My name's Deborah Taylor.

I'm a trainer at Financial Edge.

I've been working as a trainer now for about five, six years.

Before that I spent nearly 10 years working in investment banking.

I worked in equity research at Barclays, where I was an accounting evaluation analyst.

So looking at advanced valuation issues is absolutely my bread and butter, and I'll share some of my expertise with you today.

So absolutely, there's quite a lot that we're gonna cover.

So feel free to access the recording later on and review some of the topics.

Great. So what are we gonna cover? We've got an hour on a Friday to talk about advanced valuation.

Well, we're gonna start off with the assumption that we're all very comfortable with the basics of DCF and multiples, but sometimes those basics just aren't quite enough to build a really robust valuation.

So three topics that tend to come up and that we are gonna look at are, first of all, how we can build a DCF with a variable valuation date.

So that's valuing a company not on the first day of its fiscal year, which in reality only happens once every 365 days.

What happens if we're valuing a company midway through its fiscal year where we'll look at how to deal with that.

Secondly, how can we extend our WACC formula? Our basic WACC formula assumes debt and equity only.

How can we modify that to consider other elements of the capital structure? So we'll be covering that as well.

And then the final topic, a really useful topic, is how we can use some of the parts valuation for varying conglomerates.

So for those of you that are looking at valuation of particularly more mature listed companies, some of the parts valuation is a very useful technique.

So those are three topics that we're gonna cover.

We've got a whole hour for it.

I think that's a reasonable amount of time.

I will also be using Felix, as we go through the session, hopefully by accessing this webinar, you can access Felix yourselves as well.

But, as we're going through, if you need to, you can just sort of follow the, the data that I'm displaying on the screen.

I've had the odd question come in already on the q and a.

And as you can see, I'm happy to take questions as we go through.

So yeah, please don't suffer in silence.

If there's anything that you're not clear on just drop me a message in the q and a box and I will pause and respond to those as we're going through.

I'll also just allow a few minutes of q and a right at the end.

Okay. Let's dive in.

So, just a reminder that the materials that I'm going to be using in this session, they are available to you at the link that I previously shared.

So feel free to follow on, on your own screens as we are going through with that.

Okay. I am gonna share my screen now.

I've been asked to do is share the link again.

I will do that. There we go.

There's the link for materials in the chat box there.

Okay, so discounting with a variable valuation date, what do we mean by this? Well, the reality is we do rarely value a company right at the beginning of its fiscal year.

Most of the time we're some midpoint, uh, of the year during its fiscal period.

Let's have a look at this company that we're gonna value.

Okay, so here we have a timeline on a screen.

The valuation date, t equals x. I reckon that's about halfway through its fiscal year.

So we'll assume we are six months away from this company's year end.

Okay? So we've got six months till the year end.

We'll also assume we're midyear discounting.

So when we are mid-year discounting, we assume that the cash flows occur at the midpoint of a fiscal period.

Okay, so I've got someone on the chat messaging to say they can't see the link.

So just give me a, I'll see if I can answer that.

Hang on.

Ah, There we go.

I've sent the link also in the q and a box, so hopefully that's working for you.

Okay. So we are going to, uh, look at DCF where we are discounting basically at the midpoint of the financial year.

So we've got six months between the fiscal period end date and the valuation date.

But reassuming mid period discounting, which means the actual cash flows, if I just update my slide, well, the cashflow timing occurs on average at the midpoint, of the remaining time period.

So here, for example, where we have a valuation date halfway through the year, well, we've then got three months between the average point at which the cash flows occur.

'cause those cash flows occur throughout the six months. So on average occur three months from the valuation date.

That's for the first fiscal year.

What about for the next fiscal year? Well, actually the midpoint of the next fiscal year is halfway through that fiscal year.

So we've got six months, from the start of, year two is when the actual cashflow occurs.

And that, as you can see, is a whole year from our valuation date.

So what we're going to need to do is find a way to adjust our discounting, our discount factor for the correct time period.

Okay? So that's the first thing that we're gonna do, is adjust our discount factor so that our year count no longer assumes that we are valuing a company right at the start of its fiscal year.

So let's have a look at how we make those adjustments.

Well, for this particular company where we are discounting halfway through its first fiscal year, well, that period, that time period between the first cash flow and the valuation date is a quarter of a year.

So that's three months, that's a quarter of a year.

So our discount factor is gonna reflect that quarter of a year. And I'll give you a formula for calculating this very shortly.

But for this example, it's a quarter.

The second period, well, we've got a whole year between our valuation date and the timing of our next cashflow.

So our year count for our next cashflow is going to be one year, and thereafter every period is gonna go up by a year.

Okay? So if period three, it's going to be a discount factor with a year count of two, and the next year it'll be a year count of three.

Okay? So we can see in theory how this is going to work, but we need to build some formulas that are robust regardless of what the valuation date is.

But there is one further modification that we need to make when we're building our DCF using a variable valuation date.

We also need to allow for the fact that in the first fiscal, year or first forecasts, we only have a re the remaining portion of the cash flows to include in our discounting.

Remember, we're only gonna discount future cash flows.

And in this particular example, that means we're only gonna be discounting half of a full year's forecast.

Okay? So we're gonna time a portion the first fiscal forecast in our DCF just for the remaining cash flows.

