Recruitment Ready

Technicals - Advanced

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Outline

1. Corporate Structure2. Valuation3. Accounting4. Stock Pitch

Corporate Structure

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Enterprise Value

• Why do you need to add minority interest to obtain enterprise value?

– Whenever a company owns more than 50% of another company, it is required to report the financial performance of the whole company as part of its own performance

– To compare apples with apples, you must add minority interest to get to EV so that numerator and numerator both reflect 100% of the majority-owned subsidiary

• A company has 100 shares at $10, 10 options with strike price of $5 and 10 options with strike price of $15. What are fully diluted shares?

– Treasury stock method: 10 in-the-money options will be exercised 10 shares issued– With the $50 raised by the company, 5 shares are bought back– 100 + 10 – 5 = 105

• How to account for convertible bonds in the enterprise value formula?

– If in-the-money, additional dilution to equity holders– If out-of-the-money, count the face value of the convertibles as part of debt

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Restructuring

• A company has had positive EBITDA for the last 10 years but recently went bankrupt. How could this happen?

– Company cannot meet its interest obligations– Large one-time event (e.g. litigation)– Too much debt is maturing at the same time and company cannot repay principal

• What options are available to a distressed company that can’t meet debt obligations?

– Refinance and obtain new debt or equity– Sell the company or a division (what are the drawbacks of this approach?)– Restructure financial obligations with debt holders– File for bankruptcy and restructure the firm

• What can the debt holders do to recover their principal?

– Lend additional capital in form of debt or equity– Conditional financing (e.g. if the company reduces expenses, changes management, etc.)– Sale– Foreclosure

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Restructuring

• How do you calculate cost of debt for a distressed company?

– Often the public debt of a distressed company will not be very liquid, therefore it will be difficult to use bond yields as a proxy

– Look at credit spreads (CCC or D companies)

• You can sell your company by selling equity or assets, which one would you prefer?

– If you are the distressed seller, you prefer to sell your equity to get rid of liabilities and also because it is taxed higher for asset sales. However, you might get higher valuations by selling individual assets

– The buyer prefers to buy assets because he can pick and choose what is best

• How could a decline in a company’s share price cause it to go bankrupt?

– Customers, vendors, suppliers, and lenders would be more reluctant to do business with the distressed company

Valuation

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Alternative Valuation Methods

• What is an LBO and why is used in practice? What is a good target?

– The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition

– The purpose of leveraged buyouts is to allow companies (mostly PE firms) to make large acquisitions without having to commit a lot of capital

• How do you derive a liquidation value for a firm?

– Cash: 100%– A/R: 80%– Inventory: 50%– Goodwill: 0%

• When would you use sum of the parts and how does it work?

– Typically used for companies with different unrelated subsidiaries for which it would not be prudent to use a single DCF or simple comps (e.g. Samsung)

– Value every division separately (applying a multiple or building a DCF for each) and add up the values obtained

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Valuation

• How do you value a Cola distributing machine?

– Depending on the assumptions of the interviewer one might want to use any of the traditional or unconventional valuation methods we have discussed

– Not because it sounds weird that it cannot easily be valued

• We have two companies with the same financial statements and operating segments, yet company A is trading at a higher multiple than company B. Why could this be the case?

– Management– Intangibles– Recent news– Future outlook

• Company A and B are the same, except A leases products instead of owning them. For which of the two would you pay a higher acquisition multiple?

– Company A: lease would show up in SG&A, reducing EBITDA– Company B: depreciation charge does not show up in EBITDA, making it higher

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Valuation

• A company will be paying down debt in the coming years. How do we account for this in a DCF?

– Trick question. You should not, we do not look at CFF when generating UFCF

• For a mining company, would you expect higher multiples in cyclical upswings or downturns?

– During downturns because you expect commodity price to revert to mean in the future. Multiple is high because denominator is most likely to be very low at the moment

• How do you value a private company?

– Technically you can still use a DCF but you how do you get to WACC?• Estimate WACC from public comps but add in an illiquidity and perhaps size premium to reflect

the risk of the private company

– To estimate the value of a private company that is about to do an IPO, no need to add illiquidity premium as the company will soon become public

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Valuation

• What are some industry specific multiples?

– Oil and gas: EV / Production, EV / 2P Reserves– Retail: EV / EBITDAR (R = Rent)– Technology: EV / Unique visitors– Financials: Price / Book Value

• How do you value a company with negative EBITDA? Pre-revenue?

– Climb-up the ladder and use EV / Revenue– Use creative multiples like EV / Clicks

• If a company with a higher P/E acquires a company with a lower P/E, is this an accretive or dilutive acquisition?

– ONLY IF the acquisition was financed 100% with equity or cash and IF the implied P/E with the acquisition premium is still lower can you say that the deal is accretive.

Accounting

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Accounting Questions

• How is GAAP/IFRS accounting different from tax accounting?

– GAAP is accrual based but tax is cash based• Tax is only concerned with revenue/expenses in the current period and what income you owe

– GAAP uses straight-line depreciation whereas tax uses accelerated depreciation

• What are examples of non-recurring charges we need to add back to a company’s EBIT or EBITDA when looking at financial statements?

– Restructuring charges– Goodwill impairment– Asset write-downs– Bad debt expense– Legal expenses– Disaster expenses– Changes in accounting procedures

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Accounting Questions

• What are NOL’s and how are they valued?

– Net operating losses: tax credit created when a company records losses. Can be carried back 3 years (2 in USA) and forward 20 years

– You should always carry back as much as possible today and exercise the credits as soon as possible in the future

– Value = NOLs that can be carried back today*Tax rate + PV(NOLs to be used in future)*Tax rate

• What is a depreciation waterfall?Depreciation Waterfall 2013 A 2014 E 2015 E 2016 E 2017 E 2018 E

Capital Expenditures $100.00 $100.00 $100.00 $100.00 $100.00 $100.00Useful Life 5 years 5 years 5 years 5 years 5 years 5 years

Year 1 $20.00 $20.00 $20.00 $20.00 $20.00Year 2 $20.00 $20.00 $20.00 $20.00 $20.00Year 3 $20.00 $20.00 $20.00 $20.00Year 4 $20.00 $20.00 $20.00Year 5 $20.00 $20.00Year 6 $20.00

Depreciation $20.00 $40.00 $60.00 $80.00 $100.00 $100.00

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Accounting Questions

• Why would the D&A numbers from the I/S differ from the ones on the C/S? Which one should you use?

– This happens if D&A is embedded in other I/S line items. When this happens, you need to use the C/S number to arrive at EBITDA because you would be undercounting D&A

• When does goodwill impairment happen?

– When you reassess the value of the company you acquired (annual impairment test) and you find out it is worth significantly less. An example of this is tech companies that have been acquired before the tech bubble

• A company switches from LIFO to FIFO in an inflationary environment; how does it affect its statements?

– Operating income and earnings will be overstated (lower COGS). Inventory will be higher as “cheaper” items will be sold first. CFO will be higher due to increased earnings, offset by a change in NWC

Pitch a stock

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Air Canada

Strategically well

positioned

Cost cutting

strategy

Pension issues being

actively managed

The market is discounting Air Canada even though it has undertaken strong initiatives to overcome its fundamental and financial hurdles with increasing success as it emerges from bankruptcy

Turnaround Story

Other Questions?

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Contact

• Danielle Dagenais – Career Services (Finance, Investment Banking, Investment Management)

– Danielle.dagenais@mail.mcgill.ca

• Philippe Rich – Morgan Stanley (Investment Banking)– Philippe.rich@mail.mcgill.ca