Intriguing Technical Question
(Orangutan, 268
Points)
on 6/14/11 at 10:05pm
Hi guys,
I have a technical question in relation to DCF and capital raisings that some of you might be able to help me with:
- When doing a DCF for capital raising purposes (more specifically new equity), after discounting the cash flows and summing them to the PV of Terminal Value you would get to your Enterprise Value. Then you would deduct Net Debt to get to your equity value.
My question then is: does it result a Pre-Money or a Post-Money Equity Value???
wouldnt the stand alone value
wouldnt the stand alone value be pre-money, and then when you run the valuation again with the new equity thrown in there it is post-money?
^^^Yeah, I agree with above.
^^^Yeah, I agree with above. Is the capital from the round included in those projections? For example, if your DCF includes all that is going to be done with that money (i.e. buy a factory, for example), then the valuation will be post-money.
If you are instead doing a DCF that is as if the new equity hasn't come in, then it's a pre-money value.
It depends on what you've included in your model...
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alexpasch wrote: ^^^Yeah, I
^^^Yeah, I agree with above. Is the capital from the round included in those projections? For example, if your DCF includes all that is going to be done with that money (i.e. buy a factory, for example), then the valuation will be post-money.
If you are instead doing a DCF that is as if the new equity hasn't come in, then it's a pre-money value.
It depends on what you've included in your model...
I agree with alex, it's post money. I'm going to guess but you probably got the business plan from the CFO/VP of Fin or something and are using it to build Management Case FCF projections. Looking in their CFS you'll prob see a placeholder of cash inflow from the raise. If this is for an early stage co or growth capital raise, and you are modeling the expected business plan that is catalyzed from that specific raise, then the firm wouldn't have the ability to achieve that plan without the new funding, hence the fact this is a post money valuation.
DurbanDiMangus
^^^Yeah, I agree with above. Is the capital from the round included in those projections? For example, if your DCF includes all that is going to be done with that money (i.e. buy a factory, for example), then the valuation will be post-money.
If you are instead doing a DCF that is as if the new equity hasn't come in, then it's a pre-money value.
It depends on what you've included in your model...
I agree with alex, it's post money. I'm going to guess but you probably got the business plan from the CFO/VP of Fin or something and are using it to build Management Case FCF projections. Looking in their CFS you'll prob see a placeholder of cash inflow from the raise. If this is for an early stage co or growth capital raise, and you are modeling the expected business plan that is catalyzed from that specific raise, then the firm wouldn't have the ability to achieve that plan without the new funding, hence the fact this is a post money valuation.
to arrive @ pre$, run a cash burn analysis to see how much they need to bridge to cash flow positive --that's what they need to raise. back out the raise from the post$ equity value from your DCF to get a pre$ valuation. holler
So Durban, let me see if I
So Durban, let me see if I got your point: you are saying to lui that because company's forecasts already account for the capital raising (growth in revenue, new machinery, more staff, etc), your resultant Equity Value is a post-money value since company will only be able to execute business plan with that capital. Is that the idea?
And what is a "Cash Burn" Analysis? How is this analysis done?
Marbled - correct. Let's
Marbled - correct.
Let's assume this capital is funding a growth type corporate investment that will catalyze future equity value step-function style--let's assume a growth stage firm that has been already developing an early-stage game winning product in-house and needs further growth equity capital to bridge the funding needs until product traction. As you alluded to, without this capital the firm will burn much cash due to a severe increase in R&D, new PPE, FTEs, Rents, Marketing, etc, that will be required to launch this product prior to any real revenue generation.
In this scenario the management team should be sending you and your team a model reflecting their intended growth business plan--which should be producing heavy losses and heavy cash burn in early years, with hockey stick like earnings and cash flow growth as market share picks up thanks to this new business/product. Within this model will be a cash flow statement which will likely have the intended equity capital raise in financing activities.
A cash burn analysis is just a full cash flow forecast which drives your cash balance--however the end result should be identifying how much capital the company needs to offset the years of negative cash flow ("cash burn") prior to the company reaching cash flow breakeven.
The entire point of a DCF is
The entire point of a DCF is to separate operating from financing decisions. You calculate your EV based on unlevered FCF. This is not dependent on financing (i.e. you can finance the required expenditure with debt or equity which is reflected in your target mix and therefore the WACC). However, you can then calculate the implied equity value either pre-money or post-money. Pre-money would be if you used the current net debt of the company pre any equity issue. Post-money would be if you adjusted the debt for the new equity raised (e.g. in an IPO valuation where you raise primary capital to reduce leverage). Same applies to the implied per share value as you can adjust the share count for the new equity raised in a stock issue. Think some of the comments above are more relevant for VC-type valuation so be careful with this in a general banking interview (obviously if you meant VC with "new equity" instead of general IPO or a stock issue, then all good stuff).
Thank you all for the
Thank you all for the contribution. Very helpful indeed!
To Alpine: I'm not sure I understood your point. Because although you calculate your EV based on unlevered FCF, I understand that when your FCF projections assume you have successfully raised capital (more revenues, CFs, buy fixed assets, etc) you end up with a Post-money EV - without the capital you wouldn't be able to realise your forecasts / plan and consequently deliver those cash flows. Even in your IPO example - if you are raising capital to grow the company, invest in R&D and purchase a new plant, for example, your forecasts will reflect that through accelarated growth, greater revenues and cash flows, etc, therefore it is implied that the resulting EV and equity value are both post-money values. I think the concept is still the same, whether it is an IPO or not.
