Mand a toolkit generating a fcf forecast

M&A TOOLKIT

Valuation:

Generating an “As Is” FCF Forecast

© 2007-2013 IESIES Development Ltd. All Ltd. Reserved
© 2007-2013 Development Rights All Rights Reserved

Building a DCF Valuation model is a valuable career skill

JOBS VALUING DCF VALUATION SKILLS

• Management Consulting
• Corporate Development
• Investment Banking
• Equity Analysis
• Financial analysis

© 2007-2013 IES Development Ltd. All Rights Reserved

Build your valuation model in logical steps, debugging at every
stage
STEPS IN BUILDING A VALUATION MODEL
Build FCF Model
1) Enter 3 years of historical cashflow, P&L and balance sheet
2) Calculate key drivers/ratios of historical results
3) Project flat “vanilla” assumptions for key ratios
4) Calculate projected cashflow, P&L and balance sheet
5) Debug your model – check you get sensible number
Generate FCF forecast
6) Develop a “story’ on the future of the industry/business
7) Turn your story into different financial assumptions on the key drivers
8) Sense check your FCF
Build Valuation Model
9) Calculate terminal values, enterprise value, equity value
10) Compare equity value to current market capitalisation
11) Run sensitivities

Operating free cash flow is the cash generated by a business

The amount of cash,
after all taxes, that the
business generates for
its shareholders and
debtholders


Operating free cash flow equals gross cash flow less gross
investment
OPERATING FREE CASH FLOW
Earnings before interest and taxes (EBIT)
- -Cash Taxes
= Net Operating Profit Less Adjusted Taxes (NOPLAT)
+ Depreciation

=Gross cash flow
Remember:
Gross Investment
+ Increase in Working Capital
+ Capital Expenditures Leave out all
+ Investment in goodwill financing cash
+ Increase in other assets
flows!
= Gross investment

Gross cash flow
- -Gross investment

= Free cash flow from operations

Operating Free Cash Flow is equals Financing Cash Flow

USES OF FREE CASH FLOW

PAID TO PAID TO
DEBTHOLDERS SHAREHOLDERS
THE COMPANY

Interest payments Dividends

Kept as cash

[Invested in Share repurchases
Repayment of debt
buying new
businesses]


Every aspect of a company needs to be either incorporated into
FCF forecast or treated as a non-operating asset/liability

Make a decision on every cashflow and balance sheet item:

Include in the valuation by……
Is this part of the
companies normal Put it in the free
operations? cashflow forecast

Is this part of Put it as a non-operating
financing or non- asset/liability to determine
operating? the equity value


Build a FCF forecast in a logical sequence
STEPS 1-4: BUILDING A “VANILLA” VALUATION MODEL
CASHFLOW Historical Historical Estimate Forecast

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Revenue 8,267 12,246 14,789 17,085 19,427 21,815 24,251 26,736 29,271 31,857
Cost of Goods -7,684 -11,332 -13,760 -15,804 -17,970 -20,179 -22,433 -24,731 -27,076 -29,467
Gross Profit 583 914 1,029 1,281 1,457 1,636 1,819 2,005 2,195 2,389
Other income 300 760 1,169 1,281 1,457 1,636 1,819 2,005 2,195 2,389
Distribution expense 1) -508 -1,097 -1,563
HISTORICAL -1,794 4) PROJECTED FIGURES
-2,040 -2,291 -2,546 -2,807 -3,073 -3,345
Other operating expenses
FIGURES
-146 -273 -325 -427
(Calculated output) -585
-466 -502 -534 -561 -605
Operating profit (EBIT) 229 304 310 342 408 480 558 642 732 828
Cash taxes -39 -64 -37 -68 -82 -96 -112 -128 -146 -166
NOPLAT 190 240 273 273 326 384 446 513 585 663
Depreciation 25 59 106 157 209 271 335 422 510 586
Gross Cash Flow 215 299 379 430 535 655 781 935 1,095 1,248

ASSUMPTIONS
ASSUMPTIONS
New stores 67 101 100 100 100 100 100 100 100 100
Cost (RMBm)/new store
Revenue per new store
2) HISTORICAL 29
3
49
3
39
4 4.2
20
3) 4.4 4.6
PROJECTED
20 20
4.9
20
5.1
20
5.4
20
5.6
20
Other capex spend DRIVERS/ 78 121
57 RATIOS 140 DRIVERS/RATIOS (Input422
157 209 271 335 data)510
Like for like sales growth, % 2% 0% -3% 2% 2% 2% 2% 2% 2% 2%


