Welcome and happy Friday to our session on Felix.

We are going to cover DC Fundamentals today.

My name is Andrea Ward.

Lovely to have you all in my classroom.

Could you please download the resources which you can find at the bottom of my, of my screen.

There are two Excel files in there, which I'm going to use as part of the session, so that might be really useful for you.

So we're gonna talk about DCF today.

super important valuation methodology.

I'm just going to start sharing my screen.

Here we go.

You should all be able to see my slides now.

And, really important valuation methodology.

You know, out of the, out of all the valuation methodologies you might have, might have come across probably the second most important one. The first one really is multiples, where, uh, we are comparing share price of companies and their resulting multiples to earnings or ebitda EBIT to sales versus other companies, which is still extremely important, um, to assess.

So what I really wanna do today is show you how straightforward DCF is.

Um, and we're gonna go through the different steps.

So if you have any questions, put it into the webinar chat and I will pause and answer your questions.

So we're gonna quickly go through the steps and then we're gonna do little exercises for each of one of those steps.

So, such as forecasting the free cash flows, talking about briefly about weighted average cost of capital terminal value, and then how to discount.

And then I thought we should have enough time and we are going to do a, um, real life, um, DCF on Peloton.

Um, the exercise bike or exercise equipment company, um, which you might have heard of, some of you might even have, um, some of their, um, products at home.

So that's the plan, um, for the next, um, 45 minutes sort of hour.

Um, first of all, what is a discounted cash flow? All you're doing is you're forecasting the cash flows of a company, um, into the future.

So you're able to actually have a look at the business plan of the company and really think about the strategy of the company in terms of their growth, in terms of their margins, how they manufacture their business, how they provide their services.

Obviously, depending on the sector, we call this an intrinsic value as opposed to a relative valuation tool.

So relative valuations would be multiple, for instance, with where you comparing EBITDA multiples across the sector and trying to assess what the value of the company is based on those multiples.

Okay, cool thing about the DCF is you can really deep, you know, deep dive into the strategy and the business model of the company, however, it is your view of the company's value.

So that's really important to remember.

That's why the multiples are so important.

'cause they're coming from the market, the share prices, our opinions of all market participants.

And, um, and it gives us a good idea what the market thinks about the sector, what the market thinks about an individual company.

Whereas the DCF, it really is your view.

And obviously as long as you can support your assumptions and defend them, that is your view of value.

Now, what we normally do is we calculate the enterprise value through the DCF, which means we are looking at an unleveraged or unlevered free cash flow now.

And ultimately I always want to know what is the equity worth.

And so I will then take off net debt to get to the equity value, um, all the active value per share implied by the DCF.

Okay? So that's, that's what we mean by discounted cashflow analysis.

So let's very briefly talk about, um, discounting, apologies, you probably most of, you'll be very aware of this, but we always make sure that the maths is, is, okay.

So let's assume this is not discounting at the moment. This is actually grossing up, but let's assume I'm investing a hundred, um, today at 10% per annum.

I don't take the money out, but I leave it in the bank account or wherever I've invested it, um, over the next three years.

Then I will have at the end of three years, 133.1 million or dollars or whatever.

Okay? So we are accruing interest every single year earning interest on interest.

Now, discounting is the exact opposite of this.

So what if I projected that the company is going to generate 133, um, million dollars of, um, of free cash flow in year three, and I actually want to know what that is worth today.

So if my required rate of return as an investor is 10%, then I can just do the opposite discount back two today's value, and I then get that 100.

Okay? So we always, when we're talking about dcfs, we're always bringing everything back to today's value or our assumed valuation date or our assumed, um, closing date, um, of a transaction we just spent in which, um, in which, um, context we're doing this.

So I've just had a question.

Um, in terms of, um, time difference between forecasting three year, five year, tenure year, that's a super, super, um, question in terms of equity value, as long as your assumptions make sense, shouldn't make any difference, but in general, you should always forecast until the company reaches steady state. So it's a mature business.

Growth rates are normalized, margins are normalized, and that obviously depends on the sector and on the underlying company.

Okay, so, so in terms of, uh, in terms of equity value, you know, if you, if you, if you're modeling out, um, a mature business, three years might be sufficient because if you keep everything constant, you might as well just stop because mathematically will get the same numbers.

Um, so it really does depend on the underlying, underlying um, um, company.

Do you do me a favor? Thank you so much for the question. Rather than using q and a, could you use the chat because the q and a I actually have to, um, open every single time, so it's much easier if we use the chat, but that was a fantastic question, so thank you so much for that.

Okay, so, so that's, um, that was the first, um, question we had.

