VALUATION COMPARABLE COMPANIES Flashcards
Provides an overview of comparable companies analysis, a method used to value a given focus company, division, business, or collection of assets. Provides a market benchmark against which a banker can establish a valuation for a private company or analyze the value of a public company at a given point in time. Used primarily for M&A, IPOs, Rx, and investment decisions.
What is a comparable companies analysis?
Comparable companies analysis is one of the primary methodologies used for valuing a given focus company, division, business, or collection of assets (known as the target).
What does a comparable companies analysis provide?
A comparable companies analysis provides a market benchmark against which a banker can establish valuation for a private company or analyse the value of a private company at a given point in time.
In what applications do we use a comparable companies analysis?
There are a broad range of uses, such as for M&A situations, IPOs, Restructurings, and investment decision making.
What is the premise of a comparable company analysis?
The foundation is built on the premise that similar companies provide a highly relevant reference point for valuing a target given the fact that they share key business and financial characteristics, performance drivers, and risks. Therefore, the banker can establish valuation parameters by determining the target’s relative position among its peers.
What is the core of a comparable company analysis?
The core of the analysis involves selecting a universe of comparable companies for the target. The companies in the comparables universe are benchmarked against one another and the target based on various financial statistics and ratios. Trading multiples are calculated and used for extrapolating a valuation range for the target, which is calculated by applying the selected multiples to the target’s relevant financial statistics.
What are some key valuation metrics used for trading multiples?
- Enterprise Value/EBITDA (EV/EBITDA)
2. Price/Earnings (P/E)
Why are EV/EBITDA and P/E used? Following this, why those specific metrics?
For both ratios, the numerator consists of a measure of value for the company and the denominator is a financial statistic.
Multiples based on EV are used by bankers as they are independent of capital structure and other factors unrelated to business operations (tax regimes, accounting policies - GAAP / non GAAP)
What type of valuation of the company does comparable company analysis provide?
The analysis reflects the “current” valuation based on prevailing market conditions and sentiment.
Why may current valuation not be perfect at valuing the company?
Market trading levels may be subject to periods of irrational investor sentiment that could skew valuation either too high or too low. Further, no two companies are exactly the same so assigning a valuation based on the trading characteristics of similar companies may fail to capture the true value of the firm.
What are the 5 steps to conducting a comparable companies analysis?
- Select the Universe of Comparable Companies
- Locate the Necessary Financial Information
- Spread Key Statistics, Ratios, and Trading Multiples
- Benchmark the Comparable Companies
- Determine Valuation
On the base level, how do you determine a comparable company to add to the comparables universe?
Companies in the same sector (preferably sub-sector) with similar size tend to serve as good comparables.
What do you use for a target with no clear public comparables?
Often you can try use companies outside the target’s core sector that share business and financial characteristics on some fundamental level.
For example, a medium-sized manufacturer of residential windows may have no true direct public comparable, however, if you were to expand this to include companies manufacturing building products, serve homebuilders, or exposure to the housing cycle, the size of the tangible universe increases.
What information should you use to help study a comparable company?
For public registrants (Public companies or private companies who are subject to file with the SEC because of public debt securities), 10-K and 10-Q filings, consensus research estimates, equity and fixed income research reports, press releases, earnings call transcripts, investor presentations, and corporate websites provide key information
What are the key business characteristics to profile a comparable company?
- Sector
- Products and Services
- Customers and End Markets
- Distribution Channels
- Geography
What are the key financial characteristics to profile a comparable company?
- Size
- Profitability
- Growth Profile
- Return on Investment
- Credit Profile
Describe why “sector” is an important business characteristic while profiling comparable companies?
A company’s sector conveys a great deal of information regarding key drivers, risks, and opportunities. For example, cyclical sectors such as oil & gas will have dramatically different earnings volatility than consumer staples. On the other hand, cyclical or highly fragmented sectors may present growth opportunities that are unavailable to companies in more stable or consolidated sectors.
Describe why “product and services” is an important business characteristic while profiling comparable companies?
A company’s products and services are at the core of its business model. Accordingly, companies that produce similar products or provide similar services typically serve a reasonable comparables.
Describe why “customers and end markets” is an important business characteristic while profiling comparable companies?
