution Analysis 121
1. Overview 121
1.1. Definition of Contribution Analysis 121
1.2. Why is it Used? 121
1.3. What Information is Needed to Complete a Contribution Analysis? 121
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2. How to Complete a Contribution Analysis 122
2.1. Key Aspects of the Analysis 122
2.2. What are the Inputs? 123
2.3. Mechanics of the Analysis 123
3. Common Pitfalls 124
4. Case Study 124
4.1. Case Study Inputs 125
4.2. Answer These Questions 125
Discounted Cash Flow Analysis 129
1. Overview 129
1.1. What Is The DCF Analysis? 129
1.2. Why Is It Used? 129
1.3. What Information is Needed to Complete the Analysis? 129
1.4. What Does a DCF Look Like? 129
2. How to Complete a DCF Analysis 131
2.1. Key Steps of a DCF Analysis 131
2.1.1. Forecasts 131
2.1.2. Terminal Value 134
2.1.3. Discounting / Present Value 135
2.1.4. Enterprise Value vs. Equity Value 135
2.1.5. DCF Matrix 136
2.1.6. Sensitivity Analyses 136
2.2. What Are the Inputs / Where Do I Find the Information? 137
2.3. What is the Output? 137
2.4. Mechanics of the Analysis – Best Practices 138
2.4.1. Time Effects in Discounting 138
2.4.2. Terminal Value 140
2.4.3. WACC 145
2.5. Selected Special Valuation Issues / Enterprise Value Adjustments 151
2.5.1. Non-Operating Assets / Cash Flows 151
2.5.2. Minority Interest 152
2.5.3. Preferred Equity 152
2.5.4. Under-Funded Pension And Other Post-Retirement Liabilities 152
2.5.5. Provisions 153
2.5.6. Employee Stock Options 154
2.5.7. Operating Leases 154
2.5.8. Deferred Taxes 155
2.5.9. Bank Valuation – Equity Cash Flow / Dividend Discount Model 155 2.5.10. Valuation Across Currency Borders – Special Considerations 156
2.6. How to Interpret the Results 157
3. Helpful Hints 157
3.1. Sense-Checking Results 157
3.2. Surviving the MDR/DIR/VP “Grilling” 158
4. Example 159
Leveraged Buy-Out Analysis 169
1. Overview 169
1.1. What is a Leveraged Buy-Out (“LBO”)? 169
1.2. What Is A Financial Sponsor? 169
1.3. Value Creation in LBOs 172
2. How to Complete a LBO Analysis 173
2.1. Main Characteristics of a Suitable LBO Target 173
2.2. Simplified Acquisition Structure Overview 174
2.3. Sources & Uses of Funds / Capital Structure 174
2.4. How To Assess Maximum Leverage 176
2.5. Exit Strategy 177
2.6. LBO Model Inputs & Outputs 177
3. How To Use and Interpret a LBO Analysis 178
3.1. Exit Multiples 178
3.3. Choice and Use Of Projections 178
3.4. Interpretation of IRRs 178
4. Common Pitfalls 179
5. Example 180
5.1. The Amadeus Global Travel Transaction Example 180
5.1.1. Company Presentation 180
5.1.2. Key Transaction Considerations 180
5.1.3. Financial Projections 183
5.1.4. Equity Returns 183
6. Case Study 184
Credit and Debt Capacity Analysis 187
1. Overview of Credit Analysis 187
1.1. Introduction to Credit Analysis 187
1.2. Key Tenets for Analysing Credits and Debt Capacity 187 1.3. Structuring Considerations, Security, Covenants and Tenor 188
1.3.1. Overview 188
1.3.2. Security and Ranking 188
1.3.3. Covenants 190
1.4. Key Products 191
1.4.1. Overview for Non-Investment Grade Debt 191
1.4.2. Overview of Investment Grade Debt 192
1.4.3. Other Products 193
1.5. Credit Related Analyses 193
1.5.1. Overview of Debt Comparable Company Analysis 193
1.5.2. Key Credit Ratios and Metrics 194
1.5.3. Sources and Uses 194
1.5.4. Capitalisation Table 195
1.6. Issues to Consider 196
1.6.1. Key Aspects of the Analysis 196
1.6.2. Sources of Information 196
1.7. Common Pitfalls 196
1.8. Credit Comparables and Term Sheet Examples 197
1.8.1. Credit Comparables Example 197
1.8.2. Summary Term Sheet Examples 198
2. Overview of Ratings Analysis 201
2.1. Overview 201
2.1.1. The Role of the Rating Agencies in the Financial Markets 201
2.1.2. The Rating Scale 201
2.1.3. Ratings Definitions 202
2.2. Rating Methodology 202
2.2.1. Fundamentals of Credit Analysis for Ratings 202
2.2.2. Financial Analysis: Key Credit Ratios 204
2.2.3. Interpretation of Key Ratios 206
2.2.4. Information Requirements for Ratings Analysis 206 2.2.5. Suggested Outline of a Ratings Presentation 207
2.3. Distinguishing Ratings of Issuers and Issues 207
2.3.1. Notching Guidelines for Debt Ratings 207
2.3.2. Bank Loan Rating Methodology 208
2.4. Equity Credit: What It is and How an Issuer Gains It 209
2.4.1. What is Equity Credit? 209
2.4.2. Equity-Like Features of Hybrid Securities 209
2.5. Common Pitfalls 209
2.5.1. Operating Lease Analytics 209
2.5.2. PIK Instruments 210
Introduction
The Investment Banking Department Analysis Handbook is a practical guide on valuation techniques for analysts and associates at Credit Suisse. It introduces approaches and Credit Suisse preferred
methodology for financial analysis. The handbook assumes little or no experience conducting the analyses covered and can be used as a step-by-step guide when preparing analyses for the first time. This is the first edition of the Investment Banking Department Analysis Handbook and feedback from the Firm’s analysts and associates is essential to make it a success and become an integral part of both the fulltime and summer analyst and associate programmes. Please provide feedback to the Analyst and Associate Programme Manager.
The Investment Banking Department Analysis Handbook could not have been completed without the hard work and commitment of the following Credit Suisse employees: Ronan Agnew, Giuseppe Baldelli, Gemma Barclay, Alastair Blackman, Jane Brean, Stephen Carter, Bruno Delmas El-Mabsout, Didier Denat, Gabor Illes, James Janoskey, Ishan Kaul, Daniel Lawrence, Pierrick Morier, Jeff Murphy, Edouard Muuls, Guy Noujaim, Antonio Occhionero, Gianluca Ricci, Anastasia Sakellariou, Martin Schmidt, Piotr Skoczylas, Nishan Srinivasan, Flavio Stellini, Cathy Topping, Marc-Oliver Thurner, Alexander Voronyuk, Matthew Wallace, Jens Welter and Klaus Wuelfing. Their dedication to the book and the training and development of analysts and associates has been invaluable.
Christopher Horne
Comparable Companies Analysis
1.
