project report on power grid corporation ltd
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MBA Project report on power grid corporation ltd.TRANSCRIPT
Report on: Comparable Companies Analysis on PGCIL
SUMMER INTERNSHIP REPORT ON
Comparable Companies Analysis on PGCIL
Submitted By
Sandeep Chaurasia
III semester MBA
Reg. No.……………….
Under the Guidance of
Mr.
Summer Internship Report submitted to the University of Mysore in partial
fulfillment of the requirements of III semester MBA Degree examinations
2014-16
New Delhi Institution of Management
F-13, Okhla Industrial Area, Phase -1, New Delhi
110020
New Delhi Institute of Management Page 1
Report on: Comparable Companies Analysis on PGCIL
DECLARATION
I, Sandeep Chaurasia, Roll no. A-46 / Semester III / Class of 2014-16 of the MBA
(Power Management) Programme of “New Delhi Institute of Management”, Okhla
hereby declare that the Summer Training Report entitled “Comparable Companies
Analysis on PGCIL” is an original work and the same has not been submitted to any
other Institute for the award of any other degree.
A Seminar presentation of the Training Report was made on and the suggestions as
approved by the faculty were duly incorporated.
Presentation In-Charge Signature of the candidate
(Faculty)
Counter signed
Director/Principal of the Institute
New Delhi Institute of Management Page 2
Report on: Comparable Companies Analysis on PGCIL
A CKNOWLEDGEMENT
I am having great pleasure in presenting this report on ‘Comparable Companies Analysis
on PGCIL’. I take this opportunity to express my sincere gratitude to all those who have
helped me in this project and contributed to make this a success.
I would like to express my sincere gratitude to Mr.M. Taj Mukarrum (AGM) PGCIL for
giving me an opportunity to work on live project and guiding me towards my goal. He
made it sure that my stay in the company is a learning experience.
I would like to express my heartfelt appreciation and gratitude to my project head Mr.
Mukesh (Senior Account Officer). This project is a result of his teaching, encouragement
and inputs in the numerous meetings he had with me, despite his busy schedule.
I wish Gratitude to all the employees of the POWERGRID and their officials. I thank
them for their extended co-operation during my internship when working on project.
Finally I would like to thank my Institute NDIM for making this experience of summer
training in an esteemed organization like PGCIL. The learning from this experience has
been immense and would be cherished throughout life.
SANDEEP CHAURASIA
New Delhi Institute of Management Page 3
Report on: Comparable Companies Analysis on PGCIL
CERTIFICATE
This is certify that MR. SANDEEP CHAURASIA a student of MBA(FINANCE) from
NEW DELHI INSTITUTION OF MANAGEMENT ,F-13, OKHLA PHASE-1, NEW
DELHI has undergone project work on at “POWERGRID CORPORATION OF
INDIA LIMITED” under the supervision and guidance of MR. MUKESH
The details of training are as follows.
The period of training:
No of days present:
Conduct:
Certificate issued on:
MR. MUKESH
New Delhi Institute of Management Page 4
Report on: Comparable Companies Analysis on PGCIL
Table of Content
1. Overview of the Company………………………….…………..……….….……...7
1.1. Business…………………...………………....………………..........................10
1.2. Major Events………………………………….……………...……….….……11
1.3. Awards………………………………………….………………..……………15
1.4. Vision And Mission…………………………….….…………………..………18
1.5. Objectives……………………………………….….……....……………….....19
1.6. One Nation One Grid…………………………….……………………………20
1.7. Growth in Transmission Sector ………………….……....……………………21
1.8. Business Overview ………………………………….…....…………………...24
1.9. Profit Summary…………...………………..………….....……………………25
1.10. Asset Growth……...……………………………..…….……………………..27
1.11. Manpower Growth……..……………………………....………………….…28
1.12. Mergers and Acquisitions…....……………………….………………………29
2. Literature Review
2.1. Concept of Valuation.........………………………………..…………....……..30
2.2. Model of Valuation....………………………….…....................……..……….30
2.3. Methods of Valuation........................................................................................31
2.4. Usage of Valuation Analysis..............................................................................33
2.5. Valuation of a Suffering Co...............................................................................34
2.6. Valuation of a Startup Co..................................................................................34
3. Findings
3.1. Definition of CCA.............................................................................................35
3.2. Concept of CCA................................................................................................36
3.3. Steps of CCA.....................................................................................................38
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4. Bibliography………………………………………………………..……………...62
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OVERVIEW OF THE COMPANY
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Report on: Comparable Companies Analysis on PGCIL
POWER GRID CORPORATION OF INDIA LIMITED
(POWERGRID):
A ‘Navratna Public Sector Enterprise’ and ‘The Central Transmission Utility’
(CTU) of the country under Ministry of Power is one amongst the largest Power
Transmission utilities in the world. POWERGRID is playing a vital role in the
growth of Indian power sector by developing a robust Integrated National Grid and
associating in the flagship programme of Govt. of India to provide Power for
all. Innovations in Technical & Managerial fields has resulted in coordinated
development of power transmission network and effective operation and
management of Regional and National Grid.
PGCIL was incorporated on October 23, 1989 under the Companies Act, 1956 with an
authorized share capital of Rs. 5,000 Crore as a public limited company, wholly owned
by the Government of India.
Its original name was the 'National Power Transmission Corporation Limited', and it was
charged with planning, executing, owning, operating and maintaining high-voltage
transmission systems in the country. On 8 November 1990, the National Power
Transmission Corporation received its Certificate for Commencement of Business. Their
name was subsequently changed to Power Grid Corporation of India Limited, which took
effect on October 23, 1992.
POWERGRID started functioning on management basis with effect from August, 1991
and subsequently it took over transmission assets from NTPC, NHPC, NEEPCO, NLC,
NPC, THDC, SJVNL etc. in a phased manner and it commenced commercial operation in
1992-93. In addition to this, it also took over the operation of existing Regional Load
Despatch Centers (RLDCs) from Central Electricity Authority (CEA), in a phased
manner from 1994 to 1996, which have been upgraded and modernized with State of-the-
art Unified Load Despatch and Communication (ULDC) schemes. Consequently,
National Load Despatch Centre (NLDC) was established in 2009 for overall coordination
at National level.
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According to its mandate, the Corporation, apart from providing transmission system for
evacuation of central sector power, is also responsible for Establishment and Operation of
Regional and National Power Grids to facilitate transfer of power within and across the
Regions with Reliability, Security and Economy on sound commercial principles.
Based on its performance POWERGRID was recognized as a Mini-ratna category-I
Public Sector Undertaking in October 1998 and conferred the status of "Navratna" by the
Government of India in May 2008. POWERGRID, as the Central Transmission Utility of
the country, is playing a major role in Indian Power Sector and is also providing Open
Access on its inter-State transmission system.
Company has made an ambitious plan to invest more than ` 100,000 Crore during the XII
plan, matching with the envisaged generation capacity addition. This investment is
mainly towards development of transmission infrastructure for implementation of various
inter-State transmission systems including High Capacity Power Transmission Corridors
(HCPTCs), inter-regional links for grid strengthening, system strengthening schemes etc.
Out of the above capex-plan, our Company has already made a capital expenditure of `
43,195 Crore in the first two years of the plan period. The funding for capital expenditure
are planned to be met through loans from multilateral institutions such as The World
Bank, Asian Development Bank, Supplier Credit, External Commercial Borrowings
through bonds / notes, besides loans from domestic market through private placement of
bonds. Based on the ratings by both domestic and international credit agencies, our
Company do not foresee any difficulty in resource mobilisation. Our Company has
planned to add transmission network comprising about 40,000 ckm of transmission lines
and about 100,000 MVA of transformation capacity during the XII Plan. Out of this, the
Company has already commissioned about 13,760 ckm of EHV transmission lines and
about 81,390 MVA of transformation capacity in the first two years of the XII Plan.
New Delhi Institute of Management Page 9
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BUSINESS
POWWRGRID operates throughout India. Its transmission network consists of roughly
101,886 circuit kilometres and 197 EHVAC and HVDC substations, which provide total
transformation capacity of 168,063 MVA.
POWERGRID’s interregional capacity is 47,450 MW.
Example of POWERGRID owned stations include the Vizag back to back HVDC
converter station, the Chandrepur back to back HDVC converter station, the India Sri
Lanka HVDC Interconnection and the Talcher Kolar HVDC system.
POWERGRID is listed on both the BSE and NSE.
As of 30 September 2010, there were 792,096 equity shareholders holders in
POWERGRID. Initially, POWERGRID managed transmission assets owned by NTPC,
NHPC Limited and North Eastern Electric Power Corporation Limited.
In January 1993, the Power Transmission Systems Act transferred ownership of three
power companies to POWERGRID. All employees of the three companies subsequently
became POWERGRID employees.
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MAJOR EVENT’s OF POWERGRID
1989 - The Company was incorporated as ‘National Power Transmission Corporation
Limited’.
1991 - Transmission assets from Nuclear Power Corporation Limited were transferred to
the Company.
1992- Transmission assets from NTPC, NHPC and North-Eastern Electric Power
Corporation Limited were transferred to the Company, with effect from April 1, 1992,
pursuant to legislation promulgated by the Parliament. The name of the Company was
changed from ‘National Power Transmission Corporation Limited’ to ‘Power Grid
Corporation of India Limited’.
1993 - Transmission assets of Tehri Hydro Development Corporation Limited were
transferred to the Company pursuant to a memorandum of understanding executed
between the parties.
1994- The Company entered into a memorandum of understanding with the MoP, which
is revised annually. We achieved the highest rating of ‘Excellent’ under the memorandum
of understanding. Transmission assets from Neyveli Lignite Corporation Limited were
transferred to the Company, with effect from April 1, 1992, pursuant to legislation
promulgated by the Parliament.
1996 - Five Regional Load Despatch & Communication Centres were in the management
of the Company
1998 - The Company formulated an Environment and Social Policy and Procedures Code
to deal with environmental and social issues relating to its transmission projects. The
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Company was formally notified as a CTU by the GoI. The Company was declared as a
Mini Ratna Category I public sector undertaking by the GoI.
2002- The unified load despatch and communications schemes for the northern and
southern regions were commissioned. Part of the Sasaram HVDC back to back
transmission system developed by The Company was commissioned contributing
towards the development of the first phase of the construction of the National Grid. The
Company was issued a registration for Infrastructure Provider Category- I (IP-I) from
Director (BS-III), Ministry of Communications and Information Technology.
