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offerings, and share repurchases. Consider an IPO of a private company that does not have a public market valuation. To determine how public markets might value the company, an investment banker will establish the comparables universe, which may consist or one or more peer groups. He or she will use the operating metrics and valuation multiples of the public comparables to determine an appropriate valuation multiple for the private company. Example 4.X Practical Application Suppose you are an investment banker positioning a technology-focused third-party logistics company (your client) for an IPO. The company has no direct comparables, but can be legitimately positioned as either a pure-play logistics firm or a business process outsourcing (BPO) company. You expect your client to trade on an EV/EBITDA multiple. Comparable pureplay logistics companies currently trade at 8.1x LTM EBITDA, on average. Comparable BPO firms currently trade at 9.6x, on average. You would probably want to position your client as a BPO firm to take advantage of higher EBITDA multiples in that peer group and boost your client's valuation. 9.6x LTM EBITDA would therefore be your starting point is determining an appropriate multiple, and you might adjust the multiple upward if your client has better growth characteristics than comparable BPO firms, or downward if your client's business model is especially risky, for example. The valuation determined through comparable companies analysis does not reflect: The control premium a buyer typically pays in an M&A transaction, or The discount the public markets may apply to newly issued shares from an IPO.
You will be able to make the most meaningful comparisons among valuation multiples of companies in the comparables universe when peers have similar prospects for growth and return on invested capital (ROIC).
Data Collection
Once you have identified the comparables universe, the next step is to collect the necessary information on each comparable company to perform the analysis. You will need the following information for each company, as a minimum: The most recent 10-K, 10-Q, and/or 8-K earnings release (or Form 6-F and/or 20-F, in the case of some foreign companies) Consensus financial projections or a recent analyst research report with financial projections when consensus figures are unavailable News of any material events since the last reporting period for which you must make pro forma adjustments Next, plug the information you have collected into your comparable companies analysis spreadsheet.
Projected income statement items such as revenue, EBITDA, and net income usually exclude non-recurring items and are pro forma for corporate events like planned divestitures, so you won't likely have to adjust these figures.
To compare comparable companies effectively, you must understand why their multiples are different. Reasons why one company's projected EV/EBITDA multiple might be lower than that of a peer could include slower projected growth, declining margins, or higher risk, for example. Although metrics such as growth, margins, and risk are not explicit inputs to the EV/EBITDA calculation, they are implicit in equity value, which is a determinant of EV. It is often useful to compare one company's multiples to those of the peer group, collectively. To do so, calculate the high, low, mean, and median summary statistics for the group as shown in Exhibit 4.X. The median is generally the most meaningful metric, because it naturally screens outliers. Example 4.X Comparable Company Analysis Based on the following comparable company analysis, why might company Charlie trade at a premium to its peers?
Operating Metrics Valuation Metrics
Company
Alpha
22.3%
22.6%
9.6%
8.8x
8.4x
Bravo
18.4%
18.4%
8.7%
7.8x
7.5x
Charlie
25.2%
25.5%
12.7%
9.5x
9.0x
Delta
14.0%
13.7%
5.1%
7.1x
7.3x
High
25.2%
25.5%
12.7%
9.5x
9.0x
Mean
20.0%
20.1%
9.0%
8.3x
8.1x
Median
20.4%
20.5%
9.2%
8.3x
8.0x
Low
14.0%
13.7%
5.1%
7.1x
7.3x
Charlie likely trades at a premium (9.5x 2008 EBITDA vs. peer group median of 8.3x) because it has higher projected growth and margin improvement.
DCF Methodology
The DCF method of valuation involves projecting FCF over the horizon period, calculating the terminal value at the end of that period, and discounting the projected FCFs and terminal value using the discount rate to arrive at the NPV of the total expected cash flows of the business or asset. Exhibit 4.X Advantages and Disadvantages
Advantages Disadvantages
Theoretically, the DCF is arguably the most sound method of valuation. The DCF method is forwardlooking and depends more future expectations rather than historical results. The DCF method is more inwardlooking, relying on the fundamental expectations of the business or asset, and is influenced to a lesser extent by volatile external factors. The DCF analysis is focused on cash flow generation and is less affected by accounting practices and assumptions. The DCF method allows expected (and different) operating strategies to be factored into the valuation. The DCF analysis also allows different components of a business or synergies to be valued separately.
The accuracy of the valuation determined using the DCF method is highly dependent on the quality of the assumptions regarding FCF, TV, and discount rate. As a result, DCF valuations are usually expressed as a range of values rather than a single value by using a range of values for key inputs. It is also common to run the DCF analysis for different scenarios, such as a base case, an optimistic case, and a pessimistic case to gauge the sensitivity of the valuation to various operating assumptions. While the inputs come from a variety of sources, they must be viewed objectively in the aggregate before finalizing the DCF valuation. The TV often represents a large percentage of the total DCF valuation. Valuation, in such cases, is largely dependent on TV assumptions rather than operating assumptions for the business or the asset.
www.macabacus.com/valuation/methods.html