Overview
This chapter addresses the following:
„ What is the purpose of a Comparable Companies (“Compco”) analysis? What it is used for?
„ How should companies be selected for Compco analysis?
„ What are the common ratios used in Compco analysis? How are they calculated?
„ Which accounting and tax issues affect Compco analysis?
„ What are the current best practices for Compco analysis?
„ When should pro forma Compco analysis be prepared? How should the pro forma adjustments for various events be made?
„ What are the tricks for completing an error-free Compco analysis?
„ What are the common pitfalls of Compco analysis? How can they be avoided?
„ How should the results of Compco analysis be interpreted?
1.1.
Definition of Compco Analysis
Compco analysis involves comparing and/or applying multiples or yields of publicly traded companies. These multiples or yields are ratios of valuation metrics such as Enterprise Value or Market Capitalisation (“Market Cap”) and comparable profitability metrics such as EBITDA or Net Income, respectively. The main purposes of such comparisons are to perform relative valuations of public companies or to generate benchmarks for the valuation of private businesses.
Compco analysis is commonly used in the following situations:
„ To determine how a public company is valued compared with its public peers (i.e. if it is over- or under-valued by the market in comparison with similar, listed companies)
„ To value a private / limited liquidity company (where market valuations are often distorted) or an unlisted subsidiary of a company
„ As a potential sub-set of the above, to perform a sum-of-the-parts valuation of a company (i.e. where the business divisions that make up the company are diverse in business profile, and revenue model, and, therefore, require different types of comparison)
Compco analysis can also be used to assess how relatively cheap or expensive a particular sector is in comparison with others.
1.2.
Where Does Compco Analysis Fit into Overall Valuation Analysis?
It is not only vital to understand the Compco analysis itself but also how it fits into the overall valuation exercise. To avoid inappropriate conclusions, which could arise from simply using market data, it is important to apply other valuation techniques in conjunction with Compco analysis. When considering Compco analysis it is important to bear in mind the following:
Overall Market Context:
Compco analysis provides a market-based valuation. Therefore, to the extent that the market is over- or under-valuing an asset, the Compco analysis will reflect this and will mirror these market biases (e.g. take-over speculation).
For example, during the “tech boom” of 2000, the market often valued technology stocks at extremely high multiples (see the following chart) and often higher than their fundamental Discounted Cash Flow (“DCF”) valuation. Today, given the benefit of hindsight, “tech boom” multiples, though market determined, were irrationally high.
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Comparison of Forward Multiples Over Time
Historical Valuations – 1 Year Forward Enterprise Value / Revenue
3.6x 1.3x 3.4x 5.6x 9.5x 13.7x eBay Ya hoo! T e rra L ycos Ti scali Lycos Eu rope Lastmin u te.com March 2000 March 2002 As % of March 2000 multiple 32.7% 17.6% 3.1% 3.3% 3.1% 5.5% 65.4x 42.0x 104.3x 107.0x 54.1x 41.9x eBay Ya hoo! T e rra L ycos Ti scali Lycos Eu rope Lastmin u te.com US Europe 3.6x 1.3x 3.4x 5.6x 9.5x 13.7x eBay Ya hoo! T e rra L ycos Ti scali Lycos Eu rope Lastmin u te.com March 2000 March 2002 As % of March 2000 multiple 32.7% 17.6% 3.1% 3.3% 3.1% 5.5% 65.4x 42.0x 104.3x 107.0x 54.1x 41.9x eBay Ya hoo! T e rra L ycos Ti scali Lycos Eu rope Lastmin u te.com US Europe US Europe Source: Factset
Relative Valuations of Sectors:
As highlighted above, Compco analysis is often used to benchmark sectors against each other in order to analyse their relative valuations. However, comparability can be significantly impaired by structural differences between sectors in a range of areas including inter alia, risk and growth profile, cyclicality, seasonality, different accounting treatments, fiscal rules, technology life cycle and cash conversion. Later in this chapter, key adjustments, and their respective rationales, will be discussed and highlighted in detail.
Comparability of Comparables or Peers:
A Compco valuation is only as good as its set of comparable companies. To obtain an accurate valuation of a target company (the company for which the multiples are being calculated) it is critical to identify a set of listed peers that are truly comparable. Not only should the comparable companies typically be in the same sector, ideally they should also be comparable in terms of market position, size, growth rates and margins. Whilst perfect comparables never exist, benchmarking can identify the closest comparables that, with appropriate judgement, can be used in valuation analysis.
Availability of Information:
In many situations, insufficient information is available to generate the long-term forecasts required for a DCF valuation. The Compco analysis requires less forecast data.
Minority Valuation:
The Compco-based valuation provides a minority valuation of a company, since it is based on traded shares where control is not being transferred. This makes it particularly suitable for valuations in IPOs, secondary offerings, minority buy-outs and other transactions which do not involve transfer of control of the company. Both DCF and comparable acquisitions of majority stakes analysis include a control premium embedded in their valuation.
Key Pros and Cons of the Compco Valuation Methodology
Pros Cons
p Based on market benchmarks and, therefore, less dependent on subjective assumptions
q Affected by short-term market forces (e.g. bid speculation)
p Commonly used and easily understood by most investors and boards
q Difficulty in selecting best comparables
p Ideal for minority stake trading valuation (including IPO analysis)
q Availability of good quality short-term financial forecasts
p Can be used as a quick, “back of the envelope” valuation tool to support a detailed company specific approach (e.g. DCF)
q Inaccurate, unless adjustments are made (illustrated in this chapter)
q Unless placed in the context, does not always accurately account for the long-term business performance (i.e. growth beyond initial years)
1.3.
Key Concepts for Compco Analysis
1.3.1. Consistency
It is important to consider that some valuation measures apply only to equity holders (for example, Market Cap), while others apply to all stakeholders (debt holders, minorities and equity holders).
At different stages of the life cycle of a business (e.g. start-up, growth, maturity and decline) different metrics gain in relative importance when assessing value. For start-up businesses, with negative or very low EBITDA / earnings, the standard multiples are less relevant. On the other hand, for mature businesses with less growth, but greater EBITDA / earnings, and lower capital expenditure, cash flow multiples are more relevant.
„ Enterprise Value based multiples: metrics such as Revenue, EBITDA and EBITA apply to all investors
and, therefore, should be used with Enterprise Value
„ Market Value based multiples: metrics such as Profit before Tax, Profit after Tax and Net Income (post
minorities) are calculated once the cost of debt has been taken into account. Therefore, when used for the purpose of calculating multiples, they should be used with a valuation which only applies to equity holders, namely Market Cap
„ Yields: when appropriate financial metrics are divided by Market Cap, the ratios are known as yields
(i.e. a summary measure of cash flows that equity holders expect in any given year relative to current market equity value of the company). Unlike multiples, these are commonly presented as percentages. Examples of yields are Dividend Yield and Free Cash Flow (“FCF”) Yield. (See the Discounted Cash Flow Analysis chapter for a discussion on levered and unlevered FCF)
1.3.2. Full Range of Multiples
Where possible, it is important to analyse a number of different multiples, as a given company may look relatively cheap or expensive depending on which multiple is considered. For example, a company might look cheap based on a comparison of EBITDA multiples, but expensive based on a comparison of Price / Earnings (“P/E”) multiples, purely as a result of higher investment in fixed assets (and corresponding higher levels of depreciation), higher net interest and/or higher tax rate.
