Deloitte Corporate Finance

Fundamentals of Valuation
Private and Confidential

November 5, 2014
Fundamentals of valuation
This evening’s speakers
Ian Wanke
Vice President
Corporate Finance
(604) 640-3355
iwanke@deloitte.ca
Kayli Clark
Senior Associate
Valuations
Vancouver
Direct: +1 604-640-4984
Email: kayclark@deloitte.ca
Chelsea Jiang
Analyst,
Corporate Finance
Vancouver
Direct: +1 604-601-3496
Email: chejiang@deloitte.ca
1 Deloitte Corporate Finance: Fundamentals of Valuation
Ian is a Vice President in our mid-market corporate finance practice in Vancouver. Focused on
mergers and acquisitions, and financing for growth, Ian has led several transactions which have
involved strategic private and public acquirers, as well as, private equity acquirers. Ian has experience
working in manufacturing, food and beverage, mining, real estate, forestry, and other business to
business operations.
Prior to joining the corporate finance practice, Ian gained experience working for a local private equity
company, assisting with the successful close of mid-market acquisitions. Ian is a Chartered Accountant
and a Chartered Business Valuator and he holds a Bachelor of Commerce Degree from the Sauder
School of Business. Ian serves as the Treasurer on the Board of the Dixon Transition Society and he
has been published by the Chartered Professional Accountants Association of BC for articles in M&A.
Kayli is a Senior Associate in our business valuations practice in Vancouver. During her time at Deloitte
Kayli has specialized in mining valuations in connection with mergers and acquisitions, disputes,
income tax planning and corporate restructurings. In addition to mining, Kayli has experience working in
manufacturing, forestry, healthcare and consumer goods.
Prior to joining the Valuations team at Deloitte, Kayli worked for a biotechnology investment fund
specializing in early stage medical device companies. Kayli is currently pursuing both her CA and CBV
designations and she holds an Honours Business Administration Degree from the Ivey School of
Business.
Chelsea is an Analyst in the Corporate Finance Advisory group in Vancouver. During her time at
Deloitte Chelsea has focused on research in the metals and mining sector, supporting public company
mergers and acquisitions, project financing and advisory mandates.
Prior to joining the team at Deloitte, Chelsea worked for an Equity Research firm in their metals and
mining team. Chelsea currently holds a Bachelor of Business Administration from the Simon Fraser
University.
© Deloitte LLP and affiliated entities.
Fundamentals of valuation
Agenda

Fundamentals of Valuation Workshop

Deloitte Corporate Finance Overview

Valuation concepts

Discounted cash flow

Market based approaches

Case Study: Premium food company valuation

Q &A

2 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
 Deloitte Corporate Finance
Overview

3 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Deloitte at a glance
Corporate finance – part of a complete solution

Financial
Audit Tax Consulting
Advisory

Consumer Financial Advisory

Business
Mid-Market Transaction Valuation Forensic & Reorganization
Engineering & Corporate Finance Services Services Dispute Services Services
Construction • Divestitures & • Lender due • Purchase price • Forensic • Turnaround
acquisitions diligence allocation investigations • Loan portfolio
Financial Services • Private equity • Vendor due • Goodwill • Analytic & management
capital raise diligence impairment forensic • Stressed and
• Acquisitions, • Structured finance technology distressed
• Debt advisory
• Dispute
Industry

reverse takeovers • Business & advisory services

Manufacturing • Management buy-
• Acquisition & intangible asset consulting • Liquidation
outs
investments by valuations • Class action • Insolvency
• Options analysis
private equity • Pricing analysis services services
Mining & Energy groups and
Public Corporate • Fairness opinions • Expert witness • Performance
Finance financial buyers
• Litigation support Improvement
Private Equity • Fairness opinion • Anti-money • Merger
laundering Integration
• Capital markets
and IPO advisory • Business
Public Sector intelligence
• Board advisory
• Anti-corruption
• Shareholder value
Technology, analysis, strategic
partnerships and
Media & Telecom joint ventures

