to be financed

New Ventures
Finance
2013, may 14-21
International Entrepreneurship and New Ventures Finance – Pavia University
Learning Objective
The choice of financing a new venture or a general initiative strictly depend on: i) cash
flows expected from new venture and ii) risk associated to those cash flows.
(2) Valuing new ventures
Cash Flows and Risk define value.
How do you estimate the value of a new
venture? (Market Multiples)
(1)
New Ventures Financing Instrument
For new initiative there could be a strong disagreement about
cash flows expectation and risk between the entrepreneur and
the investor. What kind of instruments could resolve this type
of problem? (Convertible Instruments, Stage Financing)
When an investor (a Venture Capitalist) decide to finance a new venture insert in a
Term Sheet exit clauses like Tag Along clauses. This right assures that if the majority
shareholder sells his stake, minority holders (like Venture Capitalist) have the right to
join the deal and sell their stake at the same terms and conditions as would apply to
the majority shareholder
(3)
Clauses used to Exit the business
TAG –ALONG /DRAG - ALONG
2
Sources of New Venture Financing
(life cycle related)
Focus
Focus on
Exit
Clauses
Source: Adapted from Fig. 3, “Sources of new venture financing”, pag. 34, J.K. Smith, R. Smith, Entrepreneurial Finance, 200, John Wiley
Edition
3
Sources of New Venture Financing
The choice of financing a new venture (amount, yield) strictly depend on:
a) cash flows expected from new venture;
b) risk associated to those cash flows.
YIELD
Regarding risk, a simple basic rule in corporate finance is that the more the risk you
take the more the yield you want. Because New Ventures are highly risk investment,
required returns are very high (25% - 40% p.a.); typically investors in new ventures
(Venture Capitalist and Business Angel) do not use mathematical algorithm to
establish required return (such as Capital Asset Pricing Model) but simple rule such as
hurdle rates or 72 rule (a method for estimating an investment's doubling time). To
estimate the number of periods required to double an original investment, divide the
most convenient "rule-quantity" by the expected growth rate, expressed as a
percentage. For instance, if you were to invest $100 with compounding interest at a
rate of 9% per annum, the rule of 72 gives 72/9 = 8 years required for the investment to
be worth $200; an exact calculation gives 8.0432 years. Similarly, to determine the time
it takes for the value of money to halve at a given rate, divide the rule quantity by that
rate. Venture Capitalists typically want to double capital in 2/3 years.
4
Sources of New Venture Financing
The choice of financing a new venture (amount, yield) strictly depend on:
a) cash flows expected from new venture;
b) risk associated to those cash flows.
AMOUNT FINANCED
The amount investors can finance strictly depend upon the value of the initiative: the
more the value the more you can finance. Note that value is a function of expected
cash flows and risk associated to those cash flows.
5
Relationship between value and financed
amount
Real Estate
Loan to value ratio (for residential mortages; loan to value = 80%)
Utilities:
Value is a function of Ebitda (for valuing business equity analysts typically apply a
multiple on Ebitda)
Source: Deutsche Bank report on Hera, 11.25.2011, pag. 11
6
Cont.d
Utilities:
Sustainable Net debt is a function of Ebitda
“…Key cash flow and capital-structure developments.
Hera expects its net debt to remain below €2 billion in 2011, on the back of a reduction
of capital expenditures (capex) as it has completed the bulk of its investment plan in
the waste sector. Consequently, we have factored a recovery into Hera's financial
profile, resulting from growing cash flow generation and debt stabilization. Hera's
statements support this, acknowledging that the group projects a decline in its net
debt-to-EBITDA ratio to below 2.8x by 2014 from the reported 3.3x in 2009.”
Source: Standard & Poor Credit Ratings report on Hera, 09.30.2011, pag. 3
7
Equity Financing
A new venture is typycally financed through equity investment. This means that an
investor buy a stake in the company typically through a capital increase.
Typical question that arises:
- How much the business is worth?
- Will you lose control of the company through the capital increase?
- The amount of money the entreprenuer needs is compatible with the capital increase?
Balance Sheet
Existing Debt
Asset
New Asset
(to be financed)
Common Equity
Additional Common
Equity
(capital increase)
Agreed Business Value with Capital
Increase: 100
Capital Increase: 30
Investor’s Stake Post Capital Increase: 30%
(Paid in capital / Value of the Business =
30 / 100)
Entrepreneur stake post capital increase:
70% (100% - 70%)
8
•
•
•
The acquisition of a stake through a capital increase, is an agreement among parties
for the exchange of cash flows or claims to cash flows.
Three profiles of the agreement:
– Amount of cash flows
– Time of realization of cash flows Value of the deal
– Risk
In general, the acquisition can take place only if there is a difference of opinion
among the parties about the value being exchanged, because both need to believe
that the transaction has a positive Net Present Value. For example, if the seller’s
discount rate is 20% and the buyer’s is 10%, there are potentially many prices to
transact the cash flows.
100% Business
ValueSeller’s Perspective = 10/20% = 50
Range of Potential
Prices
100% Business
ValueBuyer’s Perspective = 10/10% = 100
9
What happens if opinions are inverted?
100% Business
ValueBuyer’s Perspective = 10/20% = 50
The deal is
unrealizable
100% Business
ValueSeller’s Perspective = 10/10% = 100
In presence of strong difference of opinion transactions can take place by structuring
the terms of the deal in such a way that both parties find the terms satisfactory.
Contingencies are used in order to condition the distribution of cash flows on the
realization of measurable future outcomes.
Contingent payments treated in this lesson are:
Convertible financial instruments
Staged financing
10
Convertible financial instruments
(for example convertible bonds)
Consider a start-up requiring € 1.000 initial funding. Furthermore, assume that the Venture Capitalist (VC)
estimates the venture would yield low cash flows with probability pr = 0,75 and high cash flows with pr = 0,25:
Year
Investment
Pr= 0,75
Pr=1- 0,75 = 0,25
Expected value
0
-1000
-1000
1
2
3
0
0
0
0
0
0
900
10.000
3.175
If the VC is going to finance the required € 1.000 and expect a 20% Internal Rate of Return, the VC would
demand 54,43% of the common equity (a stake in the company of 54,4%):
Acquired Stake = (1.000) / [3.175/(1,2)3] = Initial Funding / Equity Valuet = 0 = 1.000 / 1.837
This arrangement imposes proportional sharing of the cash flows (and associated risk) between the VC and the
entrepreneur. The expected cash flows for the VC at the end of time 3 equals 1.728 (= expected Value x Acquired
Stake = 3.175 x 54,43%)
Note that the VC the VC should get the control of the business and this fact could lead to a disagreement.
11
Cont.d
What if the project is financed by issuing a zero coupon bond convertible into the stock of the
target at the end of year 3?
Bond Price = 1.000 €
Required return by the buyer is always 20%.
What is the X% stake required by the VC through the conversion of the bond?