P/E multiples account for differences in capital structure, tax base and asset base. Other multiples focus more narrowly on operating items. The EBITDA multiple, for example, excludes all non-operating differences (e.g. depreciation).
Similarly, cash flow metrics such as EV / (EBITDA – Capital Expenditure (“Capex”)) or Market Cap / FCF, reveal how comparatively cheap or expensive a company is, in terms of its ability to generate cash-flow (important for companies that have heavy capital expenditure requirements, which are not adequately captured by Profit and Loss (“P&L”) metrics). In the following example, Mobinil appears cheap or in-line with peers on an EBITDA basis, but expensive on an (EBITDA – Capex) basis.
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VOD TEM MOBINIL COS Average
EV / EBITDA 2006 5.9x 7.6x 4.9x 8.9x 6.8x 2007 5.6x 6.8x 5.0x 8.3x 6.4x EV / (EBITDA – Capex) 2006 9.0x 11.3x 28.7x 20.5x 17.4x 2007 8.3x 9.4x 25.7x 14.4x 14.5x On a EV / (EBITDA – Capex) basis, it trades at
higher multiples Mobinil trades on lower EBITDA multiples than
the average
VOD TEM MOBINIL COS Average
EV / EBITDA 2006 5.9x 7.6x 4.9x 8.9x 6.8x 2007 5.6x 6.8x 5.0x 8.3x 6.4x EV / (EBITDA – Capex) 2006 9.0x 11.3x 28.7x 20.5x 17.4x 2007 8.3x 9.4x 25.7x 14.4x 14.5x On a EV / (EBITDA – Capex) basis, it trades at
higher multiples Mobinil trades on lower EBITDA multiples than
the average
1.3.3. Forward Looking Nature of Compco
Companies are valued by the market on the basis of expected future growth. For example, in order to value a company today, investors (as of the date of publication in August 2006) would look at EV / 2006 Expected EBITDA or EV / 2007 Expected EBITDA. While less important from a valuation point of view, Compcos are often analysed on a LTM basis – ratio of Market Cap or Enterprise Value to the previous 12 month’s operating metric (e.g. EV / LTM EBITDA).
Commonly Used Multiples and Key Pros / Cons
Multiple / Yield Pros Cons
EV / Revenue p Easily obtainable information
p Not subject to many accounting differences
p Not influenced by capital structure
q Does not account for profitability, cash flow generation, etc.
EV / EBITDA p Generally easily obtainable information
p Proxy for cash-flow generation
p Avoids distortion due to accounting rules relating to non-cash items such as D&A
p Relates value to profitability
q Fails to fully capture ability of business to generate cash, especially important in businesses with heavy fixed asset investments
q Does not capture tax differentials
EV / EBITA p Potentially a closer cash-flow proxy, as depreciation is a proxy for capex
q Capex and depreciation can differ materially
q Can be impacted by differing depreciation policies
q Does not capture tax differentials P / E p Effective for companies in the same
sector and same country
p Easily obtainable information
p Captures all operating variations between companies (including tax)
q Comparability might be limited due to different accounting rules, especially in cross-border situations
q Need to adjust for one time / non-recurring items, which can distort earnings
q Affected by capital structure EV / (EBITDA – Capex) p Relates value to ability to generate
cash
p Not affected by capital structure
q Comparability may be limited by the fixed asset roll-out strategy / cyclicality
q Ignores tax and working capital differentials
Dividend / Market Cap (commonly known as Dividend Yield)
p Relates value to cash distribution to shareholders
p Useful for analysing dividend policy (e.g. IPO situation)
q Entirely dependent on distribution policies and entirely ignores buy backs
q Less relevant for growth stocks FCF / Market Cap
(commonly know as Free Cash Flow Yield)
p Relates value to ulitimate cash generation ability
p Accounts for tax related and working capital charges in addition to Capex
q Impacted by one-off items
q Affected by capital structure
q Normally requires greater number of adjustments to be calculated
Exercise:
Consider the following multiples and determine if they are consistent and why. If they are not consistent, suggest correct alternatives. Solutions can be found in the separate Investment Banking Department
Analysis Handbook – Solution Set.
„ Dividend / Market Cap (Dividend Yield)
„ FCF / Enterprise Value
„ Market Cap / (EBITDA – Capex)
„ Market Cap / EBITDA
„ Enterprise Value / Dividend
1.3.4. Uniformity
It is important to apply a consistent multiple definition across the set of peers to ensure proper comparability. For example, if pension liabilities were included in the Enterprise Value for only some of the comparables, it would be impossible to accurately compare and derive valuation benchmarks from them. In this case, comparables excluding pension liabilities should be adjusted accordingly.
Similarly, it is important to use the same definition of the P&L item (e.g. EBITDA). For example, TV broadcasting companies have different accounting approaches to the treatment of the costs / expenses of Programming Rights. The same is true of the way some consumer companies treat brand and marketing expenditure (e.g. beer mats and umbrellas for beer companies). Some companies treat these expenditures as an operating cost, whilst others capitalise the rights as part of their assets (intangibles) and amortise them over time. In the latter case, EBITDA would be artificially high when compared to the former. On a multiple comparison basis, all other things being equal, the latter case would make the company look cheaper than the former. To make the approach truly uniform, for example, programming rights amortisation / brand expenditure should be added back to operating costs (as a proxy for the operating costs) for all peers (and reduce EBITDA).
1.3.5. Correlation
Relative valuation is theoretically correlated to the growth prospects of a company. Therefore, all other things being equal, if the target company has growth comparable to the high end of the comparables set, it should logically enjoy a valuation towards the high end of the comparables set.
A regression analysis of the 2 year forecast EBITDA Compound Annual Growth Rate (“CAGR”) versus valuation multiple would typically show a strong correlation (high R2). This is because, investors are usually willing to pay more for companies with higher growth prospects. However, it is important to bear in mind that growth will not always be the most important driver.
The other critical factor to consider for an investor is the risk attached to actually achieving the expected / forecast growth. Therefore, conceptually, multiples can be considered as 1/(i – g), where i = risk of the stock and g = expected future growth. Other things remaining constant (including relative growth forecasts between the companies), the multiple for a higher risk stock will be lower and for a lower risk stock the multiple will be higher. Inherent risk is, therefore, one of the critical reasons why stocks with similar growth profiles trade differently.