2003 - The Company entered into a joint venture arrangement with The Tata Power
Company Limited implementing a part of the entire transmission system associated with
Tala Hydro-Electric Project. The 400 kV Raipur-Rourkela transmission line developed
by The Company was commissioned and the Western region, Eastern Region and North-
Eastern Region began operating in a synchronized manner with a cumulative capacity of
50,000 MW.
- The Company secured its first international consultancy contract from Bhutan
Telecommunications.
- The Company was granted the License for maintaining and operating Internet Service
on a non-exclusive basis in India pursuant to the License Agreement dated May 29, 2003
entered into with the Assistant Director General (LR V), DoT.
2004 - The Company entered into an MoU with REC for undertaking rural electrification
works under the Rajiv Gandhi Grameen Vidyutikaran Yojana.
2005 - The unified load despatch and communications scheme for the eastern region was
commissioned.
2006- The unified load despatch and communications scheme for the western region was
commissioned.
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- The Company was granted the license for installing, operating and maintaining the
national long distance service network and providing national long distance service on a
non-exclusive basis within the territorial boundaries of India pursuant to the License
Agreement dated July 5, 2006 entered into with the Director (BSIII), DoT.
2007- Dedication of transmission system associated with Tala Hydro-Electric Project by
the Prime Minister Dr. Manmohan Singh. Listing of our Equity Shares on the Stock
Exchanges through an initial public offer.
2008 - The Company was declared as a Navratna public sector undertaking by the GoI.
2009 - The National Load Despatch Centre was established.
- The Subsidiary, Power System Operation Corporation Limited, was incorporated
- The 220 kV Double Circuit Transmission line from Pul-e-Khumri to Kabul
Transmission System (230 kms) in Afghanistan was completed.
- Commissioning of the 220/110/20 kV Chimtala sub-station at Kabul, Afghanistan.
- Commissioning of the commercial operations of the National Load Despatch Centre.
2010- The Company was selected as a consortium member to implement the National
Knowledge Network Project, a telecommunication infrastructure project. The Company
entered into an MoU with Jamia Millia Islamia University for among other things,
providing expert opinion and knowledge support in areas for deployment of new
technology such as sub stations automation, System Operator in Supervisory Control And
Data Acquisition technology/ EMS, etc.
2011 - The Company participated in the TBCB for the first time.
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2012 - The Company test charged 1,200 kV UHVAC line (the highest voltage in the
world) and established its first 1,200 kV test centre. The Company adopted vision
statement world class, integrated, global transmission company with dominant leadership
in emerging power markets ensuring reliability, safety and economy and based on this
vision statement also restated the mission statement. The Company established India’s
first Smart Grid Control Centre at Puducherry, under pilot project.
2013- The Company received its international rating from S&P and Fitch rating, for the
first time.
- The Company became a part of the NOFN project.
- The Company signed an agreement with six north eastern region states (Assam,
Meghalaya, Mizoram, Manipur, Nagaland and Tripura) to provide consultancy services
as project design cum implementation supervision consultant for implementation of the
North Eastern Region Power System Improvement Project.
New Delhi Institute of Management Page 14
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Certifications, Awards and Recognitions
The Company has received the ‘Excellent’ rating under the memorandum of
understanding with the MoP from 1993-1994 to 2011-2012.
2007 - The Company was certified for PAS 99:2006, which integrates the requirement of
ISO 9001:2008, ISO 14001:2004 and OHSAS 18001:2007 for standards in relation to
quality, environment and occupational health and safety standards respectively with
respect to design, engineering, procurement, construction of transmission systems up to
1200kV AC, +/-800 kV, HVDC, and operation, maintenance activities for transmission
system up to 800kV AC & HDVC, Supervisory Control and Data Acquisition (SCADA),
Energy Management Systems and Communication Projects.
2009 - The Company was awarded First Prize at IEEMA Power Awards
2009 - Ceremony for ‘Excellence in Power Transmission’ by NDTV Profit.
- The Company was recognised for its meritorious performance by the MoP for the year
2007-08 and won a Gold Shield for the transmission system at North Eastern region, a
Silver Shield for the transmission system at the Western region and a Silver Shield for the
early completion of the 400 kV Gooty - Raichur D/C (Quad) transmission project. The
Company was featured in the list of top 250 global energy companies compiled by Platts,
a leading provider of energy and commodities information. The Company was also
named amongst the fastest growing global energy companies ranking for 2009 issued by
Platts.
2010 - The Company was recognised for its meritorious performance by the MoP for the
year 2009-10 and won a Gold Shield for the transmission system at Western region, a
Silver Shield for the transmission system at the Eastern region and a Silver Shield for the
LILO of one ckt. Of 400 kV Maithon-Jamshedpur D/C at Mejia B.
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- The Company is certified with SA 8000:2008 for its Social Accountability System.
- The Company was mentioned as being number 18 on the list of fastest growing Asian
energy companies, according to the Platts Top 250 Energy Company Rankings for 2010.
- The Company was also featured in the Forbes Global 2000 list.
- The Company was awarded the ‘Scope Award for Excellence and Outstanding
Contribution to the Public Sector Management (2008-09) in the Large Scale PSE
Category’ by Standing Conference of Public Enterprises and DPE.
2011 - The Company was awarded the ‘Environmental Excellence & Sustainable
Development award- 2011’ by the Indian Chamber of Commerce.
- The Company was recognised for its meritorious performance by the MoP for the year
2010-11 and won a Gold Shield for the transmission system at Eastern region, a Gold
Shield for the transmission system at the North Eastern region and a Silver Shield for the
transmission system at the Southern region.
2012 - The Company was awarded the ‘Excellence in Innovation in Tower Management’
award at the INFOCOM CMAI National Telecom Awards 2011.
- The Company was conferred with ‘Power Line Awards 2012’ in the ‘Best Performing
Transmission Company’ by Power Line magazine
- The Company was awarded the ‘India Power Awards 2012’ under the ‘Largest Grid
Operating PSU category by Council of Power Utilities.
2013 - The Company was awarded the 4th DSIJ PSU Award 2012 for ‘Fastest Growing
Navratna in Non-Manufacturing Category’ by Dalal Street Investment Journal.
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- The Company also won the ‘Jury Award’ in Governance Now PSU Awards, 2013 by
Governance Now, Institute for Competitiveness and Hammurabi and Solomon.
- The Company was ranked as the ‘Best Company by country’ of All -Asia in Power
Sector Category by Institutional Investors LLC.
-POWERGRID signs MoU with Ministry of Power, Govt. of India
-POWERGRID signs Agreements with six NER States for improvement of Intra- State
Transmission and Distribution Systems
-POWERGRID bestowed with "Top Infrastructure Company Award" by Dun &
Bradstreet
2014 -MOU signed between POWERGRID and Ministry of Power for FY 2014-15
-POWERGRID signs CSR MoA with AIIMS
-POWERGRID signs MoUs for supporting "Swachh Vidyalaya Abhiyan" of Govt. of
India
-POWERGRID conferred with "Public Service Excellence Award 2014" by Delhi
Institute of Management
-POWERGRID CMD conferred with "Eminent Electrical Engineer Award"
-POWERGRID conferred DSIJ PSU Award 2013 for being the "Fastest Growing
Navratna PSU"
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VISION
World Class, Integrated, Global Transmission Company with Dominant
Leadership in Emerging Power Markets Ensuring Reliability, Safety and Economy.
MISSION
We will become a Global Transmission Company with Dominant Leadership in
Emerging Power Markets with World Class Capabilities by:
World Class: Setting superior standards in capital project management and
operations for the industry and ourselves
Global: Leveraging capabilities to consistently generate maximum value for all
stakeholders in India and in emerging and growing economies.
Inspiring, nurturing and empowering the next generation of professionals.
Achieving continuous improvements through innovation and state of the art
technology.
Committing to highest standards in health, safety, security and environment
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OBJECTIVES
The Corporation has set following objectives in line with its mission and its status
as Central Transmission Utility to:
Undertake transmission of electric power through Inter-State Transmission
System.
Discharge all functions of planning and coordination relating to Inter-State
Transmission System with-
State Transmission Utilities
Central Government
State Government
Generating Companies
Regional Power Committees
Authority
Licensees
Any other person notified by the Central Government in this behalf.
To ensure development of an efficient, coordinated and economical system of
inter-state transmission lines for smooth flow of electricity from generating
stations to the load centres.
Efficient Operation and Maintenance of Transmission Systems
Restoring power in quickest possible time in the event of any natural disasters like
super-cyclone, flood etc. through deployment of Emergency Restoration Systems.
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Provide consultancy services at national and international levels in transmission
sector based on the in-house expertise developed by the organization.
Participate in long distance Trunk Telecommunication business ventures.
Ensure principles of Reliability, Security and Economy matched with the rising /
desirable expectation of a cleaner, safer, healthier Environment of people, both
affected and benefited by its activities.
ONE NATION--ONE GRID
The Indian Power system for planning and operational purposes is divided into
five regional grids. The integration of regional grids, and thereby establishment of
National Grid, was conceptualised in early nineties. The integration of regional
grids which began with asynchronous HVDC back-to-back inter-regional links
facilitating limited exchange of regulated power was subsequently graduated to
high capacity synchronous links between the regions.
The initial inter-regional links were planned for exchange of operational surpluses
amongst the regions. However, later on when the planning philosophy had
graduated from Regional self-sufficiency to National basis, the Inter-regional links
were planned associated with the generation projects that had beneficiaries across
the regional boundaries.
By the end of 11th plan the country has total inter-regional transmission capacity
of about 28,000 MW which is expected to be enhanced to about 65000 MW at the
end of XII plan.
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Synchronisation of all regional grids will help in optimal utilization of scarce
natural resources by transfer of Power from Resource centric regions to Load
centric regions. Further, this shall pave way for establishment of vibrant
Electricity market facilitating trading of power across regions. One Nation One
Grid shall synchronously connect all the regional grids and there will be one
national frequency.
GROWTH IN TRANSMISSION SECTOR
The objective of power grid corporation of India Limited is to create a strong and
vibrant national grid in the country to ensure the optimum utilization of generating
resources, conservation of an eco-sensitive right of way and the flexibility to
accommodate the uncertainty of generation plan. While planning new generation
capacities, requirement of associated transmission capacity would need to be
worked out simultaneously in order to avoid mismatch between generation
capacity and transmission facilities.