So that's the theory. Let's now walk through the steps that we are going to take and, uh, we are going to then put that into practice.

Okay? So, uh, we are going to, uh, start off with understanding or identifying our valuation date.

And most of the time that will be using today's date. There is an Excel function, a today function, which will automatically generate, uh, today's date.

Every time you open the Excel file. It also automatically updates with, we then need to calculate the cashflow date for each time period.

And remember, we are assuming ordinary that we are mid period adjusting.

Now, for the first fiscal period, that's going to be, the cashflow date's gonna be the average.

That's the bid point between the valuation date and the first fiscal period end thereafter.

The cashflow date is going to be the midpoint of each fiscal year.

So we can use the average function in Excel, I'm sorry to calculate that midpoint in each of those time periods.

The next thing we need to do is calculate the actual number of days between the valuation date and that cashflow date.

And of course, Excel allows us to calculate the day count difference for dates just by subtracting one date from another.

Um, and so that's what we're going to do. We take the cashflow date, subtract the valuation date, and that gives you the number of days for discounting.

We then need to convert that into a year count simply by dividing by 365.

And we can then take that year count and put that into our standard discount factor calculation.

And then the final step, remember, is we then need to time a portion our first year's cash flow.

So we work out the fraction of the year that is remaining, that's the first fiscal period, end date, less valuation date divided by 365.

That gives you the fraction of the year remaining.

Multiply that by the full year's forecast cash flows, and that will give you the amount that we need to discount for that first, uh, for the first forecast period.

So that's the theory there. Let's dive in.

We are now gonna go into our workout files, and I'm gonna ask you to open up the advanced DCF valuation file, and I'm gonna ask you to scroll down to work out five.

That's the one we're gonna work in.

Um, and then we'll do a slightly more complicated example, uh, straight after.

Um, okay. So here we have, um, some information.

Uh, an analyst has prepared some full year forecasts, and we're asked to use the assumptions and the data provided to value this company as at the 1st of March, 2021.

And we'll assume cash flows fall in the middle of each period.

So there's our valuation date, the 1st of March, 2021.

We've got long-term growth rate of 3% and a cost of capital of 9%.

Um, and as soon as we see that long-term growth rate, we know that we can use our growing or growth perpetuity formula for calculating our terminal value.

We've got free cash flow forecasts for the next four years.

So we've got everything that we need to build our, uh, DCF with a variable valuation date.

Okay, so the first thing we need to do is find out the date of our cash flows.

So the first cash flow, we are looking for the midpoint between the valuation date of the 1st of March and the end of December.

So that's the midpoint of that 10 month stretch.

I'm gonna use the average formula, and I'm gonna take the average of the valuation date and that first fiscal period end, and that gives me the midpoint of the 31st of July.

In subsequent periods, the midpoint is going to be the difference, obviously the average, uh, for the beginning and the end of each fiscal period.

So we can see there the cashflow timing is slightly different in subsequent years.

It's on the 1st of July because it's the midpoint of year, end of December.

So that's gonna be the 1st of July at midpoint.

Uh, whereas the first forecast year, it's the midpoint between the valuation date and the first fiscal period end date.

Um, in terms of the days for discounting, well, the days for discounting, uh, that's going to be the difference between the cashflow date and the valuation date.

And if I lock my reference to the valuation date, I can reuse this formula as I copy out to the right. So I'm gonna copy that out to the right.

I'll display my formula. And you can see there, um, that we've got the number of days that we need to discount each of our cash flows.

Uh, we need to convert that into a year count.

So we're gonna take that divide by 3 6, 5, um, and that gives us the number of years, uh, represented by those num those days for discounting.

The next step is to take, calculate our discount factor using our new year count.

So we take one divided by one plus hour cost of capital, lock your reference to that sell, and then raise that to the power of your year count.

And I always express my discount factor as a percentage.

Just makes it easier to see the actual numbers.

And you can see there, my discount factor starts off at 96.5% all the way through to 75% for my fourth, uh, year.

The next step we must not forget to do, which is to time portion our fa our first year's cash flows for discounting.

Now, for this, we need to build a little formula, 'cause we need to work out the fraction of a year.

We know that it's basically 10 months, uh, but we can calculate that in Excel by taking our, uh, time between our fiscal period end date and the valuation date, divide that by 3 6 5.

We then multiply our free cash flow forecast for the full year, and that's gonna give us, uh, the remaining cash flows of 2647.5.

That's basically 10 months worth of that full year forecast, Right? So we've kind of set ourselves up for the variable valuation date calculations.

The rest of the process is basically going to be, uh, very similar to a standard DCF.

Uh, we will calculate our terminal value.

So we're gonna take our file years free cash flow forecast, we'll use it our growing perpetuity formula.

So multiply that by one plus your long-term growth, divide that by your cost of capital, less your long-term growth.

And that gives my terminal value.

And because I have used the growing perpetuity formula, which always assumes that the next year's cash flows occurs in one year's time, I know that I can, um, basically use my discount factor, um, for my individual explicit cashflow forecasts.

Um, as I same discount factor for my terminal values, the timing of those is completely aligned.