Could you elaborate on this "current net debt" and "adjusted net debt" that you mentioned above? My question was more directed towards whether the DCF output is a Pre or Pots-money value on a capital raising scenario.
The point is that in any
The point is that in any standard DCF, you assume that capital is available to finance your expected cash outflows (i.e. you are not capital constrained). How you want to finance this is reflected in your debt/equity mix and therefore your WACC. Typically, you would not figure out how much capital you have and then imply cash flows based on how you spend this (wrong way around). Instead, you look at a business profile based on the opportunities identified (e.g. by management) and then calculate your EV (you can of course have various scenarios depending on how aggressive you are on expanding the company). This EV doesn't change pre or post-money (i.e. it's not a function of how much capital you raise). WACC should of course be based on your long-term target capital structure and also not be impacted by any capital raisings (unless you change your capital structure policy). The implied equity value is then either pre or post-money. Pre-money would be using today's net debt before any new equity raise (i.e. to see what the value per share is today). Post-money would be using the pro forma net debt assuming the capital has been issued (if it's primary capital). For example, assume your company has an EV of 500m and current net debt of 200m, its pre-money equity value would be 300m. Then you issue 100m new equity. The EV would still be 500m, but now you would only have 100m net debt and therefore the post-money equity value would be 400m. Hope this is somewhat helpful.
Alpine wrote: This EV doesn't
This EV doesn't change pre or post-money (i.e. it's not a function of how much capital you raise).
I think you're missing the point. No one is arguing this. He's talking about equity value.
Alpine, from Enterprise Value
Alpine, from Enterprise Value to Equity Value, I understand what you are doing. You are essentially saying that because you raised new equity, your pro forma net debt will reduce and therefore you will have a higher equity value which will be post-money. In your scenario, you used the new equity to pay off part of your debt. However, remember that conceptually we want excess cash to calculate equity value, and if you raised money to finance growth and expansion, for example, this new cash won't be sitting on the balance sheet as an idle asset, and therefore your theory above will not apply - because you will use this cash to fund growth in your operations.
But going back to my original post: what I'm trying to focus is on the immediate output of a DCF model: when you sum PV of Unlevered FCF + PV of terminal value = Enterprise Value, and from that EV you subtract your CURRENT Net Debt, which results in your: a). Post-Money Equity Value; or b). Pre-Money Equity Value????
That was my doubt....
Alpine, further on this
Alpine, further on this issue, let's take your example to analyse:
1. You've got the mgmt. team with all these great, fantastic opportunities as you stated above
2. You project your cash flows based on these opps. and you come up with an EV of $500m, as per your case above
3. You then reduce it by the current Net Debt of $200m. Your resultant Equity Value is $300 million
4. Above, you say this is your PRE-MONEY Equity value - because you used CURRENT Net Debt
5. Let's say you were an investor that wanted to sponsor these initiatives and put in $50m
6. Assume the Company has 15 million shares on issue as of today (pre any capital raising)
7. Based on your comments, your Pre-Money Equity Value per share would be $20.00 ($300m / 15m shares)
8. You would get 2.5 million new shares issued to you, and end up with 14.29% of the company (2.5 million / 17.5 million shares)
BUT, as an investor you would think: hang on a second, without the capital I'm bringing in, these opportunities wouldn't be pursued and therefore those projected cash flows probably wouldn't be achievable as well. As a rational investor, you then say:
1. This $500 million EV is only achievable with my cash infusion, and cash flow forecasts imply this - that's the only way mgmt. will deliver on those opps. and cash flow forecasts;
2. As a result, when you take out current Net Debt of $200m from that EV, you would get a POST-MONEY Equity value of $300m
3. Then your ownership would be calculated as: $50m / $300m = 16.67%
4. As an investor, what would make more sense to you: the 14.29% or the 16.67% of the company, knowing that the company needs your capital to grow???
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In my opinion, if you are
In my opinion, if you are subtracting current net debt, it's pre-money and if you are adjusting for the new equity raise, then it's post money.
Someone with VC experience should comment how this applies in that situation but for a general corporate DCF, you don't assume that the company needs new investors' capital to calculate your valuation (i.e. the company is not capital constrained). New investors would invest at the existing valuation (where current investors can also invest).
Also, you wouldn't assume the new equity raised would be used immediately. You are just calculating today's equity value implied by the 500m valuation (pre and post the equity raise). You only exclude operating cash in your EV-equity bridge (i.e. if it's tied up in the company's operations, such as restricted customer deposits, cash float required to run the company, etc. - this is not impacted by any specific new equity raise - you do not exclude cash in the bridge just because you will use it at some point in the future for e.g. capex). The company will continue to raise equity and debt capital to fund its capital needs and achieve its target equity/debt mix on average over time.
DurbanDiMangus wrote: Alpine
This EV doesn't change pre or post-money (i.e. it's not a function of how much capital you raise).
I think you're missing the point. No one is arguing this. He's talking about equity value.
Agreed - was just trying to make this clear as "you end up with a Post-money EV" was mentioned. EV is not pre/post-money as this is irrelevant.