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Unformatted text preview: Finding Data in Financial Finding Data in Financial Reports
Chapter 14 Getting the EBIDTA Multiple
Getting the EBIDTA Multiple EBITDA D&A LTM Unusual Items Pro Formas # Shares Stock Options Preferred, Debt, and Cash EBITDA
EBITDA You will calculate that using your model Depreciation and Amortization
Depreciation and Amortization Nearly all companies have Depreciation and/or Amortization (D&A). The grand total for D&A is almost always provided on the Cash Flow Statement. However, you'll often see Income Statements that don't explicitly break out these individual line items. If it's not broken out separately on If it's not broken out separately on the Income Statement, Depreciation is almost always included in Cost of Sales (or Cost of Goods Sold). Amortization of Intangibles is usually included in SG&A. You should at most only estimate You should at most only estimate one of the two numbers: D or A The other one is a plug based on total D&A from the Cash Flow Statement Total D&A minus the one you found or estimated from the notes. That way we can make sure EBIT and EBITDA are both correct. CAUTION!
CAUTION! Sometimes in the Cash Flow Statement you'll see Amortization of Debt Issuance Costs, also called Amortization of Deferred Financing Costs or a variety of similar terms. This is not part of Amortization for purposes of calculating EBITDA from EBIT. We only care about operating expenses. This expense is due to the use of debt, so we ignore it. If D&A are NOT included on the If D&A are NOT included on the P&L, then.. Remember, that COGS and SG&A already include D&A expense. So when you take Revenue and then subtract all COGS and SG&A, you've already subtracted Depreciation and Amortization. So, If you've subtracted D&A to get that profit So, If you've subtracted D&A to get that profit number, do you have EBIT or EBITDA? Since the profit subtotal is after subtracting the D&A costs, it must be EBIT (a.k.a., Operating Profit). To obtain EBITDA, you'd have to add back Depreciation and Amortization to EBIT What if you can’t find D or A?
What if you can’t find D or A? Estimate Amortization and then calculate Depreciation as the difference between total D&A and Amortization Estimate amortization by dividing the Balance Sheet account for Intangibles by a number approximating the remaining life of the Asset (e.g., 1525 years). OR…
OR… If there have been no increases or decreases in Intangibles other than the Amortization charge, the change in the Intangibles balance in the Balance Sheet will be equal to the Amortization of the Intangibles. If you are lucky, sometimes, the Balance Sheet indicates the accumulated Amortization on the Intangibles parenthetically at the beginning and end of the year. Annual Filings
Annual Filings Every twelve months, public companies file an annual report with the SEC on form 10K. The 10K is filed within 90 days of the close of the fiscal year. Many (but not all) companies have a December 31 fiscal year end. Form 10K
Form 10K The 10K provides three historical years of annual Income Statements and Cash Flow Statements, as well as the last two years' Balance Sheets. The financial statements contained in the 10K are audited financial reports Quarterly Filings Quarterly Filings Every three months, public companies file a quarterly report with the SEC on form 10Q. The 10Q is filed within 45 days of the close of the quarter. 10Qs are not audited financial reports. Form 10Q
Form 10Q The 10Q provides the Income Statement for the latest quarter and for the Year to Date (YTD). A YTD Cash Flow Statement is also provided. It also provides the most recent Balance Sheet and compares it with the latest fiscal year's Balance Sheet. LTM: Latest Twelve Months' Data LTM: Latest Twelve Months' Data Once the company puts out a 10Q, the 10K becomes stale: there is more recent data that needs to be examined. But how do you construct yearly information from a 10Q? Getting the Latest Twelve Months' Getting the Latest Twelve Months' Data Start with the 12month results from the 10K (e.g., Revenue, EBIT, or whichever line items you're interested in from the Income Statement or Cash Flow Statement). From the 10Q, add the yeartodate results for the current year. – Be careful! If it's been 6 or 9 months since the fiscal year end, you'd need to use the 6 or 9month YTD results – not the 3
month results! From the 10Q, subtract the yeartodate results for last year. CAUTION!
10Qs are not audited, and often employ very aggressive accounting practices NOTE:
NOTE: If the 10K is more recent than the latest 10Q, you don't need to calculate LTM results. Just use the 12 month results from the 10K. Also, there is no such thing as an LTM Balance Sheet. The balance sheet is a snapshot at a given point in time Why LTM numbers?
Why LTM numbers? The most important reason we analyze LTM Operating results is to establish a baseline level for forecasting the company's earnings on a projected basis If a company earned $100 million in the last twelve months, it will probably earn somewhere around $100 million next year – plus or minus an annual growth factor. The Run Rate
The Run Rate The current annualized cash flow generation potential of the business, excluding nonrecurring expenses or income, and pro forma for any acquisitions or divestitures The Run Rate is the best baseline for forecasting What if the LTM ≠ the Run Rate?