4 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Deloitte Corporate Finance
One of the largest practices in the world

• Deloitte Corporate Finance Firm Revenue (2014)

– In more than 150 countries, is the world’s largest
private professional services practice in terms of
headcount and fee income.
– Offers sophisticated investment banking advice to
31%
companies participating in public and private
transactions globally.
– Boutique levels of service and industry knowledge
integrated with the market reach and technical 69%
resources of a global advisory network.
– Last year, Deloitte advised on over 350 completed
M&A transactions globally.
• Deloitte is consistently ranked as a leading
Advisory Audit
Global Mid-Market Advisor by Thomson Financial

Deloitte’s Global Footprint

North America: Vancouver, Toronto, Montreal, New York, Los Angeles, Chicago Asia: Tokyo, Hong Kong, Seoul, Beijing, Mumbai
Latin America: Sao Paulo, Santiago, Buenos Ares, Mexico City Australia: Brisbane, Sydney, Perth
Africa: Johannesburg
Europe: London, Paris, Madrid, Brussels, Oslo, Frankfurt, Berlin, Moscow, Munich, Rome, Warsaw

5 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Deloitte Corporate Finance
Complete corporate finance advisory services

Mergers and Acquisitions Corporate Advisory

• Strategy development • “Outsource” corporate

• Acquisitions or development
divestitures • Strategic assessment
• Valuations and analysis

• Execution • Board, shareholder

services

Capital Raising Other

• Capital raising • Fairness opinions

• Option analysis • Capital projects
• Private placements • Safety assessment
• Strategic investors • “Deloitte as one”

6 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Global mid-market advisory team
A global advisory platform for private companies in BC

Core Mid-Market Advisory Team in BC Global Mid-Market Corporate

Finance Team
Europe
 Austria  Luxembourg
 Belgium  Netherlands
 Central Europe  Norway
 Denmark  Portugal
 France  Spain
 Finland  Switzerland
 Germany  Russia
 Greece  Turkey
 Ireland  United Kingdom
David Lam Dallas Mcmurtrie Doug Beaton
 Italy
Partner, Mid- Partner, M&A Tax Vice President &
North America Asia Pacific
Market Advisory Advisory Director
 Canada  Australia
 Mexico  China
 United States  India
- Chicago  Indonesia
- Dallas  Japan
- Detroit  Malaysia
- Los Angeles  New Zealand
- New York Middle East  Philippines
 United Arab Emirates  Singapore
Africa  Saudi Arabia  South Korea
South America
 South Africa  Kuwait  Taiwan
 Argentina  Nigeria  Qatar  Thailand
 Brazil
 Chile

Ian Wanke Ashton Scordo Matt Miller

Vice President Senior Analyst Analyst

Matt Meyer Rob Olsen Cahal Dowds Simon Gisby Will Frame Ronald Chao Avinash Gupta
Senior VP Partner Vice Chairman Partner, CF Senior VP Partner Partner
Los Angeles Toronto UK London New York Chicago Beijing India

Strong local team with a global network of 1,300 corporate finance

professionals across 30 countries
7 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
 Deloitte’s financial sponsors group
Enhancing our private equity coverage through the acquisition of McColl
June 10, 2013 - Deloitte US has teamed up with McColl Partners LLC. Founded by former Bank of
America CEO Hugh McColl in 2001, McColl Partners focuses on strategic advice and assistance to
entrepreneurial clients in evaluating and executing mergers, acquisitions, divestitures, and private capital-
raising assignments.
Overview A Powerful Combination – Deloitte US + McColl Partners