Um, so I'm just going to, um, going to um, um, continue with my slides.

So we are happy with discounting.

So in terms of the steps, we have five steps. Okay? We need to forecast our free cash flows.

That frankly is the most difficult step, right? We tend to use, um, consensus forecast of research, um, equity research reports, um, to do the first three years.

But from, from active research perspective, you're not really going to get anything beyond those three years that is sensible in terms of a consensus forecast because not everyone actually does forecast this far or publishes it.

So we then will have to make our own assumptions.

Or alternatively, if you are working on a transaction or you're within a corporate, you obviously have management forecasts and you can use those numbers for quite a few numbers.

You might have to come up with, um, your own assumptions such as working capital, you know, longer term obviously your growth rates, margins and CapEx and depreciation relationships.

But a little bit more on that in a minute.

Then we have to calculate our discount rate. So the discount rate is the weighted average cost of capital or wac.

So this is the required rate of return of both debt and equity holders.

More than that also in a minute.

Now obviously after this five or 10 years, or maybe even three years, if you have a very mature business, um, the company doesn't disappear, right? It doesn't suddenly die because we're not looking at a project here, we're looking at a company as a going concern, which means we will calculate something called the terminal values.

And the terminal value really represents everything beyond your explicit forecast horizon into perpetuity.

Then we bring everything back to today.

So that's the discounting we've already looked at.

And then ultimately we're using the enterprise value two equity bridge, um, to get to the implied equity value or to the implied share price implied by our valuation methodology.

Okay? So those are the steps. So what we're gonna do now is we're gonna go through these steps individually and do some exercises, and then at the end we pull this all together with Peloton.

So first of all, how do we forecast free cash flows? We normally start from EBIT. So I'm looking at corporates, outside financial institutions.

Start with EBIT, which is our adjusted operating profit, okay? Adjusted for non-recurring items.

So we really want to have stuff that's gonna be around over the next, um, few years and, um, and uh, ensuring that we take out anything that's non-recurring. So large restructuring or large gains or losses on disposal of assets. Because once you've sold those assets, they don't generate any EBIT, plus you can't sell them again, you can only sell them once.

So important to remember A DCF valuation is very much organic growth only.

Okay? And, um, and looking at the business model of the business, you know, from that perspective, then we pretend that, uh, EBIT is our pre-tax profit.

So at the moment we're going to completely ignore the capital structure and therefore EBIT becomes pre-tax profit.

We will tax, um, EBIT and that gives us notepad or net operating profit after tax.

I think it actually makes more sense to remember this as normalized Operating profit, right? Because EBIT is your adjusted or normalized operating profit.

What is the rationale starting with EBIT instead of ebitda? Um, we don't really start with ebitda. We, we normally start with EBIT.

We do need EBITDA 'cause we need depreciation amortization, um, later on to actually able to calculate the free cash flow.

Okay? So, so you wouldn't tax EBITDA because depreciation amortization are tax deductible and in some countries we will, we will, um, forecast the timing difference of depreciation under tax rules and accounting rules. So create that deferred tax liability.

But, uh, but remember DNA are tax deductible.

So we might as well start with EBIT and pretend that's our pretax profit.

Hopefully that makes sense in terms of answer.

So I've got Notepad or E-B-I-A-T, which is very difficult to say. Fast notepad is much easier.

And um, and we will, um, then make this into a cash flow.

So we add back DNA, we take off CapEx, we take off our change in working capital, so things like investing further in inventories, accounts, foreseeable, you know, looking what's happening with accounts payable and anything else that's operating.

So here, really important operating, working capitalists only short term and only operating items.

There's a super, um, playlist on, um, working capsule in um, Felix, if that is still a little bit unclear.

And then we might have some other long-term operating assets.

So liabilities, um, which might be for instance, the deferred taxes I mentioned earlier on, or it might be a pension liability you forecast.

That's very unusual.

So that last one, the other we hardly ever forecast, we tend to deal separately in evaluation when we come to the bridge to equity value.

Okay? But I will talk a little bit more about this when we talk about the bridge that gives you the free cash flow.

So the free cash flow is free for what, right? Why is it called free cash flow? Well, first of all, you can see there's no interest in here.

So it is available to pay interest, it is available to repay debt, it is available to pay dividends, and it is available to buy back shares, okay? And potentially make acquisitions because obviously remember this is organic growth only. So that's our free cash flow.

So really important, um, to think about, um, that relationship between EBIT and free cash flow.

Okay? So what I'm gonna do now is I'm gonna go into our first Excel.

So if you want to open it, those you've joined a little bit later in the resource section on the bottom of the screen are two Excels.