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Transmission lines:
(All fig. in CKM)
At the
end of
6th
plan
7th
plan
8th
plan
9th
plan
10th
plan
11th
plan
During 12th
Plan(Upto
August 2015)
Upto 12th
Plan(August 2015)
+500 kV HVDC
Central 0 0 1634 3234 4368 5948 0 5948
State 0 0 0 1504 1504 1504 0 1504
JV/Private 0 0 0 0 0 1980 0 1980
Total 0 0 1634 4738 5872 9432 0 9432
765 Kv
Central 0 0 0 751 1775 4839 12600 17439
State 0 0 0 409 409 411 429 840
Private 0 0 0 0 0 0 2513 2513
Total 0 0 0 1160 2184 5250 15542 20792
400 kV
Central 1831 13068 23001 29345 48708 71023 13851 84874
State 4198 6756 13141 20033 24730 30191 11647 41838
JV/Private 0 0 0 0 2284 5605 7766 13371
Total 6029 19824 36142 49378 75722 106819 33264 140083
220 kV
Central 1641 4560 6564 8687 9444 10140 805 10945
State 44364 55071 73036 88306 105185 125010 15394 140404
JV/Private 0 0 0 0 0 830 68 898
Total 46005 59631 79600 96993 114629 135980 16267 152247
Grand
Total 52034 79455 117376 152269 198407 257481 65073 322554
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BUSINESS OVERVIEW
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FIVE YEAR’S PROFIT SUMMARY
FIVE YEAR'S SUMMARYYEARS NET PROFIT
2009-10 2205.91
2010-11 3140.12
2010-11 3140.12
2011-12 3709.09
2011-12 3709.09
2012-13 4592.78
2012-13 4592.78
2013-14 4989.62
2013-14 4989.62
0 2 4 6 8 10 120
2
4
6
8
10
12
FIVE YEAR'S SUMMARYYEARSNET PROFIT
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PROFIT AFTER DEFERRED TAX AND TURNOVER
The
company’s financial performance during FY 2012-13 has been spectacular,
achieving a turnover of Rs. 13,328 Crore and a Net Profit of Rs. 4,235 Crore as
compared to Rs. 10,785 Crore and Rs. 3,255 Crore respectively during FY 2011-
12. With the addition of huge transmission network, the gross asset base of the
Company has been enhanced to more than Rs. 80,600 Crore in FY 2012-13 from
Rs. 63,387 Crore in FY 2011-12. At the end of FY 2012-13, the company has a
Net worth of Rs 26.216 Crore.
The company could excel in its financial performance due to prudent financial
management, with key indicators registering impressive growth at the end of FY
2012-2013 since 1992-93.
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Turnover at Rs 13,328 Crore, up by 21.02 times from Rs 634 Crore.
Profit at Rs 4,235 Crore, up by 17.87 times from Rs 237 Crore.
Gross Block at Rs 80,600 Crore, up by 22.89 times from Rs 3,521 Crore.
ASSET GROWTH
Our Gross fixed assets were Rs. 80,600 Crore as of March 31, 2013. Our fixed
assets consist of plant and machinery such as transmission lines, substations,
HVDC, ULDC, Telecom equipment and other transmission equipment; buildings;
land; office equipment; fixtures; and motor vehicles. Fixed assets value increased
by 22.06% in Fiscal 2008 as compared to Fiscal 2007, increased by 13.84% in
Fiscal 2009 as compared to Fiscal 2008, increased by 7.15% in Fiscal 2010 as
compared to Fiscal 2009, increased by 16.53% in Fiscal 2011 as compared to
Fiscal 2010 and increased by 25.91% in Fiscal 2012 as compared to Fiscal 2011.
These increases are mainly due to the commissioning of new transmission assets.
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MANPOWER GROWTH
(2014-2015)
• Revenue Rs.380 cr.
• Net Income Rs. 44.97cr.
• Operating Income Rs.99,529,000
• Net Income Rs. 50,463,000
• Total Assets Rs. 15,830,088
• Total Equity and Liabilities Rs. 15,830,088
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Mergers and Acquisitions
In 1991, it took over transmission assets from NTPC, NHPC, NEEPCO, NLC, NPC,
THDC, and SJVNL.It also took over the operation of existing Regional Load Despatch
Centres (RLDCs) from Central Electricity Authority (CEA), in a phased manner from
1994 to 1996.
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LITERATURE REVIEW
Valuation
Valuation is the process of estimating what something is worth. Items that are usually
valued are a financial asset or liability. Valuations can be done on assets (for example,
investments in marketable securities such as stocks, options, business enterprises,
or intangible assets such as patents and trademarks) or on liabilities (e.g., bonds issued by
a company). Valuations are needed for many reasons such as investment analysis, capital
budgeting, merger and acquisition transactions, financial reporting, taxable events to
determine the proper tax liability, and in litigation.
Models of Valuation
Valuation of financial assets is done using one or more of these types of models:
1. Absolute value models that determine the present value of an asset's expected
future cash flows. These kinds of models take two general forms: multi-period
models such as discounted cash flow models or single-period models such as
the Gordon model. These models rely on mathematics rather than price
observation.
2. Relative value models determine value based on the observation of market prices
of similar assets.
3. Option pricing models are used for certain types of financial assets
(e.g., warrants, put options, call options, employee stock options, investments
with embedded options such as a callable bond) and are a complex present value
model. The most common option pricing models are the Black–Scholes-
Merton models and lattice models.
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Common terms for the value of an asset or liability are market value, fair value,
and intrinsic value. The meanings of these terms differ. For instance, when an analyst
believes a stock's intrinsic value is greater (less) than its market price, an analyst makes a
"buy" ("sell") recommendation. Moreover, an asset's intrinsic value may be subject to
personal opinion and vary among analysts.
Methods of Valuing Business Entities:
There are commonly three pillars to valuing business entities: comparable company
analyses, discounted cash flow analysis, and precedent transaction analysis.
Discounted Cash Flow Analysis Method
This method estimates the value of an asset based on its expected future cash flows,
which are discounted to the present. This concept of discounting future money is
commonly known as the time value of money. For instance, an asset that matures and
pays $1 in one year is worth less than $1 today. The size of the discount is based on
an opportunity cost of capital and it is expressed as a percentage or discount rate.
In finance theory, the amount of the opportunity cost is based on a relation between the
risk and return of some sort of investment. Classic economic theory maintains that people
are rational and averse to risk. They, therefore, need an incentive to accept risk. The
incentive in finance comes in the form of higher expected returns after buying a risky
asset.
For a valuation using the discounted cash flow method, one first estimates the future cash
flows from the investment and then estimates a reasonable discount rate after considering
the riskiness of those cash flows and interest rates in the capital markets. Next, one makes
a calculation to compute the present value of the future cash flows.
Guideline Companies Analysis Method
This method determines the value of a firm by observing the prices of similar companies
(called "guideline companies") that sold in the market. Those sales could be shares of
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stock or sales of entire firms. The observed prices serve as valuation benchmarks. From
the prices, one calculates price multiples such as the price-to-earnings or price-to-book
ratios—one or more of which used to value the firm. For example, the average price-to-
earnings multiple of the guideline companies is applied to the subject firm's earnings to
estimate its value.
Many price multiples can be calculated. Most are based on a financial statement element
such as a firm's earnings (price-to-earnings) or book value (price-to-book value) but
multiples can be based on other factors such as price-per-subscriber.
Precedent Transaction Analysis Method
The third-most common method of estimating the value of a company looks to
the assets and liabilities of the business. At a minimum, a solvent company could shut
down operations, sell off the assets, and pay the creditors. Any cash that would remain
establishes a floor value for the company. This method is known as the net asset value or
cost method. In general the discounted cash flows of a well-performing company exceed
this floor value. Some companies, however, are worth more "dead than alive", like
weakly performing companies that own many tangible assets. This method can also be
used to value heterogeneous portfolios of investments, as well as nonprofits, for which
discounted cash flow analysis is not relevant. The valuation premise normally used is that
of an orderly liquidation of the assets, although some valuation scenarios (e.g., purchase
price allocation) imply an "in-use" valuation such as depreciated replacement cost new.
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Usage of Valuation Analysis
Valuation analysis is required for many reasons including tax assessment, wills and
estates, divorce settlements, business analysis, and basic book keeping and accounting.
Since the value of things fluctuates over time, valuations are as of a specific date like the
end of the accounting quarter or year. They may alternatively be mark-to-market
estimates of the current value of assets or liabilities as of this minute or this day for the
purposes of managing portfolios and associated financial risk.
Some balance sheet items are much easier to value than others. Publicly traded stocks and
bonds have prices that are quoted frequently and readily available. Other assets are harder
to value. For instance, private firms that have no frequently quoted price. Additionally,
financial instruments that have prices that are partly dependent on theoretical models of
one kind or another are difficult to value. For example, options are generally valued using
the Black–Scholes model while the liabilities of life assurance firms are valued using the
theory of present value. Intangible business assets, like goodwill and intellectual
property, are open to a wide range of value interpretations.
It is possible and conventional for financial professionals to make their own estimates of
the valuations of assets or liabilities that they are interested in. Their calculations are of
various kinds including analyses of companies that focus on price-to-book, price-to-
earnings, price-to-cash-flow and present value calculations, and analyses of bonds that
focus on credit ratings, assessments of default risk, risk premia, and levels of real interest
rates. All of these approaches may be thought of as creating estimates of value that
compete for credibility with the prevailing share or bond prices, where applicable, and
may or may not result in buying or selling by market participants. Where the valuation is
for the purpose of a merger or acquisition the respective businesses make available
further detailed financial information, usually on the completion of a non-disclosure
agreement.
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Valuation of a Suffering Company
Additional adjustments to a valuation approach, whether it is market-, income-, or asset-
based, may be necessary in some instances like:
Excess or restricted cash
Other non-operating assets and liabilities
Lack of marketability discount of shares
Control premium or lack of control discount
Above- or below-market leases
Excess salaries in the case of private companies
There are other adjustments to the financial statements that have to be made when
valuing a distressed company. Andrew Miller identifies typical adjustments used to recast
the financial statements that include:
Working capital adjustment
Deferred capital expenditures
Cost of goods sold adjustment
Non-recurring professional fees and costs
Certain non-operating income/expense items
Valuation of a Startup Company
Startup companies such as Uber, which was valued at $50 billion in early 2015, have a
valuation based on what investors, for the most part venture capital firms, are willing to
pay for a share of the firm. They are not listed on any stock market, nor is the valuation
based on their assets or profits, but on their potential for success, growth, and, eventually,
possible profits. The professional investors who fund startups are experts, but hardly
infallible, see Dot-com bubble.
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Findings
Primary Valuation Methodology-‘Comparable Company
Analysis – CCA’
Definition of Comparable Company Analysis
A process used to evaluate the value of a company using the metrics of other businesses
of similar size in the same industry. Comparable company analysis (CCA) operates under
the assumption that similar companies will have similar valuations multiples, such as
EV/EBITDA. Analysts will compile a list of available statistics for the companies being
reviewed, and will calculate the valuation multiples in order to compare them.