So no concerns with using that, right? The next step is to calculate the present value of my free cash flow. So I'm gonna take my free cash flow for my first forecast periods and multiply that by my discount factor.

And then in subsequent years, I take the full year's cash flow and my discount factor for each year, and that gives me the present value of my cash flows.

Then my present value of my terminal value.

As I mentioned, I just take my final discount factor and apply that to my terminal value for the final period.

And that gives me my present value of my terminal value.

And finally, my enterprise value.

Well, that's just gonna be the sum of all the present value of my cash flows plus the present value of my terminal value.

And there we go. I have an enterprise value of 58349.5.

Okay? So that's the, the steps that we follow.

Um, a question I'm sometimes asked, um, is kind of what problem we are trying to solve when we are doing this, because you could just say to me, well, Debs, you could just assume the valuation data is at the start of the year.

And I completely agree, but having been an equity research analyst, um, it does present you with a bit of a problem.

Okay? So for example, if I assume I'm always valuing a company at the start of the fiscal year. So here we have a company where, um, we are valuing it on the start, uh, of its, um, of its first day of its fiscal periods.

And we'll assume that for the whole of the duration of that year, I've just built a little mini DCF.

And you can see there my enterprise value, uh, 1592.8, or my cash flows being discounted.

Well, at some point, I'm gonna need to roll my model forward, okay? And if I roll my model forward on the last day of the fiscal year, suddenly, um, these cash flows here are going to become my first forecast year.

So when I roll this forward, and this basically year one in my previous forecast becomes year zero, then my enterprise value jumps up because effectively I'm discounting the next year's cash flows by one year less.

And those are bigger because of the effects of growth growth. So the benefit of this technique, the variable, uh, valuation date technique, is that you end up with a valuation every day it rolls forward, or every time you open your model, it rolls forward by a day, and it's seamless when you transition from one fiscal period to another.

So a very useful, um, technique.

Um, before we move on from this, um, let's do one more cal set of calculations. We're gonna build a mini model.

Uh, we're gonna do that for Keurig Dr. Pepper.

So I'm gonna ask you now to open up the advanced DCF Keurig Dr Pepper workout file.

Um, very, very simple. We do need to build some forecasts.

Um, and then we are going to, uh, build a little DCF using those forecasts.

So a little bit more involved, um, but just allows us to kind of see something that's a bit more realistic in terms of how A DCF would look.

So we've got all the assumptions that we need.

Um, those assumptions are mostly based on consensus numbers.

You can see there the comments, um, alongside those assumptions.

Um, so let's build our forecast.

First of all, it'll just take a few minutes.

It won't take very long, right? So first of all, let's forecast our sales for each forecast year. And I'm gonna do that just in the first year to start with, and then copy those across.

So my ca my sales for the first year are 16.2 billion or just under that.

Um, and then I'm gonna take my EBITDA margin assumption and apply that to my sales.

So I now have my forecasts book card Dr.

Pepper's, uh, EBITDA for 2025, and we're gonna have to come back to the EBIT.

We're gonna jump down to CapEx next, um, because we're gonna need to calculate CapEx and then DNA to calculate our EBIT, uh, we've got a CapEx assumption.

So CapEx to sales, a 3.7% pretty standard for a consumer business to have CapEx to around three to 4% of sales.

So let's multiply that by your sales figure, multiply by minus one to show that as a cash outflow.

And that gives me CapEx of minus 599.2.

Now in terms of the DNA, um, here we are gonna take our CapEx figure, divide it by our CapEx to DNA ratio there, and then multiply that by minus one to give a negative, uh, to give a positive figure for our DNA, uh, in our, um, free cashflow calculation.

So I've got 587.5 of DNA.

Um, that means I can now go back and update my EBIT forecast 'cause I have my ebitda, I subtract my DNA, um, that then allows me to calculate my EBIT. So my EBIT for correct Dr. Pepper in the first forecast year is 4287.3.

Next step is to calculate the tax on that.

So if we take our effective tax rates, multiply that by your EBIT, multiply that by minus one, and that gives us a tax on our EBIT.

And if we add the EBIT and deduct that tax, that's gonna give us our notepad.

So we are nearly there with our free cash flow calculation for, uh, the first year.

The final piece of the jigsaw is of course, our change in operating working capital.

Now we've got assumption here, um, that, uh, operating working capital and net operating working capital is negative for ox pepper. It does have very large, uh, very long payables days, very, a lot of negotiating power.

Its suppliers. Um, so we're gonna take that assumption minus 16%, multiply that by sales.

And that gives us our, uh, first forecast years operating working capital.

Now it's negative operating, working capital in both the historical and the first forecast period.

It's becoming more negative and increasing your liabilities.

That's gonna give us a cash inflow in our free cashflow calculation.

So if I take the prior year figure, subtract the first forecast year figure, that gives me a small cash inflow of 68.2 of my change in operating working capital.

The final step in our free cash flow calculation is then just to sum your notepad down to through your reinvestment, uh, requirements.

And that gives me my free cash flow of 3314.9.

When you're building that, just be careful that you don't double count your notepad and your EBIT and tax there.

So just be careful with that.

Once we've done that, we can then copy across all of our forecasts to the right to the end of 2030.

And we've got all of the ingredients we need to mix up our DCF.