Could you please open DCF fundamentals, workout, empty, and uh, and I'm going to just go through a couple of exercises as we go through the individual steps of our discounted cash flow analysis.

Okay? So we'll start with workout number one.

Um, we've got a little forecast, um, sales costs operating probably, let me just get rid of copilot and, uh, hide this until every document.

Um, we've got, um, some balance sheet items you don't actually need anymore.

And for long term assets, just read, um, equals PP and e. So we've just lumped that all together, okay? Um, and we've got, um, our debt and equity, which we don't need because we're only going to calculate free cash flow in this exercise.

So I'm gonna start with EBIT.

We're only looking at our forecast years.

'cause the historical cash flow I'm not going to get, if I were to buy the business or if I were to buy the shares, right? Doesn't belong to me as a shareholder, belongs to the old shareholders.

So in this case, we are assuming that operating profit equals EBIT.

We cannot see any non-recurring items above EBIT, uh, or operating profit, which means I can just assume EBIT equals operating profit.

Then I'm gonna pretend that's my pretax profit.

So I'm going to tax this, but a tax rate of 20%, I'm gonna make this negative.

So I can just sum this up. I'm gonna show you my formula.

Just let me just set this up and, um, just summing this up, gives me a notepad or normalized operating profit after tax of 216 million.

Then I'm going to have a look at my working capsule items.

So I have short term operating assets and when assets go up, cash goes down.

Okay? So the way to model this in Excel, always just say last year, minus this year, don't even have to think about it. Don't want too many minus signs informally, because that's very confusing at some point.

So my assets have gone up by 2.8 million. That means I have for instance, more inventory, which I haven't sold yet.

Okay? So that locks up cash or I have more accounts receivable, so I have made more sales on credit.

I, my, my customers haven't paid me yet.

So a cash outflow do the same for operating liabilities.

So operating liabilities, um, when they grow up, then you preserved cash, you've still got more cash in the business. So this year minus last year will always work.

So in this case, let's assume it's my accounts payable, I am waiting to pay them and I'm waiting a little bit more or I have more accounts pay 'cause I've sold more, which, um, you know, might be the case.

We dunno what the revenues were in year zero and I have 5.5 million more cash in the business.

And then finally changing long-term assets rather than doing CapEx depreciation separately. What I'm doing here is I'm going to just purely, um, assume that's the net delta.

So CapEx reduces my property plant and equipment and depreciation then, um, sorry, increases my so CapEx, lemme repeat this.

CapEx increases my property, plant and equipment, but reduces my cash flow whereas depreciation is the opposite.

Okay? So all I'm gonna do here is I'm just going to say last year minus this year.

So that's effectively your CapEx.

So minus CapEx plus depreciation, which we saw in our, um, no, and that doesn't work. It doesn't exist. Minus CapEx, um, plus depreciation, which we saw in our definition of, um, free cash flow, which means I can calculate my free cash flow.

So I start from notepad, add all the other stuff, but already the right plus minus signs can just sum it up.

And then if I copy this to the right, I can have a look what this looks like.

And you will see that we have a sub sudden drop in in, um, in the free cash flow in year three because we suddenly have a massive increase in our property plant and equipment.

So it must be quite an asset heavy company because we um, we are suddenly, you know, expanding our asset base. So maybe, um, and I gave this example earlier today, like a steel company where you effectively shut down the steel oven I that whole big factory that makes the steel and rebuild it.

And that that means you have very lumpy, um, CapEx spend, right? Because you might not do that every single year depending on the size of the company.

Okay? So let me have a look. Relating cash is the concept of net bearing.

Fine only, hang on a second, let me just read, I've got two questions, lemme just have a quick look at that.

Um, is the concept of net borrow for financing activities only? Yes, correct. Net borrow only belongs to financing activities if net borrowing is negative.

Well that depends on what happens in your balance sheet, right? So if your net borrowing is negative in the cashflow, clearly you've repaid some debt, okay? So net borrowing is only financing activities and if net borrowing is negative in your cashflow, then clearly you've repaid some debt. So have a look at your balance sheet, okay? Uh, figure simply how do you forecast those? Good question.

How do I forecast them? So I forecast them by using equity research reports, okay? Particularly for the first, um, first, um, apologies for my typing, um, spelling even, um, for the first three years, you can get good research, um, from, um, from, um, the, the brokers.

Okay? So you will get sales, you will get operating profit.

Um, you, you probably will have to make an assumption on interest expense and tax expense.

And um, and then for some of the other items, CapEx, you will get normally some assumptions and the rest you probably will have to come up with yourself.

