Session :Various Valuation

Techniques for M&As (part-II)

Course : Mergers and Acquisitions

Presented by Prof. Manish Popli
How to find the comparable companies?

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 How to find the comparable companies?

• This is not a straightforward task!

• Generally, a comparable firm is one whose

– profitability,
– potential growth rate in earnings or cash flows, and
– perceived risk is similar to the firm to be valued.

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 How to find the comparable companies?

• What other characteristics should be looked for better comparability?

– Same industry
– Similar in market served, or geography (country risk, growth rate etc.)
– product offerings ,
– size and so forth

• It gets complex when firms are globalized (have business in different geographic
territories, with different risk profiles and different growth rates)

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 How to find the comparable companies?

• Sometimes analysts use correlation between the operating income/revenue to be

valued and the comparable firms.

• Valuation done using the comparable company method does not include the
purchase price premium

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 Comparable Companies’ Method

• Advantages of using EBITDA as a value indicator?

– Some firms could have negative earnings rather than negative EBITDA.

– Moreover, net income can be significantly impacted by the way the firm choses
to calculate depreciation (e.g. straight line vs. accelerated)

– Can be compared across firms having different levels of leverage.

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 Comparable Companies’ Method

• Other Possible Indicators ?

• Subscribers(telecom) :

• Cases shipped(liquor)

• Number of customers

• Website hits

The above and similar indicators are known as value drivers (we shall see in the case
next class)

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Comparable Transaction Method

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 Comparable Transactions Method

• The comparable transactions approach is conceptually similar to the comparable

companies approach

• The multiples used to estimate the value of the target are based on purchase
prices of comparable companies that recently were acquired

• Price (i.e., market-value)-to-earnings, sales, cash-flow, EBITDA, and book-value

ratios are calculated using the purchase price for the recent comparable transaction

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Cautions in Relative Valuation Methods

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 Cautions in Relative Valuation Methods

• What could be the issues?

• Multiples can be deceptively simple.

– This method should be used for triangulation (reliability and validity) of other
measures such as FCFF.

• Problems due to Market misevaluations and accounting issues.

– Accounting numbers such as Net profit etc. could be outcome of accounting
creativities.
– Can have business cycle effects.

• Does not consider (in comparable transaction approach) :

– specific changes that may be made in the target post-merger
– specific synergies that may be available in the target post-merger

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 Relative Valuation Methods

• So, why relative Valuation?

– “ A little inaccuracy sometimes saves tons of explanation”

H.H. Munro

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Applying Asset-Oriented Methods

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 Applying Asset-Oriented Methods

• Tangible Book Value

• Book value is a much-maligned value indicator, because book asset values rarely
reflect actual market values

• They may over- or understate market value. For example, the value of land frequently
is understated on the balance sheet, whereas inventory often is overstated if it is old or
obsolete

• Ignores Intangibles assets .

Where can we use this method?

Example: Financial services companies, where tangible book value is primarily cash or
liquid assets

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 Liquidation Value Method

• Liquidation or Breakup Value

• The terms liquidation and breakup value often are used interchangeably

• Liquidations or breakup value is the projected price of the firm’s assets sold
separately less its liabilities and expenses incurred in liquidating or breaking up the
firm

• Any idea where it can be used ?

• Liquidation value approach is used to determine the minimum value of the company
in the worst-case scenario of business failure and eventual liquidation.

• It is particularly appropriate for financially distressed firms

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 Liquidation Value Method

• Caveats:

• Highly Appraiser Specific

• How to go about breaking the company:

– Group/Divison/plant/Machinery

• Again, it may also ignore intangible assets.

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Key Fundamentals

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 Key Takeaways

• Industry fundamentals

– Industry structure analysis

– great company in a bad industry

– struggling company in a booming industry

– How cyclical is the industry

• Markets and products

– Geographical spread and country risks

– Government regulation

• Where are we in the business cycle?

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 Key Takeaways

• No Valuation is perfect !!
– Various techniques gives us the contours/boundaries
of the value of the firms.

• Identify the opportunities to create or add value/ Clinically

examine all assumptions.

– Be conservative in evolution of future revenue synergies.

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 Key Takeaways

• Always carry out sensitivity analysis to gauge the value of

the firm in each of the possible different scenarios.

• Product line or vertical wise valuation is suggested.

– Don't bite off what you can't chew

– Digestibility hypothesis (Choice between JV and M&A !)

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Determining when to use the Different Approaches

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 Different approaches to Valuation

• Discounted cash flow is preferred when:

– The firm is publicly traded with identifiable cash flows

– An analyst has a long term horizon

– An analyst has confidence in forecasting the firm’s cash flow

– A firm’s competitive advantage is expected to be sustainable

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 Different approaches to Valuation

• Comparable companies

– Readily available inputs

– Many firms exhibit similar growth, return, and risk characteristics

– An analyst has a short-term time horizon

– An analyst has confidence that the markets are on average right

– Sufficient information to predict cash flows is lacking

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 Different approaches to Valuation

• Comparable transactions

– Many recent transactions of similar firms exist

– An analyst has a short-term horizon

– An analyst has confidence that markets are on average right

– Sufficient information to predict cash flows is lacking

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 Different approaches to Valuation

• Liquidation value

– An analyst wants to know asset values if they were liquidated today

– Assets are separable, tangible, and marketable

– Firms are bankrupt or subject to substantial financial distress

– An orderly liquidation is possible

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Thanks

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