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Leveraged Buyouts, and Mergers & Acquisitions

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Leveraged Buyouts, and Mergers & Acquisitions Chepakovich valuation model 1 Chepakovich valuation model The Chepakovich valuation model uses the discounted cash flow valuation approach. It was first developed by Alexander Chepakovich in 2000 and perfected in subsequent years. The model was originally designed for valuation of “growth stocks” (ordinary/common shares of companies experiencing high revenue growth rates) and is successfully applied to valuation of high-tech companies, even those that do not generate profit yet. At the same time, it is a general valuation model and can also be applied to no-growth or negative growth companies. In a limiting case, when there is no growth in revenues, the model yields similar (but not the same) valuation result as a regular discounted cash flow to equity model. The key distinguishing feature of the Chepakovich valuation model is separate forecasting of fixed (or quasi-fixed) and variable expenses for the valuated company. The model assumes that fixed expenses will only change at the rate of inflation or other predetermined rate of escalation, while variable expenses are set to be a fixed percentage of revenues (subject to efficiency improvement/degradation in the future – when this can be foreseen). This feature makes possible valuation of start-ups and other high-growth companies on a Example of future financial performance of a currently loss-making but fast-growing fundamental basis, i.e. with company determination of their intrinsic values. Such companies initially have high fixed costs (relative to revenues) and small or negative net income. However, high rate of revenue growth insures that gross profit (defined here as revenues minus variable expenses) will grow rapidly in proportion to fixed expenses. This process will eventually lead the company to predictable and measurable future profitability. Unlike other methods of valuation of loss-making companies, which rely primarily on use of comparable valuation ratios, and, therefore, provide only relative valuation, the Chepakovich valuation model estimates intrinsic (i.e. fundamental) value. Other distinguishing and original features of the Chepakovich valuation model are: • Variable discount rate (depends on time in the future from which cash flow is discounted to the present) to reflect investor’s required rate of return (it is constant for a particular investor) and risk of investment (it is a function of time and riskiness of investment).[1] The base for setting the discount rate is the so-called risk-free rate, i.e. the yield on a corresponding zero-coupon Treasury bond. The riskiness of investment is quantified through use of a risk-rating procedure. • Company’s investments in means of production (it is the sum of tangible and intangible assets needed for a company to produce a certain amount of output – we call it ‘production base’) is set to be a function of the revenue growth (there should be enough production capacity to provide increase in production/revenue). Surprisingly many discounted cash flow (DCF) models used today do not account for additional production capacity need when revenues grow. • Long-term convergence of company’s revenue growth rate to that of GDP.[2] This follows from the fact that combined revenue growth of all companies in an economy is equal to GDP growth and from an assumption that Chepakovich valuation model 2 over- or underperformance (compared to the GDP) by individual companies will be eliminated in the long run (which is usually the case for the vast majority of companies – so vast, indeed, that the incompliant others could be treated as a statistical error). • Valuation is conducted on the premise that change in company’s revenue is attributable only to company’s organic growth rate. This means that historical revenue growth rates are adjusted for effects of acquisitions/divestitures. • Factual cost of stock-based compensation of company’s employees that does not show in the company’s income statement is subtracted from cash flows. It is determined as the difference between the amount the company could have received by selling the shares at market prices and the amount it received from selling shares to employees (the actual process of stock-based compensation could be much more complicated than the one described here, but its economic consequences are still the same). • It is assumed that, subject to availability of the necessary free cash flow, the company’s capital structure (debt-to-equity ratio) will converge to optimal. This would also have an effect on the risk rating of the company and the discount rate. The optimal capital structure is defined as the one at which the sum of the cost of debt (company’s interest payments) and its cost of equity (yield on an alternative investment with the same risk – it is a function of the company’s financial leverage) is at its minimum. References [1] Amine Bouchentouf, Brian Dolan, Joe Duarte, Mark Galant, Ann C. Logue, Paul Mladjenovic, Kerry Pechter, Barbara Rockefeller, Peter J. Sander, Russell Wild, "High-Powered Investing All-In-One For Dummies", 2008, ISBN 9780470186268, p. 596. [2] Peter J. Sander, Janet Haley, "Value Investing For Dummies", 2008, ISBN 9780470232224, p. 214. Article Sources and Contributors 3 Article Sources and Contributors Chepakovich valuation model Source: http://en.wikipedia.org/w/index.php?oldid=433037062 Contributors: Bearcat, CactusWriter, Edward, Investor123, Katharineamy, R'n'B, Ronz, SMasters, 2 anonymous edits Image Sources, Licenses and Contributors Image:Chepakovich model-chart1.JPG Source: http://en.wikipedia.org/w/index.php?title=File:Chepakovich_model-chart1.JPG License: Public Domain Contributors: investor123 License Creative Commons Attribution-Share Alike 3.0 Unported http:/ / creativecommons. org/ licenses/ by-sa/ 3. 0/ Fundamental analysis 1 Fundamental analysis Fundamental analysis of a business involves analyzing its financial statements and health, its management and competitive advantages, and its competitors and markets. When applied to futures and forex, it focuses on the overall state of the economy, interest rates, production, earnings, and management. When analyzing a stock, futures contract, or currency using fundamental analysis there are two basic approaches one can use; bottom up analysis and top down analysis.[1] The term is used to distinguish such analysis from other types of investment analysis, such as quantitative analysis and technical analysis. Fundamental analysis is performed on historical and present data, but with the goal of making financial forecasts. There are several possible objectives: • to conduct a company stock valuation and predict its probable price evolution, • to make a projection on its business performance, • to evaluate its management and make internal business decisions, • to calculate its credit risk. Two analytical models When the objective of the analysis is to determine what stock to buy and at what price, there are two basic methodologies 1. Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprice the security. 2. Technical analysis maintains that all information is reflected already in the stock price. Trends 'are your friend' and sentiment changes predate and predict trend changes. Investors' emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does not care what the 'value' of a stock is. Their price predictions are only extrapolations from historical price patterns. Investors can use any or all of these different but somewhat complementary methods for stock picking. For example many fundamental investors use technicals for deciding entry and exit points. Many technical investors use fundamentals to limit their universe of possible stock to 'good' companies. The choice of stock analysis is determined by the investor's belief in the different paradigms for "how the stock market works". See the discussions at efficient-market hypothesis, random walk hypothesis, capital asset pricing model, Fed model Theory of Equity Valuation, Market-based valuation, and Behavioral finance. Fundamental analysis includes: 1. Economic analysis 2. Industry analysis 3. Company analysis On the basis of these three analyses the intrinsic value of the shares are determined. This is considered as the true value of the share. If the intrinsic value is higher than the market price it is recommended to buy the share . If it is equal to market price hold the share and if it is less than the market price sell the shares. Fundamental analysis 2 Use by different portfolio styles Investors may use fundamental analysis within different portfolio management styles. • Buy and hold investors believe that latching onto good businesses allows the investor's asset to grow with the business. Fundamental analysis lets them find 'good' companies, so they lower their risk and probability of wipe-out. • Managers may use fundamental analysis to correctly value 'good' and 'bad' companies. Eventually 'bad' companies' stock goes up and down, creating opportunities for profits. • Managers may also consider the economic cycle in determining whether conditions are 'right' to buy fundamentally suitable companies. • Contrarian investors distinguish "in the short run, the market is a voting machine, not a weighing machine".[2] Fundamental analysis allows you to make your own decision on value,
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