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Time is like cleavage, squeeze and you will get some!
If you have 8 rst-round interviews and 4 second-rounds, thats only 10 hours of interviewing. That totals less than an entire day. Dont stress out. Be productive.
Getting the answer right is 50% of the challenge; the other 50% is how you choose to deliver it!
Dont bring the Vault Guide to your interviews, and if you do, dont let them see it. It is such a faux pas!
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Company Proles
Use the following pages to organize information about the companies you are interviewing with:
Company: Date/ time of interview: Who interviewed you: Industry/ product groups: Three recent transactions (include dates): 1. CEO Name: Company: Date/ time of interview: Who interviewed you: Industry/ product groups: Three recent transactions (include dates): 1. CEO Name:
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Company Proles
Company: Date/ time of interview: Who interviewed you: Industry/ product groups: Three recent transactions (include dates): 1. CEO Name: Company: Date/ time of interview: Who interviewed you: Industry/ product groups: Three recent transactions (include dates): 1. CEO Name:
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I Valuing a Company
The core of corporate nance and one of the most critical areas in investment banking and advisory.
Denition: This method takes the projected cash ows of a company, discounts them back at a relevant discount rate, taking into consideration the companys capital structure and how one may want to treat leverage.
Discounting cash ows isnt difcult, its deriving the free cash ows that can be challenging. The method which you use to discount these cash ows is another headache in itself. Then, nding the appropriate discount rate can be problematic. Make sure you understand the various techniques used in DCFs.
Six easy steps 1. Derive adjusted EBIT 2. Arrive at free cash ows 3. Decide how to discount free cash ows 4. Determine discount rate 5. Decide how to calculate terminal value 6. Apply discount rate and nd net present value
Step 2: Arrive at free cash ows Adjusted EBIT (+) Non-cash Operating Expenses (D&A, ESO) (-) Cash Tax Payments (-) Increase in Operating Working Capital (-) Capital Expenditures = Free Cash Flow D&A can be found in the Cash Flow Statement ESO may be embedded into SG&A (FASB 123)
Step 1: Derive adjusted EBIT Reported EBIT (-) Non-Recurring Charges = Adjusted EBIT Common examples of non-recurring charges are legal settlement fees, restructuring charges and asset impairment charges. Adjusting for these gives a more organic and accurate perspective on EBIT.
Step 4: Determine discount rate If using WACC... apply CAPM using given asset beta
Exit Multiple Method Assumes multiple of free cash ows after projected period
Note: You might get a variety of questions on the DCF, which are designed to evaluate your intuition behind the technique.
D&A is a non-cash operating expense. Hence, to make sure that free cash ow is derived only from cash-related items, D&A must be added back to EBIT.
Why subtract the increase in operating working capital? Working Capital = Net Current Assets - Net Current Liabilities When working capital increases, it means one of two things (or both): (i) Your net current assets are increasing Accounts Receivable (not converting recorded sales to cash quickly enough) + Inventory (not converting goods to cash quickly enough) (ii) Your net current liabilities are decreasing Accounts Payable (payables are met using cash = cash outow) Hence, it is apparent that an increase in working capital corresponds to lower levels of cash, and must be subtracted to reect the appropriate movement of cash in/ out of the company.
How is beta treated in the APV method? Simply put, you must unlever current beta because you are assuming an all-equity rm: Unlevered Beta =
Use the CAPM to arrive at the new cost of capital, which is your discount rate. DTS are then valued at the cost of debt, and added back.
How does the continuing value method treat terminal value like a perpetuity? Terminal Value =
Usually, you do a ve-year revenue projection based on: (i) management expectations; and/or (ii) slightly increasing growth rate Key drivers for growth include: (i) revenue enhancement (ii) improved cost management In a DCF youre really just interested up to the EBIT line.
Selected Cash Flow Statement Items ($ in millions) Cash Flows from Operations Depreciation & Amortization Cash Flows from Investing Purchases of PP&E
2008E
2011E
2012E
$5.7
$5.7
$5.7
$5.7
$5.7
$10.1
$9.9
$7.5
$12.8
$6.3
The cash ow statement is used to nd D&A and capex for a basic DCF. For more complex DCFs, you may have to look into details in Operating Cash Flows to nd minute changes in working capital or adjustments to EBITDA.
