Relative Valuation Using Market Comparables PROBLEM 9 MINI-CASE PRICING SHARES FOR THE MINI-CASE FRAMCO RESOURCES IPO that engages in the ican oil and natural Framco Resources is an independent oil and natural gas company that engages acquisition, development, and exploitation of onshore North American oil and gas properties. The company has followed a strategy of growth through the develo of its inventory of drilling locations and exploitation projects, and selectively pu acquisitions. The firm's current management team hrst purchased a significant own ship interest in Framco (which was a public entity) in December 1997 and because has achieved substantial growth in reserves and production. In 2003, the compan taken private through a buyout financed using debt capital and equity capital provided by a private equity partner. Late in 2005, Framco's board decided that the time was right for the firm to once again become a public entity by doing an initial public offering of its shares Framco's board selected an investment banker, who prepared a preliminary analy. sis of possible offering prices for Framco's shares, found in Exhibits P9.1 and P9.2 The valuation analysis utilizes valuation ratios based on the current enterprise values of five independent oil and gas companies and three key valuation metrics that are com- monly used in the industry: estimated reserves: estimated earnings before interest, taxes depreciation and amortization, and maintenance capital expenditures (EBITDAX); and firm free cash flow. Exhibit P9.2 contains estimates of Framco's equity and enterprise valuation that would correspond to different IPO share prices. This analysis is based on the assumption that Framco will sell 51.6 million shares of stock for a price of $20 to $30 per share. To complete the comparative analysis, Framco's CFO provided the investment banker with the necessary estimates of his firm's proved reserves for 2005, EBITDAX for 2006 and 2007, and free cash flow. These estimates are found below: Valuation Metric 2005E proved reserves 2006E EBITDAX 2007E EBITDAX Firm free cash flow Framco Estimates $700 million $302 million $280 million $191 million a. Calculate the valuation ratios found in Exhibit P9.1. using Framco's valuation rics for each of the alternative IPO prices found in Exhibit P9.2. b. Based on your calculations (and assuming the valuation metrics are used by to make value comparisons among independent oil and gas firms), what price think Framco's shares will command at the time of the IPO? e. The actual offering price for Framco's shares is not set until the pricing with the investment banker the night before the offering date. At this me investment banker has not only updated comparables data such as tha Exhibit P9.1 but also has indications of interest for purchasing the new sh book). Additionally, Framco's investment banker reviewed Framco's estimates of the valuation metrics, which were virtually identical to t rics are used by investors ns), what price do you the pricing meeting this meeting, the uch as that found in amco's most recent al to the estimates Relative Valuation Using Market Comparables indicating an oversus of the range of prices price outside the orig. found in Exhibit P9.1. However, the book was quite strong, indicati scription for the 51.6 million shares at prices at the upper end of the found in Exhibit P9.2. Should Framco try to raise the offering price out inal range set forth in Exhibit P9.2? Why or why not? Exhibit P9.1 Industry Comparables Used in Framco Resources IPO Pricing Analysis Firm Valuation Ratios Firm Free Cash Enterprise Value E . NOSE Reserves 2006 ERIT DAX 2007 ERIT DAX Firm Free Cash Flow' How $2.81 Firm Characteristics (millions) 2006E 2007E 2005E EBIT- Reserves DAX DAX 7.311 53.210 $2,873 7.220 3.806 3.299 1,411 601 602 1,232 380 $20,547 21.280 7.15 Company Company #1 Company #2 Company #3 Company 4 Company US 3.50 6.40 5.59 6.45 7.94 4,781 2.05 2,508 2,355 252 341 7.96 6.000 5.12 798 100 2.95 5.90 23 Mean Median 2.95 6.00 7.15 Firm free cash flow is calculated in the usual way and includes company estimates of maintenance capital expenditures Exhibit P9.2 Enterprise Value Estimates for Framco Based on Alternative IPO Share Prices Expected IPO Share Prise $20.00 $22.00 $24.00 $26.00 $0.00 $0.00 Diluted shares outstanding (millions) 5100 51.00 51.60 1.00 51.00 51.60 Equity value (millions) $1,032 $1,135 $1,238 $1,342 $1.445 $1.548 Plus: Net dels (millions) 740 637 SS 5 34 Enterprise value (millions) $1,772 51.824 $1,875 $1,927 $1,978 $2.000 Net debt equals interest-bearing debt less cash (250,000). The interest-bearing debt total declines with increasing IPO share prices because half the additional proceeds resulting from a higher price are used to retire Framco's