Business Valuation Modeling: Part II

Corporate Finance Institute®

 Course Objectives

Explore in detail how to construct Understand how to perform a Explore in detail how to construct
a comparable company analysis merger analysis on several a precedent transactions analysis
targets using comparable
company data

Understand the components of a

Public Information Book and
where to source each of the
components

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 Comparable Company Analysis

Corporate Finance Institute®

 Session Objectives

Understand the advantages and Identify key criteria to consider Gather comparable company
considerations of using when searching for relevant data and calculate the applicable
comparable company analysis as comparable companies metrics to perform the valuation
a valuation tool analysis

Understand how dilutive

securities and subsequent events
affect comparable company
analysis

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 What is Comparable Company Analysis

Comparable company analysis is a valuation methodology which derives the value of a business from
the current trading multiples of similar public companies.
It is a relative form of valuation, as opposed to the discounted cash flow (DCF) analysis which is an intrinsic
valuation method.

Companies with similar The basis for value is Commonly used Extremely useful and
characteristics should current trading multiples include simple to perform as
trade at similar multiples of comparable EV/EBITDA, P/E and P/CF. data is public and
multiples, all else being companies. readily available.
equal.

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 Advantages and Considerations

Like other valuation techniques, there are advantages to using comparable company analysis as well as
several considerations that need to be taken into account.

Advantages Considerations

• Based on widely available public • There are no perfect comparables

information
• Difficult to adjust for intangibles (i.e.
• Simple to perform and establish a strength of management, growth
benchmark for value potential)

• Potentially large number of publicly • Less useful when there are few or no
traded comparables public comparables

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 Identifying Appropriate Comparable Companies

The quality of the comparable company analysis is dependent on having a set of the most relevant peer
group. The appropriate peer group should be similar in several respects.
Some of the more important ones are:

Industry and Company Geographic Risk and Growth Profitability

Business Size Location Potential Profile
Operations

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 Sources of Comparable Company Information

1. S&P Capital IQ 2. Public Filings 3. Equity Research

4. Press Releases 5. Other Public Filings 6. Other Financial

Websites

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 Sources of Comparable Company Information

Capital IQ is a market intelligence platform designed

by Standard & Poor’s that is widely used in many
areas of corporate finance, including investment
banking, equity research and asset management.

Capital IQ is a powerful tool that can save a financial analyst a great deal of time with this type of merger
model. Financial information can be directly downloaded into Excel instead of downloading a company’s
filings from EDGAR and then manually inputting that information.

Financial
Real-time Research Global Market Fixed Income
Statement
Market Data Estimates Data Information
Information

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 Impact of Potentially Dilutive Securities

The effect of potentially dilutive securities must be determined when performing comparable company
analysis.
In calculating a company’s market capitalization and enterprise value, the number of fully diluted shares
should be used. Implicitly the market also uses fully diluted shares to value a company’s stock.

“In-the-money” “In-the-money”

Options and Warrants Convertible Securities

Treasury Stock Method If-converted Method

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 Basic vs. Diluted Shares Outstanding

Basic Shares Outstanding Diluted Shares Outstanding

• The total number of shares held by • The total number of shares a

shareholders including insiders but
not including a company's treasury
VS. company would theoretically have
if all dilutive securities were
shares exercised and converted into
shares

• Examples of dilutive securities:

warrants, options, convertible
debt, preferred shares

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 Basic vs. Diluted Shares Outstanding – Example

The following is an excerpt from Alphabet Inc.’s balance sheet, taken from its 10-K for the year ended
December 31, 2019. The number of common shares outstanding as at that date is 688.3 million and is
comprised of Class A, B and C shares.

Basic Shares Outstanding

Alphabet Inc. (2020). Form 10-K 2019. Retrieved from https://abc.xyz/investor/static/pdf/20200204_alphabet_10K.pdf?cache=cdd6dbf

The number of diluted shares outstanding will depend on the number of dilutive securities
outstanding and the share price of the company.

