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Copal Partners

Investment Banking Module

Index
Table of Content
Introduction to Investment Banking

Valuation Methodologies

14

A. Valuation Techniques

18

B. Comparable Company Analysis

21

C. Comparable Transaction Analysis

95

D. DCF Valuation

112

Pitch book Building

150

A. Profiles

154

B. Case Studies

175

C. Industry overview

187

D. Research Techniques

205

What is Investment Banking?


Is it investing? Is it banking? In reality, it is neither!
Investment banking, or I-Banking, as it is often called, is the term used to describe the business of advising
corporates around their financial needs and raising capital for companies

Buy & Sell securities for their clients and provide stock advice

Sales and Trading

Facilitate buying and selling of stocks, bonds, options, currencies, derivatives and
other financial products (Flow & Exotic)
Clients include Institutional Investors like pension funds, mutual funds, private clients/
HNIs and individual investors, investment arms of non-finance companies
Follow stocks and make recommendations on whether to buy, sell or hold securities
Prepare Initiation Reports, Sector Reports and also Market Reports

Equity Research

Corporate Finance /
Advisory

Provide investment ideas for the Sales & Trading Group


Analyze and forecast economic trends, interest rate movements and other industry
level parameters and perform valuations on companies within industry sectors they
follow
Work with clients in determining financing needs and structuring specific financial
strategies
Provide underwriting services on issue of equity or debt securities
Provide advice on Mergers and Acquisitions, foreign exchange, economic and market
trends, and specific financial strategies such as corporate restructurings
3

Dynamics/ Relationship between various institutions

Financing

M&A

Corporate Finance

Corporate Finance

Prospectus,
Placement
memorandums,
Valuation,
Underwriting

M&A valuation,
Deal structuring,
Restructuring,
Asset sales and
purchase,
Synergy analyses

Equity Research

Analyst Presentation

Equity Research

Initiation reports
Coverage report
Road shows

Coverage Report

Coverage report
Event Report
Deal notes

Corporates
Sales & Trading

Sales & Trading

Market making
Proprietary Trading

Market making
Proprietary Trading
Chinese Wall

Typical Corporate Finance Deal Team


Title

Managing Director

Experience

8+ Years

Education

Top Undergraduate
Universities,
Usually Top-Tier MBA

Vice President

3- 8 Years

Top Undergraduate
Universities,
Usually Top-Tier MBA

Associate

0-3 Years

Top Undergraduate
Universities,
Usually Top-Tier MBA

Analyst

0-1 Years

Top Undergraduate
University

are legally bound to observe.

Role
Managing Directors primarily pitch ideas to
clients to source deals.
Managing Directors spend most of their time in
bringing business to the banks, executing
transactions for clients and maintaining existing
client relationships.
Vice Presidents are also responsible for finding
new clients and servicing existing clients. VPs
however spend more time managing Analysts
and Associates and in the pitch book creation
process
Associates manage analysts work and are
primarily responsible for financial models and
pitch book creation. In addition, they may be
involved in dealing with the MDs and going
over details of potential deals or discussing
numbers (commercial and financial DD)
Analysts perform all research and analysis,
build financial models and put together the
pitch book (deal coordination, commercial and
financial due diligence)

Role of Corporate Finance


To make it convenient, from now onwards by Investment Banking we would mean Corporate Finance

Corporate Finance

Financings

Client Advisory
Includes:
Acquisitions
Private Company Sale
Public Company Sale
Corporate Restructuring
Corporate Divestitures
Joint-Ventures

Includes:
Initial Public Offerings (IPO)
Secondary Offerings
Debt Syndication
Equity Private Placements

Bankers generally generate business through pitching transaction ideas to clients. Pitch Books - presentations
the bankers use for their clients, contain general information and include a wide variety of selling points they make
to potential clients. Pitch books almost always include valuation and research analysis on a number of companies
and/or industries
Pitch books again can be categorized as follows:
General : Usually, general pitch books include an overview of the I-bank and detail its specific capabilities
in research, corporate finance, sales and trading, primarily used to showcase credentials.
Deal-specific. Deal-specific pitch books are highly customized and are prepared specifically for the
transactions that bankers are proposing to their clients

What are the various types of groups within an Investment Bank?


There are broadly two types of groups within a typical investment bank (or investment banking division):
Product groups: The three most well known product groups are mergers and acquisitions (M&A),
leveraged finance and restructuring.
The products of an Investment Bank, are basically advisory for M&A, Financing, Restructuring, etc., hence a
Group covering any of the above activities would be a Product group
Bankers in Product groups have product knowledge and tend to execute transactions (respectively M&A
transactions, leveraged buyouts (LBOs) and restructuring transactions/bankruptcies).
For e.g. an M&A banker would be a specialist in deal structuring (equity or cash etc.), types of deal
structures, takeover codes (legalities, regulation) in a particular country etc .
Industry groups (also called sector groups or domains): Bankers in industry groups cover specific industries
and develop expertise in a particular sector. They tend to do more marketing activity (pitching).

Examples of common industry groups include FIG (Financial Institutions Group), Healthcare, Consumer/Retail,
Industrials, Natural Resources, TMT (Telecom, Media and Technology.. Often subgroups exist within the broader
group. For example, a Healthcare group may be segregated into biotechnology, medical devices,
pharmaceuticals, etc.

Top Global Investment Banks (M&A)


Worldwide Announced deals - 2010
Financial Advisor
Goldman Sachs & Co
Morgan Stanley
JP Morgan
Credit Suisse
Citi
Barclays Capital
Deutsche Bank AG
Bank of America Merrill Lynch
UBS
Lazard
Rothschild
HSBC Holdings PLC
Nomura
Evercore Partners
BNP Paribas SA
Jefferies & Co Inc
Greenhill & Co, LLC
Houlihan Lokey
Blackstone Group LP
Santander
Centerview Partners LLC
RBC Capital Markets
KPMG
Mizuho Financial Group
RBS
Source: Thomson Financial

Deal Value (in $mn)

Freeman Fees (in $mn)

425,164
346,039
330,835
327,179
299,167
265,094
242,883
236,383
231,960
188,637
127,830
98,194
87,404
79,257
78,350
72,904
70,551
61,464
54,777
51,225
50,161
48,909
44,578
43,279
41,921

1,952.8
1,421.7
1,400.3
1,046.4
729.4
715.6
831.5
906.6
850.9
845.0
746.5
212.0
320.6
209.4
300.1
354.3
202.3
349.6
169.6

344.0

153.2
11

Number of Deals
325
331
280
249
185
133
224
204
230
259
245
79
171
35
110
114
47
167
41
47
13
133
327
121
59

Transaction Volumes
Completed Deals Worldwide: Annual Transaction Volume
Date Effective/Unconditional

Deal Value (in $mn)

Number of Deals

2008
2009
2010
2011

1,924,659
1,848,453
1,893,852
824,484

24,890
30,431
32,114
8,762

Industry Total

6,491,448

96,197

Excludes Equity Carveout, Exchange offers and Open Market Purchases

Source: Thomson Financial


12

Role of KPOs in the Investment banking industry

CLIENT
MARKETING

RESEARCH
& ANALYSIS

Investment Banks
DEAL
EXECUTION

KPOs

13

Copal Partners

Valuation Methodologies

14

Valuation Methodologies
Valuation Methodologies can be categorized as under:
A. Fundamental valuation: A stand-alone valuation methodology to compute the intrinsic value of an asset
B. Relative valuation: Valuing an asset relative to its peers

A. Fundamental Valuation:
The DCF (WACC, FTE, APV) model of valuation is a fundamental method.
Value of firm (equity) is the PV of future cash flows.
Ignores the current level of the stock market (industry).
Appropriate for comparing investments across different asset classes (stocks vs. bond vs. real
estate, etc).
B. Relative Valuation:
Comparable company analysis and comparable transaction analysis are relative valuation methods
Relative valuation is based on P/E ratios and a host of other multiples.
Can not compare value across different asset classes (stocks vs. bond vs. real estate, etc).
Can not answer the question is the stock market over valued?
Can answer the question, I want to buy a tech stock, which one should I buy?
Can answer the question, Which one of these overpriced IPOs is the best buy?

