3.12) Public Comps and Precedent Transactions Flashcards
- Can you walk me through how you use Public Comps and Precedent Transactions in a valuation?
First, you select the companies and transactions based on industry, size, and geography (and time for the transactions). Then, you determine the appropriate metrics and multiples for each set – for example, revenue, revenue growth, EBITDA, EBITDA margins, and revenue and EBITDA multiples – and you calculate them for all the companies and transactions. Next, you calculate the minimum, 25th percentile, median, 75th percentile, and maximum for each valuation multiple in the set. Finally, you apply these numbers to the financial metrics of the company you’re analyzing to estimate its Implied Value. For example, if the company you’re valuing has $100 million in LTM EBITDA, and the median LTM TEV / EBITDA multiple in a set of comparable companies is 7x, then the company’s implied Enterprise Value is $700 million. You then calculate its Implied Value for all the other multiples to get a range of possible values.
- Why is it important to select Public Comps and Precedent Transactions that are similar?
Because the comparable companies and transactions should have similar Discount Rates and Free Cash Flow figures (in theory…). Remember that a company’s valuation multiples depend on its Free Cash Flow, Discount Rate, and Expected FCF Growth Rate. If the companies in your set all have similar Discount Rates and Free Cash Flows, it’s easier to conclude that one company trades at higher multiples because its expected growth rate is higher. If the companies do not have similar Discount Rates and Free Cash Flows, it’s harder to draw meaningful conclusions.
In practice, it’s almost impossible to find multiple companies with “similar” FCF figures, so this exercise is more important for getting similar Discount Rates.
- How do you select Comparable Public Companies and Precedent Transactions?
You screen based on geography, industry, and size, and also time for Precedent Transactions. Here are a few example screens:
- Comparable Company Screen: U.S.-based steel manufacturing companies with over $500 million in revenue.
- Comparable Company Screen: European legacy airlines with over €1 billion in EBITDA.
- Precedent Transaction Screen: Latin American M&A transactions over the past 3 years involving consumer/retail sellers with over $1 billion USD in revenue.
- Precedent Transaction Screen: Australian M&A transactions over the past 2 years involving infrastructure sellers with over $200 million AUD in revenue.
- Are there any screens you should AVOID when selecting Comparable Companies and Precedent Transactions?
You should not screen by both financial metrics and Equity Value or Enterprise Value. For example, you should NOT use this screen: “Companies with revenue below $1 billion and Enterprise Values above $2 billion.” If you use that screen, you artificially constrain the multiples because TEV / Revenue must be above 2x for every company in the set.
- Public Comps and Precedent Transactions seem similar. What are the main differences?
The idea is similar – you use Current valuation multiples from similar companies or deals to value a company – but the execution is different. Here are the differences for Precedent Transactions:
- Screening Criteria: In addition to industry, size, and geography, you also use time because you only want transactions from a specific period, which could be the past few years or even as long as 10-15 years ago. You might also use Transaction Size, and you may use broader screening criteria in general.
- Metrics and Multiples: You focus on historical metrics and multiples, especially LTM revenue and EBITDA, because it’s difficult to find projections as of the deal announcement date.
- Calculations: All the multiples are based on the purchase price as of the announcement date of the deal.
- Output: The multiples produced tend to be higher than those from Public Comps because of the control premium. But the multiples also tend to span wider ranges because deals can be done for many different reasons.
- Can you walk me through the process of finding the market and financial information for the Public Comps?
You start by finding each company’s most recent annual and interim (quarterly or half-year) filings. You calculate its diluted share count and Current Equity Value and Current Enterprise Value based on the information there and its most recent Balance Sheet. Then, you calculate its Last Twelve Months (LTM) financial metrics by taking the most recent annual results, adding the results from the most recent partial period, and subtracting the results from the same partial period the last year. For the projected figures, you look in equity research or find consensus figures on Bloomberg, Capital IQ, Finviz, Google/Yahoo, etc. And then, you calculate all the multiples by dividing Current Equity Value or Current Enterprise Value by the appropriate metric.
- Can you walk me through the process of finding the market and financial information for the Precedent Transactions?
You find the acquired company’s filings from just before the deal was announced, and you calculate the LTM financial metrics using those.