Comparisons often involve creating benchmarks.
Comparable company analysis is often referred to as a company's "comps".
Breaking Down ‘Comparable Company Analysis – CCA’
Comparable company analysis starts with establishing a peer group consisting of similar
companies of similar size in the same industry and region. Investors are then able to use
online resources to compare a particular company to its competitors. This information
can be used to determine a company's enterprise value and to calculate other ratios used
to compare a company to those in its peer group.
Comparable companies analysis (“comparable companies” or “trading comps”) is one of
the primary methodologies used for valuing a given focus company, division, business, or
collection of assets (“target”). It provides a market benchmark against which a banker can
establish valuation for a private company or analyze the value of a public company at a
given point in time. Comparable companies has a broad range of applications, most
notably for various mergers & acquisitions (M&A) situations, initial public offerings
(IPOs), restructurings, and investment decisions.
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The foundation for trading comps is built upon the premise that similar companies
provide a highly relevant reference point for valuing a given target due to the fact that
they share key business and financial characteristics, performance drivers, and risks.
Therefore, the banker can establish valuation parameters for the target by determining its
relative positioning among peer companies. The core of this analysis involves selecting a
universe of comparable companies for the target (“comparables universe”). These peer
companies are benchmarked against one another and the target based on various financial
statistics and ratios. Trading multiples are then calculated for the universe, which serve as
the basis for extrapolating a valuation range for the target. This valuation range is
calculated by applying the selected multiples to the target’s relevant financial statistics.
While valuation metrics may vary by sector. These multiples—such as enterprise value-
to-earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) and
price-to-earnings (P/E)—utilize a measure of value in the numerator and a financial
statistic in the denominator. While P/E is the most broadly recognized in circles outside
Wall Street, multiples based on enterprise value are widely used by bankers because they
are independent of capital structure and other factors unrelated to business operations
(e.g., differences in tax regimes and certain accounting policies).
Comparable companies analysis is designed to reflect “current” valuation based on
prevailing market conditions and sentiment. At the same time, market trading levels may
be subject to periods of irrational investor sentiment that skew valuation either too high
or too low. Furthermore, no two companies are exactly the same, so assigning a valuation
based on the trading characteristics of similar companies may fail to accurately capture a
given company’s true value.
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Steps of Comparable Companies Analysis
Step I. Select the Universe of Comparable Companies
Step II. Locate the Necessary Financial Information
Step III. Spread Key Statistics, Ratios, and Trading Multiples
Step IV. Benchmark the Comparable Companies
Step V. Determine Valuation
Step I. Select the Universe of Comparable Companies.
The selection of a universe of comparable companies for the target is the foundation for
performing trading comps. While this exercise can be fairly simple and intuitive for
companies in certain sectors, it can prove challenging for others whose peers are not
readily apparent. To identify companies with similar business and financial
characteristics, it is first necessary to gain a sound understanding of the target.
As a starting point, the banker typically consults with peers or senior colleagues to see if
a relevant set of comparable companies already exists internally. If beginning from
scratch, the banker casts a broad net to review as many potential comparable companies
as possible. This broader group is eventually narrowed, and then typically further refined
to a subset of “closest comparables.” A survey of the target’s public competitors is
generally a good place to start identifying potential comparable companies.
Study the Target
Our first task was to learn PGCIL “story” in as much detail as possible so as to provide a
frame of reference for locating comparable companies. As PGCIL is a public company,
for the purposes of this exercise we assumed that it is being sold through an organized
M&A sale process. Therefore, we were provided with substantive information on the
company, its sector, products, customers, competitors, distribution channels, and end
markets, as well as historical financial performance and projections. We sourced this
information from the confidential information memorandum, management presentation,
and data room.
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Identify Key Characteristics of the Target for Comparison Purposes
A simple framework for studying the target and selecting comparable companies is
shown in Exhibit-1. This framework, while by no means exhaustive, is designed to
determine commonality with other companies by profiling and comparing key business
and financial characteristics.
Exhibit - 1 Business and Financial Profile Framework
Business Profile
1. Sector
2. Products and Services
3. Customers and End Markets
4. Distribution Channels
5. Geography
Business Profile
Companies that share core business characteristics tend to serve as good comparables.
These core traits include sector, products and services, customers and end markets,
distribution channels, and geography.
Sector
Sector refers to the industry or markets in which a company operates (e.g., power
generation, consumer products, healthcare, industrials, and technology). A company’s
sector can be further divided into sub-sectors, which facilitates the identification of the
target’s closest comparable. Within the industrials sector, for example, there are
numerous sub-sectors, such as aerospace and defense, automotive, building products,
metals and mining, and paper and packaging. For companies with distinct business
divisions, the segmenting of comparable companies by sub-sector may be critical for
valuation.
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A company’s sector conveys a great deal about its key drivers, risks, and opportunities.
For example, a cyclical sector such as oil & gas will have dramatically different earnings
volatility than consumer staples. On the other hand, cyclical or highly fragmented sectors
may present growth opportunities that are unavailable to companies in more stable or
consolidated sectors. The proper identification and classification of the target’s sector and
sub-sector is an essential step toward locating comparable companies.
Products and Services
A company’s products and services are at the core of its business model. Accordingly,
companies that produce similar products or provide similar services typically serve as
good comparables. Products are commodities or value-added goods that a company
creates, produces, or refines. Examples of products include computers, lumber, oil,
prescription drugs, and steel. Services are acts or functions performed by one entity for
the benefit of another. Examples of common services include banking, installation,
lodging, logistics, and transportation. Many companies provide both products and
services to their customers, while others offer one or the other. Similarly, some
companies offer a diversified product and/or service mix, while others are more focused.
Customers and End Markets
Customers A company’s customers refer to the purchasers of its products and services.
Companies with a similar customer base tend to share similar opportunities and risks. For
example, companies supplying automobile manufacturers abide by certain manufacturing
and distribution requirements, and are subject to the automobile purchasing cycles and
trends.
The quantity and diversity of a company’s customers are also important. Some
companies serve a broad customer base while others may target a specialized or niche
market. While it is generally positive to have low customer concentration from a risk
management perspective, it is also beneficial to have a stable customer core to provide
visibility and comfort regarding future revenues.
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End Markets A company’s end markets refer to the broad underlying markets into which
it sells its products and services. For example, a plastics manufacturer may sell into
several end markets, including automotive, construction, consumer products, medical
devices, and packaging. End markets need to be distinguished from customers. For
example, a company may sell into the housing end market, but to retailers or suppliers as
opposed to homebuilders.
A company’s performance is generally tied to economic and other factors that affect its
end markets. A company that sells products into the housing end market is susceptible to
macroeconomic factors that affect the overall housing cycle, such as interest rates and
unemployment levels. Therefore, companies that sell products and services into the same
end markets generally share a similar performance outlook, which is important for
determining appropriate comparable companies.
Distribution Channels
Distribution channels are the avenues through which a company sells its products and
services to the end user. As such, they are a key driver of operating strategy,
performance, and, ultimately, value. Companies that sell primarily to the wholesale
channel, for example, often have significantly different organizational and cost structures
than those selling directly to retailers or end users. Selling to a superstore or value retailer
requires a physical infrastructure, sales force, and logistics that may be unnecessary for
serving the professional or wholesale channels.
Some companies sell at several levels of the distribution chain, such as wholesale, retail,
and direct-to-customer. A flooring manufacturer, for example, may distribute its products
through selected wholesale distributors and retailers, as well as directly to homebuilders
and end users.
Geography
Companies that are based in (and sell to) different regions of the world often differ
substantially in terms of fundamental business drivers and characteristics. These may
include growth rates, macroeconomic environment, competitive dynamics, path(s) - to-
market, organizational and cost structure, and potential opportunities and risks. Such
differences—which result from local demographics, economic drivers, regulatory
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regimes, consumer buying patterns and preferences, and cultural norms—can vary greatly
from country to country and, particularly, from continent to continent. Consequently,
there are often valuation disparities for similar companies in different global regions or
jurisdictions. Therefore, in determining comparable companies, bankers tend to group
U.S.-based (or focused) companies in a separate category from European- or Asian-based
companies even if their basic business models are the same.
For example, a banker seeking comparable companies for a U.S. retailer would focus
primarily on U.S. companies with relevant foreign companies providing peripheral
guidance. This geographic grouping is slightly less applicable for truly global industries
such as oil and aluminum, for example, where domicile is less indicative than global
commodity prices and market conditions. Even in these instances, however, valuation
disparities by geography are often evident.
Financial Profile
1. Size
2. Profitability
3. Growth Profile
4. Return on Investment
5. Credit Profile
Financial Profile
Key financial characteristics must also be examined both as a means of understanding the
target and identifying the best comparable companies.
Size
Size is typically measured in terms of market valuation (e.g., equity value and enterprise
value), as well as key financial statistics (e.g., sales, gross profit, EBITDA, EBIT, and net
income). Companies of similar size in a given sector are more likely to have similar
multiples than companies with significant size discrepancies. This reflects the fact that
companies of similar size are also likely to be analogous in other respects (e.g.,
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economies of scale, purchasing power, pricing leverage, customers, growth prospects,
and the trading liquidity of their shares in the stock market).
Consequently, differences in size often map to differences in valuation. Hence, the
comparables are often tiered based on size categories. For example, companies with
under $5 billion in equity value (or enterprise value, sales) may be placed in one group
and those with greater than $5 billion in a separate group. This tiring, of course, assumes
a sufficient number of comparables to justify organizing the universe into sub-groups.
Profitability
A company’s profitability measures its ability to convert sales into profit. Profitability
ratios (“margins”) employ a measure of profit in the numerator, such as gross profit,
EBITDA, EBIT, or net income, and sales in the denominator. As a general rule, for
companies in the same sector, higher profit margins translate into higher valuations, all
else being equal. Consequently, determining a company’s relative profitability versus its
peers’ is a core component of the benchmarking analysis (see Step IV).
Growth Profile
A company’s growth profile, as determined by its historical and estimated future
financial performance, is an important driver of valuation. Equity investors reward high
growth companies with higher trading multiples than slower growing peers. They also
discern whether the growth is primarily organic or acquisition-driven, with the former
generally viewed as preferable. In assessing a company’s growth profile, historical and
estimated future growth rates for various financial statistics (e.g., sales, EBITDA, and
earnings per share (EPS)) are examined at selected intervals. For mature public
companies, EPS growth rates are typically more meaningful. For early stage or emerging
companies with little or no earnings, however, sales or EBITDA growth trends may be
more relevant.