15

Fundamental Valuation Concepts


Fundamental analysis is a technique that attempts to determine a securitys value by focusing on
underlying factors that affect a company's actual business and its future prospects.
On a broader scope, one can perform fundamental analysis on industries or the economy as a whole. The
term simply refers to the analysis of the economic well-being of a financial entity as opposed to only its price
movements.
The various fundamental factors can be grouped into two categories: quantitative and qualitative.

Quantitative capable of being measured or expressed in numerical terms.

Qualitative related to or based on the quality or character of something, often as opposed to its size
or quantity.

Fundamental analysis serves to answer questions, such as:

Is the companys revenue growing?

Is it actually making a profit?

Is it in a strong-enough position to beat out its competitors in the future?

Is it able to repay its debts?

Is management trying to cook the books?

16

Relative Valuation Concepts


Relative valuation answers the question How does the value of an asset compare with the values assessed
by the market for similar or comparable assets
Absolute values of comparable assets are standardized for the purpose of comparison. Friendly The
Board recommends the offer
How would you compare a pencil priced at Rs.10 with another pencil priced at Rs. 20?
Standardized values values with a common numerator are called price multiples
Comparing the price multiples of comparable assets can give an indication of whether an asset is under or
over valued.
If Rs.10 pencil lasts 10 days and Rs. 20 pencil lasts 16 days, is Rs. 10 pencil over or under valued
compared to the Rs. 20 pencil?
Everything else being equal, which one would you buy?

17

Copal Partners

Valuation Techniques

18

Valuation Overview
Valuation is the process of determining the current worth of an asset. Valuation answers the question How
much will it cost to acquire the asset?
Further Valuation analysis is done to answer questions like:
How much should Acquirer pay to buy the target?
Is the price offered for the company fair to shareholders?
Is company undervalued / overvalued in the industry?
What is the underlying value of the business against which debt is being issued?
Should we buy/sell/hold positions in a given security?
Thus, Investment banks perform valuation on firms, or parts of firms for several reasons:
Contribution into a Join Venture or Mergers & Acquisitions (Buy side or sell side engagements)
Recommended bid for an acquiring firm
Assess Public equity offerings IPO etc
Floatation of debt or equity or credit
Valuations are not scientific. It is highly dependent on a strong set of assumptions and inputs. A valuation is
only as good as the quality of inputs. Analyst look at a variety of valuation methods to quantify value.

19

Valuation Techniques
There are three primary methods of valuing a company:
Comparable Company Analysis (Trading Comps) Trading Comps analyze key valuation ratios of
comparable companies that are trading in the market to give an indication of what fair value is and compares
firms financial performance to its market value.
Comparable Transactions Analysis (Transaction Comps) Transaction Comps analyze value based on
historical takeout multiples of comparable targets to give an indication of what one would have to pay to
acquire the company. It also includes control premium.
Discounted Cash Flow (DCF) Discounted cash flow analysis is based on cash flow generation potential of
business. It uses projected cash flows in the future to determine the value of company at the present time. It
involves discounting levered / unlevered cash flows by equity cost of capital or weighted average cost of
capital.

20

Copal Partners

Comparable Company Analysis


(Trading Comps)

21

Index
Table of Content
Overview

23

Key Definitions

24

Source of Information

29

Selection of Comparable Companies

31

Equity and equity linked information

32

Market Capitalization

41

Balance Sheet

47

Enterprise Value

58

Income Statement

61

LTM & Calendarization

74

Understanding Multiples

78
22

23

Key Definitions
Market capitalization

Represents the market value of all outstanding shares


Calculated as Total number of shares outstanding x current share price

Stock Options

A privilege, in which the underlier is the common stock of a corporation,


that gives the buyer the right, but not the obligation, to buy or sell a stock at
an agreed-upon price during a certain period of time or on a specific date
A right granted to employees of a company to buy a certain amount of
shares in the company at a predetermined price. Employees typically must
wait a specified vesting period before being allowed to exercise the option

Warrants

A derivative security or certificate that gives the holder/ bearer the right to
purchase securities (usually equity) from the issuer at a specific price within
a certain time frame

Convertibles

Securities, usually bonds or preferred shares, that can be converted


into common stock at a specified conversion price

24

Key Definitions (contd)


Fully Diluted shares

Represents the number of shares that would result if all stock options,
warrants and convertible debts were traded in for stock.
Treasury stock method is used in determining the number of
shares outstanding
Results in an increased number of shares outstanding and decreased
earnings per share

Treasury stock method

The purpose of the Treasury method is to account for the cash generated by
the exercise of options and/or warrants
Treasury stock method assumes that the options and/or warrants are
exercised at the beginning of the year (or issue date if later) and such
proceeds are used to repurchase outstanding shares of common stock
Example
Current share price
Shares outstanding
Options/ warrants outstanding
Exercise price
Proceeds from conversion of in the money options
Stock buyback (at premium)
Diluted Shares
25

$ 50
400 mn
10 mn
$ 25
10 x $ 25 = $ 250mn
$ 250 / $ 50 = 5 mn
400 + 10 5 = 405 mn

Key Definitions (contd)


Total debt

Includes all interest bearing obligations both long-term and short-term


such as loans, credit facilities etc
Excludes in-the-money convertible debt

Minority Interest

Represents portion of equity not owned by the majority shareholder - a


significant but non-controlling interest of less than 50%

Preferred equity

Represents class of stock carrying preference over equity stake holders to


receive dividend and repayments in the event of liquidation

Capital lease

A lease that transfers substantially all risks and rewards of ownership to


the lessee

Cash and cash


equivalents

Represents cash, marketable securities and short-term investments that can


easily be converted to cash

26

Enterprise Value
Formula to calculate Enterprise Value

Total Enterprise Value (TEV or EV) is the term bankers use when
they refer to the total value of a company (also referred to as
Aggregate Value)

Market Capitalization
+ Total
Debt

Enterprise value is a measure of the actual economic value of a


company at a given point of time. It reflects what it would actually cost
to purchase the entire company