To calculate the company’s Transaction Equity Value and Enterprise Value, you use the purchase price the acquirer paid, and you move from Equity Value to Enterprise Value in the same way you usually do, using the company’s most recent Balance Sheet as of the announcement date. You calculate all the valuation multiples the same way, using Transaction Equity Value or Transaction Enterprise Value as appropriate.
- How do you decide which metrics and multiples to use in these methodologies?
You usually look at a sales-based metric and its corresponding multiple and 1-2 profitability-based metrics and their multiples. For example, you might use Revenue, EBITDA, and Net Income, and the corresponding multiples: TEV / Revenue, TEV / EBITDA, and P / E. You do this because you want to value a company in relation to how much it sells and how much it keeps of those sales. Sometimes, you’ll drop the sales-based multiples and focus on the profitability or cash flow-based ones (EBIT, EBITDA, Net Income, Free Cash Flow, etc.).
- Why do you look at BOTH historical and projected metrics and multiples in these methodologies?
Historical metrics are useful because they’re based on what happened in real life, but they can also be deceptive if there were non-recurring items or if the company made acquisitions or divestitures. Projected metrics are useful because they assume the company will operate in a “steady state,” without acquisitions, divestitures, or non-recurring items, but they’re also less reliable because they’re based on future predictions.
- When you calculate the forward multiples for the comparable companies, should you use each company’s Current Equity Value or Current Enterprise Value, or should you project them to get the Year 1 or Year 2 values?
You always use the Current Equity Value or Current Enterprise Value. NEVER “project” either one.
A company’s share price, and, therefore, both of these metrics, reflects past performance and future expectations. So, to “project” these metrics, you’d have to jump into the future and see what future expectations are at that point in the future and then jump back to the present.
- What should you do if some companies in your set of Public Comps have fiscal years that end on June 30th and others have fiscal years that end on December 31st?
You have to “calendarize” by adjusting the companies’ fiscal years so that they match up. For example, to make everything match a December 31st year-end date, you take each company with a June 30th fiscal-year end and do the following: * Start with the company’s full June 30th fiscal-year results. * Add the June 30th – December 31st results from this year. * Subtract the June 30th – December 31st results from the previous year. Normally, you calendarize to match the fiscal year of the company you’re valuing. But you might pick another date if, for example, all the comparable companies have December 31st fiscal years but your company’s ends on June 30th.
- How do you interpret the Public Comps? What does it mean if the median multiples are above or below the ones of the company you’re valuing?
The interpretation depends on how the growth rates and margins of your company compare to those of the comparable companies. Public Comps are most meaningful when the growth rates and margins are similar, but the multiples are different. This could mean that the company you’re valuing is mispriced and that there’s an opportunity to invest and make money. For example, maybe all the companies are growing their revenues at 10-15% and their EBITDA at 15-20%, and they all have EBITDA margins of 10-15%. Your company also has growth rates and margins in these ranges. However, your company trades at TEV / EBITDA multiples of 6x to 8x, while the comparable companies all trade at multiples of 10x to 12x.
This result could indicate that your company is undervalued since its multiples are lower, but its growth rates, margins, industry, and size are comparable. If the growth rates and margins are very different, it’s harder to draw conclusions.
- Is it valid to include both announced and closed deals in your set of Precedent Transactions?
Yes, because Precedent Transactions reflect overall market activity. Even if a deal hasn’t closed yet, the simple announcement of the deal reflects what one company believes another is worth. Note that you base all the metrics and multiples on the financial information as of the announcement dates.
- Why do Precedent Transactions often result in more “random” data than Public Comps?
The problem is that the circumstances surrounding each deal might be very different. For example, one company might have sold itself because it was distressed and about to enter bankruptcy – but another company might have sold itself because the acquirer desperately needed it and was willing to pay a high price. Some deals are competitive and include multiple acquirers bidding against each other, while others are targeted and involve no auction processes.
- How do you factor in earn-outs and expected synergies in Precedent Transactions?
You generally don’t factor in expected synergies because they’re quite speculative. If you do include them, you might increase the sellers’ projected revenue or EBITDA figures so that the valuation multiples end up being lower – assuming that you’re using projected metrics. Opinions differ about earn-outs, but you could assume they have a 50% chance of being paid out, multiply the earn-out amounts by 50%, and add them to the purchase prices. Other people ignore earn-outs or add the full earn-out amounts to the Purchase Equity Value and Purchase Enterprise Value.
