Investment Banking

Valuation Training

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Table of Contents

1. What are we Valuing? 1

A. Valuing a Public Company 2

B. Valuing a Private Company 3

2. Valuation Methodologies 4

A. Comparable Companies 6

B. Precedent Transactions 9

C. Discounted Cash Flow 12

D. Leveraged Buy-out 19
1. What are we Valuing?
What is a Firm and What are we Trying to Value?
A business can have many components to its capital structure, all of which have some form of claim on the overall
business. Firm value represents the aggregate value of all interests in a business.

Creditors  A firm is a group of assets (and associated liabilities) that is

used to produce output through the transformation of inputs
(e.g. labour, materials, property etc.) and in doing so generate
Minority Interests profit for its owners

Pref. Shareholders  Equity, put simply, is  Debt is money which is borrowed

the money that is
Common Shareholders injected into the
company by the
owners of the company
Firm Value in return for shares
from investors and financial
institutions and has an agreed
rate of return (e.g. interest) and
repayment terms between the
company and the lender

 When we value a firm we are essentially attempting to put a value on the equity and the debt injected into the company
 Both debt and equity holders have a claim on the assets and the profits generated by those assets
– As mentioned above, the claim that debt holders have on the profits generated is usually already agreed (e.g. interest)
– Equity holders are then entitled to the remaining profit of the company (net profit)
 Given that equity and debt holders are entitled to a proportion of profits, several of the methods that we use to value firms are based on the
profit streams of companies and this is what we will focus on today
– However depending on the industry you work in, different valuation methodologies exist some of which may not be based on profits
 Note that for publicly listed companies, market values already exist and enterprise value can be calculated from market data
– However the methodologies discussed today are also used by analysts to determine whether a publicly listed company is over/
under-valued and what is a “fair value” for a company
Firm Value is the collective value of all stake holdings (equity, debt, etc.) with claims on a valued asset
(e.g. operating assets) or economic streams (e.g. revenue, EBITDA) generated by such assets.

1 What are we Valuing?

A. Valuing a Public Company
The Composition of Enterprise Value
For a public company, we are able to calculate firm value based on publicly available information.

Market Capitalisation = Value of shares in the market

Share Price x Number of Shares
Equity
+ Value
Net Impact of Options =
No. of Options x (Share Price – Avg. Exercise Price)
+
In-the-Money Convertible Securities
Potential Shares from In-the-Money Convertibles x Share Price
+
Total Debt =
Debt (LT, ST, Out-of-the-money Convertible) + Finance Leases
Net
– Debt
Liquid Resources
Cash + Marketable Securities
–
Market Value of JVs and Associates
+
Market Value of Minority Interests
Value of shares potentially issued from
options, net of cash received
Value of shares potentially issued from
convertible securities (see later)
Bank loans, overdrafts, bonds,
convertible debt as well as
finance leases
Not only cash in the bank, but also
securities held by the company
readily saleable
Interests in companies partially owned
but which the company does not have
control (owns <50%)
Interests of third parties in
subsidiaries under the company’s
control (owns >50%)

2 Valuing a Public Company

B. Valuing a Private Company
Valuation Methodologies
The most commonly used methodologies in our advice to clients are outlined below.
Multiples Based Valuation
Comps Based Valuation
A (Inc. Sum-of-the-Parts)
 Multiples-based technique with
reference to relevant publicly-traded
market prices
 Based on relative valuations of
public companies that are most
comparable to our target
 Valuation multiples of such
companies are applied to earnings
metrics of our target company
(e.g. sales, EBITDA) to
derive valuation
3 Valuing a Private Company
B Precedent Transactions
 Multiples-based technique with
reference to relevant completed
M&A transactions
 Similar to comps based valuation
 Multiples are applied to earnings
metrics – sales, EBITDA
Cash Flow Based Valuation
C Discounted Cash Flow D Leveraged Buy Out
 Most common methodology to  Valuation based on the maximum
estimate the fundamental of amount a potential private equity
“intrinsic” value investor can afford to pay for the
business to achieve a target return
 Valuation is based on cash flows
attributable to the firm, irrespective
of capital structure
 Value equal to the sum of
the present values of such
cash flows
 Discounted Cash Flow valuations
are founded on the premise that
company value is equal to the value
of future cash flows generated by
the company and available to be
paid out to investors, discounted at
the required rate of return
demanded by investors
2. Valuation Methodologies
Summary Financial Data – Company A Company A

Our analysis will be based on the following dummy company, Company A.