+ Minority
Interest
+
Preferred Stock
+

One could believe that a possible way to calculate the value of a


company would be to look at the value of the assets in the companys
balance sheet. This is a common misconception because the assets
in the balance sheet are recorded using the historical value and thus it
is not the value the company has today

Capital Leases
Cash & Cash Equivalents
= Enterprise Value
or
EV

Generally for public companies TEV = market value of the equity +


total debt (short and long term) + minority interest + preferred stock +
capital leases cash and cash equivalents
The method and assumptions for calculation of enterprise value
varies with every financial institution, banker and industry

58

Enterprise Value vis--vis Market cap


Enterprise value
is a measure of the actual economic value of a company at a given point of time
reflects the actual purchase price anyone acquiring the company would have to pay
indicator of how the market attributes value to a firm as a whole
many investors use the current value of all of a company's outstanding shares or market capitalization, as
a proxy for its economic value
Why doesn't market capitalization properly represent a firm's value?
Although market capitalization is the key component of the actual economic value of a company, it is not the
only one. In order to calculate a more Accurate value we need to consider the other things which come as a
baggage along with the company when it is acquired. We have to take into account all the obligations which are
now to be discharged by the acquirer
Role of Debt and Cash
In the event of a buyout, the buyer has to pay the equity value and would have to assume/ repay the companys
debt. Of course, the buyer gets to keep the cash available with the firm, which is why cash needs to be deducted
from the firm's price

59

Enterprise Value
Example 1. What is the Market Cap & EV for the company:
B/S as on 31 Dec 2010 (in CNY mn):
Cash
Debt
Minority Interest
Current exchange rate for HK$ to CNY is 1.1

200
175
50

Share Price (in HK$)


Shares outstanding (in '000)

a) Market Cap is CNY 25 mn & EV is CNY 50 mn.


b) Market Cap is HK$ 25,000 mn & EV is CNY 25,025
mn. c) Market Cap is HK$ 27.5 mn & EV is CNY 52.5 mn.
d) Market Cap is CNY 27.5 mn & EV is CNY 52.5 mn.
The correct answer is (d)!!!!!!!!
Share Price (HK$)

5.00

Share Price (CNY) = SP(HK$) X HKD CNY Exchange Rate


Share Price (CNY) = 5.00 X 1.10 = CNY 5.50
Market Cap (CNY mn) = 5.50 X 5,000 / 1,000 = CNY 27.5 mn
Enterprise Value (CNY mn) = Market Cap + Debt + Minority Interest Cash
Enterprise Value (CNY mn) = 27.5 + 175 + 50 200 = CNY 52.5 mn

60

5.00
5,000

Income Statement
Income Statement Information
Revenue/ Net Sales: Income from sales of goods and services, minus the cost associated with elements such
as returned or undeliverable merchandise, discounts, and allowances. Also called sales revenue, net sales,
net revenue, and sales
Other revenues: The total revenues which the company has earned may include other revenues incidental to
business. These are revenues derived from activities not directly related to the operations of the Company
and therefore should not be included in turnover. For instance, Rental income should not be included in
turnover. However, revenues of real estate companies will primarily consist of rental income. Therefore,
identify the Companys business and decide the composition of revenues accordingly
EBITDA: EBITDA means earnings before interest, taxes, depreciation and amortization. It is an indicator of the
cash earnings that a company generates from its on going and recurrent operations regardless of its capital
structure. EBITDA can be used to analyze the profitability between companies and industries, because it
eliminates the effects of financing and accounting decisions. (EBITDA is often used as an indicator of
unlevered cash flow in case of scarce information).
EBIT: EBIT means earnings before interest and taxes. It measures the income that a company generates from
its on going and recurrent operations. Also called Operating Income or Income from Operations
Net Income: Net Income represents total earnings available to common shareholders. Net Income is derived by
subtracting all costs of doing business, depreciation, interest and taxes from revenues. Share of minorities for
the period and preferred stock dividends, must also be deducted to arrive at Net Income.
61

Income Statement (contd)


Income Statement Information - Normalization
Normalization refers to the process of adjusting/ removing the effect of extraordinary and one-time items
from components of Income Statement (revenues, EBITDA, EBITA, EBIT & Net Income)
For the purpose of Comps, companies have to be evaluated and compared on basis of trading / valuation
metrics and thereby it is imperative that any exceptional and non-recurring items impacting the operating results
of a company be removed and cleaned, so as to make its results comparable within its peer group
Some examples of exceptional / non-recurring items include restructuring charges, impairment, gain on sale
of fixed assets, income from divested business etc
Always read through the Notes to Financial Statements and MD&A closely to identify extraordinary items.
Details of exceptional items are generally found in the Notes to financial statements and MD&A
Rule for making adjustments
ADD Exceptional charge, non-recurring expense or loss
REDUCE Exceptional or non-recurring gain, one-time gains
For adjusted net income, make appropriate tax adjustments for the tax impact of such extraordinary items. Read
the MD&A closely for actual tax impact of exceptionals, if available. If not, use the marginal tax rate for making
tax adjustments. Marginal Tax rate should be effective or statutory tax rate.

62

Income Statement (contd)


Income Statement Information
Let us consider the case of Novell Inc.
Example: Normalized Revenue

If you look at the Consolidated Statement of


Operations you would say that the companys
revenue for FY 2010 would be USD 811.871 mn.
But it is equally important to check the
Management Discussions & Analysis
(MD&A) section of the Annual 10K, where
you will find the breakup of the total net
revenue figure.
There you might find any exceptional item
which shall not be included as a part of core
revenue
of company.
This is the reason why it is very important to
carefully review the notes to the financial
statements and the MD&A section.
Also, always consider Net revenue after
deducting sales tax and not the Gross
Revenue!!

Net Revenue = USD 811.871 mn

63

Income Statement (contd)


Income Statement Information
Example: Normalized EBIT

The Company states that its operating income


was USD 84.437 mn Is this equal to EBIT? No!
Look carefully at the line items above the
operating income. These include the following
expenses which are non-recurring and not
directly related to the operation of the business
: Restructuring expenses, impairment of
goodwill, impairment of intangible assets,
purchased in process research & development,
gain on sale
of property, plant and equipment, gain on sale
of subsidiaries.
These items should not be included in the EBIT
calculation. We need to adjust for these one
time expenses or gains to get the correct EBIT

Company has not reported any amount


except restructuring expenses, hence we will
adjust EBIT for the latter.

EBIT = 84.437 + 2.774 = $ 87.211 mn

64

Income Statement (contd)


Income Statement Information
Example: Normalized EBITDA
EBITDA is one of the most commonly used
terms by investment banker because it is an
efficient way to understand the efficiency
and profitability of a company
EBITDA is calculated as
Normalized EBIT + Depreciation and
Amortization
Always remember to take Depreciation &
Amortization from the cash flow statement

EBITDA = 87.211 + 30.298 = USD 117.509 mn

65

Income Statement (contd)


Income Statement Information
Example: Normalized Net Income

In the Consolidated Statement of Operations,


the Company reports a net income of USD
377.366 mn
We need to adjust the reported Net income
figure to get the normalized net income like we
did for the previous EBIT calculation. The
company has a couple of non-recurrent and
extraordinary items which also have to be
adjusted to get the accurate net income. One
of such items is the Impairment / write down of
Investments
Now is net Income equal to:
= 377.366 -7.413+2.774= $ 372.727 mn.
Wrong!

