My experience as a financial analyst at CASIM

In this article, Liangyao TANG (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2021-2022) discusses the valuation methodologies in private equity and venture capitals based on her experience at the CAS Investment Management Co., Ltd.

CASIM

Chinese Academy of Sciences Holdings Co., Ltd., also referred to as CAS Investment Management Co., Ltd., is the first state-owned asset management company approved by the Assets Supervision and Administration Commission of the State Council (SASAC). Its predecessor is the Chinese National Economic Council-CAS Scientific and Technological Promotion & Economic Development Foundation. On April 12, 2002, CAS investment completed the industrial and commercial registration and was restructured into a limited liability asset management company.

Logo of CAS Investment Management.

Source: CAS Investment Management.

Since 2008, CAS Investment has carried out Private Equity fund investment business as an institutional investor. It had directly invested in many strategic emerging industries that helped shape China’s technological development. As of the end of 2018, the registered capital of CAS Investment was 5.1 billion RMB, holding more than 50 companies, which mainly distributed in information technology, high-end equipment manufacturing, environmental technology, and new materials. For the past 25 years, CASIM has supported over 300 successful commercialization and industrialization of technological development, some of which have become the industrial bellwethers and have contributed to promoting scientific achievement conversion in China. The Investment portfolio include Cambricon Technologies, Farasis Energy, ThunderSoft Technologies, and SIASUN Robostics.

My Mission

Passionate about creating value for enterprises and gaining a more on-edge understanding of the business world, I carried out a four-month internship as a Financial Analyst in the CAS Investment Management Co., Ltd. During that time, I joined the team and worked together with a Managing Director and a senior analyst. My responsibility is to conduct market research and desktop analysis for the project, which has allowed me to quickly dive into the TMT industry, especially the e-commerce sector. I conducted more than 20 financial statement analyses, operation strategies analyses, and market analyses to evaluate different investment opportunities. The qualitative analysis includes competitor benchmarking, business model analysis, supply chain and distribution analysis. Quantitatively includes building financial models to calculate future cash flow and income stream, and building market models to estimate the potential market size and market share. In addition, I also performed due diligence by conducting more than 50 interviews with industry experts on multiple projects. During the financial due diligence, I utilized Excel VBA to process and analyze ratios in the massive inventory and operation data to verify the authenticity of the target company’s financial performance. Those analytical work have greatly improved my hands-on ability to build market models and identify potential investment risks. I co-delivered the formal investment proposals for distribution to the Investment Committee, an infrequent task given to an intern during the past several years.

Knowledge and skills required

This investment analyst role requires the candidate to have a deep understanding of the business world and the target industry to be able to value the future potential of a business. The candidate also has to have the critical thinking ability to identify the risks and make rational decisions. During this experience, I have significantly reinforced my knowledge in financial statement analysis and market analysis. I also gained a solid improvement on my fast-learning abilities, analytical skills, and logical thinking capacities, which could be very beneficial for me moving forward in my career path.

Key financial indicators to understand valuation

When and what valuation method should be used has always been a matter of constant debate in the financial industry. The valuation methods depend on different stages of development and different rounds of financing of companies. This brings great differences in the estimated value of firms, resulting in no unified framework in the industry. The valuation can be said to be the most difficult part of a project. The valuation methods that are often used in Private Equity and Venture Capital firms include price-earnings ratio (P/E), price-book ratio (P/B), price-earnings growth (PEG), discounted cash flows (DCF), etc. I describe a few of them below.

P/E

The P/E method is one of the most common valuation methods. There are usually two types of price-earnings ratios for listed companies: historical price-earnings ratio (also called Trailing P/E) and forecasted price-earnings ratio (also called Forward P/E). The historical P/E ratio uses the current market value to divide by the earnings of the company in the previous financial year (or earnings in the previous 12 months). On the contrary, the forward P/E ratio uses current market capitalization, divided by the company’s earnings for the current fiscal year (or earnings for the next 12 months). Investors invest in the company’s future and estimate the present value for the company’s future operating capabilities. Therefore, the calculation formula using the price-earnings ratio method is:

Enterprise value = forecast price-earnings ratio × company profit for the next 12 months.

The price-earnings (P/E) ratio can be chosen from those of the comparable companies, their direct competitors, or the average price-earnings ratio of the industry in which the target company is located. The price-earnings ratio mainly depends on the expected growth rate of the company. The company’s valuation at its growing stage usually is much higher than that of a company at its mature stage. Also, it depends on the business’s risk level or the risk tolerance from the investors. A lower price-earnings ratio is used for a risker business because investors would demand a higher return from the investment.

EV/EBITDA

Another commonly used ratio in private company valuation is the EV/EBITDA ratio. The ratio is used to compare the enterprise value (EV) with the Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA). This gives investors a sense of how many times of the EBITDA they will have to pay if acquiring the target enterprise. Comparing the EV/EBITDA ratio of a company with the industry average and direct rivals also gives investors an idea of a fair target price. This method could leave out the effect of the company’s depreciation, inventory, non-recurring income and expenditure. Therefore, it is a good supplement to the price-to-earnings ratio valuation method.

P/B

The price-to-book (P/B) ratio is the ratio of market value/ tangible net assets value, or the ratio of share price per share to total book value per share. The EV of the firm is the same as discussed above in the P/E ratio section, and the book value is equal to total assets minus the intangible assets and total liabilities. The P/B ratio demonstrated important information about its market value compared to its accounting measures.

The advantages of this method are that the net assets’ data is easy to obtain, and the book value of net assets usually is authentic and less manipulated than net profit. Additionally, even if the company hasn’t been profitable, the price-to-book ratio is rarely negative, so it’s easier to calculate. However, the book value is affected by the choice of accounting policies. If companies implement different accounting standards, the price-to-book ratio will lose comparability. Secondly, the P/B ratio will not be a good measure for those companies with very few fixed assets. Those companies normally have a bigger portion of intangible assets, such as goodwill, intellectual property, brand reputation, and so on, which are not taking into consideration in the book value and could be easily manipulated. For example, for the service providers, media and entertainment producers, and IT companies, the company’s potential has very minimal relevance with its fixed assets. Therefore, the P/B ratio can be meaningless in some cases.

To sum up, the valuation of private enterprises, especially for start-up companies, is a unique and challenging task. The process is usually a combination of scientific computation and some flexibilities. No valuation method is perfect; analysts need to be very flexible and sharp with the method and the supplementary information they use to draw an objective conclusion.

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Useful resources

McKinsey & Company (23/10/2019) Pricing: The next frontier of value creation in private equity

Insider Intelligence (06/01/2022) Financial Services Industry Overview in 2022: Trends, Statistics & Analysis

BVCA Private Equity Explained

About the author

The article was written in March 2022 by Liangyao TANG (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2021-2022).