This is the working capital calculation. Note that there is no debt on Boheas company, so that this is technically an all-equity rm.
Market Data
Market Data Asset Beta () Risk-free Rate (rf) Market Return (rm) Discount Rate 0.85 5.0% 8.0% 7.6%
Market data is often provided to you, although the risk-free rate can be found online. Asset betas can be derived from comparables if not provided. The CAPM formula is: WACC = rf + (rm - rf) where (rm - rf) is also known as the market risk premium
Here we do some adjustments to EBIT. Boheas company is assumed to be a vanilla company with no real problems, so there are no non-recurring charges to be added back.
Market Data Asset Beta () Risk-free Rate (rf) Market Return (rm) Discount Rate 0.85 5.0% 8.0% 7.6%
The total valuation is the sum of all the PV-ed cash ows and the terminal value. Here we have valued Boheas company at a cool $271.5 million.
Disadvantages
Highly sensitive to assumptions used, such as WACC, long-term growth rate and terminal value
Capital markets volatility has little impact on the analysis Forecasted cash ows are uncertain
Trading Comps
Denition: This method looks at market values to derive price multiples used to measure a companys value based on a specied metric, such as Sales or EBITDA
Narrow it down If in retail, is it in the luxury sector? If in auto parts, is it in the OEM or aftermarket sector? If in aerospace, is it in the engine or aircraft construction sector?
Nature of business Retailers are different from wholesalers, manufacturers and distributors, even within the same broad industry Example: Diageo plc, an international alcoholic beverages manufacturer, is not a great comp if you are valuing a soft drinks retailer
Customer demographic Factors to consider include age, gender, socioeconomic status, geography Example: Saks Fifth Avenue, a high-end luxury chain retailer, is not a good comp if you are valuing a discount apparel chain, such as Dress Barn
Similar growth stories and concepts Niche brands may be the only existing company in its specic space and can be hard to nd comps for Example: Seven for All Mankind and Under Armour are good comps for Crocs if looking at novel growth strategy and niche concept
Trailing vs. forward multiples LTM = Last Twelve Months - used for historical analysis NTM = Next Twelve Months - used to forecast numbers (get from Thomson, Bloomberg, general analyst consensus, etc.)
Transaction Comps
Ann. Date Target Acquirer
Denition: This method examines similar precedent transactions and their valuation characteristics to derive price multiples used to value a company
Fort Garry Brewing Co. Ltd. Lakeport Brewing Income Fund Sleeman Breweries Ltd. Bouvet-Ladubay Hardys & Hansons plc Taittinger S.A. Vincor International Inc. Marie Brizard et Roger International
Russell Breweries Inc. Labatt Brewing Company Limited Sapporo Breweries Limited United Spirits Ltd. Greene King plc Caisse Rgionale Constellation Brands Inc. Belvdre
$4.20 163.5 345 17.7 500.8 1841.1 1375.7 384.6 Max Median Mean Min
36.5% 36.3% 13.3% -45.0% -16.0% 30.0% 45.0% 33.1% 29.5% 13.3%
Nature of acquisition Hostile takeovers - higher valuation due to opposing management board
Timing of acquisition Industry booms - bubble (tech boom, real estate boom) numbers may be inated Credit situation - less leverage may mean depressed valuations
Transaction structure Stock-swap deals - higher valuation due to increased stock risk
Leveraged Buyouts
Denition: LBO models help analysts see how a nancial sponsor may evaluate a company. It is a useful valuation technique that backs out entry/ exit multiples given a required IRR.
A company is purchased at a multiple of its EBITDA, of which a certain % is nanced by debt. The companys future cash ows (usually 5 years) are used to pay down debt. In this process, the original equity value is increased, and upon exit, nancial sponsors pay down remaining debt and extract prots from the amplied equity value.
Key drivers Cash - How much cash can this company generate going forward? Can it convert revenues to income to cash effectively? Debt - How much debt can you layer onto this company? How fast can it pay back debt? What kinds of debt can it sustain?