66

Income Statement (contd)


Income Statement Information
Example: Normalized Net Income
Adjust for Tax : Always remember that when you are dealing with net income you have to account for the
tax implications of an increase or decrease in profits. Net income is always calculated after taxes, and in a
way expenses act as a tax shield, as the higher expenses you have the less taxes you pay.
Thus, One time and extraordinary charges have to be adjusted for tax. Here, we shall use the statutory tax rate of
the country of incorporation of the Company (which is 40% in case of Novell Inc. as it is a US company )
There are certain cases we need to remember when we charge Net Income for tax such as
1. Always charge Exceptional or one off items for tax whenever company is reporting net profit in its books.
2. In case company is reporting net loss, tax adjustment is done only if loss turns into profit after adjusting
for exceptional items and than tax is charged on the whole figure including net loss.
3. If the resulting figure for net loss remains negative even after adjusting exceptional items, there will be no
tax adjustment at all.
4. Remember to tax-effect all adjustments to net income, if items relate to an after-tax financial statistic and
are tax-deductible. Do not tax adjust a net loss or non-tax deductible items such as goodwill
Therefore, the adjusted Net Income

= 377.366 + ( -7.413+2.774)* (1- 0.40) = $ 374.582 mn

67

Income Statement (contd)


Income Statement Information
Example: Normalized EPS
Earnings per share (EPS) represents the portion of a company's earnings, net of taxes and preferred
stock dividends, but before equity dividends allocated to each share of the companys common stock
Basic EPS = Normalized Net income
Weighted average
basic shares outstanding
Basic EPS = $ 374.582 / 349.741
= $ 1.071

Diluted EPS = Normalized Net income


Weighted average
diluted shares outstanding

Diluted EPS = $ 374.582 / 353.447


= $ 1.059

68

72

Income Statement Information Indicative exceptional list


S. No.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30

Line item
Joint Venture
Discontinued operations
Restructuring cost / expenses
Expenses related to merger and acquisition transactions
Write down / Impairment of assets (both tangibles and intangibles
including goodwill)
Impairment of leasehold expenses
Loss / Gain on sale of tangible & intangible assets
Loss / Gain on sale of investments, other than marketable
Amortization of deferred compensation
Equity based compensation expense- stock options or warrants
Writing back of any provisions or reserves
Gain/Loss on sale of marketable securities
Income from associates / affiliates
Litigation settlement
Loss / Gain on sale or termination of an operation
Foreign currency exchange gain / loss
Accounting changes
Tax benefit from exercise of options
Provision for doubtful accounts
Amortization of debt issuance costs
Expenses associated with the Sarbanes Oxley Act
Rental income
Government grants or subsidies
Severance costs
Facilities consolidation
Gain / Loss on early extinguishment of debt
Early retirement costs
Redundancy costs
Donations
Amortization of Negative goodwill

Add Back
Y
Y
Y
Y

Tax adjustment
Comment
Y
Different treatment for different purposes
Y
No tax adjustment if net of tax
Y
Y

Y
Y
Y/N
Y
Y
Y/N
N
Y
Y
Y
Y
Y/N
Y
N
Y
Y
N
Y
Y
Y
Y
Y
Y
Y
Y

Y
Y
Y
Y
Y
Y
Y
Y
Y
Y

No tax adjustment on Goodwill

Loss/ Gain on strategic investment is exceptional

Provision is exceptional or not

No tax adjustment if net of tax


Cumulative effect relating to exceptions is exceptional

N
N
Y
Y
N
Y
Y
Y
Y

To be excluded from EBIT calculations

Restructuring expense

Y
Y
N

Item can be treated as exceptional or normal depending upon the industry and analysis
73

Understanding Multiples
Multiples are ratios with equity value (Price) or enterprise value (EV) in the numerator and a standardizing factor
(Earnings, Sales, Book Value, etc.) in the denominator.
Price/Earnings (PE) and variants (PEG and Relative PE)
EV/EBIT
EV/EBITDA
EV/Cash Flow
EV/ Book Value of Assets
EV/Sales
P / Book value
Both the value (the numerator) and the standardizing factor ( the denominator) in multiples represent the
same claimholders in the firm
For instance, value of equity is standardized with equity earnings, and enterprise value (value of entire firm)
is standardized with EBITDA or book value of assets
For multiples to make sense, the standardizing factor (earnings, EBITDA, etc) must be computed using
same accounting rules across all firms being compared

78

Multiples Example 1
EV/EBITDA=9.90x, EV/EBIT=12.38x, P/E=26.67x
EV/Sales=3.94x, EV/EBITDA=9.85x, EV/EBIT=12.31x, P/E=26.67x
79

Using Multiples
In order to use a multiple effectively to pass judgment on valuation of a firm:
Know how the multiple was computed
Same multiples can be computed differently. For instance, P/E can be computed as Price/LTM
Earnings, Price/Fiscal Year Earnings, or Price/Forward Earnings Estimate
Define the comparable asset universe of the multiple
It can be all firms in a sector, industry, entire market, or any subset thereof
Understand the fundamentals (growth, risk, profit margin, etc. ) that drive the multiple, and the nature of
the relationship between the multiple and each fundamental variable
These relationships explain the variations in multiple across firms
The relationship between a fundamental (like growth) and a multiple (such as PE) is seldom linear.
For example, if firm A has twice the growth rate of firm B, it will generally not trade at twice its PE ratio
It is impossible to properly compare firms on a multiple, if we do not know the nature of the
relationship between fundamentals and the multiple
Know the cross sectional distribution of the multiple across comparables
Multiples have no value when looked at in isolation

80

Price/Earnings (PE Ratio)


PE = Market Price per Share / Earnings per Share
There are a number of variants on the basic PE ratio, based upon how the price and the earnings are defined
Price is usually the current price
Though some like to use average price over last 6 months or year
EPS can have following variations
Time variants: EPS in most recent financial year (current), EPS in most recent four quarters (trailing), EPS
expected in next fiscal year or next four quarters (both called forward) or EPS in some future
year
Primary, diluted or partially diluted EPS
EPS before or after extraordinary items
EPS measured using different accounting rules for outstanding shares (options expensed or not, pension
fund income counted or not, etc)

81

Multiples Example 2
Example 2. Calculate the Basic P/E, Diluted P/E, adjusted Basic P/E & adjusted Diluted P/E multiple with
the following information:
(all figures in US$ mn except share data)
Share price $10.00
Shares outstanding

1,000

Wtd. Avg. shares outstanding (Basic) 950


Wtd. Avg. shares outstanding (Diluted) 990
Revenue

5,000

Restructuring charges

1,000

One-time Insurance recoveries


Non-recurring charges
EBIT

500

300

1,500

Interest Expenses

500

Reported Net Income

500

(after adjusting tax @30%)


a) P/E 19.00x, Diluted P/E 19.80x, Adj. P/E 19.00x, Adj. Diluted P/E
19.80x b) P/E 19.00x, Diluted P/E 19.80x, Adj. P/E 8.96x, Adj. Diluted P/E
9.34x
c) P/E 19.00x, Diluted P/E 19.80x, Adj. P/E 7.31x, Adj. Diluted P/E
7.62x d) P/E 19.00x, Diluted P/E 19.80x, Adj. P/E 4.13x, Adj. Diluted
P/E 4.30x

