1. The PBSN Finance Executive

2. Who We Are

3. Goals
1. Learn basic finance acumen
 Career guidance
 Personal investing
2. Teach tools to valuate an equity at a beginner level
 Value Investing, Basic Accounting, Comparables, Discounted Cash Flow
 Searching for intrinsic value of an equity

4. Stock Pitch Utility
Why do we try to determine the intrinsic value of a stock?
 To buy undervalued stocks as an investor
 Determine merger/acquisition price
 Determine price for stock issuance

5. Value Investing

6. Value Investing
 Seeks companies that are undervalued by the financial markets
 Key Assumptions:
 Stocks can be neglected and value discrepancy can exist
 Entry point in short run does not matter
 Efficient market hypothesis in the long run

7. Value Investing Criteria
 High margin of safety (33%)
 Low trading multiples: P/E < 15, P/B < 1.5
 Healthy balance sheet and low amount of debt
 Predictable free cash flows
 Simple, understandable business model
 Defensible economic moat

8. Stock Pitch Structure

9. Picking a Company
 What do you like? What do you understand?
 Read the news, Seeking Alpha, Motley Fool, ThomsonONE
Consumer
Media and Financial Natural
Retail Healthcare Technology Industrials Real Estate
Telecom Institutions Resources
Goods

10. Overview and Business Model
Overview
 What is the business? Metrics
Business Model Ticker PBSN
Investment Thesis
 Basic numbers and company statistics IPO Date Sep-11
Current Price $50.00
Internal
 What do they do? Be thorough! Target Price $10.00
External
Revenues $500 MM
Valuation Market Cap $1000 MM
Catalysts
Risks

11. Investment Thesis
Overview
 Why is this a good company to buy?
Business Model
Investment Thesis
 Give a couple of reasons that summarize the best features
Internal
 “Summary” slide of what you’ll say
External
Valuation
 Why is the market wrong?
Catalysts
Risks

12. Internal
Overview
Internal:
Business Model
Investment Thesis
 Who runs the business? Management team?
Internal
 Examine balance sheet and debt maturity
External
Valuation
 Microeconomic factors, company specific
Catalysts
Risks

13. External
Overview
External:
Business Model
Investment Thesis
 What is the condition of this industry?
Internal
 What is going on in the macroeconomy that affects this business?
External
Valuation
 Activity of competitors?
Catalysts
Risks

14. Catalysts and Risks
Overview
Catalysts are specific events that will occur that support your thesis
Business Model
Investment Thesis
 E.g. drug release, new movement to China, new legislation
Internal
Risks are things that prevent your investment thesis from being realized
External
Valuation
 E.g. currency risk, business risk, management sucks
Catalysts
Risks

15. Accounting Basics

16. Why are Financial Statements Important?
 Allows investors and creditors to use the financial information provided to
evaluate:
 Financial conditions
 Asset investments
 Operating results
 Potential problems
 Projections
 Equity
 Etc.

17. Filings
 Annual Report
 Includes financial statements, company performance, etc. and is intended for
shareholders and other interested parties
 10-K
 More detailed annual report
 Released annually
 10-Q
 Released quarterly

18. Income Statement
 Measures financial performance over a period of time
 Shows a business incurs its revenues and expenses
Revenues
- COGS
= Gross Profit
- Expenses
= EBIT
- Interest
- Taxes
= Profit

19. Balance Sheet
 Shows a financial position at a specific point in time
 Fundamental balance sheet equation:
 Assets = Liabilities + Owner’s Equity
 Shows asset investments and how they are supported, revealing a lot
about the company’s financial health

20. Statement of Cash Flows
 Cash inflows and outflows over a period of time
 Cash impact of the operations and decisions of a business
 Shows how well positioned a company is to fund its future growth
through existing operations
 Important to note sources and uses of cash as well as the matching of
these sources and uses

21. Flow Through Question
How does a $10 decrease in depreciation affect all the financial statements?

22. Flow Through Question
How does a $10 decrease in depreciation affect all the financial statements?
Income Statement:
 Operating income would increase by $10
 With a 40% tax rate, net income would increase by $6
Cash Flow Statement:
 Net income goes up by $6 and depreciation decreased by $10
 Subtract the non-cash depreciation increase ($4)
Balance Sheet:
 Fixed assets increase by $10, but cash is down $4 (assets are up by $6)
 Increase of $3 from net income flows to retained earnings to balance (A = L + E)

23. Market Value vs. Book Value
Book Value Market Value
• price paid for a particular asset • current price of the asset
• historical cost • determined by demand and supply of the
• price shown on a balance sheet market
• useful to help track profits and losses • is a more accurate value of the asset’s current
value