Other factors that could affect valuation are as follows:
„ Low liquidity of stock (without a free and regular trade of a stock, valuations can become distorted)
„ Operating factors, such as number, and strength, of competitors and barriers to entry
„ Rights attached to shares (all other things being equal, a class of share with greater voting rights attached to it should trade at a premium to a class of share with less voting rights)
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Regression Analysis: EV / Sales ‘06E vs. Sales CAGR (‘06E - ’08E)
R2 = 98.3% 0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 3.0x 3.5x 4.0x 0% 2% 4% 6% 8% 10% 12%
Sales Growth ('06E-'08E)
EV / Sales ('06E)
Note: Dummy numbers
1.3.6. Relevance of Multiple
Aside from assuming basic uniformity and consistency in the application of numbers, it is important to ensure that any multiple being used as a valuation benchmark is relevant to the target company – judgement and common sense is required for this. For example, companies that have only recently been established may have negative or slightly positive EBITDA, which would be likely to make this metric meaningless from a Compco perspective.
1.4.
Selection of Comparable Companies
The following sources are available to assist in the selection of the comparable companies set:
„ Equity research reports usually contain a Compco analysis showing the comparables used by the analyst. Equity research can be obtained from:
§ Research & Analytics (http://research-and-analytics.csfb.com)
§ Thomson Financial
§ Multex
„ Bloomberg lists the key competitors in each sector which could form a basis for a set of comparables
„ Colleagues – those that have been involved in precedent work in the sector and especially those that have sector experience
„ Annual reports – companies often benchmark relative share price performance
1.5.
Specific Sector Multiples
Compco analysis should be conditioned to the particular sector. As mentioned previously, due to the various operating and financing structures observed in different sectors, the same operating parameters cannot necessarily be applied across all companies / sectors for a multiples based valuation.
For example, in businesses where capital expenditure is lumpy (such as for lottery companies which typically sign long-term contracts with governments to provide services – capital expenditure occurs when these long-term contracts begin) it may be preferable to use EBITA, as depreciation smoothes out the Capex spend over the period of the contract, whereas with a cash-conversion multiple such as EBITDA – Capex, may be affected by the lumpy nature of Capex spend (absent any normalisation adjustment). The following table illustrates selected industry specific multiples. Consult industry bankers for the appropriate metrics when preparing Compco analysis.
Selected Industry-Specific Multiples
Multiple Sector Comments
EV / Revenue Various „ Early stage companies
EV / Subscriber Various „ Subscriber based businesses, such as Cable and Direct To Home (DTH)
EV / EBITDA Various „ Many Industrial and Consumer industries, but not Banks, Insurance, Oil & Gas and Real Estate
EV / EBITA Various „ Commonly used in several Media industry sub-sectors, Gaming, Chemicals and Bus & Rail industries
„ Used when EBITDA multiples are less relevant due to significant differences in asset financing (e.g. mix of leases, rentals, ownership)
EV / EBITDAX Oil & Gas „ Excludes exploration expenses
EV / EBITDAR Retail, Airlines „ Used when there are significant rental and lease expenses incurred by business operations
EV / Reserves Oil & Gas „ Used when looking at Oil & Gas fields and companies heavily involved in upstream
„ Gives an indication of how much the field is worth on a per barrel basis
EV / Production Oil & Gas
Ports
Airports
„ For producing fields, gives value on a barrel per day production basis
„ For container ports, gives value per tonne of cargo handled
„ For airports, gives value per passenger through airports EV / Capacity Oil & Gas „ For refiners, gives a value metric in terms of barrel per
day of refining capacity Market Cap / Book
Value (“P/BV”)
Technology / Banks / Insurance
„ Used for Semiconductor industry
„ Book value of equity is used since there can be significant earnings fluctuation in this sector
„ Bank’s shareholders equity is important because it is looked at as a buffer / protection for depositors EV / FFO(1) Real Estate „ Principally used in the US
P/E Various „ Often using normalised cash earnings, excluding both exceptional items and goodwill amortisation
PEG ratio(2) High Tech, High Growth
„ Big differences in growth across companies (EV/EBITDA)/EBITDA
CAGR(3)
High Growth „ Used in Specialty Retail industry and when valuing emerging markets IPO candidates
„ Big differences in growth across companies
(1) Where FFO represents Funds From Operations
(2) Where the PEG Ratio represents (P/E) / Earnings Growth Rate (3) Where CAGR represents Compound Annual Growth Rate
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1.6.
Frequency of Updates
The table below provides a guide as to when the various components of the data in a Compco should be updated.
Compco Item Source(s) Frequency
Share Price Factset, Bloomberg Daily
# of Shares Outstanding Company accounts / website, RNS announcements (UK companies only), Bloomberg, Equity Research
Quarterly or as appropriate
Options Outstanding Company accounts obtainable from website or Thomson Financial
Annual
Balance Sheet Data Company accounts obtainable from website or Thomson Financial
Quarterly
Book Value of Minorities Balance Sheet Quarterly Market Value of
Minorities
Factset or Bloomberg if publicly traded, brokers’ Sum-of-the-Parts if unlisted
Fortnightly or as appropriate
Income Statement Data (Actual)
Company accounts obtainable from website or Thomson Financial
Quarterly
Income Statement Data (Forecasts)
Forecasts obtainable from equity research reports (accessible from Thomson Financial or Multex)
Fortnightly
Cash Flow Statement Data (Actual)
Company accounts obtainable from website or Thomson Financial
Quarterly
Cash Flow Statement Data (Forecasts)
Forecasts obtainable from equity research reports (accessible from Thomson Financial or Multex)
Fortnightly
Debt Rating SDC, S&P or Moody’s Reports, Bloomberg
Quarterly
M&A Company Press Releases,
Mergermarket, Equity Research, SDC
As appropriate
1.7.
Formatting
1.7.1. Overall Formatting of Output
As the Compco output will be used by others, it is important that the output sheet contains all information and is formatted in a user-friendly way.
1.7.2. Pages and Tables
Both output and input pages of the Compco file should be formatted to print. Typically, pages should be set up using font size no smaller than 8.
In terms of tables, one year of historical multiples (representing LTM period) and at least two years of forward multiples should be shown. Also included on the output sheet should be the following:
„ Relevant growth rates and CAGRs (for forecast years)
„ Margins
„ Share price
„ Share price as % of 52 week high
„ Market Cap
„ Net Debt and other adjustments1
„ Enterprise Value
1.7.3. Names
The Compco analysis should always be neatly labelled, including the following:
„ Name of sector / sub-sector
„ Names of the companies
§ The comparables should be segregated according to any sub-categories (e.g. small cap vs. large cap or emerging market vs. mature markets) or alphabetically, depending on the circumstance and personal preference
1.7.4. Notes and Sources
The output page should always include the sources used in completing the Compco analysis. The broker and the date of the report used should always be noted.
Whenever any adjustment is made, it is essential that this be noted on the output page. Again, include the source used for making the adjustment and the reason for the adjustment.