Tranches of debt Revolving credit facility... (this is like Penn Bursar) plus Senior debt (secured, Term Loan A) Junior debt (subordinate, Term Loan B) Mezzanine debt (high-yield, junk)
Typical leverage multiples Some deals are 80% nanced by debt; current credit situations have made lenders much more cautious, so 50-50% deals may be more common nowadays
Why is there circularity in a LBO model? There can be inherent circularity in a LBO model because to nd cash available for debt repayment (ending cash balance), you need net income (beginning cash balance), but you cant unless you have interest expense, but you cant do that unless you nd debt outstanding, which you cant nd unless you nd cash available for debt repayment to determine exactly how much debt you can pay down. In short, its one big vicious cycle and bankers solve it (or pretend to) by setting their Excel spreadsheets to manual, and allow Excel to iterate the calculations 10,000 times.
What advantages or disadvantages do LBO shops have over corporates? LBO shops are believed to have more nancial muscle, but potential lack of veteran industry knowledge (especially when having to deal with labor unions, think Cerberus and Chrysler deal of summer 2007).
Enter in 2007 EBITDA: $20.0 million Entry Multiple: 5.0x LTM EBITDA Transaction Value: $100.0 million Leverage: 3.0x LTM EBITDA Debt: $60.0 million Sponsor Equity: $40.0 million
During the Holding Period.... Through a series of operational enhancements and working capital improvements, Alex Goods EBITDA grew steadily over the years, leading to high levels of free cash ow. Debt was paid down at $5.0 million a year.
Exit in 2012 EBITDA: $25.0 million Exit Multiple: 5.0x LTM EBITDA Transaction Value: $125.0 million Outstanding Debt: $35.0 million Sponsor Equity: $90.0 million
Debt
$112.5
$75.0
$37.5
$0
2007PF
2008E
2009E
2010E
2011E
2012E
DCF
LBO
$0
$50
$100
$150
$200
In a 100% stock deal, if Acquirer P/E > Target P/E, the deal is accretive to the acquirer. Example I Acquirer P/E: 12.0x Share price: $60.00 EPS: $5.00 # of Shares: 1,000.0 Net Income: $5,000.0 Target P/E: 10.0x Share price: $30.00 EPS: $3.00 # of Shares: 4,000.0 Net Income: $12,000.0 Example II (share price, # of shares are the same) Acquirer P/E: 12.0x Share price: $60.00 EPS: $5.00 # of Shares: 1,000.0 Net Income: $5,000.0 Target P/E: 10.0x Share price: $60.00 EPS: $6.00 # of Shares: 1,000.0 Net Income: $6,000.0
Pro-forma Total Net Income: $5,000.0 + $12,000.0 = $17,000.0 1 share of Acquirer is worth: $60.00/ $30.00 = 2 shares of Target # of Shares Issued: 4,000.0/ 2 = 2,000.0 New Total # of Shares: 1,000.0 + 2,000.0 = 3,000.0 New EPS: $17,000.0 / 3,000.0 = $5.67 vs. Old EPS of $5.00, accretion % = 13.3%
Pro-forma Total Net Income: $5,000.0 + $6,000.0 = $11,000.0 1 share of Acquirer is worth: $60.00/ $60.00 = 1 share of Target # of Shares Issued: 1,000.0/ 1 = 1,000.0 New Total # of Shares: 1,000.0 + 1,000.0 = 2,000.0 New EPS: $11,000.0 / 2,000.0 = $5.50 vs. Old EPS of $5.00, accretion % = 10.0%
Acquirer P/E
- Higher P/E means lower standalone EPS - Accretion based on difference between standalone EPS and pro-forma EPS - Larger difference = more accretion!
- Higher share price means fewer shares issued to buy target - Fewer issued shares means smaller number of pro-forma shares - Smaller number of pro-forma shares means higher pro-forma EPS - Accretion based on difference between standalone EPS and pro-forma EPS - Larger difference = more accretion!
# of Acquirer Shares
- Fewer standalone acquirer shares means means smaller number of pro-forma shares - Smaller number of pro-forma shares means higher pro-forma EPS - Accretion based on difference between standalone EPS and pro-forma EPS - Larger difference = more accretion!
Practice Questions
How do you derive Free Cash Flows?
You are valuing a private company with no directly related comparables. What can you do?
What factors might lead to inated transaction values in your transaction comps?
What does the recent credit situation mean for leveraged buyout shops?