1.000 = (900*0,75 + X% * 10.000 * 0,25)/(1.23)  X% = 42%
The financier can benefit of the downside protection supported by the convertible bond (contingent claim) so
he can accept a lower participation (at the end of year 3).
Note that the expected cash flows for the VC is 1.728, the same yielded by the common stock arrangement.
However, using convertible bond differs from the latter in that it reduces the risk of underperformance
borne by the VC, helps to screen out entrepreneurs with unrealistic projections, and motivates the
entrepreneur who accepts the deal. In addition, the entrepreneur may hold a more optimistic view of the
probability of low and high cash – flows realizations and therefore would prefer the convertible alternative.
In this scenario (prob.=75%) the firm will be in default because the total
value of assets will be lower than the value of the bond. Therefore the
bond-holder will receive the assets of the firm.
12
Cont.d
The example illustrates the use of risk shifting to solve the valuation problem. In convertible
instruments, rather than offering a proportional share of the business (post capital increase) below
the acceptable limit to the entrepreneur, the investor shifted part of risk of the business
underperformance to the entrepreneur. The VC is trying also to provide the strongest possible
incentives for the entrepreneur to do at least as well as projected: if the business exceeds plan, then
the entrepreneur will share disproportionately in the benefits of doing so.
13
Accounting treatment of convertible bonds
Convertible bond = straight bond + call option on the value of
assets of the issuer with exercise price equal to the nominal
value of the bond.
IAS 39 requires to unbundle the financial instrument and to
account for the two basic instruments (bond and option)
separately:
• Straight bond = financial liability
• call option = equity
14
Accounting for a convertible bond:
an example
Convertible Bond Details
A) # of Convertible Bonds Issued
2,000
B) Face Value
1,000 €
C) Total Proceeds = A x B
D) Interest Rate
E) Maturity
F) Conversion Details
G) Market Interest Rate for a Similar Debt without Conversion Option
2,000,000 €
6.00%
3 Years
1 bond for 250 shares at any time
9%
Step 1: Computing the Liability Component of the Instrument
H) Present value of the principal – 2,000,000 € - payable at the end of 3
Years = C / (1+G)^3
1,544,367 €
I) Annual Interest Payment for 3 Years = C x D
120,000 €
J) Present value of the annual interest – 120,000 € for 3 years =
I x [1 - (1+G)^-3]/G
303,755 €
K) Total Liability Component = J + H
1,848,122 €
Step 2: Computing the Equity Component of the Instrument
L) Total Equity Component = C - I
15
151,878 €
15
Staged financing
Consider a New Venture that
has investment capital needs of
$700.000 per year for five years,
beginning at time 0.
Valuation Template 6
Single-Stage Investment - Venture Capital Method
Income Statement Information
Year
0
Earnings Before Interest and After Tax (NOPAT)
1
2
($500,000)
($200,000)
$700,000
$700,000
3
4
$400,000 $1,400,000
5
$2,500,000
Cash Flow Information
External Funds Required to Support Operations
$700,000
$700,000
$700,000
$0
Equity Capital Raised
$3,240,927
Beginning Cash Balance
Uses of Cash
Cash Invested in Marketable Securities
Return on Invested Cash (4%)
Ending Cash Balance
$3,240,927 $2,642,564 $2,020,267 $1,373,077
$700,000
$700,000
$700,000
$700,000
$2,540,927 $1,942,564 $1,320,267
$673,077
$101,637
$77,703
$52,811
$26,923
$2,642,564 $2,020,267 $1,373,077
$700,000
$700,000
$700,000
$0
$0
$0
$0
$0
$0
$0
$0
Investor Valuation and Ownership Allocation
Investor Hurdle Rate
50.00%
Continuing Value Earnings Multiplier
Continuing Value of Venture
Required Future Value of Investment = 3.240.927 *(1+50%)5
Ownership Share Required
45.00%
40.00%
35.00%
30.00%
25.00%
15
The New Ventures is expected to
generate Earnings by the end of
year 5 of $ 2,5 mln. A public
equity offering is projected at the
end of year 5 at a value of $37,5
mln (= typical earnings multiple
of comparable companies of 15x
applied to forecasted earnings of
$ 2,5 mln).
Venture Capitalist requires:
- for an investment at time 0 a
50% return;
- for an investment at time 1 a
45% return (fewer risk)
-…
- … a 25% return for an
investment made at time 5.
$37,500,000
$24,610,789
65.63%
By financing the whole amount
at time 0 the required return by
the Venture Capitalist is 50%
==> required stake is 65,63%
16
Staged financing
Valuation Template 7
Multi-Stage Investment - Venture Capital Method
Income Statement Information
Year
0
Earnings Before Interest and After Tax
1
2
($500,000)
($200,000)
$700,000
$700,000
3
4
$400,000 $1,400,000
5
$2,500,000
Cash Flow Information
External Funds Required to Support Operations $700,000
Equity Capital Raised
$1,373,077
$1,373,077
Beginning Cash Balance
Uses of Cash
Cash Invested in Marketable Securities
Return on Invested Cash
Ending Cash Balance
$1,373,077
$700,000
$673,077
$26,923
$700,000
$700,000 $1,373,077
$700,000
$700,000
$0
$673,077
$0
$26,923
$0
$700,000
$700,000
$700,000
$0
$700,000
$700,000
$700,000
$0
$0
$0
$700,000
$700,000
$0
$0
$0
$0
$0
$0
$0
$0
Investor Valuation and Ownership Allocation
Investor Hurdle Rate
50.00%
45.00%
40.00%
35.00%
30.00%
Continuing Value Earnings Multiplier
If the investor doesn’t want to loose
control, the VC will ask for
financing in successive stakes. The
key reason behind stage financing is
the resolution of uncertainty. More
information becomes available with
the passage of time and gives the
VC the option to abond the project if
the new information is not
promising. This option is valuable,
and we know from option theory
that the more the uncertainty the
more the value.
That’s the reason why the VC asks
for a fewer stake.
25.00%
15
Continuing Value of Venture
$37,500,000
Investor's Required Future Value and
Equity Share
Third Stage [910,000 = 700,000*(1+30%)^1]
Second Stage [3,767,723 = 1,373,077*(1+40%)^3]
First Stage [10,426,803 =
Required
Required
Beginning
Ending
Share
Share
2.43%
2.43%
10.30%
10.05%
31.77%
27.80%
Value
$910,000
$3,767,723
$10,426,803
40.28%
$15,104,527
1,373,077*(1+50%)^5]
Ownership Required
27,8%=10.426.803/37.500.000
17
Investor's Required Future Value and
Equity Share
Required
Required
Beginning
Ending
Share
Share
Value
2.43%
2.43%
$910,000
Second Stage
10.30%
10.05%
$3,767,723
First Stage
31.77%
27.80%
$10,426,803
40.28%
$15,104,527
Third Stage
Ownership Required
1)
Determine the required future value corresponding to each stage financing
•
I stage: 1,373,077*(1 + IHR1)5 = 1,373,077*(1 + 50%)5 = 10,426,803.5
•
II stage: 1,373,077*(1 + IHR2)3 = 1,373,077*(1 + 40%)3 = 3,767,723.3
•
III stage: 1,373,077*(1 + IHR4)1 = 700.000*(1 + 30%)1 = 910,000
2)
Determine the required ending share corresponding to each stage financing
•
I stage: 27.80% = 10,426,803.5/37,500,000
•
II stage: 10,05% = 3,767,723.3/37,500,000
•
III stage: 2.43% = 910,000/37,500,000
Total final share = 40.28%
3)
Determine the required beginning share (i.e. just after the investment)
corresponding to each stage financing
•
This take in account the dilution due to successive issues of new shares  next slide
18
Determining the Required Shares of Staged
Investment post-investment
Determining the required fraction of equity when future rounds of
financing are anticipated.