Okay, so let's have a look down here, uh, at what we've got.

So first of all, we've been given the cost of capital, uh, for KE Dogs Pepper.

Um, you'll see that that's been taken from our, um, from our Felix, uh, WAC calculator.

So you can see here that I've used an industry, uh, beta, uh, 20 year, uh, risk-free rates, equity risk premium of six, 6% there, giving us a whack at the moment for ox pepper of 7.97%. That's the number that we are using.

Uh, got long-term growth of 2.5%.

Um, so the next step we can do is calculate our terminal value based based on a perpetuity formula.

So using the same formula that we used earlier, multiply your final cash flow by one plus G, divide that by your cost of capital unless your long term growth.

And that gives me a terminal value of 72890.4, We're now into the world of discounting.

So we're gonna do our variable vis, uh, valuation date discounting now.

So you'll see here with user today function.

So today, function with empty brackets, uh, generates a valuation date of to date, which is of course the 28th of March, 2025.

Um, you'll then see that I have, uh, built a little conditional formula here to calculate the percentage of the cash flows that we need to incorporate in our DCF.

So, um, I've just set the condition that if the valuation date is greater than the previous year's, uh, uh, fiscal period end, then we time apportion that cashflow.

Otherwise, we take a hundred percent of the cash flow.

So that just means that we always end up only time apportioning the first forecast year, right? The next step, of course, is to calculate our cash flow date, and we will mid period adjust our cash flows.

So we're gonna use the average function, remember for mid period adjusting our cash flows, we'll take the valuation dates, uh, and the fiscal period end dates we go up, okay? And that gives us the 14th of August, 2025 for the first forecast periods cash flow.

Um, in all subsequent periods, we're just gonna take the beginning and the end of the fiscal period.

Okay? So that gives us, uh, cash flows eight for the next forecast year of 1st of July.

That's the mid point of that year, okay? We then need to convert that into a year count.

So we are just going to basically calculate the data discounting and convert it straight into a year count, all in one step.

So we take our cashflow date, we subtract our valuation date, and if you lock your reference to that valuation date, we can reuse the formula and then divide by 365.

And that gives that year count that we can then use in our discount factor calculation.

Next step is to build your discount factor.

So this hopefully feels quite, uh, straightforward for you.

One plus our cost of capital.

I'm gonna lock my reference so I can reuse my formula, raise that to the number of years for discounting, and I get 97.1% as my discount factor for my first period and copy that to the right.

So we then have all of our discount factors available.

We're then going to calculate the present value of our free cash flows.

So what we're gonna do is for each forecast year, we take the full forecast cash flow, multiply it by the percentage adjustment, um, for that first year, and then multiply that by your discount factor and then copy to the right.

There we go. So we've got the present value of our free cash flows all calculated.

Uh, the next step is to calculate, uh, the sum of the present value of our cash flows. So I'm gonna sum all those cash flows together.

We're then gonna calculate the present value of our terminal value, and that's just our terminal value, uh, for 2030, multiplied by the discount factor for 2030, uh, giving me a terminal value, uh, in present value terms of just under $50 billion.

And I can then sum together the cash flows and the terminal value to give an enterprise value for Co Dr. Pepper about $65 billion. Okay? And if we want to, we can then continue going over our EV bridge.

So we deduct add debt, add cash and investments given an equity value of $52 billion, divide that by the share count. That's the fully diluted share count, and that gives us an implied value of $38, which compared with the closing price at yesterday, $34 gives us a premium of 11.6%.

You might be tempted to go back and question whether or not you agree with, uh, some of those assumptions, particularly I think the working capital assumption's quite punchy for Kerry Dr. Pepper having that negative working capital all the way through the forecasts.

But at least we can be comfortable the fact that the actual valuation technique is really robust in terms of it only capturing future cash flows and, uh, and make making sure that those cash flows are discounted exactly by the number of days, uh, between the cashflow date and the valuation date.

So that is, uh, a technique that we can use for particularly when we are building a valuation where we need to keep updating that.

And particularly if there's a risk that we're gonna roll over from one fiscal period to another during our valuation, it does avoid that kind of step change in our value.

Any questions coming in on the, on the chat or the q and a? I'm just having a quick look. I can't see any questions.

I will just pause before we move on.

Okay, in that case, let's keep going.

Um, we'll go back to our slides.

Uh, our next topic is cost of capital.

Okay? So, uh, let's remind ourselves, uh, of the normal WAC formula.

Uh, so remember, we ordinarily assume that a company has either equity or debt financing, and we use a weighted, uh, a weighting of the, uh, cost of capital for our equity and our debt.

Um, so that uses our required return on equity and the percentage financing from equity, and that's using market values.

Um, uh, and then the cost of debts multiplied by the weighting of debts.

And then remember, we have that tax shield one minus the tax rate because our cash flows are un levered, they do not capture any, uh, interest in our cash flows.

And therefore the tax shield that arises with interest is of course included in our WAC formula.

The only other thing to flag is to remember that we are using target capital structure in our weighting, okay? So, um, particularly if you've got a younger company, um, it may not yet be at that target capital structure.

We need to make sure that we use those target weightings in our WAC to discount our cash flows.

However, what if, when we're looking at the target capital structure, we identify that we think maybe this, this company will have some financial assets or other sources of finance in its targets, capital structure.

