3 Major valuation methodologies
Comparable Companies; Precedent Transactions and DCF.
Rank 3 valuation methods from highest to lowest expected value.
No ranking that always holds. In general, precedent transactions will be higher than comps due to the control premium built into acquisitions.
What is Precedent transactions?
Precedent Transaction Analysis, also known as “M&A Comps,” “Comparable Transactions,” or “Deal Comps,” uses previously completed mergers and acquisitions deals involving similar companies to value a business.
Multiples used in precedent transaction?
the same multiples as Comparable Companies’ Analysis (or “Comps”). In particular, Enterprise Value/Sales, Enterprise Value/EBITDA and Earnings/Earnings Per Share (EPS) are the most commonly used metrics.
Difference between comparable company analysis and precedent transaction?
Unlike in Comparable Company Analysis, the basis for value comparison is the price paid by the purchaser for a business, rather than the traded market values of the company’s securities.
These prices can be different because there is a control premium—the value ascribed to being able to control a business rather than simply own a percentage of the equity in it.
Why Precedent Transaction Analysis will typically result in valuations that are higher than standard Comparable Company Analysis.
because there is a control premium—the value ascribed to being able to control a business rather than simply own a percentage of the equity in it.
Why use Precedent transactions?
- To value a private business.
- To evaluate the market demand for acquiring a company, based on volume and number of previous deals.
- To provide data analytics in assessing m&a and trends.
How to calculate Premium paid(%)?
Premium Paid (%) = (Acquisition Price ÷ Last Trading Price – 1) × 100
When would you not use a DCF in valuation?
the company has unstable or unpredictable cash flows(tech or bio-tech startup);or
when debt and working capital serve a fundamentally different role.
What other valuation methods are there?
- Liquidation valuation, valuing a company’s assets, assume they are sold off and then subtract liabilities to determine how much capital equity investors receive
- LBO Analysis
- Replacement Value - Valuing a company based on the cost of replacing its assets
- Sum of the parts
- M&A premiums analysis - analyse M&A deals and figure out the premium that each buyer paid
When do you use an LBO Analysis?
When there is a leveraged buyout, also used to establish how much a PE would pay, normally lower than what companies in order to set a floor on a possible valuation.
Most common multiples used in valuation?
- EV/Revenue
- EV/EBITDA
- EV/EBIT
- P/E
- P/B
Technology firms? what multiples?
EV/Unique Vistors and EV/Pageviews rather than traditional ones
What would you use in conjunction with Free Cash Flow multiples – Equity Value
or Enterprise Value?
For Unlevered Free Cash Flow, you would use Enterprise Value
But for Levered Free Cash Flow you would use Equity Value.
Remember, Unlevered Free Cash Flow excludes Interest and thus represents money available to all investors, whereas Levered already includes Interest and the money is therefore only available to equity investors.
What is levered and unlevered free cash flow, what is the difference between them?
Levered cash flow is the amount of cash a business has after it has met its financial obligations. Unlevered free cash flow is the money the business has before paying its financial obligations.(leverage is another name for debt)
The difference between the levered and unlevered cash flow is also an important indicator. The difference shows how many financial obligations the business has and if the business is overextended or operating with a healthy amount of debt.
How do you select comparable companies/precedent transactions? 3 main considerations?
- Industry classification
- Financial criteria(Revenue, EBITDA)
- Geography
- for precedent transactions, you have to consider date of transactions
What are the flaws with public company comparables?
- No company is 100% comparable to another company.
- The stock market is emotional
- Share prices for small companies (thinly-traded) may not reflect their full value.
Flaws with precedent transactions?
- Past transactions are rarely 100% comparable
2. data on precedent transactions is generally more difficult to find than it is for public company comparables
What is capital expenditure?
Capital expenditures, commonly known as CapEx, are funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, an industrial plant, technology, or equipment.
The Formula for CapEx Is
\begin{aligned} &\text{CapEx} = \Delta \text{PP\&E} + \text{Current Depreciation} \ &\textbf{where:}\ &\text{CapEx} = \text{Capital expenditures} \ &\Delta \text{PP\&E} = \text{Change in property, plant, and equipment} \ \end{aligned}
CapEx=ΔPP&E+Current Depreciation
Difference between EV/EBIT, EV/EBITDA, and P/E multiples all measure a company’s profitability, the difference between them, when to use each one?
P/E depends on the company’s capital structure whereas EV/EBIT or EV/EBITDA are capital structure-neutral.
- Use P/E for banks, financial institutions and other companies where interest payments/expenses are crucial
- EV/EBIT or EV/EBITDA, consider if D&A is large or not or Capex and fixed income is important or not
How do you value a private company?
Same as public, the main 3 methods.
- 10-15% discount to private since private is less liquid
- valuation shows enterprise value rather than per-share price
- estimate WACC using public data
