Chapter 13 PPT - Holthausen & Zmijewski 2019

Chapter 13
Introduction to
Market Multiple
Valuation
Methods
© Cambridge Business Publishers 2019 1 Corporate Valuation by Holthausen & Zmijewski
Discussion Topics

How We Use Market Multiples
 The market multiple valuation process
 Using market multiples to value the firm and
its equity
 Using market multiples to value transactions

Market Multiple Valuation
 Two standard market multiple valuation methods are
 Using multiples from publicly traded comparable companies
 Using multiples from comparable transactions
 Simplistic description of the process
 Measure a market multiple – the relation between value and
usually an earnings-based or cash flow-based denominator
(such as EBITDA) for comparable companies with known
values of the numerator and denominator
 Measure the value of the company you want to value –
multiply the company’s measure of the chosen denominator by
the market multiple of the comparable companies (comps)

Market Multiple Valuation Methods
 How can this work? Think “twin” company
 AXP Co. is publicly traded, $500 value, all equity
 Future FCFs = $20, $24, $28, $32, $36, $40, $44, $48, then g=2%
 EXP Co. has an unknown value
 Future FCFs = $25, $30, $35, $40, $45, $50, $55, $60, then g=2%
 EXP Co. has exactly the same risk as AXP Co.
 What is the value of EXP Co.?
 Do not need market multiple, EXP’s FCFs = 1.25 AXP’s FCF,
thus, VEXP = 1.25 VAXP
 FCF multiple for AXP = $500 / $20 = 25
 VEXP = 25 (AXP muliplte) x $25 (EXP FCF)=$625

Market Multiple Valuation Process
 Alternative names for the market multiple valuation
method include “comparable company valuation,”
“guideline-company valuation,” “relative valuation
analysis,” “direct comparison valuation,” and “twin
company approach”
 As is clear from the various names used to describe the
market multiple valuation method, comparable companies
—or “comps”—play a major role in this valuation method
 One of the most important steps in a market multiple
valuation is to identify the comparable companies

 The main challenges in conducting a market
multiple valuation are
 Identifying appropriate comparable companies that
are priced similarly to the company being valued
 Making the necessary adjustments to the financial
numbers that are used to measure the market multiples
of the comparable companies as well as those used to
value the company of interest.
 The goals of such analyses are to align the
characteristics of the comparable companies with
those of the company being valued
Market Multiple Valuation Methods
 Must also
 Choose the multiple – which denominator (unlevered
earnings, EBIT, etc.) and what timing
 Measure a denominator (whether it is unlevered
earnings, EBIT or anything else) that represents the
long-run performance of the companies (adjusting
financial statements) to make the comparable
companies and the company being valued as close to
being “twins” as possible


Using Market Multiples to Value the Firm
 Measuring firm value versus enterprise value
 Part of the process of aligning the comparable companies to
the company being valued is eliminating excess assets and the
effect of excess assets on earnings and cash flows
 One “short-cut” approach taken to eliminate excess assets is
to assume all cash is excess cash
 Enterprise value = firm value – cash
 Enterprise value = (VD – Cash) + VPS + VE + …
 Net debt = VD – Cash
 When we measure enterprise value instead of firm
value, we assume that all companies have the same
required cash requirements (proportional to value)
 Note the consistency (or lack thereof) of the numerator
and denominator

Using Market Multiples to Value Equity

Non-Accounting-Based Market Multiples
 Do non-accounting-based market multiples make
sense?
 Yes, as long as the denominator is correlated with
expected FCFs – any denominator can work if it
is correlated with expected FCFs
 Some non-accounting denominators
 Telecomm companies – population or subscribers
 Retail companies – square feet of retail space
 Services companies – employee headcount

 Market multiples vary over time because of
changes in market conditions and the state of the
economy
 Thus, we generally use current multiples – not historical averages
– to value a company as of the valuation date

