Multiples

Question 1

What are the most common multiples?

Answer 1

EV/Revenue, EV/EBITDA, EV/EBIT, P/E, P/BV (Book Value)

Question 2

Which types of multiples do you know?

Answer 2

• Equity Multiples
• EV Multiples
• Lagging and Leading Multiples
• Trading and Transaction Multiples

Question 3

What are pros and cons of a multiple valuation?

Answer 3

Pros:
- Simple concept
- Robust if retrieved properly
- More multiples means more meaningful valuation
- Generate valuation range
- Highly relevant in practice
- Easier to defend than other methods
Cons:
- Very condensed metrics
- Dependency on many factors requires proper adjustments
- Adjustments can take a lot of time
- Only works if a lot of comparables exist
- Multiples assume identical companies
- Very short-term oriented
- Relative valuation (company can be very good and still have low valuation if market peers are bad)

Question 4

Does multiple for future years tend to increase or decrease?

Answer 4

They usually fall, assuming growing company EBITDA grows as well and lowers multiple. In EV/EBITDA, EV is reflection of all future cash flows (that hopefully tend to grow) while EBITDA is a present metric.

Question 5

Is valuation more meaningful using EBIT or EBITDA multiple?

Answer 5

Both possible. EBITDA is important because it is at top of IS and therefore very comparable. However, asset intensive companies like heavy manufacturing tend to be valued using EBIT multiples as it reflects how many assets they have and how they depreciate.

“References to EBITDA make us shudder – does management think the tooth fairy pays for Capex?” -Warren Buffet

Question 6

When would you use EBITDAR multiples (R = Rent)?

Answer 6

Rent and operating leases are also excluded so we are even closer to revenue. EBITDAR multiples are used if companies in an industry use highly different ownership and rent strategies (e.g. two clothing discounters, one rents shop, one buys them). Mostly used in retail industry.

Question 7

Why would you use a sales multiple?

Answer 7

If other metrics are negative.

Question 8

Where is the biggest difference when using a multiple before or after financial results?

Answer 8

Everything above are EV multiples, everything below are Equity multiples.

Question 9

When would you use EBITA multiples?

Answer 9

Alternatively, to EBIT multiples as depreciations (material) are excluded but amortizations (immaterial) are included.

Question 10

Is the development of P/E or EV/EBITDA multiples more volatile over time?

Answer 10

P/E multiple is more volatile as equity investors only get residual value that is affected by many factors, especially debt. E.g. €1b EV, €100m EBITDA, €500m Equity, €50m Earnings. Both multiples are 10x. If EV increases to €1.1b EV/EBITDA is 11x. But Equity also increases to €600 and multiple becomes 12x because of leverage.

Question 11

Which multiples are capital structure neutral and which are not?

Answer 11

Everything before financing in IS is EV multiple and therefore capital structure neutral (e.g. EV/EBIT). Everything below isn’t (e.g. P/E).

Question 12

When is a P/E multiple especially useful?

Answer 12

• As addition to other (EV) multiples (given similar capital structures)
• When small parts of equity are acquired (therefore often used on buyside)

Question 13

How can a theoretical P/E be determined?

Answer 13

P = Dividend_1 / (r-g)
= EPS_1 * Payout Ratio / (r-g)
= EPS_0 * (1+g) / (r-g)

P/E = P/EPS
= EPS * (1+g) * Payout Ratio / (r-g) / EPS
= Payout Ratio * (1+g) / (r-g)

Question 14

Would you use a multiple either for the previous/current/next year?

Answer 14

Either current or next. Last year is over and therefore not relevant.

Question 15

A peer group of engine manufacturers has a median multiple of 8x with a low range around it. One of them has 4.5x. What could be reasons for it?

Answer 15

Company in difficult state, potentially going towards restructuring. EBITDA still strong but valuation and resulting EV already low. Also if EBITDA are way too high and not believed by market.

Question 16

Why do multiples need to be adjusted?

Answer 16

Throughout IS a lot is dependent on accounting standards. Therefore identical companies could be valued at different multiples and you need to adjust them to still get same value.

Question 17

On which variable do you select multiples?

Answer 17

• Industry
• Company Size
• Similar margins
• Similar growth
• Similar geographic focus
• Similar position in supply chain
• Similar product portfolio
• If P/E multiples are used then similar capital structure

Question 18

When are trading multiples higher than transaction multiples?