Debts you can forecast quite easily by looking at the debt schedule, um, in a company's financials 'cause it gives you an idea on what they're, um, having to repay.

And then equity is obviously a result of net income and dividends. So have a look at the dividend policy.

What I might suggest to you is, um, is in terms of forecasting on Felix, there is a great, um, playlist under, under the modeling piece which um, shows you how to forecast and how to model out a company.

Okay? So maybe have a look at that playlist 'cause we don't have enough time unfortunately in this session to cover that in detail.

Okay? So, um, any other questions on workout number one? Super questions guys, keep them coming because uh, it's lovely to get some interaction with you.

Okay? So please do let me know if you have any other questions.

Okay. Right, so that's the free cash flow.

We forecasted this, it is the so-called unlevered free cash flow or cash flow to enterprise or cash flow to firm IE to all capital providers of the company.

Okay? So what I'm doing at the moment is I'm buying the entire company rather than just the equity.

Okay? Second step is our weighted average cost of capital.

Um, now here we could spend, um, days on this.

Um, as I did doing my studies, um, basically what we're doing is we're having a look at how much equity and how much debt the company has.

We use market values here. Really important. We're basically pretending what if the company didn't exist? And I want to build exactly the same company in today's money, I obviously will have to use market values, okay? So you never ever use book values other than for the debt. Sometimes we cheat a little bit and just use the book value.

'cause if the company's credit rating hasn't changed dramatically, interest rates haven't changed dramatically, the book value will be very similar to the market value.

So take the debt and equity, either current structure or target capital structure.

So something that you believe the company's going to have long term.

And then we multiply this with a cost of debt and this will be tax affected because obviously interest is tax deductible and we multiply, um, the equity with the cost of equity.

So the proportion of equity, the cost of equity, um, and the cost of equity is based on capital asset pricing model, which basically means I, the minimum return I will always get is risk free, right? So that I put my money into a government bond plus something extra to invest in a stock.

And that is dependent on the market risk premium and the risk exposure of the company to market risk.

If, if you're interested in weight average cost capital, a little bit more about how to calculate this, have a look at the playlist on wac, okay, I haven't gone exercise for this one.

We're just going to use a number that's given.

So that's step number two.

Step number three is our terminal value. Okay? So we forecasted, let's say for 10 years and we're now steady state.

So the company doesn't grow at 10% per annum.

The margins aren't exceptionally high because obviously competition will, um, will um, diminish your margins, right? So your competitive advantage is competed away.

Long term companies cannot outgrow the economy 'cause they will take over the world and ultimately universe that doesn't work.

Even an apple couldn't do that.

Even Nvidia will not be able to do that right at the moment they're growing very fast.

Absolutely and they will probably continue for some time, but long term so into perpetuity, no company can achieve this, right? So what do we do with year 11 onwards? Well we've got the terminal value, okay? So we are now at steady state.

Our margins, our growth rates are normalized and we can have now two different methodologies to calculate the terminal value.

We either do it as a growing perpetuity and you can see the formula there.

If you're not familiar with this formula, I would suggest you either have a look in Felix or Google the derivation of the growing perpetuity formula.

It's also in our financial math materials.

Basically saying my last forecast year is year in I year 10.

I take that out for one year, which is my first forecast, free cash flow for the perpetuity and then I capitalize it at white minus um, the long-term growth rate.

The long-term growth rate should not be higher than the nominal growth rate in the economies you're operating in, right? Because otherwise you're gonna take over the economy and that just doesn't work.

So please be very careful in terms of your assumptions on long-term growth rates.

The alternative way of calculating this is basically saying an EV multiple.

So at the end of year 10, I'm going to sell the business and whoever pays me for the business will pay for year 11 into perpetuity free cash flows.

Okay? So I'm gonna check with money and that will then cover year 11 into perpetuity.

So they will at that point also do that DCF and do the same approach.

We use enterprise value multiples because obviously we are before interest in our free cash flow.

So we need to really match apples and apples. Okay? So on this one I think we need to do two exercises, right? Just so you can see how that works.

The maths is really straightforward.

Go back into, um, my, um, go back into my um, little um, exercise.

Go to exercise number five please.

Okay, so what we're gonna do here, so we're gonna calculate the terminal value of the business, okay? And um, and um, we've got the assumption that it is 7.5 x EBIT and this would be at the end of year three, right? So all I'm gonna do this is very simple.

I'm going to calculate 7.5 x times the EBIT of that um, year.

And again, I'm assuming that, um, that EBIT equals operating profit because there are no non-recurring items.

Now how do I come up with 7.5? Well, I would want a multiple that reflects a mature, stable business.

