Valuation Method – Comparable Companies Analysis

Valuation Method – Comparable Companies Analysis

1. In this blog, we shall discuss about valuation method – comparable companies analysis to value target companies in M&A
2. My last post on valuing a company using Discounted Cash flow is provided here
3. Valuing a company using Comparable Companies Analysis primarily looks at how the market has priced similar assets that the acquirer is looking to acquire.This involves comparing the target company within the same industry, size, revenues, Geo and valuation multiples to estimate the value of the target company.

Valuation Method – Comparable Companies Analysis steps

The steps to perform Comparables Companies Analysis is:

Valuation Method – Comparable Companies Analysis step 1 – Derive Valuation Multiples

• The 1st step is to identify the valuation multiples to be used for arriving at the Enterprise value. Different valuations analysts use different multiples based on the target industry.
• The most common valuation multiples used are EV/Revenue; EV/EBITDA where EV stands for Enterprise value.
• The valuation multiples of the peer companies are calculated and then extrapolated with Target company revenues/EBITDA to arrive at the target enterprise value.

The multiples are calculated as follows:
Market Capitalization = Share price * No of shares outstanding
Enterprise Value = Market Capitalization + Total Debt – Cash
EV/Revenue multiple = Enterprise value/Revenues YTD
EV/EBITDA = Enterprise value/EBITDA YTD

• The free cash flow to the Firm, Cost of debt, equity and the WACC – Weighted Average cost of capital are calculated in the same way like that of Discounted Cash Flow model.The link is provided here

Calculation of Terminal Value

• The terminal value calculated in this method is different from the DCF method.
• The EBITDA multiple is selected from the list of peer companies and is multiplied with last year EBITDA number of the target Proforma Income statement.

Terminal value = EBITDA multiple selected * EBITDA of the last year proforma income statement
Value of Operations = Present value of Total FCFF including terminal value *(1+WACC)^1/2

• The remaining values like Non Operating assets (Cash), Enterprise value, Non equity claims, Equity value is calculated in same way like DCF method.The link to DCF post is here.

Benefits of Comparable Company Analysis

• The calculation of FCFF in Comparbles analysis can be repurposed from the pro forma financials statements prepared in DCF.Hence DCF and Comparables are generally done together.
• Comparables company analysis incorporate the market view by assesing the valuation multiples of the peer companies.
• Comparables analysis are easier to do.

Disadvantages of Comparables Company Analysis

• It is difficult to get an exact set of peer companies that exhibit the same growth, forecast or are of the same size, Capital structure. In some cases, it is difficult to get publically listed companies with same characteristics as Target companies.
• In digital acquisitions, most of the companies are either startups or do not have a long historical track record.Hence obtaining a peer list of companies for such targets is a challenge.

Conclusion

1. Valuation method – comparable companies analysis is focused on the market approach where the valuation multiples of the peer group of companies that exhibit the same characteristics as the target company is derived.
2. The most common valuation multiples used are Revenue multiples – EV/Revenues and EBITDA multiples – EV/EBITDA
3. Comparables company analysis is often used in conjunction with the Discounted Cash Flow model to value the target company.
4. Comparables approach is simple but has it’s own advantages and challenges.Valuations arrived from DCF and Comparables would be different and can be compared against each other to converge on the approximately price of the target.