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Deloitte Corporate Finance

Fundamentals of Valuation
Private and Confidential

November 5, 2014

Fundamentals of valuation
This evenings speakers
Ian Wanke
Vice President
Corporate Finance
(604) 640-3355
iwanke@deloitte.ca

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 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

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 Corporate Finance: Fundamentals of Valuation

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

Deloitte Corporate Finance: Fundamentals of Valuation

Deloitte LLP and affiliated entities.

Deloitte Corporate Finance


Overview

Deloitte Corporate Finance: Fundamentals of Valuation

Deloitte LLP and affiliated entities.

Deloitte at a glance
Corporate finance part of a complete solution
Audit

Financial
Advisory

Industry

Financial Services

Manufacturing

Mid-Market
Corporate Finance

Private Equity

Valuation
Services

Forensic &
Dispute Services

Lender due
diligence

Purchase price
allocation

Forensic
investigations

Private equity
capital raise

Vendor due
diligence

Goodwill
impairment

Debt advisory

Acquisitions,
reverse takeovers

Structured finance

Analytic &
forensic
technology

Management buyouts

Public Corporate
Finance
Fairness opinion

Capital markets
and IPO advisory

Transaction
Services

Divestitures &
acquisitions

Options analysis

Mining & Energy

Consulting

Financial Advisory

Consumer
Business
Engineering &
Construction

Tax

Public Sector

Board advisory

Technology,
Media & Telecom

Shareholder value
analysis, strategic
partnerships and
joint ventures

Deloitte Corporate Finance: Fundamentals of Valuation

Acquisition &
investments by
private equity
groups and
financial buyers

Business &
intangible asset
valuations

Reorganization
Services
Turnaround
Loan portfolio
management
Stressed and
distressed
advisory services

Dispute
consulting

Liquidation

Pricing analysis

Class action
services

Insolvency
services

Fairness opinions

Expert witness
Litigation support

Performance
Improvement

Anti-money
laundering

Merger
Integration

Business
intelligence
Anti-corruption

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 worlds largest


private professional services practice in terms of
headcount and fee income.
Offers sophisticated investment banking advice to
companies participating in public and private
transactions globally.

31%

Boutique levels of service and industry knowledge


integrated with the market reach and technical
resources of a global advisory network.
Last year, Deloitte advised on over 350 completed
M&A transactions globally.

69%

Deloitte is consistently ranked as a leading


Global Mid-Market Advisor by Thomson Financial

Advisory

Audit

Deloittes 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

Deloitte Corporate Finance: Fundamentals of Valuation

Deloitte LLP and affiliated entities.

Deloitte Corporate Finance


Complete corporate finance advisory services
Mergers and Acquisitions
Strategy development
Acquisitions or
divestitures
Valuations
Execution

Capital Raising

Corporate Advisory
Outsource corporate
development
Strategic assessment
and analysis

Board, shareholder
services

Other

Capital raising

Fairness opinions

Option analysis

Capital projects

Private placements

Safety assessment

Strategic investors

Deloitte as one

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
Global Mid-Market Corporate
Finance Team

Core Mid-Market Advisory Team in BC

David Lam
Partner, MidMarket Advisory

Dallas Mcmurtrie
Partner, M&A Tax
Advisory

Doug Beaton
Vice President &
Director

Europe

Austria

Belgium
Central Europe

Denmark

France

Finland

Germany

Greece

Ireland
Italy
North America
Canada
Mexico
United States
- Chicago
- Dallas
- Detroit
- Los Angeles
- New York
South America
Argentina
Brazil
Chile

Ian Wanke
Vice President

Ashton Scordo
Senior Analyst

Africa
South Africa
Nigeria

Luxembourg
Netherlands
Norway
Portugal
Spain
Switzerland
Russia
Turkey
United Kingdom
Asia Pacific
Australia
China
India
Indonesia
Japan
Malaysia
New Zealand
Philippines
Singapore
South Korea
Taiwan
Thailand

Middle East
United Arab Emirates
Saudi Arabia
Kuwait
Qatar

Matt Miller
Analyst

Matt Meyer
Senior VP

Rob Olsen
Partner

Cahal Dowds
Vice Chairman

Los Angeles

Toronto

UK London

Simon Gisby
Partner, CF
New York

Will Frame
Senior VP

Ronald Chao
Partner

Avinash Gupta
Partner

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.