If you could value a company using only one method, which would you choose?
(This is a question that has no right or wrong answer, unless you say something like Im going to put some numbers in a hat, close my eyes and pick one at random. As long as you set up the correct scenario and defend your choice logically, you will be ne. Bankers ask this question to see how analytical and quick you can be.)
10-Q This contains the companys nancial performance over the last scal quarter, as well as year-to-date and LTM statistics.
Proxy Statement (DEF 14-F) This contains shareholder and ownership data, which can also be found on Bloomberg.
8-K This is the current report, and is used by companies to le current reports on events like entry/ termination of a denitive material agreement, material impairments, etc.
20-F This is the same as the 10-K, but for non-U.S. companies.
Income Statement
This is a warm-up question. It is, in fact, an open lay-up. You may answer it in 2 steps:
I. Function of I/S
- Summary of an entity's results of operation is revealed in the income statement - Provides information about revenues generated and expenses incurred - Differences between revenues and expenses are identied as net income or net loss
Balance Sheet
I. Function of B/S
- Reveals economic resources owned and claims against those resources (liabilities and owners' equity) - Prepared as of a specic date, whereas the I/S and Statement of Retained Earnings cover a period of time
Cash Flows from Investing Activities Purchases of PP&E (a.k.a. capital expenditures) Purchases of Investment Instruments Cash Flows from Financing Activities Short-term Borrowings Any debt-related stuff... issuance/ repayment of notes Effect of Exchange Rate Changes on Cash Net Change in Cash & Cash Equivalents Ending Cash Balance
Very impressive if you mention this! Say, if this were a multinational company, then realistically, it will be effected by cross-border exchange rates.
Income Statement
I. Function of I/S
Balance Sheet
I. Function of B/S
Draw it here:
Income Statement
Balance Sheet
What happens on the B/S? Increase in D&A of $100 = decrease in PP&E of $100 Decrease in net income of $60 = decrease in Retained Earnings of $60 .... there seems to be a gap of positive $40, lets look for it....
What happens on the C/F? Increase in D&A of $100 = increase in Cash Flows from Operations by $100, because D&A is added back in the C/F as a non-cash expense Recall the decrease in beginning cash balance of $60 ... here you nd the increase in ending cash balance of $40....
RECONCILE
Does this belong to the B/S? Increase in ending cash balance of $40 = Increase in cash of $40 ... the balance sheet balances!....
Draw it here:
Income Statement
Assets
Balance Sheet
Liabilities
Stockholders Equity
Balance Sheet
....
RECONCILE
Does this belong to the B/S? ... the balance sheet balances!....
Draw it here:
Income Statement
Assets
Balance Sheet
Liabilities
Stockholders Equity
Balance Sheet
....
RECONCILE
Does this belong to the B/S? ... the balance sheet balances!....
Draw it here:
Income Statement
Assets
Balance Sheet
Liabilities
Stockholders Equity
What do you think about your GPA? Do you think you should be doing better? This tests your reaction to questions that are on the offense. Be honest and say that you could be doing better, but you are well-rounded and hence, satised with your performance. You are proud that you are involved in many extra-curricular activities and that if you were graded on them, you would probably have a 4.0 GPA. Mention that every semester is a new slate and that you always strive to allocate your time efciently.
If I could only write three words to remember you by, what would they be? I tend to answer this with two serious buzzwords and a funny, memorable one; example: driven, efcient and diet Coke fanatic. Answer this question at your discretion! Have a backup in case no laughter ensues. Some bankers suck.
What was on the Wall Street Journal today? They arent asking you this question because they dont know whats on the WSJ. They want to see how you answer this question. I always said, Usually I skim through the columns on the rst page between classes. What jumped out at me today were the news about <x>, <y> and <z>. Sometimes, Id have an extra something-something, such as an interesting, non-nancial article in the back pages. Again, use this only if you feel good rapport with your interviewer (which you should have!). It shows that you are interesting and that you actually read the WSJ, even if you dont. Anyone can spit out the top three headlines.. differentiate yourself!
What is/ are your greatest weaknesses? The granddaddy of all bullshit. Change your weakness into something good. Self-deprecation can be humorous. List two (incl. one backup) here: 1. I can be 2. I can be BUT : BUT: