VALUATION BY MULTIPLES

Professor Artur Raviv

Kellogg School of Management

Valuation By Multiples 1

Outline

Overview and basic steps in valuation

based on multiples
Enterprise, equity and industry-specific
multiples
Practical issues and adjustments
Limitations and pitfalls

Valuation By Multiples 2

1
Overview of Multiples Analysis

Use observed prices of comparable businesses

(properly scaled)
Value an apartment based on $/square foot
What is the equity value of firm X ?
Net income of X is $10M
Comparable Firm Y has net income of $20M and
equity value of $400M
Y is valued at 20x earnings, i.e. P/E ratio is 20x
Apply 20x P/E ratio to Firm X’s net income
Equity value of Firm X = 20*$10M = $200M

Valuation By Multiples 3

Enterprise (Firm) Value Multiples

Sales
EBIT
EBITDA
EBITDA less CapEx
Cash from Operations
Gross Profit
Total Assets
Net Fixed Assets
Valuation By Multiples 4

2
Equity Value Multiples

Net income
Earnings before taxes
Cash available for Equityholders
Book value of equity
Notes:
Equivalently can use the corresponding per
share values (EPS, book value/share, etc.)
Leverage affects equity multiples

Valuation By Multiples 5

Industry-specific multiples

number of subscribers (cable)

square footage (retail)
proven reserves (oil)
hits (web site)

Valuation By Multiples 6

3
Illustration

Find the value of Firm X with:

net income of $10M
EBITDA of $40M
$50M in net debt

Comparable Firm Y:
Equity value is 20x net income (P/E ratio is
20)
Enterprise value is 6x EBITDA
Valuation By Multiples 7

Illustration

1. Apply the income multiple (P/E ratio) to

Firm X’s net income
Equity value of X = 20*$10M = $200M
Enterprise value=$200M+$50M= $250M

2. Apply the EBITDA multiple to X’s EBITDA

Enterprise value of X = 6*$40M = $240M
Equity value of X = $240M - $50M = $190M

Valuation By Multiples 8

4
Example: Valuation of Evanston Ltd, a private
company

Competes in same industry as publicly-traded New York Inc, Boston Corp, and
San Francisco Ltd. Revenue EBIT Net Income
Enterprise
Company Equity Value Value (EV) LTM (1) 2016E LTM 2016E LTM 2016E

New York Inc. $2,500 $2,850 $980 $1,176 $100 $120 $58 $72
Boston Corp. 250 295 450 495 36 40 12 14
San Francisco Ltd. 360 450 500 540 45 49 15 18

EV/Revenue EV/EBIT P/E

Company LTM 2016E LTM 2016E LTM 2016E

New York Inc. 2.9 2.4 28.5 23.8 43.1 34.7

Boston Corp. 0.7 0.6 8.2 7.4 20.8 17.9
San Francisco Ltd. 0.9 0.8 10.0 9.2 24.0 20.0

Average 1.5 1.3 15.6 13.4 29.3 24.2

Median 0.9 0.8 10.0 9.2 24.0 20.0
(1) Note: LTM=last 12 months

Are these comparable companies?

New York Inc. is clearly much larger with higher margins and growth
Average multiples vs. median multiples?
Use industry median multiples when range is large to eliminate impact of outliers
Valuation By Multiples 9

Valuation of Evanston Ltd

Performance Metric Revenue EBIT Net Income

LTM 2016E LTM 2016E LTM 2016E

Evanston Corp. 400 436 34 37 14 15

Median Multiple 0.9 0.8 10.0 9.2 24.0 20.0

Implied EV $360 $363 $340 $340 $386 $350

Net Debt 50 50 50 50 50 50

Implied Equity Value $310 $313 $290 $290 $336 $300

Revenue and EBIT multiples  Enterprise value (EV)

Net Income multiple  Equity value

Valuation By Multiples 10

5
Additional Considerations

Be consistent in applying multiples

Use historical (trailing) multiples for historical performance metrics
affected by short-term events
Use expected (leading) multiples for expected performance metrics
Comparable companies analysis
Market valuation (trading) multiples
Transaction multiples –
might include “control premium,” synergies, etc.
older acquisitions may not reflect current market value
Key multiples are different for various industries
Sales multiple – e.g. high-growth internet companies with little or negative
earnings
EBITDA less Capex multiple – e.g. capex-intensive industries such as telecom or
semiconductor
Price-to-book multiple – e.g. for industries where balance sheet reflects
economic value, i.e. banks

Valuation By Multiples 11

Pros and Cons of Multiples

Pros Cons

Quick and relatively simple No “perfect” comparables –

analysis every company is different in
Can be used to value both private risk, growth, size, etc.
and public companies It is a relative (vs. absolute)
Reflects current market and/or valuation. What if market is
transaction sentiment inefficient?
Transaction multiple analysis may Different companies have
indicate appropriate control different accounting standards
premium Data on precedent acquisitions
Shortcut to DCF can be sparse or misleading (i.e.
Multiple = 1/(r-g) different motivations)
Acquisition multiples paid not
indication of “true” value

Valuation By Multiples 12

6
Multiples vs. DCF valuation

Value of a firm equals the sum of

discounted future cash flows
If cash flows are growing at a constant
rate g, CF1
PV 
rg
Therefore cash flow multiple can be
interpreted as
1/(r  g )
Valuation By Multiples 13

Common Pitfalls

Comparing companies with different size, operating performance,

leverage, growth and risk characteristics
Not adjusting for accounting differences
E.g. LIFO vs. FIFO inventory valuation
Not adjusting for non-recurring items: asset sales, discontinued
operations..
Applying incorrect valuation metric for specific industry
E.g. Price-to-book for tech company; EBIT for capex-intensive industry with high
D&A
Using wrong numerator (i.e. equity vs. enterprise value)
Not comparing like time periods – different fiscal year ends
Using same multiple for different lines of businesses – each should be
valued separately
Use of averages rather than medians if range is large
Failure to understand terms and circumstances of precedent
acquisitions

Valuation By Multiples 14