Deloittes 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 capitalraising assignments.
A Powerful Combination Deloitte US + McColl Partners

Overview
Central
20 professionals
Chicago
Detroit

Dedicated Financial Sponsors group to ensure unparalleled


understanding of private equity market dynamics

Proven track record under Mr. Hugh L. McColl Jr., former Chairman
and Chief Executive Officer of Bank of America

The Financial Sponsors Group maintains dialogue with over 300


financial sponsors in a wide variety of markets throughout the United
States and internationally.

DCF has real-time information on which groups are interested in


recapitalization transactions.

Regular dialogue with these financial sponsors provides meaningful


insight into the investment communitys interests in prospective
acquisitions. As a result of our close relationships, DCF has
developed a strong understanding of each sponsors investment
thesis and behavior during transaction processes.

Extensive experience providing mergers and acquisitions advice


exclusively tailored to middle market clients

Customized sell side process to meet clients specific goals

Northeast
15 professionals
New York
West
15 professionals
Los Angeles

Southeast
58 professionals
Atlanta
Charlotte

Mid-America
9 professionals

Dallas

Houston

Talent
Number of Partners/Principals/Directors: 25

Number of advisors: 120+

Deloitte Corporate Finance: Fundamentals of Valuation

Deloitte LLP and affiliated entities.

Illustrative transaction experience


Deloitte success stories

has acquired

has acquired

has acquired

Has acquired
Has acquired an interest in
Has sold 50% of its interest in

The undersigned acted as advisor to


Makin Metals Ltd.

The undersigned acted as advisor to


Northern Mat & Bridge Ltd.

The undersigned acted as


advisor to Lesley Stowe Fine
Foods Ltd.

The undersigned acted as advisor


to 4Refuel

The undersigned acted as advisor


to Eminata Group

The undersigned acted as


financial advisor to CPX

Agrifoods International
acquired selected business locations from

has acquired

(a Swander Pace Capital, Jefferson Capital &


United Natural Foods Inc. partnership.)

has acquired

Has acquired

invested in

Has acquired

&
Earths Own and Meadowfresh
INLAND PACIFIC DISTRIBUTORS LTD.
The undersigned acted as exclusive
advisor to Tom Harris Cellular

The undersigned acted as exclusive


advisor to CBV Collection Services Ltd.

The undersigned acted as financial


advisors to the shareholders of
Inland Pacific Distributors Ltd.

Deloitte Corporate Finance: Fundamentals of Valuation

The undersigned acted as advisor


To Norsat

The undersigned acted as exclusive


financial advisor to Earths Own and
Meadowfresh

September 2012
The undersigned acted as exclusive
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

The undersigned acted as advisor


to West Coast Engineering

The undersigned acted as advisor


to Sequel

Has acquired

Has acquired

Has acquired

The undersigned acted as advisor


to Fitness World

The undersigned acted as advisor


to Sprott-Shaw

a subsidiary of

The undersigned acted as advisor


to Vancity

The undersigned acted as advisor


to Eminata Group

Has acquired

Has acquired

Has acquired

Has acquired

Has acquired

Has acquired

The undersigned acted as advisor to PJ


White Hardwoods Ltd.

The undersigned acted as due diligence


advisor Yellow Point

The undersigned acted as advisor


to Pizza 73

The undersigned acted as advisor


to Datawave

The undersigned acted as advisor


to Soyaworld

The undersigned acted as advisor


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:

Hammond Kennedy, Whitney &


Company, Inc.
has invested in

R.S.T. Instruments Ltd.


