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FINM3005/FINM6005 Corporate Valuation/Applied Valuation

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FINM3005/FINM6005
Corporate Valuation/Applied Valuation
Assignment Guidelines

Lecturer: Dr. Mohammed Abdullah Al Mamun

Teams need to submit the assignment involving valuation and analysis of a listed company. This note sets down the objectives for assignment, lists what needs to be submitted, and provides some direction on how to approach the particular phase of analysis. The guidelines can be considered ‘soft’, in the sense that every item mentioned may not be relevant for every company. Also, there may be other aspects not included on the list that should be considered. The overall aim is to produce analysis that is suitable given the stated objective. Teams should think about what is required for an informed judgement on their company, rather than just use the guidelines as a checklist to follow.

Assignment Summary

Assignment	Group Assignment
Due Date	Friday, October 11, 11:55pm
Weighting (%)	30%
Marks	100
Purpose	Part 1 • Build and submit a company model for evaluation • Generate a DCF valuation Part 2 • Value the company based on selected multiple and asset-based methods • Submit worksheets detailing the analysis • Write-up the company outlook and your analysis in a research note format
Instructions	See page 2-6
Marking Criteria	See page 7-8
Submission Details	1. Use wattle (online) submission 2. All files submitted to be named as follows: FINM3005 Ass - Team (number) - (description) Example 1: FINM3005 Ass - Team 31 -- Company Model.xls Example 2: FINM3005 Ass - Team 31 – Company Report.docs Note: Assignment will not be considered submitted until they comply with the above requirements. Failure to do so may incur late penalties.
Extensions & Late Penalties	No Extensions, Refer Course Outline for Late Penalties
Communication with the lecturer regarding assignment questions	Do not use email correspondence as a method for asking questions relating to the assignment. Prepare and bring all assignment questions to the workshops and lectures!

Part #1 – Company Model and DCF Valuation

Objective

Produce a company model and provide a DCF valuation of your company reflecting estimates of future cash flows from current operations.

What You Need To Prepare

1. Company model – integrated financial accounts, forecasts, valuation, summary tables and charts

2. Explanatory notes and assumptions – to be incorporated within the model (excel file) as needed

Guidelines

Part #1 involves building the company model that provides the foundations for your future analysis. Hence it is highly recommended that you read the guidelines for all assignments before starting work. Ideally you would be advanced in your research into the company and industry for Part #1, so that you are well informed when structuring your model and making any initial forecasts.

Company Model

The company model itself is the major item to be prepared for Part #1. It is envisaged that teams will build upon the KGW model template found on Wattle. Augmentations to the KGW model should facilitate an insightful and meaningful analysis of the company, focusing on key drivers of the business and the company valuation. The augmented model should contain the following:

• A meaningful amount of historical data

• Separate analysis of key business segments (all linked into central accounts)

• Model focused around key drivers of the overall business and/or its segments

• Estimation of continuing value (making clear assumptions about future return on capital, etc)

• Valuation of non-operating assets (i.e. other items of value not included in DCF valuation)

• Estimation of cost of capital (use a separate worksheet, and justify inputs where appropriate)

• Division of DCF-based enterprise valuation into equity and non-equity claims

• Estimate of equity value per share

• Assumptions and inputs clearly identified (ideally consolidated into separate worksheet)

• Analysis of ROIC, including decomposition (important for linking valuation to business outlook)

• Summary tables and charts (including charts of key value drivers / ROIC decomposition)

It is highly recommended that a separate sheet be established to carry all key input assumptions (e.g. margin components, growth rates, capital spending determinants, cost of capital inputs, etc), as well as to gather the main output, with all being linked to the model. It is much easier to do sensitivity analysis and updates under such a structure, rather than having the main inputs and outputs spread throughout the model. Using a distinct colour for input assumptions is also a useful practice.

Explanatory notes should be included within the model itself, as needed for the marker (and other team members) to understand the work done. Notes should identify items such as key assumptions, sources, methods used, basis for forecasts, etc. Ways to include explanatory notes include:

− Create a “Notes” column, perhaps to the right of the modelled cells

− Insert a text box (see “Insert” tab)

− Insert comments within the relevant cell itself (see “Review” tab) Page 3

Part #2 – Multiple and Asset Based Valuation, Research Note

Objective

Round out the valuation with a range of appropriate multiple-based and asset-based valuations and preparing a research note.

What You Need To Prepare

1. Additional worksheets that detail all the multiple-based and asset-based valuation analysis

2. A research note summarizing your valuation analysis

Guidelines

This part completes the valuation analysis by including some appropriately selected multiple-based and asset-based valuation techniques. Listed below is a list of potential valuation measures. Rather than addressing every item on the list below, teams should only consider valuation metrics that make sense for their company. For assessment purposes, you will be evaluated on the effectiveness and

NOT the quantity of your analysis.