• Dedicated Financial Sponsors group to ensure unparalleled

Central
20 professionals understanding of private equity market dynamics
• Chicago
• Detroit
• Proven track record under Mr. Hugh L. McColl Jr., former Chairman
and Chief Executive Officer of Bank of America
Northeast
• The Financial Sponsors Group maintains dialogue with over 300
15 professionals
• New York financial sponsors in a wide variety of markets throughout the United
West States and internationally.
15 professionals
• Los Angeles
• DCF has real-time information on which groups are interested in
recapitalization transactions.
Mid-America
Southeast 9 professionals
• Dallas
58 professionals
• Houston
• Regular dialogue with these financial sponsors provides meaningful
• Atlanta
• Charlotte
insight into the investment community’s interests in prospective
acquisitions. As a result of our close relationships, DCF has
developed a strong understanding of each sponsor’s investment
thesis and behavior during transaction processes.
Talent
 Number of Partners/Principals/Directors: 25
• Extensive experience providing mergers and acquisitions advice
 Number of advisors: 120+ exclusively tailored to middle market clients

• Customized sell side process to meet clients’ specific goals

8 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
 Illustrative transaction experience
Deloitte success stories
has acquired
The undersigned acted as advisor to
Makin Metals Ltd.
acquired selected business locations from
The undersigned acted as exclusive
advisor to Tom Harris Cellular
advisor to CBV Collection Services Ltd.
9 Deloitte Corporate Finance: Fundamentals of Valuation
has acquired
The undersigned acted as advisor to
Northern Mat & Bridge Ltd.
has acquired
INLAND PACIFIC DISTRIBUTORS LTD.
The undersigned acted as financial
The undersigned acted as exclusive
has acquired
The undersigned acted as
advisor to Lesley Stowe Fine
Foods Ltd.
Has acquired
advisors to the shareholders of
Inland Pacific Distributors Ltd.
Has acquired
Has acquired an interest in
Has sold 50% of its interest in
The undersigned acted as advisor The undersigned acted as advisor The undersigned acted as
to 4Refuel to Eminata Group financial advisor to CPX
Agrifoods International
(a Swander Pace Capital, Jefferson Capital &
has acquired United Natural Foods Inc. partnership.)
Has acquired invested in
&
Earth’s Own and Meadowfresh
The undersigned acted as exclusive September 2012
financial advisor to Earth’s Own and
Meadowfresh
The undersigned acted as advisor The undersigned acted as exclusive
To Norsat advisor to Kicking Horse Coffee.
© Deloitte LLP and affiliated entities.
 Illustrative transaction experience
Deloitte success stories

CIBT Corporation

Has acquired
Has acquired an interest in Has invested in Has acquired Has acquired Has acquired

a subsidiary of

The undersigned acted as advisor The undersigned acted as advisor The undersigned acted as advisor The undersigned acted as advisor The undersigned acted as advisor The undersigned acted as advisor
to Vancity to West Coast Engineering to Sequel to Eminata Group to Fitness World to Sprott-Shaw

Has acquired Has acquired Has acquired Has acquired Has acquired Has acquired

The undersigned acted as advisor to PJ The undersigned acted as due diligence The undersigned acted as advisor The undersigned acted as advisor The undersigned acted as advisor The undersigned acted as advisor
White Hardwoods Ltd. advisor Yellow Point to Pizza 73 to Datawave to Soyaworld to SASD

10 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
 R.S.T. Instruments Ltd.
Location: Maple Ridge, BC
Line of business: Manufacturer of geotechnical equipment
Ownership: Private; 3 Entrepreneurs
Assignment: Majority sale of equity

Overview:
• RST’s products provide critical data and geotechnical measurement information for: civil
infrastructure projects, mine site construction and monitoring, oil and gas and pipeline
developments, as well as, environmental and utility projects. RST has customer around
Hammond Kennedy, Whitney &
the globe.
Company, Inc.
has invested in Process:

• Educated management on various opportunities available: minority sale, majority sale,

R.S.T. Instruments Ltd.
The undersigned acted as exclusive financial
advisor to R.S.T. Instruments Ltd.
100% sale.
• Prepped the business for sale, completed a vendor due diligence assignment, and
reached out to a list of 128 prospective purchasers developed by Deloitte.
Outcome:
• Maximized value by maintaining competitive tension and encouraging increased bids to
gain exclusivity privileges.
• ~ 70% equity sale to HKW was completed on July 31, 2014 allowing the vendors to
realize the majority of their share capital appreciation.
• Ensured that all three shareholders were permitted to retain equity ownership going
forward, even if they choose to retire at a later date, consistent with their objectives.