Return on Investment
Return on investment (ROI) measures a company’s ability to provide earnings (or
returns) to its capital providers. ROI ratios employ a measure of profitability (e.g., EBIT,
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NOPAT, or net income) in the numerator and a measure of capital (e.g., invested capital,
shareholders’ equity, or total assets) in the denominator. The most commonly used ROI
metrics are return on invested capital (ROIC), return on equity (ROE), and return on
assets (ROA). Dividend yield, which measures the dividend payment that a company’s
shareholders receive for each share owned, is another type of return metric.
Credit Profile
A company’s credit profile refers to its creditworthiness as a borrower. It is typically
measured by metrics relating to a company’s overall debt level (“leverage”) as well as its
ability to make interest payments (“coverage”), and reflects key company and sector-
specific benefits and risks. Moody’s Investors Service (Moody’s), Standard & Poor’s
(S&P), and Fitch Ratings (Fitch) are the three primary independent credit rating agencies
that provide formal assessments of a company’s credit profile.
Screen for Comparable Companies
Our search for comparable companies began by examining PGCIL public competitors,
which we initially identified by perusing the CIM as well as selected industry reports. We
then searched through equity research reports on these public competitors for the
analysts’ views on comparable companies, which provided us with additional companies
to evaluate. We also reviewed the proxy statements for recent M&A transactions
involving companies in PGCIL sector, and found ideas for additional comparable
companies from the enclosed fairness opinion excerpts. To ensure that no potential
comparables were missed, we screened companies using SIC/NAICS codes
corresponding to PGCIL sector.
These sources provided us with enough information to create a solid initial list of
comparable companies (see Exhibit-2). We also compiled summary financial information
using data downloaded from a financial information service in order to provide a basic
understanding of their financial profiles.
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Exhibit - 2 List of Comparable Companies
(Rs. In Crore)
List of Comparable Companies
Company Equity Value Enterprise Value
NTPC LTD 107933 178251
Power Grid Corpn 72013 157846
NHPC LTD 20481 37710
Tata Power Co. 18432 61273
Neyveli Lignite 14395 17118
Step II. Locate the Necessary Financial Information.
Once the initial comparables universe is determined, the banker locates the financial
information necessary to analyze the selected comparable companies and calculate key
financial statistics, ratios, and trading multiples (see Step III). The primary data for
calculating these metrics is compiled from various sources, including a company’s SEC
filings, consensus research estimates, equity research reports, and press releases, as well
as financial information services.
The most common sources for public company financial data are SEC filings, as well as
earnings announcements, investor presentations, equity research reports, consensus
estimates, press releases, and selected financial information services. Depending on the
sector and point in the cycle, however, financial projections tend to be more meaningful.
Estimates for forward year financial performance are typically sourced from consensus
estimates as well as individual company equity research reports. In the context of an
M&A or debt capital raising transaction, by contrast, more emphasis is placed on LTM
financial performance. LTM financial information is calculated on the basis of data
obtained from a company’s public filings.
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SEC Filings: 10-K, 10-Q, 8-K, and Proxy Statement
As a general rule, the banker uses SEC filings to source historical financial information
for comparable companies. This financial information is used to determine historical
sales, gross profit, EBITDA, EBIT, and net income (and EPS) on both an annual and
LTM basis. SEC filings are also the primary source for other key financial items such as
balance sheet data, capital expenditures (“capex”), basic shares outstanding, stock
options/warrants data, and information on non-recurring items. SEC filings can be
obtained through numerous mediums, including a company’s corporate website (typically
through an “Investor Relations” link) as well as The Electronic Data Gathering, Analysis,
and Retrieval (EDGAR) and other financial information services.
10-K (Annual Report)
The 10-K is an annual report filed with the SEC by a public registrant that provides a
comprehensive overview of the company and its prior year performance. It is required to
contain an exhaustive list of disclosure items including, but not limited to, a detailed
business description, management discussion & analysis (MD&A), audited financial
statements and supplementary data, outstanding debt detail, basic shares outstanding, and
stock options/warrants data. It also contains an abundance of other pertinent information
about the company and its sector, such as business segment detail, customers, end
markets, competition, insight into material opportunities (and challenges and risks),
significant recent events, and acquisitions.
10-Q (Quarterly Report)
The 10-Q is a quarterly report filed with the SEC by a public registrant that provides an
overview of the most recent quarter and year-to date (YTD) period. It is less
comprehensive than the 10-K, but provides financial statements as well as MD&A
relating to the company’s financial performance for the most recent quarter and YTD
period versus the prior year periods. The 10-Q also provides the most recent share count
information and may also contain the most recent stock options/warrants data. For
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detailed financial information on a company’s final quarter of the fiscal year, the banker
refers to the 8-K containing the fourth quarter earnings press release that usually precedes
the filing of the 10-K.
8-K (Current Report)
The 8-K, or current report, is filed by a public registrant to report the occurrence of
material corporate events or changes (“triggering event”) that are of importance to
shareholders or security holders. For the purposes of preparing trading comps, key
triggering events include, but are not limited to, earnings announcements, entry into a
definitive purchase/sale agreement, completion of an acquisition or disposition of assets,
capital markets transactions, and Regulation FD disclosure requirements. The
corresponding 8-Ks for these events often contain important information necessary to
calculate a company’s updated financial statistics, ratios, and trading multiples that may
not be reflected in the most recent 10-K or 10-Q.
Proxy Statement
A proxy statement is a document that a public company sends to its shareholders prior to
a shareholder meeting containing material information regarding matters on which the
shareholders are expected to vote. It is also filed with the SEC on Schedule 14A. For the
purposes of spreading trading comps, the annual proxy statement provides a basic shares
outstanding count that may be more recent than that contained in the latest 10-K or 10-Q.
As previously discussed, the annual proxy statement also typically contains a suggested
peer group for benchmarking purposes.
Equity Research
Research Reports Equity research reports provide individual analyst estimates of future
company performance, which may be used to calculate forward-looking multiples. They
generally include estimates of sales, EBITDA and/or EBIT, and EPS for future quarters
and the future two- or three-year period (on an annual basis). More comprehensive
reports provide additional estimated financial information from the research analyst’s
model, including key items from the income statement, balance sheet, and cash flow
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statement. These reports may also provide segmented financial projections, such as sales
and EBIT at the business division level.
Equity research reports often provide commentary on non-recurring items and recent
M&A and capital markets transactions, which are helpful for determining pro forma
adjustments and normalizing financial data. They may also provide helpful sector and
market information, as well as explicitly list the research analyst’s view on the
company’s comparables universe. Initiating coverage research reports tend to be more
comprehensive than normal interim reports. As a result, it is beneficial to mine these
reports for financial, market, and competitive insights. Research reports can be located
through various subscription financial information services such as Fact Set, OneSource,
and Thomson Reuters.
Consensus Estimates: Consensus research estimates for selected financial statistics are
widely used by bankers as the basis for calculating forward-looking trading multiples in
trading comps. As previously discussed, the primary sources for consensus estimates are
First Call and IBES, which can be located through Bloomberg, Fact Set, and Thomson
Reuters, among other financial information services. The banker typically chooses one
source or the other so as to maintain consistency throughout the analysis.
Press Releases and News Runs a company issues a press release when it has something
important to report to the public. Standard press releases include earnings
announcements, declaration of dividends, and management changes, as well as M&A and
capital markets transactions. Earnings announcements, which are accompanied by the
filing of an 8-K, are typically issued prior to the filing of a 10-K or 10-Q. Therefore, the
banker relies upon the financial data provided in the earnings announcement to update
trading comps in a timely manner. A company may also release an investor presentation
to accompany its quarterly earnings call, which may be helpful in readily identifying key
financial data and obtaining additional color and commentary. In the event that certain
financial information is not provided in the earnings press release, the banker must wait
until the filing of the 10-K or 10-Q for complete information. A company’s press releases
and recent news articles are available on its corporate website as well as through
Bloomberg, Factiva, LexisNexis, and Thomson Reuters, among others.
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Financial Information Services
As discussed throughout this section, financial information services are a key source for
obtaining SEC filings, research reports, consensus estimates, and press releases, among
other items. They are also the primary source for current and historical company share
price information, which is essential for calculating equity value and determining a
company’s current share price as a percentage of its 52- week high. Financial information
services, such as Bloomberg, may also be sourced to provide information on a company’s
credit ratings. If practical, however, we suggest sourcing credit ratings directly from the
official Moody’s, S&P, and Fitch websites to ensure accurate and up-to-date information.
Step III. Spread Key Statistics, Ratios, and Trading Multiples.
The banker is now prepared to spread key statistics, ratios, and trading multiples for the
comparables universe. This involves calculating market valuation measures such as
enterprise value and equity value, as well as key income statement items, such as
EBITDA and net income. A variety of ratios and other metrics measuring profitability,
growth, returns, and credit strength are also calculated at this stage. Selected financial
statistics are then used to calculate trading multiples for the comparables.
As part of this process, the banker needs to employ various financial concepts and
techniques, including the calculation of last twelve months (LTM) financial statistics,
calendarization of company financials, and adjustments for non-recurring items. These
calculations are imperative for measuring the comparables accurately on both an absolute
and relative basis (see Step IV).
Calculation of Key Financial Statistics and Ratios
In this section, we outline the calculation of key financial statistics, ratios, and other
metrics in accordance with the financial profile framework introduced in Step I.
Size (Market Valuation: equity value and enterprise value; and Key Financial Data: sales,
gross profit, EBITDA, EBIT, and net income)
Profitability (gross profit, EBITDA, EBIT, and net income margins)
Growth Profile (historical and estimated growth rates)
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Return on Investment (ROIC, ROE, ROA, and dividend yield)
Credit Profile (leverage ratios, coverage ratios, and credit ratings)
Size: Market Valuation
Equity Value
Equity value (“market capitalization”) is the value represented by a given company’s
basic shares outstanding plus “in-the-money” stock options, warrants, and convertible
securities—collectively, “fully diluted shares outstanding.” It is calculated by multiplying
a company’s current share price by its fully diluted shares outstanding.
Calculation of Equity Value
Equity Value = Share Price x Fully Diluted Share Outstanding
+ +
When compared to other companies, equity value only provides a measure of relative
size. Therefore, for insight on absolute and relative market performance—which is
informative for interpreting multiples and framing valuation—the banker looks at the
company’s current share price as a percentage of its 52-week high. This is a widely used
metric that provides perspective on valuation and gauges current market sentiment and
outlook for both the individual company and its broader sector. If a given company’s
percentage is significantly out of line with that of its peers, it is generally an indicator of
company-specific (as opposed to sector-specific) issues.