82

Multiples Example 2 (contd)


Correct answer is (b)!!!!!!!!!...
Reported net income = US$ 500 mn
Adjusted net income = Net income + Restructuring charges* - One-time Insurance recoveries* + Nonrecurring charges*
* Adjusted for tax @ 30%
Adjusted net income = 500 + (1,000 500 + 300)*(1-0.3) = US$ 1,060 mn
Reported Basic EPS = 500/950 = US$ 0.53

Reported Diluted EPS = 500/990 = US$ 0.51

Adjusted Basic EPS = 1,060/950 = US$ 1.12

Adjusted Diluted EPS = 1,060/990 = US$ 1.07

Reported Basic P/E = 10.00/0.53 = 19.00x

Reported Diluted P/E = 10.00/0.51 = 19.80x

Adjusted Basic P/E = 10.00/1.12 = 8.96 x

Adjusted Diluted P/E = 10.00/1.07 = 9.34x

83

PE Fundamentals
To understand the fundamentals, start with a basic equity discounted cash flow model
Dividend discount model for equity price

P0

DPS1
r g

Where, DPS1 is dividends per share next year, r is equity risk, and g is perpetual growth rate
The above relationship implies that, other things held equal:
Higher growth firms will have higher PE ratios than lower growth firms
Higher risk firms will have lower PE ratios than lower risk firms
Firms with lower reinvestment needs will have higher PE ratios than firms with higher reinvestment rates

84

Enterprise Value (EV) Ratios


While Price earnings ratios look at the market value of equity relative to earnings to equity investors, Enterprise
Value ratios look at total value of the firm relative to total operating earnings or free cash flows
The form of value to cash flow ratios that has the closest parallels in DCF valuation is the value to Free Cash
Flow to the Firm, which is defined as:
EV/FCFF
EV = Market Value of Equity + Market Value of Debt - Cash
FCFF = EBIT (1-t) - (Cap Ex - Depreciation) - Chg in Working Cap

85

Multiples Example 3
Example 3. What is the EV/EBITDA, EV/EBIT and EV/FCFF for the company:
(all figures in US$ mn)
Share Data

Income Statement

Share Price

$5.00

Revenue

Shares outstanding

1,000

COGS

270

SG&A

200

B al an ce Sh eet

1,000

Cash

200

R&D

50

Debt

175

Restructuring expenses

30

Minority Interest

50

EBIT
Tax rate

450
30.0%

Cash Flow Statement


Depreciation

50

Amortization of intangibles

50

Capex

100

Change in Working Capital

(75)

a) EV/EBITDA = 9.14x, EV/EBIT = 11.17 & EV/FCFF =


12.88x b) EV/EBITDA = 8.66x, EV/EBIT = 10.47 & EV/FCFF
= 12.88x c) EV/EBITDA = 8.66x, EV/EBIT = 10.47 & EV/FCFF
= 12.23x d) EV/EBITDA = 9.14x, EV/EBIT = 11.17 &
EV/FCFF = 12.23x
86

Multiples Example 3 (contd)


Correct answer is (c) !!!!!
EV

= (5*1,000) + 175 + 50 200 = $ 5,025 mn

Adjusted EBIT

= Reported EBIT + Restructuring expenses

Adjusted EBIT

= 450 + 30 = $ 480 mn

Adjusted EBITDA

= Adj. EBIT + Depreciation + Amortization of intangibles

Adjusted EBITDA

= 480 + 50 + 50 = $ 580 mn

FCFF

= Adj. EBIT * (1 - tax rate) (Capex D&A) Change in working capital

FCFF

= 480 * (1-0.3) (100 50 50) (-75) = US$ 411 mn

EV/EBITDA= 5,025 / 580 = 8.6x


EV/EBIT

= 5,025 / 480 = 10.4x

EV/FCFF

= 5,025 / 411 = 12.2x


87

EV Ratio Alternatives
Most analysts find FCFF to complex or messy to use in multiples (partly because capital expenditures and
working capital have to be estimated) They use modified versions of the multiple with the following
alternative denominators such as EBIT or EBITDA
EBIT: pre-tax operating income
EBITDA: earning before interest, taxes, depreciation, and amortization
Assume that you have computed the value of a firm, using discounted cash flow models. Rank the
following multiples in the order of magnitude from lowest to highest?
EV/EBIT
EV/EBITDA
EV/FCFF

88

Why use EV/EBITDA?


It can be computed even for firms that are reporting net losses, since earnings before interest, taxes
and depreciation are usually positive
For firms in certain industries, such as cellular, which require a substantial investment in infrastructure and
long gestation periods, this multiple seems to be more appropriate than the price/earnings ratio
In leveraged buyouts, where the key factor is cash generated by the firm prior to all discretionary
expenditures, the EBITDA is the measure of cash flows from operations that can be used to support debt
payment at least in the short term
By looking at cash flows prior to capital expenditures, it may provide a better estimate of optimal
value, especially if the capital expenditures are unwise or earn substandard returns.
By looking at the value of the firm and cash flows to the firm it allows for comparisons across firms with
different financial leverage.

89

Other Common Ratios


EV/Sales: ratio of the market value of the firm to the sales
Price/Book Value: ratio of market value of equity to the book value of equity, i.e., the measure of shareholders
equity in the balance sheet
If the market value of equity refers to the market value of equity of common stock outstanding, the book
value of common equity should be used in the denominator
If there is more than one class of common stock outstanding, the market values of all classes (even the
non- traded classes) needs to be factored in.
EV/Book Value: ratio of sum of market value of equity and market value of debt to sum of book value of
equity and book value of debt

90

Choosing Between Multiples


There are dozens of multiples that can be potentially used to value an individual firm. In addition, relative
valuation can be relative to a sector (or comparable firms) or to the entire market (using the regressions,
for instance). However, since there can be only one final estimate of value, there are three options:
Use a simple average of the valuations obtained using a number of different multiples
Use a weighted average of the valuations obtained using a number of different multiples
Choose one of the multiples and base your valuation on that multiple

The best approach is to choose a set of relevant multiples that make most sense for that industry or sector,
given how value is measured and created

91

Sector Multiples
Sector

Multiple Used

Rationale

Cyclical Manufacturing

PE, Relative PE (Firm PE Relative to


Market PE); Often with normalized
earnings

Stable industry with established


fundamentals

High Tech, High Growth

PEG (PE/Growth Rate)

Big differences in growth across firms

High Growth, No Earnings

EV/Sales, Price/Sales

Zero or negative earnings

Heavy infrastructure

EV/EBITDA

Capital intensive, with high


depreciation expense

Financial Services

Price/Book Value, PE

Operations for these companies is


borrowing and lending debt, we only
consider equity related ratios

Retailing

Price/Sales, EV/Sales

Low margins across board, Value is


predominantly measured with sales

92

Copal Partners

DCF Valuation

112

Index
Table of Content
Time value of money

114

Cost of capital

127

Free Cash Flows (FCF)

137

Sensitivity Analysis

138

DCF-based valuation

139

Terminal Value

145

Equity Value from Firm Value

148

Advantages and Disadvantages of DCF

149

113

Time Value of Money


Lets review the three main concepts used in DCF-based valuation
Time value of money
Cash flows
Present value (PV)
Net present value (NPV)
Perpetuities
Discount rate
Cost of Capital
Cost of Equity
CAPM
Cost of Debt
WACC
Free Cash Flow (FCF)
Free cash flow to firm (FCFF)
Free cash flow to equity (FCFE)

114

Cost of Capital
Corporate capital budgeting decisions are based on expected return on investment
Investment examples include building a new plant, launching a new product, or acquiring another company
Cost of Capital is the required return necessary to make a capital investment worthwhile
Capital is provided as either debt or equity, hence Cost of capital includes Cost of Debt and Cost of Equity
Cost of Capital = Weighted average of Cost of Debt and Cost of Equity
The Cost of Capital determines the optimal way for the company to raise money (through a stock
issue, borrowing, or a mix of the two)

127

Cost of Equity
The cost of equity is the rate of return that investors require to make an equity investment in a firm
There are two approaches to estimate the cost of equity
Dividend-growth model
Risk and return model
Dividend growth model specifies the cost of equity to be the sum of the dividend yield and the expected growth
in earnings
Useful for mature companies that distribute most of the earnings to shareholders as dividends
Risk and return model, on the other hand, tries to answer two questions:
How do you measure risk?
How do you translate this risk measure into a risk premium?

We will use Risk and return model to compute Cost of Equity

128

CAPM
CAPM or Capital Asset Pricing Model is a risk and return based model for computing expected return on equity
(Cost of Equity to the firm)
According to CAPM, expected return of a security or a portfolio equals the return on a risk-free security plus a
risk premium
Re = Rf + b (Rm- Rf)
Rf: Rate of return for a risk-free security
Beta b: measure of equity risk relative to market portfolio
Rm: Expected return on market portfolio (average risk investment)
Rm-Rf: Market risk premium
Example: Compute the expected return on IBM stock, given that risk-free rate is 4%, IBM beta is 1.4, and
market risk premium is 5.5%
Re [IBM] = 4% + 1.4*5.5% = 11.70%
Implies that in the long-term, investors expect to earn 11.70% return on IBM stock

129

CAPM Inputs
Rf: Riskfree rate
Usually the short-term US Govt. T-bill rate or the long-term US Govt. Security rate, since they have no
default risk
The choice between short-term rate and long-term rate depends on the investment horizon
Firm valuations are over a long-term horizon, so use long-term US Govt. Bond rate for firm valuation

Beta b: measure of equity risk relative to market portfolio


= 1 ... Average risk investment (same as Market Portfolio)
> 1 ... Above Average risk investment
< 1 ... Below Average risk investment
= 0 ... Riskless investment

130

CAPM Inputs (contd)


Computing Beta:
Approach 1: Regress the historical return on equity (Re) with historical market portfolio return
(Rm) Regression output::

Re = a + b Rm

Where a is the intercept and b, the slope of regression, is the beta of stock and measures the riskiness of
the stock.
This approach has several issues:
High standard error
Beta is based on historical business and leverage of the firm, either or both of which may be different in
the present
Approach 2: Bottom-up approach
Find out the businesses that a firm operates in
Find the unlevered betas of other firms in these businesses
Take a weighted (by sales or operating income) average of these unlevered betas
Lever up using the firms debt/equity ratio

131

Estimating Cost of Equity


Lets estimate Intels Cost of Equity
Intel equity beta: 1.36
Current risk-free rate: 4.5% (long-term US Government Bond Rate)
Risk premium = 5.5% (Historical value)
Expected return on equity using CAPM:
Re = 4.5% + 1.36*5.5% = 11.98%

Hence, Intel needs to make at least 11.98% as return for their equity investors. This is the hurdle rate for
projects, when investments are analyzed from an equity standpoint. In other words, Intels Cost of Equity
is
11.98%

132

Cost of Debt and its Estimation


Cost of Debt is
the market rate of interest at which the company can borrow today
corrected for the tax benefit it gets for interest payments
Cost of debt = Rd = Interest rate on debt (1 - tax rate)
Caution: Cost of debt is not the interest rate at which the company obtained the old debt that it has on its books

Use one of the following to estimate cost of debt


If the firm has long-term bonds that are traded, use the current yield to maturity on firms bonds as the
interest rate in cost of debt calculation
If the firm is rated, use the rating and a typical default spread on bonds with that rating to estimate the
interest rate
If the firm has recently borrowed long-term from a bank, use the interest rate on the borrowing
If the firm is not rated and no other information about recent bank loans is available, use interest
coverage ratio (EBIT/Interest expense) of the firm to estimate a rating and use the default spread on
bonds with that rating to estimate interest rate
Quick (and dirty) computation of cost of debt: current interest expense/book value of total debt

NOTE: The cost of debt has to be estimated in the same currency as the cost of equity and the cash flows

133

Cost of Capital (WACC)


Market Value of Equity (E) should include the following
Market Value of Shares outstanding
Market Value of Warrants outstanding
Market Value of Conversion Option in Convertible Bonds

Market Value of Debt is more difficult to estimate because few firms have only publicly traded debt. There are
two solutions:
Assume book value of debt is equal to market value
Estimate the market value of debt from the book value?

134

Cost of Capital (WACC) (contd)


A firms Cost of Capital is calculated by taking a weighted average of the firms cost of equity and cost of debt.

WACC represents the investors opportunity cost for investing in a particular business instead of others with
a similar risk.

Cost of capital so computed is called Weighted Average Cost of Capital or WACC

WACC

E
* Re
V

D
* Rd (1 Tc )
V

Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V=E+D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

WACC is used as the discount rate for all cash flows with risk that is similar to that of the overall firm

135

Cost of Capital (WACC) (contd)


Example: Compute IBMs WACC, given:
Re = cost of equity = 11.7%
Rd = cost of debt = 8%
E = market value of the firm's equity = $150
billion D = market value of the firm's debt = $50
billion Assume Tc = 35%
V = E+D = $200 billion

WACC

E
* Re
V

WACC[IBM ]

D
* Rd (1 Tc )
V

150
*11.70%
200
10.08%

50
*8%(1 35%)
200

IBMs Cost of Capital: 10.08%

136

Free Cash Flow FCF


Free Cash Flow to Firm (FCFF) is the cash flow that is generated by companys operations and available to
all the companys capital providers (investors), including both debt and equity
Computed as operating income less expenses, taxes, and changes in net working capital and investments
Measures company's profitability after all expenses and reinvestments
FCFF is also equal to the sum of CFs paid to or received from all the capital providers (interest, dividends,
new borrowing, debt repayments and so on)

FCFF = CF available to all investors = EBIT taxes increases in working capital +/- deferred taxes + D&A - Capex

Free Cash Flow to Equity (FCFE) is the portion of FCFF that is available to companys equity investors.
This is a measure of how much cash can be paid to the equity shareholders of the company after all
expenses, reinvestment and debt repayment
FCFE = CF available to equity investors only = Earnings after interest and taxes increases in working capital
+/- deferred taxes + D&A - Capex

137

Sensitivity Analysis

Sensitivity Table

Sensitivity Analysis aim at showing the value impact if changing individual key assumptions or the main
value drivers. Following is an example of valuation sensitivity to assumptions regarding cost of capital and
terminal growth.

