DCF - Convertible Debt Treatment
There's two DCF scenarios where I'm not 100% sure how to approach the discount rate and what value I'm ultimately arriving at with the discounting (EV or equity value). Can anyone check my logic below?
In both situations we assume the company is not planning on taking on any straight debt.
- A company that has no debt whatsoever:
- For this company, WACC = Ke (since there's no debt in the WACC weighting of debt / equity)
- The type of cash flows we want to be valuing are levered FCFs. Levered FCFs include the impact of interest income (significant for this company) and expense (there's none)
- Discounting the levered FCFs, we get to equity value. We don't make any adjustments for net debt or minority interest (company has significant minority investments) since these are already included in the equity value
- For a company that has lots of convertible debt, but no straight debt
- For this company, we assume that all the converts will convert soon in the future--i.e., we assume there is no debt, so WACC = Ke (**I know that Damodaran would say that you should split the convert into 2 portions, a convert option (equity) portion and a straight debt portion, then figure out what the market rate on the straight debt would be...)
- Is it still right to use unlevered CFs and discount them at the WACC (which is effectively Ke)? If yes, then when we make the standard adjustments to get from EV to equity value, do we assume there's no debt (given that we already assumed it all converts), but we do account for the cash balance and minority interest?
Would appreciate any help!
Here's what I think: because a company doesn't have debt it doesn't mean the cash flows take cash into account. I/S is consolidated -- minority interest effects are still there unless you took them into account.
You're essentially doing an unlevered fcf dcf, but your wacc=kE. If the company had $1 in debt, how would the analysis and value differ from the one in question here? WACC would be the same but you'd have to add cash back.
As far as convertibles go, I'd do an adjusted WACC, where the first years it's a WACC then it converts into your kE. Same principle applies as above. LFCF = CF to equity holders. Minority interest CFs do not correspond to equity holders.
DCF Question (RE Management Company w/ Convertible Pref. Shares) (Originally Posted: 04/20/2017)
I am about to do valuation for a pitch to the principal shareholder of a listed real estate management company (sellside proposal), with football field included. This will be based on public information only, so I can't do anything too detailed (i.e. sum of the parts or valuation of specific assets/properties).
On top of RE management (e.g. fee-based property maintenance), the company also does development and brokerage services. Since this is my first time dealing with this sector, any advice on what to look out for would be really appreciated. The projections for the development business seems to be the most difficult of the 3 businesses, due to its "flow-based" nature.
As for multiples, I plan on just using EV/EBITDA and EV/EBIT trading/transaction multiples. (Not too sure if this matters for valuation method but the company has negative net debt.)
Also, the company has convertible preferred stock outstanding (out of the money) as well, so would the Cost of Preferred Stock be the dividend yield, weighted to the proportion of the sum of Debt/Equity/Pref. Stock, for WACC? Or are there other better methods? The main problem with this is that the yield is based on an absolute value multiplied by LIBOR + x bps, so I am open to suggestions.
Any advice would be really helpful. Thanks in advance.
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