Fraction of Equity Required = Ending Fraction of Equity Required
/ (1 - Sum of Ending Fractions Required by Investors in Future
Rounds)
Using this equation, the required share of the investor in the
second round is 10.30 percent.
10.30 % = 10.05 % / (1 - 2.43 %)
Similarly, the required share for the investor in the first round is
31.77 percent.
31.77 % = 27.80 % / (1 - 2.43 % - 10.05 %)
19
Determining the Required Shares of Staged Investment preinvestment
To determine the required fraction of equity with respect to the existing
number of shares before the capital increase (pre-investment) you need to
consider also the % of ownership required by the “current” capital
increase in addition to the future rounds of financing.
Fraction of Equity Required = Ending Fraction of Equity Required /
(1 - Sum of Ending Fractions Required by Investors in “current” and
Future Rounds)
Example
Using this equation, the required share of the investor in the second
round is 11.48% of shares existing at the moment of the second capital
increase (not 10.30% as in the previous slide, which referred to the total
number of shares after the capital increase).
11.48% % = 10.05 % / (1 – 10.05% - 2.43 %)
20
Stage Financing: an example
Digital Sky Technologies
Status: Corporate Investor
Founded: 2005
Location: Moscow, London
Russian Internet holding company, Digital Sky, grabbed 1.96% of
Facebook stock in May of 2009 when it spent $200 million at a $10
billion valuation. Digital Sky, which is largely backed by a wealthy
Russian oligarch, is the owner of Facebook clone VKontakte, the largest
social network in Russia. Under the direction of Managing Partner, Yuri
Milner (pictured), Digital Sky has also amassed sizeable positions in
Zynga and Groupon, and is reportedly in talks to buy a substantial
stake in Twitter. DST followed its initial stake in Facebook with large
block purchases of stock from existing Facebook shareholders and
employees. Digitial Sky also joined Goldman Sachs in 2010 for the
investment bank's multi-hundred million investment round, with DST
ponying up $50 million for yet another .1% of the firm (at a $50 billion
valuation).
Source: http://whoownsfacebook.com/
Goldman Sachs
Status: Corporate Investor
Founded: 1869
Location: New York, NY
Sterling-plated investment bank, Goldman Sachs (NYSE: GS)
appears to have the inside track underwriting a future
Facebook IPO with its participation in a $1.5 billion capital
raise. Finalized January of 2011, the transaction included a $450
million investment from Goldman Sachs, $50 million from DST,
and $1 billion from unnamed foreign investors. The deal valued
Facebook at $50 billion. The financing created controversy as it
appeared to be a way for Facebook to sidestep U.S. securities
laws forcing privately-held companies to make SEC filings once
they reach a 500 shareholder threshold. Facebook stated it will
begin disclosing financial information, or stage an initial public
offering, by April 2012.
21
Stage Financing: an example
Digital Sky Technologies
A) Acquiring Date
B) Acquired Stake
C) Price Consideration ($ mln)
D) Implied Facebook Equity Value 100% ($ mln) = C / B
May 2009
1.96%
200
10,204
January 2011
0.10%
50
50,000
Digital Sky Technologies acquired a stake in Facebook in may, 2009 paying
$ 200 mln for a 1,96% stake ==> 100% Implied Facebook Value = $ 10 bln
20 months later, Digital Sky Technogies acquired a 0,10% stake, paying $
50 mln ==> 100% Implied Facebook Value = $ 50 bln
Why?
- In January, 2011 there is fewer uncertainty about future cash flows, so the
investor ask for a fewer anualized return
22
Computing Implied Annual Return for Facebook
Investment made by DST
A) First Investment Date
B) Second Investment Date
C) Exit Date
D) Investment Period for 1st Investment (year) =(C - A) / 365
E) Investment Period for 2nd Investment (year) =(C - B) / 365
st
F) Price Consideration @ 1 Investment Date ($ mln)
G) Price Consideration @ 2nd Investment Date ($ mln)
H) Exit Price ($ mln) = IPO Price
I) Implied Annual Return for 1st Investment = (H / F)(1/D) - 1
nd
(1/E)
I) Implied Annual Return for 2 Investment = (H / G)
-1
01/05/2009
01/01/2011
18/05/2012
3,05
1,38
10.204
50.000
104.000
114,1%
70,1%
23
Valuing new ventures and start up
companies with the Market Approach
1) Brief description of the Market Approach
2) Types of multiples
3) Types of Adjustment to market multiples
4) How to select comparable companies in practice
5) How to choose the correct multiple
6) Application: Facebook valuation
24
Market Approach - Valuation Indicators
Price
Multiples
Price multiples are ratios of the stock price to some measure of
fundamental value. The intuition behind price multiples is that
they tell the investor what one share buys, whether that is
earnings, cash flow, net assets, or some other measure of value
Enterprise
Value
Multiples
Enterprise value multiples are ratios of total firm value divided
by a measure of fundamental value, such as earnings before
earnings and taxes (EBIT), sales, or operating cash flow.
Method of comparables: compares the price and enterprise value multiples of the subject firm with those
of similar assets:
 The similar assets are referred to as the comparables, comps, guideline assets, or guideline companies.
 For example, we could compare the P/E multiple of a subject firm with that of firms that are comparable
in terms of risk, profitability, and growth. The comps could be a similar firm or a group of firms in the
same industry.
 If a firm had a higher P/E than the comparables, it would be deemed overvalued. Note that this
assumes that the comps themselves are correctly valued.
 The economic rationale for the method of comparables is the law of one price—i.e., identical assets
should sell for the same price.