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 Treasury Stock Method

The treasury stock method is used to calculate the incremental shares outstanding from a company’s in-
the-money options and warrants. This method implies that the money obtained from exercising in-the-
money options is used for stock repurchases.

There are two major assumptions:

1. The company repurchases common 2. When exercising warrants and options,

shares at an average price dictated by the exercise date assumed is the start
the market using the capital obtained of the reporting period.
when investors exercise their options.

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 Treasury Stock Method

The formula for calculating the additional shares outstanding using the treasury stock method is:

Additional Shares Outstanding = Shares From Exercise – Repurchased Shares

K
=n 1–
P

Where
n = Shares from options or warrants that are exercised
K = Average exercise share price
P = Average share price for the period

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 Treasury Stock Method – Example

The following are excerpts from Snap Inc.’s 10-Q for the quarterly period ended June 30, 2020. The number
of common shares outstanding is 1,469,220,405. Assume that for treasury stock method purposes, the
average share price for the period was $26.64.

Dilutive Effect of Stock Options

$9.60
= (5,851,000 + 1,157,000) x 1 –
$26.64
= 4,482,595

Dilutive Effect of RSUs / RSAs

= 152,972,000

Diluted Share Count = 1,469,220,405 +

4,482,595 + 152,972,000 = 1,626,675,405

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 If-converted Method

For the if-converted method, the same principle applies to convertible securities and other equity-linked
instruments whereby in-the-money items are assumed to be converted into additional shares.
Common convertible securities which provide investors the option to be converted into common shares
include:

Convertible Bonds Convertible Notes Convertible Preferred

Shares

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 If-converted Method

Conversion ratio determines the number of common shares an investor gets for each convertible
security. This ratio is fixed over the life of the convertible bond as specified in the security agreement.
The conversion ratio is based upon the conversion price at which the convertible bond converts at.

Bond Par Value

Example: Conversion Price =
Conversion Ratio
Bond Par Value: $1,000 (Face Value) $1,000
=
50
Conversion Ratio: 50
= $20

If the share price is above the conversion price, the investor might consider converting the bond
because the value of the shares is greater than the par value of the bond.

Value of Converted Shares

Par Value of Bond
(P = $22)
50 shares x $22 = $1,100 > $1,000

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 If-converted Method – Example

Continuing with the Snap Inc. example, the following are excerpts from the same 10-Q. The number of
common shares outstanding are 1,469,220,405. Assume that the average share price is $26.64.

Dilutive Effect of 2025 Notes

= none since 130% of the conversion price

($21.68 x 130% = $28.18) is higher than the average price

Dilutive Effect of 2026 Notes

= $1,265 MM / $22.81

= 55.5MM shares
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 Pro Forma Adjustments to Comparable Company Analysis

Making pro forma adjustments to comparable companies' balance sheet items is a necessary part of
comparable company analysis. Pro forma adjustments are required to capture the effects of material
events that are not reflected in a company’s most recent filings (i.e. those that occur after the balance
sheet date).
Material events for which pro forma adjustments should be made include, but are not limited to:

M&A Transactions Financings Legal Settlements

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 Using Comparable Company Information to Assess
Acquisition Opportunities

Corporate Finance Institute®

 Session Objectives

Understand when conducting a Build a merger model using

merger analysis using comparable company data
comparable company date is
appropriate

CorporateFinance
Corporate Finance Institute®
Institute®
 Merger Analysis

A business combination occurs when two companies come together, either by way of a merger or an
acquisition by one company of the other.