Fiscal Year Ending 31 December

£ Million, Unless Otherwise Stated 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E

P&L

Sales 1,000.0 1,082.0 1,157.7 1,221.4 1,270.3 1,317.3 1,356.8 1,390.7 1,418.5 1,446.9 1,475.8 1,505.3

Growth 8.2% 7.0% 5.5% 4.0% 3.7% 3.0% 2.5% 2.0% 2.0% 2.0% 2.0%

EBITDA 130.0 162.3 196.8 224.7 241.4 256.9 271.4 278.1 283.7 289.4 295.2 301.1

Growth 24.8% 21.3% 14.2% 7.4% 6.4% 5.6% 2.5% 2.0% 2.0% 2.0% 2.0%

Margin 13.0% 15.0% 17.0% 18.4% 19.0% 19.5% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0%

Depreciation (50.0) (54.1) (60.2) (64.7) (68.6) (72.4) (74.6) (76.5) (78.0) (79.6) (81.2) (82.8)

% Sales 5.0% 5.0% 5.2% 5.3% 5.4% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5%

EBIT 80.0 108.2 136.6 160.0 172.8 184.4 196.7 201.7 205.7 209.8 214.0 218.3

Growth 35.3% 26.3% 17.1% 8.0% 6.7% 6.7% 2.5% 2.0% 2.0% 2.0% 2.0%

Margin 8.0% 10.0% 11.8% 13.1% 13.6% 14.0% 14.5% 14.5% 14.5% 14.5% 14.5% 14.5%

Cash Flow

CapEx (67.5) (68.7) (69.8) (71.2) (73.4) (76.1) (76.1) (76.5) (78.0) (79.6) (81.2) (82.8)

% Sales 6.8% 6.4% 6.0% 5.8% 5.8% 5.8% 5.6% 5.5% 5.5% 5.5% 5.5% 5.5%

CapEx/Depreciation 135.0% 127.0% 116.0% 110.0% 107.0% 105.0% 102.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Net Working Capital (50.0) (54.1) (57.9) (61.1) (63.5) (65.9) (67.8) (69.5) (70.9) (72.3) (73.8) (75.3)

% Sales (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)%

Change in Working Capital 4.1 3.8 3.2 2.4 2.4 2.0 1.7 1.4 1.4 1.4 1.5

4 Valuation Methodologies
Valuation Summary Company A

Based on various valuation methodologies, we have arrived at the following range of values for Company A.

1 Comparables 1,160 1,781

2 Comparables – 20% Premium 1,392 2,138

3 SOTP 1,696 1,889

4 SOTP – 20% Premium 2,035 2,267

5 Precedents 1,200 2,419

6 DCF 1,799 2,332

7 Simple LBO 1,600 1,862

500 1,000 1,500 2,000 2,500 3,000

5 Valuation Methodologies
A. Comparable Companies
The Concept of Multiples
The principal of comps based valuation is based on comparing our target company to publicly listed companies to derive a
“fair” valuation.

Comps Based Valuation (Inc. Sum-of-the-Parts)

 Based on relative valuations of public companies that are most comparable to our target

 Valuation multiples of such companies are applied to earnings metrics of our target company, e.g. sales, EBITDA to
derive valuation

 Compare and benchmark company on both qualitative and quantitative metrics. Examples of such metrics include
– Sales and EBITDA growth
– EBITDA margin and future margin uplift
– Geographic Diversification
– Quality of Brand and international potential
– Stage in company lifecycle, etc.

 Decide whether company should be placed on a valuation multiple at a discount or a premium to the different comps
given the metrics analysed above and value it at a suitable multiple

 Using this analysis we can also look at whether current publicly listed companies are undervalued or overvalued
compared to its peer group

6 Comparable Companies
Calculating Comp-based Valuations Company A

Based on our comparable companies analysis, Target Company A is valued between £1,160m and £1,781m on a trading
basis and between £1,392m and £2,138m on a take-out basis.