Method of Comparables
Example
Valuation through multiples of comparables consists in identifying a ratio “value/accounting
quantity” for comparable companies and then estimating the value of the target company
through the application of the following formula:
Value = (Mean / Median ratio of comparable) x (Accounting quantity for the target company)
Valuation of Alfa
Net income t=0 Alfa
100
Mean P/E of comparable companies 17.23x
Value estimate for Alfa
1723
A
B
AxB
This is a “Quick and Dirty”
approach for valuing a company
Price per
Share t=0
Comparable company1
Comparable company2
Comparable company3
Comparable company4
Comparable company5
…
Comparable company n
EPSt=0
10.1
5.55
2.73
1.57
4.31
…
20.33
1.00
0.10
0.40
0.16
0.40
…
2.00
Mean
P/E
10.1x
55.5x
6.8x
10.0x
10.8x
…
10.2x
17.2x
Method of Comparables
Example
Why dirty? We need to adjust for non-core income components…
A
B
C= A - B
D
E=C /D
Adjusted Net
Non-core Income Adjusted
Net income t=0
P/Eadjusted
N
of
shares
Net Income t=0
Income per share t=0
components
100.0
0.0
100.0
100.0
1.00
10.1x
10.0
-70.0*
80.0
100.0
0.80
6.9x
150.0
50.0**
100.0
375.0
0.27
10.2x
110.0
0.0
110.0
700.0
0.16
10.0x
200.00
0.00
200.00
500.0
0.40
10.8x
…
…
…
…
…
…
500.00
0.00
500.00
250.00
2.00
10.2x
Comparable company 1
Comparable company 2
Comparable company 3
Comparable company 4
Comparable company 5
…
Comparable company n
* Goodwill Impairment
** Capital gains from stocks sales
Valuation of Alfa
Net income t=0 Alfa
Mean P/E of comparable companies
Value estimate for Alfa
Mean
Standard Deviation
Coeff. Variation
100
9.70x
970
9.70x
1.38
0.14
P/E
10.1x
55.5x
6.8x
10.0x
10.8x
…
10.2x
17.23x
18.82
1.09
A
B
AxB
The estimated value for Alfa changes due to the adjustments. The adjustments had the effect of
making the companies more “comparable” in order to be able to obtain a value estimate using a
mean of the P/Es. Could we do more in to increase the quality of our analysis?
Value Maps
Value maps are regressions, in which the dipendent variable is a market multiple while the indipendent
variable(s) is(are) accounting index(es) or performance indicator(s) able to explain market multiple:
Multiplei = a + b x Performancei
Predicted P/E Based on Cross - Sectional Regression)
P/E adjusted
Growth rate
g = b x ROE
11.0x
10.8x
10.1x
1.00%
10.6x
Comparable company 2
Comparable company 3
6.9x
0.55%
10.4x
10.2x
1.10%
Comparable company 4
10.0x
0.90%
Comparable company 5
10.8x
2.40%
…
Comparable company n
…
…
10.2x
P/E adjusted
Comparable company 1
P/E = 9.371 + 62.16 x g
R² = 0.880
10.2x
10.0x
9.8x
9.6x
0.60%
9.4x
0.00%
If g Alfa = 3%
Then
P/E adjusted Alfa = 9,371 + 62,16 x 3% = 11,24x
Value of Alfa = P/E x Alfa Net Income = 11,24 x 100 = 1.124
0.50%
1.00%
1.50%
Growth rate g
2.00%
2.50%
3.00%
Asset and Equity Side Multiples
Asset Side
Enterprise Value
Sales
Ebitda
Ebit
Nopat
Cash Flows
Invested Capital
Equity Side
Market Cap
Sales
Ebitda
Ebit
Net Income
Cash Flows
Book Value
 Asset Side Multiples (Enterprise Value Multiples) = Enterprise Value / Accounting
Quantity
 Equity Side Multiples (Price Multiples) = Market Cap / Accounting Quantity
Price-to-Sales Multiple
Rationales & Drawbacks
Price-to-Sales is the market price of the stock divided by the sales, on a per share basis.
According to a survey, about 20 percent of analysts use this ratio in valuation.
DRAWBACKS
RATIONALES
Compared to EPS and book value, sales are less
subject to manipulation or distortion. For
example, by choosing different expensing
conventions, managers can affect the level of
EPS. Sales, however, are before all expenses.
Sales are always positive, so the P/S can be
used even if EPS is negative (i.e., when the P/E
is not meaningful).
Research has found that the P/S may be
particularly appropriate for valuing the stocks
of
mature,
cyclical,
and
zero-income
companies.
The P/S is not as volatile as the P/E because
EPS reflects operating and financial leverage.
The P/S may be more meaningful than the P/E
when EPS is abnormally high or low.
Empirical research finds that differences in the
P/S are significantly related to differences in
long-term stock returns.
High growth in sales does not necessarily
indicate positive EPS and cash flow. To have
value, a firm must ultimately generate earnings
and cash flow.
Stock prices are net the cost of debt (interest
expense). However, sales is a predebt (preinterest expense) figure, so the P/S numerator
and denominator are not consistent. For this
reason, some analysts prefer the enterprisevalue-to-sales ratio because enterprise value
incorporates debt value.
The P/S does not capture differences in cost
structures among companies.
Although the P/S is less subject to distortion,
revenue recognition practices can still distort the
P/S. For example, analysts should look for
company practices that tend to speed up revenue
recognition.
Price-to-Cash Flow Multiple
Rationales & Drawbacks
Price-to-Cash Flow is the market price of the stock divided by the Cash Flows.
RATIONALES
DRAWBACKS
Cash flow is less subject to manipulation by
management than earnings.
When cash flow from operations is defined as
EPS plus noncash charges, then items such as
noncash revenue and net changes in working
capital are ignored. If the firm uses aggressive
revenue practices (e.g., front-end loading sales),
the cash flow measure will also be distorted.
Price-to-cash-flow ratios are more stable than
P/Es because cash flow is more stable than
earnings.
Reliance on cash flow rather than earnings
addresses the issue of differences in the
quality of reported earnings.
Empirical research finds that differences in
price-to-cash-flow ratios are significantly
related to differences in long-term stock
returns.
Theoretically, free cash flow to equity (FCFE) is
preferable to cash flow for use in the price
multiple. However, FCFE is more volatile and
more frequently negative than cash flow.
As cash flow has become more popular among
analysts, firms have found new ways to enhance
it. For example, a firm can sell off its accounts
receivable to speed up the recognition of cash
flow.
Price-to-Earnings Multiple
Definitions: adjustments to earnings and prices
Raw multiples generally requires corrections in order to allow for a meaningful comparison and a
proper use in valuation. We distinguish between two types of corrections that also generate two
class of multiples:
Adjusted Multiples:
These are multiples for which an adjustment has been made to the NUMERATOR in order to
correct the measure by:
 Excluding non operating assets (for instance a big share in a related company)
 Including third parties assets
Clean Multiples:
These are multiples for which an adjustment has been made to the DENOMINATOR in order to :
 Enhance the quality of the Net Income (addition of quantities not represented in the income
statement)
 Subtraction of non repeatable income components (stock options; goodwill and intangibles)
 See next slide….
In the case of P/E multiples, adjusting the numerator is not generally necessary. It is far more
common to “clean” the denominator.
Price-to-Earnings Multiple
Issues in Calculating EPS
When using P/Es, the analyst should adjust the EPS for the following:
1. POTENTIAL DILUTION OF EPS: The analyst’s job is made easier here because firms are required to report
basic EPS and diluted EPS. Basic EPS utilizes the actual number of shares outstanding during the period.
