Lesson 7 - Comparative Valuation Approaches Flashcards
What is comparative analysis?
Involves comparing the subject company to “comparable companies” in the same industry.
What types of comparative analysis are there?
Benchmarking
Analysis of public equity market data (public company multiple approach)
Analysis of recent transactions (transaction multiple approach)
Acquirer rules of thumb
Purpose of comparative analysis
Provide a general understanding of the risk-reward dynamics in a given industry
Assess overall reasonableness of the valuation conclusions
Should companies be in the same industry and only undertake the same business functions as the subject business?
Yes
What factors do you consider when choosing comparable companies?
Company size - revenues, assets, number of employees
Level of diversification - “pure play” firms are better comparable
Degree of vertical integration
Relative market share
Cost structure and degree of operating leverage; capital vs. labor intensive business
Financial structure (capital mix)
General principles
Companies in commodity type industries make better comparable than companies with a large number of proprietary products
Industries should be well defined
Comparison is more meaningful in mature industries rather than in emerging ones
Possible Comparability Adjustments:
Adjustments may be required to enhance comparability:
Differences in accounting policies:
Inventory valuation Depreciation methods Revenue recognition R&D expenditures Future income taxes Differences in income tax rates Differences in financial structure
Determining appropriate capital structure for subject business:
Various measures of financial leverage
Debt serviceability
Use of Benchmark Analysis
Evaluating the adequacy of net trade ___________ _____________.
Working Capital.
Assessing reasonableness of projected operating results:
Profit margins Asset utilization Operating cost structure Employee head counts Sales or profit per employee
Public Company Multiple Approach
What are the applications of this approach?
Identify public companies that are comparable to the subject company.
Establish valuation multiples for the comparable company(s) based on the trading price of its stock
Apply the public company multiples to the subject company
Equity value approach
Starting point is to establish the market capitalization of the public company:
Shares outstanding X current market price of the stock
Commonly used multiples under the equity value approach:
Price/earnings ratio - (market capitalization divided by earnings available to common shareholders
Market/book ratio - (market capitalization divided by book value of common equity)
Enterprise value approach:
Starting point is to establish enterprise value (“EV”). What is enterprise value?
Market capitalization plus FMV of “net debt”. Net debt is defined as all interest bearing debt, capital leases and preferred shares, net of cash or near cash assets.
What are some commonly used multiples under the enterprise value approach?
EV/EBIT
EV/EBITDA
EV/Revenue
The EV approach is superior to the equity value approach in that it eliminates biases introduced where companies have different:
Accounting policies
Capital Structures
Tax Rates
Be careful how you use the public company multiple approach because there are significant differences between the public equity market and the market for an en bloc or controlling interest in a business (either public or private)
Investment time horizons
Volatility in stock market prices
Degree of liquidity
Public equity market transactions take place between minority shareholders
Amount of information available to investors
The level of negotiations that take place
Application of public equity market information to privately held businesses is limited because public companies:
Are usually much larger
Are often vertically or horizontally integrated
Are spread over broad geographic areas
Have management that has greater depth and strength
Emphasize accounting earnings and stock price
Can access a larger number of funding sources
Transaction Multiple Approach
Identification and analysis of transactions involving comparable companies provides the following information:
Degree of liquidity in a given industry
Perceived risks and rates of return
Identification of likely buyers for the subject company
Post-acquisition synergies that might be expected
Reasonable price range
Application of the Transaction Multiple Approach:
Identify companies who have acquired companies comparable to the subject company
Determine the basics on which they have valued the acquisition targets (i.e. Equity and/or EV multiples or rates of return.
Apply multiples or threshold rates of return to the subject company
In the transaction multiple approach, direct application of transactional information is rarely possible due to:
Lack of sufficient information
Uniqueness of each transaction
Transaction price includes post acquisition synergies that are difficult to quantify