Illustrative Compco Output
Comparable Company Multiples – Mature Incumbents Industry
(€ in millions, except per share amounts – calendarised for 31 Dec YE)
Belgacom BT Group Deutsche Telekom Eircom France Telecom KPN OTE Portugal Telecom Swisscom Telecom Italia Telefonica Telekom
Austria Telenor TeliaSonera Median Country Belgium UK Germany Ireland France Netherlands Greece Portugal Switzerland Italy Spain Austria Norway Sweden
Stock Price (Local currency) 26.00 2.15 13.82 2.14 18.63 9.33 19.16 9.91 410.00 2.28 12.85 19.75 80.25 46.20
Local currency EUR GBP EUR EUR EUR EUR EUR EUR CHF EUR EUR EUR NOK SEK
Stock price to 52 week high (15.8%) (9.2%) (16.2%) (12.7%) (27.9%) (5.8%) (0.8%) (5.1%) (5.5%) (18.2%) (9.3%) (4.7%) (2.1%) (9.0%) (9.2%)
Stock price to 52 week low 4.0% 9.5% 8.0% 43.4% 5.9% 47.6% 39.4% 35.2% 5.7% 2.7% 5.7% 34.7% 64.1% 30.1% 9.5%
Market Value - Actual(1) 8,957 26,470 57,991 2,300 49,118 19,592 9,415 11,187 14,906 42,374 61,713 9,505 17,475 21,369
+ Financial Debt(1) - 16,001 44,647 2,588 53,225 9,981 3,440 7,584 1,476 39,351 55,332 3,344 3,995 2,375
- Cash and Cash equivalents(1) (534) (4,161) (6,008) (495) (5,211) (1,041) (1,512) (3,912) (656) - - (139) - (2,002)
Enterprise Value - Actual(1) 8,423 38,310 96,630 4,393 97,132 28,532 11,343 14,859 15,726 81,725 117,045 12,709 21,469 21,742
Enterprise Value - Actual(1) 8,423 38,310 96,630 4,393 97,132 28,532 11,343 14,859 15,726 81,725 117,045 12,709 21,469 21,742
+ Unfunded Pension Liability 508 844 3,774 578 2,519 1,034 694 1,912 840 - - 95 225 171
+ MV of Minorities 1,664 - 4,795 - 11,543 257 3,556 2,141 1,888 381 8,015 21 2,873 3,561
- MV of Uncons.Associates - (393) (1,300) - (876) - (368) (1,022) - (3,266) (2,264) (5) (3,338) (6,006)
Adjusted Enterprise Value 10,595 38,761 103,899 4,972 110,318 29,823 15,224 17,889 18,454 78,840 122,796 12,820 21,229 19,468 Adjusted Enterprise Value / EBITDA
2006 5.0x 4.8x 5.1x 7.9x 5.8x 6.4x 7.1x 7.6x 7.1x 5.9x 6.2x 6.5x 5.6x 5.5x 5.9x
2007 5.2x 5.0x 5.0x 7.3x 5.7x 6.4x 6.4x 7.3x 7.2x 5.7x 6.0x 6.5x 5.3x 5.3x 5.7x
2008 5.3x 5.3x 4.9x 7.2x 5.6x 6.5x 6.0x 7.1x 7.3x 5.6x 5.8x 6.4x 5.2x 5.4x 5.6x
Adjusted Enterprise Value / (EBITDA - Capex)
2006 6.9x 10.5x 9.4x 13.6x 9.1x 10.3x 16.5x 12.2x 10.3x 9.1x 9.9x 9.6x 17.3x 9.1x 9.9x 2007 7.0x 11.7x 8.9x 12.1x 9.1x 10.3x 11.5x 10.7x 10.6x 8.3x 9.2x 9.3x 12.6x 8.3x 9.3x 2007 7.1x 11.9x 8.6x 11.7x 8.8x 10.2x 9.9x 10.3x 10.9x 8.0x 8.7x 9.1x 11.3x 8.3x 9.1x Price / Earnings 2006 10.8x 10.9x 13.2x 17.0x 10.4x 15.5x 24.3x 21.0x 13.2x 14.1x 11.7x 18.4x 16.0x 11.9x 13.2x 2007 11.5x 11.9x 13.7x 11.7x 9.7x 14.9x 15.1x 16.7x 13.6x 12.7x 11.4x 15.5x 14.8x 11.6x 12.7x 2008 11.7x 12.9x 14.0x 10.5x 9.0x 14.9x 12.6x 15.1x 13.9x 11.6x 10.3x 13.6x 15.0x 11.9x 12.6x Equity FCF Yield 2006 10.7% 7.5% 10.8% 9.2% 13.9% 11.1% 5.4% 6.2% 7.2% 10.7% 11.9% 10.7% 1.7% 7.7% 10.7% 2007 10.6% 6.3% 11.2% 11.4% 13.9% 10.6% 10.2% 8.2% 7.3% 12.3% 12.9% 11.2% 2.9% 8.7% 10.6% 2008 10.7% 5.9% 11.6% 12.2% 14.4% 10.5% 12.3% 8.7% 6.9% 12.5% 14.1% 11.6% 4.0% 9.0% 11.6% Methodology
(1) Actual Market Value, Financial Debt, Cash and Cash equivalents and Enterprise Value are based on information from latest available financial statements adjusted for any further transactions taken into account in the forecasts. Market Value reflects fully diluted shares outstanding on a treasury method basis. Financial Net Debt reflects consolidated group net debt and is calculated as short- and long-term interest bearing liabilities less cash and equivalents. Convertible securities are included in Debt until actually converted (i.e. excluded for calculation of fully diluted shares outstanding).
2.
How to Complete a Compco Analysis
2.1.
Sourcing Data – Market Cap
2.1.1. Share Price
„ The share price is obtained from Factset. CS excel is linked to Factset directly and will download share price information automatically, provided the correct share ticker is linked
„ Other sources for share price information, which could be used as crosschecks, are Bloomberg or Datastream, with the Financial Times also a potential source
„ Certain companies have multiple classes of shares. To determine the Market Cap of these companies, the share price for shares in each class must be determined. Company Annual Reports disclose (usually in a note to the financial statement called Share Capital) the various share classes
„ Share prices used should all be from the same date
Example: Telecom Italia – Ordinary Shares and Savings Shares (€ in millions, unless specified)
Telecom Italia
Stock price for ordinary shares €2.22
Fully diluted ordinary shares outstanding (m) 13,618
Savings shares current stock price €1.98
Fully diluted savings shares outstanding 5,902
Market Cap 41,935
„ Certain companies have unlisted shares. While these shares might not be priced on a public market, they do form part of the total equity of the firm and should be included in the Market Cap. The share price of listed shares can serve as a proxy for the share price of unlisted shares. However, it is important to keep in mind that, in reality, there are usually differences in the voting rights assigned and dividend payout policies to various classes of shareholder, which might lead shares of different classes to trade differently
2.1.2. Number of Shares
Shares outstanding is available from the latest financial statements of a company. The starting point for research should always be the company’s own official data, but if this information is not available in the interim statement and if the Annual Report is out of date, then press releases, equity research reports or Bloomberg can be used. For UK companies, RNS announcements are also a useful source of information.