Customers: companies with a similar customer base tend to share similar opportunities and risks. For example, companies supplying automobile manufacturers abide by certain regulations (for distribution) and are subject to purchasing cycles and trends. The quantity and diversity of a company’s customers are also important. While it is generally positive to have low customer concentration from a risk management perspective, it is beneficial to have a stable customer core to provide visibility and comfort regarding revenue forecasting.
End Markets: end markets refer to broad underlying markets into which a company sells its products and services. A company’s performance is generally tied to economic and other factors that affect its end markets. Companies that sell products and services into the same end markets generally share similar performance outlook, which is important for determining appropriate comparable companies
Describe why “distribution channels” is an important business characteristic while profiling comparable companies?
Distribution channels are a key driver of operating strategy, performance, and ultimately value. This is a result of organisation and cost structures dependent on specific levels and tiers of distribution channels.
Describe why “geographies” is an important business characteristic while profiling comparable companies?
Companies that are based in (and sell to) different regions of the world often differ substantially in terms of fundamental business drivers and characteristics. These may include growth rates, macroeconomic factors, competitive dynamics, paths-to-market, organizational and cost structure, potential opportunities and potential risks. These differences can vary greatly from country to country and continent to continent. Consequently, there are often valuation disparities for similar companies in different global regions or jurisdictions. Therefore, a banker would tend to group U.S.-based (or focused) companies in a separate category from European- or Asian-based companies even if the basic business models are the same.
Describe a time when geography as a business characteristic may be less applicable?
It is less applicable for truly global industries such as oil and aluminium where domicile is less indicative than global commodity prices and market conditions. However, this should be taken with a grain of salt as valuation disparities (as a result of geography) are often evident.
Describe why “size” is an important financial characteristic while profiling comparable companies?
When we consider size, typically we measure in terms of market valuation (equity value and enterprise value) as well as key financial statistics (sales, gross profit, EBITDA, EBIT, and net income). Companies of similar size are more likely to have similar multiples than companies with significant size discrepancies. This reflects the fact that companies of similar size are also likely to be analogous in other respects, such as economies of scale, purchasing power, pricing leverage, customers, growth prospects, and trading liquidity of their shares in the stock market). Consequently, differences in size often map to differences in valuation.
Describe why “profitability” is an important financial characteristic while profiling comparable companies?
A company’s profitability measures its ability to convert sales into profit. Profitability ratios employ a measure of profit in the numerator, such as gross profit, EBITDA, EBIT, or net income, and sales in the denominator. Companies in the same sector, higher profit margins translate to higher valuations all else being equal. Consequently, relative profitability is a core component of benchmarking analysis.
Describe why “growth profile” is an important financial characteristic while profiling comparable companies?
A company’s growth profile, as determined by its historical and estimated future financial performances, is an important driver of valuation. Equity investors reward high growth companies with higher trading multiples than slower growing peers. They also discern whether growth is organic (preferable) or acquisition-driven. Historical and estimated future growth rates for financial statistics (such as EBITDA and EPS) are examined at selected intervals. For mature public companies, EPS are typically more meaningful. For early stage companies, with little or no earnings, sales or EBITDA growth trends may be more relevant.
Describe why “Return on Investment” is an important financial characteristic while profiling comparable companies?
Return on Investment (ROI) measures a company’s ability to provide earnings (or returns) to its capital providers. ROI ratios employ a measure of profitability (EBIT, NOPAT, or net income) in the numerator and a measure of capital (Invested Capital, Shareholder’s equity, total assets) in the denominator. Most commonly used ROI metrics are ROIC (invested capital), ROE (equity), ROA (assets). Dividend yield, which measures the dividend payment that a company’s shareholders receive per share owned, is another return metric.
Describe why “credit profile” is an important financial characteristic while profiling comparable companies?
A company’s credit profile refers to its creditworthiness as a borrower. It is typically measured by metrics relating to a company’s overall debt level (leverage) as well as its ability to make interest payments (coverage), and reflects key company and sector-specific benefits and risks. Moody’s, S&P, and Fitch ratings are the three primary independent credit rating agencies that provide formal assessments of a company’s credit profile.
How do you screen for companies in a comparables company analysis?
Firstly, bankers check to see whether any established lists of comparable companies exist, as banks often update sector lists (with multiples and other financial data) each quarter.
