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Valuation is in the eye of the beholder
The value of a firm is can vary based on circumstances & the type of buyer
Fair market value (FMV)
Minority interest
Controlling interest
Financial buyer
Strategic buyer
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Why do we need to value companies?
To determine the price at which to offer new securities
To determine the price at which to buy or sell a company
To determine the price at which to purchase or sell an ownership interest in a company
To determine tax implications Generational transfer
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There is a relationship between control & value
LOW ------------------- CONTROL-------------------- HIGH
HIG
H --------- V
AL
UA
TIO
N---------- L
OW
Strategic Buyer
Minority Interest
Financial Buyer(Private Equity)
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3 Measures of Firm Value
Market Value of Equity - MVE
Total Enterprise Value - TEV
Book Value - BV
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Public market value of equity
If a Company is listed on a stock exchange and its equity shares are publicly traded, then you can derive its equity valuation based upon the share price and number of shares outstanding
This type of valuations is known as: Public Market Valuation Market Value of Equity (MVE), or Market Capitalization
The “Public Market Valuation” provides one perspective on the Company’s valuation: it illustrates at what value minority shareholders are willing to buy and sell the equity shares of that company
MVE only reflects value to common stock owners and does not consider other company stakeholders/capital providers
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Public market value of equity Share price
Can be found from many publically available sources Use closing share prices as of the night prior to valuation date
Shares outstanding - BASIC Basic shares outstanding found on page 1 of both 10K and
10Q Use most recent filing date Basic share count 8Ks may contain information on additions/subtractions to Basic
shares since most recent K or Q Shares outstanding – FULLY DILLUTED
Basic shares + additional shares from: In the money employee stock options, and, In the money convertible securities
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Treasury stock method - ESOP
(A) Add all potential common shares that a company may be required to issue in connection with:Employee stock options
(B) Assume proceeds from exercise are used to buy back common shares in the open market at the current company stock price and calculate # of purchased common shares
(C) Subtract # of repurchased commons shares (B) from (A) = NET DILLUTIVE SHARES FROM ESOP
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Treasury stock method – ESOP
Use only “vested” or “exercisable” employee stock options
Use only “in the money” options
Use closing stock price from day before valuation date
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Treasury stock method – employee stock options
JAKK Stock price as of 9/20/2010 - $22.00
JAKK Basic shares as of 6/30/2010 10Q – 27,911,076
JAKK ESOP Information from 12/31/2009 10K:
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Outstanding Exercisable Weighted Weighted Weighted Average Average Average Option Price Number Life Exercise Number Exercise Range of Shares in Years Price of Shares Price $11.56 - 19.27 148,271 3.13 $ 16.21 148,271 $ 16.21 $19.85 - 22.01 258,944 1.56 $ 21.23 210,044 $ 21.04 $22.11 - 22.11 37,500 5.00 $ 22.11 37,500 $ 22.11
Treasury stock method – Convertible Securities
Convertible securities are a combination of debt and equity Major components:
Face amount – amount borrowed, generally in $1,000 denominations An interest rate A repayment date Conversion rights
Conversion rights give the holder the right to exchange their debt for equity in the security issuer The amount of equity a holder receives in exchange for their debt claim depends on the conversion
price
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Treasury stock method – Convertible Securities
(A) Add all new shares that would be issued if “in the money” convertible securities were converted
(B) Subtract the claims associated with convertible securities from balance sheet Most often debt or preferred stock
(C) Make interest expense adjustment to relevant period income statement
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Treasury stock method - Convertible Securities Example
Current stock price = $55.00
Face amount of convertible security = $1,000
Conversion price = $25.00
Conversion ratio ($1,000/Conversion price) = 40
The Conversion ratio can be interpreted as how many shares of stock an issuer would need to issue per $1,000 of face value of the convertible securityIf the Convertible holder exercises their conversion right they give up the right to receive repayment of their $1,000 at a 4% interest rate in exchange for 40 shares of the issuers common stock A Conversion Price less that current stock price = “in the money”
40 X $55 = $2,200 > $1,000
Dilutive Shares = Face/Conversion Price = 1,000/25 = 40
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Treasury stock method convertible notes
On November 10, 2009 the Company sold an aggregate of $100.0 million of 4.50% Convertible Senior Notes due 2014 (the "Notes"). The Notes are senior unsecured obligations of JAKKS, will pay interest semi-annually at a rate of 4.50% per annum and will mature on November 1, 2014.
The conversion rate will initially be 63.2091 shares of JAKKS common stock per $1,000 principal amount of notes (equivalent to an initial conversion price of approximately $15.82 per share of common stock), subject to adjustment in certain circumstances. Prior to August 1, 2014, holders of the Notes may convert their Notes only upon specified events.
