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10 Cards in this Set
- Front
- Back
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Compare private and public equity valuation by explaining differences in Company Specific Factors and Stock Specific Factors. |
The differences between private and public companies can be grouped into company specific issues and stock specific issues.
Company specific issues include:
Company size Stage in life cycle Quality of management Management and shareholder overlap
Stock specific issues include: Liquidity Restrictions on marketablity
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Describe the three uses of private company valuations?
Pg 266-267, equity |
Transaction related: These are used when a company is in need of new financing or is potentially selling itself. Transactions include IPO's, performance based management compensation, sale of company in acquisition
Compliance related valuations: Generally apply to financial reporting requirements and tax issues.
Litigation related valuations: Have to do with any valuations needed for legal actions being brought on the firm. |
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What are the three approaches to private company valuation, and what factors contribute to an analyst selecting each?
Pg 268-269, equity |
The methods used to value a private company are extremely similar to those used to value public companies, they just have different names.
Income approach: Finds the present value of future cash flows (DDM, FCFF approaches for public)
Market approach: Values the firm using prices of recently sold comparable assets (comparable method).
Asset-based approach: Valuing the company by finding the difference between the company's assets and liabilities.
The three factors to consider when selecting a valuation method for private companies is: 1. Stage in life cycle: A company in the early stages of its life cycle may have extremely uncertain cash flows. 2. Firm size: Price multiples from large public companies should not be used when valuing small private companies. 3. Operating vs nonoperating assets |
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Explain normalized earnings when valuing a private company, and the adjustments needed to get to normalized earnings.
Pg 269-271, equity |
Normalized earnings are the earnings that the company would achieve IF it were to be bought. When finding normalized earnings, an analyst needs to make adjustments to the company's earnings to eliminate those costs/revs that would no longer exist if the company were to be acquired.
This includes: Higher manager compensation Real estate owned by company that does not directly relate to operations etc |
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Differentiate between strategic and non- strategic buyers for a private company.
What differences are there in the valuation process for each?
Pg 271, equity |
Strategic buyers: Strategic buyers are ones that operate in the same line of business as the potential target company. They are looking to purchase the private company to unlock synergies.
Non-strategic buyers: Those buyers that are in different businesses and will not unlock any synergies in the purchase of the private company. |
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Explain the steps to valuing a company using the Free Cash Flow method, the Capitalized Cash Flow method, and the Excess Earnings method.
Relate these to public firm valuation to help remember.
Pg 274-277, equity |
Free Cash Flow: This is a two period valuation model that assumes a long term growth rate to find a terminal value, and then discounts the terminal value and the near term cash flows at a different rate.
Capitalized Cash Flow: Assumes a single growth rate for the company and is simply the single stage discount model used to value public companies.
Excess Earnings Model: This model is very similar to the residual income model to valuing a public company. An analyst needs to find the earnings that should be generated by the WC and FC a private company has on their books. The difference between what the company actually makes and what they should've made is their excess capital (residual income). The analyst then finds the growth rate for this residual income, discounts it back and adds it to the WC and FC on the private company's books. |
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When estimating the discount rate for a private company, explain CAPM, expanded CAPM and the Build Up method.
Why is CAPM less useful with private companies?
Pg 278-279, equity |
The issue with using the CAPM to value a private company is the estimation of Beta is extremely difficult to be accurate with. This is true for the extended CAPM as well
CAPM: Same as public company
Extended CAPM: CAPM equation, but there is an additional term in the equation which accounts for the added risk of the private company (size, illiquidity, etc)
Build up: Uses the different risk factors to build up to the beta estimate. It is assumed that the beta begins at the market beat (1) and then estimated levels of risks for different factors are added. |
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Explain the three different market based methods of valuing a private company, and what are the advantages/disadvantages to each?
pg 280-285, equity |
Guideline Public Company Approach: This method uses market data for current publicly traded firms to value the private company. When using this method, the analyst needs to add a "control premium" to the value of the equity portion to reflect the premium in the event of an acquisition.
Guideline Transaction Approach: This method uses the data from previous acquisitions to value the private company. Because the transactions were for the entirety of the private company, the prices and financial data already reflect the "control premium" and thus no adjustments need to be made.
Prior Transaction Approach: This method uses the transaction of the private company's individual stock to value the company. |
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Describe the asset based method for private company valuation.
pg 286, equity |
The asset based approach measures the value of a company's asset and liabilities and takes the difference between the two to find the current value of the firm.
If the company is considered a going concern, this method is rarely used because it is much more difficult to find comparable values for the firms assets than it is to find comparable values for the firm itself (so the other approaches make more sense) |
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Explain the adjustments needed when accounting for discounts for lack of control and discounts from lack of marketability.
How does one estimate each?
What are the downsides to these estimations?
pg 286-289, equity |
DLOC: The way to think about this is investors with a controlling interest will enjoy benefits that minority shareholders will not (control of retention ratio, information, etc). A discount can be estimated to isolate that factor which is largely based on the control premium.
DLOC = 1 - [1 / (1 + CP)]
Discount for lack of marketability: This can also be termed "discount for lack of liquidity" because it reflects the discount needed because of a holders inability to sell the investment. There are a few ways of measuring DLOM, all of which are very subjective.
1. Measure the value of restricted shares that cannot be sold anyway. 2. Measure the value of a put option divided by the value of the stock to isolate value of selling the asset. (recall a put is the right to sell the asset) 3. Measure the difference between the value of the stock prior to IPO and the value of the stock immediately after the IPO.
It is important to remember that when applying these discounts, they are not additive. This means that if DLOC is 12% and DLOM is 14%, the discount is NOT 26%. The discount would be:
1 - [(1-DLOC)(1-DLOM)]
Example on page 289 |
