Extensive notes of everything that was said during class and everything that was mentioned on the slides. There is no coursebook available for this course but fortunately this summary is the perfect tool for studying the exam and successfully making the group work.
L1: Key valuation concepts and main
valuation methods
There are three types of decisions that need to be made, investment
decisions, financing decisions and dividend decisions. When you are a
manager who makes investment decisions, you need to look if the NPV is higher
than the hurdle rate. If you are a manager that makes financing decisions, you
are going to try to match assets and liabilities (long term liabilities to finance
(long term) fixed assets etc.) and look for the appropriate types of funding.
These three types of decisions all rely on the principle that as a financial
manager you should maximize the value of the business. Maximizing the
value of the business IN THE LONG TERM, not in the short term. If you are making
decisions which are not sustainable that might even damage the value of your
company.
Valuation
The need for valuation emerges from two things:
• Decisions in the corporate finance domain
o Capital increase
o M&As
o IPOs
o Management buy-outs
• Evaluation of corporate strategy
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, Basic valuation principles
1. Entity: If we are valuing the company we should look at the company as a
whole and not forget specific parts. E.g. people look at the tangible assets but
forget to look at the intangible assets (brand names, patents, trademarks etc.)
these contribute to the value of the company as well.
2. Equity: In most of the cases we are most interested in the value of the
shares, even though we need to look at the entire company. Shareholders are
the ultimate owners of the company.
3. Subject dependence: Imagine that an entrepreneur and venture
capital specialist are going to conduct a valuation. They have the same image
about how the future is going to look like but still come up with different
valuations, why? The VC has diversified risk, he might invest in other firms as
well. For the entrepreneur typically the entire world is in the organisation.
Therefore they can get to different valuations.
4. Future oriented: If we look at the accounting methods, that is looking
backwards. In CF we look forwards. That is a problem with accounting based
valuation techniques, they are not future oriented.
5. Time dependence: You always incorporate the most recent information
which is out there, that might mean that you need to collect information at
different points in time. But you need information that is forward looking, as
much forward looking as possible or as recent as possible. (The world does not
end at December 2017. If you conduct a valuation which is forward looking you try to
incorporate as much as the information about 2018, that is forward looking as well.)
6. Going concern: We are conducting a valuation assuming that the
company is going to survive until infinity. If companies are in financial
problems we will need to account for that in our valuation techniques.
Valuation myths
“A valuation is an objective search for ‘true’ value”
There is no such thing as true value. Take for example M&A’s, you have an
acquiror and a target. Both of them have financial advisors which will perform a
financial valuation of the target company. But the advisor of the target will
always come up with a higher valuation and the acquiror will come up with a
lower valuation. Even if you have 2 potential acquirors that have the same image
of what the future is going to look like, they still can come to very different
valuations, because once the target is integrated in the acquiring company it can
create synergies etc. with one company but not with the other.
“A good valuation provides a precise estimate of value”
2
,It is better to have a range for the estimated value. You use different valuation
methods and that provides you with a range. Then you need to look what drives
the differences between the valuations outcomes of the different techniques.
“The more quantitative a model, the better the valuation”
Some people say that they make valuations models based on feelings, this is
questionable. In other valuation models you just put something in and the
valuation comes out but nobody knows what happens in between, this isn’t
optimal either. Another thing that can happen is that you make so much
assumptions and look at so many different aspects that you forget to look at the
big picture so you end up making assumptions that aren’t compatible.
A good valuation is a combination of understanding the context of the
company and having good models. But you don’t want to have only financial
models, it should be a combination.
Valuation in practise - IPOs
Banks use at least 2 valuation methods. The mostly frequently used methods
(from high to low) are:
• Discounted free cashflow model
• Multiples
• Dividend discount model
So in many industries, the discounted free cashflow model is used as the
basic valuation method and multiples are used as a cross-check. Companies
that perform IPOs are typically a bit more stable already, therefore people say
that it makes more sense to use the discounted FCF model and the multiples.
When multiples are used it is most often the price/earnings multiple that is
used. However there is no specific reason why that should be the most heavily
used one. Other often used options are the price/cashflow multiple,
enterprise value/EBITDA multiple, …
Valuation in practice – Venture capital
In a context where there is much more uncertainty multiples become the
number one valuation method. Then the discounted FCF model and then rules
of thumb.
An explanation that is often given for why multiples are used more than
discounted cashflows when it comes to venture capital is that if you have a lot of
uncertainty you can’t predict the FCFs very well, you would have to make too
many assumptions. These are not certain and can be wrong and therefore the
discounted FCF model is not that frequently used.
3
, But that does not make sense, if you are using multiples you are also making
assumptions. Maybe you are not thinking about them but you are making them.
In the discounted CF model you simply make your assumptions explicitly whereas
in the multiples you do it implicitly. So people think they don’t make assumptions
when using multiples, but they do.
4 key valuation methods
Relative Intrinsic Contingent
Book value
valuation valuation claim valuation
Adjusted book
Multiples Entity-DCF Decision trees
value
Recent private
Liquidation value Equity-DCF Black-Scholes
transactions
DDM
APV
Economic profits
and EVA
Building blocks for valuation
• OPERATIONS: what is going to be key in any valuation? The operations
and the cashflows that result from those operations will be central in your
valuation.
o The operations of the firm form the basis for a valuation
o What distinguishes a firm from similar firms?
Product or service
Know how
Unique market position
R&D
Patents
Specific contracts
Skilled labour
…
Example Kinepolis: Operations? People pay to enter the movie theatre (key driver:
number of visitors), selling food, show commercials before the movie, they host events,…
But there is one more crucial component: they want to be the best cinema operator
and they are also a real estate manager, they own many of the complexes in which its
movies are being played.
Competitors typically work with operating leases, but for Kinepolis, all the operations
happen within their own buildings. So it is important to notice these things because it are
fundamental components.
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