Value Company With Negative Free Cash Flows

How do you value a compnay with negative free cash flow for 2007? Do you look at an average of the last five years? I believe that you look at multiples, could somebody please confirm that.

Negative FCF Valuation

If you have a negative free cash flow value in a historical year - this is not necessarily relevant to the valuation moving forward. In this case you should focus on forward looking valuation methodologies both intrinsic valuations and comparable analysis based methods which we will discuss below. The same holds true for negative free cash flow in the projection window - however, if there is negative free cash flow through the majority of the projection window you will likely be unable to use a discounted cash flow analysis.

Intrinsic Valuation with Negative FCF

If you are doing a discounted cash flow analysis - you can proceed with the valuation as normal as long as the free cash flow is not negative in the terminal year and if the sum of the discounted cash flows in the projection window are not negative. Again - if the negative free cash flow value is in the historical period - it does not matter for the purposes of the valuation.

Read more about how to do a discounted cash flow analysis.

Comparable Analysis with Negative Free Cash Flow

If you are valuing a company with a metric like price to free cash flow and the past year of cash flow is negative - you should use the next year estimate for free cash flow to determine a share price. IE if it is 2017, and the last twelve months had negative cash flow, you should use the projected next twelve months cash flow to determine the share price (alternatively you could use the 2018 estimate).

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Comments (19)

Apr 22, 2008 - 12:58am

Is the firm cyclical? If so, you can "normalize" earnings, by looking at the most recent positive cash flow CYCLE, and taking an average. If it's a one time thing, you want to know why. From there, it's a judgement call. If it's long term: you have some problems.

You can also value claims on the company (equity and debtholders) as a real option.

Apr 22, 2008 - 11:11am

If they are projecting positive future EBITDA, find a good public comp set and apply their EV/2008E EBITDA and EV/2009E EBITDA multiple to try and get a ballpark valuation. If you are trying to value a private company, might want to put on a discount of 10% or so for the illiquidity. Would be tough to use precedent transactions as they are generaly valued at a EV/LTM EBITDA which is worthless if the EBITDA is negative.

At the end of the day, any buyer, be it the public or otherwise, will be buying the future earnings. Though historical is not worthless by any means, you can't drive a car looking in the rearview mirror.
Apr 22, 2008 - 1:39pm

The appropriate answer totally depends on your investment thesis.

As mentioned before, for an early-stage company you may be using metrics that indicate future earnings potential (even though the idea of using revenue multiples makes me throw up a little in my mouth), while earnings from cyclical businesses (e.g., logging companies, residential builders) should always be normalized to the extent possible.

Alternatively, one could purchase a cash flow negative business based on nothing more than asset value (although outstanding liabilities must be taken into consideration) if the game plan is to profit by liquidating those assets of the unprofitable business.

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Apr 22, 2008 - 1:40pm

DCF with negative cash flows (Originally Posted: 12/11/2013)

Doing a 10-year DCF on a company that from year 7 onwards has negative profit and fcf. It is a mature industry, company is in decline so no turnaround expected. So:

1) Is it ok to discount all cash flows (+ve or -ve) @ given discount rate?

2) Perpetuity value becomes negative as well (negative last year cash flow and negative terminal growth rate).

Does that make sense?

Apr 22, 2008 - 1:42pm

1. yes, discounting is still ok by the same discount rate (edit: AS LONG AS the CoC/WACC stays the same. because of the fact that your perpetuity value is negative, i'd question whether your WACC stays the same because the underlying business fundamentals are changing).

however, it doesn't make sense to do a DCF this way because a company like this won't be going on for 'perpetuity' conceptually. you'd have to end the DCF before perpetuity under the assumption that the company is either going bankrupt, closing shop, or getting acquired.

Apr 22, 2008 - 1:47pm

Kidflash -- not sure I understand this...what do you mean by ending the DCF? Do you mean not just taking a TV and just taking PV of CFs Y1-Y7 and using that as enterprise value?

Apr 22, 2008 - 1:50pm


@ CaR: Not sure I understood you...; PV of TV is negative as well (negative Y10 FCF @ negative TV "growth" rate) yields negative TV (and hence negative PV of TV).

Going off what kidflash said, if you're getting negative CFs in your forecast, you shouldn't use a perpetuity model. Instead, take your terminal year EBITDA and apply an exit multiple to it (these vary by industry/stage of business cycle; try looking at comparables. Some people use EV/EBITDA as the exit multiple, but since you can't determine that without your TV, that might not always make sense. ). Say your determined exit multiple is 8; take terminal yr. ebitda and multiply by 8, and then add your negative CFs. That will give you your EV figure.

Apr 22, 2008 - 1:44pm

Realistically speaking, if the company has negative cash flows into perpetuity after year 7, you should calculate a liquidation value at that date and discount back to the present.

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