Comparables Valuation

8 Key excerpts on "Comparables Valuation"

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  eBook - ePub

  M&A

  A Practical Guide to Doing the Deal

  • Jeffrey C. Hooke(Author)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  The large number of assumptions and calculations involved in devising a firm’s intrinsic worth limit this method’s use on Wall Street. Professionals prefer short, concise value indicators, such as the P/E and EV/EBITDA ratios, which summarize the relevant DCF statistics into one number. The subject firm’s value ratios are then compared with those of similar businesses, just as the historical analysis used comparable company data to study a firm’s financial condition.

  Note

  1. Interview with Ron Everett, Business Valuation Center, March 12, 2014.

  Passage contains an image

  CHAPTER 15 Valuing M&A Targets Using the Comparable Public Companies Approach

  For the purpose of pricing a target, the M&A industry favors the (a) comparable public company and (b) comparable acquisition value approaches, which are sometimes referred to as “relative value.” Comparable public company analysis is the subject of this chapter. To determine a price range for a takeover opportunity (most of which are private), practitioners examine what stock market investors pay for similar, publicly traded businesses.

  The objective of comparable public companies analysis (i.e., relative value) is to establish the price at which a privately owned business would trade on the stock exchange. To this hypothetical price is added a “control premium” in order to reflect the fact that an acquirer purchases 100 percent ownership, rather than the small amounts of individual firm equity that trade publicly on a day-to-day basis.

  Relative value is a favorite topic of TV talking heads, Wall Street analysts, and corporate finance executives. They discuss the positive and negative aspects of a stock, and then evaluate those attributes against firms participating in the same industry. Valuation parameters are then compared and contrasted, resulting in statements such as “Kroger is undervalued relative to Safeway because Kroger’s growth rate is higher yet its P/E ratio is lower.” Other popular ratio comparators are EV/EBITDA, EV/sales, and price/book. Rarely do commentators mention a discounted cash flow.

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  eBook - ePub

  The Art of Capital Restructuring

  Creating Shareholder Value through Mergers and Acquisitions

  • H. Kent Baker, Halil Kiymaz(Authors)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  In practice, however, the value of the equity is often found by discounting the expected cash flows for the entire enterprise at the firm's weighted average cost of capital and subtracting the value of the other claims, such as debt and preferred stock. The residual is then the value of the equity. Because firms do not often produce reliable cash flow forecasts within the normal course of business, and as cash-flow forecasts developed within the context of the acquisition can be biased and self-serving, Delaware courts still rely on comparable company analysis to determine value in appraisal proceedings. The economic rationale for valuation using comparable company analysis is the law of one price : In an efficient market, identical securities or goods should have the same value and therefore, the same price. Using the known values of comparable publicly held companies or premiums from comparable public transactions, multiples can be constructed that express value relative to some measure of earnings or revenue. For example, one of the most commonly used multiples is referred to as the EBITDA multiple, which stands for “earnings before interest, taxes, depreciation, and amortization.” The EBITDA multiple is constructed by finding the enterprise values of the public comparable companies and dividing those values by each firm's EBITDA. The resulting multiple represents how many dollars of enterprise value are represented by one dollar of EBITDA. The mean or median EBITDA multiple computed from the sample of comparable firms is multiplied by the EBITDA of the firm being valued. That product is an estimate of the enterprise value of the firm under consideration

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  eBook - ePub

  How to Be an Investment Banker

  Recruiting, Interviewing, and Landing the Job

  • Andrew Gutmann(Author)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  The first of our three primary valuation methodologies is the comparable company methodology. Other names for this methodology include comparable companies, compcos, trading comps, market comps, public comps, or just comps. The basic purpose of comparable companies is to value a company by comparing it with other similar publicly traded companies. Specifically, we will use a set of valuation multiples to help us make the comparison.

  Bear in mind our real estate example. We said earlier that if we were trying to value an apartment we would first look for similar apartments that recently sold. Then we would calculate a valuation multiple such as price/square foot for each of the similar apartments. If similar homes have sold for $1,000/square foot then we will likely conclude that our apartment is also worth approximately $1,000/square foot. Assuming the size of our home is about 1,000 square feet, then we can say that our home should be worth about $1 million ($1,000/square foot multiplied by 1,000 square feet).

  We will do this same exercise for companies. Let's suppose that we are trying to value a manufacturing company and let's suppose that our analysis informs us that similar manufacturing companies have an enterprise value of about eight times their recent year's EBITDA. If the company we are valuing has an EBITDA of $100 million, then we can estimate our company's enterprise value at about $800 million.

