Wednesday, July 24, 2013

Pignataro, Financial Modeling and Valuation

Paul Pignataro has written a book that even “dummies” can understand. In Financial Modeling and Valuation: A Practical Guide to Investment Banking and Private Equity (Wiley, 2013) he takes Walmart as a case study and walks the reader step by step through its financials as well as the Excel key strokes required to hardcode them.

The first part of the book builds a complete financial model from the company’s income statement, cash flow statement, depreciation schedule, working capital, balance sheet, and debt schedule. The second part undertakes a valuation analysis, including a discounted cash flow analysis, a comparable company (in this case Costco) analysis, and a precedent transactions analysis.

Walmart works well as a focal company, at least until the author gets to the chapter on precedent transactions. Using precedent transactions to assess the approximate value of a company is similar to using comparable recent real estate transactions to assess the approximate value of your house. If, however, your estate is so big that nothing like it has sold recently, you have a problem using this method. (An aside: in case you missed it, the most expensive U.S. estate ever to be formally listed hit the market in May—Copper Beech Farm in Greenwich, CT, with a $190 million price tag. The not so applicable precedent in Greenwich sold for $45 million in 2004.) The closest Pignataro could come was the KKR acquisition of Dollar General.

This book assumes no prior knowledge of Excel coding. Here’s a single example of the many Excel formulas and tips the author offers. Most people who use Excel have experienced that dreaded circular reference error message. Usually it’s simply operator error, but if you’re building a financial model of a company and haven’t changed your Excel settings you’re bound to encounter it. “In a fully linked model, there is one major, yet important circular reference flowing through the statements. This circular reference is related to the debt and interest. Specifically, if debt is raised in the debt schedule, cash at the end of the year will increase and therefore interest income will increase. As interest income links to the income statement, net income is increased. That net income increase flows to the top of the cash flow statement, and increases cash and, more importantly, ‘Cash flow before debt paydown’ at the bottom of the cash flow statement. This cash flow before debt paydown links to the debt schedule and increases the cash available to paydown debt, and therefore increases the cash at the end of the year, which increases the interest income, and so on.” (p. 242) The author explains how to adjust Excel settings (found under “File,” “Options,” “Formulas,” and “Calculation options”) to enable iterative calculations and how to fix the number of iterations Excel should cycle through.

Pignataro is the founder and CEO of the New York School of Finance, which means that he knows a thing or two about training investment professionals from scratch. So if you’re interested in a career in investment banking or private equity or if you’re an investor, retail or institutional, who wants to learn more about the nitty-gritty of valuation, this book fills the bill.

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