So it will not be today's multiple, okay? Because obviously as companies mature, you know, ultimately their multiples will come down 'cause you have lower growth expectations, your margins are stabilized, et cetera. So you're not going to trade on crazy high multiples.

Those multiples would come down, okay? And you basically would have a look at comparable companies, comparable sectors, what has happened to multiples over that time.

So what does the 1463 represent? It represents the value of free cash flows at the end of year three of year four into perpetuity.

So ultimately later on, I will have to discount this back to year zero to make sure that I capture the value as of today.

'cause I don't really care what it is worth in year, three years time.

I want to know what the company is worth today.

I want to either buy it today, you know, I want to buy some shares in the company today, so I don't wanna buy them in three years, right? So I will always bring everything back to today's value.

Then we're gonna do, um, um, work out number seven.

So we're gonna do the perpetuity. Okay? So, um, we've got similar flows here.

We've got a cost of capital of 9.5% and a long-term growth rate of 2%.

So have a look at economic forecast in terms of long-term growth rates, right? This is quite low because obviously this is sort of the target for inflation for most, um, countries.

So, you know, maybe, you know, it really is a, a business which is super mature and and operating in, in um, very low growing countries.

But I'm just going to assume the numbers are correct.

So, um, the terminal value will be my free cash flow in year end.

So that's year three. I'm going to take that out by one year.

So grow about 2% and then I'm going to capitalize it as a growing perpetuity.

Okay? So I get um, a value of 2 2 9 2 0.2.

You can see the formula. So what is this? This is the value of all free cash flows from year four onwards into perpetuity at the end of year three. At this point, assuming that my free cash flow will on average grow at 2% per annum forever.

So one year it might be 1% another year, one and a half percent, another year 3%, but on average I'm assuming that it is 2% per annum.

Okay? So this is how we calculate our terminal value.

Any questions on this, let me know, right? Just put your questions into the chat, that'd be absolutely fantastic, right? Let's go back to our steps.

Let's see where we are in terms of different steps.

So we've done our free cash flow forecast. Oops da that was one, two, um, early.

So we forecast our free cash flows, which is the most difficult piece.

We figured out a cost of capital, okay? Then we calculated the terminal value.

Now the next thing we need to do is we need to discount to today's value.

So let's have a quick look at our slide and then we go straight into an exercise.

So you can see here I have a profile of five years of free cash flow forecast.

I also have a terminal value at the end of year five because remember year six into perpetuity, company doesn't disappear.

And all I'm gonna do is I will build discount factors.

So in finance we tend to build the discount factors rather than just using the NPV function.

'cause we often have a partial period or stop so called stop period at the very beginning because we don't always buy companies at the end of the year or buy a share at the end of the year or, or do an I period at the end of the year, right? So that's why we tend to build discount factors and to present value this, all we can do is multiply the free cash flow with a discount factor and um, and then also apply the discount factor of year five to the terminal value.

Add that all together and that is your enterprise value as of today. So just a little bit of maths, not complicated, just division and multiplication and to the power off, right? So really straightforward.

So if we go into workout number nine, okay, then we can do a very quick ex um, example of this.

So we've got our free cashflow forecast.

We also have a terminal value of 3.681 billion.

So all I'm gonna do, the first thing I'm gonna do is I'm going to build my discount factor.

So one plus the 9%, I'm gonna fix that with F four so that I can copy this 'cause uh, I don't want to build the same formula twice and then to the power of my year count.

Okay? So this is what we normally do, um, in, in finance.

Then I can calculate.

So these are the discount factors for the individual. Yes.

I can then multiply my free cash flow with that discount factor which automatically will bring it back to today's value.

Okay? The sum of these three cash flows will give me the value of the first three years.

So that's 1.9 billion.

And then I'm also going to present value my terminal value.

So the three six, um, eight one, and I'm going to multiply this also with my 77.2% discount factor.

Okay? If I then sum these two up, I will get to a total enterprise value.

So the market value of all assets operating us of this business of 4.75, 5.6, um, whatever the currency is, whatever the denomination is.

Okay? So that is the enterprise value as of today.

So really straightforward in terms of maths, just gotta pay a little bit of attention to when you're hooking this all up.

Okay? So that was step number four.

Only one step remains, right? We want to know what the equity value is. So I, I don't really care just about the enterprise value, but I'd quite like to know what is the value to the shareholders.

So what we do need to do now is need to go from the enterprise value down to equity.

We call this the bridge, okay? Now in our free cash flow, we have not forecasted anything to do with non-core assets, right? We have not received from investments, we have not, um, included for instance rental income from an investment property. So let's assume I'm running a normal op, you know, manufacturing business and I've got a separate property which a titled investment property.