Diluted EPS utilizes the number of shares that would be outstanding and the accompanying earnings if all
executive
stock
options,
equity
warrants,
and
convertible
bonds
were
exercised.
The P/E from diluted EPS is typically higher than that from basic EPS. Analysts generally prefer diluted EPS
P/Es because they make comparisons across firms more relevant.
2. TRANSITORY, NONRECURRING EARNINGS COMPONENTS THAT ARE FIRM SPECIFIC: When
calculating a P/E, the analyst should focus on the earnings that are expected to continue into the future. These
earnings are referred to as the underlying earnings (also referred to as the persistent earnings, continuing
earnings, or core earnings).
3. TRANSITORY EARNINGS COMPONENTS THAT ARE ATTRIBUTABLE TO BUSINESS OR INDUSTRY
CYCLES: Due to earnings volatility from business or industry cycles, the most recent four quarters of earnings
for a firm may not reflect the long-term earning potential of a firm. This is particularly true for cyclical firms,
such as auto and steel companies. In this case, the P/E may be inflated based on deflated earnings at the bottom
of the business cycle and deflated based on inflated earnings at the top of the business cycle. This effect is
known as the Molodovsky effect and is corrected by calculating an EPS under midcycle conditions, known as
the normalized or normal EPS. On the slides to follow, we will examine two different methods for calculating a
normalized EPS.
4. DIFFERENCES IN ACCOUNTING METHODS (WHEN COMPARING P/ES OF VARIOUS FIRMS):When
comparing firms, the analyst should adjust for differences in EPS calculation so that the P/Es are comparable.
For example, an analyst may be comparing one company using LIFO (last in, first out) inventory accounting
(permitted by U.S. GAAP but not the IFRS) with another using FIFO (first in, first out) accounting.
Clean Multiples
Example: Underlying Earnings
Reported EPS from previous four
quarters
$4.00
Restructuring charges
$0.10
Amortization of intangibles
$0.15
Impairment charge
$0.20
Stock price
$50.00
As stated on the previous slide, the analyst should focus on the earnings that are expected to
persist into the future, which are referred to as underlying earnings. Some firms will report
adjusted earnings, pro forma earnings, or core earnings. These reported figures, however, are
not always equal to the underlying earnings desired for P/E calculation. In these cases, the
analyst will need to adjust the firm’s figures.
We will calculate the core earnings that a firm may report on the next slide.
Clean Multiples
Example: Underlying Earnings
P/E based on reported earnings  $50  $4.00  12.5
Reported core earnings  $4.00  $0.10  $0.15  $0.20  $4.45
P/E based on reported core earnings  $50  $4.45  11.2
Underlying earnings  $4.00  $0.20  $4.20
P/E based on underlying earnings  $50  $4.20  11.9
Core earnings are a non-IFRS and non-GAAP concept, so there are no prescribed rules for their calculation. In
this example, the firm adds the restructuring charge ($0.10), the amortization of intangibles ($0.15), and the
impairment charge ($0.20) to the reported EPS to obtain core earnings of $4.45. The resulting P/E is 11.2.
The analyst then scrutinizes the firm’s accounting statements and determines that the firm has consistently
reported charges from restructuring and amortization. If we consider the only nonrecurring charge to be the
impairment charge, then only it is added to the EPS to arrive at underlying earnings of $4.20. The resulting
P/E is 11.9. Note that this P/E is more likely to indicate that the stock is overvalued, relative to the P/E
calculated from the firm’s reported core earnings.
This analysis process may require an examination of the footnotes and management discussion sections in the
accounting statements. Earnings can also be decomposed into accrual and cash flow components, giving
greater weight to the cash flow component because it may be more persistent.
Clean Multiples
Example: Normalized Earnings
Example
Year
EPS
BVPS
ROE
2010
$0.66
$4.11
16.1%
2009
$0.55
$3.67
15.0%
2008
$0.81
$2.98
27.2%
2007
$0.73
$2.12
34.4%
2006
$0.34
$1.61
21.1%
2011 stock price
We will examine two different methods
for calculating a normalized EPS.
1)Method of historical average EPS:
Normalized EPS = Average EPS over
the most recent full cycle.
2)Method of average return on equity
(ROE):
Normalized EPS = Average ROE over
the most recent full cycle × Current
equity book value per share.
$24.00
The first method does not account for changes in a business’s size, whereas the second method does. For
this reason, the second method is often preferred.
Using the second method, the analyst may want to adjust the current book value per share if the current
value is distorted due to write-downs. Normalized earnings can also be estimated by using a long run
ROE if a more recent ROE is negative.
Clean Multiples
1) Method of historical average EPS
1) Method ofExample:
historical average
EPS
Normalized
Earnings
($0.66  $0.55  $0.81  $0.73  $0.34)
1)
Method
of historicalEPS
average
Average
(normalized)
 EPS
 $0.618
5
($0.66  $0.55  $0.81  $0.73  $0.34)
Average (normalized) EPS 
 $0.618
5
2) Method of average ROE
($0.66  $0.55  $0.81  $0.73  $0.34)
Average
(normalized)
 $0.618
P/E
 $24.00
 $0.618 EPS
38.8
5
2) Method of average ROE
2) Method
of average
ROE
P/E
 $24.00
 $0.618
38.8  27.2%  34.4%  21.1%)
(16.1% 15.0%
Average
ROE

 22.8%
2) Method
of average
ROE
5
P/E  $24.00  $0.618
38.8  27.2%  34.4%  21.1%)
(16.1% 15.0%
Average ROE  (16.1%  15.0%  27.2%  34.4%  21.1%)  22.8%
Average

22.8%
5ROE  Current equity book
Average ROE
(normalized)
EPS

Average
value per share
5  34.4%  21.1%)
(16.1%  15.0%  27.2%
Average (normalized)
EPS  22.8%  $4.11  $0.937
ROE 
 22.8%
5
Average (normalized) EPS  Average ROE  Current equity book value per share
Average
ROE  Current
Average (normalized)
(normalized) EPS
EPS 
 Average
22.8%  $4.11
$0.937 equity book value per share
Average
 $4.11
$0.937 equity book value per share
Average (normalized)
(normalized) EPS
EPS 
 22.8%
Average
ROE  Current
Average
(normalized)
 22.8%  $4.11  $0.937
P  E  $24.00
 $0.937EPS
 25.6
P  E  $24.00  $0.937  25.6
Adjusted Multiples
Example: EV/EBITDA
Assume the market cap. of listed company Alfa is equal to 50 € mln, its EBITDA is 10 € mln and
its net financial position is equal to 40 € mln.
The company has a 10% share in listed company Beta (Beta market cap = 70 € mln), recorded in
the balance sheet between the assets for a total value of € 2 mln.
The net third parties’ book value of Alfa, equal to 3 € mln (minoritiy interests), is referred to the
participation in Gamma (fully consolidated) of which Alfa has a 80% share of the total capital.