Valuing Transactions with Market Multiples
 An alternative numerator to firm value or
enterprise value is the price or value at which a
transaction occurred – for example, in a merger
or acquisition (Chapter 16)
 Since the price or value at which an acquisition
occurs is typically higher than the immediately
preceding market value (firm value or enterprise
value), acquisition multiples are typically higher
than market multiples based on prices of
publicly traded companies
What Drives Variation
in Market Multiples?
 Two key drivers – risk and growth

Key Market Multiple Drivers
 What causes the differences in the market multiples
across companies?
 Are these differences the same for all market multiples—
for example, in the case of EBIT and unlevered
earnings?
 We begin with an outline of a simple framework
underpinning market multiple valuations—the case of a
cash flow perpetuity.

 From the DCF valuation model, we can measure the
value of an all equity-financed firm as
FCF1 FCF2 FCF3 FCF
VF, 0     ... 
1+r  1+r  2  1+r  3  1+r 

 We can restate the DCF valuation as a constant-growth

perpetuity – where g1, ∞ is the present value weighted
average growth rate for the company’s free cash flows
from Year 1 in perpetuity
FCF1
VF, 0 
r  g1, 
Present Value Weighted Average Growth Rates
 Remember from Chapter 6 that any series of
infinite cash flows can be summarized as a
constant growth perpetuity if
 FCF1 is positive
 r (discount rate) is constant
 g1, ∞ is the present value weighted average growth
rate from Year 1 to infinity measured using the Year

1 FCF FCF
VF, 0  1
r  g1,

Present Value Weighted Average Growth Rates
 We can also measure the present value weighted
growth rate from Year 0 through ∞ using the free
cash flow from Year 0
FCF0   1  g0, 
VF, 0 
r  g0,

 We can use this formula to rewrite our market multiple
valuation formula for the free cash flow multiple,
MM[VF,0/FCF1], as
 If we use free cash flow from Year 0 (instead of Year 1),

then this formula must include the growth rate from
Year 0 to Year 1
 It should be clear that risk and growth affect free cash

flow multiples – moreover, they impact all multiples
Free Cash Flow MM Example
 Value a privately owned, 100% common equity-financed
company as of the end of Year 0
 The company
 Free cash flow for the current year, Year 0, is $100 million
 Expected free cash flow of $117.78 million next year (Year 1)
 The present value weighted average growth rate for the expected
free cash flows is 6% using Year 0 and is 5% using Year 1 as the
base year
 The company has one comparable company
 Value of the comparable is $13,375.1 million, 100% equity
financed
 Free cash flow for the current year, Year 0, is $1 billion
 Expected free cash flow is $1,337.51 million for Year 1
 Both companies have the same cost of capital of 15%.
 What are the free cash flow multiples of the comparable
company based on its Year 0 and Year 1 free cash flows?
Why are they different?
Publicly Traded Comparable Company
Year 0 Year 1
Free Cash Flow $ 1,000.00 $ 1,337.51
Growth Rate 33.75%
Cost of Capital 15.00%
Value as of End of Year 0 $ 13,375.1
Free Cash Flow Multiple: V0 FCFt

Based on Year 0 13.4 inputs = $ 13,375.1 $ 1,000.0
Publicly Traded Comparable Company r FCFt V0

Present Value Wtd Avg Growth - Year 1 5.00% inputs = 15% $ 1,337.5 $ 13,375.1

 Value the privately owned company using the free cash
flow market multiples of the comparable company based
on both the Year 0 and Year 1 free cash flows. Why are
the valuations different, and which one is more likely to
be the better valuation?
Company Being Valued
Valuation Using the Free Cash Flow Multiple from Comparable Company: FCFt Multiple
Based on Year 0 $ 1,337.5 inputs = $ 100.0 13.4

 Measure the value of the privately owned company using
the discounted cash flow valuation method, and compare
it to the free cash flow multiple valuations
Cost of Capital 15.00% g FCF1