Well, we can extend our WAC formula to capture those other elements.

So let's think about a real company's capital structure.

It may well have, for example, other forms of finance.

It may well have an NCIA non-controlling interest.

We could take the view that actually even as the company matures there is there are likely to be other stakeholders with an interest in some of the subsidiaries of the company that we are trying to value.

What are the expectations of those investors in terms of their required, uh, return on that capital? Likewise, it could be that the company is likely to have cash in its capital structure.

There could be some structural reasons, regulatory reasons.

For example, why this company will always have some cash in its capital structure.

Well, we can anticipate that we'll always be a return on that cash, and we need to include that in our wack formula.

So we're gonna extend our WAC formula beyond the two terms that we've already looked at.

And we're gonna do that by adding the, uh, additional term for any other sources of finance.

For example, the NCI there, we take the weighting of NCI relative to the whole enterprise value, and we multiply that by the required return, the investors in that non-controlling interest.

Now, an common question is, well, how do I under, how do I estimate what the required return is for a non-controlling interest? Well, remember if we have an idea of what that non-controlling interest relates to, which subsidiary, well, the expect a return for an investor in the non-controlling interest is the same as any other investor in that subsidiary.

So as soon as we have an idea of what the nature of these subsidiaries operations are, we can start to build some expectations of their required return.

So we often use the beverages industry as we've seen in our case studies, that it's very common, particularly, for example, Coca-Cola has a non-controlling interest in some of its bottling operations.

And so if we have an idea of what kind of return is required for the risk associated with bottling operations, we could use that.

Uh, if we are incorporating non-controlling interest into their cost of capital, uh, the next term is to include the cash.

So if we think there's gonna be some structural reason that cash is gonna remain in a company's capital structure, uh, as it matures, we can incorporate the cash within that, but we have to be a little bit careful because this is not a cost of capital, it's a return on capital.

So you'll see that there's a negative there.

We are not adding this term, we are subtracting the return on cash.

And as well, we are gonna take into account a tax adjustment on that return on cash.

'cause of course, any additional profits generated from interest income will be taxed.

So we need to think for each type of financing, not only is it return on capital or a cost of capital, but also is there a tax effect.

So here we have our extended formula, um, incorporating, uh, both, uh, cash and a non-controlling interest. But we could do the same for other forms of finance.

For example, if there were preference shares, we would include those preference shares. What's the cost of that financing? Um, is there a tax shield? Usually not when it comes to preference, uh, in, uh, dividends.

So we wouldn't normally have a tax shield within that.

So, um, we can keep building our wack formula out as long as we like, but we have to be taking the view that that is, um, part of its long-term capital structure.

And I'm gonna kind of keep hearing me kind of banging on about that point because it is important that it's a strategic reason that they'll have that in their capital structure, uh, for the long term.

Um, okay, let's go and have a little workout on that topic.

And we're gonna just go onto the next workout, uh, which is workout six.

And before I dive into that workout, I think it's always useful to have an EV bridge, uh, on the screen in front of us.

So, uh, we can refer to this as needed.

Okay? So there's our EV bridge from EV to equity.

Um, in workout six, we're calculating the cost of capital for this company.

Starting off by assuming there are no financial assets in the target capital structure.

So no cash at all in the first iteration. Okay? We've been told that this company has 9% cost of equity, 3.5% cost of debt.

The marginal tax rates 21%, and the debt financing percentage is 40%.

Um, so let's calculate the cost of capital.

Assuming there is no, there are no financial assets, no cash in the capital structure.

So we start off with our cost of equity.

We're then gonna multiply that by one minus the debt financing percentage.

We're then gonna add to that the cost of debt, multiply that by the debt financing percentage, and then multiply that by one minus the marginal tax rate. Don't get that tax shield on debt.

So that gives me a weight, average cost of capital using my normal WAC formula of 6.5%.

However, we're now gonna modify that calculation to see how that changes.

If we now assume that there are financial assets and there's financial assets, um, we assume they're just cash, they're going to be 5% of, uh, EV however, debt is going to remain at 40% of EV.

So that means the equity component's gonna shift.

If our equity, if our assets go up and debts unchanged, that must mean our equity, uh, goes up.

Okay? So let's recalculate the equity percentage, uh, in our financing structure.

So we're gonna take one minus our debt financing percentage plus the financial assets.

That means that equity must now be 65% of our EV.

So now let's build our WAC formula.

So we are going to, uh, take our cost of equity, multiply it by the equity financing percentage, we're then gonna add our cost of debt, multiply it by the debt financing percentage, and multiply that by one minus our marginal tax rate.

We are now gonna incorporate the return on cash, so it's a return rather than a cost.

So we're gonna subtract, and that's gonna be our return on financial assets is 6% multiplied by the percentage of 5%.

And we need to allow for the fact that return is gonna be a taxed amount. So we're gonna multiply by one minus the marginal tax rates, and that gives me a new cost of capital 6.7%.

Now that cost of capital is higher than the cost of capital that we had before.

So those financial assets are increasing our cost of capital.

Now, intuitively, that actually should make sense 'cause what we've done is we've incorporated additional assets in the capital structure, which are earning a return of 6%, but all of that, uh, is being financed by equity, which costs 9%.