The Enterprise Value of the adjusted EV/EBITDA is calculated as follow:
Enterprise Value
+ Market capitalization Alfa
+ Net financial position Alfa
+ Market value of third parties’ book value
- Market value of participations
=
=
=
=
=
EBITDA Alfa = 10 € mln
Enterprise Value / EBITDA Adjusted = 87 / 10 = 8,7x
50
40
(1-80%) x 20
10% x 70
87
Selection of Comparables Stocks
When using the method of comparables, the analyst will compare the price multiple for the subject stock
with the mean or median price multiple of similar stocks. The price multiple of the comparison is referred
to as the benchmark value of the multiple.
The analyst’s choices for the comparison stocks and the benchmark value of the multiple include the
following:
1) the company’s peers within its industry,
2) the company’s industry or sector,
3) a representative broad market equity index, and
4) the average historical price multiple for the subject firm.
There are many different industry classification systems, such as those provided by Standard and
Poor’s/MSCI Barra, Dow Jones/FTSE, and others. The analyst should be aware that the different
classification systems can group firms differently.
When making conclusions based on the benchmark value of the multiple, the analyst should adjust for
differences in the fundamentals of the subject stock and the comparison group. Financial ratios can
highlight differences in liquidity, asset use efficiency, financial leverage, interest expense coverage, and
profitability.
Method of Comparables
Using Peer Company Multiples
Peer companies usually are intended as firms operating in the same sector of the target company, although
there are exceptions (Porsche is usually considered to be more similar to luxury brands than to other
automotive companies).
This criteria is consistent with the idea underlying the method of comparables: the law of one price—i.e.,
identical assets should sell for the same price. Instead of comparing P/Es, the analyst can equivalently
multiply the subject firm’s EPS by the benchmark P/E to derive an estimated stock value that can be
compared with the firm’s actual stock price (see the example on the slides to follow).
The analyst should examine whether differences in P/Es can be explained by differences in fundamentals,
including risk and expected earnings growth. Firms with expected earnings growth higher than the
benchmark should sell for higher price multiples. Firms with higher risk than the benchmark should sell for
lower price multiples.
One method of adjusting for differences in expected earnings growth between the firm and the benchmark
is to calculate the P/E-to-growth ratio (PEG), where the firm’s P/E is divided by the expected earnings
growth in percent. All else equal, firms with lower PEGs are more attractive than firms with higher PEGs.
Firms with PEGs less than 1 are often considered especially attractive.
PEGs must be interpreted with care, however, for the following reasons:
 The PEG assumes a linear relationship between P/E and growth, but using the dividend discount
model (DDM) to derive a justified P/E demonstrates that the relationship is not linear (see next slide).
 The PEG does not account for differences in risk.
 The PEG does not account for the earnings growth duration. For example, if the denominator is the fiveyear growth rate, this would not capture differences in longer-term growth prospects.
How to Choose the Correct Multiple
In order to valuate a company using the multiples method with
the comparables approach, we need to:
1)
2)
3)
Distinguish between true multiples and fake multiples
Select the multiple with the least historical cross-sectional
dispersion
Apply the multiple’s mean/ median value of comparable
companies to the accounting value of the target company
True and fake multiples
True Multiples: causality link between the accounting variable and the
market price
Vs
Fake Multiples: no causality link between the accounting variable and
the market price
For a multiple to be significant there need to be a linear relation
between the accounting variable at the denominator and the market
price. If the relation is perfectly linear by doubling the accounting
quantity at the denominator the market capitalization should double
also.
True and fake multiples
Example
Company
Variabile
Market Cap
Sales
Ebitda
Ebit
Net Income
A
B
C
D
100
70
18
16
10
50
80
11
8
5
30
55
5
4
3
70
35
12
8
7
Sales
Ebitda
Ebit
Net Income
Market Cap
Correlation
0.057
0.975
0.954
1.000
==> Market Cap / Sales = Fake Multiple
==> Market Cap / Net Income = True Multiple
True and fake multiples
Example
Market Cap vs Sales (correlation = 0,057)
Market Cap = 57.2826+0.087*x
110
A
100
Market Cap vs Net Income (correlation = 1,000)
Market Cap = 0+10*x
110
A
100
90
80
70
90
80
D
60
60
B
40
Market Cap
Market Cap
50
C
30
20
30
D
70
40
50
60
Sales
70
80
90
B
50
40
30
20
2
C
3
4
5
6
7
Net Income
8
9
10 11
True and fake multiples
How to identify the multiple to use in valuation
A perfectly linear relation between the accounting variable and the price
guarantees the stability of the multiple in its cross-sectional dimension.
Perfect stability of the multiple  no cross-sectional volatility
In order to select the best multiple we need to pick the one with the least crosssectional dispersion. However the cross sectional dispersion cannot be
measured by the simple standard deviation between multiples, because the
standard deviation doesn’t take in account the different levels assumed by
the multiples (see the example for Market Value/Sales and Market
Value/EBITDA multiples).
This is why we use instead a coefficient of variation calculated as follows:
Coefficient of Variation = Standard Deviation/ Mean
The multiple with the least dispersion
Example
Company
Multiple
Market Cap
Sales
Ebitda
Ebit
Net Income
Company
A
B
C
D
100
70
18
16
10
50
80
11
8
5
30
55
5
4
3
70
35
12
8
7
A
B
C
D
0.6x
4.5x
6.3x
10.0x
0.5x
6.0x
7.5x
10.0x
2.0x
5.8x
8.8x
10.0x
Multiple
Market Cap / Sales
1.4x
Market Cap / Ebitda
5.6x
Market Cap / Ebit
6.3x
Market Cap / Net Income 10.0x
Standard
Deviation
0.69x
0.65x
1.20x
0.00x
Mean
1.15x
5.48x
7.19x
10.0x
Coefficient
of Variation
0.60
0.12
0.17
0.00
Using a Value Map:
an example (check Facebook valuation at different times)
Multiple used: Price to sales
Peers: Internet Information Provider (GICS sector), Worldwide, with Market Cap >
$ 100 mln
Variable used to explain Price to Sales multiple: Ebitda Margin, Expected Growth
Baidu Inc. ADS
14.00
12.00
y = 24.72x + 0.778
R² = 0.531
Price to Sales (may 2009)
10.00
Google Inc. Cl A
8.00
NHN Corp.
Webzen Inc.
6.00
Sohu.com Inc.
Yahoo! Inc.
Akamai Technologies Inc.
4.00
EarthLink Inc.
-20.00%
Digital River Inc.
Aufeminin.com S.A.
SK Communications Co. Ltd.
Iliad S.A.Daum Communications Corp.
United Internet AG
2.00
Peer 1 Network Enterprises Inc.
eAccess Ltd.
United Online Inc. GMO Internet Inc.
Buongiorno S.p.A.QSC AG iiNET Ltd.
DADA S.p.A.
Forthnet S.A.
Tiscali S.p.A.
freenet AG
Reply S.p.A.
Transcom WorldWide S.A.
