Corporate Finance

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Corporate Finance Valuation Using Multiples An
Introduction (??????????????)
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Recall the balance sheet
Total Value Liability Value Equity Value V
E D Eequity Ddebt
Liability
Assets
Equity
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Market Value

• However, we are interested in the current market
  value of the firm (division or project).
• Thus, we need the market value of equity as
  opposed to the book value of equity.
• We also need the market value of debt.

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P/E in valuation

• One popular method is valuation using multiples.
• The P/E ratio is often used in the Multiples
  valuation.
• P refers to the price per share of stock. E
  refers to the earnings the company makes.
• If the P/E multiple is 10, this means that an
  increase in earnings by 1 yen is associated with
  a price increase of 10 yen (on average).

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Cont.

• Multiples is just another term for scaling.
• P/E is not the only scaling or multiples variable
  used.
• Multiples involves several steps choosing the
  right sample of firms, choosing the right
  multiples, projections for the firm in question.

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P/E Multiples valuation

• Obtain the P/E for similar firms. Firms in the
  same industry, for example, with similar
  characteristics.
• Average the P/E over the selected firms. The
  average gives us the (average) industry P/E
  multiple.
• Multiply the forecasted earnings per share with
  the industry P/E multiple to obtain a forecast of
  the price.

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Choosing the firms to average

• The selection criteria is very difficult to
  determine in practice you need to understand the
  industry you are analyzing.
• Outliers in general should not be included.
• Too few firms, then one or two companies dominate
  the multiple. Too many companies then the sample
  may no longer be representative.

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• Industry classification
• Use of technology
• Clients
• Firm size

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Price EPS P/E Est. EPS Mar.
97 Mar. 98 Hitachi 1100 21 52.38 16 Matsush
ita 1920 36 53.33 39 Toshiba 690 19 36.31 19
(avg. P/E) 47.34 Sony 8640 105 82.28 86
Sony price est. EPS x avg (P/E) 86 x 47.34
4,071 This is the estimated price for March 1998
given information in 1997.
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Variations Forecasted Earnings in Multiples

• Use the forecasted P/E for each firm. In other
  words, use the estimated earnings, to obtain the
  average P/E. Since we are interested in the
  future (expectations) this is appropriate.

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Other Multiples

• Multiples are not limited to P/E. Depending on
  the industry other multiples might be
  appropriate. Depending on the information you
  can obtain, you can probably calculate better
  scales.
• Examples Value/Sales, Value/EBIT, Price/number
  of chains, etc.

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Firm Sales Value-
Value Sales Hitachi 11,392,500 4,126,419 2.76
Matsushita 5,970,915 6,794,852 0.88 Toshiba 4,0
31,798 5,265,138 0.76 (avg. value/sales)
1.46
Estimated sales for 98 is 6,100,000 (Sony), Debt
2,482,296 6,100,000 x 1.46 8906,000 is
estimated value Equity Value 8,906,000 - debt
6,423,704 6,423,704/374 17,175 (shares
outstand.374)
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The value to sales ratio using 1997 figures for a
larger set of firms is 0.97. Then, Sonys price
per share is about 9,800 for 1998. Firms
include Hitachi, Matsushita, Mitsubishi,
NEC, Pioneer, Sanyo, Sharp, Toshiba.
Thanks to R. Otsuka for assistance.
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Multiples

• Notice that on the numerator we always have some
  number which reflects the value of the company
  stock price, total market equity value, total
  firm value (enterprise value).
• Denominator a variable which drives the business
  and creates value earnings, sales, number of
  chain stores,etc.

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Valuing Non-listed Firms and Divisions

• The Sony example is simply to illustrate the
  procedure involved in multiples based valuation
  (relative valuation).
• We use comparable firms for valuing companies
  which are not listed.
• To value divisions of a firm we can use
  comparable companies as well. Companies with a
  single line of business (same line of business as
  the division).

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Recent Issues

• How have internet industry firms performed
  (financially)?
• Earnings positive?
• Stock prices high? low?
• Can we use a P/E multiple?
• What multiples would you suggest?

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Multiples (????????)

• Difficult to use P/E multiples
• Thus, analysts moved towards price-revenue
  ratios. Sales is relatively large and positive.
• Use non-financial data in multiples analysis as
  done in other industries (chain stores,
  hospitals, etc.)

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Forecasting Revenues

• Portals (gateway to internet)
• Content/Community providers
• E-tailors (sell goods/services on internet)
• Analyst forecasts uniformly underestimate
  revenues. Average underestimate is 11.

Trueman, Wong, Zhang
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Web Usage Measures

• Unique Visitors number of different visitors who
  visit the firms web per month.
• Pageviews number of pages viewed by visitors per
  month.
• Minutes number of minutes spent on firms
  website per month.

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Cont.

• For e-tailors, analyst forecast errors are
  correlated with all three web traffic growth
  measures.
• Portal and content firms analyst forecast errors
  correlated with unique visitor growth.
• Web usage information provides additional
  forecast information on the margin.