Pick your forecast period to achieve stability by the end year

RIGHT FORECAST PERIOD

Explicit Forecast Examples
Period
5 years Businesses with stable cashflows in
developed markets PRINCIPLE:
•Utilities In order to value in
•FMCG perpetuity, businesses
must be stable by the
10 years Typical businesses outer year of the
forecast:
15 years Businesses with unstable yet predictable •Stable market share
cashflows: •Sustainable growth
•Cyclical businesses (chemicals, shipping) rate
•Low term investment (airports, oil) •No net investment
•Fast growth emerging markets (China)

YYDDMM Syndicate Case_name
© 2007-2013 IES Development Ltd. All Rights Reserved 8

The more you practice, the better you will get at modeling

GENERAL TIPS ON VALUATION MODEL BUILDING
•Think through key value drivers, ratios and economics of the
industry/company you are modeling – include as assumptions
•One source principle: Set it up so that changing one cell impacts
all related cells, don’t have to remember to enter twice
•Don’t “hardwire” numbers; even if you think it won’t
change, set it up as a separate assumption
•Make it easy to edit – you are certain to want to change your model
•Start simple. Get something that works, then incrementally
make it more accurate/complicated, don’t build something
complicated and never know where the bugs are
•Best practice is to Project P&L, Balance sheet as well as Cash flow (can
simplify, but MUST project Working Capital and fixed asset register)


Build your valuation model in logical steps, debugging at every
stage
STEPS IN BUILDING A VALUATION MODEL
Build FCF Model
1) Enter 3 years of historical cashflow, P&L and balance sheet
2) Calculate key drivers/ratios of historical results
3) Project flat “vanilla” assumptions for key ratios
4) Calculate projected cashflow, P&L and balance sheet
5) Debug your model – check you get sensible number
Generate FCF forecast
6) Develop a “story’ on the future of the industry/business
7) Translate story into different financial assumptions on key drivers
8) Sense check your FCF
Build Valuation Model
9) Calculate terminal values, enterprise value, equity value
10) Compare equity value to current market capitalisation
11) Run sensitivities

Think about your future business “story” as three or four acts

STEP 6: CREATE A BUSINESS “STORY”
Act I:
Starting Point

Act II:
Development
Business Financial
Story Assumptions
Act III:
Resolution

Act IV:
Finale

The art of financial modeling is knowing what detail you have to
put in, and what you can leave out

THE GOLDEN RULE OF FINANCIAL MODELLING

80/20
• Don’t sweat the small stuff
• Focus your time and attention on what matters
• The purpose is insight and understanding….
• ….not accounting perfection
• Start simple
• Layer on complexity as you need it


Don’t flex every assumption, pick the 2-5 that are the key drivers
of the economics
STEP 7: CREATE A BUSINESS “STORY”
Act I:
Starting Point

Act II: Only flex 2-5 Key
Development Assumptions
Business e.g.
Story • Gross margin
Act III: • LFL Growth %
Resolution • New stores
• New store
economics
Act IV:
Finale

Then translate your 4 Acts into consistent financial assumptions
on the key drivers
KEY ASSUMPTIONS
ACT I ACT II ACT III ACT IV
LAND GRAB BLOODBATH CONSOLIDATION STABILITY
Year 2007-2008 2009-2011 2012-2014 2015-2016
Gross Margin

Number of
new stores

LfL Sales
Growth

New store
economics

Assumptions should be best estimate of the midpoint
– only overlay “conservative” once, not at every level

Your assumptions should be consistent with the business story
for each Act
KEY ASSUMPTIONS
ACT I ACT II ACT III ACT IV
LAND GRAB BLOODBATH CONSOLIDATION STABILITY
Year 2007-2008 2009-2011 2012-2014 2015-2016
Gross Margin 15% 14.5% 15% 15.5%

Number of 100 50 50 20
new stores

LfL Sales -1% -2% +1% +2%
Growth

New store 6-7 years 8-9 years 7 years 6-7 years
Economics
(payback)

You will not be right.
Your objective is to be credible and defensible

You can build a reputation as a “scary numbers person” if you
master a few quick checks
QUICK CHECKS OF A VALUATION MODEL
Key numbers
1) Is the base (last historical) year right?
2) Are there any jumps in the first forecast year? Can you explain them?

3) Is the terminal value year realistic?
4) Does Depreciation roughly equal capex in the terminal year?

Patterns over time
•Can you explain why the key ratios (e.g. store margin %) change over time?
•Are there unusual jumps between years? Can you explain them?
•Are ratios and patterns stable by the outer years of your forecast?
•Predict how changing one number will impact the FCF. Then change it and test
your prediction.
•What costs have you assumed toIES Development Ltd. All andReserved fixed?
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be variable Rights what

Mand a toolkit generating a fcf forecast

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