“We are glad to have Deloitte on our side. Their level of execution, experience and access to global investors ensured that we had all the right
players at the table. We have now secured a partnership for our company that will accelerate further growth and opportunities for us. From
transaction readiness, to marketing, to negotiations, the Deloitte team guided us every step of the way to achieve the best possible results. Thank
you Deloitte and a job well done to David and Ian.”
Rob Taylor, President & CEO of R.S.T. Instruments Ltd.

11 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
 Valuation concepts

12 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Valuation concepts
Use of valuation

What is the purpose of a valuation exercise?

Value a purchase

Value a sale

Calculate a liquidation value

Price an Initial Public Offering

Perform scenario analysis

Evaluate managerial performance or decisions

13 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Valuation concepts
Elements of value

What is the difference between Equity Value and Enterprise Value?

Fundamental valuation equation FMV of Equity

Enterprise Value = Common shares + Preferred

= FMV of equity + FMV of debt– Redundant assets shares +Minority interest

Re-arranged Enterprise Value

Equity Value = Discounted free cash flows +

= Enterprise value - FMV of debt + Redundant assets Terminal value

14 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Valuation concepts
Capital structure

Mortgage
(aka Debt) ?

Down
Payment ?
(aka
Equity)

What is the Enterprise Value of the house? Mortgage + Down Payment

15 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
How do you measure value?
Valuation approaches and methods
Asset
Approach
Modified net
Liquidation
assets
Valuation methodology descriptions
Asset approach
The current value of a company’s net
assets as the prime determinant of value.
This approach is used when:
1. A business is not viable as a going
concern and it maximizes value under
liquidation; or
2. A company is properly valued as a
going concern but where the going
concern value is closely related to the
value of its underlying assets
16 Deloitte Corporate Finance: Fundamentals of Valuation
Income
Approach
Discounted
Capitalization
cash flows
Income approach
Value is ascribed based on the company’s
ability to generate future discretionary cash
flow and earn a reasonable return on
investment after consideration of risks
related thereto.
The DCF method is a form of the income
approach whereby projected cash flows,
attributable to an asset, are converted to
the present value through discounting.
Market
Approach
Guideline
M&A
public
transactions
companies
Market approach
Involves determining the fair market value
of a company based on activity ratios
derived from the analysis of guideline
public company trading prices and market
transactions that can be applied to the
company in question.
Both merger and acquisition activity and
stock market activity are considered in
deriving various value measures to apply.
© Deloitte LLP and affiliated entities.
 Discounted cash flow

17 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Overview
What is it?
Ascribes value to a company based on its ability to generate future discretionary cash flow and earn a reasonable return on
investment after consideration of risks related thereto

Limitations
Risk of realization, limited historical information (e.g., start-ups), forecasting Income

When is it used? Major cornerstones

• When comparable companies / precedent transactions 1. Cash is King
are not available
- “If it don’t jingle it don’t count”
• When the cash flows are expected to change
2. Time value of money
significantly (i.e. Unprecedented growth)
- Opportunity cost
• When there are multiple business streams with different
levels of risk - Reflection of risk

• For start-ups when the company does not have a history 3. Net present value
of earnings - Only undertake transactions with positive NPV
• When IRR is a key factor in the investment making
decision

18 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Step 1 – Determine free cash flow

C$000 2014F 2015F 2016F 2017F 2018F 2019F

EBIT 100 119 141 169 209 274
Add:
Depreciation 20 25 32 38 40 25
EBITDA 120 144 173 207 249 299
Less:
Tax (24) (29) (35) (41) (50) (60)
Capital expenditures (50) (50) (50) (50) (50) (50)
Change in WC (1) (1) (1) (2) (2) (2)
FCFF 45 64 87 114 147 186

Discount factor 0.91 0.83 0.76 0.70 0.64 0.58

PV FCFF 41 53 66 79 93 108
Sum of FCFF 441
Terminal value 994
Enterprise value 1,435

Can start a DCF with net income, NOPAT, EBT, EBIAT, etc.