So we are basically, we've increased the equity financing component from 60 to 65% to finance those additional assets, which are earning a return below the cost of that additional capital.

So what we effectively have is now a capital structure, which is suboptimal.

Yeah, it's basically a more, um, more expensive overall cost of financing.

So this is one of the reasons we have to really be very careful when we are, um, assuming that a company is gonna have lots of cash in its capital structure in the long term, we have to ask ourselves, do we really believe that? Because actually it's quite a costly thing to do, to be sitting on cash, it's earning a low return or even other financial assets if they're earning a low return.

It's not really an efficient use of capital, okay? So we have to have a good structural reason for that to be included.

As I say, one of the most common reasons for that is regulations.

So maybe the CI payments company or, um, some kind of, uh, other firm where they are required to hold some level of cash for structural reasons, and therefore, uh, we feel comfortable including in the target capital structure.

So that is how we extend our WAC formula.

Uh, before we kind of wrap up on that topic, um, I'll just give you a a few more considerations to highlight.

Um, a common question that we get as trainers is often, well, can't we just use net debt rather than thinking about, you know, incorporating cash and debt into our WAC formula using the extended, uh, formula? Well, although that might feel very easy and convenient, using net debt incorrectly assumes that the cost of debt is the same as the return on cash.

And as we can see there, the effect that that's not the case.

And actually you end up, uh, really kind of distorting your wack.

So if we really feel that cash is a, you know, material part of the company's financing, in the longer term, it's much more sophisticated to actually build the extended wack formula.

Okay? Um, we do need to make sure when we're doing that, that we haven't included the cash or financial assets somewhere in the EV.

Sometimes with restricted cash, we treat that as part of our, um, our operating working capital.

So we just need to make sure, um, that we are not double counting those assets, uh, or the effects of tho that financing.

Okay. Um, and then the final one, a bit of a bug bear for me because I've definitely come across this when I was at my desk as an analyst, um, is just, you know, there's lots of data sources out there, um, for, um, grabbing, uh, beta values.

Uh, for example, Bloomberg is a very rich source of beta information.

Um, but just be very careful, um, when you are taking those values.

'cause there's different variations, there's different time horizons.

Um, there are levered and unlevered betas.

So just be very cautious when you're plucking numbers off of a system to make sure you understand the data point that you're using and it's the correct one.

Um, and also we try to make sure it's as forward looking as possible.

So particularly if you have companies which operate in relatively stable industries, but there's been a lot of volatility in other industries.

So for example, a really good example is a, you know, after the global financial crisis, it really did distort some of the consumer business data.

You know, 'cause we had a lot of volatility affecting financial services companies.

Um, it will really, um, provide a very normally low beta.

So just be a little bit cautious and you can absolutely adjust upwards to normalize.

So to make it more forward looking, um, ultimately WAC is an estimate.

It's an important estimate in your valuation.

Um, so, um, science will only get you so far.

You need to then make sure that it, the number basically makes sense in the context of what you're seeing elsewhere in the market.

So that is, uh, our extended WAC formula and some, uh, additional considerations when you're building your WAC estimates.

I'll just pause in case there's any more questions.

You're very quiet on the quick q and a today.

I can't see anything coming in, Right? In that case, we'll keep going onto our final topic, which is some of the parts valuation.

Um, and feel free to pop, uh, questions into the chats, uh, about some of the previous topics if, uh, if you want to.

Okay. Right. Uh, now particularly if we are valuing public companies, uh, which tend to be more mature businesses, more diverse businesses, it does present a challenge when it comes to particularly using multiples in valuation.

Okay? So diver diverse businesses, we often refer to 'em as conglomerates.

And we have an example of a conglomerate on the screen there.

Walt Disney for those of us with, uh, young children will be, uh, feeling the pain of the diversification of, uh, Disney as we, uh, uh, have to find ways to entertain our children.

Uh, we have broadcasting and cable business, we have theme parks and we have content and movie production.

Now, those types of businesses actually in reality have very different capital intensities, very different risks, and therefore, uh, very different, uh, valuation multiples associated with them.

For example, broadcasting and cable, that's kind of the jewel in the crown for Walt Disney because, you know, a subscription business, a very stable, predictable income stream, very ro robust growth as well, gives a nice high multiple.

So broadcasting cable companies tend to trade or did trade on around EBT EBITDA of 20 times, uh, when these materials were produced.

Um, theme parks, again, a very stable, robust income stream, A lot more capital intensive nonetheless, uh, so slightly lower multiples. They typically, uh, trade on about 15 times.

Um, and then finally, the, the content to movie production business actually very high risk, very capital intensive, developing new content that you don't even know, uh, if it would be successful or not.

Um, EV to EBITDA around 12 times.

So quite different multiples, uh, for the different parts of the business.

And the question is, well, which multiple should we apply for malt Disney's uh, earnings? Well, the reality is we don't have to, you know, uh, pick a single multiple because we can just effectively value each segment, uh, as a separate business unit, okay? So we're gonna value each segment using an appropriate multiple.

We can then add together the value of each segment to build the sum of the parts as the enterprise value.

Okay? Now, once we've done that, we've got the enterprise value for the whole business, we would then go over the EV bridge in the usual way.