Few factors that are subject to sensitivities are:


Revenue growth, price , Volume
EBIT, EBITDA, PE Margins
Capex, Cost of Capital
There are many lot many other potential sensitivity variables. However, the focus on those factors which have
the greatest uncertainty or the greatest value impact.

138

DCF based Valuation


DCF-based valuation analysis discounts projected (expected) cash flows of a firm with an appropriate
discount rate to determine firms value in present time
The fundamental choices for DCF-based valuation
Cash flows to Discount
Free Cash Flows to Equity (FCFE)
Free Cash Flows to Firm (FCFF)
Discount Rate
Cost of Equity
Cost of Capital (WACC)
Base Year Numbers
Current Earnings / Cash Flows
Normalized Earnings / Cash Flows

139

DCF based Valuation (contd)


Firm / Equity Valuation Overview
There are two approaches to valuation: A firm can be valued from two different perspectives
Firm valuation (Enterprise Value or Transaction Value) represents the value of all capital invested in business
EV = Equity Value + Net Debt
Equity valuation (Market Value or Offer Value) Value attributable to owners of the company after paying debt.
Firm valuation vs. equity valuation
Firm
Firm valuation values the entire
business including both debt
and equity claims thereby giving
value of the company to debt

Debt (D)

Assets
(A)

Equity (E)

Claim holders

holders and shareholders.


A = D+E
Equity valuation values just the equity claim in
business i.e. value of a company to shareholders

140

DCF based Valuation (contd)


Equity vs. Firm Valuation
Equity Valuation: value just the equity stake in the business
Obtained by discounting expected cash-flows to equity (FCFE),
i.e., the residual cash-flows after meeting all operating
expenses, tax obligations, interest and principal payments,
and reinvestment needed for future growth

t n

ValueEquity

FCFEt
t
Re )

(1
t 1

Discount rate used is the Cost of Equity

t n

Firm valuation: value the entire business, including, besides


equity, the other claimholders in the firm
Obtained by discounting expected cash-flows to the firm
(FCFF), i.e., the residual cash-flows after meeting all operating
expenses, taxes, and reinvestments needed for future
growth, but prior to debt payments
Discount rate used is the weighted average cost of capital
(WACC)

141

Value Firm

(1
t 1

FCFFt
t
WACC )

n = life of the company

DCF based Valuation (contd)


DCF-based Firm Valuation
Common steps:
Compute firms WACC
WACC can be in nominal terms or real terms, depending upon whether the cash flows are nominal or real
WACC can vary from year to year depending on changes in cost of equity or cost of debt

Obtain latest financial statements for the firm


You may want to normalize the earnings and cash flows

Project future earnings and cash flows (FCFF) for 5-7 years by estimating an expected growth rate in sales
and earnings during this period
Growth rate may also vary from year to year

For fast growth companies, estimate when the firm will reach stable growth and what characteristics (risk &
cash flow) it will have when it does

For mature companies, estimate a nominal growth rate for cash flows beyond the projection period. This is
usually equal to the growth rate of the economy
142

DCF based Valuation (contd)


DCF-based Firm Valuation

Value of Firm
=
Present value of operating FCFF during explicit forecast period (5-7 years)
+
Present value of cash flow after explicit forecast period (Terminal
Value)

143

DCF based Valuation (contd)


Computing FCFF
Start with EBIT
Less: Taxes on EBIT
Plus or minus: change in deferred taxes
= NOPLAT (Net Operating Profits less adjusted
taxes) Add: Depreciation and Amortization
Plus or minus: Change in Working Capital
Less: Capital Expenditure
=Operating Free Cash Flow
Plus or minus: Cash flow from Non Operating Investments
=Cash Flow available to investors (FCFF)

NOTE : FCFF does not include any of the financing related cash flows such as interest expense or dividends

PVF CFF

(1
t 1

FCFFt
WACC )

144

Terminal Value
Two ways for estimating terminal value:
Assume that the firm will generate the last forecast year cash flows in perpetuity
Can also assume a modest growth rate (usually equal to the GDP growth rate)

Terminal Value
=

C n (1 g )
WACC g

Cn = FCFF in the last year of forecast


g = cash flow growth rate in perpetuity

Compute terminal value as a multiple of EBITDA in the last year of forecast


Use current EV/EBITDA multiple to estimate terminal value

Terminal Value
=

EBITDA *
n

EVcurrent
EBITDAcurrent

145

n = last year of forecast

DCF Worksheet Example

146

Cash Flow Considerations


Capital Expenditures:
Treatment of R&D expenses
Treatment of operating leases
Acquisitions
Other capitalizable expenses
Normalization of earnings and cash flows
Treatment of one-time/unusual/restructuring expenses

Tax rate:
Marginal tax rate vs. Effective tax rate?

Treatment for Minority holdings, Preferred Equity or Pension Obligations


Options, Warrants, and equity value portion of convertible debt
Revenue and earnings growth rate

147

Equity Value from Firm Value


Steps:
Compute present value of all operating cash flows during projected years
Add: Present value of terminal value
Add: Present value of minority interests

Total value of firm


Less: Value of outstanding debt
Less: Value of outstanding options
Less: Value of outstanding
warrants
Less: Value of equity portion of convertible debt
Total Equity Value
Divide by: Number of number of outstanding shares
Value of equity per share

148

153

Sources
165

Company Website or Filings


Presentations

Brokers Rating
Reflects the market / broker views on fundamentals of the Company i.e. a higher rating reflects strong
fundamentals & hence low level of risk and a lower rating reflects weak fundamentals & hence high level of
risk
Indicates the analyst consensus
The Brokers rating chart gives the breakup of the total number of Buy, Hold and Sell recommendations over
an last twelve months (LTM) period
The section on Analyst Commentary provides commentary on the company from the analysts research reports
The commentary highlights the strengths of the company and how it has been able to benefit from these
strengths. It may also include the Companys recent developments and which may have affected the
share price and/or the analyst recommendation of the company

Sources

Databases such as Bloomberg, FactSet, Capital IQ, Thomson etc


166

Share Trading Analysis


Share trading analysis provides an overview of the share price and the various trends related to capital markets
This section is key to any of the books prepared
The purpose of this section is to understand and analyze the share price and capital market movements
with respect to the chosen company
Various types of charts prepared
Relative share price performance
Annotated share price performance
Volume at price and liquidity analysis
Overview of Research analyst ratings
Development of Consensus Estimates
Broker Comment Frequency Analysis
Valuation methods used by research analysts

167

Share Trading Analysis (contd)


Relative share price performance
Used to compare the performance of the companys
share with respect to the primary index in the market
Points to remember
Always consider closing price of the stock instead
of the last traded price
The closing price to be considered should be of a
day prior to the date on which it is created