LBi International N.V.
0.00
-10.00%
0.00%
Expected Sales Growth (2009 - 2011)
10.00%
20.00%
30.00%
40.00%
Using a Value Map:
an example (check Facebook valuation at different times)
Baidu Inc. ADS
14.00
y = 18.23x - 2.060
R² = 0.588
12.00
Price to Sales (may 2009)
10.00
Google Inc. Cl A
8.00
NHN Corp.
Webzen Inc.
6.00
Yahoo! Inc.
Sohu.com Inc.
Akamai Technologies Inc.
Digital River Inc.
4.00
Aufeminin.com S.A.
SK Communications Co. Ltd.
Daum Communications Corp. Iliad S.A.
United Internet AG
2.00
Peer 1 Network Enterprises Inc.
eAccess Ltd. EarthLink Inc.
GMO InternetUnited
Inc. Online Inc.
iiNET
Ltd.
Buongiorno S.p.A.
QSC
AG
DADA S.p.A.
Forthnet
S.A.
Tiscali S.p.A.
freenet AG
Reply S.p.A.
Transcom WorldWide S.A.
LBi International N.V.
0.00
0.00%
10.00%
20.00%
Ebitda Margin 2009
30.00%
40.00%
50.00%
60.00%
70.00%
Using a Value Map:
an example (check Facebook valuation at different times)
Baidu Inc. ADS
y = 75.78x 2 + 12.34x + 0.599
R² = 0.736
14.00
12.00
Price to Sales (may 2009)
10.00
Google Inc. Cl A
8.00
NHN Corp.
Webzen Inc.
6.00
Sohu.com Inc.
Yahoo! Inc.
Akamai Technologies Inc.
4.00
EarthLink Inc.
-20.00%
Digital River Inc.
Aufeminin.com S.A.
SK Communications Co. Ltd.
Iliad S.A.Daum Communications Corp.
United Internet AG
2.00
Peer 1 Network Enterprises Inc.
eAccess Ltd.
United Online Inc. GMO Internet Inc.
Buongiorno S.p.A.QSC AG iiNET Ltd.
DADA S.p.A.
Forthnet S.A.
Tiscali S.p.A.
freenet AG
Reply S.p.A.
Transcom WorldWide S.A.
LBi International N.V.
0.00
-10.00%
0.00%
Expected Sales Growth (2009 - 2011)
10.00%
20.00%
30.00%
40.00%
Estimated Value of Facebook (may 2009)
Price01.05.2009 / Sales2009
= a + bMargin x Ebitda Margin2009 + bGrowth x (Sales2011 / Sales2009)1/2 -1 + bGrowth2 x [(Sales2011 / Sales2009)1/2 -1]2
Statistica della regressione
R multiplo
R al quadrato
R al quadrato corretto
Errore standard
Osservazioni
0,957079938
0,916002008
0,905502259
1,007559278
28
ANALISI VARIANZA
gdl
Regressione
Residuo
Totale
3
24
27
Errore
standard
Coefficienti
Intercetta
Ebitda Margin
Sales Growth
Sales Growth 2
Operating Income 2009
Depreciation & Amortization
Ebitda 2009
Revenues
Ebitda Margin
Effective Sales Growth
Baidu Sales Growth
Price to Sales
Sales 2009
Implied Equity Value
SQ
265,6929174
24,36421676
290,0571342
-1,81
11,29
9,26
56,62
MQ
88,56430581
1,015175698
Stat t
0,416283532 -4,339899597
1,578574442 7,153075689
2,611837696 3,546398195
10,24459818 5,527281155
262,00
78,00
340
777,00
43,8%
118,5%
35,4%
Based on
Based on
Comparable's
Realized
Sales growth
growth
(Baidu)
13,502
93,68
777,00
777,00
10.491
72.793
F
Significatività F
87,24037225 4,77475E-13
Valore di
significatività
Inferiore 95% Superiore 95%
Inferiore
95,0%
Superiore
95,0%
0,02% -2,665795711 -0,947461756 -2,665795711 -0,947461756
0,00% 8,033644964 14,54967996 8,033644964 14,54967996
0,16% 3,872048463 14,65318451 3,872048463 14,65318451
0,00% 35,48096318 77,76858579 35,48096318 77,76858579
Estimated Value of Facebook (January 2011)
Price01.01.2011 / Sales2010
= a + bMargin x Ebitda Margin2010 + bGrowth x (Sales2012 / Sales2010)1/2 -1 + bGrowth2 x [(Sales2012 / Sales2010)1/2 -1]2
Statistica della regressione
R multiplo
R al quadrato
R al quadrato corretto
Errore standard
Osservazioni
0,956943275
0,915740431
0,90671262
1,831021354
32
ANALISI VARIANZA
gdl
Regressione
Residuo
Totale
Intercetta
Ebitda Margin
Sales growth
Sales growth 2
Operating Income 2010
Depreciation & Amortization
Ebitda 2010
Revenues
Ebitda Margin
Baidu Sales Growth
3
28
31
MQ
340,0766019
3,352639197
F
Significatività F
101,4354906 3,78237E-15
Coefficienti
Errore standard
Stat t Valore di significatività
Inferiore 95% Superiore 95% Inferiore 95,0% Superiore 95,0%
-1,739073042 0,748383945 -2,32377118
2,76% -3,272068039 -0,206078045 -3,272068039 -0,206078045
12,95749478 2,646865244 4,895411587
0,00% 7,535637187 18,37935238 7,535637187 18,37935238
-10,02647207 5,690415435 -1,761992983
8,90% -21,68275953 1,629815394 -21,68275953 1,629815394
118,0192115 13,12090175 8,994748506
0,00% 91,14226295
144,89616 91,14226295
144,89616
1032,00
323,00
1355,00
1974,00
68,6%
51,6%
Based on Comparable's
Sales Growth (Baidu)
Price to Sales
Sales 2010
Implied Equity Value
SQ
1020,229806
93,87389752
1114,103703
33,379
1974,00
65.890
Estimated Value of Facebook (18 May 2012) – Input of
Regression
Pric e to Sales
Ebitda Margin
Sales Grow th
Pric e to Sales
ln Pric e to Sales Ebitda Margin
Sales Grow th
Google Inc. Cl A
6,86x
55,22%
19,2%
eAccess Ltd.
0,22x
30,69%
6,2%
Baidu Inc. ADS
18,78x
57,84%
39,8%
GMO Internet Inc.
0,71x
17,75%
5,0%
Yahoo! Inc.
4,28x
37,72%
2,6%
Digital River Inc.
1,41x
20,80%
4,8%
NHN Corp.
5,19x
33,01%
14,7%
InfoSpace Inc.
2,35x
15,43%
6,4%
LinkedIn Corporation
17,79x
18,90%
51,9%
LBi International N.V.
1,97x
16,23%
17,1%
Groupon Inc.
4,84x
-6,79%
30,3%
iiNET Ltd.
0,69x
14,99%
10,1%
Iliad S.A.