What if the LTM There are two key factors you may need to adjust for to make LTM results more closely resemble the prospects of the company on a goforward basis: Unusual, nonrecurring or onetime expenses/income Acquisitions or Divestitures Unusual items
Unusual items When getting your LTM operating profit (EBIT) results… Add back any unusual expenses Subtract out any unusual income Staying Above the Line Staying Above the Line What to do about Extraordinary Loss on Debt Retirement, Net of Taxes? Since this is BELOW the line, you don’t add it back to operating profit Spotting Unusual & NonRecurring Spotting Unusual & NonRecurring Items Financial statements show more than one period of financial results. If you see a particular line item for one or two periods only, it's likely to be a non
recurring item. After all, it didn't "recur" on a historical basis. Check the footnotes and MD&A to be sure BE CAREFUL:
BE CAREFUL: Unusual Items aren't always broken out as separate line items in the financial statements. Sometimes they're buried in the MD&A or the Footnotes For example, MD&A says firm incurred $5MM in SG&A severance costs related to the closure of a facility. This is non
recurring, so you should add the $5mm back to Operating Profit. Acquisitions and Divestitures Acquisitions and Divestitures If there was an acquisition or a divestiture midway in the year, then you must read the MD&A to find out the accounting treatment Acquisitions under U.S. GAAP are accounted for using the Purchase Accounting method Under Purchase Accounting
Under Purchase Accounting The results of the Target are included from the date of the acquisition. Think about what that means for the numerator and denominator of our Enterprise Value / EBITDA multiple Remember, we need to have a consistent numerator and denominator in order to get a meaningful multiple Getting a good EBITDA multiple
Getting a good EBITDA multiple If we show the combined value of the two businesses in our numerator (Enterprise Value), we need to have a full twelve months of the combined EBITDA in our denominator The Pro Forma results present the company as if the Target had been owned for a full year No Impact on the Numerator No Impact on the Numerator EV = (Price * # Shares) + Debt – Cash + Preferred Enterprise Value already includes the value attributable to the Target Under Purchase Accounting, the Balance Sheet includes the Debt borrowed (or Cash used) to consummate the acquisition. If shares were issued as consideration paid to the Target, the Equity Market Capitalization includes the value of these newly issued shares. Impact on the Denominator Impact on the Denominator Under Purchase Accounting, if an acquisition is closed midway through the LTM period, it will only be reflected in the Income Statement and Cash Flow Statement from the date of acquisition So, the LTM Income Statement and Cash Flow Statement results must therefore be calculated to determine the impact of the transaction on EBITDA. Purchase Accounting Adjustments Purchase Accounting Adjustments Example Suppose AcquirorCo bought TargetCo on September 30, 1999. You are calculating an LTM as of June 30, 2000 The LTM data you calculate will include nine months of TargetCo's results If you can find data for TargetCo for the quarter from July 1 to September 30, 1999 (or estimate it), you should add those results to arrive at Pro Forma LTM financials for the combined businesses Where to Find ProForma Financial Where to Find ProForma Financial Results? Companies typically disclose proforma financial results when they make acquisitions, which can often be found in form 8K or in an amended 10
K or 10Q If you're provided with a proforma Income Statement for the fiscal year and the yearto
date period this year and last year, you have enough information to calculate the LTM. Remember…
Remember… Start with the 12month Pro Forma fiscal year results Add the YeartoDate Pro Forma results for the current year Subtract the YeartoDate Pro Forma results for last year But what if you're provided with But what if you're provided with incomplete information? It's common to only get proforma YTD results for the current year (not the prior year Start with LTM results excluding the acquisition (stripping out any impact of the acquisition using the information provided in the pro formas) Add 12 months of results for the target Add 12 months of adjustments (if any) for synergies, Amortization, and other adjustments Use ONLY cash adjustments
Use ONLY cash adjustments It is typical to only get proforma Income Statements (not Cash Flow Statements). Determine whether proforma adjustments are cash adjustments (e.g. cost savings expected from closing overlapping operations) or non
cash adjustments (e.g. Amortization and Depreciation related to Purchase Accounting adjustments). Remember that D&A adjustments will decrease Operating Profit but should have no impact on EBITDA Divestitures are easy to account for Divestitures are easy to account for in getting the proforma financials. As long as the Divestiture is material, the Balance Sheet and Income Statement should disclose the impact of the Discontinued Operation as a separate line item. The Operating Profit numbers should only include the core business ("Continuing Operations"). Back to the numerator
Back to the numerator
Finding the components of EV Where to Find Shares Where to Find Shares Outstanding? The starting point for calculating the number of shares is to find out how many shares are currently outstanding. This is provided on the front cover of the most recent 10Q. If an acquisition or share issuance has happened subsequently, you may need to refer to available proforma information What if there are A and B shares?
What if there are A and B shares? Usually, they only differ in terms of voting rights (check the footnotes to be sure). If that is the case, just add them together to get the total Shares Outstanding What about nasty stock options?
What about nasty stock options? Stock options also have an impact on Enterprise Value. An option gives the holder the right (but not the obligation) to purchase a share of stock for a fixed price (the Strike Price). If the option can be freely Exercised, the option is said to be Vested An option will always have An option will always have some positive value
Whether in the money or out of the money, options always have value until the Expiration date, after which they are worthless BlackScholes Model
Intrinsic and Time value Factors affecting option values
Factors affecting option values Option prices are: Increasing with volatility Increasing in intrinsic value of the stock Increasing in time to maturity Increasing in interest rates Getting just the intrinsic value
Getting just the intrinsic value Option Value = MAX(0, Stock Price Strike Price) So the total value of all the options is: Options Value = Number of Options * MAX(0, Stock Price Average Strike Price) Getting the total Common Equity Getting the total Common Equity Value Total Common Equity Value = Value of Stock plus Value of Options Shares Outstanding * Share Price + MAX(0, Stock Price – Avg Strike Price) * Number of Options The Treasury Stock Method The Treasury Stock Method (Diluted Shares) Total Common Equity Value = Diluted Shares * Share Price Where "Diluted Shares" represents the number of shares after adjustment for the impact of stock options Calculating Diluted Shares
Calculating Diluted Shares Diluted Shares = Shares Outstanding + IF(Stock Price > Strike Price, Number of Options Number of Options * Strike Price / Stock Price, 0) What does this Mean? Suppose everyone exercises their options. Suppose everyone exercises their options. Then for every option outstanding, one share would get issued. But the company doesn't need to keep this many shares outstanding. The company gets some money from the exercise of the options. It can use that money (the option exercise proceeds) to buy back some shares of stock on the open market. So, Take the Strike Price and So, Take the Strike Price and multiply it by the number of options That represents the total cash paid into the firm by option holders if everyone exercised their options.
Divide by the stock price. That represents the number of shares that can be bought back by the company (retiring the shares). Subtract the number of options the company was able to buy back from the number of options exercised, and you're left with the number of additional shares effectively created by the exercise of stock options What about the “IF” part?
What about the “IF” part? The IF part of the formula basically just says: If the Options are "In The Money", then run the calculation and figure out how many Diluted Options there are. Otherwise, they have zero impact Total Common Equity Review
Total Common Equity Review Total Common Equity Value = Shares Outstanding * Share Price + MAX(0, Stock Price Strike Price) * Number of Options
Total Common Equity Value = Diluted Shares * Share_Price Of course, if there are no stock options, this calculation simplifies to:
Equity Value = Share Price * Number of Shares The Rest of the Enterprise Value The Rest of the Enterprise Value Equation The balances for Preferred Stock, Debt, and Cash come from the most recent Balance Sheet for the company (i.e., the most recent 10Q). Remember, do not perform LTM calculations on Balance Sheet data Recognizing Debt
Recognizing Debt The key is to identify whether the Liability represents money that is borrowed and incurs Interest Expense. If so, it is Debt Debt Bonds Notes Capitalized Lease Obligations Debentures LongTerm Obligations (check footnote) What about shortterm Debt and What about shortterm Debt and Current Maturities of longterm Debt? These Current Liabilities are usually, but not always, treated as part of Enterprise Value Preferred Stock
Preferred Stock Preferred Stock is a class of Equity that has seniority over Common Stock in a liquidation (i.e., gets paid before Common gets paid). Preferred often receives quarterly dividends as well. Preferred may or may not be Convertible into Common Equity Check the terms of the Preferred by Check the terms of the Preferred by looking at the footnotes If it is convertible, you'll need to figure out which of the following is greater and use it for the Enterprise Value calcuation: The value of the Preferred shown on the Balance Sheet, or The value if converted into Common (based on the Common Stock share price times the number of shares received upon conversion) Which Assets are treated as Cash? Which Assets are treated as Cash? Cash, Marketable Securities, and short term Investments can all be used to repay Debt or pay out dividends Most Common Multiples
Most Common Multiples Enterprise Value / Revenue (LTM or projected Revenue) Enterprise Value / EBIT (LTM or projected EBIT) Enterprise Value / EBITDA (LTM or projected EBITDA) Enterprise Value / EBITDACapex (LTM or projected EBITDA and Capex) Price per Share of Common Stock / Next Year's Projected EPS (a.k.a., Price / Next Fiscal Year's EPS, or Next Fiscal Year's P/E Ratio) Price per Share of Common Stock / Projected EPS Two Years from Now (a.k.a. Price / EPS Two Years from Now, or Next Year's P/E Ratio) Note on P/E multiples
Note on P/E multiples P/E multiples typically use projected EPS data in the denominator. Widely available and is Wall Street's best guess of next year's results (or the year after). Conventional Wisdom: Better to use projected EPS data than stale LTM EPS data. Revenue multiples
Revenue multiples There are even more restrictions when using other multiples like Revenue. For two companies to trade at the same Revenue multiple, the projected margins on the two companies should look similar over time In addition to the other comparability requirements How about Equity/Interest?
How about Equity/Interest? Interest Expense does not accrue to holders of Common Equity ...
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