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Valuation
M&A involves using more than one valuation technique to
arrive at a valuation that we think is fair. The most common
techniques used are:
PUBLIC COMPS
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equity research reports, industry reports, the company’s 10K where its
discusses competitors and Bloomberg (Quote 2) to identify the most
comparable peers. (look at filing 8K, prospectuses when they do a filing
for new debt or equity – in freeedgar.)
Understand why Equity • The goal of the analysis is to understand how the markets is valuing the
valuation and Enterprise peer group in terms of Price to Earnings, Price to Book value, Price to
valuation are different Cashflow to Equity, What the PEG ratio is, Enterprise Value to
Revenues, EBITDA, Net Assets etc. Also understand if merger
premium is already built into price – industry group should know this.
• Using these, we will try to value the target bearing in mind that public
comps don’t reflect the “control premium” that an acquirer will pay for
buying control of the target. The control premium is generally around
30% for U.S. transactions. Also, some companies that are widely
perceived to be acquisition targets may have some premium built into
their stock price.
1. Equity Multiples: P/E (Price / LTM EPS, Price / 1-Year forward EPS, Note
that the Earnings need to be after Preferred Dividends so that they are
earnings that are available to Common shareholders), Price to Book
(Price / Book value of equity per share).
2. Enterprise Value Multiples: EV/Revenues, EV/ EBITDA, EV/EBIT (Note
that the Revenues, EBITDA and EBIT multiples could be computed for
LTM and 1-Year forward projected numbers)
TRANSACTION COMPS
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LBO
• Goal is to understand how much value a financial buyer (with no
operating synergies) could buy the target for
• To understand the economics of an LBO lets do an example: Company
A’s equity market capitalization is $100MM and it has Debt of $75MM.
This year it reported EBITDA of $50MM. A financial sponsor realizes
that the even if it bought the stock at a 30% premium to market for
$130MM, it could generate attractive returns. So, the sponsor
approaches management and structure a deal where the firm borrows
an additional $100MM to buy back stock. The sponsor supplies the
remaining $30MM required to buy the public float and ends up owning a
100% of the equity of the firm. The new firm has $75MM of old and
$100MM of new debt outstanding which is sustained by the $50MM of
annual EBITDA and an equity cushion of $30MM.
• To finance a LBO, the restructured company has to have a Debt to
Total Capitalization (Debt+Equity) not exceeding 80% and a Debt to
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EBITDA ratio that does not exceed 5.0x. Note that these could vary
based on the nature of the industry.
• Assume current market scenarios for pricing the new debt
• The exit mechanism is an important element since it defines what the
sponsor will do in, say, 5 years to exit the investment. In other words,
is the sponsor planning an IPO or sale to strategic players? The
sponsor’s returns will be driven by EBITDA growth rate, margins
improvements, Capex, and exit multiples
• In a LBO, the entire equity is privately held, while in a Leveraged
Recapitalization, there is usually a small percentage owned by publicly.
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(1) Closing price: most recent closing stock price (from Bloomberg, ILX
or Populator). Prices for all companies should be as of the same
date.
(2) Equity value: last closing stock price multiplied by number of shares
outstanding. Shares outstanding from front page of latest 10K, 10Q,
or other public document adjusted for options or other instruments in
existence (if applicable). Note date of shares outstanding on the
exhibit. The following is a list of definitions of shares outstanding:
• Basic: The actual outstanding shares which can be found on the cover of
the latest 10Q or 10K.
• Diluted: This is the Basic shares plus the dilutive impact of any “in-the-
money” options or warrants that are outstanding as calculated by the
Treasury stock adjustment method. Look for average strike price and if
lower than closing price then assume would convert. Look at public
comps template. Option info is in 10K.
• Fully diluted: Basic + All options and warrants (as if all converted into
equity)
• Average: This calculates the average shares that were outstanding during
the year or quarter
(3) Firm value (or Enterprise Value): Equity market value + LT debt +
ST debt + preferred stock + Minority Interest (-) cash. (Enterprise
value may value from firm to firm or industry to industry – sum of total
value of firm. Comes from cash flows of business.)
• Use net income to common for common share price
• Up to EBIT – still enterprise #’s. As soon as you pay interest – the
net income belongs to equity holders.
LT debt: from latest 10K/Q under N/C liabilities – LT debt plus
redeemable pfd. (Other types of pfd. stock are not considered LT
debt.)
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(4) Equity value multiples: While the Firm value multiples reflect how
the business is valued, equity multiples reflect how equities are valued
relative to the net income or EPS (LTM and projected) and Book value
(latest available).
– Divide the LTM NI by the weighted average number of shares
outstanding from the most recent 10Q to calculate LTM EPS.
(Do not use LTM average shares!)
– Divide stock price by LTM EPS
Projected P/E: Get median I/B/E/S estimates for the next two years.
(Available on Bloomberg, Infocenter, Insight, or Populator by inputting = IDD
(“ticker,” “FY1MEDIA” or “FY2MEDIA,” 0). These estimates are reported on
fully diluted basis and updated every Thursday. Always use median I/B/E/S
(not mean) to avoid skewed data values. Calendarize earnings estimates as
needed
Projected net income multiple: Multiply forward I/B/E/S by I/B/E/S projected
weighted average shares outstanding (=IDD (“ticker,” “ibesshrs,” 0) to obtain
projected net income. (Note that I/B/E/S shares are not fully diluted and
are source from Exlel not “street” analysts. It is thus important to
check to see that I/B/E/S projected shares outstanding are consistent
with credible brokerage reports; if not, use most recent 10-Q shares
outstanding to derive fully diluted shares.) Divide projected net income
into current equity value.