Dilutive Shares = 100.0mm/15.82 = 6.32mm shares
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MVE is not the same as Shareholder’s Equity (Book Value)
Book value =
the total amount shareholders contributed to a company based on the price they paid for shares
when the company initially sold the shares +
the retained earnings a company has accumulated at the time of measurement
Or…Assets - Liabilities
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Shareholder’s equity in SEC filings
Additional paid in capital
The proceeds a company receives from the sale of common stock in excess of the stock’s “PAR VALUE”
Comprehensive income/(loss)
Direct adjustments to shareholder’s equity not reflected in a company’s retained earnings
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MVE is not the same as Shareholder’s Equity (Book Value)
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Company IPO Current Stock Price $56.0Shares Sold 10 Shares Outstanding 45Price per Share $25.0Capital Raised $250.0 MVE $2,520.0
Company Follow-On Offering 1Shares Sold 15Price per Share $33.0Capital Raised $495.0
Company Follow-On Offering 1Shares Sold 20Price per Share $42.0Capital Raised $840.0
Retained $425.0Equity Book Value $2,010.0
MARKET VALUE OF EQUITYBOOK VALUE OF EQUITY
Total Enterprise Value MVE reflects only the value of a firm to common
shareholders
MVE ignores other capital providers
Total Enterprise Value (TEV) is a measure of the value of claims held by all capital providers to a company including all ownership interests and debt
TEV = MVE + Debt + Preferred Stock + Minority Interest – Cash
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TEV is not effected by capital structure
TEV is the value of a company’s operations independent of how the company chooses to finance itself
The TEV formula dictates that any change in the amount of any capital item will be equally offset by an equal change in another capital item
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Base Case Adj. Pro formaMVE $750.0 $750.0PLUS Debt $250.0 $100.0 $350.0PLUS Pref. Stock $35.0 $35.0PLUS Min. Interest $15.0 $15.0(LESS) Cash ($50.0) ($100.0) ($150.0)Enterprise Value $1,000.0 $0.0 $1,000.0
TEV is not effected by capital structure
355 Maple Street
Current Owner’s Mortgage = $0
Sale Price = $600,000
355 Maple Street
Current Owner’s Mortgage = $500,000
Sale Price = ?
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Why do we subtract cash to calculate TEV
355 Maple Street is for sale for $600k We purchase the house with:
$300k Mortgage (Debt) $300k Equity (MVE)
TEV = $300k Debt + $300k MVE = $600k Suppose 355 Maple Street has a secret room with $100k cash
that we get to keep if we buy the house We purchase the house for $700k
$300k Mortgage (Debt) $400k Equity (MVE)
TEV = $300k Debt + $400k MVE - $100k Cash = $600k
Because the MVE already reflects the cash value exactly we would be double counting if we did not subtract cash
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Three measures of firm value
1. Market Value of Equity (MVE) Share price x Fully diluted shares outstanding
2. Total Enterprise Value (TEV) MVE + Debt + Pref. Stock + Min. Int.- Cash
3. Book Value of Equity Assets – Liabilities, or Common stock + additional paid in capital + retained
earnings+ comprehensive income/(loss)
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Valuation frameworks
Comparable Public Companies
Precedent Transactions
Discounted Cash Flow
Internal Rate of Return (IRR)
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Relative Multiple Based
Intrinsic Cash Flow Based
Relative Multiple Based Approaches
A valuation multiple is the ratio between a financial metric and a measure of value Example: TEV/ Revenue Multiple If TEV = $1,000 and Revenue = $100 TEV/ Revenue Multiple = $1,000/$100 = 10x
By comparing multiples calculated for comparable companies/transactions you can derive implied valuations for target firms Target Firm Revenue = $50 Comparable companies average TEV/Revenue = 10x Implied Target TEV = $50 x 10 = $500
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Relative Multiple Based Approaches
Two types of multiples: Operating or unlevered Equity or levered
Leverage refers to the relative amount of Debt/Equity used to finance a company
TEV is an unlevered measure of value
MVE is a levered or equity measure of value
Metrics are also unlevered or levered
Revenue EBIT EBITDA
Net Income
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Unlevered
Levered
Relative Multiple Based Approaches
Always match unlevered measures of value with unlevered financial metrics
Always match levered measures of value with levered financial metrics
NEVER MIX UNLEVERED & LEVERED TEV/Net Income
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Measure of Value Financial Metric Multiple
TEV Revenue TEV/Revenue
TEV EBIT TEV/EBIT
TEV EBITDA TEV/EBITDA
MVE Net Income MVE/Net Income
Share Price EPS P/E
Comparable Public Companies Analysis - COMPS
You can value a target company based on how similar companies trade in the public markets
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STEP TASK
1. Select comparable public company universe
2. Spread key income statement, balance sheet, and cash flow information
3. Calculate key financial ratios, performance metrics and trading multiples
4. Benchmark comparable company statistics from 3 against target company
5. Determine appropriate multiples and multiple ranges
6. Calculate implied valuation ranges for target company
Selecting a universe of comparable public companies
This process is as much art as it is science
Differences in comparable company universes can lead to wide variances in implied valuation ranges
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Business Profile Financial Profile
Industry Size*
Sector Growth
Products & Services Profitability
Business Model Credit Profile
Customers Capital Structure
Geography
Why do different companies trade at different valuation multiples?