DCF Value as of End of Year 0 $ 1,177.8 inputs = 5.00% $ 117.8
Company's Implied Free Cash Flow Multiple Based on DCF Valuation: FCFt V0
Based on Year 0 11.8 inputs = $ 100.0 $ 1,177.8
Comparison of Present Value Weighted Average Growth Rates

Company Being Valued r FCFt V0

Present Value Wtd Avg Growth - Year 1 5.00% inputs = 15% $ 117.8 $ 1,177.8

What Drives Variation
in Market Multiples?
 How Do We Assess Comparability?
 Know What Factors Drive Variation
in Market Multiples

PepsiCo, Inc. (Pepsi)
 At the end of its 2014 fiscal year (December 27, 2014), Pepsi was trading with an equity
market capitalization of roughly $139 billion (after eliminating $5 billion in assumed excess
cash and short-term marketable securities)
 Assume that Pepsi will maintain its capital structure at 24% debt (4% cost of debt) and has an 8%
weighted average cost of capital (rWACC = 8%). Based on these assumptions, Pepsi’s debt is $43
billion and its total market capitalization is $182 billion
 We assume Pepsi does not hold any excess cash in the future.
 Revenues drive Pepsi’s financial model.
 We use Pepsi’s present value weighted average growth rate of roughly 4% to forecast Pepsi’s
revenues from 2015 onward.
 We drive Pepsi’s cost structure (other than income tax expense and interest) using its 2014 relation
between its cost structure and revenues
 Cost of goods sold is 46.5% of revenues
 Selling, general and administrative expenses are 35.0% of revenues
 Depreciation is 4% of revenues
 Use the simplifying assumption that Pepsi’s average income tax rate (25.0% globally) is equal to its
marginal income tax rate for interest.
 Use these and other forecast drivers to forecast Pepsi’s income statement through 2025.

Pepsi – Forecast Drivers and Risk Factors

Pepsi – Income Statement
Forecasts and Drivers

Pepsi –
Balance
Sheet
Forecasts
and
Drivers

Pepsi – Free Cash Flow Forecasts

Pepsi – DCF Valuation
 What drives Pepsi’s value based on this simple

financial model?

Pepsi – Market Multiples
 What drives Pepsi’s market multiples based on this simple financial

model?

Pepsi – Forecast Drivers and Risk Factors
Drive Pepsi’s Value and Market Multiples

What Are the Factors for Assessing
Comparability for Different Multiples? For
…
 Enterprise Multiples  Equity Multiple
 Free Cash Flow  Equity Free Cash Flow
 Unlevered Earnings  Earnings
 EBIT  Price-to-Earnings
 EBITDA  Market-to-Book
 Revenue  Revenue
 Total Invested Capital

Free Cash Flow Multiple

Sensitivity
of Pepsi’s
Free Cash
Flow
Multiple
Valuation
to
Differences
in the
Multiple
Drivers

From FCF Multiple to
Unlevered Earnings Multiple
 Unlevered Free Cash Flow (FCF) = Unlevered Earnings (E)
+ Depreciation & Amortization (DEPR)
– Net Operating Working Capital Requirements (ΔNOWC)
– Capital Expenditures (CAPEX)
 The Pepsi Financial Model:
 Revenues = R1 = R0 x (1 + g) → ΔR1 = g x R0
 Depreciation & Amortization = DEPR% x R1
 ΔNet Operating Working Capital Requirements = NOWC% x g x R0
 Capital Expenditures = Depreciation & Amortization + Growth Capital Expenditures
CAPEX = DEPR% x R1 + CAPEX% x g x R0
 Unlevered Free Cash Flow =
FCF1 = UE1 + (DEPR% x R1) – (NOWC% x g x R0) – (DEPR% x R1 + CAPEX% x g x
R0)
FCF1 = UE1 – (NOWC% x g x R0) – (CAPEX% x g x R0)
FCF1 = UE1 – (NOWC% + CAPEX%) x g x R0
Pepsi’s Unlevered Earnings Multiple
 Substitute the free cash flow formula based on unlevered
earnings for FCF1 in the perpetuity formula
 Divide both sides of the equation by unlevered earnings

