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 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

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

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

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 $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

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”

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

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

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

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?

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

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

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