The undersigned acted as exclusive financial
advisor to R.S.T. Instruments Ltd.

RSTs 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
the globe.

Process:

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


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
Enterprise Value
= FMV of equity + FMV of debt Redundant assets

Re-arranged
Equity Value
= Enterprise value - FMV of debt + Redundant assets

14

Deloitte Corporate Finance: Fundamentals of Valuation

FMV of Equity
= Common shares + Preferred
shares +Minority interest

Enterprise Value
= Discounted free cash flows +
Terminal value

Deloitte LLP and affiliated entities.

Valuation concepts
Capital structure

Mortgage
(aka Debt)

Down
Payment
(aka
Equity)

What is the Enterprise Value of the house?


15

Deloitte Corporate Finance: Fundamentals of Valuation

Mortgage + Down Payment


Deloitte LLP and affiliated entities.

How do you measure value?


Valuation approaches and methods

Asset
Approach

Liquidation

Modified net
assets

Income
Approach

Capitalization

Discounted
cash flows

Market
Approach

Guideline
public
companies

M&A
transactions

Valuation methodology descriptions


Asset approach

Income approach

Market approach

The current value of a companys net


assets as the prime determinant of value.

Value is ascribed based on the companys


ability to generate future discretionary cash
flow and earn a reasonable return on
investment after consideration of risks
related thereto.

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.

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

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.

Deloitte Corporate Finance: Fundamentals of Valuation

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?
When comparable companies / precedent transactions
are not available
When the cash flows are expected to change
significantly (i.e. Unprecedented growth)
When there are multiple business streams with different
levels of risk
For start-ups when the company does not have a history
of earnings

Major cornerstones
1. Cash is King
- If it dont jingle it dont count
2. Time value of money
- Opportunity cost
- Reflection of risk
3. Net present value
- 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
EBIT
Add:
Depreciation
EBITDA
Less:
Tax
Capital expenditures
Change in WC
FCFF
Discount factor
PV FCFF
Sum of FCFF
Terminal value
Enterprise value

2014F
100

2015F
119

2016F
141

2017F
169

2018F
209

2019F
274

20

25

32

38

40

25

120

144

173

207

249

299

(24)
(50)
(1)

(29)
(50)
(1)

(35)
(50)
(1)

(41)
(50)
(2)

(50)
(50)
(2)

(60)
(50)
(2)

45

64

87

114

147

186

0.91
41
441
994

0.83
53

0.76
66

0.70
79

0.64
93

0.58
108

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
EBIT
Add:
Depreciation
EBITDA
Less:
Tax
Capital expenditures
Change in WC
FCFF
Discount factor
PV FCFF
Sum of FCFF
Terminal value
Enterprise value

2014F
100

2015F
119

2016F
141

2017F
169

2018F
209

2019F
274

20

25

32

38

40

25

120

144

173

207

249

299

(24)
(50)
(1)

(29)
(50)
(1)

(35)
(50)
(1)

(41)
(50)
(2)

(50)
(50)
(2)

(60)
(50)
(2)

45

64

87

114

147

186

0.91
41
441
994

0.83
53

0.76
66

0.70
79

0.64
93

0.58
108

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
EBIT
Add:
Depreciation
EBITDA
Less:
Tax
Capital expenditures
Change in WC
FCFF
Discount factor
PV FCFF
Sum of FCFF
Terminal value
Enterprise value

2014F
100

2015F
119

2016F
141

2017F
169

2018F
209

2019F
274

20

25

32

38

40

25

120

144

173

207

249

299

(24)
(50)
(1)

(29)
(50)
(1)

(35)
(50)
(1)

(41)
(50)
(2)

(50)
(50)
(2)

(60)
(50)
(2)

45

64

87

114

147

186

0.91
41
441
994

0.83
53

0.76
66

0.70
79

0.64
93

0.58
108

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
EBIT
Add:
Depreciation
EBITDA
Less:
Tax
Capital expenditures
Change in WC
FCFF
Discount factor
PV FCFF
Sum of FCFF
Terminal value
Enterprise value

2014F
100

2015F
119

2016F
141

2017F
169

2018F
209

2019F
274

20

25

32

38

40

25

120

144

173

207

249

299

(24)
(50)
(1)

(29)
(50)
(1)

(35)
(50)
(1)

(41)
(50)
(2)

(50)
(50)
(2)

(60)
(50)
(2)

45

64

87

114

147

186

0.91
41
441
994

0.83
53

0.76
66

0.70
79

0.64
93

0.58
108

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
EBIT
Add:
Depreciation
EBITDA
Less:
Tax
Capital expenditures
Change in WC
FCFF
Discount factor
PV FCFF
Sum of FCFF
Terminal value
Enterprise value

2014F
100

2015F
119

2016F
141

2017F
169

2018F
209

2019F
274

20

25

32

38

40

25

120

144

173

207

249

299

(24)
(50)
(1)

(29)
(50)
(1)

(35)
(50)
(1)

(41)
(50)
(2)

(50)
(50)
(2)

(60)
(50)
(2)

45

64

87

114

147

186

0.91
41
441
994

0.83
53

0.76
66

0.70
79

0.64
93

0.58
108

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 firms 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)

Ke = rf + (rm rf)

Geometric average excess return of the


market index over rf

TSE 300 or S&P 500

Long term average preferred

Risk Free Rate (rf)

Beta () 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)

Ke = rf + (rm rf)

Market return = 12.0%

Therefore, market risk premium = 7.0%

Risk Free Rate (rf)

Beta () 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 = * (1 t)

Sources:

Cost of debt is adjusted for the tax rate

Credit spread or yield of liquid


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%


Cost of debt is adjusted for the tax rate

Assumptions:
Kd = 7.0%
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

C$000
EBIT
Add:
Depreciation
EBITDA
Less:
Tax
Capital expenditures
Change in WC
FCFF
Discount factor
PV FCFF
Sum of FCFF
Terminal value
Enterprise value

0.5
2014F
100

1.5
2015F
119

2.5
2016F
141

3.5
2017F
169

4.5
2018F
209

5.5
2019F
274

20

25

32

38

40

25

120

144

173

207

249

299

(24)
(50)
(1)

(29)
(50)
(1)

(35)
(50)
(1)

(41)
(50)
(2)

(50)
(50)
(2)

(60)
(50)
(2)

45

64

87

114

147

186

0.91
41
441
994

0.83
53

0.76
66

0.70
79

0.64
93

0.58
108

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


representative mature steady growth
phase

140%

Factors to consider:

100%

Cyclicality

120%

80%

Representative year
Depreciation and CapEx

60%
40%

Terminal Value Approaches


P/CF multiples
Dividend discount models
Capitalized cash flows

20%
0%
-20%
-40%
Utilities

Tobacco

Sporting Goods

Value of forecast period cash flow

32

Deloitte Corporate Finance: Fundamentals of Valuation

High Tech

Terminal Value

Deloitte LLP and affiliated entities.

Discounted cash flow


Terminal value capitalized cash flow

C$000
FCFF
Discount factor
PV FCFF
Sum of FCFF
Terminal value
Enterprise value

0.5
2014F

1.5
2015F

2.5
2016F

3.5
2017F

4.5
2018F

5.5
2019F

45

64

87

114

147

186

0.91
41
441
994

0.83
53

0.76
66

0.70
79

0.64
93

0.58
108

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

C$000
EBIT
Add:
Depreciation
EBITDA
Less:
Tax
Capital expenditures
Change in WC
FCFF
Discount factor
PV FCFF
Sum of FCFF
Terminal value
Enterprise value

0.5
2014F
100

1.5
2015F
119

2.5
2016F
141

3.5
2017F
169

4.5
2018F
209

5.5
2019F
274

20

25

32

38

40

25

120

144

173

207

249

299

(24)
(50)
(1)

