1. The PBSN Finance Executive

2. Who We Are 3. Goals1. Learn basic finance acumen Career guidance Personal investing2. 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 UtilityWhy 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 ConsumerMedia and Financial Natural Retail HealthcareTechnology Industrials Real Estate Telecom InstitutionsResourcesGoods 10. Overview and Business ModelOverview What is the business?Metrics Business ModelTickerPBSNInvestment Thesis Basic numbers and company statistics IPO Date Sep-11 Current Price$50.00Internal What do they do? Be thorough!Target Price $10.00External Revenues $500 MM Valuation Market Cap$1000 MMCatalystsRisks 11. Investment ThesisOverview Why is this a good company to buy? Business ModelInvestment Thesis Give a couple of reasons that summarize the best featuresInternal Summary slide of what youll sayExternal Valuation Why is the market wrong?CatalystsRisks 12. InternalOverviewInternal: Business ModelInvestment Thesis Who runs the business? Management team?Internal Examine balance sheet and debt maturityExternal Valuation Microeconomic factors, company specificCatalystsRisks 13. ExternalOverviewExternal: Business ModelInvestment 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?CatalystsRisks 14. Catalysts and RisksOverviewCatalysts are specific events that will occur that support your thesis Business ModelInvestment Thesis E.g. drug release, new movement to China, new legislationInternalRisks are things that prevent your investment thesis from being realizedExternal Valuation E.g. currency risk, business risk, management sucksCatalystsRisks 15. Accounting Basics 16. Why are Financial Statements Important? Allows investors and creditors to use the financial information provided toevaluate: 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 expensesRevenues- 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 + Owners Equity Shows asset investments and how they are supported, revealing a lotabout the companys 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 growththrough existing operations Important to note sources and uses of cash as well as the matching ofthese sources and uses 21. Flow Through Question How does a $10 decrease in depreciation affect all the financial statements? 22. Flow Through QuestionHow 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 $6Cash 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 ValueBook ValueMarket 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 sheetmarket useful to help track profits and losses is a more accurate value of the assets currentvalue 24. Equity vs. Enterprise ValueEquity ValueEnterprise Value also the market capitalization of the enterprise value = market capitalization +company preferred equity + minority interest + net value attributable to shareholdersdebt (total debt cash and cash equivalents) 25. Capital StructureDebt or Equity? 26. Ratio Analysis Used to analyze the historical trends and compare these trends to that ofthe industryCategories: Profitability Investment utilization Liquidity Stability Growth 27. Ratio ExamplesProfitability InvestmentLiquidityStability/Leverage GrowthUtilization Vertical Analysis Inventory Current Ratio Net Worth to Sales Growth Return on AssetsTurnover Acid TestAssets Profit Growth Return on Equity Fixed Asset Age of Debt to Assets Asset GrowthTurnoverReceivables Debt to EBITDA Growth Total Asset Age of Inventory CapitalizationTurnover Age of Accounts Debt to EquityPayble 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 valueAdvantagesDisadvantagesUsefulSimplisticRelevantStaticSimpleDifficult to compare 30. Common MultiplesEnterprise MultiplesEquity MultiplesEnterprise Value/SalesPrice/EarningsEnterprise Value/EBITDA Price/Book ValueEnterprise 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 = $3,000,000Price per ShareMarket CapitalizationOREarnings 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 = $3,000,000Price per ShareMarket CapitalizationOREarnings 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 AnalysisShare Market LTM2013E 2014ELTM 2013E 2014E Price Capitalization EV/EBITDA EV/EBITDA EV/EBITDA Price/EPS Price/EPS Price/EPSCompany A $15.00$1,6758.17.8 7.4 15.114.514.1Company B $20.00$2,2306.66.5 6.4 12.312.111.5Company C $12.00$1,5237.27.3 7.1 16.516.315.4Company D $10.00$1,0847.76.9 6.9 12.812.212.1Company E $18.00 $985 6.56.3 5.9 11.210.810.1Mean7.22 6.966.74 13.58 13.18 12.64Median 7.2 6.96.912.8 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 ValueWhat 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 FlowThe cash available after laying out money related to operations andexpanding 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 sheetFree Cash Flow What is available to us 44. Forecasting ModelMid-Year Convention YHistorical Period CAGRProjection Period2009 20102011 (09 - 11) 2012 20132014201520162017Sales $3,567.0$4,827.0 $5,662.026.0%$5,034.4 $5,487.5$5,926.4 $6,400.6 $6,848.6$7,328.0 % growthNA 35.3%17.3% (11.1%)9.0%8.0% 8.0% 7.0%7.0%COGS 2,282.0 2,565.03,223.058.0% 3,428.93,731.5 4,030.04,352.44,657.1 4,983.0Gross Profit$1,285.0$2,262.0 $2,439.037.8%$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 380.0 376.0357.0 8.2% 412.8450.0 486.0524.8561.6 600.9EBITDA$905.0$1,886.0 $2,082.051.7%$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 & Amortization587.0 664.0772.014.6% 735.0801.2 865.3934.5999.9 1,069.9EBIT$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 56.0 132.0434.4162.0178.7 193.0 208.5 223.0 238.7EBIAT $262.0$1,090.0 $875.682.8%$295.6 $326.1$352.2$380.4$407.0$435.5Plus: Depreciation & Amortization587.0 664.0772.014.6% 735.0801.2 865.3934.5999.9 1,069.9Less: Capital Expenditures60.0 108.0193.0 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$1,294.2Total$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 ValueTotal value of all cash flows beyond the operating model time period1. Exit Multiple Method Used for most companies with a tangible exit period Multiply terminal year EBITDA by LTM EV/EBITDA2. 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 ModelMid-Year Convention YHistorical Period CAGRProjection Period2009 20102011 (09 - 11) 2012 20132014201520162017Sales $3,567.0$4,827.0 $5,662.026.0%$5,034.4 $5,487.5$5,926.4 $6,400.6 $6,848.6$7,328.0 % growthNA 35.3%17.3% (11.1%)9.0%8.0% 8.0% 7.0%7.0%COGS 2,282.0 2,565.03,223.058.0% 3,428.93,731.5 4,030.04,352.44,657.1 4,983.0Gross Profit$1,285.0$2,262.0 $2,439.037.8%$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 380.0 376.0357.0 8.2% 412.8450.0 486.0524.8561.6 600.9EBITDA$905.0$1,886.0 $2,082.051.7%$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 & Amortization587.0 664.0772.014.6% 735.0801.2 865.3934.5999.9 1,069.9EBIT$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 56.0 132.0434.4162.0178.7 193.0 208.5 223.0 238.7EBIAT $262.0$1,090.0 $875.682.8%$295.6 $326.1$352.2$380.4$407.0$435.5Plus: Depreciation & Amortization587.0 664.0772.014.6% 735.0801.2 865.3934.5999.9 1,069.9Less: Capital Expenditures60.0 108.0193.0 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$1,294.2Total$5,635.6 48. Weighted Average Cost of CapitalFirms cost of capital, will be discount rate usedUse market value instead of book value to reflect actual valuationWACC = % 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 5Discount Cash flow by 1Cash flow by 2Cash flow by 3Cash flow by 4Cash flow by 5 Terminal Valueyearyears years years years 52. Enterprise to EquityWe have arrived at enterprise valueEnterprise 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 ValueTreasury Stock Method: count number of in-the-money call options todetermine the diluted shares outstandingEquity 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 8.9x9.4x9.9x10.4x 10.9x 12.0% 56.33 54.35 54.35 56.33 60.30 12.5% 57.31 55.29 55.29 57.31 61.37WACC 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