For example, a company may have missed its earnings guidance or underperformed
versus its peers over the recent quarter(s). It may also be a sign of more entrenched issues
involving management, operations, or specific markets.
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‘In-The-Money’Options and Warrants
‘In-The-Money’ Convertible Securities
Basic Share Outstanding
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Calculation of Fully Diluted Shares Outstanding A company’s fully diluted shares are
calculated by adding the number of shares represented by its in-the-money options,
warrants, and convertibles securities to its basic shares outstanding. A company’s most
recent basic shares outstanding count is typically sourced from the first page of its 10-K
or 10-Q (whichever is most recent). In some cases, however, the latest proxy statement
may contain more updated data and, therefore, should be used in lieu of the 10-K or 10-
Q. The most recent stock options/warrants information is obtained from a company’s
latest 10-K or, in some cases, the 10-Q.
The incremental shares represented by a company’s in-the-money options and warrants
are calculated in accordance with the treasury stock method (TSM). Those shares implied
by a company’s in-the-money convertible and equity-linked securities are calculated in
accordance with the if-converted method or net share settlement (NSS), as appropriate.
Options and Warrants — The Treasury Stock Method assumes that all tranches of in-
the-money options and warrants are exercised at their weighted average strike price with
the resulting option proceeds used to repurchase outstanding shares of stock at the
company’s current share price. In-the-money options and warrants are those that have an
exercise price lower than the current market price of the underlying company’s stock. As
the strike price is lower than the current market price, the number of shares repurchased
is less than the additional shares outstanding from exercised options. This results in a net
issuance of shares, which is dilutive.
Convertible and Equity - Linked Securities Outstanding convertible and equity linked
securities also need to be factored into the calculation of fully diluted shares outstanding.
Convertible and equity-linked securities bridge the gap between traditional debt and
equity, featuring characteristics of both. They include a broad range of instruments, such
as traditional cash-pay convertible bonds, convertible hybrids, perpetual convertible
preferred, and mandatory convertibles.
This section focuses on the traditional cash-pay convertible bond as it is the most “plain-
vanilla” structure. A cash-pay convertible bond (“convert”) represents a straight debt
instrument and an embedded equity call option that provides for the convert to be
exchanged into a defined number of shares of the issuer’s common stock under certain
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circumstances. The value of the embedded call option allows the issuer to pay a lower
coupon than a straight debt instrument of the same credit. The strike price of the call
option (“conversion price”), which represents the share price at which equity would be
issued to bondholders if the bonds were converted, is typically set at a premium to the
company’s underlying share price at the time of issuance.
For the purposes of performing trading comps, to calculate fully diluted shares
outstanding, it is standard practice to first determine whether the company’s outstanding
converts are in-the-money, meaning that the current share price is above the conversion
price. In-the-money cash-pay converts are converted into additional shares in accordance
with either the if-converted method or net share settlement, as applicable. Out-of-the-
money converts, by contrast, remain treated as debt. Proper treatment of converts requires
a careful reading of the relevant footnotes in the company’s 10-K or prospectus for the
security.
If-Converted Method - In accordance with the if-converted method, when performing
trading comps, in-the-money converts are converted into additional shares by dividing the
convert’s amount outstanding by its conversion price once converted, the convert is
treated as equity and included in the calculation of the company’s equity value. The
equity value represented by the convert is calculated by multiplying the new shares
outstanding from conversion by the company’s current share price. Accordingly, the
convert must be excluded from the calculation of the company’s total debt.
The conversion of in-the-money converts also requires an upward adjustment to the
company’s net income to account for the foregone interest expense payments associated
with the coupon on the convert. This amount must be tax-effected before being added
back to net income. Therefore, while conversion is typically EPS dilutive due to the
additional share issuance, net income is actually higher on a pro forma basis.
Net Share Settlement For converts issued with a net share settlement accounting feature,
the issuer is permitted to satisfy the face (or accreted) value of an in-the-money convert
with cash upon conversion. Only the value represented by the excess of the current share
price over the conversion price is assumed to be settled with the issuance of additional
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shares, which results in less share issuance. This serves to limit the dilutive effects of
conversion by affording the issuer TSM accounting treatment.
Enterprise Value - Enterprise value (“total enterprise value” or “firm value”) is the sum
of all ownership interests in a company and claims on its assets from both debt and equity
holders. As the graphic in Exhibit 1.10 depicts, it is defined as equity value + total debt +
preferred stock + non controlling interest – cash and cash equivalents. The equity value
component is calculated on a fully diluted basis.
EXHIBIT-Calculation of Enterprise Value
Enterprise
Value
Total
= Debt –
Cash and Cash
Equivalents
Equity
Value +
Preferred
+ Stock +
Non
controlling
Interest
Theoretically, enterprise value is considered independent of capital structure, meaning
that changes in a company’s capital structure do not affect its enterprise value. For
example, if a company raises additional debt that is held on the balance sheet as cash, its
enterprise value remains constant as the new debt is offset by the increase in cash.
Size: Key Financial Data
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Sales - (or revenue) is the first line item, or “top line,” on an income statement. Sales
represents the total dollar amount realized by a company through the sale of its products
and services during a given time period. Sales levels and trends are a key factor in
determining a company’s relative positioning among its peers. All else being equal,
companies with greater sales volumes tend to benefit from scale, market share,
purchasing power, and lower risk profile, and are often rewarded by the market with a
premium valuation relative to smaller peers.
Gross Profit - defined as sales less cost of goods sold (COGS), is the profit earned by a
company after subtracting costs directly related to the production of its products and
services. As such, it is a key indicator of operational efficiency and pricing power, and is
usually expressed as a percentage of sales for analytical purposes. For example, if a
company sells a product for $100.00, and that product costs $60.00 in materials,
manufacturing, and direct labor to produce, then the gross profit on that product is $40.00
and the gross profit margin is 40%.
EBITDA - (earnings before interest, taxes, depreciation and amortization) is an important
measure of profitability. As EBITDA is a non-GAAP financial measure and typically not
reported by public filers, it is generally calculated by taking EBIT (or operating
income/profit as often reported on the income statement) and adding back the
depreciation and amortization (D&A) as sourced from the cash flow statement.42
EBITDA is a widely used proxy for operating cash flow as it reflects the company’s total
cash operating costs for producing its products and services. In addition, EBITDA serves
as a fair “apples-to-apples” means of comparison among companies in the same sector
because it is free from differences resulting from capital structure (i.e., interest expense)
and tax regime (i.e., tax expense).
EBIT - (earnings before interest and taxes) is often the same as reported operating
income, operating profit, or income from operations on the income statement found in a
company’s SEC filings. Like EBITDA, EBIT is independent of tax regime and serves as
a useful metric for comparing companies with different capital structures. It is, however,
less indicative as a measure of operating cash flow than EBITDA because it includes
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non-cash D&A expense. Furthermore, D&A reflects discrepancies among different
companies in capital spending and/or depreciation policy as well as acquisition histories
(amortization).
Net income - (“earnings” or the “bottom line”) is the residual profit after all of a
company’s expenses have been netted out. Net income can also be viewed as the earnings
available to equity holders once all of the company’s obligations have been satisfied (e.g.,
to suppliers, vendors, service providers, employees, utilities, lessors, lenders, state and
local treasuries). Wall Street tends to view net income on a per share basis (i.e., EPS).
Profitability
Gross profit margin - (“gross margin”) measures the percentage of sales remaining after
subtracting COGS (see Exhibit). It is driven by a company’s direct cost per unit, such as
materials, manufacturing, and direct labor involved in production. These costs are
typically largely variable, as opposed to corporate overhead which is more fixed in
nature. Companies ideally seek to increase their gross margin through a combination of
improved sourcing/procurement of raw materials and enhanced pricing power, as well as
by improving the efficiency of manufacturing facilities and processes.
EXHIBIT Gross Profit Margin
Gross Profit Margin = Gross Profit (Sales - COGS)
Sales
EBITDA and EBIT margin are accepted standards for measuring a company’s
operating profitability (see Exhibit 1.13). Accordingly, they are used to frame relative
performance both among peer companies and across sectors.
EXHIBIT 1.13 EBITDA and EBIT Margin
EBITDA Margin = EBITDA
Sales
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EBIT Margin = EBIT
Sales
Net income margin measures a company’s overall profitability as opposed to its
operating profitability (see Exhibit 1.14). It is net of interest expense and, therefore,
affected by capital structure. As a result, companies with similar operating margins may
have substantially different net income margins due to differences in leverage.
Furthermore, as net income is impacted by taxes, companies with similar operating
margins may have varying net income margins due to different tax rates.
EXHIBIT 1.14 Net Income Margin
Net Income Margin = Net Income
sales
Growth Profile
A company’s growth profile is a critical value driver. In assessing a company’s growth
profile, the banker typically looks at historical and estimated future growth rates as well
as compound annual growth rates (CAGRs) for selected financial statistics.
Return on Investment
Return on invested capital (ROIC) measures the return generated by all capital
provided to a company. As such, ROIC utilizes a pre-interest earnings statistic in the
numerator, such as EBIT or tax-effected EBIT (also known as NOPAT or EBIAT) and a
metric that captures both debt and equity in the denominator (see Exhibit 1.16). The
denominator is typically calculated on an average basis (e.g., average of the balances as
of the prior annual and most recent periods).
EXHIBIT 1.16 Return on Invested Capital
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ROIC = EBIT
Average Net Debt + Equity
Return on equity (ROE) measures the return generated on the equity provided to a
company by its shareholders. As a result, ROE incorporates an earnings metric net of
interest expense, such as net income, in the numerator and average shareholders’ equity
in the denominator (see Exhibit 1.17). ROE is an important indicator of performance as
companies are intently focused on shareholder returns.
EXHIBIT 1.17 Return on Equity
Net Income
Average Shareholders’ Equity
ROE =
Return on assets (ROA) measures the return generated by a company’s asset base,
thereby providing a barometer of the asset efficiency of a business. ROA typically
utilizes net income in the numerator and average total assets in the denominator (see
Exhibit 1.18).
EXHIBIT 1.18 Return on Assets
Net Income
Average Total Assets
ROA =
Dividend yield is a measure of returns to shareholders, but from a different perspective
than earnings-based ratios. Dividend yield measures the annual dividends per share paid
by a company to its shareholders (which can be distributed either in cash or additional
shares), expressed as a percentage of its share price. Dividends are typically paid on a
quarterly basis and, therefore, must be annualized to calculate the implied dividend yield
(see Exhibit 1.19). For example, if a company pays a quarterly dividend of $0.05 per
share ($0.20 per share on an annualized basis) and its shares are currently trading at
$10.00, the dividend yield is 2% (($0.05 × 4 payments) / $10.00).