I get some in rental income from this that probably will have not been covered in your free cashflow forecast 'cause it'll probably be shown outside your operating profit.

So what we really need to do is have another look at the balance sheet and identify any non-core assets such as investments such as investment properties, et cetera, and value them separately.

Okay? So for an investment property, I would get a surveyor to have a look at this and give me a market value for an investment in, in another company I would do a separate valuation because the dividends don't necessarily completely reflect that value, et cetera, et cetera.

So the non-class have a look at your balance sheet, the long-term assets, if there are any items in there which you have not reflected in your free cash flow forecast.

Once you've done this, you've got the total end pathway, then we take off net debt.

So debt minus cash. Cash is being used to repay the debt.

We might have something called debt equivalent. So this is always the sort of headache stuff.

So you might have some underfunded pension liabilities, you might have some um, special using the value of the business to the shareholders.

We would put those into the bridge.

We might have some non controlling interests who might not own all of our um, subsidiaries a hundred percent.

So that doesn't belong to my shareholders, but my free cash flow included a hundred percent of the uh, subsidiaries.

So I need to take that off to ultimately get to the active value of the business.

Now if I'm a pri if I'm buying a private company, obviously you know, I would've, hopefully had access to management in terms of forecast.

But um, if I'm value a private company, I stop here and that's the active value of the business.

If I value a public company, I divide by shares outstanding to get to the implied share posts of the business.

Okay? So pretty straightforward.

The bridge really is very important outside financial institutions because there we just look at equity value straight away to understand what is happening with um, with um, you know, the actual equity value.

So one last simple exercise.

Um, if you go into exercise number 11 for me please.

So we're just gonna do one of these bridges, okay? And what I'm gonna do, um, I'm just going to, I've actually insert two rows which might not be in your model at the moment.

So just to split it all up, so I've inserted plus cash and market for securities minus debt.

Okay? So deduct debt which gives you your net debt. So you can just see the numbers. So the enterprise value of the business and the sum of present value of the free cashs of the explicit um, forecast.

Um, um, period plus the present value of the terminal value.

Okay? So we've done this earlier on in terms of our numbers.

Then I'm going to add the cash and the marketable securities because I haven't valued them yet. Plus you can use them to um, to repay debt.

I'm going to take off anything to do with debt.

So short term debt and current portion of long-term debt, okay? As well as the long-term debt itself.

And then the long-term liabilities I'm going to assume are operating liabilities.

So my assumption here is assume, um, operating liabilities 'cause I haven't got any more information and I am going to assume that they're already covered in the free cash flow forecast of that company.

And then I can calculate ultimately my equity value. So in this case you can see that the equity value is higher than the enterprise value because we have quite a big portion of cash sitting on the balance sheet, okay? Unusual, but it does happen.

Um, you know, and obviously having some debt is really good news because from a corporate finance perspective, debt is always cheaper than equity, right? So you want to have some debt because of the tax shield on interest which is reflected in your work.

So that was um, the introduction to DCF and DCF fundamentals.

Okay? What we are gonna do now, can you please have a look at the second file I've provided and we are going to do a quick um, quick analysis of Peloton.

Okay? So if you know anything about Peloton, Peloton is um, is um, um, hasn't been doing very well in during COVID did brilliantly 'cause everyone obviously needed to exercise at home.

So it sold a huge amount of the exercise and machines and be it be it bikes or or treadmills or whatever. And obviously the big important thing is, is the software.

Um, um, but since COVID they haven't done very well. They've restructured a few times change management et cetera, but um, they seem to be sort of somewhat recovered now and uh, doing a little bit better.

Let me just have a look quick look 'cause there's a question.

Yes, absolutely. So, and we are taking into the bridge are always non-operational.

However, if you have debt equivalents like pensions, they would be operational.

Okay? So it really does depend on the company.

Um, if we have any debt equivalence, um, if they're quite big like um, pension deficits, we would take them into account.

Okay? Right? Good question, right? So Peloton, let's have a quick look what we have in this model, we have a little model someone has built, okay? We are going to pretend we're at the end of June 25 and dying, um, from then onwards and someone's built a little model and we're going to use this to quickly do a DCF.

Okay? So the first thing I'm gonna do is I'm going, just going to hook up my um, 2024.

Um, I'd only put EBITDA in here because I need EBITDA in a minute for my exit multiple, okay? So, um, I'm just going to hook up one year and then, and then um, copy it all in one go to the right.

Let me just zoom in a little bit 'cause this is even for me a bit too small.

But then I'm gonna hook up my EBIT.