Comparable Companies Analysis

EV / Sales EV / EBITDA

Share Market Enterprise 2014–2016 2014–2016 2014 EBITDA

Company Price (p) Cap (£m) Value (£m) 2014 2015 2016 2014 2015 2016 Sales CAGR EBITDA CAGR Margin
Company B 375 5,025 6,556 2.1x 1.9x 1.8x 10.5x 8.6x 8.2x 8.0% 13.3% 22.0%
Company C 1,052 768 968 1.3x 1.2x 1.2x 9.3x 7.3x 7.3x 5.4% 12.7% 17.0%
Company D 786 3,276 3,576 1.6x 1.5x 1.5x 8.9x 7.7x 7.6x 5.0% 7.9% 19.4%
Company E 105 1,074 1,199 1.1x 1.1x 1.0x 9.2x 8.9x 8.3x 4.9% 4.9% 11.8%
Company F 832 202 252 1.5x 1.3x 1.2x 14.5x 9.3x 9.2x 9.9% 25.3% 14.0%
High 5,025 6,556 2.1x 1.9x 1.8x 14.5x 9.3x 9.2x 9.9% 25.3% 22.0%
Mean 2,069 2,510 1.5x 1.4x 1.3x 10.5x 8.4x 8.1x 6.7% 12.8% 16.8%
Median 1,074 1,199 1.5x 1.3x 1.2x 9.3x 8.6x 8.2x 5.4% 12.7% 17.0%
Low 202 252 1.1x 1.1x 1.0x 8.9x 7.3x 7.3x 4.9% 4.9% 11.8%

Indicative Valuation – Company A

£ in Millions

Multiple Value

Low High Low High

Takeout Multiples and Control Premia
2015E Sales £1,082 1.1x 1.9x £1,136 £2,056
 However, when public companies are acquired, a premium is
2015E EBITDA £162 7.3x 9.3x £1,184 £1,507
usually paid to the current share price to persuade shareholders to
Implied EV 1 £1,160 £1,781 cede control of the company to the acquiror
Implied 2014E EBITDA Multiple 7.1x 11.0x – This is known as the control premium and varies from market
to market
Take-out Premium 20%
 Valuations including a premium are known as “takeout valuations”
Implied EV (Inc. Premium) 2 £1,392 £2,138

Implied 2014E EBITDA Multiple 8.6x 13.2x

7 Comparable Companies
Sum-of-the-Parts Company A

If a company is comprised of several separate distinct parts, we may value it based on fair valuations for each part of
the business.

Comps Based Valuation (Inc. Sum-of-the-Parts)

 Several companies can be split into separate and distinct operating assets
– Companies can be split into parts by operation or by geography for example

 Each part can therefore be valued individually to come up with a sum-of-the-parts valuation

 Whilst each part can be valued in various ways, we commonly use a range of valuation multiples for each part to derive a fair value for
the company
– With public companies, this sum-of-the-parts valuation can then be used to see whether the company is currently over or undervalued at
the current share price and whether there is value to be “released” from breaking up the company

EBITDA Multiple Valuation

Company A 2015E EBITDA Low High Low High
Beer £62.8 9.5x 10.5x £596.7 £659.5
Juice 11.0 8.0 9.2 88.3 101.5
Soft Drinks 44.0 12.0 13.5 527.8 593.8
Wine 23.7 9.0 10.2 213.3 241.7
Spirits 20.8 13.0 14.1 270.1 292.9
Group Total 3 £162.3 10.5x 11.6x £1,696 £1,889
Take-out Premium 20%
Take-out SOTP Value 4 12.5x 14.0x £2,035 £2,267
Implied Multiple

8 Comparable Companies
B. Precedent Transactions
Principles of Precedent Transactions
The principles of precedent transaction analysis are very similar to comparable companies analysis, although there
are some key differences.

Precedent Transaction

 Similar to comps based valuation, multiples are applied to earnings metrics based on analysis of historical transactions

 Principles of precedent transactions are very similar to comparable companies analysis, although there are a few key
differences which need to be highlighted

 Transaction multiples are generally historic (last twelve months or LTM) to the extent possible and not forward-looking
like comps

 Transaction multiples will generally include a control premium and so the value derived is a take-out multiple rather than
a trading multiple

 Comps use current market data and as such are based on current investor sentiment on a particular sector. However,
since transactions are historic, the market may have evolved significantly since then and the multiple may not be
relevant any more

 There may be factors that are particular to a relevant transaction e.g. structure that may have had an impact
on valuation

9 Precedent Transactions
Calculating Precedent Transactions
When calculating enterprise value in precedent transactions, you need to make sure you are calculating a value for
100% of the company.

