Valuation Introduction & Price multiples

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1 Valuation Introduction & Price multiples Mergers & Acquisitions

2 The valuation spectrum

3 Valuation methods Methods of valuation: Discounted dividends Discounted free cash flow Adjusted DCF model Discounted abnormal earnings Price multiples Accounting valuation Rules of thumb We will concentrate on Price multiples and Discounted cash flow.

4 The keys to successful M&A deals Right reasons Right price Right information Right implementation Strategy Valuation Due diligence Integration

5 Valuation elements in M&A There are five value elements involved in determining the price that is paid for an acquisition: The as is value of the target s equity The minimum control premium that needs to be offered to the target s shareholders The value of the net synergies that can be derived from the combination The costs incurred in prosecuting the acquisition The standalone value of the acquirer s equity (only relevant when shares are offered as payment for the target s equity)

6 The M&A valuation task the negotiating range Net synergies Costs Synergy leakage Minimum control premium Negotiating Range Standalone value of the target Value of the target to the acquirer

7 Common techniques used in M&A valuation Multiples Market multiples - comparable publicly traded companies this analysis indicates how the stock markets are valuing companies that are similar to the target Transaction multiples - precedent comparable transaction analysis this analysis indicates the valuations at which prior M&A transactions have been done in the same industry as that of the target. Discounted cash flow - DCF analysis is one of the most important valuation techniques it can be used to determine standalone value and value of synergies Sum-of-the-parts analysis If a target has more than one line of business, the financial adviser will value each business separately. Therefore, each part might have its own market multiples, transaction multiples and DCF (with different WACCs for each part). The total value is the sum of the parts.

8 What is to be valued the equity or the whole firm? Enterprise value is the value of the whole firm the value of debt plus the value of equity Equity value is the value of what remains after debt investors claims have been satisfied Debt usually means interest bearing liabilities in this context Sometimes equity value is estimated directly and sometimes indirectly. Equity value = enterprise value value of debt Investment by share holders (equity) Enterprise Value Investment by debt holders (interest bearing debt) To purchase a business the acquirer generally pays equity value (but also inherits the debts of the acquired business)

9 What do multiples measure? What value are multiples measuring? Are we always measuring just the value of equity? Or do we sometimes measure the value of debt and equity? Some measure Equity value: PE ratio PB ratio Some measure Enterprise Value (EV): EV/Sales EV/EBIT EV/EBITDA Note - if using EV must deduct the value of debt to estimate equity

10 What are price multiples? A price (or valuation) multiple is a combination of two things a value driver and a market price Value drivers can be anything the valuer considers appropriate revenue, profit (in all its forms), earnings per share, book value etc. The price used must be consistent with the value driver The price of equity (market capitalisation) or The price of debt and equity (enterprise value) This combination can then be expressed as a multiple for example the PE ratio (or price earnings multiple), or EBITDA multiple

11 Using the multiple method Multiples work by: Choosing a value driver on which to base the valuation Determining a sustainable or maintainable (normal) amount of that value driver How do we estimate that number? Applying a multiple to that sustainable amount of the value driver Multiples are generally chosen from a comparable firm (or a set of firms) What constitutes a comparable firm? How do we arrive at a list? A great deal of judgement is used to get answers Value = Sustainable amount of value driver x Chosen multiple

12 Types of multiple market multiples Market multiples estimate standalone value A market multiple is determined by comparing the current trading level of a Company to its peer group of companies The peer group is a set of companies that are most similar to the target in terms of business mix and strategy, geographic risks(same country), margins, size etc. To find a good peer group start broad and then narrow the list to the most comparable peers. Refer to equity research reports, industry reports, the company releases The goal of the analysis is to understand how the market is valuing the peer group in terms of your chosen multiple or multiples So market multiples are a measure of relative value this company should trade at the same level as its peers If you want to estimate the real economic value of the equity or firm you must use discounted cash flow (fundamental economic value)

13 Common market multiples Equity Multiples: PE ratio MPS or Market capitalisation EPS Earnings after interest and tax Note that the Earnings need to be after Preferred Dividends so that they are earnings that are available to ordinary shareholders PB ratio Price per share or Market capitalisation BV of equity per share BV of ordinary shareholders equity Enterprise Value Multiples: EV/Revenue EV/ EBITDA EV/EBIT

14 Transaction multiples The goal here is to understand the multiples at which transactions in the target s industry sector have been announced or completed. The importance difference with market multiples is that in this case, a control premium is built into the offer price and therefore the multiples. Specifically, determine the pricing of past deals as compared to the target s financial performance and unaffected (pre-announcement) market value Transactions selected should be as comparable to our proposed transaction as possible, so one should look for recent deals, where a company with highly similar business was acquired, in the same country as the target etc. Transaction multiples include the premium paid (offer price premium are often expressed as % of 1-day, 1-week and 4-week preannouncement trading prices - VWAPs).

15 Trailing v leading market multiples To explain the difference lets consider the PE ratio. A trailing PE is the relationship between last period s known EPS and today s market price. A leading PE is the relationship between next period s expected EPS and today s market price. Remember: since market price varies the time/date of the market price you use is very important. Which is better? Most analysts generally consider a leading PE to be a better predictor of equity value. Do you agree?

16 An aside: explaining PBs What does the table below have to do with explaining the PB ratios of the companies on the brand name list?

17 Price multiple relationships Relationship of Price/book and Price/earnings ratios PB PE Rising stars High High high growth high current return Falling stars High Low high current return low growth Recovering Low High rebounding returns firms high growth Dogs Low Low low current return low growth