DCF for distressed companies?
Why are DCFs not very useful for valuing distressed companies from the perspective of an RX advisory shop? Is it any different for distressed investors?
My thinking (for RX shops) is that they just care about resizing the capital structure in the near term while DCF tries to determine the value of the business from a long term view. Also, it may be more useful to just value the company using the lower end of multiples of its comps because that'll inform you of what the market is willing to pay for it (rather than projecting out what cash flows will exactly look like in the next 5-10 years, which will likely be wrong due to the wide range of scenarios for distressed companies). Is this the right way to think about it?
Bump
Probably because DCF is cap structure agnostic and doesn't factor in the distress.
DCF gets you enterprise value, which is what you want (as it informs you of how much debt the business handle). If you value a distressed company on a levered basis, you'd get an equity value that's close to zero. So I don't think this is the right idea.
I think you are thinking about this a little backwards. The DCF value is meaningless unless the company can service the debt which is what i was getting to.
You don't value the company (intrinsically / hypothetically) and then apply a capital structure to that. You need to work with what exists there today and that current stream of cash flows to try to determine optimal capital structure if the company is in distress.
That makes sense - apologies for misinterpreting what you said. So given that we "need to work with what exists there today and that current stream of cash flows" (DCF is flawed here because it projects out cash flows?), is that why the market multiple method (or using avg multiple of comps) is more useful than DCF?
I don't think I perfectly understand the question.
But how I would value this would be:
1) Apply some discount multiple which factors in that this is in distress
2) Model out the cash flows / capital structure to look at the paydown over time. Make some exit assumptions and return assumption and back into what you're willing to pay for this today.
But I'm not in Rx so i dont really know. I do know they barely touch DCF though.
Analyst at a top rx shop here. Not sure how it’s done internally at other shops but DCFs are pretty standard valuation methodologies and are used all the time in putting forth a formal valuation in the disclosure statement for ch. 11 processes.
Certain industries, such as those in structural decline or those that are highly cyclical, may need adjustments to the treatment of the terminal value, but we still use them.
Understanding the value of an asset is core to understanding where the value breaks and what class is the fulcrum.
Defer to this guy then. Our team barely knew their way around an income statement but i dont actually know for sure.
Lol, what does this even mean? (genuine question)
Thanks for the input. How would you even be able to project out what FCF will be in a few years for a distressed company? Isn't there a very wide range of scenarios / different RX solutions it could go through -- how would you be able to factor all of that in?
Basically is the purpose of a DCF for a distressed company just to support a valuation that gives your client the best recovery or is it actually helpful in determining what the business is worth (perhaps from the perspective of a distressed investor)?
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