  There are five steps to performing the comparable companies methodology:

  1. Selecting comparable companies (selecting comps).

  2. Spreading the comparable companies (spreading comps).

  3. Normalizing the comparable companies (normalizing comps).

  4. Calculating valuation multiples.

  5. Analyzing and applying appropriate multiples to the company being valued.

  You are not likely to be asked in an interview what the five steps you go through when performing a comparable company analysis are. Others may categorize or aggregate them into fewer or more steps. However, you should be able to walk an interviewer through the general process.

  Step 1: Selecting Comps

  The first step in performing the comparable company methodology is to select a number of companies that are similar, or comparable, to the company being valued. The company being valued is often referred to as the subject company. This process is often referred to as picking comps, with “comps” being short for “comparable.” The set of comparable companies selected are often referred to as the comp universe.

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  eBook - ePub

  An Insight into Mergers and Acquisitions

  A Growth Perspective

  • Vinod Kumar, Priti Sharma(Authors)
  • 2019(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  5.5 Transaction Analysis Transaction Analysis of mergers and Acquisitions tries to estimate the value of the target by comparing it with its peers. The underlying principle for transaction analysis is the “Law of One Price.” Law of one price in the context of valuations states that companies that are operating in identical businesses should be priced equally by the market.

  Transaction Analysis is of two types :

  1. A. Comparable Company Analysis (or) Relative Analysis.  
  2. B. Transaction-Based Valuations.  

  5.5.1 Comparable Company Analysis

  This method is alternatively known as market-based valuation method. As the name implies, the valuation parameters are derived by calculating certain ratios relative to that of market. Those identified parameters are then multiplied with the respectable target’s (valuing company’s) fundamental parameters to arrive at the intrinsic value of the company.

  For ascertaining the intrinsic value under this approach, two measures are used:

  1. i. Price multiples.  
  2. ii. Enterprise value multiples.  

  5.5.1.1 Price Multiples

  In price multiple valuation, based on the actual price of the stock, the actual multiples such as Price/Sales, Price/Book Value, Price/Cash Flows, Price/Earnings, and Price Earnings/Growth (PEG Ratio) are identified.

  These identified multiples are then compared with the benchmark multiples. Benchmark multiples usually applied are:

  1. a. Peer group average (or) Median ratio.  
  2. b. Industry average/Median ratio.  
  3. c. Index ratio.  
  4. d. Average historical multiple ratios of the same company.  

  If the valuing company’s equity stock is not listed in the stock exchange, the reverse calculation takes place. That is, the benchmark multiples are found first based on the closest peer group companies and then the average of all the multiples are taken out. Based on the average, the fundamental parameters of the company being valued are multiplied to arrive at the intrinsic value of the takeover candidate.

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  eBook - ePub

  Business Valuation

  Theory and Practice

  • Marco Fazzini(Author)
  • 2018(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  volatile performances. In such cases the correlation between EV and performance measure may be weak. The experience of speculative bubbles suggests that market euphoria can lead to the overestimation of comparable companies and, consequently, of the target company.

  The choice of the multiple also depends also on the reference time frame . Valuers can choose from among different types of multiples: current, trailing, forward.

  Current multiples are obtained by comparing stock prices and the last available balance sheet.

  Trailing multiples are obtained by comparing stock prices and the results of the last 12 months before the date chosen to calculate the index. Results on the previous 12 months are taken by the four-quarterly report or the last biyearly report provided by the companies.

  Forward multiples are obtained by comparing stock prices and the expected results of the following year or those of the next ones. Estimations are usually taken by the consensus forecast, published by financial analysts’ associations.

  In very volatile markets, using multiples based on historical data (current and trailing) is preferable.

  Finally, in an equity-side valuation it is necessary to select comparables that have the same tax rate . For example, earnings taxed at 15%, 25%, or 35%, respectively, lead to significantly different P/E values. To prevent non-homogeneous comparisons, it is advisable to compare companies that are subject to equivalent tax systems.

  5.5.2 Selection of Peer Group in the Comparable Transaction Method

  In the comparable transaction method, the choice of the sample requires analyzing several parameters, both quantitative and qualitative. More specifically—as mentioned—one has to consider that this method can be based on prices that reflect premiums linked to transaction-related synergies or specific competitive advantages, which cannot be extended to the target company. The following parameters must be taken into consideration:

  1. 1. industry;  
  2. 2. geographical scope;  
  3. 3. dimension and performance;  
  4. 4. reference time period;  
  5. 5. type of transaction;  
  6. 6. target of the transaction;  
  7. 7. suspensive conditions of the contract.  