Potential Valuation Measures

P/E ratios

Cash flow multiple

Enterprise value

Dividend yield

Price/sales

Price/book

Sum-Of-The-Parts (SOTP)

Takeover valuation

Composite valuation (summarises all measures examined, including the DCF valuation)

While there is no prescription for the format, an ideal submission might incorporate these elements:

Valuation clearly focused on prospective rather than historic earnings or cash flows (which means accessing consensus broker forecasts to form prospective ratings for comparatives).
Analysis should ideally address “absolute” as well as “relative” valuation issues, i.e. not only how the stock is priced versus its comparatives, but some sense of whether the stock itself or its comparative group is cheap or expensive in its own right.
A solid basis for establishing appropriate valuation multiples. Possibilities include reference to history, relative versus the market, comparative companies.
Identification of key issues impacting your findings, e.g. validity of comparisons; maintainability of earnings; accounting or other normalisation issues; etc.
Dilution of EPS, etc is required for share issues, claims like convertibles, options, etc.

Data on comparable companies will be provided by the lecturer in due course, although teams may wish to look further afield if so inclined.

Research Note

The research note is the final item you are required to submit. It should summarize: (a) your major modelling choices and key assumptions, (b) your outlook for the company and its industry, plus associated forecasts; and (c) your DCF valuation and other valuation matrix, and how they link to the outlook. Your analysis should be supported by appropriate charts and tables. Assume the target audience involves professional investors who have a good understanding of company modelling and valuation and are largely interested in understanding the basis of your analysis and DCF valuation.

Suggestions on Format

The format of the research note for Assignment is at the discretion of the groups: do what you think is necessary to best present your analysis within the recommended page limits. You may structure your research note submission in an analyst report format (see Assignment folder at Wattle for example). Nevertheless, for groups looking for some guidance, the following broad structure is suggested:

Body of report (4-6 pages)

1. Summary (1 paragraph) – Convey your key messages right up front.

2. Background (1 paragraph) – Brief description of company, industry and structure of model

3. Outlook (2-4 pages) – Describe what you have assumed about the company and industry outlook, and how it links to your modelling. Aspects like revenue growth and margins would be addressed here. ROIC might also be addressed, especially if your analysis hinges on sustainable profitability.

4. Other (0-½ page) – Some aspects such as capex, growth opportunities and valuation of non operating assets might be presented in a separate section.

5. DCF valuation (1 page) – As well as presenting the valuation, cover off on any other relevant

items for the DCF analysis, such as cost of capital and continuing value assumptions.

Appendices (3-page limit) – Use this space to make more detail available, in support of the write up appearing in the body. If anything appears in the appendix, it should be referenced in the body.

Tables and Charts – Exhibits that are central to your story should be included in the body; others can appear in the appendix. While this choice is up to each group, the body of the report might contain at least the following:

− Summary table – provides an overview of the key inputs and outputs

− Presentation of key value drivers – the marker expects to see charts or a table of the four key value drivers of revenue growth, margins (EBITA margin, NOPLAT margin), capital efficiency (capital turnover) and ROIC (possibly before and after goodwill and intangibles).

These may appear under either the outlook or the DCF valuation section, as appropriate.

Other tables and charts that may prove useful, some of which might appear in the appendix, include:

− DCF valuation summary

− Cost of capital calculations

− Condensed financial statements (worth doing; look at a few broker reports for ideas on setup).

Other

− Title page: You might show company and team, possibly your DCF valuation and recommendation.

− Referencing: Teams are expected to acknowledge sources whenever reliance is placed on data, analysis or statements arising from private third-party sources. Information that is generally known to ‘the market’, such as company announcements, need not be referenced.

− Presentation: It counts, so make your report as polished and readable as possible. Using two-thirds of the page for text and one-third margin for charts and tables can be a good idea. Selective use of dot points is recommended, especially when listing facts or assumptions.

− The research note should stand alone: It should not be necessary for the marker to look at any excel files to understand your analysis. (But it doesn’t mean that the marker won’t look at your excel files.)

Scenario analysis – This is compulsory

Sensitivity analysis – This is optional. Nevertheless, additional marks may be awarded for groups which include sensitivity analysis in a manner that enhances their investment case. See Lecture 9 for further details on how to conduct the analysis.

The recommendation: Groups are expected to come up with a recommendation of either ‘Buy’, ‘Hold’ or ‘Sell’. This recommendation should reflect an ‘investment’ rather than ‘trading’ view. That is, you should be informing investors with a horizon of (say) 1-3 years how they should be approaching the stock. Feel free to add some colours around the recommendation within the text. For example, you might wish to flag developments that would change your recommendation (e.g. events that would turn a hold into a buy or sell). Or you might wish to highlight shorter-term ‘trading’ considerations that an investor may wish to take into account when adjusting their position.

Some Advice on Valuation Measures

Below is a sketch of what is expected under selected measures.

