Unlevered Free Cash Flow: What Goes in It, and Why It Matters (20:30)

In this tutorial, you’ll learn all about Comparable Company Analysis (CCA), also known as “Public Comps” or “Comps” – including why it works, what it tells you, and how to complete the process efficiently without access to expensive subscription services.

A DCF is split into the Explicit Forecast Period (Part 1) and the Terminal Period (Part 2).

You always start in Part 1 by projecting the company’s Cash Flows over 5-10 years, and sometimes more than that, and you almost always use Unlevered Free Cash Flow because it doesn’t depend on the company’s capital structure, it’s faster and easier, and it gets you the most consistent results.

Unlevered Free Cash Flow should reflect only items that are:

1) Related to or “available” to all investor groups in the company – think of it as “Free Cash Flow to ALL Investors”; and

2) Recurring for the company’s core-business operations.

Unlevered FCF corresponds to Enterprise Value, which represents the value of the company’s core-business Assets to ALL investors in the company.

As a result, you ignore most items on the financial statements, and Unlevered FCF usually includes only:

1) Revenue
2) COGS and Operating Expenses
3) Taxes
4) Depreciation & Amortization (and sometimes other non-cash charges)
5) Change in Working Capital
6) Capital Expenditures

You IGNORE Net Interest Expense, Other Income / (Expense), most non-cash adjustments, most of the CFI section, and the CFF section on the CFS.

Example for Steel Dynamics

We include the common items above, and we ignore the Asset Impairment Charges (non-recurring), Net Interest Expense (only available to Debt investors), and Other Income / Expense (non-core-business activity).

We include but modify the Income Tax Expense, and instead of Net Income on the CFS, we use NOPAT, equal to EBIT * (1 – Tax Rate), instead.

On the Cash Flow Statement, we include the Depreciation & Amortization add-back, exclude Impairment Charges and Gains/Losses (non-recurring), and exclude Stock-Based Compensation (affects only the Equity investors, changes share count, and is not a real non-cash expense).

We do include Deferred Income Taxes as well because a DCF should reflect the company’s actual Cash Taxes paid, but they decrease as a % of Income Taxes over time and should not be a major value driver for most companies.

Then, we keep everything in Working Capital, we keep CapEx in Cash Flow from Investing but drop everything else, and we ignore everything in Cash Flow from Financing (items are non-recurring, or related to just Equity or just Debt investors).

Example for Snap

It’s very similar; keep Revenue, Cost of Revenue, and all Operating Expenses, modify the Income Tax figure, use NOPAT rather than Net Income, and include D&A, Deferred Taxes, the Change in Working Capital, and CapEx.

We might include the Purchases of Intangible Assets as well, depending on the company’s plans and how they’re contributing to the business.

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