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EXHIBIT 1.19 Implied Dividend Yield
Most Recent Quarterly Dividend Per Share × 4
Current Share Price
Implied Dividend Yield =
Credit Profile
Leverage - Leverage refers to a company’s debt level. It is typically measured as a
multiple of EBITDA (e.g., debt-to-EBITDA) or as a percentage of total capitalization
(e.g., debt-to-total capitalization). Both debt and equity investors closely track a
company’s leverage as it reveals a great deal about financial policy, risk profile, and
capacity for growth. As a general rule, the higher a company’s leverage, the higher its
risk of financial distress due to the burden associated with greater interest expense and
principal repayments.
Debt-to-EBITDA - depicts the ratio of a company’s debt to its EBITDA, with a higher
multiple connoting higher leverage (see Exhibit 1.20). It is generally calculated on the
basis of LTM financial statistics. There are several variations of this ratio, including total
debt-to-EBITDA, senior secured debt-to-EBITDA, net debt-to-EBITDA, and total debt-
to-(EBITDA less capex). As EBITDA is typically used as a rough proxy for operating
cash flow, this ratio can be viewed as a measure of how many years of a company’s cash
flows are needed to repay its debt.
EXHIBIT 1.20 Leverage Ratio
Leverage = Debt
EBITDA
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Debt-to-total capitalization - measures a company’s debt as a percentage of its total
capitalization (debt + preferred stock + non controlling interest + equity) (see Exhibit
1.21). This ratio can be calculated on the basis of book or market values depending on the
situation. As with debt-to-EBITDA, a higher debt to- total capitalization ratio connotes
higher debt levels and risk of financial distress.
EXHIBIT 1.21 Capitalization Ratio
Debt
Debt + Preferred Stock + Noncontrolling Interest + Equity
Debt-to-Total Capitalization =
Coverage - Coverage is a broad term that refers to a company’s ability to meet (“cover”)
its interest expense obligations. Coverage ratios are generally comprised of a financial
statistic representing operating cash flow (e.g., LTM EBITDA) in the numerator and
LTM interest expense in the denominator. There are several variations of the coverage
ratio, including EBITDA-to-interest expense, (EBITDA less capex)-to-interest expense,
and EBIT-to-interest expense (see Exhibit 1.22). Intuitively, the higher the coverage
ratio, the better positioned the company is to meet its debt obligations and, therefore, the
stronger its credit profile.
EXHIBIT 1.22 Interest Coverage Ratio
EBITDA, (EBITDA – Capex), or EBIT
Interest Expense
Interest Coverage Ratio =
Credit Ratings A credit rating is an assessment by an independent rating agency of a
company’s ability and willingness to make full and timely payments of amounts due on
its debt obligations. Credit ratings are typically required for companies seeking to raise
debt financing in the capital markets as only a limited class of investors will participate in
a corporate debt offering without an assigned credit rating on the new issue.
The three primary credit rating agencies are Moody’s, S&P, and Fitch. Nearly every
public debt issuer receives a rating from Moody’s, S&P, and/or Fitch. Moody’s uses an
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alphanumeric scale, while S&P and Fitch both use an alphabetic system combined with
pluses (+) and minuses (−) to rate the creditworthiness of an issuer.
Supplemental Financial Concepts and Calculations
Calculation of LTM Financial Data U.S. public filers are required to report their
financial performance on a quarterly basis, including a full year report filed at the end of
the fiscal year. Therefore, in order to measure financial performance for the most recent
annual or LTM period, the company’s financial results for the previous four quarters are
summed. This financial information is sourced from the company’s most recent 10-K and
10-Q, as appropriate. As previously discussed, however, prior to the filing of the 10-Q or
10-K, companies typically issue a detailed earnings press release in an 8-K with the
necessary financial data to help calculate LTM performance. Therefore, it may be
appropriate to use a company’s earnings announcement to update trading comps on a
timely basis.
As the formula in Exhibit 1.24 illustrates, LTM financials are typically calculated by
taking the full prior fiscal year’s financial data, adding the YTD financial data for the
current year period (“current stub”), and then subtracting the YTD financial data from the
prior year (“prior stub”).
EXHIBIT 1.24 Calculation of LTM Financial Data
Prior
Fiscal Year
Current
Stub
Prior
LTM = + – Stub
In the event that the most recent quarter is the fourth quarter of a company’s fiscal year,
then no LTM calculations are necessary as the full prior fiscal year (as reported) serves as
the LTM period. Exhibit 1.25 shows an illustrative calculation for a given company’s
LTM sales for the period ending 9/30/08.
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EXHIBIT 1.25 Calculation of LTM 9/30/08 Sales
($ in millions)
Q1 Q2 Q3 Q4 Q1 Q2 Q3
3/31 6/30 9/30 12/31 3/31 6/30 9/30
Prior Fiscal Year
Plus: Current Stub
Less: Prior Stub
Last Twelve Months
Fiscal Year Ending December 31
2007 2008
$750
$1,000
$850
$600
Calendarization of Financial Data - The majority of U.S. public filers report their
financial performance in accordance with a fiscal year (FY) ending December 31, which
corresponds to the calendar year (CY) end. Some companies, however, report on a
different schedule (e.g., a fiscal year ending April 30). Any variation in fiscal year ends
among comparable companies must be addressed for benchmarking purposes. Otherwise,
the trading multiples will be based on financial data for different periods and, therefore,
not truly “comparable.”
To account for variations in fiscal year ends among comparable companies, each
company’s financials are adjusted to conform to a calendar year end in order to produce a
“clean” basis for comparison, a process known as “calendarization.” This is a relatively
straightforward algebraic exercise, as illustrated by the formula in Exhibit 1.26, used to
calendarize a company’s fiscal year sales projection to produce a calendar year sales
projection.
EXHIBIT 1.26 Calendarization of Financial Data
(Month #) × (FYA Sales)
12
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Next Calendar Year (CY) Sales = +
(12 – Month #) × (NFY Sales)
12
Note: “Month #” refers to the month in which the company’s fiscal year ends (e.g. the
Month # for a company with a fiscal year ending April 30 would be 4). FYA = fiscal year
actual and NFY = next fiscal year.
Adjustments for Non-Recurring Items - To assess a company’s financial performance
on a “normalized” basis, it is standard practice to adjust reported financial data for non-
recurring items, a process known as “scrubbing” or “sanitizing” the financials. Failure to
do so may lead to the calculation of misleading ratios and multiples, which, in turn, may
produce a distorted view of valuation. These adjustments involve the add-back or
elimination of one-time charges and gains, respectively, to create a more indicative view
of ongoing company performance. Typical charges include those incurred for
restructuring events (e.g., store/plant closings and headcount reduction), losses on asset
sales, changes in accounting principles, inventory write-offs, goodwill impairment,
extinguishment of debt, and losses from litigation settlements, among others. Typical
benefits include gains from asset sales, favorable litigation settlements, and tax
adjustments, among others.
Non-recurring items are often described in the MD&A section and financial footnotes in
a company’s public filings (e.g., 10-K and 10-Q) and earnings announcements. These
items are often explicitly depicted as “non-recurring,” “extraordinary,” “unusual,” or
“one-time.” Therefore, the banker is encouraged to comb electronic versions of the
company’s public filings and earnings announcements using word searches for these
adjectives. Often, non-recurring charges or benefits are explicitly broken out as separate
line items on a company’s reported income statement and/or cash flow statement.
Research reports can be helpful in identifying these items, while also providing color
commentary on the reason they occurred.
In many cases, however, the banker must exercise discretion as to whether a given charge
or benefit is non-recurring or part of normal business operations. This determination is
sometimes relatively subjective, further compounded by the fact that certain events may
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be considered non-recurring for one company, but customary for another. For example, a
generic pharmaceutical company may find itself in court frequently due to lawsuits filed
by major drug manufacturers related to patent challenges. In this case, expenses
associated with a lawsuit should not necessarily be treated as non-recurring because these
legal expenses are a normal part of ongoing operations. While financial information
services such as Capital IQ provide a breakdown of recommended adjustments that can
be helpful in identifying potential non-recurring items, ultimately the banker should
exercise professional judgment.
When adjusting for non-recurring items, it is important to distinguish between pre-tax
and after-tax amounts. For a pre-tax restructuring charge, for example, the full amount is
simply added back to calculate adjusted EBIT and EBITDA. To calculate adjusted net
income, however, the pre-tax restructuring charge needs to be tax-effected50 before
being added back. Conversely, for after-tax amounts, the disclosed amount is simply
added back to net income, but must be “grossed up” at the company’s tax rate (t) (i.e.,
divided by (1 – t)) before being added back to EBIT and EBITDA.
Adjustments for Recent Events - In normalizing a company’s financials, the banker
must also make adjustments for recent events, such as M&A transactions, financing
activities, conversion of convertible securities, stock splits, or share repurchases in
between reporting periods. Therefore, prior to performing trading comps, the banker
checks company SEC filings (e.g., 8-Ks, registration statements/prospectuses) and press
releases since the most recent reporting period to determine whether the company has
announced such activities.
For a recently announced M&A transaction, for example, the company’s financial
statements must be adjusted accordingly. The balance sheet is adjusted for the effects of
the transaction by adding the purchase price financing (including any refinanced or
assumed debt), while the LTM income statement is adjusted for the target’s incremental
sales and earnings. Equity research analysts typically update their estimates for a
company’s future financial performance promptly following the announcement of an
M&A transaction. Therefore, the banker can use updated consensus estimates in
combination with the pro forma balance sheet to calculate forward-looking multiples.
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Calculation of Key Trading Multiples
Once the key financial statistics are spread, the banker proceeds to calculate the relevant
trading multiples for the comparables universe. While various sectors may employ
specialized or sector-specific valuation multiples (see Exhibit 1.33), the most generic and
widely used multiples employ a measure of market valuation in the numerator (e.g.,
enterprise value, equity value) and a universal measure of financial performance in the
denominator (e.g., EBITDA, net income). For enterprise value multiples, the denominator
employs a financial statistic that flows to both debt and equity holders, such as sales,
EBITDA, and EBIT. For equity value (or share price) multiples, the denominator must be
a financial statistic that flows only to equity holders, such as net income (or diluted EPS).
Among these multiples, EV/EBITDA and P/E are the most common.
The following sections provide an overview of the more commonly used equity value and
enterprise value multiples.