So this just comes from that little model.

Um, in the next tab, let's make sure in the right year, unfortunately we don't actually have matrix integrity in this model.

I have to have a chat with our analyst.

Got an interest rate of 21%. Okay? I can therefore calculate notepad and let me just again get rid of um, copilot because that is just irritating whenever that shows up.

Here we go. And, um, hang on a second, let me just do that again.

Um, so times one minus the tax rate.

So this is my notepad, okay? And uh, my depreciation amortization, um, I can get from my income statement 76.3 million.

My CapEx I'm going to get from my cash flow.

So if I just go down a bit, you can see that's the CapEx of 17 million.

And by change in operating working capital is also in my cash flow of 0.4 million for 2016.

Sum that all up. IE from notepads downwards, okay? So be careful with the sum function 'cause it might back send some in a little bit more and you're suddenly overvaluing the business and I get 276.8 million versus a notepad of 260 17.

So you can see the big thing here is the depreciation amortization.

They've really cut back their CapEx program 'cause that's, this is obviously related to historical, um, historical, um, capital expenditure.

I'm just gonna give you a quick idea where I've got these numbers from.

So depending on your Felix subscription on the right hand side you'd be able to find Peloton.

And as part of this, you've got all of the filings of Peloton and you've got evaluation tab.

And on the very bottom are the financial forecasts for Peloton.

This is based on FactSet, which we are just feeding into, into um, Felix.

Okay? My numbers might be slightly outta date. We're just gonna ignore that, um, because I just pulled a file I could find on our system, um, this morning.

Okay? But so, but I think they are actually very up to date.

So what we're gonna do is copy this to the right in the final year you should have a free cashflow of 285.8 million.

Okay? So that's free cashflow.

So next thing we're gonna have a look at is what is the discount, right? So I've got a bit of a gray box up here 'cause gray for me means comes from Felix.

Now go back to Felix.

You can see on the top right side we have a WAC calculator.

I've assumed a market was premium of 6%.

I'm gonna use the company speeder and I get 10.8%.

Can you see that here on my screen where my mouse is 10.8% of wac which I'm gonna use? And these numbers are completely up to date, okay? We, uh, we, we have a team of analysts who actually um, you know, feed in a lot of this analysis and then obviously fax it which gives us the um, the uh, forecasts which is based on um, brokers, um, research.

So the other thing I've done is I've named this cell wac. You can see on the top left in my model, um, WAC or if you want to know where this belongs to, if you hit F five, you just click on wack, it takes you automatically to the cell. This is like an F four with a dollar signs, just a bit easier for me to build my formula.

So going to build my discount factor one divided by one plus wack two, the power of my year account will give me the discount factor for Peloton for the first year up to the fifth year, okay? And I can then calculate the present eye of my free cash flows.

Obviously I would've spent a lot more time in terms of coming up with the assumptions on the top here, lots of ratio analysis, et cetera, comparison to companies within the sector to make sure that, uh, that my forecast makes sense, right? So we don't just do this in two minutes, but we only have a limited amount of time.

And as I said, have a look at the forecasting and modeling materials in Felix 'cause they will walk you through how to do this.

Okay? So next thing I'm gonna do is term the value, right? So that was step number one, forecast free cash flows.

Step number two is, uh, my, my terminal value.

So I'm going to assume I'm going to exit at eight x I'm gonna show you where I got this one from.

This is a bit more of assessment, right? And I had a look at the comms of uh, Peloton and the best ones publicly listed in the US are electronic arts, which is a gaming company and exponential fitness.

The average median EBITDA multiple is 11.3 times, but that is based on next year's earnings.

And obviously I am doing the terminal value at the end of year five.

So I really do want a multiple that reflects a mature business.

So I'm not gonna use 11.3.

What I'm gonna do is I'm going to use eight x, okay? At the moment, as you can see here, Peloton is trading on 9.3 times.

So I'm going to reduce this further to eight x in terms of exit multiple because that's sort of quite good multiple for into your business. You had s growth rates and margins um, normalize and become less exciting.

So eight x times the EBITDA of the final year. And that's the only reason why I've got EBITDA here on the top.

So I have it all on one screen and now I can't see the rest of my screen.

So what I'm going just do is um, just um, bring that um, in a bit more column B so you can see my numbers.

Okay? So that's eight x EBITDA in year five.

Remember that represents year six into perpetuity, um, at the end of year five.

So now let's pull this all together.

So the sum of my present value of free cash flows are these five which I've already discounted.

I'm going to calculate the present value of terminal value by discounting it with exactly the same factor In this case, I'm assuming everything happens at the end of the year.

