Valuing Private Companies in FIG
Hi all,
Looking to switch into FIG and a few questions have come up while prepping for interviews:
- If you are dealing with a small, unlisted financial institution:
- Are illiquidity discounts still applied when looking at public comps’ equity value multiples and if so, are the typical illiquidity discounts the same as they would be when valuing companies in other industries (i.e. in the 20-30% range)?
- Are there alternatives to comparable comps, precedent transactions and DDMs if the institution’s balance sheet is tiny relative to peers + the institution does not issue dividends?
- If you wanted to sell a loan book of a lender, rather than the entity itself, are you “allowed” to forecast and discount cash flows as you would for a regular DCF (e.g. project forward future interest earned, interest expenses, loss rate, cost of funds and assume all loans are paid back/become bad debts by x date)?
- My understanding is that DCFs are a no-go for FIG, even if you are focusing on LFCF, as there are too many issues in terms of estimating the cost of capital, differentiating between what is cash flow from financing vs operations and the fact that capex + NWC have a completely different purpose compared to an upstream oil company for example. However, I am wondering whether you can gauge a rough valuation by using a proxy for cash flow (e.g. net interest income – impairment – opex)?
- In a typical M&A deal, you will typically assume that the acquirer either assumes the debt of the target or refinances the debt due to change of control provisions embedded in the debt arrangements. How does this work in FIG?
- If debt is such a significant proportion of total capital (e.g. in the vicinity of 80-90% in most cases), are you expected to pay down and refi all the debt? How does this impact the purchase price?
Thanks in advance!
Bump
Bump
Here's what to do in the aforementioned scenario, assuming you work in FIG:
Step 1 - Turn on computer
Step 2 - Pull up your resume
Step 3 - Send your resume to EVERY non-FIG banker on the street
Step 4 - Get another job
Step 5 - Quit, because no one wants to work in FIG
bump
Very quick responses as I'm currently on the toilet.
1.1. Yes there are illiquidity discounts but perversely there are change of control premiums. I.e. think about the premium you have to offer on the current price of a stock to buy majority shares (if doing a public to private). I think the change of control premium 'nets' out any illiquidity discount. Your trading comps should be relatively consistent with your PTs.
1.2. Confused by your question and why there wouldn't be any dividends? Can I ask what type of business you're referring to? Always start with the main source of revenue and use the most appropriate valuation methodology. E.g. if looking at a bank focus on DDM, P/BV and P/E multiples. I always prefer P/BV as it immediately tells you whether their return on equity is higher than their cost of equity and vice versa.
If you're looking at a business which has both capital light and capital heavy business models then do a sum of the parts valuation. E.g. you're valuing a loan servicing and loan acquiring business. Value the loan servicing revenue streams on an EBITDA Multiple on the loan acquiring on a P/BV
2. Correct you never use a DCF on a financial institution even if you're using levered FCF because its almost impossible to get from Net income to LFCF - hence we use DDMs and your only real variable from net income to dividends will be your regulatory capital.
However, it is very common to use a DCF to value a loan book or a bond. When valuing a loan book or a bond using a DCF don't get confused by thinking youre forecasting/discounting 'FCFE' just think of the coupon as any form of cash flow.
At a very high level yes think of your interest income, interest expense and then you're impairments. By 'opex' if you mean servicing costs then yes.
3. Don't think of fig assets in the way you normally think of businesses. e.g. a normal business you have your equity value + your debt which gets you EV. In FIG think of your Equity value as your EV. Debt is not a form of capital in the conventional manner as it directly creates your revenue.
e.g. for a bank, deposits are a form of liabilities or 'debt'. However when a bank changes ownership hands the deposits will not be given back to the depositors.
Long story short, the debt is not repaid or refi'd - it is a core part of the business not a type of capital in the conventional way.
If you have any questions fire away and I will try to answer them when I have a bit more time. If you can't tell im a banking (and non-bank lending) guy not an insurance guy however I also work on capital light transactions such as wealth management, asset management etc.
Great post. Would you have any colour on best practices when modelling a lending business such as a bank? Which line items are the most important, what metrics do you look at?
Also, how do you forecast financials? What are the key assumptions that you make?
Re: the point about no dividends, perhaps not for a private company but for the subsidiary of a commercial bank (for example), how would you think about a DDM?
I’d imagine dividends are distributed at the parent level, so if you’re trying to value the subsidiary separately, would you just assume a certain payout ratio and discount accordingly to get to implied eq value?
Assume a CET1 ratio and a leverage ratio as constraints, and discount the maximum dividend you can extract every year.
I think a DCF of sorts can be done for a loan book, i.e. even in a securitization, the equity portion of the book is valued via a DCF (more akin to an O&G / Mining NAV model if anything though in the sense of projecting till depletion) at a set discount rate
Voluptatem minus consequatur quos nesciunt occaecati aut deleniti. Dicta harum est laudantium recusandae. Vitae sed aliquid et. Nesciunt ut voluptates aut non mollitia sequi aut. Sint fugit minima culpa hic et ipsa. Eius nesciunt earum quibusdam quo cumque nulla dolor.
Est id quo aut aut illum. Quo asperiores quia blanditiis quasi et deserunt atque et. Atque consequuntur distinctio quam aut.
Iure rerum excepturi suscipit iste harum neque aliquid. Reiciendis esse sint neque necessitatibus suscipit tempore vitae.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...