Otherwise, the banker should examine the target’s public competitors. These competitors generally share key business and financial characteristics and are susceptible to similar opportunities and risks. Public companies discuss their primary competitors in their 10-Ks, annual proxy statement DEF14A, and potentially in investor presentations.
Further, equity research reports, especially initiating coverage, often list research analyst views on target comparables and competitors.
An additional source for locating comparables is the proxy statement for a relatively recent M&A transaction in the merger proxy section as it contains excerpts from a fairness opinion.
Bankers could screen for companies in CapIQ, FactSet, and Thomson Reuters using SIC or NAICS codes. This is usually used to ensure no company is overlooked by casting a wide net.
Also, you could leverage the knowledge of the senior bankers on the team to determine comparable companies for the universe. Often senior bankers can refine a preened list to add nuanced opinion and expertise.
In trading comps, how is valuation driven? Which drivers are more meaningful?
Valuation is driven on the basis of both historical performance (LTM financial data) and expected future performance (consensus estimates for future calendar years). Depending on the sector and point in the cycle, financial projections tend to be more meaningful. Estimates for forward-year financial performance are typically sourced from consensus estimates.
In the context for M&A or debt capital raising transaction, more emphasis is placed on LTM financial performance, which is calculated on the basis of data obtained from a companies public filings
What is a 10-K report and what does it contain?
A 10-K is an annual report filed with the SEC by a public registrant that provides a comprehensive overview of the company and its prior year performance.
- detailed business description
- management discussion and analysis (MD&A)
- audited financial statements
- supplementary data
- outstanding debt detail
- basic shares outstanding
- stock options and warrant
- other information about the company sector, its segment details, customers, end markets, competitions, opportunities and risks, significant events, and acquisitions
What is a 10-Q report and what does it contain?
The 10-Q (quarterly) report is a quarterly report filed by a public registrant that provides an overview of the most recent quarter and year-to-date YTD period. It is less comprehensive than the 10-K, but provides financial statements, MD&A, and recent share count information and warrant/option information.
What is an 8-K report and what does it contain?
The 8-K (current) report is filed by a public registrant to report the occurrence of material corporate changes or events that are important to shareholders or security holders (typically within 4 days after occurrence). Key events include:
- earnings announcements
- entry into a definitive purchase/sale agreement
- completion of an acquisition or disposition of assets
- capital market transactions
- Regulation FD disclosure requirements
The 8-Ks often contain important financial statistics and trading multiples that may not be reflected in the most recent 10-K or 10-Q.
What is a proxy statement and what does it contain?
A proxy statement is a document that a public company sends to its shareholders prior to a shareholder meeting containing material information regarding matters on which the shareholders are expected to vote. It is also filed with the SEC on Schedule 14A. It also may provide basic share outstanding counts that may be more recent than that contained in the 10-Q or 10-K.
What are equity research reports and what do they contain?
Equity research reports provide individual analyst estimates of future company performance, which may be used to calculate forward-looking multiples, including estimates of sales, EBITDA and/or EBIT and EPS for future quarters (and future 2,3 year period). The reports may also provide commentary on non-recurring items and recent M&A and capital market transactions, which are helpful for determining pro forma adjustments and normalizing financial data.
What are consensus estimates and what do they contain?
Consensus estimates for selected financial statistics are widely used by bankers as the basis for calculating forward-looking trading multiples in trading comps. Primary estimates are First Call and IBES, found through Bloomberg, FactSet, and Thomson Reuters. Typically a banker chooses one source to maintain consistency throughout the analysis.
What is a press release and what does it contain?
A company issues a press release when it has something important to report to the public, including earnings announcements, declaration of dividends, and management changes, as well as M&A and capital markets transactions.
What sources can I use to find income statement data such as: Sales, Gross Profit, EBITDA, EBIT, Net Income, EPS
Most recent 10-K, 10-Q, 8-K, and press releases
What source can I use to find research estimates?
First Call or IBES, individual equity research reports
What source can I use to find Balance Sheet data such as : Cash Balance, Debt Balances, Shareholders’ Equity?
Most recent 10-K, 10-Q, 8-K, and press releases
What source can I use to find Cash Flow Statement data such as : Depreciation and Amortization, Capital Expenditures?
Most recent 10-K, 10-Q, 8-K, and press releases
What source can I use to find Share Data such as Basic Shares Outstanding?
