Debt free cash free is a pre-finance valuation
Training course provider: Valuation. This is our underlying view of the value of the business [points to LHS of previous chart showing debt free cash free value]. You’ve got a 50:50 chance Linklaters of getting this right. This is our view of underlying business value. Do you think that’s, and again people can get confused with English terms here, is that pre-finance or post finance? It’s the underlying view of business value, it’s our view of underlying business value. Is that pre-finance or post finance – what do we think – a 50:50 chance here.
Delegate: It’s post. Training course provider: See you’re so… you’re so… you’ve got a 50:50 chance. Has anybody got a different answer? Well in English we’d probably say it’s “pre” and in valuation it’s a pre-finance number. So probably a pre-finance number. Pre-finance number – do you agree? Pre-finance number? I’m the trainer aren’t I? This is a pre-finance number. This is before, this is another way of thinking about it, this is before the business is divided up between banks and shareholders. That’s why I would say it’s a pre-finance value. Store this away. In fact it might be helpful to write a note. It’s the view of underlying business value. What we would say is it’s the value before the business before it’s divided up between banks and shareholders, we’d probably say it’s a pre-finance value. What were you going to say?
Delegate: Pre-finance.
Training course provider: Pre-finance.
Delegate: Because it ignores the capital structure.
Training course provider: It does, and you’re sounding like a man who has had a flirtation with valuation and finance at some time because that’s what the finance jocks would say, that’s what the finance experts would say. It doesn’t take account… this is before you decide how much debt you are going to put into the business. Before you decide what the capital structure is going to be. Absolutely right. We would say it’s a pre-finance value. So store that away, write it down in your packs. Perhaps on this chart it’s the pre-finance value, it’s our view of underlying business value, it’s a pre-finance value.
EBITDA is a pre-finance earnings stream
Now, I’m going to ask you to focus up here and I know you’re not accountants and I’m pushing the limits with you guys, and I’m going to ask you to imagine a profit and loss statement, and you guys don’t need to understand all this stuff I am sure, but what’s at the top of the profit and loss statement? A very easy question. Jamie, what’s at the top of the profit and loss statement? The revenues? Revenues, or sales. And then we have in English anyway, I don’t know whether you use the same terms, but its cost of sales. What would you call the next line down? Delegate: Gross profit. Training course provider: Gross profit and then we have admin costs and then what we have is EBIT. I tell you what, let’s do it this way. Admin costs excluding... I’m just getting a little bit more prescriptive… we could deconstruct it this way if you like. So the way we could do it is we could have gross profit, admin costs, we get down to EBITDA, then we could take off our depreciation and amortisation (ask me during the break if you don’t know what those are), we could get down to EBIT. Then we’d take off our interest cost. So what I’m doing is I’m working my way down the P&L. These are my costs of financing the business and I get down eventually to net profit before tax. And then I’m running out of space. You know what’s coming next. I know Carmen you know this. We take off the tax and then we’re down to net profit after tax. Correct? Absolutely.
So, net profit after tax, EBITDA. I’m going to ask you to think, in your minds: EBITDA, net profit after tax. EBITDA, net profit after tax. Which of those numbers… I know people can get confused with English… which of those numbers is the pre-finance one?
Delegate: EBITDA.
Training course provider: Ah you guys are hot! I know the guys from Madrid had a good night out last night, we can get that on tape if you like. EBITDA is the pre-finance number.
Pre-finance earnings x EBITDA multiple = pre-finance value
So what’s this chart about here? This is a chart for valuation people, this is a chart for finance jocks, this is a chart really for bankers not lawyers. What I’m going to tell you is what we would do when we are valuing a business, when we’re trying to get to the pre-finance value, what we would do is take pre-finance earnings. When we’re trying to get to the pre-finance value we take pre-finance earnings, multiply them by our multiple.
To get from the pre-finance debt free cash free or enterprise value to shares value: subtract debt
To get to the shares value, to get from here [points to LHS showing debt free cash free value] to here [points to RHS showing shares value] what we do is subtract the debt.
When I say to bankers: “Which route do you tend to go?” they will tend to tell me this one [points to route one]. The reason that they go this route to value businesses (and you guys don’t need to know this), the reason they go this route, is that all the analysis strips out the impact of what you were saying Sir: capital structure. When they go that route one to value a business it strips out the impact of capital structure. This is a pre-finance earnings to get to our pre-finance value. Subtract the debt to get to shares value.
How bankers value businesses
If I survey bankers, and I do this in my rooms when I’ve got bankers, if I say to them: “If I can give you two routes to value the business, which would you prefer to go?” and they will always go this route one here. That’s why I’ve got that one up here: “more common”. So the route a banker would take to value a business, you knew some of you before you came into the room that it was about a multiple of earnings. The thing that I’m teaching you now is that the way that they would do this is they would take the pre-finance earnings, multiply that by an enterprise value (which is the same as our debt free cash free value) to EBITDA multiple. OK so what they do is take the pre-finance earnings times the EBITDA multiple, gives them the enterprise value (which we’re saying is the same as debt free cash free), subtract the debt gives us the shares value. That’s the route a banker would go to value a business. You don’t need to know that as part of your jobs. But if you are interested, I will email to Anna a copy of the slides that you’re seeing, which are a little bit more detailed than the pack you’ve got in front of you, so you will get a copy of this coming through.Valuation with EBITDA multiples: CPD course exam 1
So let’s sit our exam. You guys all relaxing, maybe going to sleep. This second group here, just have a look at the screen. The bankers are they going to take the pre-finance earnings, or the after-finance earnings? Are they going to take EBITDA or net profit after tax, what do you think? What’s the banker going to do? Delegate: EBITDA. Training course provider: Absolutely, he’s going to go that route isn’t he? Linklaters I’m giving you a few clues here. The banker (I’ve just given you the lecture) is going to go with one or four. Delegate: One Training course provider: Who’s saying one? You’ve got a 50:50 chance haven’t you? Come on hands up, be high be proud, come on. Alright. Nobody likes lawyers who are not prepared to provide opinions. Hands up high again. Who’s thinking it’s one? I’m teaching you too well. Alright. Let’s try and see what happens. You don’t need to worry about this too much. What we know is that businesses are valued as a multiple of earnings. The bankers will take this funny thing here, EBITDA (earnings before interest, tax, depreciation and amortisation) multiply by a multiple and subtract the value of debt. Let’s see if you were right. Fabulous. Well done.More valuation training material
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