Business Combination

Merger Acquisition
When two companies combine When one company proposes to
under mutual agreement to form a offer cash or its shares to acquire
consolidated entity another company

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 Detailed Merger Modeling

Building a robust merger model is a detailed process involving several steps:

Step 1: Step 2: Step 3: Step 4: Step 5:

Creating Valuing each Making Modeling the Performing

detailed of the acquisition business accretion /
forecasts for businesses assumptions combination dilution and
both separately sensitivity
companies analysis

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 Merger Modeling Using Comparable Company Information

Often building a detailed merger model is not a feasible task, particularly when several potential
acquisition targets need to be evaluated in a short period of time.
In such cases, a dynamic, though less detailed, merger model is needed to quickly assess the impact
of a business combination. The difference with this type of model is that instead of developing financial
forecasts for each company, current capitalization and publicly available information is used.

01. 02. 03. 04.

Gathering publicly Making acquisition Modeling the Performing accretion
available information assumptions business / dilution and
combination sensitivity analysis

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 Key Components of the Merger Model

Inputs and Comps Data Acquisition Consolidated Acquisition

Assumptions Structure Entity Analysis

Acquisition Current Acquisition price, Pro forma Accretion /

premium, capitalization and financing, and capitalization and dilution and
financing mix, financial data, financial financial sensitivity
and transaction financial forecasts statement performance analysis
costs adjustments

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 Precedent Transactions Analysis

Corporate Finance Institute®

 Session Objectives

Understand the advantages and Identify key criteria to consider Gather relevant precedent
considerations of using precedent when searching for relevant transactions data and calculate
transactions as a valuation tool precedent M&A transactions the applicable metrics to perform
the valuation analysis

Corporate Finance Institute®

 Precedent Transactions Analysis

Precedent transactions analysis is a method of company valuation where past M&A transactions are
used to value a comparable business today.

Precedent
Transactions
Analysis

Generally uses The basis for Values implied by Useful when Valuable in
the same value is the price precedent comparable assessing M&A
multiples as with actually paid by a transactions are public trading activity and
comparable purchaser versus generally higher multiples are not consolidation
company analysis current trading than with comps available trends
multiples because of the
control premium

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 Advantages and Considerations

Like other valuation techniques, professional judgement is often required when interpreting the data and
determining an appropriate value range.

Advantages Considerations

• Based on readily available public • Value implied by historical transactions

information
• Implied valuation multiples reflect real
M&A transactions
• Potentially reveals information about
market demand for certain types of
assets and industry trends
may not be representative of the current
market
• Past M&A transaction are rarely directly
comparable
• Multiples obtained can often vary
considerably

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 Identifying Appropriate Precedent Transactions

The quality of a precedent transaction analysis is dependent on having a set of the most relevant
transactions. When identifying relevant transactions, several criteria must be considered.

Industry & Transaction Size Geographic Type of Acquirer Transaction

Financial Location Rationale
Characteristics

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 Sources of Precedent Transaction Information

1. S&P Capital IQ 2. Press Releases 3. Merger Proxies / Public

Tender Documents

4. Equity Research 5. Other Public Filings 6. Other M&A

Databases

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 Searching for Precedent Transactions

Without Capital IQ or other similar databases, conducting a precedent transactions analysis can be a rather
time-consuming and manual process.
The process typically involves reviewing historical news releases found on the company’s website and
conducting an internet search for transactions within a particular industry.

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 Public Information Book

Corporate Finance Institute®

 Session Objectives

Understand the purpose and use Identify the contents and sources
of a Public Information Book of information for a Public
Information Book

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 What Is a Public Information Book

A Public Information Book (PIB) is a document that compiles all available public information on a
particular company.

Business / Industry Understanding

Creating Detailed Financial Models

Assessing Investment Opportunities

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 What Is Included in a PIB

A PIB generally contains information from the company’s latest annual and quarterly reports, investor
presentations, equity research reports, industry information, news articles and recent conference calls.

Annual Reports Quarterly Reports Recent Press Investor

Releases Presentations

Equity Research Credit Reports Conference Call Industry Reports

Reports Transcripts

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 Sources of Information

Publicly Available Information Paid Services

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