10-K, 10-Q, or Proxy Statement, whichever is most recent
What source can I use to find Share Data such as Options and Warrant Data?
10-K or 10-Q, whichever is most recent
What source can I use to find market data such as Share Price Data?
Financial Information services such as Bloomberg
What source can I use to find credit ratings?
Rating agencies’ websites, Bloomberg
What are the key metrics to use when looking at a size (market valuation)?
Equity value and Entreprise value: Key Financial Data: sales, gross profit, EBITDA, EBIT, and net income
What are the key metrics to consider when looking at profitability?
Gross profit, EBITDA, EBIT, and net income margins
What are the key metrics to consider when looking at growth profile?
Historical and estimated growth rates
What are the key metrics to consider when looking at Return on Investment?
ROIC, ROE, ROA, and dividend yield
What are the key metrics to consider when looking at Credit Profile?
Leverage ratios, coverage ratios, and credit ratings
What is Equity Value?
Equity Value, or market capitalization, is the value represented by a given company’s basic shares outstanding plus ‘in the money’ stock options, warrants, and convertible securities - collectively fully diluted shares outstanding.
What is the formula for Equity Value?
{Share Price} x {Fully Diluted Shares Outstanding}
Fully Diluted Shares Outstanding =
{Basic Shares outstanding
+ in-the-money options and warrants
+ in-the-money convertible securities}
What does Equity Value represent?
It represents the market capitalization of the firm available to shareholders. Equity Value is the Enterprise Value minus Net Debt so it is the residual value that remains after satisfying the debt obligations of the firm.
What does Equity Value highlight when compared to other firms and what else can we use with it for more perspective?
Equity Value provides a measure of relative size to other companies, therefore, for insight on absolute AND relative size, the banker can look at the company’s current share price as a percentage of its 52-week high. This provides a perspective on valuation and gauges the current market sentiment and outlook both for the individual company and its broader sector.
How do you calculate Fully Diluted Shares Outstanding?
A company’s fully diluted shares outstanding are calculated by adding the number of shares represented by its in-the-money options, warrants, and convertible securities to its basic shares outstanding. Incremental shares represented by a company’s in-the-money options and warrants are calculated in accordance with the treasury stock method (TSM). Shares implied by a company’s in-the-money convertible and equity-linked securities are calculated with the if-converted method or net share settlement (NSS).
What is the Treasury Stock Method
The TSM assumes that all the groups of in-the-money options and warrants are exercised at their weighted average strike price with the resulting option proceeds used to repurchase outstanding shares of stock at the company’s current share price. In-the-money options and warrants are those that have an exercise price lower than the current market price of the underlying company’s stock. Since the strike price is lower than the market price, the number of shares repurchased is less than the additional shares outstanding from exercised options thus the net issuance of shares is dilutive.
Assume:
Current Share Price: $20
Basic Shares Outstanding: 100
In-the-money Options: 5
Weighted Average Exercise Price: $18
Talk me through what happens.
With 5million shares in the money, at an $18 exercise price (lower than the $20 current price), the holders of the options can buy shares at $18 and sell at $20, realising $2 in differential. Under the TSM, the company purchases shares with the dollar generated from the exercised options ($18 x 5million = $90M). Now, with the $90M on hand, the company purchases shares at market price of $20 = $90M/$20 = 4.5 million shares. The net new shares is the 5 million options less the 4.5 million repurchased = 0.5million. These shares are added to the basic shares outstanding to derive fully diluted shares of 100.5M.
What are some types of convertible and equity-linked securities?
Convertible and equity-linked securities bridge the gap between traditional debt and equity, and include instruments such as cash-pay convertible bonds, convertible hybrids, perpetual convertible preferred, and mandatory convertibles.
What is a cash-pay convertible bond (convert)?
A convert is a straight debt instrument and an embedded equity call option that provides for the convert to be exchanged for a defined number of shares of the issuer’s common stock under certain circumstances. The value of the embedded call option allows the issuer to pay a lower coupon than a straight debt instrument of the same credit. The strike price (conversion price) represents the share price at which equity would be issued to the bondholders if the bonds were converted and is typically set at a premium to the company’s underlying share price at the time of issuance.
If the converts are out-of-the-money, they remain treated as debt.