• The main aim is to come up with an estimate of the target PE for your stock and derive a valuation by: Price = PE * EPS.

• First decide the best way to arrive at the target PE, then arrive at your estimate using the data at your disposal. Explain what you have done in the excel file. Data series provided should be used selectively and intelligently. Don’t try to analyse everything that has been made available.

• Some aspects you might consider:

− Trading history of the absolute (raw) PE and relative PE versus market and/or comparable companies, considering the industry as well as the company itself

− Reliability of comparatives; implication of any difference for the multiple

− Relation between prospective and ‘trend’ earnings

• Your PE should be applied to normalized, diluted EPS. Provide a table setting out your calculations.

Enterprise Value

• The aim is to derive a valuation as follows: (a) estimate enterprise value by applying a target multiple to either EBIT or EBITDA from operations; (b) add non-operating assets; (c) deduct other financial claims (net debt, etc) to get an equity value; (d) divide by number of shares to obtain a target share price.

• This part should be largely approached as a relative valuation exercise, i.e. select a target multiple for your company by reference to the multiples for a selection of comparable companies.

• To limit an opened-ended exercise, you are only expected to estimate multiples for 4 or 5 companies.

• Create a table setting out the calculations for each company. Include this table in your submission.

Asset Valuations

• Price/book – The aim is to select a target Price/Book ratio and apply this ratio to asset backing per share to arrive at a valuation. The approach should be similar to P/E analysis, i.e. decide the target ratio after examining a range of relative and absolute data, taking into account fundamental determinants.

• SOTP – A value is derived by breaking the company into parts, valuing each part by reference to the value on which similar assets trade in the market, adjusting for any corporate overheads and non-equity claims, and dividing by number of shares. The basis of the reference values should be made clear. Presentation might be done via a single table, plus accompanying notes.

• Takeover valuation – The idea is to estimate what a potential bidder might pay for the company.

The price up to which a successful bid would be both EPS-neutral and NPV-neutral can be considered. Assumptions will need to be made about synergy benefits and funding costs, which may require forming some sense of the nature of any prospective bidder.

Composite Valuation

• Summarizes by averaging across valuation measures (either simple or weighted average).

• Present in a table which reports all valuation measures, including your DCF valuation.

• Consider providing a high/low range for each valuation measure, as well as the overall composite.

FINM3005/FINM6005
Corporate Valuation/Applied Valuation
Marking Sheet for Group Assignment

Item	Criteria for the marker to consider:	Grade	Weight	Mark
1. Company model	• Did the team effectively build on the KGW template? • Was the model well-structured? In particular, was the model designed to analyse an appropriate set of business drivers, given the nature of the company? • Was there an analysis of ROIC and its components? • Were the forecasts coherent? • Was the model easy to follow? • Are there any technical errors? (e.g. incorrect treatment of items, accounts don’t balance, doesn’t reconcile to company reports, incorrect share capital, etc)		30%
2. Cost of capital	• Was the basis of the following cost of capital inputs properly explained, with supporting analysis provided where appropriate? − Beta estimates − Cost of debt − Risk-free rate − Target capital ratio • Are there any technical errors? (e.g. failure to account for all sources of capital, formulas applied incorrectly, etc)		10%
3. Explanatory notes	• Were explanatory notes and assumptions included within the model in an effective and efficient manner?		10%
4. Multiple- and/or Asset-based valuation	• Is the choice of multiple- and/or asset-based valuation measure(s) appropriate for the company and industry? • Is the valuation analysis technically, correct? PE Valuation − Have the PEs used in valuing the company been justified? − Is there evidence that all relevant considerations have been taken into account, including potentially both absolute and relative PEs? − Is there a table setting out estimation of the EPS on which valuation − is based, including normalizations or dilutions? Enterprise value or EBIT multiple valuation − Have the multiples used in valuing the company been justified, with evidence that all relevant considerations have Been taken into account? − Have 2 comparable companies been examined in providing a basis for multiple selection? − Is there a table clearly setting out the calculations?		20%
5. Research Note	• A recommendation is provided (i.e. Buy, Sell or Hold); Clear investment advice is offered; Foundations for recommendation and advice are well- explained (including setting out link with valuation analysis) • Important assumptions or uncertainties are highlighted • Valuation analysis from DCF, multiple and or asset-based valuation is appropriately presented and integrated into the investment case • Logical structure to discuss and flow of argument; Note is polished and easy to read; Effective use of tables and charts • A final valuation is provided, and its basis made apparent, including Valuation Summary table • Good presentation		20%
Overall evaluation	Additional marks may be awarded for the following: • Summary table, including composite valuation • Providing a valuation range • Excellent presentation • Evidence of understanding of key concepts • Examination of additional (relevant) valuation metrics • Corrections made from Assignment 1 feedback		10%
Raw mark before penalty
Applicable late penalties			Total after Adjustment
Marker Comments:

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