Presentation Outline. Why Value? Determining Business Value Difficult to Value Businesses Strategies to Increase Value

Transcription

1 Business Value

2 Presentation Outline Why Value? Determining Business Value Difficult to Value Businesses Strategies to Increase Value

3 My Background Investment Fund Manager Business Valuation Consultant Entrepreneurship Promoter Education: Engineer, MBA, CFA, CIM

4 Financing Underground Mines

5 Financing Canadian Farms

6 Why Value? Business Valuation Financing Strategic Transaction Generation change Measure of entrepreneur's progress Basis for Valuation Financial Fundamentals Firm, Equity or Asset value?

7 Approaches to Valuation DCF valuation Comparable present value of expected future cash flows P/E, P/B, P/S, P/FCF, EV/EBITDA, others Industry Metrics Option Valuation Cost Based Approach Investor s Approach

8 1. Discounted Cash Flow Valuation What is DCF? Present value of the expected cash flows Philosophical Basis Intrinsic value is based upon return and risk over time Assumptions in DCF Cash flow over life, growth rate, discount rate

9 Characteristics of DCF Valuation Considerations Less exposed to market moods and perceptions More useful to firm valuation Understand the business and evaluate its characteristics But, assumptions may be noisy DCF works best Cash flows are positive Track record of cash flows Proxy for risk = discount rates Long time horizon Catalyst available to reach to full value

10 DCF Assumptions: Cash Flow Estimate the current earnings Investment Historical earning: EBITDA, Free cash flow Consistency and/or growth Fundamental analysis Capex Current and future working capital needs Adjust accounting earning GAAP and extraordinary items Normalize for third party ownership

11 DCF Assumptions: Growth Annual Growth Constant? Growing more than GDP? Terminal Growth Future long term growth Growth patterns Barriers to entry Stage of Industry

12 DCF Assumptions: Discount Rate Consistent with riskiness Cost of Capital Cost of Equity dividend-growth model, risk and return model (e.g., CAPM), industry average model (Historical Industry Returns). Cost of Debt: market interest rate, default premium and tax rate, new debt and not existing, credit rating, YTM of existing bonds Other Issues: Currency for both equity and debt Nominal versus Real

13 2. Comparables Compare with market prices of others Philosophical Basis Intrinsic value impossible to estimate Value is whatever the market is willing to pay Information Needed comparable assets a standardized measure (sales, earnings, cashflow or book, cap rate) Market Inefficiency

14 Market Comparables examples Market/Index P/E P/B P/S EV/EBITDA S&P 500 Index S&P/TSE 60 Index Nasdaq 100 Index Russell 2000 Index Apple Corp Facebook Coca Cola Corp

15 Why use Comparables? Considerations Reflect market perceptions and moods More relevant for transaction Requires less information/ assumptions But does not reflect true value Also assumes market efficiency Works best Easiest to use when Good comparables available Prices of comparables available Acceptable common variable available Great for investors with short time horizons Linked to a benchmark Use mispricing advantageously

16 Industry Metrics Sector Metric Value IT Services Revenue/employee $60-75k Internet Services Number of Users $ Gold Mining Ozs of Gold in Situ $75-90/oz Oil/Gas Production Barrels Oil Equi/day $60-75k Agricultural Farm Land holding $1,000/acre

17 Feature of Options Option Valuation Derive value from an underlying asset May be call or put, with contingent pay-off Have fixed maturity Quantitative models for valuation available Examples of Option Valuation Patents and other barriers to entry License agreement Equity in a distressed firm Exploration or biotechnology firm

18 Brand value creates barriers to entry for others.

19 Cost Approach Historical acquisition plus implied return Modified by valuing assets Replacement Value Goodwill valuation

20 Philosophy Methodology VC Method Half of new ventures fail Nine of ten ventures just return capital Tenth venture must be a home run All of them should demonstrate the possibility Forecast future results ( success ) Estimate likely value in future Likely dilution from new issues Discount by required return Arrive at Post-money and pre-money value Many Projects Viable but not fundable

21 Simplified VC Computation Net Income (year 5) $8,000 PE ratio (year 5) 15x Investment required t=0 $5,000 VC target rate of return 60% Year Investment 5000 Net Income x x $8,000 Valuation t=5 $120,000 Valuation = Post money $ 11, % Valuation = Pre-money $ 6,644 57% VC ownership $ 5,000 43%

22 VCs Expect up to 20x Stage Discount Rate Multiple Seed 80% + 20x + Start Up 50-70% 8-14x 1 st Stage 40-60% 5-10x 2 nd Stage 30-50% 4-8x Bridge 20-35% 2-4 Public 15-25% 2-3 If you want $5,000,000 for 20%, it should be a $500 million business

23 Valuing Hard to Value Firms Superfast revenue growth No earnings (NI<0) No history No comparables

24 Issues: Negative Earnings Can t estimate growth >> Normalize Earnings Are earnings normally positive? Firm had a bad year Cyclical firm during a recession How long with this last? Historical earnings in the industry

25 Issues: No History/ Comparables No History >> Use comparables This is how software firms get valued at IPO Locate comparables with similar business and industry life cycle quality of information No Comparables >> Use history Use DCF or other methods

26 Value Creation in Existing Business Increase cash flows or efficiency Reduce reinvestment needs (WC + Capex) Achieve higher growth Reinvest to higher growth in new products/markets Reduce cost of capital Reduce operating risk/volatility Reduce Operating leverage, cost cutting and layoffs Change finance mix Choose right market for debt and equity Reduce Tax burden Divest poor investments

27 Value Creation in New Areas Increasing market share Launching new products Entering new markets Acquiring other businesses Vertical Integration: controlling Supply chain Horizontal Integration: economies of scale

28 Strategies to Create Value Barrier to Entry Patents, copyrights First Mover Advantage Branding Competitive Advantage Licenses and sanctioned monopolies Distribution or off-take agreements Exploration agreements Exclusivity Barrier to Exit Sticky products Switching Costs and Cancellation Policies the thermonuclear war

29 Protection of Value Collapse Hedge against Disaster Currency Operational Product liability Pitfalls One-man show Me-too products Under-maintained equipment undisclosed liabilities Exit Routes M&A Private Equity IPO RTO

30 About Excalibur Capital Toronto based Hedge Fund, Operating since 1997 Investment Focus Includes: Seek emerging growth companies Seek innovative companies with large market opportunity Buy in private placements w equity kicker We look for: Credible execution plan and resourcefulness Solution to reducing customer s pain (Val Prop) Achievable business milestones Disclosure of problems and plan to fix Management s own financial commitment And investment fits into our structure.