Calculating Precedents Example Calculation

 When calculating precedent transactions, we need to calculate the implied EV as  Company B acquires 75% of Target 1 for an equity value of £750m
well as the most recent LTM metric (e.g. Sales, EBITDA, EBIT)  Company B has net debt outstanding of £250m
 Note however that on several occasions, not enough data will be in the public  Target 1 reported 2013 Sales and EBITDA of £900m and £120m and recently
domain to calculate a multiple reported 3Q14 Sales and EBITDA of £750m and £105m for the first nine months
ended 31 September 2011. In 3Q10 it reported Sales and EBITDA of £650m and
 The calculation of EV is as presented previously, however, there are some key £100m respectively for first nine months ended 31 September 2013
points to take into consideration when analysing precedent transactions:
– Is the transaction value stated the amount paid for equity or the total company?
Price Paid (£m) 750
– In several cases, the acquiror does not purchase 100% of the company and as
a result the equity value stated needs to be grossed up to 100% to calculate Percent Acquired 75.00%
the correct value Implied Equity Value 1,000
– Does the value stated include the net value of options?
Net Debt 250
 When calculating LTM metrics, we will use the last reported numbers, taking into
account the last interim results the company has released Implied EV 1,250
– LTM EBITDA = Last Reported Full Year EBITDA + Last Reported Interim FY13 Sales 900
EBITDA – Prior Year Interim EBITDA Plus: 3Q14 Sales (L9M) 750
– Note that if the last reported numbers are the full year results, we do not need
Less: 3Q13 Sales (L9M) (650)
to make any adjustment for interims
LTM Sales 1,000
Implied EV / LTM Sales 1.3x
FY13 EBITDA 120
Plus: 3Q14 EBITDA (L9M) 105
Less: 3Q13 EBITDA (L9M) (100)
LTM EBITDA 125
Implied EV / LTM EBITDA 10.0x

10 Precedent Transactions
Calculating Precedent-Based Valuations Company A

When choosing valuing companies based on precedent transactions, whilst qualitative and quantitative comparisons
should be made, you will also need to look at details around the transaction to determine the correct multiple.

Precedent Transactions
EV / LTM

Date Announced Target Acquiror Transaction Value (£m) Sales EBITDA EBIT
5 June 2014 Target 1 Company C 1,250 1.3x 10.0x 16.3x
2 January 2014 Target 2 Company C 230 3.0x 12.3x 25.4x
26 May 2013 Target 3 Company A 500 1.1x 12.6x 14.4x
1 April 2013 Target 4 Company B 150 3.1x 13.4x 19.1x
21 February 2013 Target 5 Company D 2,000 2.0x 13.0x NA
High 2,000 3.1x 13.4x 25.4x
Mean 826 2.1x 12.2x 18.8x
Median 500 2.0x 12.6x 17.7x
Low 150 1.1x 10.0x 14.4x

Precedent Transactions Choosing Multiples

 When choosing what multiple to apply to an LTM earnings figure, there may be
EV / EBITDA Value some precedent transactions which are more relevant than others
Low High Low High – Here for example, only transactions 1–5 are relevant from all available
LTM Sales £1,000 1.1x 3.1x £1,100 £3,100 precedent transactions
LTM EBITDA £130 10.0x 13.4x £1,300 £1,737
 As with comps, quantitative and qualitative comparisons between companies is
forms the basis of your judgement
Implied EV 5 £1,200 £2,419
 However, there are other factors that may need to be accounted for which are
Implied LTM EBITDA Multiple 9.2x 18.6x transaction specific such as
– Was the acquisition, an acquisition of a minority stake?
– Did the acquiror already own a stake in the target?
– What was the strategic rationale behind the transaction?

11 Precedent Transactions
C. Discounted Cash Flow
Discounted Cash Flow – Key Building Blocks
With a DCF valuation, we are attempting to put a value on the future operating cash flows of the company that are
available to be paid out to both equity and debt investors.