 The numerator is equal to the percentage of unlevered earnings
invested (plowed back ratio, PBUE) in working capital and CAPEX
 We can restate the plowback ratio, PB, in terms of the forecast

drivers demonstrating that market multiple determinants are a
function of the forecast drivers


Sensitivity
of Pepsi’s
Unlevered
Earnings
Multiple
Valuation
to
Differences
in the
Multiple
Drivers

The EBIT Multiple

Pepsi’s EBIT Multiple

Sensitivity
of Pepsi’s
EBIT
Multiple
Valuation
to
Differences
in the
Multiple
Drivers

The EBITDA Multiple

Pepsi’s EBITDA Multiple

Sensitivity
of Pepsi’s
EBITDA
Multiple
Valuation
to
Differences
in the
Multiple
Drivers

The Revenue Multiple

Pepsi’s Revenue Multiple

Sensitivity
of Pepsi’s
Revenue
Multiple
Valuation
to
Differences
in the
Multiple
Drivers

The Total Invested Capital Multiple

Pepsi’s Total Invested Capital Multiple

Sensitivity
of Pepsi’s
Total
Invested
Capital
Multiple
Valuation
to
Differences
in the
Multiple
Drivers
Takeaways from Pepsi Example
 Different multiples have different properties regarding what fundamental
characteristics must be controlled for in the selection of the comparables
 All multiples are affected by business risk, capital structure (through its
impact on the cost of capital) and growth
 Unlevered free cash flow multiples have the best properties – but affected
by risk, capital structure and growth
 Unlevered earnings multiples, in addition, do not control for investment
differences
 EBIT multiples, in addition, do not control for income tax rate differences
 EBITDA multiples, in addition, do not control for differences in
depreciation which should be correlated with maintenance CAPEX
 Revenue multiples, in addition, do not control for differences in operating
cost structures

Why Free Cash Flow Multiples Are
Not Very Popular
 Recall the formula for free cash flows
 CAPEX and to some extent changes in accruals

(ΔWCO) are lumpy, and thus, vary over time more than
earnings varies over time
 Unlevered FCFs and especially Equity FCFs are also
more likely to be negative, and we cannot use a negative
value in a market multiple valuation
 Thus, FCF multiples are not commonly used unless
the company and its comparables are in steady state
Caution
 The formulas derived for the various ratios are based on
the simple model we created for Pepsi
 The formulas and Pepsi example were created to make
clear what fundamental factors must be held constant
between the company being valued and the comparable
companies and to demonstrate how different ratios have
varying sensitivity to various fundamental factors
 As such, one cannot simply plug estimates of the various
inputs (e.g., Tax%, Depr%, OE%, etc.) in the equations
shown for any firm and solve for an appropriate multiple
for that firm
Competitors Are Not Always the Best
Comparable Company
 Telsa Motors designs, develops, manufactures, and sells fully
electric vehicles and advanced electric vehicle powertrain
components and was the first company to commercially produce a
U.S. federally-compliant electric vehicle, the Tesla Roadster
 Tesla was incorporated in 2003 and went public on the NASDAQ in
2010
 Who are Tesla’s comparable companies?

Equity Multiples
 Effect of financial leverage
 Affects both enterprise value and equity value
(numerators)
 Does not affect any of the denominators for enterprise
value-based multiples
 Affects all of the denominators for equity value-based
multiples (except revenue, if you use revenue)
 As a result, the formulas for the equity value-based
multiples are more complex than the formulas for
the firm value-based multiples
Equity
Multiples

Does Company Size Matter?
 Controlling for the size of the comparable companies is
popular in practice when selecting comparable
companies
 We have no theoretical model that includes size as a
determinant of market multiples
 Empirical research is mixed on whether or not
controlling for size is helpful for choosing comparable
companies after controlling for industry and other factors
 On the other hand, we know size is correlated with some
value relevant aspects of a company such as stock
returns even after controlling for expected returns
measured using the Capital63Asset Pricing
© Cambridge Business Publishers 2019
Model
Corporate Valuation by Holthausen & Zmijewski
MM Company
 MM Company has 3 potential comparable
companies
 MM and all of the potential comparable companies
have the same FCF growth rate and risk
 Which of the potential comparable companies is
the best company to use to value MM Company?