24. Equity vs. Enterprise Value
Equity Value Enterprise Value
• also the market capitalization of the • enterprise value = market capitalization +
company preferred equity + minority interest + net
• value attributable to shareholders debt (total debt – cash and cash equivalents)

25. Capital Structure
Debt or Equity?

26. Ratio Analysis
 Used to analyze the historical trends and compare these trends to that of
the industry
Categories:
 Profitability
 Investment utilization
 Liquidity
 Stability
 Growth

27. Ratio Examples
Profitability Investment Liquidity Stability/Leverage Growth
Utilization
• Vertical Analysis • Inventory • Current Ratio • Net Worth to • Sales Growth
• Return on Assets Turnover • Acid Test Assets • Profit Growth
• Return on Equity • Fixed Asset • Age of • Debt to Assets • Asset Growth
Turnover Receivables • Debt to • EBITDA Growth
• Total Asset • Age of Inventory Capitalization
Turnover • Age of Accounts • Debt to Equity
Payble • Lon-Tem Debt
Interest Coverage

28. Comparable Companies

29. Comparable Companies Analysis
 What is a multiple?
 An expression of market value relative to a key statistic to relate to that value
Advantages Disadvantages
Useful Simplistic
Relevant Static
Simple Difficult to compare

30. Common Multiples
Enterprise Multiples Equity Multiples
Enterprise Value/Sales Price/Earnings
Enterprise Value/EBITDA Price/Book Value
Enterprise Value/EBIT Price/Sales

31. Multiples: An Example
 Price to Earnings (P/E) multiple
 Example
 Price per Share = $12
 Share Count = 1,000,000
 Market Capitalization = $ 12,000,000
 Net Income = $3,000,000
Price per Share Market Capitalization
OR
Earnings per Share Net Income

32. Multiples: An Example
 Price to Earnings (P/E) multiple
 Example
 Price per Share = $12
 Share Count = 1,000,000
 Market Capitalization = $ 12,000,000
 Net Income = $3,000,000
Price per Share Market Capitalization
OR
Earnings per Share Net Income
 Price /Earnings = 4.0x

33. Trailing vs. Forward
 Trailing
 Compares the current value of a metric to its historical values
 TTM : Trailing Twelve Months
 Forward
 Compares the current value of a metric to its projected values
 Use consensus estimates (from ThomsonONE, Bloomberg, etc.)

34. An Example
Comparable Companies Analysis
Share Market LTM 2013E 2014E LTM 2013E 2014E
Price Capitalization EV/EBITDA EV/EBITDA EV/EBITDA Price/EPS Price/EPS Price/EPS
Company A $15.00 $1,675 8.1 7.8 7.4 15.1 14.5 14.1
Company B $20.00 $2,230 6.6 6.5 6.4 12.3 12.1 11.5
Company C $12.00 $1,523 7.2 7.3 7.1 16.5 16.3 15.4
Company D $10.00 $1,084 7.7 6.9 6.9 12.8 12.2 12.1
Company E $18.00 $985 6.5 6.3 5.9 11.2 10.8 10.1
Mean 7.22 6.96 6.74 13.58 13.18 12.64
Median 7.2 6.9 6.9 12.8 12.2 12.1

35. Selecting Comps
 Peer group:
 Similar size
 Same region
 Same industry

36. Selecting Comps
 Company Documents
 Management Information Circulars
 Company presentations
 Annual and quarterly reports
 Other Resources
 Google Finance
 ThomsonOne
 Bloomberg

37. Selecting Comps: An Example

38. Selecting Comps: An Example
 Found at www.sedar.com (or www.edgar.com for American companies)
 Go to ‘Search Database’
 Search
 Company Name: ‘Royal Bank of Canada’
 Document Type :‘Proxy Circular
 Open latest Management Information Circular
 Key word search: ‘Comparator Group’

39. Discounted Cash Flow Analysis

40. The Discounted Cash Flow Analysis
 A company is worth the present value of all of its future cash flows
 Can reveal how the drivers work such as margins, growth
 Strengths:
 Extremely useful when no other pure play companies exist
 Utility as a sanity check
 Weaknesses:
 Heavily assumption based and easily manipulated
 Forecasting future projections is extremely difficult

41. Present Value
What do we need?
 1. Value of Forecasted Cash Flows Free Cash Flows for Free Cash Flows beyond
forecasted period forecasted period
 2. Value of Terminal Value
 3. Weighted Average Cost of Capital
 4. Present Value of Forecasted Cash Flows
 5. Present Value of Terminal Value