1. FCF for 10 Years 2. WACC 3. Terminal Value 4. NPV

Using DCF Method

Free Cash Flow WACC Net Present Value
=
= E/(E+D)*Cost of Equity FCFTx(1+g) =
+
EBITDA D/(E+D)*Cost of Debt K–g
FC1*(1+WACC)-1
+
– FC2*(1+WACC)-2
+
Cost of Equity Using Multiple Method FC2*(1+WACC)-3
CapEx
= + ....
Rf + beta*(EMRP) Apply a multiple +
– to the Terminal EBITDA (FC +TV)*(1+WACC)-10
10

Change in WC Cost of debt =

(Rec –Pay + Inv) (Rf + Credit differential)
*(1-t)
–

Tax on Operating Profit Proportion

of Debt and Equity

12 Discounted Cash Flow

Calculating the FCF
A Basic Definition of Free Cash Flow is
The amount of cash that a company has left over after it has paid all of its expenses, but before any payments or
receipts of interest or dividends, before any payments to or from providers of capital and adjusting tax paid to what
it would have been if the company had no cash or debt

Sales X
Operating Costs (X)
EBIT X
Depreciation X
Amortisation X
EBITDA X
Changes in Working Capital X/(X)
Operating Cash Flow X
Tax Paid (X)
CapEx (X)
FCF before Interest X/(X)
Interest Paid (X)
Free Cash Flow X/(X)

13 Discounted Cash Flow

Calculating the WACC
The WACC for a company is calculated from a specific formula. Citi have issued guidelines for estimating the correct
parameters for this calculation.

 After calculating the required rates of return for both debt and equity investors, we then weight these required returns according to a target capital structure for the
company, to come to an overall cost of capital for the company

Weighted Average Cost of Capital (WACC) =

Cost of Equity x (Equity/(Debt + Equity)) + Cost of Debt x (Debt/(Debt + Equity)) x (1 – Tax Rate)

WACC Calculation – Company A

WACC Analysis  The Cost of Equity is based on the CAPM and the following formula

Low High KE = Rf + β(Rm – Rf)

Cost of Equity 3.8% 3.8%
Risk Free Rate (30 Year) 3.8% 3.8% where KE is the cost of equity Rf is the risk free rate and
Equity Market Risk Premium 5.0% 7.0% (Rm – Rf) is known as the equity market risk premium
Equity Beta 1.07 1.07  The EMRP is estimated by Citi to be between 5–7%
Adjusted Equity Market Risk Premium 5.4% 7.5%
Sovereign Risk Premium 0.0% 0.0%  Relevant government bonds are used for the risk free rate
Inflation Differential 0.0% 0.0%  The Beta is calculated by taking an average of asset betas of comparable
Small Cap Premium 0.0% 0.0% public companies
Cost of Equity 9.1% 11.3%
Cost of Debt
 Tax rate is usually the company specific tax rate
Risk Free Rate (10 Year) 3.8% 3.8%  Industry average is usually used for debt/capitalisation unless a specific target is
Credit Spread 1.0% 2.0% known for the company
Inflation Differential 0.0% 0.0%
Cost of Debt (Pretax) 4.8% 5.8%
Effective Marginal Tax Rate 30.0% 30.0%
Cost of Debt (Aftertax) 3.4% 4.1%
Debt/Capitalisation (Market) 30.0% 30.0%
WACC 7.4% 9.1%

14 Discounted Cash Flow

The Concept of Present Value
When deriving a value for a company’s cash flows, we need to take into account the future timing of the cash flows in the
forecast period.

 Once we have derived an overall required rate of return for the company, the cost of capital, we are able to value the
value of the cash flows generated by the company in terms of how much it is worth today, the Present Value
– The value of £1 tomorrow is worth less than the value of £1 today

 Say an investor has £100 to invest today and his required rate of return is 10%
– In 1 year, he will want to receive 10% of £100 = £10 in addition to the £100. Therefore, to the investor, receiving £110
in one year is equivalent to receiving £100 today, i.e. £110/1.1 = £100
– In 2 years, he will want to receive 10% of £100 and 10% of £110 in addition to the original
£100 = £100 x 1.1 x 1.1 = £121
– In 3 years… etc.