19 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Step 1 – Determine free cash flow

C$000 2014F 2015F 2016F 2017F 2018F 2019F

EBIT 100 119 141 169 209 274
Add:
Depreciation 20 25 32 38 40 25
EBITDA 120 144 173 207 249 299
Less:
Tax (24) (29) (35) (41) (50) (60)
Capital expenditures (50) (50) (50) (50) (50) (50)
Change in WC (1) (1) (1) (2) (2) (2)
FCFF 45 64 87 114 147 186

Discount factor 0.91 0.83 0.76 0.70 0.64 0.58

PV FCFF 41 53 66 79 93 108
Sum of FCFF 441
Terminal value 994
Enterprise value 1,435

Add back non-cash expenses and deduct non-cash gains. Remember – Cash is King

20 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Step 1 – Determine free cash flow

C$000 2014F 2015F 2016F 2017F 2018F 2019F

EBIT 100 119 141 169 209 274
Add:
Depreciation 20 25 32 38 40 25
EBITDA 120 144 173 207 249 299
Less:
Tax (24) (29) (35) (41) (50) (60)
Capital expenditures (50) (50) (50) (50) (50) (50)
Change in WC (1) (1) (1) (2) (2) (2)
FCFF 45 64 87 114 147 186

Discount factor 0.91 0.83 0.76 0.70 0.64 0.58

PV FCFF 41 53 66 79 93 108
Sum of FCFF 441
Terminal value 994
Enterprise value 1,435

DCF is used to estimate how much the company is worth which includes impact of taxation

21 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Step 1 – Determine free cash flow

C$000 2014F 2015F 2016F 2017F 2018F 2019F

EBIT 100 119 141 169 209 274
Add:
Depreciation 20 25 32 38 40 25
EBITDA 120 144 173 207 249 299
Less:
Tax (24) (29) (35) (41) (50) (60)
Capital expenditures (50) (50) (50) (50) (50) (50)
Change in WC (1) (1) (1) (2) (2) (2)
FCFF 45 64 87 114 147 186

Discount factor 0.91 0.83 0.76 0.70 0.64 0.58

PV FCFF 41 53 66 79 93 108
Sum of FCFF 441
Terminal value 994
Enterprise value 1,435

Capital expenditure is a cash outflow required to support continued growth and working capital is the
cash required for day to day operations

22 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Step 1 – Determine free cash flow

C$000 2014F 2015F 2016F 2017F 2018F 2019F

EBIT 100 119 141 169 209 274
Add:
Depreciation 20 25 32 38 40 25
EBITDA 120 144 173 207 249 299
Less:
Tax (24) (29) (35) (41) (50) (60)
Capital expenditures (50) (50) (50) (50) (50) (50)
Change in WC (1) (1) (1) (2) (2) (2)
FCFF 45 64 87 114 147 186

Discount factor 0.91 0.83 0.76 0.70 0.64 0.58

PV FCFF 41 53 66 79 93 108
Sum of FCFF 441
Terminal value 994
Enterprise value 1,435

Free unlevered cash flow available to all capital providers

23 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Discount rate

Free cash flow to firm  WACC = cost of equity (x%) + cost of debt (y%)

• Discount rate is compensation required (opportunity cost) for the stakeholders (FCFF) or
equity holders (FCFE)
• It accounts for the time value of money and adjusts the riskiness of the forecasted cash
flows
• Target weights for capital structure are the best choice
– Trends in the firm’s financing
– Trends in the industry
– Explicit statements from management

24 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Cost of equity – CAPM

Capital Asset Pricing Model

Market Risk Premium (rm – rf)
• Geometric average excess return of the
Ke = rf + β (rm – rf) market index over rf