Shares outstanding can be shown in the following two ways:
„ Basic: options, warrants and convertibles are not included; or
„ Fully Diluted: assumes all exercisable in-the-money options, warrants and convertibles are exercised
§ Outstanding versus Exercisable Options: It should be noted that not all outstanding options are exercisable. It is common for companies to issue options with a vesting period (a minimum period of time during which they remain un-exercisable). Therefore, even if these options are technically in-the-money they can not be exercised if the vesting period has not expired. Since these options can not be exercised (even when technically in-the-money) they should not form part of the share capital of the company. Therefore, when calculating shares outstanding, only the exercisable options should be used in the fully diluted calculation.
For valuation purposes, the fully diluted number of shares outstanding is almost always used. Shares resulting from exercisable options or convertibles that are in-the-money should be added to shares outstanding. Options are in-the-money if the strike price of these instruments is less than the current market price. This means that a holder of these securities would rationally exercise the option to realise a gain by selling in the market, as underlying shares are available at less than market price. Usually the notes to the financial statements in the Annual Report will illustrate the various tranches of options and
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warrants, describing average strike price per tranche. Equivalent information will also be disclosed for convertible instruments.
Weighted average shares outstanding is a measure of the average shares that were outstanding during a particular year. As with shares outstanding this can be basic weighted average shares or fully diluted weighted average shares (the latter assumes that all in-the-money options were exercised).
During the course of the financial year, the company will typically have exercised options and/or convertible instruments, undertaken share buy-backs, rights issues, etc. It will rarely be the case that the number of shares outstanding will be the same for a company over the course of the year.
Valuation occurs at a point in time rather than over a period of time (e.g. Market Cap refers to a point in time not a period). Therefore, shares outstanding and not weighted average shares should always be used for valuation purposes.
Please note that it is convention to use price at close of the trading day to avoid any intra-day price fluctuations.
2.1.3. Foreign Exchange Translation (P&L versus Balance Sheet Translation)
The CS Compco shell will automatically convert the financial statements of the various comparables to Euros (or any other currency needed), as long the correct exchange rate ticker is included. The CS template automatically downloads this information from Factset.
P&L items (recorded over the financial year) should be translated at the average exchange rate for the financial year. Balance Sheet items should be translated at the exchange rate at the point that the Balance Sheet was recorded.
2.2.
Sourcing Data - Financial Statements and Financial Projections
2.2.1. P&L and Cash Flow Statement
Historical information should be obtained from the company’s previous year-end Financial Statements. Financial Statements can be obtained from the company’s website or the Thomson Financial database. Forecasts are obtained from broker reports. It is advisable to use CS research, if CS covers that particular company. If CS research does not cover the company, another major broker can be used unless a smaller broker has particular insight into the company (e.g. if the smaller broker is also the company’s corporate broker for UK companies). Ideally, if not CS research, it is preferable to use a common broker for as many of the comparables as possible.
In any event it is essential to benchmark the selected broker forecast (including CS) against consensus forecasts, such as I/B/E/S. For the purpose of the Compco analysis it is crucial that the forecasts used are representative of the market view. Therefore, even when a particular broker has detailed financial forecasts, these should not be used for the analysis if they are outliers compared with consensus forecasts.
To obtain a CS research model the procedure is as follows: For European Companies
The front page of each CS research report carries the name of the analyst covering that particular stock.
„ The current process is set out below but please always check for changes in policy which may be put in place from time to time
§ Permission (via e-mail) must be requested from Richard Kersley, David Mathers or Debra Batey, before contacting the research analyst to obtain models
§ Once permission has been granted, the same e-mail (i.e. with the permission) should be forwarded to the research analyst requesting the model
For US Companies
„ US Equity research models may be downloaded via the Model Repository in Spider (http://spider.app.csfb.net/nirvana.asp?Direct=Y)
„ At times, European research analysts cover US listed companies (companies that operate in Europe but are listed in the US) and these may not be available on Spider
„ For US listed models, analysts must be contacted via a LCD chaperone and not directly
„ Paul Barry, Anna Marie Mottram or Katrina Glover from LCD should be requested to act as chaperones in the same email sent to Richard Kersley, David Mathers or Debra Batey requesting permission to obtain US models
2.2.2. Consensus Forecasts
Rather than using an individual broker, for more detailed analysis it would normally be preferable to use consensus estimates. Factset can download consensus estimates from I/B/E/S directly onto the CS excel sheet. In addition to I/B/E/S, Multex also provide consensus forecasts for headline metrics. Note that consensus metrics from these sources include estimates of all brokers and, therefore, are affected by outliers.
Build up consensus forecasts by using all available research notes and creating averages for each financial item (e.g. Revenues and EBITDA). Judgement should be exercised when creating a consensus from scratch to avoid distortions, which can arise from including outliers (e.g. bullish or bearish estimates). Judgement also needs to be exercised when compiling consensus numbers for outer years as, typically, there will be fewer brokers forecasting outer years – thus changing the basis of the consensus.
Individual Analyst Forecast Consensus Estimates Pros p If using the same analyst for all
companies, ensures consistency of underlying assumptions(1)
p Ensures transparency with respect to definition of key line items (e.g. EPS)
p Ability to select reputable brokers
p Broadest possible view, not affected by view of just one analyst
p Easily explained / justified
Cons q Selection may be an outlier q Includes effect of outliers unless manually computed(2)
(1) For example, in the case of upstream oil and gas companies, the commodity price assumption (2) This is particularly true of mean consensus. Consider using median instead
2.2.3. Balance Sheet
Balance Sheet information should always be obtained from the latest financial statements issued by the company. Presentations to analysts and the press release that accompany interim statements may also provide supplementary information.
Some companies may not disclose sufficient information to calculate Net Debt, neither in their interims nor disclosed separately. In this case, the numbers used by brokers should be applied and noted accordingly.
2.2.4. Accounting Standards and Related Issues
Companies’ financials are not always comparable due to differing accounting rules under the different Generally Accepted Accounting Principles (“GAAP”). The following table highlights the main differences between IFRS and US GAAP.
Some companies / brokers might show both local GAAP and IFRS restatement. In this case, it is preferable to use IFRS to facilitate comparability.