Answer 18

Transaction multiples have a time lag and therefore if market is high trading multiples can be substantially higher

Question 19

When comparing trading and transaction multiples, which takeover premium would you expect?

Answer 19

Between 10-30%

Question 20

When would you not use a multiples valuation?

Answer 20

Two cases:

• When few peers are available
• When company has negative EBITDA etc. it leaves you with only sales multiples or industry specific multiples

Question 21

What are some industry specific multiples?

Answer 21

• Technology: EV/Unique Visitors, EV/Pageviews, EV/Subscribers
• Retail/Airlines: EV/EBITDAR (Rent): because rent can be highly variable
• Energy: P/MCFE, P/MCFE/D (MCFE = 1m cubic foot equivalent, D = day), P/NAV
• REITs: Price/FFO, Price/AFFO (AFFO = adj. funds from operations); adds back depreciation and subtracts gain on sale of property
• Healthcare: EV/Beds
• Mining: EV/EBITDAX (Exploration)

Question 22

Could you use EV/NI?

Answer 22

No, never! EV is for all investors, Net Income just for equity investors.

Question 23

Which valuation leads to lowest, which to highest valuation?

Answer 23

No rule but DCF and Transaction Multiples usually highest because transactions include premium and DCF is usually rather optimistic. Trading multiples are usually lower as they don’t include premiums and can be very low depending on market.

Question 24

How do you know if an industry specific multiple is meaningful?

Answer 24

Only if it’s actually related to company. You could do regression analysis on e.g. EV and Beds (for hospital) and find out if there is a positive correlation.

Question 25

Why can’t you use Equity Value/EBITDA instead of EV/EBITDA?

Answer 25

Because EBITDA goes to all investors not just equity investors.

Question 26

What would you use with FCF multiples – Equity Value or EV?

Answer 26

Trick question: UFCF with EV and LFCF for Equity Value; UFCF excl. interest and thus represent money available to all investors whereas levered FCF incl. interest and therefore is only available to equity investors.

Question 27

In which case would you still use Equity Value / EBITDA?

Answer 27

Very rare but for large financial institutions with big cash balances for negative EVs; however, in most cases you would use other multiples such as P/E or P/BV with banks anyway.

Question 28

Has an asset intensive business higher or lower EBITDA multiples?

Answer 28

Two factors go into formula, EV and EBITDA. EBITDA stays same as no depreciations have been recorded yet, so we only look at EV. To find EV we have to get to FCF. Asset intensive business has more depreciations so lower pretax income (which is slightly offset by tax-shield) and lower NI. Assuming Capex equals D&A our FCF is lower by the same amount as NI and we receive lower FCFs. So, asset intensive businesses have lower EV/EBITDA multiples. Intuitively, this means that two same businesses create the same value but one of them has to use assets to do it, while the other has an advantage and doesn’t have to own that many assets to achieve the same amount of EBITDA.

Question 29

Company decides to finance itself through debt and equity. What differentiates Equity Story and Credit Story in their documents?

Answer 29

Equity story concentrates on growth and profit chances of investment (profit growth, expansion, new products etc.). Credit story concentrates more on stability and continuity than on the upside

Question 30

Which function has the prospect in a bond emission?

Answer 30

“All-in-one” document due diligence. Contains all information about company, historical financials, descriptions of company risk and all additional information. The prospect is created in collaboration with audit company and has to be approved by financial regulator (SEC, BaFin,…). Similar to VDD.

Question 31

EV/EBIT(DA) and P/E all measure company’s profitability. What’s the difference?

Answer 31

P/E depends on capital structure, whereas the other two are capital structure neutral. Therefore, you use P/E for banks, financial institutions, and other companies where interest payments/expenses are critical.

Question 32

Two businesses with vending machines, in one you own them, in the other you lease them. Which one would you pay more for?

Answer 32

For the one where you lease them. Both pretax expenses are the same so you get the same EV. However, leases are reflected in SG&A so you have lower EBITDA, resulting in a higher multiple. If you own the machines, EBITDA is not affected because you subtract D&A afterwards.

Question 33

One company with 40% EBITDA margin trading at 8x EBITDA and another with 10% EBITDA trading at 16x EBITDA. What’s the problem with comparing these two?

Answer 33

Drastically different margins – the 40% margin company will usually have a lower multiple, whether or not its actual value is lower. In this case we would screen based on margins. You would never try to normalize EBITDA multiples based on margins.