42. Free Cash Flow
The cash available after laying out money related to operations and
expanding its asset base
Sales • Top line of revenue, starting figure
- COGS • Operational expenses
- SG&A • Operational expenses
= EBITDA • Earnings Before Interest, Tax, D&A
- D&A • Not a use of cash
= EBIT • EBIT, good proxy for cash flow

43. Free Cash Flow
EBIT (1-t) • Account for the effect of tax
+D&A • Not a cash item
- CapEX • Deduct costs that are needed to expand asset base
• Net Working Capital accounts for changes in balance
- Increase in NWC sheet
Free Cash Flow • What is available to us

44. Forecasting Model
Mid-Year Convention Y Historical Period CAGR Projection Period
2009 2010 2011 ('09 - '11) 2012 2013 2014 2015 2016 2017
Sales $3,567.0 $4,827.0 $5,662.0 26.0% $5,034.4 $5,487.5 $5,926.4 $6,400.6 $6,848.6 $7,328.0
% growth NA 35.3% 17.3% (11.1%) 9.0% 8.0% 8.0% 7.0% 7.0%
COGS 2,282.0 2,565.0 3,223.0 58.0% 3,428.9 3,731.5 4,030.0 4,352.4 4,657.1 4,983.0
Gross Profit $1,285.0 $2,262.0 $2,439.0 37.8% $1,605.4 $1,756.0 $1,896.5 $2,048.2 $2,191.6 $2,345.0
% margin 36.0% 46.9% 43.1% 31.9% 32.0% 32.0% 32.0% 32.0% 32.0%
SG&A 380.0 376.0 357.0 8.2% 412.8 450.0 486.0 524.8 561.6 600.9
EBITDA $905.0 $1,886.0 $2,082.0 51.7% $1,192.6 $1,306.0 $1,410.5 $1,523.3 $1,630.0 $1,744.1
% margin 25.4% 39.1% 36.8% 23.7% 23.8% 23.8% 23.8% 23.8% 23.8%
Depreciation & Amortization 587.0 664.0 772.0 14.6% 735.0 801.2 865.3 934.5 999.9 1,069.9
EBIT $318.0 $1,222.0 $1,310.0 103.0% $457.6 $504.8 $545.2 $588.9 $630.1 $674.2
% margin 8.9% 25.3% 23.1% 9.1% 9.2% 9.2% 9.2% 9.2% 9.2%
Taxes 56.0 132.0 434.4 162.0 178.7 193.0 208.5 223.0 238.7
EBIAT $262.0 $1,090.0 $875.6 82.8% $295.6 $326.1 $352.2 $380.4 $407.0 $435.5
Plus: Depreciation & Amortization 587.0 664.0 772.0 14.6% 735.0 801.2 865.3 934.5 999.9 1,069.9
Less: Capital Expenditures 60.0 108.0 193.0 2.4% 595.2 (131.7) (142.2) (153.6) (164.4) (175.9)
Less: Increase in Net Working Capital (33.1) (32.3) (34.9) (33.0) (35.3)
Unlevered Free Cash Flow $962.5 $1,042.9 $1,126.4 $1,209.6 $1,294.2
Total $5,635.6

45. Operating Model Assumptions
 Analyst estimates
 Items as a % of historical basis of sales
 Items historically identical
 Growth of the economy

46. Terminal Value
Total value of all cash flows beyond the operating model time period
1. Exit Multiple Method
 Used for most companies with a tangible exit period
 Multiply terminal year EBITDA by LTM EV/EBITDA
2. Gordon Growth Method
 Used for largest companies that could “grow indefinitely”
 Apply growth rate to terminal year cash flow in perpetuity
 Terminal FCF * (1+ Growth Rate)/(Discount Rate – Growth Rate)
3. Liquidation Value
 Book value of company, the most conservative approach