(29)
(50)
(1)

(35)
(50)
(1)

(41)
(50)
(2)

(50)
(50)
(2)

(60)
(50)
(2)

45

64

87

114

147

186

0.91
41
441
994

0.83
53

0.76
66

0.70
79

0.64
93

0.58
108

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

Growth
Rates

Revenue
Working Capital
Expenses

Tax
Rates

Tax break incentives


Long term rate

Margins

Gross margin
EBITDA margin

Analyst
Reports

Often most accurate public info


May not be specific enough

Terminal
Value

Timing
Terminal growth rate

Management

Product / customer life cycle


Assessment of market potential

35

Deloitte Corporate Finance: Fundamentals of Valuation

Historical
Averages

Management

5 year geometric average


AR, Inventory, AP turnover
Historical margins
Forecast and targets
Corporate strategy

Deloitte LLP and affiliated entities.

Discounted cash flow


Summary

Forecast future cash


flows after cash
taxes

Estimate future
working capital and
capital expenditure

Assess reasonableness of results

Select the correct


discount rate

Discount the cash


flows and terminal
value

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

Markets 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

Advantages

Disadvantages

Criteria for a good


comparable

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


Market determined value precedent has been established

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

Operate in a similar industry and geographic region

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

Price /
Earnings

Price /
Cash Flow

Enterprise
Value /
EBITDA

40

Attributes
Well known and widely used, easy to understand
Forward looking (forecasted earnings)
Hard to compare companies with low or negative earnings,
or multiple-sector corporations
Distorted by capital structure
Selection of proper comparables is key

Examples
Large caps
Blue chip stocks
Older, steady earnings companies

Focuses on cash flow most closely aligned with


shareholders interests
Eliminates most accounting / financing distortions
Can be used with negative earnings
Short-term focus
Subjectivity in choosing proper comparables

Eliminates capital structure distortion


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

Deloitte Corporate Finance: Fundamentals of Valuation

Deloitte LLP and affiliated entities.

Comparable company analysis


Multiple overview

Multiple

41

Attributes

Examples

Price /
Net Asset
Value

NAV describes the company's current asset and liability


position
Easy to calculate a target price
Fair value of assets on a fully liquidated basis

Enterprise
Value /
Reserves

Proven and probable (2P) refers to geologic reserves 50%


chance of recovery
Not cash-flow based

Mining companies
Oil & Gas companies

Enterprise
Value /
Revenue

Doesnt account for cost structure


Can be used to compare start ups with negative cash flow

Technology companies
Restaurants

Deloitte Corporate Finance: Fundamentals of Valuation

Mining companies
Large asset bases

Deloitte LLP and affiliated entities.

Comparable company analysis


Illustrative example
Public Companies

Ticker

Flagship Asset

Coal Type

Stage

Location

Market Cap

EV

Total
Resources

EV / Total
Resources

NAV*

(C$M)

(C$M)

(Mt)

(C$/t)

(C$M)

P / NAV

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

14.27

n/a

n/a

Buffalo Coal Corp.

TSX:BUF

South Africa

Thermal and met

Production

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

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

397

0.01

143

0.05x

Cardero Resource Corp.

TSX:CDU

Canada

Metallurgical

PFS completed

11

525

0.02

37

0.17x

EastCoal Inc.

TSXV:ECX.H

Ukraine

Thermal

Development

96

0.07

n/a

n/a

Compliance Energy Corp.

TSXV:CEC

Canada

Thermal and met

PFS completed

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?

Advantages

Disadvantages

Precedent transactions are typically an easy analysis to perform


Market determined value precedent has been established

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

Criteria for a good


transaction

43

Operate in a similar industry

Consist of a similar transaction size and within a reasonable time frame


Similar transaction type (i.e. share or asset transaction)

Deloitte Corporate Finance: Fundamentals of Valuation

Deloitte LLP and affiliated entities.