What do multiples represent?
How do we select the appropriate multiples to asses the value of a Target firm?
The goal is to select a range of multiples from companies that are most similar to the TargetBusiness ProfileFinancial ProfileALL ELSE EQUAL
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Financial Profile - Size
Generally measured in market capitalization or revenue Differences in size can impact valuation multiple
differences Why?
Risk Economies of scale Purchasing power Liquidity Access to capital Growth prospects
Size impact on multiples is generally not linear but tiered
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Financial Profile - Profitability
Generally measured by: Gross margin EBIT margin EBITDA margin Net income margin
All else equal, higher margins translate into higher multiples
From each dollar of sales more earnings are available for respective capital providers
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Enterprise Value Multiples
Equity Value Multiples
Financial Profile - Profitability
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M ultiples Analysis
SharePrice % off 52- Market Enterprise TEV / Revenue TEV / EBITDA Price / Earnings
Company Name Ticker 12/19/2008 w eek High Capitalization Value Cash Debt LTM FYE+1 LTM FYE+1 LTM FYE+1
Kraft Foods, Inc. KFT $26.67 23.7% 39,345.0 59,201.0 737.0 20,593.0 1.39x 1.35x 9.4x 9.1x 13.8x 14.0x
ConAgra Foods, Inc. CAG 15.98 35.7% 7,144.4 10,236.7 296.4 3,388.7 0.85x 0.81x 8.1x 6.9x 13.8x 11.0x
H.J. Heinz Company HNZ 37.25 29.7% 11,741.7 16,547.3 927.7 5,733.2 1.58x 1.63x 8.9x 9.1x 12.8x 12.9x
General Mills, Inc. GIS 59.00 18.1% 19,975.0 27,495.7 $639.6 $7,918.0 1.91x 1.89x 11.2x 10.0x 16.7x 15.1x
Kellogg Co. K 42.63 27.1% 16,284.5 21,149.5 684.0 5,549.0 1.67x 1.62x 8.8x 9.0x 13.7x 14.2x
Median 27.1% $16,284.5 $21,149.5 $684.0 $5,733.2 1.58x 1.62x 8.9x 9.1x 13.8x 14.0x Mean 26.9% $18,898.1 $26,926.0 $656.9 $8,636.4 1.48x 1.46x 9.3x 8.8x 14.2x 13.4x
M argins Analysis
Revenue Grow th EBITDA Grow th EPS Growth LTM CapEx % EBIT Margin EBITDA Margin Net MarginCompany Name FYE '07-08 FYE '08-09 FYE '07-08 FYE '08-09 FYE '07-08 FYE '08-09 of Revenue LTM FYE+1 LTM FYE+1 LTM FYE+1
Kraft Foods, Inc. 8.4% 17.6% -5.9% 12.9% -5.5% -4.7% 3.0% 12.5% 12.6% 14.8% 14.9% 6.7% 6.4%
ConAgra Foods, Inc. 10.2% 9.3% -7.2% 14.6% -4.1% 18.8% 3.4% 8.0% 9.3% 10.5% 11.6% 4.3% 5.1%
H.J. Heinz Company 11.9% 0.6% 8.5% -2.5% 6.7% 7.4% 2.8% 14.9% 14.9% 17.7% 17.9% 8.7% 9.0%
General Mills, Inc. 9.7% 6.4% 7.7% 2.0% 11.9% 0.9% 4.0% 13.9% 15.7% 17.0% 19.0% 8.3% 9.1%
Kellogg Co. 8.0% 11.0% 6.3% 0.6% 10.5% -1.6% 3.7% 16.0% 15.1% 18.9% 18.0% 9.3% 8.8%
Median 9.7% 9.3% 6.3% 2.0% 6.7% 0.9% 3.4% 13.9% 14.9% 17.0% 17.9% 8.3% 8.8%Mean 9.6% 9.0% 1.9% 5.5% 3.9% 4.2% 3.4% 13.1% 13.5% 15.8% 16.3% 7.5% 7.7%
Financial Profile - Growth
Historical & forward looking
Higher growth equates to higher valuation multiples
Examine financial metrics
Sales, EBIT, EBITDA, Net Income, EPS
For early stage companies
Sales and other operating metrics: Customers, Locations, Employees
Growth and size can be offsetting
Must examine growth & profitability together
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Financial Profile – Return on investment
Ratios that employ a measure of profitability in the numerator and a measure of capital in the denominator
How efficient is a firm at providing a return to capital providers
Return on Invested Capital (ROIC)
EBIT / Avg. Net Debt + Total Equity
Return on Equity (ROE)
Net Income / Avg. Shareholder Equity
Return on Assets
Net Income / Avg. Assets
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