So deduct the value of net debt to give the value of equity, and that, uh, is your sum of the parts valuation.

Uh, the only slight tweak, the slight modification that we have to consider is whether or not, um, the enterprise value for the business as a whole, um, is app.

Whether it's appropriate to assume it is for some of the parts.

Sometimes we take the view that actually having those segments all under one umbrella, one sort of, uh, one group of businesses will create synergies.

So actually the businesses together co compliment each other and therefore we, um, may take the view that there is a conglomerate premium.

So the business as a whole is worth more than the sum of the parts, if so, great.

Um, but on the flip side, um, and definitely something that you know, is kind of coming to the fore a lot at the moment with companies in some sectors is the prospect of having a conglomerate discount, which is where you add together the business units.

The total value of the business is actually less than the sum of the parts.

And that's usually because, um, the businesses are not complimentary, they're a distraction.

Uh, maybe there's a part of the business which is really struggling, and that usually is a distraction for management.

Um, and therefore the market just doesn't recognize the value of that underperforming segment.

So, um, uh, we would then need to think about applying a discount.

The next question would be, well, how do you estimate the premium or the discount? Well, my starting point would always be to look back over time and say, well, over the last few years, how has the company traded relative to the sum of its parts? So if we can see that over the last few years, traditionally the company has traded at a 10% discount or premium to the sum of the parts.

But if there's been no change to the business in the last few years, we would assume that continues.

So there's an element of judgment in there, but we start off with what we've seen in recent years.

Um, now of course, what we would expect to see if a company has persistently traded at a discount to some parts, well that's usually a prompt for the company to spin off an underperforming segment.

And as I mentioned, we've seen, you know, a little bit of this recently, particularly in the food industry.

We've had, um, for example, Kellogg spinning off, um, its cereals business.

Um, at the moment we've got Unilever in Europe, uh, spinning off, um, its, uh, ice cream business.

So we do get that, uh, when, you know, a company's trading at a material discount for some of the parts.

And, you know, management's efforts to resolve that, uh, are not appreciated by the market. Usually the best thing to do is to spin it off.

But until it happens, we are forced to value the companies, um, as one entity, um, using some of the parts valuations.

So let's have a little go at building some calculations around that. We'll start off with a very simple generic calculation, and then we're gonna have a go at valuing a real conglomerate, uh, using our data in Felix.

Let's go back to our workout file.

Um, and we are gonna go down to, uh, workout eight.

We're going, uh, just use some of the parts valuation to value.

Uh, alpha Inc.

A fictional company with three segments, A, B, and C, uh, and analyst is very helpfully provided first year forecast EBITDA figures for each segment.

You can see that the most material segment is segment A.

Uh, but when we look at the multiples, which are appropriate for each of those segments, well, we've got 10.5 times for segment A, 11.9 times segment B, but the jewel in the crown here is actually segment C. It's a small, probably high growth segment, which attracts a much higher multiple.

Uh, so let's build our valuation for each segment.

And to do that, um, it could not be easier.

We just take the forecast, EBIT DAF for each segment and the appropriate multiple.

And I'm gonna copy those formulas down.

Um, and once I've done that, I add them together and that gives me a total combined enterprise value of 22,876.

That's the enterprise value of the whole business.

We won't worry about any conglomerate premiums or discounts.

Um, and instead all we need to do is go over our EV bridge.

We start with our enterprise value, we add on cash, we subtract debts and non-controlling interests.

And that gives me an enterprise, sorry, an equity value of 15664.1.

That's the theory. Now, the reality is in practice, um, we have to come up with these multiples. And so we're gonna do that.

Now very briefly for, um, Pepsi, which is a conglomerate, it has a snacks business and a beverages business.

But the reality is it would be very difficult to, um, value Pepsi, um, without some of the parts.

If we have a look in Felix, I'm just gonna open up, uh, PepsiCo's valuation at the moment.

Um, I know that your assumption might be that Coca-Cola makes a great comp for Pepsi.

Well, in some ways it does for the beverages business, but you can see here that the multiple, that Coca-Cola trades are 19.1 times versus Pepsi 12.9 times very, very different.

And we might start off assuming that's 'cause Pepsi's undervalued by the market, but when you compare PepsiCo's valuation to the food business, uh, well the food industry, well, a lot of those multiples are lower, and that reflects the fact that the food part of the PepsiCo business is valued on a, a lower multiple because it's lowering growth, lowering margins. It's a much more competitive, more saturated and more mature market than beverages.

Um, so we're gonna take, uh, Coca-Cola out the equation for now.

Um, but we are going basically, uh, use, uh, the peers to value, uh, PepsiCo for its different businesses.

Uh, so let's have a look and see the, first of all, have a look at the different segments that PepsiCo has.

So it has, uh, two major food businesses in North America. It has a FritoLay that's the potato chips business and the Quaker Foods business.

Um, and we're gonna combine those together and have that as the snacks business for North America.

Uh, we'll have the beverages business for North America, and that is very comparable to, uh, Coca-Cola.

Uh, we then have latam, and I'm gonna include within latam all the other, um, areas which I would consider to be more, um, emerging markets.

Uh, and then we'll have the Europe business.