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Key Differences Between IFRS and US GAAP
Subject IFRS US GAAP
Extraordinary items The use of the term extraordinary items is prohibited. IFRS otherwise allows flexibility in the presentation of line items - certain items may be separately identified
Defined as being both infrequent and unusual. Negative goodwill is presented as an extraordinary item
Cash flow statements – definition of cash and cash equivalents
Cash includes cash equivalents with short-term maturities (typically less than three months) and subject to insignificant risk of changes in value. May include cash overdrafts
Similar to IFRS, except that bank overdrafts are excluded
Revenue recognition Based on several criteria, which require the recognition of revenue when risks and rewards have been transferred, revenue can be measured reliably, the selling entity no longer has control over the goods sold and it is probable that economic benefits from the transaction will flow to the selling entity. When delivering a service, which is not completed at the balance sheet date, the entity also needs to be able to measure the stage of completion of the transaction at the balance sheet date
Similar to IFRS in principle, based on four key criteria. Extensive detailed guidance exists for specific types of transactions
Employee benefits: pension costs – defined benefit plans
Projected unit credit method is used to determine benefit obligation and record plan assets at fair value. If the entity takes the corridor
approach, actuarial gains and losses (which are less than 10% of the pensions’ assets or liabilities) can be deferred. Many UK companies take the option to recognize all actuarial gains and losses through equity as they arise. Plan assets value is market / fair value
Similar to IFRS but with several areas of differences in the detailed application
Acquired intangible assets Capitalised if recognition criteria are met; amortised over useful life. The criteria for recognition are that it is probable that the expected future economic benefits of the asset will flow to the entity, and that the cost can be measured reliably. Intangibles assigned an indefinite useful life are not amortised, but reviewed at least annually for impairment. Revaluations are permitted in rare circumstances
Similar to IFRS, except revaluations are not permitted at all
Internally generated intangible assets
Research costs are expensed as incurred. Development cost is capitalised and amortised only when specific criteria are met
Research and development costs are expensed as incurred. Some software and website development costs are capitalised
Convertible debt Convertible debt (fixed number of shares for a fixed amount of cash) accounted for on a split basis, with proceeds allocated between equity and debt. The fair value of the liability component is calculated first and the equity component is a residual
Conventional convertible debt is usually recognised entirely as a liability, unless there is a beneficial conversion feature
2.2.5. Calendarisation of Statements
Different companies have different financial year-ends. For example, many UK companies have a March year-end.
For Compco analysis, the financials of all companies should be calendarised to a common year-end (typically December). In most situations, calendarisation is usually aligned with the year-end of the target company. It is important to note that forecast estimates may also require calendarisation. Remember to check the basis on which they are presented when completing the Compco analysis.
In the example below, the company has a March year-end. To obtain December year end financials for 2006, 3 months from the financial year 2006 financials (or ¼) and 9 months from the financial year 2007 financials / forecasts (or ¾) are taken. As a formula, this would be:
EBITDADec’06 = ¼ * EBITDAMar’06 + ¾* EBITDAMar’07
Calendarisation to December YE of a Company with YE March
Mar 2005 Dec 2005 Mar 2006 Dec 2006 Mar 2007
1/4 of FY 2006 3/4 of FY 2007
FY 2007 for a March YE company FY 2006 for a March YE company
FY 2006 for a December YE company
Mar 2005 Dec 2005 Mar 2006 Dec 2006 Mar 2007
1/4 of FY 2006 3/4 of FY 2007
FY 2007 for a March YE company FY 2006 for a March YE company
FY 2006 for a December YE company
2.2.6. LTM Financials
In certain cases (e.g. where forecast financials are unavailable for a publicly traded company) it is useful to consider the actual performance of the company over the last 12 months. To obtain LTM financials for a company that has released its 9-month results, the computation would be as follows:
EBITDALTM 2
= EBITDA9m’05 + (EBITDA2004 – EBITDA9m’04)
Similarly, to obtain LTM financials for a company that has released its 6-month results, the computation would be as follows:
EBITDALTM3 = EBITDA6m’05 + (EBITDA2004 – EBITDA6m’04)
2
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2.2.7. Adjustments to Financial Projections
Normalisation
Since the objective of the Compco analysis is to arrive at the underlying value of a company, any effects that are temporary or one-off in nature should be stripped out, in order to prevent the generation of an inaccurate multiple. This is known as normalising financials.
Typical normalisation items include:
„ Restructuring charges
„ Tax holidays
„ M&A related annualisation
„ Write-offs
„ Redundancy payments
„ Exceptional income / expenses, for example:
§ Impairment of goodwill
§ Gains or losses from asset sales
§ Pension gains
§ Unrealised gains or losses from hedging activities
§ Litigation or insurance settlements
„ Discontinued operations
Example: Non-recurring Income / Charges (Exceptionals)
The example below demonstrates a step-by-step approach to eliminating exceptional items from the Compco analysis to derive a normalised Compco:
Step 1 – Identify the Exceptional Items
(€ in millions, unless otherwise specified)
Note 2006 2007 2008
EBITDA (11) 3,000 2,150 3,308
D&A (200) (210) (221)
EBIT 2,800 1,940 3,087
Net Interest expense (75) (79) (83)
PBT 2,825 1,861 3,004
Tax expense (1,090) (745) (1,202)
Tax rate 40.0% 40.0% 40.0%
Net income 1,635 1,117 1,803
Check notes for any exceptional items
Note 2006 2007 2008
EBITDA (11) 3,000 2,150 3,308
D&A (200) (210) (221)
EBIT 2,800 1,940 3,087
Net Interest expense (75) (79) (83)
PBT 2,825 1,861 3,004
Tax expense (1,090) (745) (1,202)
Tax rate 40.0% 40.0% 40.0%
Net income 1,635 1,117 1,803
Check notes for any exceptional items
Step 2 – Determine if the Exceptional Item Needs to be Tax Adjusted
Note (11) 2006 2007 2008
Exceptional item included in EBITDA 0 (1,000) 0
Exceptional cost included in EBITDA
Note (11) 2006 2007 2008
Exceptional item included in EBITDA 0 (1,000) 0
Exceptional cost included in EBITDA
Step 3 – Tax Affecting the Exceptional Item, if Required
2006 2007 2008
Exceptional 0 (1,000) 0
Tax rate 40.0%
Tax shield (400)
Tax adjusted exceptional item (600)
Pre-tax exceptional item will need to be tax
affected before adjustment is made to net
income
Value of tax shield that will be lost
Net adjustment at Net Income level
2006 2007 2008
Exceptional 0 (1,000) 0
Tax rate 40.0%
Tax shield (400)
Tax adjusted exceptional item (600)
Pre-tax exceptional item will need to be tax
affected before adjustment is made to net
income
Value of tax shield that will be lost
Net adjustment at Net Income level
Step 4 – Adjust for Tax Affected Exceptional
2006 2007 2008
EBITDA 3,000 2,150 3,308
Adj. EBITDA 3,000 3,150 3,308
Reported Net Income 1,635 1,117 1,803
Adj. Net Income (without tax treatment) 1,635 2,117 1,803 Adj. Net Income (with tax treatment) 1,635 1,717 1,803
No tax adjustment required at EBITDA level
2006 2007 2008
EBITDA 3,000 2,150 3,308
Adj. EBITDA 3,000 3,150 3,308
Reported Net Income 1,635 1,117 1,803
Adj. Net Income (without tax treatment) 1,635 2,117 1,803 Adj. Net Income (with tax treatment) 1,635 1,717 1,803
No tax adjustment required at EBITDA level
Step 5 – Calculate the Multiple
Market Cap Enterprise Value Multiples 2006 2007 2008 EV / EBITDA (unadj.) 10.0x 14.0x 9.1x EV / EBITDA (adj.) 10.0x 9.5x 9.1x P/E (unadj.) 15.3x 22.4x 13.9x
P/E (adj. without tax treatment) 15.3x 11.8x 13.9x P/E (adj. with tax treatment) 15.3x 14.6x 13.9x
25,000 30,000
Not adjusting overstates, while incorrectly adjusting
(w ithout tax treatment) understates the multiple Market Cap Enterprise Value Multiples 2006 2007 2008 EV / EBITDA (unadj.) 10.0x 14.0x 9.1x EV / EBITDA (adj.) 10.0x 9.5x 9.1x P/E (unadj.) 15.3x 22.4x 13.9x
P/E (adj. without tax treatment) 15.3x 11.8x 13.9x P/E (adj. with tax treatment) 15.3x 14.6x 13.9x
25,000 30,000
Not adjusting overstates, while incorrectly adjusting
(w ithout tax treatment) understates the multiple
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Example: Mergers and Acquisitions Adjustments
An acquisition or disposal by a company distorts the reported growth profile of a company’s financial results – it may also impact Net Debt. For this reason, it is important to make a pro forma adjustment to the company’s financials so that they can be analysed on a like-for-like basis. The best sources for information to enable accurate pro forma adjustment are the company’s website (investor relations) and equity research.
