fundamentals dr. michael ho professor of practice …...fundamentals of valuation bank analyst...

Fundamentals of Valuation

Bank Analyst Training July 28, 2016

Dr. Michael Ho Professor of Practice and Morris Plan Chair of Consumer Credit Darden School of Business, University of Virginia

Session Agenda • Characterizing the challenge • Surveying the tools • Applying and interpreting the results

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What is Value? • Context, context, context • Eye of the beholder • Value versus price • Value creation and value drivers


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Opening Thoughts on Valuation • Valuation is an art, not a science • Valuation is a discipline • Valuation is a process, not an outcome • Valuation is cross-functional


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Standard Valuation Methodologies • Relative value (price)

• Relative (multiple) valuation • Comparable company analysis • Precedent transactions analysis

• Intrinsic value (value) • Discounted cash flows


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Relative Valuation • The “Theory”

• Market (e.g., stock, bond, real estate, etc.) sets prices such that supply = demand

• Market participants gather and process all data deemed relevant to determine the appropriate market-clearing price

• Market prices can be observed (e.g., Wall Street Journal) • Market participants’ valuation methodologies cannot be observed


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Relative Valuation Proposition:

If all market participants value the financial performance of companies using similar algorithms,

Then... Price = ƒ(financial performance)

or, prices will depend upon observable financial measures


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Relative Valuation • Issues

• The “perfect” comparable • Extraordinary items • The “best” benchmark • Timeframe of benchmark • “NMF” • Outliers


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Comparable Company Analysis • What it is • How it is used

• Industry trends • Peer group comparison • Stock market perspective on value


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Comparable Company Analysis • What it tells us

• How the company, if it were publicly traded, might be priced by the stock market • Reflects current market sentiment and comparables (i.e., industry) financial

performance • Non-control share transactions (i.e., atomistic trades)


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Comparable Company Analysis • Caveats

• No perfect comparables • By definition, dependent upon current market and economic conditions • Significant size and scope differences


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Precedent Transactions Analysis • Precedent Acquisitions

• What it is • How it is used

• M&A market trends in activity (“hot” and “cold” markets) • Acquirers’ perspectives on value


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Precedent Transactions Analysis • What it tells us

• How the company might be valued in an M&A transaction • May or may not include the value of control


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Precedent Transactions Analysis •Caveats

• No perfect comparables • Valuation characteristics highly dependent upon market activity • No direct indication of the motivations of the acquirers • Lack of forecasted target company data • Data sometimes unavailable, although better for financial institutions


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Relative Valuation Analysis • Applying and interpreting the results

• Identifying meaningful implied valuation ranges • Over/under-weighting the included transactions (the “spin”) • Price or value?

• Public versus private company (liquidity) • Application context (control transaction)


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Cash Flow Valuation • What it is

• The three components • Forecasted cash flows • Discount rate (cost of capital) • Terminal, or residual value


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Cash Flow Valuation: Forecasted Cash Flows • Issues • Utilize:

• Financial statement analysis • Competitive analysis • Financial accounting

• What is being valued? • i.e., to whom do the cash flows (value) accrue?


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Cash Flow Valuation: Cost of Capital • Introduction and motivation

• What does the discount rate: • Represent/capture? • Adjust for?

• Decomposing the discount rate • Risk-free component • Risk premium


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Cash Flow Valuation: Terminal Value • aka Residual Value • Why? • How?

• Relative multiples • Perpetuity models

• Competitive market model • TVTermYr = CFTermYr / r

• With growth • TVTermYr = CFTermYr (1+g) / (r-g) • g = perpetual growth rate


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Cash Flow Valuation: Terminal Value • Important reminders

• The terminal value represents the forecasted ongoing value of the company, not sale proceeds

• Terminal value is in the terminal year 4 Still need the present value

• Terminal value parameters should be appropriate for • Industry • Where company will be in the terminal year

• Proportion of total value attributable to terminal value is often very high 4 Think carefully about your assumptions


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Cash Flow Valuation • How it is used

• Value of a specific strategy and outlook • Value of potential synergies • Gaining insight into the value drivers of a business

• What it tells us • The value in current dollars of the forecasted net cash

flows generated by the business under a given outlook


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Cash Flow Valuation • Caveats