debt. Relative Valuation Using Market Comparables PROBLEM 9 MINI-CASE PRICING SHARES FOR THE MINI-CASE FRAMCO RESOURCES IPO that engages in the ican oil and natural Framco Resources is an independent oil and natural gas company that engages acquisition, development, and exploitation of onshore North American oil and gas properties. The company has followed a strategy of growth through the develo of its inventory of drilling locations and exploitation projects, and selectively pu acquisitions. The firm's current management team hrst purchased a significant own ship interest in Framco (which was a public entity) in December 1997 and because has achieved substantial growth in reserves and production. In 2003, the compan taken private through a buyout financed using debt capital and equity capital provided by a private equity partner. Late in 2005, Framco's board decided that the time was right for the firm to once again become a public entity by doing an initial public offering of its shares Framco's board selected an investment banker, who prepared a preliminary analy. sis of possible offering prices for Framco's shares, found in Exhibits P9.1 and P9.2 The valuation analysis utilizes valuation ratios based on the current enterprise values of five independent oil and gas companies and three key valuation metrics that are com- monly used in the industry: estimated reserves: estimated earnings before interest, taxes depreciation and amortization, and maintenance capital expenditures (EBITDAX); and firm free cash flow. Exhibit P9.2 contains estimates of Framco's equity and enterprise valuation that would correspond to different IPO share prices. This analysis is based on the assumption that Framco will sell 51.6 million shares of stock for a price of $20 to $30 per share. To complete the comparative analysis, Framco's CFO provided the investment banker with the necessary estimates of his firm's proved reserves for 2005, EBITDAX for 2006 and 2007, and free cash flow. These estimates are found below: Valuation Metric 2005E proved reserves 2006E EBITDAX 2007E EBITDAX Firm free cash flow Framco Estimates $700 million $302 million $280 million $191 million a. Calculate the valuation ratios found in Exhibit P9.1. using Framco's valuation rics for each of the alternative IPO prices found in Exhibit P9.2. b. Based on your calculations (and assuming the valuation metrics are used by to make value comparisons among independent oil and gas firms), what price think Framco's shares will command at the time of the IPO? e. The actual offering price for Framco's shares is not set until the pricing with the investment banker the night before the offering date. At this me investment banker has not only updated comparables data such as tha Exhibit P9.1 but also has indications of interest for purchasing the new sh book). Additionally, Framco's investment banker reviewed Framco's estimates of the valuation metrics, which were virtually identical to t rics are used by investors ns), what price do you the pricing meeting this meeting, the uch as that found in amco's most recent al to the estimates Relative Valuation Using Market Comparables indicating an oversus of the range of prices price outside the orig. found in Exhibit P9.1. However, the book was quite strong, indicati scription for the 51.6 million shares at prices at the upper end of the found in Exhibit P9.2. Should Framco try to raise the offering price out inal range set forth in Exhibit P9.2? Why or why not? Exhibit P9.1 Industry Comparables Used in Framco Resources IPO Pricing Analysis Firm Valuation Ratios Firm Free Cash Enterprise Value E . NOSE Reserves 2006 ERIT DAX 2007 ERIT DAX Firm Free Cash Flow' How $2.81 Firm Characteristics (millions) 2006E 2007E 2005E EBIT- Reserves DAX DAX 7.311 53.210 $2,873 7.220 3.806 3.299 1,411 601 602 1,232 380 $20,547 21.280 7.15 Company Company #1 Company #2 Company #3 Company 4 Company US 3.50 6.40 5.59 6.45 7.94 4,781 2.05 2,508 2,355 252 341 7.96 6.000 5.12 798 100 2.95 5.90 23 Mean Median 2.95 6.00 7.15 Firm free cash flow is calculated in the usual way and includes company estimates of maintenance capital expenditures Exhibit P9.2 Enterprise Value Estimates for Framco Based on Alternative IPO Share Prices Expected IPO Share Prise $20.00 $22.00 $24.00 $26.00 $0.00 $0.00 Diluted shares outstanding (millions) 5100 51.00 51.60 1.00 51.00 51.60 Equity value (millions) $1,032 $1,135 $1,238 $1,342 $1.445 $1.548 Plus: Net dels (millions) 740 637 SS 5 34 Enterprise value (millions) $1,772 51.824 $1,875 $1,927 $1,978 $2.000 Net debt equals interest-bearing debt less cash (250,000). The interest-bearing debt total declines with increasing IPO share prices because half the additional proceeds resulting from a higher price are used to retire Framco's debt