A few quick questions interviewing at L/S for the first time...
I come from PE so beg your pardon if these are basic questions but
- I'm modeling a SW company. Do I need to model GAAP or do I need to model the non-GAAP way that management likes to talk about?
- Do I need to model the full 3 statements, or is down to cash flow fine? Full three statements won't move the needle for the point I'm trying to make.
- Do I need to model FCF less SBC, or can I just take out SBC in my returns analysis to factor in dilution? In my mind, a lot cleaner.
Thank you
Based on the most helpful WSO content, here are some insights to guide you:
GAAP vs. Non-GAAP Modeling:
When modeling a software company, it's common to focus on non-GAAP metrics, as these are often the numbers management emphasizes in their guidance and discussions. Non-GAAP figures can provide a clearer picture of the company's operational performance by excluding one-time costs, restructuring charges, or other adjustments. However, always cross-check with GAAP numbers to ensure there are no significant discrepancies or manipulations that could mislead your analysis.
Full 3 Statements vs. Cash Flow:
If the full three statements won't materially impact the point you're trying to make, focusing on cash flow should suffice. Many hedge fund analysts prioritize cash flow modeling to understand the true profitability and operational efficiency of the business. However, ensure your cash flow analysis is detailed enough to capture key drivers and potential risks.
FCF Less SBC vs. Adjusting for SBC in Returns Analysis:
Adjusting for SBC (Stock-Based Compensation) in your returns analysis to account for dilution is a cleaner and more straightforward approach. This aligns with how many investors evaluate software companies, as SBC can significantly impact shareholder returns. Just ensure you're transparent about your methodology and its implications.
Good luck with your interview—sounds like you're on the right track!
Sources: Basic Guide Ramping Up On A Company With Public Information Part Three, Anatomy of the 10-K, Software LBO Models for Practice, Corporate Finance Q&A with accountingbyday, BJM85, STorIB, and djfiii
Following helpful
You wanna use adjusted numbers (non-gaap) — press releases provide reconciliation.
Don’t need to model out every single line. I aggregate everything non essential in other assets/liabilities in my models. Obviously want to have notable line items like receivables so you can see if they are ticking up / may have to take a charge on PNL due to rev rec.
In terms of FCF (I’m not in tech), but FCF = cash from ops less capex. If SBC is notable I’ll have another line under FCF that is FCF less SBC.
I have never actually done the NOPAT + non cash - capex - nwc that I memorized for my interviews out of college. This is pretty standard practice in public equities.
ty king. timely response, very helpful, this is great. appreciate you.
Why FCF less SBC? why does anyone do this? instead of just incurring the additional dilution in share count for returns analysis?
Think the reason ppl don’t do it like that w/ dilution in the public mkts is bc you’re not looking at an investment like a PE firm would. You’re looking at a target price vs where the stock is trading rn - not a detailed returns analysis. Think in PE you have much more control/capital locked up for much longer so care much more abt the targeted IRR or whatever you guys use.
Fcf less SBC isnt a super common by any means but ive used it before.
This is more of my own pet peeve/tangent — but if a company pays their comp in stock (+cash from ops) and then repurchases shares to offset dilution (-cash from fianncing) there it is literally just moving $ from one bucket to another and they should get zero credit for it in FCF.
Great point. Learned something. Makes perfect sense. Banana for you. Again, super helpful don't know where I'd be without the good folks of the community.
SBC should be considered like any other compensation. If the firm wasn’t to compensate via stock options, they would likely have to increase cash comp by a similar amount, so it’s reasonable to think of total comp opex line item as comp and benefits + SBC. This gets a little tricky at times when companies have super lumpy SBC expenses, and that’s why companies tend to add back SBC as an EBITDA adjustment, but from a cash flow and valuation perspective it should be treated as an expense.
Yeah always tend to net it through adjusted EBITDA
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