Methodology: In considering the bids by buyout funds, we look at three valuation methodologies:
1. Adjusted Present Value – The APV methodology allows to value the operations while assuming it is all equity financed. This allows us to discount the Free Cash Flow at the cost of equity. After present valuing the FCFs, we then proceed to value the interest tax shields. APV is commonly used when a firm’s capital structure is expected to change over the investment horizon as the interest shields are valued separately compared to a regular Discounted Cash Flow Method.
2. Comparable Company Analysis – In a comparable company analysis, we look at companies that are similar to the company being analyzed. We then find the median or average valuation metric for the set of comparable companies. Finally, we apply that median valuation metric to our company’s relevant metric to find a value for our company.
3. Precedent Transaction Analysis – Precedent transaction analysis looks at comparable companies that are involved in M&A transactions. As with comparable company analysis, we find a median valuation metric and apply it our company’s relevant matric to find a value for our company.
Key Considerations for the various Valuation Methodologies:
1. APV method tends to be a precise, reliable method if the projections and assumptions are well backed up as the APV values individual cash flows. However, the valuation is very sensitive to modeling assumptions including but not limited to discount rate, terminal growth rate, and sales growth. That is why it is important to sensitive important drivers to see a range of values.
2. If we believe that markets are reasonably efficient, valuation metrics for comparable companies give us a good baseline for what a company is worth. However, no two companies are alike and thus finding a good comparable company list can be challenging.
3. Similar to comparable companies, precedent transactions give a good sense of the M&A market for companies within a specific industry. However, it faces the same flaw of the difficulty of finding comparable transactions. Furthermore, market forces also have a significant impact on the valuation output.
- Gugnir and Partners
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