(5) Long-term EPS growth rate: Get median I/B/E/S estimate from
Infocenter, Insight, or Populator by typing = IDD (“ticker,” “MEDLTG,”
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Price/cash flow per share: Cash flow refers to operating cash flow,
or NI plus D&A plus deferred taxes plus other non-cash charges,
divided by average number of shares outstanding; this result is then
divided into most recent stock price.
(7) Last 12-Month (“LTM”) statistics: In order to see how a firm trades
it is customary to calculate LTM Revenues, EBITDA, EBIT, Cashflow
and Net Income or EPS (before any extraordinary items). Say, you
are spreading comps in September 2001 for a company that has a
Jan-Dec financial year. You would calculate the LTM EBITDA as
follows: FYE 12/31/00 EBITDA (from 10K) + 6-Month EBITDA for
2001 (from the 10Q dated 6/30/01) (-) 6-Month EBITDA for 2000 (from
the 10Q dated 6/30/01).
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Closing Equity Firm Firm value/LTM Firm value/FY1 (first Price per share/EPS LT growth Optional multiples
proj. year)
Company Price¹ Value² Value³ Revenue EBITDA EBIT EBITDA EBIT LTM FY1 FY2 rate P/BVPS P/CFPS
($) ($MM) ($MM) (x) (x) (x) (x) (x) (%) (x) (x)
Comp 1
Comp 2
Comp 3
Comp 4
Comp 5
Mean
Median
Company financials
Implied firm value
Net debt
Implied equity value
Implied equity value per share
Implied premium/ (discount)
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Trading comparables
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Trading comparables
Exhibit: Selected credit and operating statistics
Growth² Margins Returns Credit
Sales Earnings EBIT Earnings ROE ROC Leverage Interest coverage5 S&P/Mdy
Company¹ L3YA L3YA N5YA L3YA LTM L3YA LTM LFY LFY Book³ Mkt.4 L3YA LTM Rating
(%) (%) (%) (%) (%) (%) (%) (%) (%) (%) (%) (x) (x)
Comp 1
Comp 2
Comp 3
Comp 4
Comp 5
Mean
Median
Company
1
All financial information is before extraordinary items. All LTM figures are for the period ending (latest 10K/Q date). Three-year averages for the fiscal years (date)–(date)
2
Next 5-years average annual EPS growth rate represents mean estimates from I/B/E/S report of (date)
3
Total debt divided by total debt and book value as of (latest 10K/Q)
4
Total debt divided by total debt and current market value
5
EBIT divided by gross interest expense
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Objective
Assist explanation of equity trading multiples by analyzing key operating
figures and ratios.
Explanation
(1) Projected LT growth rates: Get Value Line (in the Library)
estimates for sales and cash flow; I/B/E/S estimates from Populator
for EPS = IDD (“ticker,” “MEDLTG,” 0)]
(2) LTM EBIT margin: Exclude any extraordinary items and one-time
occurrences (e.g., restructuring charges). Divide LTM EBIT by LTM
total revenues. Use most recent financial statements for these figures
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Common shares Used for equity and firm valuations. On the front page of the latest
outstanding 10K/Q near the bottom
LT debt LT debt plus redeemable pfd. stock plus minority interests (if any).
Other types of pfd. stock are not considered LT debt. (10K/Q)
Net interest expense Interest expense from income statement less interest income and
less capitalized interest which is usually found in the PP&E
footnote (10K/Q)
EBIT Earnings before gross interest expense and taxes but after minority
interest and equity interest in subsidiaries
Operating cash flow Net income plus D, D &A plus changes in deferred taxes plus other
noncash charges. (From cash flow statement, but before working
capital changes, which are discretionary)
EPS Fully diluted, before extraordinary items. Watch for stock splits; if
net income/shares outstanding differs from EPS by more than 10
percent, try to find any. Remember that some discrepancy is
normal, as total shares outstanding does not usually equal fully
diluted weighted average shares outstanding
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1
The idea is that since EBIT, EBITDA, and sales are not affected by the Company’s choice of
capital structure (as cash flow, earnings, EPS, and book value are) the appropriate multiples
use total capital and not just equity capital
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(b) Calculate Book Value by taking Common Equity accounts from the
annual report or 10K/Q immediately prior to the date of the
transaction.
(c) Divide Book value and LTM net income into the equity purchase
price; divide LTM Revenues, EBITDA and EBIT into Aggregate
purchase price. The results are the comparable transactions
multiples.
9. Estimated LTG rate: Calculate estimated long-term growth rate by
taking the latest median I/B/E/S LTG rate prior to announcement of
transaction. (Available on Intracenter, Insight or Populator)
10. Description of Target’s business: Summary of target’s business
activities; from Bloomberg, S&P Tear Sheets, or Value Line
11. Other transaction multiples
(Check with senior team member to ascertain whether inclusion is
appropriate)
(a) P/E - price earnings ratio can be calculated by dividing the offer
price per target share (cash transaction) or the issue price per
acquirer share times the exchange ratio (stock transaction) by LTM
EPS available prior to transaction date
NB: This is not the same multiple as dividing the Equity purchase
price by LTM net income. Transaction P/E value are often
compared to the P/E values of a comparable industry or
composite group on the transaction date.
(b) Price/Operating Cash Flow: Divide offer price per target share (cash
transaction) or issue price per acquirer share times exchange ratio
(stock transaction) by LTM OCF available prior to transaction date
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Calculation:
Net income (excluding extraordinary items and before preferred
dividends, equity income and minority interest)
+ After-tax interest expense (net interest expense (1- average tax rate))
+ Depreciation & amortization & deferred taxes & other non-cash charges
– Capital expenditures
– Difference between beginning and ending Net Working Investment
(“NWI”)
= Free cash flow (unlevered)
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