MM Company Income Statement (Year 1)
Revenue (Sales) $
MM Co.
322.0
COMP A
$ 644.0
COMP B
$ 966.0
COMP C
$ 632.5
- Operating Expenses (Costs) -225.4 -405.7 -676.2 -442.8
 Current - Depreciation
Earnings Before Interest and Taxes $
-23.0
73.6 $
-46.0
192.3 $
-69.0
220.8 $
-57.5
132.3
financial - Interest
Earnings Before Income Taxes $
0.0
73.6 $
0.0
192.3 $
0.0
220.8 $
0.0
132.3
- Income Tax Expense -22.1 -57.7 -79.5 -39.7
statements and Earnings $ 51.5 $ 134.6 $ 141.3 $ 92.6
free cash flow Balance Sheet (Year 0)

Total Invested Capital (Net) $ 230.0 $ 460.0 $ 690.0 $ 575.0
schedule for Debt

Equity
$0.0
230.0
$0.0
460.0
$0.0
690.0
$0.0
575.0
MM and its Debt and Equity $ 230.0 $ 460.0 $ 690.0 $ 575.0
potential Free Cash Flow (Year 1)

Earnings Before Interest and Taxes $
MM Co.
73.6
COMP A
$ 192.3
COMP B
$ 220.8
COMP C
$ 132.3
comparable - Income Tax Expense
Unlevered Earnings $
-22.1
51.5 $
-57.7
134.6 $
-79.5
141.3 $
-39.7
92.6
companies Depreciation
Investment
23.0
-34.5
46.0
-69.0
69.0
-103.5
57.5
-86.3
Free Cash Flow $ 40.0 $ 111.6 $ 106.8 $ 63.8
After-Tax Interest 0.0 0.0 0.0 0.0
New Debt 0.0 0.0 0.0 0.0
Equity Free Cash Flow $ 40.0 $ 111.6 $ 106.8 $ 63.8

MM Company
 Some basic % of Revenue
Revenue (Sales)
MM Co.
100%
COMP A COMP B COMP C
100% 100% 100%
financial relations Operating Expenses
Depreciation Expense
-70%
-7%
-63%
-7%
-70%
-7%
-70%
-9%
and market Earnings Before Income Taxes 23% 30% 23% 21%
Income Taxes -7% -9% -8% -6%
multiples Earnings 16% 21% 15% 15%
 Which company is Effective Tax Rate 30% 30% 36% 30%
the best comparable Margins, Returns, and Other MM Co. COMP A COMP B COMP C
Return on Investment 22% 29% 20% 16%
company for a Unleverd Profit Margin 16% 21% 15% 15%
multiple based on Revenue to Total Assets 1.40 1.40 1.40 1.10
 FCF COMP A COMP B COMP C

 Unlevered Earnings Market Multiples Based on the Value of the Firm
Value of the firm $ 1,594.2 $ 1,525.9 $ 911.8
 EBIT Free cash flow multiple 14.3 14.3 14.3
Unlevered Earnings Multiple 11.8 10.8 9.8
 EBITDA EBIT Multiple 8.3 6.9 6.9
EBITDA Multiple 6.7 5.3 4.8
 Revenue Revenue (Sales) Multiple 2.5 1.6 1.4
Total Invested Capital Multiple 3.5 2.2 1.6
 Total Invested Cap

MM Company
 MM Company valuation based on each
comparable company
Input for Valuation Based on
MM Co. COMP A COMP B COMP C Average Median
DCF-Based Valuation $ 571.7
Market Multiples Based on the Value of the Firm:

Free Cash Flow Multiple $ 40.0 $ 571.7 $ 571.7 $ 571.7 $ 571.7 $ 571.7
Unlevered Earnings Multiple $ 51.5 $ 610.2 $ 556.3 $ 507.4 $ 558.0 $ 556.3
EBIT Multiple $ 73.6 $ 610.2 $ 508.6 $ 507.4 $ 542.1 $ 508.6
EBITDA Multiple $ 96.6 $ 646.3 $ 508.6 $ 464.2 $ 539.7 $ 508.6
Revenue (Sales) Multiple $ 322.0 $ 797.1 $ 508.6 $ 464.2 $ 590.0 $ 508.6
Total Invested Capital Multiple $ 230.0 $ 797.1 $ 508.6 $ 364.7 $ 556.8 $ 508.6
% Difference from DCF-Based Valuation:

Free Cash Flow Multiple 0% 0% 0% 0% 0%
Unlevered Earnings Multiple 7% -3% -11% -2% -3%
EBIT Multiple 7% -11% -11% -5% -11%
EBITDA Multiple 13% -11% -19% -6% -11%
Revenue (Sales) Multiple 39% -11% -19% 3% -11%
Total Invested Capital Multiple 39% -11% -36% -3% -11%

Choosing Comparable Companies
 Understand the business
 Using industry classification codes
 Matching fundamental value drivers

Understanding the Business
 The first step in identifying potential comparable
companies is to understand the businesses in which the
company operates
 Identify all of the industries in which the company has
significant operations
 Then we identify its competitors
 The company often identifies its primary competitors in its
financial statements and other public filings
 Various financial websites also identify competitors
 Analyzing the industries (business segments) in which the
company operates is another way we can identify the
company’s competitors

1311 Crude Petroleum & Natural Gas
1531 Operative Builders
2834 Pharmaceutical Preparations
3674 Semiconductors & Related Devices
3714 Motor Vehicle Parts & Accessories
3845 Electromedical & Electrotherapeutic Apparatus
4911 Electric Services
5812 Retail-Eating Places
6331 Fire, Marine & Casualty Insurance
7370 Services-Computer Programming, Data Processing, Etc.
7372 Services-Prepackaged Software
7373 Services-Computer Integrated Systems Design
7374 Services-Computer Processing & Data Preparation
7990 Services-Miscellaneous Amusement & Recreation
Industry Classification Codes
 Implementing a market multiple valuation with any
precision is generally not as simple as calculating the
mean or median multiple of every company in a
particular SIC code or industry
 Controlling for the differences in value drivers across
companies is necessary when trying to ensure the
comparability of the comparable companies and the
company being valued

Industry Market Multiples Distribution

Industry Market Multiples Distribution

Assessing Comparability – Bottom Line
 A market multiple valuation is complex because of the complexities
for identifying truly comparable companies
 A company’s direct competitors are a good starting point
 Choosing close competitors usually controls for business risk, as close
competitors usually, but not always, have similar business risks
 Usually insufficient for choosing the final set of comps, however, simply
selecting close competitors is not sufficient to ensure the companies are
comparable…
 A company’s product lines, customer types, market segments, types
of operation, … are all important aspects to consider but even after
these are taken into consideration, two companies can be the same
along these dimensions yet not be comparable on all of the
characteristics that are important to assess comparability for a
market multiple valuation

Few If Any “Perfect COMPS” Exist

Effects of Transitory Earnings
 Effect of transitory earnings on growth rates
 Avoid transitory shocks

