Valuation & Deal Analysis

The desk at a glance

Valuation is not a desk in an org chart; it is the work every other desk does before it can say a number out loud. It is here as a shelf of its own because the techniques are shared, they are learnable in an evening each, and they are the part of investment banking a reader can actually check — unlike a negotiation, a discounted cash flow can be rebuilt on a page of paper.

The one idea that matters more than any technique: a valuation does not set a price; a negotiation does. Analysis sets the range within which an argument can be made. Where inside that range a deal lands comes from who else is bidding and what happens if nobody signs — which no model contains and no model should pretend to.

The second idea, which follows: there is no single value. The same business is worth different amounts to different owners, because a buyer that can remove duplicated costs or fund more cheaply can pay more without overpaying. That is why fairness opinions speak about ranges and about one specific offer, and never about what a company is worth.

Who does what

• The analyst builds the model, and owns the assumptions in it whether or not they were chosen. The first valuation of any target is built from public filings and is wrong in known directions.
• The client's management supplies the forecast. This is the single largest input and the one nobody outside the company can check.
• Diligence produces the adjustments that change the answer: real working capital, real capital expenditure, contracts that end. The gap between the model before and after is where renegotiations come from.
• The valuation committee inside the bank signs off before an opinion is delivered. It exists because an opinion is a liability, not a slide.
• The shareholders, eventually, who read the ranges in the takeover document — usually the most accessible worked valuation anybody will ever see, and it is free.

What decides whether this desk is busy

Six mechanisms, each with the direction it pushes in and the thing to watch. None of them is a forecast, and none is a number that goes out of date.

The calendar this business keeps

Every desk has a rhythm its regulars plan around and a newcomer discovers by being surprised by it.

How this desk reaches the rest of the site

The deals and the instruments are one subject. These are the corridors — each one a mechanism, not a resemblance.

What is actually being paid for

Almost none of this work is billed on its own. It is inside an advisory fee, which is why the incentives are worth stating plainly: the analysis is produced by somebody who is paid if the transaction happens. That does not make it dishonest and it is not a comment on anybody's conduct — but it is the reason the methods are conventional, disclosed and cross-checked against each other rather than left to judgement.

The one piece usually paid for separately is the fairness opinion, and often at a flat fee that does not depend on completion. The logic is exact: an opinion on whether a price is fair should not be delivered by somebody whose fee depends on the answer being yes.

What a fairness opinion says is narrower than almost every reader assumes. It says the consideration is fair, from a financial point of view, on a stated date, on stated assumptions. It does not say the price is the best obtainable, that the transaction is a good idea, or what the company is worth.

Which blocker decides across this desk

• Price6 of 10The two sides cannot agree what it is worth.Decides: Cost of capital, Discounted cash flow, Exchange ratio, Precedent transactions, Sum of the parts, Trading comparables. Matters on 4 more.
• Financing1 of 10The money is not there, or its cost moved under the deal.Decides: LBO analysis. Matters on 2 more.
• Approval1 of 10A regulator, a court, a board or a shareholder vote says no.Decides: Fairness opinion. Matters on 2 more.
• Diligence5 of 10What was found when the buyer actually looked.Decides: Accretion and dilution, Discounted cash flow, Precedent transactions, Sum of the parts, Synergies. Matters on 4 more.
• Execution3 of 10Documents, disclosure, timetable, and the people running it.Decides: Accretion and dilution, Fairness opinion, Synergies. Matters on 7 more.

The outputs, in the order they appear

• The comparable companies analysis — where the peer set is chosen, which is itself most of the valuation. See trading comparables.
• The precedent transactions analysis — what was actually paid for similar businesses, including the premium for control. See precedents.
• The discounted cash flow — the only method that values the business itself rather than by reference to others, and the one most sensitive to assumptions nobody can observe. See the DCF and the arithmetic underneath it.
• The buyout model — the same cash flows run backwards: not what is it worth, but what can be paid at a target return. See LBO analysis.
• The sum of the parts, where a group is worth more taken apart than together. See the sum of the parts.
• The accretion and dilution analysis — not a valuation at all, but the number a buyer's board will actually ask about. See accretion and dilution.

Run the numbers

Interactive: the bridge from enterprise value to a share priceEasy

Almost every argument about what a buyer paid is an argument about one line in this bridge rather than about the headline number.

Enterprise value ($m) Gross debt ($m) Cash ($m) Minority interests ($m) Pension deficit ($m) Associates and investments ($m) Shares outstanding (m)

Net debt

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Equity value

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Per share

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Debt share of enterprise value

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Claims ahead of the shares

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Reading

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Which items belong in the bridge, and at what value, is an accounting and negotiating question. This computes a bridge; it does not settle what goes on it. Information and education only. Not advice, not a valuation, and not a quote for anything.

How the analysis goes wrong

• Comparing enterprise value with equity value. Debt, cash, pensions, leases and minorities sit between them, and this is the commonest error a newcomer makes.
• A terminal value doing all the work. In most discounted cash flows the terminal value is the majority of the answer, and it is a division by a small number.
• Peers chosen to reach a conclusion. Adding or dropping two names moves the median more than most analytical work does.
• Adjusted earnings that only adjust upwards. Each add-back may be defensible; the direction of all of them together is the tell.
• Synergies counted at announcement and never revisited. The buyer's shareholders pay for them up front whether or not they arrive.

Concepts to master

• The bridge from enterprise value to equity value, written out once and understood, prevents more errors than any other single thing on this shelf.
• A multiple is a statement about which companies this one belongs with, not a fact about it — see valuation as a mechanism.
• The discount rate is mostly unobservable, and anyone can move the answer by a quarter within a defensible range, which is the honest reason results are quoted as ranges. See the cost of capital.
• Accretion is arithmetic, not value. A deal can add to earnings per share and destroy value, and the mechanism is simple enough to see on one line.
• The same multiples are quoted every day on the listed side, where the market rather than a buyer sets them — see cash equities.