 We use this concept therefore to derive the following formula for the present value of future cash flows which fall at the
end of the year in every year from now

CF1 CF2 CF3 CF4

PV = + + + + …
(1+K)1 (1+K)2 (1+K)3 (1+K)4

Where CF is the cash flow in its respective year and K is the required rate of return (the WACC)

15 Discounted Cash Flow

Mid-year Cash Flow Convention
A company’s cash flows are continuous and we need to account for this in valuing cash flows over the forecast period by
using the mid-year convention.

 Cash flows for a company are continuous and do not fall to the investor at the end of the year in every year as the
formula in the previous slide suggests

 We generally therefore use a mid-year convention, where we assume for valuation purposes that the cash flows that are
generated in every year fall in the middle of the year and we value them on that basis

 In order to do this, we need to divide the formula in the previous slide by (1+K)0.5 to essentially shift cash flows back by
half a year

 As a result the formula on the previous slide changes to as follows

CF1 CF2 CF3 CF4

PV = + + + + …
(1+K)0.5 (1+K)1.5 (1+K)2.5 (1+K)3.5

16 Discounted Cash Flow

Terminal Value
The terminal value of a company is the future value of the cash flows of the company after the forecast period and
into perpetuity.

 Whilst we have discussed valuing cash flows over a discrete period of time (e.g. 10 years), we also have to value the cash flows of the
company post the forecast period into perpetuity
 The value of the cash flows into perpetuity is known as the Terminal Value and can be calculated in one of two ways
– Applying an multiple to a profit metric (e.g. EBITDA) in the final year (Comps Method)
– Consider the “steady state” of the company and value its future cash flows based on an assumption as to the average long term growth
rate of the cash flows into perpetuity (DCF Method)
 Both methods can be used as a cross check against each other to see if the result is sensible
 However note that the value derived is the value of the cash flows into perpetuity at the end of the forecast period (e.g. in 10 years time if
the forecast period is 10 years long) and therefore needs to be discounted back to present value
– However, note that we do not use the mid-year convention for discounting back

Comps Method DCF Method

 The approach used here is the same as in our comps
based valuation focusing on average trading multiples of
comparable companies
 You can use any profit metric you see suitable, although EBITDA
most commonly used
 Note that the metric used should be excluding any
exceptional items
 Assuming a 9.0x EBITDA multiple we derive a terminal value
(future value) of £301m x 9 = £2,710m
 For this, there are two steps to be taken
– Calculate adjusted terminal year CF accounting for any
exceptional items and equalising CapEx and depreciation
 In the long term CapEx = depreciation and so if CapEx is
higher than depreciation we need to add the difference to the
final year FCF and conversely if lower
– Assume a perpetuity growth rate (g)
 The FV of the terminal value is then derived from the
following formula
FCFT x (1+g)
(K – g)

17 Discounted Cash Flow

Discounted Cash Flow Model Company A

Year Ending 31 December

£ in Millions 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Sales 1,082 1,158 1,221 1,270 1,317 1,357 1,391 1,419 1,447 1,476 1,505 Terminal
EBITDA 162 197 225 241 257 271 278 284 289 295 301 EBITDA
Depreciation (54) (60) (65) (69) (72) (75) (76) (78) (80) (81) (83)
EBITA 108 137 160 173 184 197 202 206 210 214 218
Taxes (41) (48) (52) (55) (59) (60) (62) (63) (64) (65)
Taxed EBITA 96 112 121 129 138 141 144 147 150 153
CapEx (70) (71) (73) (76) (76) (76) (78) (80) (81) (83)
Deprecation 60 65 69 72 75 76 78 80 81 83
(Increase)/Decrease in WC 4 3 2 2 2 2 1 1 1 1
Other 0 0 0 0 0 0 0 0 0 0
Unlevered FCF 90 109 119 128 138 143 145 148 151 154
Time Period 0.5 1.5 2.5 3.5 4.5 5.5 6.5 7.5 8.5 9.5 Final Year
FCF
WACC 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3%
Discount Factor 0.96 0.89 0.82 0.76 0.7 0.65 0.6 0.55 0.51 0.47
PV of FCF 86 97 97 97 97 92 87 82 77 73
PV of Forecast Cash Flows 884