Equity Value Multiples
Price-to-Earnings Ratio / Equity Value-to-Net Income Multiple The P/E ratio,
calculated as current share price divided by diluted EPS (or equity value divided by net
income), is the most widely recognized trading multiple. Assuming a constant share
count, the P/E ratio is equivalent to equity value-to-net income. These ratios can also be
viewed as a measure of how much investors are willing to pay for a dollar of a
company’s current or future earnings. P/E ratios are typically based on forward-year
EPS53 (and, to a lesser extent, LTM EPS) as investors are focused on future growth.
Companies with higher P/Es than their peers tend to have higher earnings growth
expectations.
The P/E ratio is particularly relevant for mature companies that have a demonstrated
ability to consistently grow earnings. However, while the P/E ratio is broadly used and
accepted, it has certain limitations. For example, it is not relevant for companies with
little or no earnings as the denominator in these instances is de minimus, zero, or even
negative. In addition, as previously discussed, net income (and EPS) is net of interest
expense and, therefore, dependent on capital structure. As a result, two otherwise similar
companies in terms of size and operating margins can have substantially different net
income margins (and consequently P/E ratios) due to differences in leverage. Similarly,
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accounting discrepancies, such as for depreciation or taxes, can also produce meaningful
disparities in P/E ratios among comparable companies.
The two formulas for calculating the P/E ratio (both equivalent, assuming a constant
share count) are shown in Exhibit 1.30.
EXHIBIT 1.30 Equity Value Multiples
Equity Value
Net Income
Share Price
Diluted EPS
Enterprise Value Multiples - Given that enterprise value represents the interests of both
debt and equity holders, it is used as a multiple of unlevered financial statistics such as
sales, EBITDA, and EBIT. The most generic and widely used enterprise value multiples
are EV/EBITDA, EV/EBIT, and EV/sales (see Exhibits 1.31 and 1.32). As with P/E
ratios, enterprise value multiples tend to focus on forward estimates in addition to LTM
statistics for framing valuation.
Enterprise Value-to-EBITDA and Enterprise Value-to-EBIT Multiples EV/EBITDA
serves as a valuation standard for most sectors. It is independent of capital structure and
taxes, as well as any distortions that may arise from differences in D&A among different
companies. For example, one company may have spent heavily on new machinery and
equipment in recent years, resulting in increased D&A for the current and future years,
while another company may have deferred its capital spending until a future period. In
the interim, this situation would produce disparities in EBIT margins between the two
companies that would not be reflected in EBITDA margins.
For the reasons outlined above, as well as potential discrepancies due to acquisition-
related amortization, EV/EBIT is less commonly used than EV/EBITDA. However,
EV/EBIT may be helpful in situations where D&A is unavailable (e.g., when valuing
divisions of public companies) or for companies with high capex.
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EXHIBIT 1.31 Enterprise Value-to-EBITDA and Enterprise Value-to-EBIT
Enterprise Value
EBITDA
Enterprise Value
EBIT
Enterprise Value-to-Sales Multiple EV/sales is also used as a valuation metric,
although it is typically less relevant than the other multiples discussed. Sales may provide
an indication of size, but it does not necessarily translate into profitability or cash flow
generation, both of which are key value drivers. Consequently, EV/sales is used largely
as a sanity check on the earnings-based multiples discussed above.
In certain sectors, however, as well as for companies with little or no earnings, EV/sales
may be relied upon as a meaningful reference point for valuation. For example, EV/sales
may be used to value an early stage technology company that is aggressively growing
sales, but has yet to achieve profitability.
EXHIBIT 1.32 Enterprise Value-to-Sales
Enterprise Value
Sales
Sector-Specific Multiples - Many sectors employ specific valuation multiples in addition
to, or instead of, the traditional metrics previously discussed. These multiples use an
indicator of market valuation in the numerator and a key sector-specific financial,
operating, or production/capacity statistic in the denominator.
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Step IV. Benchmark the Comparable Companies.
The next level of analysis requires an in-depth examination of the comparable companies
in order to determine the target’s relative ranking and closest comparables. To assist in
this task, the banker typically lays out the calculated financial statistics and ratios for the
comparable companies (as calculated in Step III) alongside those of the target in
spreadsheet form for easy comparison (see Exhibits 1.53 and 1.54). This exercise is
known as “benchmarking.”
Benchmarking serves to determine the relative strength of the comparable companies
versus one another and the target. The similarities and discrepancies in size, growth rates,
margins, and leverage, for example, among the comparables and the target are closely
examined. This analysis provides the basis for establishing the target’s relative ranking as
well as determining those companies most appropriate for framing its valuation. The
trading multiples are also laid out in a spreadsheet form for benchmarking purposes (see
Exhibits 1.2 and 1.55). At this point, it may become apparent that certain outliers need to
be eliminated or that the comparables should be further tiered (e.g., on the basis of size,
sub-sector, or ranging from closest to peripheral).
Once the initial universe of comparable companies is selected and key financial statistics,
ratios, and trading multiples are spread, the banker is set to perform benchmarking
analysis. Benchmarking centers on analyzing and comparing each of the comparable
companies with one another and the target. The ultimate objective is to determine the
target’s relative ranking so as to frame valuation accordingly. While the entire universe
provides a useful perspective, the banker typically hones in on a selected group of closest
comparables as the basis for establishing the target’s implied valuation range. The closest
comparables are generally those most similar to the target in terms of business and
financial profile.
We have broken down the benchmarking exercise into a two-stage process. First, we
benchmark the key financial statistics and ratios for the target and its comparables in
order to establish relative positioning, with a focus on identifying the closest or “best”
comparables and noting potential outliers. Second, we analyze and compare the trading
multiples for the peer group, placing particular emphasis on the best comparables.
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Benchmark the Financial Statistics and Ratios
The first stage of the benchmarking analysis involves a comparison of the target and
comparables universe on the basis of key financial performance metrics. These metrics,
as captured in the financial profile framework outlined in Steps I and III, include
measures of size, profitability, growth, returns, and credit strength. They are core value
drivers and typically translate directly into relative valuation.
The results of the benchmarking exercise are displayed on spreadsheet output pages that
present the data for each company in an easy-to-compare format (see Exhibits 1.53 and
1.54). These pages also display the mean, median, maximum (high), and minimum (low)
for the universe’s selected financial statistics and ratios.
A thoughtful benchmarking analysis goes beyond a quantitative comparison of the
comparables’ financial metrics. In order to truly assess the target’s relative strength, the
banker needs to have a strong understanding of each comparable company’s story. For
example, what are the reasons for the company’s high or low growth rates and profit
margins? Is the company a market leader or laggard, gaining or losing market share? Has
the company been successful in delivering upon announced strategic initiatives or
meeting earnings guidance? Has the company announced any Recent M&A transactions
or significant ownership/management changes? The ability to interpret these issues, in
combination with the above-mentioned financial analysis, is critical to assessing the
performance of the comparable companies and determining the target’s relative position.
Benchmark the Trading Multiples
The trading multiples for the comparables universe are also displayed on a spreadsheet
output page for easy comparison and analysis (see Exhibit 1.55). This enables the banker
to view the full range of multiples and assess relative valuation for each of the
comparable companies. As with the financial statistics and ratios, the means, medians,
highs, and lows for the range of multiples are calculated and displayed, providing a
preliminary reference point for establishing the target’s valuation range.
Once the trading multiples have been analyzed, the banker conducts a further refining of
the comparables universe. Depending on the resulting output, it may become apparent
that certain outliers need to be excluded from the analysis or that the comparables should
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be further tiered (e.g., on the basis of size, sub-sector, or ranging from closest to
peripheral). The trading multiples for the best comparables are also noted as they are
typically assigned greater emphasis for framing valuation.
After completing Steps I to III, we were prepared to perform the benchmarking analysis
for PGCIL.
The first two benchmarking output pages focused on the comparables’ financial
characteristics, enabling us to determine PGCIL relative position among its peers for key
value drivers (see Exhibits 1.53 and 1.54). This benchmarking analysis, in combination
with a review of key business characteristics (outlined in Exhibit 1.3), also enabled us to
identify PGCIL closest comparables—in this case, Lajoux Global, Momper Corp., and
McMenamin & Co. These closest comparables were instrumental in helping to frame the
ultimate valuation range.
Similarly, the benchmarking analysis allowed us to identify outliers, such as Vucic
Brands and Paris Industries, which were determined to be less relevant due to their size
and profitability. In this case, we did not eliminate the outliers altogether. Rather, we
elected to group the comparable companies into three tiers based on size—Large-Cap,
Mid-Cap, and Small-Cap. The companies in the “Mid-Cap” and “Small-Cap” groups are
closer in size and other business and financial characteristics to PGCIL and, therefore,
more relevant in our view. The companies in the “Large- Cap” group, however, provided
further perspective as part of a more thorough analysis.
We used the output page in Exhibit 1.55 to analyze and compare the trading multiples for
PGCIL comparables. As previously discussed, financial performance typically translates
directly into valuation (i.e., the top performers tend to receive a premium valuation to
their peers, with laggards trading at a discount). Therefore, we focused on the multiples
for PGCIL closest comparables as the basis for framing valuation.
Step V. Determine Valuation.
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The trading multiples of the comparable companies serve as the basis for deriving a
valuation range for the target. The banker typically begins by using the means and
medians for the relevant trading multiples (e.g., EV/EBITDA) as the basis for
extrapolating an initial range. The high and low multiples for the comparables universe
provide further guidance in terms of a potential ceiling or floor. The key to arriving at the
tightest, most appropriate range, however, is to rely upon the multiples of the closest
comparables as guideposts. Consequently, only a few carefully selected companies may
serve as the ultimate basis for valuation, with the broader group serving as additional
reference points. As this process involves as much “art” as “science,” senior bankers are
typically consulted for guidance on the final decision. The chosen range is then applied to
the target’s relevant financial statistics to produce an implied valuation range.
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BIBLIOGRAPHY
1. http://www.powergridindia.com/_layouts/PowerGrid/User/index.aspx?
LangID=English
2. https://en.wikipedia.org/wiki/Power_Grid_Corporation_of_India
3. http://www.moneycontrol.com/india/stockpricequote/power-generation-
distribution/powergridcorporationindia/PGC
4. https://www.edelweiss.in/company/Power-Grid-Corporation-of-India-Ltd.html
5. http://powermin.nic.in/growth-transmission-sector
6. http://www.powergridindia.com/_layouts/PowerGrid/WriteReadData/file/
Investors/Annual_Report/AR_2013-14.pdf
7. http://as.wiley.com/WileyCDA/Section/id-400478.html
8. http://www.investopedia.com/terms/c/comparable-company-analysis-cca.asp
9. https://en.wikipedia.org/wiki/Valuation_(finance)
10.
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