Context
Since joining Megabank Asset Management three months ago you have been busy learning the ropes. You are about to grab dinner at 7 pm when your line manager, Charles de Vitry, sends you an email, reproduced below:
From: Charles de Vitry: Global Investments <charles.devitry@mam.com>
To: Sally Baum: Global Investments <sally.baum@mam.com>
Subject: Valuation of Cloudy Bay for tomorrow at 10 am
Hi Sally
I’ve just been told by Peter from the Investment Committee that we have been approached to bid on a stake in the Cloudy Bay Vineyards Limited. To start the process we are expected to submit an “Expression of Interest” form, in which we have to indicate the price we would be happy to pay per share. Although this is purely indicative and not a legally binding commitment, it is considered bad form to back out of an expression of interest. The Investment Committee will be meeting tomorrow at 10 am to discuss our Cloudy Bay; they will be expecting me to have an opinion about the value of Cloudy Bay. So I need your help: Can you run some numbers and come up with an equity valuation for Cloudy Bay as a whole (and a price per share)?
I’ll need a 5-7 page report (in pdf format please). I’d like a brief overview of Cloudy Bay, its industry, the overall economy, a description and motivation of your valuation approach, key assumptions and valuation drivers, the actual “base case” valuation (of the equity of the whole firm and price per share) and some scenario analysis showing what the valuation might look like if we change the key valuation drivers. I’ll be presenting this to the committee so make sure it looks professional. You should be able to locate financials for Cloudy Bay on the New Zealand Companies Office website1 under the “Documents” section.
You can use any information that is publicly available. Be sure to send me your Excel calculations just in case I get challenged on any of the numbers. I’ll be boarding my plane in 15 mins and should be back in town tomorrow morning by 9:15 am. It would be great if you could email me the overview before then so I can have a look at it while taking the taxi to the meeting.
Thanks, Charles
Example report outline
The lines in bold are report section headings. The alphabetic lists underneath the bold section headers describe the type of content that each section should contain.
You should free feel to adapt the outline below to suit your valuation approach; however, do ensure that you cover all the elements listed below in your report.
Executive Summary
- Price: Mid-point estimate, Low and High estimates
- Date of valuation
- One-line valuation approach summary
- Most important valuation drivers
- Key risks (industry, regulatory, market, technology)
Purpose
- Who and what is the report for?
- Limitations, caveats, and disclaimers
Context
- Economic Backdrop
- Industry Developments
- The Firm
Methodology
- Summarise alternative methodologies
- Select a methodology and motivate why you prefer this methodology to the alternatives
- Set out the chosen methodology in sufficient detail
Valuation
- Valuation output (valuation in $/share)
- Key inputs and intermediate variables
- The risk-free rate, Market Risk Premium
- Equity beta, equity discount rate [, debt discount rate, D/E ratio, WACC]
- Growth rate(s), profit margins, a terminal value
Scenario Analysis
- Define scenarios for Pessimistic, Base case, Optimistic
- Report Valuation + 2-4 key variables from each scenario
- Scenarios could be based on possible economic outcomes or possible industry or technological developments.
Appendix and References
The valuation process – some tips and hints
- You should already know how to do the calculations for a valuation – that is what the second part of this course is all about. So what follows is really a bit of a guide about the rest of the process.
- Stage 1: Find the key documents and information so you understand the business you are valuing and the industry it operates in (and the country or countries, if you are not familiar with it/them)
- Financials (aka Annual Reports, Interim Reports), Company website
- Wikipedia entry, Regulatory filings, News reports (google, Factiva, Reuters, Bloomberg)
- Same for other firms that are comparable
- Stage 2: The business
- What business does the company engage in? How does it make money? Who are its customers, its suppliers, its employees, its regulators?
- How is the company funded? Who owns the equity in the firm? Is it listed? Does it have any debt? Bonds, shareholder loans, or bank loans? What are the terms – interest rate, maturity?
- What are the drivers of growth, market share, and profitability? Who are its competitors?
- Key risks and opportunities.
- Stage 3: The valuation approach
- What is the appropriate valuation approach for the company? Refer back to notes and readings for guidance.
- Sketch out a “mindmap” of the valuation. Start with the basics – cash flows and discount rates – then work out backward what you need in order to calculate each component until you arrive at underlying inputs or assumptions.
- Stage 4: The model
- Build the model in Excel. (This is where most inexperienced people start.
- Build-in checks and balances
- Do a reality check – try a few “quick and dirty” calculations. Based on your valuation, what is the implied growth rate? What is the P/E ratio? Does it make sense? How does it stack up against competitors?
- Conduct scenario analysis for key uncertainties.
- Stage 5: Presenting the valuation (See the Example Report Outline above)
- The presentation should address the following points
- The valuation midpoint and range. (Any reader should be able to find this in under 2 seconds after picking up the document.)
- Include valuation target name, valuation date, and valuer contact details (that’s you!)
- Motivation. Why are you doing the valuation, what will it be used for, who is using it?
- Firm and industry overview. Economic backdrop.
- Description of valuation approach. What approach did you take and why did you decide on it. (Motivate the decisions you made the revaluation approach)
- Key inputs and assumptions.
- Overview of the valuation calculation. Often best presented in a table format.
- Scenario analysis. (Graphs can be useful here.)
- Disclaimer. (Not needed for assignments, but in the real world you’ll need one. Talk to the people in your legal department or ask a lawyer for help.)
- Proofread the document for spelling mistakes and grammatical errors. Ensure the presentation looks professional. (Muted and few colors, clear headings – search for investment bank research notes to see how others do it.)
- In real life you do not always progress smoothly from one stage to the next; often there is a bit of moving back and forth as you run into problems or discover new information.