47. Forecasting Model
Mid-Year Convention Y Historical Period CAGR Projection Period
2009 2010 2011 ('09 - '11) 2012 2013 2014 2015 2016 2017
Sales $3,567.0 $4,827.0 $5,662.0 26.0% $5,034.4 $5,487.5 $5,926.4 $6,400.6 $6,848.6 $7,328.0
% growth NA 35.3% 17.3% (11.1%) 9.0% 8.0% 8.0% 7.0% 7.0%
COGS 2,282.0 2,565.0 3,223.0 58.0% 3,428.9 3,731.5 4,030.0 4,352.4 4,657.1 4,983.0
Gross Profit $1,285.0 $2,262.0 $2,439.0 37.8% $1,605.4 $1,756.0 $1,896.5 $2,048.2 $2,191.6 $2,345.0
% margin 36.0% 46.9% 43.1% 31.9% 32.0% 32.0% 32.0% 32.0% 32.0%
SG&A 380.0 376.0 357.0 8.2% 412.8 450.0 486.0 524.8 561.6 600.9
EBITDA $905.0 $1,886.0 $2,082.0 51.7% $1,192.6 $1,306.0 $1,410.5 $1,523.3 $1,630.0 $1,744.1
% margin 25.4% 39.1% 36.8% 23.7% 23.8% 23.8% 23.8% 23.8% 23.8%
Depreciation & Amortization 587.0 664.0 772.0 14.6% 735.0 801.2 865.3 934.5 999.9 1,069.9
EBIT $318.0 $1,222.0 $1,310.0 103.0% $457.6 $504.8 $545.2 $588.9 $630.1 $674.2
% margin 8.9% 25.3% 23.1% 9.1% 9.2% 9.2% 9.2% 9.2% 9.2%
Taxes 56.0 132.0 434.4 162.0 178.7 193.0 208.5 223.0 238.7
EBIAT $262.0 $1,090.0 $875.6 82.8% $295.6 $326.1 $352.2 $380.4 $407.0 $435.5
Plus: Depreciation & Amortization 587.0 664.0 772.0 14.6% 735.0 801.2 865.3 934.5 999.9 1,069.9
Less: Capital Expenditures 60.0 108.0 193.0 2.4% 595.2 (131.7) (142.2) (153.6) (164.4) (175.9)
Less: Increase in Net Working Capital (33.1) (32.3) (34.9) (33.0) (35.3)
Unlevered Free Cash Flow $962.5 $1,042.9 $1,126.4 $1,209.6 $1,294.2
Total $5,635.6

48. Weighted Average Cost of Capital
Firm’s cost of capital, will be discount rate used
Use market value instead of book value to reflect actual valuation
WACC = % of Equity in Capital Structure * Cost of Equity
+ % of Debt in Capital Structure * Cost of Debt (1 – tax)
Capital Structure = Long Term Debt/Long Term Debt + Equity

49. Capital Asset Pricing Model
 Cost of Equity is how much return stockholders expect from company
 Risk Free Rate: 10 or 20 U.S Treasury Yield
 Beta: Google Finance
 Expected Market Return: 5-10%

50. Cost of Debt
 Cost of debt is the yield the company could raise in the public market
 Getting Cost of Debt:
 Use a Bloomberg Terminal and look it up
 Apply a % spread based on its credit rating on top of risk-free rate (Yahoo)
 If no credit rating, a synthetic risk can be derived from its financial ratios (interest
coverage)
 Look at current yield of bonds (Morningstar)
 If no debt, base it on comparables
 Then use (1-t) to account for the effect of tax
 Usually historical basis
 Can weight taxes in different regions based on income yielded

51. Discounting Those Cash Flows
Discount Year 1 Discount Year 2 Discount Year 3 Discount Year 4 Discount Year 5
Discount
Cash flow by 1 Cash flow by 2 Cash flow by 3 Cash flow by 4 Cash flow by 5
Terminal Value
year years years years years

52. Enterprise to Equity
We have arrived at enterprise value
Enterprise Value • How much to take over the entire company
- Debt • Debt would make it more difficult for us to pay
- Minority Interest • Our stake in another company, does not affect us
- Preferred Shares • We do not own them
+ Cash • Would “help buy the company”
= Equity Value • Also known as Market Capitalization

53. Intrinsic Value
Treasury Stock Method: count number of “in-the-money” call options to
determine the diluted shares outstanding
Equity Value/Number of Shares Outstanding = Stock Price

54. Sensitivity
 Do a two-way table with exit multiple/perpetuity rate and your WACC
(most sensitive calculations)
Implied Share Price
Exit Multiple
8.9x 9.4x 9.9x 10.4x 10.9x
12.0% 56.33 54.35 54.35 56.33 60.30
12.5% 57.31 55.29 55.29 57.31 61.37
WACC
13.0% 57.31 55.29 $55.29 57.31 61.37
13.5% 56.33 54.35 54.35 56.33 60.30
14.0% 54.43 52.54 52.54 54.43 58.23

55. Other Popular Valuations
 Precedent Transaction
 Use whenever applicable
 Leveraged Buy-Out Model
 Use in private equity or acquisition is likely
 Net Asset Value Model
 Use for REITs, natural resources
 Dividend Discount Model
 Use for dividend focused companies, FIG
 Real Options Valuation
 Use for companies with multiple decisions and to impress your friends

56. The PBSN Finance Executive