• TSE 300 or S&P 500

• Long term average preferred

Risk Free Rate (rf) Beta (β) – Company specific risk

• Long term sovereign bonds • Regression analysis

• Pre-calculated data sources

• Comparable companies

25 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Cost of equity – CAPM

Capital Asset Pricing Model

Market Risk Premium (rm – rf)
• Market return = 12.0%
Ke = rf + β (rm – rf)
• Therefore, market risk premium = 7.0%

Risk Free Rate (rf) Beta (β) – Company specific risk

• Risk free rate = 5.0% • Assume Beta = 1.2

26 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Cost of equity – CAPM

Capital Asset Pricing Model

Ke = 5.0% + 1.2 (12.0% – 5.0%) = 13.4%

27 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Cost of debt

Cost of debt

Kd = 𝒌𝒅 * (1 – t) Sources:
• Credit spread or yield of liquid
• Cost of debt is adjusted for the tax rate company bonds traded in the market

• Yield on recent bond issues

• Credit spread of similar companies

over government bonds

28 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Cost of debt

Cost of debt

Kd = 7.0%* (1 – 20.0%) = 5.6% Assumptions:

• Kd = 7.0%
• Cost of debt is adjusted for the tax rate
• Tax rate = 20.0%

29 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Weighted average cost of capital

Capital Asset Pricing Model

Ke = 5.0% + 1.2 (12.0% – 5.0%) = 13.4%

Cost of Debt

Kd = 7.0%∗ (1 – 20.0%) = 5.6%

Weighted average cost of capital

WACC = 13.4%(50.0%) + 5.6%(50.0%) = 9.5%

30 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Step 2 – Determine discounted cash flow and terminal value

0.5 1.5 2.5 3.5 4.5 5.5

C$000 2014F 2015F 2016F 2017F 2018F 2019F
EBIT 100 119 141 169 209 274
Add:
Depreciation 20 25 32 38 40 25
EBITDA 120 144 173 207 249 299
Less:
Tax (24) (29) (35) (41) (50) (60)
Capital expenditures (50) (50) (50) (50) (50) (50)
Change in WC (1) (1) (1) (2) (2) (2)
FCFF 45 64 87 114 147 186

Discount factor 0.91 0.83 0.76 0.70 0.64 0.58

PV FCFF 41 53 66 79 93 108
Sum of FCFF 441
Terminal value 994
Enterprise value 1,435

Discount factor = 1/(1+0.095)^mid-period

31 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Terminal value

Terminal Value Considerations Forecast Period Cash Flow vs. Terminal Value
• When the company reaches a 140%

representative mature steady growth 120%

phase
• Factors to consider: 100%

• Cyclicality 80%
• Representative year
60%
• Depreciation and CapEx
40%

Terminal Value Approaches 20%

• P/CF multiples
0%
• Dividend discount models
-20%
• Capitalized cash flows
-40%
Utilities Tobacco Sporting Goods High Tech

Value of forecast period cash flow Terminal Value

32 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Terminal value – capitalized cash flow

0.5 1.5 2.5 3.5 4.5 5.5

C$000 2014F 2015F 2016F 2017F 2018F 2019F
FCFF 45 64 87 114 147 186

Discount factor 0.91 0.83 0.76 0.70 0.64 0.58

PV FCFF 41 53 66 79 93 108
Sum of FCFF 441
Terminal value 994
Enterprise value 1,435

Terminal value calculation

1. Take the final year of cash flow and multiply by (1+ growth rate)
 Free cash flow: 186 * (1+0.03) = 111
2. Divide the free cash flow by the (discount rate - growth rate)
 Capitalized cash flow: 111/ (0.095-0.03) = 1,713
3. Discount the terminal value to present using the discount factor in the final year
 Terminal value: 1,713*0.58 = 994

33 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Step 2 – Determine discounted cash flow and terminal value