2,70x
39,26%
19,0%
QSC AG
0,52x
16,71%
1,6%
Akamai Technologies Inc.
4,67x
45,34%
13,9%
SK Communications Co. Ltd.
1,26x
8,35%
9,2%
United Internet AG
1,45x
17,30%
8,4%
Peer 1 Network Enterprises Inc.
2,39x
22,63%
12,6%
freenet AG
0,45x
10,47%
-1,0%
Buongiorno S.p.A.
0,90x
11,37%
11,3%
Sohu.com Inc.
1,95x
36,72%
18,6%
Asia Pacific Systems Inc.
1,33x
13,80%
20,1%
Daum Communications Corp.
3,60x
33,47%
16,8%
Reply S.p.A.
0,37x
12,49%
4,0%
EarthLink Inc.
0,68x
25,17%
1,3%
Aufeminin.com S.A.
2,97x
33,63%
11,6%
NIC Inc.
3,95x
24,00%
11,3%
CS Loxinfo PCL
1,49x
25,97%
3,4%
eAccess Ltd.
0,22x
30,69%
6,2%
Webzen Inc.
6,77x
46,97%
58,1%
Mean
3,54x
25%
15%
Coefficient of Variation
1,27
Median
1,97x
23%
11%
Correlation with Price to Sales
0,58
0,96
0,453
0,766
Estimated Value of Facebook (18 May 2012)
Price18.05.2012 / Sales2011
= a + bMargin x Ebitda Margin2011 + bGrowth x (Sales2014 / Sales2011)1/3
Statistica della regressione
R multiplo
R al quadrato
R al quadrato corretto
Errore standard
Osservazioni
0,896679649
0,804034393
0,788960116
2,056372638
29
ANALISI VARIANZA
gdl
Regressione
Residuo
Totale
Intercetta
Ebitda Margin
Sales Growth
2
26
28
SQ
MQ
451,098882 225,549441
109,9453791 4,228668428
561,0442611
Coefficienti Errore standard
Stat t Valore di significativitàInferiore 95% Superiore 95% Inferiore 95,0% Superiore 95,0%
-2,782
0,817224389 -3,403777609
0,22%
-4,461478851 -1,101821304
-4,461478851
-1,101821304
8,710
2,764069931 3,151109239
0,41%
3,028259237
14,39151335
3,028259237
14,39151335
30,750
3,4280172 8,970114163
0,00%
23,70331544
37,79609584
23,70331544
37,79609584
Sales Growth Linkedin
Sales Growth Baidu
Sales Growth Groupon
Google Historical
51,92%
39,84%
30,31%
73,27% 57,95%
Ebitda Margin
Sales 2011
56,02%
3.711
Min Google
Max Google
Groupon
Historical Sales Historical Sales
Sales Growth
Growth
Growth
14,35
11,42
19,92
24,63
3.711
3.711
3.711
3.711
53.249
42.370
73.915
91.397
Linkedin
Baidu Sales
Sales Growth Growth
Price to Sales
Sales 2011 Facebook
Equity Value
F
Significatività F
53,3381713
6,28548E-10
18,06
3.711
67.030
EXIT CLAUSE FOR VENTURE CAPITALISTS
DRAG ALONG AND TAG ALONG CLAUSES
54
Drag Along and Tag Along Clauses
Entrepreneurs typically ask for DRAG - ALONG RIGHT
A right that enables a majority shareholder to force a minority shareholder to
join in the sale of a company. The majority owner doing the dragging must
give the minority shareholder the same price, terms, and conditions as any
other seller.
This is designed to protect the majority shareholder. Because some buyers are
only looking to have complete control of a company, drag-along rights help to
eliminate minority owners and sell 100% of a company's securities to the
buyer.
Venture Capitalists typically ask for TAG - ALONG RIGHT
A contractual obligation used to protect a minority shareholder (usually in a
venture capital deal). If a majority shareholder sells his or her stake, then the
minority shareholder has the right to join the transaction and sell his or her
minority stake in the company. Tag-alongs effectively oblige the majority
shareholder to include the holdings of the minority holder in the negotiations
in order to facilitate the possibility that a tag-along right is exercised.
TAG ALONG RIGHT are used to prevent Private Benefits of control
extraction.
55
Private Benefits of Control
Traditional finance assumes that all the common stocks have been created equal
and each shareholder receives the same payoff per share owned. In the last twenty
years, however, a different view has slowly gained acceptance. According to this
new view, a controlling shareholder can obtain some benefits that are not shared
by other shareholders: the so-called private benefits of control (e.g. secretary used
for personal scope; huge CEO’s remuneration / principal shareholder).
How can you measure private benefits (Barclay – Holderness, 1989)?
The price per share that an acquirer pays for the controlling block reflects the cash
flow benefits from his fractional ownership and the private benefits stemming
from his controlling position in the firm. By contrast, the market price of a share
after the change in control is announced reflects only the cash flow benefits that
non-controlling shareholders expect to receive under the new management.
Hence, as Barclay and Holderness have argued, the difference between the price
per share paid by the acquiring party and the price per share prevailing on the
market reflects the differential payoff accruing to the controlling shareholder.
56
Private Benefits of Control: an Example
Shareholder A
(Controlling
Interest)
Venture
Capitalist
10%
Market
70%
Asset
Cash & Equivalentes ...
...
Real Estate Buildings 100
Total Assets
200
Company Alfa
(Industrial Firm)
Liabilities
...
20%
70%
Company Beta
(Real Estate Firm)
30%
Other Shareholders
...
200
Company Alfa sell to Company Beta Real Estate Buidings for their Book Value (100) ==> no capital gain for shareholders
of company A in Income Statement
Company Beta acquires real estate buidings and value them at 120. So ther is an immediate capital gain for shareholders
of company B. How is it possible?
57
Private Benefits of Control: an Example
1)
2)
How is it possible?
Company B, a real estate company, is able to better manage this type of buildings, realizing
significant cost cutting (i.e. special synergies). The net present value of the special synergies is exactly
20. Because Company B is the only player being able to achieve this kind of synergies they do not
recognize the NPV in the price.
Shareholder A decide to sell real estate buidings for his own benefit. If this is the case:
A) Real Estate Buiding Fair Value
120
B) Book Value = Selling Price
100
C) Capital Gain for Company B Shareholders = A20- B
Shareholder A = C x 70%
14
Other Shareholders = C x 30%
6
D) Capital Loss for Company A Shareholders = B-20
-A
Shareholder A = D x 20%
-4
Venture Capitalist = D x 10%
-2
Market = D x 70%
-14
Net Gain for Shareholder A
10
Net Gain for Other Shareholders 6(B)
Net Loss for VC
-2
Net Loss for the Market
-14
Total
0
Literature (L. Zingales, A. Dyck, “Private Benefits of Control: An International Comparison”)
underline that huge control premium are recognized in acquiring controlling stakes for those
companies like company A (for wich control is achievable through small stakes). A possible
explanation is the extraction of private benefits fo control.
58