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Valuation: Comps and Premiums

Valuation: Comps and Premiums. Executive Masters Program Tim Thompson. Valuation methods – stand alone. Market capitalization (price) Comparable multiples Discounted cash flow. Market Capitalization. Market efficiency Market value of equity, E E = (Numbers of shares outstanding)*P/sh

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Valuation: Comps and Premiums

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  1. Valuation: Comps and Premiums Executive Masters Program Tim Thompson

  2. Valuation methods – stand alone • Market capitalization (price) • Comparable multiples • Discounted cash flow

  3. Market Capitalization • Market efficiency • Market value of equity, E • E = (Numbers of shares outstanding)*P/sh • Plus market value of debt, D • Value of firm = D + E • Problems • May not think market is correct • Valuation target may not be publicly traded

  4. Comparable multiples • Assumes comparable companies are comparable in every possible dimension • Especially in risk and growth

  5. Comparable multiples method • Select a set of comparable firms • Pick an activity measure • E.g., Sales, Operating income, EBITDA • Calculate the value of each comparable company as a multiple of activity measure • Choose representative value or range • Apply multiple to activity measure at target company

  6. Example: NI multiple (P/E ratio) • Want to value Crazy Car Wash (CCW) • Private firm, has $55M in debt • What is equity of CCW worth? • CCW Net Income, LTM = $20M, Exp(next year) = $22M • One comparable: Kooky Kar Wash • Publicly traded, 10M shares @ $5/sh • Net Income, LTM, $5M, Exp. Next year, $5.5M • NI multiple = E/NI(LTM) = $50M/$5M = 10X • NI multiple (forward) = E/NI(next year) = $50M/5.5M = 9.1X

  7. Apply the multiple to CCW • Last twelve month’s multiple • Equity of CCW = 10 (20M) = 200M • Expected next year’s multiple • Equity of CCW = 9.1 (22M) = 200M • Answer’s the same: why? • Because I rigged it! • But, on average they should be the same • Forward looking estimates don’t have “noise”

  8. What is the total value of CCW? • Equity • $200M (estimated by multiples) • Plus Debt • $50M • Value = 200 + 50 = $250M

  9. Equity vs. operating multiples • Net income is an equity measure • After debt interest payments subtracted • So you measure the multiples as market value of equity divided by activity number • Operating multiples • Activity measure (e.g., sales, operating profit) is prior to subtracting interest • So you measure the multiple as market value of equity plus net debt divided by the activity number

  10. Example: EBITDA multiples • Add’l info on Kooky Kar Wash • They are unlevered (no debt) • EBITDA (LTM) = $10.5M, Next yr. $11.5M • Add’l info on CCW • EBITDA (LTM) = $48M, Next yr. $52M • KKW multiple, (E+D)/EBITDA • LTM, (50M+0)/10.5M = 4.76X • Next yr. = 50M/11.5 = 4.35X

  11. Apply EBITDA multiple to CCW • LTM • Value of CCW = ($48M)(4.76X) = $229M • Next yr’s • Value of CCW = ($52M)(4.35X) = $226M • Value of equity? • V – D = E = $227.5M – $50M = $177.5M • Which is better: equity multiple or operating multiple?

  12. Pitfalls of multiples • Totally rests on comparability • Seems to require fewer assumptions: illusory --- you just don’t know what assumptions you are making! • Have information about strategy, expectations, etc., use it! • Comparable industry not the same as comparable value • Investment needs • Fixed/variable cost ratio differences • Different accounting standards • Accounting numbers are backward looking • Value is forward looking

  13. Valuation of M&A target • Premiums paid • Typcially pay a control premium • Comparable transaction multiples • Typically higher than trading multiples because of control premium • DCF (including synergies) • This is the reason you are willing to pay control premium

  14. Apply to Interco • Premiums paid • Comparable transactions • DCF • WACC of Interco • Unlevering/relevering • High leverage throws off WACC • Terminal multiples • Interpret as FCF growth perpetuity

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