0.5 1.5 2.5 3.5 4.5 5.5

C$000 2014F 2015F 2016F 2017F 2018F 2019F
EBIT 100 119 141 169 209 274
Add:
Depreciation 20 25 32 38 40 25
EBITDA 120 144 173 207 249 299
Less:
Tax (24) (29) (35) (41) (50) (60)
Capital expenditures (50) (50) (50) (50) (50) (50)
Change in WC (1) (1) (1) (2) (2) (2)
FCFF 45 64 87 114 147 186

Discount factor 0.91 0.83 0.76 0.70 0.64 0.58

PV FCFF 41 53 66 79 93 108
Sum of FCFF 441
Terminal value 994
Enterprise value 1,435

Equity value: Enterprise value less net debt plus redundant assets

34 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Forecasting assumptions

To forecast cash flows, what assumptions do you need to make?

Common Assumptions Sources

• Revenue • 5 year geometric average

Growth Historical
• Working Capital • AR, Inventory, AP turnover
Rates Averages
• Expenses • Historical margins

Tax • Tax break incentives • Forecast and targets

Management
Rates • Long term rate • Corporate strategy

• Gross margin Analyst • Often most accurate public info

Margins
• EBITDA margin Reports • May not be specific enough

Terminal • Timing • Product / customer life cycle

Management
Value • Terminal growth rate • Assessment of market potential

35 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Discounted cash flow
Summary

Forecast future cash Estimate future Discount the cash

Select the correct
flows after cash working capital and flows and terminal
discount rate
taxes capital expenditure value

Assess reasonableness of results Compare results

• Cash is King • Comparable companies analysis

• Assess the timing of the investment • Precedent transactions analysis
• Sensitivity analysis

36 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
 Market based approaches

37 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Market based approaches
Overview

Common methods

• Comparable company analysis • Precedent transaction multiples

Comparable Company Analysis Precedent Transaction Multiples

• Public market valuation • Sale transactions

• Market’s shortcut to DCF • Focused on change of control situations

• Does not reflect M&A control premium • Includes a control premium

Limitations
• Difficult to identify pure-play comparable companies or transactions

• Market inefficiencies

• Approach is often used as a ‘quick’ methodology, and can be misapplied

38 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Comparable company analysis
Theory and methodology

• Consists of a comparison of several companies’ operating and trading statistics

Methodology • Price that the market is willing to pay for a dollar of cash flows or assets for companies
that have similar growth prospects or risk profiles

• Precedent transactions are typically an easy analysis to perform

Advantages
• Market determined value – precedent has been established

• Include control premium and synergy assumptions, which are not public knowledge
and are often transaction-specific
Disadvantages
• Precedent transaction valuations are easily influenced by temporary market
conditions

• Operate in a similar industry and geographic region

Criteria for a “good
comparable” • Have a similar size of operations and type of products
• Have similar growth opportunities and risk profile

39 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Comparable company analysis
Multiple overview

Multiple Attributes Examples

• Well known and widely used, easy to understand Large caps

• Forward looking (forecasted earnings) Blue chip stocks
Price / • Hard to compare companies with low or negative earnings, Older, steady earnings companies
Earnings or multiple-sector corporations
• Distorted by capital structure
• Selection of proper comparables is key

• Focuses on cash flow – most closely aligned with

shareholder’s interests
Price / • Eliminates most accounting / financing distortions
Cash Flow • Can be used with negative earnings
• Short-term focus
• Subjectivity in choosing proper comparables

• Eliminates capital structure distortion

• Widely accepted methodology, especially in takeovers
Enterprise • More cash flow oriented than earnings oriented
Value / • More complex to calculate
EBITDA
• Higher needs for consistency between numerator and
denominator

40 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Comparable company analysis
Multiple overview

Multiple Attributes Examples

• NAV describes the company's current asset and liability

Price / position Mining companies
Net Asset
• Easy to calculate a target price Large asset bases
Value
• Fair value of assets on a fully liquidated basis

Enterprise
• Proven and probable (2P) refers to geologic reserves – 50% Mining companies
Value /
chance of recovery Oil & Gas companies
Reserves
• Not cash-flow based

