Valuation Model for Serial Acquirer - how to account for future debt?

[Tintin]

Hi,

 

I'm looking at a serial acquirer that reinvests all of its annual earnings back into M&A, but juices its returns on equity by using an equal amount of debt.  This 50/50 strategy allows the company to double the pace of acquisitions.

 

The conceptual issue that I have is how to model for the present value of the company's FUTURE debt that does not exist as of today.  It seems to me that in order to arrive at a reasonable valuation, I cannot simply assume that all of the estimated future free cash flows will be coming back to the equity holders given that in order to generate those cash flows a significant amount of debt that is yet to be taken out will be needed.

 

If I use the present value of EXISTING debt in my bridge from EV to equity, this won't take into account any of the FUTURE debt that the company will require in order to generate those growing cash flows, and my concern is that this will lead me to overvaluing the present value of the company's equity.

 

Any direction in this area would be much appreciated.

 

Thanks.

 

 

 

 

[Spekulatius]

I think you just need to account for the cost of the future debt and make some assumptions about interest rates to do so. Should be pretty simple.

[ValueArb]

The complexities of this reminds me of why Buffett never does DCFs. His quote is something along the lines of if the value doesn't just jump out at you its an easy pass.

 

I guess my approach would be to worry less about the cost of future debt and more about the predictability of the company's future revenue growth. For example if it is a rollup, when does it run out of easy acquisitions and how does that change it's returns on equity? If it's a PE firm focusing on a specific niche, what is it's competitive advantage and how comfortable am I that it can sustain that advantage in producing superior returns on deals?

[ratiman]

Why not just look at return on capital? It shouldn't matter how it's funded. I think somebody won a Nobel prize for proving that.