The index should always be rebased to the


companys share price in order to have an
apples to apples comparison

Stock exchange
websites

Sources

Databases such as
Bloomberg, FactSet,
DataStream, Capital
IQ etc

168

Share Trading Analysis (contd)


Annotated share price performance
Prepared exactly as a normal share
price performance chart with the
only difference being the inclusion
of news that reflect the changes in
the share price movement
Always look for dates where there
has been a drastic change in the
share price movement vis--vis its
primary index. Thereafter look for
news that have triggered those
changes in the share price

Press releases from company website

Sources

Stock exchange websites


Databases such as Bloomberg, FactSet, DataStream, Capital IQ etc

169

Share Trading Analysis (contd)


Volume at price and
liquidity analysis
Objective is to show in a
chart how has traded
volume of the share been
distributed between
different price ranges

Sources

Stock exchange websites


Databases such as Bloomberg, FactSet, DataStream, Capital IQ etc

170

Share Trading Analysis (contd)


Overview of Research analyst ratings
Gauges different analysts perception of the stock and what kind of recommendation they are making on it
The purpose is to understand the view of the market on the stock

Sources

Research reports
Databases such as Bloomberg, Capital IQ etc

171

Share Trading Analysis (contd)


Development of Consensus Estimates
Gauges the consensus estimates on Revenues, EBITDA and EPS for the future years and how they evolve
Consensus estimates represent the market perception on the future operational results of the company
Always calendarize the estimate to have a constant point of reference

Sources

Databases such as Bloomberg, Reuters, Capital IQ etc

172

Share Trading Analysis (contd)


Broker Comment Frequency Analysis
Conduct a qualitative analysis of the perception of
the stock in the market, identifying key and
recurrent themes in the different analyst reports
Categorize these themes as positive and negative
to indicate analyst comments
Key themes may include: trends in the industry,
technological trends, extraordinary events, risks,
challenges etc

Sources

Research reports

173

Share Trading Analysis (contd)


Valuation methods used by research analysts
To describe the valuation methods used by the research analysts covering the stock
Information to be included:
bank/broker name
main valuation methods used
main comparable companies used for valuation purposes
key comments on the valuation of the company

Sources

Research reports
174

Copal Partners

Case Studies

175

Data gathering (contd)


Develop a Search Strategy
Using the Internet to search for business valuation information
is potentially one of the most efficient ways
Boolean logic is the basic logic system used for online searching;
uses three logical operators: AND, OR and NOT
The AND connector means that all search terms connected by the
AND must be present
The OR connector requires either term to be present
The NOT connector returns records where the designated
term does not appear
Another helpful search logic tool is truncation. Truncation, also
known as wild card searching, allows searching of word variations
Wild cards can vary from database to database but usually
are either the * or ?
Evaluate Information
The following questions should be asked for evaluation:
Who authored this information? - Is the authors name and affiliation
disclosed? Is there an e-mail address so that you can inquire
further? Is the author the creator or the compiler of the information?
Who is publishing this information? - Can the producer be
identified and contacted? Is it a professional organization? Does
the organization have a particular bias? Who is the intended
audience?
What can you determine about the content? - How complete is the
information? Is it an abstract of the complete text? Are the
references documented, current and relevant?
201

Creating an analysis structure


Providing an overview and describing a situation
Always start with the subject familiar to the target audience
Establish facts about the subject
Prove it is a profitable venture for investment
Highlighting opportunities arising out of the situation

Identify and state the factors that are creating opportunities

Establish facts and future prospects of the available opportunities

Compare available opportunities


Tapping opportunities through M&A
Show how M&A can help in tapping opportunities
Prepare a supply/value chain showing benefits of the transaction to both
the acquirer and the target
Appendix
Should contain all necessary definitions of the jargons used in the presentation
Include profiles of the selected target companies
Include previous transactions & comps for that industry
202

Project execution
Insights through primary research
Using insights from industry personnel will help in a deeper understanding of
the industry on which you are working
Create a call list within 1-2 days so that the questions that arise from the
hypothesis are sent to these contacts
Assign 1 or 2 persons to check for information on companies,
industry associations and their contact details
Send the interview requests by email at the beginning of the study. This
allows for the process to get started while the team conducts the secondary
research
The same set of questions should not to be sent to all persons in the mailing list.
Queries sent to different persons should be pertaining to their respective
areas of operations

Do not just write an email for information request and wait for people
to respond. Be proactive, keep calling until you get the desired data
from external and internal contacts
Follow a reasonable caution while calling up external sources

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Project execution (contd)


Apply So what analysis to convert a data dump into a storyline
For all facts and information on each slide, always ask yourself so what
Always present in a way that forces reader to prompt so what and then answer it in the next section. Keep
doing this unless no such question arise
If the implication of a slide comes out clearly, it transforms a data dump into a value-added analysis

Key questions:
So what does this mean?
Will this affect the sector, economy or the region being analyzed?
Will the impact be positive or negative?
Is the rate of change fast or slow? (Will the impact be strong and immediate or not?)
Does this get you closer to proving or disproving your current hypotheses?

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Copal Partners

Research Techniques

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Introduction
There are a lot of research methodologies used to prepare an Industry piece. The most extensively used
techniques are as follows:
A. SWOT Analysis
B. PESTEL Analysis
C. Porters Five forces model

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SWOT Analysis
A. SWOT Analysis: An analysis of STRENGTHS,WEAKNESSES, OPPURTUNITIES and THREATS.
Extremely useful tool for understanding and decision-making
Applicable in all businesses and organizations
Provides a framework for reviewing strategy, position and direction of a company or business proposition,
or any other idea
Can be used for business planning, strategic planning, competitor evaluation, marketing, business
and product development and research reports
Presented as a grid, comprising four sections, one for each of the SWOT headings
SWOT analysis can be used to assess:
company (its position in the market, commercial viability, etc)
method of sales distribution
product or brand
business idea
strategic option, such as entering a new market or launching a new product
opportunity to make an acquisition
potential partnership
changing a supplier
outsourcing a service, activity or resource
an investment opportunity

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PESTEL Analysis
B. PESTEL Analysis
PESTEL is an acronym for Political, Economic, Social, Technological, Environmental and Legal
PESTEL Analysis helps analyze factors in the macro-environment that affect the decisions of the managers
of any organization
Examples include: Tax changes, new laws, trade barriers, demographic change, government
policy changes etc
Helps analyze the many different factors in a firm's macro environment
It is important not to just list PESTEL factors because this does not in itself tell much
Need to find out, which factors are most likely to change and which ones will have the greatest impact
on the company i.e. each firm must identify the key factors in their own environment

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Porters Five forces model


C. Porters Five forces model
It is designed to explain the relationship between the five dynamic forces that affect an industrys performance;
these are the:
intensity of competitive rivalry;
threat from new entrants;
threat from substitutes;
bargaining power of buyers;
bargaining power of suppliers.
The Five Forcers Analysis model tries to identify what factors shape the character of competition within
an industry.
Targets the assessment of the structural attractiveness of the analyzed industry.
Finally the Five Forces Analysis pinpoints strengths and weaknesses in a company and
discovers opportunities or threats within the industry

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Competitive forces at work in the industry

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