Enterprise Technology companies

• Doesn’t account for cost structure
Value / Restaurants
Revenue
• Can be used to compare start ups with negative cash flow

41 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Comparable company analysis
Illustrative example

Total EV / Total
Flagship Asset Stage Market Cap EV NAV*
Public Companies Ticker Coal Type Resources Resources P / NAV
Location (C$M) (C$M) (Mt) (C$/t) (C$M)
Junior & Mid-Tier Producers
Rhino Resource Partners LP NYSE:RNO Appalachia Metallurgical Production 117 192 356 0.54 n/a n/a
SouthGobi Resources Limited TSX:SGQ Mongolia Thermal and met Production 109 211 912 0.23 585 0.19x
Cockatoo Coal Limited ASX:COK Australia Thermal Production 63 104 1,892 0.06 n/a n/a
Xinergy Ltd. TSX:XRG US Thermal Production 20 249 72 3.45 n/a n/a
Pacific Coal Resources Ltd. TSXV:PAK Colombia Thermal Production 17 46 88 0.52 n/a n/a
Atlantic Coal plc AIM:ATC US Metallurgical Production 12 25 2 14.27 n/a n/a
Buffalo Coal Corp. TSX:BUF South Africa Thermal and met Production 8 28 83 0.34 57 0.13x

Average 2.77 0.16x

Average excl. high & low 1.02 n/a

Developers
Atrum Coal NL ASX:ATU Canada Metallurgical Feasibility 218 208 1,567 0.13 n/a n/a
Rey Resources Limited ASX:REY Australia Thermal DFS completed 56 53 457 0.12 n/a n/a
Resource Generation Limited ASX:RES South Africa Thermal and met Development 72 39 3,031 0.01 n/a n/a
Fortune Minerals Ltd. TSX:FT Canada Metallurgical Development 36 35 472 0.07 88 0.41x
Coalspur Mines Limited ASX:CPL Canada Thermal Development 15 86 756 0.11 1,593 0.01x
Jameson Resources Limited ASX:JAL Canada Thermal and met PFS completed 25 22 99 0.23 96 0.26x
Stanmore Coal Limited ASX:SMR Belview Thermal and met Development 19 1 920 0.00 n/a n/a
Goldsource Mines Inc. TSXV:GXS Canada Thermal PEA completed 14 13 150 0.09 n/a n/a
Prophecy Coal Corporation TSX:PCY Mongolia Thermal Production 19 20 3,754 0.01 n/a n/a
Morien Resources Corp. TSXV:MOX Canada Thermal and met PFS completed 11 10 120 0.08 n/a n/a
Colonial Coal International Corp. TSXV:CAD 7 5 397 0.01 143 0.05x
Cardero Resource Corp. TSX:CDU Canada Metallurgical PFS completed 6 11 525 0.02 37 0.17x
EastCoal Inc. TSXV:ECX.H Ukraine Thermal Development 6 6 96 0.07 n/a n/a
Compliance Energy Corp. TSXV:CEC Canada Thermal and met PFS completed 2 1 131 0.01 n/a n/a

Average 0.07 0.18x

Average excl. high & low 0.06 0.16x

42 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.
Precedent transactions
Theory and methodology

• Looking at historical prices for completed M&A transactions involving similar companies
to get a range of valuation multiples
Methodology • Basis for a precedent transaction analysis is that a rational investor should place a
similar value on similar assets
• Why do precedent multiples tend to be higher than comparable company multiples?

• Precedent transactions are typically an easy analysis to perform

Advantages
• Market determined value – precedent has been established

• Include control premium and synergy assumptions, which are not public knowledge
Disadvantages and are often transaction-specific
• Precedent transaction valuations are easily influenced by temporary market conditions

• Operate in a similar industry

Criteria for a “good
• Consist of a similar transaction size and within a reasonable time frame
transaction”
• Similar transaction type (i.e. share or asset transaction)

43 Deloitte Corporate Finance: Fundamentals of Valuation © Deloitte LLP and affiliated entities.