Transitory Earnings and Growth Rates
 A transitory shock is a temporary – for example, a one-
year – change in a company’s free cash flow or earnings
 Temporary downturn
 Write-off of an asset
 Restructuring charge
 One-time revenue shock
 One-time tax benefit
 A transitory shock will have a larger effect on the
company’s free cash flow or earnings than it has on its
value because value depends on future performance,
which is expected to continue as it did before the
transitory shock
 Transitory shocks can have large effects on a company’s
market multiples
Transitory Shocks – Illustration
 Value a privately owned, 100% common equity-financed
company as of the end of Year 0 - the company
Actual Actual Forecast Forecast Forecast Year 4
Company Being Valued Year -1 Year 0 Year 1 Year 2 Year 3 Onward
Free Cash Flow $ 94.26 $ 97.09 $ 100.00 $ 103.00 $ 106.09 $ 109.27
Growth Rate 3.00% 3.00% 3.00% 3.00% 3.00%
 The company is expected to grow at 3% and has one

comparable company that is also expected to grow at 3%
after Year 1 but has a transitory shock in Year 0
Actual Actual Forecast Forecast Forecast Year 4
Publicly Traded Comparable Company Year -1 Year 0 Year 1 Year 2 Year 3 Onward
Free Cash Flow $ 1,885.2 $ 1,200.00 $ 2,000.00 $ 2,060.00 $ 2,121.80 $ 2,185.45
Growth Rate -36.35% 66.67% 3.00% 3.00% 3.00%
Cost of Capital 13.00%

Value as of End of Year 0 $ 20,000.0
 Both companies have the same cost of capital of 13%.
Transitory Shock & MMs Example
 What are the free cash flow multiples of the comparable
company based on its Year 0 and Year 1 free cash flows?
Why are they different?
Publicly Traded Comparable Company V0 FCFt
Free Cash Flow Multiple:


 Value the privately owned company using the free cash
flow market multiples of the comparable company based
on both the Year 0 and Year 1 free cash flows. Why are
the valuations different, and which one is more likely to
be the better valuation?
Valuation Using the Free Cash Flow Multiple from Comparable Company: FCFt Multiple

 Measure the value of the privately owned company using
the discounted cash flow valuation method, and compare
it to the free cash flow multiple valuations
Cost of Capital 13.00% g FCF1

DCF Value as of End of Year 0 $ 1,000.0 inputs = 3.00% $ 100.0
Free Cash Flow Multiple Based on DCF Valuation: FCFt V0

Company Being Valued r FCFt V0


Continuing Value
 Multiples to measure current value versus
continuing value
 Cyclical industries

Current Value versus Continuing Value
 Since the continuing value date is some number of years after the
valuation date, the main question or challenge here is to forecast
how the market multiples will have evolved by the continuing
value date
 Using current market multiples to measure continuing value
assumes that the future growth and performance prospects
(including capital expenditure and working capital requirements)
at the continuing value date are the same as the current growth
and performance prospects of the comparable companies
 It may be the case that the best comparable companies for a
market multiple valuation of a company on the valuation date
can differ from the best comparable companies to assess the
multiple at the company’s continuing value date

 Here is a
company
with
decreasing
growth
rates
 How do
its market
multiples
evolve?
 See how
the market
multiples
decrease
with the
decreasing
growth
rate

 The same type of effect occurs as a result of
declining profitability or any other change in a
value driver that occurs between the valuation
date and the continuing value date that affects a
market multiple being used to assess value

Cyclical Industries
 A related issue arises for companies in cyclical industries
in which market multiples vary over time depending on
where the industry is in its cycle
 Multiples tend to be the highest when the industry is
coming out of the trough of the cycle, and the lowest
soon after it passes the peak of the cycle
 Current multiples measured when an industry is at the trough
(or peak) of its cycle measure market multiples reflecting that
trough (or peak) of the cycle
 We would need to have the same economic environment at the
continuing value date to use these multiples
 If the forecasts represent the midpoint of the cycle, the
multiples used should also reflect that midpoint
What We Covered

