Some notes on firm valuation in MA transactions by juanagui


									Some notes on firm valuation in
      M&A transactions
     Firm valuation approaches in
          M&A transactions
• There are several approaches to valuing a firm before an
  acquisition transaction, but we will focus on the following (the list
  below is incomplete):

    – Current market value of the firm

    – Trading multiples based on comparable firms

    – Transaction multiples of comparable acquisitions

    – Discounted cash flow approach
• The valuation exercise can be quite complex, but it is important
  to remember a few guiding principles

    – Throughout the exercise, it is important to always “think like an
      investor” meaning focus on whether an M&A transaction will create
      value or not

    – The aim of valuation analysis is to assess the true or intrinsic value
      of the firm; this value is not observable and the valuation estimates
      obtained through the various approaches not only do not give us
      the intrinsic value but also include measurement errors
– The aim of valuation is to exploit profit-making opportunities form a
  difference between the current price and the intrinsic value of a firm

– The estimates obtained by the various approaches offer a range of
  values for the firm and will be very useful during negotiations

– Thus, it is important to scrutinize the estimators, the underlying
  assumptions, to perform sensitivity analysis and to eliminate
  estimates in which we don’t have confidence
Current market value, trading multiples
      and transaction multiples
• The current market value of a firm is the sum of the market
  value of its equity and the market value of its debt

• For debt, we should use market values, but book values will be
  close to market values unless there has been a change in the
  firm’s credit rating or the general level of interest rates

• Calculating the firm’s debt, we ignore deferred taxes and current

• The current market value is an important reference point
  because it gives us the market’s valuation of the firm
• Valuation through trading multiples is nothing other than the
  multiples valuation approach that we discussed earlier

• It is important to select the appropriate sample of peer firms that
  match the evaluated firm in terms of current line of business,
  outlook for the future, financial policy and size

• We can use equity or firm multiples

• Equity multiples such as P/E ratio, market-to-book ratio, can be
  used to obtain estimates of stock prices
• Firm multiples are
   –   Firm value/EBIT
   –   Firm value/EBITDA
   –   Firm value/sales
   –   Firm value/book value of assets

• These can be used to estimate market values of the firm

• Transaction multiples are used as an additional benchmark
  because they include the premiums paid for target firms
• Similar equity and firm multiples are used in the case of
  transaction multiples

• The difference between trading and transaction multiples is that
  the latter will include the premiums paid for obtaining control of
  the acquired firms
           DCF valuation of a firm

• Obtain forecasts of Free Cash Flows to the Firm (FCFF) for an
  horizon of 5-10 years

• Estimate the terminal value of the firm under some reasonable
  growth assumption

• Estimate the firm’s cost of capital

• Use the above information to obtain the PV of future FCFF plus
  the firm’s terminal value
• To obtain estimates of the firm’s value of equity through the
  DCF approach we can

    – Use DCF to estimate the firm’s value and subtract from that the
      value of the firm’s debt

    – Use DCF to discount the FCFE at the firm’s cost of equity (we use
      the same steps as described above in the case of FCFF)
• FCFF is given by

FCFF = EBIT (1-tax rate) – (capital spending – depreciation) – change in
  noncash working capital

• The terminal value is given by

   TV = (FCFF(1+g))/(WACC-g)

• FCFE is given by

   FCFE = FCFF – debt payments + new debt issued
 Example: Valuation of UIUC Corp.

• To value this firm, we will use three approaches (example
  shown in class)

   – DCF approach based on forecasts of earnings, capital expenditures
     and working capital needs for the next five years

   – Trading multiples from peer firms

   – Information from transaction multiples

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