Using Comps Method Using DCF Method

Terminal EBITDA 301 Final Year Cash Flow 154
EBITDA Multiple 9.0x Perpetuity Growth Rate 2.0%
FV of Terminal Value 2,710 Terminal FCF 157
Discount Factor 0.45 WACC 8.3%
PV of Terminal Value 1,226 FV of Terminal Value 2,518
Discount Factor 0.45
PV of Terminal Value 1,139
Implied Enterprise Value 2,111 Implied Enterprise Value 2,024

EBITDA Multiple Property Growth Rate

8.5x 9.0x 9.5x 1.5x 2.0x 2.5x
7.8% 2,117 2,189 2,260 7.8% 2,092 2,202 2,332 6
WACC 8.3% 2,043 2,111 2,179 WACC 8.3% 1,934 2,024 2,129
8.8% 1,971 2,036 2,101 8.8% 6 1,799 1,873 1,959

18 Discounted Cash Flow

D. Leveraged Buy-out
Principles of an LBO
Given the increase in M&A activity by private equity players, working out how much they can potentially pay to generate a
required return has become a key driver of valuation.

 In a leveraged buyout the principle is as follows

– A company is acquired for a given price through a combination of debt funding (usually between 50–70% of total funding) and equity from
the private equity firm
– Over the next few years, the company increases its profitability and also uses its cash generated to pay down the debt that the PE firm
has used to acquire the business
– In the medium term, usually 3–5 years, the company is sold, based on a higher EBITDA with the proceeds being used to pay back debt
(which is now lower than when the company was acquired originally) and the difference in the exit price and the level of debt goes to the
private equity player
 The private equity player generates returns from selling its equity in the business for a substantially higher price and as such, we can derive
a maximum price payable today for the company by setting a level of target returns for the private equity player

On Acquisition 2013 2014 215 On Exit

Debt Equity

19 Leveraged Buy-out
Example LBO Model Company A

Generally speaking, a private equity player will look to generate returns in excess of 20%, although this will vary from
sector to sector.

Cash Flow Statement – Company A  We have acquisition of the target for £1,500m financed through £900m of
funded debt and £600m equity
£ of Million 2015 2016 2017 2018
EBIT 137 160 173 184  Every year the company generates cash and by 2018, the net debt of the
Depreciation (60) (65) (69) (72) company is only at c.£600m
EBITDA 197 225 241 257  We have assumed an exit at 9.0x EBITDA in 2018 valuing the company at
Change in WC 4 3 2 2 c.£2,300m on exit
Net Interest (61) (57) (52) (46)
– Given implied net debt of c.£600m in 2018, this implies an equity value of
Tax (23) (31) (36) (42)
Capex (70) (71) (73) (76)
c.£1,700m on exit
Change in Net Debt 47 69 82 96  The internal rate of return (IRR) is the return made on the investment and is the
Starting Net Debt 900 853 785 702 same in principle to the discount rate
Closing Net Debt 853 785 702 607 – The IRR is the rate of return on the investment where the present value of
the future cash flows to the equity investor at that rate is equal to the initial
Exit Valuation – Company A value of equity used to buy the business
EBITDA 257  The IRR in this case is 29.8%, i.e. £1,705m discount back 4 years at a rate of
Exit Multiple 9.0x 20.0% gives us a value of £822m
Exit Value 2,312
Less: Net Debt (607)
 Therefore based on a value on exit, we are able to calculate the maximum price
Equity Value 1,705 payable by a firm today to generate a given return
Target IRR 20.00%
Discount Factor 0.48 Max Price Calculation – Company A
Implied Current Value of Equity 822
Plus: Net Debt on Acquisition 900 EBITDA 257
Implied Acquisition Value 1,722 Exit Multiple 9.0x
Exit Value 2,312
Target IRR Less: Net Debt (607)
15.0% 17.5% 20.0% 22.5% 25.0% Implied Equity Value 1,705
8.0x 1,728 1,660 1,598 1,543 1,493 EV on Acquisition 1,500
8.5x 1,801 1,727 1,660 1,600 7 1,546 Less: Net Debt on Acquisition (900)
Exit Multiple 9.0x 1,875 1,795 1,722 1,657 1,598 Equity Value on Acquisition 600
Cash on Cash Return 2.8x
9.5x 1,948 7 1,862 1,784 1,714 1,651
Implied IRR 29.8%
10.0x 2,022 1,929 1,846 1,771 1,704

20 Leveraged Buy-out
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