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  eBook - ePub

  Encyclopedia of Financial Models, Volume II

  • Frank J. Fabozzi(Author)
  • 0(Publication Date)
  • Wiley

    (Publisher)

  Relative valuation methods can also be useful in another way when constructing DCF models. Most DCF models include a “terminal value,” which represents the expected future value of the business, discounted back to the present, from all periods subsequent to the ones for which the analyst has developed explicit estimates. One way to calculate this terminal value is in terms of a perpetual growth rate, but the choice of a particular growth rate can be difficult to justify on the basis of the firm’s current characteristics. An alternative approach is to take current valuation multiples for similar firms and use those values as multiples for terminal value (see Damodaran, 2006, Chapter 4, pp. 143–144).

  KEY POINTS

  • Relative valuation methods tend to receive less attention from academics than DCF approaches, but such methods are widely used by practitioners. If relative valuation approaches suggest that a company is cheap on some metrics but expensive on others, this may indicate that the market views that company as being an outlier for some reason, and an analyst will probably want to investigate further.
  • Choosing an appropriate group of comparable companies is perhaps the most challenging aspect of relative valuation analysis. Where possible, an analyst should seek to identify six to 12 companies that are similar in terms of size, geography, and industry. If this is not possible, then an analyst should feel free to relax one or more of these parameters in order to obtain a usable universe.
  • Determining an appropriate set of valuation multiples is also important. Calculating a single set of multiples is likely to provide fewer insights than using several different metrics that span multiple time periods. It is conventional to use consensus estimates of future financial and operating performance, as these presumably represent the market’s collective opinion of each firm’s prospects.
  • Most relative valuation analysis is performed using standard multiples such as price/earnings or firm value/sales. Under some conditions, using industry-specific multiples can be valuable, though there may be fewer consensus estimates for such data, and there may also be less intuition about what is the “fair” price for such ratios.

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  eBook - ePub

  Governance and the Market for Corporate Control

  • John L. Teall(Author)
  • 2014(Publication Date)
  • Routledge

    (Publisher)

  Chapter 5

  Takeover valuation

  INTRODUCTION

  Corporate acquisition activity spawns a significant amount of valuation effort by competing potential acquirers. Target firm shareholders need valuation estimates to guide their reactions. Many takeover attempts are litigated, necessitating further valuation efforts. This chapter discusses valuation techniques used by the various parties to the takeover. These parties are likely to include financial analysts working for the competing acquiring and target firms and their advisors, which will probably include accountants, law firms and investment banks. Much as the typical real estate appraisal relies on multiple approaches, the three primary approaches to takeover valuation are the Comparables Approaches, the NPV Approaches and the Replacement Value Approach. Each of these approaches will rely on financial statement analyses.

  An empirical study by Kaplan and Ruback (1995) of 51 leveraged transactions between 1983 and 1989 found that median estimates of cash flow present values were within 10 percent of the market values of the transactions and that present value analysis performed at least as well as or better than the comparables analyses. However, the comparables data seemed to provide a useful supplement to NPV analyses in that their addition seemed to improve the target valuations.

  THE COMPARABLES APPROACHES

  Using the Comparables Approaches involves comparing the target firm to a group of other firms with similar operating circumstances. In some instances, there will be obvious firms to serve as comparisons. Many analysts rely on Standard Industrial Classification (SIC) or North American Industry Classification System (NAICS) codes to identify a target firm’s peer group. Several institutions including Dun and Bradstreet provide data for ratio comparisons. For example, Dun and Bradstreet provide “average” ratio levels for firms in a number of different industries.

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  eBook - ePub

  Wiley Interpretation and Application of IFRS Standards

  • (Author)
  • 2019(Publication Date)
  • Wiley

    (Publisher)

  similar to the unquoted equity instrument being valued, the investor needs to understand, and make adjustments for, any differences between the two equity instruments. These could include economic rights (e.g., dividend rights, priority upon liquidation, etc.) and control rights (i.e., control premium).

  Comparable company valuation multiples assume that the value of an unquoted asset can be measured by comparing that investment to a similar investment where market prices are available. There are two main sources of information about the pricing of comparable company peers: quoted prices in exchange markets (for example, the Singapore Exchange or the Frankfurt Stock Exchange) and observable data from transactions such as mergers and acquisitions.

  In doing a comparable company valuation (trading multiples or transaction multiples), you would need to ascertain the following:

  1. Identify a comparable peer company for which information is available.
  2. Select the performance measure that is most relevant to assessing the value for the investee (i.e., earnings, equity book value or revenue). Once selected, derive and analyse possible valuation multiples and select the most appropriate one (e.g., EBIT, EBITA, EBITDA or P/E). Note that this may need to be adjusted for differences between the companies that may impact the multiple being used (e.g., size of the business where revenues are being used).

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