• Reflects a single view of the future • Adjusting for the risk/uncertainty of the future • Terminal/residual value comprises a significant percentage

of the overall value • Does not reflect the value of strategic flexibility (i.e., real

option value) • Typically a significant dispersion of expectations for the

future • Involves a number of assumptions to derive both the net

cash flows, terminal/residual value and discount rate


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Implied Valuation • A complete valuation perspective incorporates the:

• Assessment of operations and business model of the business • Outlook for future revenue and cash flow growth • Current market conditions for other companies in the industry (or similar

industries) • Public trading value • Transaction value


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Implied Valuation

Implied Value

Tradable Minority (“Normal Price”)

Control - Financial Value

Control - Strategic Value

Non-tradable Minority

Marketability / Liquidity Discount

Financial Premium (e.g., optimal capital structure, working capital management)

Minority Interest Discount

Strategic Premium (e.g., synergies, defensive offense, irrationality)


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Key Points • Intrinsic value is unobservable

• We can only estimate it

• So many methods, so little time • So many viewpoints, no guarantee of convergence

• There are no “right” answers in valuation, but there

are many wrong ones.


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Defining a Valuation Range

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• Use several estimators • Exercise the estimators to get several estimates • Scrutinize the assumptions and “key bets” • Identify hidden options • Consider unquantifiable factors • Triangulate

Triangulation Graph


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Valuation Case Study: Background • UnionBanCal Corporation’s acquisition of Pacific Capital

Bancorp • Announced in March 2012 • Completed in May 2012

• UnionBanCal Corporation is a wholly owned subsidiary of The Bank of Tokyo-Mitsubishi UFJ, Ltd. • Primary operating subsidiary is Union Bank

• Pacific Capital Bancorp is a bank holding company • Primary operating subsidiary is Santa Barbara Bank & Trust, N.A.


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Valuation Case Study: Fairness Opinion • Sandler O’Neill provided the fairness opinion • Scope of review:

• the merger agreement; • certain publicly available financial statements and other historical financial information of the Company

that Sandler O'Neill deemed relevant; • certain financial statements of UNBC that Sandler O'Neill deemed relevant in determining UNBC's

financial ability to undertake the merger; • internal financial projections for the Company for the years ending December 31, 2012 through

December 31, 2014 as provided by and discussed with senior management of the Company and an internal long-term growth rate for the years ending December 31, 2015 and 2016 as provided by senior management of the Company;

• a comparison of certain financial and other information for the Company with similar publicly available information for certain other commercial banks, the securities of which are publicly traded;

• the terms and structures of other recent mergers and acquisition transactions in the banking sector; • the current market environment generally and in the commercial banking sector in particular; and • such other information, financial studies, analyses and investigations and financial, economic and

market criteria as Sandler O'Neill considered relevant.


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Valuation Case Study: Fairness Opinion • Disclaimer

“In order to fully understand the financial analyses, these tables must be read together with the accompanying text. The tables alone do not

constitute a complete description of the financial analyses. The preparation of a fairness opinion is a complex process involving

subjective judgments as to the most appropriate and relevant methods of financial analysis and the application of those methods to the particular

circumstances.”


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“In arriving at its opinion, Sandler O'Neill did not attribute any particular weight to any analysis or factor that it considered. Rather Sandler O'Neill made qualitative

judgments as to the significance and relevance of each analysis and factor. Sandler O'Neill did not form an opinion as to whether any individual analysis or factor (positive or negative) considered in isolation supported or failed to support its opinion; rather Sandler O'Neill made its determination as to the fairness of the

merger consideration on the basis of its experience and professional judgment after considering the results of all its analyses taken as a whole. The process, therefore, is not necessarily susceptible to a partial analysis or summary description. Sandler O'Neill believes that its analyses must be considered as a whole and that selecting portions of the factors and analyses to be considered without considering all factors and analyses, or attempting to ascribe relative weights to some or all such factors

and analyses, could create an incomplete view of the evaluation process underlying its opinion.”


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“Also, no company included in Sandler O'Neill's comparative analyses

described below is identical to the Company and no transaction is identical to the merger. Accordingly, an analysis of comparable companies or

transactions involves complex considerations and judgments concerning differences in financial and operating characteristics of the Company and

other factors that could affect the public trading values or merger transaction values, as the case may be, of the Company and the

companies to which it is being compared.”


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Market Intelligence, a division of S&P Global Inc. .

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fundamentals dr. michael ho professor of practice …...fundamentals of valuation bank analyst...

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