Annualisation is an important concept, especially in the context of an M&A pro forma. Companies consolidate acquired business financials in their financial statements from the time of completion of the transaction. Therefore, if a transaction completes in, say June 2005, the target will only be consolidated from June onwards (assuming acquirer’s year ends in December).
If no pro forma adjustment is made, on a Compco basis the EV would consolidate the entire equity value of the target (for a 100% acquisition), but the EBITDA would only include the target’s performance for 6 months, making the multiple artificially high.
The multiple should be adjusted by annualising 2005 EBITDA. For example, if the 6 month EBITDA is €500m, the annualised 12 month EBITDA in the following manner, €500m/(6/12) = €1,000m.
Obviously, if available, it is better to use the target’s actual 2005 EBITDA rather than to annualise on a straight-line basis.
In the example below, Company A acquires Company B – because of the high multiple paid for the acquisition (15.0x one year forward EBITDA) the pro forma multiple rises by nearly half a turn.
Step 1: Annualise for Acquisition at end June 2006
(€ in millions, unless specified)
Dec YE 2006 2007 2008
EBITDA from target 500 1,750 3,063
EBITDA for target 1,000 1,750 3,063
Only 6 months of EBITDA consolidated in 2006
EBITDA annualised for 12 months (e.g. 6 months
multiplied by tw o)
Dec YE 2006 2007 2008
EBITDA from target 500 1,750 3,063
EBITDA for target 1,000 1,750 3,063
Only 6 months of EBITDA consolidated in 2006
EBITDA annualised for 12 months (e.g. 6 months
multiplied by tw o)
Step 2: Pro Forma the Acquiror’s EBITDA
(€ in millions, unless specified)
Dec YE 2006 2007 2008
EBITDA (acquiror) 10,750 12,000 13,250
EBITDA (target) 1,000 1,750 3,063
Acquiror's pro forma EBITDA 11,750 13,750 16,313 Assumes no synergies
Dec YE 2006 2007 2008
EBITDA (acquiror) 10,750 12,000 13,250
EBITDA (target) 1,000 1,750 3,063
Acquiror's pro forma EBITDA 11,750 13,750 16,313 Assumes no synergies
Step 3: Pro Forma the Acquiror’s Capital Structure
M&A Valuation(1) Multiple Valuation 15.0x 15,000 Price 85 Shares outstanding 705 Market Cap 59,925
Existing Net Debt 125
Adjustments 21,608
Adj EV 81,658
Acquisition finance 15,000
Pro forma adj EV 96,658
Step 4: Calculate Multiples
EBITDA Multiples 2006 2007 2008
Standalone 7.6x 6.8x 6.2x
Pro forma (not annualised) 8.6x 7.0x 5.9x
Pro forma (annualised) 8.2x 7.0x 5.9x
Non-annualised multiple is artificially inflated
EBITDA Multiples 2006 2007 2008
Standalone 7.6x 6.8x 6.2x
Pro forma (not annualised) 8.6x 7.0x 5.9x
Pro forma (annualised) 8.2x 7.0x 5.9x
Non-annualised multiple is artificially inflated
In addition, the following factors should be considered:
„ Synergies from combination: any assumptions on synergies from an acquisition should be duly noted and sourced in the file. Synergies could materially alter the multiples
„ Acquisition of minority stake: minority stakes should not be pro forma adjusted as they are excluded from the Compco analysis (consolidated analysis) in any case (see below)
Minority Interests and Income from Associates
Typically a company will have subsidiaries and associates as part of its group structure. General accounting rules for subsidiaries and associates are as follows:
„ Subsidiaries
A subsidiary is a company over which the holding company exercises significant control – typically 51% or more ownership. In such a case, the subsidiary company will be fully consolidated. A parent recognises 100% of the assets and liabilities of its subsidiaries on a line-by-line basis. Minority interest is recognised at the bottom of the balance sheet as a separate part of equity. Similarly, in the income statement, 100% of the subsidiaries’ income is recognised on a line-by-line basis, but minority interests are separately identified (and deducted) at the bottom of the statement. The target company may exercise control though owning less than 50% of the equity (e.g. through contractual agreements). In such a case it will be consolidated as a subsidiary.
„ Associates
An associate is a company where control is not held (i.e. typically owns less than 50% and typically more than 20%) by the holding company. An entity is treated as an associate when the parent has significant influence over it (i.e. it can influence but not control the financial and operating policies of the entity). This may arise through share ownership, or other means (e.g. appointment of directors or contractual arrangements). From an accounting perspective, these assets are included using the Equity Method. Under the Equity Method the parent recognises, in one line, its share of the assets and liabilities of the associate – including any goodwill that arises on the acquisition. The parent will recognise its share of the associate’s net income on one line of the income statement.
Proportionate consolidation is not permitted under IFRS for associates.
„ Joint Ventures
A joint venture arises where there is joint control between the parties. The economic shareholding does not have to be split on a 50:50 basis; rather it is the ability of each party to prevent the other venturer/s from exercising control alone that results in a joint venture.
A joint venture can be accounted for under the equity method or on a proportionate consolidation basis. Whichever method is chosen should be applied to all joint venture interests of the relevant group.
Efficient Market Theory
The Efficient Market Theory is centred on the concept that prices of securities are the result of perfect and efficient information. In other words, markets see through the accounting rules that give companies greater credit (in their financials via full consolidation) for subsidiaries than their ownership would strictly warrant (when the subsidiary is not 100% owned). In theory, the market price of equity only credits companies up to their level of ownership in the subsidiaries.
This means that multiples may look distorted by inconsistencies between the numerator and denominator, in the absence of any further adjustments. Consider the EV / EBITDA multiple – the numerator “EV” consists of Net Debt (determined by the accounting rules described above) and Market Cap (based on the efficient market theory). The denominator consists of EBITDA (determined by the accounting rules as described above). Thus, while accounting rules give the company full credit in the financials even when