Key Concepts and Takeaways - 1
 Two market multiple methods –
 Publicly traded comparable companies
 Comparable transactions
 Two key steps
 Identifying the comparable companies
 Adjusting financial statements for comparability
 Use various types of denominators for the multiples to
measure the enterprise value (firm value minus cash)
and equity value
 Important to have consistency in the numerator and
denominator
 Denominators can be cash flow-based, earnings-based,
balance sheet-based, and non-accounting-based
 While value drivers such as risk and growth are
important, many multiples are affected by value drivers
such as cost structure, working capital and capital
expenditures
 Not all multiples are equally affected by variations in
particular value drivers
 When using a multiple in which expenditures (expenses
or investments) are not deducted in the calculation of
the denominator, that expenditure is more important for
assessing comparability than when using a multiple in
which it is deducted in the calculation of the
denominator (EBIT and income tax structure)
 To select comparables
 Understand the company’s businesses
 Identify the industries in which the company operates
 Companies and analysts identify potential comparables
 Do not rely solely on the company’s standardized industry
classification code
 Transitory shocks have a larger effect on free cash flow
or earnings than on value – avoid them or adjust for
them

 To use current market multiples to measure continuing
value, assess whether the key drivers – for example,
performance and risk – are expected to remain constant
 The best comparable company for a continuing value
multiple might not be the same as the company that is
best to measure the current value of the company
 Companies in cyclical industries have a similar
challenge – current multiples might not reflect the
underlying economics at the continuing value date

*** END ***
Chapter 13
Introduction to Market
Multiple Valuation
Methods

Chapter 13 PPT - Holthausen &amp; Zmijewski 2019

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 13 PPT - Holthausen &amp; Zmijewski 2019

Uploaded by

Copyright:

Available Formats

Chapter 13

© Cambridge Business Publishers 2019 2 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 3 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 4 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 5 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 6 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 8 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 9 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 11 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 12 Corporate Valuation by Holthausen & Zmijewski

 Services companies – employee headcount

© Cambridge Business Publishers 2019 13 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 14 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 17 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 18 Corporate Valuation by Holthausen & Zmijewski

 We can restate the DCF valuation as a constant-growth

rate from Year 1 to infinity measured using the Year

© Cambridge Business Publishers 2019 20 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 21 Corporate Valuation by Holthausen & Zmijewski

 If we use free cash flow from Year 0 (instead of Year 1),

 It should be clear that risk and growth affect free cash

Free Cash Flow Multiple: V0 FCFt

Publicly Traded Comparable Company r FCFt V0

© Cambridge Business Publishers 2019 24 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 25 Corporate Valuation by Holthausen & Zmijewski

Cost of Capital 15.00% g FCF1

Comparison of Present Value Weighted Average Growth Rates

Publicly Traded Comparable Company r FCFt V0

Company Being Valued r FCFt V0

© Cambridge Business Publishers 2019 26 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 27 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 28 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 29 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 30 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 31 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 32 Corporate Valuation by Holthausen & Zmijewski

 What drives Pepsi’s value based on this simple

© Cambridge Business Publishers 2019 33 Corporate Valuation by Holthausen & Zmijewski

 What drives Pepsi’s market multiples based on this simple financial

© Cambridge Business Publishers 2019 34 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 35 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 36 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 37 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 38 Corporate Valuation by Holthausen & Zmijewski

 Divide both sides of the equation by unlevered earnings

© Cambridge Business Publishers 2019 40 Corporate Valuation by Holthausen & Zmijewski

 We can restate the plowback ratio, PB, in terms of the forecast

© Cambridge Business Publishers 2019 41 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 42 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 43 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 44 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 45 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 46 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 47 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 48 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 49 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 50 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 51 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 52 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 53 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 54 Corporate Valuation by Holthausen & Zmijewski

© Cambridge Business Publishers 2019 56 Corporate Valuation by Holthausen & Zmijewski

 CAPEX and to some extent changes in accruals

© Cambridge Business Publishers 2019 59 Corporate Valuation by Holthausen & Zmijewski

Chapter 13 PPT - Holthausen & Zmijewski 2019

Chapter 13 PPT - Holthausen & Zmijewski 2019