And uh, then summing these two up will give me the enterprise value of Peloton based on current estimates in the market.

Okay? So 2.9 billion.

Now it'll be really interesting to see what's going happen in terms of uh, my implied share post.

My next debt I'm gonna take from the latest balance sheet outstanding, which I have here.

Um, if you remember the column E is my June, 2025.

So, um, short-term debt plus long-term debt and then minus any cash the company has, I just go up and find the cash position. Here we go at 9 2 4 0.1. So I have net debt of 566 million.

If I take this off I will get to the equity value, okay? Which is 2.388 billion. Okay? I'm just gonna pause here so you can have a look at my screen.

I'm just gonna have a look at the next question.

So if the valuation date is December 25, given those numbers are reported as of June 24, do we discount by one and a half years Sabbath? No you don't. If your valuation date is December, 2025, you will take half a year of 2026. That's your stop period and you just discount that by half a year to get to December, 2025.

Okay? So if you have a partial year, you either forecast on a quarterly basis or monthly basis for that partial year or you forecast the whole year and just take half it, it depends on the seasonality of that business, but you wouldn't suddenly go back by one and a half years 'cause you are trying to value the business as, as of end of December, 2025.

So think about your timelines.

Is it common practice to use terminal EV LTM ebitda, uh, multiple or can we use other multiples? You can absolutely use other multiples.

Most commonly we use EBIT and EBITDA multiples.

Sometimes we might use a sales multiple, but I'll be very careful with that one because I really would like the profitability to to be in that multiple.

And to be honest, any company at this point should be making some profits and uh, and I would be more comfortable using a, an EBITDA or EBIT multiple. But you could cost check against the sales multiple.

The one thing you cannot use are PE multiples or price to book multiples, right? Because they're after interest and my free cashflow forecast here is all before interest.

So you would be mixing apples and bananas, you would get fantastic food salad, okay? So that doesn't really work.

Um, so it has to be an enterprise value multiple.

Okay, so there we go.

Um, so not another question on discounting.

So so you disregard the year 2025 forecast.

Um, are you talking about Peloton or are you talking about um, a specific other company? If your year end is December 25, I would discount December the 2025 year.

This one my year end is June, not December. Okay.

So what I would do here is I would uh, I would ignore the June 25 forecast, which I did anyway 'cause we are in July 25.

So this is already history effectively, right? We just had forecast 'cause I hadn't published yet and I would, if I'm in December, I would literally just take half a year of 2026, okay? And bring it back to the end of December. Brilliant.

Okay, let me finish my, uh, let me finish my, um, let me finish my, uh, I come back to that final question in a minute.

Um, let me finish my valuation now so that we don't get too sidetracked here.

So my equity value is 2 3 8 8 0.3 my shares outstanding.

Um, I'm gonna take again from, um, Felix, if you look at um, at Felix you've got an enterprise bridge in here, which is really cool.

I love this. So for instance, shares outstanding, you can actually just click through and get the actual number of shares from the s underlying SEC document which they had to file so you know exactly where this is coming from.

Okay, so in this case I'm going to use 3 9 8 0.639 8.6 and I can calculate the implied share price by the, um, the CF, which is 5 99.

Let me have a look at what the current share price is. Current share price is 6 77. Okay, so clearly higher.

So let's have a look at how much of a, um, premium that is compared to my view of 5 99 13% premium.

So why is this? Well I presume the market is giving management a little bit more benefit of the doubt that they can really turn the company around and really believe in their new strategy, right? By by because they're now doing a lot more licensing of their, of their software, um, and the market is expecting more growth, okay? So therefore they are giving Peloton a higher, higher valuation.

Alternatively, it might mean that the market is overvaluing peloton.

Um, and this could be potentially a signal to actually sell the share and take your profit.

Please note, I am not recommending to either buy or sell Peloton.

Okay? That's really important to remember.

But uh, but it's really interesting that, that the market is trade, you know, is giving it, um, a higher, higher valuation.

Okay, I've got another question.

Why equity analysts may add 2% premium on top of cost of equity estimated I do not know.

I would have to see the actual, um, research report.

Um, that is rather unusual, um, that they just add a random number of 2%.

So maybe talk to the research analyst to find out why they have done that.

Okay? So ladies and gentlemen, you have done, um, gone through the different steps of DCF analysis.

You will find that the maths is pretty straightforward.

You have also just quickly done a real life DCF on Peloton and please remember I'm not giving any investment recommendations on the company.

I hope you found it useful and I hope to see you again in one of our upcoming Felix live sessions.

Bye for now and have a fantastic weekend. Goodbye.