So I'm gonna do is I'm gonna extract this table, I'm gonna copy this and pop it into a blank file.

So let's go down here.

So PepsiCo valuation, I'm just gonna paste, uh, the numbers I've just extracted.

Um, I want the, uh, core, the core EBIT, uh, for PepsiCo's segments there.

And I'm gonna use that to co basically re carve up the segments slightly.

So I'm gonna have North America, uh, food and snacks.

I'm gonna have, uh, north America beverages.

I'm gonna have Europe and I'm gonna have latam and rest of the world.

Okay, so let me grab the values.

Um, and the reason I'm doing this is this allows me to work out the relative proportions of the different parts of the business.

So I'm gonna grab Europe and then latam and the rest of the world is just a plug.

So subtract all the other segments and just double check.

My total does add up to what we had in the actual press release. This is a 2024 EBIT. Okay? And in percentage terms, let's see what proportion the snacks business is.

That's about 47.5%. So it's actually nearly half of the business is food and snacks.

Um, then 20, just over 20% is North America beverages.

And then Europe and latam are about 15%.

And those are a mix of beverages and food and snacks. Okay? So again, just double check that everything adds up. We've got a hundred percent there.

Now what we are then gonna do is use that to assume that allocation would apply to the EBITDA of PepsiCo.

So if I go back to Felix, uh, 2025 ebitda. So the first forecast year is EBITDA for, uh, PepsiCo is 18 thou, oh, 18.492 billion.

So if I go back to my spreadsheet, my EBITDA, uh, 18 409 2.

And I'm gonna assume, and it is a bit of a bit stretching assumption, um, that my percentages can be applied to that, uh, forecast ebitda.

So it does assume that all of these different businesses have the same capital intensity, say a bit of a stretch, but in the time we've got, um, maybe not, uh, the worst assumption to make.

Okay? So we now have our ebitda, um, for each segment.

Um, I then need to go and find, you know, my comps for each segment.

But this is the beauty of this process.

Some of the parts is I'm effectively now unlocking more available comps because I'm no longer just looking for conglomerate food and beverages businesses.

I can now look for pure play food and snacks, pure play beverages, you know, that operate in those regions.

Uh, so it basically unlocks many more comps for me.

It makes my life much easier as an analyst.

Um, now in terms of the food businesses for North America, we've got Mondelez, uh, general Mills, anova, that's the former Kellogg's business and ConAgra and the multiple that those trade on. So excluding Pepsi, uh, the average multiple is 20, is 12.9 times ebitda.

So let's grab those multiples.

Um, and I'm just assuming it's the median, but obviously in reality you'd want to do a little bit of, uh, benchmarking to uh, consider this.

Um, and then for beverages, I can use my comps builder.

Um, indeed I will use Coca-Cola for the beverages business for North America.

I'll also use Monster and I'll also use, uh, Keurig Dr. Pepper. And we can see apart from Keurig, Dr. Pepper, um, you know, those beverages companies do trade on much high multiples. It's got a medium multiple of 19.1 times reflecting, look much higher growth, much higher margins.

So quite uh, a different, uh, valuation set there.

Um, so 19.1 times beverages business, whoops, lemme see that spreadsheet.

So 19.1 times multiple.

Um, in terms of Europe, we do have some, uh, European data.

We don't have it in the comps builder in Felix, but we do have relative valuation.

Um, and I'm just gonna grab, I assume that most of the business is food, food producers.

So forward multiple there or 12 times.

Um, and in fact, let's have a look at the beverages multiples in Europe as well.

Beverages and tobacco, uh, is about 9.4 times.

So let's go for about, let's go for 10 and a half times, somewhere, somewhere between those for European food and beverages.

And then about nine times I did do, I have a little look at latam and emerging markets valuation multiples for food and beverages and other staples.

And nine times seems about reasonable. Okay? So we then take our forward EBITDA and our multiple for each segment.

And as we go down, we build our EV for each segment.

And then if we add those together, that gives us a combined enterprise value before any conglomerate premium or discounts of about 244 billion uh, dollars.

Let's see how that compares to PepsiCo's actual valuation. If we go back, uh, at the moment, the market is valuing PepsiCo, um, at around, uh, at an EV of about 240 billion.

So we're not far off, are we? So that actually seems much more justifiable based on our calculation there.

Um, obviously we've done that without any real benchmarking.

We would want to understand within each of those, uh, segments, uh, how PepsiCo compares to each of those peers.

Um, but um, hopefully you'll agree that that approach is much more robust than trying to, um, just use very soft judgments on the multiples.

Uh, we're actually now looking for pure play, uh, comps in our analysis, uh, and unlocking many more peers, uh, for use in our valuation.

So that is some of the parts valuation.

Um, and that brings us to the end of our hour together.

So I hope you found that session useful.

Um, as I say, the solution files that we've that to what we've been doing today are available also for download.

The video recording of today is also available for review.

Um, that'd be made available later today.

So, um, I hope you found that session helpful to you and enjoy the rest of your Friday.

Um, I'll be here for another couple of minutes, um, just in case anyone has any follow-up questions, take care and hopefully see you again for a future webinar.

Okay. Uh, I haven't had any questions coming in on the q and a or the chat, so I'll close the webinar now.

Thank you.